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October 2008 | Home
U-M HERITAGE »
Time machine
Stand outside the Fishbowl and Mason Hall, and you're right where U-M began. Take a trip through time in this slideshow.
Sports
The accidental coach
As a young man, Red Berenson kept preparing for life after hockey. Now 68, he's still among the best in the business.
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Alumni
Student by student by student
Doug Ross is proving that inner-city schools really can work.
Health
Is there a smoking gene?
If your first cigarette gave you a buzz, your affection for smoking might be genetic.
TALKING ABOUT WORDS »
Campaigns and slogans
The presidential campaign has generated new words and catchphrases, but will anyone ever match the best political slogan ever?
TALKING ABOUT MOVIES »
Pine vs. Holly
Britain's legendary Pinewood Studio has produced some of the world's best and, alas, worst films.
Business
Who's to blame?
October 14, 2008
A sign seen recently on Wall Street (photo edited). The economic crisis makes most of us angry, but while there's plenty of blame to go around, much of the crisis results from massive structural changes in the economy.
The current economic crisis is frequently compared to the early years of the Great Depression, with financial institutions falling left and right: Bear, Lehman, Fannie, Freddie, AIG, and more to come. The comparison seems overblown—we don't have 20 percent unemployment just yet.
But in one sense, it is apt: we are in a crisis of economic institutions, not just a financial crisis, and it cannot simply be blamed on "Wall Street greed," as one presidential candidate has suggested. The next administration will need to engineer a thoroughgoing overhaul of the regulatory system, just as Franklin Roosevelt did. What is required is not just a reform of Wall Street, but a broader rethinking of the place of finance in a service-based economy.
Finance has seeped deeply into the lives of Americans. By 2001, most households were invested in the stock market through mutual funds and retirement plans, and the media provide a constant background hum about the market. Most home mortgages are securitized (bundled together into bonds and sold to institutional investors), and for many homeowners and credit card holders, daily movements in LIBOR (the London Inter-Bank Offered Rate) are critical to their monthly budget.
And it doesn't stop there, as Wall Street found ways to securitize all kinds of cash flows, from credit card receivables and student loan payments to lawsuit and insurance settlements. As a result, the well-being of most households is tied to financial markets far more extensively than in the past.
The new financial system was touted as a way to manage risk by spreading it to those who could bear it best. But it has also trained people to think like investors, for better or worse. Millions of homeowners refinanced their mortgages or took out equity lines of credit to pay for things they could not afford on their wages alone, and by 2005 the American household savings rate turned negative for the first time since the Depression. In explaining the financial crisis in July of this year, President Bush stated that "Wall Street got drunk." But Wall Street was just the bartender. We all got drunk.
The roots of the crisis go deeper than recent financial bubbles. The transition from a manufacturing to a service economy in the U.S. was bound to create social dislocations. Since Bush took office, the manufacturing sector has lost 3.7 million jobs. After countless rounds of layoffs, GM and Ford each offered to buy out their remaining hourly workers earlier this year. Meanwhile, the biggest U.S. employers today are overwhelmingly in retail: Wal-Mart alone employs more Americans than the dozen largest manufacturers combined.
The strains created by this transition were partly masked by the real estate bubble. One of the economic bright spots in recent years was the housing sector, which created millions of jobs—by one estimate, almost one-quarter of the jobs created between 2003 and 2006 were in housing-related industries. At the height of the bubble, the U.S. had 400,000 mortgage brokers and more than a million real estate agents. It is safe to say that real estate is not likely to lead us out of the current crisis.
It took the Great Depression to force a full reckoning with the social implications of America's corporate-industrial economy. The Roosevelt Administration created a host of new institutions to regulate finance and vouchsafe economic security,from the Securities and Exchange Commission and FDIC to Fannie Mae and Social Security.
Within a generation, corporations had taken on many of the roles of the welfare state in funding employee health care and retirement security. This system endured for decades, but the cost is now prohibitive for many companies—including the automakers that originated it.
President Bush sought to address the decline of the old system through his "ownership society" initiative, which he envisioned in his second inaugural: "We will widen the ownership of homes and businesses, retirement savings and health insurance—preparing our people for the challenges of life in a free society. By making every citizen an agent of his or her own destiny, we will give our fellow Americans greater freedom from want and fear, and make our society more prosperous and just and equal." As "agents of their own destiny," individuals would no longer rely on corporate employers or governments to vouchsafe their economic well-being: they would rely on financial markets, through various personal accounts. The central part of the initiative would have allowed individuals to put some of their Social Security contributions into the stock market.
But anyone who staked their prosperity on financial markets in the last decade regrets it now. The S&P 500 today is significantly below where it was ten years ago, meaning that individual investors would have been better off parking their savings in a federally insured bank. Millions of homeowners who bought houses that stretched their means now find that their house is worth less than what they owe. Those with job opportunities elsewhere face the choice of either coming up with the cash to make up the difference or abandoning their home to foreclosure. Employer-sponsored health care plans charge increasing fees and cover fewer people, as medical care grows ever more expensive. And college costs continue to rise at rates far higher than the returns available to savers. The failure of the ownership society to provide "greater freedom from want and fear" is evident.
Blaming our economic crisis on "greed on Wall Street" makes little sense. Do we imagine a golden era when Wall Streeters were selfless public servants? Can we declare a "war on greed"? What is now clear is that the regulatory system we have in place is hopelessly mismatched to what finance looks like today, and how it fits with the real economy. The U.S. requires a thoroughgoing overhaul of its regulatory institutions for a service-based, globalized economy. This is the task facing the next administration.
is Wilbur K. Pierpont Professor of Management at the Ross School of Business at the University of Michigan. He is the author of the forthcoming book Portfolio Society: How Finance Has Reshaped America.