Ten Years After Lehman (3): The Haves

by Edward Chancellor*

The Greek philosopher Aristotle attacked the charging of interest on grounds that lenders demanded more money in return than they supplied. This ancient prejudice against interest lingers in the French economist Thomas Piketty’s claim that inequality increases when the return on capital, a quantum which includes the rate of interest, is higher than that of economic growth. Yet the overwhelming evidence from the easy money that followed Lehman Brothers’ demise shows that inequality really takes off when interest rates are maintained at artificially low levels.

In the decade after 2008, the U.S. central bank has maintained its fed funds rate at a level below the rate of inflation. The Federal Reserve also used quantitative easing and other newfangled monetary tools to bring down long-term interest rates. This unconventional monetary policy was intended to boost household wealth and spending. It ended up inflating a handful of asset price bubbles. Since wealth is unevenly distributed, the bulk of the gains in the United States and abroad have been enjoyed by the rich.

This is what happened in the UK, where the Bank of England followed the Fed’s playbook. A 2012 study by the Bank found that quantitative easing had boosted household wealth by more than £600 billion but that nearly two-thirds of these gains had gone to the richest 10 percent of households. Another study by S&P Capital IQ found that in the aftermath of the crisis the wealthiest decile of UK households had increased their share of financial assets at the expense of the poorest. As former UK financial regulator Adair Turner writes: “quantitative easing has been good for the rich, and ultra-easy monetary policy thus exacerbates inequality”. Few would disagree with this conclusion.

American income inequality has been especially aggravated by the Fed’s interest-rate policy. Most executive pay is linked to share-price performance. When easy money gooses the stock market, as it did in the years after the Lehman bust, corporate chieftains and their extended retinue receive an unearned windfall. Management has also used cheap debt to repurchase shares rather than invest in new plant and equipment, as the Fed intended. Since 2013, companies in the S&P 500 Index bought back approximately $2.4 trillion of stock, helping boost share prices, according to Standard & Poor’s. The executive pay bonanza got even bigger.

Easy money has particularly aided Wall Street as it recovered from the Lehman shock. The financial sector, including insurance and real estate, soon regained its position as a U.S. economic powerhouse, accounting for nearly a third of GDP growth between 2010 to 2015, up from 14 per cent between 1998 and 2008, according to the Bureau of Economic Analysis. Bankers’ bonuses returned with a vengeance – with the average payout rising to the highest level since 2006, New York state’s comptroller estimates. These bonuses derive largely from fees levied on securities issuance, corporate-finance activity and on assets under management.

U.S. corporate-debt levels doubled since 2008, says Goldman Sachs. M&A activity soared to a record $2.5 trillion in the first half of 2018, according to Thomson Reuters. AT&T’s recent $85 billion takeover of Time Warner could generate up to $390 million in bank fees, Freeman & Co has said. Investment-management fees also picked up as the stock market rebounded after 2009. Activists have pushed venerable companies from Procter & Gamble to Campbell Soup to engage in financial engineering to increase shareholder returns, and thereby justify their management fees.

Life has been particularly sweet for the private-equity world. The current leveraged-buyout boom has been spurred on by some of the cheapest financing in history. Private-equity firms even used low-cost debt to snap up repossessed properties after the housing bust. Blackstone’s listed residential business, Invitation Homes, has become one of the country’s largest landlords. The buyout barons have never had it so good. Over the past five years, Blackstone founder Stephen Schwarzman is estimated by the Wall Street Journal to have earned more than $3.2 billion in dividends and fund payouts.

But consider how easy money has treated the not-so-privileged. The financial crisis hit them hard. As many as 10 million homes were repossessed, according to the St. Louis Fed. Since the middle classes have most of their wealth tied up in their houses, they experienced the greatest proportionate losses in the downturn. New York University economist Edward Wolff estimates that median wealth fell by a staggering 47 percent between 2007 and 2010. The surge in unemployment after the financial crisis and a weak jobs market in the subsequent years further contributed to income inequality.

Central bankers claim that ultralow interest rates have helped fix the jobs market. This year, the official unemployment rate has fallen below 4 percent, its lowest level since 1969. That’s good news, but the share of the workforce employed or actively seeking work declined after 2008 and remains depressed at below 63 percent, the Bureau of Labor Statistics reports. Unconventional monetary policies contributed to the productivity slowdown which has hurt incomes. Until their recent pickup, U.S. wages stagnated in the years after 2008.

Nor did the poor benefit directly from the Fed’s zero interest rates. In fact, interest charges for “subprime” households actually rose as banks tightened lending standards. Because the less well-off maintain a higher proportion of their liquid assets in cash, they have also suffered most from deposit rates being held for years below the level of inflation.

Most workers own financial assets indirectly through their pensions or retirement plans. The decline in long-term rates has pushed up the value of pension liabilities, more than offsetting gains from investments. A pensions crisis affecting both private and public pension plans looms on both sides of the Atlantic. Ultralow rates have sounded the death knell for the defined-benefit pensions which enabled the postwar generations to enjoy a secure retirement.

Commentators from Aristotle to Piketty have argued that high interest rates aggravate inequality. Yet the ultralow rates of recent years have made it harder for the “have-nots” to accumulate the resources to buy a home or build a nest egg. The “haves” have enjoyed soaring wealth gains. The chief beneficiaries of easy money have been those on Wall Street with access to cheap loans. Michael Hartnett, chief investment strategist at Bank of America Merrill Lynch puts it this way: “Never in the field of monetary policy was so much gained by so few at the expense of so many.” And he’s right.

*Edward Chancellor is a financial historian, investment strategist and journalist. His book “Devil take the hindmost: A history of financial speculation” was a New York Times Notable Book of the Year.