The Fed’s most recent financial-stability report recants – as well it should — the confident view of systemic resilience touted just late last year. Now, the Fed sees trouble ahead – little wonder. Even so, it is stoutly confident that its power to print dollars and some regulatory touch-ups will set the system a humming in short order. Would that it will, but almost surely it won’t. Once the Fed withdraws all its trillions in rescue dollars – assuming it ever can – the financial system will be as fragile as it was late last year because the U.S. economy will be as unequal. Indeed, since we’re now still more unequal and sure to stay that way for the foreseeable future, finance will be still more fragile. An economy in which the top one percent has more wealth than the entire bottom ninety percent – i.e., the U.S. – is a house of cards no matter its fortress banks.
The Fed thought finance in 2019 was fine and that finance in 2020 is readily fixable because all of its analyses focus only on finance. This led the Fed then and now to miss extraordinary risk. For example, both the November and May reports state that U.S. household debt is at a “moderate” level to income. As is all too often the case, the Fed reaches this conclusion by relying on aggregate data that do not take distributional realities into account.
As we noted in a recent EconmicEquality blog post, 28% of the U.S. population last October had more monthly debt than it could pay at all or would be able to pay if a $400 shock came along. By just the first week of April, the number of Americans who couldn’t pay their monthly bills grew by 12.5%.
What this is now, God only knows, but we do know that, the last time a group of Americans lost their paychecks, the pain was immediate and the macroeconomic damage was acute. In 2018, the Federal government shutdown deprived many federal workers of two paychecks, causing them to fall behind even though most of their bills had yet to arrive. At the time, this stunned economists – after all, the average full-time federal salary in 2018 was $85,556, making average-salaried workers denizens of the second highest U.S. income quintile and many doing far better than that. Even so, 62 percent of furloughed employees reported that they experienced significant financial hardship evidenced in struggles to pay rent, meet mortgage obligations, or make even minimum credit-card payments.
Moderate debt? Not if borrowers can’t pay it because more than income determines debt-service capacity. Rent, medical bills, child-care costs, and so much more make it difficult for most of the middle class to make ends meet without crushing debt.
The Fed missed more than just the critical question of how much debt is too much debt. A distributionally-nuanced understanding of employment shows instantly why the Fed’s preferred employment construct obscured profound macroeconomic weakness. As we’ve noted before, the Fed has never reckoned with all the nation’s under-employed or those seeking more work for more money. In its most recent report, the Fed’s own data showed that one out of five workers last October – when the Fed thought employment was awesome – wanted more work than he or she could find. Studies going even more deeply into wage growth found nominal wage growth well below what “full” employment should create, especially for workers who are not college-educated white men.
How many people in how much trouble does it take to make a financial system fragile no matter the capitalization of its largest institutions? There is no research of which I know yet to guide us to this answer, but there is important and compelling work – work from within the Fed itself no less – that tells us that the leading cause of financial crises isn’t the financial system, but the economic inequality that leads policy-makers to think it is resilient when it isn’t.
Research from the Federal Reserve Bank of San Francisco recently updated shows still more clearly the link between economic inequality and financial-crisis risk. This paper deploys exhaustive research across decades in 17 countries based on statistical correlations of inequality, productivity, credit growth, and crises. Although productivity has a strong impact on crisis risk, a widening income share for the top one percent is the most predictive antecedent to a crash even when controlling for an array of other possible causes, including the asset-price bubbles that gave the Fed so much pause yet again in its latest financial-stability report.
As I said, the top one percent’s share in late 2019 was at a record high. One month later, the Fed still thought financial stability was essentially sound. This is like thinking I’m healthy because all of my limbs work fine without checking to see if my heart is beating fast enough to keep them going. Financial systems are expressions of economies, not economies themselves, and financial systems thus cannot be sound if their economies are sick. Inequality makes financial systems ill under the best of market circumstances. The COVID pandemic’s impact on economic equality could put the financial system in the ICU if the Fed fails to heed the blinking lights.