The Flaw

I just saw the Premiere of David Sington’s movie The Flaw at Sundance. The movie explores the root causes of the financial crisis in the US that led to the recent global economic meltdown. I found it astonishing. One might expect the familiar discussion of collateralized debt and predatory lending, and the filmmakers in Q & A after the movie said they set out to tell that story but stumbled onto something completely different.

In the last 30 years, US GDP has doubled, but real wages for 90% of Americans have gone down in that time. Think about that for a second, total US financial prosperity has increased 100% but 90% of us are making less money. The upshot is that ALL that money, the 100% increase in US GDP, has gone to the other 10% who are the richest people in America (for instance in 2006, 800 billion dollars or 6% of the total US GDP went to just 15,000 people in the US). What the filmakers noticed is the only other time income inequality got as high as it is now was in 1929, the year of the last financial collapse. They go on to make a pretty compelling argument of how these numbers led to the current crisis.

Basically, to maintain the mid-20th century experience of increasing prosperity for the 90% of Americans with less income, the 10% who are actually making more money lent some of it to the rest of us through easy credit (credit cards and mortgages). This provides the rest of the population with  a social and economic experience of increased wealth and economic growth without the need to actually increase wages. There’s an additional benefit that all those loans further transfer wealth upwards through loan fees and interest payments. And these are no small numbers… in 2007, bank profits accounted for 40% of all profits in America.

The film suggests that a fundamental cause of the boom-bust bubbles of the last 30 years (most recently the internet boom and the housing bubble) goes something like this… Because wages are stagnant, normal people can no longer improve their socio-economic status through hard work. So when there appears to be growth potential in a new market (i.e. the internet or houses) middle class people see it as a way to actually move up in the world and are likely to pour their life savings into it. The filmmakers found strong evidence that the most recent collapse wasn’t really caused by a massive increase in loans to risky borrowers as is commonly perceived. Rather it was that people who once were stable home owners were turning into people who were a credit risk. As house prices went up, more people began to refinance to pull equity out of their houses, thinking they could make a lot of money in real estate or pay off their other credit debts. But since house prices were way over actual values, people were actually just spending the last of the real equity they had accumulated in their lives. When house prices reset towards normal, once stable people were stuck with huge mortgage payments on houses worth a fraction of the inflated market value and they defaulted on their loans, losing the equity they had spent their whole lives accumulating.

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