When Easy Credit Replaces Wage Increases, Prosperity is Fragile and America's Middle Class Suffers

The American middle class has been in trouble for decades, but this was not obvious until the recession of 2008 because consumer purchases held up. How was that possible? The simple answer is that financiers devised ways to loan money that severed the link between profits and middle-class wellbeing. Reckless trading in mortgage-backed securities and other asset-backed instruments allowed the issuers of credit to make record profits, regardless of whether consumers could pay off their debts. When millions became unable to pay back loosely regulated loans, the United States plunged into financial crisis. To put recovery on sound footing, policymakers must boost middle-class incomes and block the reemergence of reckless credit practices. 
 
An Earlier Virtuous Cycle of Consumption and Earnings 
Prior to the deregulation of banks and consumer credit in the 1980s and 1990s, creditors were  obligated to evaluate the credit-worthiness of borrowers, creating a tight link between borrowers’ income and the profits creditors reaped from making loans. 
 
  • For consumers, borrowing money meant you had to prove you could pay it back. Jobs, earnings, and educations had to be verified, and lenders “sized up” would-be borrowers in face-to-face interviews. Creditors’ reputations depended on making well-grounded loans.
  • Profits for U.S. companies depended on consumer spending tied to middle-class earnings, and borrowing rested on solid earnings prospects. All roads to profits and prosperity ran through the paychecks of millions of Americans. 
  • Economic recessions occurred if credit became too tight or wages did not keep pace with rising economic productivity. Consumer spending went down and profits suffered. 
During the era of the virtuous cycle, profits, productivity, and earnings rose together. To keep the cycle functioning, U.S. government policies until the early 1980s curbed financial excesses by banks, investors, and lenders. Government also aimed to stimulate aggregate demand among the middle class and the poor, because their spending power fuelled the entire economy. 
 
 
Kevin T. Leicht is Professor and Chair at the Department of Sociology at the University of Iowa, and Director of the Iowa Social Science Research Center. He is a member of the Scholars Strategy Network. 

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