The Real Strength and Weakness of the American Economy

Note: In this piece, I take a break from my usual topic of the green economy to discuss the current financial crisis. I'll be back with commentary on green issues soon.--MM

How bad is the economy? According to some well respected financiers, it is in its worst shape since the Great Depression. That was the judgment of George Soros in a recent article. And at Goldman Sachs' annual meeting yesterday, CEO Lloyd Blankfein echoed other Wall Street leaders in calling it the worst economy in 55 years. The consensus on Wall Street is that the travails of the financial markets denote a weak-even cataclysmic economy.

But at yesterday's Goldman meeting, Blankfein also successfully defended his $68.5 million compensation in 2007 to shareholders. And, asked his opinion of the future, he hazarded that the financial turmoil may be almost over and that the economy should resume expanding in the fourth quarter. Another Great Depresssion? Thankfully, no. What we have seen is the collapse of an asset bubble that enriched a limited swath of the population over the last eight years. Those able to benefit from global liquidity made fortunes and some have had to give them back. But current financial market turmoil is not synonymous with the real strength and weakness of the US economy. The strength is that of the American people and the weakness is the stressed state of the middle class.

The source of the recent financial crisis--the inability of sub-prime borrowers to make monthly payments- has its roots in middle class stress. The sub-prime lending boom helped push home ownership from about 65% of American households to about 70%. This last 5%, what might be termed, if flipped around, the 30 to 35% percentile of American households, proved unable to make monthly payments. The conventional wisdom is that they deserve their fate-for taking out no doc loans or choosing to walk away from houses once their equity disappeared. The fact that incomes for the lower four quintiles of Americans have been flat or declining in real terms for years, that sub-prime borrowers typically must pay double digit interest rates in contrast to their well heeled counterparts and that budgets are being devoured by rising health care and gas costs has gone ignored.

Indeed, when one looks at proposed solutions to the housing crisis, conspicuously absent are provisions to strengthen the middle class. The housing bill passed by the Senate yesterday contains billions in funds for home builders and money to demolish housing to reflate prices, but not one provision to raise the after tax incomes of American families..

NDN has highlighted a series of specific ways to rebuild the American middle class from putting a laptop in every backback to strengthening our ideas based economy to reforming health care. Investment in new clean technologies promises to restore American technology leadership while updating environmental standards has the potential to create millions of new green collar jobs. It can be done! During the 1990s, income inequality began to decline thanks to the positive influence of Clinton era policies only to expand as a result of the Bush tax cuts and related measures.

The recent unprecedented activities of the Fed-designed to stem the financial crisis-may indeed be ushering in a new era of Fed activism. While they have an emergency quality, reform of our financial architecture is needed to keep pace with changes in financial markets. However, the Fed's actions and reform at the Fed will not address the problem at the root of the recent crisis-the growing financial stress experienced by America's working families. As Paul Krugman has tirelessly observed but as others have refused to acknowledge, the Gini index of inequality and numerous academic studies unequivocally show the gulf between the wealthiest Americans and every one else increasing at an alarming rate. The next president and Congress must deal with this issue.

At the end of the day, even a stratum as light as that of hedge fund managers and private equity managers cannot comfortably exist astride a financially stressed nation. America must reacquaint itself with the real source of strength in our economy, not the financial markets per se but the economic health of the working families who undergird it.