The Economic Crisis was Not an Economic One

economic crisis

The economic crisis of 2007 was not an economic one. Why?

The inflation adjusted US housing price index in 1900 was close to 102 (Base year 1890, 100). In 2000, it was 120, and in 2007 it was close to 195. From 1890 to 1990 (100 years), the percentage increase was 25%. From 2000 to 2007 (7 years), it was a whopping 62.5% (Source: Observations, Saturday, July 23, 2011).

For 100 years, the framework in people’s mind was an average annual price growth of 0.25% for housing. All of a sudden, people’s framework of housing price growth changed phenomenally. What was the cause? It was nothing but financial innovation and a conducive environment.

Is financial innovation bad? Consider this. More than 60% of Americans own a house. The remaining 40% of Americans need a house. This is a huge opportunity in the housing industry. We need to build a lot of houses and we need fund for this. Who will finance a huge amount to this housing sector? Neoliberalism does not allow the government to take an active role of this social benefit. The free market forces will find a way to solve this housing problem. In deed! The free market forces found a way.

The total asset value of houses (Single family owning a house) in US was about $20 trillion in 2000. These assets are not productive except that it meets the cost of staying in a house. If you own a house you don’t need to pay rent. If not it costs you a rent. These assets are investments made in the past. What if these house owners are encouraged to build houses for the rest of 40% Americans who do not own a house? Great idea. The house owners can be financed taking the collateral security of their houses. In turn, the house owners can build a second home that can be rented out. As there is huge demand for houses, the asset price will continue to increase. In addition to house rent, the second home will also produce capital gains for the owner. A safe bet for the financial institutions.

Besides, there are other positive aspects for the US economy. Demand for raw materials, capital goods, and labor will place the economy in robust growth. Wage increase will improve income level and purchasing power. In turn, consumption will increase resulting in higher GDP. This really sounds good. Then what went wrong?

It is the greed of financial institutions and some people. The financial innovation was not executed prudently. Loans were sanctioned on bad assets and these bad assets were clubbed with good assets (Securitisation, another financial innovation) in order to get more funds from other higher financial institutions in the hierarchy. The higher financial institutions did not scrutinize the securities. Hedge funds were brought into the game to avoid risks (yet another financial innovation). All these unscrupulous financing happened just to make more profits while the Sun is shining. The Sun was shining but a volcano erupted and spewed dirt that screened the Sun. The edifice built by the financial innovations collapsed. The weak pillars could not withstand the huge load.

Once you start feeding you should not break it before the task is completed. In case of housing loans, the repayment period is very long. People need income continually in order to repay the loans. Otherwise, the loans will require liquidation. The bubble bursts and asset prices come down drastically that deteriorates liquidation process. This is what happened once you stopped feeding. Greed screens prudence.

Disbelief is one important factor that put the break on feeding. A mere 25% growth of asset price over a period of 100 years from 1890 to 1990 had changed to around 62.5% from 2000 to 2007 over a period of just 7 years. Suddenly, people realized that this growth is unbelievable. How long will it go?

Secondly, the wage growth of the 40% American who do not own house was not matching with the asset price growth of 62.5% from 2000 to 2007. Let us see some data: From 1948 to 1973, the productivity was up at 96.7% while the hourly compensation was up at 91.3% for the same period. However, from 1973 to 2013, the productivity was up at 74.4% while the hourly compensation was up at a mere 9.2% for the same period (Automation could be the reason behind that, added by author). Source: EPI analysis of Bureau of Labor Statistics and Bureau of Economic Analysis of data.

That means the wage growth was absolutely not changing and it was stagnating for quite a long period (40 years!). To whom the new houses are built? The newly built houses are just show-pieces, owned by the rich.

Thirdly, the shelter costs have been increasing faster than the costs of other items. Shelter is considered a minimal human need, along with food and other consumer items. Median monthly housing costs, which include utility costs, have increased by 128%, from $348 in 1985 to $793 in 2005 (Source: U.S. Department of Housing and Urban Development Office of Policy Development and Research). While wage is almost stagnating, the shelter costs increased by 128%. That means people reduced their expenditure on food and other consumer items in order to pay the increased shelter costs. When 40% of Americans reduce an expenditure of $445 monthly on food and other consumer items, what is expected to happen? Recession.


The economic crisis was just one of the dimensions of social order. While the American Social Structure (groups, strata and class, as well as the system of relations between them) provided an opportunity to build numerous houses to the 40% of Americans who do not own a house, the interactions between the sub-structures were not in order. While the American people have not yet completely shifted their mindset (framework) from the past, unbelievable asset price increase instilled doubt in their mind and in the institutions. The crisis within the institutions was another dimension that was not in order. Demography is another dimension which is undergoing severe crisis currently.


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