September 12, 2013 / 9:09 PM / 4 years ago

COLUMN-Lehman's legacy of inequality: James Saft

(James Saft is a Reuters columnist. The opinions expressed are his own)

By James Saft

Sept 12 (Reuters) - Of the many regrettable aspects of the failure of Lehman Brothers, perhaps the worst is that it led to policies which expanded and reinforced economic inequality in the U.S., often through unfair means.

When Lehman went down five years ago it set in train forces which could easily have led to the failure of many financial institutions. Faced with the possibility of taking large swaths of the banking system into effective government control, first the Bush and later the Obama administrations chose instead to shelter institutions and executives from the consequences of their actions.

That involved creating a variety of policies which subsidized large banks and helped to dig a moat around their businesses. This went hand in hand with monetary policy which both supported banks and kept artificially high the value of financial assets and real estate.

The reasoning behind the bailouts ran that, though it was patently unfair to shield banks from market discipline, to continue on despite being not simply illiquid but bankrupt was better than the damage which would be caused by the alternative.

As for extraordinary and easy monetary policy, central bankers maintained that keeping banks afloat and ramping up the value of assets were simply side effects of policies the main intent of which was to rescue the economy and create jobs.

Both of those arguments are very contentious, but one thing which isn’t is that the net result of the policies has been to increase economic inequality.

Income in the U.S. is as skewed to the top end as it has been since the Census Bureau began keeping reliable records in 1947, and after falling in 2007, inequality has risen in each successive year. When you measure inequality in the distribution of wealth, the owning of assets, the U.S. is now the fifth most unequal country in the world, trailing only Namibia, Zimbabwe, Switzerland and Denmark.

Monetary policy has been key in increasing inequality because, as the ownership of assets was heavily skewed going into the crisis, a policy which supports asset prices has the effect of exacerbating inequality in wealth terms. This is borne out by a 2012 study from the Bank of England. (here)

Remember too that this is part of the point of quantitative easing, to create a wealth effect where people feel better off and hopefully spend some of their paper gains.


QE may or may not be temporary, and the uplift to asset prices isn’t likely to last forever. More permanent, and more troubling, is the way in which the bailout solidified the position of finance, a sector which at its current size acts as a private and unproductive tax on the rest of us.

Because regulation has yet to solve the too-big-to-fail problem, in which the largest banks get cheaper funding due to the belief that they won’t be allowed to follow Lehman into that great good night, we have an unlevel playing field in finance.

We also have an effective subsidy, or rather multiple subsidies, to an industry which has proved itself remarkably immune to the power of technology to bring down costs and improve products.

Whereas retail and wholesale trade have shrunk as a percentage of GDP, finance has risen and risen, from 15 percent in 1980 to close to 22 percent today, with the rise continuing even in the face of the greatest financial crisis since the Great Depression. (here)

That's in large part because finance is a sector run by and for the benefit of employees, who use complexity and government licenses to extract unfair rents from clients. That's very clear if you compare compensation to other similarly complex fields. (

To sum up, we had a sector which had grown too big and was acting as a drag on the economy, all while doling out too much in client money to insiders. Our reaction to bad decisions and the verdict of the market was to create even more incentives to commit capital to banking and give special status to some banks, all while failing to hold executives accountable.

You can just about make a case that some of the rise of inequality in the U.S. is the result of globalization and talent getting its just reward.

It is also, sadly, the result of financialization, in which we give incentives to the talented to do perverse things with our money and keep too much of it for themselves.

The policy response to Lehman Brothers has cemented that. We may have to wait for another crisis to see it undone. (At the time of publication, Reuters columnist James Saft did not own any direct investments in securities mentioned in this article. He may be an owner indirectly as an investor in a fund. For previous columns by James Saft, click on ) (Editing by James Dalgleish)

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