Global Journal of Human Social Science, E: Economics, Volume 21 Issue 4

levels of education. 8 b) Household Sector This is largely attributable to the economic rent collected by financial institutions since 1980. Revenues g en erated by major banks and other financial firms were not “clawed back” during the global financial crisis. For example, the insurance company AIG, issued credit default swaps (CDS) that provided insurance to major financial institutions who purchased the swaps. The premiums paid to AIG were utilized to pay bonuses and dividends to shareholders. These funds were not used to build reserves against potential losses, given the assurances of a senior official at AIG that the instruments being insured (CDOs, etc.) were AAA-rated, meaning reserves were not required. In any case, the U.S. Government ended up paying $180 billion to pay off holders of these swaps in full (with no haircut applied), as senior executives at AIG walked away with their compensation intact. Suppression of wages compelled households to borrow to purchase homes, autos, education, health care, etc., resulting in rising levels of financial fragility. Stagnant wages have elevated corporate profits since the early 1980s (see chart below). Figure 3 8 Phillipon and Reshef (2008). Volume XXI Issue IV Version I 6 ( E ) Global Journal of Human Social Science - Year 2021 © 2021 Global Journals Transforming Financialization and Inequality in a Post-Covid World Home purchases were a significant driver of economic activity during the early 2000s. House prices doubled in value (in the 20 major U.S. cities) and mortgage debt likewise increased from $6.83 trillion to $12.76 trillion between 2000 and Q2 2006. House prices peaked in Q2 2006 and then proceeded to fall by 33.6% by Q1 2012. Throughout the house price boom from 2000 to 2007, mortgage rates declined as financial institutions extended loans to numerous customers, including subprime and Alt-A loans. Many of these loans were packaged into securities and sold to investors via Collateralized Loan Obligations (CDOs), etc. To illustrate how this process worked, suppose a homeowner purchased a home in Q1 2000 for $100,000, borrowing $80,000. She held a 20% equity position (equal to $20,000) in the home. Over the next six years, the home doubles in value. Throughout this period, this homeowner has been refinancing the mortgage, given declining interest rates, and each time increases the amount she has borrowed, while retaining her 20% equity position. The mortgages peak in Q2 2006 at $160,000, meaning she now has a $40,000 equity position in the home. The additional $80,000 she has withdrawn in equity over the six-year period have been used to support her income. It has also contributed to growth in aggregate demand, though importantly it is a liability for the borrower, so it will need to be repaid. Real estate prices peak in Q2 2006, and then began to decline, slowly at first, and then, into the crisis, rather abruptly. The value of her home declines by 33.6% from Q2 2006 to Q1 2012, meaning that the home is now priced at $132,800. She is now underwater by $27,200, given her outstanding mortgage of $160,000. Admittedly, this example simplifies reality, given that the homeowner would have paid down the mortgage, etc., but the reality holds. Many homeowners Source: Federal Reserve, FRED, Author