Financial and political crisis in America

This American economist believes that rising interest rates at the fastest pace in decades has paved the way for another round of the US regional banking crisis. On the other hand, according to the results of the Gallup Institute survey in America, the level of pessimism of the population of this country towards the state of democracy has reached the lowest level in the last 40 years. Only 28% of adults in America are satisfied with democracy; which shows a significant drop of 35% compared to the previous record.

With the upheaval of the American economic and financial system, a large number of banks and firms are forced to declare bankruptcy while private markets and key industries have collapse as well. These reflect not only an unsustainable collection of government administrative practices and capacities but also question the legitimacy of the American state as a representative of democracy as well. In this chapter, the primary strains surrounding the American state are discussed. It also points out the deep-rooted dysfunctionalism in the operation of the American state's administrative institutions. To be able to understand current financial and economic turmoil occurring, the nature of unsustainability is presented in detail. Situated functionalism value in studying state sustainability is also illustrated.

The historian Joseph J. Ellis describes the early days of the United States as “a decade-long shouting match” characterized by “shrill, accusatory rhetoric, flamboyant displays of ideological intransigence, intense personal rivalry, and hyperbolic claims of imminent catastrophe.” In more recent times, the Vietnam War and Watergate deeply divided the country, and the administrations of Presidents Bill Clinton and George W. Bush were marked by sharp partisan conflict.

But while political polarization has been all-American since the start of the US, its current upswing threatens to make it the worst in history. Sharp divisions between Republicans and Democrats have created gridlock in Washington, DC, between the president and Congress and within Congress itself. The political scientists Christopher Hare, now at University of California, Davis, and Keith T. Poole of the University of Georgia write that “the level of polarization in Congress is now the highest since the end of the Civil War.”

The latest manifestation of this polarization has been the presidential primary race, defined by the emergence of real-estate magnate and reality-TV star Donald J. Trump on the right, and Senator Bernie Sanders on the left. Both Trump and Sanders espouse positions that only recently would have been way out of the mainstream—such as deporting 11 million undocumented immigrants (Trump) and providing free public college tuition for all (Sanders). The strong, durable support both candidates receive illustrates how polarized US politics has become.

Research I’ve conducted with Atif Mian of Princeton University and Francesco Trebbi of the University of British Columbia suggests a reason politics has come to this: an increase in polarization after banking and financial crises is common and predictable.

A banking battle
Greece's debt crisis polarized Europeans, and the debtor-creditor relationship evolved into a political tug-of-war.

How financial crises cause polarization

In the US, decisions made during the 2007–10 financial crisis to rescue Wall Street fueled public anger that still resonates with voters of both parties. The aftermath of the crisis—which included erasure of trillions of dollars of housing wealth and continued income stagnation for the working and middle classes while the wealthy benefited from rising asset prices—has provided fertile ground for even more partisanship and polarization.

“The 2008–2009 economic collapse and its aftermath,” writes New York Times opinion columnist Thomas Byrne Edsall in his 2012 book The Age of Austerity, “have converged to generate a dog-eat-dog political competition over diminishing resources.”

This polarization, our evidence indicates, is a product of the banking crisis.

We used the American National Election Study (ANES) Time Series Cumulative Data File to follow respondents’ self-reported liberal-conservative scores from 1948 to 2008, and then brought the file more up to date by adding data from the 2012 ANES Time Series Study, as well as data (from Poole and New York University’s Howard Rosenthal) that estimates legislators’ positions on the basis of their roll-call voting records. Combined with a comprehensive data set (covering 1800 to 2008) on global financial crises assembled by Carmen Reinhart and Kenneth S. Rogoff of Harvard University, these findings led us to some general conclusions about the impact of financial crises on political polarization.

Polarization in Congress has increased steadily over the past four decades, but our research suggests that it rose more sharply after banking crises and market crashes. And this pattern extends beyond the US: after financial crises, polarization among voters was common across all 70 countries sampled in the Reinhart-Rogoff data set.

We also took data from about 250,000 individual interviews from 60 countries, in which respondents described their political ideologies, and we matched that with Reinhart and Rogoff’s pre- and postcrisis indicators to construct a picture of people’s ideological tendencies five years before and after financial crises.

Our conclusion: financial crises tend to radicalize electorates. After a banking, currency, or debt crisis, our data indicate, the share of centrists or moderates in a country went down, while the share of left- or right-wing radicals went up in most cases.

What does this do to political decision making? Not surprisingly, we find, after almost any financial crisis, ruling governments became substantially weaker, while opposition coalitions grew stronger. This increased overall political partisanship and fragmentation, often leading to gridlock and ineffectual policy making, just when bold moves and major financial reforms might have been particularly beneficial.

It’s a catch-22 that could in turn lead to further disaffection and polarization among the electorate, prolonging the impact of a crisis. It takes a charismatic leader to break the stalemate, someone who can implement good policies and manage the polarization. President Franklin D. Roosevelt was one such leader. Using fireside chats and a lot of effort, he managed to form a coalition large enough to pass legislation that helped pull the US out of the Great Depression.

The debtor-creditor relationship is crucial

Princeton’s Nolan McCarty, University of Georgia’s Poole, and NYU’s Rosenthal attribute the polarization after financial crises to increased income inequality, which leads to conflict between the haves and have-nots. That explanation has merit.

My colleagues and I focused especially on the nature of the debtor-creditor relationship, which after a crisis can become a political tug-of-war.

Every banking crisis is associated with excessive lending. In his masterpiece Manias, Panics, and Crashes: A History of Financial Crises, the great economic historian Charles P. Kindleberger finds that “asset price bubbles depend on the growth of credit.” As the bubble develops, borrowers who are less and less creditworthy take on more and more debt.

To simplify greatly, this is what happened in the US housing bubble of the 2000s. Between 2000 and 2007, US household debt doubled to $14 trillion, and the household debt-to-income ratio skyrocketed from 1.4 to 2.1, an increase matched only in the early years of the Great Depression.

As Atif Mian and I documented in our 2014 book House of Debt, there was a big expansion in lending to marginal borrowers during this period. Astonishingly, mortgage-credit growth for home purchases and income growth became negatively correlated as the bubble developed, and many borrowers—even those in the middle class—used the rising value of their homes to extract equity and to finance consumption.

Unfortunately, a financial system that thrives on massive use of debt by households concentrates risk squarely on debtors, who bear the brunt of any losses. So, when the housing bubble turned into a bust, the most-marginal homeowners took the biggest hit.