Inequality is Killing Capitalism
LONDON – It is generally agreed that the crisis of 2008-2009 was caused by excessive bank lending, and that the failure to recover adequately from it stems from banks’ refusal to lend, owing to their “broken” balance sheets.
A typical story, much favored by followers of Friedrich von Hayek and the Austrian School of economics, goes like this: In the run up to the crisis, banks lent more money to borrowers than savers would have been prepared to lend otherwise, thanks to excessively cheap money provided by central banks, particularly the United States Federal Reserve. Commercial banks, flush with central banks’ money, advanced credit for many unsound investment projects, with the explosion of financial innovation (particularly of derivative instruments) fueling the lending frenzy.
This inverted pyramid of debt collapsed when the Fed finally put a halt to the spending spree by hiking up interest rates. (The Fed raised its benchmark federal funds rate from 1% in 2004 to 5.25% in 2006 and held it there until August 2007). As a result, house prices collapsed, leaving a trail of zombie banks (whose liabilities far exceeded their assets) and ruined borrowers.