August 2013

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Middle Class Nightmare

by Jonathan Wallace

A foundational proposition I want you to think about while reading this essay is: nations with an expanding middle class have a long period of growth and prosperity ahead of them; nations with a shrinking middle class, unless they succeed somehow in reversing the trend, face decay, violence and oblivion.

Freud may not have been aware he was stating a rationale for the peaceful and secure role of a middle class in Totem and Taboo:

A king's taboo is too strong for one of his subjects because the social difference between them is too great. But a minister may without any harm serve as an intermediary between them. If we translate this from the language of taboo into that of normal psychology, it means something like this. A subject, who dreads the great temptation presented to him by contact with the king, can perhaps tolerate dealings with an official whom he does not need to envy so much and whose position may even seem attainable to him. A minister, again, can mitigate his envy of the king by reflecting on the power which he himself wields. So it comes about that smaller differences between the amounts of the tempting magical force possessed by two people are less to be feared than greater ones. James Strachey Tr. (1950), p. 33.

Similarly, an intermediate class between the poorest and their sovereign also acts as one whose position may be attained and who need not be envied so much.

The destruction or dwindling of a middle class does not bode well for a nation. W.G. Forrest notes that wealth was concentrated in fewer hands as Spartan population declined due to war casualties and low fertility, while there was no path for helots or outsiders to become Spartan citizens. “It was Sparta’s failure to see the need for social mobility that destroyed her.”A History of Sparta (1968) p. 153. In the feudal system, we again see the creation and then the centuries-long subjugation of a middle class:

Some time after the fall of the Roman Empire, we find mention of large bodies of allodial proprietors imbued with all the spirit of Northern freedom, and corresponding in some measure to our present middle classes. That these freeholders were eventually reduced to feudal subordination, and that the great body of the population gradually sank into slavery, or into a state little better than slavery, has already been pointed out. Henry Boothby Barry, The Advantages and Disadvantages of the Feudal System (1849) pp. 49-50.

What has been somewhat mischaracterized as the "Great Peasant Revolt of 1381" included substantial participation and leadership by the nascent middle classes of wealthy farmers, townsmen, and guild workers, and even some members of the lower nobility. Made desperate by a poll tax which fell disproportionately upon the middle classes, the revolt was not only of the villeins against the barons, but an attack by "the unchartered townsman on his suzerain, of the skilled or unskilled laborers of the city upon their employers, of the urban democrats upon the urban oligarchs". Charles Oman, The Great Revolt of 1381 (Oxford: Clarendon Press 1906), p. 21

Today, the American middle class is rapidly shrinking, forced downwards by the mortgage crisis, crushed by student and health care debt. “A Pew Research Center study, 'The Lost Decade of the Middle Class,' released in August, found that ‘since 2000, the middle class has shrunk in size, fallen backward in income and wealth, and shed some — but by no means all — of its characteristic faith in the future.’” Charles Blow, “The Morose Middle Class”, The New York Times, April 26, 2013,

This isn't happening by accident

In The Folly of Fools, his book on human self deception, sociobiologist Robert Trivers examines the varieties of human self-deception, the situations in which, to serve psychological motives such as the avoidance of fear or social complaisance, we are forced to hold quite contradictory ideas in our heads, or an irrational one to the exclusion of a sensible one.

One such act of self deception is to regard the decline of the middle class as if it were a motiveless, random change in the weather, an act of God not of humans. Like global warming, the causes of middle class decline are evident to anyone who will see them.

As I get older, life actually seems simpler, as the explanations I deduce for human behavior become easier to phrase and seem to be more resounding. I realized some time ago that, both at the personal and global level, it is useful to see the world in terms of two basic human attitudes, two types of people: those who believe they are a higher life form than me on the evolutionary scale, and those who know they are not. A very trivial case is the lawyer who whispered to me in court that I had accumulated some dust on the back of my suit jacket, sitting on a dirty bench. He was acting from a sort of rough equality, of compassion, according to the Christian and Kantian categorical imperatives: doing unto others; acting in the way he would most desire to become a universal law, of telling each other the truth. The young people who lied to me in order to rent my house, then resold shares to inebriated people who broke my furniture,thought they were a higher life form. The negotiation of treaties, however ineffective, to do necessary things in rough equality which are beyond the reach of any one nation (manage emissions, remove landmines) shows a commitment to these imperatives. Invasions of other nations, even in the pretense of helping them to democracy, but which involve the indiscriminate destruction of lives and property, betray even at the level of the individual soldier the belief we are a higher life-form than the adversary.

Kant summed this dilemma up by describing two attitudes to other people: that they are ends in themselves, or means to our ends. It seems plain to me that in any nation which really hews to the idea of equality, that we are all ends and not means, nothing could be permitted to be done by citizens which attacked or harmed the middle class. In a nation really committed to understanding people as ends, the philosophy would be something like this: step one, let's build and sustain the middle class, while inviting the poor to join it and creating the maximum number of pathways into it; step two, the vast majority of the entire nation becomes middle class, with the exception of a few people who are so chaotic or mentally ill they are unable to accept the invitation. In this model, some of us are wealthier than others, but endorse the same middle class, democratic values as the rest, a solution modeled in Athens, where the classes genuinely seemed to like and trust one another, and at least aspired to in Britain in portions of its recent history: for example, during World War II, when everyone fought for the country and took the same risks.

The middle class has been under attack in the United States for decades. This week President Obama rightly said that this Is NOT a Good Thing, and vaguely suggested ways of addressing it, but neither the President or anyone in the mainstream (except for a few outlier columnists like Charles Blow and Nicholas Kristof in The Times) have said what is happening. It is really left to the Libertarians, the philosophical attack dogs of billionaire expansion, to express the rationale, which would need to be done in two flavors:

Original. A rising tide lifts all boats. Only by allowing the unrestrained creativity and productiveness of the very rich will we ever achieve the economy needed to create the middle class and lift the poor into it. Billionaires create jobs; government regulation keeps them from doing so and eventually may drive them out of our country altogether. A lack of government equals prosperity.

The middle class is now rapidly shrinking thirty-three years or so into a Libertarian experiment (I am somewhat arbitrarily dating it from the election of Ronald Reagan; you could say that in a sense, however, the entire United States, from 1776 on, has been a libertarian experiment). We therefore need the New version of the Libertarian statement, which would repeat the original version above and would include an additional clause something like the following:

New. The attack on the middle class was not caused by the billionaires, but by the remaining vestiges of government intervention. If you join us in ensuring that there can be no government intervention whatever, you will see the middle class return to full strength, and the impoverished again offered a multitude of roads to their own improvement.

Raise your hand of you believe this explanation. First, it doesn't make any sense, because the rich are getting richer: how is it possible that "dead hand" of government could succeed only in holding down the bottom two classes, leaving the top one free to aggrandize? Doesn't simple logic, Occam's Razor, demand that we consider theories that the very same policies which are allowing the rich to increase their wealth radically are harming the rest of us, that in fact the wealth they are acquiring is actually taken from us?

An interesting sidelight on the means/ends opposition: People who work for the billionaires, as lawyers, flacks, and philosophical attack dogs, may easily fall into the error of thinking that they themselves are ends, not means, to their masters. The lawsuit brought by Koch against the Cato Institute, to consolidate his control over it as a tool of his political goals, is a rather delightful reminder that even a particularly knowledgeable and competent horse is considered livestock, not a person, by its master.

Steady state and big bang

Years ago I wrote here that the fundamental difference between democracy and capitalism is that the former survives on the "steady state" theory while the latter believes in the "big bang". The vision of the Framers at the time they made the Constitution was that it was a document for the ages, that the United States themselves would survive forever, growing and adapting to changed historical circumstances and capturing these adaptations in amendments to the Constitution as an organic, living document. But Wall Street itself is more project- and event-oriented. You just need to watch its activities for a year or a decade to ascertain this: democracy has gradual developments, like abolition or suffrage, but Wall Street has fads, like savings and loans, leveraged buy outs, Internet start ups, and mortgages. If Wall Street was based on a steady state theory, then the statement "a rising tide lifts all boats" would actually mean something, as would the transient best selling business books whose titles predict "DOW 30,000" a year or two in the future.

Part of the self deception about Wall Street is, as I said above, that destructive events, like the 1929 or 2008 collapses, are portrayed as inexplicable hurricanes, mere acts of God which temporarily distort the rising tide. In fact, the history of Wall Street has no baseline; it is nothing but a collection of bubbles and slumps. Wall street concentrates on something, like mortgages or the Internet, until a bubble results. Then there is a slump, and the brokers start looking for the next bubble.

In such an environment, the clients and investors are means, not ends: means to becoming a billionaire, getting rich, making a killing at someone else's expense. Wall Street sells the myth we can all make money together, but when Wall Street people talk to one another privately, I suspect they are more likely to use war metaphors: in order for someone to win, someone else has to lose.

Thus it would be natural that any political structure Wall Street encounters, unless seen purely as an obstacle, would be viewed at best as a means, not an end, including democracy itself. What inherent need or desire would a billionaire feel---unless he had a massive superego impregnable to temptation--for universal suffrage, or a growing middle class, or the First Amendment? These things are useful for precisely so long as they help him to make a dollar, and not a minute longer. Democracy itself, in the Wall Street world view, is a bubble.

What happened

Wall Street is constantly looking around for new products to sell, and people to sell them to. In an unregulated marketplace, Wall Street is prone to develop risky products, which are sold to the clients as if they were normal and safe.

Over the years, there have been examples of some relatively simple but dangerous products, sold by retail brokers to individuals. Brokers sell promissory notes in private companies to retired people with money but not much sense. There is no secondary market for these, and if the company fails, the customer loses her entire investment. Some brokers have lured clients into trading commodities, a marketplace nobody should be in who is unable to take fearful losses. Merely persuading a client to trade stock on margin--borrow money from the broker to buy new stocks--has resulted in the destruction of clients' entire net worth in a sinking market.

Most brokerage contracts include an arbitration clause, and the arbitrators are industry people who cut the brokers tremendous slack for activities a court would blame. Even before mortgage-backed securities and the 2008 slump, Wall Street had subtracted itself from the normal governance of laws in this country.

The Internet bubble, and the mortgage crisis, which occurred almost back to back, are both examples of a new freedom on Wall Street's part to harm the middle class. The securities laws for decades required full disclosure of risk, and banned the brokers from selling certain kinds of products. In the hype of the Internet bubble, all of the usual rules for evaluating a stock were suspended. Wall Street was allowed to decree that anything which touched the Internet was magic and that neither profit, or even a profit model, was expected. Offerings were over-subscribed in which it was impossible to imagine how the company could ever make any money.

In the meantime, Wall Street had begun to build a no-risk model for itself. Investment banks do not lose money on IPO's. They negotiate a price at which they buy the newly issued stock from the company, say $9, and flip it the same day to institutional investors at $12, who flip it at whatever the market will bear. Like a Ponzi scheme, offerings rely on the existence of a last, least informed, most screwed group who will be the last to buy, say at $30 or $120, and never sell at a profit: the middle class retail investors who read about a stock in the newspaper, or who receive a very belated tip from their broker, and buy a stock which has already been wrung dry of all profit. From that point of view, an entire class of daily conversation, and of business reporting and columnizing in newspapers, about how to pick retail stocks, how long to hold them, etc., is on the same practical and moral level as conversations about systems for beating the slot machines at Foxwoods.

When the Internet bubble collapsed, Wall Street immediately started looking for the next, and made a rather interesting transition from something fanciful, the Internet, to something staid, real property. In mortgage backed securities, however, Wall street found a science fiction way of exploiting something as old and well known as real estate. A common feature with the Internet bubble was the abandonment of quality: Wall Street dumped bad start-ups on us then, and crappy mortgages on us now. Something had happened in the decades since the 1950's which resulted in Wall Street never being required to sell a quality product.

Libertarians, as they always do, blame the vestiges of government. Certainly there was a push to offer home ownership to people who had been red-lined out of access to mortgages. What this meant was that there were employed people, who might lack credit ratings because they hadn't borrowed money, and who lived in zip codes where the banks didn't have offices and didn't lend. Wall Street accepted this small mission with alacrity, and ran through the goalposts and into the next county, offering adjustable rate products to people with no credit. The brokers themselves called one type of sub-prime mortage a "liar's loan" because the borrower was allowed to invent his income without providing any verification.

Adjustable rate products had no moral or business reason to be offered in this marketplace. For a sophisticated, well funded investor, an adjustable rate product allows her to benefit from low rates when the market is low, offset by the manageable risk of paying high rates later. Many unsophisticated borrowers were never told the rate would reset. Initial rates were set artificially low in order to persuade them into the product: some mortgages were interest only, or even had negative amortization: the mortgage amount actually increased as you paid. Eventually, a $1000 monthly payment would reset to an unaffordable $3500.

The official rationale was that there would be an endless opportunity to refinance at lower rates when the mortgage reset. But this is like going into a Ponzi assuming you will be part of the last group to get their money out, rather than the first group not to. The brokers knew that this new real estate bubble would eventually collapse as all bubbles do. While in the Internet marketplace they were risking that some of their more credulous customers would lose a substantial part or even all of their savings, in the mortgage marketplace, they were risking something graver than that: the loss of a home for the great majority of their subprime clients and actual homelessness for some.

When did it become acceptable to sell such products, and on what theory? "Caveat emptor"? "A rising tide lifts all boats"? The hypocrisy of this latter is completely exposed by the subprime mortgage marketplace. An unregulated Wall Street will always make money by exploiting and harming whom it can. The unequal are the easiest to exploit: more credulous and they can't afford lawyers to fight back. Someone charged with a mere violation of possession of a small amount of pot in New York gets a free lawyer, but someone losing her house does not. Most of the people in foreclosure nationwide are unrepresented.

A sidelight to this shameful story is that of mortgage fraud. A new breed of con man developed, who approached homeowners against whom foreclosure actions had been recently filed and said, I can save your home for you if you put it in my name. I will fix your credit and give you back your home in one year. The con man upon receiving the deed then took a mortgage draining out any equity the homeowner had, pocketed it, and either vanished or flipped the house to someone else. At a time when the homeowner couldn't get any relief from anyone, professional criminals with no pretense of title were able, with no screening or investigation, easily to get major banks to loan them a half million dollars or more. District attorneys have not shown much interest in prosecuting these people, in some cases blaming the victim for doing business with them.

The professional mortgage brokers made commissions on all this. Like the retail sellers of Internet stocks, they did not care about reputation, or the future of their firms, or even their jobs. The killing is all, and reputation nothing. One of the assurances my company had, when a 135-year old prestigious investment bank took us into what proved a bad IPO in the 90's, was the length of their existence and the height of their reputation. But they merged with someone else immediately after.

Wall Street at a higher level was finding new ways to exploit the subprime bubble. It was bundling the mortgages into securities it sold clients, and then creating derivatives which did well when the securities did badly. These products were created by quants, young financial geniuses, and often not understood even by the CEO's. But they basically acted as insurance. If the derivatives functioned properly, the brokerage could not lose. It was selling a crappy product to its own corporate clients, and taking out insurance that assured it a profit when the product, as expected, did badly.

One or two of the Wall Street firms failed to design the evil products well enough, or took gambles which were too greedy, and hit a brick wall when the bubble collapsed. But the majority of the bad actors are still out there, selling other products, and some are even venturing back into mortgage backed securities and derivatives again. After the 1929 crash, scores of stockbrokers and bankers who had contributed to it were prosecuted. Since 2008, almost no-one. Even under an apparently liberal Democratic administration, there has been a change in the rule-book: Wall Street now has a free pass to prey on the middle class.

I am not sympathetic to the argument that people who took adjustable rate mortgages deserved what happened to them. That is the same argument that people who sign their home over to a con man deserve the result. It leaves the criminals free to exploit and harm while blaming the victims.

The 2008 crash harmed middle class people who were nowhere near the mortgage or derivative marketplaces. I lost about 40% of my net worth, and I had no mortgage, nor even any investment in risky stocks or anything I knew was mortgage- or real-estate-related. I was concentrated in conservative mutual funds. A rising tide may not lift all boats, but a maelstrom sucks down everyone in the vicinity except the people who started it.

Means and dehumanization

The way we see ourselves in movies is quite revealing as a portrait of our aspirations, if not our realities. A fine British movie, Mrs. Miniver, which Winston Churchill pronounced "better than ten battleships" for bolstering wartime morale, portrayed the British class system as three levels of quirky people bound to each other by ancient trust and affection. The classic Its a Wonderful Life portrays a small town America in which the local banker, George Bailey, is a compassionate businessman whose far-sight is indistinguishable from philanthropy: he will fight hard to keep you in your house, because that is best for you, best for him and also the best result for America.

I don't know to what extent George Bailey ever existed, but contrast him to the bankers of today. Small homeowners put into disastrous adjustable rate mortgages have nobody they can call at the bank. As part of the bundling process, their mortgages were sold and resold, so from day to day they may not even know who the owner is, and it is certain that the new owner has no George Baileys working for it, or even anyone whose job it is to talk to homeowners in plain language. In foreclosure cases in New York, the courts have set up a system where a court clerk attempts to mediate a settlement, but the system has massively failed because the banks send a different ignorant per diem lawyer, unaware of the facts and unauthorized to settle, to every conference. The courts in theory have the power to haul the CEO of Citibank or Bank of America into court and shout at him, but haven't. New York judges are elected officials and need campaign contributions.

The dehumanization of homeowners takes its place against a fabric of similarly motivated choices as society and business migrate from an artisanal, expertise-based model to an assembly line model in a variety of industries. When you call the service number at many Fortune companies, you now get a polite, well educated individual in India who seems to have good morale and a certain eagerness to help, but who speaks English as a second language and quickly hits a knowledge wall: she understands various terms as defined in a handbook or by her American trainer, which is not at all the same as being George Bailey, and understanding you and your situation. Many other business roles, which used to be performed by people who knew what they were doing as permanent employees, have similarly been outsourced, in even more disastrous ways.

One I got a brief look at from the inside was document review. Forty years ago, when companies were conducting mergers or large scale litigation, teams of the most recently hired young attorneys sat in rooms going through boxes of documents. They were young associates, with entry level (which back in the day meant quite generous) Wall Street lawyer salaries and benefits, and with a prospect, if they worked really hard, of graduating to better work and making partner someday. They thus had an incentive to conduct mind-numbingly boring tasks with care and intelligence. Today, these same reviews are conducted by teams of temporary, hourly paid, alienated lawyers, sitting in huge warehouse-like rooms, with no security or benefits and no hope of a better future. The difference in results is plain: lawsuits have already resulted when hundreds of privileged documents, which should have been withheld, are released to the adversary, because the drone lawyers weren't paying attention and no-one was reviewing their work. An artisanal model has morphed into a broken assembly line.

If you look around the landscape, what else do you see? The demonization and destruction of labor unions. College tuition becoming unaffordable; and Republicans asking why college is so important anyway. American firms are increasingly hiring Chinese and Indian software developers because they are better educated and will work for less; Americans determined to get an education emerge with $140,000 in debt simply for a dental technician degree, and upwards of $600,000 for one young doctor I read about, who said she had a chance of being clear of debt before she turned sixty, as long as she worked nonstop and never took any time off to have a child.

Families are ruined every day by high health care costs and a lack of insurance, or the surprise discovery that the insurance they have doesn't cover the emergency they just encountered. The drop in interest rates, fostered by the Fed so that businesses will be borne up on a tide of cheap money, has dictated that the retired cannot stay retired, but many of them cannot find jobs either. It is also forcing people, who can no longer make more than a half percent on federally insured investments such as CD's, to move their money back into the risky end of the marketplace, where brokers can again start selling them promissory notes, commodities trades and fraudulent stocks.

Why isn't Congress protecting us? After the 1929 crash, Congress adopted the Glass-Steagal act, forbidding banks from trading in risky securities. A Republican Congress repealed it in 1999, just as the Internet bubble was collapsing, and in time for the mortgage bubble to start. Repeal sponsor Senator Phil Gramm said, "We are here today to repeal Glass-Steagall because we have learned that government is not the answer." Bill Clinton, playing Republican in order to have a legislative legacy, signed the repeal and was still defending it in 2008: "On the Glass-Steagall thing, like I said, if you could demonstrate to me that it was a mistake, I'd be glad to look at the evidence. " In 2008 and after, we saw scores of failures of banks which had invested in mortgage-backed securities.

The meta-data informing all these things I have just listed is that our society, despite the representations of President Obama and other liberals, is in the midst of an open season lasting decades in which Wall Street is allowed to hunt and kill the middle class for sport. As a result, we are sliding back to a medieval model, of barons and serfs.

In a nation of rising inequality and increased predation by a ruthless oligarchy, what can our other "rights" possibly mean?

The First Amendment
Makes transcendent
Your right to complain
As you circle the drain.