The Wealth Gap Preoccupies Wall Street

Bill Gates
Bill Gates during a panel discussion on “Investing in African Prosperity” at the Milken Institute Global Conference in Beverly Hills, California, on May 1, 2013. Gus Ruelas/Reuters

Bill Gates, the founder and chairman of Microsoft, is the richest man in the world, with an $81.7 billion fortune that places him atop the staggeringly rich 1 percent of human beings who own nearly half the wealth on planet Earth.

Got a problem with that?

You probably do if you're a 1960s-inspired proponent of social justice, a populist advocate of living-wage campaigns, a humanitarian supporter of nonprofits working to end poverty (think of U2 singer Bono's "One" group) or a rabble-rousing Occupy Wall Street protester.

But lately you may also have a problem with that if you're a big financial or economic institution.

Once the concern of idealistic do-gooders and obscure academics penning scary equations with squiggly symbols, the growing difference between the super-rich and what the World Bank estimates is 2 billion people living on less than $2 a day is increasingly grabbing the attention of those once likely to ignore it.

Wall Street banks, at least one financial-ratings agency, the Federal Reserve and American and European economic policymakers aren't interested in the wealth gap for moral or ethical reasons: amid a tepid economic comeback from the biggest financial crisis since the Great Depression, the hotly disputed question is whether income and wealth inequality exacerbate financial crashes and impede economic recovery.

The emergence in recent years of an ultra-wealthy elite—particularly in the United States, home to 41 percent of the world's millionaires, or 14.2 million Americans, according to big Swiss bank Credit Suisse—is not news, of course. What is new is the attention the phenomenon is getting from banks and institutions involved in the recent financial meltdown. "The changing distribution of wealth is now one of the most widely discussed and controversial of topics," Credit Suisse wrote in its annual Global Wealth Report last month.

The bank, which devoted its entire report to the issue, found that while growth in global wealth inequality was largely in remission between 2000 and 2007, China and India excepted, it did an about-face after the mortgage and credit meltdown in 2007-2008.

"Prior to 2007, most countries show little change in inequality, or a slight decline; after 2007, wealth inequality has tended to increase," Credit Suisse wrote, adding that global wealth topped $263 trillion last June, an 8.3 percent rise over the previous 12 months. The biggest share of that pie is in North America, meaning mostly the United States, where individuals hold more than $91 trillion, just over one-third of the world's total wealth. One eye-popping finding: The amount of new wealth rich Americans added last year—$12.9 trillion—more than made up for the amount they lost during the meltdown ($12.3 trillion).

How does a global financial crisis produce such riches? How does a sow's ear become a silk purse for a select few, leaving millions of struggling homeowners, low-income workers and the unemployed high and dry? And if, as economist Timothy Smeeding, a former director of the Institute for Research on Poverty, puts it, "capital is winning; labor is not," what does it all mean for future economic growth?

Economists blame a range of disparate factors: fiscal policy, tax breaks, low wages, the cheap electronics we all buy thanks to globalization, poor education and demographics. One likely culprit in the fiscal policy arena, Credit Suisse says in an indirect but unmistakable way, is the Fed's handling of the mortgage meltdown.

"It is likely that the abrupt switch from decreasing inequality up to 2007 to increasing inequality in the years after 2007 is linked to the change in the relative importance of financial assets in household wealth, which followed the same pattern."

Translation: Pre-crash, cheap interest rates fueled low-cost mortgages that later imploded and nuked the value of nonfinancial assets (i.e., housing) that are the prime source of wealth for the middle class. By contrast, cash, stocks, bonds and other investments (i.e., financial assets that are the main source of wealth for the ultra-wealthy) bounced back and created even more wealth for the already rich.

In other words, the gap-widening "change" cited by Credit Suisse is captured in the stock market boom since the 2008 crash, itself increasingly seen as the product of the taxpayer-funded $700 billion bailout of Wall Street and the massive Fed bond-buying program known as quantitative easing, now ended, that injected $4.5 trillion into the economy.

Credit Suisse is not alone. Fed Chairwoman Janet Yellen, in an October 17 speech in Boston titled "Perspectives on Inequality and Opportunity From the Survey of Consumer Finances," jolted observers with a series of un-Fed-like comments on the gap between rich and poor. Noting that "the extent of and continuing increase in inequality in the United States greatly concerns me," Yellen said, "I think it is appropriate to ask whether this trend is compatible with values rooted in our nation's history, among them the high value Americans have traditionally placed on equality of opportunity."

Major development banks and institutions, including the World Bank, the International Monetary Fund and Organisation for Economic Co-operation and Development, have been sounding alarm bells about the extent of rising inequality since 2011, and President Barack Obama made the issue the main theme of his 2012 State of the Union address.

New data continue to raise eyebrows: development nonprofit Oxfam International, in an October 29 report titled "Even It Up: Time to End Extreme Inequality," said the number of global billionaires has more doubled since the financial crisis, to 1,645 individuals. Those people, including Gates, now have as much wealth as do 3.5 billion people, or half the planet, OxFam said, adding that "the gap between the rich and the poor is spiralling out of control."

But it's not just left-leaning ideologues who are concerned. In a blurb on the Oxfam report, Andrew Haldane, chief economist for the Bank of England, said that "there is rising evidence that extreme inequality harms, durably and significantly, the stability of the financial system and growth in the economy." Nobel laureate economist Joseph Stiglitz had his own blurb: "The extreme inequalities in incomes and assets we see in much of the world today harms our economies, our societies and undermines our politics."

Last August, Standard & Poor's, the credit ratings agency, startled Wall Street with a report titled "How Increasing Inequality Is Dampening U.S. Economic Growth, and Possible Ways to Change the Economic Tide."

The report's takeaway: "At extreme levels, income inequality can harm sustained economic growth over long periods. The U.S. is approaching that threshold." S&P took it one step further by wading into the realm of social policy, arguing that better and more-attainable education, from preschool through college, would bolster gross domestic product, with a single extra year for undereducated workers equating to an extra $525 billion, or 2.4 percent more, within five years.

Income inequality "is a natural part of a market economy and keeps us going," Beth Ann Bovino, chief economist at S&P and one of the thinkers behind the report, tells Newsweek. "But is there a point where it can be too extreme and damage long-term growth?"

Morgan Stanley, the Wall Street bank that in late 2008 received $10 billion in bailout money, which it repaid within a year, took on the issue on September 22 in a "U.S. Economics" research note titled "Inequality and Consumption."

"Laid bare, then exacerbated by the financial crisis, income inequality explains divergent consumer spending behavior in the recovery," the note's authors, Ellen Zentner and Paula Campbell, wrote. "Understanding its drivers, and what will work to level the playing field, helps us to anticipate spending patterns going forward."

Like Credit Suisse, Morgan Stanley pegged collapsed housing values as exacerbating the wealth gap by driving down the value of nonfinancial assets (houses) while financial assets (stocks and other investments predominantly held by the wealthy) rebounded. "The ensuing run-up in financial wealth in the wake of the crisis further exacerbated the gap," the authors wrote, adding that "the amazing run-up in shareholder equity has gone to the benefit of only the top 10 percent income group, leaving the majority of households behind."

The zinger came in Morgan Stanley's swipe at the Fed's stimulus program, which has just ended. "The Fed's massive program of quantitative easing, in which it has purchased large amounts of longer-term assets, drove investors away from fixed income and into equities and other riskier investments. Indeed, consumers holding financial assets"—i.e., the already wealthy—"have experienced unprecedented growth in wealth."

A common thread cited in the reports by Credit Suisse, Morgan Stanley, S&P and Yellen's written speech is Thomas Piketty, the French economist whose controversial best-seller "Capital in the Twenty-First Century" uses centuries of global tax data to analyze the emergence in recent decades of a super-wealthy elite. Piketty's argument is that when returns on investments (stocks and the like) outpace economic growth, the rich grow richer and more numerous and the rest don't. That gap, he argues, can lead to deep political and social divisions.

But the new attention to wealth inequality by banks and financial-sector companies may even be rooted in capitalism itself.

Austrian economist Ernst Fehr and German economist Klaus Schmidt, who jointly coined the term "inequity aversion" in a widely read 1999 academic paper, argue that a dislike of unfair situations is not just a moral attitude but an ingrained preference. "A large share of the people," Fehr, the chairman of the economics department at the University of Zurich, tells Newsweek, "are willing to give up resources to establish what they consider to be an equitable situation."

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