Will The Recession Make Inequality Worse?

Over on New York Times Economix blog, economist Simon Johnson has an interesting post about a phenomenon he believes might be going on within this recession. He thinks that, since Americans with the most credit are disproportionally affected by this recession, the middle class is likely to suffer worst. As a result, the recession may increase the gap between the rich and the poor. I think he's mostly right, but possibly underestimates the effect that the recession has had on the rich.

Here's the gist of his argument:

Think about this in terms of individuals and the households in which they live. Some people have lost their jobs and are finding re-employment very difficult; many will exhaust their unemployment benefits soon. Others find that what they owe on their mortgages far exceeds the value of their home. And many find they have been cheated by financial products, particularly home loans and credit cards -- which is why we need effective consumer protection for finance, and in a hurry.

The traditional American recession remedy is to move to another, more prosperous part of the country. But nowhere is exactly booming at present. And how do you move if you can't sell your house?

And it might even be worse. As I noted earlier this month, those with credit troubles might actually end up unemployed for longer, since credit checks by employers are becoming increasingly common. So not only will they not be able to move to get new employment, their credit troubles might stack the deck against them as well.

How does the debt burden breakdown among classes? Johnson's Baseline blog included a recent post by Mike Konczal in which he includes a chart below that originated at the LA Times:

debt inequality.jpg

Even though subprime mortgages are blamed on the housing market collapse, it seems pretty obvious that the borrowers having too much credit are more individuals with moderate income than lower income. That's why the middle class might have the most to lose in this environment.

I think, however, that Johnson might not have given enough consideration to the massive amount of wealth that many high-net worth individuals have lost during this recession. The rich tend to have a lot of investments, and investments have done pretty terribly across the board since 2008. While the stock market has been improving in recent months, it's still no where near its pre-recession highs.

This could be more a case of a waning tide lowering all boats. The rich probably seems relatively better off than the middle class because, well, they're still rich. That doesn't mean they haven't incurred significant losses as well, however. But those losses might be a lower proportion of their wealth than the losses of the middle class -- especially if most of its wealth was in the equity of now underwater homes.

One potential "solution" some might call for is inflation. After all, inflation helps those who have a lot of debt. So can inflation bring about better equality for those with more debt? Probably not. The wealthy are probably savvy enough with their investing to shield themselves from inflation through various investment strategies.

In fact, I think inflation would most adversely affect the poor. First, with less credit availability, they would probably benefit less than the other classes who had more debt. Second, the U.S. government would be a loser in this scenario because its debt would lose value and it would be forced to pay out more for Treasury inflation-protected securities it's issued. This would also hurt the poor, since the government might be forced to allocate less money to social programs and entitlements to restore fiscal confidence.

So what can we do about the potential problem that Johnson explains? Unfortunately, I don't think there are any easy answers. But if you've got one, feel free to share in the comments section.