Engine of Inequality. Karen Petrou

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To Basil, whose tireless patience, encouragement, and critical rereading made this book possible along with so much more.

Acknowledgments

      Grateful thanks are extended to Matthew Shaw, whose research helped to ensure that this book is as right as we can make it, and to Arezou Rafikian for her never-ending cheerful willingness to clean up all my typos. Space does not permit thanks also to the many bankers, policy-makers, industry critics, and friends who have read portions of the manuscript and provided both encouragement to be sure this story is told and constructive comments to make sure it's told correctly. Appreciation also to Leah Spiro, my bulldog agent; Bill Falloon, a very helpful editor; Ellen Kadin, who framed key parts of the initial proposal; Barbara Hendricks; and Mark Fortier and his crack advisory team. Finally, a pat on the head for Zuni, my German Shepherd guide dog. Her unflagging and enthusiastic presence got me to and from many meetings, speeches, and drinks with friends that honed my thinking.

About the Author

      Dubbed by the American Banker “the sharpest mind analyzing banking policy today — maybe ever,” Karen Petrou is one of the most sought-after financial consultants in Washington and one of the most influential experts on financial policy and regulation in the world. She is Managing Partner of Federal Financial Analytics, the Washington, DC, financial services consulting firm she co-founded in 1985. It does not lobby for anyone, providing strategic and policy analysis and advisory services to major financial institutions and global central banks. Her views can be found almost every day in the Financial Times, American Banker, Wall Street Journal, NPR, CNBC, and many other media. In addition to testifying before the US Congress, she has spoken before the Federal Reserve Banks of New York, St. Louis, San Francisco, and Chicago; the European Central Bank; the International Monetary Fund; and many other governmental, industry, and academic groups. She also provides strategic guidance to foundations on a pro bono basis in connection with work by her and her husband, Basil, to create new funding instruments to speed biomedical research. Winners of the Visionary Award in 2019 from the Foundation Fighting Blindness for this work, the Petrous live in Washington, DC, with Zuni, a German Shepherd guide dog.

Introduction

      In 2008, the financial system collapsed suddenly and, to many regulators and central bankers, seemingly without warning. The “great financial crisis” that ensued wrought havoc, but by 2010 the financial system stabilized and stock markets began their upward climb. By 2013, the Federal Reserve was confident that the “Great Recession” that followed the great financial crisis had ended, with financial markets also well on their way to becoming bulletproof thanks to tough new banking rules. The US central bank thus proclaimed that all was right with the national economy and financial system even though only a tiny percentage of Americans benefit from rising financial markets, underemployment was endemic, and anyone who tried to save his or her way to a better life lost ground every day due to ultra-low interest rates.

The Obama Administration also congratulated itself on the sound economy and resilient financial system, Hillary Clinton campaigned on renewed prosperity, Americans knew more than economists about their own struggles, Donald Trump won, markets climbed higher, economic growth remained weak, and America grew ever angrier as economic inequality rose even higher. By 2020, COVID blew away every one of the foundations on which the Fed thought the economy and financial system so securely rested. A decade of rising financial markets atop acute economic and racial inequality made the US as vulnerable to an economic shock as an ill-kempt nursing home to the coronavirus.

      I'm among the Americans who got angrier and angrier from 2010 to 2020 as America became increasingly unequal while well-intentioned policy-makers assured us that, as the Fed likes to say, the US economy was in a “good place.” In my day job, I analyze monetary and regulatory policy to assess its strategic impact on financial-services companies and markets, doing so for major corporations, central banks, and those elsewhere in the financial market who make or lose money based on what policy-makers do. This isn't exactly a job in the inequality trenches, but it does afford a unique perspective on the totally perverse effect of post-2008 financial policy: acute inequality and resulting risks to both growth and financial stability.

      As the 2016 campaign began, I also saw another consequence of post-crisis financial policy: voter fury about the deaf ear most financial decision-makers gave to the warp-speed disintegration of the American middle class, economic despair in communities of color, and profound distrust across what was once the US's manufacturing and agricultural heartland. Calls resonated for policies founded on populism, nativism, and even racism – calls that turned out to be clarion to all too many because vast swaths of the US were in acute economic distress no matter the aggregate growth and employment numbers with which the Federal Reserve comforted itself.

      Because my nature is one of an analyst, not an advocate, I dove into the data. As you'll see from all of it in this book, the more one knows the hard facts of financial policy's inequality impact, the angrier one becomes. I thus switched into advocate mode.

In 2016, I told a group of global central bankers that income inequality is the battlefield casualty of post-crisis reform,¹ urging them to clean up their own mess, not count on changes to taxation, spending, technology, or other policies somehow to do it for them. The central bankers were receptive, but none acted. Inequality then climbed higher as post-2008 monetary and regulatory policy continued unchanged, leading me in another speech to central bankers in 2018 to make a still more forceful case for rapid financial-policy reform.² Again, central bankers listened but did no more.

This