The Flaw: money-grabbing and misery in modern America

I have finally watched the 2011 documentary The Flaw. Pulling together interviews with a range of academics and experts, as well as people involved in and affected by the sub-prime mortgage fiasco, the film works as a highly watchable insight - albeit a polemical one - into the causes and consequences of the financial crisis in America.

A few ideas from the film stood out for me:

• Asset markets are naturally prone to bubbles because they fail to obey the normal rules of supply and demand. People tend to buy more of an asset - equities, property, etc - as its price rises, driven by the belief that the price will continue to rise and that they will therefore make a profit when they sell the asset. This fact implies that stock market and property bubbles are pretty much inevitable in market capitalism.

• Asset bubbles and income inequality are intrinsically linked. As assets inflate in price, wealthier people have the spare cash to invest in assets, so they tend to be the ones to profit most from asset price increases.

• Income inequality in turn inflates asset market bubbles and damages the real economy, since the very wealthy spend proportionately less of their income, compared to the average citizen, on real goods and services and proportionately more on assets.

• Over the last 30 years, banks have, as we all know, put more and more of their resources into financial instruments based around personal debt (notably mortgages and credit card debt, and derivatives thereof). This is because these instruments offer a quick return. In other words, bankers have - surprise, surprise - been trying to maximise their profits. The consequence, however, is that banks have come to see the real economy - i.e. factories, small businesses, infrastructure, etc - as a less attractive destination for their capital.

This last point helps to explain not only the untenable rise in obscure financial engineering that led to the financial crisis itself, but also the drop-off in investment in the real economy and the decline in manufacturing. This link holds true, I suspect, not only for the US, which is very much the focus of The Flaw, but also for the UK.

You have to wonder whether the catastrophic events of recent years will convince banks to shift their priorities back from obscure financial instruments to lending in the real economy. Sadly the evidence from lending figures so far suggests that this isn't happening. And herein lies a reason why we all need the bonus culture to be dismantled for good. So long as bankers are motivated to seek out fast profits, they will do so in the way they know best, i.e. constructing and trading credit default swaps and the like. Thus there will be less money available to support businesses and projects that actually employ people in a sustainable way and create wealth for the broader population.

My one cheerful thought to come out of the film was a realisation that, in the UK at least, things could have been worse. The Flaw shows how the bursting of the US house price bubble had miserable consequences for individual home owners burdened with mortgages that they never should have been granted. Many now owe considerably more than their houses are worth. This hasn't happened to the same degree here in the UK because house prices have not crashed as dramatically as they have in the US, not to mention Ireland, Spain and so on. For this scrap of good fortune, we in the UK should, for now, be grateful.