Income Inequality Did Cause the Financial Crisis
**Income Inequality Didn’t Cause the Financial Crisis**
There’s something intuitively compelling about the idea that America’s growing income inequality helped fuel the 2008 financial crisis. The narrative, which got an official stamp from Congress’ Democrat-led Joint Economic Committee back in 2010, goes something like this: As middle class wages stagnated, families borrowed more to prop up their standard of living. Banks, along with Fannie Mae and Freddie Mac, happily provided them with unaffordable mortgages, which they then skillfully repackaged and sold as securities. Eventually, the whole house of cards collapsed, plunging us into the Great Recession.
The story is downright elegant — a sort of grand, unified theory of our present economic woes. But according to a new study, it’s plain wrong.
The working paper, from Professors Christopher Meissner of the University of California, Davis and Michael Bordo of Rutgers, looks at whether there is a consistent historical relationship between rising income inequality and financial crises, using economic data on fourteen countries, including the United States, from between 1920 and 2008. It finds that although big financial busts tend to follow on the heels of credit booms like the mortgage bubble, there is no statistical relationship between the expansion of credit and the share of a country’s income going to it’s top 1 percent.
What does drive loose lending? Low interest rates and an expanding economy. When credit is cheap and times are good, people borrow. Simple.
At least, I disagree with the conclusion in the headline. The article’s argument that looser lending has more to do with GDP and interest rates than it does with inequality is probably correct. But the prolem that caused the recession wasn’t loose loans. The problem was stupid loans. And that’s where income inequality kicks in.
The problem wasn’t just that some people have more money and some people have less. The problem was that the investors making decisions regarding table funding, securitization, and all the other stuff I won’t bore you with were so far removed from the people actually recieving the loans that they had no idea whether the information they were relying on was sound. They were just trying to get money without asking where it came from.
If you had lived in or worked in some of the most vulnerable communities after 2000 or so, you knew there were problems. If you had talked to anybody who had talked to anybody who lived in the vulnerable communities you knew there were problems. The strip-mining of impoverished communities was chugging along as planned—but the equity had run out. The people who saw this first hand knew what was happening. But the finance people only saw the numbers.
Loose credit doesn’t inherently lead to collapse. Nor are complicated systems inherently prone to collapse. But when the guys at the top of the Jenga tower stop caring how things are going at the bottom, things topple. Social stratification caused the recession.