Did income inequality help cause the financial crisis?

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Back in May, I did a Q&A with University of Chicago economist Raghu Rajan, who argues that income inequality contributed to the financial crisis. Over the weekend, the NYT dove into that topic, highlighting the work of Harvard Business School’s David Moss:

Mr. Moss said that income inequality might have complicated links to financial crises. For instance, inequality, by putting too much power in the hands of Wall Street titans, enables them to promote policies that benefit them — like deregulation — that could put the system in jeopardy. Inequality may also push people at the bottom of the ladder toward choices that put the financial system at risk, he said. And low-income homeowners could have better afforded their mortgages if not for the earnings gap.

I’m not sure that income inequality is the thing that puts too much power in the hands of Wall Street titans, but the idea that homebuyers inappropriately financed their homes is similar to what Rajan talks about.

The argument is that part of the reason we wound up with a ultra-low interest rates and lax lending and 0% down mortgages is because that’s the only way people could afford to buy things and not feel as if they were slipping behind.

In the NYT piece, Glenn Hubbard is presented as having a different point of view: that policymakers inappropriately tried to address income inequality by boosting homeownership when they should have instead been focused on education—the thing that ultimately leads to more desirable workers and higher wages.

I’m not sure that’s as different a perspective as it’s made out to be. I think Hubbard is just being explicit about how income inequality translates into easy credit. Policymakers are under pressure to make members of the middle class feel richer even though, relatively speaking, they aren’t. Helping consumers borrow more in order to finance their consumption is the simplest way to get there.

The alternative, Hubbard says, is to improve education. Although, as Rajan noted in our conversation earlier this year, “education” isn’t just about schooling. It’s also about the priorities and actions of families and communities. This is a country that often idealizes the jock before the nerd, one that has been known to interpret intelligence as putting on airs. Unfortunately, that doesn’t get you good jobs or high incomes in a globalized economy.

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