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Did the Poor Cause the Crisis?
WASHINGTON, DC "“ The United States continues to be riven by heated debate about the causes of the 2007-2009 financial crisis. Is government to blame for what went wrong, and, if so, in what sense?
In December, the Republican minority on the Financial Crisis Inquiry Commission (FCIC), weighed in with a preemptive dissenting narrative. According to this group, misguided government policies, aimed at increasing homeownership among relatively poor people, pushed too many into taking out subprime mortgages that they could not afford.
This narrative has the potential to gain a great deal of support, particularly in the Republican-controlled House of Representatives and in the run-up to the 2012 presidential election. But, while the FCIC Republicans write eloquently, do they have any evidence to back up their assertions? Are poor people in the US responsible for causing the most severe global crisis in more than a generation?
Not according to Daron Acemoglu of MIT (and a co-author of mine on other topics), who presented his findings at the American Finance Association's annual meeting in early January. (The slides are on his MIT Web site.)
Acemoglu breaks down the Republican narrative into three distinct questions. First, is there evidence that US politicians respond to lower-income voters' preferences or desires?
The evidence on this point is not as definitive as one might like, but what we have "“ for example, from the work of Princeton University's Larry Bartels "“ suggests that over the past 50 years, virtually the entire US political elite has stopped sharing the preferences of low- or middle-income voters. The views of office holders have moved much closer to those commonly found atop the income distribution.
There are various theories regarding why this shift occurred. In our book 13 Bankers, James Kwak and I emphasized a combination of the rising role of campaign contributions, the revolving door between Wall Street and Washington, and, most of all, an ideological shift towards the view that finance is good, more finance is better, and unfettered finance is best. There is a clear corollary: the voices and interests of relatively poor people count for little in American politics.
Acemoglu's assessment of recent research on lobbying is that parts of the private sector wanted financial rules to be relaxed "“ and worked hard and spent heavily to get this outcome. The impetus for a big subprime market came from within the private sector: "innovation" by giant mortgage lenders like Countrywide, Ameriquest, and many others, backed by the big investment banks. And, to be blunt, it was some of Wall Street's biggest players, not overleveraged homeowners, who received generous government bailouts in the aftermath of the crisis.
Acemoglu next asks whether there is evidence that the income distribution in the US worsened in the late 1990's, leading politicians to respond by loosening the reins on lending to people who were "falling behind"? Income in the US has, in fact, become much more unequal over the past 40 years, but the timing doesn't fit this story at all.
For example, from work that Acemoglu has done with David Autor (also at MIT), we know that incomes for the top 10% moved up sharply during the 1980's. Weekly earnings grew slowly for the bottom 50% and the bottom 10% at the time, but the lower end of the income distribution actually did relatively well in the second half of the 1990's. So no one was struggling more than they had been in the run-up to the subprime madness, which came in the early 2000's.
Using data from Thomas Piketty and Emmanuel Saez, Acemoglu also points out that the dynamics of the wage distribution for the top 1% of US income earners look different. As Thomas Philippon and Ariell Reshef have suggested, this group's sharp increase in earning power appears more related to deregulation of finance (and perhaps other sectors). In other words, the big winners from "financial innovation" of all kinds over the past three decades have not been the poor (or even the middle class), but the rich "“ people already highly paid.
Finally, Acemoglu examines the role of federal government support for housing. To be sure, the US has long provided subsidies to owner-occupied housing "“ mostly through the tax deduction for mortgage interest. But nothing about this subsidy explains the timing of the boom in housing and outlandish mortgage lending.
The FCIC Republicans point the finger firmly at Fannie Mae, Freddie Mac, and other government-sponsored enterprises that supported housing loans by providing guarantees of various kinds. They are right that Fannie and Freddie were "too big to fail," which enabled them to borrow more cheaply and take on more risk "“ with too little equity funding to back up their exposure.
But, while Fannie and Freddie jumped into dubious mortgages (particularly those known as Alt-A) and did some work with subprime lenders, this was relatively small stuff and late in the cycle (e.g., 2004-2005). The main impetus for the boom came from the entire machinery of "private label" securitization, which was just that: private. In fact, as Acemoglu points out, the powerful private-sector players consistently tried to marginalize Fannie and Freddie and exclude them from rapidly expanding market segments.
The FCIC Republicans are right to place the government at the center of what went wrong. But this was not a case of over-regulating and over-reaching. On the contrary, 30 years of financial deregulation, made possible by capturing the hearts and minds of regulators, and of politicians on both sides of the aisle, gave a narrow private-sector elite "“ mostly on Wall Street "“ almost all the upside of the housing boom.
The downside was shoved onto the rest of society, particularly the relatively uneducated and underpaid, who now have lost their houses, their jobs, their hopes for their children, or all of the above. These people did not cause the crisis. But they are paying for it.
Simon Johnson, a former chief economist of the IMF, is co-founder of a leading economics blog, http://BaselineScenario.com, a professor at MIT Sloan, and a senior fellow at the Peterson Institute for International Economics. His book, 13 Bankers, co-authored with James Kwak, is now available in paperback.
Copyright: Project Syndicate, 2011. www.project-syndicate.org For a podcast of this commentary in English, please use this link:http://media.blubrry.com/ps/media.libsyn.com/media/ps/johnson16.mp3
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Username Password New registration Forgotten password lukehlee 08:15 19 Jan 11What of course precipitated the financial crisis – i.e. the immediate cause -- was that we did not effectively regulate the creation of sub-prime financial products. Despite the potential risks of those products, financial institutions went ahead, as it was felt they contributed to increasing the level of consumer spending. We now know we were wrong. So, to our peril, we did not put a stop to what we now recognize as a dubious policy that exacerbated the situation. Finally, from the housing market bubble burst to the financial meltdown, the economy has now plummeted to a perilously catastrophic level.
What, then, is the real cause of the current economic and social crisis? The conventional answer is that it is the housing market bubble burst or the sub-prime mortgage system failures. That’s the simple answer. But what underlies those?
I believe we have made a serious mistake in the market or economy over the last 20 to 30 years, but we have not considered this at all in our ruminations about the economy. If we do not fix this mistake, I strongly believe that we cannot create enough jobs and also make sustainable economic growth. That is, this economic and social tailspin cannot be stopped. It could even develop into a far worse crisis.
I would strongly suggest you see this article about the mistake: "Breaking Down the Economic Death Spiral – and Saving the World Economy" http://t.co/8pMwQh7
AUTHOR INFO Simon Johnson Simon Johnson, a former chief economist of the IMF, is co-founder of a leading economics blog, http://BaselineScenario.com, a professor at MIT Sloan, and a senior fellow at the Peterson Institute for International Economics. His book, 13 Bankers, co-authored with James Kwak, is now available in paperback. MOST READ MOST RECOMMENDED MOST COMMENTED America's Political Class Struggle Jeffrey D. Sachs New Year's Hope against Hope Joseph E. Stiglitz Global Risk and Reward in 2011 Nouriel Roubini Why is Rape Different? Naomi Wolf The Fallen Heroes of the Financial Crisis Jean-Paul Fitoussi A New World Architecture George Soros No Time for a Trade War Joseph E. Stiglitz America's Political Class Struggle Jeffrey D. Sachs Avatar and Empire Naomi Wolf The Risky Rich Nouriel Roubini New Year's Hope against Hope Joseph E. Stiglitz Israel's Wrong Friends Ian Buruma Why is Rape Different? Naomi Wolf Demand or Supply? Raghuram Rajan Armageddon Can Wait Kenneth Rogoff ADVERTISEMENT PROJECT SYNDICATEProject Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
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What of course precipitated the financial crisis – i.e. the immediate cause -- was that we did not effectively regulate the creation of sub-prime financial products. Despite the potential risks of those products, financial institutions went ahead, as it was felt they contributed to increasing the level of consumer spending. We now know we were wrong. So, to our peril, we did not put a stop to what we now recognize as a dubious policy that exacerbated the situation. Finally, from the housing market bubble burst to the financial meltdown, the economy has now plummeted to a perilously catastrophic level.
What, then, is the real cause of the current economic and social crisis? The conventional answer is that it is the housing market bubble burst or the sub-prime mortgage system failures. That’s the simple answer. But what underlies those?
I believe we have made a serious mistake in the market or economy over the last 20 to 30 years, but we have not considered this at all in our ruminations about the economy. If we do not fix this mistake, I strongly believe that we cannot create enough jobs and also make sustainable economic growth. That is, this economic and social tailspin cannot be stopped. It could even develop into a far worse crisis.
I would strongly suggest you see this article about the mistake: "Breaking Down the Economic Death Spiral – and Saving the World Economy" http://t.co/8pMwQh7
Project Syndicate: the world's pre-eminent source of original op-ed commentaries. A unique collaboration of distinguished opinion makers from every corner of the globe, Project Syndicate provides incisive perspectives on our changing world by those who are shaping its politics, economics, science, and culture. Exclusive, trenchant, unparalleled in scope and depth: Project Syndicate is truly A World of Ideas.
Project Syndicate provides the world's foremost newspapers with exclusive commentaries by prominent leaders and opinion makers. It currently offers 54 monthly series and one weekly series of columns on topics ranging from economics to international affairs to science and philosophy.
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