Did the Poor Cause the Crisis?

http://www.project-syndicate.org/commentary/johnson16/English

Did the Poor Cause the Crisis?
Simon Johnson

2011-01-19

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.

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