Did the Poor Cause the Crisis?
by Simon Johnson, Peterson Institute for International Economics
Op-ed in the Project Syndicate
January 19, 2011
© Project Syndicate
The United States continues to be riven by heated debate about the causes of the 2007–09 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 United States responsible for causing the most severe global crisis in more than a generation?
Not according to Daron Acemoglu of MIT (and a coauthor 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 website.)
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 toward 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 United States worsened in the late 1990s, leading politicians to respond by loosening the reins on lending to people who were "falling behind." Income in the United States 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 percent moved up sharply during the 1980s. Weekly earnings grew slowly for the bottom 50 percent and the bottom 10 percent at the time, but the lower end of the income distribution actually did relatively well in the second half of the 1990s. So no one was struggling more than they had been in the run-up to the subprime madness, which came in the early 2000s.
Using data from Thomas Piketty and Emmanuel Saez, Acemoglu also points out that the dynamics of the wage distribution for the top 1 percent 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 United States 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., 2004–05). 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 overregulating and overreaching. 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.