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How income inequality caused the crash

Kevin Drum is as excited as Mike Konczal and I are that an economist is coming out with a book blaming income inequality for the financial crisis. In his recent (do read it) New Yorker piece on the death of the Chicago School, John Cassidy describes the heresy of U of Chicago prof Raghuram Rajan as revealed in Rajan’s upcoming book Fault Lines: “the initial causes of the breakdown were stagnant wages and rising inequality.”

Here’s my uncredentialed take on Rajan’s point, from the epilogue of Our Lot:

For the financially skilled and illiterate alike, taking on extreme debt became, in many instances, a rational act. At first the troops selling debt were greeted as liberators— because they sure looked like it. In the de cade that began with President Clinton’s second term, Americans, on the whole, were prosperous as they’ve never been before, making more money and buying more things, no small thanks to the larger economic force of the debt surge itself. At the boom’s peak, home equity loans alone pumped up the gross domestic product by more than 2 percent.

But in the real world, that new wealth was proving illusory. Just try to send kids to a competitive college on $54,000 a year, the income of the typical American family. See if you can find a good school district, career, and home in the same place (without a PhD or an MBA). And pray that you don’t have to deal with a serious illness, with or without health insurance.

Americans coped with increasingly extravagant but necessary expenses through trillions in borrowing against rising property values. In 2004, the nation’s homes were collectively worth $19 trillion, $12.5 trillion of which was home equity yet to be tapped. That year, homeowners took out another $1 trillion in home equity loans and credit lines, and spent most of the money to pay off other debts.

Why did so many borrow so much? There’s no one answer, of course, except perhaps an economic habit that has united a culturally disparate nation for generations. Second only to oil, the U.S. economy runs on anxiety—on the gambles of more than three hundred million people scrambling for security.

January 12th, 2010 | Tags: income inequality, Kevin Drum, Mike Konczal, Raghuram Rajan
Posted in A Lot More | 3 Comments »