That awkward time when income inequality did NOT cause GFC

In one of the most read posts on this site that I’ve ever written, I argued that everyone was too quick to blame the financial crisis on abstract “suits” in glass towers, when the people at the other end of the deal were just as much to blame. The post attracted some quite heated responses, this for instance:

Complete and utter BS. Even many people who work in the financial industry don’t believe this theory! Do you seriously think if all those excessive waitresses, etc. had “lived within their means” the financial crash wouldn’t have happened, and everything would be just fine? Really? You still believe this in 2011?! No serious economist would agree with the premise of your post. BTW, at no point in the New Yorker profile did it describe this man as living beyond his means as being the cause of his troubles, so you basically misread the entire point of the article.

Well, far be it from me to gloat but…

No, Democrats: Income Inequality Didn’t Cause the Financial Crisis – Jordan Weissmann – Business – The Atlantic.

There’s something intuitively compelling about the idea that America’s growing income inequality helped fuel the 2008 financial crisis. The narrative, which got an official stamp from Congress’ Democrat-led Joint Economic Committee back in 2010, goes something like this: As middle class wages stagnated, families borrowed more to prop up their standard of living. Banks, along with Fannie Mae and Freddie Mac, happily provided them with unaffordable mortgages, which they then skillfully repackaged and sold as securities. Eventually, the whole house of cards collapsed, plunging us into the Great Recession.

The story is downright elegant — a sort of grand, unified theory of our present economic woes. But according to a new study, it’s plain wrong.

The working paper, from Professors Christopher Meissner of the University of California, Davis and Michael Bordo of Rutgers, looks at whether there is a consistent historical relationship between rising income inequality and financial crises, using economic data on fourteen countries, including the United States, from between 1920 and 2008. It finds that although big financial busts tend to follow on the heels of credit booms like the mortgage bubble, there is no statistical relationship between the expansion of credit and the share of a country’s income going to it’s top 1 percent. 

What does drive loose lending? Low interest rates and an expanding economy. When credit is cheap and times are good, people borrow. Simple.

That would be serious economists  concluding that the GFC came as a result of overconfidence due to the ongoing boom. It even came with the kind of graph that I like: not wasting much space but showing a lot of data (in this case, two time series showing no significant correlation).
What does this actually show? That making it easier to get credit does not necessarily make the top 1% richer and conversely, when the top 1% get richer, it is not necessarily easier to get credit. There is no real relationship between income inequality and ease of credit.
So as I said before, the reason the GFC happened is that people were careless and took out loans that they could never conceivably pay back. A loan agreement is between two people, it is not just something fabricated by a bank.

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