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Did the Poor Cause the Crisis_ - Simon Johnson - Project Syndicate

Did the Poor Cause the Crisis_ - Simon Johnson - Project Syndicate

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THE HOPEFUL SCIENCE
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. Isgovernment 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 witha preemptive dissentingnarrative. 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 inthe run-up to the 2012 presidential election. But, while the FCIC Republicans write eloquently, do they have any evidence to back uptheir 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 FinanceAssociation’s annual meeting in early January. (The slides are onhis 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’ preferencesor 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 – suggeststhat 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 holdershave 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 Kwakand I emphasized a combination of the rising role of campaigncontributions, the revolving door between Wall Street and Washington, and, most of all, an ideological shift towards the view that finance is good, more finance isbetter, 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 toget 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 receivedgenerous 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 reinson 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 storyat 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. Weeklyearnings 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 lookdifferent. As Thomas Philippon and Ariell Reshef have suggested, this group’s sharp increase in earning power appears more related to deregulation of finance (andperhaps 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 themiddle 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 – mostlythrough 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 providingguarantees 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 – withtoo 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 smallstuff 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 rapidlyexpanding 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 thecontrary, 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 narrowprivate-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 fortheir 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 withJames Kwak  , is now available in paperback.
Copyright: Project Syndicate, 2011.www.project-syndicate.orgFor a podcast of this commentary in English, please use this link:http://media.blubrry.com/ps/media.libsyn.com/media/ps/johnson16.mp3You might also like to read more from
Simon Johnson
or return to
our home page
.Reprinting material from this website without written consent from Project Syndicate is a violation of international copyright law. To secure permission, please contactdistribution@project-syndicate.org.
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Did the Poor Cause the Crisis? - Simon Johnson- Project Syndicate http://www.project-syndicate.org/commentary/johnson16/Englis1 of 5 9/4/2011 11:14 P
 
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. Wenow 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 thehousing 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-primemortgage 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 aboutthe 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, thiseconomic 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 /8pMwQh7Brett 12:47 20 Jan 11The answer is yes and yes.Bad loans then dressed up as something different and on sold in a poorly regulated way. Mind you, it has all happened before; Tulips, South Seas, Tech.... Thistime is was property. You don't have to be a rocket scientist (well, I actually am one), to see the movement of money from the tech bubble to the create theproperty bubble. (I predict the Green Bubble next).The best answer to who, Poor People or Rich Market People causing the crisis, is, what headline or what marketing or what spin you want to put on the statistics.All will be right or wrong, or both at the same time.My money (ha ha, sorry for the pun) is on Bill Clinton wanting more poor people to own their own homes leading to NINJA loans. If this didn't happen, then theRichy Rich and his mates wouldn't have the chance to on sell the bad loans (as something else).LeroyDumonde 02:52 20 Jan 11I liken the poor (i.e. blacks and Hispanicshttp://capitalgainsandgames.com/blog/edmund-l-andrews/1773/sarah-palinization-financial-crisis)caused it meme tosomething similar that goes on with the drug war.It is commonly assumed (by both the left and the right) that so many blacks and Hispanics are in prison for drug offenses because they are the ones that do allthe drugs (the right blames this on black and Hispanic "family values" while the left blames it on the fact that they're poor).But the fact is it just doesn't add up. That is, blacks and Hispanics simply don't have enough money to be buying all those drugs. And I, having grown up in thesuburbs, can assure anyone that there's lots and lots of drugs being done by white people.This is just pure crystallized racism.By the way, for a really excellent cris de c
œ
ur against the drug war read Mike Gray's "Drug Crazy" and checkout his websitehttp://drugcrazy.com/index.htm.Bythe way, by the way I have absolutely nothing to do with Mike Gray or his publisher. I bought the book several years ago and just found it laid out the facts verywell (if in a slightly sensationalist style but then he is in showbiz).Cross posted at:http://economistsview.typepad.com/economistsview/2011/01/simon-johnson-the-poor-did-not-cause-the-crisis.html#comment-6a00d83451b33869e20148c7cb319f970celadamsil 04:24 20 Jan 11Please address the effect of the Community Reinvestment Act on subprime lending by both private lenders and the GSAs.dionramasami 12:00 21 Jan 11Thank you Mr Sachs for providing a very insightful look into American politics and economy. It sure does put things into perspective. We need more macroeconomists like you in this world. Your contribution to making the US and the rest of the world especially the developing world a better place for everyone ishighly appreciated.LeroyDumonde 07:52 21 Jan 11Uh-oh Simon dionramasami has mistaken you for Jeffrey Sachs. Oh well, Paul Krugman apparently gets mistaken for Tom Friedman(http://krugman.blogs.nytimes.com/2010/12/04/broadway-this-morning/). Which is absolutley absurd. He actually looks like an older, bearded Jim Dangle(http://community.nytimes.com/comments/krugman.blogs.nytimes.com/2010/12/04/broadway-this-morning/?permid=16#comment16).But at least you can be happy that you're in a higher class of mistaken identity.
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Did the Poor Cause the Crisis? - Simon Johnson- Project Syndicate http://www.project-syndicate.org/commentary/johnson16/Englis2 of 5 9/4/2011 11:14 P
 
EMichael 05:50 21 Jan 11But in stopping a fraud such as this in the future, the important thing is to understand the sectors most responsible, Investment banks and rating companies.Without them, the crisis does not happen.The thought that the GSEs were responsible is inane when you understand that in the largest housing boom in US history they LOST 40% of market share.http://cop.senate.gov/documents/testimony-102710-cecala.pdf The thought that government programs to increase homeowners(like the CRA) were responsible is ludicrous when you understand that the amount of CRA loansdecreased for the 10 years prior to the boom and right through the boom.http://www.jchs.harvard.edu/publications/governmentprograms/n08-2_park.pdf No question there was fraud in many sectors, but the investment banks and ratings companies led the way and committed the most fraud."Citicorp's key mortgage credit guy testified many months ago before the Financial Crisis Inquiry Commission (FCIC) that 80% of Citi's mortgages sold to Fannieand Freddie were sold under false "reps and warranties."http://neweconomicperspectives.blogspot.com/2011/01/economic-philosophy-that-has-completely.html" Wall Street's pooling and packaging loans didn't involve due diligence on the underlying quality of the loans. Since underwriting standards by mortgage lendershad dropped precipitously, many of these complex deals given top ratings went bust within months in 2007.That alone is evidence of the industry's falling standards. Prior to these problems, the mathematical chances of a default on a top investment grade rating wereless than 1 percent. What changed is that structured finance became popular _ the practice of pooling together loans and offering slices to investors at differentrisk levels....In another bit of explosive evidence, the panel on Friday will release an e-mail from a Standard & Poor's employee acknowledging complicity in building up adoomed market."Rating agencies continue to create an even bigger monster _ the CDO market. Let's hope we are all wealthy and retired by the time this house of cards falters,"the employee wrote on Dec. 15, 2006."http://www.mcclatchydc.com/201...And guess what?We are stuck with it. We cannot prosecute the thieves and fraudsters. Because they are too big to fail, and they would fail if we ever made clear the truth andprosecuted the bankers and raters.There is not a single major bank in the US(and Europe) who could survive being forced into taking back the fraudulent bonds they sold. And that will be true foranother decade or two.And one day the problem will be "fixed". All the forclosures will be done. All the losses taken by the investors will be taken. All the investors will settle forpennieson the dollar for the fraud the banks and rating companies committed. And everything will be back to normal.Unless they do it again....kentwillard 06:05 22 Jan 11No one gets the irony of the accusation that housing goals or CRA requirements caused the housing bubble. One simple fact is needed; during the peak bubbleyears most high risk mortgages (subprime, neg-am ARMs, Alt-A, and many jumbo primes) did not require income to be documented. Thus the borrowers' incomewas whatever they stated it to be, and it was often significantly above their actual income. Of course this overstatement of income created both higher housingdemand, and then higher defaults.What does overstating income do to Fannie & Freddie's goals for low-income and low-to-moderate income lending? It hurts it. I know because I used to work atFannie Mae. Fannie & Freddie probably actually did a lot more low income lending than they knew about or could prove. But they didn't guarantee those Alt-Aloans, (which had horrendous losses and are mostly responsible for their downfall) in order to hit housing goals. They guaranteed those loans because theythought they would increase profit and market share. And they were terribly wrong.And of course, most subprime mortgages weren't even originated through a bank, or guaranteed by Fannie & Freddie, so there was no CRA of HUD lending goal.Again, they were made because they were believed to be profitable. And for a while, they were. The mania of an asset bubble blinds many people.cheeheongquah 02:45 22 Jan 11IS not Wall Street protected by the government? So how can you vindicate governemnt as one major cause of the crisis? Remember also the Fed which was andis under pressure to comply with the goals set by Congress and the government.Quah, Chee-Heong joebhed 03:31 23 Jan 11Speech Governor Randall S. Kroszner , Board of Governors of the Federal Reserve System, Washington, D.C. December 3, 2008The Community Reinvestment Act and the Recent Mortgage CrisisEvidence on CRA and the Subprime CrisisOver the years, the Federal Reserve has prepared two reports for the Congress that provide information on the performance of lending to lower-incomeborrowers or neighborhoods--populations that are the focus of the CRA.3These studies found that lending to lower-income individuals and communities has beennearly as profitable and performed similarly to other types of lending done by CRA-covered institutions. Thus, the long-term evidence shows that the CRA has notpushed banks into extending loans that perform out of line with their traditional businesses. Rather, the law has encouraged banks to be aware of lendingopportunities in all segments of their local communities as well as to learn how to undertake such lending in a safe and sound manner.dhlii 04:45 24 Jan 11
Did the Poor Cause the Crisis? - Simon Johnson- Project Syndicate http://www.project-syndicate.org/commentary/johnson16/Englisof 5 9/4/2011 11:14 P

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