Fault Lines And Its Role In The 2008 Financial Crisis

In my essay I will explore the ‘fault lines’ described by Dr Raghuram Rajan in his 2010 book Fault Lines and the extent of its role in the 2008 financial crisis. I will focus my debate on the income inequality of the United States and how the governments push for easy credit had catastrophic consequences on the financial state of the economy in the years after it’s implementation. I will look at the policies errors and factors that played roles in worsening the crises as well as looking at alternative methods that political powers could have pursued to have avoided this financial disaster.

Firstly, wages in the US and in many developed economies have become frequently less equally distributed amongst the population. This has stemmed greatly

As statistics such as above, of the wealthy getting richer and the poor staying poor, became public knowledge the majority public wanted something done about it. The government should have therefore enacted a plan of longterm educational improvements to increase the number of well skilled workers to compete down wage rates among the highly skilled positions and move a greater majority of workers into higher wage brackets and therefore narrow the gap between the rich and poor. The Bush administration however had an alternative policy in which they took something that every American aspired to having, and made it attainable. They did this by making home ownership affordable for the masses through pushing lenders to offer low interest mortgages to low income households. This however, as warned by many economists including R. Rajan (2010), was only a cheaper short term fix for the problem in making the poor feel momentarily richer. The government carried through these plans to win over the electorate and made it possible for low income families to buy low interest mortgages with as little as no downpayment necessary. The risk was deemed acceptable at the time because if the home owner defaulted, the bank would repossess the house — which had been rising in value for years — and sell it back to the market to recover its losses. This worked for years as families

This was noticed by other investment banks and hedge funds who wanted in on the action and so mortgages were bundled together and traded to these new investors. These bundles of varying risk mortgages meant that the investor would receive the mortgage payments from thousands of home owners every month. They demanded more collateralised debt obligations and this is when evermore risky mortgages were created. In a bid to find new mortgagors, banks started offering loans with no down payment or even proof of income necessary. This was deemed acceptable in the eyes of many bankers, as long as they could sell on that collateralised debt obligation before homeowners defaulted — that’s exactly what happened though. Home owners defaulted on their mortgages and the bank would repossess the house. As this became more and more frequent banks found themselves with a countless number of houses to sell in the market, but no one wanted to buy anymore. Houses flooded the market and forced prices down at a huge rate. House prices fell by up to 50% and 60% in Miami and Las Vegas respectively (Krugman, 2012: 112), home owners still paying their $150,000 mortgage found their house was now only worth $60,000 and walked away from the house and mortgage too. All of the traded mortgages now were worth a fraction of what