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Fault Lines
How Hidden Fractures Still Threaten The World Economy
In Fault Lines, author Raghuram Rajan unveils the global economy’s hidden fractures that led to the 2008 financial crisis. These blinks show that greedy bankers weren’t the only ones to blame; our economic system had deep systemic flaws as well. Importantly, they outline what we can do as a society to prevent similar crises in the future.
- Anyone who wants to understand the financial crisis of 2008
- Anyone curious how future economic crises could be prevented
- Anyone interested in global economics or international trade
One of the few experts to have seen the 2008 crash coming, Raghuram G. Rajan, formerly chief economist with the International Monetary Fund (IMF), is a professor of finance (on leave as of 2013) at the Graduate School of Business at the University of Chicago and the governor of the Reserve Bank of India.
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Fault Lines
How Hidden Fractures Still Threaten The World Economy
- Read in 16 minutes
- Contains 10 key ideas
Synopsis
In Fault Lines, author Raghuram Rajan unveils the global economy’s hidden fractures that led to the 2008 financial crisis. These blinks show that greedy bankers weren’t the only ones to blame; our economic system had deep systemic flaws as well. Importantly, they outline what we can do as a society to prevent similar crises in the future.
Key idea 1 of 10
The advent of cheap loans was one fault line of the crisis, and banks and politicians were complicit.
One of the most significant fault lines that led to the global financial crisis was growing income inequality in the United States.
In the years leading up to the crisis, the wage gap grew. While the average income of top earners increased, the average median income stayed nearly the same. For example, in 1997, the median household income was $51,704, yet by 2009, it had barely budged to $52,196.
Why the growing gap? Basically, the country’s workforce couldn’t meet the labor demands of the market. America needed more and more highly educated people to work in the growing technological sector, but schools weren’t producing enough qualified candidates.
This drove the top income level up while the median stagnated. It also explains why the income gap was strongly related to education level: In 2008, the median income of a high school graduate was $28 per hour, while the median for a college undergraduate was $48, some 72 percent more.
Every worker is a potential voter, of course; so U.S. politicians sought to do something about the problem. Seeing that their electorate needed more money, they encouraged cheap loans.
With the support of politicians, banks began expanding easy credit, especially to low-income households. This so-called subprime lending, which we'll look at more closely later became popular, while interest rates were lowered.
The immediate positive effects were straightforward: more spending meant more growth. Yet the growth was fueled by debt. People were essentially just postponing paying their bills.
And as you'll see in the following blinks, this American spending spree didn’t just affect the United States but also the rest of the world.
Key ideas in this title
- The advent of cheap loans was one fault line of the crisis, and banks and politicians were complicit.
- Exporting countries tried to shove their surpluses at the U.S., but the U.S. could only absorb so much.
- Low interest rates caused a boom in cheap mortgages, overheating the U.S. housing market.
- Subprime mortgages served the short-term needs of politicians and people, but did great damage.
- Financial models use past behavior to predict the future. Yet this time, we had no data at all.
- Rating agencies also miscalculated the risks of subprime mortgages, saying they were a safe bet.
- Financial incentives pushed all parties to grab all they could, without raising a red flag.
- Irresponsible risk-taking needs to be curbed in the financial sector to foster long-term stability.
- Better schooling, more reliable safety nets: Sustainable growth requires long-term solutions.
- Final summary