6 ideas
When income growth stalls for the middle and lower classes, politicians find it easier to expand access to credit than to fix the underlying earnings gap. In the US this took the form of affordable-housing mandates, Fannie Mae and Freddie Mac mandates, and FHA lending. These policies let stagnant incomes pass for rising consumption, and they channelled cheap mortgage money to the riskiest borrowers.
Technological change raised the premium on skills faster than the US education system could supply skilled workers, so wages diverged sharply between the well-educated and everyone else. The real fix is slow and hard: better schooling and training. That slowness is exactly why politicians reach for quick substitutes like easy credit.
Export-led economies such as Germany, Japan and China built growth models that suppressed domestic consumption and relied on foreign demand. Their surplus savings flowed into the US and financed its debt-fueled spending. This created a global imbalance in which American borrowing propped up world demand, so neither side had an incentive to adjust until the system broke.
Because the US has thin unemployment benefits and health coverage tied to jobs, jobless recoveries create intense political pressure to restore employment quickly. The Federal Reserve responds by holding interest rates very low for a long time. That fuels asset bubbles and risk-taking, turning a social-policy gap into a monetary-policy distortion.
Financial managers are paid on returns relative to peers, so they can manufacture apparent outperformance by taking hidden tail risks. These are bets that pay steadily in normal times and blow up rarely but catastrophically. When authorities are expected to bail out the system in a crisis, taking such risk becomes individually rational, and everyone crowds into the same fragile positions.
At the 2005 Jackson Hole conference honoring Alan Greenspan, Rajan presented a paper asking whether financial development had made the world riskier. He argued that compensation structures encouraged hidden tail risks and herding. Prominent attendees dismissed the argument as misguided and anti-innovation, which illustrates how consensus during a boom suppresses warnings about systemic fragility.