The Keeping-Up-With-the-Joneses Myth

Why did poor households take on so much new debt in the years leading up to the financial crisis?
Reuters

Behind the Great Recession, there was a credit crunch. Behind the credit crunch, there was a housing bust. And behind the housing bust, there was an explosion in debt in mid-2000s among low-income households.

So what was behind that?

One explanation begins with inequality. The idea is that the rich-poor gap leads to credit booms—as the poor try to close the gap with borrowed money— and this leads to defaults, financial busts, and recessions. This story would make the "keeping-up-with-the-Joneses principle" a key player in the great crash. It would also implicitly shift some of the blame to low-income people being, well, jealous and greedy for the lifestyle of their richer neighbors.

There are two problems with this story. First, there's no evidence that inequality actually leads to credit booms, in the first place. Second, a new paper finds that the parts of the country where poor families took on the most debt weren't the areas with the most inequality. They were the areas with the least inequality. 

To examine whether big rich-poor gaps turn poor people into big borrowers, researchers looked at local levels of income inequality and debt-accumulation. They found that poor households didn't borrow more in high-inequality areas. Instead, poor households borrowed more in poorer areas (i.e.: areas with less overall inequality). In short, it's the opposite of what the keeping-up-with-the-Joneses effect would predict. Poor households borrowed more when they had poor neighbors, not rich neighbors.

How come?

One possible answer is that banks operating in richer counties were more likely to reject loans to poorer families. "Lower-income mortgage applicants in high-inequality regions are rejected more frequently and pay higher mortgage rates than similar applicants in low-inequality regions," they write.

Another plausible answer is that predatory lenders were preying on poor families in poor areas. Gail Burks, president and CEO of Nevada Fair Housing Inc in Las Vegas, told the Financial Crisis Inquiry Commission that she had witnessed a "metamorphosis" in the lending industry that had given birth to "predatory lending practices such as flipping loans or misinforming seniors about reverse mortgages." From the report:

State officials from around the country joined together again in 2003 to investigate another fast-growing lender, California-based Ameriquest. It became the nation's largest subprime lender, originating $39 billion in subprime loans in 2003, mostly refinances that let borrowers take cash out of their homes, but with hefty fees that ate away at their equity. … [Fraudulent practices included]  inflating home appraisals; increasing the interest rates on borrowers loans or switching their loans from fixed to adjustable interest rates at closing; and promising borrowers that they could refinance their costly loans into loans with better terms in just a few months or a year, even when borrowers had no equity to absorb another refinance."

It's plausible that subprime lenders, seeking poor families they could dupe into an egregious deal, sought poor families where they knew they'd be: In poorer zip codes along the coast and sun belt. In this light, "Keeping up with the Jonses" didn't mean poor families trying to mimic their rich neighbors. It meant poor families mimicking the poor, duped family next door.

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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