Income Inequality is Caused by a Lack of Moral Hazard

It is becoming the consensus of opinion leaders that income inequality is becoming a major political issue. Mayor DeBlasio,  who ran on this issue in the recent New York City mayoral race, won by a 43% landslide.

There are various causes cited on both sides of the political aisles. Conservatives cite globalization and advancing technologies allowing corporations to either export jobs overseas or replace workers here with automation. Liberals favor a more progressive tax structure in order to redistribute wealth. Both sides cite numerous facts, figures and academic studies to support their view. And both are wrong.

The real cause of income inequality is what economists call “moral hazard.” Simply explained, it means that human beings will take significant financial risks if they are assured they will not suffer the consequences. For example, a blackjack player may be unwilling to take a $10,000 loan to gamble; however, the same individual would be perfectly willing to gamble away a $10,000 loan given the assurance that the loan did not have to be paid back.

Over the past generation, major financial interests have generously donated to both political parties so that they can speculate with impunity. Beginning in the 1980’s with the issuance of Brady Bonds to bail out banking interests who over-lent to Latin American countries, we have witnessed bailouts of major financial interests when they made bad bets on the following: commercial real estate, the Mexican Peso, the Russian ruble and the emerging Asian economies. This culminated in the bailout of Goldman Sachs, Citibank and JPMorgan when they over-lent to homeowners.

This damaged the middle class and decimated minority neighborhoods. In fact, over the past six years, African-Americans have seen their net worth decline over 75%, mostly due to the loss in housing equity. In the meantime, the stock market has more than doubled in value and real estate prices where investment bankers and hedge fund managers tend to congregate – lower Manhattan, New York and Connecticut suburbs along with elite playgrounds such as the Hamptons, Nantucket, Martha’s Vineyard and coastal California – have skyrocketed.

The Dodd-Frank bill essentially codified politically-connected financial institutions as “too big to fail,” meaning that the next bailout can proceed without the annoying process of having to ask Congress for the money. Even the ACA (Affordable Health Care Act also known as Obamacare) contains what are called “risk corridors” to assure insurance company solvency should healthy young people refuse to buy insurance and opt to pay the penalty.

Public policy should be aimed at breaking up large financial institutions while letting those who make bad bets suffer the consequences. Allowing major financial institutions to continue to speculate with taxpayer money will simply accelerate the problem, allowing more and more wealth to be accumulated in fewer and fewer hands and threatening the country’s political stability.