Information and Financialization: Credit Markets as a New Source of Inequality

Abstract

Driven by financialization and rising demand for credit, household sector debt in OECD countries has risen sharply. We argue that this rise in private debt has become a significant driver of inequality because access to, and the terms of, credit vary by the risk of default, which is closely tied to income. The effect is magnified by a trove of new data that allow lenders to more accurately assess individual risks, thereby linking interest rates more closely to the underlying risk distribution. This inequalizing logic is conditioned by social transfers and by government regulation of financial markets. We test our model with data on mortgage interest rates and access to credit, using the government takeover of Fannie Mae and Freddie Mac (FM/FM) in the United States (resulting in regulatory change) and the Hartz-IV reform in Germany (resulting in changes to social transfers) as exogenous changes in important parameters of our model.