Testimony On “State of the American Dream: Economy Policy and the Future of the Middle Class”
I highlight the financial market risks faced by the U.S. middle class using the 2007-2009 financial crisis as an example. The 2007-09 financial crisis disproportionately affected the middle class due to three distinct channels. First, the wealth losses fell disproportionately on the middle and lower-middle class. Second, the foreclosure externality amplified these wealth losses further. Third, the aggregate demand externality stemming from the wealth shocks created a large increase in unemployment that also disproportionately affects the middle class.
I argue that the middle class and indeed the overall U.S. economy remain at risk due to a fundamental flaw in our financial system: the inability of standard debt contracts to adjust to a changing macro environment. I propose Shared Responsibility Mortgages (SRM) as an alternative. SRMs are built on two relatively minor adjustments to the standard 30-year fixed rate mortgage. I discuss how SRMs can be implemented and argue that SRMs would have prevented most of the negative effects of the 2007-09 housing collapse on the middle class and the U.S. economy.