Income Inequality

By Demyanyk, Yuliya | Regional Economist, October 2006 | Go to article overview

Income Inequality


Demyanyk, Yuliya, Regional Economist


Time for Predatory Lending Laws?

Income inequality, the gap between the rich and the poor, seems to indicate a higher probability of a predatory lending law being adopted. States that recently adopted predatory lending laws had higher than average levels of income inequality over the past 10 years than their nonadopting counterparts.

Predatory lending-an illegal activity by lenders or brokers leading to a further decrease of well-being of relatively poor individuals-could generate greater inequality between individuals in the U.S. economy. Predatory lending laws, the laws aimed at reducing fraudulent lending activity, may do the most good in reducing inequality in states where inequality is larger.

Between 1999 and last year, 24 states plus the District of Columbia adopted laws to combat predatory lending. The law in each state is designed to restrict origination of specific types of loans-mostly mortgages- and/or to require lenders to disclose details about those loans to state regulators.

Predatory lending, even though it lacks an exact definition, is most often associated with lending to relatively poor borrowers, to those who are uneducated about the lending process and to those whose credit scores are low. Borrowers with incomes and/or credit scores below a certain threshold are usually not able to obtain credit unless they pay higher prices for their loans. Such loans are called subprime or high-cost loans. Not all high-cost loans are predatory, though.

Lending is considered predatory, or fraudulent, when lenders or brokers:

* take advantage of borrowers by charging very high fees that are not justified by a risk factor;

* issue loans knowing they can never be repaid or would almost certainly lead to home losses and complete bankruptcy; or

* change the terms of a loan at closing, thus knowingly misleading borrowers.1

The relatively weak are both the easiest prey for predatory lenders and those most likely to suffer the greatest economic losses. If predatory lending-which tends to hurt poor people disproportionately more than those who are better off-is populated in an economy, then inequality may increase.

Income Inequality

Income inequality in the United States is greater than in any other developed country. Moreover, it has been increasing during the past 25 years.2 Whatever the actual level of an individual's income, a person might be discouraged and unhappy if he or she is relatively poorer than many other people in society. Therefore, rising income inequality might be considered harmful to society not only because it represents a disparity between people, but also, as some research shows, because it can cause slower economic growth, an increase in crime, worse overall well-being, poor educational outcomes and even higher death rates, the same way a higher level of poverty (absolute, not relative) would.3

Besides predatory lending, there are a number of possible factors that can be responsible for inequality in a society. Differences in education and abilities create wage differentials leading to income differences; race, gender and cultural differences can give rise to discrimination in the labor market. Also, income inequality can rise if wealth circulates only among those who have the means to invest and to increase already existing wealth.

Several country-wide economic factors may affect inequality as well. For example, some research studies show that faster economic growth and greater economic development in an economy would benefit the rich and the poor equally. Because the "boats" of both would rise the same, however, the level of inequality would remain the same.4

Other studies show that countries with better-developed financial intermediaries experience faster declines in both inequality and poverty.5 However, financial development that offers greater credit availability to previously left-out borrowers (those with lower credit scores and incomes) can also open the door for more fraudulent lending. …

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