Some economists and observers have argued that the Great Recession was caused by income inequality, that is, by the great earnings gap between high and middle-low earners. Interesting, but that does not accurately address how homeowners calculate their homeowning capability. Homeowning capability is relevant to the explanation of the crisis, of course, because it was Americans' collective economic inability to sustain the increase in home prices that led to the collapse. Households evaluate their homeowning prospects, not in terms of the income of the moment they would buy, but in terms of long-term (i.e., decades) increase of their income (e.g., lifetime earnings, lifetime savings). First, prospective homeowners plan savings for down payments; then they plan their budgets to accomodate their new home. They assume, given fixed rate mortgages, when they buy the home, that the percentage of income demanded by P&I&taxes will be at the highest. The percentage will decline over the years, as their income rises. They also plan future savings in terms of the difference between increasing income and increasing home equity. In other words, behind home ownership is the social-economic escalator. Economists should, empirically, look first to a slowing of the social-economic escalator as the precipitant cause of the housing crisis (halt in rising demand and housing prices, then increasing foreclosures). What happened in the decades of the 1990s and 2000s that broke the expectation of prospective homeowners and new homeowners that they could calculate home ownership in traditional terms of lifetime income and savings on the escalator of social-economic mobility? Did mobility slow down? I think it did, in the sense that some sectors in American society benefitted from globalization of the economy and the prosperity of specific industries, such as computing, while many other sectors declined, such as manufacturing and garment-fabrication and the small businesses that served them. The number of persons employed in these declining sectors declined, and fewer persons could enter them, thereby removing whole sectors of the economy from social-ecnomic mobility these industries had traditionally offered.
Update. September 3, 2010. Joel Kotkin argues that in the last generation, upward mobility has diminished in the world's largest cities--LA, New York, London, and so on. (H/T Instapundit)