The Resolution Foundation organised a fantastic event this morning, the UK launch of House of Debt, with both authors (Mian and Sufi) on stage alongside Martin Wolf and Stephanie Flanders. Standing room only, and an astonishingly eminent audience, a Who’s Who of the economic world. Plus me.
But from their presentation (and implicit in the response from Wolf), the basic thesis Mian and Sufi promulgate is not new territory. It is familiar from Richard Koo, Hyman Minsky, and even Irving Fisher, and rests of the idea that the asymmetric quality of debt creates systemic risks in its very nature. Take any economy humming along fine, and if you add to it a bunch of debt contracts – half of the population with a obligation to repay the other half a fixed amount, come what may – then you will have a source of potentially huge instability. If the indebted half are relying on certain high asset values, and those asset values fall, they will devote their energies to paying down the debt rather than spending on stuff. If the lending half don’t have as high a propensity to spend, the overall effect is a drop in economy-wide spending.
They enhance the story considerably with lots of data, showing how economic distress maps onto initial levels of debt. So it looks like the causal factor. Debt is the culprit. Debt is damaging and dangerous.
I had quibbles with this deterministic tale. The macro authorities are curiously passive, watching helplessly as the underwater households drag the whole economy down. Flipping quickly through their book, it appears that Chapter 11 deals quickly with the inability or unwillingness of the fiscal or monetary authorities to do anything about the fall in spending. Central bank law, fears about public debt or wrongheaded attachment to their inflation-fighting credibility all . impede the authorities from acting to boost spending again.
This struck me as an extremely short and glib way of dismissing a giant topic. For a start, it seems clear that their pessimism rests strongly on the initial levels of rates/inflation; no one believes the central bank cannot act to boost spending if rates or NGDP growth were 10% going into the crisis. This makes me think that the story is really about central bank unwillingness or inability when near the zero lower bound –which shifts the debate entirely. An interesting observation they make is that financial crises makes the world of politics so fragmented and dysfunctional – hello, Tea Party, hey there, UKIP – that relying on the authorities is naive.
So having somehow accepted the premise that widespread adoption of debt in an economy is like chucking bits of dynamite all over the park during Bonfire Night, the discussion of the solutions entered similar realms of political unreality. I have not had the time to do justice to the book by reading it, so forgive me if these impressions are misleading. But the discussion focussed on: more contracts should be like equity, not debt; and in a crisis the authorities should sink capital in forcing debt writedowns.
But both of these are just as politically brave and unlikely as getting the central banks to do their jobs properly and keep spending on track. Using regulations to ban or restrict debt-like contracts because of their explosive nature in a crisis would be the biggest interference in capitalism since Mao suggested the peasants all smelt iron in the garden. If banks were forced to adopt shared-equity mortgages, what would guarantee the demand? What would prevent non-banks – or you or me – from offering vanilla debt instead? And as for the debt-writedown in a crisis solution, it sounds like the biggest taught example of moral hazard yet to be attempted.
And as might be expected, there were suggestions to ban bank money itself as one answer.
I doubt very much I have done the book justice, so may revisit this. But for the moment I think the case against debt is overstated. Debt levels in a badly managed economy can have a deep effect on the shape of a crash and recovery. But this is different from showing that the economy will always be badly managed, or that we are doomed by our past debts to a certain grim future.