I’ve had quite a journey this morning. Starting with Arnold Kling, continuing with Lawrence Summers, and with stops at Mian and Sufi’s book and Vernon Smith’s paper, I’ve revisited the “balance sheet” hypothesis of the late recession. From Dr. Summers’s Financial Times op-ed here’s the kernel of it:
High quality global journalism requires investment. Please share this article with others using the link below, do not cut & paste the article. See our Ts&Cs and Copyright Policy for more detail. Email ftsales.support@ft.com to buy additional rights. http://www.ft.com/cms/s/2/3ec604c0-ec96-11e3-8963-00144feabdc0.html#ixzz343gemEWV
Mian and Sufi point out a variety of problems with this approach. First, they note that data on credit spreads suggest that the financial system was fully repaired by late 2009, and that even though the economy at that point was very depressed, growth has been anaemic since. Second, they observe that spending on housing and durable goods such as furniture and cars decreased sharply in 2006 and 2007, well before any financial institution became vulnerable. Likewise, they note that the initial impetus behind recession in the US appears to have been a decline in consumer spending. Additionally, the authors observe that when asked why they were not borrowing more, even small businesses, the sector most dependent on banks, more often than not blamed a lack of customers rather than banks’ unwillingness to lend.
None of this sits easily with what Mian and Sufi call the banking view of the Great Recession. They argue that, rather than failing banks, the key culprits in the financial crisis were overly indebted households. Resurrecting arguments that go back at least to Irving Fisher and that were emphasised by Richard Koo in considering Japan’s stagnation, Mian and Sufi highlight how harsh leverage and debt can be – for example, when the price of a house purchased with a 10 per cent downpayment goes down by 10 per cent, all of the owner’s equity is lost. They demonstrate powerfully that spending fell much more in parts of the country where house prices fell fastest and where the most mortgage debt was attached to homes. So their story of the crisis blames excessive mortgage lending, which first inflated bubbles in the housing market and then left households with unmanageable debt burdens. These burdens in turn led to spending reductions and created an adverse economic and financial spiral that ultimately led financial institutions to the brink.
Policy measures were largely targeted at a) bolstering the banks and b) ordinary pseudo-Keynesian pump-priming. If we truly experience a recession because of excessive household debt, neither of those really address the problem and our subsequent experience, continued low employment, is to be expected. Why weren’t other solutions tried? Dr. Summers’s view is that solutions targeted at solving the problem of excessive household debt were politically impossible.
Why? If, as I believe, not a single incumbent would have lost his or her seat running on a platform of mortgage reduction, what rendered such a strategy politically impossible? I’ll offer a few potential explanations:
- Malice
- Donors
- Stultified political discourse
1. Malice
Consistent with the prevailing Western thought of the last several millennia, from Plato to Paul of Tarsus to Thomas Aquinas to Kant, I reject this idea.
2. Donors
If the objective of our elected officials rather than doing the will of the people or serving the good of the people has become retaining office and as a means to that end amassing a huge “war chest” to ward off serious political competitors, we should hardly be surprised at the vigor with which those official curry favor with the financial sector. I note, too, that neither political party has any particular aversion to the financial sector and companies and individuals in the financial sector, the primary beneficiaries of the vast increase in wealth among the very richest over the period of the last forty years, gives to both parties with fairly even hands.
3. Stultified political discourse
This is my preferred explanation. The policy preferences and arguments between the two major political parties settled into their present form twenty or thirty years ago and no dissenting view has penetrated either party since. This would be hardly surprising considering the length in office of present incumbents.
Consider Illinois. The senior Senator from Illinois, Dick Durbin, has served as senator since 1997 and prior to that served in the U. S. House of Representatives since 1983. The junior senator from Illinois, Mark Kirk, has served since 2010 and prior to that served in the House since 2001. Long tenure in office is the norm in Washington rather than the exception. In the Illinois House delegation Bobby Rush, Luis Gutierrez, Danny Davis, and Jan Schakowsky have all had long tenures in office (15-20) years and most of Illinois’s present delegation succeeded someone who served a long tenure in office. Not exactly fertile ground for new and exciting ideas.
That’s unlikely to change. Most of Illinois’s incumbents don’t face serious opposition.
Dealing with a few banks was easier than dealing with the population at large, and I don’t think you could ignore the banks anyway. A position had to be taken about what the government would do or not do with the crumbling financial sector. The government took the “low risk,” but “low results” option.
Had the Administration got behind a different economic plan, it would have passed Congress. That’s simply the nature of partisanship.
Summers seems to be arguing against some sort of involuntary cram-down on the mortgages that would have hurt the banks. The better bottom-up approach would have been to help the borrowers first, by paying off the extent of their underwater indebteness, which would have helped the banks as well. The political problem could have been dealt with by dropping the payroll tax. (I see the political problem as bailing out the upper-middle class owners of McMansions, but I don’t think it was that serious of a problem — Congress loves this group)
IIRC that’s what I argued for at the time. I could search around but I’m pretty sure that’s the position I took.
I don’t see how one could make a moral hazard argument against that with a straight face while bailing out banks.
BTW, that was another politically impossible alternative: bailing out the banks without bailing out the bankers.
That’s something else that I pointed out at the time: the overwhelming preponderance of the household debt is held by the top quintile of income earners.
But that’s just what would have happened. People don’t know quite how to apply a moral standard to CitiBank or Wells Fargo, they do know how to apply it to their brother-in-law who bought way more house than he could afford and is now taking a justified beating.
The argument would have been that we are helping the reckless and irresponsible at the expense of the industrious and responsible.
It might have worked, but might not have, and we don’t allow for experimentation – just look at the absurd reactions to Mr. Obama’s “Singles. . . doubles. . .” remark. We as a people lack the maturity for that. Our politicians must know exactly what to do and exactly how to do it and anything else is a sign of weakness and incompetence. Americans would rather have a swaggering imbecile who is 100% convinced of his own rightness, than anything that smacks of experimentation with all its attendant doubt.
As for no politician losing his job for proposing that the hard-working taxpayer bail out his spendthrift neighbor, I think you’ve got that wrong. You seem to believe people are rational. You persist in this generous world view despite the fact that the Congressional GOP has voted 50 times to symbolically repeal a program based on the success of their most recent presidential candidate.
In any event, it’s all speculative. It would have had very little chance of passing.
The problem is largely in the financial sectors they have little or no understanding about. The problem that Richard Koo describes about Japan is the tip of the iceberg.
The private banking system and the public banking system are intertwined due to the repeal of Glass-Steagall. If this is nothing more than the ravings of a madman, you will never understand what happened, and you will be shocked when it happens again.
The hole that needed to be filled was not a few trillion dollars. It was tens of trillions of dollars, and the vast majority of this money would go to the very people that the Democrats whine about.
I don’t see how your DINORS point doesn’t mesh with malice. At some point bailing out those rich enough to buy politicians while throwing a couple of fig leaves at everyone else becomes morally reprehensible, and totally obvious to all involved.l at the policy-making level. Especially when the ‘bankers’ got saved along with the ‘banks’.
Examples: CDOs (from AIG in particular) did not of necessity need to be paid out at one hundred cents on the dollar. That decision was made to help, both directly and indirectly, the richest people in the country at the expense of everyone else.
QE Lazy Eight (along with the first two iterations) has been a massive pump inflating the assets of the richest. Others have been helped, but even there it’s mostly people well off to begin with. And all with a massive debt that can do nothing to help the poor.
In the meantime, the people who lost jobs, or the young coming up, have been encouraged to take on massive (for them) levels of nondischarable debt with little or no prospect of getting jobs to pay off that debt.
Taking it all in, the policy choices chosen, on a bipartisan basis, have been to enrich the rich and enslave the poor thru debt.
That is pure malice.
A thing that could have been done: underwater mortgage relief.
A thing that could be done today: make student loan debt dischargable.
Neither would or will be done, because these things would help the middle and the bottom, and cut down on the number of islands and yachts that the Elisons and Soroses of the world could buy.
I’d cast a vote for malice. Maybe you roam about nicer areas of the internet than I do, but I keep encountering libertarians and conservatives who really do feel that people in financial problems WITHOUT EXCEPTION are cheats, liars, morons, and other losers who absolutely deserve whatever problems they’re in, and that not one penny of tax money should be wasted on them. “Waste” as defined meaning Medicaid, Extended Unemployment, Disability, Food Stamps, and (often) Social Security.
You might want to take a look at some of Arnold Kling’s columns where he gets going on the woes of a future in which 90 per cent of the is out of work because their “preference” for government subsidies. (You want to tell me “preference” is the correct technical term for choice and economists use it all the time? I have a bridge you might want to buy.)
I based my calculation on the very large percentage of mortgages that were underwater. In 2009 it was 25%. That doesn’t sound like much but it translates into a very large proportion of those who’ve bought their homes over the last 15 years. A lot more than “spendthrift neighbors”.
I don’t believe you understand how Congressmen think. We elect members of the House district by district, not at large. For Congressmen the issue is how something plays in their district not nationally.
The reason they keep doing this over and over is that, given the intractable opposition in the Senate, it’s a repercussion-free way of making a statement of position which plays well in their home districts.
In other words, it doesn’t cost them anything and bolsters their positions within their districts. What’s not to like?
The policies we followed were bipartisan positions enthusiastically supported by both Republicans and Democrats and certainly not limited to “libertarians and conservatives”.
I don’t see it. Those underwater would be cast as greedy and reckless. The forces opposed to relief would have gone to work on the usual fault lines – race, age, region. We’d have heard no end of how it’s all the fault of Californians and Floridians who foolishly thought they’d get rich off speculation. Senators from flyover country would have fought it.
This should be do-able, but probably isn’t, given the current state of our Congress. Maybe if the GOP takes the Senate they’ll rush off to deal with immigration, tax reform and student loan debt, but I doubt it. The institution is completely dysfunctional. They don’t do anything. They haven’t done anything for a very long time. For once the Roman analogies are on-point.
The Republicans won’t do anything about making student loans dischargable because they like debt slaves. The Dems won’t because they LOVE LOVE LOVE debt slaves. The current situation is in large measure the work of Joe Biden. That lets you know who’s side the Dems are on, what they want and how they mean to get it.
So that’s 75% opposed. Plus the half of the 25% who were in denial. I’m being rather facile there, but bear in mind that the GOP is doing all it can to keep the 90% or so of Ohio women of reproductive age who use birth control from getting birth control. The Congress stops the overwhelming majority of people who want gun control from getting gun control. If Congress did what voters want, we’d have a very different country on all sorts of fronts.
Not to sound like Ice, but Congress does what money wants, and only secondarily what people want. The money didn’t want mortgage relief and the people would have been easily manipulated. Here’s what you’d hear on Fox News 24/7: “So some retiree who saved his money and invested cautiously now has to pay for some California yuppie who thought he’d get rich flipping houses? Or some inner city hustler who used federal guarantees to get in over his head and now wants still more welfare?”
And the line on MSNBC would be, “This will disproportionately help the rich – people in gated estates who made million dollar bets. At very least this program should be means-tested.”
Fox would play the race and age and regional cards, MSNBC would go class warfare, the banks would form a PAC and run attack ads, the whole thing would be portrayed as socialism on the one side and welfere-for-the-rich on the other side.
We have never had a debt jubilee. Go back and watch the Santelli screed which probably had something to do with the start of the Tea Party. They werent mad about banks being bailed out, they were pissed because some individual homeowners MIGHT be bailed out, which really didnt happen. Bailing out the bankers to avoid another Depression was (sort of) acceptable. All of those homeowners were liars, lazy, cheaters or minorities. Pick one. (Heaven knows I hate ot get Michael going, but the CRA was prime culprit on the right even when it affected only about 6% of mortgages.)
Still, this is beyond politics and is now cultural. Read Graeber. (I know. A very inconsistent book, but the history is important.) There is a broad swing of the pendulum going on in our culture about how we treat debt. The tendency over the last 50-70 years has been to favor creditors well over debtors. By culture, we now accept and believe that if someone cannot pay their debts, they alone are responsible. They must have made bad choices. They must accept the consequences. Creditors are, for the most part, being held blameless. This is an old problem.
Steve
“The issue which has swept down the centuries and which will have to be fought sooner or later is the people versus the banks. ”
Lord Acton
You’re assuming that anybody who doesn’t have a direct stake is opposed. I think that’s almost certainly wrong and that you’re ignoring the network effects. If it required a majority of sick people to be concerned about a disease, there’s a lot of diseases that would have been ignored that are getting serious attention.
For example, the lifetime risk that you’ll die of cancer is about 25% and your lifetime risk of developing cancer whether you die from it or not is around 40%. Somehow we’ve been able to sustain a “war on cancer” for the last forty years. My explanation of that: network effects.
Don’t worry, Reynolds, you don’t sound like me because you support the policies the government has implemented completely, and I am opposed to most of what was done.
No need to bail out only certain groupings like people underwater. Congress could have mandated an account at the Fed for every American over the age of 22 (which would not have been difficult to achieve logistically) and deposited $50,000 into each with the requirement that the money be used to repay creditors first. Anything left over was theirs to keep.
Banks would have fought it tooth and nail due to:
1)loss of interest paymenta
2) Net financial assets injected into households. Banks hate government spending because those dollars lessen the need for households to take out loans. Precisely why they advocate austerity measures; removing fiscal policy leaves debt the only way our economy can expand and gives banks tremendous political leverage.
Everyone thinks they may get cancer. Most don’t think they’ll try to buy a million dollar home on a 100k income.
Predatory Lending
Only in the Godfather movie will either your brains or your signature be on the contract. Banks can’t force people to obtain credit, and there is a reason under age people cannot bind themselves to a contract.
Risk was transferred from borrowers to lenders as down payments decreased and loan to value increased. Credit 101.
The primary cause of defaults wasn’t an increase in rates – the so-called “liar loans” that know-nothings cite – but rather loan to value breaches.
Defaulters put their loans to banks and went off and took advantage of lower rents. Banks are getting killed on each foreclosed mortgage.
Fraudulent Syndication
40-45% of all mortgages were actually held on lenders balance sheets.
Syndicated loans were securitized into risky to AAA cash flow tranches. The ratings agencies weren’t asleep at the wheel, AAA tranches got rated, well, AAA, with 20-30% overcollateralization. The equity or near equity tranches were not rated AAA, the institutional investors knew very well the risk they were buying and oh by the way, they effectively provided the down payments for those poor, poor sub-prime borrowers.
(A more sophisticated view would delve into relative risks – or ratings drift -, but sophisticated commenters on this subject are in short supply here.)
Who was the single largest buyer of subprime mortgages? The US government through its subsidy of Fannie and Freddie. Better to blame banks than the government, eh?? Same as it ever was……
Its fascinating to see the invective and proposals in this thread about just putting student loan debt – a form of debt just like mortgages championed by government and their friends in academia – without considering what it will do to the price of student loans down the road. Ever wonder why mortgages can be had for a mere 4%, credit cards for 8-9%, or 16% if you default, 20% for “payday loans” and, well, let’s not talk about the price charged by loan sharks, especially if you don’t pay on time. Then we are back to the Godfather.
Banks can’t force people to obtain credit, and there is a reason under age people cannot bind themselves to a contract.
A predatory loan doesn’t mean forcing anyone to accept, it means tricking an ignorant person into a loan the originator knows they’ll never pay back. Of course the banks are getting killed; the job of the firm these days is to take the heat while the firm’s employees walk away with large bonuses as they defraud the firm itself. “I’ll Be Gone, You’ll Be Gone” wasn’t some water-cooler joke it was a way of life.
Adam Levitin has a response to Summer’s review:
In any case, the Administration had no understanding of the bankruptcy system. This was one of my great frustrations in 2008-2009. The Administration was staffed with economists and the occasional non-bankruptcy lawyer, none of whom had the foggiest notion of how consumer bankruptcy works, but a tremendous fear of the process. Nor did any of these folks seem to want to get educated at the time. I nearly fell off my feet when in I got a call in February 2010–after the failure of cramdown–from a respected economist who was workign as at the NEC with questions about the basic mechanics of Chapter 13. I couldn’t believe that there wasn’t a memo on hand, etc. covering the issue.
http://www.creditslips.org/creditslips/2014/06/summers-and-cramdown.html
Everyone thinks they may get cancer. Most don’t think they’ll try to buy a million dollar home on a 100k income.
I think the network effect that most people did understand was the downward pull on home prices. There were huge number of people who weren’t in million dollar homes, but were becoming upside down in their mortgages because their home’s value was plummeting. And even those that weren’t in danger of going below zero equity saw their greatest asset losing value.
I agree that there would have been plenty of opportunistic, ginned up opposition, but on something this important the political capital should have been spent. Don’t forget that Barack Obama enjoyed a tremendous amount of it at that time, and the audience I described would have been receptive to a PR pitch for some combination of debt relief and/or cram down.
CS:
At the time I would not have supported it, and I’m a Democrat, a liberal and an Obama supporter.
Wasn’t happening.
Ben
Your posts at June 8 5:06 and June 9 4:28 are two of the most stupid and ridiculous things I’ve ever read here. And that’s saying a lot. Do you understand loan economics in the least?