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:
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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:
- Stultified political discourse
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.
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.