How Do You End a Balance Sheet Recession?

There is an op-ed at Bloomberg (hat tip: Bill McBride) from Amir Sufi and Atif Mian on what I think may be a very important study of theirs on the relationship between household debt and unemployment. Using county by county data they find a direct relationship between “household balance sheets” and unemployment:

The weakness in household balance sheets and the associated pullback in spending are directly responsible for the lion’s share of employment losses in the U.S. economy. This deficiency remains the most significant impediment to a robust recovery.

Our research suggests that 65 percent of the job losses from 2007 to 2009 came from the drop in household spending induced by the collapse in home prices and its effect on a highly levered household sector.


The declines in consumption are far too large to be explained by the drop in house prices alone. It was the combination of collapsing home values and high debt levels that proved disastrous. High-debt areas have been plagued with delinquencies, deleveraging, and the inability to refinance into lower rates — all characteristics of overleveraged households.

Further, low levels of consumption in high-debt areas continue to be a major drag. For instance, in the second quarter of 2011, auto sales in U.S. counties with the most debt remained a whopping 40 percent below their 2006 levels. By contrast, in areas that had healthy balance sheets before the recession began, the declines in spending were short-lived and a robust recovery is under way.

That would appear to provide more evidence for Richard Koo’s “balance sheet recession” hypothesis.

I think it’s pretty obvious that, if the problem is too much indebtedness, the solution is less indebtedness. A graph at something I linked to earlier today suggested an enormous distance yet to go. Tragically, the rate at which indebtedness is declining has actually slowed. Additionally, I can’t help but wonder if there’s a qualitative difference between a decline in indebtedness due to paying off a loan and a decline in indebtedness due to foreclosure. The preponderance of the decline seen so far has had the latter cause.

I remain skeptical that Keynesian pump-priming fiscal stimulus presents a solution and it appears that I’m not alone in that view, even among Keynesians. From David Rosenberg:

Canada’s fiscal progress didn’t happen because of the economy—that much is certain. It took years of painful retrenchment and tax increases, and it took public acquiescence to make it stick. For America, it will end up playing out much the same way. And the process will be contractionary, deflationary, and very bullish for the bond market as supply recedes, and ultimately pave the way for more sustainable economic growth, including the return of capitalism.

I don’t have a problem with first aid but it must be accompanied by treating the underlying problems or your efforts are futile. If the underlying problem is household debt, fiscal stimulus per se is no solution. I have heard very, very few proposals for reducing household debt. Presumably, the Powers That Be believe in the Think System. Think, men, think! That’s sure to do it.

8 comments… add one
  • PD Shaw Link

    When we look at household balance sheets and why they aren’t clearing, I think we have to consider the role of bankruptcy in giving debtors a fresh start. Looking at non-business bankruptcy filings for the last ten years:

    2001 1,452,030
    2002 1,539,111
    2003 1,625,208
    2004 1,563,145
    2005 2,039,214
    2006 597,965
    2007 822,590
    2008 1,074,225
    2009 1,412,838
    2010 1,536,799

    Once you take into account time-shifting as a result of the Bankruptcy Reform Act of 2005, these numbers appear very stable to me. With such a dramatic increase in household-debt to income ratios beginning in 2000 (from 1.4 to 2.2 in 2010), you would expect the bankruptcy to be much higher. The most likely answer is the legal changes in 2005 made bankruptcy less available or less attractive. The law has imposed a ceiling on bankruptcies so that the debts will not clear.

  • PD Shaw Link

    For those who like charts on quarterly bankruptcy filings through midpoint of 2011.

  • When you adjust it for the increase in population over the last ten years it’s even more striking.

  • Ben Wolf Link

    A large cut to payroll and income taxes for the middle class would accelerate the deleveraging process.

  • A large cut to payroll and income taxes for the middle class would accelerate the deleveraging process

    I guess it depends on what you mean by “the middle class”. If you define it as “the middle three income quintiles”, there’s not enough tax being paid by the lower two of the three to come up with a “large cut”. The fourth quintile has debt and is paying taxes but I’m not sure it’s enough to matter. Besides, targeting that closely would be tricky.

    Most of the debt is held by the top quintile, cf. here. Politically, it’s going to be pretty difficult to justify cutting their taxes. Tax cuts for the rich?

  • steve Link

    @PD- Excellent point. That same bankruptcy act also exempted some financial instruments from clawbacks. It also placed some of those same instruments ahead of others in priority for repayments. So, it has become much more difficult for the average guy to declare bankruptcy and start over. It made it much easier for financials to shift assets before declaring bankruptcy and to get their assets back out of a failing enterprise. Good deal if you knew you were highly leveraged and trading in risky assets.

    To the larger topic, I have been pretty pessimistic for a while now. I dont think anything other than time and/or a major technological breakthrough resolves the balance sheet issue.



  • PD Shaw Link

    @steve, I’m not familiar with the clawback provisions. The two main issues with the reform I can think of are:

    1. It increased the initial cost of filing by increasing the filing fee, any cost of credit counseling and legal costs (more paperwork, more lawyer liability eliminated general practioners from field) A quick google indicates a central Florida judge explained that the avg. legal cost to hire a bankruptcy attorney is $1,250 and $2,500 plus filing fees and other costs. This makes it difficult for people out of a job to afford bankruptcy.

    2. Means testing limits the ability of adequate bankruptcy protection for people above the state’s median income. I’m guessing a lot of homeowners are above a state’s median income and that lack of access to Chapter 7 liquidation and lack of income to pay off debts under a three to five year plan under Chapter 13 might mean there is no benefit to bankruptcy. You just wait until foreclosure.

  • Ben Wolf Link


    It won’t be much, your correct. But any reduction in taxes means that much more income available for deleveraging.

    This is where the non-ideological aspects of MMT shine: Cullen Roche on its conservative wing is pushing a massive tax cut for that very reason, while Bill Mitchell on the progressive wing wants stimulus and the Jobs Guarantee. Very different policies from people on different ends of the political spectrum, and both largely accomplish the same goal of getting rid of the debt and creating consumer demand.

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