More on a Balance Sheet Recession

Kenneth Rogoff gives a different prescription for dealing with “balance sheet recessions”:

Many commentators have argued that fiscal stimulus has largely failed not because it was misguided, but because it was not large enough to fight a “Great Recession.” But, in a “Great Contraction,” problem number one is too much debt. If governments that retain strong credit ratings are to spend scarce resources effectively, the most effective approach is to catalyze debt workouts and reductions.

For example, governments could facilitate the write-down of mortgages in exchange for a share of any future home-price appreciation. An analogous approach can be done for countries. For example, rich countries’ voters in Europe could perhaps be persuaded to engage in a much larger bailout for Greece (one that is actually big enough to work), in exchange for higher payments in ten to fifteen years if Greek growth outperforms.

As I see it our key problem is that we’re mollycoddling the banks, just as the Japanese did. The big banks are insolvent. They were insolvent in 2008. They’re still insolvent. Propping them up just prolongs the agony.


I’m still trying to figure out what to do about a balance sheet recession. One of the ways I thought I’d approach it was by considering previous successful strategies other countries have used in dealing with their own balance sheet recessions. The only other example I could find was Japan (the country for which the term was coined) and 20 years later Japan is still going through its recession. Real GDP growth has never returned to the levels it experienced prior to 1992 and GDP growth in 1991, the last year of growth over 3%, was substantially lower than the average GDP growth over the preceding decade. I’m not finding this encouraging.

7 comments… add one
  • We all know about too big to fail banks that cause systemic risk in ways we still don’t fully understand. The FDIC currently is pricing that systemic risk in terms of insurance premiums to these large banks. The risk they are pricing is $0.

    This is nonsense on stilts. Raise the premiums sufficiently and you’ll both have enough money to cover the problems and a lot fewer banks who are interested in getting that big.

  • That’s more grist for my ongoing gripe about things being called insurance that aren’t insurance. For a plan to be insurance premium paid must be proportional to risk.

  • Drew Link

    “…the most effective approach is to catalyze debt workouts and reductions.”

    This of course is the standard model in private enterprise. Go through workout – negotiate extended maturities, decide who gets the haircuts, and, for senior claimants making concessions, award them (affectionately known as “cramming down”) the futures (the jr notes or equity).

    Dave I believe is correct. The banks are largely busted, or at least very impaired. But we didn’t use the standard model. GM?? The worst example of crony capitalism in my life. Yeah, they went through workout allright, and awarded the union (and campaign contributing) cronies of Obama a piece of the action even at the expense of those with the most hallowed and previously realiable position in the cap structure: a perfected first priority lien. Criminal. And people wonder why the money isn’t flowing……..

    So we need to do it, but we need to do it right.

    Japan –

    Japan has taken the Paul Krugman route. Repave every highway, redo every bridge in the country…….etc. If it doesn’t work? Double down. Doesn’t work again? Repeat. We see the folly there. And at least they had a saving society to finance it……for awhile.

    This recent “deal” is a travesty. Politicians, including our illustrious president, can’t look beyond the next election……and the little guy be damned.

    I know what I’m about to say will generate the usual flurry of arrows…….

    50 years of bad policy has no elegant solutions. But we have to unleash the private sector and quit “coddling” the subsidized and less productive sectors: government itself, finance, health care, education, etc. This generally bring howls of scorn about “killing demand” or being cruel to workers in those sectors, or wanting to slaughter grandma. No elegant solutions, people. A value judgment will have to be made: we need to migrate to a productive private sector employee – subject to the demands of the marketplace, for better or worse – or an employee of a subsidized sector. Its a value judgment I’m comfortable with on the merits, but when one considers that so many of those subsidized “workers” are simply being bribed for their votes………..I sleep very well at night.

  • steve Link

    “But we have to unleash the private sector”

    Is this code for lower tax rates for the wealthy?

    Targeting nominal growth, ala Sumner, is tempting, but not sure it is politically feasible as a deliberate strategy. In Rogoff’s book they note that it takes 5-10 years, on average, to work through these crises. I think it will mostly just take time to work off inventory. I am very skeptical that anything will make a large difference until those empty houses and office buildings are filled.


  • Icepick Link

    I would assume the proper paliative for a balance sheet recession is to “repair” the balance sheets – work off debts, haircuts, bankruptcies, etc.

    This whole post gives me pleasure, as I agree with pretty much everything in the post, and in the comments. Especially the first two comments, as that has been a gripe of mine as well. (That’s one my wife and friends have heard ad nauseum.)

    I think I will just turn off the machine now and bask in the warm glow….

  • Sam Link

    Is this code for lower tax rates for the wealthy?

    (emphasis mine)
    There’s no question this would help. If people like Drew would actually convince their congresspeople to adopt more efficient taxation that broadened the base and taxed consumption even if it meant more government revenue we’d be better off. Hating government and loving the private sector in the abstract is, surprise surprise, not leading to good, accountable government. When (small “c”) conservatives in other countries accept that government isn’t going away, they can focus on making it better.

  • Drew Link

    Is this code for lower tax rates for the wealthy?


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