Restructuring Private Debt May Be Better Option than Austerity or More Stimulus
by Steve Clemons and Richard Vague
In the Spring of 2011, the Obama administration started to rev up a campaign called "The Summer of Recovery" and planned to deploy the President, VP Joe Biden, and the economically connected Cabinet members and advisers to go to all parts of the country, particularly battleground states, and convince Americans that things were getting better, that jobs were being created, and that the vector of the nation was pointing in a great direction.
The Summer of Recovery became a Summer of Anxiety as the jobs machine sputtered and as other parts of the global economy slowed reducing demand for American exports. Voices like Paul Krugman and former Labor Secretary Robert Reich lambasted the White House for not having been Keynesian enough and not opening the government spending spigots to more deeply invest in U.S. infrastructure, shore up deteriorating state balance sheets, and keep more Americans employed and in their homes that were still being foreclosed at record rates.
But Republicans, who under George W. Bush's leadership hatched the conditions of inattentive and lax regulatory attention that contributed significantly to the Great Recession of 2008-2009, decided to convince Americans that the nation's economic malaise was a product of Obama's massive government post-crisis spending. In a dangerous game of government debt limit brinksmanship, House Speaker John Boehner and his Tea Party-fearing Republican caucus took the nation to the brink of default.
Even though the crisis that had unfolded had been a function of behavior in private debt markets, the debate about what to do next has focused entirely on what level of debt the government should deploy or cut back.
The debt-hawks and uber-Keynesians may both be well meaning in their desire to steady the U.S. economic ship and relaunch it towards growth -- but they are distracted by ideology and conventional economic thinking from looking at more compelling causes of major economic crises and more efficacious policy responses.
It's private debt that matters most.
There is about $24 trillion in consumer and business debt held in the United States today and this dwarfs the federal debt, money supply, and the nation's GDP.
In a short report (pdf) we are releasing today that explores the behavior of private debt before and after economic crises -- not only in the U.S., but in Japan as well as a number of European nations -- we have noted that (1) a fast run-up of private debt combined with (2) a level of private debt more than 150% of GDP were evident in both the Great Recession of 2008-2009 as well as in America's Great Depression.
Federal debt was inconsequential to these crises. Charts in the report (pdf) we are posting today make clear that Spain, economically beleaguered today, was in excellent federal balance sheet health before the recent Eurozone financial quakes started.
So as a predictor of future crises, we suggest that private debt growth rates combined with the absolute level of non-government, private debt are the two most important factors to flag.
Once a private debt-triggered crisis starts, attention turns typically to the government and whether it will reform through austerity programs and conditioned loans or whether the government will inject capital resources of its own to keep the economy primed and liquid.
What is interesting about the recent Great Recession and the American case is that while many economic pundits speak about post-crisis deleveraging, the private debt total only declined by 3% in the U.S. and is now increasing again, essentially reaching today the pre-crisis level of private debt.
That's right. The private debt load in the U.S. today is roughly the same as the private debt load held in early 2008. This is of enormous consequence as consumers and businesses that are overburdened with debt cannot lead an economy to higher growth. Government spending can provide some stimulus, but our analysis shows that this stimulus is significantly less efficient in stimulating GDP growth than re-jiggering and triggering private spending. And while private debt typically matters more than government debt, a total debt load for an economy does matter. Ask Japan.
Federal austerity may be necessary at some point, but austerity in government accounts does not give the private sector any relief from these record high burdens of private debt.
The Great Recession of 2008-2009, from which there are still repercussions in the U.S. and global economies, resulted from a massive surge in consumer loans -- 98% in just five years -- and as just stated but to remind for emphasis, the combined total of U.S. business and consumer loans is basically at the same level as at the moment this crisis hit.
The Great Depression was also caused by a massive private debt buildup. The ensuing implosion of a 36% contraction in the economy tracked an almost-as-massive 25% paydown in debt, since paying down debt uses money that would otherwise have been used for spending or investment.
Clearly, what policymakers wanted and achieved in the contemporary crisis was avoiding a massive private debt paydown and subsequent contraction. Thus, the Great Recession did not become the Great Depression II. But the debt overhang that was retained is also of great cost, stifling growth well into the future.
The Great Depression and the Great Recession were the only two periods in the past century that were preceded by a 40+% decade of growth in private debt-to-GDP while the U.S. had a ratio of overall private debt-to-GDP greater than 150%, territory where the U.S. economy remains floundering in today. The private sector cannot lead the economy to strong growth until it has lower leverage, but it has not de-levered. Some economists invoke inflation or alternatively, "strong growth" as the solution to high debt -- but even with the most optimistic expectations, a private debt correction will require the clock to tick for a generation or more.
The best alternative for reducing debt levels without the economic contraction caused by paydown (as during the Great Depression) is restructuring loans.
Dollar for dollar, a restructuring of problem loans -- with appropriate moral hazard consequences intact -- would provide as much or more stimulus than government spending, without the GDP-suppressing effect of additional government debt. A trillion dollars of private debt restructuring of loans could provide as much stimulus as a trillion dollars of government spending.
Some argue that the political moment for restructuring America's debt load may have passed, and the complexity of large-scale restructuring may be too daunting, but the fact remains that America's high levels of private sector debt will inhibit the private sector from leading the economy out of its malaise.
Commentators like Paul Krugman and others have argued that the U.S. would benefit from more government spending and that higher federal debt levels would be relatively inconsequential. They give two reasons. First, they argue that the U.S. had higher debt levels in 1945 and overcame them. Second, the US government debt level is less than a number of other countries.
However, even though Krugman is right that U.S. federal debt is below 1945 levels, America's total debt level -- government plus private sector debt -- is 65% higher and at an all-time high.
Secondly, even though U.S. federal debt is lower than some other countries, those nations have lower GDP growth than the U.S. while key countries with lower debt loads than the United States have higher GDP growth rates. It strikes us that a lower 'total' debt ratio constitutes a competitive economic advantage globally and that all other things being held equal, high debt levels suppress GDP growth.
Restructuring debt, and writing down assets over ten-year terms could have an enormous impact on economic activity in the United States. More working Americans could remain in their mortgage-stressed homes after those mortgages were written down and banks compelled to take the write-offs over time.
The U.S. government could encourage its mortgage lending operations to essentially write off debt for Americans and allow them to relaunch their financial activity. Such a strategy could replicate the go-go growth in the U.S. in the 1950s after significant deleveraging that occurred in the era previously -- but rather than contracting the economy, these restructured loans could actually immediately kick start growth.
In ancient times and as recorded in the old Testament of the Bible, the Land of Israel forgave all debts periodically, and the economic basis point for lands and slaves was reset in what was called "Jubilee."
Perhaps the economic system we have built today that seems addicted to ever higher levels of private sector debt, not to mention public debt, needs a modern Jubilee as well -- and whether they are working Americans facing impossible economic hurdles or Greek citizens facing a future as permanent serfs in a Germany-dominated Europe, finding a way to restructure and write down debt held by financiers and banks is the fastest and most effective way to bolster healthy economic growth.