This article is part of Sweet Forgiveness, a forum on debt relief.
Mark A. Calabria
The responses to the financial crisis have been defended as saving our economy, protecting everyone. The reality is otherwise. A massive housing bubble burst, reducing household wealth by more than $6.5 trillion with resulting losses in mortgage-related assets. The actions of 2008 and since have largely been a struggle over who will bear those losses.
Our society is poorer than we had believed because we over-invested in something—housing—whose value dropped in our eyes.
With the subjective devaluation of housing came a drop in spending. When wealth falls, consumption follows. But after an initial sharp decline, consumer spending has recovered to its trend. We’re about $300 billion behind where we would have been without the initial drop. This $300 billion is approximately what one would expect households to spend out of about $6 trillion in home equity, which was lost. So the reduction in consumer spending is not the result of a drop in aggregate demand, but almost exclusively the result of a reduction in household wealth.
Mike Konczal correctly identifies this decline in spending as a result of declining wealth, but he erroneously believes that spending can be increased by “repairing” household balance sheets via forced debt forgiveness. While that might increase the spending of some households, it would decrease the spending of others, leaving overall spending at-best unchanged. Advocates of debt forgiveness forget that net debt in society is always zero. One person’s liability is an asset on the balance sheet of another. Do Konczal and other debt-forgiveness advocates believe society would be wealthier if the U.S. government defaulted on its debt?
Although some in the debt-forgiveness camp implicitly recognize that they are advocating a transfer of wealth, they deem such a transfer just. They may argue that debtors have been cheated or that creditors have rigged the political system. Setting aside the fact that any borrower who has been defrauded has redress to the courts, the political system itself is extremely debtor-friendly. The consumer credit revolution of the late 1960s and ’70s brought legislation, such as the Truth in Lending Act, which established methods for borrowers to achieve debt relief. Recent years have illustrated the extent to which the foreclosure process favors borrowers. Data from earlier this year showed that payments on more than 70 percent of mortgages in foreclosure had not been made for more than twelve months. And many states, such as California, limit the lender’s collection to the value of the house while it’s in foreclosure. In most of Europe, by contrast, borrowers would see their wages garnished to satisfy a mortgage default. Under no definition can our foreclosure process be described as favoring the lender.
Picking winners and losers is bad for society.
Lenders may be seen as undeserving, either because they received government assistance or are blamed for the crisis. But the truth is that mortgages are ultimately held less by lenders than by investors. As we witnessed in the auto bailouts, the investors taking the hit are often pension funds representing public employees, such as teachers and firefighters. In fact one of the largest investors in the United States represents the pension assets of California public employees. It’s hard to argue that middle-class and sometimes upper-class defaulting homeowners are more deserving than retired teachers.
Forced debt forgiveness also ignores that markets adjust and price these political risks in the cost of borrowing. In states where lenders cannot collect from a defaulted borrower’s non-housing assets or income, lenders charge higher rates. Attempts to rewrite contracts via politics will see offsetting changes in the terms of future contracts. To the extent that these new terms are inefficient and mutually beneficial transactions become harder to achieve, social welfare will be reduced.
To suggest that damaged household balance sheets are holding back spending misses the obvious fact that consumers are spending. While household spending rates have been higher, they are currently above their low point during the bust. Household savings rates, as a percentage of income, are also considerably below levels witnessed during the supposedly golden economic years of the Clinton administration. The question isn’t why families are saving so much, but why they are saving so little.
Ultimately there are two models in our society for social cooperation, one based upon voluntary consent, particularly in the realm of contracts, and one based upon coercion and theft. Using government to transfer wealth from citizens A to citizens B may make B feel wealthier. Citizens B might spend more. But just as likely is that A will spend less. As important, A might invest less. Some will be tempted to replace A and B with groups they either like or dislike, trying to distract us from the fact that rather than a society that practices equality before the law, we have a society that picks winners and losers based upon their political influence. In such a society, resources will be invested evermore in the transfer of wealth rather than in its creation.
To comment on this forum, click here to return to the lead article by Mike Konczal.