I’d like to thank all the respondents for their contributions, which focus on three major concerns. Several commentators express skepticism about the idea that a balance-sheet recession is holding the economy back. They believe instead that a wealth effect is the source of the problem. Others take issue with my characterization of creditors and bankruptcy law. And still others think I give insufficient attention to the social and economic context that has driven the growth of household debt.
Dean Baker and Mark Calabria suggest that the collapse in housing values, rather than overleveraged consumers, is driving the weak economy. The problem is simply that people are poorer because of the drop in prices, not that they are worried about excessive debt. Though this may seem like a technical argument, the difference has significant consequences for understanding what has happened and where we need to go. According to their account, if we had no mortgages but the same housing bubble and housing crash, we’d still have a prolonged recession and slow recovery. So reducing housing debt won’t by itself help the economy (though it will help the individuals involved), because housing debt isn’t dragging us down. Instead, we need policies that would restore housing prices.
It isn’t clear though why there should be a nationwide wealth effect in housing. Wealth effects are easily understood for your stock portfolio, but you don’t live in your stock portfolio. Housing is both something you invest in and something you consume. Though your house might be worth half as much, any future housing you would want to purchase also costs half as much.
Moreover, studies by Amin and Sufi, among others, are finding that the decrease in spending relative to the decrease in housing prices is far greater than any previous estimate would have told us. The presumed wealth effect isn’t strong enough to explain this drop-off. Large debt overhangs also have held back past recoveries in this country and others, suggesting that debt has a central role in how we should approach this crisis.
Creditors and Bankruptcy
Marcus Cole worries that I support “the popular urge to ‘occupy’ all creditors.” Mark Calabria worries that making debt relief easier will lead to a society of “coercion and theft” vis-à-vis investors and lenders. They argue that difficult lending situations are zero-sum—a debtor’s gain is a lender’s loss—or that attempts to help debtors are moralizing distractions whose advocates are looking for villains to explain the ups-and-downs of the business cycle.
Robert Hockett provides a compelling response to these arguments. I’d add that pushing for reform is arguably more beneficial to creditors, investors, and lenders in solving the collective action problem Hockett points to. The trustees and servicers designated to handle the system can’t manage a crisis of this proportion, and our country and our neighborhoods are living through the consequences.
These troubles are products of what is conventionally called “deregulation”—though Louis Hyman observes that this term is a misnomer. What really happened is a re-regulation of the financial sector. Mortgage-backed securities were designed to make modifying loans difficult, thereby creating a collective action problem. The housing market collapse exposed the weaknesses of this strategy.
Indeed, one of the major purposes of bankruptcy has been to solve these collective action problems. Contra Cole, I know of no theory that says bankruptcy’s sole, or even principal, goal is to reduce the cost of capital ex ante. There are many other goals: encouraging entrepreneurial activity, allowing firms to resolve debt overhangs so that they can pursue profitable activities, social insurance, and fixing collective action problems among creditors. These may reduce the cost of capital, or not, but these are all important goals.
Debt is a political crisis that requires a political response.
That said, it isn’t even clear that allowing for lien stripping in bankruptcy would increase mortgage rates and undercut homeownership, as Cole suggests. As Joshua Goodman and Adam Levitin have recently found, historically, permitting cramdown produces a minor 0.1–0.2 percentage point increase in mortgage interest rates, significantly less than banking lobbyists predicted.
The issue isn’t bankruptcy losses versus no losses, but losses in bankruptcy versus losses in foreclosure. Given that investors are seeing big losses on homes they foreclose on, with some estimates higher than 50 percent, calling for bankruptcy reform isn’t, in Hockett’s phrasing, robbing Peter to pay Paul.
Looking Backward and Forward
How does this story fit into the changing economy of the past 30 years? How should it affect the evolution of American politics? We should, after all, think of this crisis as a political one that requires a political response.
Jacob Hacker and Nathaniel Loewentheil raise something I don’t address directly: the role of self-reinforcing growth in political and economic inequality over this time period. The shadow banking sector evolved outside the normal, tested, regulatory framework of traditional banking, and the bubble, debt, conflicts, and crisis are all the result of this regulatory drift.
Tamara Draut explains how the shifting fortunes of the middle and working classes amid this move toward shadow banking have inflated credit-card debt. Political decisions have forced greater spending on household basics, education, and health care. At the same time, income has stagnated or fallen and the risks associated with being unemployed have increased. But she also notes that fixing our housing market isn’t enough to enhance the economy in the long term. We need a stronger safety net. Hyman goes further: beyond the safety net, the government needs to ensure that better investment opportunities, especially in small business, are available.
As Barbara Fried points out, America’s on-your-own culture—in which every misfortune is recast as an opportunity for finger-wagging blame—is also implicated here. Fried and I largely agree: rather than assume that everyone can foresee everything and plan accordingly, we should forego the special pleasures of incessant moralistic condemnation, accept that luck and uncertainty are normal parts of our lives, and emphasize risk-sharing. Fried also notes that this individualism is ingrained and that, rather than fight it, a more effective approach might be to concentrate on economic prosperity for all.
These political and cultural concerns are important. Because debt is a byproduct of political choices and institutions and is suffused with cultural meaning, the call for reform must be attached to a conception of broad-based prosperity and adequate social insurance, which are also political matters, and needs to address ideas about personal responsibility that get in the way of sensible solutions.
Thus the significance of Hacker and Loewentheil’s insight that focusing on debt “makes the challenge of reform appear both smaller and larger than it really is.” Debt as a political project is too small because we need to tackle anemic government investments, runaway health-care costs, failed private systems for retirement security, and money-dominated politics. But it is too big because it requires a cultural revolution in how we think about borrowing, lending, and credit.
Instead, it would be easier to fight for that more equitable society directly, which would also solve many debt problems. I think this is correct and should serve as a reminder to place the issue of debt in the proper social context. But we should also think about those confronting debt now, who are facing the effects of political choices that have generated stagnating incomes, runaway inequality, and serious barriers to full employment. As debtors suffer, they are dragging the economy down. Helping them helps us all.