Robert Skidelsky, Professor Emeritus of Political Economy at Warwick University and a fellow of the British Academy recently published a piece over at Project Syndicate in which he strongly advocates for the forgiveness of debt as a means to push the economic recovery along. Most economic prediction models have forecast growth around the world at far higher levels than what has come to pass, and there is talk that forecasts going forward will have to be revised downward. The reason for this, he argues, is that the medicine prescribed to alleviate the damage caused by the financial crisis was contraindicated. While the lowering of interest rates, the printing of money, the infusion of capital into failing banks, and the increasing government spending all serves to buoy the economy, but the real silver bullet is debt forgiveness. I agree.
With fiscal, monetary, and exchange-rate policies blocked, is there a way out of prolonged recession? John Geanakoplos of Yale University has been arguing for big debt write-offs. Rather than waiting to get rid of debt through bankruptcies, governments should “mandate debt forgiveness.” They could buy bad loans from lenders and forgive part of the principal payable by borrowers, simultaneously reducing lenders’ collateral requirements and borrowers’ debt overhang. In the US, the Term Asset-Backed Securities Loan Facility (TALF) program and the Public-Private Investment Program (PPIP) were in effect debt-forgiveness schemes aimed at sub-prime mortgage holders, but on too small a scale.
But the principle of debt forgiveness clearly has applications for public debt as well, especially in the eurozone. Those who fear excessive public debt are the banks that hold it. Junk public bonds are no safer for them than junk private bonds. Both lenders and borrowers would be better off from a comprehensive debt cancelation. So would citizens whose livelihoods are being destroyed by governments’ desperate attempts to de-leverage.
Philosophically, the debt-forgiveness approach rests on the belief that creditors share culpability for defaults with debtors, since they made the bad loans in the first place. As long as the borrower has not misled the lender at the time of taking the loan, the lender bears at least some responsibility for the transaction.
Here in the United States, much of the sluggishness of the recovery can be pinned directly to the so-called housing and debt overhang. There are simply too many foreclosures to work through quickly and far too many people servicing loans that exceed the value of the home. There are too many people servicing student loans, credit cards, and other debt. Toss in a heavy dose of unemployment, consumer deleveraging, and banks hoarding cash–desperate to firm up their balance sheets lest the public be made aware of how financially troubled they really are–and you have a recipe for a sluggish recovery. Unfortunately, we here in the United States cling to a ridiculous notion that consumers who took on debt, even fraudulently inflated debt, must pay back what they owe at any cost. The theory goes that to do otherwise is to “reward irresponsible behavior.”
The theory has no merit. This principled position has the practical effect of suffocating the economy far longer than necessary. The pragmatic approach, albeit ethically unsavory to some, frees up disposable income to make better investments, purchase goods, and save for retirement. With consumers–like the banks–finally out from under student loan debts, failed mortgages an exorbitant credit card balances, the economy is resuscitated. The government, being the only entity with the means to both force the creditors to take their medicine and the ability to take on debt itself in order to purchase the debt of the consumers should do so. Most notably, it is specifically at this point, when interest rates are predictably low, that borrowing costs make such an action less troublesome. Once the economy regains its footing, the government is free to restructure its fiscal policy in order to service its own debt effectively. It is the knowing failure to take this approach seriously that has led to the near collapse of Greece, and may lead to a near collapse in Spain and other southern European nations as well.
If the United States and Europe do not finally succumb to fundamental and practical fiscal policy soon, the recession is nearly certain to stretch on for at least a decade. Millions more will lose their homes and jobs. Trillions of dollars in potential growth will be forfeited to satisfy a misguided notion of responsibility.
Update: At the cost of contradicting my own argument, recent reports indicate that American debt as a percentage of disposable income is at 1984 levels. I simply can not buy this data yet. If it is true however, then there is something dramatically wrong with the very foundation of our economy.