They argue that, rather than failing banks, the key culprits in the financial crisis were overly indebted households. Resurrecting arguments that go back at least to Irving Fisher and that were emphasised by Richard Koo in considering Japan’s stagnation, Mian and Sufi highlight how harsh leverage and debt can be – for example, when the price of a house purchased with a 10 per cent downpayment goes down by 10 per cent, all of the owner’s equity is lost. They demonstrate powerfully that spending fell much more in parts of the country where house prices fell fastest and where the most mortgage debt was attached to homes. So their story of the crisis blames excessive mortgage lending, which first inflated bubbles in the housing market and then left households with unmanageable debt burdens. These burdens in turn led to spending reductions and created an adverse economic and financial spiral that ultimately led financial institutions to the brink.
Pointer from Tyler Cowen.
Summers points out that Mian and Sufi’s suggestion that we should have bailed out homeowners is probably not correct. I feel even more strongly than Summers does about this.
Suppose that we accept the balance-sheet recession story. Some comments and questions.
1. Vernon Smith is also a proponent.
2. What was the difference between the damage to consumer wealth caused by the dotcom crash of 2000 and by the housing crash of 2007-2008? Was it solely the fact that the latter had been financed more by borrowing?
3. Suppose that there had been no debt-fueled consumer boom in 2005-2006. What would there have been instead? A sluggish economy? A more sustainable boom?
4. Suppose that we take a PSST perspective. Then the period from the late 1990s to the present is one long, painful, still-unfinished adjustment to the Internet and factor-price equalization. We happened to have a sharp boom-bust cycle in home construction in the middle of it, but even during the boom we did not have four consecutive months of gains in employment over 200,000. Then, in 2008 we had a panic about large financial institutions, leading to a big increase in government intervention, which mostly consisted of transfers of resources to less-productive businesses, such as GM, Citigroup, and Solyndra.
Debt and the broader distribution of it. A recession.
I wonder if the government is responsible to fix with dollars a problem it created with dollars. This would make me an odd Austrian but I’m fine with that. I believe the debt was incurred partly due to money illusions.
One thing is for sure, financial institutions to the brink, in the sense that their market value has soared to the maximum possible.
In 2007-2008, The Gift of The Greenspan Put, traded out “money good” US Treasuries for the most distressed (read toxic) of investments and confidence, that is trust, in the finanicial sector restored.
Through Global ZIRP, reinforced by pursuit of yield investing, we now have an Empire of Debt, more stunning, more spectacular then in 2007.
We are not going to have another housing crisis, we are going to have a financial crisis, as the debt implodes and as investors head to the stock market exit door.
A whole new system of government is coming; and it will be characterized by “democratic deficit”.
…consisted of transfers of resources to less-productive businesses, such as GM, Citigroup, and Solyndra.
Indeed, but we seem to have trouble finding productive businesses anywhere. And gov’t spending, at all levels, …sheesh. A local town is building a water storage tank… a year for construction? A proposed 9/11 memorial… 700 million? We spend so much for so little that soon we will be able to spend everything for nothing.