Boston Review, November 2012
In an op-ed titled "Sweet Forgiveness," Mike Konczal raises many important points about recovery from the Great Recession, but, in assessing the length and duration of the downturn, he places undue weight on underwater homeowners.
Following on the work of Atif Mian and Amir Sufi, Konczal argues that the $1.1 trillion debt of 15 million underwater homeowners is the main factor holding back the recovery. If these homeowners could somehow be brought back above water, they would increase their spending and normal economic growth would resume.
But some simple calculations suggest that this explanation is implausible.
First, it is important to remember that one person’s debt is another’s asset. If we eliminate $1.1 trillion in underwater debt then we also eliminate $1.1 trillion in mortgage-related assets held by individuals, public and private pension funds, and other institutional investors. While underwater homeowners, restored to solvency, likely have a higher propensity to consume than their creditors do, it is hard to see the difference being large enough to affect the economy significantly.
Suppose that underwater homeowners would spend fifteen cents out of every dollar of housing wealth, while their creditors spend just three cents. If we could snap our fingers and eliminate all underwater debt, the additional consumption would add a bit more than $130 billion, 0.8 percent, to annual GDP—a substantial boost, but nowhere near the five percentage point shortfall the Congressional Budget Office sees between actual and potential output.
Actually, the fifteen-cent assumption is almost certainly too generous. Estimates of the average amount of underwater debt vary, with the high end at roughly $75,000. Let’s assume that’s right. If we expect these homeowners to spend, annually, 15 percent of each dollar of debt we have eliminated, that amounts to $11,250 per year. According to the Census Bureau, the median income for homeowners is $62,500. It’s unlikely that even solvent families have $11,250 a year for discretionary spending.
The standard effect of housing wealth provides a simple alternative explanation for the length and severity of the downturn. The pre-crash economy was driven by the housing bubble. When the bubble burst, the construction boom ended, costing us $600 billion in annual construction spending. We also lost $8 trillion in housing wealth and gave up roughly $500 billion in annual consumption. The latter figure is in keeping with what we know about the effect of housing wealth on consumption: for every dollar your house is worth, you will spend an additional five to seven cents.
Konczal’s balance-sheet explanation would have the economy sustaining bubble levels of consumption even without bubble levels of housing wealth. That is difficult to understand. The household saving rate was near zero at the peak of the bubble, while the pre-bubble average was 8 percent. Is there any reason to expect the saving rate to fall back to zero if the bubble does not re-emerge?
What we really need is something to replace the demand created by the housing bubble. In the short term, this must come from the government, which is why all economically literate people celebrate the budget deficit. In the longer term we will have to look toward more balanced trade to make up the shortfall in demand. Underwater homeowners need and deserve help, but that alone won’t reverse the downturn.
I’m more convinced by Konczal’s analysis of tightening bankruptcy laws. The financial industry has effectively enlisted the government as a full partner in its debt collection efforts.
This is big government—really big government. Creditors can now use the power of the state to make up for their own ineptitude in assessing credit risk. As Konczal notes, the increased powers can even lead people to use Social Security benefits, which are generally exempt from seizure by creditors, to make payments.
Debt collection has the same negative effect on work incentives as taxes do. If someone has to pay ten cents of every dollar they earn to a creditor, it is as much a disincentive to work as a ten percentage point increase in the income tax rate. How can any honest supporter of small government approve of the increased role of the government in debt collection over the last two decades? Conservatives are very happy with big government; they just are smart enough not to admit it.
Konczal’s discussion of the government’s role as a debt collector is extremely valuable. And the analysis of the recession is an important corrective to the Reinhart-Rogoff twilight zone orthodoxy that a financial crisis somehow condemns us to a decade of stagnation. But the balance sheet–recession story simply does not fly.