More from economist Steve Keen • George Warren
Last time I promised you more details on Australian economist Steve Keen’s ideas for an American year of Jubilee to forgive the massive amount of private debt in our country, now close to three times the debt the government owes, and three times our annual Gross Domestic Product. Much of this debt should never have been created, because it was done to create debt which could be pooled and sold in small pieces to meet the ravenous greed of Wall Street brokers, who could sell such debt faster than the normal housing economy could produce it.
When you have housing demand so far exceeding supply because of such artificial circumstances, you obviously drive up the cost of housing, and then you compound the error by devising ways to approve persons who under normal circumstances would never be granted a mortgage.
According to Wikipedia, "in economic theory a moral hazard is a situation where a party will have a tendency to take risks because the costs that could incur will not be felt by the party taking the risk. In other words, it is a tendency to be more willing to take a risk, knowing that the potential costs and/or burdens of taking such risk will be borne, in whole or in part, by others. A moral hazard may occur where the actions of one party may change to the detriment of another after a financial transaction has taken place." The lenders expected to dispose of these loans for great profit immediately, and to hell with future considerations. In Keen’s view, the moral hazard clearly lay with the lenders rather than the borrowers; because they funded a disguised Ponzi scheme by inflating asset values without adding to society’s productivity.
Finance is valuable in a capitalist economy when it provides capital to fund entrepreneurial activity, fund genuine housing needs, or provides consumer finance for large purchases such as automobiles. It is destructive when it promotes leveraged speculation, whether in the stock and commodities markets, or the real estate market. If history is a guide, the U.S. cannot return to a prosperous economy until the level of private debt returns to about the level of GDP, or about one-third of its present amount.
According to Keen, the question is not whether we should or should not repay the private debt, but how should we go about NOT paying it! Qualitative easing (QuaE) is a shift of the Fed into buying more risky securities from financial institutions, thus substituting the backing of the U.S. government for that of more risky borrowers (the recent TARP program is a good example). Quantitative easing (QE) is when the federal government creates fiat money (out of nowhere) by buying bonds (usually short term) from banks with the equivalent of newly printed greenbacks. This money is supposed to grease the economy into more activity. The recent Obama stimuli were supposed to accomplish this, but they have not because many consumers and businesses are already overleveraged to the hilt. Keen’s premise is new quantitative easing money should now go directly to the public, instead of the banks.
To oversimplify, he would give a specific amount of this money to every taxpayer, with the proviso that it must be applied to any debts owed by the taxpayer. Those who have no debt would be rewarded for their prudent behavior. Those with debt would be rewarded by relief to the extent their share of cash would reach toward their debt. Presumably all these folk would then be ready to spend more cash and boost the economy. Keen says if we don’t take this approach, we are looking at stagnation for the next 15 to 20 years; and holds up as an example the Japanese economy; which has not recovered since their 1990 crash; because they have pretended the inflated value of their financial assets was real. But if we cut spending and raise taxes at the same time, as we are about to do; we will be repeating Japan’s critical mistake of 1997, when their stagnant economy was completely crippled. I cannot warn loudly enough against that perilous course!
As a fiscal conservative, these QE gift ideas repel me, but I commend Keen for thinking outside the box. And the thought of the US reliving Japan’s stagnant economy of the last twenty years frightens me. We have already endured nearly five years. So I offer a top of the head alternative. Forget the free cash to all. Let the government refinance the mortgage of every owner occupied home with a new mortgage of equal amount, bearing 2 percent simple interest (non-compounding), payable only in one lump sum at a time equal to the existing mortgage maturity date. The remaining principal debt and accrued interest would also be due at sale if the home is sold before the mortgage final maturity date. The relieved borrower would now have his old monthly mortgage payment as new expendable funds. Reasonable home price inflation should begin immediately; bringing reward to those who own their home outright. This mechanism would serve the purpose of kick-starting the economy, thus bringing in more much needed new tax revenue. But its principal recovery mechanism would prevent an individual homeowner from milking the system for immediate personal profit, and allow for eventual recovery of all taxpayer funds.
More from Keen next time.
Printed in the January 3, 2013 edition