Top Economists Told Obama that Economic Recovery Required a Reduction In Private Debt, But Obama and His Economic Team Chose the Big Banks Instead

We’ve extensively documented that too much private household debt is killing our economy.

While Ben Bernanke and other economists who are running our economic policy literally believe that the amount of private debt doesn’t matter and isn’t even important to quantify, economists at the “central banks’ central bank” – the Bank of International Settlements – and many other leading economists say that  high levels of private debt create a tremendous drag on the economy.

And Obama can’t plead ignorance.

Business Insider notes today:

A number of economists privately told Obama that his recovery policies were weak in one key area: They didn’t do enough to address the mountain of homeowner debt.

The Washington Post reported yesterday:

One year and one month before President Obama won reelection, he invited seven of the world’s top economists to a private meeting in the Oval Office to hear their advice on what do to fix the ailing economy. “I’m not asking you to consider the political feasibility of things,” he told them in the previously unreported meeting.

There was a former Federal Reserve vice chairman, a Nobel laureate, one of the world’s foremost experts on financial crises and the chief economist of the International Monetary Fund , among others. Nearly all said Obama should introduce a much bigger plan to forgive part of the mortgage debt owed by millions of homeowners who are underwater on their properties.

***

[The Obama administration pooh-poohed the need to reduce homeowner debt.] The meeting highlighted what today is the biggest disagreement between some of the world’s top economists and the Obama administration. The economists say the president could have significantly accelerated the slow economic recovery if he had better addressed the overhang of mortgage debt left when housing prices collapsed. Obama’s advisers say that they did all they could on the housing front and that other factors better explain why the recovery has been sluggish.

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Former budget director Peter Orszag has said that “a major policy error” was made. And Christina D. Romer, formerly Obama’s top economist, has said that the driving ideas “may have been too limited” and that there needs to be a bigger focus on reducing mortgage debt — a process known as “principal reduction.”

“The new evidence on the importance of household debt has convinced me that we are likely going to need to help homeowners who are underwater,” she said last month. “Many of these troubled loans will need to be renegotiated and the principal reduced if we are going to truly stabilize house prices and get a robust recovery going.”

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Atif Mian, now a Princeton professor, came to focus on how finance can destabilize an economy. He saw how foreign money had flooded Latin America in the 1980s and Southeast Asia in the 1990s, leading to borrowing booms and financial crises.

Not long before the U.S. recession, Mian and another young economist, Amir Sufi of the University of Chicago’s business school, saw a similar trend here. “The common link to the emerging market crises,” Mian said, “is that it all starts with leverage.”

The two economists compared what happened in U.S. counties where people had amassed huge debts with those where people had borrowed little. It had long been thought that when property values declined in value, homeowners would spend less because they would feel less wealthy.

But Mian and Sufi’s research showed something more specific and powerful at work: People who owed huge debts when their home values declined cut back dramatically on buying cars, appliances, furniture and groceries. The more they owed, the less they spent. People with little debt hardly slowed spending at all.

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Historically, Sufi said, “places that have bigger recessions usually have stronger comebacks.” But his calculations showed that since the end of the recession, places with high levels of debt have not had robust recoveries.

Other economists — from both political parties — were making the same point around the time Obama came to office. Blinder, a Clinton administration official, and Martin Feldstein, a Reagan administration official, developed plans calling on the government to commit hundreds of billions of dollars to restructure millions of mortgages with lower interest rates and principal balances.

Said John Geanakoplos, a Yale economist who proposed a plan to reduce principal: “I think the missed opportunity to forgive principal at the end of 2008 and beginning of the 2009 was the biggest mistake the administration made in trying to deal with the crisis.”

So why didn’t the Obama administration accept the proposals to reduce homeowner debt?  The Post notes:

But despite exploring many proposals, the administration did not see a plan that did not have the potential to cause “effects worse than the cure,” he said, such as cratering the financial system by forcing banks to absorb huge losses.

In other words, the government chose the big banks over the little guy, dooming both.

The administration – under the false banner of “homeowner relief” – simply threw money at the big banks to “foam the runway” so they wouldn’t suffer a crash landing.

As some of the leading modern economists argue, forcing big banks, bondholders and other creditors to write down some of their bad debts is the only way out of our economic malaise.    We need a debt jubilee.

Category: Bailouts, Credit, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

10 Responses to “Why Obama Chose Big Banks Over Debtors”

  1. endorendil says:

    Ok, but how do you avoid a crash landing in case of a debt jubilee?

    On a technical note: the paper your initial link points to states that “(t)hough lending by a non-bank financial company to another entity doesn’t create money, it does create debt”. Leverage makes this incorrect, does it not?

  2. denim says:

    More wrong solutions to the wrong problem. Mortgage holders would like nothing better than enough income to pay the mortgage and have the house value stable if not increasing. The self imposed austerity of the unemployed citizen is decreasing aggregate demand in the economy. Lack of aggregate demand is the root cause of the recession. The citizen with no job cannot contribute to the aggregate demand. The government needs to step in, either by directly hiring or by letting contracts to a contractor who would be required by the terms of the contract to hire a specific number of unemployed citizens.

  3. Conan says:

    All you have to do is trace the alumni of Goldman Sachs and Robert Rubin. Then see if the policies they advocated won or lost the debate.

    A) If it was a policy for one of these alumni, then Big Banks and the 1% made a fortune.

    B) If they lost the debate, then the lobbyist take over and whatever was enacted in law was either made useless by the loop holes inserted into it or by the regulators not doing their job.

    President Obama made a huge error in wasting one of the biggest crises of our time:

    A) No re reform, Glass–Steagall Act, Too Big to Fail, Leverage not at 10:1, but over 30:1, regulation of derivatives as insurance products on an exchange.

    B) He should have taken over the banks, wiped out the share holders and bond holders, recapitalized them and then sold them later under a new leadership.

    C) Next he should have had every perpetrator at the least to have their ill be gotten gains clawed back and at best to be brought to court under criminal charges.

    However, the Goldman and Rubin folks won the day behind closed doors and history will speak for itself.

  4. Greg0658 says:

    these pages are above my pay grade (sorta) .. j6p advice:
    - tax stagnate cash
    - do not allow pooling in money centers – diversify – use the other 11 FedResBankZones equally .. along some land and population metric – would probably need land useage fluffy language – to encourage real real exportable gdp to reach balanced trade globally for real preciouses

    all thats a kick the can – as capitalism is unmanageable from here & beyond .. our OpSys requires the growth in population – in generally peaceful expansions – thats what folks want .. tho the game is so compelling

    ~~
    I read down the page adding comments as they came to my influenced yet not brain ..
    ~~
    ‘Leverage’ – does seem to be the great atomic bombs (maybe correlation) millions of get rich quick and bundle away the risk – BRs search & spin “I’ll get mine then you’ll be – next” you know the rest – we’re living it*
    ~~
    Conan I think were sorta on the same page – but I really do think folks in the Summer of ’07 were very worried for our survival – especially NYC

    ~~

    I saw a segment (heard it too) a rant on the fluctuations of JDeere&Co – joked the original bean pile pushers seem to have a handle now on their stock – a’rrr .. my rants these days are on the OpSys to achieve those preciouses – and I’m getting tired of being repetitive (as you all are probably reading them)

    best wishes kids – I know your moms & dads care – but you know its hard to fight “imitation is the sincerest form of flattery”

    * http://www.ritholtz.com/blog/2011/03/crowd-source-get-yours-and-get-out/

  5. [...] Big Picture on why Obama’s administration has chosen the Big Banks over Main Street debt relief.  Which reminds me: I’ve seen cars with a “We are the 99%” bumper [...]

  6. DeDude says:

    The question is not whether Obama listened, there is no way he could have gotten serious housing debt relief through the political system. The Banks had already been bailed out by Bush. The “moral hazard issue” was just way to hot to allow debt reduction to those who had borrowed more than they could handle, while those who had been more responsible and prudent got nothing. The way it should have been done was through a revision of bankruptcy laws to allow judges to write down the debt. Initially they were chickens, afraid that it might destabilize the banks, and after the midterm elections they had no way of getting that through congress.

  7. Conan says:

    Here is the composition of the House and Senate in 2009:
    http://www.infoplease.com/ipa/A0774721.html

    Congress Years Total Dems Reps Others Vacant Total Dems Reps Others Vacant
    1th 2009–2011 100 57 41 2 2 435 256 178

    So after many promises of Hope & Change and loudly saying all that Bush did was wrong. Here is the Democratic power given by the American people in an undisputed mandate to do something of consequence.

    The Senate Dems had 57% and with Independents 59% only 1 vote from Super Majority
    Then in the House they had 59% control.

    Thus it is hard to dispute that the power wasn’t there to get things done. The point I made is that the Goldman & Ruben disciples convinced Obama not to do what needed done. If he would have given one quarter the effort as Obama Care was allocated, history would have told a much different tale.

    Bottom line a wasted crises that could have benefited us all greatly and shown that there was rule of law and Main Street mattered more than Wall Street.

    PS This is not a mutually exclusive argument, there is no reason he couldn’t have addressed in a substantive manner the systematic ills of the financial system AND THEN done Obama Care. After all he was elected for four years and hindsight being 20/20 may have prevent the political consequences in the midterm election for having done Obama Care instead of Fixing the financial system plus punishing those that did wrong.

  8. spooz says:

    The way to avoid moral hazard for debt forgiveness would be to issue a citizens dividend that must be used to pay off loan balances. This could be part of a new look at The Chicago Plan, where the debt is first transferred to the Treasury. Money creation would be taken away from the banks and given to the government, and the financialization of our economy could be reversed.

    http://www.imf.org/external/pubs/ft/wp/2012/wp12202.pdf

  9. spooz says:

    To clarify, everybody would receive the citizen’s dividend, but debtors would have to use it to pay off loans before spending it.

  10. DeDude says:

    What democratic power ??? Sorry but 1 vote from a super majority is still one vote short. And given the nature of one of those “independents” it was actually 2 votes short of getting anything done that wasn’t agreeable to Wall Street.

    I agree that there was and still are to many Ruben and Goldman people in the administration, and they may have had their influence. But by the time Obama took office the immediate (we are all gonner die) economic crisis had been averted and there were neither legal nor legislative tools to do what needed to be done. Both ObamaCare and the financial reform legislations were woefully inadequate, but also the best that could be done within the constitution – and better than the alternative of nothing.