Modern Debt Jubilee

Michael Hudson’s sim­ple phrase that “Debts that can’t be repaid, won’t be repaid” sums up the eco­nomic dilemma of our times. This does not involve sanc­tion­ing “moral haz­ard”, since the real moral haz­ard was in the behav­iour of the finance sec­tor in cre­at­ing this debt in the first place. Most of this debt should never have been cre­ated, since all it did was fund dis­guised Ponzi Schemes that inflated asset val­ues with­out adding to society’s pro­duc­tiv­ity. Here the irresponsibility—and Moral Hazard—clearly lay with the lenders rather than the bor­row­ers.

The only real ques­tion we face is not whether we should or should not repay this debt, but how are we going to go about not repay­ing it?

The stan­dard means of reduc­ing debt—personal and cor­po­rate bank­rupt­cies for some, slow repay­ment of debt in depressed eco­nomic con­di­tions for others—could have us mired in delever­ag­ing for one and a half decades, given its cur­rent rate.

We should, there­fore, find a means to reduce the pri­vate debt bur­den now, and reduce the length of time we spend in this dam­ag­ing process of delever­ag­ing. Pre-cap­i­tal­ist soci­eties insti­tuted the prac­tice of the Jubilee to escape from sim­i­lar traps (Hud­son 2000; Hud­son 2004), and debt defaults have been a reg­u­lar expe­ri­ence in the his­tory of cap­i­tal­ism too (Rein­hart and Rogoff 2008). So a prima facie alter­na­tive to 15 years of delever­ag­ing would be an old-fash­ioned debt Jubilee.

But a Jubilee in our mod­ern cap­i­tal­ist sys­tem faces two dilem­mas. Firstly, in any cap­i­tal­ist sys­tem, a debt Jubilee would paral­yse the finan­cial sec­tor by destroy­ing bank assets. Sec­ondly, in our era of secu­ri­tized finance, the own­er­ship of debt per­me­ates soci­ety in the form of asset based secu­ri­ties (ABS) that gen­er­ate income streams on which a mul­ti­tude of non-bank recip­i­ents depend, from indi­vid­u­als to coun­cils to pen­sion funds.

Debt abo­li­tion would inevitably also destroy both the assets and the income streams of own­ers of ABSs, most of whom are inno­cent bystanders to the delu­sion and fraud that gave us the Sub­prime Cri­sis, and the myr­iad fias­cos that Wall Street has per­pe­trated in the 2 decades since the 1987 Stock Mar­ket Crash.

We there­fore need a way to short-cir­cuit the process of debt-delever­ag­ing, while not destroy­ing the assets of both the bank­ing sec­tor and the mem­bers of the non-bank­ing pub­lic who pur­chased ABSs. One fea­si­ble means to do this is a “Mod­ern Jubilee”, which could also be described as “Quan­ti­ta­tive Eas­ing for the pub­lic”.

Quan­ti­ta­tive Eas­ing was under­taken in the false belief that this would “kick start” the econ­omy by spurring bank lend­ing.

And although there are a lot of Amer­i­cans who under­stand­ably think that gov­ern­ment money would be bet­ter spent going directly to fam­i­lies and busi­nesses instead of banks – “where’s our bailout?,” they ask – the truth is that a dol­lar of cap­i­tal in a bank can actu­ally result in eight or ten dol­lars of loans to fam­i­lies and busi­nesses, a mul­ti­plier effect that can ulti­mately lead to a faster pace of eco­nomic growth. (Obama 2009, p. 3; empha­sis added)

Instead, its main effect was to dra­mat­i­cally increase the idle reserves of the bank­ing sec­tor while the broad money sup­ply stag­nated or fell, for the obvi­ous rea­sons that there is already too much pri­vate sec­tor debt, and nei­ther lenders nor the pub­lic want to take on more debt.

A Mod­ern Jubilee would cre­ate fiat money in the same way as with Quan­ti­ta­tive Eas­ing, but would direct that money to the bank accounts of the pub­lic with the require­ment that the first use of this money would be to reduce debt. Debtors whose debt exceeded their injec­tion would have their debt reduced but not elim­i­nated, while at the other extreme, recip­i­ents with no debt would receive a cash injec­tion into their deposit accounts.

The broad effects of a Mod­ern Jubilee would be:

1. Debtors would have their debt level reduced;
2. Non-debtors would receive a cash injec­tion;
3. The value of bank assets would remain con­stant, but the dis­tri­b­u­tion would alter with debt-instru­ments declin­ing in value and cash assets ris­ing;
4. Bank income would fall, since debt is an income-earn­ing asset for a bank while cash reserves are not;
5. The income flows to asset-backed secu­ri­ties would fall, since a sub­stan­tial pro­por­tion of the debt back­ing such secu­ri­ties would be paid off; and
6. Mem­bers of the pub­lic (both indi­vid­u­als and cor­po­ra­tions) who owned asset-backed-secu­ri­ties would have increased cash hold­ings out of which they could spend in lieu of the income stream from ABS’s on which they were pre­vi­ously depen­dent.

Clearly there are numer­ous com­plex issues to be con­sid­ered in such a pol­icy: the scale of money cre­ation needed to have a sig­nif­i­cant pos­i­tive impact (with­out exces­sive neg­a­tive effects—there will obvi­ously be such effects, but their impor­tance should be judged against the alter­na­tive of con­tin­ued delever­ag­ing); the mechan­ics of the money cre­ation process itself (which could repli­cate those of Quan­ti­ta­tive Eas­ing, but may also require changes to the legal pro­hi­bi­tion of Reserve Banks from buy­ing gov­ern­ment bonds directly from the Trea­sury); the basis on which the funds would be dis­trib­uted to the pub­lic; man­ag­ing bank liq­uid­ity prob­lems (since though banks would not be made insol­vent by such a pol­icy, they would suf­fer sig­nif­i­cant drops in their income streams); and ensur­ing that the pro­gram did not sim­ply start another asset bub­ble.

Taming the Finance Sector

Finance per­forms gen­uine, essen­tial ser­vices in a cap­i­tal­ist econ­omy when it lim­its itself to (a) pro­vid­ing work­ing cap­i­tal to non-finan­cial cor­po­ra­tions; (b) fund­ing invest­ment and entre­pre­neur­ial activ­ity, whether directly or indi­rectly; © fund­ing hous­ing pur­chase for strictly res­i­den­tial pur­poses, whether to owner-occu­piers for pur­chase or to investors for the pro­vi­sion of rental prop­er­ties; and (d) pro­vid­ing finance to house­holds for large expen­di­tures such as auto­mo­biles, home ren­o­va­tions, etc.

It is a destruc­tive force in cap­i­tal­ism when it pro­motes lever­aged spec­u­la­tion on asset or com­mod­ity prices, and funds activ­i­ties (like lev­ered buy­outs) that drive debt lev­els up and rely upon ris­ing asset prices for their suc­cess. Such activ­i­ties are the over­whelm­ing focus of the non-bank finan­cial sec­tor today, and are the pri­mary rea­son why finan­cial sec­tor debt has risen from triv­ial lev­els of below 10 per­cent of GDP before the 1970s to the peak of over 120 per­cent in early 2009.

Return­ing cap­i­tal­ism to a finan­cially robust state must involve a dra­matic fall in the level of pri­vate debt—and the size of the finan­cial sec­tor— as well as poli­cies that return the finan­cial sec­tor to a ser­vice role to the real econ­omy.

The size of the finan­cial sec­tor is directly related to the level of pri­vate debt, which in Amer­ica peaked at 303% of GDP in early 2009 (see Fig­ure 15). Using his­tory as our guide, Amer­ica will only return to being a finan­cially robust soci­ety when this ratio falls back to below 100% of GDP. Most other OECD coun­tries like­wise need to dras­ti­cally reduce their lev­els of pri­vate debt.

Since finance sec­tor prof­its are pri­mar­ily a func­tion of the level of pri­vate debt, this implies that the level of debt needs to shrink by a fac­tor of 3–4, while employ­ment in the finance sec­tor needs to roughly halve. At the max­i­mum, the finance sec­tor should be no more than 50% of its cur­rent size.