Well, the best article I've read on this is here http://www.interfluidity.com/v2/3212.html
Short version, the current recession/depression is an active political choice made because politically there's more real political support for high unemployment/low inflation than there is for low unemployment/moderate inflation. We don't really pay much attention to the high unemployment/low inflation model because on the surface it seems like a political loser, but when we talk around it or people act in self-interest, it's actually pretty popular.
There really is a conservative plan for fixing the economy. We just don't talk about it. A steady reduction in wages will result in lower prices keeping purchasing power on par (or even improving it) without the nasty part of making creditors worse off, or at the very least, have to work a bit harder for it.
That's the Conservative/Austerity plan when it comes down to it. Now, that it doesn't actually work is an entirely different can of worms. That it actually ends up making Debt to GDP ratios worse is completely out of the picture. But, people should understand that everything they say or do on the economy has to do with instituting this plan.
I just wish they were honest about it.
Democracy is the process in which we determine the government that we deserveThat is correct — conservative economic policy is designed for the specific purpose of causing wage deflation. It ignores the fact that wage deflation will not solve the current crisis, but will in fact make it worse. It ignores (or rather, revels in) the fact that wage deflation will exacerbate income inequality. It is a tool of the rich to make themselves richer at the expense of everyone else.
edited 3rd May '12 9:15:53 AM by Fighteer
"It's Occam's Shuriken! If the answer is elusive, never rule out ninjas!"I'm aware of the FDIC. I'm merely pointing out that as creditors ourselves, we would be opposed to people taking away the money that we lent to the banks. Not one person thinks, "Oh, well, that'd be completely justifiable if the government just said we can't get our money back." We have the FDIC to protect us, but as commercial lenders, banks don't have that. Which is fine. I'm okay with them losing on bad investments. I'm okay with them losing when they act unethically. What I'm not okay with is this idea that we should just say, "Well, if the ones with debt can't easily pay it off, too bad for the creditor." Because as creditors ourselves, we would be horrified at the thought that our bank accounts could get wiped out.
You are entitled to your money back when you lend it to someone. You aren't in an investment. When you invest, you're saying, "I'll take a percentage gain/loss based on the amount of money I'm putting into your project/company." When you loan, you are making an agreement saying, "You need this money now, I don't. Only take this money if you are willing to pay it back over X period of time with Y% interest." When they agree, they are entering into a contract, and you are entitled to get what's contractually yours. Bankruptcy can cancel that out, and banks are aware of that and adjust interest rates up accordingly.
As for how banks don't get the best out of default, that would only happen in rare cases. Say you owe $300,000 on your house that's worth $350,000. If you go into default, the bank sells your house, immediately recouping the principal (and paying you back $50,000). But what if the housing bubble means you have a larger principal than the worth of your house?
Say you owe $500,000 on your $250,000 house. If you can no longer afford to pay and the bank defaults, they sell your house and now you only owe $250,000 - if you go bankrupt, that's how much they lose. Principal reduction would seem to make them more money than default if you could make payments on a mortgage between $500,000 and $250,000. But if they default, they immediately have $250,000 with which they can make a new loan and start collecting interest, whereas if they go with principal reduction, they have to wait for you to pay off some amount (less than they're owed) before they can use that money. You'd have to deduct the opportunity cost of having a new loan with a better credited lendee before you could say that principal reduction would be the best choice.
And even if it were the best financial choice in an individual case, that's not always the best financial choice in the long run. Say you own a parking lot, and someone parks there illegally. You give them a ticket for $50 and they don't pay it. Filing a lawsuit to collect that $50 is going to cost way more than $50, but you might file anyway to send a message to people that your parking lot isn't free to park in. Otherwise, people start parking for free in your lot, knowing that you won't do anything about it.
Much to my BFF's wife's chagrin, No Pants 2013 became No Pants 2010's at his house.If we didn't have deposit insurance, and I deposited 10,000 bucks in a bank, and the bank was in default, I'd be okay with the government "buying" my right to that 10,000 deposit for some price under 10,000 dollars.
Loans are a form of investment. That's why there's a risk premium-because of the possibility of default. When you make a loan, you're not entitled By the Grace of God to be repaid for it.
Unless it's T-Bills.
edited 3rd May '12 12:22:55 PM by TheyCallMeTomu
Vericrat, nobody is entitled to get their money back in any venture. Principal is not some magic number that can't ever go down. When you invest in the stock market, you can lose money. When you loan money, you take a chance that the person you are loaning it to won't pay it back. That chance is generally reflected in the interest rate — higher risk demands a higher rate of return.
You can take out insurance against losses on a loan; banks do it all the time. Consumers also have a form of insurance coverage for the money they deposit with banks in the FDIC.
Recovery of principal is not a moral issue. It's a business issue. Yes, of course, you enter into a contract and have an obligation to pay back. If you breach that obligation, you're a terrible person for welching and you should feel great shame, blah blah.
But we allow people to get out of debt via bankruptcy and discharge debts via default. It's how the system works; it accounts for the possibility of failure to repay.
If I'm a consumer with an overwhelming debt burden and no resources, the issue is not my moral obligation to repay my creditors. That is already forfeit. The question is what amount the creditors stand to recover. By all measurements, after the legal fees, costs incurred in repairing and selling the property, the depressed nature of the foreclosure market, and other factors, foreclosure is a terrifically bad deal for the bank compared to a principal reduction.
Your hypothetical example, of a $500,000 home that's now worth $250,000, but the bank gets back all of the principal, is (no offense) baloney. If the bank forecloses, it's already out whatever principal and interest payments would have been made during the proceedings. It will have to take over maintenance on the property after the owner is evicted, it will have to bear the burden of making the property salable, or pass that burden via property auction to a third party, in which it will be lucky to recoup even half the potential sale price. And you aren't even counting legal fees and other costs.
Meanwhile, the consumer will probably declare bankruptcy to discharge the remainder of the debt. The bank is pretty much out that money as well, plus all the potential interest it would have earned as profit during the lifetime of the loan. When all is said and done, it would be lucky to recoup a quarter of its investment.
This juxtaposed against a reamortization of the loan at $250,000, with the bank writing down half the value. If the borrower can subsequently repay the modified loan, the bank still earns interest payments, doesn't incur all the legal costs, and stands to recover most of its investment in the long run. The consumer doesn't get their credit wrecked and can continue living in their home. It's a win-win for all involved.
"It's Occam's Shuriken! If the answer is elusive, never rule out ninjas!"Because the consequences of treating banks as people include situations like the one we're in now.
Share it so that people can get into this conversation, 'cause we're not the only ones who think like this.It's easier to get people to pay their bills when a) the population of those who are incapable of paying bills despite their best efforts is small, and b) society is functioning healthily enough for a law enforcement system to prosecute fraud. You don't have that when banks fuck everything up like they have now.
Share it so that people can get into this conversation, 'cause we're not the only ones who think like this.@Starship: I don't think anyone, not even the most liberal economist, has said anything about enabling consumers to arbitrarily welch on their debts. That's absurd. However, extraordinary times call for extraordinary measures. In this situation, the Fed would make good on the banks' mortgage losses through fiscal expansion. It's already been doing that through quantitative easing, just not as directly.
The fears that this would be inflationary are reactionary and unfounded. As Krugman points out, you cannot have more than nominal inflation when demand is insufficient to drive up prices, no matter how much money is in the system. This is an absolute law of money, and one that almost everyone on the Very Serious Person crew seems to have forgotten.
If a mortgage relief program turns out to be inflationary, the Fed can apply the tools it has always applied in such situations: raise the federal funds rate.
edited 3rd May '12 2:40:12 PM by Fighteer
"It's Occam's Shuriken! If the answer is elusive, never rule out ninjas!"Yes, precisely. You get it now. The economy is actually trying to deflate, but the Fed can't issue bonds with a negative interest rate, and so it ends up sucking up all the private investment money that isn't going towards the economy, because people aren't buying shit.
That is a symptom of the trap but not the cause of it.
edited 3rd May '12 2:39:16 PM by Fighteer
"It's Occam's Shuriken! If the answer is elusive, never rule out ninjas!"Tomu, let me put it this way. A significant rise in core inflation now would actually be a good thing for the economy, because it would devalue both private and public debt and motivate people and businesses to spend now rather than later, thus helping to restore full employment, which is at the heart of the crisis.
Inflation is the demon you worry about after you've taken care of the starving kids, not before.
"It's Occam's Shuriken! If the answer is elusive, never rule out ninjas!"Hyperinflation?
Would a return to the Bretton Woods System
be a good idea? Or the Gold Standard?
By the way, I've added an update to the European Debt Crisis thread — Fighteer, you'll like it, as it about Krugman.
Keep Rolling OnNo god no, not hyperinflation.
Actually, inflation in and of itself isn't the goal. It's just a natural result of getting back to full employment. It's the getting back to full employment that's the goal. If for some reason the latter happens without the former (and I do think it is possible) then so be it.
For the wonks out there, there's generally two types of inflation. Cost-Push and Demand-Pull. Cost-Push is when costs go over prices, forcing them up, and Demand Pull is when demand outstrips supply. I actually could see full employment, at least in the short term not really resulting in either, because productivity gains means there's a lot of slack to give in terms of costs (labor is way undervalued right now), and also because consumers stand pretty much pat on prices, as well as there being plenty of goods and services to meet the existing demand.
edited 3rd May '12 3:05:54 PM by Karmakin
Democracy is the process in which we determine the government that we deserveReturning to the gold standard or any other form of limit on the ability of governments to create funds would be disastrous in a liquidity trap economy. If we want to turn into Greece, that would be an excellent way to go about it.
edited 3rd May '12 3:44:10 PM by Fighteer
"It's Occam's Shuriken! If the answer is elusive, never rule out ninjas!"I think I'm awesome and I think the world should tremble before my awesomeness.....
....Okay, not really. But I'd like to become awesome. And that'll never happen if I'm too enamored of my own ideas and beliefs to see clear reason.
Also
edited 3rd May '12 3:54:24 PM by TheStarshipMaxima
It was an honor

@Vericrat: The FDIC already insures bank deposits — precisely the opposite of the scenario you are talking about. What's more, the federal government cannot, by definition, "run out of money". If writing down debt drives banks into insolvency, it can bail them out. Banks got record bailouts at the start of the financial crisis and it arguably saved the banking system from collapsing. Oodles of principal that existed almost entirely in peoples' imagination was lost.
The point is not that banks should be magically immune from principal loss — that's ridiculous. The point is that banks have decided to take a stance where they would rather risk a massive loss of investment in the form of default rather than a lesser loss in the form of principal reduction on current loans. This is in total ignorance of the fact that by doing this, they would open the floodgates to substantial future increases in prosperity, giving them far more business in the long run.
In short, the only scenario in which banks "win" by denying principal reduction is one where you count victory in narrowly moral terms that both ignores the future and the fact that banks themselves are largely responsible for the consumer debt problem in the first place.
Further, banks don't have to lose any money if the consumer bailout is funded by the Fed through bond issuance. We're at the zero lower bound and long term interest rates on treasuries are the lowest they've been in history; if there's a time that we can afford such measures, it's now.
This actually leads into one of Krugman's other points — why, given the facts, is the business community so resistant to the idea of government providing solutions to the economic crisis? The only way it makes sense is if they've so convinced themselves of their importance that the mere idea that government can step in and fix a mess is a violation of their collective sense of self-worth. They have profited astronomically since 2008 by, essentially, blackmailing the government with the threat of wrecking the economy.
Remember the "too big to fail" rhetoric being spewed about the big financial institutions? Who let them get that big? And did they get smaller post-crisis? What you see here is the result of an institutional takeover of political power by banks. Banks have given themselves the power to literally write or veto legislation. That has to stop or this crisis will just keep happening, over and over and over.
edited 3rd May '12 7:38:21 AM by Fighteer
"It's Occam's Shuriken! If the answer is elusive, never rule out ninjas!"