In "Stress Test," his recently released memoir, former Treasury Secretary Tim Geithner recounts the pivotal days of late 2008 and early 2009 during which he worked with the Bush and Obama administrations to preserve the global economy and steer the U.S. from the brink of an economic calamity unseen since the worst days of the Great Depression.
Yet while Geithner's book has received plaudits for its forthrightness and candor, his defense of the Wall Street bailouts — and, crucially, his decision not to devote as much time or resources to similarly providing those with underwater mortgages with financial assistance — has been strongly criticized (check here and here, for just two examples).
Salon recently called up one of Geithner's critics, the University of Chicago Booth School of Business' professor Amir Sufi to discuss Geithner, the bailouts and "House of Debt," the new book written by Sufi and co-author professor Atif Mian on how household debt led to the economic calamity of 2008 (among many others) and what we can do to make sure the next economic downturn isn't nearly as devastating to millions of regular people. A lightly edited version of our conversation follows.
So what's the basic argument of "House of Debt"?
We decided to write this book because we, based on our research, came to the conclusion that elevated levels of household debt in combination with a crash in house prices is almost always what sets off very severe economic downturns. This is true for the United States in the Great Recession, it was true for Japan in their lost decade, it was true in the Great Depression in the United States as well. So this book is going through the evidence we’ve built up over the last six or seven years in our academic research, supporting this channel of what causes severe economic downturns, and we tried to write it up in an accessible way. The main reason we decided to write a book for the general public was because we believed an alternative view has become in some sense too powerful, and that is the view that if we save the banks we can save the economy. In that alternative view, severe economic downturns are due to a financial crisis or a banking crisis that makes banks unable to lend, and we just disagree that that is the primary force. We think it’s an important force, but not the primary one, and we really worry because people who subscribe to this banking view automatically think that things like debt write-downs, or debt forgiveness, are a bad idea, because they think it will further harm banks. So they become kind of singularly focused on saving banks even though the core problems really reside in the household sector, and specifically foreclosures and essentially too much debt for households.
I'll be a bit less politic than you are — when you talk about this "alternative view" of the Great Recession and the idea that if we save the banks, the rest will work itself out, you're talking about a frame of analysis most obviously endorsed by former Treasury Secretary Tim Geithner, yes?
Yeah, I agree with that. And what’s interesting is, in the book, we basically don’t ever talk too much directly about Mr. Geithner. I think he’s only mentioned once in the book, in a positive light ... In the last two weeks, his book has been released, and he has been essentially completely unrepentant in his book about housing policy. He’s been very stubborn in some sense, saying — he kind of alternates between two conflicting views. On one hand, he says maybe we should have done more. But on the other hand, he says, "Oh, even if we’d done more on housing it wouldn’t have made any difference." In a lot of our recent writing, we felt like [Geithner's policies on housing debt] had to be addressed because we think the basic facts are wrong in his argument ... I think that his views, as he has written them in his book, really do reflect that singular focus on saving banks at the expense of thinking about other issues that perhaps are more important; and the issue we highlight most is that, essentially, households are drowning in a sea of debt. And if that’s the case, it’s not going to help much saving banks, the economy is still going to crash. And that’s exactly what we saw in the United States, and that’s what we continue to see in Europe.
Stipulating that you're not only not Tim Geithner but that you pretty fundamentally disagree with him on some issues, how do you think he and his supporters would defend their policy choices?
The two arguments that politicians — or policymakers, I should say — tend to make is, first, that [household debt] was an immensely complex issue. It was too complicated. That’s the comment that comes out very forcefully in Mr. Geithner's new book: He calls it an impossibly complex problem. I find that, personally, hard to believe. I think the financial system is also a very complicated problem, and yet they were able to navigate that system to provide funds to equity holders and creditors and banks. The second argument that’s usually made is that it wouldn’t have made a big difference, anyway, had you prevented foreclosures or tried to forgive some debt. And look, I’m a researcher; I live in a world based on trying to demonstrate facts based on solid evidence; and I think that’s what we’ve done in the top peer-reviewed journals in our field. So I have no idea where that argument comes from. To me, it’s demonstrably false in the data.
It doesn't make much sense, intuitively, this idea that if you give money to people with terrible mortgages it won't help them and the economy at large.
I think one of the main facts that we highlight in the book, which seems to be underappreciated by those who adhere to this banking view, is this differential spending propensity of people who are borrowers versus savers. This is a very important point that goes all the way back to Keynes, and we have done research in a variety of settings showing lower-income, more-indebted borrowers tend to have a much higher propensity to spend out of income or wealth shocks; and we highlighted in our piece that we wrote on FiveThirtyEight that that is the main reason the housing crash really led to such a dramatic decline in spending. We contrast that to the tech crash in 2001, and we make the point that the tech crash wiped out significant amounts of wealth of very rich people. And in some sense, [the rich] don’t respond. The analogy I always give in my book talk is: If Bill Gates loses $35,000, he’s not cutting back spending. But if a household who has only $40,000 loses $35,000, they’re going to cut back massively on spending. It’s that distributional issue that’s so key to understand, which I think adherents to this banking view don’t seem to appreciate to the degree that’s in the data and that’s in our book.
So knowing what you do now, if you could go back in time and change Washington's response to the '08 crash, what would you do differently?
We highlight a few proposals in the book. I think it’s useful to start with the general principle before getting into the specifics, and the principle is: You need massive write-downs of household debt. Now how you accomplish that can be a bit tricky, but the things we highlight in the book were, for example, implementation of mortgage cram-down — that is, allowing judges in chapter 13 bankruptcy [cases] to write down mortgage debt in addition to unsecured debt.
Another idea, which is supported by even Glenn Hubbard, who was the economic adviser to presidential nominee Mitt Romney, is ... very aggressively to allow underwater homeowners to refinance into lower interest rates. Their claim — and I think it’s correct — is that in 2008, had you done this very aggressively, you could have had almost 30 million homeowners refinance into much lower interest rates; and it’s hard to find a single economic rationale for not allowing an underwater homeowner who’s solvent on their mortgage from refinancing into a lower rate. It’s hard to find anybody on the political spectrum who thinks that’s a bad idea. And yet it didn’t get done. It’s almost shocking. I don’t know the inner workings of D.C. well enough to know why it didn’t get done. But it didn’t ...
I think it’s really important for people to understand what an outlier our response to the Great Recession was in this regard, with regard to household debt. After the Great Depression, we had the abrogation of the Gold Clause, which was a massive debt write-down. We also had the Homeownership Loan Corporation, which bought up mortgages at face value and then wrote them down. We talk about in the book, the Panic of 1819, one of the first financial panics in United States history, and we showed that, after that panic, state governments immediately imposed a moratorium on debt payments, especially for farmers ... If you look at that episode, it’s quite striking, because the politicians — we even have a quote in the book from a senator from Illinois who basically says, "We know these farmers kind of got out of hand, they got too exuberant and too optimistic; but in some sense we all got caught up in this craziness and we should just forgive them for doing that." And it’s kind of remarkable how different the rhetoric that comes out of Washington, D.C., now is. It’s all the fault of the borrower, we should impose all the losses, we should punish the borrower. That’s very unique from historical circumstances. Something’s different, it seems today, than it was in the past.
Yeah, contrast previous responses to Rick Santelli's infamous freakout.
We kind of draw that [comparison]. We have the Santelli quote in the book, and we don’t explicitly compare those two reactions but I mean, it tells me something, there’s something quite interesting — I don’t know if interesting is the right word — but it tells us something pretty deep about our cultural attitude that perhaps we have less of a problem in bailing out banks than in bailing out our neighbors. I’m kind of an inherent optimist so I don’t believe that’s an innate reaction that we have. Instead, I think that maybe there’s some forces that kind of foment that opinion within people. But it’s hard for me to imagine that I would have more anger toward my neighbor getting bailed out of their mortgage versus a bank, especially since house prices crashed and that really wasn’t the fault of my neighbor.
Well, I tend to be more pessimistically inclined, but I would say that I think your sense that there’s a disconnect here is right. I don't think people have changed how they feel about their fellow neighbors, though; rather, I think the responsiveness of the political system to how people feel has changed ... Anyway, how dramatically would you change the distribution of bailout funds between Wall Street and Main Street, if you could?
The proposal we have in mind in the book is that losses in home values are distributed equally between creditors and debtors, so instead of imposing all of the losses on the homeowner first, you basically evenly split it. That’s kind of the calculation that we do in the book. And we make the argument that the recession would have been far less severe had we had that kind of distribution. I think one thing I want to make clear in terms of just thinking about the banks versus homeowners is: We do believe that there is a role of the government in stabilizing a banking system that is facing a panic and a run. But our main argument is that stabilizing the banking system does not necessarily require you to subsidize equity holders and creditors in banks. What it requires is that you back deposits and you back the payment system, and that’s really our problem with the way banking policy was carried out in the Great Recession ... it seemed to go much further than just protecting the payment system. It seemed to go toward this view of the world where the TARP proponents are saying, "We have to save banks because we need banks to lend more!" And if you just think about it, intuitively, that’s just crazy. We all know that the economy is way over-indebted in 2008, so the notion that we need just for banks to lend more, it just kind of doesn’t even make sense, it doesn’t even pass the smell test in some sense.
Why is it, you think, that banks tend to oppose the kind of remedies you're promoting in the book?
I think the problem is that managers at banks have far too short-term of a focus. They think about the immediate future, so when you propose an idea like, maybe we should have banks write down debt and take a loss on their equity in the short run, I think they immediately resist that — even if it were the case ... that doing so would actually lead to stronger economic growth and therefore health of the bank in the long run. There’s something about that dynamic of focusing so narrowly on the short-term that leads, I think, bankers to oppose any attempt to try to reconsider mortgage contracts. I think another point we make in the book which is very important —
So, just to clarify, you're saying it might be that banks oppose these measures because they're focusing more on their next quarter rather than their next year or even further into the future?
Yeah, exactly. Especially when it comes to the way capital regulation works, they’ll essentially have to take a hit to their equity in the short run, even if in the long-run renegotiation of these mortgages would lead to higher payments. Those higher payments are going to happen over the next five years, whereas the hit to their capital is immediate.
Got it. Anyway, you were saying ...
I think this is very important: We discussed this at length in the book, how securitization led to a situation in which there is no doubt it was harder to renegotiate mortgages than it had been in prior episodes’ declines in house prices. So, in that case, even if the banks — or the servicers who ultimately bought the mortgage-backed securities — even if they wanted to renegotiate the mortgage because they realized it was better to prevent foreclosure, it was very difficult, legally, to do so. And this point has been made very strongly in the academic research ... you see very strongly that this friction was there, it was very difficult to renegotiate, even if you wanted to, because securitization set up this web of interconnections that made it very difficult to manage who owned what, who was for it, who you had to get on board, etc. So that screamed for more government intervention to at least facilitate that renegotiation process, and there were very strong proposals even before the financial crisis.
In terms of the economy today, is over-indebtedness on Main Street still an issue?
One of the big issues that we focused on in the book is student debt, and a lot of the same principles carry through when we think about student debt. Again, our main problem with debt is that it has this asymmetric impact on the debtor: in this case, the student who is just graduating from college. So, for example, we did a blog post detailing all the numbers, but essentially the unemployment rate for students more than doubled when they graduated in 2009 versus 2007; and it simply makes no sense to punish that student with all of these very high-interest payment and high debt burdens when the economy collapsed through no fault of the student. It’s not the students' fault they happen to graduate right in the midst of a severe downturn. I think there’s solid research now showing, mostly coming out of the Federal Reserve Bank of New York, showing that these elevated student debt levels are hurting home buying, they’re hurting car purchases, and that just shows you we need to have policies that automatically forgive debt when we have these massive economic shocks.
Well, I can certainly say that as someone who was in a good chunk of debt after college — and, through a lot of happenstance, was able to mostly get out of it — I have a strong inclination to run 100 miles away from any kind of economic investment that would put me back into debt, even if it's the right move in the medium- or long-term.
That’s exactly the point we make in the book — the way we structure student debt forces young people, who at some point are the most vulnerable given that they haven’t had time to build up assets, to bear a huge amount of aggregate economic risk. That’s just crazy. There’s no one in the world that would write down an economic model that would tell you we should force the most vulnerable people to bear the most aggregate economic risk. So that’s why we think we need to fundamentally rethink the way student debt works.
Does that mean the student debt we have in the economy right now is similar to the household debt in that it's kind of a ticking time-bomb for the economy at large? Or is it more an issue of this debt sort of dragging on the economy and making the recovery weaker than it need be?
I think it’s more just a weight rather than a ticking time-bomb. The big difference between student debt and mortgage debt is that mortgage debt gets written on houses, and so if house prices fall dramatically, you can see skyrocketing default rates. With student debt, you can see skyrocketing default rates if the economy completely collapses again, but that, in my view, is not that likely. Instead, like you said, it acts as a weight for people between the ages of 22 and 35, and that weight is going to remain there for some time. The research ... shows people that graduate in the midst of the severe downturn have persistent, long negative effects on their employment and wages. It’s really quite depressing because what it means is, people who are unlucky enough to graduate in 2009, through no fault of their own, see consequences that last even 15 years later; and what that means is, if we keep forcing these harsh debt contracts on these people, you are going to consistently see them consuming less, purchasing less, and being less likely to save for a car or a home or a washing machine — an investment, as you put it — all of those things are going to weigh on the economy until we resolve this issue.