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:
- Debtors would have their debt level reduced;
- Non-debtors would receive a cash injection;
- The value of bank assets would remain constant, but the distribution would alter with debt-instruments declining in value and cash assets rising;
- Bank income would fall, since debt is an income-earning asset for a bank while cash reserves are not;
- The income flows to asset-backed securities would fall, since a substantial proportion of the debt backing such securities would be paid off; and
- 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.