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I did not set out to be an economist. In college at the University of Chicago I never took a course in economics or went anywhere near its business school. My interest lay in music and the history of culture. When I left for New York City in 1961, it was to work in publishing along these lines. I had worked served as an assistant to Jerry Kaplan at the Free Press in Chicago, and thought of setting out on my own when the Hungarian literary critic George Lukacs assigned me the English-language rights to his writings. Then, in 1962 when Leon Trotsky’s widow, Natalia Sedova died, Max Shachtman, executor of her estate, assigned me the rights to Trotsky’s writings and archive. But I was unable to interest any house in backing their publication. My future turned out not to lie in publishing other peoples’ work.
My life already had changed abruptly in a single evening. My best friend from Chicago had urged that I look up Terence McCarthy, the father of one of his schoolmates. Terence was a former economist for General Electric and also the author of the “Forgash Plan.” Named for Florida Senator Morris Forgash, it proposed a World Bank for Economic Acceleration with an alternative policy to the existing World Bank – lending in domestic currency for land reform and greater self-sufficiency in food instead of plantation export crops.
My first evening’s visit with him transfixed me with two ideas that have become my life’s work. First was his almost poetic description of the flow of funds through the economic system. He explained why most financial crises historically occurred in the autumn when the crops were moved. Shifts in the Midwestern water level or climatic disruptions in other countries caused periodic droughts, which led to crop failures and drains on the banking system, forcing banks to call in their loans. Finance, natural resources and industry were parts of an interconnected system much like astronomy – and to me, an aesthetic thing of beauty. But unlike astronomical cycles, the mathematics of compound interest leads economies inevitably into a debt crash, because the financial system expands faster than the underlying economy, overburdening it with debt so that crises grow increasingly severe. Economies are torn apart by breaks in the chain of payments.
That very evening I decided to become an economist. Soon I enrolled in graduate study and sought work on Wall Street, which was the only practical way to see how economies really functioned. For the next twenty years, Terence and I spoke about an hour a day on current economic events. He had translated A History of Economic Doctrines: From the Physiocrats to Adam Smith, the first English-language version of Marx’s Theories of Surplus Value – which itself was the first real history of economic thought. For starters, he told me to read all the books in its bibliography – the Physiocrats, John Locke, Adam Smith, David Ricardo, Thomas Malthus, John Stuart Mill and so forth.
The topics that most interested me – and the focus of this book – were not taught at New York University where I took my graduate economics degrees. In fact, they are not taught in any
university departments: the dynamics of debt, and how the pattern of bank lending inflates land prices, or national income accounting and the rising share absorbed by rent extraction in the Finance, Insurance and Real Estate (FIRE) sector. There was only one way to learn how to analyze these topics: to work for banks. Back in the 1960s there was barely a hint that these trends would become a great financial bubble. But the dynamics were there, and I was fortunate enough to be hired to chart them.
My first job was as mundane as could be imagined: an economist for the Savings Banks Trust Company. No longer existing, it had been created by New York’s then-127 savings banks (now also extinct, having been grabbed, privatized and emptied out by commercial bankers). I was hired to write up how savings accrued interest and were recycled into new mortgage loans. My graphs of this savings upsweep looked like Hokusai’s “Wave,” but with a pulse spiking like a cardiogram every three months on the day quarterly dividends were credited.
The rise in savings was lent to homebuyers, helping fuel the post-World War II price rise for housing. This was viewed as a seemingly endless engine of prosperity endowing a middle class with rising net worth. The more banks lend, the higher prices rise for the real estate being bought on credit. And the more prices rise, the more banks are willing to lend – as long as more people keep joining what looks like a perpetual motion wealthcreating machine.
The process works only as long as incomes are rising. Few people notice that most of their rising income is being paid for housing. They feel that they are saving – and getting richer by paying for an investment that will grow. At least, that is what worked for sixty years after World War II ended in 1945.
But bubbles always burst, because they are financed with debt, which expands like a chain letter for the economy as a whole. Mortgage debt service absorbs more and more of the rental value of real estate, and of homeowners’ income as new buyers take on more debt to buy homes that are rising in price.
Tracking the upsweep of savings and the debt-financed rise in housing prices turned out to be the best way to understand how most “paper wealth” has been created (or at least inflated) over the past century. Yet despite the fact that the economy’s largest asset is real estate – and is both the main asset and largest debt for most families – the analysis of land rent and property valuation did not even appear in the courses that I was taught in the evenings working toward my economics PhD.
When I finished my studies in 1964, I joined Chase Manhattan’s economic research department as its balance-of-payments economist. It was proved another fortunate on-the-job training experience, because the only way to learn about the topic was to work for a bank or government statistical agency. My first task was to forecast the balance of payments of Argentina, Brazil and Chile. The starting point was their export earnings and other foreign exchange receipts, which served as were a measure of how much revenue might be paid as debt service on new borrowings from U.S. banks.
Just as mortgage lenders view rental income as a flow to be turned into payment of interest, international banks view the hard-currency earnings of foreign countries as potential revenue to be capitalized into loans and paid as interest. The implicit aim of bank marketing departments – and of creditors in general – is to attach the entire economic surplus for payment of debt service.
I soon found that the Latin American countries I analyzed were fully “loaned up.” There were no more hard-currency inflows available to extract as interest on new loans or bond issues. In fact, there was capital flight. These countries could only pay what they already owed if their banks (or the International Monetary Fund) lent them the money to pay the rising flow of interest charges. This is how loans to sovereign governments were rolled over through the 1970s.
Their foreign debts mounted up at compound interest, an exponential growth that laid the ground for the crash that occurred in 1982 when Mexico announced that it couldn’t pay. In this respect, lending to Third World governments anticipated the real estate bubble that would crash in 2008. Except that Third World debts were written down in the 1980s (via Brady bonds), unlike mortgage debts.
My most important learning experience at Chase was to develop an accounting format to analyze the balance of payments of the U.S. oil industry. Standard Oil executives walked me through the contrast between economic statistics and reality. They explained how using “flags of convenience” in Liberia and Panama enabled them to avoid paying income taxes either in the producing or consuming countries by giving the illusion that no profits were being made. The key was “transfer pricing.” Shipping affiliates in these tax-avoidance centers bought crude oil at low prices from Near Eastern or Venezuelan branches where oil was produced. These shipping and banking centers – which had no tax on profits – then sold this oil at marked-up prices to refineries in Europe or elsewhere. The transfer prices were set high enough so as not to leave any profit to be declared.
In balance-of-payments terms, every dollar spent by the oil industry abroad was returned to the U.S. economy in only 18 months. My report was placed on the desks of every U.S. senator and congressman, and got the oil industry exempted from President Lyndon Johnson’s balance-of-payments controls imposed during the Vietnam War.
My last task at Chase dovetailed into the dollar problem. I was asked to estimate the volume of criminal savings going to Switzerland and other hideouts. The State Department had asked Chase and other banks to establish Caribbean branches to attract money from drug dealers, smugglers and their kin into dollar assets to support the dollar as foreign military outflows escalated. Congress helped by not imposing the 15 percent withholding tax on Treasury bond interest. My calculations showed that the most important factors in determining exchange rates were neither trade nor direct investment, but “errors and omissions,” a euphemism for “hot money.” Nobody is more “liquid” or “hot” than drug dealers and public officials embezzling their country’s export earnings. The U.S. Treasury and State Department sought to provide a safe haven for their takings, as a desperate means of offsetting the balance-of-payments cost of U.S. military spending.
In 1968 I extended my payments-flow analysis to cover the U.S. economy as a whole, working on a year’s project for the (now defunct) accounting firm of Arthur Andersen. My charts revealed that the U.S. payments deficit was entirely military in character throughout the 1960s. The private sector – foreign trade and investment – was exactly in balance, year after year, and “foreign aid” actually produced a dollar surplus (and was required to do so under U.S. law).
My monograph prompted an invitation to speak to the graduate economics faculty of the New School in 1969, where it turned out they needed someone to teach international trade and finance. I was offered the job immediately after my lecture. Having never taken a course in this subject at NYU, I thought teaching would be the best way to learn what academic theory had to say about it.
I quickly discovered that of all the subdisciplines of economics, international trade theory was the silliest. Gunboats and military spending make no appearance in this theorizing, nor do the all-important “errors and omissions,” capital flight, smuggling, or fictitious transfer pricing for tax avoidance. These elisions are needed to steer trade theory toward the perverse and destructive conclusion that any country can pay any amount of debt, simply by lowering wages enough to pay creditors. All that seems to be needed is sufficient devaluation (what mainly is devalued is the cost of local labor), or lowering wages by labor market “reforms” and austerity programs. This theory has been proved false everywhere it has been applied, but it remains the essence of IMF orthodoxy.
Academic monetary theory is even worse. Milton Friedman’s “Chicago School” relates the money supply only to commodity prices and wages, not to asset prices for real estate, stocks and bonds. It pretends that money and credit are lent to business for investment in capital goods and new hiring, not to buy real estate, stocks and bonds. There is little attempt to take into account the debt service that must be paid on this credit, diverting spending away from consumer goods and tangible capital goods. So I found academic theory to be the reverse of how the world actually works. None of my professors had enough real-world experience in banking or Wall Street to notice.
I spent three years at the New School developing an analysis of why the global economy is polarizing rather than converging. I found that “mercantilist” economic theories already in the 18th century were ahead of today’s mainstream in many ways. I also saw how much more clearly early economists recognized the problems of governments (or others) relying on creditors for policy advice. As Adam Smith explained, a creditor of the public, considered merely as such, has no interest in the good condition of any particular portion of land, or in the good management of any particular portion of capital stock. … He has no inspection of it. He can have no care about it. Its ruin may in some cases be unknown to him, and cannot directly affect him.
The bondholders’ interest is solely to extricate as much as they can as quickly as possible with little concern for the social devastation they cause. Yet they have managed to sell the idea that sovereign nations as well as individuals have a moral obligation to pay debts, even to act on behalf of creditors instead of their domestic populations.
My warning that Third World countries would not to be able to pay their debts disturbed the department’s chairman, Robert Heilbroner. Finding the idea unthinkable, he complained that my emphasis on financial overhead was distracting students from the key form of exploitation: that of wage labor by its employers. Not even the Marxist teachers he hired paid much attention to interest, debt or rent extraction.
I found a similar left-wing aversion to dealing with debt problems when I was invited to meetings at the Institute for Policy Studies in Washington. When I expressed my interest in preparing the ground for cancellation of Third World debts, IPS co-director Marcus Raskin said that he thought this was too far off the wall for them to back. (It took another decade, until 1982, for Mexico to trigger the Latin American “debt bomb” by announcing its above-noted inability to pay.)
In 1972 I published my first major book, Super Imperialism: The Economic Strategy of American Empire, explaining how taking the U.S. dollar off gold in 1971 left only U.S. Treasury debt as the basis for global reserves. The balance-of-payments deficit stemming from foreign military spending pumped dollars abroad. These ended up in the hands of central banks that recycled them to the United States by buying Treasury securities – which in turn financed the domestic budget deficit. This gives the U.S. economy a unique free financial ride. It is able to self-finance its deficits seemingly ad infinitum. The balance-of-payments deficit actually ended up financing the domestic budget deficit for many years. The post-gold international financial system obliged foreign countries to finance U.S. military spending, whether or not they supported it.
Some of my Wall Street friends helped rescue me from academia to join the think tank world with Herman Kahn at the Hudson Institute. The Defense Department gave the Institute a large contract for me to explain just how the United States was getting this free ride. I also began writing a market newsletter for a Montreal brokerage house, as Wall Street seemed more interested in my flow-of-funds analysis than the Left. In 1979 I wrote Global Fracture: The New International Economic Order, forecasting how U.S. unilateral dominance was leading to a geopolitical split along financial lines, much as the present book’s international chapters describe the strains fracturing today’s world economy.
Later in the decade I became an advisor to the United Nations Institute for Training and Development (UNITAR). My focus here too was to warn that Third World economies could not pay their foreign debts. Most of these loans were taken on to subsidize trade dependency, not restructure economies to enable them to pay. IMF “structural adjustment” austerity programs – of the type now being imposed across the Eurozone – make the debt situation worse, by raising interest rates and taxes on labor, cutting pensions and social welfare spending, and selling off the public infrastructure (especially banking, water and mineral rights, communications and transportation) to rent-seeking monopolists. This kind of “adjustment” puts the class war back in business, on an international scale.
The capstone of the UNITAR project was a 1980 meeting in Mexico hosted by its former president Luis Echeverria. A fight broke out over my insistence that Third World debtors soon would have to default. Although Wall Street bankers usually see the handwriting on the wall, their lobbyists insist that all debts can be paid, so that they can blame countries for not “tightening their belts.” Banks have a self-interest in denying the obvious problems of paying “capital transfers” in hard currency. My experience with this kind of bank-sponsored junk economics infecting public agencies inspired me to start compiling a history of how societies through the ages have handled their debt problems. It took me about a year to sketch the history of debt crises as far back as classical Greece and Rome, as well as the Biblical background of the Jubilee Year. But then I began to unearth a prehistory of debt practices going back to Sumer in the third millennium BC. The material was widely scattered through the literature, as no history of this formative Near Eastern genesis of Western economic civilization had been written.
It took me until 1984 to reconstruct how interest-bearing debt first came into being – in the temples and palaces, not among individuals bartering. Most debts were owed to these large public institutions or their collectors, which is why rulers were able to cancel debts so frequently: They were cancelling debts owed to themselves, to prevent disruption of their economies. I showed my findings to some of my academic colleagues, and the upshot was that I was invited to become a research fellow in Babylonian economic history at Harvard’s Peabody Museum (its anthropology and archaeology department).
Meanwhile, I continued consulting for financial clients. In 1999, Scudder, Stevens & Clark hired me to help establish the world’s first sovereign bond fund. I was told that inasmuch as I was known as “Dr. Doom” when it came to Third World debts, if its managing directors could convince me that these countries would continue to pay their debts for at least five years, the firm would set up a self-terminating fund of that length. This became the first sovereign wealth fund – an offshore fund registered in the Dutch West Indies and traded on the London Stock Exchange.
New lending to Latin America had stopped, leaving debtor countries so desperate for funds that Argentine and Brazilian dollar bonds were yielding 45 percent annual interest, and Mexican medium-term tessobonos over 22 percent. Yet attempts to sell the fund’s shares to U.S. and European investors failed. The shares were sold in Buenos Aires and San Paolo, mainly to the elites who held the high-yielding dollar bonds of their countries in offshore accounts. This showed us that the financial managers would indeed keep paying their governments’ foreign debts, as long as they were paying themselves as “Yankee bondholders” offshore. The Scudder fund achieved the world’s second highest-ranking rate of return in 1990.
During these years I made proposals to mainstream publishers to write a book warning about how the bubble was going to crash. They told me that this was like telling people that good sex would stop at an early age. Couldn’t I put a good-news spin [on the dark forecast] and tell readers how they could get rich from the coming crash? I concluded that most of the public is interested in understanding a great crash only after it occurs, not during the run-up when good returns are to be made. Being Dr. Doom regarding debt was like being a premature anti-fascist.
So I decided to focus on my historical research instead, and in March 1990 presented my first paper summarizing three findings that were as radical anthropologically as anything I had written in economics. Mainstream economics was still in the thrall of an individualistic “Austrian” ideology speculating that charging interest was a universal phenomena dating from Paleolithic individuals advancing cattle, seeds or money to other individuals. But I found that the first, and by far the major creditors were the temples and palaces of Bronze Age Mesopotamia, not private individuals acting on their own. Charging a set rate of interest seems to have diffused from Mesopotamia to classical Greece and Rome around the 8th century BC. The rate of interest in each region was not based on productivity, but was set purely by simplicity for calculation in the local system of fractional arithmetic: 1/60th per month in Mesopotamia, and later 1/10th per year for Greece and 1/12th for Rome.
Today these ideas are accepted within the assyriological and archaeological disciplines. In 2012, David Graeber’s Debt: The First Five Thousand Years tied together the various strands of my reconstruction of the early evolution of debt and its frequent cancellation. In the early 1990s I had tried to write my own summary, but was unable to convince publishers that the Near Eastern tradition of Biblical debt cancellations was firmly grounded. Two decades ago economic historians and even many Biblical scholars thought that the Jubilee Year was merely a literary creation, a utopian escape from practical reality. I encountered a wall of cognitive dissonance at the thought that the practice was attested to in increasingly detailed Clean Slate proclamations.
Each region had its own word for such proclamations: Sumerian amargi, meaning a return to the “mother” (ama) condition, a world in balance; Babylonian misharum, as well as andurarum, from which Judea borrowed as deror, and Hurrian shudutu. Egypt’s Rosetta Stone refers to this tradition of amnesty for debts and for liberating exiles and prisoners. Instead of a sanctity of debt, what was sacred was the regular cancellation of agrarian debts and freeing of bondservants in order to preserve social balance. Such amnesties were not destabilizing, but were essential to preserving social and economic stability.
To gain the support of the assyriological and archaeological professions, Harvard and some donor foundations helped me establish the Institute for the Study of Long-term Economic Trends (ISLET). Our plan was to hold a series of meetings every two or three years to trace the origins of economic enterprise and its privatization, land tenure, debt and money. Our first meeting was held in New York in 1984 on privatization in the ancient Near East and classical antiquity. Today, two decades later, we have published five volumes rewriting the early economic history of Western civilization. Because of their contrast with today’s pro-creditor rules – and the success of a mixed private/public economy – I make frequent references in this book to how earlier societies resolved their debt problems in contrast with how today’s world is letting debt polarize and enervate economies.
By the mid-1990s a more realistic modern financial theory was being developed by Hyman Minsky and his associates, first at the Levy Institute at Bard College and later at the University of Missouri at Kansas City (UMKC). I became a research associate at Levy writing on real estate and finance, and soon joined Randy Wray, Stephanie Kelton and others who were invited to set up an economics curriculum in Modern Monetary Theory (MMT) at UMKC. For the past twenty years our aim has been to show the steps needed to avoid the unemployment and vast transfer of property from debtors to creditors that is tearing economies apart today.
I presented my basic financial model in Kansas City in 2004, with a chart that I repeated in my May 2006 cover story for Harper’s. The Financial Times reproduced the chart in crediting me with [as] being one of the eight economists to forecast the 2008 crash. But my aim was not merely to predict it. Everyone except economists saw it coming. My chart explained the exponential financial dynamics that make crashes inevitable. I subsequently wrote a series of op-eds for the Financial Times dealing with Latvia and Iceland as dress rehearsals for the rest of Europe and the United States.
The disabling force of debt was recognized more clearly in the 18th and 19th centuries (not to mention four thousand years ago in the Bronze Age). This has led pro-creditor economists to exclude the history of economic thought from the curriculum. Mainstream economics has become blindly pro-creditor, pro-austerity (that is, anti-labor) and anti-government (except for insisting on the need for taxpayer bailouts of the largest banks and savers). Yet it has captured Congressional policy, universities and the mass media to broadcast a false map of how economies work. So most people see reality as written by the One Percent, and it is a travesty of reality.
Spouting ostensible free market ideology, the pro-creditor mainstream rejects what the classical economic reformers actually wrote. One is left to choose between central planning by a public bureaucracy, or even more centralized planning by Wall Street’s financial bureaucracy. The middle ground of a mixed public/private economy has been all but forgotten, denounced as “socialism.” Yet every successful economy in history has been a mixed economy.
This essay is excerpted from the introduction to Killing the Host.
Michael Hudson’s new book, Killing the Host is published in e-format by CounterPunch Books and in print by Islet. He can be reached via his website, [email protected]
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I’d submit that every successful economy in history has also been a classical ethnic nation-state with generally homogenous, conservative preferences. Multi-national empires and, I’d submit, democratic republics, inevitably end up with a rent-seeking class that proceeds to steal everything not nailed down and requires debt and currency devaluation to stay afloat.
The German Democratic Republic doesn’t even have a minimum wage, but seemed to have a strong social contract with its workers: take care of the institutions, and the institutions will take care of you. That contract has been unilaterally breached, with German business dreaming of cheap labor from the Middle East and Africa. The Reagan Era (which, as a conservative, pains me to admit) ushered in much the same model in the US. We have become the world’s flophouse for 320M atomized strangers.
A lot of hard lessons are about to be re-learned, by everybody on the spectrum from Marxism to Austrian school.
I’ve always wondered how people in Mesopotamia managed to get credit in the time leading up to a jubilee. Who would be loaning money if the debts will soon be forgiven? I know “read my book” lol, but maybe you could give me a hint
That financial dynamics create booms and busts is not new.
What was “new” was (still is for some) the widely accepted belief that human beings could be manipulated and trained to be homo economicus, a contented being living in a stable world run by wise men at the top. This belief could only be supported by the denial of human nature.
Financial dynamics are rooted in human nature. By denying human nature the wise men at the top have created the most interconnected, fragile (non-robust) bubble the world has ever known. Bubbles there have always been, but in the past the natural system was more dispersed and therefore robust than our globalized world today.
Billions of people live completely insulated from nature and natural systems. They have no hope for survival except the persistence of the systems supported by the bubble.
When this bubble bursts there will be no way to keep the systems going except by command.
I’m sure all the powerful “commanders” in the various nations will be able to get along just fine, but if not, “Nature bats last.”
Good stuff.
Quite.
The system is set up in such a way to make it in their immediate interests but doing so kills the economy in the longer term.
Yes, it makes perfect sense as a way of rebooting the economy as excessive debt threatened to kill it.
Interesting how the ancient world figured out a way to ameliorate the problem and unfortunately not surprising how the study of debt has been erased from academia – this is the problem with hiding history.
Classically, the vast majority Third Estate was tended to and “looked after” by the much smaller an d much more prosperous First and Second Estates. We seem to have reverted to this.
” Who would be loaning money if the debts will soon be forgiven? ”
That was the point.
The knowledge that a jubilee would be coming at regular (60 year? 3 generation?) intervals encouraged creditors not to lend near this time. This kept the debt from increasing past the point of servicing and thus preserved the society.
It worked.
excellent article….great insights…
but how can change come about in this environment?
First we have to get people to realize the facts–that the USA controls the world… and the corporations control the USA…why can they control the USA? Because it is too big for the people to have any effect…also the population is too diverse to unite…large and diverse is a recipe for pseudo-democracy.
Bring power back to the states via an article 5 constitutional convention of the state legislatures.
The idea is that with careful analysis of somebodies ability to pay you don’t need something like a recurring jubilee to curtail lending. The problem is that has been abandoned for political and other reasons. The US government wanted Latin America in debt. Wall Street wanted to buy mortgages when there were no good borrowers left. The government wanted to buy votes with cheap loans.
When I bought my house as an engineer with 3 years experience and rising salary I still needed to get my Dad to cosign on an FHA backed loan on a dump that was worth about 2.75 times my salary. Now they bring in a mirror to see if you are still alive.
The system worked reasonably well for 50 years but you eventually run out of people with the capacity to borrow while the money piles up in the banks. In the 80s that money was put to use lending on unnecessary commercial real estate and junk bonds (many who promptly defaulted).
As the author of this piece notes – the countries he analyzed had no ability to safely pay back those loans and they were made anyway.
They recently re-instated the minimum wage, for better or worse.
” The middle ground of a mixed public/private economy has been all but forgotten, denounced as “socialism.” Yet every successful economy in history has been a mixed economy.”
Please cite examples of long term ‘successful mixed public/private economies’.
The problem is that once governments get their hands on anything, especially parts of the economy, they will without fail expand their power and influence, they will seize more & more through a variety of tactics. The proverbial ‘camel’s nose in the tent’.
It must be considered a law, rather than a theory.
Usually people are not as careful with other people’s money as they are with their own. “Careful analysis” was more often applied when bankers had their own capital at risk, but even then there was always more risk taken when prospects were good than when it looked like hard times were coming. RISK is inherent in capitalism and no amount of analysis can completely eliminate it. Booms and busts were much more frequent in the 19th century even though capitalists had their own capital at risk.
If you observe human behavior (and allow for the fact that personalities vary within populations for reasons that are beyond manipulation) then it is obvious that when cautious people observe less cautious people profiting from risks, they lower their perception of risk and begin to mimic them (thence Popular Delusions and the Madness of Crowds). The problem being that eventually one depletes the supply of “greater fools” and the bubble bursts leaving the ultimate fools holding the bag.
One does not need a lot of analysis to know that short term risk decreased enormously when the US government adopted a policy of encouraging risk by “stimulating” the economy in 1961. The “risk” of continued growth was transferred to later generations, but it was not a “risk”, it was a certain doom. The identity of the “ultimate fools” in this case is still to be determined, but the future is not looking good for those who placed their trust in continued growth of the economy funding pensions and benefits in the style we are presently enjoying (I was born in 1946). It is too close to call for whether or not I will outlive the “good times”.
It would be interesting to know whether or not “jubilees” were ever practiced for any length of time (or at all), but, given human nature, the free market alternative is the business cycle with all the suffering that busts bring with them. Growth creates instability, the greater and faster the growth, the greater the following instability.
“Curtailing lending” as you have observed is the course of any prudent lender with his own capital at risk, but the guy left holding the bag when a bubble bursts takes ruinous losses. The pains of those losses prompted the founding of the Federal Reserve, which at its heart was an attempt to override human nature.
My point is that “careful analysis” sufficient to prevent booms and busts (or a cry for a jubilee) does not agree with a “careful analysis” of human nature (IMO).
It is interesting that you miss the most important element of banking: banks create loans which creates deposits. Money is created out of thin air. The banks only obligation is to make sure the loan gets paid i.e. they need to back the money they make.
Money is literally debt. One of the strongest effects of this is that new debt MUST be created to fund interest that is going to come due. The debt does not have to be to the same borrower but the system as a whole must grow.
Why isn’t modern bankruptcy a more flexible and sophisticated way of achieving the jubilee relief?
Mortgages on homes which were carefully controlled because the GMAs would only accept conforming loans were not a problem until the private mortgages companies started making loans outside of those restrictions. Commercial real estate loans were not a problem until S&Ls were allowed in and the usual restrictions of having the principals have 20-30% of their own money in and signed lease contracts were thrown away.
There is plenty of data on how to do things right. That people don’t do things right is another issue.
Modern bankruptcy especially at the corporate level has actually made things worse. If you have ever been a senior secured bondholder going through a chapter 11 where the principals get another chance to screw you again you would know.
First they find some brokerage to float some bonds. You buy them because supposedly you are the senior secured bondholder and likely to get back 90% or more of your money in bankruptcy. While the corporation is operating the principals are doing everything they can to enrich their private lives. In to BK you go. A judge allows debtor in possession financing to provide the extra money to keep the corporation going. After the reorg you are no longer in the senior secured position those providing the financing in BK are. Maybe they give you 20% of your money in the reorg. Rinse and repeat until all the bondholders are wiped out.
I am sure there are more details that a finance guy would know but this is the bottom line of what happens and this is why I don’t blame Trump for his bankruptcies – everybody using OPM is in on the scam.
Yes a system where all mortgages get sold to a government department and you are required by law to have a corporate job (what we have now) is a clearly superior system than allowing private mortgages.
Right now you can have perfect credit, 90% down and you will get denied a loan if you don’t have two years of tax returns that a government bureaucrat has decided is the right amount. You will get denied by EVERY bank – this loan is not legal under Dodd Frank. In other words, someone that statistically has a fraction of one percent chance of defaulting is locked out of the mortgage market. Someone with an awful corporate job scraping by on $50k a year, however, can get a loan with a tiny down payment any day of the week.
I am not sure, but you seem to be arguing that there is, or was, some way to waltz this camel through the eye of the needle. I will argue that when you point to the mortgage “crisis” you are pointing at an effect, not a cause. Once this nation set out on a course of a credit fueled expansion the arc of graph linked below was set in stone until the final collapse (of which we are in the early stages).
https://research.stlouisfed.org/fred2/graph/?id=TCMDO,
The link will not support added data, but if you scroll down to the “ADD DATA SERIES” button and type “Gross Domestic Product” you can see that the rate of debt expansion dwarfs the rate of “growth” of GDP (whether you select “chain linked” billions or not).
If you examine the debt growth since the recent crisis you will see the basis for Paul Krugman’s argument that the Fed needs to have expanded its balance sheet by $16 trillion, he wants to keep the party going. He also admires the Chinese Communist Party and their management of China’s economy.
I agree with Mr. Krugman that if we do not continue the expansion we are headed for disaster, I just do not believe that the disaster can be averted.
In the 1950s the FED was dominated by skinflint banker types typified by the statement of Wm. McChesney Martin’s dictum, “My job is to take a way the punch bowl just as the party gets going.” That ended in the ’60s as the FED came under more and more political pressure, culminating in the passage of the Humphrey Hawkins Act in 1973 which was privately understood to be a “shot across the bow” of the FED.
JFK faced a recession in 1961 and he famously “jawboned” the Steel Industry, but much less well known is that he pressured the FED to ease up – thus began the slippery slope. At every turn since then politicians, both Republican and Democrat, have blinked every time nature started to take its course and logic would dictate that bankers decline to renew loans. And every time we have edged a little farther up and out on the limb.
The mortgage debacle was not different in kind from the ongoing immigration debacle, just another attempt to keep nature from taking its course.
The critical point is understanding that money lending for consumption is inherently damaging.
Yes, with lots of careful regulation you can prevent it destroying an economy in a decade but as soon as that regulation is removed the economy will go off a cliff because of money lending for consumptions’ internal logic.
1. To make a profit a money lender has to extract more than they put in i.e. money-lending for consumption is inherently deflationary.
Not at first – at first people are spending more than they have because of the loans (hence the boom) but for the money lender to make a profit then over time they *must* extract more than they put in (hence the bust).
2. If everyone’s income goes on a mixture of necessities and discretionary spending then in theory the bank’s maximum profit will be at the point where every penny of discretionary spending is being used to pay back previous loans.
Except it won’t because well before that point the economy would have collapsed from the lack of discretionary spending.
#
In a nutshell – if unrestrained the internal logic of money lending leads to guaranteed economic destruction.
Mr Hudson,
A very interesting and timely article on the model of economics that you studied and researched, perhaps best described as Institutional Economics. MMT certainly updated a great deal, especially its critiques of RBC models. What I discern from my own background, which is only indirectly related to traditional economics (I studied derivatives and computation), is that there has been a sort of muddled thinking in economics, primarily emanating from Chicago and then rapidly spreading elsewhere, with the central and ridiculous notion that perfect wage flexibility will lead to automatic market clearing. Of course that never happens. As a conclusion it is the detritus that remains when a wilful ignorance of precisely what you wrote is substituted by mindless application of “elegant” mathematics.
While I certainly am a fan of Institutional Economics and its insights as applicable when an economy is operating at or tolerably near some equilibrium (pardon the expression for the lack of a better), I cannot think of any prescriptive model during sharp and prolonged deviations from equilibrium – for example the Great Depression 1929-39 and the Great recession 2008-2012) – that can outperform the dynamic models with their pedigree in Hicks-Keynes-Samuleson, updated by Mankiw-Krugman-Blanchard.
So therefore I passionately believe what is wanting in the modern context is a serious merger of Institutional economic rules and parameters with the prescriptive actions of the NK models.
I am afraid the pure Chicago Modigliani-Lucas-Sargent models have failed miserably time and again to yield any hopes of usefulness, but their political favour, inexplicably, seems to enjoy the resilience of teflon!
Yes a system where all mortgages get sold to a government department and you are required by law to have a corporate job (what we have now) is a clearly superior system than allowing private mortgages.
Why do people like you always resort to making stuff up and mischaracterizing everything somebody says? Nobody was forced to make conforming loans. There were also jumbo loans, usually at a higher interest rate. However the GMAs only bought conforming loans which had to have the necessary documentation and fall withing the necessary income to payment ratios that were deemed to make the loan highly unlikely to default. The banks had to find somebody else to buy their jumbo loans or hold them to maturity.
I am arguing that years of data on successful loan payoffs show exactly what is needed to determine beforehand if a loan is likely to be paid off or not. As long as we stuck to those standards we didn’t have a problem. Of course, not many loans got made.
woah. this is about as good as it gets. spot on.
The critical point is understanding that money lending for consumption is inherently damaging.
What do you mean by consumption? Is a car consumption in today’s world, is a TV, is a musical instrument? A lot of consumption is about making life something other than the drudgery it was for the lower classes in ages past. It isn’t the financing of consumption that is the problem it is the willingness of people to lend for consumption that can never realistically be paid back. People used to have to bring in pay stubs to get financing on a lousy 200 dollar stereo, now they just sign their name.
Probably because people like me actually lend their own money in the private mortgage market and know the reality of the market. You quite literally have no idea how the market currently operates but think you are qualified to offer an opinion.
Dodd Frank requires exactly what I said it does. Instead of trying to be right on an internet forum (with limited and wrong information) I would suggest you put that energy into finding out how the law works.
On the plus side, people like you are my customers so I really shouldn’t be annoyed. The same kind of brain power goes into understanding what you are signing when you get a mortgage.
Therein lies the rub.
Say an individual’s productivity is on a scale of 1-10 and a person has a maximum potential productivity of 7 but they live in a town where the only jobs available to them have a productivity of 6. In that case loaning them money for a car that allows them to get a productivity 7 job in the next town is actually (human) capital investment.
In other cases a loan for a new(er) car is consumption.
Money-lending for production i.e. that leads to increased productivity may be *net* benign because even though the money-lender still has to extract more than they put in the increase in overall productivity caused by the loan *may* outweigh it.
Another grey case for example might be mortgage lending which insists on 10% deposits. Again the money lending part will be inherently deflationary because the lender has to extract more than they put in but if all those forced savings are plowed into local business investment the *net* result might still be benign.
etc
The base line though must be the recognition that money-lending for consumption is *inherently* damaging.
It is not inherently or necessarily deflationary, inflationary or price neutral. There is for any individual, a consumption model which she smooths over her lifetime. Note that it does not require an individual to explicitly model or plan. It is an aggregative outcome.
Second, Consumption and Investment are simply related, with Investment being the integral of all future consumption. Thus the creditors’ profits are either invested or available for current consumption. Here, only the rate of consumption plus Investment if unmatched by the rate of money supply growth, will result in inflation or deflation.
Regulation is obviously important, and its withdrawal or absence in not a failure of the model but that of the political architecture.
Again, this obtains if lifetime consumption for the aggregate is not smoothed. This smoothing does not require a complete absence of volatility around mean consumption. There will be volatility, but its reversion to the mean can be aided by a combination of fiscal and monetary policy, acting as ballasts or shock absorbers. Simply put the overall production function of the economy needs to operate within well specified parameters of Aggregate Demand. If the natural rate of interest charged on credit is bounded by the growth rate of income achieved by the mean representative, then economic collapse need not occur, and when episodes of volatility emerge, policy mechanism and regulations are indicated, not a rejection of the model.
A modern economy, engaged beyond ordinary consumption and investment, deeply rooted in research and development cannot exist without a functioning credit model, for savings and therefore the credit we generate, is precisely what facilitates R&D; a polemicist might observe that in the absence of credit we should be reduced to a more or less static, non-developing, non-discovering, non-inventing, even foraging society.
It is a pleasure to see in these pages, someone I agree with entirely on matters economic, especially as they relate to mortgages and credit growth vis-a-vis the growth of output. Many others are simply drawing from the hip with limited study, ergo understanding.
In full agreement. People need to read and understand Dodd Frank.
Hi Sam it always amazes me that people have such fixed ideas in areas where they don’t have expertise.
Dodd Frank not getting the difference between non standard income and low/no deposit and non standard income and a high deposit is a mammoth flaw. People with high deposits have incredibly low default rates.
yup, skin in the game being key over non-standard income.
your posts are blowing smoke
respond with meaningful and logical counter-arguments for you sound like a nitwit caught in a vacuum.
1. To make a profit a money lender must extract more than they put in.
Yes or No?
2. In theory a money lender would be making maximum profit when all discretionary income in the economy is repaying loans.
Yes or No?
I would encourage you to read the lifetime investment-consumption models. The two “points” that you proffer are similar to statements such as “Gluttony is injurious to health. Yes or No?” So they are trivially correct. What matters are rates of growth of things such as income, consumption, rate of interest and savings. Which is what I said in paragraph #2 and beyond of https://www.unz.com/mhudson/bubbles-always-burst/#comment-1169341
Your argument is a bit of a tautology, but even so it omits an important variable, which is one of the points I am trying to make – the economic environment in which the loans are made usually determines the credit worthiness of the borrower.
For the last 50 years the economic environment has been an expansion based on exponentially increasing debt (see the chart I referenced at the Federal Reserve FRED site). I don’t think that even Paul Krugman believes this can go on forever.
Far beyond mortgages that can not be paid off when the expansion stops there are pensions, Social Security, trillions in business debts, millions of jobs, labor contracts, and the whole “way of life” they support. All of this has been built on the expansion of credit at an expanding rate.
You argue that “careful analysis” would avoid the problem. I (and thousands of economists) argue that accurate analysis cannot be done once unsustainable credit expansion distorts the environment.
Once again, the extending of mortgages to less credit worthy borrowers was an effect, not a cause. It was a desperate attempt to keep the expansion going.
So you mean that a law passed in 2010 is what cause the mortgage bubble that burst in 2008. Is that the intelligence you are talking about? How does that in any way have to do with what were considered conforming loans?
Once again, the extending of mortgages to less credit worthy borrowers was an effect, not a cause. It was a desperate attempt to keep the expansion going.
Really, only by your claim that endless expansion was necessary. We used to have what were called recessions when people stopped lending and asset prices dived and bad loans got cleared out and things improved after awhile. Then a bunch of idiots called economists thought they could fix all this. Each time they fixed it they dug a deeper hole.
If Greenspan had let the country have a recession after the 1987 stock market crash then 3 years of lending on commercial real estate and junk bonds would not have happened and the 1990 S&L crisis would have been far weaker and the RTC might not have been needed which gave the wealthy another chance to enrich themselves at taxpayer expense and required even more “liquidity”.
I have discussed only the current market. Even skim reading what I wrote would make that obvious. This has reached the “Never argue with a fool…” stage so you are welcome to attack points I make without any fear of a response going forward.
I will reiterate, however, that I lend my own money in the private mortgage market and have a very large incentive to make sure I know what the reality of the market is.
“Really, only by your claim that endless expansion was necessary.”
What we have here is failure to communicate, either that or you are switching sides.
I’ll go you one better than 1987: when Nixon closed the gold window in 1971 he had an obvious choice of defending the dollar (and causing a deep recession) or continuing the expansion. There has been no recession since the 1950’s that was anything more than a blip on the screen as debt continued on its expansion.
I have not argued that endless expansion is necessary, only that once begun it can only end in pain and the longer it continues the worse it will be. What I have argued is that by the time of the mortgage debacle (which you argued was the cause of our trouble) it was already too late.
Did you even read the quote from Von Mises? Can you understand it? Did you look at the Federal Reserve data?
I see, I am the fool because you responded to me first with some blather which you claim is about today yet never mentioned that and I am supposed to have divined that due to your superior intelligence alone? Where did I even mention I was talking about specifically today in my original post?
I am not switching sides only making the claim that IF you stick to strict lending standards and IF you stick to strict standards on lending institutions you don’t need anything like a jubilee. These are easily determined by the long history we have of successful banking. That is it. You guys are the ones reading all this other irrelevant stuff into it.
All of our present problems are due to government or private individuals thinking they were somehow smarter than history and, unfortunately for the rest of us, had people in high places willing to offload their losses onto us in the name of “saving the system”.
Bankers made the decision to give what they thought was a no-cost sweetener to home buyers in the 60s – assumable mortgages. With no inflation who would ever assume somebody else’s mortgage and take on a high interest short term second for the difference?
Government with prodding from the S&L industry cut the premiums S&Ls paid to the FSLIC when it seemed it was more than adequately funded.
By Carter’s time money market funds and assumable mortgages were killing the S&L industry. It was estimated that 15 billion was needed to wind the industry down and clean out all the insolvent S&Ls.
The S&L industry was basically mom and pop thrifts with each S&L being a few branches mostly in one congressional district and a large source of campaign funds for House members.
They kicked the can down the road and let S&Ls take on more risk by lending on more than just houses and small apartment blocks.
That wasn’t fixing the problem and Reagan gave them more rope but he also starved the regulatory agencies making sure the thrifts were solvent.
Crooks moved in and started making bad loans or loans to themselves if they were developers. The FSLIC fund was soon depleted. Rather than go to Congress for money to wind the industry down the FSLIC started negotiating with solvent thrifts in places like California to take over the dogs in places like Texas and Florida and gave them special regulatory treatment – they could count their “goodwill” as capital reserves.
By the time of the collapse that should have occurred in 1987, but was delayed to 1990 by Greenspan, major money center banks were also on the ropes. Congress renigged on those regulatory treatments making previously solvent California S&Ls insolvent overnight.
The RTC was created to allow wealthy people to buy real estate from the government for 40 cents on the dollar (well that is not how it was advertised).
This is how you keep digging the hole deeper. Giving away assumable mortgages was something that is basically blameless – who would know that inflation was going to flare up like that? However, not having the courage to do what was economically necessary is what caused the real problems and let the problem grow like cancer.
There have always been booms and busts and there have always been some bankers/financiers who were less prudent than others. This is a normal environment.
When government decides to “stimulate’ the economy it favors the risk takers. In addition to changes in behavior, conservative banks have been swallowed up by more speculative banks and conservative companies have been swallowed up by companies that take more risk.
The changed business/banking behavior is an effect, the cause is government stimulus. Banks have enriched themselves taking risk because government was backing their play – this was rational behavior. Banks that stuck to strict standards got swallowed up or crowded out.
Your statement above is a tautology. To quote Wikipedia on the word, a tautology (in rhetoric) is “a self-reinforcing pretense of significant truth”.
While blaming the sociopaths clamoring to occupy the top rungs of the social/financial/political ladder is attractive, I think de la Boetie’s “Discourses” five centuries ago reveals that it is consent of the members of a society that underlies all systems.
People today are maniacally optimistic, so people are chosen and institutions arise to given them what they want, even if what they want is phenomenally self- and socially-destructive. “Extraordinary Popular Delusions and the Madness of Crowds” was published over 170 years ago. Nothing has changed.
Robert Prechter’s Socionomic hypothesis offers an intriguing explanation for the increasingly foolish social actions we see all around us (economics and finance being but two of a larger field of follies.) From saturation-level propaganda mainstreaming relatively rare personal deviance to a total repudiation of honest money, and the embrace of socialist-democracy’s collectivism to the widespread fad of donning tattoos like press-and-peel decals, high time preference is so pervasive that we don’t even notice adults living in the Perpetual Now, a condition we used to associate only with small children.
Socionomics posits that social action emanates from social mood, and social mood rises and falls in a fractal pattern elucidated by R.N. Elliott in the 1930’s and 1940’s. It further postulates that within that pattern, the final “wave” occurs amidst a backdrop of less-parallel fundamentals, i.e., the final upwave in a rally has weaker underpinnings. The graphically astounding asset value rally since 1974/1982 came amidst the greatest buildup of credit and debt (AKA monetary debasement) in recorded history even as measures of social health (e.g., stable families, good jobs, wise stewardship of politics, industry and even civilization itself) plunged.
In essence, the collective human experience follows a natural cycle and the Socionomic Hypothesis provides an explanation for why our current situation exists. Decades from now it’s likely that attitudes toward credit and debt will have returned to those that existed in the early 19th century, and a new set of problems/opportunities will beset human societies. Only dead things don’t change.
There is serious reason to question if the current regime has the consent of a reasonable plurality/majority of members. There is no doubt that a majority of the populace believed/believes that old cultural norms were unfair with regard to “minorities” (African-Americans/Negroes whatever). The current system of favoritism to same is far from universally accepted. There is a counter-current in play in this regard.
Another counter-current is in regard to dependence on the larger society for one’s survival. Hard-core survivalists are a minority, but the number of people who question our (US) government’s ability to provide succor is quite large.
I disagree. What I find is a pervasive sense of foreboding. The maniacal optimism one sees is more like the actions of a school of fish in a net, thrashing to one side or the other in hopes of escaping. Yes, it takes a strong sense of hope for the opportunity of escape, but hope is neither belief nor optimism.
If one measures against the 1950s in the US you have an argument, but most of human history has been pretty bleak. What we have lost is the willingness to hold up standards towards which the people should strive.
No doubt there are cycles, but the population peak we seem to be approaching speaks of something more profound, not like that which has gone before.
JMO
http://www.merriam-webster.com/dictionary/tautology
You need a new definition. From this I don’t see the redundancy in stating that if you do one, you don’t need the other.
That is a one-liner for one definition. If you follow the link several lines below to the Encyclopedia Britannica you get the following:
From Wikipedia one gets:
Your logic boils down to the fact that if you don’t loan money to people who are likely to default then you won’t have as many defaults. That is certainly true in a limited sense, but sheds no light on the larger subject.
It is akin to “if a frog had wings he wouldn’t bump his ass every time he hopped”.
You get the same result with a monopolistic capitalist, or even in a “Private / Public Partnership.
Differences are in the cost of capital. Governments can always borrow for less as they have the power to tax, so are always lower risk borrowers. This makes their marginal costs much lower and the profit maximizing point where marginal cost meets marginal revenues, is moved sharply in favor of consumers (they will produce more “goods and services”).
You also have a governance issue. Consumers can revoke a politician’s mandate but not that of a dumb or obnoxious entrepreneur where only money talks.
If politicians depend on money to get elected this skews the results…
Your mileage might vary.