‘Debt that can’t be paid, won’t be’

The world’s peoples and governments, including us Americans, collectively owe more money than ever can be repaid.  How we got to this point and what it means are the topics of a book I finished reading last week, KILLING THE HOST: How Financial Parasites and Debt Bondage Destroy the Global Economy by Michael Hudson.

Classical economists distinguished between earned and unearned income, between hard-working laborers and merchants and what they called “rentiers,” people who “got rich in their sleep” by collecting income from land or financial assets.

They condemned what they called “rent-seeking,” which was the attempt to set up as toll-keeper for some part of the economy.

A great deal of 18th and 19th century economic thought was devoted to how to shift income away from landlords, monopolists and holders of financial assets, and into the hands of those whose efforts created real wealth.

In his book, economist Michael Hudson told how this distinction came to be forgotten in the 20th century, and what followed.

Operations of finance, insurance and real estate sector of the economy came to be regarded as equivalent to the production of actual goods and services, and the bidding up of prices of financial assets came to be regarded as equivalent to increase in real wealth.

All income came to be regarded as “earned” income.  The result is that more and more of the economy consists of the transfer of wealth from the real economy to the financial sector, but our economic blinkers keep us from seeing it.

There are many ways to increase financial wealth without increasing real wealth.  Corporations that use their profits to buy back stock increase the stock price and enrich shareholders, for example.  But unlike investment in machinery, research and development or new products, stock buybacks do not make the corporation itself more valuable or more viable.  Rather they drain the institution of needed resources.

Leveraged buyouts are a means of enriching investors by loading corporations with debt.  Corporate stock is bought with borrowed money, and then the profits of the corporation go to repaying the debt.   The creditors have a priority claim over the requirements of the company for investment in new machinery, new products and research.  The more solvent the corporation, the more vulnerable it is.

For most of my life, I regarded it as a law of nature that house prices would always go up, and that home ownership was the best investment.  Hudson made me understand that the housing market was supported by a steady increase of federal loan guarantees and easing of mortgage lending requirements.  House prices were inflated by the fact that more and more people took home mortgages, on easier and easier terms, at greater and greater risk.

This process accelerated under Ronald Reagan, and still more under Bill Clinton and George W. Bush.   Wall Street’s prosperity and the income of the super-rich came more and more from extracting wealth from the system, rather than facilitating the creation of new wealth.

As Hudson repeatedly wrote, debt that can’t be paid, won’t be.  The result was the financial crash of 2008.  The question then became who would absorb the loss.

The rational method would have been to write down the debts to what the borrowers could afford to pay, which would have allowed the economy to restart and would have taught lenders and holders of mortgage-backed securities a lesson about prudence.

Instead the Federal Reserve and the U.S. Treasury bailed out the banks and the bond-holders, while allowing foreclosures to proceed.

Much the same story played out in Europe, except that the foreclosures were against whole countries, such as Greece, rather than individuals.

The bulk of Hudson’s book is a detailed but clear description of how the United States and the European Union shielded banks, bond-holders and speculators from loss in the recent financial crisis, at the expense of debtors and the public.

Hudson concluded his book by proposing a series of reforms to make banks and financial institutions the servants rather than the masters of the real economy.  Even though these reforms are mostly sensible and moderate, I think it would take a major political upheaval to enact them.

LINKS

Bubbles Always Burst: the Education of an Economist by Michael Hudson, from the introduction to Killing the Host.

Parasites in the Body Economic: the Disasters of Neoliberalism, an interview of Michael Hudson for Counterpunch Radio.  An excellent summary of the essence of his book.

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Note.  I added a paragraph and a link after posting this.

Tags: Financialization, Killing the Host, MIchael Hudson, Wall Street