NY Review of Books May 9, 2013
The Debt We Shouldn’t Pay
Robert Kuttner
Debt: The First 5,000 Years
by David Graeber
Melville House, 534 pp., $32.00; $22.00 (paper)
At the heart of the argument about how to revive a depressed economy is
the question of debt. When political leaders and economists debate the
subject, they refer mostly to public debt. To conservatives, the
economy’s capacity for recovery is impaired by too much government
borrowing. These escalating obligations, they claim, will be passed
along to our children and grandchildren, leaving America a poorer
country. Liberal economists, such as Paul Krugman and Joseph Stiglitz,
have replied that only faster growth rates and higher gross domestic
product will reduce the relative weight of past debts. Budget austerity,
in their view, will shrink demand and slow growth, making the debt
burden that much heavier.
As important as this debate is, there’s something missing. Public debt
was not implicated in the collapse of 2008, nor is it retarding the
recovery today. Enlarged government deficits were the consequence of the
financial crash, not the cause.1 Indeed, there’s a strong case that
government deficits are keeping a weak economy out of deeper recession.
When Congress raised taxes in January at an annual rate of over $180
billion to avoid the so-called fiscal cliff, and then accepted a
“sequester” of $85 billion in spending cuts in March, the combined
fiscal contraction cut economic growth for 2013 about in half, according
to the Congressional Budget Office. Moreover, some of the causes of
public deficits, such as Medicare, reflect to a large extent
inefficiency and inflation in health care rather than profligacy in
public budgeting.
It was private speculative debts—exotic mortgage bonds financed by
short-term borrowing at very high costs—that produced the crisis of
2008. The burden of private debts continues to hobble the economy’s
potential. In the decade prior to the collapse of 2008, private debts
grew at more than triple the rate of increase of the public debt. In 22
percent of America’s homes with mortgages, the debt exceeds the value of
the house. Young adults begin economic life saddled with student debt
that recently reached a trillion dollars, limiting their purchasing
power. Middle-class families use debt as a substitute for wages and
salaries that have lagged behind the cost of living. This private debt
overhang, far more than the obsessively debated question of public debt,
retards the recovery.
The debt debate is reminiscent of Tom Stoppard’s Rosencrantz and
Guildenstern Are Dead. In a grand inversion, minor characters have
usurped center stage, while the more important ones are out of sight.
The quarrel about public debts is really a proxy for the argument about
how to produce a strong recovery. To that end, we should be discussing
how to relieve the burdens of private debts and prevent future abuses of
the power of the financial industry to create debt and engage in
speculation.
As the economic anthropologist David Graeber shows in his encyclopedic
survey, Debt: The First 5,000 Years, since antiquity
the struggle between rich and poor has largely taken the form of
conflicts between creditors and debtors—of arguments about the rights
and wrongs of interest payments, debt peonage, amnesty, repossession,
restitution, the sequestering of sheep, the seizing of vineyards, and
the selling of debtors’ children into slavery.
He quotes the classical historian Moses Finley as saying that in the
ancient world all revolutionary movements had a single program: “Cancel
the debts and redistribute the land.”
Despite the implications of Graeber’s history for events since 2008, the
present economic distress scarcely figures in his book. Rather, he has
written an authoritative account of the background to the recent crisis.
Both erudite and impertinent, his book helps illuminate the omissions of
the current debate and the tacit political conflicts that lurk behind
technical budget questions.
Graeber, an American teaching at Goldsmiths, a part of the University of
London, begins his book with an anecdote. He is attending a garden party
at Westminster Abbey. The guests are international activists and
do-gooders, corporate liberals as well as antiglobalization radicals. He
falls into a conversation with a lawyer for a foundation and explains
his involvement in the campaign to stop the International Monetary Fund
from imposing austerity on third-world nations. He mentions the biblical
Jubilee, in which Hebrew kings periodically proclaimed debts forgiven.
“‘But,’ she objected, as if this were self-evident, ‘they’d borrowed the
money! Surely one has to pay one’s debts.’”
Graeber reminds her that even in standard economic theory, “a lender is
supposed to accept a certain degree of risk.” Indeed, the higher the
anticipated return, the more likely the danger of default. Yet the
premise that “surely one has to pay one’s debts” is so persuasive,
Graeber writes, “because it’s not actually an economic statement: it’s a
moral statement.” A debt, by definition, is something you owe that must
be repaid.
In Graeber’s exhaustive, engaging, and occasionally exasperating book,
three themes stand out. One is the “profound moral confusion” in our
understanding of debt. A second is the perennial struggle over debt
forgiveness, and who receives it. A third is the function of debt in the
politics of social class and social control.
Despite extensive scholarly efforts to find an example, Graeber reports,
there is no historical evidence of an actual primitive economy that ran
on barter. Why is he making this point? In fact, two thousand years
before kings began minting coins, there was credit. Before paper,
accounts were kept on clay tablets. Landowners gave peasants provisions
on promise of repayment. And where there is credit, there is of course
debt. What appears to be a random excursion sets up a central discussion
about debt and reciprocal obligation.
Graeber observes that debt is often conflated with sin. The version of
the Lord’s Prayer drawn from Matthew (used by most Protestant
denominations) asks God to forgive us our “debts,” while most
translations of Luke (and the Catholic liturgy) ask forgiveness for our
“trespasses” or “sins.” Graeber notes that in modern German, the same
word, Schuld, means both debt and guilt. Likewise in several ancient
languages. In market terms, he writes, a debt is “an exchange that has
not been brought to completion.” One party received the goods; the other
is owed a payment. To fail to honor a debt, therefore, is to be in a
condition of guilt on both moral and economic grounds.
But though individual failure to repay a debt is considered ethically
abhorrent, there are times when sound economics requires debt
forgiveness. In the case of a broad downturn,2 debt ceases to be purely
a moral question, and becomes a pragmatic one: Will it help the overall
economy for the law to demand that debts always be paid in full? Was it
economically sensible to throw debtors into jail? Is it sensible now to
force troubled corporations or banks to liquidate? To compel sales of
millions of homes in a depressed market? To destroy the economic
potential of entire nations so that they can service old debts that were
incurred corruptly by previous governments or banks? Society properly
discourages borrowers from taking on imprudent burdens, and the
prospective loss of property or even liberty functions as a deterrent.
But in a general collapse, debt forgiveness may become necessary if the
economy is not to sink further.
My own research explores a pivotal event in the history of debt—the
invention of modern bankruptcy, in 1706, by ministers of Queen Anne.
Before 1706, bankruptcy simply meant insolvency, and the bankrupt was
packed off to debtors’ prison. It dawned on the reformers of the day
that this practice was economically irrational. As the legal historian
of bankruptcy Bruce Mann wrote, “it beggared debtors without
significantly benefiting creditors.”3 Once behind bars, a debtor had no
means of resuming productive economic life, much less satisfying his
debts. In this insight was the germ of Chapter 11 of the modern US
bankruptcy code, the provision that allows an insolvent corporation to
write off old debts and have a fresh start as a going concern.
The British devised the concept of legal discharge from debt not out of
a sudden attack of compassion but because the economic crisis of the
1690s had put much of the merchant class in jail. The cause was not
improvident or immoral behavior on the part of debtors, but general
economic dislocation beyond their control, caused by the confluence of
bubonic plague, recent wars with France, and a storm that devastated the
merchant fleet in 1703. The future novelist Daniel Defoe was a leading
pamphleteer promoting the idea that debtors might settle with creditors
at so many pence to the pound and then have their debts legally
discharged. Defoe had himself spent some months in debtors’ prison in
1692 and 1693.
But when the law was finally enacted, allowing a magistrate to settle
debts with partial repayment, only substantial merchants could qualify
for relief. Common debtors still languished in jail, since their penury
had scant wider consequences. Yet an important conceptual breakthrough
had occurred. Canceling some debts was deemed economically efficient.
Legal historians such as Bruce Mann have observed that, for capitalism
to proceed, it was necessary to shift the economic thinking and legal
policy governing debt from moral questions to instrumental ones.
Modern macroeconomics—the deliberate manipulation of interest rates and
public deficits to smooth out cycles of boom and bust—dates only to the
1930s. But long before there was macroeconomics, there was the option of
debt relief. In the first decade of the eighteenth century, British
leaders did not comprehend that public borrowing and spending could be
useful counterweights to private business slumps. But the government
grasped that if the commercial class was kept in jail, the economy would
collapse.
The struggles over what was called “the money issue” in
nineteenth-century America were also about the terms of credit and debt.
Farmers and artisans thrived when credit was plentiful; they suffered
when financial panics caused bankers and merchants to call in loans and
thus shrink the money supply. One remedy for credit scarcity was a
central bank that could make more money available, but popular mistrust
of concentrated wealth delayed creation of one for more than a century.
When the Federal Reserve was at last legislated in 1913 after a
succession of financial panics, Congress put it under the control of
commercial bankers. Not until the Great Depression and the Franklin
Roosevelt era did the US government became serious about debt relief,
with a series of policies that refinanced distressed home mortgages,
reformed and recapitalized banks, extended relief to bankrupt consumers,
financed a huge war debt at below-market interest rates, and wrote off
some of the international debts of allies and enemies alike. (Britain,
America’s closest ally, received near-total forgiveness of wartime
Lend-Lease debt.)
Germany, today’s enforcer of Euro-austerity, was the beneficiary of one
of history’s most magnanimous acts of debt amnesty in 1948. The Allies
in the 1920s made the catastrophic error of helping to destroy Germany’s
economy with reparations and debt collection policies. In the 1940s,
after a brief flirtation with World War I–style reparations, the
occupying powers agreed to behave differently: they wrote off 93 percent
of the Nazi-era debt and postponed collection of other debts for nearly
half a century. So Germany, whose debt-to-GDP ratio in 1939 was 675
percent, had a debt load of about 12 percent in the early 1950s—far less
than that of the victorious Allies—helping to produce postwar Germany’s
economic miracle. Almost every German can cite the Marshall Plan, but
this larger act of macroeconomic mercy has disappeared from the
political consciousness of Germany’s current austerity police. Whatever
fiscal sins the Greeks committed, the Nazis did worse.
The debt write-offs of the 1930s in the US and the 1940s in Germany were
a short-lived interlude in a long history in which debt politics as
applied to common people usually favored creditors. From biblical times
through the nineteenth century, debt peonage—a state of servitude in
which the debtor is stripped of rights—and debtors’ prisons were more
the norm. The question of who gets debt relief reflects the distribution
of political power—and power normally lies with large creditors such as
banks. The Roosevelt era stands out as an exception.
kuttner_2-0509143.jpg
Library of Congress
A sign in Birmingham, Alabama, during the Great Depression, 1937;
photograph by Arthur Rothstein from The Bitter Years: Edward Steichen
and the Farm Security Administration Photographs, published recently by
D.A.P./Distributed Art Publishers
The double standard in debt relief that favored large merchants, present
at the creation of bankruptcy law in 1706, persists today in many
different forms. It gets surprisingly little attention in the debt
debates. Despite the tacit assumption that “surely one has to pay one’s
debts,” the evasion of repayment is both widespread and selective.
Corporate executives routinely walk away from their debts via Chapter 11
of the national bankruptcy law when that seems expedient. Morality
scarcely enters the conversation—this is strictly business.
Even more galling is the fact that the executives who drove the company
into the ground often keep control by means of a doctrine known as
debtor-in- possession. A judge simply permits the company to write off
old debts, while creditors collect so many cents on the dollar out of
available assets. Every major airline has now been through bankruptcy,
and US Airways has gone in and out of Chapter 11 twice. In this process,
all creditors are not created equal. Since banks typically have liens on
the aircraft, bankers get paid ahead of others. Major losers are
employees and retirees, since Chapter 11 allows a corporation to break a
labor contact or reduce pension debts. Shareholders also lose, but by
the time bankruptcy is declared, the company’s share value has usually
dwindled to almost nothing. Much of the private equity industry uses the
strategy of acquiring a company, taking it into bankruptcy, thus
shedding its debts, and then cashing in on its subsequent profitability.
Despite the misleading term private “equity,” tax-deductible private
debt is the essence of this industry, which relies heavily on borrowed
money to finance its takeovers.
Homeowners, however, are explicitly prohibited from using the bankruptcy
code to reduce their outstanding mortgage debt. White House legislation
proposed in 2009 would have allowed a judge to reduce the principal on a
home mortgage, as part of the effort to contain the economic crisis.
Congress rejected the measure after extensive lobbying by the financial
industry. Consumers may use bankruptcy to shed other debts, but a
revision of the law signed by President Bush in 2005 subjects most
bankrupt consumers to partial repayment requirements, while bankrupt
corporations get a general discharge from their debts. Thanks to the
influence of the same financial lobby, the rules of student debt provide
that the obligations of a college loan follow a borrower to the grave.
Nor is there Chapter 11 for nations. The “relief” provided by the
European Union or the IMF typically takes the form of additional loans
that the debtor nation uses to pay interest on old debts. The government
ends up deeper in debt. Ireland, with low public debt levels in 2008,
became in effect a ward of Brussels because the Irish state assumed the
debts of insolvent Irish banks that had irresponsibly funded bad debt.
The European authorities used a similar double standard in the case of
Cyprus, condemning ordinary savers to lose up to 60 percent of their
assets, in order to pay for the speculative sins of financiers.
Large banks, meanwhile, have benefited from extensive debt forgiveness
thanks to governments. In the fall of 2008, every major US bank was on
the verge of insolvency because banks had recklessly incurred debts to
finance speculative investments, often using derivative instruments such
as credit default swaps that had been created by the same group of large
banks. When their debts overwhelmed their assets, the government did not
permit these banks to fail (except for Lehman Brothers), or even to use
Chapter 11 (which would have wiped out shareholders). Government simply
made the banks whole, through the Troubled Asset Relief Program (TARP).
The Federal Reserve has continued relief through extensive purchases of
dubious bonds from banks. The entire economy gains from the stimulus to
demand, but bankers who would otherwise lose their jobs are the
immediate beneficiaries.
Despite the shift in the thinking about debt from a purely moral
question to at least partly an instrumental one where business is
concerned, the earlier emphasis on sin lingers when it comes to common
debtors. Proposals for debt relief for homeowners, college graduates, or
Greece encounter resistance cloaked in the language of moral opprobrium
and “moral hazard,” the danger that debt relief will reward and thus
induce reckless behavior.
Public policy remains stymied on the question of how to clean up the two
large, now nationalized entities that hold or underwrite most of
America’s mortgages, Fannie Mae and Freddie Mac. The answer is not to
conclude that the United States put too much faith in home ownership,
which remains a fine way for the nonrich to accumulate financial equity.
The original Federal National Mortgage Association (FNMA), nicknamed
Fannie Mae, was a public entity. It used government borrowing to
purchase mortgages and replenish the working capital of lenders. Public
FNMA had no scandals, and when it was working effectively, from its
founding in 1938 to its privatization in 1969, the US rate of home
ownership rose from about 40 percent to over 64 percent. The trouble
began when Wall Street invented complex, exotic, and easily corrupted
mortgage bonds, and private Fannie began purchasing high-risk mortgages
in order to protect its market share. The remedy is to restore Fannie to
a public institution with high lending standards, not to kill it.
Thanks to a small number of insurgent voices and evidence from Europe
and the US about the negative effects of austerity policies, the double
standards of debt relief are beginning to command skeptical attention.
Stiglitz and Krugman, both Nobel laureates, have long questioned the
prevailing assumptions about the wisdom of austerity, and they have
lately been joined by more orthodox economists.
Carmen M. Reinhart and Kenneth S. Rogoff, whose 2009 book, This Time Is
Different: Eight Centuries of Financial Folly, was reviewed in these
pages by Krugman and Robin Wells,4 are best known for demonstrating that
the most severe downturns of the entire economy typically follow
financial crashes. In passing, This Time Is Different mentioned a
provocative concept, “financial repression.” The idea was that when debt
is strangling an economy, it may make sense to hold down interest rates,
and let inflation decrease debt, or otherwise constrain financial
burdens on families and companies to help the rest of the economy
realize its potential. The Federal Reserve, under Ben Bernanke, has kept
interest rates exceptionally low, incurring criticism that it is risking
inflation. Rogoff, formerly chief economist of the IMF, goes further. He
would have the Fed deliberately set as a target an inflation rate of 4
or 5 percent as an open strategy of reducing debt burdens by inflating
them away, an idea that horrifies the bond market.
kuttner_3-0509143.jpg
Lauren Greenfield/Institute
A street in California’s Inland Empire, east of Los Angeles, in 2009,
where the number of houses facing foreclosure was so high that the area
was nicknamed ‘Foreclosure Alley’
Reinhart, in a subsequent paper co-written in 2011 with M. Belen
Sbrancia,5 reviewed the experience between 1945 and 1980, and found that
there had been continuing financial repression. Real interest rates
(i.e., adjusted for inflation), they calculated, were negative on
average for the entire period, helping to “liquidate” public debt,
partly because the Federal Reserve had a policy of financing the large
expenditures of World War II at low costs. During the same era, tight
regulation limited speculation by large financial institutions and other
investors, so that cheap credit could flow to the real economy without
inviting financial bubbles. The 1933 Glass-Steagall Act, for example,
prohibited commercial banks from underwriting or trading securities. Yet
despite a controlled bond market whose investors suffered negative
returns of -3 to -4 percent, the years between 1945 and 1980 were the
era of the greatest boom ever.
These findings defy a core precept of conservative economics, the
premise that economic growth requires financial investors to be richly
rewarded, an idea disparaged by critics as trickle-down economics. The
postwar era, by contrast, was an age of trickle-up. Some creditors lost
in the short run, but broadly shared prosperity stimulated private
business. Eventually, the rising tide lifted even the yachts.
Another former IMF official, Anne O. Krueger, an appointee of George W.
Bush, recently reiterated her call for Chapter 11 bankruptcy for
indebted countries. When she first proposed the idea as deputy managing
director of the IMF in 2002, Krueger was fairly shouted down by
officials of the US Treasury and leading bankers. In January 2013, she
argued that “a clear mechanism [to allow nations to use bankruptcy]
could have prevented all sorts of problems in the eurozone.” With a
Chapter 11 law, Greece could have written off old debt and used new
borrowing to finance new growth, just like a private corporation. Even
acknowledging past bad behavior (as in the case of many corporate
bankruptcies), a Chapter 11 for countries could sensibly combine
incentives for honest bookkeeping with macroeconomic policies that write
off old debt for the sake of recovery.
The discussion about relief of private indebtedness, however, is still
mostly offstage. The particulars no longer involve the sequestering of
sheep or the seizing of vineyards. But the ten million Americans at risk
of losing their homes to foreclosure, or recent graduates who cannot
qualify for mortgages because of their monthly payments on college
loans, have become modern debt-peons. At the same time entire economies
abroad, indentured to past debts, find themselves in a metaphoric
debtors’ prison where they can neither repay creditors nor resume
productive livelihoods.
These debt traps are not immutable. Government could refinance mortgages
directly using the Treasury’s own low borrowing rate, as was done by
Franklin Roosevelt’s Home Owners’ Loan Corporation. Fannie and Freddie,
remade into true public institutions, could provide the refinancing. The
Obama administration’s existing mortgage relief program, run through
private banks, excludes the most seriously underwater homeowners. The
terms largely prohibit significant reductions in mortgage principal
owed, and these limitations should be liberalized by the administration.
For students, an Obama administration program permits about 1.6 million
of the 37 million college borrowers to finance education costs by paying
a small surcharge on their future income taxes, instead of incurring
debt. This option could be made universal. The group Campus Progress
proposes allowing college debtors, who currently pay an average of
almost 7 percent interest, to refinance their debt at the ten-year
Treasury borrowing rate of about 2 percent. This would save young adults
$14 billion this year alone. The EU could refinance the debts of small,
depressed nations using eurobonds, and the European Central Bank could
make clear that it will buy as much sovereign debt as it takes to defend
government bonds from speculative attacks.
The crack in the intellectual consensus on public and private austerity
is the beginning of a more realistic national debate about debt. But
such debt relief policies are a long way from being enacted. The sheer
political power of creditors and the momentum of the austerity campaign
suggest that more damage to the economy may be done before any large
change takes place.
1 The budget was in surplus as recently as 2001. The Bush tax cuts
and the cost of two wars created new deficits, but these were only about
3 percent of GDP in 2008. ↩
2 The economist Irving Fisher defined a great depression as a
condition of “debt deflation,” in which the value of debts broadly
exceeded the value of their collateral. See Irving Fisher, “The
Debt-Deflation Theory of Great Depressions,” Econometrica, Vol. 1, No. 4
(October 1933). ↩
3 Bruce H. Mann, Republic of Debtors: Bankruptcy in the Age of
American Independence (Harvard University Press, 2002), p. 18. ↩
4 The New York Review, May 13, 2010. ↩
5 Carmen M. Reinhart and S. Belen Sbrancia, “The Liquidation of
Government Debt,” National Bureau of Economic Research Working Paper
16893, March 2011; see www.nber.org/papers/w16893. ↩
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