Debt Forgiveness as Economic Stimulus

Anthony Kammer 

Following up on an earlier piece about the student loan bubble, I wanted to share two graphics that depict the over $550 billion in student loan debt carried by U.S. households.

The first shows 2011 student loan debt relative to 2000 debt.

The second reveals how much faster student loan debt has grown relative to all other household debt. If you look closely, it’s possible to notice that since 2008 Americans have reduced their dependence on credit with the exception of student loans.

With default rates rising, the student loan bubble has gotten a lot of attention in the past few months. The Chronicle recently reported that students are bearing an increasing percentage of university costs. A pieceat the Washington Monthly demonstrated that many of the added costs have come from increased administrative hiring. And a number of other articles have explored how the debt has impacted people in their 20s and 30s. While it’s tempting to debate how the student loan bubble is or is not like the subprime mortgage crisis, I simply want to note that it has the same potential to create political rifts when the debt proves unpayable.

During the debt ceiling debates back in July, Rep. Hansen Clarke (D-MI) proposed a resolution in the House entitled “H.Res. 365 — Expressing the sense of the House of Representatives that Congress should cut the United States’ true debt burden by reducing home mortgage balances, forgiving student loans, and bringing down overall personal debt.” While this bill is just sitting in committee, it seems noteworthy for being one of the only post-crisis bills that acknowledges what’s actually straining the global economic recovery: high levels of private debt.

The political turmoil in Europe, the subprime/foreclosure crisis, and the student loan/unemployment disaster facing the United States all boil down to the same issue. Creditors made a lot of bad, risky loans leading up to the financial crisis in 2008. But rather than take losses for those loans, what we’ve seen across Europe and the U.S. has been an attempt to use the legal system and political pressure to make sure these creditors get 100 cents on the dollar. Borrowers and, in many cases, taxpayers (in the form of austerity programs) have been tapped to make sure that debt does not get written down. In the U.S., politicians have proven more willing to see homeowners foreclosed on than ask banks to start refinancing mortgages, and student loans were made virtually unforgivable in 2005 when the bankruptcy code was amended.

These outcomes are not mandated by economic principles. Rather, they are political choices that reflect a systematic preferencing of creditors over borrowers. They also happen to be economically bad policies. After a bailout and two rounds of quantitative easing, banks have still not resumed the lending necessary to achieve sustained job growth, and politicians need to realize that policies that protect creditor interests at the expense of an over-leveraged population are postponing economic recovery.

With private debt at record high levels, debt relief (whether in mortgage writedowns, loan forgiveness, or some other form) has enormous potential as an economic stimulus. It would free a portion of people’s paychecks to start purchasing again, stimulating demand and creating jobs. And it would keep many others in their homes. As Kenneth Rogoff, a professor of economics at Harvard and former chief economist, recently wrote, “the global economy is badly overleveraged, and there is no quick escape without a scheme to transfer wealth from creditors to debtors, either through defaults, financial repression, or inflation.”

This deleveraging process can happen through austerity and defaults or it can happen through sensible policies that write down debt in ways that can stimulate the economy. David Graeber has written a fantastic book, Debt: The First 5000 Years, that shows how debt has been at the middle of political disputes for all of recorded history. And Bob Kuttner noted quite early in an excellent piece for the American Prospect that debtor-creditor tensions are likely to become far more pronounced and more central to our political debates.  Debt resolution is already threatening the stability of the European Union. The sooner American policymakers realize what the current phase of the financial crisis is really about, the sooner we can devise a coherent response and begin the recovery.

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