Tag: Economics

It would be music to the ears of many people who jump out of their beds and lose all their sleep after hearing the word debt. The basic idea that this book promotes is that debt is bad in every context — individual or country — and should be replaced with other financial instruments like stocks. But don’t be surprised if people come up tomorrow and game the stocks!

Coming back to the discussion about this book. It is a fine account of what happened in the last Great Recession and who caused it and how. The reason I am writing this review is because I think it is a good work by mainstream economists who got their hands dirty with real data in trying to understand how the whole episode unfolded.

Although I am going to write about the main hypothesis proposed in the book, that does not take away the joy from reading it because the message lies in the finer details and explanations given by the authors. The authors claim that too much debt was accumulated by low credit score individuals who defaulted in large numbers and kick-started the crisis. Now you would say that there is nothing new with this idea and it has been presented countless times before. But that is the reason you need to get to the details.

The low credit score allowed large numbers of people to accumulate debt in the belief that real estate prices would continue to rise. Everyone was riding on this bubble and making money before large-scale defaults turned everything upside down and sent the system spiralling downhill. But how does default on home loans start this cycle of fall in GDP and large-scale unemployment? The authors argue that the people who borrowed money belonged to the poorest section of society. A fall in house prices and the associated income loss forced these low-income households to cut down on their spending. Once they cut down spending it led to large-scale layoffs, further fuelling this vicious cycle. Now, job losses or mild recessions are nothing new for the economy — but why in this particular case did the normal equilibrium balancing forces not kick in? To know this and understand how the puzzle fits together, it’s better to lay your hands on the book.

Another important dimension that the book covers is about our response to the crisis. Given the huge bailouts to the banks, it makes sense to know whether taxpayers’ money was put to the best possible use. Both households and bankers played their role in fuelling the bubble, but banks being the central pillar of the economy received most of the support both during and after the crisis. There is no doubt that banks should have been saved, but households were almost completely left out. Since household spending fall was one of the primary reasons for prolonged recession and unemployment, could the government have done better by showing some leniency to households? Could the government have done more to alleviate the housing problem?

This brings you to the last part of the book — when after understanding the mechanism, one can argue whether debt is a good instrument or can be replaced by other means. The authors argue that debt puts the entire risk on the borrower instead of spreading it through the economy, unlike other financial instruments like insurance. I think here they take a very extreme step by advocating a completely new system, but this comes from the fact that they understood the problem through the lens of the last recession. Ignoring debt during normal periods can have a large negative impact on the overall economy — something the authors have completely ignored. My takeaway from the last section and this book would be to not relax the credit norms too much and start another bubbly episode. But given that this is just a book, the authors are allowed to voice such opinions!