As more economists, including Joe Stiglitz, join the chorus reminding us that this recession is not just a normal recession, but a financial contraction, it is worth thinking more fully what that means. We mentioned Ken Rogoff‘s analysis before, but he is by no means alone in pointing out that a major obstacle to recovery during a financial contraction is debt overhang. Total American debt (private and public) is 288% of GDP, Britain’s 495% just tops Japans’ 492%, France, Spain and Italy are in the 300s. Household and non-financial companies, each, in the US are somewhere between 75-100% of GDP. Regardless of how cheap credit is, everyone is stuck with a balance sheet problem, which is why, even though there is lots of cheap credit out there, few want to borrow to invest. That is why the dispute over which best policy instruments would be best is a dispute over how to resolve the balance-sheet problems facing households, businesses, and governments – inflate it away? more stimulus? pray?
As far as it goes, this analysis tells us about one element of a financial contraction. But it does not tell us everything, and a few stories that were somewhat lost in the mix of the debt-ceiling ‘debate’ remind us of some less discussed dimensions. Two stories that caught our eye were, first, a Wall Street Journal article from March reporting the rise of something akin to modern debtors prisons. The second article was the decision to drop or essentially stop criminal investigations into IndyMac Bancorp, New Century Financial Corp and Washington Mutual. What unites these two stories is the way they indicate, in the famous phrase, who can do what to whom.
After all, the balance sheet problem is not just a matter of who is able to pay their debts, but also who is allowed to collect, and at what rate. That is to say, another major feature of a financial contraction is the distributional struggle over whose debts are honored in full, in part, or not at all. This is a major feature of a financial contraction because that contraction involves, on the one hand, a sudden worsening of the ability of debtors to pay, and a sudden increase in creditors wanting their money. This distributional struggle is necessarily mediated by the state, because the claims are all legal claims – debts called in. Though creditors run around screaming about the sanctity of contract, we know that, at a time when the ability to pay is considerably outweighed by current demands on that ability, contracts can and will be renegotiated. But whose, and how?
That is where the real politics comes in, and that is when these random, seemingly unconnected reports start to tell a larger story. Remember, for instance, that Goldman Sachs was made whole, paid back every dollar that A.I.G. owed it, basically via the government bailout of A.I.G. At the time, there were protests indeed. Eliot Spitzer, writing in Slate, made the point:
“But wait a moment, aren’t we in the midst of reopening contracts all over the place to share the burden of this crisis? From raising taxes—income taxes to sales taxes—to properly reopening labor contracts, we are all being asked to pitch in and carry our share of the burden. Workers around the country are being asked to take pay cuts and accept shorter work weeks so that colleagues won’t be laid off. Why can’t Wall Street royalty shoulder some of the burden? Why did Goldman have to get back 100 cents on the dollar? Didn’t we already give Goldman a $25 billion capital infusion, and aren’t they sitting on more than $100 billion in cash? Haven’t we been told recently that they are beginning to come back to fiscal stability? If that is so, couldn’t they have accepted a discount, and couldn’t they have agreed to certain conditions before the AIG dollars—that is, our dollars—flowed?”
The point isn’t that Goldman Sachs stands alone, but rather that there is a whole politics behind the way the balance sheet problem is resolved. The current way seems to be lean hardest on the least well off, right down to the recreation of a modern version of debtors prisons, to lean not very hard on medium-level banks, even those involved in systematic mortgage fraud, and to give the most support to the banks at the top. That is the thread that connects the stories: the current way of managing the debt crisis is to do it in the way that least disturbs the existing class structure.
To put it another way, it is true that the debt overhang is a major problem. But neither creditors nor debtors are a uniform class. A.I.G.’s debt problem was not the same as the average American household’s. Goldmans Sachs’ credit claim was not the same as workers who lost their pensions. This is just another reminder that, for every general economic problem, there is usually more than one way to resolve it, and the choice between them is a matter of political and social power. The United States continues to put the full weight of the state behind not just one of the more economically useless (fiscal austerity + pseudo-inflationary monetary policy) but one of the least equitable approaches – one that will only reinforce the existing lines of political power that produce this outcome in the first place.