Opportunity missed in U.S. bailout?
Sometimes, the aftermath is more devastating than the storm. That is the story of the 2008 financial crisis. It was disastrous at the time, but what has been worse is how long it has lingered. That halting recuperation is why the global economic meltdown is still at the center of the political debate in the Western world.
Much of the discussion is a replay of the familiar battle between the economists John Keynes and Friedrich Hayek: Is the solution stimulus or austerity? Amir Sufi, a professor at the University of Chicago Business School, has been doing provocative research that suggests we should be focusing on a different angle.
The real issue, in Mr. Sufi’s view, is where stimulus dollars should be targeted.
He believes the U.S. government made a costly mistake by focusing on bankers and not homeowners. Mr. Sufi’s argument matters, and not just because there will, inevitably, be another financial crisis. He thinks the intellectual bias that prompted the bailout of Wall Street but not Main Street risks derailing Europe’s recovery, too.
“In my view, excessive levels of household debt were the reason the recession was so severe,” Mr. Sufi told me, speaking by phone from Chicago. “If you look at the spending decline that drove the great recession, that was coming from the households.”
When their mortgages went underwater, Americans stopped buying, and the rest of the economy, which had been driven by consumer spending, sputtered, too. “Households, especially at the bottom, are very sensitive to house prices,” he said. “In 2008 and 2009, they drove the recession. We basically missed the boat.”
Mr. Sufi’s thesis helps to explain one of the mysteries of the U.S. economy today. As a report published this month by Bain and Co. explains, money is cheap and plentiful. Titled “A World Awash in Money,” the Bain analysis argues that one of the defining realities of this decade will be a global “capital glut.” Bain predicts the global capital pool will swell to nearly $1 quadrillion by the end of this decade, creating an ocean of “capital superabundance” 10 times greater than the world’s underlying gross domestic product.
Here’s the puzzle: With so much money sloshing around, why is the recovery so lackluster? In Mr. Sufi’s view, one reason is that not everyone is able to dip into this overflowing capital pool. As he explained in a recent paper: “It could be that there’s a 55-year-old household that had their house price drop by 40 percent and they therefore have no net worth available to them. They were planning on drawing down home equity for retirement, and they find themselves underwater, and they cut back on consumption and they save like crazy. If this describes the world, policy could support the banks with infinite resources and it’s not going to lead to any additional spending by levered households.”
Income inequality is central to this story: The financial crisis has hit poorest households hardest. Mr. Sufi has found that the households in the 90th percentile of net worth distribution have seen almost no decline in their wealth. Meanwhile, households in the middle and at the 25th percentile have experienced “a dramatic reduction in net worth.” That’s because financial assets, which have rebounded strongly, are overwhelmingly owned by households in the 90th percentile. If households in the median and at the 25th percentile have any assets at all, “it’s basically housing assets.”
As Mr. Sufi points out, “given the strong recovery in financial asset prices, but the languishing housing market, we can see why the lower part of the net worth distribution has been hammered in this recession.” The result is constrained consumer spending and a sputtering recovery.
What is more puzzling is why the United States mustered the will to rescue its beleaguered bankers but not its underwater homeowners. One reason is political muscle. Mr. Sufi himself is one of many economists who have shown that lobbying by the financial services industry influences legislation. (That is hardly a shocking finding — bankers are expected to be rational enough to spend lobbying dollars because they work.)
Ideas matter, too. The economist Willem Buiter has argued that what he calls “cognitive capture” helped cause the financial crisis. Regulators, legislators and academics were not on Wall Street’s payroll, but they came to see the world from the bankers’ point of view. “There was very influential academic work on the importance of saving banks. The view that household debt plays an important role in causing financial crises was less prominent,” Mr. Sufi said. “Policy makers can’t just be bought off. They have to see bankers as key to the economy.”
Mr. Sufi thinks it is probably too late to jump-start the U.S. economy by helping its less well-off homeowners. But he believes the United States’ missed opportunity holds an important lesson for Europe. The U.S. mistake, in Mr. Sufi’s view, was to give political priority and financial support to credit-holders — the banks — while ignoring the distress of debt-holders. He thinks Europe is repeating that error.
In Europe, as in the United States, the creditors, led by Germany, have overwhelming political power. But they may be winning a Pyrrhic victory — as in the United States, when debtors are hammered too hard, it is tough for the overall economy to grow.
As it appears in the International Herald Tribune on November 22, 2012.