James Rickards is a hedge fund manager in New York City and the author ofCurrency Wars: The Making of the Next Global Crisis from Portfolio/Penguin. Follow him on Twitter: @JamesGRickards
It's time for a candid dialogue on one of the most fraught subjects in U.S. economics—debt forgiveness. The country is awash in unpayable debt that acts like an anchor on growth. If creditors insist on repayment in full and if policymakers continue to support creditor demands at taxpayer expense, the current liquidity trap will accelerate its downward spiral. Notions such as "the sanctity of contract" and the "moral obligation" to repay debt are all well and good in normal economic times. Yet, the times are far from normal.
There is no doubt that a well functioning system of credit is the lubricant to the wheels of commerce. Farmers have always needed credit to buy seed and fertilizer, which was repaid at harvest time. Merchants have always used credit to finance inventories and discount receivables. These forms of credit have three things in common. They are self-liquidating, relatively short-term, and provide collateral. Such loans are the essence of banking properly understood.
The conventional view is that debtors have a moral obligation to repay debts under all circumstances and the law is stacked heavily in favor of that view. Bankruptcy is one path to debt relief. However, recent changes by legislatures have made it harder for debtors to be relieved from student loans, underwater mortgages, and unsecured consumer credit. The debtor, it seems, must be run to ground.
Yet, is this the best path toward economic growth? America has always been a country of fresh starts and personal reinvention. In the Oklahoma Dust Bowl of the 1920s, Americans packed up their cars and headed to California where jobs in agriculture were plentiful. In the recession of the late 1980s, thousands of laid off steel and autoworkers headed from Michigan to Texas and Tennessee where new jobs with Dell, IBM, and Japanese transplant factories were opening up. These adjustments took place before computers, credit scores, and profiling of applicants were widespread.
Today the tyranny of credit scores and bank intransigence stands in the way of a fresh start for millions of Americans. Many cannot sell their homes because their mortgages are greater than the home value and banks will not provide relief. Those able to move cannot even get apartments, let alone buy homes, if their credit scores are impaired. Employers increasingly use credit scores as a screening device in the hiring process so that millions of perfectly honest and reliable workers cannot get jobs if they have experienced temporary distress. Our labor system has become more rigid and sclerotic—more like Europe—and will remain so until debt relief and some kind of fresh start on credit scores can be implemented.
Even on moral grounds, it seems difficult to put the entire burden of adjustment on the debtor. For every imprudent debtor there is an overzealous and reckless lender. To suggest that creditor greed for profits and bonuses had nothing to do with the spread of unpayable debt in recent years is naïveté. Even today, banks will not reduce mortgage principal because they want to retain lucrative mortgage servicing fees. This behavior is no less reprehensible than that of the most calculating debtor.
Interestingly this economic problem is not new. In fact, it is ancient. The Bible's book of Leviticus provides that every 50 years all mortgage debt is to be forgiven. This occurrence was called the Jubilee Year. This may seem like a shocking imposition on creditors and a free ride for debtors. Yet, consider the behavioral feedback loops. In the 10th year after the last Jubilee, lenders might lend freely for a 20-year term. By the 45th year it seems likely that long-term credit would have dried up because the lenders were as aware of the coming Jubilee as the debtors. This was a self-regulating system that deleveraged itself before credit bubbles grew out of control and threatened a widespread collapse. It was an orderly deleveraging that seems enlightened in comparison with the disorderly and draconian deleveraging our economy is experiencing today.
It seems unlikely that creditors will voluntarily do the right thing and provide needed debt relief. Yet, by insisting on repayment in full, creditors will find that they increasingly get nothing as the liquidity trap and deleveraging metastasize into a full-fledged general debt repudiation and default.
So far in this crisis, government has facilitated the doomed behavior of creditors by propping up banks with taxpayer funds and propping up asset values with printed money. This levitation act will end with even more disastrous consequences than if the problems had been confronted candidly from the start.
It is not too late for government to do the right thing. Mandatory debt forgiveness in part—a modern Jubilee—for underwater mortgages, student loans, and excessive consumer credit balances would be a tonic for the economy. Many banks would promptly fail which would be a breath of fresh air since they are de facto insolvent already. New banks could be formed readily and some of the failed banks could be reemerge in the IPO market stripped of bad assets. Banking could return to its classic functions while consumers would be chastened into more prudent and sensible behavior. Labor mobility would be restored and wealth inequality would be mitigated.
Some problems are just not as hard as they look. Our post-modern policymakers and economists should take a lesson from the ancient Israelites. It's time for a Jubilee.