The dangers of debt

The two authors of the newly released book “House of Debt,” Princeton University economist Atif Mian and University of Chicago economist Amir Sufi, will discuss their findings at an event today in downtown DC. Much of the attention to the book has been due to Mian and Sufi’s argument that the failure to sufficiently help underwater homeowners was a large reason for the severity of the Great Recession and the slow recovery from it. The argument, powerful on its own, has been given even more attention as “House of Debt” was released just two weeks after the publication of former Secretary Treasury Tim Geithner’s memoirs, in which Geithner defends the policy response to the financial crisis.

The debate about the proper response is a vital one, but focusing solely on that aspect of the book sells “House of Debt” short. Mian and Sufi present a powerful argument against debt and our economy’s overreliance on it. As the economists point out, debt is the anti-insurance. Debt amplifies economic shocks, making households, countries, and firms more economically fragile.

Throughout the book, Mian and Sufi give examples of ways we use debt that could be made more like equity and rely less on debt. Student debt, a topic of frequent conversation these days, is one example. The authors argue that student loans could be replaced by agreements to repay the investor with a fixed share of the student’s income every year. This repayment system would insure that students who fall on hard times wouldn’t be overwhelmed with debt payments.

The authors even speculate that sovereign debt could be amended so that repayment is based on a country’s gross domestic product. Given the connection between sovereign borrowing and declines in consumption in the Eurozone, Mian and Sufi may well be onto something.

Other work has shown how our banking sector is too reliant on debt financing. “The Bankers’ New Clothes” by economists Anat Admati of Stanford University and Martin Hellwig of the Max Planck Institute is a powerful argument for requiring financial firms to use more financing from their earnings or the stock market than through borrowing. The banks of the pre-crisis era were so fragile and toppled so easily because they were highly leveraged.

Of course, debt shouldn’t be abolished. Lending is a necessary and important part of our economy. But overreliance on debt threatens economic stability and prosperity. How and where we pull back on debt is a question we need to answer soon.

May 29, 2014


Credit & Debt

Connect with us!

Explore the Equitable Growth network of experts around the country and get answers to today's most pressing questions!

Get in Touch