Michael Hudson: Debt: The Politics and Economics of Restructuring 2/4

all right our next papers by Michael Hudson at the University of Missouri Kansas City when Tom told me that the topic of this session was the politics of restructuring I thought that I was here mainly to talk about the solutions and what to do after the debts are written down after the economy crashes after people see that the they've been on a wrong track for the last few years and realized that there has to be an alternative so I thought that the first session on this program today was going to be about how austerity won't work how it is inherently self-destructing and I could go from there but imagine my surprise when I heard that austerity does work that economies can borrow their way out of debt and that the neoliberal liberal dream of Latvia can be can work for the rest of Europe until all of Europe is plunged into the kind of disaster that Latvia had fortunately we could see it coming and ironically in a David Smith magazine one of my favorites international economy I wrote three years ago about the Latvian situation when what the Europe took a poll and one-third of Latvians of working-age intended to emigrate within the next five years from Latvia because they couldn't pay the debts the World Bank at the time had Latvia and the Baltics at the very top of business friendly nations as you heard what does it mean to be business friendly it had the highest workplace accident rate in Europe the lowest health care the most abusive labor conditions and that was why the Latvians were basically leaving the country so I want to set the stage for the solutions that I have by the defining what much of the problem is and how damaging austerity is it is imposing a huge waste of economic shrinkage right now and it's a waste of labor a lot of waste of production and there's also an enormous redistribution of wealth between creditors and debtors in the last 30 years in the United States the top 1% have doubled their share of the returns to wealth interest dividends rent and capital gains the problem is that the winners are not willing to give up their gains and they are willing to push economies into depression in order to continue the business as usual approach the businesses usual approach means you don't have to change the structure of the economy you can continue where you are as long as you can have the European authorities create their trillion dollars to enable governments to borrow their way out of debt to me that sounds like an oxymoron and they're the internal contradiction is that austerity makes the depths harder to pay a shrinking economy has less tax revenue so it's going to exacerbate the budget deficit which now is used as an excuse for calls to cut back spending which is going to drain even more from the economy adding a tax drain to the to the debt drain so the problem is that if you repay the depths you can't use this income to buy goods and services and so markets shrink and there's a declining spiral so if you don't write down the depths if you keep the debts in place that means the debt overhead as you've just heard in the preceding talk is going to shrink the economies by imposing financial and fiscal austerity and polarizing nations even further between debtors and creditors so the choice that I'm going to outline later in the talk is either you write down debts or you suffer a chronic recession that's much worse than a recession there is no way to recover while you're keeping the present death overhead in place and I'll give you an example from the US statistics in the United States 40% of the American labor budget goes for housing the wage withholding for Social Security and medical care is 15% other debt service credit card student loans is about 10% and other taxes income taxes and sales taxes are 10 to 15% so of the take home budgets of American workers 75% is spent on non goods and services that that means only 25% is available for spending in the market now giving this monthly nut of the paycheck there is no way that I can see that American labor or labor in any financial eyes de Cana me is able to compete with economies that are less financialized that have lower housing costs where the government picks up the infrastructure costs of pensions and schools and basically has a lower cost structure now the problem is of course political and that I think is what our session is supposed to be on political solutions and the problem is that there is no fair solution that everybody gains on you can't grow yourself out of debt when you have a debt burden that is already at today's levels somebody has to lose and as you've seen in the United States the banks have been blocking a solution in the earlier session this morning you had I heard the phrase robbing Peter to pay Paul but the fact is that under today's conditions at least in the United States you're robbing the 99% to pay the 1% as my friends on Occupy Wall Street put it and that's the political setting and the problem is that while that this what you're seeing today and for the last thirty years has turned around and inverted the last eight centuries of legal and economic development in the West ever since the schoolmen of the thirteenth century developed the theory of just price and value theory to ask what is a fair price for bankers to charge and the answer was what is their cost of doing business ever since that the laws have been more and more rewritten to favor the debtors you don't have debtors prisons anymore you have personal bankruptcy laws that free individuals from debt that free corporations from debt but the idea of bank of clean slates has only recently been developed on an economy-wide scale you had it for instance in the brady plan for latin american third-world debt in the 1980s after mexico said that it couldn't pay but right now there is enormous resistance to applying that kind of a right down to today's situation the problem is that not changing not having a debt rate down means debt deflation and the debt deflation means a shrinking economy and if the economic structure has not changed there is no way of getting out of the economic problem that you have and the problem is that there's not only the real problem of the debt overhang that was mentioned there's a problem of economic theory and the illusion that all debts can be paid the illusion that banks lend customers only for projects that are going to enable the customers to actually repay the loans and the bankers make a calculation and calculate what the customer can repay but that's not what happens at all back in the 1960s I was Chase Manhattan banks balance of payments analyst and my job was to focus on the latin-american countries Argentina Brazil and Chile and my job was to calculate how much of a balance of payment surplus they could generate and the idea of the bank marketing department was the entire economic surplus could be used to pay debt service to the seven major American banks and pretty quickly we found out that there wasn't any surplus to pay the banks and there was a the International Department had got very upset because he said look I get promoted for making loans and the real estate guys making all the loans yours telling us that they can't afford to repay and he took it up the David Rockefeller we went across the street to the Federal Reserve Bank and the Federal Reserve Bank said it's an America's interest to make these loans to Latin America Mr Hudson according to your calculations Britain can't afford to repay any more of its debt can it and I said well that's right okay I don't see any way in which it can get the money to repay the debt and the Federal Reserve man said ah but did you take into account the fact that the US Treasury is going to always lend Britain the money to pay we will never let it go down I said well that's from a deus ex machina from outside the system yes you can lend them the money to repay and since David Rockefeller was a very good American citizen he believed in doing what was the government wanted him to do and begin to real own take the lead in lending to Latin America so the problem here is one of the economic models that we use they don't build debt into the economic models Steve Cain tomorrow is going to be talking on that they really don't work the economic surplus into economic models in the sense that the classical economists did they don't look at unproductive credit and they don't distinguish the transfer problem of if you do own debt how do you pay debt in a foreign currency even if you can tax and given them out away as the Germans did in the 1920s how do you convert this domestic currency into the foreign debt to pay the hard currency creditors very very hard so the problem is I have to talk already I want to get into the possible remedies for all of this my faith the basic approach to remedies I think was put forth about 300 years ago in the state of New York when it was still a colony of England and that's something that's still on the books of New York law the fraudulent conveyance principle British sharpies would come over and make loans to they wanted to get in their own hands the rich farmlands of upstate New York they would make loans to farmers more than could be repaid and at that time you could ask for repayment of the debt whenever you wanted so the British creditors would ask for payment before the crop was in so the colony passed the fraudulent conveyance law and that law said that if a lender makes a loan to a debtor that cannot be paid Reeth in the reasonable course of business the loan is declared null and void and canceled now you can imagine how many real estate loans today have been made by the liar's loans the fraudulent loans what proportion of real estate loans are unable to pay when you have one quarter of American real estate in negative equity and you have default rates well the surprising as it may seem the the only modern usage of the fraudulent conveyance law has been on the junk bond takeovers of the 1980s companies defended themselves against corporate raiders by saying wait a minute if you borrow the money to buy our firm and replace equity with debt then you're going to have to carve up the firm outsource the labor downsize and do what Sam Zell did with the Chicago Tribune if you years ago grab the pension fund the ISA employee stock ownership program and use it to pay the creditors so now there's a lawsuit in the Chicago Tribune by the employees against Sam Zell using the fraudulent conveyance principle I think the idea of bringing debts within the ability to pay has to be the guiding principle of any debt restructuring there are also attempts to legislate a reasonable ability to pay under normal circumstances when Sheila Bair was a head of the Federal Deposit Insurance Corporation she had proposed that banks roll back their mortgages to a level where the mortgage and housing costs would absorb 32 percent of the borrower's income when I first worked on Wall Street in the 60s the rule of thumb was 25% a bank would calculate your income figure that you could pay 25% of that for housing and mortgage and that was how they made the loan as long as you could pay 30% of the down payment in the form of equity and the loan would be self amortized over 30 years this is not how things have worked out there will be another chance for this after the asset price inflation leads to the future bank failures and Sheila Bair also had thoughts when of a public option for credit infrastructure for the bank's when the United States bailed out Citibank and AIG and when your Europe bailed out the Royal Bank of Scotland and the Anglo Irish Bank the government became the chief shareholder in these banks that meant that it could have supplied a public options no matter how what problems you might have from government-owned banks they don't make liar's loans they don't speculate in the exploding interest rate loans they don't have collateralized debt obligations they would act like the savings banks and the SNL's used to do so the government could have operated Citibank and the other banks as an alternative providing credit card rates with penalties of less than 29 percent per year you all but none of these really can be done because the banks were stonewalling any attempt to write down their claims and so they're forcing a position where there's no real way of making debts reasonably within the ability to pay I think the only alternative in many cases is going to be the German economic miracle case the most successful debt cancellation of our time was the Allied monetary reform of 1947 when all debts in Germany except for minimum working balances owed by employers to employees were written off and they could do that because most debts were owed to the to the Nazis and they didn't want them to pay I think when you restore the financial system after other crisis one of the key guidelines should be that financial and fiscal reform need to go together you can't solve the financial debt problem without changing the tax system you've just heard about how the tax system favours debt financing over equity financing there was a long discussion in the 19th century by followers of Salamone over why debt was preferable I'll give you again I want to use Latvia as an example of how not to do it three years ago when I wrote the article I was research director of the Riga Graduate School of Law they had a 1% property tax and a 59 percent flat tax on labor which they still have not including the excise taxes imagine of 59 tax flat tax unemployment split between the employer and the employee and the 1% property tax we had a meeting Derk Mesmer was added who will be talking tomorrow we met with the property assessor and she had written her dissertation on the last assessment they had on property which was on 1917 on which the tax were based that is why you had a real estate bubble in Latvia if you don't follow the classical tax policy and collect the free lunch rent of the land rent not the building rent monopoly rent and mineral rent or the natural resource rent Latvia is exports his recovery has been cutting down its forests in exporting oil not really something that's affected by wage deflation if you don't shift the tax on to the real estate gains from the site value then this rent value is going to be available to be pledged to the banks and that's the problem 200 years ago day 20 would record or wrote everybody expected banks to finance industry but that's not what has happened industry now issues its own direct commercial paper it doesn't go through the banks 80 percent of bank loans in America and England are real estate loans they've funded real estate they funded loans already and existed in existence and they've financed monopolies so the problem is that you have a dysfunctional financial system that instead of lending to create the means to repay the debt it adds to the overhead as was just said and by adding to overhead the more debt you have the more the economy prices itself out of the market and prevents itself from paying the debt and leads to a situation either where you write the debts down to what they can pay or you enter austerity and you become a disaster story which is why Latvia is put forth as a neoliberal dream of where you have GDP falling by 25 percent labor emigrating we met with a bank regulator I'll just end up by saying of to say what is their going to do when you have so many defaults the bank regulator said well we've saved the banks from a price decline in property we've say that when somebody wants to borrow you don't pledge the property is the backing for the loan you have your father or your children and your sisters and your brothers and your cousin signed the loan so the entire family is liable for the loan you can imagine the effect of the crash in property prices in Latvia when the entire family is a pledged the result is that mothers are telling their kids you'd better emigrate to buy a loan to get a job and in fact what had happened was that many of the Latvians before were emigrating to ireland you've seen what's happened to Ireland it's not Maleny more Latvia is indeed a test case in an object lesson but I think for the opposite reasons that you heard earlier the same I'm commenting on this on a paper that'll be out tomorrow at breakfast you'll get the Frankfurter Allgemeine at site on where i go and i explained this in greater detail you

Channel: New Economic Thinking

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Length: 21min 2sec (1262 seconds)

Published: Fri Apr 13 2012