Is 'Financial Repression' The Solution to the Trillions In Unpaid Debt Arising From The Pandemic?

As most who read this blog know, financial posts are often a feature when I am not writing about astrophysics, math, deep politics, climate change or atheist ethics.  Right now, for those who may not read the financial pages, a huge concern is the mounting debt loads which have leaders around the world biting their nails.   It is useful here to consult the graphic showing debt as a percentage of GDP for  5 specific nations and a generic "advanced economies" overall.   This is from the recent Wall Street Journal article 'Debt Battle Awaits Post-Virus World', June 15, p. A2)

On top of this, there is now  a sobering article for The Atlantic’s July/August 2020 issue — which warns another banking calamity is a strong possibility and which ought to be required reading for  all sentient Americans.  It also, to me, clearly shows why Trump - the most ineffectual, incompetent leader in over 100 years- cannot be allowed a repeat performance. (Aside from this, I am still puzzled by recent polls showing a plurality of Americans - 48% to 35 %-  favor Trump over Joe Biden to deal with the economy. Ahem...this is the same Bozo who crashed the economy leading to 42 million unemployed, folks!)

Anyway, with respect to the Atlantic piece, UC Berkeley law professor Frank Partnoy writes:

"After months of living with the coronavirus pandemic, American citizens are well aware of the toll it has taken on the economy: broken supply chains, record unemployment, failing small businesses. All of these factors are serious and could mire the United States in a deep, prolonged recession. But there’s another threat to the economy too. It lurks on the balance sheets of the big banks, and it could be cataclysmic. Imagine if, in addition to all the uncertainty surrounding the pandemic, you woke up one morning to find that the financial sector had collapsed"


The prime culprit?  The 'CLO' or collateralized loan obligation.  According to Prof. Partnoy:

"After the housing crisis subprime CDOs naturally fell out of favor. Demand shifted to a similar — and similarly risky — instrument, one that even has a similar name: the CLO or collateralized loan obligation. A CLO walks and talks like a CDO, but in place of loans made to home buyers are loans made to businesses — specifically, troubled businesses. CLOs bundle together so-called leveraged loans, the subprime mortgages of the corporate world. These are loans made to companies that have maxed out their borrowing and can no longer sell bonds directly to investors or qualify for a traditional bank loan.”

Adding:

"CLOs have been praised by Federal Reserve Chair Jerome Powell and Treasury Secretary Steven Mnuchin for moving the risk of leveraged loans outside the banking system.”

Understated in all the huff and puff about expanding debt is that  just because CLOs are  "praised" by Powell doesn't mean they aren't risky.  (Recall before the 2008 credit crisis and housing collapse, the then Fed Chair Alan Greenspan praised adjustable rate mortgages - ARMS - at the heart of the housing meltdown).  Also, we know most of the outstanding debt - probably 75 %   - is not from stimulus packages such as the CARES Act- but a combination of extended tax cuts and overleveraging in the financial markets.   Two years ago the warning was sounded by the IMF as reported (April 17, 'IMF Sounds Alarm On Excessive Global Borrowing' )  in The Financial Times, though the leveraging debt was not mentioned specifically, i.e.:

"The world's $164 trillion debt pile is bigger than at the height of the financial crisis a decade ago, the IMF has warned, sounding the alarm on excessive global borrowing.  The fund said the private and public sectors urgently need to cut debt levels to improve the resilience of the global economy, and provide greater firefighting ability it things go wrong... World borrowing is more than twice the size of the value of goods and services produced and 225% of global gross domestic product. This is 12 percentage points higher than the peak of the previous financial crisis in 2009.

Vitor Gaspar, the director of fiscal affairs at the  IMF, singled out the U.S. for criticism, saying that it was the only advanced country that was not planning to reduce its debt pile - with the recent tax cuts keeping public borrowing high."


Meanwhile, in the WSJ Business & Investing section  one is alerted to the understated role of  leverage (i.e.  'In Selloff, A Trading Strategy Is Faulted' (Feb. 9th,  2018, p. B11). So  we learned:

"Risk parity funds aim to reduce the danger from a collapse in any one market by limiting bets on more volatile assets like stocks and commodities, and use leverage to load up on safer assets such as government bonds."

In other words, these funds use debt, i.e. leverage,  to purchase safer bonds.   However, as the piece goes on to point out, when volatility jumps the leverage can force the funds' automated trading strategies to dump those assets, forcing a selloff.  Let me add here both individual investors and whole companies have now taken to the leverage 'drug'  to place their market bets using borrowed money.  The losses they have accrued, along with decades of trillion dollar tax cuts,  have helped to monumentally add to the $164 trillion in global debt.  But WHO is being asked to pay now, even with the party still going on? Well, the average Joe and Jane on Main Street.

In a separate WSJ piece, Paul Hannon warns us:

"In the U.S. and elsewhere, government debt is set to soar this year, reflecting lower tax revenue and the cost of financial aid to households during lockdown. The International Monetary Fund forecasts that U.S. government debt will reach 131%  of annual economic output this year, up from 109% in 2019."

Hannon makes clear Joe and Jane American are going to have to pay the piper, especially if we are to avoid bank collapses such as forecast by Prof. Partnoy.   While the Federal Reserve has ruled out negative interest rates (for now) three other options are on the table, none of them palatable:

1) Apply more austerity using a combination of spending cuts and higher taxes. However, the worry of the financial elites is that this may trigger even more political division and austerity protests along with the ones against the police.

2) Allow inflation to roar back  diminishing the value of the dollar and thence, the magnitude of the debt owed.

3)Financial repression is therefore preferred. (According to a 2015 paper by economists Carmen Reinhart and M. Belen Sbrancia, it lowered the average interest bill for 12 governments by between 1% and 5% of GDP from 1945 to 1980).  It therefore "played an instrumental role in liquidating the massive debt accumulated during World War II"

Basically, financial repression means sustaining policies that ensure interest rates remain low.  These would include: central bank purchases of gov't bonds and regulations prodding investors to hold such securities.  (Since March, the Fed has slashed its benchmark interest rate to near zero, bought $2.1 trillion in Treasury and mortgage bonds, and rolled out numerous lending programs).

Of course, apart from savaging savers, the repression strategy would cut ordinary citizens' spending even more.   Now, according to the latest data, one will also have to add spending pullbacks by the wealthy.

Economists at the Harvard-based research group Opportunity Insights estimate that the highest-earning quarter of Americans has been responsible for about half of the decline in consumption during this recession. And that has wreaked havoc on the lower-wage service workers on the other end of many of their transactions, the researchers say. According to  Michael Stepner, an economist at the University of Toronto:

“One of the things this crisis has made salient is how interdependent our health was. We’re seeing the mirror of that on the economic side.”

As income inequality has grown in the U.S. , so has inequality in consumption. That means that when the rich spend money, they drive more of the economy than they did 50 years ago. And more workers depend on them.  When workers lose jobs or the rich stop spending in those job areas it translates into acute financial pain. Add in the pandemic and the situation becomes intolerable - which means more stimulus money has to be infused.

This is why Fed Chair Jay Powell told the Senate Banking Committee two days ago that congress needs to pump more money in,  and especially  that it should consider extending unemployment benefits beyond the current July 31 cutoff date.    He also warned the recovery would be long and arduous and jobs not likely to return until consumers felt confident enough to go out and partake in the economy, i.e. in dining out, cinema attendance, even shopping for durable goods. In Powell's words: 

"Some form of support for those (unemployed) people going forward is likely to be appropriate.  There are going to be an awful lot of unemployed people for some time until a vaccine appears."

In the heat of a battle like this, no one is obsessing about how much pandemic -related debt is exploding.   As the World Bank's chief economist explains it (WSJ, ibid.): "This is a war. In a war, you worry about winning the war, and then you worry about paying for it."

So true.

Update: From WSJ  June 19, p. A8 ('Americans Skip Millions Of Loan Payments')

"Americans have skipped payments on more than 100 million student loans, auto loans and other debts since the coronavirus hit the U.S., the latest sign of the toll the pandemic has taken on people and finances.  The number of accounts in deferral, forbearance or some other type of relief reached 108 million at the end of May, according to credit reporting firm TransUnion."

"The surge in missed payments suggests that the flood of coronavirus related layoffs has left many Americans without the means to keep up with their debts. Many people have used up their stimulus checks and unemployment benefits."

From same page story ('Debt Relief Has Ripples'):

"Benign though the many debt forbearance decisions may seem, they're rippling through the financial food chain with unpredictable consequences. America is living out a financial experiment unseen in modern times - testing what happens when the economy deals a devastating blow to millions of borrowers, but lending institutions behave as if it hadn't.

Repo agents and debt collectors may be criticized but they clear the detritus of soured loans, recycling the lent capital.  Their activity helps keep money moving between lender and borrowers, especially high risk borrowers. .. With the credit recycling machinery largely frozen, banks may be less willing to make loans."

See Also:

Economic Policy

Instead of Bailing Out For-Profit Colleges, Congress Should Cancel Student Debt

Reinhart-Rogoff’s Fuzzy Spreadsheet Math – and The Howling Austerity Fetishists

The recent paper by two Hah-vahd eggheads (Carmen Reinhart and Kenneth Rogoff) that when debt as Percentage of GDP hits 90% it leads to negative growth, has taken D.C. by storm. Well, let me clarify that: It has spurred the austerity hawks – including Paul Ryan and Tom Coburn – into doing backflips to demand gov’t spending be cut. Only one problem: a grad student ran the numbers himself on an Excel spreadsheet and found the Harvardians botched their analysis- leaving out several rows in their analysis and at least four countries, including Belgium and Canada.


Grad student Thomas Herndon did a run of the mill academic paper, entitled "Growth in a Time of Debt",  in which he exposed several errors including: simple coding errors, data omissions and peculiar aggregation procedures. Incredibly, when the spreadsheet errors were corrected, lo and behold the nations sporting debt at 90 percent or more of GDP were no longer in recession (the Rogoff -Reinhart paper showed growth typically defined for them at -0.1%) but with a reasonable 2.2 %. (This contrasts with 4.2% when debt is below 30% of GDP).

But never mnid uncovering the errors - which are definitely significant because the percent of growth is the issue on which austerity pivots- the abundant austerity freaks in congress don't want to hear it. You see, the issue isn't about whether the Rogoff -Reinhart paper was correct or not, but rather that it provided - at least for a time- special cover for the austerity - spending cut crowd to howl like banshees. Especially for Obama to make many more cuts so they can come to the table, agree no a sequestration resolution, and allow millions to leave on their flights on time.

But as blogger Richard Eskow also observed on smirkingchimp.com:

"Economists Carmen Reinhart and Ken Rogoff seem surprisingly unremorseful. And austerity's paid pitchmen are still hawking their wares."

As Eskow added:

"Their response can be boiled down to "Numbers. Shmumbers. Surely too much debt is bad, right?"

Well, of course such a cavalier attitude isn't suprising, given the dynamic duo are high-powered academics who've clearly invested lots of brain energy into their work. I mean, no academic wants to be forced to recant an error in a paper that earlier received so much welcome (from the Neoliberals) far less several errors - possibly making the whole paper useless.

But what I have found interesting is the inevitable comparisons with this austerity paper and the lies told the American people to justifying making war on Iraq ten years ago. This was noted in a recent article: Curveball: Spies, Lies, and the Con Man Who Caused a War  (American Prospect.) In the interview  therein,  Pete Drogin notes that all of the CIA intelligence used to justify the Iraq War - all of it -- traced back to a single, self-interested party. This fraud was also the source for Judith Miller's highly influential (and entirely false) reporting for the New York Times. All of that, together with the shrill calls from other corporo-media, had the American people polling for war by early 2003.

Curveball didn't need to prove his claims because the decision had already been made to go to war. He just needed to sound plausible enough for Miller and all the other self-interested hacks inside and outside of government.

 

As Drogin says in the interview, the Curveball episode was "a conspiracy of ineptitude driven by tawdry ambitions, spineless leadership, and fear." It wasn't that "they failed to connect the dots," says Drogin. They "made up the dots."

  Hmmmmmm.....sounds to me an awful lot like austerity economics and the babble of the Neoliberal imps who support it. The nuts and screwballs who want their cuts, despite the fact we remain in a low aggregate demand environment.

What has interested me, however, is how the Governor of the Central Bank of Barbados (De Lisle Worrell)  shrugged when recently asked about Barbados low rate of growth (barely 1% last year) and high % of debt of GDP, essentially dismissed it. He also dismissed the worries of some that it might spark an IMF intervention. "What intervention?" he sneered, and in so many words. Adding that Barbados has mainly gone its own way for over 350 years and will continue to do so. He noted the low growth is directly connected to the continued credit crisis and low aggregate demand - especially in the U.S. - where most of the island's tourists hail from. DUH!

So he isn't worried because he grasps that Barbados' economic fortunes are cyclical, with the tourist dollar. For a time this was counterbalanced by offshore banking operations, until capitalist-Neoliberal scumballs like Nicholas Sarkozy (at assorted OECD meets) castigated it and called a pox upon all the banking houses of the Caribbean as harboring monies of  "criminals". In one fell swoop, the economic Neoliberal naysayers set the offshore banking business back at least a decade.  Also, they had better watch themselves if they ever think of tripping in Bim.

But a point Gov. Worrell ought to concern himself with is the $400 m going out each year from the island to pay for fuel imports to runs buses, over 100,000 cars and taxis.  Unless the island gets a grip on this they will enter into a sovereign debt crisis.

As for the U.S. - the real worry isn't any similar such thing but rather another, possibly greater recession, especially if too many imbeciles in D.C. keep buying into and pushing their austerity economics - based on spreadsheet errors in a high falutin' Harvard economics paper!