We’ve known for over 4,000 years that debts need to be periodically written down, or the entire economy will collapse.
After all, debt grows exponentially … while economies only grow in an s-curve.
The ancient Sumerians and Babylonians, the early Jews and Christians, the Founding Fathers of the United States and others throughout history knew that private debts had to be periodically forgiven.
Two prominent economists – Professor of economics and director of the Julis-Rabinowitz Center for Public Policy and Finance at Princeton University (Atif Mian), and Chicago Board of Trade Professor of Finance at the University of Chicago Booth School of Business and co-director of the Initiative on Global Markets (Amir Sufi) – wrote last year:
Debt forgiveness makes a lot of sense when the economy experiences a large-scale negative shock that is beyond the control of any one individual.
History seems to understand this lesson well. The 48th provision of the Code of Hammurabi, written more than 3,500 years ago in Mesopotamia, states that: “If any one owe a debt for a loan, and a storm prostrates the grain, or the harvest fail, or the grain does not growth for lack of water, in that year he need not give his creditor any grain, he washes his debt-tablet in water and pays no rent for this year.” The main threat to economic activity in ancient Mesopotamia was a drought, and one of the first legal codes understood that debt should be forgiven if such a negative shock occurred.
In 1819 when agricultural prices in the United States plummeted leaving farmers overly indebted and unable to pay their mortgages, politicians ran to their defense. Many state governments immediately imposed moratoria on debt payments and foreclosures. Senator Ninian Edwards of Illinois pushed through national legislation to forgive farmers’ debt, arguing that the country should have sympathy for the farmers who, like the rest of the country, got caught up in the short-lived “artificial and fictitious prosperity.”
During the Great Depression … the government-funded Home Ownership Loan Corporation established in the 1930s also helped ease debt burdens and reduce foreclosures by lowering interest payments.
During the Great Recession [i.e. the downturn starting in 2007], policy-makers followed a very different strategy. Underwater homeowners were left drowning, with no meaningful assistance. It is a striking contrast, one that everyone should contemplate. What was different this time? Almost every reason for lack of action was likely present in the previous episodes.
We aren’t alone in noticing the historical discrepancy. Here is Brad DeLong, a top economic historian, in his review of our book:
All I can say is that I thought that this was the system that we had. I thought–from the Great Depression era history of the HOLC and the RFC, from the 1980s history of the Latin American debt crisis, from the 1990s history of the RTC, from innumerable emerging-market crises, et cetera, that we understood very well that this is what we should do. Whenever the financial system got sufficiently wedged we resolved it–we turned debt into equity, and we crammed losses down onto debt holders whose investments were ex post judged to have been ex ante unwise.
And from my standpoint the true puzzle is why Bernanke, Geithner, and Obama were so uninterested in pulling out the Walter Bagehot-Hyman Minsky-Charlie Kindleberger playbook and following it in housing finance from 2009-2014. Did they read no history?
The architects of the crisis response typically cite history as motivation for aggressive bank bailouts. But on the problem of excessive household debt, it appears that much history was forgotten.