The Big (Stupid) Idea: Universal Personal Bankruptcy
to Save America's Economy
by Gary North: Mass
Inflation, Yes; Hyperinflation, No
I have just
read the most monumentally stupid article in the history of financial
journalism. Nothing else I have ever read comes anywhere near it.
It is not just stupid. It is magnificently stupid. It is something
so incomparably stupid that Paul Krugman could only dream of writing
something like it.
It was written
by Brett Arends.
I have gone
after Mr. Arends before.
But I never dreamed that he could write anything as bad as this.
I never dreamed that anyone could.
Here is the
headline: Massive default is best way to fix the economy.
Then there is the subhead: Clearing away the debt is the only
What debt is
he talking about? All mortgage debt. Also, a few trillion in consumer
Not the government's
debt? Oh, no. Not that. That was never mentioned. Just private consumer
debt. All of it.
want to fix this economic crisis? You want to put people back to
work? You want to light a fire under the economy?
way to do it. Fast. And relatively simple.
not going to like it. You're not going to like it at all.
A national Chapter 11 bankruptcy.
I do not like it. Let me tell you why. This may take time. Stick
with me. You are about to go down the rabbit hole. You are about
to go through the looking glass. You are about to enter the Twilight
fastest way to fix this mess is to see tens of millions of homeowners
default on their mortgages and other debts, and millions more file
up to the home owners? Haven't they resisted doing this? Isn't this
why the scenario he wants has not taken place? In other words, aren't
the decisions of individual families opposed to what Mr. Arends
proposes? And if they are, why does he think he is wiser than the
F. A. Hayek
had a phrase for this collectivist arrogance: the fatal conceit.
He is implicitly
arguing that there is something wrong with the free market. The
fastest way out of the supposed debt crisis is for a mass default.
But the free market is not producing this result: clogged courts,
wiped-out credit ratings of ex-home owners, and houses at 50% of
today's prices. He never mentions these results. He never utters
the free market's key phrase: "At what price?"
told you that you wouldn't like it.
I don't like
it much either. It sticks in the craw that people got to borrow
all that money and won't have to pay it back.
But you know
what? The time to stop that was five or 10 years ago, when the
money was being lent.
The money for
everything we own is long gone. Once we buy it, the money is gone.
So what? The asset still has some value.
In a mortgage
loan, the collateral is not gone. The house has some value. In any
case, the home owner's credit rating is not gone. This is a crucial
form of capital. If he defaults, it will be gone.
It is obvious
what Mr. Arends is really after: universal default, leaving every
defaulter's credit rating equal to the others. There is supposedly
safety in numbers.
I will tell
you something else there would be: tens of millions of new renters
with poor credit ratings. How soon would they get back into
mass Chapter 11 is, by far, the least obnoxious solution to our
the real cause of our economic slump isn't too much government
or too little government. It isn't red tape, high taxes, low taxes,
the growing divide between the rich and the poor, too much government
debt, too little government debt, corporations, poor people, "greed,"
"socialism," China, Greece, or the legalization of gay marriage.
It isn't, in short, any of the things all the various nitwits
say it is.
When it comes
to economic nitwits, no one matches Brett Arends. Let me prove this
the debt, stupid.
Let us not
miss the main point. It is the point Mr. Arends has missed. "It's
the credit, stupid." (1) The creditors are wiped out if
the home owners get to keep the houses, or (2) the home owners'
credit ratings are wiped out if they declare bankruptcy and are
evicted. Take your pick. Mr. Arends never says which scenario he
not his long suit. Neither is economic logic.
hocked up to the eyeballs, and then some. We're at the bottom of
a lake of debt, lashed to an anchor. American households today owe
$13.3 trillion. That has quadrupled in a generation. It has doubled
just in the last 11 years. We owe more than any other nation, ever.
And for all the yakking about how people are "repairing their balance
sheets," they're not. From the peak, four years ago, they've cut
their debts by a grand total of 4%.
It is time
for you to see the statistics that Mr. Arends has obviously never
seen. These are published by the Federal Reserve System. The FED
traces household debt repayment as a percentage of disposable income.
What we find is that the percentage of monthly debt repayment does
not fall below 15% or go above 19%. It is down to about 16.4% for
home owners. You can see the figures back to 1980 here.
In short, there is no household debt crisis. Mr. Arends is
trying to deal with a crisis that does not exist.
than a quarter of American mortgages are underwater. Many are deeply
underwater. In states like Nevada and Florida the figures are astronomical.
This is true.
But at least one
third of houses are owned free and clear. Of the 66% that aren't,
one quarter are underwater. That means that 75% aren't 75%
of 66% of the houses.
key thing to understand is that most of that money has gone to what
a fund manager friend of mine calls "money heaven."
Then on what
basis do the lenders mainly the Federal Reserve System and
investment funds keep these "money heaven" loans on their
books at face value? This is fraud on a massive basis. We are not
facing a crisis of national consumer debt. We are in the middle
of a fraudulent banking system crisis. Mr. Arends does not
mention this crisis. He thinks that universal bankruptcy will provide
a comparatively cost-free solution to a non-existent personal debt
crisis. It would instead collapse the credit markets.
of these debts will never, ever be repaid in real money. Not gonna
Who is to say?
I know! How about the borrowers? Shouldn't they say? Shouldn't they
have the legal right to say? Aren't they saying, loud and clear,
by not defaulting? Why would anyone think that he has a better idea,
unless he is suffering from the fatal conceit?
how corporations handle this kind of situation.
happens all the time.
On the contrary,
it rarely happens. This is why there is still a capital market for
debt. If it happened all the time, we would be living in the stone
and bondholders find they have lent, say, $1 billion to a company
whose assets and earning capacity will only repay, say, $300 million.
What happens? Does the company soldier on with $1 billion in debt
it can never repay? Do the stockholders send back their dividend
checks? Do they sell their homes to pay off the bonds?
Not a chance.
The company goes through Chapter 11. The creditors 'fess up to
their blunder, they face up to their losses, and they fix it.
They write down the loans and take the equity instead. The balance
sheet is cleaned up, and the company starts again.
can start over again only because there is still a capital market.
To move from the individual case to mass overnight national bankruptcy
is a fatal conceit. If all the creditors get stiffed, they will
not lend again at low rates . . . not to American private borrowers,
anyway. But he ignores this.
Most of the
objections to this idea are well-meant, but misinformed.
It is Mr. Arends
who is misinformed misinformed on a scale that makes all
other financial commentators look like Warren Buffett.
fund manager I asked raised the issue of "moral hazard." Why should
anyone pay their mortgage if some people were getting a pass, he
For the same reason GE and Verizon kept paying the coupon on their
bonds while Lehman Brothers defaulted. You want to keep your credit
standing. And you want to keep your equity.
defaulted, but if every other bank had defaulted, there would have
been a catastrophe. Lehman defaulted all by its lonely, over-leveraged
a company defaults, the stockholders get wiped out. If a homeowner
defaults, the bank takes the home. I like keeping my home, as well
as my savings, and my credit rating. Most people are the same.
But what if
they all defaulted at once, even when they did not have to, as Mr.
Arends advises home owners to do? Then there would be a collapse
of the American economy on a scale never before seen. Or, alternatively,
there would be inflation by the Federal Reserve on a scale never
will say the financial impact would be terrible. But the banks would
just be facing up to reality. And a lot of these mortgages are already
trading at distressed levels.
that 75% of home owners with mortgages are not underwater, and of
those few who are, the vast majority are paying off their mortgages.
will say, "why should people get away with borrowing imprudently?"
The response: Why should the banks get away with lending imprudently?
the blithering idiots who ran Fannie Mae and Freddie Mac put the
U.S. government's guarantee on the loans. The government let them
get away with this. The banks handed off the mortgages to the idiotic
packagers, who sold to them to the trusting investors.
It's not the
banks, stupid. It's the Federal government, which implicitly underwrote
the entire stinking housing mess, and then nationalized the mortgage
market exactly three years ago.
no point telling people not to borrow money. They always will. I
have yet to see a Wall Street executive turn down free money. I
have yet to see a company in an IPO say, "Don't give us so much
money!" People like money. They will take as much as they are offered.
This man thinks
that lots of loan money will be offered to newly bankrupt borrowers
by shell-shocked creditors after a $13 trillion default.
There is only
one way that such a widespread, overnight default could take place:
by U. S. government decree.
a free economy, the people who are supposed to ration the loans
are the lenders. Banks are supposed to lend carefully and responsibly.
What else are they paid for? Accepting deposits? You could hire
people on minimum wage to do that.
the bankers did not do this. Sophisticated investors did, after
the credit-ratings agencies gave subprime loans a AAA rating. Fannie
Mae and Freddie Mac put together the rotten investments. Banks merely
brokered the packages.
will be few loans after the national Chapter 11 not to the
U.S. private sector, anyway. This is my main point. The loans will
then go to the U.S. government, which Mr. Arends exempts from the
Chapter 11 cure-all. He never mentions the Federal government's
will say, "it's immoral" for borrowers to default. Alas, most of
these people are being inconsistent. They are usually the first
ones to defend a company when it closes down a factory and ships
the jobs to China, or pays the CEO $50 million for doing a bad job,
on the grounds that "this ain't morality, pal, this is business!"
No, it's not
business. It's a massive transfer of wealth. (1) The creditors get
the property of the defaulted borrowers. They get the houses, the
assets, everything. That is why home owners keep paying their debts.
They do not want this transfer. Or (2) the creditors get nothing.
This would be contract violation on an historic scale.
when Main Street wants to do the same thing, they start screaming
live in an economy based on morals and fairness.
11 for all mortgages could be done fast only if the U.S. government
passed legislation allowing it. This would be the largest transfer
of wealth in American history. If anyone claiming to be in need
of deliverance is delivered, 100%, then there would be no more mortgages
and no more consumer debt.
also be no more capital markets.
Mobile doesn't charge me what's "fair" each month. They charge me
what's on the contract.
At long last,
he gets to the key word: contract.
contract is renewable each month. If Mr. Arends stops paying, he
will be "evicted" by T-Mobile.
He is calling
for one of two outcomes:
The transfer of all mortgaged houses to the creditors
2. The 100% expropriation of the creditors
He thinks one
of these would cure the American economy of its woes. He never says
employer doesn't pay you more if you need more. He pays you your
economic value. Did Dick Grasso give back his bonus? Bob Nardelli?
Dick Fuld? We operate in an economy based very firmly on contracts,
and nothing else. Companies, and the wealthy, live by the letter
of the law.
Mr. Arends is calling for the greatest single violation of contract
in American history a true social revolution.
mortgage contracts allow for default. Half of the states in this
country are "non-recourse," which broadly speaking means you can
send in the keys and walk away from a bad loan. The other half are
sort of "semi-recourse." The bank can come after you for any shortfall,
but only in a limited way. Broadly speaking they can't touch retirement
accounts and basic assets. You can typically keep your car, personal
effects, often things like life insurance.
Most of the
people who are deeply underwater don't have that much anyway.
to say, "if someone borrows money, they should repay it." Generally
speaking, I agree. I pay all my debts. But while that makes sense
when applied to any individual, it doesn't work so well when it's
applied to everyone.
Here it is:
Keynesianism's bait and switch. Usually, it is applied to
thrift. It is called the paradox of thrift. If everyone saved more,
we are told, it would cripple the economy. But the point of the
free market is that individuals decide. They do not make
the same decisions at the same time.
When most home
owners are paying their mortgages, then any theory of the benefits
of universal default leads to a highly destructive scenario. It
is hypothetical: "cures the economy fast, fast, fast." But it cures
it in a way that destroys the law of contracts and therefore the
predictability of long-term capital.
have tens of millions who cannot repay their debts. But they are
all trying to. That sucks huge amounts of money out of the economy.
And that means these people cannot function properly as consumers
or workers. That's the reason people aren't coming into your restaurant.
It's the reason people aren't taking your yoga class. It's the reason
they haven't hired you to redo the kitchen.
This is a reworked
version of the paradox of thrift. It is nutty, just like the paradox
of thrift is.
I owe you $100.
I pay you back at $5 a month. You spend the money: investing it
or buying consumer goods. Arends says that my paying you your $5
"sucks . . . money out of the economy." Sorry, but Mr. Arends is
not making any economic sense. That is because he has bought into
the Keynesian grab-bag of errors. Debt repayment does not suck money
out of the economy.
so tens or hundreds of millions of perfectly responsible business
owners and employees are also suffering from this slump. That's
the reason we have a shortage of demand. That's the reason no one
1850 metaphor of the broken window, breaking a window provides jobs
and economic growth. This is Mr. Arends' update of Bastiat's metaphor.
He argues that paying off your contract for the replaced window
hurts the economy.
Is this nuts?
It surely is.
worse: People who are underwater on their mortgage, but who do not
want to default, cannot move to where the jobs are either. They
are stuck with their home.
I see. They
do not want to default. Imagine that! But Mr. Arends thinks they
are silly not to default. He is proposing universal default. He
thinks it will help the economy.
through what it would do to the market value of Freddie Mac and
Fannie Mae bonds. Oh, my. The FED holds over a trillion dollars
worth of these bonds. Oh, my, oh, my.
want to break this logjam? Try Chapter 11 for the nation. Massive
defaults. Clear the decks, clean the books.
forgets what happens to anyone navigating on a river when he is
located downstream from a logjam. This is where the nation's creditors
are the alternatives?
cutbacks, higher taxes, and a balanced budget? In a normal economy,
fine. But in this situation, when the private sector is also slashing
its spending, that could lead to absolute catastrophe. That's
what happened in the Great Depression. And our debt levels are
worse than in the Great Depression.
Here it is
again: the Keynesian paradox of thrift. Under his scenario, the
economy will surely get less thrift. When the creditors are stiffed
in one huge default, there will be lots less thrift. What little
there is will go to the Federal government or foreign markets.
borrowing? That's the Keynesian solution. "The consumer can no longer
borrow like a crazy person," says the Keynesian, "so Uncle Sam has
to do so instead." It's just transferring private madness to public
pure Keynesianism, he now warns against Keynesianism.
That's probably the least bad alternative. But it's just default
by another name. And instead of taking money from the imprudent
banks that caused the problem, it robs grandma's savings.
So, the next
best alternative to universal mortgage and consumer debt default
is . . . universal currency default.
I would hate
to think of his even less desirable alternatives. Maybe World War
before, advanced economies have gone through what we are going through
now namely a massive hangover after a massive debt binge.
was the U.S. in the 1930s, the second was Japan in the 1990s.
didn't get out of it until the 1940s unleashed inflation and reduced
the debt's value in real terms.
hasn't gotten out of it. They have deflation, while government
debt has skyrocketed.
Japan has had
no price deflation. This is a standard myth promoted by journalists
who have never looked at the data. See for yourself here.
correct moral hazard is to punish the banks who lent imprudently
by making them eat their own losses.
It's not the
banks, stupid. It's the Federal government, which now owns Fannie
told you that you wouldn't like it. I don't either. But the alternatives
So, there you
have it. The stupidest article in the history of financial journalism.
He was right.
I didn't like it.
North [send him mail]
is the author of Mises
on Money. Visit http://www.garynorth.com.
He is also the author of a free 20-volume series, An
Economic Commentary on the Bible.
2011 Gary North
Best of Gary North