(Photo: AP/Rex Features)
Note: This is adapted from the new preface to the just-published paperback edition of Debtors' Prison: The Politics of Austerity Versus Possibility. (Vintage)
In the era when it was common to throw people in jail as a punishment for debts they could not pay, the result was perverse for both debtor and creditor. The debtor's economic life ended-in prison there was no way the inmate could earn money to repay debt; thus there was no way the creditor could be made whole.
The invention of bankruptcy in 1706 during the reign of Queen Anne of England offered an ingenious solution. A magistrate would evaluate the assets of the bankrupt party; creditors would be repaid at so many pence on the pound; the debt would be considered discharged and the debtor could get on with his life. This was the origin of the modern Chapter 11 bankruptcy, in which a corporation is able to settle old debts for pennies on the dollar and then begin again with a clean slate. Even the statute of Queen Anne was a variation on a more ancient, now abandoned, concept-the biblical Jubilee, in which debts were forgiven after 50 years.
Bankruptcy reform was a significant breakthrough because it de-linked what was presumed to be a moral imperative from what was economically sensible. It was widely deemed immoral not to pay debts. Further, if profligate behavior had caused the crippling debt, forgiveness would be that much worse. Yet economic theory deems bankruptcy efficient, because it allows commerce to proceed; it allows entrepreneurs to take risks knowing that they will not face total ruin if they miscalculate. It writes off yesterday's debt for the sake of tomorrow's growth. Even financiers (who want to be paid back) accept the occasional corporate bankruptcy as the price of enterprise. There is a broader analogy here.
Although the notion that debts must be repaid has moral overtones, in this case pragmatic economic logic trumps conventional moral wisdom. When a bankruptcy judge approves a settlement allowing old debts to be written off, the behavior that wrecked the company is not at issue unless it is criminal. The only question for the judge to decide is whether the company can survive if it gets debt relief. Otherwise, it is liquidated and the creditors share the remains.
Ever since 1706, however, bankruptcy law has been replete with double standards. At its inception, bankruptcy was only for the commercial class. Merchants worth more than 1,000 pounds could get relief. Ordinary deadbeats stayed in jail. In recent decades, the double standards have only worsened.
Consider the situation facing several indebted nations today.
They are being punished for past behavior deemed profligate-even if the government responsible for the debts is long gone; even if the citizens who suffer the consequences were not party to the government's schemes; even if the nation is the victim of generalized depression that it did not create.
But there is no Chapter 11 for nations, even though the investors in their sovereign debt took the same kind of knowing risks as investors in corporate bonds. Yet nations such as Greece are being pressed so hard to pay back debts that their economic life is strangled. Like the bankrupt merchant of Queen Anne's day, the more they are, the less capacity they have to repay debts.
The effort of a new government in Greece to win some debt relief, and the crushing response of Europe's rulers, shows just how punitive and foolhardy is this policy consensus. Europe's elite would rather destroy Greece than agree to debt relief that contradicts their pre-1706 conceits about the morality of debt repayment. The new government of Greece, elected in January 2015 on a commitment to re-negotiate debts and win relief, was given only a few months reprieve. The larger austerity program was unrelenting.
A similar reality rooted in similarly perverse concepts and policies still confronts millions of American homeowners whose houses are worth less than the mortgages on them. In the vast majority of cases, this is not the fault of the homeowners. Most were innocent bystanders with the bad luck to get caught in a general economic downdraft that depressed property values. Some were cheated by subprime swindlers. But Congress, presented in 2010 with a bill to create a new category of bankruptcy to give underwater homeowners the same sort of relief available to corporations, voted it down under pressure from Wall Street.
A third category of people sandbagged by crushing debt before their economic life even begins is recent college graduates. Their parents and grandparents were able to attend public universities essentially for free. A summer job often would cover the cost of very modest tuitions and fees. Today, young adults are saddled with debts totaling over $1.2 trillion-not because they were profligate in their consumption of lattes and smartphones, but because the system changed the rules on them.
Just to tighten the noose, Congress in 2005 changed the bankruptcy laws to make it far more difficult for individuals to declare bankruptcy and get a fresh start.
Corporations are still able to declare bankruptcy, write off old debts, and resume their business operations. Often the same executives who drove the business into the ground are able to keep control. Indebted former students, on the other hand, are explicitly barred from using the bankruptcy laws. They can never get out from under their debts, which follow them to their graves-a minor exception being partial forgiveness for public service.
In each of these cases-country debt, underwater homeowner debt, student debt-the crushing debt load functions like a lead weight on economic possibility. Yet the harsh morality of the creditor class overrules common sense.
The most fiscally profligate nation of all time was Nazi Germany. In addition to his other misdeeds, Hitler ran up debts equal to about 675 percent of GDP. Greece is being kept in debtors' prison for a debt level of less than 200 percent of its GDP. Whatever Greece's sins, it's fair to say that Hitler's were worse.
So what did the victorious Allies do after World War II? Did they strangle the postwar German economy either as retribution or in order to try to collect debts that could not be paid? That was the catastrophic mistake the Allies made after World War I in the punitive reparations terms of the Treaty of Versailles, which in turn seeded the German economic crisis of the 1920s, Nazism, and a second world war.
Instead, the Allies actually learned from history-perhaps helped along by the threat of Stalin's presence on West Germany's borders-and wrote off nearly all of Hitler's debt. By the early 1950s, Germany, which had lost the war, enjoyed a debt ratio of about 10 percent of GDP. America, which had defeated Germany, had a debt ratio of more than 100 percent; Britain, more than 200 percent.
The German postwar economic miracle was built on debt relief. But Greece, which suffered one of the most brutal German occupations of any European nation, is being denied relief, primarily by Germany.
This is the real debt problem-the merciless and economically stupid failure to write off old debt. It is the opposite of the claim that is relentlessly promoted by conservative groups, who tell a story of debts that must always be paid and of public debt burdening future generations. The reality is the opposite. It is growth that tames debt and makes it less burdensome; sometimes it takes debt relief to restore growth.
Here in the United States, the Peter G. Peterson Foundation and a variety of front groups that it has created have spent more than $1 billion to propagate the story of public debt destroying America's economic future. In this view, only austerity-budget cuts intended to pay down debt-can spare America from this fate.
This view violates the most basic logic of economics. If an economy is in a deep recession, balancing the budget is the worst policy that can be pursued, because fiscal contraction during a downturn reduces the rate of growth. The government's books may eventually balance, but at a needlessly depressed level of economic output. This is what has occurred in Greece, where forced austerity has caused the economy to shrink by more than 25 percent and the budget is still not in balance.
A deep recession is a time of depressed private sector activity. Notwithstanding high preexisting public debt, a recession is the right time for government to borrow, invest money publicly, create jobs, and restore growth. As GDP increases, the debt ratio comes down. This is precisely what occurred during the long economic boom in the 25 years after World War II. The huge wartime borrowing had pushed the debt ratio to more than 120 percent-far higher than today's. But that debt ratio gradually came down, to less than 30 percent by the 1970s, not because we tightened our belts and paid off old debt, but because of an expanding economy.
Peterson and the deficit hawks have continued to warn that deficits and debts are courting sky-high inflation, on the theory that government borrowing crowds out business borrowing and pushes up rates. But in a subpar economy, demand for credit is depressed and the inflation never arrives. That the austerity mongers have been proven wrong again and again has not diminished their puritanical crusade.
President Obama needlessly succumbed to the allure of the deficit hawks in 2010. He defined America's prime economic problem not as prolonged stagnation but as excessive public debt. He appointed a bipartisan commission inspired by the Peterson Foundation, chaired by Erskine Bowles and Alan Simpson, to come up with a belt-tightening program. Mercifully, the commission could not agree on a plan that met its required supermajority. But Obama's embrace of austerity rather than recovery cost Democrats the 2010 midterm election. Republicans went on to enforce deep budget cuts through other means such as the budget "sequester."
Only when the Federal Reserve embraced heroic monetary policies of bond purchases on a scale unknown since World War II-more debt!-did the economy begin a real recovery. The debt-to-GDP ratio began coming down faster than projected-not mainly because of the budget cuts but because growth was resuming. Obama finally abandoned austerity economics in his 2015 State of the Union Address. By then, the political damage was done. Republicans controlled both Houses of Congress and his proposals for increased public investment were dead on arrival.
Europe, meanwhile, continued on a much more austere course-demanding budget cuts, resisting debt relief. Only in late 2014 did the European Central Bank, after years of capitulating to resistance from Chancellor Angela Merkel, begin a program, modeled on the Federal Reserve's, of large-scale bond purchases as a form of long-overdue stimulus. But the bond purchase program initiated by Bank President Mario Draghi is probably too little and too late. It was initiated only after Europe was in a deflationary spiral, and it will not be sufficient as long as Europe continues to impose fiscal headwinds.
Needless to say, these austerity policies are politicians playing with fire.
The combustible mix of high unemployment, fear of terrorism, and backlash against immigrants in general is energizing far-right nationalist parties on a continent that has had more than its share of them.
Greece has a small neo-Nazi party, but its own firsthand experience with actual occupying Nazis during World War II inoculates the country against embracing Nazism.
In the United States, we have our own version of this dynamic. A prolonged period of stagnation, with too little help from the government and an uneven recovery that benefits mainly the top 1 percent, has led to widespread pocketbook frustration. That frustration, in turn, has spawned the Tea Party movement and pushed the Republican Party to the far right. Republican obstruction and antigovernment sentiment in turn blocks the recovery policies that the economy needs.
The remedy for debtors' prison is both intellectual and political. We need to appreciate that austerity is no cure for depression. We need a Chapter 11 for countries, to write down the burden of old debt. In the same spirit, we need debt relief for students and for underwater homeowners. And on both sides of the Atlantic we need large-scale programs of public investment-yes, some of it financed by debt-in order to restore growth, create jobs, and thereby reduce the debt ratio as time goes on. The choice is whether to reduce the burden of past debt by austerity, or by expansion. The preferred course ought to be obvious.
When the first edition of Debtors' Prison was published two years ago, I hoped that the weight of evidence, the power of argument, and the failure of conventional policies would have led to a course correction by now. There has been partial change in the United States, but a doubling down on perverse policies in Europe. So the potential of our economies remains behind bars at terrible human cost, and the political stakes only grow. Tragically, far too many people are still wedded to a pre-1706 ideology that conceives of debt as a moral question rather than one of pragmatic economics. What is good enough for corporations, which use Chapter 11 to get a fresh start, should be good enough for the rest of us.
