The Debt Economy

[marmar]

from the New Yorker:



The Debt Economy
by James Surowiecki

November 23, 2009


John Kenneth Galbraith wrote that all financial crises are the result of “debt that, in one fashion or another, has become dangerously out of scale.” The recent financial crisis was no exception, with everyone—homeowners, private-equity investors, our biggest banks—taking on enormous amounts of debt. If it’s frustrating that the government is footing the bill to clean up the mess, it’s even worse that the government helped pay for the debt binge that created the mess in the first place, thanks to a tax system that actually subsidizes borrowing. Debt didn’t get dangerously out of scale because the system was broken. It got out of scale, in part, because the system worked.

The government doesn’t make people go into debt, of course. It just nudges them in that direction. Individuals are able to write off all their mortgage interest, up to a million dollars, and companies can write off all the interest on their debt, but not things like dividend payments. This gives the system what economists call a “debt bias.” It encourages people to make smaller down payments and to borrow more money than they otherwise would, and to tie up more of their wealth in housing than in other investments. Likewise, the system skews the decisions that companies make about how to fund themselves. Companies can raise money by reinvesting profits, raising equity (selling shares), or borrowing. But only when they borrow do they get the benefit of a “tax shield.” Jason Furman, of the National Economic Council, has estimated that tax breaks make corporate debt as much as forty-two per cent cheaper than corporate equity. So it’s not surprising that many companies prefer to pile on the leverage.

There are a couple of peculiar things about these tax breaks—which have been around as long as the federal income tax. The first is that they’re unnecessary. Few people, after all, can save enough to buy a home with cash, so home buyers naturally gravitate toward mortgages. And businesses like debt because it offers them tremendous leverage, making it possible to put down a little money and potentially reap a huge gain. Even in the absence of the deductions, then, there would be plenty of borrowing. The second thing about these breaks is that their social benefits are pretty much nonexistent. Advocates of the mortgage-interest deduction, for instance, claim that it increases homeownership rates. But it doesn’t: in countries where mortgage deductions have been eliminated, homeownership rates haven’t dropped. Instead, the deduction simply inflates house prices. The business-interest deduction, meanwhile, may lower an individual company’s taxes, but it also means that the over-all corporate tax rate is higher, so its real impact is to give companies with lots of debt an unjustified advantage. .........(more)

The complete piece is at: http://www.newyorker.com/talk/financial/2009/11/23/091123ta_talk_surowiecki

[phantom power]

1. A fact we talk about in machine learning all the time...

you get the behavior that you reward.

[DJ13]

2. We wouldnt have had a debt crisis if workers made enough to pay cash

[RaleighNCDUer]

3. Outside the big ticket items - houses and cars - paying cash for

consumer purchases makes up the difference in itself. IOW, don't buy ANYTHING on credit and avoid all interest payments. The difference in your pocket is the amount of the interest you would otherwise be paying.

Simple in concept, but damned hard for some people to grasp.

[mdmc]

4. --

[onethatcares]

5. anyone notice that lately

the price of automobiles is no longer shown in the television adds. Just the monthly lease amount. The other item is now it's "the well qualified" rate. I'm sure the "less qualified" rate is a buttbuster beyond proportions.

Remember when a house actually cost what it was worth? Maybe I'm missing something here, but in 1979 we bought a 3 br 1 bath home on a lot and a half for 29K. The bank made sure we had money in savings, in downpayment, in escrow and every other which way to sunday, along with a j o b.
House next door sold for 234K 4 years ago, corner lot, 1 small bedroom/1 bath. I wouldn't want that payment come hell or high water.