Living in Bubble-Land: Dealing with Debt in the Age of Irresponsibility

[Andy Wilson]

Two books not for the fainthearted are David Graeber's Debt: the First 5000 Years and Reinhart and Rogoff's This Time is Different. Neither text could be described as light bedtime reading but both offer many insights into the phenomena of debt. As can be deduced from the title of Graeber's book, debt is nothing new:  in fact it's been around a very long time.

Debt has a habit of coagulating around the least wealthy, least privileged in society. Indeed, it might be argued that the only the wealthy have the means to issue credit, although actually this isn't always the case. However, it is true that credit has been mostly provided by autocratic rulers, governments, powerful financial institutions and a miscellany of individuals endowed with the necessary muscle to collect payment in kind should the unfortunate debtor fall behind on repayments.

This tendency for debt to accumulate around the necks of the poor in ancient Mesopotamia frequently resulted in entire families being sold into slavery. Although this provided a convenient free labour force for the autocratic rulers, even that had its limits of usefulness when set against the ensuing human misery and suffering, and perhaps the increasing risk of revolt among the debt-ridden population. Hence every so many years there would be a debt amnesty, and literally the slate (used to record debt) would be wiped clean.  This cancelling out of household debt can be regarded not so much as charity but an astute political move that probably helped ensure the longevity of the incumbent ruler.

In much more recent times, and especially in the last eighteen or nineteen years, we have seen a massive increase in the level of household debt in Ireland. It may come as a surprise to many people that the most unsustainable rises in house prices - a key factor in the rapidly increasing levels of household debt - actually took place in the late 1990s not the years immediately proceeding the subsequent bursting of the property bubble.  At that time, house prices were doubling in less than four years. At the height of the insanity (1998), property prices rose by almost thirty percent in one single twelve month period.

Although the annual rate of increase in house prices tailed off somewhat in the years after 1998, between 1993 and the beginning of 2007, average house prices rose by approximately 360 percent, from €67,000 to €310,000. When wage and consumer price inflation is factored in, the increase was about 290 percent.  In other words, to get back to where we were in terms of affordability, average property prices would have to fall by at least 65 percent. In actual fact, the fall will have to be considerably greater than this, because firstly the generous credit terms offered in  former years no longer exist, and secondly because personal savings have been replaced by burgeoning private debts. And also, thanks to the recent building mania, there are still several hundred thousand surplus (empty) dwellings in Ireland. It is hardly surprising the number of new houses being built has fallen by 90 percent since the 2006 peak.

However, it is important to keep a sense of perspective. Most people in this country are still well off in global terms. Many families own two cars,  which when allowing for depreciation, tax, insurance, maintenance and running costs, probably cost more per annum than provision of food.  People take holidays with a misplaced sense of entitlement, when really, it is a privilege not afforded to many billions in the world.

Nor is property ownership a prerequisite for living a fulfilling life. I can make the latter statement with some degree of confidence, because I am not a property owner, nor is it particularly an aspiration. On the other hand, I would not deny that long term security of tenure, whether through ownership or some form of lease arrangement, has many important positive outcomes in terms of sustainability, not least of which is the ability to make long-term strategic plans.

I will talk more about Reinhart and Rogoff at a later date. This Time is Different is an immense work that deserves detailed examination. But briefly, the premise is that the current global crisis, which at the time of writing (2009) Reinhart and Rogoff ranked as the second most severe and widespread economic crisis of the industrial era, bears many of the same features as other historical crashes. By their analysis, the current crash is not actually any different: the same trends occurred during the bubble phase and the same warning lights flashed. Repeatedly so. The problem was that the cheerleaders for the bubble - which included almost all politicians and anyone else with an interest in making a fast buck - argued that this time was different, that everything was under control. This time apparently, people were smarter, safety measures more sophisticated, fundamentals stronger.  Except they weren't. In fact mostly, people acted as if they were decidedly dumber.  Similar foolish words had been uttered at the onset of the financial crash that preceded the Great Depression. In truth a state of collective delusion prevailed, willingly aided and abetted by the media.

In one sense however, there is an irony in the title chosen by Reinhart and Rogoff. Their detailed analysis of past economic booms and crashes, although hugely impressive, did not examine the impact of scarce finite resources. Their presumption, that any crash will eventually be succeeded by an increase in economic activity, ignores the utter dependency of economic activity on energy availability. This time, actually, it will be different. 

But to return to the discussion in hand, how is the vexing issue of excess debt to be resolved?  A quick reflection will confirm some degree of debt is necessary to facilitate trade. Why? Simply because it is not always possible to pay for goods simultaneous to taking receipt of them. Mostly, they are either paid for in advance, which means money must be found by the buyer ahead of any possible sales revenue, or they are paid for in arrears, which obliges the seller to provide a period of credit. The problem is that interest is commonly charged on credit, which then requires further economic growth, and that clearly can go only so far on a planet of finite material and energy resources

Of course it's an entirely different sort of problem when the debt can no longer be serviced, and particularly if the asset purchased has subsequently fallen precipitously in price, and hence can no longer be sold to clear the outstanding debt. This is the situation with many mortgage holders. The asset is worth less than the outstanding debt. In other words, negative equity.

There have been many discussions in Ireland of how to deal with this situation. Undoubtedly, it is very distressing for many of the people involved. However, there is this idea in some circles that the fault lies entirely with the institution that provided the finance. This proposition requires further scrutiny.

When a person borrows money, there are two possibilities, either they intend to pay back the money on the agreed terms, or they don't. If I run up debts during the course of my business activities, there is a clear intention to clear these debts within a reasonable period. Quite apart from the moral issues, word would soon get around my suppliers if I stopped paying for goods received. Trust would evaporate, and credit would quickly dry up. Much of the essential  component of world trade relies on trust.

Of course, I could hide behind the facade of a limited company, which absolves me personally from any unserviceable debts, leaving me free to repeat the same trick elsewhere under a different company name. However, these abandoned debts rarely disappear completely but are passed on down the line in the form of increased bank charges, hiked insurance rates, or increases in the costs of future goods, shared among the wider population.  

When the unpaid debts end up in the hands of the state, which is the case with mortgages originally provided by failed financial institutions since taken into state ownership, and also in cases where the state has foolishly underwritten corporate bank losses with unlimited guarantees to bondholders and other  'investors' (read 'speculators'), the servicing of these debts then requires that money be taken from state expenditure intended for other things, such as education or the provision of health services.

So if I don't intend to pay my debts, to pay what I owe, then it must also be acknowledged that someone else, somewhere, most likely will pick up the tab. Am I comfortable with that? Mostly, I'm not, though there might be exceptions. I suspect most other people, if they really stop to think about reneging on debt, and its likely consequences, would feel the same. Free lunches don't exist in the real world.

Is it really viable for the mortgage holders to not pay their mortgages? The total sum involved, according to the Central Bank is around hundred and ten billion euro, around three times the annual state expenditure on health, education and welfare combined. Even spread over fifty years, the cost of absorbing this debt, never mind any interest payable, would hurt. In reality it is an impossible task. 

And  isn't there something very wrong about spreading the costs of debt over the wider population, which of course includes many people who through their own prudence, or in some cases good fortune, did not get into debt in the first place? In actual fact debt is rarely if ever socialised in the true sense of the word. That is to say, debt never is spread equally among a population. The rich can avail of lower interest rates, more generous repayment terms, corporate write-offs and a host of other tricks to ensure the debt burden falls mainly elsewhere, that is, on the poor.

So what should be done? As has been said elsewhere, there are no 'solutions', just outcomes. But some outcomes are preferable to others.

One creative suggestion is to inflate away the bulk of debt by giving all citizens an amount of cash equivalent to the average mortgage. Given that governments - or more typically the associated central banking institution - create money out of thin air as a standard procedure, logistically speaking this cash bonanza would be quite simple to enact. The one catch is that a country needs to actually have control of its currency, which of course Ireland, being part of a larger currency region, does not. But Ireland could leave the euro if it wanted, and a number of a economists (including the late Richard Douthwaite) did propose this.

Although the wiping out of debt through the equal-opportunities expansion of the money in circulation might seem an attractive  proposition to someone like me, who does not have a mortgage and  who could perhaps anticipate the imminent arrival of a large sum in my local credit union account, finite resource issues suggest that encouraging the population to go on yet another spending spree may not be the smartest idea in town.  

While it has been suggested, in relation to the above proposal, that spending be restricted to goods or services that have clearly sustainable purposes, the problem is actually identifying any such products or activities.  Recent Irish history is littered with the debris of various scams and cons masquerading under 'green' or 'eco' credentials. They are epitomised best perhaps by the ludicrous chimney-mounted wind turbine, that in its working life would generate less energy than was used by the employee of the turbine company in driving from the company premises to the home of the latest proud owner of eco-junk in order to carry out the installation.

Where creation of money universally applied at grass roots level might work is in instances where the prevailing currency has lost all credibility, thereby creating a need for setting up a new currency from scratch. Instead of a bank, government or some autocratic ruler owning the currency, why not have it owned by the people  instead?

Meanwhile, back to the defaulting mortgage holders. Since I began writing this piece, the total number of them has probably already risen.  The obvious equitable solution is for an agreed partial default applied to all owner-occupiers, with the buy-to-let crowd (the speculators and gamblers) left to fight their own corner. So how would this partial default work?  Basically part of the mortgage is written off. Much of the tab for the balance, unfortunately, will probably be picked up by the state, and will be subsequently laid across the entire population, prudent and less prudent alike. It's a kind of charity, but one far more acceptable than an across-the-board get-out-of-jail-free for the mortgage holders. The responsibility has to be shared. 

The extent of the write-off would depend on when the mortgage was taken out and the prices prevailing at that time. In order to be fair, the write-down would have to apply equally to all household mortgages of a particular start date, not solely the ones currently in arrears. In all likelihood the average write-down will have to be around thirty percent, but significantly higher for mortgages entered into at the height of the bubble.

For those who still find they cannot maintain payments, at least they will have the option of selling and more or less clearing the mortgage that remains. They can start again, free of the horrible burden of unsustainable levels of debt, and hopefully a little wiser for the experience.  When you borrow something, mostly you have to pay it back.

[Andy Wilson]

More reflections on debt

The thirty percent write down of domestic mortgages discussed in the initial article is no small matter. The amount involved is some 35 billion euro. The annual interest alone would total close to two billion euro per annum, an amount sufficient to plant and maintain all the trees Ireland could ever accommodate on the two million or so hectares of land that might be deemed suitable, as well as leaving plenty for other things.

The repayment period would be likely to last many decades. Unfortunately it's hard to see how Ireland  might accomplish this, certainly not when set against a backdrop of imploding revenues and simultaneously exploding external costs. In fact, it is debatable whether the entity of the state will make it past the next two decades. But even if the state ceases to exist, it's likely the debts will remain, most probably passed on to a modern Chinese version of the East India Company (complete with its local offices of administration) that will then relentlessly demand its pound of flesh from the peasantry.

It's interesting that the Irish government is in the process of pre-empting this situation, conjuring into existence forty year bonds, a kind of debt servitude deferred for two generations.

Thus, the partial write-down, of debt that I discussed earlier, although providing some welcome short-term relief, may also prove to be something of a toxic legacy down the road. Therein is the hard choice. Who should be sacrificed: the neighbours or the grandchildren?

So perhaps it is worth revisiting some of the other options in relation to debt default. For example, it has been argued that if all mortgages were withheld, the state in turn would be obliged to renege on its own debts and financial obligations, many of which are to either to the IMF-ECB-EU troika or to private speculators (usually given the name bondholders). There is an understandable appeal in this. However, there is no imperative for the state to do this (and certainly not with the incumbent administration). Action A does not necessarily compel Action B.

And as this administration has already made it very clear that it won't burn the bondholders, how long might Ireland wait before an administration is elected that might? Forever, probably, given that at the last day of asking, the electorate voted in place a new government that pretty much offered to rubber stamp all that had gone before, and which is now in the process of creating a multi-generational instrument of debt. Not to mention the various plans to sell off the family jewels.

This is like the inverse of having your cake and eating it - not having a cake and at the same time having nothing to eat.

Even if the state did unilaterally default, the issues of personal trust referred to in the earlier article still remain unresolved. In the future, how many of those who defaulted on mortgages also default on other financial contracts?  Or can all - including those in their vast, unsustainable, often unheatable MacMansions - now be assumed to have learnt the all important lesson, that society mainly requires debts to be honoured?  I know tradespeople - hard working, conscientious people - who are still waiting to get paid for work carried out on some of these supersized, high calorie properties, many years after the event. I can't imagine them being too impressed with any unilateral debt defaults.

The example of the autocratic ruler wiping the slate clean of all debts - as in ancient Mesopotamia - is not especially useful in this regard. He (or she) owned everything and could clearly afford such magnanimous gestures.   

The other side of this argument, often implied if not expressed in detail, and rarely if ever teased out to its logical conclusions, is that debt default should be used as a tool to hasten the demise of a disastrous and destructive system that will fail anyway, eventually. In other words, by causing the system to crash ahead of its unnecessarily drawn out death-throes, we have a chance to rebuild now, while some useful resources still remain. This is actually a very sensible idea, but given the associated hardship will then be fast-forwarded from some unspecified time in the future (albeit probably quite soon) to the present, to the immediate, it may be something of a hard sell.

I suspect this hastening an inevitable collapse is not exactly what many of the proponents of default have in mind. For many, it's not so much a case of wanting to end a messy and sometimes violent binge that has already gone on way too long but rather, by virtue of the cash freed up by not paying outstanding debts, to further prolong the party. The problem is that the root causes are not the same in all cases, but include misfortune, gullibility and lack of knowledge, as well as denial of the facts, irresponsibility, self-interest and (in some cases) just straightforward greed, often masquerading as virtuosity.

Meanwhile there appear to be a new generation of conmen and tricksters running around Ireland, delivering sermons heavy on mysticism and often ladled thickly with references to 'Celtic' times. The new messiahs, apparently immediately ready to pull down the temples of the moneylenders, proclaim loudly this is now the time to wipe all debts.  Abandon all money, they cry. We don't need it, they claim. The universe will provide.

In between times they probably examine the droppings from crows or the entrails of still-born lambs. I wonder how these charlatans and sellers of snake oil expect to get fed in this wonderful money and debt-free future, since clearly they have no food-growing skills, nor any other useful post-crash skills for that matter.  As the food is unlikely to manifest out of thin air in an appropriately Biblical manner, perhaps their presumption is that they can trick some other able-bodied person or persons to grow their food for them.

Thus a new class of social parasites is born.  Given a chance they would quickly set themselves up as a new elite of 'chiefs', (in their eyes, so badly needed by the ignorant peasantry), and see about acquiring a few slaves.

Just to dispel for once and for all this silly stuff about the mystic past - the Celts or rather, those of Iron Age times that in Ireland we now call by that name, were traders.  They traded in a lot of things, for example iron and salt, but it is the trade in slaves - particularly slave girls - that is of interest here.

The cumal (slave girl), in addition to being a commodity that could be conveniently sold to the rough men who plied the Atlantic trade routes, or exchanged for other goods, was also the unit of currency in ancient Ireland. That is, the slave girl, the daughter of someone from a lower-class clan (or someone in debt) but nevertheless a young woman of flesh and blood, with feelings and hopes for the future, was the commodity on which the value of everything else - sacks of grain, livestock, tools, items of jewellery even - was based. The prevailing exchange rate probably varied from season to season, but may have been something like three cows, or twelve sacks of grain per slave girl. Presumably if too many died from ill-treatment, scarcity resulted, and the relative value of the cumal would rise.

Its seems that slavery was out of vogue with the first Christians to arrive in Ireland (though that changed later when the church-supported mercantilists of the later Medieval period required an expendable labour force to toil in South American silver mines or on the sugar plantations of the Caribbean) and it was the teachings of early Christianity which helped rid Ireland of this quaint but rather unpleasant tradition.

However, this is a digression.

Let's suppose for a minute we did have an unilateral debt default.  Then, as our monetary supply is entirely predicated upon the creation of new debt - that is, the supply of new money at interest by central banking institutions - presumably we would also have no money. So people wouldn't be able to be paid at their place of employment or receive their welfare payments at the post office, and no one would be able to buy anything in the shops. As banks would have no further purpose they could close their doors, without bothering to turn off the lights on the way out (they'd be going out soon enough anyway once the power stations ran out of fuel).

At an international level, imports of oil and food would cease.

Depending on how well or poorly the country mobilised the remaining resources, in as little as four to six weeks, the first cases of death from inadequate food intake or hypothermia might occur. Certainly, much better outcomes would be possible, but well below what was achieved in Cuba, where imports during the Special Period, when imports did not entirely cease and where there was much greater food-producing capability, in real terms (and where the population still lost one third of its body weight).

And while new, local currencies, perhaps in tandem with harsh penalties against usury (the lending of money at interest) might come into place to facilitate local transactions, these are unlikely to be of much use regarding international trade.  Actually, any monetary system that refused to play the interest game, and that showed any capability to survive, would pose a significant threat the wider global (interest-based) ponzi scheme, rather in the manner of Cuba's continued existence to the United States (which resulted in an extremely penal and long-lasting trade embargo, still partly in place more than two generations later).

So to ask the question again, shorn of all superfluous trappings and ambiguity, is this what the majority of debt defaulters really want? I suspect not.

Later, we will examine in detail what might happen if sectors of the population, this time with their eyes fully open regarding the possible consequences, collectively decide to opt out of the global ponzi scheme, and start again from first principles: trust and honesty.