Monday, February 29, 2016

Debt Takes a Holiday

Back in 2008-09 there was a lot of talk about loan forgiveness for underwater mortgages.  (Those are mortgages where the principal owed exceeds the value of the house.)  At the time, the idea was that for the most part the efficient solution to the then housing crisis was for for the current occupant to remain in the home.  TARP, the program to save the remaining big banks and restore liquidity to the system, had $50 billion allocated for this purpose, to provide assistance. (In other words, the federal government would absorb some of the debt, which along with partial debt forgiveness would make the renegotiated mortgages viable.)  I did not track this well, but I seem to recall that money didn't spend quickly and may have never been spent in full.  Many people were dispossessed from their homes, part of the human tragedy that ensued after the housing bubble burst.

We are having something of a replay of this movie in my state, Illinois, where our hedge-fund manager as governor seems to want all the state debt to be repaid in full, asap, regardless of the social cost.  This is a cutting off your nose to spite your face solution, and it really shows a lack of intelligence and creativity.  I will not otherwise invoke Paul Krugman in this piece, but one point he made during the aftermath of the housing bubble, over and over again, is that many people have the implicit belief that penance must be done in the form of economic sacrifice after having incurred a rather large debt.  This is how the Germans seemed to regard the Greeks.  Look how that ended up for Europe.  There's a lesson from that experience, if anyone cares to take a look.

At a macroeconomic level, we need more government and for the foreseeable future.  The economy is weak.  This is certainly true at the global level.  It is even true within the U.S., in spite of the reasonably low unemployment rate.  So the lack of government spending in Illinois, is like pressing the macroeconomic brake when the right thing to do is step on the gas.  I am writing this in a way to abstract entirely from the very large human dislocation that is being created as a result of the lack of budget, where various public organizations are reducing services or shutting down entirely.   I don't want to make an emotional argument here.  I want this to be logical/coolly reasoned/should make sense to everyone regardless of political stripe, sort of argument.

At a minimum the state should refinance its debt now and the Feds could help with that to assure the state gets the most favorable rates, by serving as a guarantor of principal repayment....eventually.  As we are currently at or near zero interest rates, this matters a great deal.  Indeed, there is talk of negative interest rates, a sure sign that the economy's health is far from robust.

The thing is, if the interest rate were really zero and if there really were a federal guarantee on state debt, then the loans could be paid off when it is in the interest of the borrower to do so.   Presumably this would happen over time as the borrower achieved some financial health.   In contrast, the need to make draconian spending cuts now is entirely in the mind of those who hold the state debt and those who represent them, for fear that there will be default.  Ironically, playing the cards as they are is making default more likely by exacerbating the grim conditions at a macroeconomic level.

Debt forgiveness at a state level, absorbed by the Feds, clearly has an element of moral hazard to it.  What is to prevent the same behavior, excessive and wasteful spending, from happening again in the future? And in Illinois, where there is a historic proclivity toward corruption, who would want to bet against that happening again down the road, even if some needed reforms were put into place?

The argument here is not that there is no moral hazard.  Rather is that it is a fool's errand to attend to that issue now.  One thing at a time.  The state needs to operate and be functional.  I see this mostly in Higher Ed where the situation is really grim, but really this is true of all public agencies in the state.  The needs that their services satisfy are entirely orthogonal to the debt issues.  Those needs should be addressed immediately.

Excessive state and municipal debt have not emerged as issues in the current Presidential campaign.  But it is an urgent problem that requires a real solution.  If memory serves, in the 2008 campaign, there was hardly a mention if at all of the stimulus package that became the first major bill once President Obama assumed office.  People need to read some history - the lesson of New York City in the mid 1970s might be a good example - about how such issues actually do get resolved.  The macroeconomic situation then was quite different.  It was a time of high inflation.  So parts of the solution would need to accommodate how things are different now.  But the elements would be largely the same. 

Instead of moving toward a solution now, what we currently have amounts to self-flagellation.  Maybe that is a necessary first step, though I have my doubts, as to make all parties more flexible when the actual negotiation does happen.  Illinois' example may be more difficult than elsewhere, of this I'm not sure, because some of the spending is guaranteed in the state constitution, and the courts have made clear that the legislature can't simply ignore those guarantees.

Difficult does not mean impossible.  Killing the patient to invoke a cure is not good medicine.  Surely these thoughts are shared by most everyone around the state.  But there appears to be gridlock between the governor and the legislature.  A solution would seem to require an arbitrator from outside the political process.  Absent that, it might be helpful, as I'm trying to suggest here, not to ask about what comes next but rather to move to the endgame and then work backwards from that.  The endgame I have in mind has Illinois still a robust state.  If we can agree on just that, it would be progress.

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