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House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again Paperback – 23 Jun 2015
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"The most important economics book of 2014; it could be the most important book to come out of the 2008 financial crisis and subsequent Great Recession. Its arguments deserve careful attention, and its publication provides an opportunity to reconsider policy choices made in 2009 and 2010 regarding mortgage debt. "House of Debt" is important because it persuasively demonstrates that the conventional meta-narrative of the crisis and its aftermath, which emphasizes the breakdown of financial intermediation, is inadequate. . . . All future work on financial crises will have to reckon with the household balance sheet effects they stress. After their work, we can still believe in the necessity of financial rescues; however, we can no longer believe in their sufficiency. And after their work, we have an important new agenda of reforms to consider if future crises are to be prevented."--Lawrence Summers "Financial Times "
"Mian and Sufi are convinced that the Great Recession could have been just another ordinary, lowercase recession if the federal government had acted more aggressively to help homeowners by reducing mortgage debts. The two men -- economics professors who are part of a new generation of scholars whose work relies on enormous data sets -- argue . . . that the government misunderstood the deepest recession since the 1930s. They are particularly critical of Timothy Geithner, the former Treasury secretary, and Ben Bernanke, the former Federal Reserve chairman, for focusing on preserving the financial system without addressing what the authors regard as the underlying and more important problem of excessive household debt. They say the recovery remains painfully sluggish as a result."--Binyamin Appelbaum "New York Times "
"Sufi and Mian have been publishing important work on this topic for the last eight years, beginning well before the 2008 crisis. Their arguments are compelling and deserve widespread attention, especially at a time when Tim Geithner and others are trying to rewrite history - and when many homeowners still need help."--Richard Eskow "Huffington Post "
"The economists Mian and Sufi are our leading experts on the problems created by debt overhang (and the authors of an important new book on the subject, "House of Debt"); they looked at Geithner's claims about the benefits of debt relief to the economy and showed that they are absurdly low, far below anything current research suggests."--Paul Krugman "New York Review of Books "
"Much has been written about the boom and subsequent bust that rocked the US economy during 2007-2009, but insightful and informed analysis is much rarer. This book is one of those rare gems. It offers an in-depth look at the state of housing, consumer credit, household incomes, and debt around the crisis and presents an informed discussion about its causes and consequences. The analysis of crisis resolution has resonance, not only for the United States, but for the many countries that are still entangled in severe financial difficulties."--Carmen Reinhart, Harvard University
"Atif Mian and Amir Sufi, our leading experts on the macroeconomic effects of private debt, have a new blog [www.houseofdebt.org]-- and it has instantly become must reading."--Paul Krugman "New York Times "
""House of Debt" is a very important book, reaching beyond surface explanations of the Great Recession to identify the fundamental cause--excessive private debt built up in the pre-crisis boom years. It combines meticulous empirical research with an ability to see the big picture. Its message needs to be heeded and its proposals for reform seriously considered if we are to avoid repeating in future the mistakes of the past."--Lord Adair Turner, former chair, Financial Services Authority
"Mian and Sufi have produced some of the most important and compelling research on the impact of debt on consumer behavior during the recent housing bubble and bust. This excellent new book presents and expands this research in a rigorous, yet engaging and accessible way."--Christina D. Romer, former chair of the Council of Economic Advisers
"This is a profoundly important book that makes a huge range of serious empirical evidence on the financial crisis accessible to a broad readership. A compendium of Mian and Sufi's own celebrated work would already be a spectacular contribution, but this book is so much more. Although the authors present all views in a balanced, scholarly way, their quiet insistence that we should have moved faster to write down household mortgages is well-reasoned and compelling."--Kenneth Rogoff, Harvard University
"Perhaps the most important single lesson of the crisis is that beyond some point the growth in debt adds to the fragility of the economy more than it adds to either personal welfare or aggregate demand. Atif Mian and Amir Sufi argue this persuasively in "House of Debt.""--Martin Wolf "Financial Times "
About the Author
Atif Mian is the Theodore A. Wells '29 Professor of Economics at Princeton University and director of the Julis-Rabinowitz Center for Public Policy and Finance. Amir Sufi is the Chicago Board of Trade Professor of Finance at the University of Chicago Booth School of Business.
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I found the concept that the modern day banking system is setup so the rich implicitly lend to the poor quite fansinating. Moreover, this effect is amplified with leverage. During a recession the poor suffer considerably because a greater portion of their wealth is tied to debt - the effect of leverage increases the chance of their entire wealth being wiped out. The wealthy on the otherhand have less debt and big deposits which benefit from consirderable protection from the central bank - lender of last resort. Net result - poor indebted are not protected but the wealthy cash-rich are.
The votex effect on foreclosed homes was also interesting. Poor areas where owners often had big mortgages saw a greater incidence of foreclosure. To add to the misery of that local area, foreclosed properties were often sold in firesales as the banks were only interested in getting back the value of the loan. This action lowered the value of homes in the local area and caused even more foreclosures The result was that poor areas were hit hard, while wealthy ones retained most their value. As a home usually makes up the bulk of most people's wealth - the poor suffered considerably.
I guess what struck me is that the authors proved quite convincingly that debt creates inequaility in an economy - especially at extreme levels. Ironically in Europe and North America, households remain highly levered and traditional credit lines have been replaced by less regulated shadow banking.
To be honest I didn't put most arguements in this book to memory, but these points certainly hit home for me.
Take it on a vacation, but don't expect it to last long, it is extremely short. The good thing is that it's divided into short chapters (<1 hr each) and then further subdivided, so it's great to read over lunch breaks or just before bed.
1. Always quoting relevant research, but never attempting to talk over your head, they start by explaining how the poorest 20% of homeowners on average lost their entire net worth in the crisis, all while the richest 20% came out unscathed. How come? Simple: 1. The top 20% mainly hold financial assets that were protected by the Fed 2. The top 20% are indirectly the guys holding on to the mortgages that the poorest 20% are still paying or alternatively the US government guaranteed by taking over the obligations of Fannie and Freddie. All the recent talk about inequality? Go no further. The authors have it covered by page 40. Next!
2. They then explain that the poorest 20% have a marginal propensity to consume that is a large multiple of that of the richest 20%, an effect that also works in reverse and explains most of the fall in consumption (and thus aggregate demand) in the economy once their home equity had wiped out their lifetime savings. Yes, I'm confusing wealth effects with income effects here, but only for the sake of brevity. The authors do not! In short, the way you lose your house is you lose your income first (for example, divorce cuts it in half or illness in the family keeps you from working), next you miss payments, then you lose the house, which represented all your wealth to cap it all off. Alternatively, it's all set off when your monthly payment rockets up. And that's how the spending stopped! Charts are provided that measure this impact and irrefutably demonstrate that this process was in full swing, with spending on cars, furniture etc. on its knees a good 2 years before anybody knew the word Lehman.
3. It does not end there. Banks sell foreclosed homes into a weak market, forcing prices lower, which drives everybody's house price down, forcing people's home equity down to below zero who have done nothing wrong. These are people who can make their mortgage payment, and indeed mostly carry on doing so. Meantime, however, they are in negative wealth, with the inevitable negative effects on spending, especially among the poor.
4. Lots of lower spending all-round then forces companies to trim production and triggers unemployment. This was to me the most fascinating part of the book. Through little parables about countries linked through trading etc. the authors demonstrate how lower spending in conjunction with three distinct inflexibilities in the labor market (1. It's easier to fire people than to cut pay 2. It's difficult to move labor around, especially when it's wedded to a house it cannot sell 3. Retraining does not happen instantly) inevitably leads to job losses even in parts of the country or indeed the whole planet where no overleveraging and no housing bubble ever occurred.
I'm probably making a total hash of explaining this here, but the authors don't; they totally rock.
5. Next, they explain how debt not only doomed the poor, it actually triggered the whole housing bubble to begin with. Their work here is, for lack of a better word, forensic. They go state-by-state, nay, ZIP code by ZIP code splitting America by (i) high/low leverage (ii) high/low constraints in expanding city limits (iii) high/low credit score and demonstrate that credit expansion led price house appreciation. NOT the other way round. The analysis is fascinating and totally convincing. Leverage came first, house price appreciation followed. Page 83 is where to look. But, needless to say, higher house prices of course subsequently also led to further borrowing by households who famously "used their house as an ATM."
6. My second-favorite part of the book comes next. It explains how even those who believe homes are overpriced are left with no choice other than to get involved if irrational buyers use leverage: It's pages 110 to 113 and I won't spoil it for you here, it's a total gem of an argument. And it's followed by an equally elegant argument (originally by Andrei Shleifer, the man who best refuted the efficient market hypothesis AFAIC) on who would lend into this type of boom: investors who are misled into doing so by investing in securities specifically designed by the banking sector that provide enhanced yield by dint of over-exposing them to "neglected risks." Like -10% HPA, for example.
And so on... I still can't believe how much they've managed to pack in. In summary, the Great Recession was not caused by the Lehman incident. Contrary to the literature about the "breakdown in financial intermediation" theory promoted by our self-styled saviours, it was caused by debt, and in particular by the overindebtedness of the poor.
Next, they train their laser onto the inadequate response of policy makers. In one sentence, the most efficient thing to have done would have been partial debt foregiveness. Period. A chapter is dedicated to how hopeless all other policies (fiscal response, monetary response, you name it) are in comparison. And the blame is laid at the feet of those in charge.
This is so persuasive, that in response Larry Summers took it upon himself to review the book in the FT, lavishing it with praise, but also pointing out 5 (count'em) reasons his hands were tied.
All in the space of 187 pages.
Admittedly, the book could have been even shorter. The authors dedicate a fair few pages to the purpose of debunking the "save the banks, save the economy" theory that informed the policies of the Paulson / Bernanke / Geithner response to the crisis. They needn't have. More people believe in UFOs today than in the importance of Citibank, AIG or Goldman Sachs in our future prosperity, let alone their propensity to hold up the economy through the provision of credit. On the other hand, if you ever bump into somebody who chooses to defend the indefensible, you can always mail him his own personal copy of "House of Debt" and if he is remotely honest or open-minded that should settle the argument.
It's all capped by a rather lengthy proposal regarding Shared-Responsibility Mortgages. I work in the markets and I have no idea who will buy them, especially since the Fed has had to buy the much simpler paper that nobody wanted.
But from where I'm sitting the contribution of the book is elsewhere. It's both the definitive account of what happened to the American economy from 2006 to 2014+ and a powerful punch in the stomach for anyone who advocates the "democratization of debt" as a path to prosperity.
Buy it, read it and lend it to a friend. Spread the word!