Debt Relief for Whom? Part I

Two new books address debt from opposite ends of the financial scale. In The Case for a Debt Jubilee in the United States, Richard Vague proposes a practical way to forgive crushing middle class debt. In The Lords of Easy Money, Christopher Leonard traces How the Federal Reserve Broke the American Economy as it protected the big banks that acquired unpayable debt.

Part I: The Case for a Debt Jubilee

I asked my physical therapist, Patrick, age 29, what he’d do if he didn’t have heavy debt from his training. “First, I’d buy a house,” he said. “Then, maybe invest. Maybe buy some houses to fix up. Maybe…As it is, I’m very careful. I put away a little money each month.” He was shocked when I told him that 65 years ago, my husband went through public universities all the way to a PhD without paying tuition. But Patrick is lucky. He makes a decent salary at a good job he loves.

The student debt burden has grown from about $481 billion in 2006 to $1,476 billion in 2022. It paralyzes many middleclass lives and drags down the economy. Some students received worthless degrees from shady for-profit colleges. Since over 90% of that debt is owed to the federal government, Bernie Sanders has called on President Biden to simply wipe it out.

As Richard Vague explains in The Case for a Debt Jubilee, debt has been essential to economic exchange since the beginning of civilization. Yet debt inevitably grows to destructive levels. In the ancient middle east, kings periodically proclaimed a debt jubilee for small debtors. Small farmers had their land restored and their children returned from debt servitude. That way kings both reduced the debt drain on the economy, and reasserted royal power over wealthy merchants and nobility.

In 2021, all private debt in the US stood at $39 trillion, and public debt at $30 trillion, compared to GDP of $23 trillion. Private debt has risen inexorably since 1950, from 50% of GDP back then to 165% in 2021, down a bit from its peak during in 2008. It exceeds public debt, which ran around 100% after 2008 until spiking in the Covid epidemic to 129%. (See Vague’s statistics for the US.) Student debt presently occupies public attention. But mortgage debt is far larger. After peaking during the 2008 crisis, it is again rising rapidly to over $11 trillion in 2021.  Medical debt is smaller, about $140 billion, but upends the lives of millions of US families. The Covid epidemic has left many millions of families and small businesses desperately behind on mortgage and rent payments.

Vague offers practical and politically feasible ways to reduce debt burdens.

Forgiveness of student debt creates “moral hazard.” That is, the possibility of forgiveness may induce people to assume more debt. That was the logic behind a 1976 federal law banning bankruptcy for student debt. Blanket forgiveness, as proposed by Bernie Sanders, is unfair and politically bad news. More than half of student debt is owed by people, like my PT Patrick, who hold graduate degrees. A third of student debt is owed by people in the top 20% of income. To forgive their debt along with the debt of poor diploma-mill victims is to spend public money helping the relatively well-to-do. It would produce a legitimate howl from families who saved money for education. It would give Republicans another club to beat up Democrats for favoring the educated coastal elites.

Fortunately, as Vague points out, there already exists a federal program that could wipe out student debt without controversy. Under the Public Service Loan Forgiveness Program, students who engage in designated public service work, and make 120 consecutive loan payments can have the balance of their debt forgiven. So far, the government has applied criteria so narrowly that few students qualify. Expand this program broadly, Vague says, to allow students to “work off” their debt in many forms of service, such as Peace Corps, teaching or providing health care in under-served areas or other forms of community service. Professionals like Patrick could work a few years in a rural clinic. (Public service loan forgiveness won’t address the causes of the student debt explosion: State and federal tax cuts have led to cuts in funding for public colleges. At the same time, the federal government’s expanded student loan program has encouraged private colleges to raise tuition and allowed for-profit colleges to prey on unwary young people.)

The collapse of the 2008 housing bubble left ten million households “under water,” that is, owing more on mortgages than the value of their homes. The federal government offered them a limited program of interest rate reductions, but no write down of mortgage debt. It’s understandable why. First, due to the volume of bad loans, lenders were grossly over-leveraged, that is, debt was many times equity. Forcing them to write down mortgages (taking a simultaneous bite from assets and equity) would have revealed that they were insolvent (having negative equity) and liable to collapse. Second, just as with student debt, writing down homeowners’ underwater mortgages creates problems of moral hazard, fairness and politics. Moral hazard in that the prospect of mortgage relief might encourage people to take on more debt. Fairness and politics in that a write-down seems unfair to homeowners who had always kept up with their mortgage payments and/or who had not foolishly bought overpriced homes at the peak of the bubble. In 2010 the Tea Party crusaded on the unfairness of mortgage interest relief.

Vague cleverly squares this circle as follows: At a homeowner’s request, banks would write down a mortgage to market, and reduce monthly payments as well. But as a special crisis dispensation, banks would be allowed to write off the loss over thirty years, instead of taking it at once. And the homeowner would agree to give the bank a share of the increased value of the house when it was eventually sold. This legal device offers a win-win deal for both homeowners and banks, without the appearance of a giveaway to the foolish and undeserving. It would have allowed many families to stay in their homes. As a new real estate bubble takes shape, it may soon be necessary again. (The device of a 30-year write-off was used successfully in 1983 to allow the big banks to write off debts owed by Latin American nations.)

A major 2015 survey found a quarter of those 18-64 reported difficulty paying medical bills, with little difference between those having or not having insurance. Some 2% of these, which translates to about a million people nationally, filed for bankruptcy that year. Health care debt should be easier to forgive. There’s no moral hazard problem as people don’t get sick or injured on purpose. The best solution, Vague writes, would be single-payer health insurance. But as long as that’s politically off the table, he proposes means-tested relief: Individuals with under $85,000 in household income could apply to the federal government for reimbursement of debt incurred for major categories of medical expenses, including diabetes, heart disease and cancer.

In 2005 Congress enacted a tough new bankruptcy law on the assumption that reckless spendthrifts were abusing bankruptcy. But it turned out that most people file for bankruptcy in desperation after life catastrophes, notably large medical bills, job loss or small business failure. Vague proposes a number of major reforms to bankruptcy law. These include allowing homeowners to modify mortgages, renters to avoid eviction if they continue paying rent, car owners to keep their cars by paying off the value over time, and individuals to discharge student loans like other consumer debt.

Vague estimates that these reforms could result in as much as $1.5 trillion in debt relief, mostly for households. In addition, he proposes that the income tax code be changed to make it less favorable to corporate debt.

Vague completed the book before the current surge in prices. The Federal Reserve is now struggling to raise interest rates from near zero. Even as Americans step up borrowing, higher rates will increase interest payments on debt. Student loan rates are their highest in many years. Higher rates may also trigger a sharp decline in asset values, notably stocks, bonds and real estate. A debt jubilee couldn’t be more urgent.

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