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Business News/ Opinion / Think of debt as pollution
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Think of debt as pollution

Adair Turner's new book, Between Debt and the Devil, describes the current system and what's wrong with it

Photo: Hemant Mishra/MintPremium
Photo: Hemant Mishra/Mint

There are so many works on the global financial crisis by now that it’s getting harder to justify any more, but Adair Turner’s new book, Between Debt and the Devil, is definitely worth your time.

Turner’s method is straightforward: He describes the current system and what’s wrong with it.

That’s been done, to be sure, but the book develops a strong and persuasive central theme. The problem, Turner says, isn’t so much with them—with the banks and other financial firms, that is. It’s with us, and our addiction to a certain kind of debt.

The book’s main argument turns on the distinction between debt that’s used mainly to finance new business investment, and debt that’s used mainly to buy existing assets, especially real estate. The first, you might say, is about financing economic growth; the second is at least partly about bidding up prices. Pre-crash financial orthodoxy said the mix of credit between those different uses could safely be left to lenders and borrowers to decide for themselves. That was wrong, Turner argues.

Borrowing to buy a house looks pretty safe from both sides of the transaction. Banks get a claim on the property, so their exposure to default is capped; and borrowers have an ownership stake they would otherwise lack, so their mortgage repayment serves as a form of saving. Yet this appearance of safety is an illusion: “Lending against real estate—especially existing real estate, whose supply cannot be increased easily—generates self-reinforcing cycles of credit supply, credit demand and asset prices."

These cycles, moreover, are inevitably unstable. Between 2000 and 2007, Turner points out, mortgage credit in the US more than doubled; house prices soared as well. As the cycle gains momentum, rising prices fail to check the demand for borrowing. On the contrary, they add to it—until the cycle swings into reverse and everything unravels. The crash levels the asset valuations but leaves the debts that caused them standing. Deflation, if it gets a grip, actually adds to the real burden of the debts. That makes a strong recovery very hard to engineer.

Many factors, in this telling, contribute to the sequence. For instance, banks over-lend partly because of the protections and subsidies they enjoy, and people and firms over-borrow because debt enjoys tax privileges. At the very least, Turner argues, debt should be treated neutrally for tax purposes. But it would make more sense, he says, to tax it as a kind of pollution.

More generally, the book argues that it’s necessary to deliberately manage the credit cycle. You need so-called macro-prudential regulation—such as varying the maximum permitted loan-to-value ratio for housing loans according to where you stand in the cycle.

The main fault of Between Debt and the Devil is that it covers so much ground. It discusses just about every domestic and international factor that plausibly contributed to the crash, and just about every feasible domestic and international policy response. To keep the book at manageable length, Turner keeps all discussion brief. He name-checks author after author, and mentions study after study on issue after issue—showing excellent taste and thorough familiarity. The book always serves as a superb guide to the available reading, but it doesn’t succeed every time in explaining the issues adequately.

Still, I recommend it highly. Turner brings an unusual combination of credentials. As a former chairman of the UK’s Financial Services Authority, he’s a paid-up member of the economic-policy establishment; he’s also a genuinely radical thinker, and unafraid to say what he thinks. On some issues, notably in calling for “direct monetary financing" of government deficits, he’s struck out on his own and put big, bold ideas on to the policy agenda. More power to him. Bloomberg

Clive Crook is a Bloomberg View columnist.

Comments are welcome at otherviews@livemint.com

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Published: 30 Nov 2015, 10:38 PM IST
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