Thursday, June 27, 2013

How to get credit costs down

It was only an estimate, yesterday's post. I don't know the exact numbers. But you get the idea: The cost of credit is a big number. And when we are making payments on debt, we can't use that money to buy other things we want.

That's a drag, in more ways than one.

So maybe we want to get the cost of credit down, the cost of accumulated debt, get it down. I'm for that.

How could we do it?

Well, what does the cost of credit depend on? The cost of credit depends on how much debt there is, and the interest rate on all that debt.

To reduce the cost of credit, we can reduce how much debt there is or we can reduce interest rates. One or the other, or both of these things must be done if we want to reduce the cost of credit in our economy.

But you know, interest rates are already as low as they can go. Rates have been falling since 1981, and now they are at the zero lower bound. We can't really lower interest rates more. And that means we can't reduce the cost of credit by lowering interest rates.

So what's left? The only choice left is to reduce how much debt there is. It's simple, when you get right down to it.


Oilfield Trash said...

This solution is equivalent to a Jubilee, but in our modern capitalist system we face two dilemmas. Firstly, in any capitalist system, a debt Jubilee would paralyze the financial sector by destroying bank assets.

Secondly, in our era of securitized finance, the ownership of debt permeates society in the form of (ABS) that generate income streams on which a multitude of non-bank and pension funds.
Debt abolition would inevitably also destroy both the assets and the income streams of owners of ABSs, most of whom are innocent bystanders such as pension funds and IRA.

So you would need a way to short-circuit the process of debt-deleveraging, while not destroying the assets of both the banking sector and the members of the non-banking public who purchased ABSs.

Below is one proposal that could work, which was introduced by Steve Keen.

A Modern Jubilee would create fiat money in the same way as with Quantitative Easing, but would direct that money to the bank accounts of the public with the requirement that the first use of this money would be to reduce debt. Debtors whose debt exceeded their injection would have their debt reduced but not eliminated, while at the other extreme, recipients with no debt would receive a cash injection into their deposit accounts.
The broad effects of a Modern Jubilee would be:

1. Debtors would have their debt level reduced;

2. Non-debtors would receive a cash injection;

3. The value of bank assets would remain constant, but the distribution would alter with debt-instruments declining in value and cash assets rising;

4. Bank income would fall, since debt is an income-earning asset for a bank while cash reserves are not;

5. The income flows to asset-backed securities would fall, since a substantial proportion of the debt backing such securities would be paid off; and

6. Members of the public (both individuals and corporations) who owned asset-backed-securities would have increased cash holdings out of which they could spend in lieu of the income stream from ABS’s on which they were previously dependent.

Clearly there are numerous complex issues to be considered in such a policy: the scale of money creation needed to have a significant positive impact (without excessive negative effects—there will obviously be such effects, but their importance should be judged against the alternative of continued deleveraging); the mechanics of the money creation process itself (which could replicate those of Quantitative Easing, but may also require changes to the legal prohibition of Reserve Banks from buying government bonds directly from the Treasury); the basis on which the funds would be distributed to the public; managing bank liquidity problems (since though banks would not be made insolvent by such a policy, they would suffer significant drops in their income streams); and ensuring that the program did not simply start another asset bubble.

We currently do not have the political leadership or operational infrastructure to deal with anything this complex even if (big if) the FIRE sector was supportive of reducing their income streams. We may have no other option but to grind it out for the next 20 years, which will most likely bring on more political destabilization and polarization.

geerussell said...

For the sake of completeness, there's a third option after cutting interest rates and reducing the amount of debt. In balance sheet terms, the burden of debt isn't the amount of debt but the ratio of debt to equity. Leverage. It can be reduced by reducing debt or increasing equity.

If only there were another sector that could make the policy choice to inject more equity onto the private sector's balance sheet.

Greg said...

"If only there were another sector that could make the policy choice to inject more equity onto the private sector's balance sheet."

; )

If only ...... where might we find such a sector...hmmmmm

The Arthurian said...

Warren seems to think interest cost is a good thing.

Greg said...


Warren is referring to interest income on govt securities, which are held by private sector, not interest income to banks. Yes, both levels are affected by monetary policy since as The fed lowers its rates banks usually lower their rates to borrowers and vice versa, but I dont think its correct to imply Warren thinks interest costs (on borrowers of bank money) is a good thing.

If you look at the totality of his policy prescriptions you would likely come to a different conclusion.