The end of debt?

by John Quiggin on February 22, 2012

In ordinary language, a debt is a morally and legally binding obligation to (re)pay somebody. But that’s not the only commonly-used definition of debt. In corporate finance, “debt” refers to a class of securities with a fixed interest payments, senior to equity in claims on assets. Until late C20, this description carried with it much of the freight associated with the ordinary definition – failure to repay debt would involve the end of the corporation as a legal person, so any honest and prudent corporate manager sought to avoid this, and to keep a good credit rating. That all changed with junk bonds and Chapter 11 – corporations now routinely restructure, to wipe out debt (particularly debt owed to employees).

Then there’s sovereign debt, which has always been a special category. Historically, loans to sovereigns debt were more like the reciprocal obligations described by Graeber than like the debts owed by subjects to sovereigns. If you lent to a king (your own, or a foreigner) you gained favor, and hoped to be well paid, but couldn’t do much about it. That attitude extended more generally to aristocratic debtors (exemplified by Becky Sharp and Rawdon Crawley in Vanity Fair).

What happens when this view of debt becomes more general As I’ve written previously, current trends imply that most Americans will sooner or later go bankrupt, and of course millions more have defaulted on mortgages in the current crisis. For most of those involved, this event has been catastrophic, and has carried with it a burden of shame and guilt. But, as with divorce, it’s hard to maintain a moral stigma for a life-event that is so commonplace (the fact that bankruptcy is private, while divorce is public, cuts both ways here).

I don’t have an answer on this, only a question. If everyone treated debt as a financial instrument, to be managed in whatever way suited them, how would/will society and the economy change?

{ 16 comments }

1

Ebenezer Scrooge 02.22.12 at 9:41 pm

John’s ordinary-language definition of debt is circular, because it is mighty hard to define “payment” without adverting to debt. I therefore prefer another definition: “an obligation denominated in monetary terms.” This requires an independent definition of “money,” which isn’t easy, but I don’t think is circular.

2

Typhoon Jim 02.22.12 at 9:47 pm

Here is something of an empirical start, at least:

http://www.bloomberg.com/news/2012-02-20/icelandic-anger-brings-record-debt-relief-in-best-crisis-recovery-story.html

If the debt is too onerous, the terms must change. The depth of the renegotiation will likely depend on how long the initial belief that the terms were reasonable holds.

3

Stephen 02.22.12 at 10:05 pm

Are you sure that in the US bankruptcy has always been “catastrophic, and has carried with it a burden of shame and guilt”?

I have the impression (can’t give detailed references, sorry) that in Europe that has generally been so, since the bankrupts had deceived, impoverished and defrauded their close neighbours. Americans bankrupts, in the early days, by contrast had impoverished creditors on the far side of the Atlantic who deserved no better: later, had impoverished people far away from where they were, or where they had been but were no longer.

4

The Raven 02.22.12 at 10:44 pm

“If everyone treated debt as a financial instrument, to be managed in whatever way suited them, how would/will society and the economy change?”

See strategic default, passim.

5

Omega Centauri 02.22.12 at 10:51 pm

To second Ravens point, it has become quite common the treat mortages that are seriously underwater, as non-recourse financial instruments. Quite a large number of individuals have “mailed in the keys” or gotten banks to OK a shortsale to get out from under what were esentially leveraged investments gone bad.

I question the statement that says a majority of Americans will eventually go bankrupt. Is the median hoiusehold in that bad a shape?

6

JW Mason 02.22.12 at 11:13 pm

Good question!

One obvious answer is the creation of a new class of super senior obligations, as we are already seeing e.g. with student loans, which cannot be discharged in bankruptcy. Of course, this easier to do legally than culturally.

The broader point, which I think is rejected (for different reasons) both on the left and the right, is that the long trend of modernity is toward a diminishing rathe than increasing role of markets, property and monetary obligations. For most of us, a much smaller share of our claims on the social product take the form of property ownership than 100 years ago. (Of course for the rich this is not so.) If you look at the assets of the typical American household, they are dominated by implicit Social Security wealth, followed by the home, which is property but not simply property, and pension assets, which again are property-like but certainly not property in any straightforward sense. (Admittedly within the narrow category of private pensions there is some trend in the direction of property.) Not to mention of course “human capital” in the form of credentials, etc., which cannot be sold or hypothecated. Similarly, the typical employment contract today carries with it a much wider penumbra of legal and social obligations than in the 19th century.

So I think John Q. is right to se a loosening -up of debt contracts but that’s part of a broader shift.

Another possible answer: a great reduction in asset-ownership for the bulk of households. Debt typically finances assets; if e.g. the typical household rented its housing rather than owned it, a lot of household debt would disappear.

7

gavinf 02.23.12 at 1:11 am

Niall Ferguson’s TV series The Ascent of Money is showing here in Oz at the moment, and makes the case – standing on a crossroads in Memphis, surrounded by repo agencies, pawn shops and payday loan joints – that loan default and bankrupcty have long been a part of everyday life in sub-prime USA, and have been become the new normal there, catalysed by Clinton’s drive to increase home ownership.

8

Peter T 02.23.12 at 1:50 am

Further to my comment on the second Graeber post, J K Galbraith made the point that in C19 America, debt and default were a normal part of development. New settlements, mining claims and other start-ups often did not pan out. In which case you defaulted and moved on. Wall St wanted hard money (the “cross of gold”), the frontier wanted soft money. Similar stories could be told in Australia, and I have the impression that the English C18 attitude to debt was not dissimilar. The last century has seen a significant hardening in the obligations on and moral judgements surrounding debt, as the hard money types influence law and society. Maybe we would just revert to earlier, more relaxed attitudes?

9

The Raven 02.23.12 at 1:52 am

“Is the median hoiusehold in that bad a shape?”

Yes. As of last November, 1/3 of Americans are one paycheck from missing a rent or mortgage payment, link, and 61% five months away.

If this becomes a norm, as John says, people will change their attitudes.

10

ben in el cajon 02.23.12 at 4:45 am

Uh, bankers might make fewer foolish loans, and those who buy those loans from bankers will have to study them more, or pay less, and the poor will be the last to believe that ethics apply in business.

11

nvalvo 02.23.12 at 5:25 am

Bankruptcy has a complex history.

Cf. 18c British debates on the “mercantile exemption” that allowed merchants — or anyone who could plausibly claim to be one — owing unpaid debts greater than £200 access to bankruptcy protections, while all others had to submit to insolvency proceedings.

As a result, there was something of an anti-bankruptcy movement, which I suspect is largely responsible for the poor reputation of bankruptcy in the Anglophone world.

12

Curmudgeon 02.23.12 at 6:01 am

@JW Mason:

I disagree with your point about long term trends away from markets and property. The long term trend, certainly over the past 30 years, has been for stronger elite property rights and increasing use of markets to decide matters of social organization and while the ability of the mode citizen to own property and participate markets has been curtailed.

The information economy has changed the both tools of production and the products of production from being physical objects that can be owned to intangible goods that consumers must pay for but can only use at the pleasure of their ultimate owners. A manufacturer or publisher can’t take a table saw or a book away from its purchaser or forbid its resale; most software and creative goods now work only as long as their publishers deigns to keep their activation servers running and resale is completely out of the question. There is no property right here for the end user but there is certainly a property right for the publisher.

As far as the growth of property rights is concerned, there is very little evidence that property rights are in any way weakening. Elite desires have been emboldened by their new ability to rent goods to consumers for ongoing revenue rather than outright sale. Elite consensus is now moving towards the view that revenue streams themselves are property. Elites have become increasingly adept at using the patent system, lobbying, and regulatory takings doctrines embedded in trade agreements to claim revenue streams as property and reject any competition or policy movements that would compromise those streams as illegitimate if not illegal. The mode citizen is in no way able to make such claims for their own revenue/wages because the barriers to entry to be heard at the elite table are too high.

Elite property rights and market access are doing very well, thank you very much. It’s just the rest of us who are being forced to replace ownership with rental as tribute to rentiers.

13

Jasiek 02.23.12 at 2:58 pm

When S has purchased a unit of A’s debt, S has released his liquidity, where the interest should be considered as the reward for releasing S’s liquidity instead of the price for saving or waiting.

The value (i.e. principal and interest combined) of the abovementioned one unit of debt is expected to be lower than the value of the principal and return A will have had when the unit of debt is due. But, A could possibly fail to meet the condition.

If S and A could precisely calculate and agree to an interest rate by empirical means, it is unlikely that A would fail to settle up. At a macro level, if the Ss and As could precisely calculate and agree to interest rates, it is unlikely that As would fail to settle up. Why can’t they calculate interest rates rightly? Why do they often end up having to renounce some of their claims? It must be because of speculative motive, which determines interest rates ex ante, as one of the two different motives for money. According to Keynes’ liquidity-preference theory, the amount of money determined by the speculative motive changes separately from the amount of money determined by the transactions motive or Marshallian k(s).

When debt was/is managed in whatever way suited the people in question, this means the amount of money held by the speculative demand would/will expand rapidly, All Ss couldn’t/can’t expect that all Bs would/will settle up in due course. When A fails, it is not only A’s but also S’s mistake (and perhaps equally), because both agreed that S lend money to A while they hadn’t ‘precisely calculated both risk and UNCERTAINTY’. This is not only about interest but principal, because the value of the principal and return A will have had when the unit of debt is due could possibly be lower or much lower than the value of the principal and interest calculated ex ante. It is because of UNCERTAINTY. A solvency risk is actually not a risk. Why did Antonio have a trouble with Shylock? Was Judge Portia’s unreasonable demand of Shylock illegitimate (in view of liquidity-preference theory)? (When a risk has not sufficiently been calculated or date not sufficiently accumulated, it also is considered an uncertainty. So, don’t wonder what if Lloyd’s had existed then.)

14

reason 02.24.12 at 11:21 am

gavinf @7 They gave Niall Ferguson a TV show? How terrible.

15

understudy 02.25.12 at 7:51 pm

re: “Yes. As of last November, 1/3 of Americans are one paycheck from missing a rent or mortgage payment, link, and 61% five months away.”

This statistic is suprisingly resliant throughout history – and I believe hasn’t changed much even since the era of full employment and 4% real economic growth in the US. Has nothing to do with debt or income, some people save money, some people don’t. 10% of people earning over $100,000 a year are in the “one paycheck away” category. It just means they don’t have wealth, not necessarily anything about their debt or the adequacy of their income

16

MinaWest 02.29.12 at 4:28 pm

Debt is becoming such a huge problem for the average American. The average consumer debt in 2010 was more than $10,000 and more fore educated Americans who were carrying student loans (>$24000 for students graduating with a bachelor’s and approximately $60,000 for grad students in 2010).

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