Why Is Debt Bad?

Debt causes and exacerbates recessions

Sean Jacobs, Hip Hop Republican, 12 November 2014

Rarely are the harmful effects of debt explained or unpacked at length. Greed is often the main explanation for the 2008 Global Financial Crisis alongside Wall Street malpractice and complaints of ‘the top one percent.’

These are certainly much easier targets for blame than household debt, which appears to have a subtle but much more potent effect in causing and exacerbating recessions. This is the message of a new book called House of Debt: How They (And You) Caused the Great Recession by American economists Atif Mian and Amir Sufi.

While technical in parts their argument is simple enough for non-economists. In the lead up to 2008, they explain, U.S. household debt ballooned to unprecedented levels. Between 2000 and 2007, for example, the total amount of household debt doubled to $14 trillion while the household debt-to-income ratio jumped from 1.2 to 2.1.

Why is this so economically lethal? Simply because high debt households crawl into a shell when the economy contracts.

But this is only part of the story. Americans, like many in other countries, have a great deal of their wealth tied up in the value of their homes. Naturally, if house prices dip, households – especially those with high debt – recoil even more.

While this is common sense the figures are staggering. The decline in home values, for example, led to a $275 to $385 billion decline in U.S. retail spending. ‘Yes, the poor were poor to begin with,’ Mian and Sufi explain, ‘but they lost everything because debt concentrated overall house-price declines directly on their net worth. This is a fundamental feature of debt: it imposes enormous losses on exactly the households that have the least.’

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