Private Debt One Driving Issue in Financial Crisis

Are people in debt because they are needy or stupid or not fully awake when it comes to financial issues? Why would anyone use a credit card to run up debt with the huge interest rates associated with it use?

Private Debt Is Crippling the Economy
August 14, 2012
Source: Anthony Randazzo, "Private Debt Is Crippling the Economy," Reason Magazine, August 9, 2012.

Many economic pundits in America have focused their gripes about economic growth in several staid categories, such as monetary policy, the struggling housing market, income inequality and the federal deficit. These are legitimate causes of economic stagnation, but there is another category that is having an outsized negative impact on growth: privately held debt, says Anthony Randazzo, the director of economic research at the Reason Foundation.

Debt isn't inherently a bad thing. The biggest challenges of debt come when loans are taken out irresponsibly (such as no income job, no job mortgages), when money is borrowed for consumption rather than investment (such as credit card debt) and when lenders are guaranteed a return of their money by law even in the case of bankruptcy (such as student loans).

Unfortunately, all of those examples of irresponsible borrowing and lending are from the past few decades in America.

•Since the mid-1990s, privately held debt has soared to record highs.
•Promises that housing prices would rise forever deluded households into taking out big mortgages.
•At the same time a bull market in equities and low interest rates for several years made the costs of borrowing appear inconsequential.
•The bursting of the housing bubble left households with high levels of debt to deleverage or to take into bankruptcy court.

What is not widely recognized is that this debt level is also preventing the private sector from rebounding after the recession. Washington has tried to solve the problem by encouraging more borrowing to get the music going again. This is backward thinking.

Rather than public policy seeking to make borrowing cheaper, American leaders need to allow for household balance sheets to deleverage. That will mean short-term economic pain in exchange for a more robust economic growth period on the other side.

And since the economy is in stall mode currently, the directly-associated pain will be muted anyway. Both President Barack Obama and his Republican opponent Mitt Romney are kidding themselves if they think they can inspire a recovery in the next several years without consumer credit levels falling and household debt levels coming down.