The recent exchange between Joe Stiglitz and Larry Summers about “secular stagnation” and its relation to the tepid economic recovery after the 2008-2009 financial crisis is an important one. History does not repeat itself, but it rhymes, Mark Twain reportedly once said. But, to paraphrase Bob Dylan, in light of our recent economic history, history doesn’t rhyme, it swears.
Stiglitz and Summers appear to agree that policy was inadequate to address the structural challenges that the crisis revealed and intensified. Their debate addresses the size of the fiscal stimulus, the role of financial regulation, and the importance of income distribution. But additional issues need to be explored in depth.
We believe a critical opportunity was missed when the balance of the burden of adjustment was tilted heavily in favor of creditors relative to debtors in the response to the crisis and that this contributed to the prolonged stagnation that followed the crisis. The long-term social and political ramifications of this missed opportunity have been profound.
Back in September 2008, when then-US Secretary of the Treasury Hank Paulson introduced the $700 billion Troubled Asset Relief Program (TARP), he proposed using the funds to bail out the banks, but without acquiring any equity ownership in them. At that time, we and our colleague Robert Dugger argued that a much more effective and fair use of taxpayers’ money would be to reduce the value of mortgages held by ordinary Americans to reflect the decline in home prices and to inject capital into the financial institutions that would become undercapitalized. Because equity could support a balance sheet that would have been 20 times larger, $700 billion could have gone a long way toward restoring a healthy financial system.
The ability to use funds to inject equity into the banks was not part of the bill presented to the US House of Representatives. So we organized for Representative Jim Moran to ask House Financial Services Chairman Barney Frank in a pre-arranged question whether it was in the spirit of the TARP legislation to allow the Treasury to use taxpayers’ money in the form of equity injections. Frank replied in the affirmative on the House floor.
This was in fact a tool that Paulson used in the closing days of George W. Bush’s administration. But Paulson did it the wrong way: he summoned the heads of major banks and forced them to take the money he allocated to them. But by doing so he stigmatized the banks.
A few months later, when President Barack Obama’s administration arrived, one of us (Soros) repeatedly appealed to Summers to adopt a policy of equity injection into fragile financial institutions and to write down mortgages to a realistic market value in order to help the economy recover. Summers objected that this would be politically unacceptable because it would mean nationalizing banks. Such a policy reeked of socialism and America is not a socialist country, he asserted.
We found his argument unconvincing – both then and now. By relieving financial institutions of their overvalued assets, the Bush and Obama administrations had already chosen to socialize the downside. Only the upside of sharing in the possible stock gains in the event of a recovery was still at issue!
Had our policy recommendation been adopted, stockholders and debt holders (who have a higher propensity to save) would have experienced greater losses than they did, whereas lower- and middle-income households (which have a higher propensity to consume) would have experienced relief from their mortgage debt. This shift in the burden of adjustment would have imposed losses on the people who were responsible for the calamity, stimulated aggregate demand, and diminished the rising inequality that was demoralizing the vast majority of people.
We did recognize a problem with our proposal: providing relief to over-indebted mortgage holders would have encountered resistance from the many homeowners who had not taken out a mortgage. We were exploring ways to overcome this problem until it became moot: the Obama administration refused to accept our advice.