The Debt Dead-end

In a recent article on Counterpunch, one of my favorite economists, Michael Hudson, does a great job explaining the dynamics of the state and local budget crisis and how it originates, in large part, to the shifting of taxation away from property. He explains:

Untaxing real estate has served mortgage bankers by freeing more rental income (the land’s site value) to be paid as interest…. New buyers must pay a price that capitalizes the property’s rental value. Less and less of this payment has taken the form of local property taxes. More and more has been paid to mortgage lenders as interest.

In other words, lowering property taxes doesn’t actually make it cheaper to own a home (unless you are wealthy enough to buy one free and clear). All it does is enable more of the money you do pay to go to the bank, and less to go to local government. The result is the municipal debt crisis that is forcing city governments to cut back on services, slash pensions, privatize parking and utilities, and lay off workers. Bondholders of municipal debt rarely suffer though; as Hudson explains, the system is rigged so that they usually get paid first. Their wealth grows at whatever interest rate the bonds pay as everyone else gets poorer.

Unfortunately, even if politicians were to wake up to the situation Hudson describes, there is not much they can do about it. High property taxes would have prevented the real estate bubble from happening, but now that it has happened, raising property taxes will only drive even more homeowners into foreclosure and erode the tax base even more. The problem must be addressed on a much deeper level.

Service cutbacks, pension slashing, and asset stripping are only a short-term solution. Whether in the case of Greece or of a local government in the United States, such measures allow the current debt payments to be made, but erode the economic vitality that would allow payments to be made in the future. Austerity measures such as these are a precondition for future lending, but when all th assets have been stripped, all the pensions have been cut, and when taxes on labor are at their maximum, the inevitable defaults will surely take place. At that point there are only two options: (1) To allow the defaults to happen, wiping out the creditors and with them, the entire financial system including everyone’s life savings, or (2) Bailing out the creditors by exchanging their defaulting loans for something else, such as fiat money from the Federal Reserve. Hybrid solutions are also possible.

Solution #2 doesn’t help the debtors, because they still must repay their loans. However, legal issues aside (laws can be changed, after all) their is in theory no reason why the Federal Reserve couldn’t buy every municipal bond and mortgage loan in the country and forgive the debt, or by fiat reduce the principle and/or interest. It could reduce the interest rate to zero or even less. This would allow municipalities to raise property taxes correspondingly, without increasing the total burden on homeowners.

While they are at it, the Fed could also buy and forgive (in part or in whole) other debts such as student loans, credit card debt, and so forth. How would you like it if the Fed bought your debts from the bank and lowered your interest rate to zero?

You’d like it, but would your bank? Well, that depends on whether you were dutifully making payments. If you were, then the bank won’t want to sell your loan, performing at say 8% interest, for Federal Reserve cash bearing no interest at all. But if your loan were delinquent, then the bank would be more than happy to unload it at full cash value. This is exactly what happened after the 2008 financial crisis, when the Fed (either directly or indirectly via the Treasury) purchased all kinds of toxic mortgage-backed securities. The banks did not suffer at all from the losing bets; it was, as Paul Krugman put it, “Heads they win, tails you lose.” And they learned their lesson: the banks continue making risking speculative investments, knowing that when they go bad, the government will have to bail them out to save the financial system.

There is an elegant solution to this problem as well, however. What if the banks were bailed out not with cash as we know it, but with a depreciating asset? If money itself were subject to a decay rate in the form of a carry charge on deposits in the Federal Reserve, then the concentration of wealth that intensifies with each bailout would be averted. This charge, also known as demurrage, is the monetary equivalent of the property taxes that Michael Hudson and many others in the Georgist tradition advocate for land. The proposal outlined in this essay avoids a catastrophic implosion of the financial system, without further enriching the very people responsible for the crisis to begin with.

We cannot go on forever bailing out the bad debts while keeping people and governments enslaved to paying the payable debts. The trend of the financial system is towards having all disposable income go to the owners of money, the creditors. And it doesn’t stop with “disposable” income, but inexorably encroaches on all income, even to the point of starvation. Such is the logic of interest-based capital.

Buying out even just the bad debts with negative-interest currency would have the effect of driving all interest rates down toward zero. Possessed of huge quantities of cash that decays in nominal value, banks would have an incentive to lend that money for refinancing higher-interest loans. Which would they rather have — cash with a carry cost of 5%, or a loan of 0% that at least maintains its nominal value?

In the book, I describe the details of such a system in considerable detail, addressing such questions as how banks would earn money, whether it would be inflationary, and so forth. Here, I will just say that this proposal does not stand in isolation, but is rather synergistic with other necessary reforms to the financial system such as breaking up too-big-to-fail institutions, imposing a tiny transaction tax on speculative financial instruments, and so on. Compared to these, negative-interest currency seems quite radical. Soon, though, we will find we have no choice.



About Charles Eisenstein

I am the author of The Ascent of Humanity and Sacred Economics. I am also a public speaker and member of the faculty of Goddard College.
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2 Responses to The Debt Dead-end

  1. Tonio Epstein says:

    About two weeks ago I heard an economist (could’ve been Michael Hudson, but I didn’t hear his name) speaking on NPR’s All Things Considered, about how the Fed could implement a QE utilizing a decaying value monetary instrument, and that it would be a practical way of giving the big banks a real incentive to fulfill the ostensible objective of actually lending the money out.
    I found that very encouraging to hear in the mainstream media. It’s not like NPR to present any “radical” ideas. However, I haven’t heard anything further in that direction. Not that I listen often enough to be able to gauge these things.
    Personally, I think the idea of the Fed bailing all debt out, a la fiat, would be a very practical and sensible way of averting the impending collapse. At some point, it will become an attractive looking solution even to the big boys. It just may be too late by then.

  2. Wow, really? Someone said that on NPR? I wonder who it was and how I could listen to that show. As far as I know, Michael Hudson hasn’t publicly advocated this idea, though I wouldn’t be surprised if he is aware of it and favorably inclined.

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