Field Notes: Household Debt and the Recovery

Why was the Great Recession so Great? On The Upshot, two professors argue that it was a lack of attention to household debt.

Amir Sufi and Atif Mian, authors of the forthcoming book House of Debt, blame the sluggish economic recovery on the government preserving banks and avoiding the problem of household debt during the recession. The authors propose that society either forgive the debts, or step in and impose some of the losses on the creditors instead of the borrowers, reports Binyamin Appelbaum in the New York Times:

There was a large body of economic research suggesting that a rise in housing values didn’t affect individual consumption very much: The standard view was that for every $1 increase in a household’s home equity, there would be 3 cents to 5 cents in additional annual purchases. But the central insight that has driven much of Mr. Mian’s and Mr. Sufi’s work is that averages can be misleading. They were convinced that as housing prices increased, less-affluent homeowners were spending a larger share of their home equity than wealthy homeowners. They found that the less affluent were spending as much as 25 to 30 cents for every dollar of that equity.

Their work was made possible by a technological revolution that has placed vast quantities of data at the fingertips of economists, allowing them to build theories about the broader workings of the economy from the details of millions of individual lives. The French economist Thomas Piketty and collaborators including Emmanuel Saez, an economist at Berkeley, have used similar financial data to explore the rise of inequality. Raj Chetty, an economist at Harvard, and his collaborators, again including Mr. Saez, have used tax data to explore economic mobility across generations.

Mr. Mian began by calling Equifax, the credit bureau, to ask whether he could buy data showing the debts of individual households, stripped of identifying information. He spoke with a series of flummoxed salespeople who gradually referred him to the head of sales — a woman who happened to live in Hyde Park, a few blocks away in Chicago.

“We now have the ability to observe data in almost all the cases, so it’s just a question of trying to convince the right parties, many of them in the private sector, to provide that data,” Mr. Mian said. “And she was willing to experiment with us.”

In a series of papers, Mr. Mian and Mr. Sufi gradually developed a theory of the boom and bust. They found evidence that lenders flush with cash had made increasingly risky loans. They found, for example, that lending volumes had risen fastest in areas where average incomes were actually in decline. This process continued until the borrowers started defaulting so quickly that the risks became impossible to ignore, and the loans dried up.

When housing prices crashed, people lost their equity, but their debts did not disappear. They cut back on consumption, and the economy fell into recession. And, importantly, the households with the largest debt burdens cut back the most. Mr. Sufi and Mr. Mian found that for every $10,000 decline in home values, families with high debt burdens reduced spending on autos by $300, while families with low debt burdens reduced spending on autos by just $100.

The proposed remedy? Appelbaum says later in the article, “What we talk about when we talk about household debt, of course, is mostly mortgages. And the two men have a proposal for making mortgages better: Lenders would agree to ease debts during downturns; in exchange, lenders would get a percentage of any gains from the eventual sale of a home.” What do you think of this idea? Tell us in the comment section below.

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