Saturday, December 8, 2007



As I have said ad nauseam in the Insightful Pontificator, the problem our economy and financial system is facing is not limited, as many seem to still suppose, to sub-prime mortgages. The problem is too much debt, at the personal, government, and, relatively recently, corporate levels. The sub-prime problem is only the most salient, the first, and, I fear, a small manifestation of this problem.

Many readers of the Pontificator, even readers who display a great degree of financial acumen, have asked me the question “What is wrong with a lot of debt?” This is not a silly question.

I can see at least three financial (leaving aside, at least for now, the moral) problems with a lot of debt, or at least with the amount of debt that permeates our financial system.

First, too much debt, and too much bad debt, can freeze the financial system. Remember the old adage that a cat who has sat on a hot stove is not likely to sit on a hot stove again. She is also not likely to sit on a cold stove. Once lenders and investors have been burned by a loose lending system disguised by what turned out to be faulty Rube Goldbergesque financial schemes, they are going to be hesitant to lend again, even to worthy borrowers. If our financial system thus seizes up, this could lead to depression.

Second, asset values have been inflated by loose credit. Even if the financial system does not seize up but merely reacts in a sane and sensible manner to a modified credit environment, credit will become less available and asset values will deflate. We are already seeing this in the housing market. A broad deflation in asset values, especially in the values of houses, which many homeowners have been using as piggy banks, could lead to a recession.

Third, even if the financial system does not freeze, and even if asset values do not deflate (We’re a little late for the second supposition, and maybe for the first.), the gargantuan debt that we have accumulated over at least the last decade or so will have to be serviced. The more of our earnings that must be used to service debt (much, if not most, of which is held overseas), the less of our output and earnings that can be used for other things, like investment and consumer spending. More money for debt service could lead to at least an economic slowdown and, given the sheer amount of debt involved, a recession.

So excessive debt levels have consequences ranging from slowdown to depression. If all three of the above scenarios take place simultaneously, a very good possibility, if not a present reality, we could be in for a rehash of the ‘30s. I’m serious.

There is, of course, the question, of what constitutes an “excessive” level of debt. Paraphrasing a Supreme Court Justice’s observations on an entirely different matter, I can’t define an excessive level of debt, but I know it when I see it. I’m seeing an excessive level of debt now.

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