Tags: Vague | debt | private | crisis

Vague Warning on Private Debt

By    |   Tuesday, 23 September 2014 07:51 AM

Readers have seen that a major theme of these articles has been that the financial crisis of 2008 was part of a long series of periodic crisis dating back at least 40 years that has become a more or less permanent fixture of American life.

So-called regulators and other policymakers have never done anything effective to interrupt this cycle of crises, partly because the financial industry model militates against this and partly because this pattern has been very fruitful for some clients and constituents. According to this theory, the Treasury and the Federal Reserve are continuing to resort to various interventions, such as quantitative easing, to forestall another crisis episode, but even they acknowledge that it is bound to recur sooner or later.

Richard Vague, managing partner of Gabriel Investments and chairman of the Governor's Woods Foundation, recently discussed his book, The Next Economic Crisis: Why It's Coming and How to Avoid It, which argues that the source of the next episode will not be a slipup in the management of the huge Fed portfolio, but rather the $11 trillion in debt held by the public. The event was hosted by New America NYC.

The author began by questioning the claim, as these articles have, that the crisis episode of 2008 could not have been predicted and that future episodes cannot be predicted — that they are "black swan" events that only occur once in a generation. His view is that not only can such episodes be predicted, they can be prevented, by focusing on private, rather than public, debt. He declared that private debt is "the biggest factor in the economy" and that it was the cause of the 2007-08 crisis, due to an "astronomical" growth in mortgage debt by 46 percent during the prior six years.

Vague warned that despite some deleveraging, private debt is still near all-time highs for both consumers and businesses. He found a corresponding growth in private debt in the five years leading to the 1929 stock market crash. A thousand skyscrapers were built across the country, which was more than in Europe. By contrast, Vague asserted that government debt was "low and stable" before the crisis episodes.

According to Vague's study of the 22 largest economies in the world, comprising 85 percent of the world's GDP, 18 percent growth in aggregate private debt in a five-year period will cause a crisis, for two reasons. First, it creates an oversupply of something, such as houses, office buildings or industrial plants. In late 19th century America, it was railroads. He found that typical monetary and fiscal policy responses can't solve these crises. What is needed, he said, are capital infusions and time to absorb the excess production.

Thus, so-called "triggering events," such as stock market crashes and bank failures, that are often blamed for the crises are not the actual cause. Vague found that the ratio of private debt in the United States to GDP has grown from roughly 50 percent in 1950 to more than 150 percent, and he warned that this in itself acts as a drag on the economy. For the top six economies, this ratio has grown since 1970 from 75 percent to 175 percent.

Vague concluded that financial regulators should monitor aggregate private debt and intervene to curb excesses. He argued that the only way to restore economic growth is to restructure private debt, such as the 9 million underwater mortgages. His response to objections grounded in concerns about "moral hazard" was that this concern was suspended to save the "too big to fail" banks. He contended that while such an intervention might be seen as impractical, it is the one way to "supercharge" economic growth.

(Archived video can be found here.)

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Richard Vague, managing partner of Gabriel Investments and chairman of the Governor's Woods Foundation, recently discussed his book, The Next Economic Crisis: Why It's Coming and How to Avoid It.
Vague, debt, private, crisis
Tuesday, 23 September 2014 07:51 AM
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