Niall Ferguson: The Great Repression
There is something desperate about the way people on both sides of the Atlantic are clinging to their dog-eared copies of Keynes's General Theory. Uneasily aware that their discipline almost entirely failed to anticipate the crisis, economists seem to be regressing to macro-economic childhood, clutching the multiplier like an old teddy bear.
The harsh reality that is being repressed is this: the Western world is suffering a crisis of excessive indebtedness. Many governments are too highly leveraged, as are many corporations. More important, households are groaning under unprecedented debt burdens.
...The solution to the debt crisis is not more debt but less debt. Two things must happen. First, banks that are de facto insolvent need to be restructured, a word that is preferable to the old-fashioned nationalisation. Existing shareholders will have to face that they have lost their money. Too bad; they should have kept a more vigilant eye on the people running their banks. Government will take control in return for a substantial recapitalisation after losses have meaningfully been written down. Bondholders may have to accept either a debt-for-equity swap or a 20 per cent "haircut" - a disappointment, no doubt, but nothing compared with the losses suffered when Lehman Brothers went under.
... The second step we need to take is a generalised conversion of American mortgages to lower interest rates and longer maturities. About 2.3 million US households face foreclosure and that number is certain to rise. For example, $US97 billion of $US200 billion of option adjustable-rate mortgages will reset in the next two years. The average monthly payment will increase by more than 60 per cent. As a result, up to eight million households could be driven into foreclosure, driving down home prices even further. Few of those affected have any realistic prospect of refinancing at more affordable rates. So, once again, what is needed is state intervention.