Should We Abolish Household Debts?

Johnna Montgomerie

• Publisher: Polity
• Year: 2019
• Print ISBN: 9781509525409, 9781509525393
• eBook ISBN: 9781509525430
• Edition: 1
• Topic: Economics
• Subtopic: Economic Policy
• Index: Economics

We live in a culture of credit. As wages have stagnated, we've seen a dramatic surge in private borrowing across the western world; increasing numbers of households are sucked into a hopeless vortex of spiralling debt, fuelled by exploitativelending.

In this book Johnna Montgomerie argues that the situation is chronically dysfunctional, both individually and collectively. She shows that abolishing household debts can put an end to austerity and to the unsustainable forward march of debt-dependent growth. She combines astute economic analysis with the elements of an accessible guide to practical policy solutions such as extending unconventional monetary policy to the household sector, providing pragmatic and affordable refinancing options, and writing off the most pernicious elements of household debt. This framework, she contends, can help us to make our economy fairer and to tackle both the housing crisis and accelerating inequality.

1
Making Money in the Debt Economy
A Primer

This chapter serves as a primer on key economic concepts that can make us understand how debt operates in today’s economy and society. Put simply, debt makes money. This is how the monetary system enables the global economy to function. For most people, money is not complex at all; how much money they have can be determined by looking at the notes/bills in their wallets or at their bank balances. But notes in circulation represent only 2–4 per cent of all money in circulation, even including demand deposits (money you can withdraw from the bank at any time); all of it is dwarfed by the amount of debt deposits within the monetary system. There is quite a large gap between everyday experiences of money and the forms of money that exist within the global monetary system. Bridging this gap requires a deeper understanding of contemporary debt money and of how it operates within the modern monetary system. The limits of space preclude a detailed examination of the many different types of money that emerged out of the technological revolution (Maurer et al. 2017), or a detailed exploration of how historical forms of money have adapted (Dodd 2014). The focus in this chapter is on explaining in simple terms how debt exists as money, so that we may understand how debt cancellation would work in practice.

Money Matters

Money is politics. Most people think that money or currency is made by printing presses turning out bills at a national mint, but this collective image is as obsolete as the printing press itself. At the very least, the production of money involves lasers and holograms on polymer-infused paper. How money is made, and the scale at which it is made, are matters that have profoundly changed, in line with the march of technology. From electronic payments to the entire digital infrastructure of interlocking accounting ledgers, the scale and scope of the global financial system are difficult to grasp, because this system operates on the scale of trillions of dollars, euros, pounds, yen, and so on. I am pulling one thread from this elaborate tapestry to demonstrate how debt and money are made together.

Let’s start at the central bank, the institution that is the manager and guardian of the national monetary systems. In its 2014 spring Quarterly Bulletin, the Bank of England makes a definitive statement regarding how money is created in the modern economy (see Figure 1.1). This statement is mirrored by the Bundesbank and the European Central Bank (European Central Bank 2015; Bundesbank 2017). It explains that money is made when commercial banks make loans. Banks do not act as intermediaries by taking savings deposits and lending out multiples of these base deposits. Most people find this impossible to believe because every economics textbook printed in the last century explains that banks do not create money, they simply administer and allocate money that already exists. That said, we know that national savings rates (especially for Anglo-American households) are at record lows, while debt (especially mortgage debt) is at an all-time high. If banks were simply intermediaries, this could not happen on such a scale. It happens because banks are not intermediaries; they are institutions that ‘make money’ by issuing loans.

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• The majority of money in the modern economy is created by commercial banks making loans.
• Money creation in practice differs from some popular misconceptions: banks do not act simply as intermediaries, lending out deposits that savers place with them, nor do they ‘multiply up’ central bank money to create loans and deposits.
• The amount of money created in the economy ultimately depends on the monetary policy of the central bank. In normal times, this is carried out by setting interest rates. The central bank can also affect the amount of money directly through the purchase of assets or ‘quantitative easing’.

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Figure 1.1 The Bank of England on money creation in the modern economy.

Source: McLeay, Radia, and Thomas 2014.

Therefore, when a bank makes a loan of any amount—500 pounds sterling, 50,000 euros or 50 million US dollars – the agreed amount of the loan becomes newly dominated currency in a newly created debt deposit account. When it comes to households, a lender issues a loan for a mortgage, a home equity loan, a small-business loan, or a line of credit for a car; the amount of that loan becomes national currency or ‘money’ that generates economic activity when it is spent. For example, money is made when a house is bought and sold, equipment purchased, an extension added, a vacation paid for, a car or a van purchased – or just on the average shopping trip for clothes or food. Issuing debt is a license to ‘print’ money for banks. Also, when debt creates money, it also generates economic activity from that debt; for example, you receive a £10,000 loan and then go out and spend that money in the economy (for an in-depth explanation, see Pettifor 2017). This is a very important time-shifting characteristic of debt money; ‘buy now, pay later’ means that economic activity is registered when newly created debt money is spent and then paid back over a longer period that is not measured.

Money matters in the economy, and the whole area of how money is made, by whom, and for what purpose is precisely what makes money political. It is a powerful illusion that money is neutral – a simple medium of exchange, or a store of value. So powerful that it enables money to be used as an instrument of political power. In today’s economy, the reality that debt creates money (not simply circulates money that already exists) in a vast digital expanse of interlocking banking ledgers explains why debt has grown to astronomical levels.

Debt Is Big Business

To understand why debt has become so pervasive requires an explanation of how retail banking operates through an ‘originate and distribute’ business model. Simply put, banks originate loans for individuals (or issue loans to them) and then distribute ownership claims to the revenue streams (interest payments, fees, and charges) from these loans throughout global financial markets. This business model makes lending to households extremely profitable for banks and those who invest in debt securities (or in ownership claims to revenues from household debt). Banks – acting as loan originators – create money by issuing new debt contracts. Loans are issued without any interference from government or regulatory oversight. This is the ‘magic money tree’, where money is created at the stroke of a keyboard and made real through the power of double-entry bookkeeping. Loan originators decide the rate of interest that borrowers are charged, again with only ‘lighttouch’ regulatory oversight. If the lender decides that it will offer a loan for 5.5 per cent or 550 per cent, it need only claim that it does so on the basis of the likely risk profile of the borrower. It does not matter that the bank itself borrows at negative real rates, or that it can create this money from nothing. Interest rates charged on loans are not linked to any underlying rate of the cost of borrowing set by lenders or to the base rate set by the central banks. Moreover, lenders have a legally enforceable claim to collect the interest payments on the loan even if the borrower falls ill and cannot make a few repayments. The ability to collect payment is not contingent on good lending practices, exercised for example by conducting affordability checks.

Debt is big business because loan originators create new money by issuing loans and have an unregulated ability to charge interest rates on the loans on the basis of what they claim to be their risk profile. In addition to originating loans, lenders make profits from distributing claims to the anticipated revenue generated from these loans, which can be traded in many different forms across global financial markets. Typically, loan contracts are for a specified term in the future; it could be five days, five years, or 25 years. A legally enforceable right to collect future interest payments on debt deposit accounts is considered revenue for a lender, and therefore it appears as an asset on the bank’s balance sheet. Banks and other loan originators (e.g., department stores or auto-lenders) gather together newly issued loan contracts (legal contracts to collect interest payments on these loans) and move them off their balance sheet, in a process called securitization.

The basic form of securitization allows banks to collateralize their assets in the same way as many other types of businesses do. For example, a T-shirt factory secures a contract for a million units for delivery in three months. The owner goes to a bank with the contract in hand and secures a loan to purchase the inputs to fill the order. In this simple transaction, the large order of T-shirts is a source of collateral, proof of anticipated future earnings that can be used to access additional financing. In a similar way, securitization allows banks (or any loan originator) to bundle together the anticipated interest revenues of outstanding loans, as a source of capital. The anticipated interest payment revenues are transferred to a special purpose vehicle (typically registered in an offshore financial centre) wholly owned by the lender. These special purpose corporate entities have only one source of revenue – interest payments on outstanding loans – and investors can purchase a claim to a portion of the revenue generated from the outstanding loan pool (this is the equivalent of corporate bonds or equity shares).

In conclusion, a great deal is said about how complicated financial products are, but ‘plain vanilla’ securitization is quite straightforward. It changes the very nature of a loan, from a contract between lender and borrower to a financial vehicle that has multiple and overlapping ownership claims against the loan originated by the bank. These ownership claims are traded across a global network of interrelated markets, which value, price, buy and sell the anticipated revenues on loan contracts. Debt provides a steady stream of present-day income that flows into the global financial system as interest payments on outstanding debts. This mechanism turns household debt into the feedstock of global financial markets. In such circumstances, the ability to originate and distribute loan contracts is a unique commercial power given to lenders, banks and the financial sector – a power that is highly profitable. Therefore debt cancellation is a deeply politically issue.

The Debt Economy

Having outlined how money is made and how this underpins the power of the financial sector, I now turn to how this feeds into the ‘finance-led’ growth model adopted in the Anglo-American economies. Initially the term ‘financialization’ described how the corporate governance of large firms came to prioritize profit-making through stock markets over profit-making through product markets (selling goods and services) (Froud et al. 2001). Gradually the term came to encompass a wider set of economic transformations, in which patterns of accumulation could be observed to shift from productive to financial activities (Krippner 2005). This is particularly true of Anglo-American economies, where low interest rates, private debt, domestic demand, asset markets and consumption coalesced to produce a period of stable growth – that is, until the 2008 crisis hit it (Hay 2013; Gamble 2009). For the sake of simplicity, I use the terms ‘debt economy’ and ‘finance-led growth’ to mark out the period starting with the credit boom in the late 1990s – roughly, the decade 1997–2007 – and ‘debt-driven growth’ to refer to the period from 2008 until the present, where debt remains an essential feature of post-crisis austerity.

Let us concentrate on the simple practicalities of debt: a new loan contract not only creates money, it generates economic activity, for example in the form of the recipient’s purchasing residential housing or goods at the shopping centre. Over the past 20 years, a recognizable set of conditions emerged: low interest rates fuelled private debt, and sluggish wages produced demand for private debt to fuel consumption. In consequence, debt was the driving force for domestic demand and inflated asset markets, which coalesced to produce a coherent trajectory of macroeconomic growth (Gamble 2009). Debt acted as a panacea, smoothing out income for households and driving up asset prices, which also allowed households to feel wealthier – at least until the 2008 global financial crisis exposed the fragile balancing act that finance-led growth was trying to manage, that is, a rapidly growing private debt stock...

Table of contents

• Cover
• Acknowledgements
• Introduction
• 1 Making Money in the Debt Economy
• 2 The Case for and against Abolishing Household Debt
• 3 Making Credit a Public Good
• 4 Debt Write-Down
• 5 Debt Write-Off
• Conclusion
• Bibliography
• End User License Agreement