House of Debt
Household leverage, not banks, as the transmission mechanism of the 2008 bust.
Summary
Mian and Sufi argue that the Great Recession was caused by household debt rather than by a banking crisis, and they support this with county-level data on household leverage, house prices, consumption and employment across the United States.
Their central finding is that spending fell first and fell hardest in the counties where households had borrowed most against housing during the boom, and that this happened before the banking system seized in late 2008. They show that the wealth effect from falling house prices was concentrated among leveraged households with high marginal propensity to consume, so a given fall in aggregate wealth produced a far larger fall in spending than an unleveraged distribution would have. Job losses in non-tradeable local sectors followed the spending collapse geographically, which is evidence that demand rather than credit supply drove the employment fall.
From the diagnosis they draw a policy argument. Debt contracts concentrate losses on the borrower, who has the least capacity to bear them, while creditors are protected. They advocate mortgage contracts with equity features, in which payments adjust to local house price indices, so that losses are shared and the aggregate demand collapse is prevented. They also argue that bailing out banks without writing down household debt addressed the wrong problem.
The empirical work is well regarded and the county-level identification is the book's strength. The policy proposal has been criticised as difficult to implement and as creating its own moral hazard and pricing problems. Other economists continue to argue the credit supply channel mattered more than Mian and Sufi allow.
Key takeaways 7
- Household spending collapsed first and hardest in the counties with the highest household leverage, and it fell before the banking system froze.
- Debt concentrates the losses from falling asset prices on the borrower, who has the least net worth and the highest propensity to cut spending.
- The employment collapse began in non-tradeable local sectors in high-leverage counties, which shows demand rather than credit supply drove it.
- Bailing out creditors while leaving household debt untouched addressed the wrong side of the problem and prolonged the demand shortfall.
- Mortgage contracts that link payments to local house price indices would share losses between lender and borrower and prevent the spending collapse.
- Credit expansion to marginal borrowers during the boom raised house prices, and the price increases then justified further lending, which is a self-reinforcing loop rather than a response to fundamentals.
- Monetary policy loses effectiveness when the households who would respond to lower rates are the ones constrained by negative equity.
Who should read it
Macro investors and policy-minded readers who want the household-leverage account of the recession, supported by unusually good geographic data.
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