Quick Credit And The Hidden Cost To The Economy Policymakers have a tried-and-true game plan for jump-starting the economy in times of severe recession: Push stimulus packages and lower interest rates so Americans will borrow and spend. But economist Amir Sufi says the way we traditionally address a recession is deeply flawed. He argues that by encouraging "sugar-rush" solutions, the nation is putting poor and middle-class Americans and the entire economy at even greater risk. This week we look at the role of debt as a hidden driver of recessions, and how we might create a more stable system.

Buy, Borrow, Steal

  • Download
  • <iframe src="https://www.npr.org/player/embed/877401074/881820488" width="100%" height="290" frameborder="0" scrolling="no" title="NPR embedded audio player">
  • Transcript


From NPR, this is HIDDEN BRAIN. I'm Shankar Vedantam. We all love to buy stuff. The best part is we don't even have to pay for anything immediately.


UNIDENTIFIED PERSON #1: Get lucky and own a new motorcycle for no money down, no interest for 90 days, no payments for 120 days.

UNIDENTIFIED PERSON #2: Celebrate Fourth of July with Colfax. Pay no interest for 60 months. That's five full years...

KEVIN HART: So I use my Freedom Unlimited card. Even when I'm spending, I'm earning 1.5% cashback on everything I buy.

VEDANTAM: It's like free money. Policymakers even tell us that a healthy economy is built on spending, so getting that second credit card is not just good for us but good for everyone. But there's a catch. In a downturn, when people lose their jobs, what are the consequences of all the debt we've taken on? Is borrowing our way out of every crisis really sustainable?

AMIR SUFI: Ultimately, it has to be that we tackle the more fundamental issue, which is, why is there so much debt? Why are people borrowing well beyond their means?

VEDANTAM: This week on HIDDEN BRAIN, the hidden manipulator behind our debt binge and how to make a system that works better for everyone.


VEDANTAM: The United States is officially in recession. Tens of millions are out of work, and many businesses are closed. With the end of the COVID-19 pandemic nowhere in sight, unemployment rates are forecast to stay high for a very long time. As we try to understand what lies ahead, we decided to first look back.

At the University of Chicago, economist Amir Sufi has a counterintuitive thesis about the real cause of the Great Recession of 2007 and 2008. Later in the conversation, we'll talk about how his ideas relate to the recession brought on by the COVID-19 pandemic. I started by asking him to paint a picture of what happened in the run up to the Great Recession in cities like his own birthplace of Detroit.

SUFI: So beginning first in 1998 but then really accelerating in 2003, '04 and '05, there just was this explosive increase in the availability of mortgage credit.


UNIDENTIFIED PERSON #3: Too many high interest monthly payments? Why not pay them off with a second mortgage?

SUFI: There was a real push to get people to borrow against their houses, people who already own their houses and also for people who were looking for properties to actually be able to get a mortgage.


UNIDENTIFIED PERSON #4: Call McKay Mortgage. Get approved before you shop for a home.

SUFI: This was reflected in - for example, the homeownership rate went up dramatically from about 1998 to 2006. And it was the first time that a lot of people, especially people with low credit scores, with low incomes, were able to actually buy properties. That's something that happened, we give the example, for example, in Detroit. It also happened on the South and West Sides of Chicago. And so we really think it was kind of a push factor that all of a sudden, it was almost as if people were kind of being asked to borrow more, more than people really seeking to borrow more.

VEDANTAM: Mortgage companies sent people house to house knocking on doors trying to get them to take out second mortgages. It was unreal. The easy access to money meant that all of a sudden, people were flushed with cash. With increased demand, home prices skyrocketed even in poor parts of the country. Then the recession struck. In Merced County, Calif., home values plunged 50%. Nearly two in three homeowners in Merced found themselves underwater. They owed more than their homes were worth.

SUFI: It's a destruction of wealth that's close to unprecedented. And that destruction of wealth is really occurring and hitting hardest people in the, say, middle and lower income ranges, even into the upper middle class. So that is - this is actually even amplified by the fact that middle-class households rely on home equity as their main source of wealth. Middle-income Americans generally don't have huge pensions. They don't usually have a lot of wealth in the stock market, a lot of wealth in bonds. And so housing really is the heart of their wealth. And as a result, a big decline in house prices really hits that group of people the hardest when it happens.

VEDANTAM: One of the consequences of a buildup in debt is that when things turn sour, people in debt cut back dramatically on their spending. Eventually, this also affects people who were not part of the borrowing boom. They get affected because demand is collapsing for products and services. They may lose their jobs. Soon, they are also forced to cut back on spending, and a vicious cycle accelerates.

SUFI: The example we give in our book, actually, is the one in Tennessee. In Tennessee, we have a lot of manufacturing plants of cars, of automobiles. And we give the example of Senator Bob Corker, who basically said we in Tennessee shouldn't care about the irresponsible borrowing that people on the East Coast and the West Coast were doing. And we then go through the statistics and show that, in fact, a lot of people manufacturing cars in Tennessee lost their jobs in 2007 and 2008. And it almost has to be because the cut in demand that was happening on these coasts. So in that sense, Senator Bob Corker's not seeing the full picture that what is happening on the coast is directly affecting his constituents.

VEDANTAM: So a lot of people attribute the Great Recession to a banking crisis, to the collapse of, you know, Lehman Brothers and other financial institutions. But when you look closely at the data, you find that there were warning signals well before the troubles that arose in the banking sector. What were those signals?

SUFI: For example, household spending started to collapse in 2007, especially household spending on what we call durable goods. These are cars or furniture or recreational vehicles. In fact, even in the summer of 2008, which is, of course, prior to the banking crisis, you see pretty dramatic declines in household spending. You see pretty dramatic declines in what we call residential investment, which is just a fancy way of saying construction, the building of homes. These were already seriously dragging down the overall economy. And in fact, the easiest way to see this is that the official dating agency, the National Bureau of Economic Research, they date the start of the recession in the fourth quarter of 2007, which is almost a full year before Lehman Brothers, before the banking crisis.


VEDANTAM: Let's underline this. With the advantage of hindsight, we now see the Great Recession started a year before the collapse of Lehman Brothers. The same pattern is also evident worldwide. Countries like Ireland and Denmark that saw painful economic contractions had something in common with places like Merced and Detroit. They were places that saw a steep buildup in borrowing. Amir says you can see the same pattern historically.

SUFI: Interestingly, there's been a huge amount of research that the recession has spawned in looking not just at other countries during the Great Recession but even historical episodes like the Great Depression, like different crises that have occurred in other countries. And a pretty systematic pattern is there in the data, which is the crisis - the banking crisis, the financial crisis - should be thought of as a symptom, not a cause - that the cause usually is some decline in house prices or some other decline in other asset prices like stock prices. And as a result of that decline, then a banking panic happens or a banking crisis.

I want to be clear - obviously, the banking crisis and Lehman Brothers makes the recession far worse than it would have been in the absence of the crisis. But it's better to think of it as more of a symptom rather than a cause, at least of the initial economic downturn that usually happens in these episodes.

VEDANTAM: So it's worth pointing out, of course, that the take that you have is not a take that's universally shared. There are people who believe that the real drivers of recessions do lie in the banking sector or in irrational currents of fear that sweep through an economy from time to time. You write, economic disasters are almost always preceded by a large increase in household debt. In fact, the correlation is so robust that it is as close to an empirical law as it gets in macroeconomics.

How do you think that theory is seen by your fellow economists? Is this widely shared? Is this a contested idea? Is it a stretch?

SUFI: I think when we first wrote our research, it was considered maybe a fringe idea. I think since then, the research has confirmed this observation. There's a lot of research that's been conducted over the last five or 10 years that has shown, not just the Great Recession, but more systematically in a number of different countries that increases in credit and, in particular, increases in household debt are systematically related to economic downturns. I'm thinking in particular by research by a trio. Jorda, Schularick and Taylor are their last names. And they collect data going all the way back to the 19th century across 17 advanced countries. And they basically show that this pattern is very systematic. It's there in the data.

People in economics usually come into discussions with their own views about how the way the world works. We think the data speak for themselves. I think at this point there's enough data out there that people are almost forced to take very seriously the idea that it's something about credit debt, in particular household debt, that seems to be related to business cycles and macroeconomic fluctuations.

VEDANTAM: There's a great mystery in this economic boom and bust. Why were lenders so anxious to give money to people with weak credit? To understand that, let's leave the world of finance for a moment and head to Hollywood. In 2009, just as the Great Recession was starting to ease, a movie came out. It was called "The Joneses." It tells a story of a well-off family of four who've just arrived at their new home, a McMansion in an unnamed American suburb.


BENJAMIN HOLLINGSWORTH: (As Mick Jones) Oh, this is it, huh?

DAVID DUCHOVNY: (As Steve Jones) Wow. It's huge.

HOLLINGSWORTH: (As Mick Jones) Yeah, this is pretty nice.

DEMI MOORE: (As Kate Jones) Quick, quick.

VEDANTAM: The thing is, this family, the Joneses, they're fake. They've been planted in the neighborhood by a huge marketing company. Their job is to make the luxury goods surrounding them seem like must-have products. As a senior manager reminds the husband, Steve Jones, his role is to be an influencer.


LAUREN HUTTON: (As KC) To succeed here, you can't just sell things. You're here to sell a lifestyle, an attitude. If people want you, they'll want what you've got.

VEDANTAM: The movie, of course, is fiction. But Amir Sufi argues that it reflects a deep truth about American life. Corporations are constantly trying to find creative ways to get us to buy things. Somewhere along the way, they realized that one of the most profitable things to sell was not golf clubs or diamonds or convertibles but money itself.

SUFI: It's just amazing how many retailers you walk into - this is true of, say, Bloomingdale's; it's also true of, say, Best Buy or Home Depot - and you go to buy whatever product that you're going to buy, and all of a sudden, the sales associate who's not, of course, any financial expert tries to offer you a credit card or tries to offer you a charge card that you should buy this on credit. I've always found that as an economist and as a financial economist, in particular, very strange.

VEDANTAM: Why would you find it strange? I mean, on the surface it actually seems like a very helpful thing to do. You're trying to buy, let's say, a new TV. And the sales associate says, you know, guess what? You don't actually have to pay for all of the TV upfront. There's a way to break it up. You can get a credit card. You can put this on the credit card. You can break up the payment so that you're only paying a small amount. Maybe you can even afford a bigger TV as a result. I mean, it's provided to the customer as a service. Why is it strange?

SUFI: I think part of the interesting issue here is the psychology behind it, which is I'm here. I've already announced I want to buy this good. I didn't come into this store thinking that I wanted to borrow to buy it. And now there's an effort actually to get me to borrow to buy it when I otherwise may not have even been thinking about borrowing. And so there's something going on here that's trying to change the way I think about the payment for this product. And it seems quite purposeful, in some sense, for the company to be doing this. And so maybe this is because I have a natural cynicism that an economist has, but I immediately want to think about, you know, what's in it for you? Why are you offering me this charge card when I had basically announced I was willing to buy this without getting a charge card?

VEDANTAM: What's interesting here, Amir, is that debt has historically had a lot of stigma attached to it. Can you talk a little bit about this idea and how marketers and companies and lenders have struggled to overcome the stigma?

SUFI: One of the things about debt that fascinates me is that a lot of cultural traditions, a lot of religious traditions do put kind of a negative view on it, that, you know, most spiritual traditions have this notion that you shouldn't borrow too much. Oftentimes, they also have some tradition that you shouldn't be lending at exorbitant interest rates or unfair interest rates. And so I think it becomes kind of part of our DNA that maybe we should be a little skeptical of borrowing too much. Of course, if you're a company that's trying to make money off financial products, overcoming what might be kind of an ingrained aversion to debt is a big challenge.

And one of the things we've noticed when we look at historical episodes - and I think the two eras that really show this quite clearly are the 1920s and the 1980s. In both the 1920s and the 1980s, it's very clear of a systematic effort through marketing to get people to be more comfortable borrowing in order to purchase things. In the 1920s, for example, there's a woman named Martha Olney at Berkeley. And she does excellent research showing that it was necessary to do a lot of advertising to get people to buy automobiles, sewing machines, other what we call consumer durables on credit. She basically says that prior to the 1920s, people never went into a store with the expectation that they would be using debt to purchase a product. And the 1920s were an era in which that all changed. She talks about kind of a cultural paradigm shift that basically got people more comfortable with the notion of buying things on debt.

VEDANTAM: And what happened in the 1980s?

SUFI: In the 1980s, interestingly, it happened in two different markets - credit card markets and the home equity market. I think most people understand credit cards, so let me focus a little bit more on home equity. A home equity line of credit or a cash-out refinancing is the idea that you already own your home. You've got some equity in it. And you go to the bank. And you basically - the bank says, OK, we'll make you an additional loan in order so that you can have some cash to redo your kitchen or redo your bathroom or whatever you want to do with that money.

Prior to the 1980s, the term home equity didn't even exist. It's fascinating. A home equity loan prior to the 1980s was called a second mortgage. Now, a second mortgage doesn't sound very nice. (Laughter) You know, if you already have an aversion to debt, a second mortgage is kind of like, OK, now I already had one handcuff on, and now you're going to put, you know, ankle cuffs on me. So there was a systematic effort - and this is all quite well documented; and in fact, we looked at our own data to see if this was true - to actually invent this term home equity. And the idea was, well, it's your equity in your home. You have every right to borrow against it. It's not a bad thing to borrow against that equity.


VEDANTAM: Amir says if you look at newspaper ads from several decades ago, you'll almost never see the term home equity. That is until about 1982 or '83.

SUFI: And then it skyrockets through the '80s. So in fact, the data do support this idea that home equity, this term, was invented in order to get people to be more comfortable borrowing against their home.

VEDANTAM: So who's the puppet master pulling the strings, convincing us to take out more credit cards and to borrow money to buy more stuff?

SUFI: I think to understand the answer to that question, it's important to think about who ultimately is behind the money that is being offered to you. And it takes kind of a bigger-picture perspective to try to answer that question. Who, ultimately, is so anxious to lend to you?

VEDANTAM: That's when we come back.


VEDANTAM: Economist Amir Sufi argues that we have failed to appreciate the role of household debt in economic crises. We tend to think that something as big as a recession can only be caused by a tectonic upheaval, like a major financial company going under. We fail to see how the debt we build up as individuals - buying things we don't need with money we don't have - can have profound effects on our lives and the larger economy. Amir wrote a book about this called "House Of Debt" along with Princeton University economist Atif Mian. It describes an enormous engine that is constantly trying to get us to borrow more money. This presents a mystery. Who is so anxious to lend to us? Where is all this money coming from?

SUFI: To answer that question, I always say it's important to understand that banks aren't people or, you know, the credit card company is not a person. Banks are owned by people. I think that's important to understand. And it's important understand who really owns the financial intermediaries that ultimately provide us with credit. And that's where we almost have to have a frank discussion about the wealth distribution and the income distribution. That is, it's the wealthy or people very high up in the wealth distribution that ultimately own the financial intermediaries that are trying to get us to borrow.

And so we call this kind of a credit push story, that if the people at the very top of the income distribution are earning more and more of the economy's income, that puts more and more pressure, more and more money is kind of coming into this financial sector and, therefore, leading to an effort to go out and make loans. So the rise in debt, the rise in credit is very closely linked to the rise in income inequality and wealth inequality.

VEDANTAM: So in other words, if I am Jeff Bezos and my net worth has gone up from $100 billion to $150 billion, I'm looking for someplace where the money that I have, not just the equity I have in Amazon but the money that I'm making, has a place to be invested. So I'm actually - I just don't want it sitting under a mattress. I want it to go out and do something. And in order for the money to go out and do something, the money has to find ways to get used. And that's where it basically gets translated into this push, as you say, for people to borrow that money.

SUFI: Right. And that whole process starts with the observation that Jeff Bezos cannot possibly spend the money he makes. It's just too much money. So we start with this observation - when I say we, this is research with Atif Mian and Ludwig Straub - we start with this observation, which is that people at the very top of the income distribution, the wealth distribution, just simply cannot spend all the money they make. And so as they earn more and more of the income, the more and more savings are going to enter into the financial system. We call it the saving glut of the rich. And that money, as you said, is in search of a return. And so that process, the rich making more and more money, is closely connected to why, when I walk into Bloomingdale's, the sales associate is trying to get me to sign up for a charge card.

VEDANTAM: Hmm, so in other words, the rise in income inequality or wealth inequality might actually be connected to the rise and the push to get people to borrow more of that money that the wealthy are trying to find someplace to invest.

SUFI: That's exactly right. And one of the interesting points is that it's not necessary that that happens. In a well-functioning economy, we would like to think that the money Jeff Bezos saves into the financial system goes out, and it finds productive investment opportunities - whatever, it helps to build a bridge, or it helps to build a business. But one of the things that's very striking is that that just is not happening, that even though the rich are saving more and more of their income, the money is being used to facilitate borrowing by everyone other than the rich. And by borrowing, I mean borrowing by people in the bottom 90% of the income distribution, borrowing by governments, for example. A lot of people don't see this connection that the government is ultimately also borrowing from Jeff Bezos in some broad sense. And so it almost has to be that there's so much more debt if the rich are saving more and more of their money.


VEDANTAM: This is not just a story about what is happening within the United States. Across the world, many countries seeking to stash their money somewhere safe look to invest it in the United States.

SUFI: And that's something that has been referred to as the global saving glut. If you put these two factors together, the saving glut of the rich and the global saving glut, they're very related. It's all about a group of people in the economy - you can think rich Americans in the United States, or you can think of the Chinese central bank - who are almost desperate to lend to people in the United States that need to borrow. And so all of that process is linked. So ultimately, the mortgages being taken out in Detroit are directly linked to decisions being made by the Chinese central bank who wants to kind of, in some sense, lend more to American borrowers.

VEDANTAM: So there's a potentially happy story here. And I want to understand why it is that happy story doesn't happen, which is that you have rich people who want their money to do something. And you have potentially poorer people who want to borrow money in order to get things that they would not have been able to get otherwise. So let's say there's a bust. Presumably, both the rich and the poor have things at stake. I mean, the rich have basically lent money to the poor, so they have money that's at stake that basically is at risk if there's a downturn. The poor have things at stake because if there's a downturn, you know, they're going to find themselves underwater. But you have a thesis that this is actually not the way the financial sector is actually constructed, that risk is actually not being distributed equally between borrowers and lenders. How does that come to be?

SUFI: It's the nature of the financial contract that's being done here. So let's make it as simple as possible. Let's take out the financial sector and just say let's suppose a rich American, let's say Jeff Bezos, directly lends to someone who's not rich. The important thing to understand is that that financial contract is what we call a debt contract. Now, we're all so used to using debt we probably don't even appreciate what that exactly means. What does it mean that it's a debt contract? And there's no way to kind of illustrate this other than through a simple numerical example.

So let's suppose the debtor borrows $80,000 to buy a $100,000 house, OK? So the house is worth $100,000. They borrow $80,000. Let's say, through no fault of their own, house prices then fall 20%. So now they're in the house. They own the house. The house value goes from $100,000 to $80,000. The question is, who actually lost money? And the fact of the way debt works, think through the logic. Let's suppose I go and try to sell my house now. Now I'm the borrower. When I sell the house to somebody else, it's only worth $80,000. So they're going to wire in $80,000 to me. And I'm going to have to pay off the mortgage. How much am I going to have to pay? I'm going to have to pay $80,000. So this example illustrates that I as the homeowner have lost $20,000.

So the entire loss of the home value is imposed on the equity holder, which in this example is the homeowner, who is the non-rich person. And in this example, Jeff Bezos actually didn't even lose a cent. And that's the nature of debt that is kind of subtle but incredibly important, that debt is protected against declines in the economy, at least protected before the equity holder is or the homeowner. And in this situation, it's the non-rich, the person who's not rich, who is taking that risk. And our broader point is that doesn't seem like a very sensible system. Jeff Bezos should, in some sense, be taking the risk. He's the person who has a lot of money and can afford to take risk and not the homeowner in this example who probably doesn't have a lot of other wealth.

VEDANTAM: So of course the people who can save money - and we've been using Jeff Bezos as an example, but he's only a stand-in for the larger idea - that the people who actually can lend money are the people who are well-off. And since the financial system - the argument you're making is that the financial system protects the interests of lenders over the interests of borrowers. A crisis means that the rich come out relatively even or potentially even ahead while the poor lose a lot of ground, which means that income inequality now widens even further.

SUFI: Exactly. Exactly. And that is the pernicious effect of debt in our view. And I want to be clear because I don't want to make the rich out to seem like villains in this story. The rich do with their money what the financial sector kind of guides them to do. So when they put their money in the bank, you know, they may not want the bank to be going out and making more mortgages. They may want the bank to go out and make productive business loans to entrepreneurs. So I think there is at least some blame here in the financial sector, that it's the financial sector that is guiding this money to be, you know, given out to entrepreneurs, to homeowners, to whoever else needs the money in the form of debt.

And one of the points we make in the book is to say that if anything, the government actually encourages exactly this kind of inefficient lending product. They, for example, make it cheaper to borrow because there's an interest tax shield on debt. You know, you get to subtract your interest off your taxes. They encourage banks to only lend via debt financing. So it's a broader problem. And I just want to be clear - it's not that the rich are villains in this story. It's just that the financial sector channels their money into more fixed income, debt-like products.

VEDANTAM: I'm wondering what your take is, not just on household debt, but debt taken on by companies and debt taken on by governments. Do they work the same way? Or do they - is there something fundamentally different about household debt compared to company debt and government debt?

SUFI: When we're thinking through household versus corporate versus government debt, I think the key question is, what is the money being used for? And the distinction we make in our research is whether the money is being used for what we would think of as kind of productive investment or if it's just being used to generate spending. And we think that there's a sharp distinction to be made between those two things. So if corporations are doing useful things with the money - building a plant, building, you know, a new technology - then, of course, that's a great thing. And we never would want to say, oh, debt is bad for that reason.

Governments kind of lie somewhere in between because governments can use debt financing to do productive things, like building a bridge, building an airport, improving the LaGuardia Airport. But they can also use debt to just transfer money to people in, let's say, the lower 50% or 90% of the income distribution and to facilitate their spending. So the real difference in our mind is not household government or corporate debt. It's productive debt versus what we call unproductive debt. And unproductive debt, again, is debt that's just fueling spending. It's not being used to invest in any kind of productive activity.

VEDANTAM: But I want to follow up on that for a second. I mean, aren't the two things related? So let's say I'm a company, and I've invested in a new plant. And let's say the new plant is making - I don't know, let's say it makes sweatshirts or water bottles. Now, for that to be a good investment, somebody has to buy those sweatshirts and those water bottles, which means somebody has to spend money. So I'm not seeing the neat distinction you're making between borrowing money to produce and borrowing money to buy because presumably, without the people who are buying, the people who are investing the money to produce would be making bad investments.

SUFI: Yeah, for sure. So let's zero in on household debt a little bit closer. When households borrow, the traditional good type of borrowing that we talk about in economic models is closely linked to the idea of spreading your income over time. And so usually, the idea is right now I'm not making as much money as I will in, say, 15, 20 years. Think about a 30-year-old just graduating from graduate school and needing to buy a house. And the idea is that it would be a good thing if that person can borrow today to, say, buy a car, buy a house, knowing that their income's going to get better over time. And then they will be able to pay back the debt when they get older.

The problem with that story is that it's increasingly looking untrue. And that is, most of the people who borrow a lot, they never end up subsequently seeing very high income. And so they often get into these debt traps where they just continue to owe and continue to owe and continue to owe. There's a lot of research coming out, for example, that people are retiring now with just way more debt than they used to. This is closely linked to a lot of the stress the elderly in this country are feeling, you know, about people having to work longer than they had planned. And so you're exactly right. There's a model of household debt that's quite good and can be productive. But that's just not the model that seems to be followed today in America.

These are models in which, you know, our future selves are unhappy with the decisions we make today. You know, in five years, the Amir Sufi five years from now will be like, why did you borrow so much to buy that car? You didn't need that car. And I at least am kind of pretty convinced that this way of thinking is the accurate way of thinking for most people, that most people make decisions today that five or 10 years from now they may not be so happy with. And if that's the way people behave, then of course borrowing can be quite problematic because I'm being encouraged to do something that my future self will be unhappy that I did.


VEDANTAM: So, Amir, you grew up in Kansas. And when you were growing up, you had to do drills in school to prepare for tornadoes. And it's an obvious idea. You want to prepare for bad times when times are good. It's a central idea behind insurance. You call debt the anti-insurance. What do you mean by this?

SUFI: So debt works the exact opposite of insurance in the following sense. If, for example, you have homeowner's insurance and God forbid there's a fire, then the insurance company is going to come to you and give you a payment to try to make you whole. Debt, in fact, works the exact opposite way, which is house prices falling by 20%, 40%, that can be as devastating to your wealth as a fire. But instead of the financial market coming to you and paying you if house prices fall, if anything, you bear the entire loss. And it gets back right to that example that I gave before, that if the economy collapses, if house prices in your neighborhood collapse, if you lose your job, debt doesn't really care. You know, debt still demands that you pay them. And so in that sense, it's the anti-insurance. There's no sympathy, you know? You wish debt had sympathy like a loved one would have sympathy. But it doesn't. If you've lost your job, suppose you have a lot of student debt, you've got a new job but then you lose it, you still got to make that student debt payment. They don't care that you lost that job. And that's the sense in which debt is just a really terrible financial product for the sake of it sharing risk across people.

VEDANTAM: So policymakers often think of solutions when the economy is sputtering. And their solutions often involve, you know, getting people buying and spending again. Invariably, what that means is getting people to borrow again. Talk a moment about this. I sense that you think this argument is like saying the best way to prevent a hangover is to stay permanently drunk.

SUFI: Exactly. I think that I understand the appeal of this solution because it's a kind of Band-Aid solution. You know, it will even work in the short run. If you just get people to start borrowing again, then probably you're going to be able to boost the economy. And maybe you should even do that at the depths of a crisis. The problem is it's not a sustainable solution. Ultimately, it has to be that we tackle the more fundamental issue, which is, why is there so much debt? Why are people borrowing well beyond their means? And in my view, that's very closely connected to the idea of stagnating middle class incomes, extreme income and wealth inequality.

So even though there's an appeal to do these kind of short run, sugar-rush solutions - let's just get people to borrow a little bit more to get past this - ultimately, it's not going to be sustainable. I'd point out even furthermore that we're starting to see that effect, that, you know, we're just not seeing very sustainable high growth anywhere in the advanced economy world. And I think it's because we keep papering over the fundamental issues with debt.

VEDANTAM: Amir Sufi and Atif Mian argue that a financial system that thrives on the massive use of debt does exactly what we don't want it to do. It concentrates risk squarely on the debtor. When we come back, what this means for the recession caused by the COVID-19 pandemic and how we can keep the most vulnerable among us from suffering the worst consequences.


VEDANTAM: This is HIDDEN BRAIN. I'm Shankar Vedantam. Economists Amir Sufi and Atif Mian believe that household debt is one of the big drivers of recessions. The bigger the buildup of debt, the more households that owe a lot cut back on their spending. The more spending gets cut, the less demand there is for goods and services, which translates to layoffs and unemployment. Even more people now find themselves behind on their debt obligations. And even more people cut back on spending. It's a vicious cycle.

One way to intervene is for the government to step in during a crisis and forgive people's debts. But this isn't just difficult to do from a financial perspective. It's difficult to do psychologically. Amir, in 2009, as the Obama administration was trying to come up with ways to soften the blow of the Great Recession and to keep ordinary people from falling through the cracks, CNBC reporter Rick Santelli delivered an impromptu speech on the floor of the New York Stock Exchange.


RICK SANTELLI: How about this, president and administration, why don't you put up a website to have people vote...

VEDANTAM: What did he say?

SUFI: He basically said how dare we forgive debt for all of these people who were so irresponsible and borrowed so much. And, you know, I always say tribalism is a very powerful force in human interaction. And so I think there's this effort to make the debtors and the creditors feel like different people. And it's those debtors that have caused all this problem. How dare we help them in any way.


SANTELLI: This is America. How many of you people want to take your neighbor's mortgage that has an extra bathroom and can't pay their bills? Raise their hand. How about we all...


SUFI: It has a very powerful ring. I think when things go badly, oftentimes people are looking for someone to blame. And that complicates the policy efforts that may be needed in order to help us experience a faster recovery.

VEDANTAM: So you would argue that there is not just psychological reasons or moral reasons to try and potentially address the questions of debt, but there are also good economic reasons to do so. Someone can say, look; if someone else decides to borrow money, it's up to them to figure out how to pay it back. On the face of it, that's not an unreasonable position. But you argue that the people who demand that borrowers always face up to their debt obligations are sometimes cutting off their noses to spite their faces. How so?

SUFI: Yeah, exactly. And I think there's two - you know, before getting into the economics of it, I think there is an important point that needs to be made, which is it's surprising to me that more people don't also place some blame on the lenders. People made some really bad loans. They made some really silly loans. In fact, there's substantial evidence that lenders purposefully misstated information to get people to borrow more. So I'm all for having people who made bad decisions bear the consequences of those decisions. But it seems like an unfair situation in which we only blame one side of the contract.

That point is related to the economic point, which is our basic idea is that both the lender and the borrower should more equally share the losses that are associated with the crisis. It's not a radical proposal. We're not saying that, of course, borrowers should be forgiven everything and they shouldn't have to bear the consequences of borrowing too much. We're just saying that in the broad scheme of things, for fairness purposes, it seems better to have a situation in which both the lender and the borrower bear some of the losses.

It's not only more fair, but it's also better economics because as we pointed out before, the borrowers are the ones that are going to massively cut back spending if you force all of the losses on the borrower. So by basically spreading the losses more equally, you actually not only do something that, in my opinion, is more fair, but you do something that's actually better for the overall economy because it's the collapse in spending that's really starting to affect everyone involved.

VEDANTAM: Is there an irony here that we don't like writing off the debt of the people in Detroit who took out second mortgages on their homes, but we seem to have a more lenient approach to debt taken out by big corporations? You know, recent presidents like George W. Bush and Barack Obama have talked about the importance of saving big companies. And I've often heard the phrase, you know, some of these companies are too big to fail.

SUFI: Exactly. In fact, funny enough, I actually do teach corporate restructuring as my main course I teach at the University of Chicago Booth School of Business. And it's kind of amazing how efficient and, to be honest, I think it's quite good the way the system works on the corporate side. You know, you wipe out the equity holders. You wipe out some debt. You give the company over to people who run it. And it just goes forward. And there's so much less baggage in terms of moral arguments and whatnot. It just kind of moves forward.

In fact, if you wrote down debt the same way for households as we often do for corporations, I think things would look quite naturally good, and the economy would be a lot more resilient than it is. So I completely agree with the premise of your question, which is I'm not sure why this has developed, where the people who are, in some sense, the ones that are most vulnerable are the people we decide that, you know, for sure they should bear the losses because they were irresponsible and they borrowed too much.

VEDANTAM: So let's look at how we might think about debt differently in a couple of different settings. Let's start by looking, for example, at student loans taken out by the college class of 2020. Many of these students are graduating with large amounts of student debt at a time when it's very hard to find a job. Their repayments are going to begin soon. How could we balance the legitimate interests of lenders, borrowers, the students and the economy as a whole when it comes to this problem?

SUFI: The answer to that question is closely connected to the example I gave before, which is the way in which the debt is born right now is squarely on the student. So let's take your example. Let's suppose the student has interest payments of, say - and debt payments - of, let's say, again, $2,000 a month that they have to pay. And they were expecting a job that would pay them $5,000 a month if there had not been this COVID crisis. Well, now they're in a situation where they can't find a job, but they still owe that $2,000. The solution that we propose in our book is to make the debt instrument more equity-like. That is, if there is a massive crisis and unemployment goes up, the debt payment owed to the creditor would automatically go down.

And you could do this in a number of ways. There's a number of implementations that you could do this. Some countries already do this. For example, Australia does that. They have what's called income-based repayment, that if you earn less, you, therefore, are going to owe less on your debt. But the general idea is to try to make debt more flexible. It's the inflexibility of debt that leads to the problem. And you want to make it more flexible so it reacts to conditions that are going on in the economy.

VEDANTAM: So if the lender says, you know, you're asking me to share in the risk if things go badly, do I share in the benefits if things go well?

SUFI: Of course. That's how equity works. And that's our proposal, is to make the product more equity-like, that if you end up becoming the next Jeff Bezos, well, maybe I should get a higher payment if I helped finance your education. And again, this idea of making the debt contracts more equity-like is ultimately about bringing back who should bear the risk. And that is the richer people in the economy. And so we're not - you know, we're not people who think risk is bad and should always be avoided. You know, finance is all built around risk, right? And taking risks should earn you a good return. It's just about the way that debt is making the wrong people bear the risk. And so these kinds of financial products that we're proposing, more equity-like products, would help the rich benefit when times are good. And they would pay the costs when times are bad. And therefore, the non-rich would have a more stable income stream, a stable payment that they're making, which would be better off for everyone.

VEDANTAM: The same thing works with borrowing to buy a home. If mortgages were an equity instrument rather than pure debt, what you owe each month would fluctuate. If home prices fall, your payments would fall, and fewer people would be at risk of foreclosure. But if you sell your home at a big profit, the lender gets a cut of the upside.

SUFI: So if things go well, the lender makes out better. If things go badly, the lender loses. And that's exactly what we want. We want the lenders to have some skin in the game, some risk that they're taking.

VEDANTAM: So a central argument that you're making is that most recessions often do not have an obvious cause like a war or a natural disaster. They sneak up on us. And you suggest the buildup of debt is a big part of the story. The recession that we find ourselves currently in, however, is clearly the result of the COVID-19 pandemic. How is the story of debt relevant to what is happening right now in the present crisis?

SUFI: Your observation is 100% correct that this crisis, unlike the one in 2007 and 8, did not originate with issues of debt. So that's for sure. The broader issue I think we have now is that any shock like this shock is going to become worse if there's too much debt outstanding. We were pretty lucky in that debt levels were not at completely unsustainable levels when this crisis hit. But this crisis is really bad. And it's going to lead to serious problems with people making mortgage payments, rent payments, credit card payments, especially if it continues on and the economy remains weak. And so even though this crisis didn't originate with issues related to debt, debt will certainly amplify it unless we have a pretty strong policy reaction.


VEDANTAM: Amir Sufi is a professor of economics and public policy at the University of Chicago Booth School of Business. Along with Atif Mian, he is co-author of the book "House Of Debt: How They (And You) Caused The Great Recession, And How We Can Prevent It from Happening Again." Amir Sufi, thank you for joining me today on HIDDEN BRAIN.

SUFI: It was a real pleasure. Thanks for having me.

VEDANTAM: This week's show was produced by Jenny Schmidt and Thomas Lu. It was edited by Tara Boyle and Rhaina Cohen. Our team includes Parth Shah, Cat Schuknecht and Laura Kwerel. We had engineering help from Gilly Moon.

Our unsung hero this week is Amir's teenage son Yasin (ph). To record this interview, we needed Amir to have two smartphones. Yasin made one of the biggest sacrifices you can ask a teenager these days. He surrendered his phone for a couple of hours. The sound quality of this episode is much better thanks to Yasin's generosity. Thank you, Yasin.

For more HIDDEN BRAIN, you can follow us on Facebook and Twitter. If you learned something new from this episode, please be sure to share it with a friend. I'm Shankar Vedantam, and this is NPR.

Copyright © 2020 NPR. All rights reserved. Visit our website terms of use and permissions pages at www.npr.org for further information.

NPR transcripts are created on a rush deadline by an NPR contractor. This text may not be in its final form and may be updated or revised in the future. Accuracy and availability may vary. The authoritative record of NPR’s programming is the audio record.