 I'm Steve Clemens. I'm a senior fellow here at the New America Foundation. This is like, you know, just old home week for me because I haven't been here for a while. As many of you know, I have another day job as editor-at-large over at The Atlantic and National Journal. But I do stop by and get my mail and there are so many friends here today, which is terrific. So I know you're not here to see me, you're actually here to hear the content and discussion between two great friends, Richard Vague, who has just published this week, The Next Economic Disaster, Why It's Coming and How to Avoid It. I like succinct books. I like books, you know, I like books that get right to the point and tell you what you need to know and then set up the debate and then put out data and then you can kind of either applaud it or rip it apart pretty quickly and they don't obfuscate behind 900 pages. So I am, before we even get going, grateful for brevity and succinctness. And we'll then have to Astral Schweninger, who's the director of the Economic Growth Program here, a great colleague co-founder of the New America Foundation, who's going to analyze and share with us whether it's a brilliant but succinct book or a challenge but succinct book. I want to recognize Senator Byron Dorgan, a great friend who's here in this second row, who's been a great voice on trade and economic policy for a long time. So I just want to tell you all in advance, he's got to get out at six. I don't care how many hands goes up, he gets the first comment or question. I won't let him filibuster though, so we'll, unless, we'll have to see. So without further ado, please give Richard Vague a round of applause. Richard Vague, I should say, just to put this in context, Richard is, you know, he identifies himself as philanthropist and kind of an all-round good guy. Richard used to be really in the United States the king of the credit card business. So when Byron Dorgan would be up there and basically saying, what's happening with credit cards and too much credit and, you know, part of that bad line of bankers and credit card chiefs, Richard Vague was among them, which is why this project has become so interesting to me. Richard created for those of you who have airline miles, you know, miles to donate to your universities, miles to buy food at Safeway, the affinity credit card was essentially invented by Richard as the founding CEO of First USA Bank, which later went to Chase. He did the same thing again for Barclays, but he's an entrepreneur. But I think as he was going through this, and if I could just do a bit of a preamble, Richard, during the buildup to the 2008 financial crisis, he began looking at balance sheets and began looking at private levels of debt, private debt levels in relation to the value of properties that we're using to collateralize those loans. And he just knew that the equation didn't add up and he'll tell a bit of this story, I think, where he began seeing that the banks were sitting on a house of cards way early and that there was in a sense a kind of structural corruption, if you will, of the process, of the regulation, of looking at things that just weren't real. And so Richard had, and he's been on I think an interesting project to begin looking at financial crises and their relations to private debt. We debate government debt. We would like to go out, you know, as others have said and kind of look at, you know, whether we're spending too much or not within the debt, if you have a financial crisis, we have countries like Spain and others that had very, very little government debt to GDP before their crisis, and where did those crises happen? They happened in the private sector debt market. So I think that is the preamble that I will bring the former king of the American credit card business who's here to talk about debt, to share with us what he thinks about the relationship between these and how strongly correlated they are to financial crises and anticipating them and what should be the remedy for either protecting ourselves or dealing with them after that. So all, please give a round of applause to Richard Vaidt. I am really, really grateful to be here today and to have all of you here with me. And a special thanks to Steve, who's doing so much to help me as I put this book together and to Cheryl Sweninger, who's done as much or more and just want to express my real gratitude to you folks. You know, as Steve mentioned, you know, a lot of the debate these days is quantitative easing and government debt, the stimulus versus austerity. And I'm going to argue that all those things are secondary considerations to private debt. And to get a little bit more into it, in his book Stress Test, Tim Geithner wrote, financial crisis cannot be reliably predicted. So they cannot be reliably prevented. And furthermore, in the section on financial reform, which is an extensive legislative accomplishment, he said the goal was to make the system safe for failure. It wasn't to prevent failure. My comments today, I'm going to argue that financial crises can be predicted and can be prevented by focusing on private debt. Now first, I think it's important to get a context for this. What I've done on this chart is map from 1997 to 2007 certain categories. This is the decade that built up to the financial crisis. And you can see here on the leftmost column, this is the growth in private debt from 1997 to 2007. That number increased by $14.4 trillion in one decade. The market was flooded with the creation of new money, because that's in essence what this is. Federal debt only increased by about three and a half trillion. The money supply only increased a little over four trillion, or excuse me, the money supply only increased about three trillion. GDP itself only moved up to about 15 trillion. Some of these other numbers that we hear about again and again and again are tiny in relation to this number. The federal budget, federal taxes, and exports. You could have reduced taxes by 10% for each of those 10 years, and you would have enabled $2 trillion to be spent in the private economy. That's a tiny number compared to the 14.4 trillion that was released through this massive buildup in private lending. The crisis of 07 and 08 was caused by a rapid increase in private debt. Here's the mortgage loan market. From 1970 to 2000, that amount grew by about 17% per year in ratio to GDP. Starting in 01, it took off on a rocket ship. It grew by 5 trillion. It doubled in about six years. That's a growth rate to GDP of 46%. And it wasn't just mortgages. If you look at private debt in total, and private debt is the sum of business debt and consumer debt. It's about 50-50 or 55-45. And consumer debt, which is around $12 trillion, 70% of that is mortgage debt. Some of these other categories we think about, like student lending is only a trillion, credit cards are only $600 billion. It's mainly mortgage debt. In total, that number grew in that five to six year period by over 20% to GDP. Now, businesses and consumers are still highly leveraged. We heard a lot about consumer deleveraging. Consumers have not deleveraged very much by historical standards. Furthermore, we're hearing a lot about how businesses are awash in cash. It's simply not true. If you look at it on a net basis, businesses are net debtors to begin with. And their net debt position is high by historical standards. We're still highly leveraged. Now, if we go beyond the US crisis in 07 and 08, we see that this same rapid five year buildup in private debt happened in all of our major financial crisis. You see it here in the 20s. See this rapid acceleration in private debt that preceded the crash of 1929? Here we see Japan's crisis of 91, 28% growth in five years prior to their crisis of 91. And we'll talk a little bit about what happened after the fact. It was, in essence, a deleveraging that created deflationary pressure. But the buildup of private debt is what brought the crisis. We see this in Asia in 97. There was a 29% growth in private debt to GDP in Korea in the period before the 97 crisis. You also see this in Indonesia here, about a 43% growth in the five year buildup. Now, in every single one of these cases, government debt to GDP is actually benign or improving in the five year period prior to the crisis. Here you see this dramatically in Spain. Spain, which of the major eurozone countries, is in the worst shape. And you can see why. There was 49% growth leading up to the crisis. They're now at a level of 216% private debt to GDP, an astonishing number. But look what was happening to the government debt prior to the crisis. It was actually improving in ratio to GDP. Businesses feel flush. Consumers feel flush. They're paying more taxes in a lending boom period. The government is receiving more revenue. Everybody feels like they're winning. When we examine this comprehensively for major economies, now I've taken the liberty to carve out the 22 economies that constitute 85% of world GDP and have a half a trillion in GDP each or more. Frankly, three countries, Japan, China, and the United States, constitute 40% of world GDP. So it's a real crisis. And if you look at this, depending on whether you kind of are a lump or a splitter, there's been 22 crises in these 22 major countries. Pretty much every one of them has seen a buildup of 20% or more in private debt to GDP in the five years prior to the crisis. The converse is true as well. Anytime you see a financial crisis, you see a buildup in private debt prior to that. Now, there's been a lot of focus on mortgage debt. A lot of folks have said it's mortgage debt in this particular case. And it was in the US 2008 crisis. But if you look across all these crises, it can be other forms of private debt. In Japan in 91, it was more commercial real estate. In South Korea in 97, it was more commercial real estate and industrial loan. All that matters is in aggregate private debt is increasing at this 20% pace. The form of debt, by the way, also is not that relevant. We saw a lot of securitizations and a lot of credit default swaps in the 0708 crisis in the United States. And as a result, a lot of people have become quite expert in those particular forms of lending. There have been a lot of crisis where there wasn't securitizations and there wasn't credit default swaps. It's been other ways that banks have used sidestep capital requirements. Another thing that I would note is sometimes in these crisis, you have delinked lending and risk. You know, there's been a lot of commentary on the fact that in mortgage markets, you know, the folks making the decisions about the loans that went into the securitizations didn't bear the risk of those loans and those were borne by someone else. Well, that's true and that's been true in a lot of crisis, but there have been a lot of crisis where that kind of delinking hasn't been that prevalent. The key is tracking the aggregates and where you have 20% growth in private debt to GDP in five years, you pretty much got yourself an issue. Now, why is it that rapid growth and private lending creates a crisis? Well, it's pretty straightforward. Any time that lending exceeds the GDP growth rate that much in that short of a period of time, it's evident that we've built too much of something. Whether it's houses or office buildings or manufacturers, if you look back in the 1800s, it was railroads, you've built too much of something and when you've built too much of something, there are two consequences. First of all, you've created a lot of bad loans. In the case of the 0708 crisis, we've probably created $2.5 trillion worth of problem loans. The banking system only has about a trillion and a half dollars worth of capital. You had a problem and that's typical for this type of crisis. You're creating more bad loans than there is capital in the system to support that. The second thing that has happened is you've built so much capacity that growth is going to have to slow down until that capacity is absorbed. If you've built a four or five year supply of housing, you can't just wave a magic wand and have that disappear. It's going to take several years for that excess capacity to be absorbed. When you have these two things happen, monetary and fiscal policy are of limited benefit. Pretty much all the discussion has been about monetary and fiscal policy. Quantitative easing, stimulus, things like this. There's only so much those two things can do. They can soften the blow. They can't solve the problem. Another thing is that triggering events, be it a stock market crash or a bank failure, is often ascribed as the reason there was a crisis. It's not true. The cow's already out of the barn by the time the stock market crash or the bank failure has occurred. The excess lending has been occurring over years. And all the crash is, and all the bank failure is, is evidence that it's happened. Another thing to note is that once runaway lending has started, and I'm terming this phenomenon of a five year rapid increase in lending, runaway lending, that can occur for years. As long as the banks keep lending, the party can continue to happen. Now we've heard a lot of things about other reasons that these crises have occurred. We've heard theories from the black swan theory to it was government debt, to it was current account deficits. We looked at all of the criteria on all of these countries. We examined 20 different factors, including government debt, including declining interest rates, including currency valuations, savings rates, current account deficits. The only one that correlates to crisis is a rapid buildup in private debt. None of these other factors are good predictors. They're either weak or non-existent factors in predicting this. So let's change the subject ever so slightly here. We've been talking about crises per se in the slides thus far. But as part from any crisis, the high level of private debt is a problem in and of itself. And I found this slide remarkable when I first came across it. But in 1950, private debt to GDP in the United States was 55%. Today, it's 156%. It's tripled in a little over two generations. And that's not just true in the United States. Here's all the major Western countries graphed and I've thrown China in here for good measure. But in 1970, all these major economies were more in the range of 50% to 100% private debt to GDP. Today, they're kind of in the 125% to 150% to 200% range. The whole world is getting highly leveraged. And we've seen a lot of headlines over the past week or so about Portugal and another lending failure in Portugal. Here's Portugal. Private debt to GDP in Portugal is 255%. The problem there's not government debt. The problem there's not this and that and the other. The problem is accumulated private debt over time. Spain, as I mentioned earlier, kind of the outlier among the major Eurozone countries at 216%. When you have that much private debt, a very simple thing occurs. And that is money that consumers across the United States would be spending on restaurants and new cars and vacations and other goods and services. They are instead diverting to service a too high level of debt. That in our mind is the reason we're experiencing a lackluster recovery. We and Europe both. And frankly, the situation's more acute in Europe than it is in the United States. So that brings us to the issue of how do you prevent a crisis and how do you repair a situation where you have too much debt in the aftermath of a crisis? Well, I was in the banking industry for most of my career and I can assure you that where regulators want to intervene, regulators can intervene. The key is monitoring the aggregates. If the regulators, the Fed and all these associated entities are looking at the rate of growth of private debt to GDP, it's fairly easy to see years in advance a problem developing. Regulators can then influence counter-cyclical credit policies. The Federal Reserve, frankly, could use private debt growth as a factor in setting interest rates. They can intervene with strengthened capital requirements. There's a lot of things they can do when they see this kind of thing developing. Which leads us to the problem of repair. You've had a crisis, you're sitting there with too much debt. How do you get out of a situation likely we currently have, frankly, across the world where we have too much private debt to GDP? Well, you could have folks pay down that debt but that brings economic contraction in and of itself. We saw this, frankly, that was the reason for the astonishing contraction in the period 1930 to 33. We could grow but there's never been a period in modern economic history where you've had GDP growth that was not matched or exceeded by private debt growth. You could inflate your way out of this but frankly we've run these models every which way we could think of and it takes a generation or more to get out of this if you rely on inflation. That only leaves one thing by process of elimination. That's restructuring debt. We have probably on the order of nine million mortgages that are under water today out of the 55 million mortgages in the United States a broad scale program to go to those consumers. However politically unpopular it might be would go a long way to boosting the economy because the net effect would be that money is freed up to spend on goods and services. Restructuring would have a salutary effect on GDP growth. It's no mystery to me why our economic recovery contends to be less than we would hope for. Now that brings us to just a couple of more slides that I have before I turn the podium over to Cheryl and that is the current situation in China. Runaway debt growth in China is at alarming levels. Here you see the history back to 97. What we've suggested is that a growth rate of 20% or more in a five year period is one that should bring concern. The growth rate in China and by the way the numbers are a little fuzzy and you get slightly contradictory numbers from different sources. But no matter which ones you rely on you're looking at growth rates that's in excess of 40 to 50%. Now where does this show up? I think probably everybody in this room has read a lot about the problems in China associated with over capacity. There are many cities that they are referring to as ghost cities that are virtually empty cities of gleaming new buildings. We also see a lot of reports about excess capacity in manufacturing. It's capacity that's being added to keep the Chinese economy growing that is not justified by demand and is resulting in increased levels of over capacity. So what is our view of what's gonna happen in China? Well, we think a crisis is possible in two to three year. Now the mitigants are very important to focus on. China has only about 32% central government debt to GDP. Now that's low by world standards. Ours is about 100%, Japan's is about 200%. So they have lots of additional borrowing capacity. They are also through the PBOC and other places holders of vast financial assets. In both cases, the capacity is, we estimate easily equal to 20 to 30% of GDP. So China does have capacity to deal with this problem. But even if a crisis is avoided, China has significant and increasing levels of over capacity. Now here's a little paradox for you. You know, China released its GDP number here less than a week ago and it was 7.5%. And everybody was relieved. Oh my goodness, that's great news. They're still growing at 7.5%. We don't need to worry. GDP growth is more a measure of the capacity being added than it is a measure of the capacity that's needed. So at a 7.5% growth number in China's economy is just evidence that the problem is compounding. China needs to pull back on their growth rates just to absorb the excess capacity they already have. We believe China's situation may be very similar to the one that we have seen in Japan. Japan had this exact situation. Rapid run up and private debt leading to 91 in 23 to 24 years of sideways growth in the period after that. You can see something like that being the case for China once they come to grips with their problem. Our view is what they will do and what they should do is act pre-imple. I mean it's a situation unlike the United States where the government in effect owns the banks. So their mandate for keeping those banks alive is different and frankly more compelling than it was in the United States. It's hard to see them not acting. But what they need to do is go in and preemptively recapitalize the banks so that those banks can in turn go and renegotiate with commercial borrowers. China has about $14 trillion in commercial loans. We estimate that easily one to two trillion of that is bad loans. It may be quite a bit higher than that. They have the capacity to preemptively deal with that. But once they do that they're gonna be faced with this decelerating growth scenario and they're gonna have the unemployment problems that they've been trying to outrun all along. And that's where they probably have to look at expanded safety net programs to deal with the social ramifications of slower growth. We think in aggregate the cost to the Chinese economy could be 20 to 40% of GDP. So with that, I'll turn it over to Cheryl. Thank you very much. Thank you. I have to grab the commas. I'm the punctuation point between speakers. So thank you very much, Richard. I just wanna underscore how unusual it is to have a person that was responsible for so much building of debt in America talk about there being too much. And I just wanted to say that Byron, had your jaw might have dropped had you heard that testimony in the Senate. I wanna thank Charles Schweniger for offering some commentary. I wanna recognize Michael Lind, who's been his partner here at the Economic Growth Program. Both of them will work together on aspects of this. But, Cheryl, I'm looking forward to you to tearing up the book. Charles Schweniger. Thank you, Steve. And thank you, Richard. We've been working alongside with Richard for the past few months and have issued several reports. Title of one is on the slide here, America's debt problem, how private debt is holding back growth and hurting the middle class. We also issued an earlier report called the U.S. Economy After the Great Recession, America's D-Leveraging and Recovery Experience. And we will issue in the fall a report on the China's debt problem. We actually might begin, if I can manage here. I don't know if, we actually might begin as sort of, I'm not gonna cover all this, so don't worry about it. And it's intriguing tease. We might actually begin where Richard left off, which is with the China. What Richard didn't say about the 7.5% economic growth, he made the very important point that it's adding additional capacity to produce that. But what he didn't say was in order to get that 7.5% growth in this past month, China had to expand its credit at the highest rate it's expanded credit for six years. Meaning you had an enormous expansion of credit that took place in the May June period, which enabled it to reach its growth targets. And this is the essential problem of China's debt problem, which is a problem for most economies that are facing debt problems. Namely that it takes an increasing amount of credit growth in order to get a certain amount of GDP. Ruchar Sharma of Morgan Stanley has estimated that what we call the credit intensity of China's economy has increased nearly four fold since 2008. So in a nutshell, this is a problem that in order to get one unit of GDP, they have to actually have four units of credit. And you can't go on through for an endless period without running into a major, major problem. Now, what's important about Richard's book is that it actually deals with two kinds of debt disasters or economic disasters. One is the acute debt disaster that we talked about that Richard spent the first part of his presentation on, which deals with these acute crisis that emerged from runaway credit. And in working with Richard on this, I think he's come up with probably the soundest criteria of any of the studies that I've seen in being able to construct an early warning system. But if you remember when Richard said we'll change the subject just a little bit, that changed from the acute debt problem to what is a chronic debt problem. And you might call it the sort of chronic debt disaster that the U.S., and I would argue China and Europe and Japan are living through now, which is that their economies are very highly leveraged, but their growth is extremely dependent upon the expansion of debt. So this is one of the most revealing, Richard had his revealing graph and Richard has his graph too. He just, it was holding back some of his ammunition on this. But what is important to look at is that beginning in the late 70s, early 80s, the divergence that began between the creation of debt and the GDP it produced, such that you have this huge gap now. And so this is, we can worry about the rapid accumulation of debt, but we also have to worry about the fact that if debt doesn't produce GDP, it suggests that something much more serious is wrong in the economy. And this is the chronic debt disaster that Richard takes up in his book when he talks about the paradox of debt. American households also became dependent on debt. This is a chart of the household debt to disposable income. You can see in order to maintain living standards, households had to take on debt to maintain their living standards. So this is our essential argument about the chronic debt problem is that it takes more and more debt to produce GDP. So in the 90s it used to take $1.79 cents of debt, additional credit to produce $1 of GDP that jumped into the 2000 to $2.78. Then with some deleveraging, we've moved down to $2.40, but it's increasing again. Now this is less than China's inefficient economy, but it's still very worrying over a period of time. Now, so it suggests that something more fundamental is wrong, that our debt problem is not just the fact that we suffered from an acute financial crisis, but that we have a more serious debt problem that signals that something's wrong in the economy. It's a debt-low-led growth, it's a debt-dependent economy. Debt-led growth has led and has been associated with big investment booms and busts. So something's wrong with our financial system because we constantly repeat a huge misallocation of capital which as Richard pointed out adds capacity that has to then be worked off or written down. So debt-led growth has led to big investment booms and busts. It also has coincided with income inequality and wealth inequality, suggesting again that we have a problem whereby we're having to create debt in order to sustain demand and living standards. It's also coincided, obviously, with the decline of labor share of income. In a slide I didn't put in here, it's also coincided with growing current account deficits, meaning that in order to be able to provide demand for the rest of the world, we have to create debt to do so. Ultimately, it's led to what we call a plutonomy, an economy dependent on very high-end consumption. If you can see the consumption share of the top 5% has grown dramatically over the last approximately two decades. Now the question, this is our other report, US economy, is whether anything has changed as a result of the crisis. Our answer is generally no, that there, we've seen as Richards pointed out that real GDP growth has been weighed down by deleveraging. This is the weakest recovery, although the one after the tech bubble was also very weak. So the argument that nothing really has changed in the debt dependent model, real wages remain flat, which means that people still must be able to borrow in order to sustain living standards or consumptions. Private sector growth has been mainly in low-wage jobs. Medium household income has fallen even with the recovery. Private investment has only rebounded modestly, so we have not been able to have a new investment-led growth as well as government, very critically, investment has fallen, which has been the weakest part of the recovery. Manufacturing output employment in spite of the very encouraging signs remains below or at 2007 levels. This was put up in April, so it may have, I think it surpassed it for a little bit. And we've only had a modest improvement in exports. So the overall sort of fundamentals have not improved. Meanwhile, we've had essentially a, I think I missed a slide here. Essentially, I missed a slide in putting this together. We've had essentially a wealth-driven recovery, a wealth and debt-driven recovery because overall leverage is very hot. So the stock market has done very well, but inequality has increased in the process. Now the problem I see, now it's not gonna happen in the acute way that Richard says, but there is a process underway whereby we're getting growth again only because we're adding debt. So this is one of the more worrying charts. One of the new drivers or ways we're accumulating sort of is that corporate debt is on the rise, but there's a big gap between the, don't know how to do the pointer, between the debt is being taken out and resulting in investment. Now that wouldn't necessarily be bad if we were China, but we're not China. We don't have access, necessarily productive capacity in a lot of things. I know Michael Dannenberg and both Richard are, don't believe, student loans as an aggregate are a major problem, but nonetheless it's one of the forms. If you look at the creation, what credit has been created, the two areas are most probably our student loan and auto loans. Yes, the numbers are relatively small. They're not a mortgage style, but they're symptomatic that families are using auto and student loans as a way of filling gaps in their income. And federal government of course has had to increase its debt to offset household deleveraging, but remember government is investment. Government debt has increased, but government investment has fallen. Anyone who knows me will know that I've been an active advocate of a very robust public investment led recovery and with running large deficits, but this is not what we've been doing. We've been increasing federal government debt without the investment. So we're falling back into the old debt dependent problem. Now there's one bright spot that I left out which was the energy oil gas revolution which is the one exception to this otherwise picture, but essentially the recovery is to again to debt dependent total leverage is about the same as it was before the crisis with the reach of flow of funds. We're working on a report on China's debt problem. I concur with most of everything that Richard said about this and would argue that our tentative conclusions are that this is more likely to be a growth event and not a financial markets event, but it will be a growth event of some significant consequence for China and the world economy. I think Steve wants to convene us to have questions and answers. Thank you very much, Cheryl. Thank you. Richard, if I can invite you up to maybe take this seat Richard here and I'll sit here on the end and I just want to ask a few questions and then have a conversation with all of you and I think we still have beer and wine left, right folks? Yeah, that's good. So beer and wine and debt, it all goes together. I just want to say, you know, when I've known Richard Vaik for a long time and so knowing that whenever you work with a friend you want to say what are the blind spots that your friend might have? And I thought maybe I've just got an eccentric successful businessman who's found a little pet project and it will be really embarrassing if I support him too much. So we went out to try to talk and Richard said go try to find people who will punch holes in this notion and one of the interesting things I found, Richard and Cheryl went out to sort of talk to senior economists, senior policy makers about this private sector debt issue and looking at data sets over time. Most of them were rather non-plus. They said, well that sounds logical. It sounds very compelling if you've got too much private but that's not new. When you actually go out into the field in profession you run into Tim Geithner quotes and the data sets didn't exist so that the large scale data sets on private sector debt across a great number of countries didn't just weren't there. So Richard hired people to come in and put those debt sets together. They're available at your website which you might wanna share with folks but I just wanna talk about the sociological dimension of this of why both of you think there has been such a blind spot to thinking about this as one of the drivers of financial instability out in the field of economics because it's weird that people when they heard about it weren't surprised but at the same time there's very little work done in this arena. Richard? I think the debate and the analysis has been nominated by the Fed and its economists and I think the Fed looks at the world through the Fed's own balance sheet and that causes them to think about the world in terms of deposits rather than in terms of loans. It's the exact opposite of the way a bank's a non-fed bank's balance sheet works. So it's very interesting. You look at Milton Friedman's monetary history United States 1864 to 1963 or whatever it is, the landmark book. It's a, you've talked about 700, 800 page book board. It's one of those. The term private debt doesn't occur anywhere in there. You know the academic institutions that have come out of the Fed think about this in terms of the Fed structure itself. Cheryl, what do you think? Well, I think there's two aspects. One is the political, of course, where we've been subject to a huge campaign about the problems of American government debt and we need to talk about that because we all know what that's been about. But particular to your question of why economists have failed is because economists, unlike Richard, don't actually deal with balance sheets. And so they don't understand also that there's multi-sectoral, and this is a problem also for people pushing the government debt problem. They don't realize that if one sector is doing something, another sector has to be doing, that there's not just, there's two sides to a balance sheet, but that actually we have four different balance sheets. We have a government sector, we have a corporate sector, we have a household sector, and we have an external sector. And so people that tend to have a balance sheet view understanding of a world economy that when Gottlieb put forward, Martin Wolf came to embrace Michael Pettis on China, you can understand the critical role that private debt plays in relationship to the public debt rather than just single-mindedly focusing on public debt. Yeah, what I've come to learn through this process is that classic orthodox economics does not include a role for private debt and the way they put forward growth theory. Well, I've thought a lot about that, and what I knew Byron Gorgon was gonna be here was wondering, to a certain extent, from the public policy person, a steward in the public policy area, when you think about the equation, you've got the, you guys in the banking sector basically kind of belly up, and I'm sort of asking how did that happen? It happens because most people think that invisible hand economics punishes bad behavior and rewards good behavior, smart investors and smart stewards of it, so that's in the private sector, and it's one of my gut feelings as to why we haven't thought about this because you've got a clearing house in the private market that varsity takes care of it, unless you have a very big event that then draws in public interest questions of what do you do to step in and save General Motors and what do you do to come in and stabilize it, invest tax dollars, then get into the mix, and it drives a lot of people then to politicize that because all of a sudden they're now in the game, but they weren't in the game before, and what you're saying is, as we build up, there are a lot of these behaviors that are replicable. I remember in the buildup on when Dean Baker and everybody was out there and saying there's a bubble building, you'd go to the World Economic Outlook Meetings or the IMF Spring Bank Meetings and they would say, well in 35% of cases like this, it's a bubble, but that's about all they would say, and furthermore they wouldn't, but it's interesting. The other element that I gotta do one other thing, we sent this manuscript in an early version out to eight economists to comment on and got lots and lots of helpful comments, but the best was one from a very orthodox economist that just trashed the manuscript and said, there is no basis for vague wild assertion that debt has anything to do with growth. Quoting. And here I've been my whole career thinking if you're gonna grow, you build a factory and you borrow to build a factory and debt is in fact integral to growth. It's interesting. The other question I have is a very thick book in contrast to this one is basically The History of Debt by David Graber and in there he talks about in ancient times about there being a jubilee, the forgiveness of debt. And so one of the other shockers is I got to sort of watch your evolution is that what you call it restructuring of debt, it really is a forgiveness of debt. And Richard went to a number of the Federal Reserve banks and met with economists attached to them and they would always go, if you do that, you open up a moral hazard problem. And I'm interested because I wanna make this political too. We had a major financial crisis with structural corruption, a key piece of it and you bailed out elements of that equation but didn't bail out many of the loan holders in the middle class because that would create a moral hazard risk for the future. Why didn't it create a moral hazard risk for the future with the other parts of the equation that got bailed out? And like in the jubilee case, isn't this a sort of case that calls for an exceptional response because that debt that just lags out there as it is now has to be a ball and chain around growth. It has to be, so if you were to bring it down and structure it to real values, you could kick back into growth probably more quickly. So tell me where I'm wrong. Richard, go ahead. Go ahead. The moral hazard question is one that's there and it's real and it's on everybody's mind. I mean, I go talk to the bartender down the street about this theory and say, well, you know, one of the things we need to strongly consider and by the way, we need to strongly consider it way more in a place like Spain or Portugal where the need is acute and we do in the United States. But let's just start with the United States. But you know, and the minute I mentioned the idea of restructuring an individual's mortgage, the reaction is immediate and visceral. That's not fair. And that's right. It isn't fair nor was saving the bank's fair. This, you know, if you're talking about a country where private debt to GDP has grown from 55% to 150% fixed percent in two generations and you wanna fix that problem, you're gonna have to deal with moral hazard issue. It's the least bad choice. In ancient Jewish communities, they did it with this jubilee. They did one kind of debt erasable and then you started over again. So why not consider something like that? Well, this is the crisis of capitalism now. We're the crisis of the world economy because if you look at it, every major geoeconomic region economy is now highly leveraged, probably more so than it can. And it will be according to Richard's analysis, a drag on growth. And so while I would favor Richard's debt restructuring and debt forgiveness at the micro private level to the extent that we can make the political case and the fairness case, but we are also gonna have to deal with this at the global macro level. And the case therefore, the global macro mechanism of getting rid of a lot of this debt is actually to extinguish it at the federal level with through the US, using the US principle reserve currency and its exorbitant privilege to do so. Unfortunately, the politics to do that is blocked. But if we are not able to in a sense extinguish a lot of this debt over the next five to 10 years, the world economy is gonna be dragged down and in a very difficult position. If you look at those leverage levels across Europe, across the United States, across China, across Japan, across Korea, wherever you look. Anybody seeing if the markets are falling right now based on Charles' comments? We'll have to run out and see. Let me open the floor to comments and questions. Paula Stern, we have a microphone for folks. Sydney is gonna run the microphone. Paula Stern. Thank you very much. And thank you very much for sharing your thesis. I had the privilege of hearing the presentation as you were working on it and came away completely concerned about China as the most imminent source of the next crisis. And therefore thinking that we were gonna spend today talking about China and what it ought to do. But this discussion just suggests that it's really, if U.S. doesn't resolve in a manner the private debt in which you describe it, that that is the greatest threat to global economic future. I'm kind of surprised by that. And I'm wondering why it appears that you're more relaxed about the China situation. Because they both are such enormous economies and can have, of course, an enormous vicious impact on the world economy, however we resolve this private debt issue. So I'm wondering if you can, which is, should I worry about more? I didn't get the sense you were relaxed about China. Well, I should have been more tense when I was talking about China. Yeah. And in fact, we're doing some work now for a follow-up. I don't know if it'll be a follow-up article or follow-up book. We're trying to go deeply in to the China situation right now and see exactly what the linkages are to the rest of the world, both trade and debt linkages. So we can pre-map what we think the contagion might be for an issue in China. But if you think about the history of the last several decades, Japan was under-leveraged and they got over-leveraged in 91. The US and Europe had low leverage and we've gotten over-leveraged in 07 and 08. The only place left that was driving growth in any material global way was China. Now they're over-leveraged. Everywhere you look in the world where you have major economies, we have too much debt and too much capacity. The worst scenario for growth as we think about it over the next generation. I mean, if I may, one of the interesting things about the US side is while aggregate levels of private sector debt remain very, very high, there's this sort of myth or belief that there's been significant deleveraging. There's been modest deleveraging, but not significantly deleveraging. So the aggregate remains there. And what I worry about is not as another crisis or a bubble bursting as much as how do you get, I worry about the middle class. And when you begin looking at those charts in the 1950s and 60s and you see that that rise of leveraging was associated to building out capacity and the middle class had its best heyday in this country. And today you've got lots of capacity, very high levels of debt and eroding middle class. And so if you put it into those equations, that is what I worry about. That's a different kind of structural crisis in my view. Paul, Paul, let me add a point quickly. Paul, you're quite right to worry about China from a growth point of view and its implications. And one of the reasons while you're, if you remember my chart where China's credit intensity has increased to four to one, that understates it. Because see China free rides off of world demand. So China's growth is actually even more dependent than debt dependent than just its own creation of debt because it relies on the US and Europe to create debt to buy Chinese goods and services and products. Therefore China is actually more debt dependent economy than the US or Europe is. Therefore it's potentially gonna suffer a much deeper and protracted blow to its economic growth as a result of this double reliance on debt. Senator, did you have a question, comment? The invisible hand you referred to a moment ago, Adam Smith's invisible hand, never contemplated enterprises too big to fail and also apparently too big to prosecute. That's tweetable. I was thinking about, I was smiling because I was on two airplanes last week and on both of them flight attendants went up and down the aisle passing out applications for credit cards. That's the business he started. That's right. The program was my program. In Congress for 30 years we had a lot of economists and businessmen and women come in front of us. And this is an interesting idea that I don't know whether you're right or wrong but it's very interesting and I think merits a significant discussion. I'm also mindful of the analyst on Wall Street who apparently predicted 10 of the last two recessions. So it's easy to spell disaster ahead but I think this is a useful discussion to have and I wanted to ask this question. Had you had a chart, 1950 to 2014, overlaid with profits of the financial service industry and growth of that industry and a tendency to number one wallpaper every college kid's room with credit card applications. Kids that didn't have a job and didn't have any money or went to Jamie Diamond at JPMorgan and said can you ease up just a bit on leveraged buyouts, on mergers, on financing, hostile takeovers. Wouldn't that be antithetical to everything that exists in the financial service industry today and I happen to know how much muscle that industry has in this town, I wrote a book about it. So how does one deal with that? Well you're exactly right. A boom is accompanied, the correlation between increase in financial institutions and a boom is pretty dramatic and financial institution profits from 1950 to the present have gone from low single digits, three or 4% of GDP to 11, 12, 13% of GDP. So you can see that what you say is exactly true and the prescription that I put forward in my book is the way to deal with this is significantly stepped up capital requirements for lenders and not just banks but all lenders and I'm not talking about the kind of adjustment, recently we had the Dodd-Frank capital requirement increase which I think is less than $100 billion in additional capital to banks. Remember, the problem was two and a half trillion dollars, an additional 100 billion in capital isn't gonna do much. You know, we're talking about a material rethinking of the capital requirements of these institutions instead of being like roughly 10 to 12% as they are now talking about 15 or 20%, it's never gonna happen but it is the correct thing for moderating growth away from financing dependent types of growth to more innovation dependent forms of growth. Bill Goodfellow. Thank you. Let me speak to the other side of this. We Americans love credit. It's like a cultural thing, we're addicted. In 1950, I don't think credit cards existed, you bought a car for cash, our parents wanted a house, they saved money until they had enough money to build it. Now, you know, we love credit, we live on credit. Nobody buys cash, go to a restaurant, nobody pays cash, maybe McDonald's. And so it's a cultural thing and there's almost like a disconnect between what you want and actually paying for it because it doesn't happen for a couple of months down the line. And credit card debt is about 21% I think so it's not very sensitive to interest. So you're really talking about a cultural change on the part of Americans. And do you want to be work with leather seats? Just adds a few dollars more to your payment. So there's a real cultural problem, it's we, how do you get around that? I got, you're one of my very favorite people in the world and the work you do in your think tank is superb work and I've benefited from your work. So I must with great trepidation and with great respect disagree. I don't think any of this is a moral problem or a moral failure. We reconstructed debt going back to 1800. We've reconstructed the debt profile of the United States going as far back as we could piece together records. Debt has always been a mechanism as Steve implies by his earlier comments. Debt was a big part of what was going on in Babylon, Egypt and France before the, debt and the use of debt is not new. And I don't think we can change human behavior. I think the solution is more the amount of capital we require our lenders to set aside for emergency. And if you made a big difference in that, that is a sufficient modulant. So capital adequacy ratios. Capital, meaningful rethinking of capital adequacy ratios. Include every kind of debt you can think of if it's structured properly. I think Bill wanted things that, I think that before this, so if you're back in the 1980s or 1985 before you'd have that divergence from credit provision to whatever, believe me my parents were addicted to debt and you had lots of folks out there. So that characteristics was as true then. The question is what structurally changed to create so much more and that's what Byron Dorsey was getting at. Banks learn how to sidestep capital requirement. I know because I was a banker and I learned how to sidestep capital requirements. I think it's also important however to stress the other part of Richard's thesis is that we need mechanisms. We need the jubilees. We need the mechanisms for restructuring the debt because I was never a believer in limits to growth in terms of population and resource. I am a believer of limits to growth when it comes to debt. You get at certain levels of debt which begins to weigh on economic growth and you have to find ways through bankruptcy, through restructuring and other mechanisms to replenish the capitalist system and the credit system. And we're at that historical point where we're going to reach limits to growth because of the debt overhang and private debt. The financial institutions will continue to be very creative to find ways to provide credit to Americans. But if you look at the balance sheets of most American households, they're not in a position to be able to take on much more debt. I mean, one of the crimes I think, I mean, not a crime, let me be careful here. One of my great disappointments in the Obama administration and the United States Senate, I had no expectations of the House. But when the financial crisis occurred, it was an extraordinary crisis because it didn't only affect the social contract in the United States, it affected America's position in the world because it removed the ability that the US had really on how to guide and counsel and nudge other economies to organize. It was a hugely consequential crisis, more consequential than the other crises because it basically knocked us off our pedestal to a certain degree. And the implications of that were that when you did bail out, I remember within one year, and I think Byron gave a speech about this once, where within one year, people at bailed out firms that were 5,000 people with million dollar plus bonuses. So 5,000 individuals at bailed out firms, and when you go and look at whatever, and I said, well, if you're gonna have that element of bailout, why not look at the fact that if you're going to write down mortgage or force a restructuring process, right? Not a full forgiveness, but force a restructuring process to mark down the values but keep people in their homes, that would then kind of keep the system going. And you could deal with the moral hazard problem by basically saying, you had a massive systemic hit on the whole economy and people that were losing their jobs and the kind of rollback was not their fault. It was the fault of the bubble bursting and these other folks that were colluding. So I think the White House and other leaders in the country failed to make that case at the time about the extraordinary moment that was. So I don't know if you have any reaction to that, Byron, but then I mean, I think you agree with me, don't you? Yeah, that's why he quit. But it's not too late. Well, I don't know, I think it is too late, but from a political feasibility standpoint, it feels to me like it's... But you had an idea to get the government regulators to say that rather than taking write-offs and restructuring loans in full, you could give them 20 years, 30 years, whatever, so that they could take that off so it didn't hit their balance sheet. Their problem is their balance sheet. And so financial institutions worried about the impact of rewriting these things, that if the regulators change that aspect, you could create an incentive structure that might move you along this way. Yeah, this happened in the Latin American debt crisis in the early 80s in a smaller, less well-known way that Volcker brought all the banks in a room and said, we're gonna let you write this debt over 10 years, go and send no more. And we think in this case, if you take this, these underwater portion of those mortgages and make the banks write that down, it threatens the capital levels of the bank, so that's not realistic. If you ask the government to socialize it by reimbursing the banks, that's not gonna fly. What I propose in the book, based on these things that have happened in the past, is just let the banks amortize that loss over 30 years if they restructure with the borrower. That creates very little current consequence and I think it's feasible for folks to consider. Yes, Kunio and then Pat Malloy. Yes. My name is, I'm sorry. Kunio Kikuchi. Kunio Kikuchi and I've been here now since 1966, but I go to Japan two to three times a year. And first notion of course is that I think everybody has a fetish as I would call it for growth. And I think growth is for countries that are not wealthy, not for countries like Japan and US and Europe, they don't need to grow because countries like China and India has to catch up with the US and Japan and Europe. As you know, China is only about third as wealthy as Japan today and they have 20 more years to go. And you know, Steve, how Japan's last 20 years of stagnation, the country has transformed itself. And so what's wrong with it? They've aged in place well. Yes. And that's a model for the rest of the world, for the rich countries. So aging in place well should we just stop growing, Richard? You know, I think you touch on a deeply philosophical issue in that economies didn't grow for thousands of years and in the industrial revolution happened and economies have grown very rapidly since that. And then if we hit this debt ceiling, we're looking at more sideways growth. So I can't speak to the philosophical issue, but I'll give you an anecdote. I had a professional woman who I happened to know that works at the University of Pennsylvania, got an advanced copy of the book. She's not an economist. She came to me and she said, you are exactly right. My family has been struggling for the past six or seven years. We pay our mortgage every month. We haven't bought a new car. We can't send our kids to the kind of schools we want. We can't, we don't take vacations and we haven't for seven years. And we're working like hell. And we're working as harder than we ever have. So that aspect of it, I think needs to be addressed irrespective of your more fundamental view of growth. Pat Malloy. And then we'll go to you. Two quick questions and then I need a drink. Oh, right here. Thank you for this, putting on a wonderful program. Third question, Pat, 30 seconds. Okay, quickly. I've been reading some articles by Ralph Gomery and Dick Silla where they talk about the movement of the United States from stakeholder capitalism, which was going on from 1950 to about 1980. And then the movement to stakeholder capitalism where everything is focused now, not on workers but on shareholder and shareholder profits. And that that's when you really had this grave discrepancy between the value added by the corporation and the workers share. And then the need to borrow to maintain a lifestyle by the workers for what they're no longer earning. And then further incentives by the shareholders and the CEOs who tied their own compensation to shareholder value to outsource jobs to further increase their own profits. Then I look at Cheryl's point about the corporations are now borrowing to buy back their own stock. Well, it seems to me that would give the CEOs higher compensation and the existing shareholders higher compensation. So that somehow this is all, it can be tied to this movement in America from stakeholder capitalism to shareholder capitalism. And what can we do about that kind of problem? You know, I can only timidly offer comments because those two folks are brilliant and their theories brilliant. But I've studied business history going back a couple of years, a hundred years in the United States. And I don't think there's anything particularly new about the way management of businesses operate versus the way they operated in the late 1800s. The thing that is different is the amount of debt that the middle class and small businesses are carrying. If you think about the immediate post World War II period, we didn't have enough capacity in the United States and we had very low levels of debt. That's a perfect formula for the rapid rise of the middle class. Because we gotta build capacity and we have a lot of room to finance it through debt. That to me is the history of the 50s and 60s in this country. Today we have, in essence, the opposite scenario, we have more capacity than we need. Still, six years later, especially in housing, and we have historically high levels of debt. That's the worst scenario for the expansion of the middle class right here in the middle. Hi, I believe your comment right here addressed the crux of the issue. In the 1950s, someone who worked for GM without an advanced degree could sustain a very high level of middle class lifestyle, pay their kids for higher education. Now, let's say Apple is the leading company of the US. They employ maybe 40,000, 60,000 here versus 500,000 GM did. And the rest are in China. About 700,000 people work for Foxconn and very soon, Foxconn is gonna come up with robots that are gonna even replace the Chinese workers. So if you look at the problem with debt, it is maybe a stemming of the problem that the income is in there. And that could have been a factor of two variables. Globalization, Temporary, for a while and ultimately, Technology. Cheryl? Yes, I think your points are very well taken and harking back to your earlier point as well that a number of factors have come together beginning in the late 70s and 80s that have created a paradigm shift. One is the technology globalization. One is the movement from stakeholder, shareholder. Another is financial innovation. And they've created a system whereby you have these correlations between the need to have an increase in private debt to offset for at least macro purposes the demand that is lacking from stagnant wages and falling household income. And I think this is becoming widely appreciated and accepted. The question is whether there is a policy program and a political program that can offer a compelling alternative to that. And that's really the challenge. Right here in the middle, this gentleman will take these two here and then we'll go for drinks. Yes. Yeah, Joe Murray, Grease Graber. I wanted to ask you how you would address the distribution issues in the United States. You say there is inadequate demand, now you touched on the wages. But what we're seeing is that the resources go to the financial sector rather than to wages. And I guess it's a political question I'm asking. How do we? Rebalance. Yeah, rebalance and rest control from the private sector who buys our presidential candidates then we get a choice between two bad options are too very limited. What is your response to Piketty? What's your better idea than Piketty? How's that as a question? Richard. Again, I'm currently reading extensively in the history of the United States in the late 1800s and I don't feel anything that's going on today is unfamiliar territory for our country. And this is kind of the way humans behave and so forth. The difference. Did you get the greatest disparities of wealth in the late 1800s? Well, there was a couple. But remember in the 1800s we had a crisis in 1819, 1837, 1853, 1873, 1893, 1906, et cetera, et cetera. It happens. As soon as the lenders forget what making bad loans does you get another crisis. I don't want to sound like a broken record. But debt, the increases in debt is a form of demand. And if you're coming from a low level of debt as we were in the 50s and 60s that was extremely healthy and fueled the expansion of the middle class and kind of made this equation work in my view. And we've got the opposite today. Cheryl? I think the only way we begin to work our way out of this is by massive public investment at this particular historical juncture. It's the only way to try to square the circle. Part of the problem now- Are you feeling your bones that we're on the edge of massive public investment? No, no we're not. We're actually working ourselves into a new problem. And so that the kind of balance sheet recession is gonna give way to a new form of stagflation. Because even though we have this overcapacity globally and still have some overcapacity domestically and we have inadequate demand, we're also robbing ourselves of the supply-side future because of both sustained periods. What happens after balance sheet recessions and financial crisis is that you have long sustained periods of underinvestment and private investment for a number of reasons not only because the financial system is risk averse but because you don't obviously have adequate demand so it doesn't drive an investment. But you also have this sort of uncertainty and caution about the future. That does provide some correction if you're solely in a domestic economy but if you're in a global economy where other countries aren't adjusting, where they're continuing to add capacity, then you can find your lack of private investment and public investment leads to deteriorating productivity capacity and productivity growth in the future. So we're in the process of a transition from creating this, from moving from a balance sheet recession and subpar growth that is driven by inadequate demand to one that is also limited by our supply capacity because partly we're also misallocating enormous amount of investment now that's going to social media companies and certain kinds of bubbles, many bubbles on the stock exchange that aren't adding any real future growth to the American economy. The Atlantic Media Company is nonetheless happy with that trend. Let me take this gentleman here for the last comment and then we'll have drinks, everybody. You can bring your question. Yes, go ahead. It's John Graham and I'd sort of like to reflect off this gentleman's question and to take the counterpoint, nobody put a gun to your head and ordered you to borrow money, right? So I appreciate that the government bails out Goldman Sachs and not the middle class but what about the role as a perpetrator of this? The student loan market is socialized, the mortgage market is socialized, Fed owns all, is gorging on Feddy Franny debt. So I appreciate revisiting capital standards but what about the government as the perpetrator and inducing people's worst instincts to over-leverage their households? Good question. The government, can I just ask you to clarify? So you're saying the government is- Subsidizing the loan expansion. I'm going to answer you in the 21st century and then you can buy a six bedroom house. Yeah, I mean we get the question, a lot of folks are inclined to blame the government for being a catalyst. Is that fair way to say it to this? And again, looking at the 22 situations where we have data, there's a lot of times that the government is a catalyst for this thing but there are occasions where the government not a catalyst. I don't think bankers necessarily, or lenders necessarily need someone to incent them to want to lend more and more. That's how you win in that game. So I think it tree the way and the other thing I would note is it's really hard when you really get inside it whether it's in the late 1800s or the 1920s or 2014 to really completely separate government and business. They're very entangled no matter where and when you look at history. The examples you provide raise another issue which is there's two competing important goals. One is to democratize access to credit and capital and how best to do that. And the other is how to properly regulate finance and avoid moral hazards and over lending and over borrowing. And I do think it's a problem when we, Michael Lynn in our economic growth and next social contract, has done a lot of work and also we published an important paper which we called Clegeocracy. Whenever you subsidize the private sector to do a public good, you develop problems of unintended consequences so to speak. And so trying to subsidize private institutions to lend to students I think is a mistake. Providing grants and direct loans at very low cost is not so. If you want to subsidize housing, let's do it in a way that doesn't subsidize the lenders. Therefore you can democratize credit and at the same time maintain the sort of fiscal and regulatory discipline that is necessary. I think it's a really interesting debate. It's an interesting point because I do think that one of the unusual questions that you clearly had before the subprime crisis, people that were over their heads before the crisis. I mean it was just sort of structurally clear. You also had a lot of Americans who were living the kind of lives that would have been predicted to be normal, stable, who were hit by the tsunami of the events, massive job contraction and you ended up with a substantial echo effect out there that began doing that. And I sort of think that's where the policy response in part failed. But I'm so pleased that we had this discussion because as we've been chugging along for a couple of years on this looking, I've been interested in the economics profession and people that had just not paid much attention to these private sector debt behaviors. And then looking both at this equation of the overall aggregate level of debt, which just to remind is about over 150% of GDP is a screaming red light combined with the rate of growth of that GDP. So you can be up there for a long time if you're not growing and maybe you can kind of inch your way out of it. But these two things correlate with an awful lot of mankind's experiences with these debt crises. And so it's interesting the data is again where that people can go. My little book, my little book that Steve mocked is out there and my mother would be so happy if you'd buy a copy. I did not mock your book. That book is the same size as John Kenneth Galbraith's fantastic book on financial bubbles. Feels so much better now. Yeah. And we have a website debt-economics.org that has all this data. It's a great, great place with all the data so that folks can go kick it around. So I want to thank Richard Vague and Charles Schweninger for spending time with us. Thank you so much.