 Great. Well, welcome everybody. Thank you for joining us. I have to thank you very much for for submitting to this I'm very excited about The chance to talk with you about your book house of debt for those of you who have not read it It's available on Amazon with one click. So Everything else in the world exactly and you know, I found in in thinking about it is is You know, it was about a debt crisis in 2008 that seems a history and that Seemed like everything had been written about it But in fact, I think if you hear at this argument and his co-author and think through Their solution not only do you learn something about 2008? But I think it has a lot of application for how we think about other problems going forward So after just to begin give us the short brief summary of the book for those here who haven't had a chance to read it Yes, thanks Tom. So actually thank you for introducing the book that way because actually it's in the subtitle as well because but one of the Rational for writing this book was not as much to describe what happened But really to look forward and say look there is some there is one very important lesson that we need to take away from the crisis of 2008 2009 Which applies looking forward and it applies not just to the US But also for Europe and for the global economy in general and I'll try to kind of explain that as as we go along The starting point of the book is really sort of the comparison of 2009 versus 2006 And this is kind of also gives you a sense of how economists like to think so if you compare 2009 Let's say in 2009 versus the end of 2006 you see that the US economy is hit very hard Loss of jobs 8.9 million people lose their jobs That's like the entire country of Switzerland getting fired or the entire workforce of Netherlands getting fired I mean, that's how big this loss was in terms of output or income US GDP declined by 10 percentage points relative to what it should have been In 2009 that's like a 1.4 trillion dollars loss In a different way it's a loss equivalent To $12,000 per household in the US and that's a loss They are bating every year relative to the counterfactual world of no recession taking place So the natural question or obvious next question is why did this happen? Why did it take place? Now from one perspective and that is kind of the way economists like to think from one perspective It's actually a big puzzle Because nothing really happened between 2006 and 2009 we had this huge Loss, but nothing really happened. What do I mean by that? Think of what it takes to Produce stuff in an economy apples oranges iPhones automobiles on the two main ingredients Human beings their skills their human capital and the physical capital that Marries that human capital and produces the goods and services that all of us then use in terms of those ingredients Nothing changed people had the same skills We had the same factories the same cities the same infrastructure and yet we could not produce as much in 2009 as we were Producing in 2006 so something kind of Strange happened and what is it? What is it? What is it really that's responsible for that big decline in output? The core argument in the book is and we give it away in the title that it's all about debt that the cause of This precipitous fall in output and employment Is the way we choose and that's an important word? It's a choice the way we choose to write financial contracts among ourselves in particular between the borrower and the lender It's the predominant contract is debt and that choice was actually responsible for the decline in output and employment Now once you hear me say it was a choice the next natural conclusion is what Tom started off with which is Because it is a choice. We can change it and we can avoid Falling falling into a similar trap the next time And not just us in the US, but also Europe also Japan. It's actually a global problem Okay, so I have so far just Asserted that debt was responsible for this big decline in output and employment Both Hamid and I my co-author we are Empiricist at heart and so anyone makes a statement. We don't believe it. We say, okay Where is the evidence? Where is the proof? So that's one of the distinguishes is distinguishing features of our work if I can kind of out my own horn Is that we use data? It's everything, you know We get micro level data from the US to paint a picture that proves that debt was actually responsible for this big decline in output and Employment so what's the what's the argument based on this on this evidence the? Key factor that the key characteristic of debt, which makes it so destructive at times for the macroeconomy is the inability of a debt contract to share risk between the borrower and The lender and in particular when I say share risk, this is really the downside risk that we are talking about So just take a standard debt contract say I Want to buy a house hundred thousand dollars is the value of the house. I only have twenty thousand dollars I go to Tom say give me a loan of eighty thousand dollars. He gives me a loan It's a standard 30 year fixed rate mortgage I buy the house and now I start living in the house now imagine that for some reason You know the animal spirit sentiments go up and down Imagine that for some reason the value of my house falls by twenty thousand dollars Okay, what happens in this relationship between Tom and myself in this example Tom is the creditor I am the borrower what happened in this relationship is that the entire Loss of in the house is twenty thousand dollars twenty percent is born by me My equity is wiped out if I'm a typical homeowner in the US It basically means the home home is also pretty much my entire asset base. So my net world. I'm basically wiped out What has happened to Tom in this example? Actually, he has lost nothing because the value of his mortgage was eighty thousand to begin with the value of my house is still eighty thousand So if I don't pay he can grab my house sell it take his eighty thousand put his put the eighty thousand in his pocket And so he actually in this example has not lost anything. I have borne the entire loss Now there is nothing immoral about this by the way, don't get me wrong if we knew what we were getting into We I voluntarily borrowed from so there's this it's not about ethics. It's about economics The problem really is if it were just me that's the end of it and you know who cares The problem really is that when the shock is Systemic when the shock is at the macro level. It's not just me. We are talking about It's millions of people like me who whose net worth has been wiped out and That loss has not been shared by people like Tom in this example who are going to be the creditors Now you can already see that there is this tension here from the social perspective Because by definition the borrowers are borrowers because they don't have the money So they tend to be poorer Less well off in the economy the lenders are going to be you know have the excess savings And so they're lending to be so they are going to be richer So what we are really talking about is that we have chosen again To have a financial system That imposes tends to impose losses on the borrower side that actually has the least capacity to bear those losses to absorb those losses And that's the fundamental problem that lack of risk-sharing is the fundamental problem So let me not take a move a step forward and sort of explain how that lack of risk-sharing actually Translates into what I started off with which is the loss of jobs the loss of output The key problem with the lack of risk-sharing is that because people the borrowers which is myself in this example They tend to be poorer they also tend to be very sensitive to these shocks to their income and wealth And so when I have this huge shock to my net wealth, what am I going? I'm going to get really scared I've lost my savings. My children's education is potentially in in question. What will I try to do? I'll try to start saving again as much as possible and The flip side of that is I'll stop spending to the extent possible So you're and if there are millions of people like me, that's going to be a huge Cutback in on on spending on aggregate demand in the economy Now imagine for a second a counterfactual where we somehow had devised a financial system that had shared this risk differently Okay, which we knew up front I'm not talking about bailouts or anything like that like up front people knew that in the event of a downturn It would have been shared differently and imagine for the sake of argument that instead of Imposing the losses on me. We shared the risk so that people like Bill Gates absorbed most of this risk you know The point is that if they had to absorb this risk they already have a lot So it's not like they are not going to buy that extra car because you know They have two million instead of three million in the bank And the economy as a result would suffer less So that's the first key argument and if you really look at the logic of this argument I'm talking about a macro externality here, which Which is kind of like secondhand smoke argument right that other people are suffering as a result of the actions that Tom and I Decide to take which is borrow or an end to each other, right? and And so the spending decline is much worse in the presence of a highly levered economy Which which has a lot of debt or borrowing on on on behalf of households That's the first step the next step is that once I cut back on spending and remember other people like me are also cutting back on spending The stuff that we used to buy other people are producing it They may not have borrowed at all right that second hand smoke effect They may not have borrowed at all but because now I'm not buying as much stuff They get fired as well and now that they get fired. They also stop but so you have this knock-on effect Start to reverberate in the economy and the process and the the the the Depression becomes deeper the recession becomes a deeper there is a second important effect which is that when I Can't when my net wealth is wiped out. It's also likely in many cases that I'll stop paying my Mortgage, which means now the asset is taken away from me and is thrown into foreclosure Because millions of people are actually going into foreclosure that actually worsens the fall in house prices And again further amplifies the the kind of effects that I'm talking about So this is very quickly in the case of the US and you know specific with the housing example is the key problem But debt which is its lack of risk sharing on the downside. So that's a great summary But there's several things that flow from that one is Mean it wasn't all the bankers Because really in fact if you read the president the State of the Union last night he Could barely spit out the word bankers. I mean it was like he you know I know I know I know we know don't like bankers in this country But you know so what you're saying a couple things jump out of me one is that a lot of people responsible For taking on debt. They shouldn't have taken that said It seems me one of the problems of this crisis. By the way, it's a real parallel I think with the climate crisis is that we massively underpriced the risk We allowed people who did it to privatize the gains and then we socialized the losses over the whole economy We do the exact same thing in nature. So Talk about what is that the role of the consumer in this? But then your idea if the problem was that we focused all the risk onto one party How do we basically spread out the risk? in a way that actually cushions the fall and Puts us with a much better trampoline to go forward in the future. Yes I got many questions for you and I we only got 20 more minutes. I don't want to miss anything Yeah, I'll try to catch up on some others first of all regarding the banks, right? So even there's a subtitle of the book which says how they and you Caused the financial crisis, right? So we deliberately put in you Some of the some people were saying look you should not say you cuz they're your buyer Why do you want to blame them? But we deliberately put the you in there to make the point that this is really about the system as a whole You know this finger pointing that this is the banker's problem or this is the borrower's problem in the example I gave between Tom and I nobody forced us yet both mature adults Entirely entering into this arrangement and so the point is that look it's not about all the excesses were done And though I don't want to belittle that point But that's not the core problem the core problem is that they're the system is not built properly And I want to push more on that in in a bit Let me address the other Part of your question which is looking forward. How do we build something alternative? How do we build something that has better capacity to absorb the downside risks? Fundamentally what that means is that we Want to move away from a world where debt is the predominant contract now? What do I really mean by that we need to define it a little bit more what I really mean by debt is a Contract which is non contingent there is no contingency in the contract in terms of what else is happening in the world That's really kind of a silly way to write a financial contract given the problems that I just talked about So what we want to move towards is we want to move towards a world where the financial contracts allow for these kinds of important Contingencies in the macro environment in particular In the book we have one specific example because mortgage is one huge asset class In the world and so we give one specific example of how we can do this in the space of mortgages The specific example is and we try to minimize the deviation from what exists in the world right now So that it is more feasible than it otherwise would have been and so the proposal that we have and it really is the philosophy That's important. So you can you can tweak the details. That's not that important But the precise proposal we have is the following it has two features So the first is you want to introduce that contingency into the standard of a 30-year mortgage and that contingency is that we link the required payments that the borrower has to make we link those payments to what is happening to the price of houses in my city and so you index the Repayment to the house price index of the city that you live in number one So if average house costs in Minnesota or Minneapolis are going down by 10% my mortgage will go down by 10% Exactly so I'm much more resilient then Against what's happening in the market exactly? So if you were making a thousand dollars a month now You will make nine hundred dollars a month, right? So there is this automatic absorption of loss for the From the borrower it goes lost goes to the creditor If that's that's the first important feature if that's all you add to this contract the lender Of course will know that up front and they know that now I'm taking in less in the event of her of a downturn So they want to jack up the price of the loan the interest rate of the loan So we want to write Introduce this product in a way that is it's neutral up front and so we introduce a second component which gives something to the lender in return for providing this insurance and What we propose is so we work out the numbers a little bit of math here, which you can work out It's quite simple But once you work out the math it turns out that I have to give very little to Tom on the upside to make him Whole in terms of the insurance that he's providing me and the idea is that basically home house prices don't go down as you know That frequently so it's not he's not really giving up much But it's really important in the sense that we can avoid 2008 kind of crises And so the upside that I want to give Tom is just five percentage points So just five cents out of every dollar of capital gains that I have at that at the time of Sale of the house not otherwise house makes a hundred thousand dollar profit for me The bank gets five thousand the bank gets five thousand This insurance premium on having insured the downside exactly, but what you know, it's interesting about your proposal Out of is it you're really saying let's take the experience of a mortgage Which is really I'm gonna put it in terms of nature a monoculture. It's a single Fixed thing and let's turn it into a polyculture ecosystem. That is so much more resilient to whatever nature whatever Storms come or whether the sun shines more You are my next co-author so next book. I'm writing with you But that's really it's really very into there's a real parallel with yes, I think and again to continue your nature example I mean, it's really I always like to think of the the macroeconomic system as a as an ecosystem And I think all of us lose if you don't think of the macro environment as an ecosystem for every buyer There is a seller of every seller there has to be a buyer So you know the supply and demand things need to equate each other in the aggregate and we currently have a system where we we kind of pretend that The contract may not be efficient But whenever the crisis comes its house prices or the Euro crisis or whatever that somebody from the outside Will come and fix it for us and we have technical names for that we call it monetary policy We call it fiscal policy right that whenever and the shock is big enough You know what we can and today we saw big bazooka right the druggy They're doing a bit big quantity easing and and and and the idea and people still believe that you know They're monetaries will say look this is this stuff works just do enough of it You know you just never did enough of quantitative easing or on the fiscal side You know just just have enough government spending and you can get out of this problem now theoretically I agree those arguments make sense on the margin, but I don't think and certainly the proof suggests that they are not sufficient They weren't sufficient in the u.s. They were not sufficient in the in the case of Japan and Europe So we really need to go back to the financial system as it is supposed to work without any outside intervention and Try to make it as resilient to these outside shocks as possible And what I think is the beauty of your proposal it's and this is another way of describing resiliency itself sustaining As you said I you know one approach is to say we wait for druggy to do the right We hope we hope he gets the numbers right or whether druggy or you know our Fed But that's all external And and we hope that that all these external rules and rule makers will do the right thing your system is What to me are the two most important words in economics and foreign policy itself sustained. It's all about internal logic and behavior That's that's that's that's exactly right. I mean the other problem in terms of Betting on an outside player is that you get into the politics a lot more often which is a different kind of contingency which is Exactly on board to economics exactly exactly. I mean, you know if there is a I know there is a theoretical argument That exists out there that says that if we had a fully functioning political system, then we can solve all it's actually a theorem We can we can solve all of these problems, right? If we had you know, you can put it in the words of the coast theorem and things like that It's and that's true. So, you know, so mathematically it is true that you know that we can we can work around this problem in other ways but practically You know just think of the the polarization in the US, but it's really there at every place These things become impractical from from a realist. What are the chances of a banks? Has anyone taken you up? Is anyone adopting this? Is anyone studying it? What are the chances we we get buying on this? very important question so I have a few observations on that First of all actually it's in the book as well the the first time I actually proposed that this was in a Senate hearing and The senator in question. It was senator Corker. I've already public In the book he said to me after I make this proposal and I say okay now he'll say, you know, yeah Let's go ahead and do it. He says to me. This is the oddest proposal. I've ever heard in my life. So, you know, that was kind of Deflated us a little bit, but we continued we persisted we wrote the book nonetheless I think they had so we I went again actually to second time the Senate to give testimony in the Senate and the second time Actually, they were more amenable to these kind of ideas both on the right and on the left So there is some recognition that we need to do things differently, but it's not it's it's not a done deal by any stretch of imagination. What is interesting in terms of response is that There I have gotten calls from venture capitalists to give you an example where they have come in and says look We really like this idea and we are actually willing to put in a lot of money behind it In fact, they they say you are too conservative in your proposal. They are willing to do full equity mortgages And the reason they give this kind of makes sense is that look we have long-term capital from pension funds and so on They want exposure to house price risk and effectively what I'm saying is I'm giving creators a direct exposure to house price risk They said to me look We don't want to kind of buy rental properties and get exposed that way its management and all that Doing it through the homeowner is like a very cheap way of doing it because you know, they will take care of the house themselves So there is there is a lot of private sector interest in it as well, but why doesn't does it not happen? I think that is a very important question. I Think it does not happen Because of our own fault, so let me try to specify the first of all if you go back to the logic of the argument that I made in The beginning in terms of the problems them associated with debt. I use the term macro externalities, right? It's kind of second-hand smoke kind of a thing When we grow externalization when we talk about externalities That's like another example would be we mandate insurance for a reason because if I'm driving on the road and I don't have insurance I may not care about it, but you know if I hit Tom and he is injured or his car gets destroyed I better have the capacity to compensate him for for the loss that he has borne So you mandate the insurance or it's the same logic again because there are these macro externalities So first the government is a logical argument for the government to be involved in this process in terms of Facilitating us moving in that direction. That's point number one point number two is the realization that we live in a world Where the situation is actually much worse? Not only is the government not helping or encouraging the system to move in the right direction It is actually putting big obstacles in the way of moving away from debt and I'll give you two specific examples The first one is just taxation and as soon as I say that like you know what I'm talking about in the US There is Actability of interest when you file your taxes both on the corporate side as well as on the household side That is Incentivizing me as a borrower, you know Suppose I have two options have the 30 year fixed rate mortgage and the proposal that we make I will not Take on the mortgage even though it is good for me or and the economy because the standard mortgage allows me to deduct interest payments At the time I file my taxes so that tilts the system in favor of debt another factor again coming from the regulatory side is The way we do bank capitalization So if you go to the basics of the Basel system that we have it puts risk weights in terms of telling banks How much capital they need to have on their balance sheet for the loans that they issue for the assets that they have on the balance sheet? It is tilted in a way that if I'm a bank and I want to think I'm deciding Should I issue a standard mortgage or should I issue this what we call the shared responsibility mortgage with this loss absorption feature? When the bank is Contemplating that question the Basel rules tell them look if you issue a standard mortgage You don't have to have much capital against because it's considered triple a very safe You don't have to have much capital against it But if you choose to issue this loss absorbing sting Guess what the capital requirements are going to be much higher. Interesting. So what is the bank going to do? I mean, it is not a coincidence that we live in an extremely levered world And this is a really dangerous trend coming now at that at the global level This is by by no means just about the US if you look at the growth of credit or you know Two sides of the same coin whether we talk about credit or debt The growth in debt or credit globally has been going up since the 80s There was you know since this deregulation and the loosening of controls capital controls and so on since the 80s Credit-to-GDP ratio has been Continuously going up so much so that even this crisis, you know We hear these terms deleveraging and so on at the global level. There has been no deleveraging We have levered up even more since 2008 2009 to give you one quick example of that it is true that the homeowners reduce the amount of debt that they have in the US but China started borrowing like crazy both their homeowners as well as their local governments and so on there is something wrong This is beyond the books. I don't want to go there too much But there's some there's something fundamentally wrong about how the system is trying to equilibrate itself It's it's the self-sustaining pieces is something the beauty and it's related to your point again There's an analogy from nature, but your system prevents contagion. There's or there's much less contagion possibility When you have this kind of internally driven system, it's much more resilient to contagion much more resilient to disease Then one that where everybody's basically playing the same game and and then our banks are interconnected And so on my banks topple from my mortgages. We help topple your banks And we really saw that you know, we we're such a short part. I want to make sure we get a few questions from the floor So anyone please But Shared services and assets in cities so that you know, for example, your car is idle 23 hours a day. Let's Use that much more efficiently optimized resources. Now. We are talking about shared responsibilities What does that mean for theory? What does that mean for policymaking and how close are you to Islamic financing? Let me answer the second question first, which is that I stay away from all such questions That the reason is that I strictly believe in the separation of religion and state and also believe Believe in the separation of religion and science and so I like to be a social scientist From those conversations in terms of the shared economy and all that kind of things I think the really interesting piece here for us to think about and my example is just a little tiny piece of it is That the technological Innovations especially on the information side because you know finance is really about information right information gathering and then making sure People are doing what they're supposed to do monitoring information and so on the technology is now really allowing us to do that much more efficiently than we ever could and as a result of that it is giving us the Capacity to do things like this sharing of the kind that I was talking about to give you one specific example You mentioned time-sharing on maybe car until then things like that In the proposal that I have remember I was giving a five percentage upside to to Tom Tom does not have to wait for me to sell my house to exercise that five percent He can guess what securitize And sell it, you know, that's a beautiful system So there's nothing wrong with securitization actually if the system works even better So technology is we should adopt it We should embrace it But we should think about the fundamentals of what we need to do with the technology to make it work for us Please Go ahead Sorry a bit of a technical point. Where are you from South Africa, okay? Banks finance the books the mortgage books with depositors money. So if the Property price drops by ten percent. How do you adjust the depositors? Right good question. I mean who's gonna accept that absolutely a very good question And the the answer is the second piece of it, which I didn't ever talked about but it's obvious The banks as they exist Don't have them Banks need to have more capital much more equity much more capacity to absorb some of these losses Themselves, and I really don't understand why we cannot think so let me give you this idea Think of where the big development on the economic side has been new technology, right? Microsoft Apple new tech and so on did they need banks to do what they did? It is all equity financed and they can raise more if they want to buy more stuff I would give them money Why are we willing to give as much money to Ellen musk as as he wants the reason is that he has developed this Credibility this reputation that I'm smart. I know what works. I know what doesn't work and people are willing to this is the kind Of banks that we want You know if they have more equity they will be forced to act like Ellen more like Ellen musk and and less like What we know them to do so there is again. There's something fundamental I know I'm making you know when you really think through that what we are we are talking about a Reformation of the financial system of the arcade the financial architecture as we as we have it and the argument is that you know It needs to work for us not not the other way around because you do adjust deposit I mean we anyone who's got their money in the bank knows. Well, I'm not getting the return. I used to get Right. Yeah, not going to market. Yeah. Yeah behind you was a question. Oh Yes Peter Holmes a court one of the reasons for your proposal is that come a shock dropping of housing prices for example There'd be less impact on the economy Isn't your proposal just spreading the risk such that the other side the bankers will be down as well There'll be less bonuses will be less BMWs bought. There'll be less Wealth spread around at that end of the society the net drop of the society will be the same That's kind of related this earlier question of you know, how do how do we deal with these the banks being able to absorb more losses? but you know banks are just an abstraction they are just intermediary between the Savers and the and the borrowers and at the end of the day somebody has to absorb those losses That's another way of thinking about it if house prices go down by trillion dollars. Well, somebody has to you know There is no way around it. You can't send it to Mars. The question is who has the highest capacity to absorb it So this is where the research comes in when you actually measure the marginal propensity to consume with respect to these wealth shocks and Income shocks it turns out that the people getting those million dollar bonuses They have close to zero marginal propensity to consume with respect to these shocks Which means at least on the margin if you take away a dollar from them. They're still going to buy the BMW so you really want to take the losses away from the people who are the most sensitive to these kind of shocks and share the risk that way which is you know the premise of Proposal that we are making after this is really fascinating and I could talk to you all afternoon about this unfortunately we have to share this room and So we're gonna have to bring it to a close, but thank you very much. Thank you really wonderful