I have genuinely no idea why William Galston thinks the point that the mortgage-debt overhang is playing a huge role in the recession constitutes a “new” theory of the recession. But I’m not peevish, so I’ll just say he’s correct and we should talk about solutions:
It’s time, then, to reexamine our housing policy from the ground up. If employers won’t hire until consumer demand increases, and if demand won’t increase until household balance sheets recover, then policymakers should focus on accelerating that recovery. Here’s a back-of-the envelope calculation: If we need to return the household debt burden to where it stood before the bubble, we can either wait another four or even five years (which is what it would take at the current rate without additional intervention), or we can speed it up by allocating the losses of principal that lenders need to accept and remove from their books. Moving the household debt to disposable income ratio from 118 percent to the pre-bubble 100 percent implies a total debt reduction of roughly $1.5 trillion.
As I said yesterday, doing that might actually end up requiring more “bailouts” of institutions paired with firings of bank managers. Politically speaking, that’s a hard lift.
This is one of several reasons why I believe that the best resolution would be to set a higher Nominal GDP growth target and clarify that the Fed is willing to accommodate Reagan-era levels of inflation if that’s what’s necessary to achieve it. Most mortgage debt, and a decent share of other debt, is denominated in nominal terms, so inflation accommodation would speed the process of getting people out from under debt overhangs. But unlike targeted mortgage relief, it would also help people (like, say, me) who have mortgages but aren’t underwater. Last, such a commitment from the Federal Reserve would also encourage high net wealth individuals and cash-rich firms to reduce their holdings of safe low-yield assets and increase their purchases of real goods and services or riskier private business investments.