Hitler may not have come to power if Germany had used helicopter money
Businessman, regulator and author Adair Turner is well known for the role he played as chairman of the UK’S Financial Services Authority during the financial crisis of 2008. He took over the regulator’s job five days after Lehman Brothers Holdings Ltd went bankrupt on 15 September 2008. He is also chairman of the Institute for New Economic Thinking (INET), New York.
In an interview in New Delhi during a recent visit, Turner spoke about applying some of the solutions he suggests in his book Between Debt and the Devil: Money, Credit and Fixing Global Finance to an emerging market like India. Edited excerpts: If in the West it is the power of Wall Street that is able to push the boundaries in banking, in India it is crony capitalism that has contributed to the twin balance sheet problem. In the framework of your book, what would be your advice to solve it? India’s bad debt problem is a bit different from the problem I address in the book. My theory is that the fundamental reason for the 2008 crisis and the difficulty of recovery from that, it was not just the financial sector, but the whole level of debt of the whole real economy—corporate and households—over 60 years. The debt-to-gdp ratio in the advanced economies went up from 50% to 100% for a set of reasons. If that occurs, and given that most of that growth of credit is against real estate, either residential, individual or commercial real estate, there is a process whereby that is accelerated reinforcing process, of more debt and higher asset prices, which then produces a crisis that is very difficult to escape from. We saw that cycle in Japan in 1980s, in Scandinavia in early 1990s and then with catastrophic effect in the US and many other countries in the run-up to 2008.
The Indian bad debt problem is not fundamentally the same as that because the biggest problem in India is lending for investment. One of the problems that the advanced economies have got is that most bank lending is not much to do with plant and machinery any longer, it is basically the purchase of real estate that already exists. But in India, bad debts are concentrated in large corporate entities which in the years where people thought the economy might grow 8-10%, invested in particular power stations and those are underutilized, low plant load factors because electricity demand has not grown as fast as they anticipated, because the economy has been slightly slow.
Also because there has been a major opportunity to improve energy efficiency which people had not anticipated. So, this is a very particular problem, the Indian bad debt problem, concentrated in heavy industry and of course, with a large role of the public sector banks rather than the private sector banks. So, it is a major problem, but it is slightly different from the one advanced countries have. However, India may get the more classic problem in the future if it allows the growth of lending against real estate to grow and grow. I would watch the danger of that, while still thinking about this particular problem that India currently has. Three questions here. One, is India’s problem a better problem to have? Two, what would be the red flags we need to look out for? When do you think the problem is getting out of hand? Three, are you saying that household leveraging is a bad idea whereas a country leveraging itself, because you speak about the ability of governments to print money to get out of a bad place, is better? It is very, very important in thinking about debt to think about three different functions that it can perform in the economy. One is the function that is described in our economics textbooks. If you read an economics text book, you would imagine that what banks do is that they lend money to businesses to buy plant and machinery to invest, that’s what the text books assume, and we need to understand this assumption and we need to understand that sometimes that can run out of control with too much investment, and that is what happened in the power industry in India.
There is a separate function that lending can perform and it is the predominant activity of banks in advanced economies today, which is to lend money to people to buy assets that already exist. And these assets are real estate. There is a role of debt in an economy, but its economic function is not the same as lending for investment. There is a third category which is lending to consumers so that they can spend money before they have the income.
One of the crucial arguments of my book is that there has not been a distinction in the economics literature, between those three different functions of debt, but they have very different dynamics, different implications. Do we need to think of good debt and bad debt? I think I would be a little bit careful about calling it good or bad. But let me answer your other question first. Is lending to individuals bad? I think there is a role in an economy for individual loans, for instance mortgage debt, it can enable people to buy houses which they would not otherwise be able to. But you can have too much mortgage debt, and if mort- gage debt is too easily available, funnily enough, it can be bad for the percentage of people who are in their own houses.
In the UK, up to about 1990 easy mortgage debt was helping drive an increase in owner occupation. But then mortgage debt got so easy to get that people were simply buying to invest, to rent out to others, and because they were already wealthy, had slightly better access to credit than others; they were able to borrow more money and drive the prices of houses up, so that many people could not even afford the deposit for the mortgage debt.
With mortgage debt, it is a complicated function where up to a certain point as a percentage of GDP, it helps drive greater ownership of houses and then when it is too easy it drives back down again.
There isn’t good debt or bad debt in a very, very simple fashion...most debts can be good up to a certain level but we can have too much of it. This is one of the important parts of economic theory that my book is about. This has been underexplored in the past. Is there a way for regulators to solve this problem without being paternalistic? Any metrics that prevent lending beyond a certain point if a person is overleveraged? There is a vital role for good regulation in controlling the banking system. In the past we’ve tended to define what good regulation is simply in terms of preventing banks going bankrupt. But my argument is: that is an insufficiently wide definition of a problem.
We can have a problem even if banks don’t go bankrupt. Because even banks that don’t go bankrupt can lend so much money that the level of leverage in the economy goes up, it gets so high that everybody begins to worry about it and then they cut their investment if they are a company and they cut consumption if they are an individual and that drives an economy into recession. We need to guard against that. How? We need sufficiently high capital ratios for banks so it can control the total amount of credit they can create.
There is an enormous natural bias, certainly when economies get beyond a certain income level, naturally a rising bias for the banking system to gravitate towards lending against real estate. Even from a banker’s point of view, it is the easiest thing to do.
As long as there is an asset, you can claim the property and sell it off. Throughout the advanced economies, there is a tendency for the banking system to get more and more focused on real estate lending. I am not arguing that you ban real estate lending. But we need to recognize that this is the naturally rising tendency to somewhat overdo it. Regulators should set slightly higher capital requirement for real estate, you do it through the risk weights, set it slightly higher than banks would naturally do for themselves. Banks can only be expected to focus on ‘am I going to be paid back,’ but they are paid back by an overleveraged borrower, who to pay back has cut consumption.
And if there are simultaneously millions of such people, even good lending, seen from a banker’s point of view, can have a bad macroeconomic effect. We need to lean against that in regulation. This is not a broadly accepted point of view. The predominant attitude to regulation across the world is still that the focus is on making sure that the financial system itself is stable and does not go into crises. What I add to that argument is that we need to look at the indebtedness of the real economy. Your solution seems to be that you only lend what you have. There has been a huge mistake in the global approach to banking regulation going back decades to allow banks to operate as very highly leveraged entities. Have you recommended a situation where banks can only lend what they have as deposits? No, there are some people who take my argument to a very strong extreme. There were a group of economists in early 1930s in America who correctly understood that the (reason the) American economy was in a catastrophic mess by 1931 was the over-expansion of credit in 1920s. Economists like Irving Fisher and Henry Simons, although in most areas of the economy they were extreme free marketers, they thought the banks were so dangerous that in the upswing would run so far out of control that, essentially, they wanted to abolish banks.
They wanted banks only to be able to lend long-term equity and debt, which essentially is to abolish banks. They talk about 100% reserve banks. Lending would not occur in banking system, banks would simply be holders of cash. In my book, I explore, should we go that far? And I think it is important that these are not crazy ideas, these are ideas of people who had observed the chaos created by an overactive expansion of credit. But I do think that we don’t need to go that far, and there is an impracticality of going that far. But once you realize that it is not mad to suggest that, you can pick a point on the spectrum which is a much higher level of capital or reserves than we currently allow the banking system to run on. India has a concept called payment banks, where no lending is allowed. Do you think they would work? What we have to see is that how will a payment bank compete with a classic bank that underprices its payment services. Banks have
Investment strategy: Former chairman of the UK’S Financial Services Authority Adair Turner says India has this specific situation of investing in gold, it isn’t there anywhere (else) in the world.