Shadow of 2008 economic crisis still hangs over US and China

Princeton economist Atif Mian says that debts have continued to rise because their root causes have yet to be addressed.

- Vikram Khanna

Suppose you buy a house for $1 million, putting 20 per cent down and borrowing 80 per cent from a bank. If the price goes down by 20 per cent, you lose all your equity, but the bank loses nothing. It can simply take the house and sell it to get its $800,000 back.

But two things then happen that will have economy-wide repercussions. First, you and maybe millions of others who have also lost their equity cut back on spending. Demand goes down in the economy, there are widespread layoffs and a recession follows. As a result, even those who still have positive equity in their homes cut back on their spending as well. Second, foreclosures increase, which sends house prices down further, intensifying the recession and creating problems for banks, many of which become insolvent.

This debt-driven crisis was basically what happened in the US and Europe during the great recession of 2008. The policy response from governments was to bail out the banks, at taxpayers' expense, both in the US and the euro zone—a blatantly unfair arrangement. Little was done for homeowners.

Atif Mian, who is a professor of economics at Princeton University, came up with a proposal to help homeowners in such a situation and prevent a deep recession. In his now-famous book, House Of Debt, written with fellow economist Amir Sufi of the University of Chicago, he proposed a "shared responsibility mortgage" (SRM), under which the bank bears some of the burden in a housing downturn. So, if property prices fall by 20 per cent, mortgage payments also go down 20 per cent, which enables payments to continue and prevents foreclosures. To compensate the banks for temporarily lower mortgage receipts, Professors Mian and Sufi proposed that banks be entitled to 5 per cent of capital gains whenever houses are sold.