Deleveraging–paying down debt–among highly indebted households is the most important factor contributing to the current economic slump, Associate Professor Atif Mian told a U.S. Senate subcommittee Oct. 4 in Washington, D.C.
In his speech before the Senate's Financial Institutions and Consumer Protection Subcommittee, Mian said a sustained economic recovery depends on “facilitating debt-reduction for underwater homeowners in the short run, and replacing non-contingent debt in the long run.”
Mian's testimony–titled Household Deleveraging, Aggregate Demand, and Unemployment–was based on years of research with Amir Sufi of the University of Chicago on the importance of household balance sheets to explain macroeconomic fluctuations.
Mian, co-chair of the Fisher Center for Real Estate and Urban Economics, first outlined the accumulation of U.S. household debt, doubling from $7 trillion to $14 trillion from 2001 to 2007. He explained that when household debt grows in a market with largely stagnant wages, the situation is not sustainable. Instead, it leads to a "deleveraging shock" that results in lower aggregate demand and a large drop in U.S. output and employment.
"Unfortunately the current deleveraging cycle in the U.S. is painfully slow," Mian said. He noted that the amount of debt paid off or written down remains "stubbornly small," at $1 trillion out of $7 trillion accumulated from 2001 to 2007.
Mian recommended policy changes such as writing down principal amounts on underwater mortgages. He also stated that going forward, to avoid over-leveraged households leading to deep economic slumps, debt agreements need “contingencies that will automatically write down the value of outstanding debt if the overall economic environment is sufficiently negative.”