In their book, House of Debt, Princeton economist Atif Mian and University of Chicago economist Amir Sufi claim reduced consumption by subprime homeowners occurred when home prices fell and caused the Great Recession. Larry Summers thought the book was “likely to be the most important economics book of 2014.” Paul Krugman cited it as evidence of “problems created by debt overhang.”
In a recent blog post, Krugman rails: “The process of deleveraging produces huge, unnecessary costs: debtors are forced to cut back, but creditors have no comparable incentive to spend more, so there is a persistent shortfall of demand that leads to great pain and waste.” He urges “fiscal deficits to support demand while the private sector gets its balance sheets in order,” and “a rise in inflation targets both to encourage whoever isn’t debt-constrained to spend more and to erode the real value of the debt.”
In my review of the book for Fortune, I counter that subprime homeowners continued consuming most all of their income, and that consumption fell because lower home prices and tighter credit standards prevented additional homeowners from also borrowing against the rising value of their homes and consuming more than they earned.
A recent study by the Federal Reserve Bank of Boston confirms my view and shows the claims of Krugman, Mian, and Sufi are inconsistent with the facts. It concludes: “There is no evidence of enough substantial balance sheet adjustment … contributing to the slow economic recovery, nor is there evidence of big enough changes in households saving behavior or risk tolerance to raise concerns about the strength of aggregate demand going forward in the wake of the crisis.”
The study elaborates: “The percent of high leverage homeowners who were repaying their nonhousing debt did not jump relative to other household types—a finding that is inconsistent with the claim that debt repayment by highly levered households has contributed to the sluggish economic recovery. … The vast majority of debt repayment by households was due to foreclosures, but debt charge-offs through foreclosure are not a form of active household debt repayment.
“Much of the drop in overall household debt was due to less new borrowing (debt inflow) rather than to abnormally high debt repayment (debt outflow). … The reduction in debt inflows is mainly due to reduced first-time home purchases as well as less second-home buying and purchases by investors.”