Deleveraging by default

One of the aspects of going bust and bankrupt is that your debts are discharged. That is not just an economic consequence, it is a balance sheet event.

This plainly obvious fact hit Guambat smack dab twixt the eyes when he read it in this very easily read interview with one of the economic authors du jour in a post in the Real Time Economics blog in the WSJ.

The economist is University of Maryland Professor Carmen Reinhart, co-author of one of the most important economics books of 2009, “This Time Is Different: Eight Centuries of Financial Folly,” a catalogue of financial crises, their causes and consequences. The book was written with her co-author, Harvard Professor Kenneth Rogoff, both of them former International Monetary Fund economists.

Here are some excerpts:

Q&A: Carmen Reinhart on Greece, U.S. Debt and Other ‘Scary Scenarios’

REINHART: There are a lot of scary scenarios out there. Take governments that were virtuous governments, and continue to be virtuous. I’m talking about Ireland now. Their public debts were trending down and they have acted quickly and they’re credible. But external debt in the private sector is huge, more than 300% of GDP. In a crisis environment, private debts become public debts pretty quickly.

It is the pattern that has been prevalent in the past, that these major financial crises have been followed by an afterwave of debt crises.

What lies ahead is a rough patch. We are going to have a period of subpar growth. We’re all in agreement we’re going to have a recovery. Everything points to a recovery. But debt is very much at the forefront of the subpar growth. There are public debt issues and private debt issues. There is still a lot of serious deleveraging that lies ahead of us. For households, deleveraging implies curbs on spending. And don’t forget that households have been the engine of growth during recoveries from more recent past recessions. Households are overstretched.

WSJ: But households have started to make some progress on deleveraging.

REINHART: How is that being achieved? Not entirely by repayment, but importantly also by default. And default has lasting consequences.

And we have a prodigious buildup in public debts and that prodigious buildup in public debts begets uncertainty in the private sector about future taxes and public sector benefits. If you’re a firm, you become more cautious about investing. If you’re a household with long-term plans, you’re also more careful. Debts are a big drag on our economy right now, and that is not going to go away quickly.

WSJ: Your research shows that when public debt hits about 90% of GDP, that is almost like a threshold for slow growth. There is some disagreement about where we are on that spectrum. If you take just debt held by the public, it is in the 60s. But if you look at all debt, gross debt, including debt held by government agencies like Social Security, it’s much higher. Where are we on that spectrum?

REINHART: Debt is debt. We’re very close to that 90%. Other government agencies are holding government debt and netting that out, but in the end the federal government is going to be liable. And gross debt of the federal government still doesn’t take into account the massive guarantees (by government-owned Fannie Mae and Freddie Mac). If anything, 90% is a generous measure.

What the data seem to reveal is that at lower ranges of debt, you really can’t make a link between debt and growth. But once you hit a certain threshold, you hit a wall. You can pile on the debt for a while, and you’re not seen as risky. You can accumulate a certain amount of debt without a threat to your debt sustainability. But then you reach a point where that debt sustainability is called into question. It becomes an issue.

And, for Guambat at least, all that academic talk needs a place to roost in the real world. Maybe it's roosting in places like Colorado Springs, Colorado:

Colorado Springs cuts into services considered basic by many

This tax-averse city is about to learn what it looks and feels like when budget cuts slash services most Americans consider part of the urban fabric.

More than a third of the streetlights in Colorado Springs will go dark Monday. The police helicopters are for sale on the Internet. The city is dumping firefighting jobs, a vice team, burglary investigators, beat cops — dozens of police and fire positions will go unfilled.

The parks department removed trash cans last week, replacing them with signs urging users to pack out their own litter.

Neighbors are encouraged to bring their own lawn mowers to local green spaces, because parks workers will mow them only once every two weeks. If that.

Water cutbacks mean most parks will be dead, brown turf by July; the flower and fertilizer budget is zero.

City recreation centers, indoor and outdoor pools, and a handful of museums will close for good March 31 unless they find private funding to stay open. Buses no longer run on evenings and weekends. The city won't pay for any street paving, relying instead on a regional authority that can meet only about 10 percent of the need.

"I guess we're going to find out what the tolerance level is for people," said businessman Chuck Fowler, who is helping lead a private task force brainstorming for city budget fixes. "It's a new day."

"How are people supposed to live? We're not a 'Mayberry R.F.D.' anymore," said Addy Hansen, a criminal justice student who has spoken out about safety cuts. "We're the second-largest city, and growing, in Colorado. We're in trouble. We're in big trouble."

Read more: http://www.denverpost.com/news/ci_14303473#ixzz0eh0GoMex