[Joseph E. Stiglitz] Debt restructuring key to recovery

NEW YORK ― The time has come for New Year’s resolutions, a moment of reflection. When the last year hasn’t gone so well, it is a time for hope that the next year will be better.

For Europe and the United States, 2010 was a year of disappointment. It’s been three years since the bubble broke, and more than two since Lehman Brothers’ collapse. In 2009, we were pulled back from the brink of depression, and 2010 was supposed to be the year of transition: as the economy got back on its feet, stimulus spending could smoothly be brought down.

Growth, it was thought, might slow slightly in 2011, but it would be a minor bump on the way to robust recovery. We could then look back at the Great Recession as a bad dream; the market economy ― supported by prudent government action ― would have shown its resilience.

In fact, 2010 was a nightmare. The crises in Ireland and Greece called into question the euro’s viability and raised the prospect of a debt default. On both sides of the Atlantic, unemployment remained stubbornly high, at around 10 percent. Even though 10 percent of U.S. households with mortgages had already lost their homes, the pace of foreclosures appeared to be increasing ― or would have, were it not for legal snafus that raised doubts about America’s vaunted “rule of law.”

Unfortunately, the New Year’s resolutions made in Europe and America were the wrong ones. The response to the private-sector failures and profligacy that had caused the crisis was to demand public-sector austerity! The consequence will almost surely be a slower recovery and an even longer delay before unemployment falls to acceptable levels.

There will also be a decline in competitiveness. While has China kept its economy going by making investments in education, technology, and infrastructure, Europe and America have been cutting back.

It has become fashionable among politicians to preach the virtues of pain and suffering, no doubt because those bearing the brunt of it are those with little voice ― the poor and future generations. To get the economy going, some people will, in fact, have to bear some pain, but the increasingly skewed income distribution gives clear guidance to whom this should be: Approximately a quarter of all income in the U.S. now goes to the top 1 percent, while most Americans’ income is lower today than it was a dozen years ago. Simply put, most Americans didn’t share in what many called the Great Moderation, but was really the Mother of All Bubbles. So, should innocent victims and those who gained nothing from fake prosperity really be made to pay even more?

Europe and America have the same talented people, the same resources, and the same capital that they had before the recession. They may have overvalued some of these assets; but the assets are, by and large, still there. Private financial markets misallocated capital on a massive scale in the years before the crisis, and the waste resulting from underutilization of resources has been even greater since the crisis began. The question is, how do we get these resources back to work?

Debt restructuring ― writing down the debts of homeowners and, in some cases, governments ― will be key. It will eventually happen. But delay is very costly ― and largely unnecessary.

Banks never wanted to admit to their bad loans, and now they don’t want to recognize the losses, at least not until they can adequately recapitalize themselves through their trading profits and the large spread between their high lending rates and rock-bottom borrowing costs. The financial sector will press governments to ensure full repayment, even when it leads to massive social waste, huge unemployment, and high social distress ― and even when it is a consequence of their own mistakes in lending.

But, as we know from experience, there is life after debt restructuring. No one would wish the trauma that Argentina went through in 1999-2002 on any other country. But the country also suffered in the years before the crisis ― years of IMF bailouts and austerity ― from high unemployment and poverty rates and low and negative growth.

Since the debt restructuring and currency devaluation, Argentina has had years of extraordinarily rapid GDP growth, with the annual rate averaging nearly 9 percent from 2003 to 2007. By 2009, national income was twice what it was at the nadir of the crisis, in 2002, and more than 75 percent above its pre-crisis peak.

Likewise, Argentina’s poverty rate has fallen by some three-quarters from its crisis peak, and the country weathered the global financial crisis far better than the U.S. did ― unemployment is high, but still only around 8 percent. We could only conjecture what would have happened if it had not postponed the day of reckoning for so long ― or if it had tried to put it off further.

So this is my hope for the New Year: we stop paying attention to the so-called financial wizards who got us into this mess ― and who are now calling for austerity and delayed restructuring ― and start using a little common sense. If there is pain to be borne, the brunt of it should be felt by those responsible for the crisis, and those who benefited most from the bubble that preceded it.

By Joseph E. Stiglitz

Joseph E. Stiglitz is University Professor at Columbia University and a Nobel laureate in Economics. His latest book, “Freefall: Free Markets and the Sinking of the Global Economy,” is available in French, German, Japanese, and Spanish. ― Ed.

(Project Syndicate)