Home > Uncategorized > Debt, levered losses, & unemployment

Debt, levered losses, & unemployment

from Asad Zaman

A previous post on “Causes of the Global Financial Crisis” provided a detailed summary of the first three chapters of “House of Debt” by Mian and Sufi. This post provides a brief summary of Chapters 4 and 5, in which they present a theoretical framework which explains why leveraged debt leads to high unemployment following a shock to asset prices. The main insight is that the problem is caused by interest-based debt contracts which put most of the risks of default on the weaker party (borrowers), and very little on the stronger party (lenders). Equitable risk sharing between lenders and borrowers would provide a solution.

Background: In the Keynesian Revolution and the Monetarist Counter-Revolution, I have explained how high and persistent unemployment after the Great Depression led to Keynesian insight that government interventions are required to create full employment. This is in conflict with the supply side view, which insists the free markets automatically lead to full employment of all productive resources, including labor. The Reagan-Thatcher era created a counter-revolution against Keynesian theory, and re-implanted the rejected supply side view at the heart of the economic theory. Accordingly, policy responses to the Global Financial Crisis were based on the wrong dogmas. Chapters 4 & 5 of HoD describes the Supply Side view, explains why it is wrong, and then provides an alternative theory to explain the GFC: the Levered Losses framework. read more

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