In contrast to the sequenced, blow-by-blow approach of Bernanke’s tome, Turner’s is a curious brew of lengthy theoretical discussions and the thoughts of economic heavyweights of the past century. Discussion topics range from the efficient market hypothesis, to historical case studies of financial crises worldwide, to anecdotes and data from the recent crisis. His title is a reference to Mephistopheles, an agent of the devil from the German tale of Faust, who tempts the emperor to distribute paper money, increasing spending and writing off state debts.
Debt overhang and the free market / Between Debt and the Devil resembles Atif Mian and Amir Sufi’s book House of Debt (which I reviewed in the Winter 2014–2015 issue), and it suffers many of the same flaws. Turner’s approach appears to come from the same New Keynesian perspective as Mian and Sufi, with many of its adherents advocating massive government intervention to address the perceived problems in the mortgage market in the wake of the financial crisis. Not surprisingly, Mian provides a blurb for the dust jacket for Between Debt and the Devil, calling Turner’s book “superb” and a “must read.”
Turner explains throughout the book what he calls the “debt overhang” problem, particularly as it relates to consumer mortgage debt. He argues the overhang is the result of a massive consumer spending binge prior to the crisis, and it also explains the weak recovery from the crisis and subsequent recession. This phenomenon is illustrated by case studies from the U.S. financial crisis drawn from House of Debt:
During the boom, households are tempted into borrowing, which appears to make sense because of rising home prices. But when house prices fall, borrowers suffer a fall in net worth, and the higher their leverage is, the greater the percentage loss they experience…. Faced with falling net worth, many households cut consumption.
Like Mian and Sufi, Turner makes value judgements about the decisions of market players in the economy and openly questions why markets should be allowed to work in an unfettered fashion. “In fact, financial markets, when left to free-market forces, can generate activity that is privately profitable but not socially useful,” he decides. Elsewhere he laments:
The pre-crisis policy orthodoxy reflected overconfidence in the power of the free financial markets to deliver optimal results…. We need to reject the idea that the quantity and allocation of private credit can be left to free market forces…. Free market forces can produce severe economic harm in advanced economies.
In a chapter called “Too Much of the Wrong Sort of Debt,” Turner cites various detailed breakdowns for bank lending in the UK and other advanced economies to reveal how financial institutions have migrated from non-mortgage lending to mortgage lending. For example, UK bank lending data reveal that nearly two-thirds is focused on residential mortgages. This prominence isn’t just a U.S. and UK phenomenon; real estate lending rose from 30 percent of lending in 17 advanced economies in the 1940s and 1950s, to nearly 60 percent today. This evidence is meant to persuade the reader that the “free market” has allocated way too much in the way of credit for real estate, and in particular residential mortgages.
But like Mian and Sufi, Turner ignores the fact that the housing market is in no way an example of an unfettered free market. He completely ignores the key role played by government intervention through a litany of provisions in the tax code, zoning regulations, and government agencies and programs to distort decisionmaking in the mortgage market. These interventions played a primary role in bringing on the crisis through aggressive incentivizing to push people to take on mortgage debt, either getting marginal borrowers to purchase homes when they may have been better off renting, or getting qualified borrowers to buy bigger homes than they would have in a truly free market. The interventions in response to the crisis have also distorted the process of realigning supply and demand post-crisis.
Right and wrong debt? / In Part IV of the book, Turner argues that the answer to the flaws in the mortgage market and financial system is “radical reform.” Authorities must “manage the quantity and influence the allocation of credit in the real economy.” He would reduce the role of what he calls “irrelevant bankers,” who make a living off of developing funding schemes for what he deems “socially useless activities” that can impose a “negative social effect.” Shockingly (at least to me as a former bank supervisor who examined the quality of banks), he argues that financial authorities’ resources that are now focused on assessing the governance and financial standing of banks should be redirected to developing massive schemes for credit allocation. “We therefore need strong public policies to constrain the total quantity of credit created and not solely to ensure solvent and better run banks,” he writes.
Turner argues that the interventions he advocates are necessary to reduce instability in the financial system and income inequality that has worsened in the past 40 years as a result of wild swings in the credit and real estate price cycle. In “Managing the Quantity and Mix of Debt,” in a section entitled “Enough of the Right Sort of Debt,” he restates his position on what the present focus of the financial system is and he suggests where the focus of the financial system should be redirected:
We have a financial system with a strong tendency to create excessive debt in residential and commercial real estate markets, but we still need to mobilize capital to support huge investments—for instance, in the area of clean energy—and debt finance will be essential to achieve that mobilization. Faced with a free-market bias toward real estate lending, interventions favoring other types of lending are justified.
Again, Turner’s inability to recognize the instability and inequality caused by interventions in the run-up to the most recent crisis undermines his analysis. The idea that the right path is to double down on interventionism, redirecting it toward more “productive” purposes, is difficult to accept.
In the book’s waning pages, he chooses to delve into matters of monetary policy that were beyond the mandate of the FSA he once led, reserved instead for the Bank of England. This does not stop him from offering an analysis of what he calls the “ultra-loose monetary policy” of the United States, Japan, the UK, and the Eurozone in recent years. This section ends with the confused statement that “with fiscal policy blocked, ultra-loose monetary policy thus seems simultaneously both dangerous and essential.” His ultimate conclusion comes down on the side of easy money to fuel a fiscal jolt. He has confidence that the monetary authorities can do the right thing and not get too reckless with the printing press. I believe he should have left the monetary discourse to those with better knowledge of the subject.
Turner spends most of his time on the economies and financial systems in the United States and the UK. However, a much more interesting case study would have been Canada. As Charles Calomiris and Stephen Haber documented in their recent book Fragile by Design, Canada has largely managed to avoid major financial crises since the mid-1800s. Turner does not consider whether Canada’s approach to mortgage lending makes our neighbors to the north less susceptible to crisis. To me this is a disappointing oversight for an author who spends so much time discussing a link between financial crises and mortgage lending. Turner cites a great many interesting economic and financial trends throughout Between Debt and the Devil, but overall his proposed policy responses are unsatisfying. A deep dive into case studies like Canada would have made the book a more relevant read.
