Modern Financial markets, despite their claim to sophistication, should take a cue from ancient biblical law and bring back the Shemittah laws.
For those who are unfamiliar with ancient biblical customs, it is interesting to note that according to biblical law every seven years is considered a “shemittah” year during which land is supposed to lie fallow, and perhaps more importantly all debts are to be forgiven. Interestingly, 2008 is a shemittah year and in ancient biblical lands, all debts would have to be annulled by early October (the Yom Kippur holiday).
In a similar vein, modern financial institutions should “annul” much of the debt, particularly CDO’s and mortgages, that is now bringing down our financial institutions. The implementation of this simple law would clearly save the financial markets and allow us all to start anew.
Ben Stein recently suggested, a similar approach in his Sunday Times editorial, and mentioned quite correctly how unfortunately it’s doubtful anyone would consider such a drastic remedy despite it’s simplicity and proven ability to work, e.g. past emerging market crises.
For example, wouldn’t the mortgage crisis come to a swift end if banks and Congress simply decided to cut the mortgage debt of home owners down to a manageable level? Real estate prices would of course fall a lot further, but at the same time foreclosures would end, people would be able to remain in their homes, and a bottom would be put in the mortgage market from which real estate would slowly recover. Amazingly, this approach wouldn’t require $700 billion and it would bail out Wall Street and Main Street. A more sophisticated version of this idea can be found on Nouriel Roubini’s site, www.rgemonitor.com.
Nouriel Roubini explains:
“When a country (say Russia, Ecuador or Argentina) has too much debt and is insolvent it defaults and gets debt reduction and is then able to resume fast growth; when a firm is distressed with excessive debt it goes into bankruptcy court and gets debt relief that allows it to resume investment, production and growth; when a household is financially distressed it also needs debt relief to be able to have more discretionary income to spend. So any unsustainable debt problem requires debt reduction. The lack of debt relief to the distressed households is the reason why this financial crisis is becoming more severe and the economic recession – with a sharp fall now in real consumption spending – now worsening. The fiscal actions taken so far (income relief to households via tax rebates) and bailouts of distressed financial institutions (Bear Stearns creditors’ bailout, Fannie and Freddie and AIG) do not resolve the fundamental debt problem for two reasons. First, you cannot grow yourself out of a debt problem: when debt to disposable income is too high increasing the denominator with tax rebates is ineffective and only temporary; i.e. you need to reduce the nominator (the debt). Second, rescuing distressed institutions without reducing the debt problem of the borrowers does not resolve the fundamental insolvency of the debtor that limits its ability to consume and spend and thus drags the economy into a more severe economic contraction. So of the five possible uses of fiscal policy…government purchase of distressed mortgages to provide debt relief to households (an HOLC-like institution) – the last option is the most important and effective to resolve this severe financial and economic crisis. During the Great Depression the Home Owners’ Loan Corporation was create to buy mortgages from bank at a discount price, reduce further the face value of such mortgages and refinance distressed homeowners into new mortgages with lower face value and lower fixed rate mortgage rates. This massive program allowed millions of households to avoid losing their homes and ending up in foreclosure. “
But, don’t expect this to happen anytime soon. Clearly, our banks and Treasury led by Paulson, are more intent on bankrupting society, rather than admitting a mistake, writing it down and letting everyone start over again.
As Keynes famously wrote in his treatise, The Consequences to the Banks of The Collapse of Money Values (August 1931), “The present signs suggest that the bankers of the world are bent on suicide. At every stage they have been unwilling to adopt a sufficiently drastic remedy. And by now matters have been allowed to go so far that has become extraordinarily difficult to find any way out.”
Keynes’ remedy during the great Depression years: “Modern capitalism is faced with the choice of finding ways to increase money values towards their former figure, or seeing widespread insolvencies and the collapse of the financial structure…after which we should all start again, not nearly so much poorer as we should expect…Individually many of us would be ruined, even though collectively we were much as before. But under the pressure of hardship and excitement, we might have found better ways of managing our affairs.”
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