Line of Inquiry: Amir Sufi on inequality’s effect on credit availability

Line of Inquiry: Amir Sufi on inequality’s effect on credit availability


So one of the big open questions is: What is the fundamental driver of these credit-supply expansions? Why all of a sudden do lenders begin to start extending credit
on such easier terms to more individuals? And that definitely is the hardest question, I think, to answer. So there are two sources of
these credit-supply expansions that people have talked about recently. One is what is called
the global savings glut. And that was really put
forth by Ben Bernanke, this idea that east Asian
countries, China in particular, after 1998, 1999, started
to stockpile this war chest of US dollar–denominated assets, and as a result were flooding
the US financial system and the advanced economies of Europe, their financial systems, with all of this money looking for somewhere to go. Another potential source of
a credit-supply expansion that I think is particularly intriguing is income inequality. So the basic idea is:
as the rich get richer and start to earn a
higher and higher fraction of the overall income in the
economy, they spend less of it. Because, at the end of
the day, how many yachts is a Bill Gates going to buy? And so they’re saving more
and more of that money. That means more money is going
into the financial system, and the financial system is
turning around trying to find somewhere to put that money. It ends up in subprime auto loans, subprime auto debt, subprime mortgages, and that ends up putting
pressure on the overall economy and leading to these household-debt booms. So I think that’s another potential source of these credit-supply expansions. This isn’t to say that
the amplifying factors are not also important. Financial innovation, behavioral biases, fraud in the financial sector— all of these, I believe, are
really important at amplifying this credit-supply expansion. But when I’m looking
for the actual source, I think this idea of financial excesses, this idea that there’s money coming into the financial sector
from some other source, is really the main culprit in
thinking about these dynamics. So, at the end of the day, what
do we do about this problem? These credit-supply
expansions tend to fuel this unsustainable rise in household debt that leads to recessions. One factor that we do
show in our research is regulators—the IMF, the OECD— seem to systematically
underestimate the impact of these household-debt
expansions on the probability of a banking crisis, on the probability of an economic recession. So, at the end of the day,
they should just incorporate these factors into their models. The other idea that we
basically push is the idea that we should have more
risk sharing in the economy. If we had more equity
financing in the system, then we think that we could
mitigate some of these factors. The other policy that
a lot of central banks have been discussing and implementing are explicit limits on the
ability of households to borrow. This, I think, could be a
step in the right direction. One of the worries we
have at the end of the day is that even if you try to
limit debt in one sector, it’s just going to end up showing
up in some other sector. It’s a bit like the Whac-a-Mole game we all played in the arcade. And so, in that sense, it may be a movement in the right direction, but I
think more research is needed. And, in fact, we’re currently researching loan-to-value restrictions,
debt-to-income restrictions in South Korea, where
the Bank of Korea there has been implementing these
over the last 10 or 15 years.

Author: Kennedi Daugherty

2 thoughts on “Line of Inquiry: Amir Sufi on inequality’s effect on credit availability

  1. Amir: you missed a key one – Banks create Credit out of thin air (they do not require some other saving to be channeled in, although it helps). However the more important part is to understand the Behavioral Dynamics among ALL Credit Institutions (including Banks) — During the expansion phase the COMPETITION among these institutions "propel" them to make Sales (ie. issue loans/credit) aggressively. Competition and Principal/Agent dynamics fuels the fire ! The lower the interest rate — the greater the need to generate relatively higher Sales/Loan Volume in order to generate the required income from the Interest differential, while ignoring the credit risk. The Risk for loans made in the initial part of the cycle is considered low (in an expanding economy), and definitely rewarding to the Sales/Employees who issue Loan/Credit (plus examine the Principal/Agent problem even with high risk borrowers — Risk is always opaque initially, versus the incentive for reward/return to the Sales person/Institution). Do you agree ?
    Best Wishes !

  2. Prof. Sufi is saying that rich people keep money in their savings accounts! No, they borrow money from banks at almost zero interest rate to speculate…

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