Steve Keen: Two proposals to eliminate the unproductive debt burden

Via Steve Keen:

“To prevent bubbles, we therefore have to reduce the appeal of leveraged speculation on asset prices, without at the same time choking off demand for debt for either legitimate investment or unavoidable borrowing. I propose two mechanisms: “Jubilee Shares” and “Property Income Limited Leverage” (“The PILL”):

1. Jubilee Shares: To redefine shares so that, if purchased from a company directly, they last forever, but after a minimal number of sales (say seven), they become Jubilee Shares that last another 50 years before they expire; and

2. Property Income Limited Leverage: To limit the debt that can be secured against a property to ten times the annual rental of that property.

Jubilee Shares

Currently, 99% of all trading on the stock market involves speculators selling pre-existing shares to other speculators. This is undertaken with borrowed money in the hope of exploiting price bubbles like that set by Yahoo! in the DotCom Bubble (see Figure 13), when that the lending itself largely causes the price bubbles.

If instead shares on the secondary market lasted only 50 years, then even the Greater Fool couldn’t be enticed to buy them with borrowed money–since their terminal value would be zero. Instead a buyer would only purchase a share on the secondary market in order to secure a flow of dividends for 50 years (or less). One of the two great sources of rising unproductive debt would be eliminated.

The objective of this proposal is to make leveraged speculation on existing shares unattractive, while still making funding IPOs and share issues attractive, and enabling genuine price discovery.

Property Income Limited Leverage

Some debt is needed to purchase a house, since the cost of building a new house far exceeds the average wage. But debt greater than perhaps 3 times average annual wages drives not house construction, but house price bubbles.

Property Income Limited Leverage (“the PILL”) would break this positive feedback loop by basing the maximum that can be lent for a property purchase, not on the income of the borrower, but on a multiple of the income-earning potential of the property itself.

With this reform, all would-be purchasers would be on equal footing with respect to their level of debt-financed spending, and the only way to trump another buyer would be to put more non-debt-financed money into purchasing a property.

It would still be possible–indeed necessary–to pay more than ten times a property’s annual rental to purchase it. But then the excess of the price over the loan would be genuinely the savings of the buyer, and an increase in the price of a house would mean a fall in leverage, rather than an increase in leverage as now. There would be a negative feedback loop between house prices and leverage. That hopefully would stop house price bubbles developing in the first place, and take dwellings out of the realm of speculation back into the realm of housing, where they belong.

Conclusion

I hope that my Minsky-inspired analysis of the source of financial market instability is compelling; I expect that my reform proposals are less so. But they are not so much radical as born from a realistic assessment, not only of the cause of financial instability, but the historical record of our past attempts to tame it.

We cannot rely upon laws or regulators to permanently prevent the follies of finance. After every great economic crisis come great new institutions like the Federal Reserve, and new regulations like those embodied in the Glass-Steagall Act. Then there comes great stability, due largely to the decline in debt, but also due to these new institutions and regulations; and from that stability arises a new hubris that “this time is different”—as the debt that causes crises rises once more. Regulatory institutions become captured by the financial system they are supposed to regulate, while laws are abolished because they are seen to represent a bygone age. Then a new crisis erupts, and the process repeats. Minsky’s aphorism that “stability is destabilizing” applies not just to corporate behaviour, but to legislators and regulators as well.

Jubilee Shares and the PILL are an attempt to write restraints on Ponzi Finance into the fabric of our society, so that bubbles do not form in the first instance, so that the positive feedback loop that turns rising asset prices into accelerating debt does not happen, and so that another financial crisis like the one we are now in never occurs again.”

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