Princeton professor warns about ‘House of Debt’

While new financial regulation has focused on bank oversight and risk management, economics and Wilson School professor Atif Mian and professor of finance at the University of Chicago Booth School of BusinessAmir Sufi argue in an upcoming book that not enough attention has been paid to the role of high levels of private, household debt in the Great Recession.

“The profession at-large and also the policy side have severely underestimated the importance of debt for the whole of the economy,” Mian explained.

Their book, called "House of Debt," is complemented by anew blogthat bears the same title and debuted inMarch. While the book focuses on the Great Recession, the blog explains breaking economic news with an emphasis on the role of credit cycles, the periodic expansion and contraction of financial lending and borrowing that occurs in economies around the globe.

“There’s room for academic journalism,” Sufi said, pointing to the new ways that information is presented, such as Nate Silver’s empirically focused FiveThirtyEight political analysis. He explained that he hopes this blog can fill some of that void in economic news.

Mian added that the blog is a way for the researchers to get word out about theupcoming bookand to highlight “issues from around the world that did not make it into the book." He emphasized that their work was very data-driven and based off prior joint research.

Mian and Sufi claim that high levels of debt exacerbate economic downturns across the country, which force individuals to reduce their spending more severely than they would need to otherwise. This makes economic lows lower.

“High levels of private debt are one parallel between the most recent recession of 2007, 2008 and the Great Depression,”Mian said.

The researchers also demonstrate that the poorest communities are the ones that borrow the most and subsequently bear the brunt of downturns.

“Areas that borrowed most were hardest hit in the decline of spending,” Mian explained. Sufi added that “Debt concentrates the effects of economic downturns on the poorest in society.”

Wei Xiong, professor of economics in the Department of Economics and Bendheim Center for Finance, spoke highly of their research.

“Atif and his co-author have done some excellent work to highlight how credit expansion affects economies,” Xiong said. “They did some of the earliest research to show that credit expansion to subprime households backfired.”

Mian and Sufi propose ways that policy makers can mitigate the negative impacts of debt on economic growth such asdebt contracts that share more of the risk between borrowers and lenders. Sufi explained that both a bank and the borrower would account for a decrease in the price of a home, for example.

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In a recent blog post, the researchers suggested that markets may be falling into the same credit pitfalls that they fell into before the recent recession. They wrote that banks are once again offering loans to subprime, or risky, borrowers.

Another post demonstrates that credit spreads —the difference in interest rates on bonds between “safe” and “risky” corporations —are decreasing, which is an excellent predictor of future downturns. While Sufi acknowledged that these models may not be perfect, he said that "At the very least, the information raises a red flag that people should be thinking about.”

The blog is located at houseofdebt.org. The book is scheduled to be released in May.