Between Debt and the Devil

A recent book, Between Debt and the Devil: Money, Credit, and Fixing Global Finance, by Adair Turner points out eye-opening facts about the true causes of the Global Financial Crisis.

And those factors were not what people think.

I’m reading this book now and it’s full of the truth about what really ails global markets and banking. I probably like it because it’s a global view using similar arguments to those in When the Bubble Bursts: Surviving the Canadian Real Estate Crash.

The book is full of technical details about banking and finance so most people won’t read it. But here’s a couple of descriptions of the main premise:

“Most credit is not needed for economic growth — but it drives real estate booms and busts and leads to financial crisis and depression.”

“Banks and shadow banking systems left to themselves are bound to create too much of the wrong sort of debt and leave economies facing severe debt overhangs.”

Adair Turner is chairman of the New Institute for Economic Thinking, the former chairman of Britain’s Financial Services Authority and the author of several books on finance and economics.

One of the main points of his book is that fixing the banks, which is basically all that has been done since the 2008 crisis, is not sufficient to fix what is wrong with the global economy.

As I argued recently in a Globe and Mail editorial the real problem is the growth in private sector debt, especially household debt, not the government debt that gets so much more attention.

Turner points out that banks will lend more and more money to private sector individuals and companies to buy more real estate, and that’s a misallocation of debt and investment. After all, does a bigger house or trading one house for a more expensive house add much to the productivity of an economy?

Banks understand real estate as collateral and there are some strong incentives in Canada to lend more money on personal real estate, primarily through the CMHC and Canada Deposit Insurance. While Turner doesn’t talk specifically about Canada his argument is spot on when applied to Canada. When private sector debt has tripled in fifteen years, as happened in Canada, and most of that debt was created by the banking system to allow people to buy real estate or to spend more money on consumption with the loan backed by real estate, something has gone terribly wrong with our financial institutions. The fact that this happened elsewhere in the world, according to Turner, doesn’t make it less of a problem.

Source: Teranet-National Bank National Composite House Price IndexTM, Statistics Canada, Bank for International Settlements, The MacBeth Group

Canadians could have been investing to build new pipelines or rapid transit in major cities or enhancing alternative energy sources, but the private sector allocated most of the new debt to build new houses and condos and to trade existing properties. The financial system has evolved to the point where real estate investment is the path of least resistance.

As a thought experiment imagine going to a Canadian bank to arrange a loan to start a new business or expand an existing business. Now picture a visit to a bank branch to obtain a new HELOC backed by equity in a home that you own. Pretty big difference, right?

The last word goes to Turner:

“Credit and real estate cycles … have been not just part of the story of financial instability in advanced economies: they are close to the whole story.”


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Hilliard, The MacBeth Group team and their clients may trade in securities mentioned in this blog.


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