Dept of Wacky Ideas: The Debt Jubilee

Ancient Hebrew tradition was marked by a regular “Debt Jubilee”, wherein all debts were forgiven every 7 years. The idea is to give every citizen the chance at a fresh start,  The idea entered leftwing discourse recently as a result of David Graeber’s book Debt, and became a fixture in the rallies of Occupy Wall Street.  One of their neater initiatives, which seems to have fallen apart in practice, was called the “Rolling Jubilee”.  The idea was to raise donations and use them to purchase defaulted consumer debt at pennies on the dollar, and then forgive them.  It’s an incredibly cost-effective way to completely transform the life of someone who has fallen on hard times.  However, the general debt forgiveness idea is kind of interesting to ponder.

First and most obviously, it would raise the nominal cost of credit.  Lenders know precisely when debts will be forgiven, and so can calculate exactly when the principal will be invalidated.  Interest rates will skyrocket, especially for larger assets on long amortization schedules (e.g., houses).  Interest rates would be much higher.  If one believes in efficient markets, and that’s probably a good heuristic here, then there’s no net change in credit availability.  Borrowers will never have to pay back lots of principal, but debt will get more expensive in terms of interest and will have principal repayments timed before the Jubilee. Even if credit availability is the same in aggregate, only rich people are liquid enough to afford it.  Except for payday loans and other extremely short-term collateralized credit.  More intriguingly, the cost of credit rises in a regular cyclical fashion.

It would introduce bizarre temporal effects.  Immediately after a Jubilee, lenders can lend out at a 7-year maturity schedule, confident that it will be repaid without interference from the Jubliee.  One year later, they can do so on a 6-year schedule, and so on.  So loan interest rates will be lower at the start of the 7-year interregnum and rise afterwards.  It would provide an exogenous stimulus for boom and bust cycles too; financing would flow freely immediately after Jubilees for construction projects and personal loans.  There’d be a huge spurt of economic activity.  At the end of the cycle people would shift out of debt assets in favor of assets that survive the Jubilee.  There would be an entirely predictable boom-and-bust cycle – though one without recurrent financial crisis, since the underlying exogenous driver is universally understood!

Revolving credit would probably be severely impacted.  Term-limited debt can survive through the magic of market-set interest rates – potentially at the same level of availability as before, if the market is truly efficient.  But revolving credit would be severely impacted because strategic default looks like a much better option.  Just keep rolling the debt over until the Jubilee, and voila, it vanishes.  The only way lenders would still offer revolving credit is with much more encumbrance than today – harsh contractual payment minimums and collateral requirements.  The net effect of the Jubilee is (possibly!) small on loans and a huge drop in revolving credit.

In terms of effects, the result of the Jubilee is to dramatically diminish the role of debt in society.  It will primarily become a tool for those with pre-existing liquidity, while the illiquid scrape by with what they can earn.  Homeownership declines dramatically.  Consumer saving rises dramatically, as consumers can no longer count on debt financing to bridge significant one-time costs or a hit to earnings.  Consumer spending drops dramatically for the same reason.  Most likely there is a decline in structural growth potential and a drop in living standards for the non-wealthy.  The Jubilee seems cool, and the idea of freeing workers from the chains of debt is an appealing one, but the substantive consequences seem on balance probably bad.

Hence the old saying, “What works in a premodern agrarian tribal society is often inappropriate for a modern postindustrial economy.”  I think Ben Franklin coined that chestnut.


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