Tuesday, February 17, 2009

Restructuring Household Budgets Harder Than Corporate Finance Restructuring?

Household balance-sheets are more difficult to restructure than corporate ones, which involve far fewer people. Politically, the process raises questions of fairness. How far, for instance, should taxpayers bail out reckless homeowners who bought mortgages they could not afford? On the other hand, the economic dislocation from unwinding a household-debt binge may be less disruptive than restructuring swathes of firms. As Anil Kashyap of the University of Chicago points out, one reason Japan was so loth to acknowledge the depths of its banking problems was the knowledge that a banking clean-up would require a large-scale restructuring of Japanese firms which, in turn, would throw many people out of work. Restructuring household debts may be political dynamite, but it would not require a wholesale remaking of corporate America.

Nonetheless, the rebuilding of American households’ balance-sheets is likely to force a reliance on government demand that is bigger and longer-lasting than many now imagine. In the aftermath of Japan’s bubble, firms spent more than a decade paying down debt and rebuilding their balance-sheets. This sharp rise in corporate saving was countered by a drop in the savings rate of Japanese households and, most importantly, by a huge—and persistent—increase in budget deficits.

A similar dynamic will surely play out in America’s over-indebted households. With their assets worth less and credit tight, people will be forced to save much more than they used to. The household saving rate has risen to 3.6% of disposable income after being negative in 2007. For much of the post-war period it was around 8%, and in the short-term it could easily exceed that. But, whereas dis-saving by Japanese households countered the corporate balance-sheet adjustment, American firms are unlikely to invest more while consumers are in a funk. Propping up demand may therefore require more persistent, and sustained, budget deficits than in Japan.
--from "America's Crisis in a Historical Concept--Worse than Japan?"



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