Edward Hadas

Debt, a little like sex, is a two-sided relationship which, when used appropriately, pleases the partners and is good for society. But both are also intoxicating and can easily become excessive and anti-social.

The financial bubble of the 2000s was the financial equivalent of the 1960s enthusiasm for “free love”. The delights of nearly free debt set pulses racing. Since the financial collapse, the dangers of uncontrolled borrowing have been recognised, but the bad habits have hardly changed.

When debt is used as it should be, lenders receive a just return on their assets and borrowers pay a just price for the use of the fruits of other people’s labour. Loans finance helpful investments and assist governments and individuals to manage periods of adverse fortune. But debt can also be used for promiscuous pleasure-seeking, unaffordable consumption, unjustified corporate investments and excessive government spending.

In the recent debt party, the United States led the world. The ratio of total U.S. debt (private, corporate and government) to GDP increased from 256 to 373 percent between 1997 and 2008, according to Federal Reserve calculations. The whole country borrowed from foreigners to fund its trade deficit. The financial sector borrowed cheaply and invested dangerously to increase returns and remuneration. Homeowners borrowed more and more to buy more expensive houses.

At first, all this indulgence appeared to be beneficial. GDP growth was strong, consumption was high, unemployment was low and higher asset values – the other side of higher debts – made borrowers feel richer. But when Lehman Brothers failed in 2008, the dangers of frequent debt relations with multiple financial partners became clear. With everyone borrowing from each other, losses on bad loans, and the fear of further losses, spread rapidly around the world. A Lesser Depression set in, and there is no end in sight.

Despite much talk about the end of an era of hedonistic borrowing, financial rectitude remains a distant prospect. Governments have stepped up borrowing just about as much as the private sector has cut back. In the United States, debt remains an alarmingly high 359 percent of GDP.

On September 15, 2008 Lehman Brothers collapsed in a heap, a bankruptcy that was followed by a recession in most rich countries. As time goes on, the severity of the disruption becomes both more apparent and more puzzling.

When Lehman failed, it was reasonable to expect the pain to be brief and concentrated. While too many houses had been built in the United States, most of the world’s real economy (comprising factories, offices, retail outlets, construction projects) was doing well. The global financial sector was more distorted, even before investors took fright at the decision to let Lehman go under. But by the middle of 2009, governments and central bankers had agreed to provide bankers and brokers with anything needed to keep them healthy.

Optimism was not justified. Although the countermeasures stopped the deterioration, the rich world now seems stuck in a Lesser Depression – many years of poor economic results and a series of financial crises. In the United States, the euro zone, Japan and the UK, real GDP per person is still lower now than it was four years ago. In all of them, GDP growth is currently either slow or non-existent.

Debt is a moral matter. While most economic activity is concerned with the “is” of how things are (investment, consumption and so forth), debts are always entwined with an “ought” – to repay. In discussing controversial debts–for example government borrowing in the euro zone and the U.S.–the moral question should be addressed directly: should these debts be paid off in full, or is some forgiveness justified?

Aristotle can help frame the argument. The philosopher condemned all lending at interest because money cannot create wealth by itself; a loan is just a way for the lender to take advantage of the borrower. Some proponents of Islamic finance make a similar argument, but it is not quite right. Capitalism has shown that loans can indeed produce wealth. If the lent funds are invested well, enabling the borrower to improve his lot and the world’s, then interest payments are the lender’s just reward for providing the fruitful funds.

But Aristotle’s moral logic remains relevant; his condemnation is appropriate for loans which do not share wealth justly between borrower and lender. Unfair loans should not be made, and where they have been, full repayment only compounds the original injustice.