Guest Post: By Incentivizing Debt, We've Guaranteed Debt-Serfdom and Stagnation

Tyler Durden's picture

Submitted by Charles Hugh Smith from Of Two Minds

By Incentivizing Debt, We've Guaranteed Debt-Serfdom and Stagnation

Incentivize debt and you create multiple overlapping death spirals.

The incentives to take on debt are so ubiquitous that we underestimate their pernicious power to trigger self-destructive behavior. Want to go to college? Just borrow the money now, with no payments until you graduate. Need some consumerist-retail therapy to lift your sagging spirits? Just use plastic, and pay for the splurge later. Want to buy a house? Hey, the interest on that 30-year mortgage is all tax deductible. It's crazy to pay taxes when there's a big fat deduction for mortgage interest.

This same set of incentives works on a national and global scale, too. Put yourself in the shoes of the typical spineless, campaign-donation-dependent politico whose primary obsession in life is clinging to power via winning the next election. Every heavy-weight constituency is protesting any tiny reduction in their share of the Federal swag, so drastic cuts are out of the question. What's the only painless option? Borrow $1.5 trillion every year to make sure the swag is fully funded and the restive constituencies are quieted for another election cycle.

But debt has a consequence called interest that feeds a destructive self-reinforcing cycle. At a certain threshold, there is no painless way to pay the interest except to borrow more money. That increases the interest payments due next year, and so the "solution" is to borrow yet more next year.

As I explain in Resistance, Revolution, Liberation: A Model for Positive Change, the Status Quo has relied on "growing our way out of debt" to overcome this cycle: if the new debt fuels a rise in productivity, the economy will grow so much faster than the debt that the relative burden of the debt actually declines.

In a simple example, if a $1 trillion economy borrows $1 trillion and invests it such that the economy rapidly expands to $5 trillion of goods and services, then the rise in national income means the interest on the $1 trillion can be paid out of the huge increase in income generated by the rising productivity.

The same is true for a company that borrows what appears to be a large sum in order to boost production. If revenues leap from $100 million to $1 billion as the result of a $100 million investment, the interest can be paid out of the higher cash flow.

The wheels fall off the "growing our way out of debt" strategy if the borrowed money was spent on consumption or invested in low-productivity purposes. After it's all said and done, the money's gone but the debt remains and the interest is still due.

This is where the housing bubble enters the picture. Given that mortgage interest (even the interest on home equity lines of credit, HELOCs) is deductible, then it was incredibly attractive for those with equity to borrow that equity for consumption, an addition/remodel or to fund another home purchase as an investment or vacation get-away.

Since the additional debt did not create any additional income, more of the household's income is now diverted to paying interest. Even if the additional debt was used to purchase a rental property, if that property's expenses (property taxes, maintenance, etc.) have outpaced rental income increases, or the equity in the rental was extracted in the bubble, then the actual rise in net income might be negligible or even negative.

I know a number of households with substantial real estate assets and upper-middle class incomes, but they are effectively low-income debt-serfs, as most of their income goes to the interest payments on their stupendous mortgages.

Now that they're heavily mortgaged, banks won't lend them more money, nor will they refinance exisiting mortgages: these heavily indebted households are now credit risks.

15% equity on $2 million in property looks like there's a net household worth of $300,000, but it's dead money, i.e. trapped capital: it cannot be tapped except by selling the property.

And since property values have fallen significantly from the top, most households are loathe to sell at depressed prices. Meanwhile, the majority of household income goes to mortgage payments, leaving little to save, invest or enjoy.

This is how high-income households enter debt-serfdom. On paper, they're still worth a lot, but it's trapped capital. On paper, they have a substantial income, but since $50,000 of it (or even $100,000 or more if the household owns multiple properties) goes to mortgage interest, their actual net income is modest or even negative.

This is why so many households have pulled money out of IRAs and 401K retirement funds: their debt service costs and essential expenses exceed their income.

It's also why income tax revenues are lower than they were "in the good old days" before the bubble popped. As median household incomes have declined 9.9% since December 2007, there is less income to tax, and large mortgage payments have reduced taxable income to mere trickles even in high-income households.

Whenever I discover a well-off friend is paying minimal Federal and State taxes, I ask, what's the trick? Answer: huge mortgage payments.

The trapped-capital equity in real estate is simply another form of phantom wealth. If too many people try to free that trapped capital by selling, the price of real estate will decline and the actual net equity left after commissions might well be near-zero. Recall there are at least 6 million homes in the shadow inventory and 12 million "underwater" households whose mortgage exceeds the market value of their house.

Since they can't sell, they are debt-serfs, indentured to their mortgages and the owners and servicers of those mortgages.

This same dynamic plays out in heavily indebted nations. Take Japan, for example. Its national tax revenues barely cover its interest payments and social security program, despite interest rates below 1%. The rest of its government expenditures must be borrowed, adding to next year's interest payment burden.

Once a critical mass of income is devoted to paying interest, there is not enough income left to invest in productive investments. Without increases in productivity, income declines, further squeezing budgets as income falls but debt service costs remain fixed.

As the relative share of income siphoned off by interest rises, there is less available for either investment or consumption, so "growth" also declines. Borrowing more to pay the interest only adds to next year's interest payments.

Incentivize debt, and you end up relying on debt as a sustitute for productivity and income. Increase debt, and there's not enough income left for productive investments that might boost income. Incentivize debt via making interest tax deductible, and you create a self-reinforcing feedback of a rising share of declining income being devoted to interest payments. With demand and borrowing both suppressed by debt-serfdom, demand for housing, goods and services declines. Borrowing more to consume simply speeds the cycle of rising interest and falling net incomes.

Incentivize debt and you create multiple overlapping death spirals. We are seeing the death-spirals play out in a fractal manner, from households to nations to entire regions. High debt levels lead to high interest payments which lead to low investment and savings rates which lead to lower productivity which leads to stagnation of income, consumption and investment: in other words, a death spiral.

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Rahm's picture

P2P lending bubble brewing, should be fun to watch the virtual pawn shops implode!  A few clicks of the button, and viola, money appears... afterall, debt = money,  under the Corzine accounting rules, right?

batterycharged's picture

The probem is with the way we run our economy.

Our economy is like that bus in the movie where if it goes under 55 MPH, a bomb goes off.

So the only way to sustain an economy like that is with debt and printing money.

We base our economy on GDP, which really should be called Gross National Consumption. Because it sure doesn't mean productivity.

People think we have too much state-planned economics now, I say we have barely any. Nothing is planned, it's all reactionary.



SDRII's picture

What is the over under on time into testimony before the first fawning article about Dimon appears on the wire?

mayhem_korner's picture



Depends on whether the hearings start on time, because the embargo on the pre-written, fawning comments is prolly set.

Sophist Economicus's picture

"Whenever I discover a well-off friend is paying minimal Federal and State taxes, I ask, what's the trick? Answer: huge mortgage payments."

Chuck, you are either a liar, or your definition of well-off is $100,00/year


CommunityStandard's picture

Truth.  Tax deductions from interest paid on mortgages is one tool in the toolbox of lowering taxes, but it's a drop in the bucket for the 1% and the investor class.  It's only a huge portion of tax deductions for middle class families.

On the other hand, $100,000 IS well-off for a majority of America.

socalbeach's picture

The author needs to expand his list of well-off friends until he gets the answer: "huge depreciation 'expense'".

Cthonic's picture

And huge business entertainment expenses.

MachoMan's picture

Answer, in part: pounding the absolute shit out of section 179

evolutionx's picture

interest rates explode across europe

spain record high

mayhem_korner's picture



"Incentivizing debt" is masterful in its simplicity and truth.  +1600

john39's picture

using debt to enslave the world is much easier than using armies...   of course for those countries that won't accept debt, there is NATO.

bigwavedave's picture

So I wont get my $3k for thingamajigs? Boo!

francis_sawyer's picture

You hereby owe $3k... Enjoy your 'thingamajig'...

Widowmaker's picture

Mission accomplished, fuckers!

km4's picture

"Borrow $1.5 trillion every year to make sure the swag is fully funded and the restive constituencies are quieted for another election cycle."

Yup and make sure to sell plenty of hopium while kicking the can down the road 

Muppet Pimp's picture

World domination by debt seems to be the MO.  See loan sharking for primer.

ATM's picture

It's sneakier than that. First they create this debt and sell it out to whomever is dumb enough to buy it then they will get bailed out by the NWO/IMF/UN who will subjugate all the prior lenders thereby illegally changing their rights  - actually nullifying them.

When the debt flows up to be fully owned by and issued by the sovereigns then it is the countries themselves that become the Peons and all the people in them.

You know, it's for the greater good.

RiverRoad's picture

You got that right.  Debt is America's main product.

akansemper's picture

does anybody know if the CDS on Greece will be triggered after the voluntary haircut, when Tsipiras wins and will stop paying creditors and renegotiate?

Widowmaker's picture

No but the rules changing is a certainty. Whatever happens you will lose, also a certainty.

Jack Sheet's picture

"At a certain threshold, there is no painless way to pay the interest except to borrow more money."

Agreed, and don't forget that the principal too has to be paid off at some stage, also by borrowing more. That's why low interest rates can lead to higher borrowing costs than high interest rates, because higher principal is taken on.

narnia's picture

90% of the cost of delivering a person a house is involuntarily & unnecessary dictated by government action (artificial scarcity, building codes, zoning codes, meters for central utility, input control & artificial scarcity, publicly provided education, and inflation). 

Centurion9.41's picture

Veritas, the combination of nanny state requirements [e.g. fire codes] and political kickbacks [i.e. building codes delivering business to political supporters] greatly increase the cost requirements.  It would be much more effective if a person could build their home as they wish and pay for any one time services [e.g. fire service/emergency] &/or infrastructure to deliver electricity/water via a 30 year fixed bill.   For recurring usage, eg monthly usage of electricity, water, garbage, the billing could remain as it is now.  Education should be a straight line and separate tax, open to vote every 3 years; that way the people living in the area could decide if they want to "invest" in their area's property values by creating a high quality school to attract families or not to attract a differnt demographic, e.g. retirees.

But such things would be too simple, much like a "flat tax", and not easily manipulated by politicians seeking power.....

azzhatter's picture

No debt=freedom, freedom= telling the oligarchy to go fuck themsleves

AnAnonymous's picture

Free men are allowed to have debt.

Slaves are not.

cranky-old-geezer's picture



The only benefit of more debt is to bankers. More debt means more interest and fee income for bankers.

Bankers are the ones creating these fiat currency systems because a fiat currency system allows an unlimited amount of currency to be printed to fund an unlimited about of debt, making bankers enormous amounts of money.

In every case bankers go hog wild with it, printing more and more currency to fund more and more debt till the value of the currency collapses, like in Weimar Germany, Zimbabwe, Argentina, etc.

It absolutely will happen with the euro and US dollar too.



AnAnonymous's picture

US citizen economics is about consumption.

Debt is powerful.

Waterfallsparkles's picture

Problem is that even if you control your debt you cannot control the Countrys debt.

Waterfallsparkles's picture

The sad thing is that the only people that do not have to worry about America's Debt are the people on Welfare.  It does not affect them.  They are the beneficiary of other peoples Money.

blunderdog's picture

A fine insight, but an unwarranted exception. Government debt itself doesn't directly impact workers any more than layabouts.  The side-effect of inflation affects everyone who transacts business in dollars.

If government debt had any direct impact on the lives of Americans, it wouldn't be as high as it is.  We'd have run Reagan out of town and started thinking about spending back in the early '90s, which really would have been a good time for it.

Umh's picture

It does seem like we have a habit of subsidizing the wrong things and people.

trilliontroll's picture

"...By Incentivizing Debt, We've Guaranteed Debt-Serfdom and Stagnation..."

There is no direct contract between creditors and debtors , it is all hidden by the banks.

Bring transparency to any one having a bank account about where her/his money really is:

stop the traditional way of banking  , charge a fee for storing the money in a safe and

have  the saver decide only on her/him -self where to put the money.

Make it easy for ANY business to offer shares, so that a lot of people can and must  share risk and profit as a team of owners.


blunderdog's picture

I think CHS has had one of those realizations about the nature of an interest-based monetary system.  This sort of thing has been understood before.

W10321303's picture

By Michael Pettis

About ten years ago I published an article in Foreign Policy that I just recently re-read.  In the article I extended one of the arguments I made in my book, The Volatility Machine, that the globalization process is driven primarily by monetary expansion and the consequent increase in risk appetite.  What was new in this piece, because I hadn’t realized it when I wrote my book, is that every period of globalization coincided with a stage of the industrial revolution in which accompanying the expansion in international trade and capital flows is a major technological boom, driven also by monetary expansion.

After re-reading the article I thought it might be useful to republish it on my blog with a couple of comments while waiting for the next entry (which should come out this week).  I think the point it makes about the process in which globalization is reversed is still worth considering.

Will Globalization Go Bankrupt?

“Only the young generation which has had a college education is capable of comprehending the exigencies of the times,” wrote Alphonse, a third-generation Rothschild, in a letter to a family member in 1865. At the time the world was in the midst of a technological boom that seemed to be changing the globe beyond recognition, and certainly beyond the ability of his elders to understand. As part of that boom, capital flowed into remote corners of the earth, dragging isolated societies into modernity. Progress seemed unstoppable.

Eight years later, however, markets around the world collapsed. Suddenly, investors turned away from foreign adventures and new technologies. In the depression that ensued, many of the changes eagerly embraced by the educated young — free markets, deregulated banks, immigration — seemed too painful to continue. The process of globalization, it seems, was neither inevitable nor irreversible.

What today we call economic globalization — a combination of rapid technological progress, large-scale capital flows, and burgeoning international trade — has happened many times before in the last 200 years.

But in spite of the enthusiasm for science that accompanied each wave of globalization, as a historical rule it was primarily commerce and finance that drove globalization, not science or technology, and certainly not politics or culture. It is no accident that each of the major periods of technological progress coincided with an era of financial market expansion and vast growth in international commerce. Specifically, a sudden expansion of financial liquidity in the world’s leading banking centers — whether an increase in British gold reserves in the 1820s or the massive transformation in the 1980s of illiquid mortgage loans into very liquid mortgage securities, or some other structural change in the financial markets — has been the catalyst behind every period of globalization.

MachoMan's picture

There isn't any incentivization of debtors to worry about...  it's a complete misdirection.  Debt, like drugs, sells itself...  As long as there is available credit, there will be someone desperate to borrow...  as long as there is a drug, there will be someone desperate to smoke it.  It has nothing to do with incentivization...  it has everything to do with the inherent nature of debt and the rudimentary desire of humans to live beyond our means.  It's something that is basic human nature...

The aspect of incentivization comes in with the people who peddle debt...  the people who take advantage of rudimentary human nature.  Ultimately meaning the sociopaths desperate for control.  We have to incentivize these people to not only suffer the losses should their debt bubble blow up, but to also ensure that any losses are always covered by the system...  there has to be a safeguard should our attempt at incentivization (bankruptcy) fail (e.g. higher reserve requirements).  At present, we have neither incentivization for the debt peddlers, but the system is incapable of withstanding the default.

I suppose this is a fairly dismissive and contemptuous view of humans...  but I think this is also founded in thousands of years of human history...  it just happens again and again and again...  fucking groundhog day with some debt implosions and a moon landing in between.  As soon as the terror gets out of the sight of one generation, it appears to strangle the next... 

Random_Robert's picture

No no no.... 


We are supposed to be incentiving confidence ... CONfidence in the system.  That's what BS Bernanke has been saying...


Oh, wait, you mean the system is BASED upon the proliferation of debt? Ewwwwww....


Ok, now I see. We are supposed to have confidence in a system based in debt at a time when global time deposits are cratering, and new debt creation has gone parabolic.


Sweet.  Where do I sign up for my pair of shiny polished shackles?