A Depressing Scenario: Mortgage Debt Becomes Unemployment Insurance
When asset values fall, the owners of collateralized loans are not in an enviable position. Nonetheless, they possess a kind of monopoly power over their borrowers that they do not possess when borrowers are solvent. Lenders maximize profits by price discriminating, but create deadweight costs in the process. From the perspective of the aggregate labor market, it is as if lenders were levying their own labor income tax, on top of the taxes already levied by public treasuries. Governments have an incentive to regulate this price discrimination, repudiate part of the private debts, cut their own tax rates, or acquire the debt themselves. These conditions may describe both the 1930s and economic events today.
I appreciate the comments and patience of many University of Chicago students who experienced an even more burdensome exposition of these ideas. I will provide updates on this matter on my blog www.panic2008.net. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.