Excessive private debt creation as a cause for the financial crisis

10 February 2014

Adair Lord Turner of Ecchinswell, Senior Fellow at the Center for Financial Studies (CFS) and at the Institute for New Economic Thinking, argued that the financial crisis and the slow post-crisis recovery were first of all caused by excessive private credit creation. Until now the measures taken to combat the crisis had focused on public debt levels rather than on private ones. Therefore, Turner thinks that the currently introduced reforms are valuable but not addressing the fundamental cause of the crisis, the rising levels of private debt, which lead to economic and financial instability. On 10 February, Turner presented his views at the CFS where he gave a lecture on “Escaping the debt addiction: monetary and macro-prudential policy in the post crisis world”.

“Over several decades prior to 2008, private credit grew faster than GDP in most advanced economies and leverage therefore grew. That was a major cause of the crisis and the main reason why the post crisis recession was so deep and the recovery so slow and weak,” Turner said. Since the crisis, indebted private households and companies have decreased their consumption and investment expenditures to reduce their debt. As a result, growth has slowed down and public debt has risen.

According to Turner, the dilemma is that additional credit seemed essential to boost growth. But the question is whether a stable growth path is possible or whether growth is bound to generate harmful instability. Turner argued that more stable growth was possible but would require new policy approaches far beyond the reforms that have been introduced up to now. He explained that growth had become more credit intensive because of three factors: 1) increasing inequality between rich and poor, 2) global imbalances driven in part by a structural tendency towards excessive savings in some surplus countries and 3) extended credit growth to finance the purchase of existing assets (in particular real estate) whose price is then influenced endogenously by the quantity of the extended credit. Turner stressed that future financial reforms would have to address each of these three factors in order to restore stability.