Debt Restructuring Would Spur U.S. Growth, Reinhart Says

A restructuring of U.S. household debt, including debt forgiveness for low-income Americans, would be most effective in speeding economic growth, said Carmen Reinhart, a senior fellow at the Peterson Institute for International Economics in Washington.

“Until we deal head-on with the fact that some of those debts are not ever going to be repaid, we will continue to have this shadow” over growth, Reinhart said today in an interview on Bloomberg Television’s “Political Capital with Al Hunt,” airing this weekend.

The U.S. recovery faltered in the first half of 2011, with gross domestic product rising at a 1.3 percent annual rate in the second quarter and 0.4 percent in the first three months. Reinhart co-wrote a book entitled “This Time is Different: Eight Centuries of Financial Folly” with Harvard University professor Kenneth Rogoff focusing on the “deep and lasting effect” of financial crises on output, employment, and asset prices.

U.S. home prices will probably continue to decline, she said. Recent data indicate that the pipeline of foreclosures in the market is still weighing on the housing recovery.

Home values dropped by the most in 18 months for the year ended in May. The S&P/Case-Shiller index of property values in 20 cities decreased 4.5 percent, the group reported last week. Sales of new homes in the U.S. also declined in June for the second straight month.

Housing Busts

In a study of housing busts during banking crises, Reinhart and Rogoff found that the average decline in home prices was 35.5 percent from peak to trough.

“Notably, the duration of housing price declines has been quite long lived, averaging roughly six years,” the authors said. The S&P/Case-Shiller index is down 32 percent from a July 2006 peak.

“We are still seeing every indication that the housing market has yet to fully recover,” Reinhart said. “And I think that that will continue still for the immediate period ahead.”

Another way to spur growth “that is kind of ugly” would be to compel faster “writedowns of bad loans in the financial industry,” Reinhart said.

Non-financial corporate balance sheets are in good condition, she said. “Our problems are in households and the financial industry and importantly linked to real estate.”

Reinhart, a 55-year-old economist, called accommodative monetary policy “very appropriate.”

Near Zero

The Federal Reserve has held interest rates at or near zero since December 2008, and expanded its balance sheet through bond purchases to $2.87 trillion. Chairman Ben S. Bernanke plans to convene the Federal Open Market Committee on Aug. 9.

“When we have the kind of combination of sub-par growth, stubbornly high unemployment, and a big debt overhang, you need low interest rates,” Reinhart said. The extension of a “stable and low interest rate environment is appropriate.”

Reinhart said Congress should leave “no stone unturned” in repairing the balance between taxes and spending.

Republicans need to accept that “average tax rates have to be higher, and Democrats have to accept that raising marginal rates may not be the way,” Reinhart said. “But I think the tax issue has to be put on the table.”

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