Housing

The rumor mill is suggesting that Obama has an “August Surprise” in the works in the form of massive mortgage writedowns by Freddie and Fannie.

Rumors are running wild from Washington to Wall Street that the Obama administration is about to order government-controlled lenders Fannie Mae and Freddie Mac to forgive a portion of the mortgage debt of millions of Americans who owe more than what their homes are worth. An estimated 15 million U.S. mortgages – one in five – are underwater with negative equity of some $800 billion. Recall that on Christmas Eve 2009, the Treasury Department waived a $400 billion limit on financial assistance to Fannie and Freddie, pledging unlimited help. The actual vehicle for the bailout could be the Bush-era Home Affordable Refinance Program, or HARP, a sister program to Obama’s loan modification effort. HARP was just extended through June 30, 2011.

It’s almost a good idea…

The reality is that until we can figure out how to deal with the huge negative equity overhang (the fact that mortgages are higher than property values) our financial system is going to be looking very zombie-like – they are working hard to hide the losses, and while they have those unrecognized losses, they’re highly risk-averse and generally unwilling to add liquidity to the system by, like, lending. They’d rather borrow fed funds and buy federal securities and lock in profits…

On one extreme, there’s an argument that we just write it off (which is what’s proposed above), give the lenders their lumps, and clear the wreckage afterward.

The problem is that this is a massive transfer of wealth from the taxpayers to the underwater homeowners; there’s also an equities problem because other homeowners (me) have lost a bunch of equity in this collapse, and we won’t get our mortgages reduced…which is why I hope this is a nonstarter for Obama, because the political fallout would be toxic.

But it’s just a few feet away from being a good idea.

What if…

…we offered people the chance to refinance at a low rate and knock 20% off the value of their mortgages, but asked them to give up their mortgage tax break and to give the lender a slice of any future increase in value?

We are massively overinvested in housing and have been for some time (note that we’re not alone, it’s a worldwide phenomenon – I should do a post on this). We see that in 1,800 sf starter homes, 4,500 sf 4br McMansions, a plethora of granite countertops and other trim that were once the province of luxury homes and now are – normal.

We’re going to downsize our housing over the next generation – smaller, cheaper, more efficient (not necessarily more urban).

How do we do that? how do we move housing from being valued as an investment (which brings consumption benefits) to being valued as consumption (which may bring investment benefits)?? the Canadians, as an example, maintain tight lending standards and don’t have a mortgage interest deduction.

We shouldn’t either.

But that transition is going to be messy and painful. So let’s bribe people to make it…

…and let’s start with the people in trouble – many of whom (like one of my neighbors) just happened to buy in the wrong place at the wrong time with too little equity – but are people who add to the community, stable, etc. etc.

So here’s a deal:

We’ll replace their current mortgage(s) up to some value $X with one at 80% of their total value at, say, 4.75% for 30 years, prepayable at any time. But you can’t deduct the interest on this mortgage.

In addition, we’ll have a second note that has a face value of one dollar, plus 33% of the profit you make in selling the home for the next fifteen years. If you don’t sell, you can pay it off for a buck.

We’ll securitize the loans, and the ‘kicker’ will have some value – Wall Street will work it out – but the value will be more than zero, which is what taxpayers would get under the plan suggested above.

It’s not perfect – there are still lots of issues, and we’re really trading losses now for revenue (higher income taxes by the beneficiaries) plus some possible future value.

But isn’t that better than trading it for nothing at all??
-

38 thoughts on “Housing”

  1. I’m not sure that “more space” is necessarily a bad thing. Yes, yes, granite counter-tops and designer polished brass taps in every home might be overkill, but bigger houses have real utility. Extra rooms mean one for every kid instead of doubling up, or having an office instead of a computer desk crammed in the corner of a bedroom, or a place for you to work on complicated hobbies instead of just plopping down in front of the TV every day.

    The problem with your idea is that it provides benefits to people now but imposes future costs on them. That’s okay, and there can be plenty of cases where it’s rational for both parties to make that trade… but it’s also the case that a whole lot of people will sign up, take the benefit now, and then bank on never having to pay the costs. It’s not going to be any more politically convenient for a future administration to impose those mortgage interest deductions than it is for the current one, and wouldn’t it be a popular move to invalidate all those “government kickers” and to have “the same home tax rules for everybody”?

    Is the plan better than just writing down the mortgages en masse? Sure, but that’s not high praise for it.

  2. Nice idea Marc. Well thought-out.

    And absolutely insane.

    You’ve seen the definition of insanity as “repeating the same old mistakes while expecting a different outcome”. Ask yourself this: which politician do you trust to implement that plan? Which existing bureaucracy? Frank and Dodd? Freddie and Fannie?

    No thanks. I’m sorry for your neighbor, but I’m not willing to subsidize his errors in judgment and timing, no matter how innocently he made them.

  3. Well, the purported Obama plan is so insane that I can’t even work up the effort to hyperventilate over it.

    I’m still thinking yours over, but I’ll ask this: Is this deal only open to people who have already fucked up their mortgage lives, or do we all get to play that game?

    (Also: What does this do to someone’s credit rating? I’m mildly negative on the notion of using credit scores as a proxy for anything other than credit, but this seems like it would have to get reported in a credit history somehow.)

  4. A 20% reduction in principal (which would lead to a 20% reduction in mortgage payments) is worth less than the mortgage interest deduction for a 60-100K/year couple. So in terms of helping them make their payments, this is a nonstarter.

    If I have a house that’s 20% underwater, what keeps me from doing this magic refinance, then sell my house immediately and walk away? For that matter, if I’m 2% underwater, why not refinance for 20% off, sell, and walk away with 66%*18%=12% of my home’s value as bonus? Will there be a new government depart of load forgiveness fairness evaluation? (Clearly you’re not getting government out of the loop here.)

    If you propose unilaterally rewriting mortgage contracts (it’s not clear whether “we’ll replace” is voluntary or not) and in the process issuing 15-year profit notes, what power on earth is going to convince me that those notes won’t be unilaterally rewritten in a few years when the next government thinks that this is really important for the economy (and their reelection prospects)?

    As written, these capital-appreciation notes have all the options on the homeowner’s side. They’d discount to near-zero. You also better sunset them gently, or you’ll construct a freeze in the housing market 14 years down the road. (Ah, look, we’ll just rewrite those notes when the time comes, right? :)

    Snark aside, if you want those notes to actually compensate for the 20% load forgiveness, then put some teeth on the holder’s side. At minimum, the note holder must have an option to buy the home (at scale-to-market, sharing profits with the current owner), and the homeowner should have the option to repay the note (with a time-declining fraction of the 20%). As proposed, those are just placebos to make us feel less enraged about those deadbeat mortgage-cheaters…

    Cheers
    — perry

  5. The political problem is that the mortgage bailouts would largely benefit a few areas of the country (CA, AZ, NV & FL), while other parts of the country are hurting from different problems.

    Outside of these boom areas, a lot of the country is hurting from long term stagnant economic growth, further slammed by the recession. In many of these areas, lost income is not likely to be a temporary blip. Helping people move to jobs makes more sense than coercing them to stay in one place.

    But I’m not sure this isn’t also a bad idea for SoCal. I have friends living in L.A. that would like to move to Torrance. They bought their home several years ago because it was what they could afford and the grade school was good. But the Junior High is not so good, and they decided to build equity and step up to more expensive housing before J.H. But they tell me that houses available in good, family friendly neighborhoods really hasn’t dropped in price. I don’t think they have a morally superior claim to any particular home since they also assumed market trends that did not pan out, but they may be able to afford a given house better than a current occupant if prices weren’t being held up by the government.

  6. I don’t know if this is just understood by all, but it bears stating: if your mortgage is underwater, refinancing isn’t an option. The banks won’t talk to you, period…at least, not until you’re on the verge of foreclosure and walking away. And more often than not, not then, either, hence the high foreclosure rates we’ve been seeing.

    I’m one of those who would love to refi at the current rates, but the advice I’ve gotten across the board is that until we have significant equity in our house, even applying for a refi is a waste of money (re: the application fee). And unless you bought before the bubble or after the collapse, that’s not going to happen for decades, if ever.

    Anyway, I assume Marc’s plan would only be available to FHA (Fannie/Freddie) loan holders, since for private mortgages the banks holding them would need some powerful incentives to play ball, and I don’t see them doing so voluntarily. Consistently they’ve preferred foreclosure to refinancing, despite the losses. Presumably they’re gambling they can hold on to the properties long enough to recoup those losses, and you’d need some profit-making scheme strong enough to overcome that risk-aversion tendency among the banks.

    If we’re talking compensating the banks for their losses in order to get them to play ball, giving the banks what would be seen/spun as “another bailout for rich bankers” would be political suicide for any who voted for it.

  7. Here’s a better idea- just let the banks foreclose, the owners declare bankruptcy, have the government buy the houses from the banks at a cut price, and then burn the houses to the ground.

    About as sane as the rest of this nonsense with the advantage of avoiding the moral hazard.

    This is lunacy- let this bubble finish working its way through. If this administration would stop scaring the life out of business we’d already be well into a stonger recovery and housing would come right along (with its lumps certainly). We keep treating the symptoms and the only medicine chosen is government spending.

  8. I think there are some pretty basic rules of the road concerning lending, that cannot be broken, without paying very stiff penalties.

    Lenders and borrowers enter a simple risk versus reward situation when negotiation a mortgage. If the loan goes bad, at least in NY state, the lender forecloses and the house is put up for auction. the lenders, get the proceeds from the austion in the order of their position 1st gets all of their loan back if the auction price exceeds the total of the first mortgage, the second the same. if their is money left the third is next and so on and so on. Fair enough.

    The basis of Mark’s argument is that an acceptance by Fanny and Freddy of 80 cents on the dollar would will stabilize the market, but it would be political suicide.

    I doubt that this would happen. first all principals would have to be lowered. And secondly, since the 80% figure is not a Mark to Market figure, a write down could cause an acceleration of the downward spiral in housing prices, because it would signal that the market for housing is in worse shape than was generally thought. Which, incidentally, I believe it is and will continue to deteriorate.

    Would that political suicide be the only fallout. I am more and more of the opinion that we are heading for a deflationary period the likes of which we have not seen since the Great Depression. The citizenry is still awash in private debt.

    Corporations are awash in cash but are not spending because they do not see where investment will make them profits. The also do not see where they will be able to have any pricing control in a more or less chronically crippled economy. I do not see where that will change in the foreseeable future. This means that unemployment will remain where it is or higher for the foreseeable future.

    My fear is also that, setting aside the irresponsibility that individuals showed in amassing debt and using their houses as cash machines, etc., let’s just focus on the incredibly irresponsible actions of our public and private lending institutions.

    These entities were supposed to be the adults in the relationship, setting strict standards as far as leverage and ability to pay when issuing loans, because that was *their business*. Over the past decade, this idea went out the window.

    In order to save the system, we allowed the financial system to avoid the catastrophe at hand brought about by their mindless lending and leveraging by allowing them to abandon a Mark to Market evaluation of assets. Once we did that we left the capitalist system and went into La La land. And, to make matters worse, it was a Republican Administration that led the way.

    As it stands now, the Democrat’s plan is to have the government print money from now until the cows come home, the Republican plan is, as far as I can see, to lower taxes. Both based not on careful consideration of how to handle the problem, but on sloganeering.

    We can not afford the Democratic “solutions” financially and I doubt that we can we afford the lowering taxes will solve everything fairy tale we have seen from the Republicans approach that we have seen from the Republicans.

    I have faith in the market to set things straight but the damage that the Financial Industry did to the Capitalist System of the past decade cannot be underestimated.

    I was looking at the foreclosures just yesterday in the Fort Meyers area, a Friend has 2 retired sisters living there and they are facing foreclosure. From what I saw that area is 40 to 60 percent underwater. In face of that, Mark’s plan would be too little, too late.

  9. I just ran across the following in tommorow’s edition of the New York Times. I am not endorsing the idea. The idea might be good or bad. But, I am endorsing the fact that people who have held to certain dogmas are realizing that the situation we are in will not be solved by dogmatic responses.

  10. Toc3, #9

    I am more and more of the opinion that we are heading for a deflationary period the likes of which we have not seen since the Great Depression.

    ….

    As it stands now, the Democrat’s plan is to have the government print money from now until the cows come home,

    Uh… is that not one of the classic ways out of the deflationary trap? Artificial inflation by printing money? I’m not saying it like it’s a good thing, per se, but it strike me as economic chemotherapy– bad, but better by far than the alternative.

    (Stimulus is another classic way out, but if that worked, I’d hate to know what the state of the economy would have been without it.)

    the Republican plan is, as far as I can see, to lower taxes

    Which in this case seems to be exactly the wrong thing to do, as it would probably reduce government revenues, but result in a bunch of corporations sitting on their cash instead of (as in a robust economy) going an reinvesting it.

    That does not make raising taxes the right thing to do, it just seems to make the Republican response seem like a disaster waiting to happen. (I’m all for the lower-taxes route to smoothe out the downside on a normal business cycle contraction, but this ain’t that.)

    (Also, completely incidentally to all that, I do wonder how the possible financial deflation interacts with the growing segment of the economy that is deflationary because it is shackled to Moore’s Law. I have no earthly idea how that changes things. I suspect no one anywhere has any earthly idea about that, and someone will get a Nobel Prize in Economics for the first good case that gets made.)

  11. The White House is denying this rumor, and might even be telling the truth. Isn’t the story here that confidence in Obama is so low that a pretty explosive accusation like this one is being given credence?

    This is an example of why Obama couldn’t stimulate the economy even if he knew how to do it. The economy is waiting for him to be driven to the sidelines.

  12. _”Uh… is that not one of the classic ways out of the deflationary trap? Artificial inflation by printing money?”_

    Japanese tried it for a decade and it failed horribly.

    _”Which in this case seems to be exactly the wrong thing to do, as it would probably reduce government revenues, but result in a bunch of corporations sitting on their cash instead of (as in a robust economy) going an reinvesting it.”_

    Companies aren’t sitting on cash reserves because they want to… the point of making profit isn’t to stick it in a McDuck style money vault to swim in.

    The core problem is government _policy_ is creating an atmosphere where it is logical to hoard capital… which in a capitalist system obviously isn’t good. This is what could feed a deflationary loop- but the deflation is the symptom not the root cause.

    First off- the idea that ‘cutting taxes’ is the Right’s only answer is a straw man. The problem with our current elitist DC political class is that if the solutions aren’t Washington actively _doing_ something they don’t seem to count. IE- stop this outrageous spending so we wont have to _raise_ taxes. Or lets get cracking on revising this business killing health care law that nobody understands but everyone knows is going to be extremely expensive and complicated for business to deal with. Lets revise the tax code so it isn’t going up and down and sunsetting and no sunsetting… making it impossible to plan long term with reliable numbers. Lets kill card check, kill this talk of a huge carbon tax or letting the EPA run rampant. All of this uncertainty is having a HUGE drag on investment… for the deadly simple reason that nobody can possibly predict their level of risk or return with this many moving pieces in Washington.

    In fact its not uncertainty that is spooking business. It is the Certainty that they are going to get boned in the coming years. The only question is how badly and how much should be set aside for the certain rainy days on the horizon.

    So yes- there are things Washington can do. But most of them are undoing things, committing to stop doing new things, and then getting the hell out of the way.

  13. As it stands now, the Democrat’s plan is to have the government print money from now until the cows come home,

    *Uh… is that not one of the classic ways out of the deflationary trap?*

    Well, no. The phrase printing money is not really what has been done here. Money in the form of credit has been injected into the economy. we have a situation where there is actually not enough money printed to come near to paying off the amount of debt that the populace had buried it self under. But nonetheless the government cannot go on printing money to cover all that leverage which it has been doing in a number of ways.

    Corporations know that and they know that with out the runaway credit that had existed during the W years, they would rather stay in cash than risk capital in a market where they do not see capital being produced.

    As the debt problem, which is much more widespread than the housing market, works its way through the economy, more and more of this debt will have to be written down.

    This leads to corporations not being able to control prices as more and more of the populace and business becomes unable to buy things and more an more products, like houses come on the market at ever declining prices.

    In these circumstances, cash is king, because everyone needs it. As for the gold bugs, gold is a hedge against inflation but it is not a means of exchange. The last time this scenario happened, the government set the price of gold at $35 and ounce and private citizens were not allowed to trade in it.

    There is no easy way out of this kind of a deflationary trap. This is why economists are so terrified of Deflation. The fed seems to have shot all of its bullets, Like the zero interest rate formula that Mark mentions, correctly, the Japanese tried to no avail.

    The backing of Fanny and Freddy exposure was another way.

    *(Stimulus is another classic way out, but if that worked, I’d hate to know what the state of the economy would have been without it.)*

    I will get back to the stimulus.

    Lowering taxes is a way to get money back into the economy. Kennedy did it and so did Reagan. but the economy was relatively healthy in both these periods. These tax cuts were like a shot of vitamins for an economy with the flu. In our present state, the world financial system is teetering on the brink of collapse and has been for the past 3 years.

    Republicans have taken the Tax Cut = Economic Stimulus as one of their basic articles of Faith. This sort of thing is what I referred to when I criticized Mark B’s comment in a another thread as religious paranoia.

    Recently the architect of the Reagan tax cuts and Greenspan in the article I linked to above, have said the situation is different now because of the extraordinary weakness in the underlying economy and the Financial Industry. But the Republicans in Congress are spouting this like some magic potion to solve things without really spelling out much.

    *(I’m all for the lower-taxes route to smoothe out the downside on a normal business cycle contraction, but this ain’t that.)*

    More and more Republicans are agreeing with you.

    So, as far as I can see, not much has been put forward to realistically deal with the problems we face and the congress. Both sides seen to be more interested in posturing.

    I am most disappointed here with the Republicans because, as I have repeatedly said during the three years that I have posted here, that they have been losing elections repeatedly because they have no philosophy or ideas.

    Recently, they have been remarkably cowardly in pandering to peoples fears and taking the simplistic ideas of people like the Tea Party Candidate in Nevada who is running for Senate and Rand Paul seriously, they also have run the the expected winner of the Florida Senate race out of the party. 3 sure senate seats now in jeopardy. But enough of my political complaints.

  14. Mark, #14:

    First off- the idea that ‘cutting taxes’ is the Right’s only answer is a straw man. The problem with our current elitist DC political class is that if the solutions aren’t Washington actively doing something they don’t seem to count. IE- stop this outrageous spending so we wont have to raise taxes. Or lets get cracking on revising this business killing health care law that nobody understands but everyone knows is going to be extremely expensive and complicated for business to deal with. Lets revise the tax code so it isn’t going up and down and sunsetting and no sunsetting… making it impossible to plan long term with reliable numbers. Lets kill card check, kill this talk of a huge carbon tax or letting the EPA run rampant. All of this uncertainty is having a HUGE drag on investment… for the deadly simple reason that nobody can possibly predict their level of risk or return with this many moving pieces in Washington.

    Mark, I might agree with you that any number of these points are good ideas and ought to be done, but I’m not seeing a direct connection between most of them and the cash-hoarding deflationary tendencies.

    For most of them, even if they went exactly the way I thought was the wrong direction, simply having them settled would reduce the volatility and uncertainty that you’re talking about as a cause of deflation.

    The one glaring exception is the continuous churn of sun-rise and sun-set taxation… but it’s too late to convince me that the Republicans have gotten religion on this, when they put the sunsets on their own tax breaks in the first place, just so they could get a good CBO score, and then immediately turned around and injected uncertainty into the process by trying to change the rules again and make them permanent.

    I’m more than willing to decry uncertainty and volatility. I’m just not willing to cede that ground to the Republicans.

    Also, to be honest, while I agree that volatility and uncertainty is part of it, I don’t think it’s the whole problem, or even the larger part of the problem. The problem is a liquidity crunch because a whole bunch of models that were used to allocate capital all blew up at once. There is the very real chance that lowering taxes just won’t work. Toc3 used the same phrase I would– it’s an article of faith on the right that lowered taxes is always the right answer. I think it’s often the right answer, but not always, and very likely not now.

  15. You can argue about the fairness of this proposal as long as you want. But consider one very big unintended consequence

    If you are prepared to write down all these mortgages, that must also mean that you are willing to write down the assessed property value by something like the same amount. And that will somehow have to apply to everybody, not just those whose mortgages are underwater. If the Federal Government suddenly says your house is worth only 80% of what it used to be, then the taxable value is suddenly going to fall.

    Local governments are strapped for cash already. What do you think will happen if they suddenly have to take a cut of up to 20% in their main source of revenue?

    It won’t be pretty.

  16. _”Mark, I might agree with you that any number of these points are good ideas and ought to be done, but I’m not seeing a direct connection between most of them and the cash-hoarding deflationary tendencies.”_

    How can you not? Put yourself in the position of a CEO, or better yet the owner of a small S business. Would you be investing right now, much less hiring? Or would you be playing wait and see? I can answer from my small slice of experience- you wait and see. You have very little idea what your expenses are going to be next year or the year after, you _must_ have cash reserves in case you find yourself upside down.

    _”There is the very real chance that lowering taxes just won’t work. Toc3 used the same phrase I would– it’s an article of faith on the right that lowered taxes is always the right answer.”_

    I would say its a well that is gone to a few too many times, but that doesn’t mean there is no water in the well. I think it is pretty close to a fact that a tax break (a permanent one, not a holiday etc) would spur commerce. You are lowering the cost of business- that almost has to spur commerce. Is that the right… much less the only solution right now? Probably not- but the reverse side of that coin is deadly certain. _Raising_ taxes, or allowing them to raise, will hurt business. And the uncertainty of when this will happen just encourages people to hold on to what they’ve already cleared.

    I think there is a bad habit of getting sucked into the macroeconomic world that we think we understand. Economics actually can be traced back to first cause. Forget about the second and third order mumbo jumbo economists are spouting and consider the incentives and disincentives being created or destroyed for the bottom line people.

  17. This WSJ article lays it out nicely- and keep in mind that not only are small businesses responsible for the majority of job growth in this company, more than half of them file their company taxes personally _and_ fall into the category designated ‘rich’ by the Democrats about to allow their taxes to rise. In other words the people you expect to do your hiring are about to see their pocket books take a further hit on January 1st.

    “Why I’m Not Hiring “:http://online.wsj.com/article_email/SB10001424052748704017904575409733776372738-lMyQjAxMTAwMDAwODEwNDgyWj.html

  18. Obviously no one has seen that the government’s latest plan is actually to have Fannie and Freddie’s offer $1000 down payment home buying.
    http://washingtonindependent.com/93795/the-return-of-the-1000-down-mortgage

    So if the theorized August Surprise is almost a good idea, what’s the real one?

    Seriously though, we need to think about housing from a game theory perspective. Being underwater only matters if you’re trying to move or can’t pay, and at any given time, most folks aren’t in those categories.

    So let’s say someone buys a house under fairly optimistic conditions. Say they buy a $500k house and put 20% down, so they have a $400k mortgage.

    A 20% write down would move the mortgage to $320k.

    * If you’re the type of homeowner who’s in trouble because you can’t pay your payment. The best case scenario is this saves them $500-600/month. Which will help some folks.
    However, they still have to be able to pay $1700-2000 a month instead of maybe the $2200-2400 they probably have to pay now.

    So that’s a good thing, but only if you fall into one pretty narrow category of folks.

    * If you’re the type of homeowner who can’t pay $1700/month, or you need to move across the country to get another job, it really depends on how much you can sell your house for. The 20% write down doesn’t get you any principle back if you lose that much or more on your sale. Which is likely. If you’ve written down your mortgage to $320k, if you only sell your house for that, you won’t get any equity out of it when you sell, so the future provisions don’t help much.

    * Worse, you’re asking people to lock in today to this program on the chance they might move or be unable to pay in the future. The future is uncertain. So for a homeowner sitting there underwater but not in an immediate predicament, the amount they save on their payment is gonna have to balance or exceed the amount of the certain loss of mortgage deductions and the uncertain expected value of the sale price of the house. Which in 10 years time, might well recover on its own. Or it might simply create an incentive for folks to hold out 15 years come hell or high water. I don’t think that second note would be worth very much to banks.

    * All of this is to say, it creates a very complicated set of incentives and probably won’t help as many folks as we might think. As a general rule, I tend to think our government could and should be in the business of simplifying (without reducing choices!) the choices we need to make.

    All of this is just a look at the homeowner’s side of the equation. For lenders, this is one way of recognizing the loss. But as you point out, AL, the whole problem is that lenders don’t want to recognize the loss. So what’s their incentive to take a loss here? Will they get their downside offset by the Feds? Wait, they are already, so moving from the real world to this world, there’s little but downside for them.

  19. Is there any reason we can’t have the government repossess foreclosed houses from Freddie/Fanny and burn them to the ground? Wouldn’t this lift the prices of the homes remaining that weren’t bought/built with bad lending practices?

  20. mark:

    Is there any reason we can’t have the government repossess foreclosed houses from Freddie/Fanny and burn them to the ground?

    Have you ever seen HUD repossessed houses? Better yet, HUD repos that have been “renovated” by the minions of the God-State to supposedly make them fit for human habitation? One would need a good reason not to burn them to the ground.

  21. True- but the government already ‘owns’ (at a bare minimum)150 billion dollars worth of Freddie/Fannie equity that they could easily take payment back in the houses themselves. Toc says the government can’t set home prices- that is true, but the government is already in the home lending and hence home owning business, so instead of getting _deeper_ into it, why not cut our losses and demolish a good chunk of the foreclosure sales by demolishing the houses themselves and turning the property into gardens or whatever and sell them when things turn around.

    Its a seemingly crazy solution (with shades of buying up hogs and slaughtering them during the depression), but is it any crazier than bailing out the worst offenders to the tune of 800 billion?

    We’ve overbuilt, that is one of the roots of this thing. Interest rates are insanely low and people are buying, but there is WAY too much dead inventory floating around killing prices which causes all these other repercussions. The government can inflate home prices by removing inventory, which will increase state revenues, which takes pressure off the feds to bail out the states.

  22. toc,
    I think, the obvious solution to the downward spiral is time and not trying to solve the problem with quackery.

    When I read the econ blogs these days, I’m ashamed. There’s lots of talk about how we (economists) don’t know anything, and lots of flailing about for solutions. But I think the reality is that politicians and large segments of the public simply don’t want to accept the standard economic explanations. Instead of fighting the good fight, economists (and politicians) keep coming up with increasingly Hail-Maryesque responses.

    So yeah, the solution to the housing crisis. My basic approach to things is to separate things into two components. First, you’ve got the stock of existing bad mortgages (a big pile of them), then you’ve got the flow of new bad mortgages still being put forth by Fannie and Freddie (as in the link above).

    1. First solution when you’re in a hole. Stop digging! Translation: stop programs like the $1000 house program I linked to above. However small they are.

    2. Further along these lines, stop as much subsidization and encouragement of poor mortgage practices by the govt as possible. While I think financial companies behaved foolishly, I’m pretty convinced by the evidence Russ Roberts (acknowledgement: he’s a former teacher of mine) accumulated demonstrating the perverse incentives the government created here. Consider this everything up to, but not including the mortgage deduction. Because much as I’d like to include that, I don’t think it’s politically feasible.

    3. That being said, at least try to sunset the damn thing (the mortgage deduction).

    4. Along the same lines, develop a plan to wind down Fannie and Freddie.

    Now for moving on to the “stock” of existing bad houses. My basic intuition if we prevent new bad loans from being made, we’ll eventually outgrow the surplus. The faster the economy grows, the better in this respect, but the fundamental idea is that demand for nice houses will continue to grow with the population and overall economic growth. A foreclosure sucks for the bank and the seller, but represents a good deal for the buyer. What we should really be looking at is making sure those guys are on a sustainable path.

  23. Mark B, #21:

    How can you not? Put yourself in the position of a CEO…

    Well, it’s not that I think those factors are good, necessarily. I agree that some of them are bad.

    But there’s a difference between a bad policy that would lead to a business contraction, and a deflationary policy.

    And moreover, when you do have a deflationary environment, it seems that cutting taxes is just a potential disaster because if the deflation is caused by anything else, the taxes don’t get invested, they get hoarded. Now tax receipts drop, but the business cycle doesn’t accelerate to compensate for that.

    That, more than anything else, is where the “article of faith” comes from. (Well, for me. Can’t speak for Toc3.)

  24. Toc,
    Lots of stuff to look at here, because there are so many different interrelated issues.

    I do not think “capitalism” as a popular conception is drastically imperiled because I think folks are increasingly understanding that it wasn’t just the “capitalist” financiers that were up to no good.

    The best analogy I’ve found in teaching economics is that you can imagine a market economy like a card game. If you can, imagine a positive sum version of poker, where, on average, the players leave the table with more than they come with via their interactions (play) with each other.

    The government plays the role of the house. They put out the chips, set the rules, and resolve disputes.

    The problem isn’t that particular players (finance) have just been crooked. Everyone recognizes that each player will try to do the best he can for himself. The problem is the house has been a willing participant who refuses to do anything about it.

    Anyway, that’s not a perfect analogy, but from that basic perspective, what we want is to restore faith in the house as the arbiter of a fair game.

    No one with any sense should think having the house come in and play everyone’s hand should work out well.

    So what to do:
    1. I don’t think we’ll have to bail out a huge number of additional debtors. Employment and payments seem to have stabilized while they’re not where we want them, I don’t see them getting obviously worse either. Homes foreclosed on will eventually be sold or rented out at levels folks can afford.

    2. The fiscal tricks, I think, are more problem than solution. The economy at large would benefit from realistic plans going forward about how to bring spending and revenue collection in line.

    Monetary policy is tricky and not well understood, even by most economists. Again, picture the card game. Money is analogous to the chips the house distributes. We use money and denominate everything with them because it saves time haggling (because otherwise we’d have to value the houses, cars, time, people offered in their bets) and enlarges the scope for trades (because money can be turned into everything else, where as winning the shirt off someone’s back might be difficult to turn into something meaningful for you).

    Anyway, this is why deflation is such an issue. You don’t want overboard inflation that makes it impossible to tell the value of what you’re betting in the game, but you want enough new chips coming available to prevent people from dropping out of the game, from bartering their stuff and getting into arguments, or what have you.

    In a world with lots of transactions and growth in real production, the amount of money in circulation has to grow too. This is incumbent on the house (in the economy, the Fed) to get right.

    Right now. Through 2008, the Fed was hyper-focused on ensuring the banking system didn’t collapse, and at some point (soon) they’re going to need to loosen a variety of the policies they’ve put in place which, while (perhaps) necessary to staving off the banking panic, are contractionary to the money supply (e.g. paying interest on reserves).

    I’ll admit to being mystified why the Fed seems to be taking such a hard line of inflation to the exclusion of their other statutory responsibilities. The charitable take is that they know/believe the banking system is still seriously broken and it needs the support. I don’t believe this myself however.

    3. This gets directly to your third point. Are banks really in just as precarious a spot as they were in 2007/8? I don’t think so. Most of the essential ones have improved both the quality of assets on their balance sheet and the quantity of reserves.

    So I tend to think the possibility of a systemic panic is not where it was. But changing the IOR policy and whatnot should be done gradually to gauge the effects we see.

    Of course, there’s a tension between the banks wanting to hold reserves and the growth of money and lending for productive activity in the economy.

  25. Michael,

    I would like to establish that we are pretty much of the same mind as far as basic economics is concerned. I would like to focus on your response to the triage thought experiment and follow what happens if deflation does enter the picture.

    Before that though I would like to answer some things in your last reply.

    *I do not think “capitalism” as a popular conception is drastically imperiled because I think folks are increasingly understanding that it wasn’t just the “capitalist” financiers that were up to no good.*

    I don’t think Capitalist Financiers were up to no good, but I do think they were incredibly bad businessmen and their actions as far as leveraging, risk aversion, etc. would not get them a passing grade in the most basic of the courses you teach.

    We are all paying the price for that.

    Also, the fact that they were not the only unprofessional characters in this fiasco, in my opinion, doesn’t expiate their culpability, ie., I never gave much credence to “The Devil made me do it defense.

    Also, as far as the thought experiment is concerned, and reality as well, pointing fingers, at this point is basically a waste of time.

    As far as the poker analogy is concerned, though useful, it is only another metaphor in the blame game. Your perspective may be perfectly correct, but engages in an argument I would like to get past.

    We have already agreed on the fact that the government can’t work both sides of the street and, at this point will have a great problem even working one side.

    *”1. I don’t think we’ll have to bail out a huge number of additional debtors. Employment and payments seem to have stabilized while they’re not where we want them, I don’t see them getting obviously worse either. Homes foreclosed on will eventually be sold or rented out at levels folks can afford.”*

    This is opinion. You may be perfectly correct, I am not arguing that. I am interested in what happens if you are not and you professional opinion on that is valuable to those of us non professionals.

    *2. The fiscal tricks, I think, are more problem than solution. The economy at large would benefit from realistic plans going forward about how to bring spending and revenue collection in line.*

    No one could disagree with this but, it does not speak to the choice laid out in the triage thought experiment. What actions will have to be taken if deflation is unavoidable and we are entering a situation where as Greenspan says we are experiencing something we have not even read about, Because, as you say, *”…there are so many different interrelated issues.”*

    I agree with you that Monetary Policy is difficult and not well understood and I believe I have a pretty good layman’s knowledge of how it is used.

    I agree about banks being coddled and that this has to end at some point.

    I believe that, globally, the massive intrusion of the public sector into the financial system in the world’s top 4 economies points to a financial system in trouble and as you would agree, the government playing too many roles that it is not capable of playing well.

    We do not agree about the shape of the world financial system. But I am not interested in opinions, *especially mine.*

    So, back to the thought experiment. Tell me how your triage decisions work if we do go into deflation and does your perspective change if we do.

    In closing, I posted above the following:

    *A close friend of mine speaks about his grandfather, who was one of the last people to sell their seat on the NYSE before the crash. He did so in 1928. No seat on the exchange sold at the price he got then until 1954.*

    To this, I would add the old saw that the War ended the Depression, which I believe is true. But it was not the beginning of the War, it was the end and the demobilization which followed.

    The Great Contribution to Recovery made by the War was the absolutely excellent job the Axis and Allied Powers did in decimating the manufacturing base and economic activity of the whole of Europe and Japan, while leaving ours untouched.

    I would really appreciate it if you would take a walk down the darker alley and tell us what you see.

  26. Toc,

    I don’t think Capitalist Financiers were up to no good, but I do think they were incredibly bad businessmen and their actions as far as leveraging, risk aversion, etc. would not get them a passing grade in the most basic of the courses you teach.

    But I don’t think most of those financial guys were making bad decisions. They were making decisions with the full knowledge that they’d be bailed out by the gvt if they got in trouble.

    You might say it’s an immoral decision, but from an economic perspective, taking more risk when you know the downside is covered is not a bad business decision.

    —————-

    Poker metaphor isn’t about blaming, it’s about understanding how an economy works. Which is necessary if you want to do triage; you have to know how it works to know what’s fixable and what’s not.

    ——————

    I am interested in what happens if you are not and you professional opinion on that is valuable to those of us non professionals.

    Now, you want to know what my professional opinion is if my professional opinion that there won’t be another big decline is wrong? :)

    Well, OK, the first thing to think about is what do we mean by another big bailout? Of banks?

    This crises fits the general “banking panic” narrative very well. You have to separate out out the sui generis problem of the panic from the underlying problems that cause the panic.

    That is, the first round of triage is to divide up the banks into “good banks” that are in trouble merely because there is a systemic panic, and “bad banks” that are likely to fail in any case.

    In the former case, the government acts as the lender of last resort until the system is stabilized. In practice, this is the majority of the bailouts we saw in 2008-2009. Most of the TARP fund and the equity extended to AIG have been repaid (not for AIG’s sake, but its insureds), and were necessary as backstops.

    In the latter case, say AIG, Fannie, Freddie, Citi, Bear Sterns and Lehman, I don’t think there’s uniform answer. The government has to weigh the risk that letting the company fail will, in fact, set off a wider panic. If yes, bail out, buy, or do whatever. Almost everyone has said, in retrospect, the shit really hit the fan when the government let Lehman fail after sending 20 years of signals that it would always protect bond holders.

    So what happens if some other big institutions fail? Well, like I said, all the big institutions have created larger buffers to insure they don’t. It’s kind of funny that in practice, the government is pushing everyone to increase their leverage again, and they’re being cautious.

    Well, my suspicion is that if the Fed and Treasury think the failure will set off a panic, they’ll bail out the bank by extending it money from the TARP slush funds and taking any iffy assets off its balance sheet via the Fed. Failing that, they’ll buy an equity stake. If they don’t think the bank failing will cause a panic, they’ll simply let it fail.

    ——————

    Tell me how your triage decisions work if we do go into deflation and does your perspective change if we do.

    We can only go into deflation if the Fed chooses for us to go into deflation. And I can’t imagine any circumstance in which that would be a wise thing to do.

    ——————-

    The Great Contribution to Recovery made by the War was the absolutely excellent job the Axis and Allied Powers did in decimating the manufacturing base and economic activity of the whole of Europe and Japan, while leaving ours untouched.

    This is the broken window fallacy, writ large. We recovered after the war (as did Europe and Japan) because the war changed the expectations of folks who went through it, not because it destroyed a bunch of perfectly good stuff.

  27. * I think it’s less facile to try to understand the group dynamic than it is to simply say the individuals in the group are all dumb.

    * No, there’s no master plan. Which is in a sense, a part of the problem in this case. Investors look to their own interest, and not to the interrelated and systemic interests. It’s like calling the folks who got trampled to death at that German disco stampede dumb for getting themselves caught in a stampede.

    * I understand that I’m not answering your questions the way you want me to, but I don’t think it can be answered the way you want it.

    Let me try to put it another way. A moderate level of inflation (and I’m not talking much more than returning us to our nominal income growth trend) seems the most obvious means by which to help borrowers.

    So when you ask to triage borrowers in the event of significant deflation, I think you’re already saying they’re hosed. Lenders, on the other hand, are positioned to weather an inflationary trend even if it’s not what they’d most prefer. I don’t see any practical methods for write-downs or stuff the like, which would theoretically help borrowers in deflation, and they would have much more obvious problems than return to inflationary income trends.

    So basically, like tic-tac-doe and global thermonuclear war, the only way to win the game is not to play.

    I also don’t think there are many economists who believe deflation is likely. Obviously it’s not a systematic survey, but I just noticed this, which seems pretty representative. http://www.nytimes.com/roomfordebate/2010/8/11/should-we-brace-for-deflation-now

    Those guys are pretty far across the spectrum, but they agree deflation is both quite unlikely and very bad.

  28. _I don’t know if this is just understood by all, but it bears stating: if your mortgage is underwater, refinancing isn’t an option. The banks won’t talk to you, period…at least, not until you’re on the verge of foreclosure and walking away._

    Which is actually a terrible decision by both banks and owners. After a foreclosure, everyone loses money. It’s actually much more profitable to keep people in their houses as long as possible. The banks have a chance to earn most of their loan back (instead of losing 30-60% in an auction), the owners have a chance to earn their house.

    It’s not that banks don’t want to do this. They just don’t have a system available to identify when a write down is good or bad (This American Life did a short story about this a year or two ago) There’s actually some good money out there for banks that know how to stabilize mediocre loans.

  29. First off- the idea that ‘cutting taxes’ is the Right’s only answer is a straw man. The problem with our current elitist DC political class is that if the solutions aren’t Washington actively doing something they don’t seem to count. IE- stop this outrageous spending so we wont have to raise taxes. Or lets get cracking on revising this business killing health care law that nobody understands but everyone knows is going to be extremely expensive and complicated for business to deal with. Lets revise the tax code so it isn’t going up and down and sunsetting and no sunsetting… making it impossible to plan long term with reliable numbers. Lets kill card check, kill this talk of a huge carbon tax or letting the EPA run rampant. All of this uncertainty is having a HUGE drag on investment… for the deadly simple reason that nobody can possibly predict their level of risk or return with this many moving pieces in Washington

    Do you think that these sort of proposals should be put down in writing? A new contract with America? If so why hasn’t that been done already, by the party? Put it before the people.

    There is no cohesive plan being put forth by the party and it leads to the anarchy that now exists. this is the worst shape the party has been in in my life time and I think in the end if it continues to be leaderless and without direction, nothing good will come of it.

  30. I agree with you that Mark’s “solutions”, at this point have no depth and appear to me to be not much more than a handful of slogans, it they are not sewn into a comprehensive plan.

    Until that is done, I don’t think the Republicans can be taken seriously. Or worse, they are devoid of any plan or understanding of what it is we are experiencing economically, world wide.

  31. Absolutely True. But, the corrosion of the tax base on one side in inevitable in any case, since the market value of homes will deteriorate as houses are auctioned off and the market writes off the value of foreclosed houses through a flooded auction Market.

    The main problem is the artificiality of the Govt. trying to create a stabilized market by fiat.

    Another point, as far as tax revenues are concerned is the corrosive effect on the economy as more and more people lose their houses, they are stripped of their economic foundations. No job, no house, no revenue, declining prices for everything, less income for corporations, less profit, etc.

    Not a very pretty scenario. We are certainly between a rock and a hard place. I am beginning to think that the homeless situation may, in the end have the worst effect on the economy, since it will be next to impossible for these people to recover in a full blown depression.

    One thing I see must be faced, if the situation is as dire as I feel it very well could be, we might be faced with the fackt that the Capitalist system will not survive in the form we have come to no it, because of the damage that has been done to it over the last ten years by the Financial Industry and their ridiculous behavior over the past decade or so.

  32. All true. And a good analysis that hits at the basic fact that the Govt. cannot set the market for housing, no matter what it does.

    as to yours statement here:

    *For lenders, this is one way of recognizing the loss. But as you point out, AL, the whole problem is that lenders don’t want to recognize the loss.*

    Correct, but how can this be? Since when have lenders been able to take an ostrich’s view on non-performing loans. Well, and when the Govt. guarantees these loans. So we have the Govt. playing both sides of the street.

    *So what’s their incentive to take a loss here? Will they get their downside offset by the Feds? Wait, they are already, so moving from the real world to this world, there’s little but downside for them.*

    Exactly, but this rope is fraying. We have had, I believe, over 200 bank failures this year. The time for foreclosures to take effect is lengthening, both because of the act that people are using their money to start new businesses in some cases and banks are now at the point that they cannot afford the foreclosure process.

    I some areas of Florida squatter have taken over houses and pay nothing. The police are less and less interested in protecting a bank’s investment by seeing a house essentially go to waste when they have other things to do. not only that an empty house is not maintained at all by the banks because they cant afford to. If a family squats, the Bank, at the very least, gets some maintenance, making squatting, bizarrely a favorable alternative for banks.

    So, what stops the downward spiral? Lowering taxes? I doubt it and so does Greenspan and the architect of the Reagan tax cuts. Continuing to play the dogma game and yell at one another from both sides of the aisle?

    One other thing, suppose unemployment goes to 15 to 20 percent?, climbing up the income ladder.

    I really don’t see much to stop that if the Japanese economy, the European economy and the U.S. economy goes into deflation. this means 3 of the top 4 economies in the world.

    As far as the forth, China is concerned, we will very quickly see how flimsy an managed economy based on no environmental or property laws and quasi-slave labor laws actually is.

    Be very clear about how this happened. The world wide financial industry was allowed for years to run roughshod over basic common sense.

    I read an article last week where Goldman Sachs reported that it lost money in the 2nd Quarter *Betting on Stock Volatility*.

    Why don’t we allow them to bet over and unders on how many times a ball will bounce during a college basketball game.

    They have seriously damaged the Capitalist system and thats why Greenspan is saying than not only has he never seen a situation like this, he has never even read about one.

  33. Mike I posted a long reply to you last night, but it seems to have disappeared. If it doesn’t soo I will re-write it. I enjoyed your post.

  34. Mike I will not rewrite my tome from last night, but i will give you a very abridged version.

    I entered this thread way back in Post #9 by saying,

    _I think there are some pretty basic rules of the road concerning lending, that cannot be broken, without paying very stiff penalties._

    So I expect that we see pretty much eye to eye as far as basic economics are concerned, especially in normal times.

    But I am not at all sure that we are in normal times, and neither it appears does Greenspan. I do not think it is out of the question to at least allow for the possibility that the Capitalist System itself has been dealt a near fatal blow by the financial industry over the past 10 years.

    To put his in perspective, A close friend of mine speaks about his grandfather, who was one of the last people to sell their seat on the NYSE before the crash. He did so in 1928. No seat on the exchange sold at the price he got then until 1954.

    So, let’s do a thought experiment.

    We have problems with the economy, Mortgage lenders and defaulting borrowers.

    Lets now do a triage system.

    1. One is afforded benign neglect, because it should recover, no matter what you do.
    2. One is given Help, because it has a chance to recover.
    3. One is given nothing because it will not survive, no matter what you do.

    In normal times I would:

    1. Help the economy by cutting taxes.
    2. I would neglect the lenders because with a write down they would survive.
    3. I would give the debtors nothing and leave them to fend for themselves, reaping the harvest of their excessive risk.

    I am not so sure that I would make the same choices in the situation we are in now.

    1. I think we will be forced to help the debtors retain their houses, because the blow to the economy will be crushing if millions of people lose their shelter. I say that because without shelter their road to helping a recovering economy will be that much more difficult.
    2. I would benignly neglect the economy, because I think it will best recover by itself and we have already used about all the monetary and fiscal tricks we have.
    3. I would let the lenders fend for themselves because I don’t think that the financial industry worldwide is in any better shape than it was 2 to 3 years ago. banks are failing at an accelerated rate. the public sector has been carring banks for years and it does not seem like they can or will survive a deflationary cycle, ie, without repayment of loans they have and will become more of a leech on the Public sector.

    This goes against everything I would normally believe in, but these guys have behaved in a completely suicidal manner for the last decade. They are being propped up by govt. guarantees, an open window at the Fed and dicey accounting.

    I would like to know what your feelings are on this. BTW, I like the dismal science and its practitioners. Your a bit like weathermen, but I like guys that can take a lickin’ and keep on tickin’.

    They reminds me of me.

  35. one other thing.

    *”1. I don’t think we’ll have to bail out a huge number of additional debtors.*

    There are 2 classes of debtors. the lending institutions who were and continue to be bailed out by the Federal Govt., in a any number of ways besides the tarp, which, I am sure you can cite like chapter and verse and individual borrowers. Who lives, who dies in thee triage if things go south and what will be the better effect of the decision to the economy as a whole?

  36. *But I don’t think most of those financial guys were making bad decisions. They were making decisions with the full knowledge that they’d be bailed out by the gvt if they got in trouble.*

    This, I guess would include the guys at Bear Stearns, Lehman Brothers, all the guys that held options at Citi, BofA, AIG, etc. Way to facile an explanation. Were they planning the crash? If they weren’t they were incredibly bad business men.

    *You might say it’s an immoral decision, but from an economic perspective, taking more risk when you know the downside is covered is not a bad business decision.*

    I am not wildly interested in judging moraity in these cases. I was a commercial Real Estate Broker in this area and morality isn’t really part of the equation.

    And, while we are at it, are you saying that the Financial Industry

    1. Knew that Bear and Lehman would collapse
    2. That there would be a run on the system 3. 3. Which they also knew would cause the Secretary of the Secretary of the Treasury to run in to Congress like Chicken Little,
    4. And, not only be made whole, but benefit by this well thought out plan?

    I know many many people in the financial industry and I never once took them to be that clever.

    *Poker metaphor isn’t about blaming, it’s about understanding how an economy works.*

    As far as I could see, your use was to blame the government, which I have no problem with.
    I just am not asking you a question about who is to blame.

    *Which is necessary if you want to do triage; you have to know how it works to know what’s fixable and what’s not.*

    Well, I have owned a company based on applications that I invented for the financial industry. My clients included the Federal Reserve Bank of New York, Merill Lynch, Deutche Bank, AIG, CS First Boston, et al. So I am have some idea of what is what is fixable and what is not.

    *Now, you want to know what my professional opinion is if my professional opinion that there won’t be another big decline is wrong? :)*

    Yup, it is called a hypothetical question of what will happen if other economists are correct and we are heading into a extended deflationary period. And, would that change your opinion of how you would handle the triage.

    If you want to do that I would appreciate it. I am aware that this is not your opinion but only an answer to a hypothetical scenario if your opinion is incorrect.

    I understand that you might not want to spend the time to draw that out in detail. If that is so, then tell me that and I will not pursue it.

    You did not address two other legs in the Triage, you only addressed the lenders. Is there a time when you favor the borrowers the lenders and the economy over both. Who do you send down the river? Is there a point where it is better forsake the lenders because they will never be able to recoup there loans and allow the borrowers to keep their houses?

    I would not think, with a further downturn that we are not very far away from an organized withholding of mortgage payments.

    Tell me how your triage decisions work if we do go into deflation and does your perspective change if we do.

    *We can only go into deflation if the Fed chooses for us to go into deflation. And I can’t imagine any circumstance in which that would be a wise thing to do.*

    This of course may well be true, but it doesn’t speak to my question

    Thanks

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