The Hopeful Science
Occupy the Mortgage Lenders
Simon Johnson
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WASHINGTON, DC – Participants in the Occupy Wall Street movement are right to argue that the big banks have never properly been investigated for the mortgage origination, aggregation, and securitization behavior that was central to the financial crisis – and to the loss of more than eight million jobs. But, thanks to the efforts of New York’s attorney general, Eric Schneiderman, and others, serious discussion has started in the United States about an out-of court mortgage settlement between state attorney generals and prominent financial-sector firms.
Talks among state officials, the Obama administration, and the banks are currently focused on reported abuses in servicing mortgages, foreclosing on homes, and evicting their residents. But leading banks are also accused of illegal behavior – inducing people to borrow, for example, by deceiving them about the interest rate that would actually be paid, while misrepresenting the resulting mortgage-backed securities to investors.
If these charges are true, the bank executives involved may fear that civil lawsuits would uncover evidence that could be used in criminal prosecutions. In that case, their interest would naturally lie in seeking – as they now are – to keep that evidence from ever seeing the inside of a courtroom.
The scale and structure of any out-of-court mortgage settlement should address the damage inflicted by the alleged pattern of behavior. Many Americans now have too much debt. About 10 million mortgages are estimated to be “underwater” (the house is worth less than the loan). And, in key markets around the US, four years into the housing slump, home prices continue to fall.
If these were commercial loans, creditors would consider restructuring them – extending the payment schedule and typically writing down principal. But, in America’s home mortgage market, this is much less common. Banks want neither millions of negotiations nor, most importantly, the need to face the losses implied on their loan portfolio.
As a result, households want to spend less and pay down their debts. To some extent, this is the natural aftermath of any credit boom. And household deleveraging in the US will take a long time.
Policymakers can respond in three ways. First, they could do nothing – apparently the preference of the Republican congressional leadership, which recently wrote to Fed Chairman Ben Bernanke to demand that he not try to stimulate the economy further.
Second, they could continue to rely on conventional monetary and fiscal policy to pull the economy out of the doldrums. This is the approach still preferred by the Obama administration, despite its poor performance.
Third, we could adopt an alternative approach that directly reduces the value of underwater mortgages. At this point, any improvement in consumer balance sheets would directly stimulate the economy and create jobs.
Start with the proposal made by Martin Feldstein, who recommends a trade: the government should reduce the value of mortgages when they are sufficiently underwater, with the government and the banks splitting the losses; in exchange, the borrower must agree that the new loan becomes “full recourse.” That means that lenders could pursue borrowers’ other assets – not just the house – in case of default.
The key to this proposal is that banks must agree; it is a voluntary debt restructuring, compelled by no legal authority. In principle, banks should be attracted to the proposal, because restructured loans are less likely to default. In practice, the banks have consistently dragged their feet on mortgage restructuring – and are laying off staff, rather than hiring people who could help them deal with an initiative of the required scale.
Feldstein calculates that the one-time cost of principal reduction would be around $350 billion. Of course, in our current fiscal environment, it will be hard to find additional resources from the budget.
But $350 billion is roughly what the financial sector as a whole earned in an average quarter during the credit boom – and profit levels in recent quarters have reached or exceeded those levels. So, if the entire write-down cost were covered by banks, most of them would lose the equivalent of no more than one year’s profits – spread over several years.
Those boom-time profits were in any case overstated, because they were not adjusted for risk. And when the downside risks materialized, the losses were largely socialized – the primary reason why US public debt has soared in recent years. Asking shareholders and management to pay a relatively small amount is entirely fair and appropriate under these circumstances.
Some in the financial sector would, of course, threaten dire consequences. In fact, bank stock prices might drop, and it is entirely possible that compensation and bonuses would be curtailed, at least in the short term. On the other hand, a large-scale settlement that legitimately and finally removed the threat of future legal action would lift an enormous cloud that hangs over some of the largest lenders, including Bank of America, and creates significant risks for the rest of the financial system.
If the banks were ever really held accountable for the social costs of their behavior, the bill would far exceed $300-400 billion. Realistically assessed, the full downside legal risks to financial institutions are in excess of $1 trillion – particularly if it can be demonstrated that the “mortgage-backed securities” sold to investors were not backed by mortgages at all, because the proper legal paperwork was never done.
Any settlement should also include the banks’ explicit agreement that they will support modifying America’s bankruptcy law to enable inclusion of mortgages in the usual court-run processes. If the Occupy Wall Street movement tells us anything, it is that the last thing the US economy needs is more households overwhelmed by debt.
Simon Johnson, a former chief economist of the IMF, is co-founder of a leading economics blog, http://BaselineScenario.com, a professor at MIT Sloan, a senior fellow at the Peterson Institute for International Economics, and co-author, with James Kwak, of 13 Bankers.
Copyright: Project Syndicate, 2011.
www.project-syndicate.org
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mcarson 05:16 21 Oct 11
I can see how this would help the banks, but why, discounting emotional reasons, would a homeowner agree to this. I owe $300,000 on a $200,000 house. I agree to rewrite the mortage to $200,000 and make the loan full-recourse. I am in a worse position than if I just bought a $200,000 house. I'm betting my entire future that NOTHING bad will happen to me, since if it does I'll have to sell everything I own and have my wages garnished for the next 20 years. I would not make that bet, I don't think you would either. People are again trying to get poor people to do something they wouldn't do themselves. Please reconsider this.
gamesmith94134 03:44 22 Oct 11
Gamesmith94134: Occupy the Mortgage Lenders
In the last months of economic debates, I think Mr. Martin Feldstein gave the best suggestion to the present “underwater” mortgage; but how can the government and banks share the losses and restructure the loans and put the borrower to agree that the new loan becomes “full course” in the modifying America’s bankruptcy law to enable inclusion of mortgages in the usual court-run processes?
Secondly, if the banker can write off just the necessary ones and keep kicking the can down the road, will another TARP available or just close it?
Thirdly, if there are just those under water ones are proposed, who isn’t? What about my neighbors have their restructure with 15% off, can I get $300,000 of my $3million dollars house after their deduction, 10% is fair price after devalued too?
The question above may require legal consultation in 365/year services; since there will be law suits and chaos in the financial system after the cherry picking process by the operators either of the legislators or banker and repeal on the “full course” and discrimination by the borrower even though it was suggestively voluntary debt restructuring.
Perhaps, there is a progressive procedure to write off in the classes of real estate across the board by the marginal market values; that if all applies across the board, each loan must come through the federal, state and city tax board and legislatures that all houses under 2 million dollars are devalued in assumption of 10%--18% are subject to voluntary basis to restructure the loans.
As in “full course”, I think the legislators must think clearly what does the “full course” mean legally? Or how the pursuit may turn into another battle after default?
Finally, a streamline progressive table schedule may propose through city, state, or federal; and who is in charge or how much liability each must share with its banker? If it would be from Mr. Obama, how will the congress pass it?
However it is advisable to contemplate the “full course” on such proposal, and the “full course” for the borrower as well, just before Martin Feldstein’s name makes a hit in the courts before any settlement should also include the banks’ explicit agreement that they will support modifying America’s bankruptcy law to enable inclusion of mortgages in the usual court-run processes.
Across the board is a bold action on eliminating the legal dispute; and Cherry picking on a voluntary basis is doomed with corruption and discrimination. It is not going to be easy but what else is out there?
May the buddha bless you?
homeowner101 12:24 23 Oct 11
mcarson, great points. I am hard-pressed to imagine a scenario in which it would be in the financial best interest of a homeowner currently underwater on a non-recourse mortgage to take this principal reduction "deal." For one, it puts the homeowner in a precarious position should anything happen in the future that damages the homeowner's ability to pay the mortgage -- unless the home value has appreciated enough from what would be today's zero equity position, the homeowner would not only face losing his home, but everything else as well. For homeowners who already have recourse loans, however, it could be a great deal -- in that case, presumably, the only aspect of their current position that would change is the negative equity.
I'm terribly concerned, though, that once again the government and the banks have met in the back room to hatch a plan to save the American real estate market -- and, in turn, the broader economy -- without any real input from the homeowners who have the most stake in this whole mess. Aren't homeowners tired of being told by the government and the banks what's best for them financially?
Molly Castelazo
http://www.Homeowner101.com
sooku 09:43 23 Oct 11
It is a terribly bad idea to expand consumers' liability beyond the mortgaged property. Consumers will help out banks and get guaranteed financial ruin in return.
The core problem is not that borowers are underwater; it is that BANKS are underwater, and run the risk of insolvency due to rapidly depreciating foreclosure properties. Banks should write off the mortgage losses and re-negotiate the loans instead of foreclosing on a house that will lost 20% of its market value in a year. Once banks realize thatt the alternative is bankruptcy, they will step up to the plate.
gamesmith94134 09:01 24 Oct 11
gamesmith94134: Obama to promote new steps to help housing woes
Have we ever come through with refinancing yet? The best strategy is put all housing in form of devaluation based on the co-ordination of the locality and the tax system. In addition, the interest rate is the denominator in finding the proper owner of the property. Mr. Obama and his team must come through the full scale economical revival in making it affordable including housing. With the falling house price, the durables and consumable will follow.
The processes will strength the salary-earned population and the retired, since our economy is not deteriorated and it jus stalled. It is time to recall on the justifiable living standard in modifying the lower standard of living. In accompanying the savings and earnings from the inflated stock prices, we can maintain strength on growth effective within the range of months after our government is committed to the sharing on the loss in the defaulted.
And, the transition of the debt indicated the contagion is under controlled, then, the investment can be infused the quick start to rebuild the confidence on the dollar and American economy while upward interest rate can make a clearer path to prosperity again with the returning of the funds to America. Then, such reinfusion in the financing system under the reconstruction of the ECB and EU, the world is saved.
Mr. Obama hit the Federal, State, City tax button, and acclaim your across the board housing with progressive devaluation. By November, 2012, you will see how our economy can come round with better position. Cherry picking is back to nowhere with those non-qualified middle-class, they will zip up their purse for their retirement or their children’s college. You must lead the middle class to conquer our present living standard by devaluation.
To the Congress and the States,”let my people go”.
May the Buddha bless you?
Batch 04:02 22 Nov 11
Hey there, Professor Conway's Econ 101 class!
bkkopp 03:31 21 Oct 11
Greed starts with the homeowner. It is the individual homeowner who not only wants a roof over his head, but an appreciating asset. It is the individual homeowner who does not mind if this appreciatiation is higher than his cost of borrowing, and higher than than the rate of inflation, excluding real estate. This not only prices his children out of the property market, but has a much wider and devastating economic effect.
The homeowner wants nothing more than an effortless and taxfree capital gain. This is pure greed without any sound economic and moral justification. The morgage broker, the mortgage lender, and ultimately the investment banker and the final investor, bundle millions of such greed-driven home mortgages. What is 20,000, 50,000, or 100,000 for the individual homeowner, becomes millions and billions in the bundling and packaging process known as securitization and investment banking.