Throwing Worse Money After Bad

This morning the Obama administration fessed up to what out side critics have been saying for some time:  its efforts to date to stem the mortgage foreclosure crisis hasn’t worked.  “Making Home Affordable” was a seventy-five billion dollar incentive to the financial industry to deal with the fact the a quarter or more  of Americans are now upside down in their homes and millions are facing potential foreclosure in no small part because of actions by the financial industry. 

The Great Double-Ought Bubble was the product of many blowing lips: the irrational monetary exuberance of the Greenspan Fed cutting interest rates to give-away rates; foolishly greedy homeowners and buyers looking to turn hearth and home into equity ATMs; rapacious realtors looking for the next commission come what may.  But the biggest lips blowing up the bubble were those of the financial industry which, from financing ridiculous rates for subprime mortgages complete with their own bubble clauses to the slicing, dicing and splicing of mortgage-backed securities spread the risks of their reckless realty practices far and wide.

So who’d a thunk that the same Wall Street suits sitting in Board Rooms and Fed meeting rooms who came up with the Foreclosure Fiasco would chose to not  sit on their hands—and the throats of homeowners—when it comes to cleaning up the festering mess?  The Obama Administration, of course.  Talk about the audacity of hope.  The “Making Home Affordable” plan relied on financial institutions to take up front risks and forego “lucrative fees”  to help out underwater  homeowners based on an appeal to do the right thing by the government.  So they didn’t, simple as that.   Who’d a thunk that? Oh, right.

Today the Administration now promises to get tough with financial firms by not paying them the cash incentives promised in exchange for modifying distressed mortgages until those mortgages be permanently de-distressed.   That would be the cash incentives that were not big enough to tempt financial institutions to modify a significant number of mortgages in the first place. 

Right.

Six or twelve  months and three or four million more home foreclosures from now, what will the Administration do?  Get really, really tough on the financial industry by halting all deliveries of cappuccinos to their walnut-paneled offices until more mortgages are modified?  That threat might actually work better. Unfortunately, by then, the country might well find itself deep in the second dip of the Great Recession and the Obama administration may find itself facing its own potential pink slip in 2012.

The real scary fact of this great meltdown  has been that, step by step, everyone involved in it, from consumers to businessmen to government officials, essentially took rational, intelligent actions in pursuing their own self interest under the system of the time.  The real scary fact of this great meltdown is that there is no one bad guy—no Enron or AIG or Michael Milken or even a good old Gordon Gecko to blame this all on.  The great meltdown has been the product of systemic failure which has resulted, amongst other things, in the tying of the mortgage industry into a Gordian knot of conflicting interests. 

Only the terrible swift sword of government action can cut through that not.

Relying on the private sector to sort out a housing crisis that it a) made; b) doesn’t fully understand; and c) has no short-term interests in fixing is taking audacious hope to the point of simple blind foolishness.  Government must use the  power of law to modify the very mortgages the financial industry refuses to do.  Without such bold, truly audacious action the  foreclosure crisis threatens to spike again, dragging the housing and financial sectors back down and dropping the entire economy back into the swirling porcelain bowl.

Last year I suggested the government pursue an aggressive National Fair Mortgage Act to, by the power of law,  reset mortgage principals back to pre-bubble assessed home values and structure these mortgages on a 30 year fixed, 4%-5% rate, with mortgage holders being compensated through tax breaks and direct government compensation for any losses.  (See the plan here.)  As foreclosures continue to soar, the economy continues to falter and the latest efforts by the Obama administration to get the banks to fix bad mortgages fail,  the powers that be might want to chew on  this idea a bit.

Continuing to try and get banks to fix loans they have no interest in fixing, however, remains throwing worse money after bad.

Happy Holidays

Happy Holidays

Senator Barack Obama has the makings of a good idea with his call for a ninety-day national foreclosure moratorium.  Such an action would give homeowners and mortgage holders time to work out more equitable loans and keep homeowners in their houses, keep houses off the market, keep housing prices from sinking as fast and keep mortgage holders out of the red.  The only problem with the Senator’s plan is that it is not immediate, aggressive and audacious enough.  As Robert Skidelsky wrote two Sundays ago in the Washington Post, this is a crisis John Maynard Keynes would have seen coming a hundred miles and sixty-two years ago.  These economic problems confronting the nation call for a Keynesian solution.  Indeed, it’s practically screaming for Keynes on fiscal steroids.

So far the government’s response has been the antithesis of Keynesianism.   I recently wrote that the Reagan revolution amounted to a subversion of Keynesian demand-side economics (which originally called for using government borrowing and fiscal policy to push money into the hands of working families and consumers) into supply-side Keynesianism: using government borrowing and fiscal policy to push money into the hands of investors and producers.  The government cut trillions of dollars in taxes on the investment class by borrowing trillions of dollars to pay for the tax cuts, pure and simple.   Now the government is engaging in supply-side socialism, using over a trillion dollars to shore up the assets—buying them, as necessary—of the investment class.

Senator Obama has realized correctly that, ultimately, the American economy is not dependent on the health of Wall Street.  Rather, Wall Street is dependent on the health of Main Street, the place where the two thirds of economic activity driven by working consumers takes place.   The Senator has not, however, been able to fully and boldly shake the shackles a generation of faux-Laissez Faire Reaganomics has placed upon our collective public policy consciousness.  He has not advocated the Keynesian solution in its entirety.  What is needed is a massive program of historical scope to shore up the financial stability of average Americans and stimulate aggregate demand.

To this end I recommend his immediate advocacy of what I call the National Housing Holiday—a ninety-day national mortgage forbearance period which will allow time to return stability and credibility to both mortgage markets and household finance.

The Plan

The President, by executive order declares a ninety-day national foreclosure and mortgage holiday—a National Housing Holiday.  This order will be subsequently codified by national statute.  Ideally the NHH should begin effective November 1.  Politically, December 1 would be a more realistic date.  Waiting until after the inauguration will pretty much guarantee a long and deep recession.

All homeowners will be allowed to defer any mortgage payments due during this period.  Homeowners would, however, continue to receive tax deductions applied to the current tax year as if they’ve made the required payments for the period.

Mortgage holders, meanwhile, will be allowed to carry these loans as paid in full on their balance sheets for the Holiday period. Mortgage holders will also be allowed to write off from taxes due the value of the mortgages missed as a permanent loss and/or qualify for a federally issued or backed bridging loan in the amount of the forbearanced mortgages to alleviate/eliminate cash flow issues for these lending and investment institutions.  The amounts received will not be levied as taxable income.

During the ninety-day holiday every mortgage in America will be recalculated to a base fixed rate to be set by Federal statute under a National Fair Mortgage Act  (FMA).  Any loss on current mortgage income endured by mortgage holders is to be offset or mitigated by either applying it against future tax liabilities or by direct one-time Federal payment as set by Federal statute.   New regulations on future mortgages concerning allowable ARMs, loan qualification standards and such will be established under the FMA.  The FMA will also create requisite effective governmental oversight of the mortgage industry by either retasking existing Federal agencies and departments or by creating a new, integrated National Mortgage Authority (under the auspices of the Department of Treasury or Federal Reserve) to facilitate the provisions of the FMA.

Under new FMA rules, the three months of mortgage holiday will be amortized under the new loan conditions set for each mortgage across a loan period extended by the three-month non-payment history.   The tax credit received by homeowners over the three-month period will be in the form of a prebate against future taxes due:  its value will be repaid to the government over the remaining life of the loan.  Losses by mortgage holders (without reference to any government assistance during said period) recovered over the life of the loan will not constitute a tax obligation on future year taxes.

Rationale

The NHH will accomplish three things directly.  First, by establishing a process to revalue mortgages under the FMA, confidence can be returned to investment and credit markets.  Uncertainty and risk are the twin demons of destruction in credit markets.  The resulting lack of confidence in credit institutions is the very devil of the system. At the heart of much of the global credit crunch is the uncertainty over the value—or lack thereof—of mortgage-associated investment instruments.  Establishing a stable, fixed value for the underlying mortgage assets will remove this uncertainty and the obstacles it presents to the normal function of credit markets thereby returning confidence to these markets.

Second, establishing a viable mortgage structure   will effectively end the current foreclosure crisis bringing greater stability to housing prices across the nation.  Housing prices significantly over-inflated during the housing bubble; a significant correction in prices to more sustainable and historic levels should and will happen.  A precipitous drop in price, however, runs the risks of both ultimately undervaluing houses and over-decapitalizing households.  Foreclosed properties not only drag down the bottom line of mortgage holders; they serve as a depressing factor on property values across the broader neighborhood, community and nation.  Factoring subprime-driven foreclosures out of the process should allow housing prices to reach a true median in a more orderly way with less collateral damage inflicted on the broader economy.  In particular, a more orderly transition in housing prices will have a less deleterious impact on state and local property tax revenues, in itself a significant concern in a weakening economy.

Third, redressing the fundamental imbalances that have been generated in household income flows because of massively inflated mortgage tied to predatory ARMs will provide significant demand-side stimulus.  The initial Housing Holiday will free up three months mortgage payments for millions of American homeowners.   Calculating roughly fifty million qualifying homeowners with an average mortgage of less than two thousand dollars, the stimulus would amount to $100 billion per month and over $300 billion over the period of the NHH.  That amount is double  the size of the tax credit passed last spring which itself accounted for perhaps up to a one percent boost in second quarter economic activity.

A large portion of the $300 billion will undoubtedly be used by households to pay off debt and/or shore up savings.  In doing so, however, millions of households will be provided the economic cushion needed to return to financial stability and credit worthiness once mortgage payments resume after the recalculation of mortgages and the end of the three month forbearance period.  Tens of billions of dollars, however, will still find their way into the consuming economy helping to keep retailers retailing across the nation and helping to keep this Holiday shopping season from being the grimmest in a generation or more.

The Cost

The public cost of the NHH stems from the cost of lost tax revenues from, and loans/direct payments to, mortgage holding institutions during and after the three-month period.  Even if the entirety of the mortgage forbearance costs during this period are ultimately absorbed by the Federal government, the cost of this immediate stimulus package would be, at $300 billion dollars, less than a third the amount of the trillion-dollars in Wall Street stabilization funding authorized to date.  Unlike the trickle-down bailout, which still has not resulted in a substantial, observable impact on average Americans, the NHH will have an immediate and direct stimulus impact.   The NHH will also be revenue neutral on household taxes.

Other costs associated from the plan will result from however the National Mortgage Act is ultimately structured and implemented.   Mortgage holders, even with government stabilization through the NHH and NMA, will undoubtedly see the value of a significant amount of mortgage assets decline.  This, however, amounts to paper losses that can be mitigated to some degree through tax write-offs and other fiscal mechanisms.  In any event, the value of many of the underlying mortgage assets—and not just those limited to subprime lending—is suspect and unsustainable under current conditions.  The gains in confidence achieved by establishing a solid valuation for all mortgage assets with the resulting return of more stability to investment and credit markets will offset, at both the macro and individual level, the costs of mortgage asset devaluation.   In other words, mortgage holders, having the choice of sucking it up and seeing some devaluation of assets under a NMA or risking the prospect of massive devaluation of said assets under foreseeable market conditions, would be wisely placed to, simply, suck it up.  There are more medium and long-term profits to be made in an economy returned to prosperity than one mired in recession. Or worse.

The Politics

Implementation of a National Housing Holiday and passage of a National Mortgage Act will be, by any measure, a particularly audacious political act.  Indeed, the NHH and NMA represent nothing less than a return to fiscal Keynesian economic and the first steps towards a systematic repudiation of the excesses of the Reagan revolution.   There will be pushback, to say the least.

The first objection to the proposed NHH is its potential cost to the Federal treasury.  As discussed above, the anticipated cost is significantly less than that already allocated to the current Wall Street bailout packages.  The United States is, however, already over ten trillion dollars in debt.  Additional Keynesian fiscal stimulus as provided for under the NHH will add another half-trillion or more dollars in debt to this mountainous pile.  Deficit hawks and average Americans alike stare in shock and awe at these almost incomprehensible amounts.

Debt, however, is not the issue here.  It is the ability to maintain and service that debt which is.  If borrowing an additional half trillion or so dollars from domestic and world markets helps keep the world’s largest economy from slipping into an economic downturn of generational proportions than it is money well-borrowed.   If the government does not borrow additional funds to stimulate the economy and the economy does then fall into a major downturn the domestic and global ramifications will truly be historical—and, potentially, unprecedentedly painful—in scope.

Slippage in the American economy is already translating into a softening of global demand resulting in a corresponding softening in global supply.  China’s economy is showing signs of declines.  As a result, global commodity prices are dipping rapidly.  Such economic rapid upheavals and deflationary pressures in the past have always been accompanied by more than their share of political mischief, instability and conflict.   Given the global challenges this economic situation presents, mitigating or avoiding entirely the worst potential impacts by accumulating an addition five to ten percent in national debt is a reasonable and, arguably, economical price to pay.  And, given the fact that in this crisis the world really has no other choice but to maintain its support of American borrowing, such funding will be made available to the American Treasury.

Ideology will play a major role in debating the NHH and NMA, to be sure.  Knee-jerk reaction from reactionary Reaganites is as certain as the next sunrise.  Witness how Senator Obama’s merest mention of any consideration of revisiting and revamping the progressively regressive tax structure of the past generation draws immediate declarations that he is a socialist.   The proposals will divide the nation directly down partisan ranks with a not small measure of Reagan Republicans opposing them if for no other reason than they are being advocated by Democrats.  And, more cynically, those politicians and pundits with an eye on 2012, whomever wins this November, may not want to see fast and effective solution to the economic problems that will bedevil America in 2009, 2010 and 2011.

Given the magnitude of the economic challenges confronting America, it can be argued that this nation is once again poised on the brink of a major trans-ideological moment when a new, national consensus may be created.  Such was the case in the 1930s when the 19th Century Laissez Faire orthodoxy collapsed into a Great Depression that gave rise to the almost half century dominance of Keynesianism and the political New Deal Coalition. Such was also the case when, by the 1970s, the excesses of New Deal politics and systematic changes in the global economy undercut Keynesianism.  The stagflation and recession of the late 1970s and early 1980s propelled the Reagan Revolution to economic pre-eminence and the Reagan Coalition to economic dominance. Now, a generation later, the excesses of the Reagan revolution and intensified structural changes to the global economy have undermined that paradigm as well.  We find ourselves in 2008, as in 1932 and 1980, once again on the doorstep of a fundamental, substantial and systemic change in economic paradigms.   Ideological and partisan challenges to a Keynesian shift are being eroded—and will, ultimately, be swept away—by the deluge of the current and growing economic downturn.

Fairness—both its reality and perception– is a major issue that must be addressed in any economic stimulus and recovery plan.  The great, national populist outcry against the so-called Wall Street bailout packages was driven directly by a common sense of unfairness.  This outcry almost derailed the attempt to bring short-term stability to American equity and credit markets.  For the more ambitious and audacious NHH and NMA to fly, all Americans—homeowners and non-homeowners, investors and workers—must be convinced that everyone will share in the cost and everyone will share in the benefits and that each individual and groups share will be equitable, if not equal, to that of others. To this end additional tweaks, incentives and sweeteners may, by necessity, be considered.

The approximately 46 million of Americans who rent housing or own homes without mortgages receive nothing, directly, by the proposed NHH.  To redress this, a tax credit/rebate/prebate   that could be claimed by such households and received in the form of direct money-transfers from the Treasury—as was done with the spring tax rebates—should be considered.  The more the amount might approximate the value of NHH to homeowners and mortgage holders the greater the cost (perhaps up to six undred billion dollars) such a program would be to the Treasury.  But so, to, the greater the fiscal stimulus and the greater the political acceptance of the overarching plan.  Additional fiscal offsets for investment institutions not directly benefiting from the NHH might need also be considered.  The point is to provide both as much fiscal stimulation as will be needed to keep the economy from deflating into depression and as much political  buy-in as will be needed to command rapid public assent.

Ultimately, the NHH and NMA is, to quote the oatmeal pitchman, the right thing to do and the right time to do it.  Redressing the fundamental inequities of the last generation that have left American households less well off in financial terms and with diminishing future prospects is both economically, politically, culturally and morally necessary.  At the end of the day, even if mom and dad knew they were buying more mortgage than they could really afford, there isn’t one child in America who is responsible for the ensuing problems.  And, as we head into the holiday season, is seems unfair, uncivilized and even un-Christian (not to mention un-Jewish, Un-Muslim, Un-Buddhist, Un-Hindu and Un-every religious and secular based system of morality) to lay the price of our national profligacy on our on progeny.

Immediate passage of the NHH means no child in America will be evicted from hearth and home this holiday.  It means no family in America will ring in the new year by losing their homes to face an uncertain winter  wandering the streets in search of shelter.  It means that we Americans really meant it when we put into the constitution that “We the People” will “provide for the common defense” and “promote the general welfare.” As we look to celebrate  the coming holidays with our families, let us remember that we are also an American family.  And, as residents of our 50th State now,  family means “Ohana”: no one gets left behind.

Next Steps

The National Housing Holiday is a stop gap measure to return stability and liquidity to both mortgage holding institutions and, more importantly, American households.   By itself the actions taken to establish clear value for mortgage-related investment  instruments and financial solvency for millions of working and consuming households will have a stabilizing impact  on the real economy significantly beyond what the current investor-driven  economic stabilization packages have had or will have.  Yet,  like the initial steps towards a New Deal taken by Franklin Roosevelt after his inauguration,  the proposed National Housing Holiday and Fair Mortgage Act are only the first steps towards a  21st Century American  Deal.  The ultimate goal of a Keynesian recovery is to not only stimulate the middle and consuming class incomes in the short term but to create an economic foundation guaranteeing expansion of these classes over  the long haul.  To that end, additional policies need be considered.

At the operational end of things would be programs like a National Fair Credit Act which would redress the usury terms lending institutions have been allowed to charge for revolving consumer credit—interest rates which in previous generations could only be charged by loan sharks and mobsters—and return them to a level that is fair and, even,  moral.  Credit relief would further enhance the buying power and standard of living of the tens of millions of American households significantly in consumer debt.   A National Housing Appraisal Standard should also be considered to prevent a return to predatory lending practices of recent years.  The task of providing greater accessible to homeownership without  compromising credit markets as occurred with the subprime debacle must also be redressed.

Of greater significance are the structural changes which need be made to an American economy.  For the last generation America has been transformed from a diamond-shaped income distribution (a broad middle class with narrower  upper and lower classes) into an hour glass economy (broad upper and lower classes and a diminishing middle class). In recent years,  as income and ownership have pooled upwards,  this hour-glass economy is giving signs of shifting into the more traditional pyramid economy, with all the potential social and political consequences such economies have engendered across history.  This transformation has been the result of twenty-seven  years of national fiscal, monetary and trade policies that have systematically favored investment classes over working and consuming classes,  capital over labor.  These policies must be reversed.  In the absence of a resurgent,  reinvigorated  middle class any economic recovery achieved over the next few years will prove to only be an expensive chimera leaving America  in an ever weakening position, domestically and globally,  over the balance  of the century.

We Americans, by sins of commission, omission or ignorance,  have dug ourselves into a very deep economic hole.  Climbing out will take time, cost money, and require sacrifice.  For a while all of us may find ourselves, to paraphrase former Federal Reserve chief Paul Volcker,  living less well.  Actions taken now, however,  can minimize this downturn and set the foundation for a true and lasting economic recovery.  A return to Keynesian policies will also be a return to the growingly prosperous Middle class America that dominated society and politics after World War II.  An economic  recovery  that economically recovers  an American middle class in decline for a generation will guarantee broad economic prosperity for the next generation—and beyond.  Staying the course with our supply-side Keynesian/socialist model,  however,  is a sure path to national economic deprivation.

And global economic irrelevance.

Told You I Was Going To Tell You

Last week I published a post entitled “Brass Backwards.”  In it I laid out my belief that the current supply-side focused economic stability and stimulus plans being implemented fail to fundamentally redress the root of the current American economic downturn. I argued what was needed was a National Mortgage and Foreclosure Holiday and  promised you a followup explaining the plan.  Well, life happens and I got delayed in publishing it but have finally gotten a chance to flesh things out.  Read the following post, “Happy Holiday.” It’s a work in progress–I’m still tweaking the numbers–but your feedback is welcomed.

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