Economics, Pethokoukis

Was not massively helping underwater homeowners a massive mistake?


In their much-praised new book House of Debt, economists Atif Mian and Amir Sufi argue the 2000s housing crash caused a much worse recession than the tech-stock crash because asset losses were more heavily concentrated among the 99% — who then stopped spending. The burst Internet stock bubble, on the other hand, “concentrated losses on the rich, but the rich had almost no debt and didn’t need to cut back their spending.”

Which raises the following counterfactual: what if Washington had pushed massive relief for underwater homeowners?

Now former Obama Treasury Secretary Timothy Geithner doesn’t think something like a principal reduction scheme would have helped much. As he wrote in his new book, Stress Test: “We did not believe, though we looked at this question over and over, that a much larger program focused directly on housing could have a material impact on the broader economy.”

Mian and Sufi disagree. Their research suggests $700 billion in principal forgiveness of underwater mortgage debt in 2009 would have produced a $126 billion spending boost. And that is the direct economic impact. In addition, write-downs “would also have had the indirect positive effect of drastically reducing foreclosures and the associated negative effects of foreclosures on the economy.”

Along the same lines a few years back, Columbia University economists Glenn Hubbard and Christopher Mayer cooked up a mass refinancing plan where homeowners with a GSE mortgage could have refinanced their mortgage with a new mortgage at low rates. This could have helped as many as 30 million borrowers save $75 billion to $80 billion a year for the duration of their mortgage. In effect, a long-term tax cut.

And there was this proposal from economist Martin Feldstein: “To halt the fall in house prices, the government should reduce mortgage principal when it exceeds 110 percent of the home value. About 11 million of the nearly 15 million homes that are “underwater” are in this category. If everyone eligible participated, the one-time cost would be under $350 billion.”

But the Geithner “save the banks, save the economy” view, as Mian and Sufi put it, won over President Obama and the day. Mian and Sufi: “The fact that Secretary Geithner and the Obama administration did not push for debt write-downs more aggressively remains the biggest policy mistake of the Great Recession.”

Back to the counterfactual: imagine a plan like the ones Feldstein, Hubbard, and Mayer proposed along with a Fed that was far more active in supporting spending starting in 2008. And now imagine no TARP and no stimulus. Under which scenario does the economy perform better?

Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.

7 thoughts on “Was not massively helping underwater homeowners a massive mistake?

  1. “To halt the fall in house prices, the government should reduce mortgage principal when it exceeds 110 percent of the home value.”

    And so those of us who were prudent would take it in the shorts for all those nimrods who bought at the top of the obvious bubble, and/or took out HELOCs so they could buy a new boat,vacations, kitchen, etc.

    • Don’t forget the ones who never should have been able to purchase a home in the first place. Child support and unemployment should never have been considered income.

      • The brokers, underwriters and others that profited from the questionable loans should have been on the hook for a portion, at least, return of fees and commissions. That would have provided ample policing action.

    • Principal reduction happens all day every day in federal bankruptcy court, in “cramdowns” that shrink debt to the reduced value of business assets.

      And where were you when Uncle Sugar bailed out Freddie and Fannie bondholders? Did they deserve to be made whole?

  2. And so what about those of us who had bought a home we could actually afford, cautiously refinanced when the assessed value went up, but money into remodeling the 20-year old interior, and found a way to keep making mortgage payments?

    I get the idea that we were fools, and the reckless people who were offered loans they couldn’t afford and had bought a house not to live in but to “flip” in order to make money are somehow victims who deserved a big pile of taxpayer money.

    Slippery slope? Moral hazard? How about we should have simply let the markets clear and let the individuals involved learn from their mistakes?

    • First off the flippers are long gone. Now it’s the market clearing part that bites in ground zero cities like Fresno, Las Vegas and Miami. A very large share of the starter home market in these cities are unsaleable because the seller would be asked to bring a five-figure check to closing (i.e. pay up the negative equity in order to sell.) Gunshy lenders see a steady stream of foreclosures ahead. So the few sales are made to investors for cash. Without intervention recovery takes years and years and more years.
      Except for bondholders and would-be slumlords, it is in everyone’s interest to restart these housing markets, as some lenders acknowledge:

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