On The Housing Market as a Driver of Stimulus

There was a New York Times editorial today calling for providing relief to the housing market through aggressive policy:

Tens of millions of Americans are being crushed by the overhang of mortgage debt. And Congress and the White House have yet to figure out that the economy will not recover until housing recovers — and that won’t happen without a robust effort to curb foreclosures by modifying troubled mortgage loans….

The administration needs better ideas. It can start by working with Fannie Mae and Freddie Mac, the government-run mortgage companies, to aggressively reduce the principal balances on underwater loans and to make refinancing easier for underwater borrowers. If the president championed aggressive action, and Fannie and Freddie, which back most new mortgages, also made it clear to banks that they expect principal reductions, the banks would feel considerable pressure to go along….

Reducing principal is a better solution than lowering interest rates, because it reduces payments and restores equity. Bankers resist, because it could force them to recognize losses they would prefer to delay. The administration has resisted, in part because principal reductions are seen as rewarding reckless borrowers….

Housing advocates and bankruptcy experts are calling for the administration to try new approaches. One would have Fannie and Freddie urge banks to let underwater borrowers who file for bankruptcy apply their monthly mortgage payments to principal for five years — in effect, reducing the loan’s interest rate to zero.

Another solution would be for Fannie and Freddie to ease the rule for refinancing underwater mortgages for borrowers who are current in their payments. The lower payments on refinanced loans would help to prevent defaults and free up money for borrowers to use for paying down principal or consumer spending.

President Obama is reportedly planning to include housing relief measures in his new jobs plan. Unless the plan includes strong support for principal reductions and easier refinancings, it will not get at the root of the problem: too much mortgage debt and too little relief.

This reflects a lot of other analysis, including New Bottom Line’s recent report “Win-Win Solution” that calls for principle writedowns to create a million jobs.

Jonathan Cohn wrote about how any new stimulus that is proposed needs to be focused on three things: size, speed and smarts.  Jared Bernstein’s FAST stimulus program is an example of this.  I think getting the housing and foreclosure markets under control is a good idea in and of itself; an added benefit is that it’ll help with the recovery.  Stimulus provided through allowing underwater homeowners to refinance into record-low interest rates and sharing the losses fairly between homeowners and creditors with reduced principal payments hits all three of Cohn’s remarks.  Plus it is possible, because it can potentially be done by sidestepping Congress.

Let’s stick with the simpler one of mass refinancing of underwater mortgages; we’ll come back to principal write-downs in future posts, but they apply even more to all three categories.  For size, Columbia Stern NYU economics professor Chris Mayer argues that getting homeowners who are underwater to refinance into record-low rates “Fannie Mae and Freddie Mac could face a one-time loss of $40 billion to $60 billion because the new HARP loans would pay lower interest rates, Mayer said. The cost would be offset by fewer defaults and it would put $50 billion to $70 billion a year in homeowners’ pockets, he said.”  (Here’s an FAQ he wrote on this.)  That’s a fair amount of money for stimulus – not enough to get us where we need to go, but definitely something.

Even better, once the can is kicked speed is going to be relatively quick.  There’s no environmental review to conduct or long-delay in actually getting this into motion; underwater consumers who want to knock a few hundred dollars off their mortgages are well-incentivized to initiate, carry out and make sure this gets completed themselves.  It outsources much of the bureaucratic requirements to those consumers who stand to benefit.

Also it is well targeted to help the economy where it is hurting the most.  There is a direct correlation between the amount of underwater mortgages and unemployment (and the relationship holds for states with deeply underwater mortgages and unemployment):

(Data source.) This stimulus will go to those places most impacted by the housing collapse, places with high unemployment that could use additional demand.

For those of you who worry about propensity to consume and/or the inter-temporal consequences of government debt, stimulus driven through the housing market will act just like a permanent tax cut.  The locked-in reduction in rates will be a permanent increase in income from the point of view of the household, giving us an absolutely great bang-for-the-buck in terms of stimulus.  For those of you who worry about deleveraging and possible cascading effects of foreclosures, lower rates will mean lower-payments which will reduce the risks of foreclosures.  Consumers can delever in a quicker and less risky, or in high-foreclosure areas deeply uncertain, way.

All in all, a great approach to helping the economy.  I hope it is a major part of the jobs package being put together for next month.

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10 Responses to On The Housing Market as a Driver of Stimulus

  1. These are the approaches I felt from the beginning. The banks end up getting a portion of any potential losses form interest revenue loss and the govt can get some of the stimulus back because now the home buyer – in addition to having extra money in their pockets – also pay less interest making their taxable income, thus taxes, higher. May not be a complete win-win-win, but kindawin-kindawin-kindawin is much better than what we have now loss-loss-win, where it seems only the banks are winning.

  2. K. Williams says:

    “”The cost would be offset by fewer defaults and it would put $50 billion to $70 billion a year in homeowners’ pockets, he said.” . . . That’s a fair amount of money for stimulus – not enough to get us where we need to go, but definitely something.”

    Come on — $50 billion? That’s a tiny drop in the bucket relative to the size of the US economy. And that’s if you assume that all of it will be spent — which it almost certainly won’t be. Whatever the arguments for allowing underwater homeowners to refinance, the notion that it would be a “driver of stimulus” surely isn’t one of them.

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  4. Lynn says:

    I am a homeowner who is current on her mortgage. I do use 85% of my income for my payment. I am in this situation because of medical problems. I made a committment to keep my house becuse it is my home. It is very difficult but I am doing it and I am not late on my payments!

    Everytime I see an article regarding homeownership, I get excited because I always hope that there will be a program that will assist me. I did apply twice for the HAMP program through my HUD approved credit counselors. BofA was so generous to offer a five year ARM instead. Of course, I am not looking for a short term fix as that will not work for a person on a fixed income.

    I think it would be an excellent idea to create a program for homeowners who are current on their payments. Make a program that is flexible to fit the specific needs of the mortgage holder. Example: I have owned my home for ten years. If I could refinance for fifteen years at a reduced interest rate it would increase my disposalable income. I can assure you, I would have no problem spending it!

    I know that BofA is desperate to rid itself of it’s mortgage mess. (One of the reason’s that their stock is in the toilet.) Maybe they are ready to be senseable and deal with a government program that will assist them in unloading their burden with the housing market. Please do not overlook the fact that Fannie and Freddie should not be held responsible for assuming the debt caused by the fraud perpatrated on them and the public by the banks.

    I support the efforts of all you smart people who are trying to find solutions to these horrific problems! I am personally grateful and thank you!

  5. Neildsmith says:

    “stimulus driven through the housing market will act just like a permanent tax cut. The locked-in reduction in rates will be a permanent increase in income from the point of view of the household, giving us an absolutely great bang-for-the-buck in terms of stimulus.”

    Wow – liberals have become conservatives. Tax cuts are the answer to all our problems.

    There was a great fear a couple of years ago that mortgage resets associated with ARM or Alt-A mortgages would doom millions to foreclosure. Did that actually happen? Or did the historically low rates cushion the blow and defuse the bomb? I know – it wasn’t enough. We need full debt forgiveness.

    Haven’t they already received a permanent tax cut – several even? What is the interest rate on all these underwater mortgages and how much will these people actually see in reduced payments – $100, $500 a month? By what mechanism does this actually create jobs when so far Americans have used all the stimulus money to save, invest, or deleverage? Once they deleverage, isn’t the lesson of this crisis that people should stay out of debt completely? Why do we think they will once again start spending beyond their means?

    Magical thinking got us into this mess and more magical thinking won’t get us out of it. If you want to save the poor pitiful homeowners from their disastrous investment strategies then go ahead, but please don’t argue that these foolish people are the key to our economic future. This scheme is welfare for fools and nothing more.

  6. mel in oregon says:

    i have to disagree neildsmith. 20% of american home loans are underwater. that’s a lot of people. many aren’t fools & haven’t done anything wrong. i really don’t give a shit if the money is put back in the economy or not. the fact remains that trickle down economics doesn’t work. the supply side that reagan started has hurt at least 80% of americans, there is plenty of supply, but no demand! reagan i’m sure had no idea who ayn rand was, but his handlers did, & told him government was the enemy of all business & we the people. so he peddled that crap & every president since has too. it may be that americans are finally waking up, hopefully, although the republican wannabees are all wingnuts. so some choice, one stooge against another.

  7. Why doesn’t the Fed just go out and buy houses? Is there some statement in their charter that says they can only buy bonds? Just have Fed agents fan out across the country and pay people whatever their outstanding mortgage amount is for their house. Then write down the asset to market value and resell it. It’s a win for the homeowner (gets out of underwater mortgage), a win for the lender (doesn’t have to write off bad debt), a win for the home market (sales of non-foreclosed homes happen and the market becomes functional again) and a win for the economy (quantitative easing that actually gets into the money supply instead of just sitting in reserve accounts back at the Fed).

    Okay, the Fed would need a lot of extra personnel to travel the nation buying houses. No problem, there are lots of unemployed people available. The Fed has no experience in real estate you say? How about the mall in Oklahoma they had to unload two years ago?

    Forget the GSEs. Any solution with them is going to be excessively complicated and prone to “tunneling“. Use the Fed. Straightforward, controllable, guaranteed to work. And will never, ever, happen :-(

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