A Creditor’s Playland, or: Cato on Housing Crisis Policy

Earlier this week we talked about a worldview in which all the laws, customs, norms and policy was geared towards only serving the interests of creditors.  A libertarian vision of defending power where “benefitting creditors is the only thing that the rules of debt should consider.”

Yesterday Mark Calabria, director of financial regulation studies at the Cato Institute, gave five steps to fixing the housing market on Cato’s blog.  Check this out:

1.   Speed up the foreclosure process.  The massive shadow inventory of homes yet to hit the market, numbering in the millions, is keeping potential buyers on the sidelines.  Why buy now when a future massive increase in supply will likely depress prices more?  It is best to get that supply to the market now.  We also, by my estimate, have about 500,000 borrowers still in their homes that have not made a single payment in over 2 years.  These borrowers will likely never get current.

2.   State Attorneys General need to either put-up or shut-up.  Holding back lending by depressing bank equity values, and not to mention dragging out the foreclosure process, is a massive 50 state targeting of bank foreclosure practices.  If the state AGs have some real evidence, then why aren’t we in court?  Either the AGs should go to court, where we can all see the facts, or they should drop what only looks like a shakedown….

5.   Exercise recourse when possible.  Many federal loans, like FHA, have a recourse option.  In the case where borrowers can pay, but simply don’t want to (due to price declines or otherwise), they should be held to account.  When FDR did mass re-fis and modifications in 1930s, he also demanded strong recourse, which was regularly exercised.  If its harmful for a bank to start a foreclosure, then it’s also harmful for a borrower, who can avoid it, to also do so.

In the first and second point, when a bank initiates a foreclosure it is just the market working its magic.  If a bank needs to foreclose we should encourage it to immediately.  Changing bankruptcy laws to protect homeowners, forcing mandatory mediations at the state level, swapping debt for equity and other government policies would just get in the way of Nature running its course.  Demanding accountability through investigations on whether or not a bank follows the proper property trail for a securitization and a foreclosure is a “shakedown”, stopping virtuous market work of getting banks executing foreclosures immediately.

In the last point, when a homeowner defaults and thus initiates the steps towards a foreclosure, the government needs to use maximum power to discipline and stop them.  By “recourse” we mean follow the debtor who is foreclosed on to the ends of the earth to collect every last penny that can be taken.  For when a debtor ends up initiating a foreclosure it is not the virtuous logic of the market working its magic through the aggregation of choices and prices, the way it is when a creditor does it.  It is something wrong that needs to be fought and combated in our laws and rules.

I like this form of libertarianism, where policy is simply the things that defend the power and hierarchy of creditors, the rich and the elite, much better than the normal “gee whiz markets are cool” kind.  There’s almost a Nietzschean zeal for the wonk world to first and foremost accept creditors as a master class to whom all policy bends. Let’s get a quick quote from Nietzsche’s On the Genealogy of Morals, Second Essay: Guilt, Bad Conscience, and Related Matters, which would make a nice follow-up point #6 (h/t Debt: The First 5,000 Years):

Have these genealogists of morality up to now allowed themselves to dream, even remotely, that, for instance, that major moral principle “guilt” [Schuld] derived its origin from the very materialistic idea “debt” [Schulden]?…By means of the “punishment” of the debtor, the creditor participates in a right belonging to the masters. Finally he also for once comes to the lofty feeling of despising a being as someone “beneath him,” as someone he is entitled to mistreat—or at least, in the event that the real force of punishment, of executing punishment, has already been transferred to the “authorities,” the feeling of seeing the debtor despised and mistreated. The compensation thus consists of an order for and a right to cruelty.

Wonk Points

Allright, enough fun.  Time for the wonk work.  The logic of each of these points is wrong.  Watch the logic in the first point – a large “shadow market” of real estate owned housing inventory is holding back the housing sector (which it is), so it is best to increase the shadow market as quickly as possible.  I would say it is quite easy to model the logic of not forcing firesales into a depressed market, especially when the market is characterized by principal-agent problems of servicers.

If you are just being introduced to the foreclosure fraud issues brought up in the second point, remember that these issues aren’t trivial.  In a real sense securitization is entirely about manipulating certain legal technicalities, ranging from trust law to bankruptcy remoteness to REMIC, in order to take advantage of certain legal and tax structures in the “financial engineering” of these financial instruments.  If the paperwork wasn’t followed that has massive consequences for other investors and for homeowners.  Remember the foreclosure moratorium last year was initiated by the servicing banks themselves, not activists or the government, because they knew thing have gone horribly wrong, and the real revolt is coming from bankruptcy judges who are tired of having a mockery made of their courts.

I love how the concept of “moral hazard” plays out here.  Homeowners need to be disciplined at even the slightest hint that they aren’t paying up, but there’s no need for an investigation into the disaster of the biggest banks and their servicing and securitization divisions.  As Matt Stoller pointed out, with no threat here there’s even less of a reason for the banks to follow the rules in the future.  And as Yves Smith pointed out (with a great chart), the way that the government in getting in the way of foreclosures is just enforcing the actually existing laws on the books, or by making it a felony to submit false representations to the courts.  What’s the moral hazard if we don’t do these things?

There doesn’t seem to be any wave of strategic defaults: in the words of the Federal Reserve Board “The fact that many borrowers continue paying a substantial premium over market rents to keep their homes challenges traditional models of hyper-informed borrowers.”  But for the last point – “In the case where borrowers can pay, but simply don’t want to” – is actually a difficult thing to figure out.  What is a good formula?  Who would we trust to determine who can pay what – the creditors themselves?  One person we trust as a society is a bankruptcy judge, hence the push for modifications.


3.   The Fed should start raising rates.  First, what bank wants to make a mortgage at 4% when their cost of funds in a few years will easily be above that?  Just like any price ceiling, artificially low rates cause shortages.  In this case current Fed policies are reducing the supply of credit, making it harder for potential borrowers to get mortgages (yes, if you can get a mortgage, the price is great).  When rates do go up, which they will, such will put downward pressure on prices, better to take that hit now.

Low interest rates are causing shortages in the housing market?  Here’s Calabria arguing in 2010 that “The Federal Reserve’s extremely loose policies earlier this decade resulted in a massive reallocation of resources from the rest of the economy into housing” – I thought it was sacrosanct among the Right that too low interest rates caused housing to skyrocket and that QE was a desperate attempt to re-inflate the housing bubble instead of suppressing it.

Wouldn’t raising rates trigger a double-dip recession almost immediately?   The interest rate should be negative, but it can’t be – raising rates would be a signal that the Fed was never going to try for either part of its mandate.  Indeed, if we want to help with the balance sheet part of the recession, the Federal Reserve should go after the mortgage rate to help with refinancing – more aggressive monetary policy, the opposite of raising rates – in order to bring down the monthly debt payment on the household’s balance sheet.  See Joe Gagnon, who suggests the Fed “should announce new large-scale purchases of agency guaranteed mortgage backed securities (MBS) with the goal of keeping the 30-year mortgage rate between 3 and 3.5 percent through the end of 2012,” along with HARP revisions.

Is this how the entire Right sees the housing market in the aftermath of the bubble?

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15 Responses to A Creditor’s Playland, or: Cato on Housing Crisis Policy

  1. Other than showing how stupid CATO is, I don’t see the point in giving them so much coverage.
    Plus, I got confused knowing where they ended and you began writing your response.

  2. JaredB says:

    Why would CATO have a director of financial regulation?!

  3. Tom M says:

    To one point, though, it would seem you agree: if the State AGs have a case, let’s get it going. The difference being Cato thinks it a bluff and you don’t.
    It does affect some perceptions that the “government” isn’t doing anything to punish wrongdoing. It isn’t.

    • EMichael says:

      The government is certainly doing something to punish wrongdoing, they are trying to stop any such punishment. Geez, what do you think the purpose of trying to drag the 50 state AGs into a ludicrous agreement is?

      What do you think the GSEs settling valid lawsuits against investment banks for pennies on the dollars is? Along with no criminal prosecutions of known cases of fraud? Geez, Citibank execs under oath in Senate testimony agreed that up to 80% of their mortgage sales to the GSEs were fraudulently presented.

      The whole purpose(at least I hope it isn’t just paying off your masters) of the government’s actions in this area has been to preserve the banking system. There is not a major bank in the US that could survive if we followed the legal recourse open to us and discovered where all the bodies lie.

  4. Cato has anticipated that eventually the discussion will turn to something like this:
    It is in their interest to accelerate foreclosures and boost interest rates before that discussion gets going because of course it’s harder to unwind foreclosures, especially where there is a subsequent good faith buyer, than to stop them in the first place.

    Cato is definitely being brazen about exalting creditors over debtors, but rather than just analyzing it, we should be out in front of it. Cato is putting a clear, simple, morally-grounded message out there, and we know it will be echoed all over the media. I wrote the piece above to stimulate creation of a simple, concise statement (our vision, not a reaction to theirs) that we can promote. We have what should be the popular position, but as usual, the left is behind in developing catchy and coherent messaging.

  5. Neildsmith says:

    Mike et al. want renters like me to pay more for our first houses. Why should we save the nice people who overpaid for housing in 2003-2007 on the backs of renters? Why is this good policy?

  6. Asher says:

    I have no idea what you’re talking about. Housing is overvalued, period. In the long term, housing values are simply a result of the people who can afford it, the product of incomes. So, since housing is overvalued, how do you propose to bring down nominal valuations? This is coming from someone, me, who was calling a housing bubble back in 2005.

    One huge problem is that current policies significantly distort the wage market. The greater the distortions in the wage market, the greater the cost of price-finding. Distortions in the wage market create distortions in the housing market. Debtors are holding onto what they have because valuations are distorted and they don’t know what else to do, but at some point valuations are going to have to adjust to realities.

  7. Asher says:

    I ran across a prominent commentator from the right who asserted that we can’t have a general recovery without a housing recovery. But since the real valuation of housing is nothing more than a reflection on a recovery of real wages I fail to see how a real recovery can happen without an adjustment in nominal housing values. Large-scale modifications in the terms of mortgages will just distort the housing market and create nominal valuations disparate from real values. This creates the opportunities for wealth transfers and, thus, rent-seeking.

    Since I am not a rent-seeker all policies that promote rent-seeking transfer resources from me to someone else. Let’s put it another way: policies that promote distortions in price-discovery, by definition, promote rent-seeking. I may not be able to specify the rent-seekers, but I know it’s going on, and I know that someone is taking from me and giving it to someone else.

  8. Cato dug up Andrew W. Mellon and reanimated him. They work wonders.

  9. Troy says:

    >Here’s Calabria arguing in 2010 that ”The Federal Reserve’s extremely loose policies earlier this decade resulted in a massive reallocation of resources from the rest of the economy into housing”

    Thing is, that’s not what really happened.

    What actually went down was the entire global economy got pulled out of the 2001 recession through an under-leveraged home sector.

    Leverage was flat through the 1990s:


    so the machine was primed to explode, thanks to falling interest rates (from 8% to 5%) and the tax cuts in 2001-2003. That got home appreciation going, and what kept it going was the feedback nature of sector job growth (construction, mortgage brokering, home depot, etc etc) and the new source of income households had via HELOC and serial refinancing.

    Home prices were driven up 2004-2005 by expanded access to suicide lending and liar loans, along with compromised underwriting and fraud protection.

    This all expoded 2007-2008. but while it lasted it pushed 6 TRILLION DOLLARS into the consumer economy, 1999-2007. YOY debt take-on exceeded $1T during the bubble:


    this was a virtual income that flowed through consumers and gave us the feel-good times.

    It was all fake, fiction, and fraud, but nobody seems willing to admit it.

  10. Dana says:

    If the lenders would work with the people utilizing the government funds that were given to them for such purpose, then we wouldn’t be in this mess. It takes 30 days or less to close on a home purchase, and usually two weeks for a refinance; yet it takes more than eight months to be approved for a lower interest rate through the Home Affordable Modification program. Then, after eight months of underwriters and processors sucking in a nice paycheck that the government authorizes, the homeowner is denied for some technicality.

    I was in the midst of a lawsuit, and my husband had just lost his job. We have children, whom we would like to remain in their home and schools, so we applied for the home affordable program.

    After eight months of repetitively asking for the same documents, as if they hadn’t received them the first time, B of A determined that my income of $3000 per month was too low to qualify for a mortgage reduction. What? They just said that I had to keep my 8% interest rate, and high payment, because my pay was too low to qualify for a lower mortgage. I figured it out, and a reduction to a 5% interest rate would have lowered our payments by $400 per month, bringing us to the 31% mortgage, which is the intention of the program. They also told us if we didn’t pay all the payments that were due during the past eight months they were playing games with our mortgage, they would foreclose. We could not refinance, as I am self-employed, making qualification next to impossible, unless you make alot of money and have excellent credit.

    When we purchased our home in 2006, we were told we could refinance after three years if we kept our payments current. Well, three years later, we’re told that the requirements have changed. Now we will no longer be able to refinance.

    Most people going into subprime mortgages were led to believe that the high interest rate could be refinanced after three years of timely payments. We finally encouraged them to repost previous overpayments to the unmade payments, and this was done. We also closed our escrow account. Then we were able to save our home.

    I would have liked to enjoy my children and watch them grow rather than fighting with B of A for eight months, on a full-time basis, just to save our home, and then get denied.

    The system is very flawed. There are too many homes on the market, and there serves no purpose to make these people homeless in hard times when they’re not selling anyway.

  11. All things depends upon the way you think to get over the crisis.

  12. jrb says:

    bankruptcy: no, some things depend upon
    a red wheel barrow

  13. Thorstein says:

    Mike, you say that “There doesn’t seem to be any wave of strategic defaults…” and then cite a FRB research paper (from June 2010?) to support your belief.

    But what about this article in Bloomberg:


    which states: “The share of strategic delinquencies … has risen to about 26 percent to 27 percent from 20 percent a year ago…

    “The share of strategic delinquencies among prime non-agency mortgages, which were typically jumbo loans larger than government-supported Fannie Mae and Freddie Mac could finance, is now almost 40 percent, up from about 30 percent a year…

    “For Alt-A loans, considered between prime and subprime in terms of expected defaults, the share [of strategic defaults] is about 35 percent, up from about 30 percent. For subprime loans, the amount is about 25 percent, up from less than 20 percent….”

    Do you think the Bloomberg research that’s being quoted is wrong? How do you reconcile your beliefs with Bloomberg’s report? Would you rebut the JPM research by saying something like: There is no generally accepted definition of what constitutes a ‘strategic default’?

  14. Pingback: Links 11/8/11 | Mike the Mad Biologist

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