A biblical Jubilee for clearing or reducing some mortgage debt? That’s the kind of radical idea you’d expect in a magazine like the Nation. But as William Greider points out in a recent Nation, more and more folks squarely in the middle are coming to the conclusion that if we don’t start radically cutting back on the principal many homeowners, whose mortgages now far outstrip the actual value of their homes, the housing market may never really recover.
Take Stephen Roach, the Morgan Stanley analyst who made headlines this summer when he floated the idea:
“Some form of debt forgiveness would be a clear positive,” Roach told me. “Debt forgiveness is a big deal when so many Americans are underwater and unable to keep up with their payments. Writing off debts would help them build up their savings. The saving rate is up, but not nearly enough. With debt reduction, people would feel less reluctant to spend money on new things. If you can do that, then companies will feel more confident about future demand, less reluctant about hiring more workers.”
Roach thinks the executive branch can engineer dramatic debt reduction with or without the approval of Congress. Fannie and Freddie together hold something like $1.5 trillion in housing loans or mortgage-backed securities. The Federal Reserve has nearly another trillion on its balance sheet. As owners, they could unilaterally grant new, more realistic terms to stressed borrowers. “Government can do this by simply telling Fannie Mae and Freddie Mac to take a write-down on their outstanding loans,” Roach explains. “Then the government can put pressure on the banks to do the same thing. The banks will resist, but they have to go along if the government is forceful enough.”
The Fed can likewise become a major influence for debt reduction, Roach says. Conservative traditionalists would naturally be appalled if the Fed directly aided the real economy of consumers and producers, but that objection was nullified by the financial crisis, when the central bank pumped hundreds of billions into nonbank corporations like AIG and General Electric.
If the Federal Reserve is reluctant to modify mortgages, says Roach, it can easily fund the process indirectly by creating new money and buying bonds issued by Fannie and Freddie, just as the Fed purchases Treasury bonds. “The Fed can assist by buying Fannie and Freddie bonds with the emphasis on reducing principal for the borrowers,” Roach explains. “It would be like ‘quantitative easing’ aimed at debt reduction,” a reference to the Fed’s purchases of mortgage-backed securities, Treasury notes and other assets to stimulate recovery.
Another mainstream financial analyst makes a similar case:
Laurie Goodman, the Amherst Securities housing-finance expert, assured the Senate Banking Committee in September that debt reduction is readily doable in the financial and real estate industries. “We actually know exactly what it takes to create a successful modification: reduce principal, give the borrower substantial payment relief and modify the borrower in the early stages of delinquency,” she said.
To illustrate, Goodman suggests that a bank or mortgage servicer could reduce an underwater mortgage from $150,000 to $115,000 with a “shared appreciation” agreement. The homeowner would no longer be underwater and would gain some positive equity. If the property is sold in the future, any appreciation in its market value must be shared with the lender. She pointed out that a major mortgage servicer, Ocwen Financial, is already doing such deals. The creditor will get
25 percent of any future market gain. In many cases, that sounds like a better deal for the lender than holding on to the bad mortgage and eventually getting nothing.
“I would like to think principal reduction would be a mandatory part of the government’s modification program,” Goodman said. “The Treasury has not let it happen.”
And as Felix Salmon notes, even some seriously “red-in-tooth-and-claw capitalists” are starting to argue it’s inevitable:
Now comes word that Greg Lippmann, of all people — one of the big winners of the subprime bust, and a man who became extraordinarily wealthy playing in the mortgage CDS market — is thinking along similar lines himself.
“Principal reductions are necessary to help ameliorate the housing crisis,” Lippmann, chief investment officer for New York-based hedge fund LibreMax Capital LLC, said in an Oct. 31 letter to investors obtained by Bloomberg News. The step will also lower losses on loans underlying mortgage bonds, he said.
In other words, Lippmann sees what’s pretty obvious — principal reductions are not only helpful but necessary if the housing mess is going to clear. The question isn’t whether they’re going to happen, it’s how they’re going to happen.
Politically, of course making this happen would be very difficult. But then again, back during the summer nobody was predicting a populist grassroots explosion either.