Should We Just Call a 'Do-Over' on the Mortgage Market?

Over at Unqualified Offerings, Thoreau asks why we shouldn't just cancel all the damn mortgages and start over.  I sense that he isn't the only one thinking this sort of thing these days, and while the temptation is to snort and say "that's ridiculous!", the fact is that something similar has been tried before, in land reform schemes that aimed to address an untenable inequality between landholders and the much more numerous unlanded poor.

More than a few people in our society feel that the banks represent this sort of unstable power, so it's not surprising that somewhat radical programs are becoming more commonly voiced.  I'd like to consider this proposal on those terms, and see whether it doesn't have some merit.

So what are the advantages of what you might call a "reboot"?  Simplicity is perhaps the greatest; the person who now has title, keeps it, free of liens.  If you are in favor of redistributing wealth, this certainly does so, away from the holders of capital and towards small landholders.

Meanwhile, you're doing a lot to clean up overburdened hosuehold balance sheets.  People being dragged under by a huge mortgage suddenly get a lot of breathing room.  Households gain assets in the place of net liabilities (their underwater mortgage).  Those assets might be leveraged for creative activity; at the very least, being freed from the fear of homelessness might enable people to take entrepreneurial risks that they otherwise wouldn't.

Obviously, a not-inconsiderable feature for many people is that this would strenuously punish bankers who are perceived to have so far gotten off scot free--and to be taking unusual liberties in the belief that they are too damn important to suffer along with the rest of us.

Sounds great!  Why not do it?

Well, as with so many things, there are a few downsides.  Start with the fact that the outstanding value of mortgage-backed securities on one-to-four family homes is about $11 trillion,   That's about 80% of GDP, give-or-take.  Now, not all of that debt is held by Americans, but essentially you're talking about wiping out value equivalent to about 70% of GDP.

Now, imagine that you suddenly lost wealth equal to 70% of your income.  What would you do?  You'd hunker down and refuse to spend any money, that's what.  So the boost from freeing folks from their mortgages would be counteracted by the contraction from people who lost money:  in their pension funds, 401(k)s and so forth.  In a very simple economic model, the contraction would be equal to the boost.  In the more complicated world we actually live in, the contraction would probably be bigger than the boost, for two reasons.  First, psychologically, we're loss averse:  humans react more strongly to losses than to gains.  And second, the pain would be concentrated on a very important sector, one where contraction tends to be felt strongly throughout the economy.  Yes, I'm talking about those institutions you all love to hate: the banks.

Of course, you may feel that this is a feature rather than a bug.  To see why I disagree, read Benjamin Roth's The Great Depression: A Diary.  When money and credit disappear, prosperity goes along with them.  Wiping out trillions worth of bank equity would almost certainly mean either another, bigger taxpayer bailout, or the kind of economic misery that only besets modern economies during financial crises, or wars.

Perhaps you think this is just the sort of drivel that would be spouted by a sellout to the banksters.  Whether you agree with me or not, virtually all of our economic policy folks do, so it's hard to see how we'd avoid the bailout.  That means that this would be not so much a transfer from banksters to homeowners, as from taxpayers to homeowners, with all the fairness complaints this would entail.  Old people who have mostly paid off their homes would get no benefit, and indeed would take a huge hit on many of their investments.  The more conservative your mortgage, and the longer you've stayed in your home, the less you'd benefit; the greatest advantages would go to those with the most recent, and irresponsible, mortgages.

(Surely we can all agree that some mortgages were irresponsible--and those people would get the biggest advantage from a foreclosure moratorium).

Worse, one presumes that between torpedoing bank balance sheets, and the unilateral cancellation of mortgage contracts, most investors would reconsider the wisdom of lending money on homes.  So now everyone's got a new asset--that has suddenly lost about 90% of its value, since the price of housing is today largely predicated on the ability to borrow.  Cue another round of contraction, as people feel poorer and stop spending.  Cue disaster from anyone who depended on selling their home to fund, at least in part, their retirement.  In fact, many of the things that Americans have used home equity for--college tuition, home repairs, getting some breathing room on the credit cards--would be badly hurt.  The ripple effects would be felt in many sectors.

In general, radical change just isn't good for economies.  When the future isn't predictible, people don't invest--and I don't just mean rich people clipping coupons on their munis.  What you see a lot in developing countries is that people don't want to make investments that should make them better off--investments in education, in agricultural equipment, in a new business.  The reason they don't is that they can't predict whether the government (or roving bands of thugs) will let them benefit from their investment.  If you aren't sure what the rules will be tomorrow, you're better off consuming as much as possible today, and saving only by hoarding currency in some hidey-hole.  The result is a cycle of underdevelopment.

That's not to say that we shouldn't punish bankers, or reform the mortgage system, or what have you.  But there are less drastic ways to sanction the bankers, clear up the titling problem, and even help struggling homeowners.  With such an endless litany of arrogance, incompetence, and even criminality coming out of the mortgage sector, radical simplicity has an undeniably compelling emotional appeal.  But the aftershocks would be distinctly unappealing.