Edesses on Mian and Sufi: House of Debt

Michael Edesses reviews the book House of Debt, by Atif Mian and Amir Sufi.  He starts with Larry Summers’s reaction to the book.  Summers, of course, was part of the inner circle, making decisions during the crisis.  Edesses’s take on that is right on the money:

Summers points out that he argued for cram-down. Nevertheless, he says, “the president and his team felt that in a world where many legislative battles lay ahead, a failure on cram-down would be costly in time and political capital.” But enormous amounts of political capital had already been spent on bank bailouts. How is it decided on what to expend political capital?

An even more questionable Summers rebuttal has to do with the proposal that the government buy underwater mortgages from banks. Summers says, “The problem was that in many cases mortgage assets were carried on banks’ books at valuations far above what appeared to be current market value. Buying them at such valuations would have been a massive backdoor subsidy to banks of the kind we would not accept. Forcing writedowns was precluded for regulators who feared what it would do to banks’ capital positions.”

I find this hard to understand. He means that banks’ capital positions were fictional, and regulators feared they would have to face reality? It is hard to escape the feeling that part of the explanation is that a policymaker in Summers’s position is more sensitive to the concerns of banks and the executives of those banks with which he is intimately familiar – one might say captured by banks, even unconsciously – than to the concerns of underwater homeowners.

I think homeowners vs. banks is really a false dichotomy.  It wasn’t good guys and bad guys, or even bad guys and bad guys.  More like bad guys and dumb guys.  And gullible guys.  I’m sure there were ladies involved as well.  Not trying to pile on the guys.

But I worked my ass off for years, and lived in a single wide trailer, in order to build my home.  I resisted the urge to borrow WAY more than made sense, although, like all the people who did so, it was easily available.  To me, it’s just plain wrong to bail out homeowners who borrowed more money than their home was ultimately worth.  And if it’s paid for with my tax dollars, well, that’s just insult on injury to me.  Maybe a cram-down in bankruptcy would be OK, to some extent, but really, if the bank loaned someone more than what in the past has been considered reasonable leverage on real estate, then the lender should eat the loss and the borrower should lose the property and suffer the credit downgrade.

This opinion excludes the illegal and immoral shenanigans pulled by the banks.

But let’s check the assumptions here when it comes to the bailout of homeowners, and even the equity like loan structure proposed by Mian and Sufi.  First, they blame the severity and length of the great recession on breakdown of consumer spending due to excessive consumer debt.

What is unique about the Mian and Sufi analysis is that they take great pains to construct the sequence of events and establish causation. In particular, they rebut the banking view, which states that it was difficult to get the economy moving again after the crisis because banks were reluctant to lend. The consequent drying-up of credit, according to this view, especially to small businesses, put a damper on economic recovery.

Instead, Mian and Sufi argue that the driver of the prolonged slump was a sustained cutback in consumption by homeowners who lost much or all of their home equity. On these points, they couldn’t be more convincing.

This brings to mind the interesting post from John Mauldin regarding GDP, and it certainly makes me think that this is what Mian and Sufi were looking at.  So this first assumption maybe could be looked at again.  Also, I have not read the book, but US consumers have really not de-levered.  See here.

But then they go on to try to fix this problem that they have identified.  I’m not sure that it needs fixing.  This is the assumption that I really doubt.  It seems to me that if we fix anything, it should be the court system and resolution of foreclosures and bad debt, which was shown to be not in working order during the crisis.  Another solution might be for the lenders to assume the risk of the loans they make.  That is, eliminate the moral hazard to the lenders which has been established via bailouts.

Mian and Sufi instead propose a way to share the risk by changing the debt contract.

the debt contract is a very poor instrument on which to base a stable economy. “If we are to avoid the painful boom-and-bust episodes that are becoming all too frequent,” say Mian and Sufi, “we must address the key problem: the inflexibility of debt contracts.”

I guess if lenders and borrowers agree to that arrangement, OK, but not sure it really fixes the problem.  And it certainly doesn’t help the bank balance sheets nearly as much as the FASB rule changes.



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