This week officials from the Obama administration, the banking regulators, and state Attorney Generals announced a settlement of claims stemming from the financial crisis. The nominal amount put forward as the cost of the settlement is $26 billion, and in return the banks will be released from civil claims on origination of mortgages and the falsification of documents in the foreclosure process, or “robosigning”. This caps off a month of political noise on the housing situation which started at the State of the Union, when the president announced a task force on financial fraud headed by officials from his administration as well as New York Attorney General Eric Schneiderman.

An investigation, and a multi-billion dollar settlement. That sounds like a lot, until you put it into perspective. Here are the numbers. Roughly half of homeowners with mortgages are underwater, which means they owe more than they own, to the tune of $1 trillion or so. And housing values are still declining so far in this “recovery”, throwing more homes underwater. In terms of an investigation, the Savings and Loan crisis used roughly 1000 FBI investigators to uncover fraud — this task force taking on a crisis forty times more severe will employ 10 FBI agents.

There’s a reason this is so inadequate to the problem at hand. For the last three years, the policy has been to impose a political solution to a math problem. It hasn’t worked. America simply has too much mortgage debt to pay back. Serious economic thinkers across the spectrum, from Democrat Alan Blinder to Republican Martin Feldstein to New York Fed President William Dudley, believe that there is only one solution — writing down the enormous creaking mound of debt. This solution is currently off the table, because writing down these unsustainable debts could cost our fragile banks enormous sums of money and possibly lead to a restructuring of one or more of our major banks. Avoiding this clear policy choice has resulted in our economy falling into a Japan-style “zombie bank” torpor, with debts carried on the books at full value which everyone knows will not be paid back at par.

This crisis of American political economy in the form of excess mortgage debt is preventing a more powerful economic recovery. Three years after Ben Bernanke used the term “green shoots” to describe a recovering economy, job growth hasn’t really revived in any meaningful way. In fact, this is by far the worst recovery we’ve had since the end of World War II. The best way to measure this is not through traditional unemployment indices (which can be gamed), but by asking the question of how many Americans are working as a percentage of the population. In 2007, this was 63 out of 100. Today, it’s a full five percentage points lower. The ratio hasn’t been this bad since the early 1980s recession, and remember, we’re in a recovery. And the labor force participation rate is dropping, which is a long-term bigger crisis. [BR: Much of this is a function of demographics of the aging Baby Boomers; In terms of Job losses, the chart below is far more damning population ratio:


Calculated Risk

The housing market’s vicious deflationary cycle demands serious policy action to match the scale of the challenge. Dropping housing values lead to foreclosures, which damage housing values, and so on and so forth. According to Zillow, roughly half of homeowners with a mortgage are effectively underwater, which means they owe more on their mortgage than their house is worth. According to Zillow, 28.6 percent of all single-family homes with mortgages had negative equity in Q3 2011. And according to CoreLogic, “10.7 million, or 22.1 percent, of all residential properties with a mortgage were in negative equity at the end of the third quarter of 2011.” (Correction hat tip Calculated Risk)

So far, the alphabet soup laden set of programs (HAMP, HARP, Hope for Homeowners) put forward by the Bush and then Obama administration have been failures. And this is because, as the Congressional Oversight Panel noted as far back as March of 2009, the single best predictor of default risk is how much equity homeowners have in a home. Many Americans, though considered homeowners, are essentially “renters with debt” (as housing analyst Josh Rosner put it). And Amherst Securities Laurie Goodman noted that with our current housing trajectory, we can expect up to 10 million more defaulted mortgages over the next decade. These foreclosures impacts housing values, reduce consumer purchases, and costs municipalities money.

The proposals on the table to solve this problem aren’t inspiring. The meager mortgage settlement deal cut via furious and dramatic negotiations is unlikely to be meaningful. This settlement is essentially a continuation of previous alphabet soup housing programs, because it would not force banks to fundamentally restructure the trillion dollar underwater mortgage problem. It will generate headlines, but it will fail to address the extent of the problem. State attorneys generals have accepted the settlement for a variety of reasons, one of the most frustrating being that they are substantially under-resourced and this deal moves cash their war. This is not how to make good policy. And the housing market will continue to suffer if our political leaders cannot acknowledge the depth of the problem.

Instead, we need some serious discussion from both the Republican candidates and the Obama administration about how to write down mortgage debt. Some proposals would reduce principal, while giving the banks an equity appreciation stake in the home. Others would deal with the problematic accounting standards which allow banks to overvalue second mortgages, and imply that one or more large banks needs to be restructured by the government. These are worth considering. We think it’s important, regardless of how policy-makers reduce the debt, to force the banking system to appropriately value mortgage debt.

Anything less would simply continue the deflation and uncertainty in the housing market.

Ultimately, we need to look at our banking and housing system and engage in a ruthless yet compassionate evaluation of whether it is working to solve our national needs. Serious thinkers in both parties recognize that it isn’t, and that we should find a way to write down this mortgage debt. Only then will we head down a pathway to a healthier banking system, and begin generating the roughly thirty million jobs that will bring America back to full employment. It’s time that the major presidential candidates, and President Obama himself, be honest with the American public, and openly recognize this as well.

Category: Bailouts, Think Tank

Please use the comments to demonstrate your own ignorance, unfamiliarity with empirical data and lack of respect for scientific knowledge. Be sure to create straw men and argue against things I have neither said nor implied. If you could repeat previously discredited memes or steer the conversation into irrelevant, off topic discussions, it would be appreciated. Lastly, kindly forgo all civility in your discourse . . . you are, after all, anonymous.

14 Responses to “On the Mortgage Settlement: There Is No Political Solution to a Math Problem”

  1. CitizenWhy says:

    Again, the official policy is to bail out the banks. This “settlement” is another bailout.

    The last thing that Geithner wants is to write down any debts owed to the banks. He is willing to write down the debt held by pension funds, causing loses to nearly every American.

    Geithner believes that if any one of the big banks collapse, then the whole economy will collapse. The crimes of the banks, to this way of thinking, is irrelevant. Obama believes everything Geithner says. Fellow Ivy Leaguers and all that.

    In other ways the banks will pay a pittance (but really will end up paying nothing), everyone else will pay the banks. That’s the policy, the Geithner Doctrine: the banks must be paid off, given plenty of money, no matter what the cost to the economy or the American people.

  2. econimonium says:

    Whenever the sentence “Roughly half of homeowners with mortgages are underwater” the phrase “at this time” should be added. Let’s say that again…”at this time”. This doesn’t mean that everyone will be underwater forever. In fact being under water doesn’t matter unless you are selling and there is no clear evidence that people are likely to walk away for simply being “under water”, this being mostly an urban myth and if you’re a regular reader of Calculated Risk you know this. So the percentage of people this adversely affects is far less.

    The real problem here is that you can’t refinance. That’s the issue and that’s the clear problem for most. If you currently have a 6% mortgage and you can’t refi back down to 4.0 or less because your house doesn’t have the value then you’re screwed and that’s when you are likely to walk. But if the banks let you, and they finance you down and your payment drops by like $700 a month you don’t care because, frankly *you have to live somewhere and rent isn’t any cheaper and you have no chance of equity there*.

    So stop this crap already with the “half of homeowners are under water”. Will they be 10 years from now? 5 years from now? Who knows right? But if you can drop people’s mortgage payments and clear out this mess you can heal the market faster. And that’s the point.

  3. olddogDALTX says:

    You make sense. Too bad nobody will listen.

  4. Pocket QQ says:

    Yep, I know an under-water homeowner whose refi was strung-out in 2009. They were trapped by Countrywide/BOA for three years at 6.8%. In January they were finally allowed to refi through Quicken Loans into a 20 year Fixed, and are still saving $500+ a month on their payments. Now they are planning their dream kitchen.

  5. Futuredome says:

    “That’s the policy, the Geithner Doctrine: the banks must be paid off, given plenty of money, no matter what the cost to the economy or the American people.”

    The Geithner doctrine? That is the whole systems doctrine. You say there is a cost to the American people, but a banking collapse lays a bigger cost. Time to admit it and come to grip with that fact.

    Are there better ways rather than the naked bailouts? Absolutely, but that would damage the cabal’s power. So you are left with waiting for the banks to return to solvency for the debt writedowns to unclog the system. Why doesn’t the media ever ask Geithner or Bernanke when the banks are going to become solvent again? I mean, that is the real question we are waiting for. The money shot. Make them answer. I think we know why they won’t ask the question.

  6. duaneteddy says:

    Obviously principal write downs are required.Banks should be required to carry mortgages at their fair market value.We have a right to know which banks are effectively bankrupt and deal with that problem. The homeowner mortgages could then be written down to fair value.
    Alternatively, give bankruptcy judges the right to treat residential mortgages the same way they treat commercial mortgages in Chapter 11. Namely, that the lender is only entitled to the value of its collateral-the current value of the house. Let them recalculate payments based on that value.
    We have to face the truth at some point to get out of this malaise.

  7. Sechel says:

    That banks are not writing down mortgage debt on their books can only be a function of government regulators allowing the same banks to value the assets above market price.

  8. number2son says:

    Yep, until Obama jettisons Geithner and his “bank-first” policies, no one with a room-temp IQ will take his administration seriously.

    And econimonium is dead on. It’s not about the market value for working folks, it’s about the monthly nut.

  9. deanscamaro says:

    “And the housing market will continue to suffer if our political leaders cannot acknowledge the depth of the problem.”

    …..political leaders WILL NOT acknowledge….. is how it should read. When you are paid off by big money, you look the other way and refuse to support the voters of this country. We have trash in office and the next election will only bring in more trash…..a sad situation.

  10. boveri says:

    Let’s get real about this zombie bank nonsense. I have to wonder if Dylan Ratigan has ever read a bank’s financial reports. They come out quarterly and state quite clearly their non-performing loans.

    These large banks are not insolvent as their adjusted equity after reduction for ALL non-performing assets is substantially in the plus column.

  11. [...] On the Mortgage Settlement: There Is No Political Solution to a Math Problem | The Big Picture [...]

  12. GroovyGeek says:

    A rational solution to valuing mortgage debt correctly is essential, however it needs to be accompanied by rational consequences for the benefiting homeowners. Equity participation of the bank in future appreciation sounds good until you think carefully about it. What if a homeowner takes the deal, then a year later sells the house with little/no appreciation? The bank is left holding the bag and the homeowner gets a “get out of jail free” card. The alternative is to chain the homeowner to the house and get them to agree not to sell for X years, e.g. X~10, to give the bank a shot at participating in the house’s appreciation. I don’t see how that is workable either.

    I am afraid that the ultimate solution will allow most deadbeats to get a free ride. Sure, the banks were greedy but so were the people who signed the paperwork. Nobody put a gun to their head to take out more than they could reasonably afford. Walking away from the house is an economically rational solution for the homeowner, and I have no moral issues with it, particularly since it has serious consequences for the delinquent party.

  13. [...] There is no political solution to a math problem Big Picture (furzy mouse). [...]

  14. Sunny129 says:


    ‘These large banks are not insolvent as their adjusted equity after reduction for ALL non-performing assets is substantially in the plus column’

    Just hilarious, you just don’t even realize who is really dumb here!

    All NON-performing assets (aka leaking towards less and less value) is ‘substantially’ (wow!) in the plus column -

    Guess this is what called M to model accounting!