A new 35 page report released today by the New America Foundation provides a comprehensive analysis of the causes of the current financial and economic crisis and recommends three core “pillar” solutions to help facilitate a sustainable long term U.S. and global economic recovery. In particular, the report advocates for a concerted effort at alleviating the corrosive effects of the mortgage debt overhang resulting from the past decade’s real estate bubble.
The Way Forward, authored by Professors Nouriel Roubini of NYU and Robert Hockett of Cornell University and Daniel Alpert, Managing Partner at Westwood Capital, a boutique investment bank, cautions that the current economic crisis does not mirror that of a traditional business cycle and that misinterpreting the ailment will lead to ineffective prescriptions. Their analysis traces the current predicament to what they refer to as the “Great Credit Bubble”. From 1996 to 2009, US debt (the majority of which is households and the financial sector) has grown to unsustainable levels from 247% to 380% of GDP. We are now in the process of working these debt levels down but the process will take many, many years. Additional factors weighing on an economic recovery are the rise of export driven economies which has impacted US job growth/wages and the record levels of income inequality.
Against this backdrop, the authors argue that absent significant mortgage debt relief, the economy risks accelerating into negative feedback loop. To address the issue, the authors segment the problem into three broad categories: borrowers that have positive equity in their homes; borrowers with negative equity in their homes but are capable of sustaining some level of mortgage debt; and the more traditional “subprime” borrower whose profile is more suitable to that of a renter. A key policy goal is to keep the borrower in the home and the home off the market.
For delinquent borrowers with positive equity but unable to meet payments due to a weak economy, the authors suggest a bridge loan facility and cite various state programs that have been effective. The argument goes, because the borrower has equity in his/her home, they have an incentive and want to stay in their home. Some kind of temporary assistance is both in the interests of borrower and lender until such time as the economic environment improves.
The report cites an estimated 25% of US mortgages are in a negative equity position. To date, mortgage modifications have focused largely on capitalizing delinquent interest and reducing the mortgage loan rate. These types of modifications have had limited success and the authors recommend implementing some kind of principal reduction or forbearance for those borrowers that are able to sustain some reasonable level of mortgage debt. The underlying recognition is that unless the loan balance approximates the market value of the home and monthly payments are affordable, the borrower has too great an incentive to default. The study does recognize the issue of moral hazard associated with a principal reduction program (i.e. the borrower essentially gets a check back for not honoring their contractual debt) and would require some kind of borrower earn-out in order to participate.
Finally, there remains that category of borrowers with negative equity who in any realistic scenario are incapable of repaying their mortgage debt. To be blunt, many if not most of these borrowers never should have been given the credit green light to become homeowners and it’s a testimony to the magnitude of the credit bubble that these would be renters became borrowers. The recommendation with respect to this last group is to convert borrowers back into renters and lenders into landlords. Again, the issue of moral hazard rears its head and the authors are cognizant that any policy implementation has both a carrot and a stick.
The Way Forward also addresses those borrowers who are non-delinquent on Agency guaranteed (Fannie Mae, Freddie Mac, Ginnie Mae) mortgages but are unable to refinance their mortgages for underwriting reasons. In total, the agencies guarantee the majority of all outstanding mortgages, to the tune of approximately $5 trillion. A significant subset of these borrowers is unable to refinance at today’s rates (30 year mortgages are hovering around 4%) due to negative home equity. The report recommends facilitating a streamlined refinancing. The argument is that since the government already bears the risk of guaranteeing payment on these loans, lowering the borrower rate would actually reduce the risk by making the payment more affordable.
A copy of the report can be accessed at the link below.
http://newamerica.net/publications/policy/the_way_forward
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