Accelerating balance sheet clean-ups
The big problem in the US economy right now is consumers are cleaning up their balance sheets. People are either dealing with debt overhangs from the previous consumption binge or they fear for their future incomes due to either wage cuts or job loss and thus they pay down debt and increase their savings. On an individual level this may be good, but in aggregate, this is a recession.
I know my family is using our marginal dollars to improve our balance sheet. Assuming no significant negative shocks in the next eighteen months, my family’s balance sheet will be the cleanest since our wedding. At that point, several deferred purchases will be contemplated, and our net consumption will increase.
A few months ago, I reiterated a proposal from several dirty fucking hippy bloggers to use the Federal government’s core competencies of borrowing money, writing checks, and collecting money to accelerate balance sheet clean-up:
The New York Times has an interesting Op-ed that echoes what some ‘Hog guest writers were saying in February 2009 on a way to stimulate the economy, improve consumer cash flow and balance sheets as well as generate some short term federal revenue… offer consumers a chance to refinance high interest revolving debt with lower interest debt offered by the federal government….
Going from 18% to 8% interest, the individual with $10,000 in credit card debt would see their initial monthly payment go from $250 a month to $167 per month. Using a declining minimum payment formula (monthly interest expense +1% of current balance), the debt burden at the end of the year is still $9,000 but the interest expense declines from $1,570 to $700. That gap of $870 is greater than the ARRA Making Work Pay tax credit…
This debt would be relatively secure and low-risk for the US government to issue as the IRS could be made the collection agency for the debt. Long term risk could be lowered by changing the minimal monthly payment formula so that the monthly minimum would be interest expenses plus 1% of principal + half the savings from the interest arbitrage. That change would accelerate the repayment of debt while also freeing up cash flow for consumers to either spend or save….
Since I wrote that piece, long term Federal interest rates have dropped another 45 basis points, so it would be even cheaper and profitable for the federal government to offer a one time debt restructuring deal. It would have the advantage of increasing short term consumer cash flow so either consumption is increased in the short term, or the balance sheet clean-up efforts take significantly less time.
The Very Serious People are coming around to this idea. Bill Gross of PIMCO wants to use the federal government’s backing of Fannie and Freddie Mac to leverage a massive refinancing scheme for fixed rate mortgages that are federally backed and where the borrowers are current on payments:
Bill Gross, who runs Pacific Investment Management Co.’s $239 billion Total Return Fund, said that policymakers “should quickly re-engineer” a plan that would refinance all non-delinquent mortgages backed by the federal government. The rate on a 30-year fixed-rate mortgage averaged a record-low 4.44 percent in the week ending Aug. 12, according to taxpayer-owned mortgage giant Freddie Mac….
Greenlaw estimates about 18.5 million taxpayer-backed mortgages are at rates higher than 5.75 percent interest.
This idea is structurally similar to the credit card idea. It would free up current cash flow that could be used for either increased balance pay-down and thus balance sheet clean-up accelerates or that cash flow would be used primarily for current consumption. It would also marginally reduce the number of mortgages that go bad as the carrying cost of a house that is marginally underwater would significantly decrease. The big losers under this proposal would be the MBS tranche holders who are only making significant money on newly purchased securities if the payback occurs over several years instead of very quickly.
Either of these proposals would accelerate balance sheet clean-up, and right now acceleration is needed.
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“This debt would be relatively secure and low-risk for the US government to issue as the IRS could be made the collection agency for the debt”
Um, as a former collection employee (10 years ago) at the IRS, I need to ask, do you have the faintest idea how dumb your blithe idea is that the IRS can just take over those kinds of debt collections? Do you have any idea how understaffed it is (back door tax cut to the republican base, ie the rich who get the loopholes and the self employed who get to cheat by declaring a small fraction of their income because of lax enforcement and then skate on the tax due if they lose the audit lottery because Collections is understaffed)? Do you have any idea how much tax owed to the government goes uncollected because Congress will not provide resources adequate to do the job? How are they supposed to set up this new debt collection? Where do people on the left and right both gets their ridiculous ideas about the IRS and its capabilities? Does anyone remember those hearing in 1998? Does anyone care about how those “reforms” crippled what capabilities the agency once had? Every time some idiot comes up with a new idea for a credit to be administered by the IRS, that takes overstretched resources away from the core work of the IRS.
The premise of this post is kinda iffy to begin with. But if you’ve given as little consideration to the rest of it as to this one provision, that sure isn’t promising.
Um, as a former collection employee (10 years ago) at the IRS, I need to ask, do you have the faintest idea how dumb your blithe idea is that the IRS can just take over those kinds of debt collections?
Anonymous, what are your thoughts on the new “health care plan”, then? It is supposed to fine people who don’t buy the “insurance”, and use the IRS as a collection agency, too.
One question:
Once the Federal government assumes the mortgage directly, does the home owner still have the option of walking away from the underwater property?
Under current law, the banks must accept the keys on in the mail in lieu of paying the full balance on the overpriced mortgage, but something tells me the IRS won’t be so forgiving. More likely, defaulters will be slapped with a tax lien for the remaining balance that will follow them around until, well, forever.
Giving up the right to walk away from a property seems a huge price to pay for a small cut in monthly payments, especially on a property whose actual value is highly unlikely to ever exceed the value of the loan, and extra especially when the IRS is made the debt collector of last resort.
The problem is not the interest rate that Americans are paying on their debt, it is the amount of that debt. Your plan does nothing to diminish the amount of debt, in fact, by encouraging increased spending to stimulate the economy it actually increases the amount of debt and, as a previous commenter points out, puts that debt in the hands of the government, who should be the lender of last resort.
Trying to sustain an economy that is 70% consumption and 20% “financial services” is insanity. When a consumer buy a flat screen television that is produced in Asia how, precisely, does that contribute to the American economy?
For those who have not seen it already, here is economist Dean Baker’s “Right to Rent” proposal:
Right to Rent
The Right to Rent Plan (includes a short, two-page PDF with the proposal)
“Where do people on the left and right both gets their ridiculous ideas about the IRS and its capabilities? Does anyone remember those hearing in 1998? Does anyone care about how those “reforms” crippled what capabilities the agency once had?”
Probably from personal experience–nobody that I know who’s poor or middle-income has ever been able to skate from their IRS responsibilities, and the IRS’s ability to do things like levy your bank account or paycheck without notice (leaving you about minimum wage to live on–I know people this has happened to) is not exactly a “crippled” capability, is it? I would say it’s some pretty awesome power.
Now granted, the IRS is a teddy bear compared to private collection agencies or the real beasts at Sallie Mae–if you cooperate and try to make payments they will generally work with you, and only use those extreme measures when people are really recalcitrant. But again, I think peoples’ personal experiences with the IRS are what inform their viewpoint that it’s a mighty tower of coercive force.
Those people have never been late on a student loan payment…
Obviously this is the plan to shift the risk of default on outstanding mortgages from those in the private sector who are holding them to Fannie and Freddie.
Anon2525 is right. Home owners with mortgages should be given the option to stay in their residences as renters for the coming five to fifteen years at the going local rental rates for comparable properties (i.e. staggered dates for the expiration of the rental option), rates which would be considerably lower than their current mortgage payments. Those who lent against the value of the property and who are holding the mortgages would take title and wait out the downturn.
Obviously this is the plan to shift the risk of default on outstanding mortgages from those in the private sector who are holding them to Fannie and Freddie.
You should keep in mind that the fund that Bill Gross manages (PIMCO) owns a large number of bonds issued by Fannie or Freddie. It would not be in the interest of that fund to have a people who have mortgages that they are paying to Fannie or Freddie default.
Those who lent against the value of the property and who are holding the mortgages would take title and wait out the downturn.
Or, as Baker argues, it would give the lenders some incentive to negotiate with the borrowers because the lenders do not want to become the landlords of thousands or millions of properties (taxes, insurance, maintenance, collecting rent).
Some outcomes that would not be good for the country:
- A large number of unoccupied, unmaintained properties (not good for lenders, not good for borrowers, not good for other residents in those neighborhoods)
- A large number of individuals and families without stable places to live
- A large number of businesses and borrowers being rewarded for bad/foolish/risky financial decisions (“moral hazard”)
anon2525 writes:
You should keep in mind that the fund that Bill Gross manages (PIMCO) owns a large number of bonds issued by Fannie or Freddie. It would not be in the interest of that fund to have a people who have mortgages that they are paying to Fannie or Freddie default.
Financial Times August 12 2010:
Bill Gross, who manages the world’s largest bond fund, said on Wednesday that he would not buy bonds backed by mortgages unless the US government continued to guarantee the debt.
His comments, in an interview with the Financial Times, will raise the stakes ahead of next Tuesday’s housing finance conference at the Treasury department, which will lay the groundwork for reform of Fannie Mae and Freddie Mac, the large government-owned mortgage finance companies.
The Treasury currently backs the debt of Fannie Mae and Freddie Mac, which in spite of ballooning losses are propping up the housing market by buying or guaranteeing new loans. Some conservative politicians and policy experts have suggested that the agencies should be privatised and the government’s involvement curtailed.
Mr Gross, the founder of the Pimco and manager of its $239bn Total Return Fund, said such a move would, in effect, cause him to withdraw from the market….
I am by no means an expert on the credibility of Gross’s statement. Here’s what Yves Smith had to say on the subject:
If Smith doesn’t think Gross’s statement is credible, then I am not going to accept what he said at face value. Of course, Gross could prove Smith to be wrong to doubt him.
Gross also said that if his own proposal was followed, it will cost his fund money:
“At PIMCO, we’d be affected by $3 or $4 billion in terms of a refunding loss,” Gross said. “But I’m here as a public advocate, not as a private [investor]. When I go back to Newport I’ll be back to managing that portfolio.”
To go back to your original point, yes, there has been a lot of MBSs moved from banks to Fannie/Freddie, and there has been a lot of discussion about this movement passing the risk of mortgages that banks believe are risky from their balance sheets to the GSEs. (And F&F have been pushing back on this, fighting with the banks to take back mortgages that have gone bad.) But are you arguing that this is relevant to Dave Anderson’s (and now Gross’s) proposal to refinance large numbers of mortgages at lower interest rates?
But are you arguing that this is relevant to Dave Anderson’s (and now Gross’s) proposal to refinance large numbers of mortgages at lower interest rates?
Yes. There will be pressure to expand the program to include everyone with an underwater mortgage who has remained current on their payments thus far, even those paying on mortgages not currently held or backed by Fannie/Freddie.