Policy Prescriptions for the Economy

Comments for the Record

Senate Budget Committee

Policy Prescriptions for the Economy

608 Dirksen Senate Office Building

Sep 15 2011 9:30 AM

by Michael Bindner

Center for Fiscal Equity

Thank you for the opportunity to comment on the hearing of Thursay, September 15th. Please include these comments in the hearing record.

There is much worry in the policy community and the markets over whether we are in or approaching a recession. This fear is misplaced, as the current economic crisis was not caused by a simple downturn in the business cycle.

The heart of the current problem is that we are in a Depression, where a Depression can be defined as a decline in asset prices below the level at which they are financed. In that regard, we are not only in a depression, but a deep depression. More importantly, this depression will continue as long as asset prices are low or as long as loan values are high.

There are four possible outcomes to this crisis.

1. Bankruptcy reform, where bifurcation of the primary residential mortgage is allowed.

2. The federal government, which is the largest holder of residential mortgages when GSEs are included, sells these assets to the Federal Reserve under TARP authority, with the Fed writing down balances of the underlying loans.

3. Inflation in the general economy, raising both wages and housing prices to the levels that can support loan values.

4. Prolonged stagnation.

The prospects for mortgage modification are bleak in this Congress. Inflation is unlikley - deflation is still much more likely. Stagnation is very likely unless modification occurs, provided the Executive Branch has the political will to do it.

Such a write down would be deflationary, as the Federal Reserve would be destroying M2 by writing down these loans - while also stimulating the economy. This is about as close to a classic win-win scenario as is possible.

A write down would also not damage tax payer equity. The asset values backing these instruments have already evaporated. An honest accounting for the related assets simply acknowledges what has already occurred. The value has already been lost and until the loss is realized, it will continue.

Such a write down would be extraordinary and would not incentivize bad behavior. Most bad mortgages have already failed - what are left are people who can afford to pay their mortgages (unless they have recently lost jobs), but cannot afford to sell. Modification will stop the slide in housing values for everyone, not just those with underwater mortgages.

The only group who has a legitimate objection are those investors who are seeking a windfall by purchasing distressed properties for speculative purposes or to consolidate greater wealth. Given the choice between supporting this group and at-risk home borrowers, the only reason to support the former is that they are also more likely to be campaign contributors. To resist either mortgage modification or bankruptcy reform for this reason would be particularly disgusting.

Thank you for the opportunity to submit these comments for the record.