As we start the New Year, the executive branch and Congress continue to pretend the gravest risk to our economy and social stability does not exist: the ongoing foreclosure crisis. The financial crisis began with the housing crisis and it will not end until we resolve housing. Government policymakers who seemingly ignore this basic fact are leading the nation to another potential catastrophe.
Last week, a number of important events occurred in Washington, including important recess appointments by President Obama. However, the most noteworthy event did not make front page news: the Federal Reserve's (apparently) unsolicited memo to the committees of Congress that oversee financial services warning of the dangers the current housing market poses for the economy.
This represents an extraordinary action and underscores both the seriousness of the continuing crisis and the absence of meaningful discussion of the problem in Washington. Bernanke's memo reviewed federal actions to date and effectively concluded that they were unlikely to solve this national tragedy. The memo concluded, in part:
The challenges faced by the U.S. housing market today reflect, in part...a persistent excess supply of homes on the market; and losses arising from an often costly and inefficient foreclosure process (and from problems in the current servicing model more generally)... Absent any policies to help bridge this gap, the adjustment process will take longer...pushing house prices lower and thereby prolonging the downward pressure on the wealth of current homeowners and the resultant drag on the economy at large.
This memo is notable for several reasons. First, it's important to remember that when the Fed speaks, it does so in sober, limited terms. So an unprompted Fed warning suggesting "a persistent excess of supply" and a "resultant drag on the economy" is comparable to the Secretary of Homeland Security holding a press conference to warn of the risk of an imminent national emergency. Second, an unprompted memo from Bernanke to the House means that he is so deeply worried he felt the need to speak out in as strong a voice as his position permits. Third, the Fed rarely speaks on issues unrelated to its direct activities. Indeed, The Wall Street Journal subsequently wrote that, "For an institution that jealously guards its independence, the Federal Reserve is wading into treacherous political waters." This further underscores the severity of the risks the Fed foresees.
Finally, a further indicator of the depth of the Fed's concerns is what may be an apparently unprecedented set of coordinated speeches by three top Fed officials. On Friday, the presidents of the New York and Boston Fed banks, and Betsy Duke, a Fed Governor, all gave speeches detailing the need for aggressive action to spur a housing recovery. For example, William Dudley, president of the New York Fed, told a group that, "The ongoing weakness in housing has made it more difficult to achieve a vigorous economic recovery."
There are a multitude of additional indicators that our current treatment of the housing sector will at minimum prevent an economic recovery and at worst have disastrous consequences for the stability of the financial sector as well as the health of the middle class. (For the record, my analysis leans toward the latter of these two viewpoints.) These include the reportedly poor health of our financial institutions (zombie banks), the administration's seeming efforts to cover this fact up, and the inevitable failure of federal homeowner assistance programs that rely on the cooperation of financial institutions whose profit incentives are in the reverse direction.
Consumer spending represents 70 percent of the nation's economy and is central to any economic recovery. To achieve sufficient aggregate demand (i.e. total spending on goods and services), this will require spending by middle-income individuals in addition to what we now call the 1%. The Fed report suggests that the housing crisis makes such a recovery unlikely.
The report found that, in the aggregate, more than $7 trillion in home equity -- more than half of the aggregate home equity that existed in early 2006 -- has now been lost, noting, "This substantial blow to household wealth has significantly weakened household spending and consumer confidence." In addition, "Middle-income households, as a group, have been particularly hard hit hit because home equity is a larger share of their wealth in the aggregate than it is for low-income households (who are less likely to be homeowners) or upper-income households (who own other forms of wealth such as financial assets and businesses)." These households have seen their home equity decline by an estimated 66 percent.
Moreover, the fear of a continuing loss of wealth (which is
a cushion against job loss or other economic emergencies), the fear of job loss
itself, the negative effects of underwater homes, lack of forbearance for
unemployment (a point the Fed particularly emphasizes), and consumers
struggling to meet mortgage payments in a far more difficult environment are
all dragging the economy down.
There is also a far worse possibility. Today, an estimated 29 percent of all homes with mortgages are underwater. In addition, at least one respected analyst estimates that a total of 14 million homes will be foreclosed on from 2007 to the end of the crisis. This represents a hard-to-imagine one in every four mortgages. With foreclosures increasing, there is now such a looming imbalance of supply and demand that, as the Fed notes, further decreases in home prices are likely. Some believe home price reductions of another 20 percent are likely. This would, in all likelihood, have disastrous consequences on at least three fronts -- and ripple effects that are impossible to predict.
First, many homeowners would be so far underwater that massive walkaways would be likely. The negative impact on consumer spending of such price declines would almost certainly lead to a vicious cycle of more job losses, leading to further walkaways by struggling consumers.
Second, the mortgage securities market would be in chaos. Nonperforming loans would lead to the forced recognition that bank capital (based on the value of mortgages in bank portfolios) is weak or insufficient.
Third, it is almost impossible to imagine foreclosures on the massive scale anticipated without dire social consequences or even some form of social unrest. As Peggy Noonan has observed, the real meaning of Occupy Wall Street is that this is just the beginning of the protests we are likely to see. "OWS is an expression of American discontent, and others will follow," she predicts. Protests and social unrest are particularly likely if people feel they are unfairly losing their homes to support irresponsible, law-breaking institutions that have successfully disregarded the fundamental rules of capitalism and good citizenship. Mechanisms to avoid this possibility are one of the central issues I address in my forthcoming book, Making Capitalism Work for the 99%: A Manifesto.
What is shocking is the almost total lack of attention the administration has paid to suffering homeowners. It's hard for me (and apparently Chairman Bernanke) to understand how the administration can possibly hope to revitalize the economy without seriously addressing the overhang of consumer housing debt. Moreover, the failure to address the risk this poses for a broader economic catastrophe borders on the inexcusable.
If President Obama is serious about saving the middle class and reducing income inequality, the administration needs to be far more aggressive in developing policies to keep homeowners as homeowners. As I have written before, this was one of FDR's central goals in the New Deal. Detailed proposals for addressing this extraordinary risk do exist. However, they will require a determined effort. There are solutions, but they are not simple.
What is most important right now is that we recognize we are in a lifeboat that will not reach land. We need to focus on implementing a meaningful solution to the problem. A clock is ticking and Washington needs to acknowledge that a witching hour is approaching.
This post originally appeared as part of the Restoring Capitalism series at the New Deal 2.0 blog, a project of the Roosevelt Institute.
Follow Bruce Judson on Twitter: www.twitter.com/BruceJudson
http://www.dailyfinance.com/2011/04/06/cram-down-mortgage-modifications-judges-banks-underwater-bankruptcy/
There is a huge level of debt out there going unpaid. Those are not on the balance sheets and often you hear a blip here and there on the radar screen about the level of debt going uncollected; but you never really hear about the impact on the banks and their debt securities. These are huge and should be equally troubling. These may be insured, but they aren't all government backed and therefore when these banks fail, and fail they must - their assets will never cover their liabilities - they will again come to the government and request taxpayer funded bailouts to remain "solvent" enough to keep their jobs.
This is trouble. This is deceptive and unless it rears its ugly head before November, will surely be an issue in Q1 2013. Somehow this drag on the economy and the impact on the middle-class continues to evade scrutiny. I'm waiting for anyone to discuss just how they intend to deal with this IED that banks are waiting to implode.
At the very core of it, I think, is: "securities fraud." But it is securities fraud that is daily propped-up by millions of dollars a day(!) in Bribery. It is also securities fraud that props up a massive system of national and international finance that allows the Government to "borrow from nowhere" the trillions of dollars that it takes to wage a half-dozen undeclared and unending Wars throughout the world.
"Ike" Eisenhower's prescient warning has come true.
In our bizarre excuse for a financial system, "debt is wealth." The Dollars that a bank, say, purports to own are in fact the Dollars that it has a piece of paper that says it has the right to receive; in other words, a (sic...) "security," short for "perfected security interest." This is the linchpin of our modern-day Rumpelstiltskin, and every single one of the people who are suckling at its boundless "receptacle" will do anything in their power to defend it. Even though it is indefensible.
The reality is that these people think nothing of throwing hundreds of millions of people (literally...) out into the street in Winter in order to preserve what their precious balance-sheets tell them, even as that picture rushes headlong into the absurd.
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The sad thing is that the memo was sent to congress as a warning, is not new information, but restates something of which they're already aware. One of the things the administration proposed was assistance to homeowners to relieve the pressure of mortgates and to restructure debt. The product wasn't even a shell of what was proposed. The congress and the administration caved to political pressure from the right to not reward and rescue individuals who were portrayed as irresponsible for their own financial situations. (One of the cellular components that produced the Tea Party zygote.)
The reality is that congress is painfully aware of what is needed. They have neither the political courage nor the vested personal interests to do it. They hide behind the cover of their ideology and politics. Until the administration has the courage to stand firm, and both sides of the isle have the courage to resist parochial, regressive Tea Party politcs, the essential responsible policies required for addressing the problem will be a long time coming and the US economy will continue to wither on the vine.
Their inaction is worse that denial. It's wilful cowardice.
Derivatives.....
credit default swaps.....
collateralized debt obligations.....
tranches.....
under-capitalized banks.....
outrageous bank activity including outright fraud and misrepresentation going unpunished.....
.............in short, deregulated banks where almost anything goes and few are prosecuted......
are the causes along with the housing crisis for our economic problems.
And don't forget to add in the huge problems in the eurozone.
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Strict re-regulation of our banks and Wall Street, getting rid of all the exotic and extremely risky investment schemes, prosecutions of the guilty, AND severe punishments will be the best way to save our economic system.
Anything else just won't do it.
****It worked after the Great Depression and for many years afterwards until they started loosening regulations in the 1980's.
The savings and loan debacle due to deregulation was a wake up call that went unheeded.
http://www.cnbc.com/id/45925851/comid/2
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Mr Judson, I guess solutions are not simple because they have to be fair, and fairness to all makes things complex, all the more so when at the heart of the matter is the re-allocation of public resources.
But it is very difficult to promote proposals which attack complexity with complexity.
Perhaps these proposals would get more attention if they were much, much simpler. And that probably means less fair. Breaking out of a crisis incurs a cost not only in money, but in fairness and even integrity. It's the price of breaking free.