Martin Feldstein of Harvard Demonstrates Total Lack of Understanding of How Real World Operates in His Home Mortgage Policy

Note to Mr. Feldstein:  The Real World Operates Different Than Harvard

One of the major problems of The Great Recession is that in addition to being a traditional economic recession where lack of adequate demand for goods and services produces low or negative growth and high unemployment, this recession has also been a Balance Sheet recession.  This means that in addition to lower incomes, which reduce demand, consumers, particularly the middle class, has been negatively impacted by a reduction in the value of their assets.

Housing is the most significant asset on the balance sheets of middle income Americans.  With home prices falling, the value of a home today for many Americans is less than their mortgage balance.  This means the house cannot be sold so the homeowner can move to a new job, the house cannot be used to support higher consumer debt and in some cases the homeowner allows foreclosure instead of continuing to make payments.

Martin Feldstein is a former Reagan economic adviser, and for someone in that position a fairly intelligent economist.  He now firmly ensconced at Harvard.  Mr. Feldstein addresses the housing issue raised above on the op/ed pages of the New York Times, and here is his solution.

To halt the fall in house prices, the government should reduce mortgage principal when it exceeds 110 percent of the home value. About 11 million of the nearly 15 million homes that are “underwater” are in this category. . . .

If the bank or other mortgage holder agrees, the value of the mortgage would be reduced to 110 percent of the home value, with the government absorbing half of the cost of the reduction and the bank absorbing the other half. . . And in exchange for this reduction in principal, the borrower would have to accept that the new mortgage had full recourse — in other words, the government could go after the borrower’s other assets if he defaulted on the home. This would all be voluntary.

which sounds nice until one considers the real world implementation of such a program, which renders such a program inoperable.  Just some of the problems are these

1. There is no “bank” which owns a mortgage.  Often the mortgage has been pooled into a mortgage backed security, and diced and sliced so that there are many owners of parts of the mortgage.  Just tracking down these owners and getting their permission to modify the mortgage is difficult and expensive, and probably not possible on a large scale.

2. Most mortgages are already full recourse to the owner.  Nothing is really gained by making them full recourse.

3. Administrative costs of the program are huge.  Appraisals are difficult and often inaccurate. 

4. If the change in principal does not change the monthly payments, little is accomplished.  And at 110% of fair value, the mortgage is still underwater, only less so.

Mr. Feldstein, like so many professional academics of all political persuasions lives in a world totally divorced from the real world.  In his world the mortgage is held by the friendly neighborhood bank, an institution eager to help out and somewhat rational in its approach to finance.

In the real world large banks are unwilling to take write downs of mortgages, even when it is in their own best interests to do so.  Banks are taking huge losses on foreclosures, losses much greater than they would take if they simply took a small write down on the value of the mortgage and allowed the home owner to remain in possession and continue to make payments.  In fact, some banks are not only giving away properties, they are paying for the cost of demolition after allowing foreclosed properties to deteriorate to the point of becoming worthless.

A handful of the nation’s largest banks have begun giving away scores of properties that are abandoned or otherwise at risk of languishing indefinitely and further dragging down already depressed neighborhoods.

The why of this is unknown, but the reality of this is uncontested.  That reality is just not seen from the ivory tower of Cambridge, Massachusetts.