I’m starting to hear calls for various different forms of assistance in response to the stress being put on the financial system as a consequence of a complicated series of events involving real estate bubbles, sub-prime mortgages, and the bundling of mortgages, ostensibly to reduce risk. Paul Krugman has called for the government to intervene with “workouts” to assist borrowers. Matthew Yglesias has written that some form of government intervention is “all but inevitable”:
The trick is that given a collapse of this magnitude, it’s all but inevitable that the public sector will do some bailing out. What one wants is, at the margin, for the largest possible portion of the bailing to go to people with the most objective need rather than the most political clout.
I seem to be seeing the word “inevitable” a lot these days. Is government intervention really inevitable in this case? Let’s remember that the Federal Reserve is not the federal government. We have a unique public/private hybrid. We haven’t had a true national bank in nearly 200 years. When the Fed acts it’s not government intervention. And when you subsidize risk it creates a moral hazard whether the subsidization is called a “bailout” or a “workout”.
Let’s not get ahead of ourselves. I agree that in a good, decent, and wealthy society we take reasonable actions to ensure that people don’t fall into serious want (whether as a consequence of their own folly or not). That doesn’t equate to a commitment to indemnifying everybody against any financial loss at all.
How many borrowers are actually in serious want as a direct consequence of this crisis? That’s where our concern should be directed. Not every default constitutes serious want. For example, a borrower who paid no down payment on a loan, has no equity in the property, and has lived in the property paying the same or less than a rental, isn’t injured by a default. It’s foreign to my nature but strategic bankruptcy is a reality but I don’t think we should subsidize it.
As a general matter you’re quite right, but one does suspect that if a workout type solution is not cued up, just in case, you may experience a serious deflationary episode nationally that could do some ugly things. Workout in the home sector might be prudent to think about to prevent price collapse across multiple segments.
Not the moment yet I would say as a theoretical observer, but not to dismiss. I believe Krugman is more getting at an FDIC solution, not a central bank one.
Or Treasury. However, they buying the mortgages not the securities thing is a bit daft, given the legal rights (whole thing about property rights….).
I agree with that, Lounsbury. Probably nobody understands the dangers of a credit crunch better than Ben Bernanke, who literally wrote the book on the subject. My point is essentially the one you made: not the moment yet but not to dismiss.
I think the value of home ownership continues to be greatly exagerated in this country. If the owner moves frequently or can’t afford to keep up payments, then the individual is better off renting. There are diminishing returns when we push the envelope of home ownership to the less advantaged. So I question the underlying assumption in Matt’s piece that access to credit for the working class to own homes is a significant public good (I might differ on loans for education or business, which can increase income). Access to affordable house, yes.
BTW/ I spoke with a local realtor and he says nothing has really changed locally. I live in an affordable housing market in which prices have always increased slowly and they apparantly still are.
I also have to question Krugman’s stated assumption that there is no longer anyone to workout a deal with. I can recall all kinds of lenders in New Orleans announcing forebearance and their willingness to work out a deal to avoid foreclosure. Your mortgage may no longer be held by the local bank, but if they are going to foreclose on your house, someone will be assigned to your mortgage, and an attorney will be hired to give notice and file the papers. If neither of these are authorized to reach a mutually satisfactory compromise, then its not the government’s job to workout a deal for them.
Right, I read you differently mate. The intervention last week and this week clearly indicates Bernake is watching.
As for Shaw, well, you’re confusing anecdote with data. Of course there are diminishing returns, but at the issue arising is not that, but a significant systematic risk. There is a careful balance between (i) moving back from a fetishisation of home ownership and poor actors in credit feel pain to teach a lesson, and (ii) playing 1929 again (well I exaggerate, but allowing a systematic risk to do serious damage to the economy).