Tag Archives: mortgage

Debt, Rights and Social Goods

1 Nov

We have been living in a society where debts, rather than rights, have been the major means for accessing basic social goods. There is now, to a degree, some resistance to this social model. Debt burdens have been a major theme of the Occupations; various state Attorneys-General have grown spines and started investigating foreclosure fraud; and Yves Smith posted a class-action filing by shareholders in Lender Processing Services, one of the worst. When coupled with the work of anti-foreclosure organizations, this amounts to a growing awareness of the problems with debt-financed access to basic social goods like housing and education. And it may lead to alternative ways of thinking about how we win access to these goods.

After all, while the previous decade has been represented as a debt-financed spending binge, when consumers lived well-beyond their means, this turns a complex story into a morality play. A major part of the credit binge was about how people get access to housing and education. Sub-prime mortgages (especially with the decline of affordable housing) were the only way for many to gain access to a home. Student loans were the only for many to gain access to higher education, and thus participate as equals in the radically unequal distribution of opportunity in theUnited States. Mike Konczal posted the following graph at Rortybomb showing the dramatic rise of student debt. In a decade, student loans have gone from a third the number of home loans to nearly equal.

If there is a reasonable expectation that debtors can meet their interest payments then in theory debt is not a particularly bad way to finance access to certain goods. It is on the individual borrower to make a judgement about reasonable debt burdens to take on.

There are, however, two problems with this. First, there might be very good social reasons to not want to yoke access to certain social goods to debt. Education is a prime example. Taking on debt means taking on a kind of discipline. One must make all future calculations about, say, educational and career choices, with the need to meet future interest payments in mind. In conscious and unconscious ways, this narrows horizons and produces a more instrumental relationship to education. We saw many of our college classmates make more conservative professional choices (corporate law, consulting, finance, medical specialist) than they might otherwise have made (public service, teaching, science, labor and public interest law) in order to ensure their ability to pay back loans.

Many have talked about how the growth of finance sucked the math and physics geniuses, who might have contributed something lasting to society, into hedge funds and investment banks. But the alteration of professional choices was much wider than that. The number crunchers at the top were, one suspects, simply lured by lucrative pay. The much more widespread, and difficult to measure, shift in career choices due to the discipline of debt burdens is probably the more important, and still ongoing, effect. If, on the other hand, access to higher education were on the other order of something like a right – a publicly financed good, provided at little or no cost, on the grounds of real equality of opportunity – then one can imagine a much different set of results. While conservatives like to talk about ‘freedom,’ this is a place where the Left ought to have the upper hand in connecting economic practices to real freedoms. Providing necessary social goods, especially education, as a right rather than through debt-financing not only reduces the disciplinary effects of the latter, it also is a way of publicly recognizing and democratically defending the real freedoms of all citizens. To be clear, this is not a moralistic criticism of debt as evil or irresponsible. It is that there might be very good reasons why society would not want to impose certain kinds of discipline on (most of) its citizens, not just because there is good reason to want them to have real equality of opportunity, but also because, simply from a social point of view, its members talents might be much more productively used in some other area than those that promise the most immediate monetary returns.

A second reason why providing social goods like housing and education through debt is a bad idea is that practice does not resemble theory. Again, the theory is that so long as each individual makes a reasonable calculation about ability to meet debt payments, there is nothing wrong with financing access to basic social goods through credit. Putting systematic fraud to one side (but remembering it is unlikely that credit can sink that far into housing and educational markets without it), there is a deep historical reason for thinking that practice was the opposite of theory. The rise of debt-financed household consumption generally was the product of stagnating wages. Consider, for instance, the rise in consumer debt-payments relative to savings.

And compare that with the fate of median real earnings during that same period:

Debt-financed consumption, was, in other words, a response to the declining ability of most households to afford consumption levels, not an increasing ability to or trust in future ability to finance debt-payments.

The entire social model, then, of offering homes, education, cars not to mention ‘non-necessities’ was built on a lie. The separation of consumption (financed by future promises to pay) from production (based on limiting present ability to earn) was a mirage. In a different kind of society, it is conceivable that one might separate a worker’s contribution in terms of effort from the amount of consuming he or she might do. But not in this one. The problem is, in this one, the underlying right to maintain a certain standard of living, or more minimally, to maintain access to certain basic social goods like housing and education, was just that: implicit. Every so often, of course, it was made somewhat public, for instance when Clinton or Bush would say something about providing housing to the poor and minorities who could not otherwise afford it (mainly by changing market incentives, and promoting sub-prime borrowing, as it turned out). But this promise was always implicit, and had to stay that way, because it was mediated through the credit system. It was never a public claim each individual had against society, in virtue of his or her needs and freedoms. Instead, access to these social goods was a matter of a complex series of private, individualized claims against other private persons and institutions like banks and employers. That is the difference between debt and right, and it is clear that the debt-based social model has failed.

To be clear, this is not some moralistic rejection of debt, or a claim that society needs to learn to live within its means. There are some situations where debt-financing is a perfectly good option – the calls for more austerity at present, for instance, is ideological claptrap. Moreover, any economy always has to take a bet on the future if it is going to innovate, and take the risk that innovations will fail. But there are certain kinds of goods that are better provided as a matter of right, both for the sake of the freedom of the persons who need those goods, and as a matter of fairness in how they are provided.

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Modifying Feldstein

18 Oct

Recently, none other than Martin Feldstein, former chief economic advisor to Reagan, made waves with a mortgage modification plan that would include principal write-downs. There is a terrible part to this plan, which has received most of the criticism, but underlying it is an important issue: loan modification as economic instrument. Feldstein’s plan in its details is awful. The plan would write down principal on under-water mortages (mortgages where the loan is larger than the value of the house) to 110% of the home value. The government would absorb half the loss, the bank the other half, and the new mortgage would have one very important feature: it would be full recourse. Mortgages are non-recourse, meaning if the homeowner defaults on the debt, the bank can go after the home, but nothing else. A full recourse loan allows the bank to hound borrowers for the rest of their lives, until principal and interest are paid off. This is a not very altered version of a plan Feldstein proposed in October of 2008, with the full recourse proposal a mainstay. Others have pointed out the obvious dangers of turning millions of homeowners into indentured servants of banks (who committed systematic fraud) – an outcome especially likely, as Dean Baker has noted, when there is high unemployment and economic stagnation. (A point that implicitly applies to student and credit-card debt…)

Unsurprising, Feldstein’s proposal is soft on the banks. But the loan modification idea is nonetheless important, and not just as a stimulus measure. The stimulus effects of loan modification, both principal write downs and restructuring of interest rates/payout schemes, are multiple. The housing market is the ground zero of the balance-sheet side of this recession. Turning non-performing loans into loans that are actually payable by homeowners would not only restore some private balance sheets, but would at least slow down housing price declines, if for no other reason than it would stall foreclosures in an already flooded market. Restoring housing prices, and the increase in revenue streams from performing loans would have a knock-on effect of increasing the value of various mortgage backed securities without requiring sorting out the mess of competing claims. Of course, the implications of this are insanely complicated, and there are issues that, as Naked Capitalism has diligently documented, still need to be resolved regarding massive fraud, improperly securitized mortgages, servicer agreements, and lots of other things we don’t really understand (herehere and here) Of course, the administration has done nothing serious, with HAMP producing pathetic results, especially since it was voluntary and focused on interest rates not principal.

A serious effort would involve strong-arming the banks to take a hit on the principal – a hit they deserve given the systematic dirty dealing, but also because everyone else has taken a hit, and that’s what happens in a debt crunch, where there are way more claims getting called in than can be met. But this is nothing new, and in fact something that happens in all other areas of consumer debt anyhow. Beyond the above considerations, there are some very important long-term reasons why it is best to force the banks to feel pain – principal write-downs and loan restructurings, without making loans full recourse. Forcing banks to feel pain for the mess they facilitated is an essential part of changing risk-management. One aspect of risk management is enacting certain kinds of laws: higher capital requirements, regulation of shadow-banking, reimposing the division between commercial and investment banking. But another key feature is the management of expectations. For example, as has often been noted, bailing out the ‘too big to fail’ creates a moral hazard because if major banks think they will be bailed out for taking systematic risks, then they will engage in much more irresponsible lending than if they thought they would have to pay the costs. The same logic goes for loan modifications and fraud prosecutions. So far, banks have learned that they are unlikely to feel much legal pain even if they manufacture false W-2 statement, engage in robo-signing, and fraudulent securitization. But even more than that, what they have learned is that, when push comes to shove, the shit runs down hill. And at the bottom lies the homeowner. But the homeowner doesn’t have to be there, and if he weren’t, it’s not unreasonable to think home loans would work differently. That is to say, loan modification is a more serious disciplinary instrument than mere legal action because it affects all loan activity, not just the illegal stuff. It is precisely the indiscriminate nature of a loan modification program that makes it effective. If every single bank thinks it might be forced to write-down perfectly legal loans if they fail to perform, then they will be more likely to take a step back from the brink the next time around. Of course, financial crises are a regular part of capitalism. A stiffer hand with banks alone will do little to change that. But there is still a general point worth noting. The banking system is (like corporations) a product of law. It is supposed to be shaped to allow for the pooling of unused savings to be lent out to where that money can be used productively – ie, in the public interest. It does not work that way now, and there are many instruments, large and small, for reasserting public control over a system in which the costs are socialized, but the profits not. A general, public program of loan modification could be seen as one step in that direction – not just for the gains in fairness, and the immediate help it would give to struggling homeowners, but for the broader assertion of public control over the banking system.

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