A number of economists privately told Obama that his recovery policies were weak in one key area: They didn’t do enough to address the mountain of homeowner debt.The Washington Post’s Zachary Goldfarb reveals this in a great new story:
One year and one month before President Obama won reelection, he invited seven of the world’s top economists to a private meeting in the Oval Office to hear their advice on what do to fix the ailing economy. “I’m not asking you to consider the political feasibility of things,” he told them in the previously unreported meeting.
There was a former Federal Reserve vice chairman, a Nobel laureate, one of the world’s foremost experts on financial crises and the chief economist of the International Monetary Fund , among others. Nearly all said Obama should introduce a much bigger plan to forgive part of the mortgage debt owed by millions of homeowners who are underwater on their properties.
Just as in during the financial crisis, the reaction of The White House was to not do much. Part of it was the result of political expediency (no big “homeowner bailout” has much chance if it needs to go through Congress) and part of it seems to be a thinking on the part of the administration that helping out over-indebted homeowners is not really plausible.
The idea that huge and persistent levels of homeowner debt remain a big economic drag should be understood by anyone familiar with Richard Koo’s “Balance Sheet Recession” framework (although the primary economist whose doing work on the subject these days is University of Chicago professor Amir Sufi, who has literally written (along with economist Atif Mian) the paper on the subject titled “Household Balance Sheets,Consumption, and the Economic Slump“).
The abstract of that paper explains how a theoretical notion (that high levels of debt were a drag) could be demonstrated in the data.
The large accumulation of household debt prior to the recession in combination with the decline in house prices has been the primary explanation for the onset, severity, and length of the subsequent consumption collapse. Using novel county level retail sales data, we show that the decline in consumption was much stronger in high leverage counties with large house price declines. Levered households experiencing larger house price declines faced larger drops in credit limits, were unable to refinance mortgages into lower rates, and paid down existing debts at a faster pace. Using zip code level data on auto purchases and exploiting within-county variation, we show that the consumption response to declining house prices was stronger in areas with more reliance on housing as a source of wealth.
The paper’s charts show a worse-than-average consumption decline in areas characterised by high debt.
Click the chart to enlarge.
Note that unlike some economic debates which break on predictably partisan lines (with liberals favouring more intervention, and conservatives favouring less) this question is a little different.
For example, in a post following up on Goldfarb today, liberal economist Dean Baker disagrees that the mortgage debt hangover is the main problem, and instead says that the main problem is just the normal collapse in asset prices, and that the real failure was the lack of a sufficiently large stimulus.
In fact, there is no need to turn to implausible underwater mortgage debt explanations for the weakness of the economy. The economy is acting exactly as those who warned of the bubble predicted. We saw a sharp falloff of residential construction as we went from a near record boom, with construction exceeding more than 6.0 per cent of GDP at the 2005 peak, to a bust where it fell below 2.0 per cent of GDP. This meant a loss in annual demand of more than $600 billion a year.
We also saw a large falloff in consumption due to the loss of $8 trillion in housing wealth. The housing wealth effect is one of the oldest and most widely accepted concepts in economics. It is generally estimated people spend between 5 and 7 cents each year per dollar of housing wealth. This means that the collapse of the bubble would be expected to cost the economy between $400 billion and $560 billion in annual demand.
There is no mechanism that would allow the economy to easily replace the combined loss of between $1 trillion and 1.2 trillion in demand that would be predicted from the collapse of the housing bubble. Therefore it is hard to see why anyone would feel the need to look to explanations involving the indebtedness of underwater homeowners, the whole downturn is easily and simply explained by the collapse of the bubble.
On Twitter today, Sufi defended his ideas in a series of tweets. Here are a few of them:
Photo: Amir Sufi, Twitter
Bigger picture, when people talk about “the debt” these days, they’re probably talking about The National Debt, even though it really doesn’t seem connected at all to the problems of the economy. Homeowner debt, however, is a real burden. There may not be much plausibly that can be done, but it should get much more attention.
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