The Way Forward: Going in Circles?

The latest proposal for dealing with the mortgage crisis comes from The Way Forward by Daniel Alpert, Robert Hockett and Nouriel Roubini (AHR), a policy paper sponsored by the New America Foundation.  AHR present is an incredibly wide-ranging proposal covering all sectors of the economy, not just housing, but I'm going to limit my comments to their mortgage crisis proposal. 

I was really hoping that there's be something innovative in the paper in terms of dealing with the mortgage crisis. There isn't.  Instead, AHR cobble together a variety of existing proposals.  The problem is that many of the existing proposals are grossly impractical (such as turning homeowners into renters en masse) and for the more practical proposals, such as principal reductions, AHR haven't figured out the catalyst for adoption, which is key. 

I don't like yucking on somebody's yum; this is a proposal that tries to grapple seriously with the mortgage problem in the US.  I wish there were more of this going on. (Hey, where's your proposal Levitin?) That said, I don't think this proposal is going anywhere. The one really novel move in AHR is its approach to loss recognition. It's also the scariest part of the proposal as it proposes taking us back into the "regulatory goodwill" accounting days of the S&Ls. 

AHR's basic move on mortgages is to divide homeowners into three buckets--unemployed, negative equity, and marginal borrowers--and then propose solutions tailored to each bucket. On a broad conceptual level, I think this is an appealing approach; different homeowners have different problems and need different solutions. More narrowly, however, I'm not sure that they have the buckets quite right and they don't address the existing foreclosure and REO inventory, which alone is a major problem. 

AHR are keenly aware that a major problem with HAMP and HARP was that they tried to avoid loss recognition by kicking the can down the road in the hope that the economy would resurrect. AHR nevertheless end up doing the same thing--they aren't ready to rip the bandaid off fast.  The goal in housing should be to get the market to clear without rely on foreclosures. AHR's approach doesn't exactly get the market to clear. Instead, it is really aimed at buying time for the market to grow out of its problems--it starts with market clearing moves, like principal reduction, and then softens the move. AHR haven't resolve the tension between loss recognition and the hope that we can grow out of the problem over time. 

For bucket 1, the unemployed, AHR propose bridge loans that will get consumers to where they can start paying again. There are some state bridge loan programs and this is a proposal to make them national.  This proposal comes from some of Bob Hockett's work.  Unfortuantely, I think a bridge loan program would be an administrative nightmare.  A bridge loan is an easy thing to do when you're dealing with a single bank or company or the like.  (Not surprisingly, the authors come from the sovereign and corporate debt world.) But to do that for millions of homeowners is administratively a nonstarter.  It takes the briefest familiarity with HAMP to know that you want to keep administrative work to a minimum to make a program work. Mandating forbearance and giving the banks (including in their role as servicers obligated to make advances) capital injections as needed would be a lot simpler to do, and it would avoids the awkward problem of direct government loans to consumers. 

For bucket 2, homeowners with negative equity, but the ability to pay, AHR propose a trade-off of principal reductions contingent on payment in exchange for quicker foreclosures and with share appreciation. This is exactly what I proposed in my Chapter M proposal, albeit in the context of bankruptcy.  And that raises the critical problem with AHR's negative equity proposal--they don't have any suggestions for how to get such a deal implemented. They don't have a stick (like bankruptcy) and their proposed regulatory accounting shenanigans (more about that later) is hardly a juicy carrot. They mention in the context of second liens the possibility of government exercising emminent domain to seize the second liens from recalcitrant banks--an idea that has been around for a while--but that's not what this proposal is based on. Beyond this fundamental flaw, there are a lot of critical details missing, such as how much principal reduction and how to deal with the problem of securitized loans, where the regulatory accounting legerdemain discussed below doesn't apply. Bottom line is that if you want to deal with negative equity, you need either a stick or a carrot or both. Otherwise the proposal is a nonstarter.