The International Monetary Fund has explicitly called for principal reductions for underwater borrowers to deleverage individual balance sheets and jumpstart a soft recovery. An endorsement of principal reductions at such an establishment level could remove some of the stigma, and force a deeper reckoning over the need for them. And the IMF goes further, stating that the US should consider cram-down, the ability for judges to discharge and rewrite the terms of mortgage debt in bankruptcy.
The IMF cited three major impediments to US growth over the next two years: household deleveraging, fiscal restraint and subpar global demand. All three go hand in hand; fiscal restraint will reduce demand, and so will deleveraging, which reduces consumption. The US cannot do much about slow global demand and growth, but we can impact our own fiscal situation here. And the IMF believes that one of the few upside risks in the economy is in the housing market:
A more positive outlook for the housing market can also be envisaged, with a faster-than-expected recovery in housing starts associated with pent-up demand. The recovery could also strengthen if the policy measures aimed at a faster resolution of the housing crisis gain traction.
Emphasis mine. What are those resolutions? Topping the list for the IMF are principal reductions:
Staff welcomes the authorities’ renewed efforts to remove the distortions that prevent a faster resolution of the housing crisis. The authorities have responded to the persistent weakness in the housing market by enacting changes to their existing housing support programs—including the expansion of the mortgage modification and principal reduction program and the easing of some of the frictions in the refinancing program. Staff supports the timely and aggressive implementation of these measures, including the participation of the Government-Sponsored Enterprises in the principal reduction program. However, in light of the importance of the housing market in securing the economic recovery and the downside risks to the outlook, additional steps could be taken to strengthen the housing recovery. These include measures to facilitate the conversion of foreclosed properties into rental units and supporting access to refinancing on a larger scale, in line with the Administration’s proposals, which would also strengthen the positive impact of lower interest rates on aggregate demand. Consideration should also be given to allowing mortgages on principal residences to be modified in personal bankruptcy without secured creditors’ consent (cram-downs).
I don’t totally agree with the REO-to-rental piece of this because of external factors which I can get into later. Still, this is a very aggressive strategy laid out. The IMF wants to see far more loan modifications, refinancings and principal reductions. They want Fannie and Freddie to agree to move principal reductions for their underwater borrowers (it’s time to make something happen on that front). And they bring cram-down back into the conversation, after years in the wildnerness. Basically the IMF calls for measures aligned with the pretensions of Administration policy, only with actual effectiveness and aggressiveness. And then they go a step beyond.
Nowhere in these recommendations does the IMF call for faster foreclosures to let the market clear. That’s because it’s a completely unsound economic policy that would cause chaos in communities. Indeed, foreclosures are still occurring at far too high rates. It’s a form of deleveraging to foreclose on a house, to be sure, but a disruptive one, where the costs far outweigh the benefits, particularly the costs to property values of those homes remaining in the neighborhood.
The IMF also calls for a replacement of the fiscal cliff with back-loaded measures that include new revenues. And they correctly peg the problem of reduced demand over the deficit as the thing holding back the recovery, supporting fiscal and monetary policies that offset that demand gap. And they want a strong implementation of the Volcker rule and regulation of the shadow banking sector. It’s hard to read the report as coming from the IMF!
This recommendation on principal reductions is in line with Mike Konczal’s recent paper explaining how mortgage debt holds back economic recovery. This is actually elemental stuff; the finance lobby has employed an army of analysts to muddy the waters and distract from the facts of the balance sheet recession, because they simply want no losses allocated to them. But just look at the facts, with the US being an excellent test case. Recovery is weaker where mortgage debt is higher. The housing crash, and the underwater crisis that tethers people to their homes, is pretty much the only kind of structural explanation for unemployment that exists – people cannot get to where the jobs are because of their mortgage debt. And foreclosures, while a form of deleveraging, are economically destructive:
There are many economic models that can explain the negative impact of the forced sale of durable goods in a depressed economy. An owner doesn’t want to have to sell an asset in a depressed market because there aren’t many buyers and the “ﬁre sale” eﬀect brings down the value of all other assets. When an economy is depressed, a ﬁre sale of housing can trigger decreased prices for other homeowners.
According to economic estimates, foreclosures reduce the price of neighboring properties by 1 percent, and the eﬀect of a wave of foreclosures can be much higher, even approaching 30 percent. These neighboring homeowners now have decreased housing values, which increase their leverage ratios. As we see from the studies mentioned above, an increase in leverage ratios decreases consumption, employment, and wages through the balance-sheet eﬀect. A new wave of unemployment, decreased wages, and leverage makes foreclosures more likely, which creates a vicious cycle.
This is very explicitly what banks are calling for. They want to offload the losses in the housing crisis on everyone but themselves. I’m glad the IMF is calling them on it. More from Mike Konczal here.