Housing Jubilee

By Marc Salomon

December 8, 2008

It has become clear that the cause of economic collapse has been the hyper-commodification of housing in service of the finance, insurance and real estate economy (FIRE) – a classic economic bubble. As the monetarists at the Federal Reserve kept interest rates artificially low over the past 15 years, in order to keep the economy out of recession, a side effect of that was to flood the housing markets with cheap money.

That flood of cheap money artificially increased demand for housing which drove the price skyward. Whether that linkage was intentional or not, it is clear that it would have been well worth the pain of deeper recession at some point over the past ten years to deflate the housing bubble before its deleveraging consumed the economy in a paroxysm. This was the latest and largest of several bubbles, running back from the S&L scandal of the 1980s, to the Dot.com boom and bust of a decade ago, and has been a characteristic mode of operations of American capitalism since Ronald Reagan and Paul Volcker.

Eventually, even more of the US economy was taken up to feed the FIRE in the form of housing, consuming more and more of US household budgets. As FIRE feeds off interest payments, mortgages are the prime source of debt, and debt generates interest. The more debt taken on to purchase appreciating real estate, or extract equity from a home, the more interest-income is generated, the more insurance premiums are generated, and all of that projected income could be securitized to theoretically spread the risk.

Unfortunately, the structured finance vehicles (SIVs) into which mortgages were securitized are poorly engineered (for failure), irreversible in that it is impossible to reconstruct the mortgages that were mashed up into SIVs; there is no way to unwind the system. It appears that the intention of slicing and dicing mortgages was to spread the risk. But when everyone takes on risk and everyone helps everyone spread the risk, the system becomes particularly vulnerable to the incestuous relationships of counterparties when the music stops and the chairs disappear. Many tens of trillions of dollars had been invested in these securities, falsely rated as low-risk, insured by the same entities now trading at junk status.

The approach of the federal government at this point, apparently shared by both lame duck and incoming administrations it that is good policy to keep the housing bubble inflated. The thinking goes that if we can just kick-start the flow of credit, then people will go further into hock to keep the FIRE burning and the SIV investors will be made whole. It will be the summer of 2007 all over again, only the White Stripes will not have presaged this economic Icky Thump, and we’ll get it right this time. But just like it is impossible to unwind SIVs, there is not sufficient debt available to reinflate the housing bubble – they’re already bargaining with an inconceivable $8,000,000,000,000.00 ($8 trillion) in borrowed and printed cash—and nothing seems to work.

Even Cher knows that we can’t turn back time, we can’t get back to there from here.

Not only are the prospects dim for reinflating the housing bubble, but that is not desirable policy for anyone but those who depend on debt-generated interest – those who would base the economy around debt as an end that spews cash, rather than debt as a means to finance economically productive pursuits. Nor is it desirable to keep housing prices high at a level the wage base cannot support, which ends up placing Americans on a treadmill in debt or rent servitude, working longer and harder for their homes with little time to live their lives, taking on more credit card debt and generating more interest for FIRE.

The assumption is that if the credit markets can be made more fluid, then these bogus housing securities will find their value and the housing bubble will self-correct. The problem with this is that it will take more time and money for this to play out, and as that slow intervention oozes forward and is not successfully dispositive, the resulting liquidity trap and deflation due to lack of confidence is consuming what little of the real economy that was not previously sacrificed on the altar of FIRE. We don’t have time to wait for right-wing economic dogma to work its way to the bottom, as prescribed by scripture, amen, as the clock is ticking and the economy is evaporating before our eyes.

Any approach to deal with the artificially inflated housing prices, must be equitable. The prudent should not take the fall for the reckless and tenants should not suffer for the sins of landlords and speculators.

The federal government should declare a partial housing debt jubilee by enacting a statute that automatically reduces the principal balances owed on all primary residence home mortgages – for those who own a single home – by 50%, and convert the terms to a 30-year fixed at 5%, a number which is not out of line for the degree of correction expected. The feds would also have to preempt state laws on taxation such as Prop 13, and open the door to revenue neutral recalibrations of tax rates in the states and localities in light of this property value reassessment downwards. And there would need to be an equivalent, equitable reduction of rents for tenants.

This elegant and equitable approach would immediately pop the bubble, put significantly more money in people’s pockets and stimulate the economy more than borrowing from Asia ever could. There are concerns about an arbitrary 50% number, but whether it is a little high or a little low, it is in the ballpark so any corrections up or down after that point will be less extreme, protracted and damaging than what we’re seeing now. Most everyone could afford to pay 50% of their mortgages and stay in their homes, and the social benefits and costs of stabilizing communities outweigh the economic costs and benefits of restarting the FIRE. And as the economy recovers, housing prices would rise at a stable and secure savings account rather than speculative casino level, homeowner nest-eggs would be preserved relatively equivalently.

Imposing a floor now would also allow the SIVs to trade again, this time at realistic values that can be sustained by the deflated wage base, transfering the financial responsibility for this mess where it belongs – to the speculative investors who signed onto the risk and stoked the bubble it in the first instance and fudged the numbers to keep it going as long as they could. Free market dogmatists on the far right seem to prefer that the economy be allowed to run off of a cliff. The Democrats seem to favor trickle down to keep the music playing even as the chairs disappear, all supporting the offloading of pain from the reckless onto the backs of the vast majority who did nothing wrong.

The question for the Democrats coming into power is whether they want to continue to keep this FIRE economy propped up, or whether they want to put the broader economy first, whether their approach will be trickle-down or trickle-up, Wall Street or Main Street, whether we will privatize profit and socialize loss, whether there will be any moral hazards for the elites, ultimately, whether debt is an end or a means. If the government can create a bubble through low interest rates, then it can deflate a bubble through statute. The risk here is that they probably have to get this one right the first time, as the rest of the world is looking for an excuse to bail on the dollar as reserve currency because the US economic and political consensus has given them every reason to.

Spare any Change you can believe in?

Marc Salomon

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