Economic Reform Australia has just alerted me to a proposal for a partial mortgage debt forgiveness proposal put forward by economists from the US Federal Reserve in January 2009. ERA reproduced this post from WhoWhatWhy, which in turn referred to a Boston Fed publication Communities & Banking and the paper “A proposal to Help Distressed Homeowners“.
The proposal includes the suggestion of a grant to homeowners who are both in negative equity and unemployed, where the grant would pay up to 25% of the repayment costs over a 2 year period.
I’m noting it here both for its own merit, and because it shows that a direct grant to debtors is feasible within the Federal Reserve system–something that I have seen disputed elsewhere. So a full debt-Jubilee, which I discussed in my BBC HARDtalk interview, is also feasible. Since the Jubilee issue is likely to rise in prominence in coming years, it’s worth recording this very early proposal that emanated from within the US Fed.
Below is the text of the paper.
A Proposal to Help Distressed Homeowners
by Chris Foote, Jeff Fuhrer, Eileen Mauskopf, and Paul Willen
With job losses generating more mortgage delinquencies, policymakers might consider whether foreclosure-prevention efforts should help homeowners with payments for a while. We propose a government payment-sharing arrangement that would work with the homeowner’s existing mortgage and significantly reduce monthly payments while the homeowner is unemployed.
We believe a payment-sharing plan stands a better chance of preventing foreclosures than longer-term but less significant payment reductions achieved through loan modification. More broadly, payment sharing could not only benefit participating homeowners, but also could protect the housing industry from escalating foreclosures and could stabilize financial markets and the economy.
In our view, previous plans based on long-term loan modifications, have been stymied because (a) contrary to the common wisdom, lenders and mortgage servicers will not always find a modification to be in their best interest, and (b) extant plans are generally unable to offer modifications to those who become unemployed.
The payment-sharing plan we propose has neither of those drawbacks. It could take the form of either a loan or a grant. In both versions, the homeowner would have to provide proof of job loss—or other significant income disruption—and proof of the home’s negative equity.
Plan Features
Negative equity does not by itself lead to default unless the amount is extremely high. Owners with negative equity who have not suffered adverse life events (for example, job loss, divorce, or illness) generally stay current on their mortgages. Negative equity is, however, a necessary condition for default. Borrowers who have positive equity usually can sell or refinance. The reason that foreclosures are rising today is that falling housing prices have increased the prevalence of negative equity at the same time that unemployment is rising—the so-called double-trigger effect.
The best way to prevent foreclosures right now is by the government offering borrowers who have experienced income disruption some temporary but significant assistance. The two versions of our proposal have five features in common. First, the government pays a significant share of the household’s current mortgage payment (25 percent and up) directly to the mortgage servicer. Second, the government’s share of the mortgage payment is equal to the percentage decline in family earned income. Third, proof of a recent and significant income disruption is required. Fourth, the assistance ends upon resumption of the borrower’s normal income stream—or after two years. Fifth, the plan caps the maximum government payment (say, at $1,500 monthly).
Addressing Challenges
The most difficult design challenge is to avoid attracting homeowners who don’t need help and inadvertently letting them game the system (a phenomenon called moral hazard). Eligible homeowners would have to prove that their equity is either essentially zero or negative. In the loan version, program participants would pay an interest rate reflecting the elevated risk the government is assuming. And the grant version would explicitly exclude homeowners having enough income (or wealth) to continue making mortgage payments despite negative equity.
The Loan Version
In the loan version, the government’s payments accrue to a loan balance to be repaid with interest at a future date. Government payments end when the homeowner’s income stream has been restored, or after two years, whichever is sooner. Because the household’s mortgage payments may rise (for example, with an adjustable-rate mortgage), the government’s payment is capped at a predetermined amount. When borrowers stop receiving government payments, they begin repaying them. They have five years to do so. If the home is sold for more than the value of the mortgage balance, the government has first claim on any remaining equity, up to the value of the loan balance, including accrued interest.
If after the payment-assistance period, the homeowner still cannot afford the monthly payment on the original mortgage, the foreclosure process may begin. The government might then seek loan repayment as it would for education loans—for example, by placing liens on future income.
The Grant Version
In the grant version, the government would provide at least 25 percent of the monthly mortgage payment for up to two years without requiring repayment. Homeowners whose adjusted gross income (average income in the two years prior to income disruption) exceeds a to be specified multiple of median family income in 2008 would not be eligible, a useful if imperfect means of excluding very high-income homeowners who likely have accumulated significant wealth to self-insure against temporary income loss.
Advantages and Disadvantages
The plan provides a significant but temporary reduction in the homeowner’s payment during the period of income loss—an advantage over loan-modification programs, which do not always lower payments sufficiently and sometimes even raise them—by adding missed payments to the outstanding loan balance. For lenders, servicers, and second-lien holders, the plan contains a more realistic recognition of their incentives and no pressure to do mortgage modifications. Even if foreclosure cannot be avoided when the government aid terminates, the housing market is likely to have recovered enough that disposal of the property will garner a higher price.
On the downside, the plan probably cannot stop homeowners who have extreme negative equity—say, 40 percent or greater—from defaulting when government aid ends. Indeed, the plan may merely delay foreclosure without any guarantee of economic or social benefit. Another concern is that the borrowers who should get help may choose to default rather than pursue a government loan. Meanwhile, the grant version raises the potential for moral hazard.
Finally, administering the program does require some cooperation from mortgage servicers—for example, giving applicants their outstanding loan balances and some home-price information. If the government chose to offer payment for such assistance, that would add cost.
Estimating Costs
The cost of the grant version is easier to estimate than the cost of the loan version. The civilian labor force is about 155 million persons. With the unemployment rate at 9.4 percent in July 2009 and continuing high, more than 14 million workers will be unemployed. An upper bound on the share of unemployed persons who are likely to be homeowners is the national homeownership rate of about 68 percent. That suggests 9.5 million unemployed homeowners. A very high upper bound on the share of unemployed homeowners likely to have negative equity is 35 percent, which implies that about 3 million persons would be eligible for the program. According to nationwide data on individual mortgages, the average mortgage balance of those who are 60-plus days delinquent is approximately $200,000, with an average interest rate of 7.7 percent.
Assuming a 30-year amortization schedule, the average yearly payment is $17,111. If the government pays 50 percent of the yearly cost on average, then the cost of providing help to 3 million homeowners is about $25 billion annually, perhaps $50 billion overall. That amount is lower than the costs of other foreclosure prevention plans.
The loan version’s cost would be smaller. Indeed, if all participants paid back their government loans, the program would cost virtually nothing in present value. Some borrowers, however, will default, and the government may therefore incur unrecovered costs. It is hard to estimate the degree of default, but the number is likely lower than in existing programs. Although no program for preventing foreclosures is perfect, we believe that ours has the best chance of success because it addresses two of the leading causes of current foreclosures in a way that other plans cannot. Policymakers may decide the plan needs tweaking, but the spillover effects of escalating foreclosures call for urgency.
First you draw the conclusion that making government financing limited causes endemic structural unemployment and then in your next comment you agree that any one input is not enough to draw a conclusion. Your contradicting yourself badly. Tell me if your last 2 comments make sense when put together.
You also didnt answer the question I posted at 11:01 pm to you.
Koonyeow
The governed are mostly apathetic and ignorant so generally there is no need to seek much consent from the governed. It seems to be a good arrangement to use government to manage some aspects of the economy on behalf of the citizenry. Potentially the government could do alot of good for its people if it employs good economic policies. Central banking also has potentially many benefits if the broader benefit is taken into account which at the moment is not the case.
Their is a long piece in the Economist http://www.economist.com/node/21542174
about the heterodox economics of the blogosphere
It covers MMT in some depth, if limited accuracy, sadly nothing on the Stock flow consistent post Keynesian school – though this has few blog hangouts apart from on here – and needs a snappier name!
I should say although I have attacked vulgar MMT ideas on here I have warmed to some key ideas of its more sophisticated thinkers over the last few months. On the sectoral balances/surpluses issue im sure they are correct, and I now accept Parguez’s endogenous view of the horizontal money circuit, government created and tax destroying money- where i differ is their historical fantasy of the origins of money – the evidence is clearly that credit and obligations preceded sovereign money and money has existed in many contexts without taxation payments – vulgar treatments confusing accounting identities with transmission mechanisms and more fundamentally the view that direct creation of state money cannot be inflationary – if not spent on productive investment and not equally matched by tax increases then I cant see how it is any different to unproductive lending for consumption or speculation, unless spent in ways which will increase the velocity multiplier it has to be inflationary and is only expansionary to the extent that it does so.
Title: You Have Nailed It, Dannyb2b
The governed are mostly apathetic and ignorant so generally there is no need to seek much consent from the governed.
Such is the human condition.
It seems to be a good arrangement to use government to manage some aspects of the economy on behalf of the citizenry. Potentially the government could do alot of good for its people if it employs good economic policies.
If you have followed Lyonwiss’s recent comments, ‘good’ economic polices are very hard to achieve. By ‘good’ I mean we also take into account the unseen.
“if not spent on productive investment and not equally matched by tax increases then I cant see how it is any different to unproductive lending for consumption or speculation”
For every £100 a government spends, it will create £100 of tax and savings for any positive tax rate within the nominal circuit – each time, every time. That induces a sequence of real transactions.
The productive investment comes from the second order spending – regardless of what the first order is spent on. The signal from the increased demand presses the private sector into quantity expansion.
Do you know many hairdressers that will put their prices up rather than cut another head of hair – just because the person requesting the service received a printed £10 note rather than an old one?
And that continues until you use up the spare capacity in the economy (as signalled by inflation), where you have to back off completely and possibly put up taxes. State money is inflationary if there is no room to quantity expand.
Which is why MMT suggests the Job Guarantee as the nominal price stability anchor. It is automatically counter-cyclical, just like the existing stabilisers. And it is least likely to run into the supply side issues that plague the ‘direct investment infrastructure’ and other old style Keynesian prop-up projects. And JG people tend to spend all their income to survive.
What MMT does is accommodate the excess nominal savings generated by the endogenous money system rather than suggesting increasing current taxes to confiscate them (or as currently happens rewarding people with interest for not spending their money).
While those excess savings stay locked away they are treated as economically inert.
Arguably what you are doing is deferring a decision on whether you have to tax those excess savings until they start being spent. Hopefully by then the real economy will be larger and able to absorb them without the government having to tax them away fully at the time.
The sovereign currency and the free float exchange rate gives the extra degree of freedom to allow the government to defer the taxation decision into the future – since the issue of ‘funding’ is moot.
So the issues are really to what degree quantity expansion happens or can be induced in the real economy over price expansion and whether the free-float exchange rate does actually free float and buffer things properly.
“the evidence is clearly that credit and obligations preceded sovereign money and money has existed in many contexts without taxation payments”
The only conclusion that MMT people I’ve read come to is that in a modern fiat money system you can use taxes to drive a currency. A starter motor or pump primer if you like. I don’t believe I’ve seen them ever say that taxes always drive the currency, or exclusively drive a currency or that historically taxes came first. Just that if you have taxes in a currency and you can enforce those taxes then that is sufficient to create a demand for the currency.
From Randy Wray’s Origin of Money paper [1993, pp 8]: “I will argue first that primitive “exchange” or “barter” did not lead to the development of markets; second, that money did not develop out of primitive “exchange”; third, that “credit money” predated commodity and government money;”
Credit is without doubt the root of money.
alainton
“where i differ is their historical fantasy of the origins of money – the evidence is clearly that credit and obligations preceded sovereign money and money has existed in many contexts without taxation payments”
Can you give just one MMT reference to back this comment up.
Here’s another article to show the MMT real viewpoint
http://moslereconomics.com/mandatory-readings/what-is-money/
“fundamentally the view that direct creation of state money cannot be inflationary –”
Likewise with thsi comment
Although I’m unsure what you mean by direct creation but still. I’m more interested in the cannot be inflationary bit.
Neil
The differences between us are narrow but important
‘For every £100 a government spends, it will create £100 of tax and savings for any positive tax rate within the nominal circuit – each time, every time. That induces a sequence of real transactions.’
Cant see the basis of the equality, without knowing the velocity multiplier (the inverse of liquidity preference) http://www.tu-chemnitz.de/wirtschaft/vwl3/downloads/paper/gechert/gechert_multiendogmoney.pdf and the rate of saving, it could be less or more than £100 and again without knowing the tax rate how much of this channel is taxable, overeliance on accounting identities where the effects are non-linear.
Given multiplier effects there will be additional effective demand for intermediate goods and non produced means of production – these being supply constrained will experiences inflation because of horizontal money expansion and lower the real wage. You also seem to presume that every response to increases in demand is to increase production and not increase price. Indeed historically such non credit backed forms of paper have always been had to be redeemable to assets or commodities to give confidence against depreciation.
I get the point about excess savings and deferred taxation but the above point about asset prices applies as well. Perhaps Keynes was not so wrong with his parable about digging holes as this would not have an inflationary effect, but, say, extra public spending to subsidise housebuilders would be.
Randall Wray was wrong by the way in assuming barter preceeded exchange markets, that idea has been discredited for the last 50 years. He is right on the credit origins of money – see David Graber for example – though the key issue from the 19th and early 20th C founders of the credit theory of money the key issue was, in Hawreys term ‘not the historical but the logical origin of money’ as a unit of account for debt.
no doubting a banks ability to create currency deposits neilw,
but they are qualitatively different to government deposits, in that its horizontal money, with no net balance sheet effect,
unlike vertical government money which adds net money as either, reserves/deposits, cash, or bonds.
“but they are qualitatively different to government deposits,”
Can you explain what this means
When commercial banks loan money the bank
Debits Bank loan (bank asset / our liability)
Credit Customer deposit (bank liability / our asset)
When the US Govt spends the commercial bank
Debits Fed reserves (bank asset / Fed liability)
Credit Customer deposit (bank liability / our asset)
What’s the big difference. The money created look identical to me. The asset held is obviously different though
NeilW
“For every £100 a government spends, it will create £100 of tax and savings for any positive tax rate within the nominal circuit – each time, every time. That induces a sequence of real transactions.
The productive investment comes from the second order spending – regardless of what the first order is spent on. The signal from the increased demand presses the private sector into quantity expansion.”
This is true for every 100 dollars anyone spends not just the government. It is important to make sure that the first order spending isnt mindless spending for the sake of secondary effects. The first order spending if not put to useful projects will have a detrimental effect on the economy. If the economy is functioning below its optimum level of growth then the new spending can be realised by expanding the money supply directly to the citizenry in measured and regular intervals through citizens accounts at the central bank. This would be done taking into account the central bank mandate of maintaining stable inflation and growth and when the upper band is reached the payments reduce or stop.
Credit in unnecesary for central banking for the purpose of conducting monetary policy.
Koonyeow
I rekon good economic policies are quite easy to identify or develop. The problem I at the moment is the lack of interest for improving the economic system. I think this is changing though.
Here’s one for you boys:
If a central bank reduces the interest rate it charges banks for money, and the banks borrow the same amount from the central banks but lend the interest margin saved by them to other banks, is that horizontal or vertical money expansion?
” it could be less or more than £100 ”
No it can’t. That £100 will always end up as tax or savings – strictly tax, central bank reserves or cash. It is constrained to the central bank. It can’t go anywhere else. The state only deals in central bank money and only the state can create and destroy it.
The more or less comes from some other £100.
“You also seem to presume that every response to increases in demand is to increase production and not increase price”
That is the key point and the fundamental argument at the centre of MMT: “it is likely that firms with excess capacity will respond by increasing real output to maintain market share.”
Hence my comment about hairdressers, and that should be the level at which stimulus is pitched. Where the supply constraints are the lowest. Of the MMT theorists I believe Scott Fullwiler has done the most detailed work on this.
Much like Steve’s work on the change in debt it is about being mostly right rather than being precisely wrong. There is a great deal of uncertainty about how the system will respond – and the only way to find out is to try. So you need to design policy with that in mind.
For example you could introduce the Job Guarantee and state that you expect it to be accommodated by quantity expansion in the economy, and that any price expansion will be recovered via a levy on the profit share.
I guess nobody cares about moral hazard these days. Debt jubilees, grants to pay off principal, all to people who borrowed too much money and paid too much for assets. Is there some reason why those people cannot simply take the loss?
So you pay people for their losses from the public purse,which is empty by the way, so you are stealing from future generations to pay the current crop of irresponsible deadbeats, then what?
Do we all get back to bubble making like nothing ever happened? The government will always cover losses, no matter how high the risks? Order the central bank to start issuing million dollar notes?
Sure, you might fear recession or depression, but ask a Zimbabwean what hyperinflation and the complete destruction of savings is like. It ain’t a walk in the park.
Neil
‘No it can’t. That £100 will always end up as tax or savings – strictly tax, central bank reserves or cash. It is constrained to the central bank. It can’t go anywhere else. The state only deals in central bank money and only the state can create and destroy it.’
You seem to be defining unproductive/idle cash balances as savings – which is not savings in my book as this is not for investment – this can dissipate the injection so less than £100 is spent on transactions in any one period. Also you fall into the trap of purely nominal rather than real accounting with no accommodation for inflation for growth or deleveraging – the financial/velocity multiplier /accelerator will generate more than £100 of real spending, and critically in doing so liquidity can pay off debt with primary and secondary transactions having a balance sheet effect (Hawtry is very good on this issue) – so far as used for productive investment will create price deflation/increased productivity and on supply constrained goods will generate inflation
I did think that economics add got over this crude nominalism treating sectoral balances like piles of treasure to be bean counted – recognition of these ‘cantillon effects’ were critical at the origin of classical economics – and doing away with Mercantalism – which is why I call MMT Mercantalist Monetary Theory.
I agree with you that so far as horizontal monetary expansion (and we need to be clear about the mechanism here and the role of the central bank) has positive rather than negative effects is a practical policy issue – but the faith of MMT that the bias will be to positive impacts does not seem theoretically grounded. I agree that a properly constricted tax and carefully targetted spending can overcome these problems – but most MMT thinkers dont explore these areas and neglect the mechanisms for transmission in the monetary circuit.
RJ the second instance is not an asset liability pair – just bookeeping entries – there is no obligation to repay as in a bank loan, their could be if the central bank introduced a policy of financial repression to top up deplenished reserves – but that would have an enormousness negative impact on the credit accelerator and would be a form of hidden taxation
China does a lot of this and it depresses consumer spending they also use a lot of direct horizontal money creation at times of financial downturns – in many ways they operate a MMT policy – pros strong growth low unemployment, cons high inflation, exploding debt through shadow banking and immanent hard landing.
@ John LikesPrivacy December 30, 2011 at 3:18 pm
Good questions. But economic theory is not about answering real questions. It is
about creating all types of propaganda material to suit the purpose of political
spin of the moment.
In US politics, big government for socialism, welfare state, Keynesianism, fascism, corporatism or whatever is expedient, has never really lost its appeal, as seen by one of Alan Kohler’s “Top 10 Charts of 2011″ (available at The Drum of ABC) copied and shown below. Will the trend continue?
Alainton
MMT is gospel how dare you question this religion.
“Alainton
MMT is gospel how dare you question this religion.”
MMT starts by understanding simple money and banking facts.
Too many (including many economists and politicians) are lost or confused by poorly understood economic theories or models. And yet do not even for example understand the simple similarities and simple difference between Govt and non Govt debt.
“RJ the second instance is not an asset liability pair – just bookeeping entries –”
Financial assets and liabilities are generated from book keeping entries. So how can it be just book keeping entries.
MMT explains money and banking extremely well and accurately. And respond directly and clearly to any questions or challenges from posters.
RJ
It seems flawed though. Its not necesary for money to enter circulation through government spending only. It seems to rely so heavily on the government affecting the economy through spending.
It would be better if money entered circulation in a broad and balanced way directly to the public. Maybe MMt would call this government spending. Once there is a stock of money in the economy and it is functioning at or close to optimal there is no need to inject new funds as the existing money will just circulate round the system anyway.
“You seem to be defining unproductive/idle cash balances as savings”
That is what the ‘net-savings’ in MMT are – nominal savings.
MMT is a nominal theory. It operates on the real circuit via a process that I see similar to electrical induction. The two influence each other, but not directly and not in a one-to-one manner. You get transformer loss in other words.
So you can have lots of cash flowing to nominal savings in the nominal circuit without it perturbing the real circuit very much at all. The macro idea is to make sure there is sufficient nominal money flowing into the bit that affects the real circuit so that it can do its thing.
” recognition of these ‘cantillon effects’ were critical at the origin of classical economics”
The Cantillon Effects apply to private expansion as much as public one. LK does a pretty good job of explaining here:
” on supply constrained goods will generate inflation”
Price rises are not inflation. Where is the wage effect?
‘Price rises are not inflation. Where is the wage effect?’
If these goods are in Sraffa terms ‘basic goods’ they will erode the real wage.
So for example there was an across the board public spending increase in a housing supply constrained city, multiplier effects will be eroded by rent increases, real wealth after rent is reduced. Or the housing market, more money chasing the same number of houses.
@Lyonwiss Agreed. The mathematics of finance and economics are well known, and none of the equations ever reach an equilibrium state.
It’s mind boggling that Prof. Keen has been arguing against the unchecked expansion of credit money for years, and yet believes that the even more morally hazardous practice of forgiving debt, or paying it down from the public purse is somehow different to the expansion of credit money, nay, a solution even.
For any kind of debt jubilee to occur,either the money supply must be expanded (dilution), or foreign creditors must take a haircut. In the case of the former, foreign creditors will see their investment eroded through currency debasement,and the population will see their savings (ha!) evaporate through inflation. In the case of the latter, foreign creditors will have to face their own populations and tell them they are about to lose THEIR savings.
In either case, the foreign (China, Japan) appetite for Western debt instruments will evaporate, leading to a further expansion of the internally generated money supply (printing) to cover government deficits, and eventually, hyperinflation. At least we will all finally get to be millionaires.
Come on Prof. Keen, WHAT MADNESS IS THIS?
“real wealth after rent is reduced.”
Which is still a change in the standard of living, not an inflation as (most) economists generally describe it, ie a general rise in prices, including the price of labour.
The extra is moved to the rentiers who control the land monopoly from more discretionary items. And where there isn’t a natural monopoly like land you will start to get substitution effects as entrepreneurs move into the newly profitable area.
One of the problems with the current malaise is that there is nowhere signalling that it needs sorting out. It is near impossible to make a decent profit, so nobody is taking a risk on investment.
Prices have to move or there is no signal as to which areas need sorting out.
It’s the overall price stability that needs anchoring and that is done in MMT via the employed buffer stock system as described by Bill in his latest blog