Burying Calvin Coolidge

Dolors & Sense

by Sanford Rose

KISSIMMEE, FL—(Weekly Hubris)—11/8/10—Everyone talks about the “moral hazard” of forgiving mortgage debt.

Forgive debt this time and getting overindebted becomes a bad habit, encouraging irresponsibility.

Possibly, but the idea smacks of Calvin Coolidge’s famous remark about not giving in to Allied demands for a renegotiation of World War I debts: “They hired the money. Didn’t they?”

Yet the real moral hazard consists of not forgiving debt.

Think about it. Perhaps the smartest analysts of real estate around, the Amherst Group, tell us that if present trends continue, 11.5 million homeowners will likely default. That’s nearly 20 percent of all 55 million households with a mortgage.

To allow this to occur would be impolitic, in the extreme.

It would shred the value of the property of those 25 million other households that own a home but do not have a mortgage.

It would push us back into an even deeper recession than that from which we have supposedly just emerged.

It would court social upheaval.

In short, it would be immoral.

Yet, as the Amherst people argue, the reduction of mortgage principal is one of the few proven ways to stem the defaults that have kept home prices skidding.

And there are ways to limit the extent of principal forgiveness.

Mortgage holders default for one of two reasons: either they can’t make the payments or they can but their equity is so negative that it doesn’t make economic sense to continue paying back inflated principal.

Help can come in a variety of ways. Most plans boil down to converting the current obligation into an affordable one by re-mortgaging at an amount that reflects realistic market valuations. But the beneficiary should be required to surrender at least 50 percent of any home-price appreciation over, say, the next seven years—a requirement that will deter program participation by many of those who currently can pay but won’t.

Other schemes concentrate on converting an impossible ownership position into a rental, while at the same giving the now-dispossessed owner first dibs on re-acquiring the home should circumstances improve, again within the aforementioned time period.

These schemes presuppose that someone is willing to take a loss—to wit, either banks or pension funds that hold mortgage paper, securitized or unsecuritized, at the obsolete historical principal values and now must adjust these values.

If, however, the recognition of these losses can be deferred, willingness to take the losses would obviously increase and, in the majority of cases, the losses, the research of Amherst and many others shows, would be less than those that would be sustained if the properties defaulted.

Indeed, ideally, if reasonable foreclosure mitigation plans were implemented, home inventories, now running at about eleven months of sales, would drop substantially. Assuming an equally far-sighted plan for sales stimulation, the inventory overhang might even fall to the point (six months) where prices effectively bottomed and even began to turn up.

In those circumstances, the forgiveness program and the concomitant institutional losses would be self-limiting. The initial losses would eventually be neutralized by the accretion of gains.

That’s the purpose of forgiveness. Properly applied, it limits damages. To the banks, yes. But also the damage to the public from a return to acute recessionary conditions.

The public has not yet accepted this approach. The spirit of Calvin Coolidge still walks the land. Isn’t it time to exorcise it?