Payback Time

Dolors & Sense

by Sanford Rose

KISSIMMEE, FL—(Weekly Hubris)—8/30/10—On TV, there is a doctor named “House,” who cures all ills. In the economic world, virtually all ills are caused by House. The kind you live in or used to live in.

The recession began with real estate. Hard times (and possibly recession redux) continue because of real estate.

The housing market is once again slipping, and everyone is too bored or too frustrated to talk about it.

A Financial Times columnist argues that the US government has done as much as can reasonably be done to buttress it. He’s wrong.

The optimal way of handling the housing bust was to force lenders holding mortgage loans to convert their balance-sheet medium- and long-term debt into equity, and then use this enhanced equity to absorb principal write-downs sufficient to bring loan balances into alignment with market values.

Doing so promptly—say, by mid-2008—would have limited the fall in real estate values, which eventually overshot on the downside nearly as much as they overinflated on the upside.

Stabilizing house prices in turn would have curbed layoffs and forestalled the cratering of consumer confidence. The recession would have been far less deep and protracted.

It wasn’t done. There was no reasoned consensus on housing then, and there is still no reasoned consensus today.

Instead, in the interim, the government has done very little besides subsidizing the banks.

Sure, there have been an alphabet of tailored housing programs that promised mortgage modification. They all have had a common thread: execution depended and still depends on the kindness of banks. Unlike Blanche DuBois, we haven’t been fortunate.

Although housing hasn’t recovered, the banks have—or at least they claim to have recovered. Their profits betoken recovery, provided we don’t analyze them too carefully.

In truth, however, neither the banks nor the economy can recover well enough unless we handle the problem we’ve blinked at for three years—bank balance sheets still top heavy with mortgages and mortgage-related paper that have unrealistic loan-to-value ratios.

So now, as we stand poised to take another real-estate bath, why doesn’t the government finally get tough with the banks?

Try this stance with them: “You allegedly now have the profits and the capital that you didn’t have three years ago and which we gave you through subsidy, principally in the form of a zero cost of borrowing. It’s time to give something back, not out of charity, but in the public interest, which is also your interest.

“We have to prevent a double dip and, to do that, you have to re-mortgage houses and forgive principal. And we are going to insist that the accountants cooperate by allowing you to stretch out the recognition of the resulting losses over at least the next five years.”

Payback time, not in anger but pro bono publico.