Geithner, Mian and Sufi on the crisis

Well, it seems that Piketty fever is finally cooling. After two months’ lively discussion of Capital in the Twenty-First Century, talk is now turning to two books whose simultaneous publication could not have been better timed.

{mosads}Former New York Federal Reserve President and Treasury Secretary Timothy Geithner’s Stress Test recounts the heady days of 2008 and after, as the George W. Bush administration and then the Obama administration worked to prevent financial meltdowns from morphing into full macroeconomic catastrophe. He concludes that, apart from the inevitable false starts and missteps that attend any triage, he and his colleagues got things essentially right. Saving the banks quickly was requisite to saving the broader economy permanently.

House of Debt by Atif Mian and Amir Sufi of Princeton University and the University of Chicago, respectively, reads things a bit differently and, to my mind, more sagely. The authors contend that Geithner and colleagues erred mightily in not focusing more on homeowners. Homeowners’ post-bubble mortgage debt overhang was a much greater long-term threat to the macroeconomy than was bank failure. It was also, as I and others argued at the time, the ultimate source of bank peril itself. Rescuing homeowners would accordingly have offered a twofer, binding the wounds that the bailouts could but bandage.

As superior to Geithner’s take on the crisis as I find Mian and Sufi’s to be, I am struck by something that all three of the gentlemen share. That is their tendency to employ the past tense, as though the crisis were safely behind us, and our only concern now were with how to avoid another. As valuable as Geithner’s and, especially, Mian and Sufi’s proposals for avoiding a replay might be, any suggestion that we’re out of “the 2008 crisis” is seriously in error.

One-fifth of the nation’s home loans remain underwater: Their debtors owe more on the loans than their homes are now worth. Another fifth have too little home equity to sell, even when selling would enable their moving to where jobs are. This is little improvement on where we were one, two … even six years ago.

In what sense is this a continuation of the 2008 crisis? The answer came 80 years ago from one who is possibly the greatest American economist of whom you have never heard: Yale’s Irving Fisher. Fisher, whom Mian and Sufi creditably cite but don’t adequately credit in my view, lost a fortune in the 1929 crash. He also suffered an embarrassing reputational hit, having publicly observed earlier the same month that stocks had reached a new “permanently high plateau” (1929’s eerie prequel to 1999’s “new paradigm”).

Fisher sought to redeem himself by uncovering the underlying dynamics of the 1920s’ paired stock and real estate bubbles and busts (yes, there were both, then as now). He also sought to understand what was prolonging the 1930s depression that followed those busts. The answer in both cases, he found, was the same – private debt.

Fisher developed these findings in his “Debt-Deflation Theory of Great Depressions,” which he elaborated both in a journal article in 1933 and in a monograph, Booms and Depressions, the year before. If you read only one more book or article on what we have been through and are still going through, let it be one of these.

Fisher found that the worst bubbles and busts are those mediated by credit and debt. Credit worsens bubbles by enabling speculators to drive prices ever higher — so much so that even non-speculators must borrow ever more heavily to buy. (John Geanakoplos, Yale’s latter-day Fisher, has found much the same.)

Debt worsens the busts that then follow these bubbles for reasons that Mian and Sufi now laudably highlight: Fixed debt obligations, which homeowners have no choice but to undertake when prices are driven by speculators, don’t drop with asset prices post-crash. Millions are left underwater. Consumer spending thus plummets. Growth and employment thus slow, then go negative. Defaults thus ensue, harming banks and other creditors. Asset prices accordingly plummet yet further, feeding back into the same downward spiral.

This is still happening post-2008. As alluded to above, 10 million households remain underwater. Ten million more have too little equity to sell and then move to where jobs are. Consumer spending by the 40 percent of Americans most likely to spend thus continues to lag, and employment and growth remain sluggish in consequence.

But we also still have it within our power to arrest and reverse this still ongoing crisis.

How? First, we must mandate that government-held Fannie Mae and Freddie Mac write-down their underwater loans — as Geithner, to his great credit, finally called for in 2012. And second, we must employ government’s eminent domain authority to purchase the millions of underwater private-label securitized (PLS) loans out of the trusts they are locked in, then write them down as well.

These write-downs will rescue debtors (homeowners) and creditors (banks and investors) alike — they’re “win-win” — by preempting near-certain and costly defaults and foreclosures. Yet they cannot be privately done on an adequate scale thanks to dysfunctional securitization contracts that were drafted in haste during the bubble years. (This is why the Home Affordable Modification Program, Geithner’s earlier answer to the mortgage crisis, was doomed ab initio. “Incentive” payments to loan servicers can’t induce loan modifications when PLS contracts prohibit them.)

I advocated that Fannie, Freddie, and the Federal Housing Authority act in these manners in 2007 through 2009, as it’s a job they were meant for and did wonderfully — even profitably — during the New Deal. In more recent years, after giving up on Washington, I have argued that states and cities should act on their own. Some are now doing so — even coordinating in so doing.

I won’t rehash the plan’s detailed mechanics and fuller rationale here; readers can find that in this New York Fed paper, among other places. Here I’ll close simply by emphasizing once more that it both can, and must, still be done. I hope Geithner, Mian and Sufi might join me in making it happen. Only then will the crisis be ended, and our authors’ (with others’) preventive proposals well-timed.

Hockett is a professor of law at Cornell University Law School.