Would government mandated principal reductions on underwater home loans bring us out of this Lesser Depression?

  • Yes! Housing debt is the problem. (53%, 92 Votes)
  • No. Unemployment must be solved first. (47%, 81 Votes)

Total Voters: 173

Housing debt is the root cause of this continued Lesser Depression, according to Harvard economist Kenneth Rogoff. Thus, solving the seemingly intractable issue of widespread housing debt among American consumers will be of paramount importance to getting the economy back on track.

Traditionally, economists serving on the Federal Reserve (the Fed) Board of Governors keep their noses out of governing policy and stick to their monetary manipulations. However, initiated by the Fed Chairman himself at the annual conference in Jackson Hole this August, economists everywhere are diverging from their typical ­speak-no-evil approach to government fiscal policy. [For more information on the Jackson Hole Federal Reserve conference, see the August 2011 first tuesday article, The Fed points the finger.]

Since Jackson Hole, representatives of the Fed have openly voiced their fears that monetary policy may be reaching its limits of effectiveness and the only option left for stabilizing the economy is for Congress to take action on the fiscal front.  And what is to be done? Allow underwater homeowners “to earn accelerated principal reduction over time,” according to the president of the influential New York Fed.

first tuesday take: Agreed and agreed. Monetary policy has driven interest rates to the zero lower bound and consumer spending remains stalled, a phenomenon some refer to as a period of secular stagnation. Money cannot get cheaper, and yet creditworthy buyers do not seem much interested in borrowing or investing.

The Fed has eased and twisted interest rates, kept inflation near or just above target and has now rightly resorted to brow beating the law-makers into taking action. [For more on the Fed’s recent monetary policy interventions, see the October 2011 first tuesday article, The Fed’s retro “twist” seeks modern dancing partners.]

What has been suggested by the Fed (and by first tuesday for years) is neither stimulus nor austerity. It is, quite simply, a debt jubilee. It is no great mystery that monetary policy no longer carries the weight it used to and it is clear why: the Fed can make money essentially free, but consumers have no access since it is presently channeled through a banking system that requires creditworthiness on behalf of the consumer.

The average consumer is no longer creditworthy. He has either defaulted on his debts or his debt-to-income ratio is cripplingly high (we now have a culture of debtors with no jobs). Thus, easy money rots like lettuce on the lenders’ shelf, preserved only by the zero interest rates of today. [For more information regarding cramdowns, see the November 2011 first tuesday article, Surprise: Frannie says no thank you to cramdowns.]

As this economy currently operates, it contains too many structural contradictions to work itself out of this Lesser Depression. In order for the economy to recover, consumers must start spending. Consumers cannot spend on a sufficient scale for recovery unless they have access to credit. Consumers cannot get credit because they have too much debt. The prevailing contradiction: where debt is the bane of the economy, credit is the cure?

Of course, this opens a whole can of worms that we will leave up to those at Occupy Wall Street (OWS) to figure out. For now, let’s cram down principal loan balances across the board on underwater homes to at least 94% of their currently appraised value and reset the payments. That will greatly help get this consumer economy going again.

re: “Time to accelerate the housing recovery” from the New York Times