Voodoo Economics Behind Government Demand for Mortgage Write-Downs by Big Banks

by Hans Bader on June 14, 2011 · 3 comments

in Bailout Watch, Economy, Legal, Regulation, Stimulus to Nowhere

In 2010, Obama administration allies proposed a trillion-dollar bailout for those lucky mortgage borrowers whose loans were owned by the government-backed mortgage giants Fannie Mae and Freddie Mac — including wealthy borrowers who have no difficulty paying their mortgage — in order to increase their disposable income and temporarily pump up the economy through the next election. Now, Obama administration officials such as Associate Attorney General Tom Perrelli are trying to achieve the same goal on a much smaller scale in settlement talks with the nation’s four biggest banks. Perrelli is demanding that they reduce the mortgages of certain favored underwater borrowers (many of whom are underwater because they didn’t make a substantial downpayment, the way thrifty people do), using the banks’ unrelated foreclosure paperwork violations as a pretext (benefiting lucky borrowers who were never foreclosed upon, much less treated improperly in any way).

But as Mark Calabria notes, this demand makes no sense at all economically. Any mortgage write-off that increases the disposable income of borrowers will reduce the disposable income of investors whose mortgage-backed securities are worth less after mortgages are partly written off. The government’s demand reflects irrational, magical thinking, a kind of voodoo economics. This  proposed rip-off of investors would not create any wealth or income, but rather merely redistribute wealth and income from investors to borrowers (reducing the disposable income of the suddenly poorer investors), discouraging future investment.

Earlier, Calabria explained why the Obama administration’s use of “TARP funds to pay for modifications of loans not owned by the federal government” exceeds its “legal authority under TARP.”

Behind the administration’s mortgage bailout proposals is the false assumption that the economy remains weak due to “a collapse” in private consumption. But as Mark Calabria notes, it’s investment that’s low now, not consumption: by the middle of last year, “private personal consumption” had already risen “higher than at any point during the boom, after reaching bottom in the Spring of 2009.” Meanwhile, “unlike consumption, which has largely rebounded, investment today is about 20% below its peak.” It’s investment that needs to increase dramatically, not consumption. The administration’s extortionate demands to the nation’s banks discourage such investment.

cs100 June 14, 2011 at 7:51 pm

You should take a history lesson on the last 20 years of economics. You seem to think that this economy will improve if we do nothing except bail out firms that are too big to fail. That does not seem to be working out to well does it? We got here in large part by deregulation. Stop blaming underwater homeowners, they did not create this problem. If fact underwater homeowners pay taxes that were used to bail out too big to fail companies. The investors can go after the rating agencies who lied about the quality of the cdo’s. Or perhaps we will find out soon the the entire way that the cdo’s were put together were illegal and the banks will be forced to pay back the investors. Again none of this is the underwater homeowners fault. Voodoo economics by banks and wall st was what caused this problem. I hope banksters get tired of living off tax payer paid bonuses because I’m sure tired of seeing them paid to fail.

Reader June 15, 2011 at 3:27 pm

cs100 is a lying dope. This web site opposed the bailout for “firms that are too big to fail” in 2008, as a simple search of this blog (or Google) would reveal. cs100 is barking up the wrong tree.

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