Arnold Kling  

Ken Rogoff on the Current Situation

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He writes,


Too many decisions, for example the recent withdrawal of monetary stimulus by the European Central Bank and the US Federal Reserve have been predicated on overly rosy growth projections.

Read the whole thing. Rogoff and co-author Carmen Reinhart have been pointing out that de-leveraging is a long, painful process. They have earned the right to be heard. I wonder if Tyler Cowen has any room for Reinhart and Rogoff in a list of potentially influential intellectuals.

Ken sees mortgage writedowns as a constructive step in the de-leveraging process. Of course, I completely disagree. About the most famous writedown program, HAMP, Mike Konczal writes,


From an ethical point of view a redefault rate this high [21 percent in the first year] is an abomination. Consumer advocates talk about predatory lending as "equity stripping" and a modification that ends in a redefault should be thought of as "wealth stripping." It keeps consumers running through costly hoops to end up no better off all so banks can juke their books on what properties are in what kind of shape.

Thanks to Mark Thoma for the pointer. As far as prophets go, I said early on in Congressional testimony that this program was simply setting borrowers up to fail. Perhaps I deserve to be heard, too.

The people who favor mortgage modifications are ignorant about how mortgages and housing work. Instead, they live in some abstract world in which somebody in a far-away office can figure out new loan terms that fit in general in spite of idiosyncratic variation. But there are many problems with this.

1. You do not know what the borrower lied about in order to get the mortgage. You don't know if this is the borrower's primary residence. You don't know the borrower's income or asset position.

2. You do not know the status of the housing market in the neighborhood. Are there a lot of foreclosures and pending foreclosures? Have prices hit bottom, or do they still have further to fall?

3. You do not know the mindset of the borrower. Do they really understand what they need to do in order to handle a mortgage on a house where the price is not going up?

Yes, de-leveraging is a theme of the current crisis. But I think that another important theme is what I call The Era of Expert Failure. As local knowledge becomes increasingly important, the central planners become increasingly ineffectual. Mortgage modifications are an illustration of that. The failure of that approach should be described as Hayek's revenge.


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COMMENTS (4 to date)
effem writes:

Arnold,
What about a government-coordinated program where principal reduction is exchanged for a property appreciation right (taxpayer gets a big chunk of future appreciation)? This is the John Hussman "solution."

Charles R. Williams writes:

It would be more effective to accelerate the foreclosure process. As you say, modifying mortgages works when the local banker is in control. Otherwise it is impractical.

It is hard to imagine a collapse in lending standards without securitization of mortgages. But securitized mortgages pose a systemic risk in that they are difficult to modify when problems arise.

On the other hand, it is hard to imagine local bankers making 30 year fixed rate mortgages with a refinancing option financed with govt insured short term deposits.

Steve Roth writes:

What do you think about his central suggestion: a few years of higher inflation?

Joe Cushing writes:

Konczal didn't say mortgage modifications--he said write downs. Very few modifications involve a write down. Write downs would be productive but they aren't happening. Most modifications involve changing interest rates and stretching out terms. I have a low rate and a low payment on my own mortgage but it's 50% under water. A write down would help me but a modification would not help much. I actually pay almost triple my payment each month.

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