Again, the magic of markets

by Henry on September 7, 2007

This FT piece on GWB’s magical market pony plan for preventing mortgage foreclosures by handing the problem over to “an opaque part of the financial system normally associated with moves to evict families from their homes” is tough and on-target.

An estimated 6m high-risk subprime loans, worth a total of more than $1,000bn, are outstanding, which will in many cases reset to higher interest rates in the next 18 months, putting more than 2.5m Americans at risk of foreclosure. … The response to this crisis outlined by the president places considerable faith in the ability of mortgage servicers to mitigate this blow by helping distressed borrowers to stay in their homes. … Edward Lazear, chairman of the Council of Economic Advisers, said: “I believe, and I think the president believes, that markets are very good at finding ways to solve problems.” But many experts claim that the mortgage service sector is not fit for this purpose. They argue it does not have the capacity to perform this role, and lacks the personnel, financial resources, technical tools, experience, incentives and oversight to deal with an economic crisis of this scale. “Theoretically, it makes sense, but not in the real world,” said Scott Syphax,a director at the Federal Home Loan Bank of San Francisco. “These institutions are not built to handle this scale and volume of problems.” … as more service companies fall into the hands of vulture investors, the task of co-ordinating a national response is likely to become complicated. “The fixes being proposed by the president are not going to result in Americans being rescued from their homes, quite the opposite,” said Richard E. Gottlieb, a lawyer who specialises in mortgage servicing.

There’s very little that I find more annoying than the “magic of markets” arguments that various right wing hacks and ideologues spew at the drop of a talking-point. It makes me want to forcibly enrol the responsible parties in an economic sociology program until they see the errors of their ways. Markets can indeed do extraordinary and impressive things, but they rather obviously depend on previously existing institutions, expertise and social conditions if they are to work. Not to mention proper incentive structures. These can’t be whistled out of thin air. The claim that a business sector composed of small firms specializing in foreclosure and themselves terrified of bankruptcy will have the appropriate motivations and expertise to stave off this crisis is self-evidently bogus, if you look at it at all closely. But sprinkle some of that schmeconomics 101 pixy dust on it, and you can get away with it, thanks to the supine US journalism industry (I don’t know of any US publication which has even mentioned this as a problem; perhaps I’m wrong).

{ 28 comments }

1

Mrs Tilton 09.07.07 at 4:13 pm

That’s “magical market pony plan for preventing mortgage foreclosures”, surely?

2

Henry 09.07.07 at 4:15 pm

indeed and it is. At least now it is.

3

Sk 09.07.07 at 4:41 pm

So the upper middle class attempted to live like the upper upper middle class, found that they can’t do so, and you are upset that GW isn’t providing enough public service protection to save them from the errors of their ways?

I never knew you were such an advocate for the not-quite-rich.

Sk

4

JJ 09.07.07 at 4:50 pm

Henry – AMEN! Jim

5

dsquared 09.07.07 at 5:01 pm

Foreclosure is not a problem for the lender, which needs to be “solved”. Foreclosure is a solution to the problem of a delinquent loan. The market did come up with a solution and this is it.

6

The New York City Math Teacher 09.07.07 at 5:43 pm

When will the cult of authoritarian credulity come to an end? Are reporters too stupid to actually look further than the pleasant market-soothing sound bite?

I work in a school where we want to aggregate developing statistics on all students, in all subjects, every three weeks with two-day diagnostic tests.

How will we grade these tests? I dunno.
How will we aggregate the statistics? I dunno.
No system exists to collect, organize, and re-disseminate the information, and more importantly, every effort to set up a real organ for doing this has been thwarted. It’s like this is a Potemkin thing.

Same thing here. As previously said, the market-legal mechanism for liquidating mortgages in distress is the foreclosure/sale. The bondholder agents have a fiduciary responsibility to their investors, and as long as no legal coercive reform or real cash relief appears, this is going to be a bigger foreclosure crisis than any since the 1930s.

7

ejh 09.07.07 at 6:07 pm

This seems to me to be a decent piece observing just how little responsibility has been exhibited by all the financial institutions involved.

8

Doug 09.07.07 at 6:40 pm

It’s entirely possible that some of the people around 43 have understood Gottlieb’s argument and decided, “Feature, not bug.”

9

SamChevre 09.07.07 at 7:46 pm

All the quoted experts seem to be connected somehow with mortgage servicers. (I didn’t note this until Megan pointed it out.)

I’m trying to figure out what a good outcome here looks like. Of course, “you made bad loans–the losses are your problem” is a bad outcome for martgage servicers; is it a bad outcome for the rest of us?

10

unf 09.07.07 at 7:49 pm

Is there some better explanation of what GWB’s plan actually is? The article is a little frustrating in that it basically amounts to, 1) a rather anodyne quote from the administration on the benefits of markets, and 2) several statements that the institutions chosen to implement the President’s plan can’t do so.

11

foxmarks 09.07.07 at 8:13 pm

“mitigate this blow by helping distressed borrowers to stay in their homes”

Who says this is the *best* or even *preferred* outcome? Maybe distressed borrowers should get bounced, some lenders take losses, and weak neighborhoods be broken. Shiva sees nothing but potential. Let’s get on with the failures and learn some lessons.

“proper incentive structures”

Ummm…if we intentionally structure incentives, we’re not really in a market anymore. Maybe I lack faith in an Incentive Commander who knows exactly what each person wants. I wonder what’s the color of his mystical pony…?

12

r4d20 09.07.07 at 8:24 pm

There’s very little that I find more annoying than the “magic of markets” arguments that various right wing hacks and ideologues spew at the drop of a talking-point …. proper incentive structures …. can’t be whistled out of thin air.

I’m a believer in “free markets” and I a completely agree.

I’ve come to believe that much of the pro-free-market talk is simply a bait-and-switch con. They are liars who do not believe in the free market but find it useful for rhetorical purposes.

They advertise “fair and efficient markets operated under the right rules”. The product they actually deliver, however, is “unfair and inefficient markets without conditions”.

Predictability is a FUNDAMENTAL precondition for free markets to work – people must be able to reasonably predict the results of their actions. The reason why arbitrary power can and often does destroy economies is because of its unpredictability – people wont work as hard or be as inventive if they are justifiably scared that the product of their labor will be taken from them without compensation. One very important aspect of this is that contracts must be enforced. A market where a party can legally agree contract with me to provide a product/service, accept payment for it, and then NOT deliver it is, in practice, not very different from one in which my property can be arbitrarily seized by an authority – and will be about as efficient.

Despite this, in many cases today, the law allows the Health Insurance companies to “reserve the right to change the conditions of service at any time without notification” – which amounts to the right to unilaterally rewrite the contract after it has been agreed to by both parties. This destroys predictability and flies in every justification of the free market yet written, but its business as usual for many people who proclaim their belief in the free market.

Its a shame but when many people say “free markets” they mean is the most brutish and primitive notion of “caveat emptor” – let the buyer beware –

13

bi 09.07.07 at 8:26 pm

ejh: An industry built on magic pixie dust? Win.

14

Thomas 09.07.07 at 8:59 pm

The mortgage servicing business isn’t ordinarily described as being in the business of foreclosing. They’re in the business of servicing the loans.

At least one servicing company has made efforts to help customers stay current in payments. In a pilot program that company reportedly helped 200 customers find jobs. In one case, the company helped pay for a car so a customer could keep working. Why? Because the mortgage portfolio is worth more when the notes are paid at full value than when they are foreclosed. (Contrary to what Dsquared says, foreclosures are a solution, but they aren’t the preferred solution. But the incentive structures are already in place.)

Now, that isn’t to say that the expertise to run this kind of program is readily available, or that this is a solution to the general problem. But, as far as I can tell, no one claims this is a magic bullet, only that at the margins efforts from servicing companies could help. (The FT emphasis on this part of the administrations’ response is unusual, not in its skepticism but in its focus.)

The alternative pushed by the folks FT talked to is a more general bailout. It’s not surprising that these folks would want that (guess what? bankers in CA are nervous!), but it is odd that FT wouldn’t mention it, and that their failure to mention it would be evidence of good journalism.

15

bi 09.07.07 at 9:11 pm

“But, as far as I can tell, no one claims this is a magic bullet, only that at the margins efforts from servicing companies could help.”

Um… so what’s Bush’s plan to solve the general problem again?

16

Shelby 09.07.07 at 11:01 pm

Um… so what’s Bush’s plan to solve the general problem again?

After reading the FT piece, I still don’t know. I don’t even know whether it’s a full plan, a suggested approach, or something in between, or whether it even seeks to “solve the general problem”. Bush’s fault? the FT’s? Who knows?

Perhaps more usefully, does anyone else have a suggestion to solve the general problem? It may be that working at the margins is the only feasible method.

17

Thomas 09.07.07 at 11:06 pm

From the WH:

Fact Sheet: New Steps to Help Homeowners Avoid Foreclosure

On Friday August 31, 2007, President Bush Announced Steps At The Federal Level To Help Homeowners In Need Of Assistance Avoid Foreclosure. These steps will help homeowners having difficulty paying their mortgages and ensure that the problems now disrupting the housing industry do not happen again. The fundamentals of America’s economy are strong – economic growth is healthy, wages are rising, and unemployment is low. The markets are in a period of transition as participants are re-assessing and re-pricing risk. One area that has shown particular strain is the mortgage market, particularly the subprime sector.

The President Announced The Following Steps To Help American Families Keep Their Homes

* 1. The President Calls On Congress To Pass Federal Housing Administration (FHA) Modernization Legislation. The President’s FHA modernization proposal would lower downpayment requirements, allow FHA to insure bigger loans, and give FHA more pricing flexibility. These reforms would empower FHA to reach more families that need help – first-time homebuyers, minorities, and those with low-to-moderate incomes – and offer more options to homeowners looking to refinance their existing mortgage.

o The Administration Will Also Launch A New FHA Initiative Called “FHA-Secure.” The President has asked Secretary Jackson to pursue important administrative changes to give FHA the flexibility to help more families stay in their homes during this time of transition in the mortgage market. The FHA-Secure program will help people who have good credit but who have not made all of their payments on time because of rising mortgage payments. For the first time, FHA will be able to offer many of these homeowners an option to refinance their existing mortgage so they can make their payments and keep their homes. FHA will also charge mortgage insurance premiums based on the individual risk of each loan, using traditional underwriting standards, so it can expand access and help even more families.

o Since 1934, FHA Has Helped Close To 35 Million People Buy A Home And Stay In Their Home. FHA is a government agency that provides mortgage insurance to borrowers through a network of private sector lenders. It also offers options to homeowners looking to refinance their existing loan. The President’s FHA modernization bill was first sent to the Hill in April 2006, and it passed the House last Congress with over 400 votes. The President has once again asked Congress to send him a clean FHA modernization bill as soon as possible so he can sign it into law.

* 2. The President Calls On Congress To Change A Key Housing Provision Of The Federal Tax Code So It Does Not Punish Families Who Are Forced To Sell Their Homes For Less Than Their Mortgage Is Worth. Current tax law counts cancelled mortgage debt on primary residences as taxable income. For example, if the value of a home declines and $20,000 of the homeowner’s loan is forgiven, the tax code treats that $20,000 as taxable income. The President proposes temporary relief to ensure that cancelled mortgage debt on a primary residence is not counted as income.

o The President Is Working With Congress In A Bipartisan Fashion To Make This Important Change. Senator Debbie Stabenow (D-MI), along with Senator George Voinovich (R-OH) and others, has introduced a bipartisan bill that would protect homeowners from having to pay taxes on cancelled mortgage debt. In the House, Representatives Rob Andrews (D-NJ) and Ron Lewis (R-KY), along with several of their colleagues, have introduced similar legislation. The President looks forward to working with Congress to reach agreement on a bill, so we can deliver this vital tax relief to American homeowners.

* 3. The President Announced That The Administration Will Launch A New Foreclosure Avoidance Initiative To Help Struggling Homeowners Find A Way To Refinance. Housing and Urban Development Secretary Alphonso Jackson and Treasury Secretary Henry Paulson will reach out to a wide variety of groups that offer foreclosure counseling and refinancing for American homeowners. These groups include community organizations like NeighborWorks, mortgage lenders and loan servicers, FHA, and Government-Sponsored Enterprises like Fannie Mae and Freddie Mac. The goal of this initiative is to expand mortgage financing options, identify homeowners before they face hardships, help them understand their financing options, and allow them to find a mortgage product that works for them.

18

Stuart 09.07.07 at 11:45 pm

The President Seems To Have A Problem With Correct Capitalisation In Sentences.

19

Martin Bento 09.07.07 at 11:51 pm

Too bad I got to the party so late. I would rather like to defend “poetic justice as fairness” from first principles.

20

Martin Bento 09.07.07 at 11:53 pm

Oops, I posted the preceeding in the wrong thread anyway. Maybe I’d better stop while I’m behind.

21

M. Gemmill 09.08.07 at 12:39 am

Foreclosure may actually even be a poor solution for the loan-holder.

When a bank forecloses on a house, they haven’t gotten their money back. They’ve gotten an empty house that they now must sell (bits and pieces of a house can’t be handed out as dividends, you know). It is entirely possible, particularly in plummeting markets and with borrowers who had creative financing (those most vulnerable to foreclosure), that a foreclosure sale will yield less than the face value of the loan. Every foreclosure sale in a neighborhood drives down the value of other homes, which only serves to compound the problem.

So, foreclosures *are* a problem for the lenders. They are also a problem for the rest of us, particularly in areas that have a lot of defaulters: it drives down property values and diminishes tax revenues for local governments and for schools, which leads to reduced services, which lowers property values, wash, rinse, repeat.

“Qu’ils mangent de la brioche” is not a good response to the situation.

22

Jasper 09.08.07 at 7:15 am

So, foreclosures are a problem for the lenders. They are also a problem for the rest of us, particularly in areas that have a lot of defaulters: it drives down property values and diminishes tax revenues for local governments and for schools, which leads to reduced services, which lowers property values, wash, rinse, repeat.

Well, they’re not really a problem for all of the rest of us. Just some of the rest of us. If one happens to find oneself in that category of fairly poor Americans known as “renters” lots of foreclosures are desirable. Just remember one thing: any grand, corporatist schemes to help lenders, hedge funds and overextended borrowers will also act a subsidization of property values. Which sucks if you’re some poor schmuck in California or Long Island who’s been working like a dog trying to save enough dough to get on the property ladder. Besides, a certain amount of financial pain may be worth it if it results from a necessary rebalancing of the economy, and if the people feeling said pain learn lessons that will benefit them in the future.

23

bi 09.08.07 at 7:36 am

Jasper:

“Besides, a certain amount of financial pain may be worth it if it results from a necessary rebalancing of the economy, and if the people feeling said pain learn lessons that will benefit them in the future.”

What kind of lessons are we talking about here, and why does it seem that only poor people have any lessons to learn from financial crises?

24

Jasper 09.08.07 at 3:41 pm

What kind of lessons are we talking about here, and why does it seem that only poor people have any lessons to learn from financial crises?

Did you not read my reference to “lenders” and “hedge funds” or did you just ignore it? Besides, I hardly think every overextended borrower is “poor” — especially in comparison to the millions of American renters who would be hurt by a taxpayer-funded scheme to prop up the price of houses.

25

Henry 09.08.07 at 4:05 pm

sk – if you don’t know what you are talking about, it usually is unwise to advertise it quite so publicly.

foxmarks – contact me by email and I’ll see if I can find you a nice Ph.D. program in economic sociology. In the meantime, I’d recommend you read some literature – say Doug North’s _Institutions, Institutional Change and Economic Performance_ which will explain (from an unimpeachably right wing point of view), precisely why we can’t expect interests to align so as to maximize productivity in the absence of appropriate institutions.

unf – nice to see you back again. The press release that thomas provides (as distinct from his analysis) gives some idea of what the administration has on the table.

thomas – as someone who studies business self-regulation and governance for a living, I can tell you that there is an unanimous consensus that pious exhortations count for diddly-squat in getting business to do things, unless they are backed up by the threat of sanctions/formal regulation. One tiny pilot program does not a precedent set. Business, after all, as right wingers are fond of telling us, are in it to make profits, not to support social responsibility etc etc.The descriptions of Bush’s initiative in the business press, as best as I can see, very nearly universally describe them using terms such as ‘modest’ – and with good reason. The exhortations count for zilch – they fulfil the same rhetorical purpose as the claims in the 1980s that mentally ill people who were being turfed out of (admittedly often horrible) hospitals, were being put out to the ‘community.’ Just as there was no community then, there is no reason to believe that the relevant firms are going to provide a single jot or tittle more flexibility on repayments than is compatible with their interests in a market facing a serious credit crunch. Which is to say, not very much at all. The FHA reforms will help a maximum of 80,000 people out of 2-2.5 million mortgage holders at risk. The Stabenow legislation _will_ be helpful – but is hardly controversial or a serious use of Presidential agenda-setting power.

jasper – fair enough that this doesn’t affect a fair chunk of the working poor. But it does affect another chunk- lots of the distressed debt is precisely from people who had rented in the past and who thought that they could own. There’s a lot that could be written about the perverse incentives towards ownership in the US tax system – but that is a topic for another post.

26

Jasper 09.08.07 at 4:23 pm

There’s a lot that could be written about the perverse incentives towards ownership in the US tax system…

Indeed.

but that is a topic for another post.

Fair enough.

27

Thomas 09.09.07 at 2:19 pm

Henry, one pilot program actually does set a precedent. The purpose of the program I described, which I don’t think is the only one but is simply one that I’m aware of as it was a local firm, was to make money, not to be socially responsible. And as I said above, it is in the interest of the note holders for the loans to be paid rather than foreclosed; the incentives, in general, are there. As for the rest: I absolutely agree that the overall program (of which this is a small, small part)(quick, find the mention of the pivotal loan servicers in the WH release)(it’s there, in a laundry list) is modest. Unfortunately, I don’t think there are good and big solutions to the subprime problem. The government could try to bail everyone out, subprime borrowers and lenders alike. I know that would be popular with some of the folks FT talked with, but it seems to set a perverse precedent. And in any case the subprime problem isn’t just increasing payments, but is primarily a matter of declining home values in select markets. If a subprime borrower paid $500,000 for a home last year (with no money down, and no closing costs!) that is now worth $450,000, even better terms on the note won’t be sufficient in many/most cases to keep that subprime borrower paying.

28

derrida derider 09.10.07 at 10:34 am

I have to say Ed Lazear is too good an economist to believe what he said. Brad deLong’s right – academics who choose to serve at senior levels in this particular administration do so at grave risk to their reputations.

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