Why Housing Is Still Hindering the Recovery
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Why Housing Is Still Hindering the Recovery


One year and one month before President Obama won re-election, he invited seven of the world’s top economists to a private meeting in the Oval Office to hear their advice on fixing the ailing economy. “I’m not asking you to consider the political feasibility of things,” he told them in the previously unreported meeting.

There was a former Federal Reserve vice chairman, a Nobel laureate, one of the world’s foremost experts on financial crises and the chief economist of the International Monetary Fund, among others. Nearly all said Obama should introduce a much bigger plan to forgive part of the mortgage debt owed by millions of homeowners who are underwater on their properties. Obama was reserved in response, but Treasury Secretary Timothy F. Geithner interjected that he didn’t think anything of such ambition was possible.

“How do we get this done through Congress?” he asked. “What could we actually do that we haven’t done?”

The meeting highlighted what today is the biggest disagreement between some of the world’s top economists and the Obama administration. The economists say the president could have significantly accelerated the slow economic recovery if he had better addressed the overhang of mortgage debt left when housing prices collapsed. Obama’s advisers say that they did all they could on the housing front and that other factors better explain why the recovery has been sluggish.

The question is relevant: Although Obama won reelection, the vast majority of voters still say the economy is weak and not getting better. Policymakers in Washington are now focused on another type of debt — the public debt all taxpayers owe — but the slow economic recovery, which depresses tax revenue, makes that problem harder to solve. Nearly 11 million Americans, or more than a fifth of homeowners, are buried in debt, owing more than their properties are worth after piling their life savings into their properties — a persistent and largely unaddressed problem that represents the missing link in what many economists consider the administration’s overall strong response to the recession.

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“Housing was the neglected piece. They have the kind of attitude that they don’t believe this is a good value for the money, this is politically unpopular, and there’s not much we can do,” said Alan Blinder, a former Federal Reserve vice chairman consulted frequently by the White House. “There were obvious things to do that academics and others started pointing out back in 2008. That could have shortened the recovery time.”

Obama’s economic advisers dispute that. Geithner said the administration chose the best options available to deal with the housing crisis. “We knew the hit to wealth would be damaging. We knew the level of debt had the potential to restrain the strength of recovery,” he said. “The only issue was, what could you do about it? What were the feasible options available? We chose the best of the feasible options.”

Obama’s advisers believe the ultimate pace of recovery is understandable, if disappointing, given the financial crisis and the collapse in housing prices, as well as surprises such as a drought this year, the European debt crisis, rising oil prices and the trade-disrupting Japanese earthquake. They argue that the course they pursued — spending more than $1 trillion on tax cuts and employment programs — helped all Americans and sped up the recovery, and that alternatives that dealt with housing debt directly were never viable.

Of the original members of Obama’s economic crisis team, Geithner, the one still in office, has pressed this point most strongly. Others have said that if the administration did make a big error in its response to the crisis, it had to do with housing. Lawrence H. Summers, formerly Obama’s top economic adviser, has said he doesn’t think the administration made a major mistake. But this month, he said at a conference in Washington that “if we made a serious mistake, the best arguments would be around questions about housing.”

Former budget director Peter Orszag has said “a major policy error” was made. And Christina D. Romer, formerly Obama’s top economist, has said that the driving ideas “may have been too limited” and that there needs to be a bigger focus on reducing mortgage debt — a process known as “principal reduction.”

“The new evidence on the importance of household debt has convinced me we are likely going to need to help homeowners who are underwater,” she said last month. “Many of these troubled loans will need to be renegotiated and the principal reduced if we are going to truly stabilize house prices and get a robust recovery going.”

Some of the most authoritative research on the role of mortgage debt in the recession and recovery — research reviewed by Obama — comes in part from an economist from Pakistan who started out studying why poor countries struggle to grow. Atif Mian, now a Princeton professor, came to focus on how finance can destabilize an economy. He saw how foreign money had flooded Latin America in the 1980s and Southeast Asia in the 1990s, leading to borrowing booms and financial crises.

Not long before the U.S. recession, Mian and another young economist, Amir Sufi of the University of Chicago’s business school, saw a similar trend here. “The common link to the emerging market crises,” Mian said, “is that it all starts with leverage.”

The two economists compared what happened in U.S. counties where people had amassed huge debts with those where people had borrowed little. It had long been thought that when property values declined in value, homeowners would spend less because they would feel less wealthy. But Mian and Sufi’s research showed something more specific and powerful at work: People who owed huge debts when their home values declined cut back dramatically on buying cars, appliances, furniture and groceries. The more they owed, the less they spent. People with little debt hardly slowed spending at all.

This was important because consumer spending makes up the lion’s share of economic activity, and even a small increase or decrease can have a big impact on growth and affect millions of jobs. From 2006 through 2009, overall consumer spending was flat, according to calculations Sufi completed for The Washington Post. But among the quarter of U.S. counties with the highest debt, it fell 5.5 percent. Without that hit, spending nationwide would have increased by 2.4 percent. In other words, indebted Americans had an outsize effect, pulling down the rest of the nation’s economy.

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Some people reduced spending because they had lost their homes to foreclosure, damaging their ability to borrow. Others no longer could tap home-equity lines of credit. Still others, facing high monthly payments, used every extra penny to pay off debt. When the Federal Reserve greatly lowered interest rates, it helped many borrowers but not those underwater, because banks wouldn’t refinance their loans. Federal Reserve data show that the number of Americans paying more than 40 percent of their income toward debt — a high threshold — declined between 2007 and 2010. But among people whose wealth had disappeared, it surged.

Historically, Sufi said, “places that have bigger recessions usually have stronger comebacks.” But his calculations showed that since the end of the recession, places with high levels of debt have not had robust recoveries.

Other economists — from both political parties — were making the same point around the time Obama came to office. Blinder, a Clinton administration official, and Martin Feldstein, a Reagan administration official, developed plans calling on the government to commit hundreds of billions of dollars to restructure millions of mortgages with lower interest rates and principal balances.

Said John Geanakoplos, a Yale economist who proposed a plan to reduce principal: “I think the missed opportunity to forgive principal at the end of 2008 and beginning of the 2009 was the biggest mistake the administration made in trying to deal with the crisis.”

The architects of the Obama administration’s response to the recession — Summers and Geithner — knew all too well the problems of a debt overhang. The two had begun their public service careers — Geithner at the Treasury Department, Summers at the World Bank — in the shadow of the Latin American debt crisis. A tough-minded rescue plan by Treasury Secretary James A. Baker III had failed and been replaced by a more generous one by Baker’s successor, Nicholas F. Brady, that finally helped Latin America shed its debt.

As Obama took office, Summers would note how the Brady plan had succeeded where the Baker plan failed. But although the new Obama administration had hundreds of billions of dollars in unspent financial bailout money available to use, it decided against any significant program to reduce the debt of underwater homeowners. “No one was in doubt that debt overhangs were an important problem,” Summers said recently at a conference. But despite exploring many proposals, the administration did not see a plan that did not have the potential to cause “effects worse than the cure,” he said, such as cratering the financial system by forcing banks to absorb huge losses.

At a more basic level, officials simply did not believe that a big program of debt forgiveness was a smart investment, costing hundreds of billions of dollars — money that it preferred to spend on a massive economic stimulus package that could much more quickly lift the economy. The administration also announced a more modest program designed to avert foreclosures by reducing mortgage payments but not the total debt balance.

In late 2009, the economy started to grow at a pace of 4 percent per year — fast enough that employment would have returned to normal by just about now. But in 2010, growth sputtered to 2 percent. The administration responded with more stimulus. But the pattern repeated itself in 2011 and this year.

Today, administration officials say they do not see the mortgage debt overhang primarily at work. Rather, they say, foreign shocks, cuts in local and state spending, and other factors dragged down the economy. Still, in the past year, Obama has expanded programs to try to better tackle mortgage debt, announcing more federal funding to write down loans and an expanded program to allow underwater homeowners to refinance. The efforts seem to have had positive effects. A greater number of underwater borrowers have reduced their principle balances and been able to refinance, and the housing market has had a modest recovery.

Not everyone is impressed, though. “I don’t see the kind of aggressive approach that could make a big difference,” Romer said in September at Hofstra University.

Many people still have a long way to return to normal, pre-boom levels of debt. Although Americans racked up $5 trillion in new mortgage debt before the crisis, they have erased only about $1 trillion of it, according to the Federal Reserve. Research by Karen Dynan of the Brookings Institution shows more than 10 percent of families would have to save all of their income for six months to pay down the debt they accumulated in the boom years.

“The housing sector is far from being out of the woods,” Federal Reserve Chairman Ben S. Bernanke said last week. “We should not be satisfied with the progress we have seen so far.”

This article originally appeared in The Washington Post.