Category Archives: housing


President Obama's Cleveland economy speech – detailed outline

This is the second of two posts. Here is the first, a much shorter high-level version of the outline contained here.

This is my attempt to build a detailed outline of the economic speech President Obama gave in Cleveland yesterday (watch it).

I used his language in some parts, but in many parts these are his concepts expressed in my words, I hope to provide more clarity.

It won’t surprise regular readers that I disagree with much of this. I have tried not to let that cloud this summary.

Detailed outline of President Obama’s Remarks on the Economy

Cuyahoga Community College
Cleveland, Ohio
Thursday, June 14, 2012

I. Big choice — two paths

A. Choice / two fundamentally different visions.
B. Choice and debate are not about whether we need to grow faster, but instead about how to:

1. Create strong, sustained growth;
2. Pay down our long-term debt;
3. Generate good, middle class jobs so people can have confidence that if they work hard, they can get ahead.

C. Big decisions. Not new challenges. Problems more than a decade in the making.

D. Being held back by a stalemate over two different paths for our country. Election should is about resolving this stalemate.

II. Define & blame Republican theory for bad stuff.

A. Long before 2008 the basic bargain had begun to erode
B. Define Republican theory: cut taxes, no regs, market solves everything
C. Results of Republican theory: worked well for the rich, but prosperity never trickled down to the middle class.

III. Be patient.

A. Not your normal recession.
B. It has typically taken countries up to 10 years to recover from financial crises of this magnitude.
C. We’re in better shape than Europe.

IV. Take credit for the good stuff

A. We acted fast. My policies are working.
B. We’re recovering from:

1. Financial crisis of 2008;
2. A decade of middle class falling behind;
3. Erosion of basic bargain over decade[s?]

V. Romney wants to repeat the failed experiment of the last decade.

A. We implemented Republican theory last decade:

1. Best way to grow the economy is from the top down;
2. Eliminate most regulations;
3. Cut taxes by trillions of dollars;
4. Strip down government to national security and a few other basic functions.

B. This failed theory created the fiscal problems we face now and the financial crisis that caused this weak economy.

C. Romney wants to return to and repeat this failed theory.

VI. Romney’s plan is bad for the middle class.

A. Keep Bush tax cuts in place and add another $5T in tax cuts on top of that.

1. 70% of those will go to >$200K/year, and >$1M/year will get an average tax cut of about 25%

B. Cut valuable government programs: student loans, Head Start, health research and scientific grants.
C. Eliminate health insurance for 33m (repeal ACA) + 19m more (Medicaid cuts).
D. Scale back or eliminate tax breaks that help middle class families: health care, college, retirement, homeownership.
E. Repeat of failed top-down growth theory.

VII. My plan is an economy built from a growing middle class. Race to the top.

A. Education;
B. Energy;
C. Innovation;
D. Investment;
E. Tax code based on American job creation and balanced deficit reduction.

VIII. I’m a centrist, look at my record.

A. I have cut taxes.
B. Fewer regulations than Bush in first three years.
C. Signed into law $2T of spending cuts.
D. Deficit reduction plan to slow health cost growth, not shift costs to seniors.
E. Domestic discretionary spending lowest share of GDP in nearly 60 years.

IX. I’m for keeping the American tradition of bipartisan government involvement in the economy.

A. Government is not the answer to all our problems, and I’m not proposing government run everything.
B. Romney and Republicans want to return us to no rules and unregulated market free-for-all.
C. America has succeeded not by telling everyone to fend for themselves, but by all of us pitching in, all of us pulling our own weight. That’s what I’m for.

I hope you find this useful.

(photo credit: Obama campaign)


President Obama's Cleveland economy speech – high-level outline

This is the first of two posts.

Here is my attempt to outline the meaty 53 minute economic speech President Obama gave yesterday in Cleveland. I built this outline to help myself analyze the speech, then realized that others might find it useful. While it is true that little of the substance was new, this is nevertheless a serious policy speech that makes what the President and his advisors think is the economic part of their best case for reelection. I will take it seriously and recommend you do so as well — this isn’t just another blow-off stump speech. This is the theory of the economic case the way the President wants you to see it.

If you’re a student of economic policy I recommend you watch or read the whole speech. No summary or analysis can substitute for the candidate’s own words and presentation.

Here is my plan of attack: summarize first; then explain; then respond. Today is just the first step, the summary.

In some cases i use the President’s words, but I’m often using my own more colloquial language to express his arguments more clearly if I can. So in some cases these are his thoughts (I think) in my words. I have done my level best to capture his arguments in their most effective and convincing form, especially when I disagree with them. I will express my disagreements another time.

This post contains just the highest level outline. The next post contains a much more detailed outline. I recommend you skim this one, then read that one.

High level outline of President Obama’s Remarks on the Economy

Cuyahoga Community College
Cleveland, Ohio
Thursday, June 14, 2012

I. Big and fundamental choice — two paths.

II. Define & blame Republican theory for bad stuff.

III. Be patient.

IV. Take credit for progress / the good stuff.

V. Romney wants to repeat the failed experiment of the last decade.

VI. Romney’s plan is bad for the middle class.

VII. My plan is an economy built from a growing middle class. Race to the top.

VIII. I’m a centrist, look at my record.

IX. I am for keeping the American tradition of bipartisan government involvement in the economy.

That’s the short, high-level outline. Here is the detailed version.

I hope you find this useful.

(photo credit: Obama campaign)


The President’s economic policy priorities

The President’s 2012 economic policy agenda emphasizes four policy challenges:

  1. the loss of American manufacturing employment;
  2. America’s dependence on oil;
  3. America’s sub-par (my phrase) education and training; and
  4. increasing income inequality.

Each of these trends began decades ago:

  • Our employment has been shifting from manufacturing to services for decades, as it shifted from agriculture to manufacturing in the 19th century (all while American manufacturing output continues to grow over time);
  • We have been dependent on oil as a fuel source for oh, about 100 years;
  • The seminal report on American education, A Nation at Risk, was published in 1983, yet it reads as if it were written this year; and
  • Income inequality has been increasing since about the 1970s, while even the spike in inequality at the very high end is probably 20ish years old.

There is nothing wrong with prioritizing long-term economic problems and challenges; in fact, quite the opposite.  Washington usually focuses only on problems and challenges that will bite before the next election.

And yet:

  • The President barely mentions the greatest long-term (and, increasingly, short-term) economic policy challenge we face, the size and growth of unfunded entitlement spending promises to the (current and future) elderly;
  • The second greatest long-term economic policy challenge, closely related to the first, continues to be the unsustainable growth in per capita health spending, notwithstanding mistaken claims that the Affordable Care Act will slow that growth;
  • The most urgent economic policy challenge we face is the slow recovery of the U.S. labor market, with housing weakness and macro/financial threats from Europe in a close second and third;
  • In last year’s State of the Union address, President Obama framed the central policy challenge as infrastructure and public investment competition from China and India, something that doesn’t really make his top four this year (his manufacturing message is somewhat different);
  • President Obama emphasizes frequently that he doesn’t want to “return to the policies of the past,” meaning the Bush era, yet these policies were not the cause of the problems he now stresses; and
  • The President is not claiming that his proposed policies would solve even a significant portion of the problems he describes.

I would like instead to see the President set economic policy priorities like these:

  • Clear out the barriers to private sector expansion and investment, in particular by reducing both the drags induced by recently enacted expansions of government and the massive uncertainty caused by lingering open policy debates;
  • Stop trying to “fix” the housing market and let housing prices find a painful but market-clearing bottom so that more normal growth could resume;
  • Make structural reforms to Social Security and Medicare and Medicaid that adapt them for inevitable demographic trends as well as evitable unsustainable promised benefit growth; and
  • Aggressively expand international trade and investment rather than throw up protectionist barriers and rhetoric.

The massive recent and planned future expansions of government are the greatest threats to ongoing American economic strength in both the short and long term. Expanding the scope of government further as the President proposes will make things worse, not better.

(photo credit: Lawrence Jackson for The White House)


The political risks of targeted mortgage subsidies

Yesterday the President announced an expansion of a program to help some homeowners who are underwater on their mortgages.  The President announced his new policy in Nevada, one of the four “sand states” where the housing bubble grew biggest.  The others are California, Arizona, and Florida.

Yesterday I wrote:

Mortgage refinancing policies are quite hard to do at scale.  If recent history is a guide, this program may help a few tens of thousands of homeowners.  That’s a trivial macroeconomic impact.  Even if it does help 900,000 homeowners, the effects will be small enough that they won’t show up on most macro forecasts.  Its greater benefit may be political: it creates another talking point for the President.

The President can contrast his action with a Congress that is blocking his broader legislative proposal. The developing Beltway conventional wisdom seems to be that while the policy benefits of this new proposal are at best small, this is unquestionably a useful political weapon for the President.

The specific policy action he is taking, however, also carries downside political risk for the President that may not be obvious at first glance.

Many elected officials have a bias toward government action: they see a problem and ask “What can we do to fix it?” The solutions they embrace often arise from an iterative process in which advisors compare the problems that exist with the policy tools available to address them and make the best possible match.

These matches are almost always highly imperfect, especially when you’re working on housing. Let’s look at two key attributes of the President’s new policy:

  • It will subsidize only a small share of homeowners.  For each newly subsidized underwater homeowner there will be many more who are, or feel like they are, in a similarly deserving situation and yet will not received subsidized aid. If we give the President maximum credit for helping “up to” 900,000 homeowners, that’s about 1 in 80 homeowners, of which there are about 75 million in total.  The actual ratio will likely be much worse.
  • Since assistance will be targeted by a set of rules, some of those who receive aid will be those whom, upon closer examination, most would deem “undeserving.”  This program helps those with a high loan-to-value ratio, which can occur either because the house’s value has declined, or because the homeowner took out or refinanced into a particularly big mortgage. While we may have sympathy for those in the first category, the homeowner who at the peak of a regional housing bubble withdrew equity from his mortgage to buy a big boat and was then hit by a housing price decline evokes far less sympathy. And if he now receives taxpayer subsidies, his neighbors are going to be ticked.

These policy features create political risk that the President’s team may be discounting or even ignoring. It is fairly easy to focus press attention on the hard luck case of a responsible homeowner who, through no fault of his own, was hit by regional housing price declines and is now locked into an underwater mortgage.

But government action to help that sympathetic homeowner will leave many more without similar aid, and if past experience is a guide, some of them will be angry at the inequities created (real or perceived). If the expanded program also results in high visibility cases of subsidized big spenders who gambled on the housing bubble by withdrawing equity, a backlash could grow.

Whatever your views on the policy merits of placing additional taxpayer funds at risk to subsidize underwater homeowners, it is a political mistake to pay attention only to the one homeowner you’re helping, and to ignore possible pushback from the 79 or more homeowners you’re not helping, as well as from the taxpaying renters.

I am not predicting a major political backlash on the President’s new policy announcement. I think it’s too small to have either a large policy or political effect, positive or negative.  I want simply to remind you that a program like this is not all political upside for the President. Don’t forget that the original February 2009 Rick Santelli explosion, which launched the Tea Party, was a reaction to an Obama Administration proposal to use taxpayer funds to subsidize targeted mortgage relief.

(photo credit: Mark Nicolson)


Democracy is SO inconvenient

In anticipation of today’s mortgage refinancing policy announcement in Las Vegas, White House Communications Director Dan Pfieffer writes:

Using the mantra “we can’t wait,” the President will highlight executive actions that his Administration will take.  He’ll continue to pressure Congressional Republicans to put country before party and pass the American Jobs Act, but he believes we cannot wait, so he will act where they won’t.

Mantra? That’s a signal to the President’s political allies: please repeat this phrase.

The new policy will allow some homeowners who are underwater on their mortgages to refinance at lower interest rates.  It does this by waiving some fees and shifting a bit of incremental risk to taxpayers through Fannie Mae and Freddie Mac, which are now in effect wholly-owned subsidiaries of the U.S. government.

This is an incremental expansion of an existing housing refinance program.  If effective, it will help some more underwater taxpayers with fixed-rate mortgages, at some risk of increased cost to taxpayers.  The Administration is using phrases like “may help up to 900,000 homeowners.” Key words are may and up to.

Mortgage refinancing policies are quite hard to do at scale.  If recent history is a guide, this program may help a few tens of thousands of homeowners.  That’s a trivial macroeconomic impact.  Even if it does help 900,000 homeowners, the effects will be small enough that they won’t show up on most macro forecasts.  Its greater benefit may be political: it creates another talking point for the President.

If this were a huge program that would help several millions of underwater mortgages at an enormous cost to the taxpayer, there would be some interesting policy tradeoffs worth exploring.  In particular, are the macroeconomic benefits of helping these homeowners refinance and potentially escape from their underwater mortgage worth the increased costs to the taxpayer and the inequities created in which one group of Americans subsidize others whose [housing] investments went bad?  These same tradeoffs exist with this new policy, but I wouldn’t lose sleep over them when the policy is small. Still, Congress should ask FHFA for detailed estimates of the increased costs and risks to the taxpayer.

I am more intrigued by the President’s new mantra, “We can’t wait.” The logic is “We can’t wait for a Republican Congress, so we’re acting with every tool we have to improve the economy. We admit it’s not enough, but that’s [Republicans in] Congress’ fault.” Never mind the near-comatose Democratic-majority Senate that is neither marking up the President’s proposals in committee nor taking up alternative House-passed economic growth bills.

The President’s argument is, in effect, “We can’t wait for democracy.” The Constitution gives the power of the purse to the Congress, not the President. If the Congress doesn’t want to enact his proposals, then it shouldn’t, and that’s how the system is supposed to work.

I am not surprised that the President is using the legislative flexibility he has to maximum effect. I am a bit surprised that he sees a political benefit in framing himself as an Imperial leader who can and should ignore democratic processes. This seems inconsistent with Democratic party rhetoric in recent years.

Democracy is so inconvenient when your party controls the Presidency and the opposition can block your legislative agenda.

(photo credit: JD Hancock)

The 10 most important American economic policy issues of 2010

Here is my view of the 10 most important American economic policy issues of 2010.

1.  The weak U.S. macroeconomy

In 2010 a weak macroeconomy once again swamped in importance all other economic policy issues.  Forecasters had predicted a tough year — the 9.7% average unemployment rate for the first 11 months of the year is not far above the Administration’s 9.3% forecast for the year.

In 2011 the most important metric will once again be the unemployment rate.  Economically as well as politically the focus will once again be almost entirely on job creation.  We need the economy to be generating hundreds of thousands of net new jobs each month.  That is unlikely but not impossible.

Most forecasters project a stronger U.S. economic growth path in 2011 than 2010, but few are projecting that growth will be robust enough to bring the unemployment rate down rapidly.  While this week’s unemployment claims took a turn for the better, that’s a volatile data set, and the labor picture over the past few months has been weak.  If the forecasts hold up, things will be bad but improving throughout 2011.  You decide whether the politics and press will focus on the bad or the improving part.

Please remember not to lean too heavily on economic projections.  My rule of thumb is that the best macroeconomic forecasts get unreliable six months out and are not much more than guesses beyond a year.

2.  The failure of fiscal stimulus

This trend began in 2009 and solidified in 2010.  The fiscal stimulus debate camps and arguments are well established, and because the debate relies on comparison to a counterfactual it may never be provably resolved, allowing economists to argue ad nauseam.

Whatever your view on the policy question, as a political matter the stimulus failed miserably.  There are a few easily identifiable errors.

  • The President repeatedly took too optimistic of a tone relative to what his experts projected on something that was largely beyond his control.
  • Team Obama gambled and lost by creating an unverifiable “jobs saved or lost” metric.  Sometimes the unverifiability worked for them, but ultimately it broke against them because a job saved by policy is neither provable nor visible.
  • The policy path the President chose in early 2009 (more accurately, the path to which he acquiesced when Congress chose it) set up countless “waste, fraud, and inefficiency” stories throughout 2010.
  • After February 2009, every time the President signed another bill “to create jobs,” he reinforced the message that his first stimulus law was failing or at best insufficient.

3.  The stimulus vs. austerity debate

The U.S. is now left of Germany and the U.K. on fiscal policy in rhetoric if not result.  That is both weird and disturbing.

4.  (Temporary?) enactment of the health care laws

The President and his allies had a huge policy victory here.  I think these laws are an unmitigated disaster, the largest economic policy mistake in a long time.  The President and his allies created a massive new entitlement, spent budget offsets needed to address our long-term spending problem and therefore made future middle class tax increases a near certainty, and turned health insurance into a regulated utility.

The ongoing pushback from Republicans, even after enactment, was a wonderful surprise from a party that had for too long been afraid to debate health policy.  Democrats had to delay implementation of the most expensive provisions for a few years, allowing Republicans time to mount a repeal campaign that continues to build steam.  My first big blog mistake of the year was prematurely declaring the legislation dead after Scott Brown’s surprise victory in Massachusetts.  My second (unpublished) mistake was assuming that the President’s signature was the endgame.  It appears the 2012 Presidential election will be in part a referendum on these laws.

5.  Enactment of financial services reform (Dodd-Frank)

This is another big policy win from the Administration’s perspective.  I have mixed feelings on the law.  Some parts (like creating resolution authority for regulators to shut down too-big-to-fail firms) are essential, others (like the Consumer Financial Protection Bureau) are harmful, and still others (like the long-term resolution of Fannie Mae and Freddie Mac) are unresolved.

Many policymakers appear to have convinced themselves that new policies and structures are (or, in a few years when the regs are complete, will be) in place to prevent large institutions from failing.  I worry that we still don’t have a good solution for the next Black Swan event when (not if) one or more of those huge institutions do fail in spite of the new, better informed, and more powerful regulators.

6.  Carbon pricing implosion

In less than four years carbon pricing has gone from front burner to burnt toast.  The Climategate data fudging scandal undermined a previously strong positive public perception of climate scientists and their advocacy.  In Copenhagen the global negotiations imploded after confronting the problem of the China-India hole in the U.S./green strategy.  A Democratic House and Senate could not agree to carbon pricing legislation, demonstrating that regional economic perspectives are at least as important as policy philosophy.  The President walked a tightrope between demonstrating to greens that he was with them and allowing himself an exit strategy when legislation inevitably failed.  West Virginia Governor (and now Senator) Joe Manchin erased any doubt by literally shooting the Waxman-Markey bill in a campaign ad.

We now appear headed down the worst possible policy path.  Congress will not enact legislation but the Environmental Protection Agency will start regulating greenhouse gas emissions and allowing/encouraging States to do so.  This is the most economically burdensome way to regulate carbon emissions.  It will be large enough to impose significant constraints on domestic power production and heavy manufacturing now, and maybe on other sectors later.  Yet any reductions in U.S. emissions will be small relative to uncapped increases from China and India.  EPA’s rules and Congressional efforts to block them will create policy uncertainty, deterring needed investment in the expansion of U.S. power production and slowing long-term economic growth.  EPA’s regulatory authority always served two purposes to those who want to price carbon:  as a threat to try to force legislative action, and as a costly fallback if legislation failed.  The fallback option never made sense.  It should but probably won’t be abandoned.

7.  The Democratic Congress’ budget failures

From the perspective of Congressional Democrats, the health care and financial services victories counterbalance their two fiscal policy failures in 2010.  Tax rates on income and capital will not increase during President Obama’s first/only term.  They failed to enact full-year appropriations bills to fund the government, resorting instead to short-term continuing resolutions.  The new Congress will have to complete the leftover appropriations work in early 2011.  Many of the President’s spending goals will be unmet as he wrestles with a Republican House majority with very different priorities.  I am pleased with both outcomes, which exceeded my initial expectations.

Both results can be traced directly to decisions by Speaker Pelosi, Senate Majority Leader Reid, and their respective Budget, Tax, and Appropriations Chairmen.  They failed because they didn’t even try to govern.  They never tried to pass a budget resolution, they delayed action on taxes until the last possible minute when Republicans were strongest, and they never tried to pass appropriations bills in the Senate.  They missed an opportunity to create a reconciliation bill that would have allowed them (and the President) to win the tax extension debate.  In each case these were unforced errors by Democratic Congressional leaders that significantly affected the fiscal policy outcomes of 2010.

8.  Rise of the Tea Party

I have not much to add here other than to recognize that the small government impetus began with the early 2009 Santelli rant and exploded into summer 2009 Town Hall opposition to Obamacare.  I now think of it not as a political party, but instead as a strong and deep anti-TARP-autos-bailout-stimulus-Obamacare-cap-and-trade-government-spending-earmarks-deficits sentiment.  In simpler terms it’s a powerful populist pushback against the expansion of government.  Over the next two years Republicans can succeed to the extent they respect this sentiment and push for smaller government and a bigger private sector.

9.  Increasing awareness of medium-term fiscal problems

The bad news is America’s long-term fiscal problems are now medium-term fiscal problems.  The good news is that Americans are increasingly aware of those problems, and pressure is building on elected officials to solve them.  While nothing transformative on this front happened in 2010, several trends are important to note.

  • The shift from long-term to medium-term is a result of two factors: (1) inaction on entitlement spending over time by both parties; (2) enormous short-term deficits that are wiping out a projected temporary deficit trough before the Baby Boom spending wave hits.  Those enormous short-term deficits result from (1) the weak economy; (2) actions taken to recover from the weak economy; and (3) a generic expansion of government spending unrelated to economic stimulus.
  • In February the President’s budget launched this round of fiscal debate by intentionally leaving a large deficit hole to be plugged by recommendations from a new Presidential fiscal commission.  The President’s goals for that commission were too focused on the short run, and it’s unclear whether he intended the commission to solve the problem, provide him with cover for a proposal in early 2011, or just to buy him time through a mid-term election year.  Nevertheless, the commission reported in December with a bipartisan package of spending reforms and tax increases, teeing the issue up nicely for 2011.
  • Enormous 2009 and 2010 deficits and massive spending increases in those years raised the prominence of both the size of government and fiscal imbalance as important policy issues.
  • Fiscal crises in Europe and looming fiscal crises in various U.S. States focus attention on the U.S. federal fiscal problem.

It’s always safe to bet against a big painful fiscal policy change, but if it’s ever going to happen, 2011 seems like as good a year as any.  The 1997 budget deal was done by President Clinton, Speaker Gingrich, and Majority Leader Lott, a D-R-R alignment.  This time we have a D-R-D alignment.

10.  Round 2 of the Obama economic team

Three of the four key Obama economic advisor slots will be manned by different personnel in 2011 than a year earlier.

Out (voluntarily):  Larry Summers (NEC), Peter Orszag (Budget), and Christina Romer (CEA)

In:  Jack Lew (Budget), Austan Goolsbee (CEA), ??? (NEC)

  • The departure of WH COS Rahm Emanuel and upcoming departure of Senior Advisor David Axelrod will also have a big effect on economic (as well as other) policy.  My sources say they were heavily involved in almost all major economic decisions, sometimes operating as a separate decision-making layer between the economic team and the President.
  • Treasury Secretary Geithner and NEC Deputy Jason Furman are now the institutional memory of the Obama economic team.
  • Both Lew and Goolsbee are insiders who were promoted.
  • The President should have filled (or at least announced) Summers’ successor at NEC weeks ago.  The fall is policy development time in the White House, and the President hurt himself by not having in place a successor to his top White House economic advisor.

Have a Happy New Year.

(photo credit: Takras)



The President discusses housing in Albuquerque

Yesterday the President spoke about the economy at a “backyard discussion” in Albuquerque. He made some interesting comments on housing which I’m going to analyze today.

I like when the President does unscripted Q&A because I can learn how he thinks about an issue and sometimes figure out how his advisors have briefed him. This is one of those cases.

I will intersperse my observations within the President’s long comment. You might be surprised at how much I agree with the President’s remarks on this topic. I know I was.

Q: And I guess my question is, what are we doing to prevent people from losing their homes?

THE PRESIDENT: Well, the housing crisis helped to trigger the financial crisis.

I agree. There’s a difference between “trigger” and “cause.” I think trigger is right.

THE PRESIDENT: And it’s a complicated story, but essentially what happened was, banks started seeing money in peddling what looked like these very low-interest-rate mortgages, no money down. Started peddling these things to folks. A lot of people didn’t read the fine print, where they had adjustable-rate mortgages or balloon payments, and they ended up being in situations where they were in homes that they couldn’t necessarily afford.

Close but not quite. Mortgage brokers were providing much of the increased volume of new mortgages, especially adjustable rate mortgages (ARMs) to “subprime” borrowers. Some banks were on the front end of this increased volume, but to just say banks is incomplete and a bit inaccurate.

With the word “peddling” the President emphasizes the theme of unscrupulous and shady lenders taking advantage of unwitting and uneducated borrowers. This is correct in many cases but it’s far from the whole story. Your bailed-out neighbor with the home-equity-withdrawal-financed boat in his driveway is another part of the story, and he knew exactly what he was doing. I wonder if the questioner wants the government to subsidize that knowing neighbor as well as the unsuspecting lending victim. In practice a government policy cannot easily distinguish between the two.

I also wonder how much we should excuse from responsibility a borrower who “didn’t read the fine print.” If you’re borrowing several hundred thousand dollars from someone, I think you should read and make sure you understand the fine print. Similarly, I hold the view that you are primarily responsible for figuring out how much home you can afford, not your lender. Your lender has an obligation to disclose and explain the terms of the loan, to provide you with complete and accurate information, and to not deceive you. We didn’t have strong enough rules in place to require that, and we now know that was a mistake. At the same time, if the borrower has complete and accurate information, it is his responsibility to act in a financially prudent manner.

Please don’t think I’m excusing or minimizing the importance of corrupt and shady mortgage brokers and in some cases bankers – there were some really bad actors who helped create this problem.

THE PRESIDENT: The banks made a whole bunch of money on all these mortgages that were being generated. But what happened was — is that when the housing market started going down, then all these financial instruments that were built on a steady stream of payments for mortgages, they all went bust, and that helped to trigger the entire crisis.

True, but again he’s incomplete with “the banks.” Many firms and players at all points along the financial chain “made a whole bunch of money on all these mortgages that were being generated.” The banks were part of this chain, as were the mortgage brokers who initiated the loans, Fannie Mae and Freddie Mac that securitized many of them, as well as hedge funds, insurance companies, pension funds, university endowments, foreign investors, and everyone else who bought securities derived from these mortgages. Bankers are a more attractive political target than, say, pension funds or university endowments. The President’s statement is correct but incomplete, and in a politically convenient way.

The President says “when the housing market started going down … they all went bust, and that helped to trigger the entire crisis.” This isn’t quite right. Even before home prices started to decline, there were problems caused by the terms of Adjustable Rate Mortgages. Many subprime ARMs had a low fixed teaser rate for the first 2-3 years, after which the interest rate would “reset” upwards. Those borrowers who understood what they were buying hoped that their home would appreciate in value during that first 2-3 years, allowing them to refinance into a fixed rate mortgage before the interest rate reset, using the higher home value as equity to support the new mortgage. The President is therefore correct that housing prices were an important factor in the collapse in value of housing-related assets, but again it’s not the whole story. That story begins with interest rate resets in subprime ARMs.

We therefore had (1) housing problems triggered by the terms of a particular type of mortgage, and (2) housing problems caused by local housing construction bubbles bursting. (1) and (2) interacted – as subprime ARM homeowners began to default, it drove down the prices of their neighbors’ homes and amplified broader housing price declines. These two problems are interrelated, but they’re not the same problem. As an example, there were subprime ARM default problems in Michigan where there was a weak regional economy but almost no housing construction bubble.

THE PRESIDENT: So the housing issue has been at the heart of the economic crisis that we’re in right now. It is a big problem because part of what happened over the last several years is, is that we built more homes than we had families to absorb them. And what’s happened now is, is that housing values have declined around the country, in some places worse than others. In Nevada, in Arizona, they’ve been very badly hit. In New Mexico, I don’t think we had the same bubble, and so prices have not been as badly affected here. But overall across the country, housing lost a lot of value.

This part is really good: “We built more homes than we had families to absorb them.” He’s absolutely right. The problem was not just mortgages, it was the actual buildings we live in. We had a housing bubble in some markets, and we still have an oversupply of homes relative to demand. As long as supply >> demand, prices will fall. That’s why I was taught by experts to watch the inventory of unsold homes. As long as that inventory remains significantly higher than the historic average, we still have an imbalance and the housing market won’t recover.

The President also knows which housing markets saw the biggest bubbles. Kudos to his staff. The big four were California, Nevada, Arizona and Florida. I still have seen no good explanation of why these four markets were so much more extreme than others.

THE PRESIDENT: Now, this is a multitrillion-dollar market, so there’s no government program where we can just make sure that whoever is losing their home that we can just pick up the tab and make sure that they can pay. And frankly there are some people who really bought more home than they could afford, and they’d be better off renting, or they’re going to have to make adjustments in terms of their house.

This part is excellent. The President is right – the housing market is so big that we can’t bail out every homeowner who lost value. And while the President is gentle about it, I can be more direct since I’m not in campaign mode. I don’t think the government should bail out someone who bought a bigger house than they can afford, especially if they had no down payment. I think doing so is unfair to the taxpayers who finance that bailout, and unfair to responsible homeowners who didn’t borrow recklessly.

THE PRESIDENT: What we have tried to do, though, is to make sure that people who had been making their payments regularly, who are meeting their responsibilities, if they could have a little bit of an adjustment with the banks, if some of the principal was reduced, if some of the interest was reduced on their mortgage payment, they could keep on making payments. The bank would be better off than if the home was foreclosed on, obviously they’d be better off, and as the housing market starts picking back up again — which it will do over time, although not in the same trajectory as it used to, right; it’s going to be more much gradual — then potentially the bank could recoup some of the money that it had lost by making the adjustments on the mortgages.

This is correct in theory, and every reporter can find cases where this is true and makes sense. But it’s really hard to scale this up. Also, advocates for these policies often conflate their justifications – should we do this because we want to help these particular homeowners, or because we believe doing so will have broader benefits for the economy?

I feel empathy for the homeowner hoodwinked into a ARM by an unscrupulous mortgage broker. To the extent we believe that many borrowers were unfairly surprised by their interest rate resets from deceptive lenders, and to the extent we feel some governmental responsibility for that surprise / bad news, then it makes sense to help them. This is the genuinely deserving case that the media likes to show us, leading us to mistakenly conclude that everyone at risk of losing his home is a victim deserving of taxpayer help.

Depending on the numbers, I can be comfortable using some taxpayer funds to help move that person into a more affordable mortgage. But since we can’t distinguish between this deserving case and the savvy-for-profit-flipper, any subsidy program will also mean we’re subsidizing people whom we all can agree don’t deserve empathy or subsidies. This is a thorny problem to which there’s no easy answer.

Then we get to the place where I disagree not just with the President’s comment, but with much of the accepted wisdom in Washington about which homeowners we should help. Remember that a homeowner with a fixed rate mortgage doesn’t see his monthly mortgage payments change, even if the market value of his home drops so far that he is underwater on his mortgage.

Example: At the height of the housing bubble, Fred bought a $500,000 Florida home with a $475,000 fixed rate mortgage. He has been making fixed monthly mortgage payments since he moved in. Now the Florida housing bubble has collapsed.Fred has $450,000 left on his mortgage, but today he could sell his home for at most $400,000. He is “underwater” $50,000, and it will take years for him to recoup that loss.

Many in Washington want to subsidize Fred, to bail him out. Some talk about paying the lender to reduce the principal on his mortgage. Others want to force his lender to write down the value of his mortgage. But while Fred has taken an enormous paper loss, he is at zero risk of involuntarily losing his home. Since his mortgage is fixed rate, his monthly mortgage payments haven’t changed, so he’s not at risk of foreclosure. He is no worse off than his cousin George in Iowa who lost $100K investing in tech stocks back in the late 90s. In fact, Fred has an option that George did not have – if he wants he can default on his mortgage, leave the house to the bank, and take the long-term hit to his credit rating. That sucks for Fred, but that’s an option George the bad-stock-investor didn’t have.

Note also the President’s “If they could have a little bit of an adjustment with the banks” language. When you look at borrowers you can divide them into three groups: (1) those who don’t need help to stay in their home, (2) those on the bubble who cannot afford to keep their home without help, but could with just a little bit of assistance, and (3) those who would need so much help from the bank or taxpayers that it’s unreasonable to assume they can ever dig out. You don’t want to spend money on group (1), and money spent on group (3) is a waste. So you try to target your policies at just group (2). That’s hard to do.

THE PRESIDENT: So we’ve set up a number of these mortgage modification programs that are out there. But I don’t want to lie to you — we’ve probably had hundreds of thousands of people who’ve been helped by it. I think there have been a couple of million who’ve applied. But that doesn’t meet the entire need because this is such a huge housing market.

Translation: The quantitative results for these mortgage modification programs are terrible. In the President’s defense, we the Bush team didn’t have much success in this either. It’s very hard for government to effectively influence mortgage modification on a large scale. Q: If a program is directionally correct and politically useful, but ineffective and inefficient with taxpayer dollars, and if you cannot design a better alternative, do you continue it or kill it?

THE PRESIDENT: And what really is probably the most important thing I can do right now to keep people in their homes is to make sure the economy is growing so that they don’t feel job insecurity. That’s probably the thing that’s going to strengthen the housing market the most over the next couple of years. If we’ve got a growing economy, unemployment is gradually being reduced, then people are going to feel more confident; they’re going to be able to make their mortgage payments; new — homeowners, people who are potentially buyers of homes, are going to say, you know what, I don’t mind entering the market because I think things have sort of bottomed out — that starts lifting prices and that gets us on a virtuous cycle instead of a negative cycle.

Good again, but I’d add something else. The foreclosure prevention programs and other housing-related interventions are helping some people keep their homes. At the same time, these programs have the side effect of slowing down the painful but necessary adjustment in housing supply. Especially after witnessing the past three years of struggling housing policy interventions, I lean toward applying the Band-Aid philosophy. Every child knows there are two ways to pull off a Band-Aid: slow and really fast. And every child learns that really fast means less total pain, but it’s scary and difficult to do.

It would be painful in the short run and politically risky to stop intervening in housing markets and let housing prices continue to fall until the excess housing supply is finally bought by bargain hunters. But once this happens we’ll be back on a gradual upward trend. It may be better for us to get the pain out of the way as quickly as possible so the healing can begin, rather than trying to artificially “bridge the gap” with ineffective policies, in hopes that we can protect a few more tens of thousands of homeowners from losing their homes. Dozens of smart people have suggested alternative policies to avoid or mitigate further housing price declines, and there is an argument that government needs to intervene to stop a self-reinforcing downward spiral. I don’t buy this argument.

This is a harsh numbers game with no easy answers. My instinct is for government to stop trying to fix the problem and just let the darn housing market find its natural bottom. I think this means more pain now, but less total pain over time. I think the recovery will come sooner and stronger if we stop trying to patch the housing market and get the painful adjustment behind us.

THE PRESIDENT: But it’s going to take some time. We’re working our way out of overbuilding in the housing market, a lot of not very sensible financial arrangements in the housing market. And we’ve got to get back to sort of a traditional, more commonsense way of thinking about housing which is, if you want a house you got to save for a while. You got to wait until you have 20 percent down. You should go for a mortgage that you know you can afford. You’ve got to — there shouldn’t be any surprises out there, right? That kind of traditional thinking about saving and thinking about the house not as something that is always going up 20 percent every year and you’re going to flip and take out home equity loans and all that — we’ve got to have a different attitude, which reflects what you talked about, more of an attitude that this is your home. This is not just a way to make quick money.

I strongly agree with the President here. I hope he’s willing to tell Members of his party that this means they have to stop insisting that the Federal Housing Administration facilitate zero down payment loans and seller-funded down payments. All homeowners need to have some skin in the game, even if this means that some people won’t be able to afford to buy homes. Certain important Congressional Democrats are the roadblock here.

While at the beginning of his answer the President focused on unscrupulous lenders, here he focuses on the gamblers/flippers. This is a different thought process than the “Banks did it to the people” model with which he began. I think there’s some truth in both stories.

I’m impressed by the depth of the President’s understanding and his thought process. I disagree with his Administration’s policies in many cases, and that includes his housing policies, but I think he gave a good answer yesterday in this Albuquerque backyard conversation.

(photo credit: Moth)