4. Some ideas about how to solve a borrowers’ crisis
Is it not ironical that the two major solutions to the lenders’ crisis: Quantitative easing and a further lowering of interest rates did so little for the median nominal income households lucky enough to remain in a job after 2008. In 2008 this income level was $50,303 and only by 2012 did it exceed the 2008 level to
$51,017.
With the lowest interest rate on record at 0.15 %, U.S. households collectively reduced their outstanding mortgage lending level by well over 10% over the period 2008-2015 or in actual amounts by $1.24 trillion from the high of $10.712 trillion over the period Quarter 1 2008 to $9.471 trillion over Quarter 2 2015.
U.S. households that fell into payment arrears were pursued through the legal system. It is important to mention that a legal system can replace economically sensible measures. This was made clear in the latest financial stability report of the Bank of England.
The Bank of England in its latest 2017 Financial Stability Report3 has developed a diagram of a “self-reinforcing feed back loop”. It shows the potential relationship between an adverse house price fall, its collateral effect, the reaction of the banking community in reducing the supply of credit, the expectation of further house price drops and “fire sales” and the reinforcement of an adverse house price shock.
3 http://www.bankofengland.co.uk/publications/Pages/fsr/2017/jun.aspx
The Bank of England’s report expresses a fear that the “self-reinforcing feedback loop” can be the cause of a next financial crisis. It is recommending steps to force banks to increase their capital buffers against such adverse events.
The situation in the U.K. differs in one major aspect from that in the U.S. In the U.K., for many years, not enough new homes were built to satisfy the needs of the growing population. Such undersupply creates an artificial scarcity effect, which pushes house prices up far in excess of average income growth. In the U.S., over the period from 1997-2007, the volume of new housing starts was well in line with the population growth over that period, but the growth in mortgage lending far exceeded the average growth in incomes.
In the U.S. the first adverse shock came from the number of households unable to continue to service their mortgage debt by 2007-2008. The legal system took over through foreclosure proceedings and repossessions.
Just to show the evidence, in table 3 an overview is provided of U.S. foreclosure proceedings started, completed and repossessions.
Economic sense to help have-nots in a financial crisis©Drs Kees De Koning
Table 3: Foreclosure filings, foreclosures and home repossessions in the U.S. 2004-2016 into financial difficulties due to mortgage borrowings, a 65% increase over 2004.
Over the period 2006-2014 22.9 million households were confronted with foreclosure filings. Over the same period 6.2 million homes were repossessed. Is it any surprise that over the period 2007-2016 new housing starts dropped of the scale?
The magic question
Could the borrowers’ crisis have been avoided? The answer is a definite yes.
Restraining mortgage-lending levels, when their growth exceeds the growth in median incomes would be a start. Comparing income growth levels with mortgage lending levels is not rocket science. However, no specific mortgage lending control measures were taken over the period 2001-2008. The common opinion was that interest rate movements would help to control the volume of
households had to dedicate an ever-increasing percentage of their incomes to
Economic sense to help have-nots in a financial crisis©Drs Kees De Koning
servicing mortgage debts or pay higher rents. This should not have happened.
However it did. The debt recovery process did not use economic means to solve the crisis, but legal means of foreclosure filings, completed foreclosures and home repossessions. The Bank of England’s feedback loop worked perfectly in this way, to the great detriment of individual households. With falling house prices, households had even less of a chance of any recovery of accumulated savings in the home. The poor were forced into deeper poverty. As stated above, this was not due to a fault of their own making.
There is another option, an economic one and one actually quite similar to providing liquidity to the banking sector, when it ran into financial problems. It can be described as a liquidity support system for individual households.
In a previous paper: “How the financial crisis could have been averted”4, the writer already illustrated such suggestion. The option could be used when a cap on mortgage-lending levels had not been enforced. In such case the setting up of a National Mortgage Bank was recommended to help households overcome their liquidity squeeze. Such an NMB could act as a lender of last resort for individual households on basis of sharing part of the asset (the home) with the NMB for its cash-flow help. Such help should be differentiated for each income class that an individual household belongs to. Low-income earners should be helped most. It is ironical that, in 1936, the U.S. Home Owners Loan Corporation was disbanded.
Had such a Corporation been in existence in 2007-2008, it could have done wonders for maintaining the liquidity position for most mortgagors and even take a subordinated share in the housing market, till mortgage lending levels were better attuned to the nominal increases in median household incomes.
Rather than buying up mortgage backed securities to the tune of $1.8 trillion, as was done, an assistance scheme to directly help households to overcome their liquidity pressures would have been a much more effective way in avoiding a rapid increase in unemployment levels and the subsequent fast increase in U.S.
government debt levels. Economic growth levels would also have been higher.
The lenders should pay a price to the NMB for the reduction in risks that the NMB manages for them. The borrowers should share -on a subordinated basis- with the NMB some of the wealth incorporated in the homes.
With the help of an NMB, mortgage borrowers can be helped –on a temporary basis- to overcome the economic pressures that the excess mortgage lending levels have created for them.
This solution is an economic, rather than a legal one. Such solution avoids the loop effects as spelled out by the Bank of England’s financial stability report.
4 https://ideas.repec.org/p/pra/mprapa/77060.html
Economic sense to help have-nots in a financial crisis©Drs Kees De Koning
The impact on households
If economists can agree that the cause of the financial and economic crisis of 2007-2008 was burdening households with more mortgage debt than their income growth would allow them to repay -without having to cut down on spending on other goods and services-, then the solution to solving or avoiding such crisis in future, becomes clearer. A direct approach to help households financially to overcome such liquidity squeeze becomes more rational. Such solution also restores the balance between the rich and poorer households. The lower income households do not lose out due to lending excesses organised by the financial sector. The lenders will need to contribute to an NMB for the lowering of their risks over the mortgage portfolio. An NMB, once it has been accepted as a viable solution, will reduce rather than increase the income and wealth gap between the rich and poor. Economic growth levels should be less affected as households are enabled to continue to spend on other goods and services. Unemployment levels would not have doubled over a short space of time. Government debt levels would not have risen so rapidly as they did in the U.S. over the last nine years.
Last but not least, an economic imperfection can be solved with economic means, rather than with the help of the legal system.
Drs Kees De Koning Chorleywood, U.K.
30 August 2017
Economic sense to help have-nots in a financial crisis©Drs Kees De Koning
References:
• Andrew Ross Sorkin: Too Big To Fail, Inside the battle to save Wall Street, published by Penguin Books, 2010
• Federal Reserve Bank of St. Louis: Fed Funds rate;
https://fred.stlouisfed.org/series/FEDFUNDS
• Bank of England, Financial Stability report June 2017;
http://www.bankofengland.co.uk/publications/Pages/fsr/2017/jun.aspx
• Kees De Koning: How the financial crisis could have been averted. MPRA paper 77060, University Library of Munich, 22 February 2017 https://ideas.repec.org/p/pra/mprapa/77060.html