Why not zero the debts?

Factual Questions
1

Right, I’m an economics dunce (as will probably be evident from this post) but I can’t see why the following theory wouldn’t work…

I’m UK based and friends were discussing the housing market, etc. We concluded that the way forward could be:

  1. Revalue all properties to “sensible” prices.
  2. Reduce mortgage values to fit the new house prices.
  3. Adjust people’s monthly mortgage repayments to reflect the new value.

Result:

  • Majority of people have lower monthly payments = more disposable income = helping the high street.
  • Affordable housing for first time buyers = resuscitated housing market.
  • Less debt in the financial sector.

So, please feel free to rip this idea to shreds as I’m eager to understand why it wouldn’t work…:dubious:

2

I dunno about the UK, but in the US the government cannot just arbitrarily change the terms of private contracts, which is what your proposal requires.

3

Plus “revaluing all properties to ‘sensible’ prices” erases a tremendous amount of wealth. And some of the value of these properties has been used to make other investments. So what happens to them?

4

It can, it’s just quite unwise to do so.

Banks would be much less keen to lend if they expected that the gov’t can reduce the amount of money owed to them as the result of a contract. Their acceptance of a loan and the interest rates they charge are based on the expectation that X% of them will be paid back to Y amount. Changing the amount means changing the incentive to lend and creating unpredictability, both of which would make it more difficult to get credit.

5

Outstanding debt is an asset in the financial sector. If you lent me $20K to buy a car and I said, “You know what I paid too much for the car, how about I only pay you back $10K?” Would you say “Phew now he only owes me $10K”?

6

One could even structure revised mortgage contracts so that higher debt could be reimposed after several years if/when housing markets recover.

I approve of the idea, and some economists and policy planners with more knowledge than you or I proposed variations of this.

Why haven’t such plans been adopted? Because Banks would have to admit to insolvency.

The insolvency could be dealt with:
[ul][li] Force banks to recapitalize; i.e. sell cheap shares to governments or bargain hunters like Warren Buffett.[/li][li] Possibly impose “haircuts” on bondholders.[/li][li] Send the most blatantly criminal bankers to prison.[/li][li] Restore sane banking regulation so further idiocies do not recur.[/li][/ul]

Why weren’t such steps taken? I’ll hide the answer in case children are reading the thread.

There is no Santa Claus.
There is no Tooth Fairy.
Banking “regulations” in post-rational America (and European countries emulating America) are designed for the benefit of bankers, not the public.

7

How would these prices be determined? Who decides what is ‘sensible’?

IOW, you want to revalue the mortgage to the new (presumably) lower value of the home? Who eats the cost difference? The bank? Does the government use tax payer money to pay the difference? You can’t just wave a wand and make it disappear…someone has to pay here.

You want to adjust their monthly payments to a lower amount…well, certainly if you revalue the property to a lower amount and let everyone refinance that would give you the opportunity to have folks pay less on their monthly mortgage. The only trick is figuring out how to essentially delete a bunch of paper wealth from the books and who will be paying for this.

Would it work the other way as well? If property values go up, are you suggesting that the property be revalued upward so and monthly repayments be adjusted upwards to reflect the new value? Why or why not?

Well, maybe. If the government is on the hook to pay for this then presumably someones taxes are going to need to go up. If the banks are on the hook then my guess is some non-zero number of them are going to go tits up…which probably means that a lot of people will lose a lot of money, and the government will have to step in to bail them out (not sure if the UK has the equivalent of FDIC…I assume it does though), which, again, probably means someones taxes are going to go up.

I don’t see how this would work, to be honest. Why would first time buyers get any benefit out of this program of yours? Even leaving aside the banks going out of business or whatever, presumably the properties in question would already be lower in price if their value has fallen…otherwise, no one would buy them (they being overvalued in a glut market, again presumably).

Brrrr? Why would there be less debt in the financial sector? There would be a lot less WEALTH in the financial sector, sure…but why less debt?

-XT

8

There’s a number of ways to do this in the US, but they’ve been rejected by the Republican/Blue Dog/Centrist coaltiion:

  1. Allow bankruptcy courts to rewrite mortgages on primary residences (they can already do this on secondary properties). This would a require a change in bankruptcy law.

  2. Have Freddie Mae and Freddie Mac unilaterally rewrite mortgages. I believe this is doable via executive order.

  3. Have the FDIC unilaterally rewrite mortgages when it seizes an insolvent bank. I believe this requires a change in the law, but I can’t remember.

But yeah, currently there’s no mechanism to allow this.

9

Well, sept, there’s also the whole, y’know, crash the entire financial system problem. And the fact that the price a house is currently worth on the open market has, and need never have, anything to do with the price aid for it some time in the past. But hey, go ahead, it’s not like people need to exercise any kind of financial judgement themselves when they can rely on 'ole uncle piggybanks to fix their foolishness.

10

Let’s assume that by some miracle, this works the first time around. Banks would never lend a single penny to anyone ever again, lest the government decided to “sensibleize” the new debt.

11

Interest rates would go up a lot, as bondholders looked at losing a lot of money in traditionally AAA-rated bonds and would think “Hmm, these are supposed to be the lowest risk place to put my money … I don’t want to potentially lose more money unless I’m being rewarded for taking that risk.”

So everybody has smaller mortgages but is paying much higher interest rates, that’s if the banks could be funded at all as lots of bondholders would probably throw in the towel at that point and take their reduced money to their hideaway on the Island from Lost (hypothetically speaking, of course).

12

What kind of “financial judgment” were they supposed to exercise? There were only a handful of economists who called the housing bubble correctly. Everyone, from the ratings agencies to the lenders to the Federal Reserve were saying that these were sound investments. And these are supposed to be the experts. The average homeowner behaved completely rationally, given the advice they were getting from the experts.

13

Didn’t read my post much, huh? Even missed “One could even structure revised mortgage contracts so that higher debt could be reimposed after several years if/when housing markets recover.”

Exclude the middle much?

Fighting ignorance since 1973. A losing battle. Move the thread to BBQ Pit for more details.

14

Hmmm… dumbest idea since sliced water.

The problem is, if a bank holds your mortgage - it means the bank will stop getting say, half your mortgage payment and also will only be able to count half your mortgage amount as an asset.

Some people seems to have the misguided idea that banks are a bunch of fat cats loaning out their own money at horrible interest rates, and it’s ok to take it all away and won’t hurt anyone. Not so. Banks take your money and my money - IRA’s and 401K’s (oer your local country’s equivalent retirement savings plan), any savings, etc. The reserve requirements are IIRC about 10% or less; this means when they get assets, they can lend money, and only have to keep 10% of it in relatvely liquid (easily sellable)assets. Most of their money is lent out again, with the understanding they are watching the balance between money out and in. Cancelling up to 50% of their assets, say, would be like declaring that they suddenly ahd 50% bad loans. Not good.

If you take away a huge amount of a bank’s assets, they cannot pay their bills. Other banks threaten to not honour their cheques and drafts, and want cash up front. Many businesses opeate on aline of credit. If the bank has to cancel the line of credit, because they no longer have the money to lend, or if they find that other banks stop honouring their cheques, then the whole business banking system falls apart.

Imagine if for every transaction you had to go to the originating bank. This is what banks do. You pay Visa, Visa remiburses its bank, which transfers to the merchants’ banks, and they eventually get reimbursed for the purchase you made. All those transfers are done in trust that at the end of the day, every bank will tally up what it owes/is owed and make it all even.

This is what was going to happen in 2008 - every bank was rumoured to be failing; each bank was wondering if they should accept a transfer from another, without cold hard cash in hand. The government had to step in and guarantee all suc transfers, which basically translates to covering the debts of overexposed banks.

So let a bunch of banks fail… Too many fail, FDIC goes broke, and the government has to step in. Your 401K is gone, except for the basic FDIC limit (not necessarily applicable, depending on how it was invested). The car makers went broke in 2008 because the banks would not make car loans, since they had no confidence they had the money to lend, or that some people would have the jobs to pay it back. This is the cascade effect. Any business that relies on people financing rather than paying cash is going to take a hit. Who pays the float on your VISA card? Maybe the bank will cancel it - they did that to quite a few customers in the last 3 years…

Mutual funds that hold bonds issued banks will lose a bundle That’s probably your pension plan. Then there’s the “getting there” issue. The longer the plan is discussed and debated, the worse it gets. The car loans are only half of it. If I think my mortgage will be cut in half, I will remortgage and take the cash and run. SO the banks will stop handing out mortgages until the issue is decided. How long does congress take to decide something? Hope you don’t have to buy or sell a house or get any major loan in that six months or more. It’s not like the banks have a magic mirror that says “Fred is honestly selling his property, Joe and Bill are just swapping properties and collecting the sales amount from the bank knowing they will not have to fully pay the resulting mortgages”.

Economics is like water. If you try to block or dam the flow one way, it will ooze out another direction and around until it flows where it was going in the first place.

15

Let’s slow down and take baby steps.

Some in this thread seem focused on sanctity of free markets, laissez faire banking, etc.
These banks would already be insolvent if governments hadn’t intervened. I’m not asking governments to declare solvent banks insolvent. On the contrary the policies supported by my detractors, who pretend to a belief in laissez-faire, are for governments to pretend insolvent banks are solvent!

And the claim that to impose moral hazard on the inconscionable frauds committed would deter future sane loans is too absurd for words.

Did I call for bank failures? What part of "Force banks to recapitalize; i.e. sell cheap shares to governments or bargain hunters " didn’t you understand?

16

Maybe not the government, but the courts restructure mortgage payments the whole time. In the UK the courts have the power to change the principals and interest rates on mortgages or vary any of the terms and conditions, and they do it regularly. Members of congress and President Obama actually proposed something along the same lines (but nowhere near as radical) as the OP’s line of thinking with its “cramdown” legislation back in 2009. All these criticisms that it’s “not allowed” or that would be “impossible to decide what’s fair” are silly - it already happens regularly.

The reason a plan as radical as the OP’s wouldn’t work is because you would instantly wipe huge amounts of assets off the balance sheets of banks and other lenders; it could potentially wipe out the financial sector overnight. In fact this scenario is almost exactly what sparked the financial crisis in the first place - banks suddenly realizing a significant amount of the supposed “assets” they held in the form of sub-prime mortgages were actually worthless, and refusing to lend to each other on the ground that everyone’s balance sheets suddenly looked too shaky, dubbed the “credit crunch”. The plan the OP proposes would essentially create exactly the same situation, but probably a lot worse since you’re planning to apply it to every single property in the country.

17

So the sales pitch to Warren Buffet will read something like:
Dear Mr. Buffet:
The government just recapitalized our loans and cost us $100 billion. Even though we’re now worth less, have lower profits and are higher risk, we think this is a perfect time to invest. At the very least, your reduced income will help you avoid higher tax rates.
Sincerely,
The Banks.

18

Septimus & MD2000, thanks! Clear and understandable responses. I guess the main points we missed (among hundreds!) are that debt to a consumer is an asset to a bank and the house of cards that the investment market is built on.

What I still don’t get is the solvency issue of masses of paper “wealth” versus the ability to fund the debt if need be. I’m off to Amazon for “economics for dummies!”

19

It might help if you consider that all of our economic system is built on the illusion that ‘paper wealth’ is meaningful and has value. When you go to the store and buy something with your paper money, or even more so when you use a credit card you are exchanging those things for something of value because both you and the vendor you are buying from believe that your piece of paper or piece of plastic with a magnetic strip and some 1’s and 0’s on it has a like value.

Same thing applies here. If you can, by government fiat or whatever, wave a magic wand and re-value something then where does it stop? Like I said earlier, does it work both ways or only in one direction? If the property increases in value can the banks go back and re-value the loan to reflect that increase? That would mean that instead of paying the principal and interest on, say, a 150k note, you now have to pay the principal and interest on, say, a 200k…right? Or does this all only work one way? Why or why not? It’s all just ‘paper wealth’ after all, yes? :wink:

-XT

20

  1. The GSE’s are now government owned. The government could unilaterally haircut the GSE mortgages without causing a financial panic, because those mortgages aren’t in the private banking/financing sector. And that’s a pretty huge chuck of the residential mortgage. There are a number of options here. The government could structure the haircut to take a loss to the government, or they could haircut enough just to break even, or they could haircut and take an interest in future sales (assuming prices recovers), or they could even reduce the debt to zero if they wanted to. The Obama administration doesn’t want to do this (IMO) because it wants to maximize ROI (assuming that property values recover). There are arguments for and against that, but I don’t see how a GSE-initiated haircut destabilizes the financial sector.

  2. As for the rest of the privately owned mortgages, once the FMV of the underlying property drops, then the value of the loan should drop as well. It’s not a 1-to-1 correspondence, because the loan value is dependent on other things, but any bank which is properly valuing its loans in a depressed market should have already taken a haircut. This paragraph assumes that banks are marking to market, though.

Are the banks still not marking to market? Anyone know? If so, why? Shouldn’t the market be liquid enough by now that mark to market should have resumed?