Schafer: Here's an idea to keep homeowners above water

  • Article by: LEE SCHAFER , Star Tribune
  • Updated: June 21, 2014 - 4:02 PM

What if all we know about the cause of the Great Recession is plain wrong?

What if it wasn’t the financial crisis that followed the September 2008 collapse of the investment bank Lehman Brothers, as the bubble burst in housing and mortgage backed securities?

It’s a question that really matters if we want to avoid another Great Recession.

And as two professors argue in a convincing new book called “House of Debt,” we really don’t get what caused the severe downturn. Of course that also means that thousands of pages of new financial regulations may not have done much to fix what’s broken.

For the authors, Atif Mian of Princeton and Amir Sufi of the University of Chicago, the main problem is the structure of the mortgage market and how it causes housing price declines to crush consumer spending.

By the late summer of 2008, the family balance sheets of many lower middle-class homeowners had already badly deteriorated, and consumption spending had slid. Automobile sales for the first eight months of 2008 were off about 10 percent from the year before.

Things certainly got a lot worse after Lehman Brothers tipped over and the financial markets seized up, but by then the Great Recession was already well underway.

Mian and Sufi explain that the poorest one-fifth of U.S. homeowners, folks who in 2007 had total debt as a percentage of total assets of about 80 percent, were already deep in recession. In 2007 their net worth was almost exclusively the equity they had in their houses. They were vulnerable to falling prices, and prices had started to fall.

If the $200,000 house with a $160,000 mortgage declined in value 10 percent, the homeowner’s net worth got cut in half.

That may not seem like a big deal, if you assume housing prices will come back. But what if prices drop 20 percent? Now the homeowner just saw net worth go to zero.

So the homeowner cut back restaurant outings, clothing, cable TV, whatever could be cut.

But while the net worth was collapsing for lower middle-class homeowners, the mortgage holder could have been just fine. The $200,000 house had declined in value to $160,000, the amount of the mortgage. The homeowner is wiped out, but the mortgage holder had yet to take a nickel in losses.

This kind of financial pain for homeowners wasn’t uniformly spread throughout the country. But the authors found that from 2006 to 2009 in the counties with the largest decline in homeowner net worth, consumer spending fell by almost 20 percent.

This was so massive that it wasn’t just the nearby shops and hair salons that felt the pain.

So if the American homeowner was under that much pressure, and if that led directly to a national economic slowdown, then doesn’t it make sense that the homeowner should have gotten some assistance?

Yes, they wrote, but it didn’t really work out that way.

One of the problems was that the bankruptcy laws prevent judges from writing down mortgage debt on a primary residence, known as a cram down.

The idea behind this was that preventing a cram down gave lenders more confidence to loan money.

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  • Amir Sufi

  • House of Debtby Atif Mian and Amir Sufi, University of Chicago Press, 192 pages, $26

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