David Dayen Looks at FHFA: The Biggest Obama Policy Mistake of the Great Recession: Friday Focus for June 13, 2014

David Dayen: The Biggest Policy Mistake of the Great Recession: “The popular conception of the Great Recession explains that…

…it stemmed from a financial shock. Housing prices stopped going up, and then Lehman Brothers fell, triggering paralysis in the credit markets. This spilled onto Main Street, and the effects still linger in terms of elevated unemployment and sluggish economic growth. But this history of the recession can’t be right, say… Amir Sufi… and Atif Mian…. Consumer purchases dropped sharply well before the September 2008 Lehman bankruptcy, and most deeply in places where home prices fell the most…. Steeper declines in net worth… led to far sharper reductions in consumer spending, and bigger job losses. But even those with no debt suffer when fire-sale foreclosures drop home prices, and lower overall demand spreads out across the country…. The normal channels of fiscal and monetary policy have difficulty dealing with highly leveraged household balance sheets. House of Debt correlates these features of recessions, and really targets debt as the core problem, arguing that it needs to be restructured during crises and prevented during better times….

“When we pitched the book, one publisher said, this is the intellectual justification for Occupy Wall Street,” said Professor Sufi in an interview. “We didn’t set out with that agenda. But one of the points we make is that the position we’re taking is not that radical if you look at history.” Indeed, Sufi and Mian emphasize that the Great Recession response to debt forgiveness was a historic outlier. During the Panic of 1819, when falling commodity prices squeezed indebted farmers, state governments immediately put a moratorium on foreclosures, and Congress easily passed a debt-forgiveness law for farmers who had credit with the federal government. In the Depression, the Home Owners Loan Corporation bought up failing mortgages and restructured them so borrowers could make cheaper payments. Even the code of Hammurabi, with its eye-for-an-eye view of justice, decrees that in lean times, a debtor can “wash his debt-tablet” and pay nothing for a year. This actually helps debtors and creditors, mainly because it brings back the economy faster and reduces the vicious cycle of foreclosures lowering housing prices further….

It is, as Amir, Sufi, and Dayan say, obvious. Debt restructuring is one of the four things that you can do and should do to boost aggregate demand after a financial crisis–the other three are: expansionary monetary policy, expansionary fiscal policy, and I bank recapitalization.

So David asks the very obvious question:

Why did the Bush and Obama administrations break with this tradition, steering aid to insolvent banks over indebted households? Sufi and Mian pinpoint the growing belief, which has taken hold among economists and policymakers that saving the banks equals saving the economy…. A cultural bias against debt has crept into these debates too, blaming homeowners as “deadbeats” who bought “too much home” and ignored the risks…. But while a 40 percent drop in home prices spares nobody, responsible or otherwise, this perspective also ignores a simple fact: There are two sides to a debt contract. “We blame the homeowner because they paid the price, but the only way that can happen is if a lender lends to the borrower,” Sufi said. “There is responsibility on both sides of the contract.”… Mian and Sufi have been drawn into a debate with Timothy Geithner, whose memoir Stress Test… came out at the same time…

It is indeed a great mystery. In my view, the obvious thing to do–once the U.S. government had nationalized FNMA and FHLMC in the summer of 2008–was for the federal government to offer every homeowner in the country a conforming-loan-rate refi, with an equity kicker attached to the deal for those Americans whose homes would not pass the 20% appraisal margin test.

But next to nothing was done–and Obama’s commitment to spend between $50 billion and $100 billion on mortgage relief was simply not kept.

Perhaps the most annoying and misleading thing in Timothy Geithner’s Stress Test is this evasion of responsibility:

We also tried to push the Federal Housing Finance Agency to pursue a similarly targeted program for loans backed by Fannie and Freddie. But acting FHFA director Edward DeMarco, a competent but cautious civil servant who did not want to inflame our Republican critics, refused to allow any principal reductions, even though FHFA’s own analysis showed they would save the government money in about half a million cases. It was amazing how little actual authority we had over Fannie and Freddie, considering they were entirely dependent on Treasury’s cash to stay alive.

Some liberals later blamed the President for their failure to provide relief, since he could have fired DeMarco at any time. But we couldn’t just appoint a new director on our own. The President did nominate well-respected North Carolina Banking Commissioner Joe Smith to replace DeMarco, but Senator Shelby blocked him, claiming he would be an administration “lapdog,” even after North Carolina Senator Richard Burr, a Republican who actually knew Smith, endorsed him as “the best nominee” and “a perfect choice.” After that experience, we had a hard time finding any willing candidates…

This was frustrating, but I don’t think a more compliant FHFA would have produced a dramatically different result. And while our numerous expansions of housing programs helped many Americans, they were still modest relative to the size of the problem. They certainly didn’t change the widespread perception that after embracing a strategy of dramatic force and creativity to save greedy financiers, we left innocent victims of the crisis adrift, vulnerable to the predations of the very banks and investors who had benefited most from our largesse. I once played a prank on Gene Sperling, pretending I had told a reporter he was the secret architect of HAMP—not just the substance, but the communications and messaging strategy. My press secretary got so worried that Gene would have a heart attack that she called to spill the beans; that’s how universally reviled HAMP was. HAMP would end up permanently modifying about 1.3 million mortgages…

I remember having conversations in 2008 with a rather large number of people–some of whom were later to work in the Obama White House–about how (a) at some point in the future it might well be in the public interest to use FHFA as an aggressive tool of macroeconomic policy, (b) the likely interim director Ed DeMarco was much too cautious to be good in this role, (c) opinions as to DeMarco’s competence and his degree of capture by those he was supposed to regulate differed widely, and (d) given FHFA’s effective independence, vetting and then managing the confirmation of a first-class director who understood the policy dilemmas and the administration’s objectives was one of the most important tasks of the U.S. Treasury. If Tim Geithner really was “amazed” to find out how little authority Treasury had over FHFA, he was the only one: the rest of us had known this from the moment of FHFA’s creation,

In that context, Geithner’s paragraphs about FHFA and DeMarco should have begun with: “My and Barack Obama’s failure to even nominate a director for FHFA before the political defeats of the 2010 election was an extraordinary act of political malpractice: we dropped the ball bigtime.”

That’s not what we get: we get evasion–a very careful tiptoeing around how this was a very big deal–distraction–no hint that getting people confirmed by the Senate was much easier in late 2009 than in 2011–and deception–“I don’t think a more compliant FHFA would have produced a dramatically different result” and “HAMP would end up permanently modifying about 1.3 million mortgages…”