How Households Can Have Higher Debt Without Borrowing More

Feb 23, 2012J. W. Mason

money-question-150New research shows that conservatives and liberals may both be missing the point when trying to explain rising levels of leverage.

money-question-150New research shows that conservatives and liberals may both be missing the point when trying to explain rising levels of leverage.

Changes in debt-income ratios can be attributed to primary borrowing, interest rates, growth, and inflation. In a new working paper, Arjun Jayadev and I apply such a decomposition to the evolution of U.S. household debt shows that changes in borrowing behavior has played a smaller role in the growth of household leverage than is widely believed. Rather, most of the increase can be explained in terms of "Fisher dynamics" -- the mechanical result of higher interest rates and lower inflation after 1980. Bringing leverage back down will similarly require contributions from factors other than reduced borrowing.

It's a well-known fact that household debt has exploded in recent decades, rising from 50 percent of GDP in 1980 to over 100 percent on the eve of the Great Recession. It's also well-known that household borrowing has increased sharply over this period. Indeed, for most people -- including many economists -- these are two ways of saying the same thing. In fact, though, they are quite different claims, and while the first one is certainly true, the second is not.

How can debt have increased if borrowing hasn't? Though this seems counterintuitive, the answer is simple. We're not interested in debt per se, but in leverage, defined as the ratio of a sector's or unit's debt to its income (or net worth). This ratio can go up because the numerator rises or because the denominator falls. Household leverage increased sharply, for instance, in 1930 and 1931 (see Figure 1). People weren’t consuming more in the Depression, but leverage rose because incomes and prices were falling faster than households could pay down debt. Similarly, changes in interest rates can change the debt burden without any shift in household consumption, because a level of spending that would be compatible with a stable debt-income ratio when interest rates are low will lead to a rising ratio when interest rates are higher.

Figure 1:

The role of interest rates, growth and inflation in shifting debt levels independent of borrowing is well-known when it comes to public debt. Indeed, "the least controversial equation in macroeconomics" (Hall and Sargent, 2011) is the law of motion of government debt:

where b is the ratio of debt to GDP, d is the primary deficit as a share of GDP, i is the nominal interest rate, g is the real growth rate of GDP, and pi is inflation. As this equation makes clear, a rise in interest rates or a fall in GDP can lead to a rising debt ratio, even if a government holds the line on spending and taxes. Conversely, a government that runs deficits can still reduce debt via inflation as long as nominal interest rates remain low, as was the case in the U.S. and most other rich countries following World War II. (Abbas et al., 2011) Indeed, as Willem Buiter and others have pointed out, the entire 90-point fall in the U.S. debt-GDP ratio in the decades after World War II can be attributed to nominal interest rates below nominal growth rates. In the aggregate, the U.S. ran budget deficits over this period.

These dynamics are familiar when it comes to public debt. As a matter of accounting, the same equation applies to household and business debt as well. But strangely, despite the example of the Depression (and Irving Fisher's famous diagnosis of rising debt burdens caused by falling prices and incomes (Fisher 1933)), no one has systematically examined what fraction of changes in private debt can be attributed to changes in interest, growth, inflation, and new borrowing. [1] In a new paper, Arjun Jayadev and I attempt to fill this gap, applying the standard decomposition of public sector debt changes to household debt in the United States for the period 1929-2011. (Mason and Jayadev, 2012.) Our findings challenge the conventional narrative about rising household debt.

What we find is that the entire increase in household leverage after 1980 can be attributed to the non-borrowing components of the equation above -- what we call Fisher dynamics. If interest rates, growth, and inflation over 1981-2011 had remained at their average levels of the previous 30 years, then the exact same spending decisions by households would have resulted in a debt-to-income ratio in 2010 below that of 1980, as shown in Figure 2. The 1980s, in particular, were a kind of slow-motion debt-deflation, or debt-disinflation; the entire growth in debt relative to earlier periods (17 percent of household income, compared with just 3 percent in the 1970s) is due to the slower growth in nominal income as a result of falling inflation. In other words, there is no reason to think that aggregate household borrowing behavior changed after 1980. Indeed, households rescued their borrowing in the face of higher interest rates just as one would expect rational agents to. The problem is that they didn't, or couldn't, reduce borrowing fast enough to make up for the fact that after the Volcker disinflation, leverage was no longer being eroded by rising prices. In this respect, the rise in debt-income ratios in the 1980s is parallel to that of 1929-1931.

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Figure 2:

Think of it this way: If you borrow money and your income in dollars rises by 10 percent a year (3 percent real growth, say, and 7 percent inflation) then you will find it much easier to pay off the debt when it comes due. But if you borrow the same amount and your dollar income turns out to rise at only 4 percent a year (the same real growth but only 1 percent inflation) then the payment, when it comes due, will be a larger fraction of your income. That, not increased household spending, is why debt ratios rose in the 1980s.

Neither the 1980s nor the 1990s saw an increase in new household borrowing -- on the contrary, the household sector in the aggregate showed a primary surplus in these decades, in contrast with the primary deficits of the postwar decades. So both the conservative theory explaining increased household borrowing by shorter time horizons and a general lack of self-control, and the liberal theory explaining it by efforts of those further down the income ladder to maintain consumption standards in the face of a falling share of income, need some rethinking. Given the increased availability of credit and rising inequality, some households may well have chosen to increase spending relative to income, and those lower down the income ladder presumably did rely on borrowing to maintain consumption standards in the face of stagnant wages. But for the household sector in the aggregate, until 2000, there is no increased household borrowing to explain.

The main results are summarized in Table 1, which shows the average contribution of each of the terms from equation 1 to the annual change in household leverage over seven periods. Positive numbers indicate factors that raised leverage, while negative numbers are factors that reduced it.

Table 1

Period ∆b d i g π
1929 to 1933 0.025 -0.049 0.024 0.023 0.023
1934 to 1945 -0.021 -0.010 0.019 -0.025 -0.008
1946 to 1964 0.028 0.023 0.031 -0.017 -0.009
1965 to 1980 -0.001 0.008 0.055 -0.027 -0.038
1981 to 1999 0.014 -0.015 0.081 -0.025 -0.025
2000 to 2006 0.050 0.033 0.080 -0.038 -0.025
2007 to 2010 -0.020 -0.067 0.079 -0.006 -0.026

In this table, i, g, and pi represent the contributions of those three terms to the change in leverage -- that is, the underlying value times the debt-income ratio at the start of the year. This is why the contribution of interest remains so much higher in the 2000s than before 1980, even though interest rates had fallen back down to their pre-Volcker levels by then. As can be seen from the table, leverage rose in the 1980s and 1990s after being stable in the previous 15 years, but the difference was not higher household borrowing. Rather, the whole difference is explained by higher interest costs and slower inflation.

An important point to note in Table 1 that in the period of the housing bubble -- 2000 to 2006 -- the conventional story is right: during this period, the household sector did run very large primary deficits (averaging 3.3 percent of income), which explain the bulk of increased leverage over this period. But it doesn't explain all of it. Even in this period, about a third of the increase in debt was due to the mechanical effects of i, g, and pi. And in the following four years, households reduced consumption relative to income [2] by nearly as much as they increased it in the bubble years. But these large primary surpluses barely offset the large gap between interest and (very low) growth and inflation over these four years. In the absence of the headwind created by adverse debt dynamics, the increase in household leverage in the bubble would have been effectively reversed by 2011.

We draw two main conclusions. First, as a historical matter, you cannot understand the changes in private sector leverage over the 20th century without explicitly accounting for debt dynamics. The tendency to treat changes in debt ratios as necessarily the result in changes in borrowing behavior obscures the most important factors in the evolution of leverage. Second, going forward, it seems unlikely that households can sustain large enough primary deficits to reduce or even stabilize leverage. Even the very large surpluses of 2006-2011 would not have brought down leverage at all in the absence of the upsurge in defaults. In the absence of large federal deficits and an improving trade balance the outcome would have been even worse, since reductions in household expenditure would have reduced aggregate income. As a practical matter it seems clear that, just as the rise in leverage was not the result of more borrowing, any reduction in leverage will not come about through less borrowing. To substantially reduce household debt will require some combination of financial repression to hold interest rates below growth rates for an extended period, and larger-scale and more systematic debt write-downs.

[1] Growing interest in leverage has led to various qualitative attempts along these lines, such as Roxburgh et al. (2010) But to our knowledge no one has applied Equation 1 to private sector debt, as we do.

[2] While the Flow of Funds show households paying down debt at an average rate of nearly 7 percent of income annually between 2007 and 2010, as reflected in Table 1, nearly half -- 3 percent -- of that is actually accounted for by defaults rather than reduced borrowing.

J. W. Mason is a graduate student in economics at the University of Massachusetts, Amherst. He blogs at The Slack Wire.

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Why Inequality Matters: 3 Ways the Mortgage Crisis Has Undermined Our Legal System

Feb 17, 2012Bruce Judson

money-justice-scalesBanks are demonstrating that if you have enough money and influence, you're not expected to follow the same laws as everyone else.

money-justice-scalesBanks are demonstrating that if you have enough money and influence, you're not expected to follow the same laws as everyone else.

For several years, I have been writing that extreme economic inequality is among the most destructive forces in a society. As inequality grows, it undermines the effective functioning of the economy, the basic tenets of capitalism, and the foundations of democracy.

Unfortunately, the housing crisis and now the housing settlement increasingly look like an example of how these mechanisms work.

One of the central characteristics of highly unequal societies is that two sets of laws develop: One set for the rich and powerful and one set for everyone else. The more unequal societies become, the more easily they accept the unacceptable, and with each unrebuked violation, the powerful actors at the top of the society gain an ever greater sense of entitlement and an ever greater sense that the laws that govern everyone else don’t apply to them. As a result, their behavior becomes increasingly egregious.

I would suggest that the robo-mortgage scandal is a strong indicator that this type of unequal justice is now becoming ever more commonplace in America. Past bank abuses are typically discussed without a sense of outrage. They have, in effect, become a recognized practice of deception with no consequences. Here are three prominent examples from the past few years:

First, the robo-mortgage scandal was discovered. As powerful members of society, the banks effectively decided what laws they wanted to follow and disregarded others. The banks claimed that their violations were technical and harmed no one. Nonetheless, the activities of the banks constituted massive fraud, perjury, and conspiracy. Bank officials have testified in court that they filed as many as 10,000 false affidavits a month. These are effectively undeniable admissions of law-breaking on a massive scale.

It’s a federal crime, punishable by up of five years of imprisonment, to knowingly file a false affidavit with the court. From the perspective of the law, you are guilty of the same perjury when you falsely testify in court or when you submit a false affidavit. In most states, filing false affidavits with the court similarly constitutes a felony offense of perjury.

If an individual citizen perpetrated this kind of massive perjury, he or she would be prosecuted. For illegal activities to take place on this type of massive scale, other serious crimes, such as conspiracy, are undoubtedly committed as well.

This week an audit of San Francisco mortgage practices, the first systematic audit in the nation, revealed that an astounding 82 percent of the cases analyzed involved suspicious activity by the foreclosing institution and concluded that a large portion of these activities probably involved felony violations of California perjury laws.

Second, when Martha Coakley, the attorney general of Massachusetts filed a civil suit related to the robo-mortgage scandal against several financial institutions, she was demonized by the financial services industry and appropriately recognized for her bravery by housing advocates seeking to end abusive bank practices.

What is noteworthy, however, is that Coakley filed a civil suit. This was a lenient effort as she undoubtedly had the ability to build a compelling criminal case against the banks (as institutions) and the bank officers who knowingly created the robo-mortgage scheme.

Third, the national housing settlement, involving the federal and state governments, was announced last week. A central concern associated with the settlement is how it will be enforced. The banks have a long and well-documented history of agreeing to settlements that will change their behavior and then failing to live up to these binding agreements. Moreover, penalties for failure to comply with these settlements are rarely, if ever, assessed.

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In her New York Times feature story, "The Deal is Done, but Hold the Applause," Gretchen Morgenson wrote about this behavior, and how it relates to the current settlement:

But perhaps the largest question looming over this settlement is how it will be policed. Recent history is littered with agreements that required banks to take specific steps to make amends. All too often, the banks have skated away from their promises.

Morgenson then recounts a series of instances where the banks failed to comply with past settlements, including this quote from a former judge involved in these processes and her conclusion:

"It's astounding that in such a huge percentage of cases the lenders are not complying," said Philip A. Olsen, a former Nevada Supreme Court settlement conference judge. "The banks have learned that they can thumb their noses at the program and it won't cost them anything."

So you have to wonder whether banks will thumb their noses at last week's settlement, too. That makes policing compliance crucial.

The full details of the settlement have not been released, but unfortunately, the most recent disclosures suggest that this enforcement power and large penalties per violation are wishful thinking. An executive summary of the provisions of the settlement can be found here. It states, among other things: "If banks fail to remedy violations, they are subject to civil penalties of up to $5 million from the court.”

While the full details may suggest otherwise, the process as described here seems to be a far cry from substantial penalties for each failure of compliance. Why does the monitor need to provide the banks with a chance to remedy violations of the settlement? The banks certainly know what they are supposed to be doing. It is a clear indication that the banks will be able to act without a sense of urgency.

In addition, have the banks agreed that they will not contest the monitor’s request of penalties to the court? If not, then, as I have noted previously, a court fight over each penalty can ensue -- with the possibility that the entire monitoring process is a charade.

I hope that I am wrong, but the above analysis certainly suggests that, in Morgenson’s words, banks will have the opportunity to “thumb their noses at last week’s settlement” without incurring serious penalties.

The stakes here are enormous. They extend beyond the housing market to the nature of American society itself. The banks’ blatant malfeasance with regard to the robo-mortgage scandal and other foreclosure-related activities has been a clear example of unequal enforcement of the laws.

Sustainable capitalism requires that all participants in a contract or bargain believe their interests will be enforced equally by the courts: Capitalism requires that Lady Justice wear a blindfold. When powerful players are permitted to alter established rules at will, capitalism ultimately collapses. Contracts and the idea of a fair bargain become meaningless as less powerful parties to an agreement know their rights will not be enforced. Over time, citizens lose faith in government and their own ability to thrive in what becomes a corrupt economy. This uncertainty leads the small businesses, which are so often cited as important to our economy, to shy away from new activities that might put them at the risk of unequal treatment.

President Obama has declared economic inequality to be “the defining issue of our generation.” I agree, but I am terrified that the most recent news related to the housing settlement is not the definition the president intends.

Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.

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The New Guard

Rethinking America’s Focus on Subsidizing Homeownership

Feb 13, 2012Kristen Tullos

Think most federal housing support goes to low-income families and renters? Think again.

Think most federal housing support goes to low-income families and renters? Think again.

What should be the role of the federal government in housing policy? Our fixation on homeownership as the primary goal has diverted resources from the programs that help those most in need of federal assistance. Most Americans are likely to associate federal housing policy with programs intended to help poor residents, such as public housing and rental assistance. They would be shocked to learn that in 2008, for every housing dollar the federal government spent on poor individuals and families, it spent approximately four dollars on middle class and affluent families. Hidden from plain view, these expenditures are primarily made through the tax code -- the largest being the mortgage interest tax deduction that subsidizes homeownership.

This homeownership-focused policy expends huge amounts of resources. The mortgage interest tax deduction is expected to cost the government $105 billion this year, which is more than double the entire budget of Housing and Urban Development, the agency tasked with administering most of the federal affordable housing programs.

While these large tax deductions are available to everyone, wealthy taxpayers benefit disproportionately. Not only does the value of the deduction increase as taxpayers move into higher income brackets, lower-income homeowners are less likely to itemize deductions. As a result, 85 percent of the mortgage-interest tax deduction goes to taxpayers with incomes exceeding $75,000. Not only is this out of line with a progressive tax structure, many experts believe that preferential tax treatment contributed to the real estate bubble. Over the last decade, there has been a huge increase in cost-burdened homeownership, defined as households paying more than 30 percent of their income on housing. While many argue that more should be done for homeowners immediately in the context of the housing crisis, there is a larger question of whether the federal government should have done so much to encourage homeownership in the first place.

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There is no shortage of inequalities in the housing sector, and many came to light through the long process of unwinding the roots of the economic crisis. The inequality between renters and homeowners is merely one of them, but it is deeply rooted in our approach to housing policy. While homeownership benefits accrue automatically through tax expenditures, waiting lists to obtain Section 8 vouchers are notoriously long. Programs that help ensure safe and affordable rental options are often underfunded, while homeownership remains the focus of our national housing agenda. For example, the Federal Reserve recently proposed converting some of the REO properties held by Fannie Mae, Freddie Mac, and the Federal Housing Authority to rental property. Even this policy is targeted at stabilizing the housing market; relieving upward pressures on the rental market is just an added benefit.

Rather than homeownership, the focus of federal housing policy should be ensuring that everyone has a safe place to call home. Resources should be allocated in a way that reflects that goal. This would require shifting to a more balanced approach between homeownership and rental assistance and making sure that federal dollars are put to their highest valued use.

Young people are increasingly aware of the affordability problem in the rental market. Many young adults have insufficient credit to qualify for a mortgage, lack the savings to make a 20 percent down payment, or are simply unable to break into an increasingly difficult job market. Our generation is feeling the effects of rising rental rates. Perhaps this recognition will create a newfound awareness of the need for affordability assistance, not just for those people who have attained the "American dream" of homeownership, but also for renters who have a similar need to maintain housing stability.

Helping people maintain shelter is not only socially beneficial, but economically rational. When a family loses its home, it can find its way through a web of homeless shelters and supportive services if it is lucky; otherwise, it becomes homeless. When people are unsheltered, the likelihood that they will need emergency health care or become incarcerated increases substantially. Emergency rooms and jails are operated at enormous expense to the public. But a sheltered person is much less likely to incur these expenses. A study in Denver found that providing housing to homeless individuals reduced their emergency health care expenses by 72.85 percent and lowered incarceration costs by 76 percent -- saving the city $31,545 per person annually.

There is an acute need for more affordable housing assistance. One and a half million American children were homeless in the years before the economic crisis hit. Almost everywhere, the estimated number of homeless people vastly exceeds the number of emergency shelter and transitional housing spaces. A renewed and serious focus on affordability means either committing new resources or redirecting them from programs, such as the mortgage interest tax deduction, that are designed to encourage home purchases rather than improve affordability.

Kristen Tullos is a Roosevelt Institute Pipeline | Fellow and a third-year student at Emory Law School in Atlanta.

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The Mortgage Settlement's Missing Piece: Will Banks Now Follow The Law?

Feb 10, 2012Bruce Judson

home-foreclosure-documentIf the ability for independent monitors to impose fines for failing to follow the law is eviscerated, we'll be back where we started -- or worse.

home-foreclosure-documentIf the ability for independent monitors to impose fines for failing to follow the law is eviscerated, we'll be back where we started -- or worse.

The country's banks agreed to change their behavior as part of the robo-mortgage settlement announced earlier this week. The announcement, however, leaves open a central question: Does the settlement include new, pre-defined penalties for banks that fail to uphold their new promises? Since a change in bank behavior is a vital piece of the settlement, the absence of an answer is highly disconcerting.

When the deal was announced, the Associated Press reported, "The conditions will be overseen by Joseph A Smith Jr., North Carolina's banking commissioner. Lenders that violate the deal could face $1 million penalties per violation and up to $5 million for repeat violators." The initial impression on reading this report is that there are real teeth to it. It sounds like the banks are agreeing to pay $1 million dollars each time they fail to perform as promised.

However, the actual press release from the Department of Justice announcing the deal reads (emphasis added):

Compliance with the agreement will be overseen by an independent monitor, Joseph A. Smith Jr. Smith has served as the North Carolina Commissioner of Banks since 2002... The monitor will oversee implementation of the servicing standards required by the agreement; impose penalties of up to $1 million per violation (or up to $5 million for certain repeat violations); and publish regular public reports that identify any quarter in which a servicer fell short of the standards imposed in the settlement.

There are two open questions. First, what does "up to" mean? Does the independent monitor have discretion over the size of each penalty? This could effectively make the million dollar figures announced by the Justice Department meaningless. Banks have argued that the tens of thousands of robo-mortgage signatures and well-documented servicing errors were all technical violations that harmed no one. Undoubtedly, they will argue that any single violation was a meaningless error.

This provision would have real meaning if we applied the same standard our nation has applied in other areas: a zero tolerance rule. What would happen if each bank knew that any violation would result in a minimum fine of $1 million? I suspect bank behavior would change significantly.

Second, can banks contest these fines? Have the banks agreed that they will pay any fines assessed by the independent monitor? If not, then once again the provisions have the potential to be meaningless. The monitor will assess fines for violations and the banks will challenge the fines through whatever venues, the courts or otherwise, have been established by the settlement. The judgment and ability of the independent monitor to set fines will have been eviscerated.

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Efforts to determine answers to these and related questions have seemingly been rebuffed. The Huffington Post reported on its efforts to understand the details of the enforcement provisions of the settlement:

Details of how the states will make sure banks follow the deal's guidelines haven't yet been released... The announcement on Thursday did not include any new information on bank penalties. A call to the Smith's office was not immediately returned. A HUD spokesman did not immediately return an e-mailed request for comment.

There appears to be near universal agreement that this settlement will do little for homeowners who have been the victims of past bad bank behavior. But there may be real value in the deal if it successfully changes bank behavior going forward. The New York Times quoted the Attorney General of North Carolina as saying, "This agreement is more important for the foreclosures we're hoping to prevent."

At the same time, The New York Times wrote, "Advocates for homeowners facing foreclosure expressed cautious optimism," but indicated that these same advocates believe rigorous enforcement is essential for the program to work:

"We're hopeful," said Joseph Sant, a lawyer at Staten Island Legal Services' homeowner defense project. "But we had a lot of programs that are good on paper. What will make the difference is that it's vigorously enforced."

The stakes here are enormous. They extend beyond the housing market to the nature of American society itself. The banks' blatant malfeasance with regard to the robo-mortgage scandal and other foreclosure-related activities has been a clear example of unequal justice. The banks have knowingly and repeatedly violated laws (such as providing tens of thousands of false affidavits to the courts) that would have landed an ordinary citizen in jail.

At the same time, successful capitalism itself depends on the enforcement of rules and contracts in a fair bargain. When powerful players are permitted to alter pre-established rules at will, capitalism ultimately collapses. Contracts and the idea of a fair bargain become meaningless as less powerful parties to an agreement know their rights will not be enforced. Over time, citizens lose faith in government and their own ability to thrive in what becomes a corrupt economy.

If the settlement enforcement provisions turn out to lack substance, these forces will be reinforced rather than counteracted. We must wait for the details. Like homeowner defense advocates, I am cautiously optimistic -- but terrified that ultimately I will be disappointed.

Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.

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FDR Alleviated Americans' Anger and Suffering Through Action

Feb 10, 2012David Woolner

The Pecora Commission got to the root causes of the Depression and the HOLC addressed the aftermath. Hopefully Obama's fraud task force and mortgage settlement are on the same course.

The Pecora Commission got to the root causes of the Depression and the HOLC addressed the aftermath. Hopefully Obama's fraud task force and mortgage settlement are on the same course.

The news that President Obama has decided to establish a special new task force to investigate abusive and fraudulent lending practices during the housing boom, coupled with yesterday's announcement of a $26 billion settlement aimed at providing relief to struggling home owners, will certainly be greeted as welcome developments by the millions of Americans still struggling under the weight of the Great Recession. But with many of the details of the practical application of the settlement still to be worked out, and with the task force having just been established, it is too early to tell how much relief will actually reach desperate homeowners or how many banks and/or individuals will face prosecution.

Given the devastation caused by the reckless and often fraudulent behavior of many of the nation's leading banks, and the overwhelming need to stabilize the housing market and provide relief to millions of homeowners, one would hope that these measures would, at the very least, be as effective as the actions taken by the government roughly 80 years ago when we faced a very similar economic crisis.

Most Americans are well aware that the Great Depression was initiated by the collapse of the stock market in the fall of 1929. It was a collapse that came about in large part because of the bursting of a large speculative bubble that had built up over time in the reckless and virtually unregulated financial climate of the 1920s. What is less well known or understood are the many other factors that played a role in the onset of the Great Depression: the decline in agricultural prices, the maldistribution of wealth and income, the collapse of the banking sector, and an equally important urban mortgage crisis. Indeed, by the time Franklin Roosevelt took office in March of 1933, it is estimated that approximately 50 percent of all urban mortgages in the United States were delinquent or in foreclosure and that an average of 1,000 homes per day were being lost.

To deal with the housing emergency and to get to the bottom of what led to the economic crisis in the first place, FDR did two things. First, he fully supported the activities of the 1932 Senate Committee on Banking and Currency that was established to investigate the causes of 1929 crash. Once in office, he moved quickly to provide relief to home owners through the establishment of the Home Owners Mortgage Corporation (HOLC).

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Thanks in large part to the zeal of Ferdinand Pecora, who was appointed to head the Senate committee investigating Wall Street in January 1933 and was quietly encouraged to carry out his work with vigor by President-elect Roosevelt, the "Pecora Commission" would uncover a whole series of unscrupulous practices in the banking and financial sector. These included interest-free loans to top executives at National City Bank (now Citibank); National City's disposal of bad loans to Latin American countries by packing them into securities and selling them to unsuspecting investors; and J.P. Morgan's list of influential "friends," including former President Calvin Coolidge, all of whom were given the opportunity to purchase stock at sharply discounted prices.

These disclosures, coupled with additional revelations about excessive salaries, bonuses, and the fact that many financial elites -- including the head of National City Bank -- did not pay any income tax in the past year, outraged the public and helped inspire the Roosevelt administration and Congress to push through some of the most important banking and financial reforms in American history. These included the Glass Steagall Act, which separated commercial from investment banking and gave us the Federal Deposit Insurance Corporation, and the 1934 Securities and Exchange Act, which created the Securities and Exchange Commission.

In the meantime, to meet the urgent housing crisis, the HOLC, which was established within FDR's first 100 days in office, provided direct relief to families facing foreclosure by buying out their existing mortgages and replacing them with new ones. The new ones weren't based on the typical non-amortized loan of seven to ten years, but rather on the far more affordable amortized mortgage of between 25 and 30 years. Over the course of its brief three-year history, the HOLC refinanced over one million homes -- roughly 20 percent of all the urban mortgages in the U.S. In the process, it revolutionized American home ownership through the institutionalization of the 30-year mortgage. It also did not cost the American taxpayer any money, as the HOLC turned a small profit when it finally closed its books in 1951.

Taken together, the measures inspired by the Pecora Commission and the relief brought to millions of American homeowners helped restore investor confidence, resuscitate the financial sector, and lay the foundations upon which our banking, financial, and housing sectors rested from more than half a century.

In making yesterday's announcement, President Obama alluded to both the new task force and the bank settlement by stating that with these measures "we begin to turn a page on an era of recklessness that has left so much damage in its wake." Eighty years ago, the twin combination of a federal investigation and direct action by the government helped alleviate the anger and anguish of the millions of Americans who suffered as the result of the greed and avarice of the wealthy few. Let us hope that the president's new task force and the agreement with our nation's major banks will do the same.

David Woolner is a Senior Fellow and Hyde Park Resident Historian for the Roosevelt Institute. He is currently writing a book entitled Cordell Hull, Anthony Eden and the Search for Anglo-American Cooperation, 1933-1938.

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The New Guard

Obama Starts a Worthwhile Conversation about How to Intervene in the Housing Crisis

Feb 3, 2012Kristen Tullos

The new mortgage refinancing program buys into the idea that the government must intervene in the foreclosure crisis.

The new mortgage refinancing program buys into the idea that the government must intervene in the foreclosure crisis.

President Obama's recently announced housing plan contains a number of excellent proposals that should help Americans struggling to make ends meet. Simplifying lending documents, streamlining the refinancing process, providing funding for innovative local interventions, and increasing the incentives for private loan modification are wise and necessary initiatives.

Many of the key parts of the plan appear specially designed to circumvent the private sector's failure to act in its own best interest. Private lenders have not had high participation rates in any of the previous incentive-based programs and have opted to foreclose in many instances where there is a more economically rational option. There have already been two million foreclosures since the beginning of the housing crisis and another two million mortgages are seriously delinquent or already in the process of being foreclosed.

In an effort to reduce the high rate of foreclosure, the major refinancing initiative proposes to shift the risk associated with underwater loans from the private sector to taxpayers. The FHA would purchase underwater mortgages from private lenders at 100 percent of the current loan amount, refinance them at lower rates, and assume the risk of those loans defaulting. This is a dream scenario for banks; they get the full amount of a loan that, if it remained on their books, would be very likely to default.

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In return for having the FHA assuming its riskiest mortgages, it makes sense that banks help fund the initiative. While the "new tax" on financial institutions intended to fund this program will be hard to pass, it is only equitable that the banks pay for this part of the plan. The tax should be calibrated to reflect the risk that taxpayers are assuming when the FHA buys the underwater mortgages. Otherwise, the FHA refinancing plan will become just another bank bailout.

Meanwhile, although reducing homeowners' monthly payments will affect the default rate, this plan does nothing to reduce the principle owed. As a result, homeowners will continue to walk away from homes that are underwater. In the third quarter of 2011, CoreLogic estimated that 10.7 million, or 22.1 percent, of all residential properties were still in negative equity. Principle reduction should be part of any serious housing proposal. In this regard, President Obama's proposal does not go far enough.

Another part of the plan was a proposal to convert some real estate owned (REO) property held by Fannie Mae and Freddie Mac into rental property. This makes a lot of sense simply because we have a surplus of empty houses and a shortage of rental properties. But why aren't homeowners already being offered the opportunity to remain in the house as renters? Institutional lenders aren't designed to be landlords (like they aren't designed to modify mortgages), but this is an opportunity for investors and management companies to fill the obvious gap. Hiring companies to manage the properties could also create local jobs, which would have an added economic stimulus.

While I wish the plan were stronger, it contains some very worthwhile proposals that will help millions of American homeowners be able to afford their mortgages. It's a pity that it is being so poorly received by Republicans in Congress. There should be a rigorous debate in Congress about the most effective intervention, not about whether intervention should take place at all.

Kristen Tullos is a Roosevelt Institute Pipeline | Fellow and a third-year student at Emory Law School in Atlanta .

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Seven Questions Begging to Be Answered Before a Foreclosure Settlement is Reached

Feb 2, 2012Bruce Judson

foreclosure-gavel-150Why the secrecy? Why the haste? Rushing into an ill-advised settlement with the banks may undo one of our last chances to avert another economic catastrophe.

foreclosure-gavel-150Why the secrecy? Why the haste? Rushing into an ill-advised settlement with the banks may undo one of our last chances to avert another economic catastrophe.

Tomorrow is the deadline for state attorneys general to sign on to a joint federal and multi-state $25 billion settlement of the robo-mortgage scandal. The settlement will involve Ally Financial Inc. (formerly GMAC), Bank of America Corp., Citigroup Inc., J.P. Morgan Chase & Co., and Wells Fargo & Co. The details of the proposed settlement have not been released. However, one thing is clear: This settlement puts the nation at further risk of another systematic financial crisis and runs counter to any notion that the actions of the Obama administration will reflect the president's newly energized populist rhetoric.

As a nation, we need to ask several questions. As a participatory democracy, we also have the right to the answers before any settlement is inked:

1. In his State of the Union Address, President Obama announced a new financial crimes taskforce, yet the administration is rushing to finalize this settlement before the taskforce begins its work. Why?

2. What is the public interest in releasing banks that have openly admitted they broke the law in tens of thousands of separate instances from liability?

3. The bank narrative has been that the robo-mortgage scandal reflected procedural issues of no consequence (despite the fact that they constituted fraud, perjury, conspiracy, and a knowing effort to mislead the court). Recently, a new narrative has emerged that suggests these activities were actually the back-end of even greater malfeasance involving tax evasion and the banks' failure to comply with basic rules in securitizing mortgages. If we are a nation where justice is blind, should we not investigate the full truth before we give the offending financial institutions another free pass?

4. Why are the terms of this settlement secret? Prosecutorial negotiations are normally secret in order to prevent the disclosure of evidence that might or might not be relevant to a later trial if the negotiations collapse. This concern does not apply here.

5. This settlement has far more of the characteristics of legislation than of prosecutorial activities. The offending banks have destroyed the wealth, livelihood, and dreams of millions of Americans. Shouldn't the public at least have two weeks to view the proposed terms of the settlement and make their views known to their state's attorney general? And at a time when trust in government is at historic lows, isn't secrecy for this type of activity the wrong way to build the much-needed confidence of the American people?

6. The press also has a constitutionally guaranteed role in our system of governance. In these unusual circumstances, isn't this precisely the type of situation where the nation would benefit from careful scrutiny of the intended settlement by the press?

7. Officials have indicated that the settlement will require banks to write down the principal on homeowner loans. Unfortunately, a portion of the $25 billion allocated for this purpose is far too little, spread across a large number of homeowners, for any write-downs to make an effective difference. So either these statements are effectively meaningless, or the settlement is based on promises of future activities by banks. To date, the nation has witnessed repeated and egregious failures by the banks to live up to promises of future behavior, with no subsequent penalties for such failures. For any release from liabilities to be effective, shouldn't it be contingent on the banks actually delivering on these promises?

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Since the start of the economic crisis, none of the administration's housing policies have succeeded. Each policy initiative has been fatally flawed. As a consequence, there's no reason to believe that the policy pursued in the current settlement will aid, rather than hurt, the housing market. Meanwhile, the secrecy surrounding this policy initiative makes its potential positive contribution to the crisis even more suspect.

A month ago, I wrote that we were a nation in denial with regard to housing prices and the impact of ongoing foreclosures. Despite a favorable rent to buy ratio, ultra-low interest rates and an "all time low cost of owning a home," housing prices are continuing downward. There is a simple explanation. With foreclosures and the so-called shadow inventory of homes, our housing supply will overshadow demand for many years to come.

With 29 percent of homeowners already underwater, this creates a massive risk for the economy. Some analysts predict that home prices will drop another 10 to 20 percent, which will put many borrowers deeply underwater. With additional price declines, underwater homeowners may start to simply walk away in droves. This will create havoc for our economy, the mortgage securities markets, and it will destroy solvency of the banks as they are forced to write-down their portfolios. The nation will be plunged into another economic crisis.

Unfortunately, all indications over the past several weeks are that this risk is continuing to grow. Indeed, the most recent reports on housing prices showed larger than expected declines in November. This reflected the third month in a row of declines. "The trend is down and there are few, if any, signs in the numbers that a turning point is close at hand," said David M. Blitzer, chairman of the S&P's home price index committee.

In his State of the Union speech, President Obama stressed assistance for "responsible homeowners." Yet the current definition of a responsible homeowner is someone with a job. (Although yesterday the president did say, "We're working to make sure people don't lose their homes just because they lost their job." ) So, at least for the moment, continued unemployment woes will keep this vicious cycle going.

Here's how this relates to the proposed settlement: All of the activities covered by the settlement took place after the crisis began. They were not unforeseen effects of once-in-a-lifetime systematic risk. They reflected willful, knowing, and egregious malfeasance and disrespect for the rule of law. There is no question that laws were broken on a massive scale with potentially enormous civil liabilities and with criminal offenses. The essence of capitalism is responsibility and accountability. The settlement ignores both.

I suspect that the existing testimony of bank officials in open court, which are effectively admissions of guilt, provides sufficient evidence to lead to state and federal suits that would make the banks insolvent. This means that, because of the banks' malfeasance and greed, the nation has the leverage to bargain for a massive write-down of mortgages -- thereby preventing an economic catastrophe. I am not advocating this option, nor am I saying it is good policy. But I do believe it would be a scandal to limit whatever leverage we have to save our economy by once again permitting gross malfeasance.

In late May, my eldest daughter will graduate from college and join the labor force. Will there be jobs for her and her classmates? Will she come of age in a decade of limited employment opportunities, the collapse of the middle class, and unequal justice while a privileged few live lives of abundance because they have corrupted our democracy? As someone who reveres our system of justice, what is the advice I should give her about working hard and playing by the rules? There is still a chance that we can turn all of this around. But rushing to settle with law-breaking banks is certainly not the way to solve the issue of inequality -- which President Obama called the defining issue of our time. It is also the antithesis of capitalism, which is based on adherence to law, a fair bargain, and accountability.

Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.

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Jeff Madrick and Tom Ferguson Sound Off on Real Messages of the SOTU

Jan 27, 2012Bryce Covert

After Obama's State of the Union on Tuesday, Roosevelt Institute Senior Fellows Jeff Madrick and Tom Ferguson took to the airwaves to dissect it. Was there substance behind the soaring rhetoric? Can the proposed policies really solve our economic ills?

Jeff Madrick joined Eliot Spitzer on Keith Olbermann's Countdown, and his analysis could be summed up as: "It was a tougher speech than I expected."

After Obama's State of the Union on Tuesday, Roosevelt Institute Senior Fellows Jeff Madrick and Tom Ferguson took to the airwaves to dissect it. Was there substance behind the soaring rhetoric? Can the proposed policies really solve our economic ills?

Jeff Madrick joined Eliot Spitzer on Keith Olbermann's Countdown, and his analysis could be summed up as: "It was a tougher speech than I expected."

Despite what some naysaying economic advisers may be telling President Obama, "he said forget about all those constraints," Jeff pointed out. "Let me go after the Chinese, let me develop some tax breaks, let me develop some tax penalties." Those FDR fans among us may remember his famous welcoming of Wall Street's hatred, a stance Obama has mostly shied away from. Yet, as Jeff notes, not only did he go after Republicans in Congress and big oil, "he said some pretty nasty things about Wall Street."

His policy proposals were important too, Jeff said. "Few things are as unambiguous as a need as updating the American infrastructure," and that was a big part of his "constant mention of jobs." Plus there was a heavy emphasis on bringing back manufacturing, although the question remains as to whether that's really possible.

Meanwhile, Tom Ferguson, while "intrigued" by some of the policies, was "underwhelmed" overall. He told Paul Jay of the Real News Network that "when you start to look at the details" of Obama's proposals, they're "almost meaningless."


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Take the plan to have a massive mortgage refinancing program. That could be "a really striking thing and it would likely have a huge effect on the economy," Tom said. But "their record in the last three years is they keep announcing programs and they all fail." Plus the taskforce on mortgage abuses "looks to me like an effort to to rein in the attorneys general" at the state level, he said.

Things were worse when it came to the "utter tameness" of the ideas around money in politics, Tom said. While banning Congress from insider trading is a good idea, "he's not really touching the essence of the money in politics problem," he points out. "He's basically punted on that one." What could he have proposed that would work? "You could do a lot by simply making the federal election commission a serious part of the civil service to get it out from under its ridiculous domination by Congress," Tom suggests. It's not just Citizens United that should be on reformers' radars.

And overall, while some of the economic policies may sound good, the underlying push from the administration for austerity and a focus on the deficit went unaddressed. "My guess is that these folks are not planning to change course on the economy," he concludes.

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Obama's SOTU Charts a Course Toward a Prosperous Millennial America

Jan 25, 2012Monika Johnson

line-of-american-peopleWith work still yet to be done, President Obama's State of the Union kept the momentum from the 2008 election going for young Americans.

line-of-american-peopleWith work still yet to be done, President Obama's State of the Union kept the momentum from the 2008 election going for young Americans.

In November 2008, I voted in my first presidential election. The summer had been a brutal battle for the Democratic nomination, and young people were campaigning in record numbers to take hold of our futures (and, of course, that of "Joe the Plumber"). That fall, approximately 23 million young people comprised almost two-thirds of the overall 5.4 million voter turnout increase. NDN states that the Millennial Generation (born 1978 - 2000) voted for Barack Obama by a 34-point margin, a 25-point increase from John Kerry's support in 2004.

Nearly four years later, the State of the Union address reminded me of the great sense of duty we felt to turn our country around. Here stood a president who had showed us that the future of our country was in our hands but fell victim to the realities of catalyzing significant political change.

At the close of his address, Obama used the capture of Osama bin Laden to allude to the enlightened self-interest lost in Congress: "One of the young men involved in the raid later told me that he didn't deserve credit for the mission. It only succeeded, he said, because every single member of that unit did their job: the pilot who landed the helicopter that spun out of control; the translator who kept others from entering the compound; the troops who separated the women and children from the fight; the SEALs who charged up the stairs. More than that, the mission only succeeded because every member of that unit trusted each other, because you can't charge up those stairs into darkness and danger unless you know that there's somebody behind you watching your back."

Obama's reference was intended to inspire Congress to overcome its partisan gridlock, but its expression on a national platform illuminated more than a slap on the wrist to politicians who had acted selfishly since the last State of the Union address. It was all too obvious that the chamber full of culturally polarized baby boomers, apathetic to the president's comments, maintains a very different perspective on the role of the individual in society than my generation does.

The president's steadfast, civic-minded tone on Tuesday reflected one that inspired Millennials to act in 2008 and powerfully endures today. Many Millennials became quickly disenchanted by Washington's realities, but have continued to turn out in record numbers to enter public service. In 2009, 16 percent more recent college graduates worked for the federal government than in the previous year and 11 percent more for nonprofit groups, according to the American Community Survey of the Census Bureau. Applications to AmeriCorps and City Year tripled, and interest in Teach for America and the Peace Corps also skyrocketed.

For many of today's Americans in our early twenties, there is no alternative to taking an active role in civil society. We are skeptical that America will always be #1 because we don't remember what life was like before 9/11 and came of age during a fiscal crisis.

The realities facing our progressive and socially conscious generation breed a sense of emergency. In the fall of 2011, the media focused on the idea of a "lost generation" of young adults holding undergraduate and master's degrees, unable to both find employment and advance in the workplace. Young people wonder if public service will continue to be an option as the wealth gap grows larger and higher education becomes more expensive.

Tuesday night, the Obama administration sought to justify our continual investment of ourselves in the future of the nation, calling upon Congress to realize their self-interest and describing promises that make young voters swoon. We elected him in 2008, and he wants to keep our support for the upcoming 2012 standoff. If fulfilled, Obama's solutions could lead to a prosperous Millennial America.

American Manufacturing: Obama's blueprint for revitalizing the American middle class began with manufacturing, highlighting a large productivity increase in science and technology industries. He referenced a national skills training program, which would partner with community colleges to transform them into career centers for emerging industries. Moreover, he outlined tax incentives for companies to "in-source," continue manufacturing domestically, and relocate to communities that lost factories throughout the recession.

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With the gradual decline of manufacturing and rise of the knowledge-based economy, the opportunity to pursue the "American Dream" has increasingly relied on obtaining a college degree. Federal Reserve Chairman Ben Bernake said in a "60 Minutes" interview that he believes the foremost driver of a rapidly expanding American wealth gap is education disparity. He stated that for college graduates the current unemployment rate is 5 percent, but for those without a degree it's 10 percent. Unfortunately, the majority of educations are funded by borrowed money. According to the U.S. Department of Education, 61 percent of students and their families at public four-year institutions, 70.6 percent at private non-profit universities, and 97 percent at private for-profit schools accrue educational debt. A college degree is becoming more indispensable, but less affordable.

This phenomenon has resulted in a saturated job market, full of young adults with bachelor's and master's degrees deep in debt. The revitalization of American manufacturing might give millions of young people the opportunity to pursue a productive and lucrative lifestyle without a college diploma and the rising debt that comes with it. In the short term, this means offering these national training opportunities through community colleges to recent high school graduates in underserved areas.

Education: While skills-based jobs should be more available to young people, higher education should be accessible. Obama rightfully pointed out that Americans owe more in tuition debt than in credit card debt, and interest rates on student loans are slated to double in July. He conveniently neglected to point out that interest on graduate Stafford loans had been altered this year in order to help balance the budget, however.

Many Millennials believe access to higher education to be the single biggest issue of our generation as tuition increases (and exponentially rising text book costs) threatens the accessibility of education to the middle class and burdens graduates with immense debt. Obama called for extending the tuition tax credit, doubling the number of work-study jobs in the next five years, and requiring that states prioritize student aid in their budgets. Finally, he stated, "Let me put colleges and universities on notice: If you can't stop tuition from going up, the funding you get from taxpayers will go down."

While these reform proposals are good, we should challenge leaders to go one step further and address the current student debt crisis. Specifically, the administration should propose better regulation of the private student loan industry to account for public service time and income-calculated minimum payments. Longer term solutions are on the rise, but a short-term solution to student debt would help alleviate a generation's fear of being economically unviable.

Trade and International Cooperation: Millennial America desperately needs a larger job market for their skills, with the highest number of college degrees compared to any other generation. However, we aren't willing to sacrifice the global perspective and civic-minded values we have developed and displayed prominently through consumer patterns.

Obama announced the creation of a Trade Enforcement Unit to investigate unfair or unlawful trade practices. He stated enthusiastically, "Our workers are the most productive on Earth, and if the playing field is level, I promise you -- America will always win." Hopefully, this unit will work alongside the World Trade Organization to promote fair trade principles for all countries. Just execution of such a governmental entity will include cooperation with international trade agreements, construction of new, progressive principles, and full participation in multilateral negotiations.

The end of the State of the Union is traditionally a "USA!" rally, but exiting Iraq and the fall of Osama bin Laden gave a little extra enthusiasm. According to the Greenberg Millennial Study, cited in Generation We, 68 percent of American Millennials questioned believe the generation of Americans under 30 has a great deal or a fair amount in common with young adults of their generation in other countries. Opportunities to collaborate with foreign universities and students are abundant, and rising leaders know the importance of not alienating our competitors. The administration should tread carefully in advancing a progressive foreign policy that emphasizes multilateral cooperation, aligning with its young supporters globalized perspectives.

Monika Johnson is the co-Chapter Head for the Roosevelt Institute | Pipeline in Washington, DC and a member of the Pipeline Advisory Committee.

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What Lessons Can We Learn from Obama's SOTU Proposals on Education?

Jan 25, 2012Amy Baral

The president's speech brought up core issues facing our educational system but he didn't always go far enough.

The president's speech brought up core issues facing our educational system but he didn't always go far enough.

Obama's State of the Union focused minimally on education. However, what he did say fits with the administration's existing policy. Focusing on retraining our workforce through partnerships with community colleges is key. Most community colleges are already well equipped to do the technical training and re-training needed for both young people and older workers to succeed in our ever-more technologically complex manufacturing economy. Additional financial support from the federal government will help make community college more affordable, especially for those out of work. Still, it's important to note that community colleges already receive funding from the state and federal governments, so what's really important is making sure that students in community colleges have access to the loans and financing they need in order to go to school while potentially remaining unemployed.

Obama's focus moved next to teachers. Turning the teacher criticism debate on its head, he stated clearly and concisely that most of our nation's teachers are strong, dedicated professionals who even use their own money to buy supplies for their classrooms. On the one hand, he argued for allowing teachers and schools more opportunities for flexibility in order to improve on strong methods without an educational bureaucracy slowing them down. Still, not wanting to let up on ensuring teacher quality, he also talked about rewarding strong teachers and getting rid of bad teachers. There's really no debate between Republicans and Democrats on this topic -- retaining and rewarding good teachers while removing bad ones is essential to ensuring that all children encounter only the best teachers during their educational experiences. The issue remains how to judge teacher quality, and Obama gave no hint on how to do that.

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Obama moved on to discussing the need for flexibility in the education system generally. While some heralded this as removing No Child Left Behind (NCLB), Obama's stated policy follows his administration's support of NCLB waivers from the Department of Education. Waivers are certainly no solution to the difficulties of NCLB, but the waiver system does allow states with innovative education programs the flexibility needed to enact true reforms without worrying about sanctions or less funding from the government. Certainly "teaching to the test" is not the type of education system the United States wants to champion, but Obama did not state that NCLB was completely failed. Retaining high standards for all students and subgroups as well as their teachers is key to ensuring a strong education system that allows every child to receive a high quality education.

Finally, Obama touched upon supporting higher education for students -- all students, including those whose parents came to the United States illegally. Adding work study grants and ensuring student loan reform is key to helping students know that college is within their reach. However, Obama's proposal to stem college costs by reducing federal funding would seemingly not help with the problem. The real reason that colleges are increasing costs at such a fast rate needs to be further understood before a policy can be developed to help flatline or reduce these costs. Higher education does need to become more affordable, but in return jobs need to be accessible to students when they graduate. To tie this back to Obama's focus on jobs, having an educated workforce is key to ensuring high-quality and high-paying jobs in the United States, but the nation itself needs to ensure that jobs are being created both for the currently unemployed and those of us still in school working toward a better future.

Amy Baral is a Roosevelt Institute | Pipeline Fellow performing legal and policy research on the Boston Public Schools, focusing on access to quality education and school choice. She is also a 1st year law student at Boston University School of Law.

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