Writing in The New York Times today, Martin Feldstein, who was the chairman of the Council of Economic Advisers under President Reagan, argued for “permanently reducing the mortgage debt hanging over America.” Failure to do so, he writes, “ means that further declines in home prices will continue, preventing the rise in consumer spending needed for recovery. As costly as it will be to permanently write down mortgages, it will be even costlier to do nothing and run the risk of another recession.” In taking this position, Feldstein puts himself in at least one-third agreement with Nouriel Roubini, Daniel Alpert and Robert Hockett, authors of The Way Forward: Moving From the Post-Bubble, Post-Bust Economy to Renewed Growth and Competitiveness, a white paper commissioned by the New America Foundation that has been getting a lot of attention. Predicting dire consequences for the economy if their prescription is not followed, the trio calls for massive restructuring of mortgage debt, huge investments in infrastructure, and a “global rebalancing” between creditor and debtor nations.
It all sounds good to me, particularly the part about the mortgage restructuring. To put it another way, what these experts are advocating is that the losses suffered in the subprime mortgage bubble have to be swallowed, and they all can’t be swallowed by the home owners alone. The lenders have to take a hit, and so does the public, through the government (which, given the number of mortgages guaranteed by Fannie Mae and Freddie Mac, is already on the hook.)
But anyone who has read Ben Tarnoff‘s recent book The Moneymakers, which I had the pleasure of reviewing for The Washington Monthly earlier this year. The Moneymakers tells the story of three counterfeiters from 18th and 19th century America, and what the three have in common is that they thrived during eras of financial innovation and loose (or non-existent) regulation. What we also learn–which is something we already kind of knew–is that the only way to cure the assault that is posed on sound money by counterfeit currency is to get it out of circulation. Authorities have to buy it out or yank it out, and force the poor farmer or the poor tavern owner or the poor banker who in this game of monetary musical chairs ended up holding the bill when the music stopped to swallow the loss–because that is the only way the overall health of the system can be restored.
What we have been suffering these last few years has been an attack by counterfeiters. Not counterfeiters of currency, which has meant less in the scheme of things since the US left the gold standard, but counterfeiters of credit–the mortgage writers who gave credit to unworthy customers, the banks who ignored their standards, the ratings agencies who abdicated responsibility, and the investment bankers who kept underwriting and leveraging the crooked practices. Our economy became awash in counterfeit credit, and even now we have not reached the bottom.
The mortgage restructuring that Feldstein and Roubini et al are calling for is simply a new way to perform the old time cleansing exercise that got counterfeit money out of circulation. But until we undertake the hard business of swallowing the loss, we’ll can’t get back to a fundamental sense of value.