Mortgage Crisis, Recession, and Bailout: Reconciling the Numbers

Written by Bruce R. Copeland on January 21, 2009

Tags: banking, credit, economics, foreclosure, investment, mortgage, payroll, recession, treasury bailout

Four months into a recession spawned by the mortgage investment banking crisis, it is worth doing some basic math on the real costs.

First some background: I supported the original treasury bailout, albeit with two important qualifications. First, I wanted the proposed $750 billion bailout to be authorized by Congress in three chunks of $250 billion instead of two chunks of $375 billion. Second, I noted that the projected actual losses from home foreclosure (at that time ~$200 billion) were a fraction of the total $750 billion requested by Dept. of Treasury for bailout. I suggested it would be safest in the long run to use the bulk of the bailout to buy up troubled mortgages or their underlying properties.

With an intensifying recession, I regret not pushing harder on these two points, or at least I regret that my congressional representatives and their colleagues didn’t listen better. The incoming Obama administration has proposed that as much as $800 billion of stimulus may be necessary to deal with the recession (on top of the $400 billion of TARP that the Bush administration has spent). Other estimates of recessionary losses are as much as $1400 billion (10% of GDP) for a severe recession. Conversely, estimated losses from failed mortgages are still only $250 billion. So how did $250 billion morph into $1200 billion? What went wrong? Well, several things. First, many of the original TARP recipients simply failed to deliver on their promises to increase lending. Second, the rest of us pretty much panicked.

As individuals we don’t make financial decisions based upon the Federal Reserve’s macroeconomic plan for an optimal economy. We make decisions based upon what we perceive to be our immediate risks. When we hear about employers laying off people because they cannot get a short term loan to make payroll or we hear that retail sales and small business contracts are drying up, we assume we may be next. Naturally we start looking for every possible way to save money—cheaper groceries, fewer DVDs, less travel, etc. The trouble is that this behavior is only productive when most other people ARE NOT doing it. When everybody tries to do this, it causes a downward spiral into severe recession or depression.

So what can we do now?

1) Get with the program or bust. This is what we need to tell the recipients of TARP I funds. They have three choices: demonstrate that the bulk of TARP funds they received are going towards qualified credit (small business loans, sound mortgages, good entrepreneurship…), return the funds, or be taken over by the federal banking system. Allow banks which pass this step to participate in 3). Carrot and stick, carrot and stick…

2) Buy up the bad mortgages. Use stimulus money to refinance failing mortgages at 12% above current market value for the property. If the current mortgage holder refuses, threaten either eminent domain or a blight tax on empty or run-down property. Negotiate hard and don’t accept no as an answer. Make it too expensive for either party to walk away from the deal. Encourage the mortgage holder to recover some of their remaining loss from the brokers and appraisers who set up the original sale. Provide some resources to achieve this. There are entire mortgage divisions of some national banks which I hear the banks would love to divest. Carrot and stick, carrot and stick…

3) Get good banks to compete for the next round of TARP funds. It may surprise you, but there are quite a number of sizeable, healthy regional and state banks that weren’t involved in the mortgage meltdown and have a good track record for fiscal responsibility. The U.S. Government needs to contract with these banks ASAP to make small business payroll loans, import/export loans, etc. to get our economy back on track. Allow these banks to make a reasonable return on loans. If some of the national banks got past item 1), have them compete too! Forget the other big national banks that spawned this crisis and are still too paralyzed by fear to make rational decisions. Carrot and stick, carrot and stick…

4) Take a deep breath and start living again. Most of us haven’t lost our jobs or our businesses. We need to stop acting like we have! I don’t mean spend money frivolously, but spend normally. If you know someone who really is struggling, consider hiring them to clean out that garage or attic you’ve been meaning to deal with. Offer to share a garden. Go fishing or camping together. Find worthwhile projects or charities to support in your community. There are lots of great deals on the stock market—invest in sound companies that weren’t involved in the mortgage meltdown.

In short we need to get hard-nosed about fixing the real problems, and we need to start behaving normally about everything else. Oh, and those people in Washington (both parties) need to begin thinking seriously about basic math involving real costs!