Day: October 30, 2008

Martin Feldstein: Stimulus Should Be Big

Conservative economist and deficit hawk Martin Feldstein is arguing that we need an economic stimulus package now (immediately after the election) that is big ($100 billion won’t cut it) and long. OK, he didn’t explicitly say it should be long, but he did say this:

Previous attempts to use government spending to stimulate an economic recovery, particularly spending on infrastructure, have not been successful because of long legislative lags that delayed the spending until a recovery was well underway. But while past recessions lasted an average of only about 12 months, this downturn is likely to last much longer, providing the scope for successful countercyclical spending.

This is basically what we said in the National Journal and what Simon said in this morning’s testimony. I’m not claiming that Feldstein listens to what we say (I strongly doubt it). But his op-ed emphasizes the fact that most economists from across the political spectrum are on the same page on this issue.

Update: “Business executives and Republicans” are on board, too.

Testimony Before Joint Economic Committee, Today

Here is the written testimony I submitted to the JEC. In my verbal presentation this morning (5 minutes only, strictly enforced) I stressed the following.

1. The global economy is slowing fast, and likely faces an unprecedented (since 1945) recesssion. The pressures on emerging markets are intense, and inflexibility in Europe in both policy (Eurozone, I’m talking about you) and labor markets (for almost all the European Union) creates serious macroeconomic vulnerability at this stage.

2. In the US, significant (OK, also unprecedented) countercyclical policies have now been put in place. In particular, the Fed is running through its anti-deflation playbook (which Mr Bernanke was kind enough to publish back in 2002). We have no idea how to properly measure the scale, let alone the impact, of this increase in: liquidity, contingent liabilities, actual or potential direct lending to almost everyone in the US, and, via unlimited swap lines to some central banks and new $30 billion swap lines to four emerging markets, to many institutions around the world.

3. So deciding what to do with fiscal policy is very hard. In other industrialized countries, you can rely on “automatic stabilizers” to a greater degree than in the U.S., meaning that their government spending (and deficit) increases in recession because unemployment benefits and the like are more generous. In the U.S., we have to make a conscious decision. And that decision needs to be made soon, within a month or so, because any fiscal stimulus works only with a time lag – and the more you want to do things that definitely raised GDP (like infrastructure), the longer the time lag.

So my recommendation is… (well, read the testimony; the numbers are on the first page; detailed recommendations follow on how to spend, for both immediate impact and longer-term benefits).

Comments welcome – there is still a long way to go, in terms of legislation design and implementation.

Update: If you want to see the actual session courtesy of C-SPAN, go here. (Note there were 8 speakers and the session was two hours long.)

Homeowner Bailout Around the Corner?

News sources are reporting more details on the possible mortgage restructuring plan for distressed homeowners first mentioned by Sheila Bair in her Congressional testimony last week. The basic outlines of the plan are:

Lenders would agree to reduce monthly payments to be affordable, perhaps based on a percentage of the homeowner’s income. The reduction could be achieved by reducing the interest rate, reducing principal, or extending the term.
If the amount the homeowner could pay would result in a mortgage worth less than the foreclosure value of the house, the loan would not be modified and the lender could foreclose.
The government would then partially guarantee the new mortgage and absorb part of the loss if the homeowner defaulted.
The numbers of 3 million homes and $600 billion in total mortgage value are being thrown around.

This is roughly consistent with the principles we outlined earlier: the lender gets more than it would have gotten in foreclosure, the homeowner is better off than being on the street, the community benefits because there are fewer foreclosures. There are three key issues that still need to be negotiated.

How much will homeowners be expected to pay? Too much, and the lenders will not have to write down their loans very much, and the government will be on the hook for risky mortgages; too little, and the lenders will not participate.
How do you solve the securitization problem, that is, the current inability of many servicers to modify loans that are owned by other parties? This may require a new law in and of itself (one suggestion here).
How do you decide which homeowners are eligible? If people who are delinquent get cheaper mortgages and people who are struggling but paying on time don’t, the latter will scream. It is still in the interests and hence within the rights of the lender, the delinquent homeowner, and the government to do the deal, but that won’t reduce the indignation.

There are also a couple of enhancements to the program that could be considered. First, shouldn’t the government – by which we mean the taxpayer – get something for its guarantee (besides the satisfaction of knowing that it’s doing what’s best for the country)? The homeowner and the lender are both better off than they would be otherwise (homeowner on the street, lender forced to foreclose), and the government is worse off (because some of these new mortgages will fail). The government could get a share in the future appreciation of the house, for example.

Second, to protect against default by the homeowner on the new mortgage, the government could secure the loan against his or her future earnings, because the government already has an enforcement mechanism it can use: the IRS. This would protect the taxpayer’s interests.

Finally, one note of caution. Loan modifications should work for some proportion of delinquent homeowners, but there are probably millions of homeowners who have no chance of paying any mortgage on their houses that would be acceptable to their lenders. People with option ARMS who made minimum payments and then saw their mortgage rates reset upward by several percentage points will not be able to pay anything close to what lenders will require not to foreclose. In conjunction with any mortgage restructuring plan, there also has to be a plan to manage the flow of properties onto the market, because a flood of foreclosures will only cause prices to plummet further. It seems like there are so many things to do, but that is the price of the situation we are in.

Update: Here’s another proposed solution to the securitization problem.