Cramdown and Why We Need Managed Default

Paul Krugman is absolutely correct about deleveraging:

In the end, I'd argue, what must happen is an effective default on a significant part of debt, one way or another. The default could be implicit, via a period of moderate inflation that reduces the real burden of debt; that's how World War II cured the depression. Or, if not, we could see a gradual, painful process of individual defaults and bankruptcies, which ends up reducing overall debt.

And that's what is happening now: as this story in today's Times points out, the main force behind the gratifying decline in consumer debt appears to be default rather than thrift.

So basically, we can do this cleanly or we can do this ugly. And ugly is the way we're going.

But this ignores the largest source of debt for most people: housing.

There was an intelligent way to fix that problem: mortgage cramdown. We force lenders to readjust the value of the mortgage (both first and second mortgages) to current market prices (and reset them to a reasonable fixed interest rate loan), use the funds from TARP and HAMP to reimburse banks for part of the loss (e.g., fifty percent of the difference; they will have to take a loss), and, if the property gains in value, then the government gets half the profits on sale (we, the people, did help you not become homeless). If you don't like the deal, you don't have to enter the program, but millions of people would take it in a heart beat. It would also help lower housing prices, which still needs to happen, as well as take housing stock off the market (and future market).

Could have done that, but did not. Would have angered Obama's and the corporate neo-liberal Democrats BFFs. Or something.

As Krugman writes, we are going to 'deleverage', the question is, will it be a controlled or crash landing?

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My money's on a crash, because the vultures in charge are looking forward to picking over the wreckage.

By stripey_cat (not verified) on 29 Sep 2010 #permalink

I think that a more important cause of the debt problem is that real incomes are falling or stagnant. That's why people who could have paid off their mortgages opted to refinance and borrow more; they weren't making enough to pay for the standard of living they thought they deserved.

I think that a more important cause of the debt problem is that real incomes are falling or stagnant.

which is also why i'd worry about Krugman's suggested cure of moderate inflation. that would work to reduce the real value of debt, but it'd just screw people over even harder if average income didn't rise to match inflation --- and with wall street and businesses both being run the way they currently seem to be, i don't have much faith in that happening.

By Nomen Nescio (not verified) on 01 Oct 2010 #permalink