Roubini: Not Out of the Woods, Significant Risks Remain

Despite the aggressive action by the Fed and EU leaders over the last few days, Nouriel Roubini thinks a severe recession is still in the cards and worries that the financial system is not out of the woods either. From his latest report (hat tip reader Dwight, boldface ours):

At this stage central banks that are usually supposed to be the “lenders of last resort” need to become the “lenders of first and only resort” as, under conditions of panic and total loss of confidence, no one in the private sector is lending to anyone else since counterparty risk is extreme. Only over time private lending will recover…

Are we close to the bottom of this financial crisis? Today stock markets – and other financial markets – will rally on the news that terrified policy makers peering into the abyss got religion and started to do in a consistent way what is necessary but financial markets will remain volatile with significant downside risks over the next few weeks as:

– details of these plans are still very fuzzy and ambiguous and with uncertain effects on various assets classes (common shares, preferred shares, unsecured debt of financial institutions, etc.);

– macro news will surprise on the downside as the economies sharply weaken and contract while fiscal policy stimulus is lagging;

– earnings news for financial and non financial firms will surprise on the downside;

– the damage done to confidence and to levered investment is already severe and the process of deleveraging of the shadow financial system will continue;

– major sources of future stress in the financial system remain; these include the risk of a CDS market blowout, the collapse of hundreds of hedge funds, the rising troubles of many insurance companies, the risk that other systemically important financial institutions are insolvent and in need of expensive rescue programs, the risk that some significant emerging market economies and some advanced ones too (Iceland) will experience a severe financial crisis, the ongoing process of deleveraging in illiquid financial markets that will continue the vicious circle of falling asset prices, margin calls, further deleveraging and further sales in illiquid markets that continues the cascading fall in asset prices, further downside risks to housing and to home prices.

More aggressive and consistent and rapid implementation of the policy plans will increase the likelihood that risky asset prices will bottom out sooner rather than later and then start recovering. A key policy tool – that is currently missing in the G7 and EU plans is to use fiscal policy to boost aggregate demand. Indeed, given the current collapse of private aggregate demand (consumption is falling, residential investment is falling, non-residential investment in structures is falling, capex spending by the corporate sector was falling already before the latest financial and confidence shock and will now be plunging at an even faster rate) it is urgent to provide a boost to aggregate demand to ensure that an unavoidable two-year recession does not become a decade long stagnation. Since the private sector is not spending and since the first fiscal stimulus plan (tax rebates for households and tax incentives to firms) miserably failed as households and firms are saving rather than spending and investing it is necessary now to boost directly public consumption of goods and services via a massive spending program (a $300 bn fiscal stimulus): the federal government should have a plan to immediately spend in infrastructures and in new green technologies; also unemployment benefits should be sharply increased together with a targeted tax rebates only for lower income households at risk; and federal block grants should be given to state and local government to boost their infrastructure spending (roads, sewer systems, etc.). If the private sector does not spend and/or cannot spend old fashioned traditional Keynesian spending by the government is necessary. It is true that we are already having large and growing budget deficits; but $300 bn of public works is more effective and productive than spending $700 bn to buy toxic assets. Is such fiscal stimulus plan is not rapidly implemented any improvement in the financial conditions of financial institution that the rescue plans will provide will be undermined – in a matter of six months – with an even sharper drop of aggregate demand that will make an already severe recession even more severe. So a fiscal stimulus plan is essential to restore – on a sustained basis – the viability and solvency of many impaired financial institutions. If Main Street goes bust in the next six months rescuing in the short run Wall Street will still lead Wall Street to go bust again as the real economy implodes further.

Moreover, the US government will need to implement a clear plan to reduce the face value of mortgages for distressed home owners and avoid a tsunami of foreclosures (as in the Great Depression HOLC and in my HOME proposal). Households in the US have too much debt (subprime, near prime, prime mortgages, home equity loans, credit cards, auto loans and student loans) while their assets (values of their homes and stocks) are plunging leading to a sharp fall in their net worth. And households are getting buried under this mountain of mounting debt and rising debt servicing burdens. Thus, a fraction of the household sector – as well as a fraction of the financial sector and a fraction of the corporate sector and of the local government sector – is insolvent and needs debt relief. When a country (say Russia, Ecuador or Argentina) has too much debt and is insolvent it defaults and gets debt reduction and is then able to resume fast growth; when a firm is distressed with excessive debt it goes into bankruptcy court and gets debt relief that allows it to resume investment, production and growth; when a household is financially distressed it also needs debt relief to be able to have more discretionary income to spend. So any unsustainable debt problem requires debt reduction. The lack of debt relief to the distressed households is the reason why this financial crisis is becoming more severe and the economic recession – with a sharp fall now in real consumption spending – now worsening. The fiscal actions taken so far (income relief to households via tax rebates) do not resolve the fundamental debt problem because you cannot grow yourself out of a debt problem: when debt to disposable income is too high increasing the denominator with tax rebates is ineffective and only temporary; i.e. you need to reduce the nominator (the debt). During the Great Depression the Home Owners’ Loan Corporation was created to buy mortgages from bank at a discount price, reduce further the face value of such mortgages and refinance distressed homeowners into new mortgages with lower face value and lower fixed rate mortgage rates. This massive program allowed millions of households to avoid losing their homes and ending up in foreclosure. The HOLC bought mortgages for two year and managed such assets for 18 years at a relatively low fiscal cost (as the assets were bought at a discount and reducing the face value of the mortgages allowed home owners to avoid defaulting on the refinanced mortgages). A new HOLC will be the macro equivalent of creating a large “bad bank” where the bad assets of financial institutions are taken off their balance sheets and restructured/reduced.

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  1. fred55

    will someone kindly explain to me why reducing the monthly payments is not sufficient, why the amount due is required (ie, windfall?)

    not all states provide that acquisition debt is nonrecourse

    therefore, wouldnt it be more fair to

    (i) reduce the monthly payments

    (ii) pursuant to commerce clause authority, reform the loan so that if not already nonrecourse the amount in excess of the current market value is nonrecourse (so you wind up with a negative am nonrecourse or partial nonrecourse loan)

    that way without having to re-record instruments or mess with stuff the taxpayer (who do you think winds up paying for this) at least is protected for any appreciation

    the only objection i can see to this is some argument that without shared appreciation the h/owner will wind up a renter and not protect the property

    why does that remind me of the national lampoon cover of the dog with a gun to its head and the caption “buy this magazine or we’ll kill this dog”

    we have to write off debt of people who lost money in houses and pay for it because if we dont they wont keep their word?

  2. Matt Dubuque

    Matt Dubuque

    The BIG global push has been to get banks to lend to one another.

    That’s quite a different thing than having banks lend to other economic actors. And THAT is what is needed to stop the threat of runaway deflation.


  3. JO

    I have respect for Roubini in that he had the guts to say what very few of his colleagues were saying on the upcoming debt disaster. For this, he deserves respect but many of these proposals in this article are pathetic Keynesian nonsense. Reduce the value of mortgages and provide debt relief to those who lived well above their means? All these bailouts and rebate schemes and the proposed “solutions” will help raise tax rates for everyone including the average middle class, many of whome lived within their means and have been disciplined. Who is standing up for the still significant number of hard working middle class who have saved, lived frugally, and bought homes they can afford? It was the policies and debt based theories of these economists that got us here in the first place. Spend and spend. New road, bridges and the like are needed but reducing morgage balances and providing debt relief to many borrowers who were reckless? As usual, these stupid proposals hurt the prudent and innocent (depositors/savers who will earn lower rates of interest, and future borrowers who will pay higher rates and more restrictive terms due to defaults of the dead beats) at the expense of the morons who lived recklessly. This is total outrage…why aren’t prominent people talking out about this ? Listening to the same people whose theories got us into this will lead to disaster. These proposals oly delay the inevitable. What the Keynesians/Monetarists forgot to tell people was what happens when the amount of debt being paid down and defaulted on exceeds (significantly so) the amount of NEW debt being created..we are at that point now…consumers and businesses are not able nor willing to take on enough new debt to overcome the amount being paid down and defaulted on. Unfortunately, we will find out the answer in the next 3-4 years. Long live the Austrian school. The only economic school that allows for true capitalism and true freedom.

  4. tyaresun

    Why not partially nationalize the auto industry, set it on the right path and privatize it again later.

    This will help Main street more than anything they can do for Wall Street.

  5. Yves Smith


    I have spoken to people who run sizable mortgage counseling organizations (note that loan servicers sometimes outsource their loan mod operations to mortgage counselors). They say that the banks (when they hold the mortgage and can do so) are not offering deep enough payment reductions to change outcomes. They also say principal reductions are the only way to make the math work.

    What you may not realize is that in past real estate cycles (remember, in local markets, you saw downturns as bad as the one we are seeing nationally), banks always found it better to keep the homeowner in place IF he has any ability to pay (ie, still had a job, basically).

    You are looking at loss severities of 40-50%, in some cases even more, on foreclosure, between hard costs and losses on resale. And that assumes the homeowner doesn’t trash the house, which is also happening with some frequency. Thus a deep cut in the mortgage balance will still leave the bank ahead of foreclosing.

    So why isn’t this happening? Most paper (80%) is held in securitization vehicles. The servicer gets paid for foreclosing, but gets very little if he mods. The argument about risk of being sued by investors is spurious in this environment. It has much more to do with servicer economics and their being set up like factories (ie, not in a position, staffing or systems-wise, to do one-off evaluation and negotiation).

    So the outcomes will be far worse than they otherwise would be if mortgage balances are not reduced.

    Yes, giving principal reductions to overextended borrowers isn’t fair. But not doing it is inefficient. It will vastly worsen the housing downturn, and that will hurt the innocent too via lower housing prices.

  6. Anonymous

    The business cycle created by this massive credit expansion ends with credit devleveraging. The idea that somehow throwing money onto the streets to spur the economy and creating some kind of soft bk for the over their heads in debt crowd doesn’t seem like a good solution. The exits are crowded and will stay that way for many years until our society begins the long process of producing meaningful productive work and citizens depend not on the DOW casino but meaninful wages,solid healthcare and yes savings!

  7. fred55

    i know why its not done. i also think you should know first hand from me (this isnt an anecdote, its one of my clients) that even warehouse (portfolio) lenders are not willing to take the hit.

    i have a client who bought a house at the peak, 93% financing with a 1st and 2nd from countrywide, and they have over the course of a year turned down 3 short sale offers at 80% of the mortgage balance.

    i have no doubt given the months they drag it out and the unrealistic standards (they say their bpo is 90%+ of original purchase price in 2007, bs) this is balance sheet fraud, ie they dont want to acknowledge reality.

    i should point out my client has not paid the mortgage in over a year and theres still been no attempt at foreclosure.

    multiply this by 10,000,000 or more.

    point is, i dont trust anyone at this point and when the banks tell you they need to lower principal to make the numbers work mathematically that has to mean they havent considered neg am, as whats the diff between a nonrecourse neg am and principal reduction other than that in the first the lender at least has a chance at getting money back?

    even sheila had some idea of doing this earlier this year, shared appreciation nonrecourse neg am.


    if you thought you saw appraisal fraud before with ninja loans, what do you think will happen when any homeowner in the us can apply for forgiveness by submitting a lowball appraisal?

  8. Anonymous

    Why is it every expert can seemingly without thought suggest that the prudent and responsible savers of this country bailout the irresponsible and over-extended and actually think it will fly without causing a civil war? I believe what is missing from the mantra of “bailing out the distressed homeowners” including McCain’s Mortgage plan is that many of us gave these people ample warning. Now these experts assume we are fine with paying up so these “special” people can stay in their mcmansions? I don’t think so..

    The sooner we accept this plan will not work the sooner we can move on to a better solution. There has to be a better way then engaging in this kind of moral hazard ..

    At the minimum let the government take over all the empty houses and rent them out. I have no problem with “transition to rental” help but this non-stop badgering of bailing out the most irresponsible of all of us is killing this country.

  9. bk

    If 80% of mortgages haved been securitised and traunched, I don’t see how it is possible to restructure mortgages and provide mortgage debt relief. I think it is a good idea and it makes good business sense but it doesn’t seem logistly possible.

  10. Anonymous

    “So the outcomes will be far worse than they otherwise would be if mortgage balances are not reduced.”

    Pure B.S. Housing prices will continue to decline until they reach a level of affordability which in bubble states like Calif is a long long way off!

  11. Anonymous

    As the previous poster claims above:

    “Yes, giving principal reductions to overextended borrowers isn’t fair. But not doing it is inefficient. It will vastly worsen the housing downturn, and that will hurt the innocent too via lower housing prices.”

    There is no evidence that favoring the most irresponsible and saving them will lessen any kind of pain we are about to feel. In fact if we keep up this kind of moral hazard I believe the consequences will be devastating. Just like the 700 B bailout was suppose to save the stock market..

    There is absolutely no leader standing up for the majority of this country who have been responsible.

    And they wonder why McCain’s numbers are dropping fast? Look at me.. I have been a conservative my whole life but last week when I heard about his new mortgage bailout I just wanted to throw up.. Only for those who are behind on their payments we be the lucky receivers.. Screw everyone else..

    Blows my mind…

  12. Mark

    I agree with many of the posters above. Perhaps mortgage modification is more efficient. However, how can you put a value on fairness and integrity? Continually bailing out the irresponsible at the expense of the prudent makes a farce of all the principles we stand for – so what if my home is theoretically worth a few extra dollars – it is simply not worth the cost of being ashamed of my country.

  13. Anonymous

    “$300 bn of public works is more effective and productive than spending $700 bn to buy toxic assets.”

    Yes. And it is ten times more effective than a bloody $3 trillion quest to “bring democracy to the middle east.”

    Stop the war(s) now. Don’t vote for Democrats or Republicans. Vote third party, or don’t vote at all.

    — Juan Falcone

  14. Don

    In essence, the multinational process now underway is to shift debt from the private (capital) sphere to the public (taxpayer) sphere.

    The underlying premise is that by doing so the fiscal crisis will be abated and that in time, debt creation can be re-started.

    Yet it is this very same public that – it is hoped – and now increasingly burdened with public debt, which will eventually begin to return to credit to fund consumption.

    Roubini argues that for this to work, household debt must be reduced. Once this debt has been reduced, by shifting it to the taxpayer instead of individuals and households, then said taxpayer will be in a position to begin borrowing anew.

    Yet the debt still remains . . . having been shifted, and I repeat myself, from private to public. The debt remains, but it has taken on new form, in the shape of taxpayer debt.

    This seems to be nothing less than a shell game. I am unable to escape what appears to me to be nothing short of circular reasoning.

  15. Abbott_Of_Iona

    Don said…

    "In essence, the multinational process now underway is to shift debt from the private (capital) sphere to the public (taxpayer) sphere."

    I think you are correct.

    I think the reason this is happening is that the private debt cannot be repaid.

    So it shifts to the public debt (the taxpayer)

    But lo & behold ~ they are the same bloody thing.

    You can repay the debt privately by paying off mortgage/credit card etc or you can pay it back publicly by tax and/or inflation.

    Something really stinks about the way this is being done.

    Why is it that Goldman Sachs is not allowed to go bankrupt?

    Who is being protected?

    It certainly is not the citizen/taxpayer/or unborn child (the next generation).

    Why does a child, not yet born, have to come into this world (in this case the Republic of the United States of America) with a debt burden that fills the coffers of Hank Paulson’s pension fund?

  16. Frank

    Americans were generally frugal and thrifty before the advent of Madison Ave and the need among the wealthy to increase consumption by the masses. We have reached a crescendo of consumption. Not only is the consumer broke, but I suspect the balance sheets of a significant portion of corporations is just more smoke and mirrors. The entire modern Western world is broke. And just when we start to get a handle on the problem, most likely we are looking at permanent shortages of exportable oil. How will that affect the value of exurban McMansions and globalized corporations? Then maybe we will reach a critical mass of electric cars, and on a hot summer night, with A/C running full tilt in NYC, etc…the grid will blow. Welcome to the future. Better buy some cans of beans for storage:)

  17. Gavin

    Yes, giving principal reductions to overextended borrowers isn’t fair. But not doing it is inefficient. It will vastly worsen the housing downturn, and that will hurt the innocent too via lower housing prices.
    Yves, love your blog but I disagree strongly on this point. Why do people insist that higher asset prices are a good thing? You are viewing housing as an appreciating asset, rather than an object of consumption.

    Artificially inflating asset prices does no good. For many responsible Americans, lower housing prices would be a very good thing.

    Insinuating that prices must stay high to preserve net wealth flies in the face of reason. This is ILLUSORY PAPER WEALTH. Any benefits to those selling homes (retirees, speculators, etc) must be directly paid by those buying the homes. I’ll argue that on a net basis, wealth is neither created nor destroyed by falling home prices. It simply redistributes purchasing power (measured in other goods) from one group to another.

    And speaking as one from a younger generation, this ponzi scheme of asset prices is untenable. The bubble goes far beyond housing. Think about social security, medicare, stock prices, national debt etc. An unfair burden is being placed on my generation, and it will correct. The question is whether it will do so naturally via economics, or separately through civil unrest and violence. Given our current policies, we may eventually see both.

  18. Abbott_Of_Iona


    Why buy cans of beans.

    That assumes Armageddon.

    Why not grow your own beans. That assumes a future. And while your at it why not lobby to change all of the nanny laws that don’t let you sell me beans. I don’t need the state to legistlate whom I can buy beans from. I don’t want to be restricted to buying beans from WalMart.

    What the f**k happend to free enterprise while Hank and his Goldman (Global) Sachs (S**ts) were carving up your country.

  19. Abbott_Of_Iona

    What is a psychopath?

    “A psychological construct that describes chronic immoral and antisocial behavior”

    What is Hank Paulson?

    Who are Goldman Sachs?

    American Psycho?

  20. Anonymous


    I understand and agree with your remarks that reducing principal on mortgage notes will in maintain a portion of property values. I also see the value in this.

    I do wonder however, if it may be better to allow values to collapse. This would in effect provide real affordable housing, would it not?

    If some suffer homelessness so that others maintain credit scores and property values then I may prefer to lose my property value and credit score so that someone else has a home.

    I speak from my own situation. And I am giving myself the short straw. Clearly this may be worse for the economy but better for the overall population.

    What I would like to see is future judgements against homeowners eliminated. I feel these create a much worse situation for both the individual and the economy. If you are forced into Ch. 7 or 13 because of a judgement then you likely file all debt rather than just that related to a property. Then an even greater loss is felt by the economy as you do not pay credit cards or other debt.

    I am lucky, I have no credit cards and I am holding out to not file Ch. 7. Still, the emotional stress has an economic effect as well. Like what we are seeing in the market, a loss of confidence more than anything else. While the issues for individuals may be varied, they do have an effect. Job performance, sick time, stress related illness and so on.

    I’m afraid that more than the economy is tightly coupled.

    I have great respect for you and I am curious what your viewpoint is. I am likely wrong as I have no idea what the domino effect may be from not utilizing a plan such as the one you suggested. I am however, interested to learn.

  21. Yves Smith


    With all due respect, you have it backwards, Writing down mortgage balances is consistent with NOT propping up asset prices. The mortgage is an asset to the bank. Refusing to write it down, or given a borrower an insufficient mod so it can try to suck blood out of a turnip and delay writing down the mortgage to reality IS letting asset values fall.

    In other words, writing down principal to reflect current market prices for underwater borrowers IS consistent with letting asset prices fall. Any other course of action is not. Banks are going to some pretty extreme steps, like not foreclosing. to try to avoid taking losses.

  22. Anonymous

    The FED is to abandon the prey to chase its shadow (vietnamese: thả mồi bắt bóng) It’s like taking painkiller when you’re hungry. The base of the problem is over-indulgence in unproductive economic activities and over-consumption.

    This only prolong the agony. You’d better to invest in cold-fusion.

  23. Yves Smith

    Some of you above are missing the point, and are also clearly unaware of what banks, who once upon a time dealt directly with borrowers, did in past housing busts.

    BANKS USED TO GIVE HOMEOWNERS MODS AS A MATTER OF COURSE. Often, but not always, in the form of principal reductions. This was NOT charity on the part of the bank, this was out of recognition that net net, the bank came out ahead, It was going to take a loss either way, but the costs and losses on foreclosure are generally severe (40% in a normal housing market, and this one is NOT normal) and would EXCEED that of making a mod or principal reduction IF the borrower had reasonable income.

    The bank would look at the borrower’s income and ability to pay a reduced mortgage versus the expenses and loss it would take on foreclosure. How hard is it to understand that this is an economic calculation, and that past experience has shown in most cases it is better to keep the borrower in place, even with considerably reduced payments?

    I do not know why this is so hard to understand. The bank would do this to make the best out of a bad situation.

    I made no case for propping up asset values, and giving mods is not going to have much impact, save by keeping inventory overhangs from getting worse and, in certain neighborhoods, by keeping homes from going vacant (they depress the value of other homes and can pose a safety risk. Squatters have been reported to move in, for instance)

    Housing prices are going to correct to sustainable levels relative to income. The tightening of lending standards, particularly regarding down payment, assures that. The correction is driven almost entirely by a belated return to prudent lending standards. Giving people mods is not going to affect the terms on mortgages.

    The reasons mods are not happening to the degree they ought to be is due mainly due to the fact that 80% of mortgages are held by securitization vehicles, which for a host of reasons, are neither inclined nor equipped to do mods. A second reason (for those cases where the originating bank holds the mortgage) is a second mortgage or home equity line held by another party gets in the way (the second is not willing to be wiped out, even though that is what would happen in a foreclosure). Third is that the banks are so capital constrained that they are doing their best not to recognize losses, and so are offering insufficient mods to keep borrowers alive a few more quarters, then lower the boom.

  24. Anonymous

    While there is no doubt that there will be massive public spending, why waste it on infrastructure and green technologies. Why not spend it on preparing for the coming large population declines by returning cleanly large areas of the country to wilderness. The Michigan peninsula is a prime candidate. So too would be the shoreline of the Chesapeake Bay, perhaps 20 or 30 miles in. A swath of wilderness 50 miles wide and each side of the Appalachian trail from Georgia to Maine would be ennobling. And, of course, Long Island represents the greatest opportunity for expanding the urban wilderness interface. Japan has tried the infrastructure thing and their population keeps declining.

  25. SlimCarlos

    >> When a country (say Russia, Ecuador or Argentina) has too much debt and is insolvent it defaults and gets debt reduction

    No, this is just not true. When Russia, Ecuador or Argentina has too much debt that is locally denominated, they inflate it away. The three examples Roubini mentions here all fell victim to massive inflations. That's how you get rid of debt. You inflate it away. This may involve breaking a currency peg, it may not. But either way the value of the local currency gets devalued against real things.

    (There may also have been defaults, but only when the debt is denominated in a foriegn currency, which renders the analogy inapplicable here.)

    We can get a clearer picture of how this happens by considering:

    >> when a firm is distressed with excessive debt it goes into bankruptcy court and gets debt relief that allows it to resume investment,

    Or it issues more equity to keep itself afloat. First it issues equity at $10, then at $5, then at $1, then at 25c, then at 5c, and finally at 1c. At which point there are 10 trillion shares outstanding, a bagful of which won't buy you a cup-o-coffee. Then it does a reverse split — i.e. it knocks a zero off its currency. Rinse and repeat.

    If the problem were isolated to a given sector, default might be an option. But it's not. The whole country is broke and an entire country can't default when the debt is demoninated in its own currency. Instead, it will undertake a series of suicide "issues", each one more desparate than the last, until the currency is worthless.

    Again, Roubini cites Ecuador (which I know quite well), Argentina (of which I know a little) and Russia (which I don't know at all.) But what I do know is that in all three cases, the local currency went to zero. This for the very reasons Roubini explains.

    To put a finer point on it, I have in front of me a bank note from El Banco Central de Reserva del Peru. It says: Diez Nuevos Soles. (Ten New Soles).

    Question: What do you think happened to the old Soles?

    Why does Roubini stop his story halfway? He identifies the problem then drops the ball when he is in the clear, on the five yard line.

    I am just a dumb engineer whilst Roubini is a rockstar financial soothsayer. You’d think he’d have taken it the distance.

  26. SlimCarlos

    >> BANKS USED TO GIVE HOMEOWNERS MODS AS A MATTER OF COURSE. Often, but not always, in the form of principal reductions.


    Do you suggest the Chinese give the US Treasury a load mod? Or do you think this pile can ever be paid back in whole hard dollars?

  27. Anonymous

    The bank would look at the borrower’s income and ability to pay a reduced mortgage versus the expenses and loss it would take on foreclosure.

    The issue as you present it is not that easy if it was it would already be done. First many of these foreclosure are investor or non-owner occupied, how will be banks deal with that issue?
    Second the rest is a pile of refi, 2nd’s, 3rd’s and bad credit, low income, loss of job etc.
    As a poster mentioned prior that folks need to become an adult in this situation and grow up. Realize the complexity of the situation and stop putting up old solutions based on another time and deal with today’s problem.

  28. Gavin

    Appreciate your comment, and from a public policy perspective I agree with you. Your clarification that you’re not supportive of artifically propping up prices makes me feel much better. And yours is certainly the voice of reason.

    But on moral grounds I still don’t like it.

    This reeks of “from each according to their abilities, to each according to their need”. In essence this gives preference to those that made poor financial decisions, penalizing through taxation those that were prudent enough to hold off buying and save. So given the choice between justice and injustice, I’ll take the former, cutting off my nose to spite my face…

  29. Anonymous

    “$300 bn of public works is more effective and productive than spending $700 bn to buy toxic assets.”

    Not if the $300 bil just goes to different political crony buddies. Think about how Chicago or NYC would dole it out as patronage.

    Something that might have a chance is $300 billion invested in fuel and energy infrastructure that ultimately both lowers end user prices and redirects cash flows from offshore back into the economy:

    1. Begin emergency electrification of the four major railroads’ mainlines.

    2. Start construction of ten nuclear power plants per year for ten years.

    3. Start construction of ten 100,000 bpd coal to liquid fuel plants per year for ten years.

    Too many people have forgotten what constitutes real economic investment. It’s safe to describe 99% of “investing” these days as either speculative paper flipping or debt financing of luxury goods.

  30. Anonymous

    It will vastly worsen the housing downturn, and that will hurt the innocent too via lower housing prices.

    I would love to be hurt by lower housing prices! Where can I sign up? I’m waiting to buy.

  31. Anonymous

    Yes, Austrians: I’m beginning to think you’re right. The *f…* Keynesians with their expansionary fiscal and monetary policies (read debt) got us into this mess. Looks like Krugman will be the last Keynesian to win the Nobel.

  32. Anonymous

    ROubini’s HOME program is trying to fix a fundamental trend since the 1970s – stagnant wages and income – with a short term gimmick.

    Nothing less than immediate tax rate reduction for working families at the expense of military spending, and an equally aggressive reduction in working hours below 20 hours, will address this issue, I fear.

    Short of this, there will be no mere repeat of the Great depression, because this time it will be much, much worse.

  33. Anonymous

    PS: I know the above comment will make me look like a lunatic, and I apologize, but the situation is really this dire.

  34. Anonymous

    For all the commentors on this blog name-calling your imaginary enemies as “dead-beats”, “low lifes”, “irresponsible”, etc. You are all getting what you so richly deserve.

    I’d bet 90% of the commentors are true-red republicans who voted for the Reagans and the Bushes of our world. You helped elect people who made it there goal to make government and/or regulation a dirty word,and as a direct result of those policies we had runaway greed via the financial system that eventually sucked even the most vulnerable into their vortex of greed.

    Why is it I who have been disciplined, who isn’t upsidedown in my mortgage, who won’t benefit from these taxpayer programs to clean up the deregulatory messes, why is it I don’t feel contempt for my fellow citizens who are hurting, burdened by massive debt??

    Why do see them and not feel that the right thing to do is help them, to raise them up?

    I’ll tell you why…its called compassion, which is something the “conservative” party has been demonizing for at least 30 years in this country.

    I feel so sorry for you disciplined, hard-working, success stories…because you don’t get that true meaning is in giving not receiving.

    I know I sound like a preacher now..but I haven’t been to church in years. I just know from having been like you that being like me makes me content regardless the circumstances and you are truly weak and empty and good for nothing until you wake the fuck up!!!!

  35. SlimCarlos

    >>ROubini's HOME program is trying to fix a fundamental trend since the 1970s – stagnant wages and income – with a short term gimmick.

    You don't sound like a lunatic at all. You are right on the money.

    The system is broke. Half measures won't work this time….

  36. john c. halasz

    Many commenters here fail to understand, though Yves has made the point fairly clearly, that mortgage modifications/reduction to realistic market values is a loss mitigation program meant to allow market prices to adjust downward to a realistic equilibrium level, without over-shooting on the downside, as is usual with collapsing bubbles. Objections based on equity considerations, rather than equity values, can be dealt with reasonably. Serial reckless MEW refinancers can be traced and excluded from consideration. A warrant with a second lien can be attached to any prinicipal reduction to recapture any future nominal house-price appreciation. Perhaps a tax credit could be figured out for those with no or low mortgages, to compensate them for their prudence, (which would especially help out the distressed retired population). Further only those who could afford the new mortgage from current income would be eligible, which would largely exclude those who simply bought too much house or speculated. But perhaps more too the point from an equity standpoint, such modifications/reductions would ameliorate the massive social and not just financial externalities involved in massive increases in foreclosures. In addition, I look favorable on Dean Baker’s proposal to allow foreclosed home owners to remain in their houses at market-rate rents, if they can afford them, though, since banks do not want to be landlords, I would assume that that would require that a government agency would buy out and hold the foreclosed mortgages, though that would probably be long-run neutral or mildly profitable. The biggest technical problems for a morgage modification plan concern how to break the limits of REMIC trusts, which would probably require legislative nullification or safe harbor provisions, and how to adequately capitalize and restaff mortgage servicers, (since servicer rights were bid out to the lowest bidders, who largely relied on increased automation, rosy assumptions and the elimination of experienced staff, as not only too expensive, but too bothersome during the boom).

    But there is a larger fiscal paradox, that extends well beyond just the housing bust. Public fiscal debt spending is required just at the point when public revenues are contracting in recession and domestic savings have been running down both during the asset-inflation boom, (“the wealth effect”, which should be more properly labelled the domestic-dissavings effect), and in the asset deflation bust. As commenters have noted that just amount to replacing public debt for private debt, and implicitly relies on the forebearance of foreign trade-surplus creditor countries, precisely at the point when trade deficits figure to be decreasing, lowering the volume of recyclable dollars, and when a lowered value of the US$ is needed and expectable anyway, as partly correcting the huge trade deficit. I have yet to see any “serious” commentator propose an obvious partial solution: a net worth or wealth surtax for as long as needed on millionaire households. Aside from the Willy Sutton reason that that’s where the money is, and the populist revenge and equity and legitimacy appeals as a claw-back,- (and, yes, virtually anyone covered, even if they did not engage in unscrupulous and irresponsible behavior directly, were advantaged by the tax breaks and spillover effects of the boom, so there is a least rough justice in the matter, not that that should concern “free market” advocates, at least those not lost in libertarian fantasies of the identity of social equity with market outcomes),- but it would provide offsetting, domestically sourced public fiscal revenues to offset the required public spending. Carve out provisions could be designed to a point to retirees and invested and reinvested capital of small business owners. But to those that would argue that such a tax would further reduce already declining financial asset values, yes, that is exactly the point,- (though perhaps payments “in kind” with suitable haircuts could be allowed to prevent cash out liquidations), since a reduction of the profitability of speculative investment based on credit in (Fictive) financial assets in favor of the formation of real capital investment in the real productive economy is what is required and desirable, since real productive capital investment and its attendant employment of labor is the source of all real wealth creation anyway. (Yes, this is aimed at the re-industrialization of the U.S. economy required to deal with the trade deficit, short of national default). At peak the asset wealth attached to the U.S. economy was $58 trillion. Assuming a coming 30-40% decline, it would be somewhere around 40-35 trillion, so a 1% networth tax would raise $300-400 billion and 2% $600-800 billion. Oh, and restoring the “death tax” would be in order as well, since its repeal was entirely a matter of fraudulent propaganda.

    The final point I’d have to make, as some economists have noted, including I think even Rogoff, is that partly nationalizing the banking system should be aiming at shrinking the size of the financial sector and especially the “shadow banking system”, as over-grown, unproductive, and prone to misallocate capital. But as yet I’ve seen nothing in the governmental proposals about triaging insolvent banks, rather that supporting the banking system carte blanche, let alone concerning the need to authoritatively re-regulate, as well as, progressively shrink the financial sector. And, in fact, recent mergers, such as with BoA and JP Morgan Chase or even the aborted Citi takeover, have only led to increased and probably illegal concentration of “too-big-to-fail” banking firms, (which, in the case of Citi at least, seem also too-big-to-succeed), which go against the need to shrink the financial system as a whole and eliminate or, at least, severely regulate too-big-too-fail concerns, with their aims of predatory, rent-seeking market domination.

  37. Anonymous

    "I think the reason this is happening is that the private debt cannot be repaid.

    So it shifts to the public debt (the taxpayer)

    But lo & behold ~ they are the same bloody thing."

    This is not quite correct. Those of us who were responsible enough not to take on excessive debt will have enough private debt shifted onto us to allow the irresponsible to borrow yet more money, and start anogther round of consumer debt driven economic activity.

    So they are not exactly the same. Shifting the debt around will cause private consumer debt to extend a little further.

    As others have commented, I have no idea why the economists I read fail to understand that this strategy obviously cannot succeed long term. The question is, why bother with it then in the short term?

    I don't see any way in which it is prudent to allow irresponsible consumers to take on more debt.

  38. Dave Raithel

    Good God, I’ve left one time warp (The Frontline episode recounting the horrors of my youth, Richard Nixon’s presidency, still showing on PBS as I write this) to fall into another.

    Roubini had me at: “A key policy tool – that is currently missing in the G7 and EU plans is to use fiscal policy to boost aggregate demand.”

    Additionally: I do not mean to diminish Fred55’s or Yves Smith’s clarifications on mortgages in any way when I repeat my observation re the Felix Salmon link a day or two earlier, I just mean to be most brief: If deflation is the future, then lenders can afford to take haircuts.

    Like many of you, I have a visceral objection that those of us who did not speculate and are current may in fact “subsidize” some “home” buyers who are not “worthy.” But I also have a sense that saving the virtuous requires saving some scoundrels. I’m also weary of the house across from ours sitting empty the last 3 months; and the one around the corner empty the last year. And this is in Columbia, MO, the heart of the heart of the heartland. When bubbles pop, the skin lands most anywhere, I guess …

    As to “blaming” the Keynesians for getting us to here (as some of the above bloggers do): Greenspan was a Keynesian? Are you high? The most interesting paper of Krugman’s I ever read was one he handed out to one of his classes at Princeton, from the early 2000’s, that wound up on the web. He explained why he was filling in for somebody to teach macro, but that he really wasn’t a macro economist, because macro went out of style sometime in the 80’s when Ph.D.’s looking for recognition prepared dissertations for monetarists or Chicago School methodological reductionists, and so nobody really DID macro anymore…But why reinvent the wheel?

    Maybe what’s going on is some zeitgeist recollection of why those of us whose parents grew up in The Depression never trusted the stock market or believed in investing in anything you could not live in or grow something on or build something inside of to exchange to another person; and we’re similarly recollecting that going to school in a building built by the WPA was just fine, and the REA put up the initial grid work that still brings power to my house, and … I actually like those Thomas Hart Benton murals in the Mo State Capital, courtesy of the WPA…

    Right, The New Deal was no different than fascism. I saw that Ron Reagan movie too…

  39. Anonymous

    Gavin @ 943 pm,

    I appreciate (and am considering)your point of view. However, I am sure that you have considered that if the US and European governments let this play out in a more laissez faire manner, the outcome would be far from giving "those that made poor financial decisions" and "those that were prudent enough to hold off buying and save" their just deserts.

    Many of the villains in the credit bubble, high (Goldman Sachs and hedge fund managers who originated but never held onto ABCP, CDOs, CMOs and CDSs, the credit rating agencies that collected consulting fees from those whom they were supposed to be rating) and low (corrupt appraisers, mortgage brokers, realtors, etc.) have walked away from the black jack table with their commissions.

    For some others who profitted from the bubble, it was just dumb luck. For example, anyone who cashed out of residential real estate between 2004 and 2007, perhaps because of a retirement or an estate sale. Even Henry Paulson was more lucky than intentionally evil when as part of becoming Treasury Sec he sold his stake in GS at 2006 share prices.

    Likewise, many of the losers (or would-be losers sans bailouts), while perhaps not as prescient as Nouriel Roubini, could hardly be called reckless or irresponsible. Take a middle class worker who happened to reach peak earning years at the height of the bubble, and decided to put their 401(k) $$ in an S&P index fund? The wipe-out of Bear Stearns, Fannie, Freddie, Wamu, and Merrill Lynch equity holders hit them, no? What about a first time homebuyer (not a Nakedcapitalism or CR reader, but not a fool) who put 15% down on a house in 2006? In a truly just world, how much would they be penalized for their poor financial decision.

    Sorry to be so long winded, but my point here is that hands-off alternative that many people seem to be in favor of does not seem to me to be a whole lot more just than the type of lender-borrower agreements that Yves is proposing.

  40. Anonymous

    just my 2cents. not saying even most people upside down have lousy credit, but a lot do. so to modify a loan for someone with lousy credit will..(.fill in the blank). Also, look how housing finance has been managed up to now. All of a sudden we are going to get it right under tremendous confusion and stress? Can we modify all these loans without more fraud and screw-ups? Someone mentioned appraisal fraud.

    Believe me, I am not saying mods aren’t the way to go, but it strikes me that there are tremendous issues and challenges involved. At best, they aren’t a panacea, not that anybody is claiming they are. But they will become their own hot potato.

  41. FairEconomist

    The “moral” outrage of people at the most reasonable forgiveness of excessive debt blows my mind sometimes. I had a long argument with a friend Saturday night who insisted bankruptcy was almost never acceptable and people who make one investing mistake should have to work double shifts until they’re 85. Mortgage reworks/cramdowns will save the taxpayer huge sums, possibly hundreds of billions, that we really can’t afford to waste. Somehow, though, people manage to get really worked up about this.

    I actually favor workouts through cramdowns. Get a workout, lose all your other assets. It seems the fairest approach – for a bad mortgage loan, the borrower pays all he can, then the bank all it can, and then the government will have to pick up the rest. Sounds right to me. As I think about these issues, I’m impressed with the wisdom of case law. Virtually all these thorny “who pays when there’s not enough money” seem to have been hammered out in centuries of bankrupcty litigation.

  42. Gavin

    @Anon & faireconomist,
    I'm not outraged at the idea of debt forgiveness. And I agree that many who are now underwater on mortgages were simply in the wrong place at the wrong time.

    My point is simply that those currently in houses they cannot afford should not be given priority over those who can afford to pay more, but were wise enough not to buy at inflated prices. Further, the latter should not be taxed exessively to pay for the mistakes of the former. That is between the borrower and the bank. And if the bank fails, so be it. We have mechanisms in place to take over insolvent banks, and taxpayer dollars shouldn't be spent until all shareholders, debtholders, and CDS holders take their fair lumps.

    I realize that many of you are terrified that doing so will collapse our financial system. Sure there will be a chain reaction of CDS, and it will wipe out a good number of hedge funds, banks, and insurance companies. But frankly, I expect this situation to devolve into a depression one way or the other. The question is whether we will collapse our currency with misguided attempts to prevent this.

    And at the end of the day, what needs to happen will happen. The financial sector will shrink, our country will stop pushing paper and peddling toxic financial instruments, and we will start producing things that will improve the quality of life for our citizens. I'm willing to go through a depression to see that happen. As if we have a choice…

  43. Richard Kline

    If the problems with individual mortgages are not resolved, we will have depression rather than ugly recession; that is what the contraction of _normal_ spending that will result implies. Some many mortgages were speculative vehicles, yes; moral outrage is justified there, and resolutions are by no means simple. The great majority of upside down mortgages are taken out by everyday folks who wanted a place to live and took out the only loan they were offered in areas where values were (temporarily) soaring. They were squeezed, and moral outrage isn’t really appropriate.

    There are only two resolutions to the problem of declining bubble mortgage prices: principal reduction or massive inflation. The first is the time tested solution, embedded in case law, and an historical best practice of longstanding, very much in the _lenders’_ self-interest. The latter is a general dissolution, which I guarantee no one on ANY side of this issue will be happy going through, so let’s just not go there.

    —But the larger issue to me is this: Any mortgage lender sitting on a non-payee for a year is lying out their rear to someone about their books. Servicer disincentives are all to relevant, and the reactor wast glass fusion which is securitized tranches are most problematic as well. But I strongly suspect that lenders have been extremely resistant to cramdowns, because they are totally insolvent if they mark their assets to the new, truer number. It’s the lies in the ledgers which are the hold-up here, to me.

  44. Anonymous

    Richard Kline,
    “But I strongly suspect that lenders have been extremely resistant to cramdowns, because they are totally insolvent if they mark their assets to the new, truer number. It’s the lies in the ledgers which are the hold-up here, to me.”
    Amen, sir.
    It’s not lack of compassion for the homeowner in distress, it’s all the deceit of the financial institutions that are preying on that sympathy that saddens me.

    I wonder how many ARMs are out there that will be adjusting to these new higher LIBOR rates. someone suggested LIBOR was pricing higher so the banks could make better numbers on the loans they have out priced to LIBOR. So will we suspend LIBOR pricing on homeowner ARMS? Wave a wand and make it happen, Paulson, our ruler?

  45. Anonymous

    The solution to the mess is well beyond my limited economic skills, but as a writer, I would like to see a permanent retirement of the tired old trope, “they were living beyond their means!” No, ‘they’ weren’t. If I see this phrase one more time I am going to vomit. This is pure urban mythology and the data don’t support it. Who are these “people” living ‘beyond their means” when most people can’t pay for basics such as food, gas, healthcare, and schooling? Most bankruptcies are for old medical bills! Wages are too low for most people, and that’s the bottom line. Hello, have you tried to buy a house in a large urban area lately? In 2006 my sister and her husband bought a crummy old house in an outlying suburb of the Bay Area. It was the cheapest they could find: 625k. It is NOT a McMansion, just a crummy old house, 1100 sq ft., with one bathroom, a rotten roof, and uninsulated windows. My brother in law commutes an hour to work. The schools are crummy and they shell out yet more money for private school for the kids. This is living high off the hog? Now the house is worth 425k. They are hanging on. They put down a huge down payment, trying to be responsible. And I don’t see how any of this was their fault or the result of being greedy. They don’t have degrees in finance or economics; how were they to know they were buying into the top of a bubble? When everyone in the MSM told them “a house is a great investment?” The majority of the people who are now underwater or in foreclosure are simply unlucky or unsophisticated people who were the last in line in a giant Ponzi scheme. Demonizing them takes the heat off the true fraudsters at the top of the pyramid. Just stop, already!

  46. YK

    Yves Smith said…
    “…The bank would look at the borrower’s income and ability to pay a reduced mortgage versus the expenses and loss it would take on foreclosure…
    …I made no case for propping up asset values…”

    When banks “look at the borrower’s income and ability to pay a reduced mortgage”.
    Do they reduce the principal to the current market price of a given house? OR
    Do they reduce the principal to where a given homeowner will be able to afford the payments? If the latter is true, this is definitely the case for propping up asset values.
    In general, availability of credit of any sort props up asset values. This applies to the original mortgages, and, to no lesser degree, to the mods.

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