Why Treasury doesn’t like principal write-downs

By Felix Salmon
March 9, 2010
Shahien Nasiripour, who did the best job of anybody, at the Treasury blogger meeting yesterday, at getting Treasury's officials to commit news. Specifically, he asked about Sheila Bair's sensible idea that mortgage principal write-downs can help keep homeowners in their homes while also maximizing the value of the mortgage to the issuing bank. And he was told, quite clearly, that Treasury has been talking to Bair about this idea, and that if it makes sense at the bank level, it probably makes sense at the federal level, too, as part of the HAMP program to make mortgages affordable.


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Well done to Shahien Nasiripour, who did the best job of anybody, at the Treasury blogger meeting yesterday, at getting Treasury’s officials to commit news. Specifically, he asked about Sheila Bair’s sensible idea that mortgage principal write-downs can help keep homeowners in their homes while also maximizing the value of the mortgage to the issuing bank. And he was told, quite clearly, that Treasury has been talking to Bair about this idea, and that if it makes sense at the bank level, it probably makes sense at the federal level, too, as part of the HAMP program to make mortgages affordable.

Except that once the meeting was over, its main architect, Treasury flack Andrew Williams, emailed Nasiripour to walk that particular idea back, saying that Treasury was NOT (his all caps) going to do anything “major” in terms of principal write-downs, and that any moves in that direction would be no more than “tweaks”.

At the dinner after the meeting, Williams did a good job of looking very interested while saying absolutely nothing as the assembled bloggers talked about the optimal treatment of bank balance sheets during a recession. Do you mark to market, thereby plunging the entire financial sector into insolvency, or do you delay and pray, risking a Japan-style lost decade?

It seems to me that insofar as Treasury has a problem with principal write-downs, that’s clearly a function of the fact that it’s worried about the consequences for banks’ balance sheets. We’re prosecuting a muddle-through strategy right now, where the government artificially props up house prices by providing substantially all of the mortgage finance in the country, in the hope that with economic recovery will come enough of a natural rebound in house prices to let the government slowly remove its support without them falling dramatically again.

A large program of principal write-downs would in effect ratify the view that house prices are not going to recover any time soon — and that’s not a view that anyone in Treasury wants Americans to have. A different senior Treasury official, trying to explain that the economy is doing much better than expected, told us in the meeting that house prices right now are higher than house-price futures were indicating a year ago. It’s a silly argument: house-price futures are highly illiquid, and they don’t give a remotely useful indication of where people expect house prices to be in the future, since insofar as they’re used at all, they’re overwhelmingly used to hedge existing long housing positions. Because there’s no one who naturally would want to take the opposite side of the trade, house-price futures always look very pessimistic.

In any case, it was clear that Treasury is trying to sell a message that the economy is doing much better than anybody had dared to hope this time last year. And since a program of principal write-downs would be incompatible with that message, it’s probably not going to happen.

Comments
10 comments so far

Felix,

What if banks could write down the principal on a home but with a profit-sharing agreement if the home sells for more than the new principal in, say, ten years so there’s enough time for appreciation to kick in again (so they get a share of the write-up), and the chance to recognise the write-down gradually and to offset the write-up against the write-down – but then if they *decline* to write down the principal on a property, force them to write the loan down to foreclosure or market value *immediately*?

This would give the banks an incentive to reprice loans to keep people in their homes, and a strong incentive *not* to foreclose and be forced to take huge losses.

Posted by voodoobunny | Report as abusive

I think you have nailed this one exactly. And here is the corollary: by betting heavily on a recovery, the Treasury will have made things much better if they are right, and much worse if they are wrong. The prudent regulator turns out to be difficult to distinguish from the prudent banker, and might as well double up and average down.

Posted by Greycap | Report as abusive

“Because there’s no one who naturally would want to take the opposite side of the trade, house-price futures always look very pessimistic.”

Felix, this is silly. A large group of people would benefit from house-price futures: those who do not currently own a house, but expect to in the future. Just as some homeowners would want to buy downside protection (e.g., they may change jobs or retire or downsize after their kids leave), the very people who will take their place want protection from the opposite direction. If I’m a recent college grad starting my first job, I’m probably not going to buy a house right away, but I might expect to buy one in the future. I would benefit from buying futures. Just ask anyone who felt pressured to buy a house in 2005 because, at then-current rates of increases, they’d never be able to afford to buy one in the future.

You could argue that *current* participants are hard to find, but it seems pretty obvious that a liquid house-price futures market could benefit many people on both sides of the transaction.

Posted by Beer_numbers | Report as abusive

“…where the government artificially props up house prices by providing substantially all of the mortgage finance in the country, in the hope that with economic recovery will come enough of a natural rebound in house prices to let the government slowly remove its support without them falling dramatically again.”

There is just simply not enough discussion about this “bailout” for every one with a home. As a renter, I resent it. Where’s my bailout? Oh wait – I don’t need one. Ha!

And yet, I am content to help out my fellow citizens even though everyone with a mortgage is… less than worthy of my help. What’s in it for me?

Posted by silliness | Report as abusive

“We’re prosecuting a muddle-through strategy right now, where the government artificially props up house prices by providing substantially all of the mortgage finance in the country, in the hope that with economic recovery will come enough of a natural rebound in house prices to let the government slowly remove its support without them falling dramatically again.”

With economic recovery BASED ON WHAT?! What is the engine of the recovery? People are losing jobs. The folks that have mortgages will pretend and extend with their lenders, but at some point they will not be able to pay their mortgage. When people don’t have jobs, they don’t pay taxes. When people don’t have jobs, they don’t buy goods and services. This means businesses fail, which means that a stock market supported by hot air eventually crashes when this whole country is marked to market. Which means multiples more of people out of work. This is not “let’s tweak” time. This is “we need to vet and elect a group of people who can save this country” time. And by we, I don’t mean the sickos who got us here. What is about self-reinforcing feedback loops do they not understand? We are going down, and going down hard, and there is no magic Captain Sully at the wheel. Enough!

Posted by UncleBillly1 | Report as abusive

who paid for the dinner afterwards?

Posted by KidDynamite | Report as abusive

“In any case, it was clear that Treasury is trying to sell a message that the economy is doing much better than anybody had dared to hope this time last year.”

Yes, but it’s not, and we know that so far all attempts to prevent home prices from deflating resulted in delayed foreclosures, at best.
Does anyone remember that in the beginning, the support for the housing market was presented as ‘taking care of the growth engine of the US economy’?
Rather pathetic, in hindsight.

Posted by yr2009 | Report as abusive

Beer_numbers, I actually thought for a while about renters who intend to buy a house in the future as natural buyers of house-price futures. But then I tried to think if I could imagine a single person who I’d advise to buy house-price futures rather than simply saving up for a down-payment the old-fashioned way, and I couldn’t. These kind of derivatives are for sophisticated investors, not for people scrounging up a down-payment.

Bullseye, Kid Dynamite!

Posted by crocodilechuck | Report as abusive

“In any case, it was clear that Treasury is trying to sell a message that the economy is doing much better than anybody had dared to hope this time last year.”

That’s why the U-3 headline unemployment rate is well below 8%, right?

Posted by klhoughton | Report as abusive
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