Larry Summers' Attempt to Rewrite Cramdown History
Larry Summers has a very interesting book review of Atif Mian and Amir Sufi's book House of Debt in the Financial Times. What's particularly interesting about the book review is not so much what Summers has to say about Mian and Sufi, as his attempt to rewrite history. Summers is trying to cast himself as having been on the right (but losing) side of the cramdown debate. His prooftext is a February 2008 op-ed he wrote in the Financial Times in his role as a private citizen.
The FT op-ed was, admittedly, supportive of cramdown. But that's not the whole story. If anything, the FT op-ed was the outlier, because whatever Larry Summers was writing in the FT, it wasn't what he was doing in DC once he was in the Obama Administration.
Let's make no bones about it. Larry Summers was not a proponent of cramdown. At best, he was not an active opponent, but cramdown was not something Summers pushed for. Maybe we can say that "Larry Summers was for cramdown before he was against it."
William Longbrake, a former vice chairman with Washington Mutual who joined the Obama transition team in early 2009, recalls an administration divided over cramdown. "My sense is that Larry Summers probably ultimately brokered the solution," said Longbrake, now an executive in residence at the University of Maryland. "It was decided, but never publicly announced, sort of like, ‘Well, we are not going to oppose it, but we are just not going to support it.' … and then, ultimately, it died."
If Longbrake is correct, then we see, at best, a divided administration economics team. From what I recall of this debate in 2008-09, however, there was no signal of a true policy divide within the administration's team over cramdown. (It certainly didn't help that they had no one on the team who knew bankruptcy.) At best there were some signs of internal power jockeying between Summers and Gene Sperling, but that's not the same as a true policy debate.
In any case, between February 2008 until cramdown's defeat in April 2009, I cannot find one public statement by Summers on cramdown. If Summers truly supported cramdown, it's a shame that he wasn't more forceful because it would have made a huge difference if someone as influential as Summers within the White House team was pushing for cramdown. The only person in the administration who was noticeably supportive of cramdown was HUD Secretary Shaun Donovan, but Donovan was a marginal voice in this policy conversation.
Summers main critique of Mian and Sufi's book is that they're (very good) ivory tower economists, but that they don't understand the complexities of the policy world. I am sympathetic to Summers' point that "it's complicated". Cramdown was, but policy isn't like an academic debate in which noting nuances is how one scores points. Policy requires up or down decisions that swallow the good with the bad, and the Obama Administration (and Summers) made the wrong decision on cramdown. At the end of the day, that's what matters.
A. Responding to Summer's Technical Claims
Still, Summers raises five major points Mian and Sufi do not address. He is correct that Mian and Sufi do not address these points, but that does not mean that there are not answer, only that it isn't Mian and Sufi's fight. Let me go through these points systematically:
(1) Cramdown risked crashing the banking system. Allowing cramdown posed three possible concerns for the banking system. Let's address each in turn.
First, there would be large scale loss recognition from cramdown itself. So what? If the banks are insolvent as a result, recapitalize them. Recapitalizing a bank is not rocket science. There was private capital that was willing to invest in banks if the balance sheets were clean. That's the whole point of the FDIC process. It cleans up the balance sheet for investors. Perhaps some bridge financing would be needed, but giving the ingenuity that the Fed and Treasury displayed when they wanted to, I'm sure they would have found a way, legality be damned.
Second, there would be some people filing for bankruptcy for relief who would otherwise have continued to pay on their mortgages. The cramdown legislation took pains to ensure that bankruptcy wasn't going to be unduly attractive and to limit eligibility. Perhaps more could have been done to avoid opportunistic filing, but there were ways to address the issue, and it bears emphasis that people do not usually file for bankruptcy lightly.
And third, bankruptcy filings would have affected not just mortgage debt, but credit card and auto debt, etc. The effect on other types of debt was a reasonable concern, but it could also have been addressed legislatively (that's what my Chapter M proposal aimed to do).
The bottom line here is that cramdown would have resulted in loss recognition. That would have wiped out equity and possibly some bondholders in the large banks, which would have to be recapitalized. That was a result the Administration found politically unacceptable. But legally and technically it was quite feasible. Instead the Administration preferred to extend and pretend. We're still paying the price.
(2) Cramdown risked chilling future lending. Nonesense. Everyone understood that 2008 was a 100-year storm and that the government wasn't going to be in the business of abrogating contracts willy-nilly. In any case, however sacred contracts might be, they aren't economic suicide pacts and never have been. Markets have responded very well in the past when the government acts like a grown-up and puts aside contracts that are socially detrimental, such as the case with gold indexation in the 1930s. What's more, we knew that mortgage markets functioned just fine when cramdown was allowed in the past, and we knew that other consumer finance markets function just fine all the time despite the possibility of having debts wiped out in bankruptcy.
(3) Cramdown posed a danger of prolonging the housing market's problems. To the extent that problems are caused by negative equity, cramdown would have fixed them. Chapter 13 bankruptcy confirms plans pretty darn fast. We're talking months, not years. It's really not clear how cramdown would have extended the housing market's problem. Instead, cramdown would have forced the housing market to clear. Instead, we got HAMP, which did exactly what Summers claims was a problem--delaying inevitable foreclosures through insufficient mods that were designed primarily to extend rather than resolve troubled mortgages.
(4) Cramdown would have raised regulatory issues. I don't know what Summers possibly means by this. There were ZERO regulatory issues involved in cramdown. Cramdown did not involve any regulators. It would have been handled by the courts. That may itself have been a reason the administration didn't like cramdown: the executive branch couldn't control the process. Claiming that there were regulatory issues is an attempt to obfuscate, sort of a "You don't understand how DC works, mumble, mumble."
Other, non-cramdown alternatives, such as pursuing something on the Home Owners' Loan Corporation model would have raised regulatory issues, but that's not cramdown. Moreover, for Summers to state that the problem with a HOLC-type proposal is that it would have to buy mortgages at par is wrong. The original HOLC didn't buy at par. Buying at par would be a subsidiy to the banks, but it's rather laughable for Summers to claim that the Adminsitration was opposed to a "massive backdoor subsidy to banks," given the enormous backdoor and frontdoor subsidies it doled out to the banking system.
(5) Cramdown had implementation issues. No, not really. That was the beauty of cramdown. It would have been very easy to implement. It would have just added a change to the terms of what bankruptcy plans could be confirmed, but the entire infrastructure was already there. If one wanted to start doing fancy stuff, like adding in a shared appreciation feature, etc. then implementation got trickier, but these features were not necessary for cramdown to work, but were instead, attempts to make cramdown more politically palatable.
In any case, the Administration had no understanding of the bankruptcy system. This was one of my great frustrations in 2008-2009. The Administration was staffed with economists and the occasional non-bankruptcy lawyer, none of whom had the foggiest notion of how consumer bankruptcy works, but a tremendous fear of the process. Nor did any of these folks seem to want to get educated at the time. I nearly fell off my feet when in I got a call in February 2010--after the failure of cramdown--from a respected economist who was workign as at the NEC with questions about the basic mechanics of Chapter 13. I couldn't believe that there wasn't a memo on hand, etc. covering the issue.
The bottom line here is that of the five issues Summers raises, one is a made-up ideological concern (#2) and three weren't actually possible with cramdown (#3, #4, and #5) but instead conflate cramdown with a bunch of other housing relief ideas. In the end, we're left with #1, which was a genuine concern, but was ultimately a question of whether immediate loss recognition and recapitalization (that is, a market clearing solution) was preferable to extend and pretend (delaying loss recognition to let the banks recapitalize with retained earnings). There was no body of scholarship clearly supporting extend and pretend; if anything, we knew the problems of that approach from Japan's experience. Instead, the only grounds for the choice were distributional. The Obama Administration needs to own that one.
B. Responding to Summers' Political Claim
Finally, Summers writes that "critics who disagree at this late date are obliged to provide an alternative analysis of the political calculus, not a mere recitation of the arguments for cram-down." Let me take up the gauntlet.
Not pursuing cramdown was the Obama Administration's worst political mistake. Period. It may well have cost Democrats the House in 2010 and ushered in the current era of complete Congressional dysfunction. Democrats took a licking in 2010 for two reasons. First, they were held responsible for the state of the economy, irrespective of the shared blame for the crisis. Second, Democrats took a licking because the Administration was perceived (rightly) as caring more about Wall Street than Main Street. Cramdown would have gone a long way to mitigating both criticisms. If cramdown had succeeded, it might have turned around the economy. Maybe not fast enough to matter for the 2010 elections, but we can't be sure. And even if cramdown had failed, had the administration had put some muscle into the effort, it could have painted the GOP as obstructing help for real people during the 2010 election. The Obama Administration could have carried the banner of the champion of Main Street instead of the protector of Wall Street. By dropping the ball of cramdown, and then doubling down on the incompetent HAMP program (which was patently flawed from inception as was regularly pointed out by the Congressional Oversight Panel), the Administration ended up owning the financial crisis instead of pinning it on the GOP. The Administration is still paying the price.
Summers' political story seems to be "We didn't have the votes, so it wasn't worth the coin." Of course, one reason they didn't have the votes was that they didn't put in the effort. They didn't have the votes on the CARD Act until the President put in some muscle, and lo, it passed.
Now I don't know how one tests these competing hypotheses, but I think I've provided a reasonably compelling alternative analysis of the political calculus. It's quite fair to second guess the Obama Administration on cramdown, and for Larry Summers to try to position himself on the side of cramdown angels now is simply disingenuous.