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IMF Structural Adjustment for US - Write Down Mortgages

posted by Alan White

I have argued for some time that deleveraging U.S. homeowners, who still carry more than $10 trillion in mortgage debt, is not only a social imperative but essential for the economic recovery.  According to the IMF in its latest semiannual report, failure to deleverage American borrowers is a continuing threat to global economic stability.  The Washington consensus is now fractured, apparently, with the IMF and economists on one side and the banks bleating on the other, with Treasury dithering in ambivalence.

Meanwhile, in vaguely related news, S&P, in a bid to restore its credibility after the massive reclassification of AAA mortgage-backed securities to junk, now takes a flyer into the budget debate and announces US Treasury debt's AAA rating is under review.  Really S&P?  Where would you then suggest SWF's park their excess capital instead?  Fannie and Freddie issues, perhaps.


Even if the country goes completely down the toilet, and it takes two wheelbarrows full of U.S. currency to buy a loaf of store brand bread - if we take all the treasury bills and notes and put them into separate tranches, then we'll still get a AAA rating from S&P, right?

I clicked on the link in the above post to the IMF report. It appears to be hundreds of pages. The first chapter alone is 76 pages. I skimmed it and it appears to list several concerns, household leverage being one, which occur across numerous countries, the USA being one. While debt writedowns are identified as one solution, others were also identified and the first chapter did not seem to prefer one vs another. That discussion takes less than 5% of the first chapter, just to put it in perspective.

Which, frankly, doesn't surprise me as the IMF is a bureaucracy and bureaucracies tend to be noncontroversial and indecisive.

Perhaps there is a later section that reads as the post claims it does. If not, I think it is quite a stretch to suggest that the IMF has aligned itself with the author's policy preferences in particular.

@mt: I didn't see that language in there either, and I skimmed Chapter III, dealing with housing finance.

What I *did* see in the report was a statement that excessive credit in the run-up to the crisis created a damaging "procyclical" situation on the back end such that rampant foreclosures and underwater homeowners with incentive to default have created an ongoing unstable housing market that is far from stabilizing.

That's not really new or controversial I don't think.

I didn't say that US homeowner debt was the only threat to global financial stability, just that it is an important contributor. Here are the first two paragraphs from page 1 of the IMF report verbatim:

Risks to global financial stability have declined since the October 2010 Global Financial Stability Report, helped in part by improving macroeconomic conditions. However, sovereign balance sheets remain under strain in many advanced economies, structural weaknesses and vulnerabilities in the euro area pose significant risks to bank balance sheets, credit risks remain high, and capital inflows to emerging markets could strain their absorptive capacity.
Many advanced economies are struggling with the legacy of high debt and excessive leverage. High debt levels are evident in many parts of the global economy, including households with negative equity, banks with thin capital buffers and uncertain asset quality, and sovereigns facing debt sustainability challenges.

"Meanwhile, in vaguely related news, S&P, in a bid to restore its credibility after the massive reclassification of AAA mortgage-backed securities to junk, now takes a flyer into the budget debate and announces US Treasury debt's AAA rating is under review. "

No it hasn't. It has changed the outlook for the rating. Which means that there is a lowish chance that it may put the rating on review some time in the next two years unless things improve.

I was less focusing on the "it's a problem" assertion and more focusing on your third sentence which asserts that the IMF is affirmatively sponsoring consumer debt writedowns. My reading (and I admit I did not read the entire thing) is that they list it as one among several options and they identify, as they do in respect of the other options, pros and cons about it. In the first chapter, they also note that bank balance sheets are a concern (although more so in Europe) which they note is a "con" regarding consumer debt writedowns. I didn't see anything along the lines of "the US should impose consumer debt writedowns", hence my opinion that the third sentence of your post is a stretch of the IMF's actual position (or lack thereof) in the debate.

These IMF people keep thinking about ways to create problems especially for the middle class people. Now it seems to be the homeowner's turn.

This feels like one of those "Annie Hall" moments (www.youtube.com/watch?v=OpIYz8tfGjY)!

I and other IMF staff have been calling for principal writedowns for years, whether it be in U.S. Article IV reports or working papers. We have also been pushing for allowing cramdowns of mortgages on principal residences.

Such policy recommendations may not be in big flashing lights, because in such reports, we're typically covering a lot of territory. hOWEVER, For those that require hand holding, just go to Box 1.3 on page 43 (www.imf.org/external/pubs/ft/gfsr/2011/01/pdf/chap1.pdf).

And here are some specific recommendations from our U.S. Article IV Staff Reports. The first one is from the 2010 report:

"In case the housing market destabilizes again, more policy action would be warranted. Policy options could include expanding the loan modification program, including by providing additional incentives to investors and services and loosening some of the eligibility requirements, as well as increasing further the subsidies on principal writedowns. Allowing mortgages to be renegotiated in courts (“cramdowns”) is another policy option, as staff advocated in the past."

From the 2009 report:

"With estimates of underwater households ranging from 8½ million to over 20 million, policies (such as subsidies) to directly address the complicated negative equity issue should be considered. Most mortgage analysts acknowledge that negative equity combined with rising unemployment are the primary drivers of default risks (data point to a positive and strong correlation between foreclosures and number of underwater homeowners)."

And the 2009 report:

"In staff’s view, a scheme with greater creditor incentives [for principal writedowns] could betterlimit macroeconomic risks without significantly adding moral hazard. Issuing “negative equity warrants” that allow the creditor to share profits from future sales could expand the scope of the current scheme, which runs the risk of limited take-up by lenders. In addition, bankruptcy reform allowing judges to “cram down” reduced mortgage principal on primary residences—as is already allowed for other houses and all other debt—would provide further incentives for creditors to participate. This is particularly important where writedowns are complicated by second lien holders (some 40 percent of subprime and Alt-A mortgages) and by servicers of securitized assets (some 75 percent of mortgages originated in 2007 were securitized). Both actors have limited incentives to pursue loan modifications that crystallize losses upfront. While allowing courts such discretion could raise borrowing costs to homeowners, it could also encourage better risk management by lenders, and recent evidence suggests that the effect on mortgage costs through moral hazard is likely to be small."

That last one should read "the 2008 report".

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