Benjamin Studebaker

There’s an important fight going on in the Federal Housing Finance Agency that you may not have heard about. Actually, you might not even have heard of the FHFA. They’re the guys who oversee Fannie Mae and Freddie Mac, the state-run mortgage buying businesses. Here’s the trouble–Fannie and Freddie possess a lot of mortgages for which the owners of these mortgages are “underwater”. Not that there’s been any flooding, of course.

Back in the days of the housing bubble, house prices were going up and up, and buyers had to take out great big mortgages in order to buy houses, which they were anxious to do because, if the prices keep going up, it only gets more financially arduous to buy a house the longer you wait. Of course, eventually, this bubble burst, and housing prices collapsed. Now, ordinarily, if you’ve bought a house with a mortgage and you lose your job and can no longer afford to make the payments, you just sell the house. Typically, the house is worth more than what you originally paid for it, so even if you have only paid a tiny fraction of the mortgage off, you can usually flip the house and move on. However, when the bubble burst, this suddenly didn’t work anymore–the houses were not worth more than they were when they were bought, in fact, they were worth less. This is what “underwater” means in this context. A homeowner owes more money on his house than he will receive if he sells the house on the market, and so he has no means of paying back his loan. For people who are “underwater”, any financial emergency, be it a health problem or a job loss, can quickly result in default. This makes the banks that own these mortgages nervous about being repaid, and it makes the homeowner nervous about spending money. Both want to squirrel money away in the event of that financial disaster that threatens to cause the loss of the home for the homeowner, and a default on the loan for the bank. All of this not spending that the homeowner and the bank are engaging in takes money out of the economy, reduces demand, and prolongs our economic malaise. In the special case of Fannie and Freddie, the government is on the hook for those defaults, which means the cost of default hurts all of us as taxpaying citizens.

Fortunately, the Department of the Treasury came up with a little plan to help reduce the risk of default for taxpayers and banks and to help the homeowners keep their homes–a win-win for both debtor and creditor. The Treasury asked the FHFA to provide debt relief to the homeowners, restructuring the debt to make it easier to repay. To facilitate this, the Treasury offers to chip in 63 cents for each dollar of debt relief spent by the FHFA. By reducing the number of defaults, it’s estimated that around $1 billion is likely to be saved, with 500,000 homeowners retaining their homes who otherwise would have been unable to do so. With the Treasury aid, the FHFA as an agency is expected to gain $3.7 billion. In addition to the homeowners keeping their homes and the banks and taxpayers not having to suffer losses from default, this proposal frees up the homeowners to spend again and makes the banks less nervous about default. This increased confidence should lead to more spending from all parties involved, and consequently work as stimulus of a kind–stimulus that the government is expected to make money from. Profitable stimulus.

Of course, having the read the title, you know that there’s a problem. He goes by the name of Ed DeMarco. He runs the FHFA, and he’s worried that homeowners who are not at risk of defaulting will deliberately default in order to gain access to the programme, leading to a small net loss for the government. First of all, the policy has safeguards against precisely that. But even if DeMarco were right, his agency, the FHFA, would still be expected to profit, and, more importantly, even if this debt relief isn’t profitable stimulus, that rarest of fruits, it is still stimulus. It still will increase spending and increase confidence. It still will allow 500,000 homeowners to keep their homes. It is still good policy, and, in any case, it is not Ed DeMarco’s job to decide what policies the executive branch carries out–that’s the job of the President and the cabinet, the very people who ordered that the FHFA carry out the debt relief programme.

Now, because Ed DeMarco is part of the apolitical civil service, he cannot be fired outright. He can however be transferred to a job of equal rank in a different part of the service and replaced by the administration via a recess appointment, and that is just what needs to happen. In a rare case in which the executive branch can do something to the economy’s benefit without obstruction from stone age economists, it must not suffer the obstinacy of a bureaucrat. It is entirely within the President’s power to resolve this problem today, and Obama’s continued dithering and political cowardice on the subject is to the detriment of hundreds of thousands of Americans directly, and to the economy as a whole.

Source List:

The FHFA’s own analysis of the programme:

http://www.fhfa.gov/webfiles/24111/PF_TechApp73112.pdf

Paul Krugman:

http://krugman.blogs.nytimes.com/2012/07/31/fire-ed-demarco/

http://krugman.blogs.nytimes.com/2012/08/01/more-demarco/