Author: Megan McArdle

Today, I became a big beneficiary of the enormous marketing budgets of pharmaceutical companies.  I know many of y’all suspected it all along.   But sadly, there was no massive check waiting for me in the mail today.  No, what happened is, I went to the pulmonologist for a lung function test, because my asthma has been steadily getting worse for months.

The bad news is what I already knew–I am no longer well controlled
enough with Singulair and a rescue inhaler, and I need to go on inhaled
steroids.  The good news is that I left with an armful of free samples,
so that I can figure out which inhaled steroid works for me most
cost-effectively.  That’s courtesy of those bloated marketing budgets
you hear so many complaints about, more than half of which go to free samples.

This isn’t such a great deal for the pharmaceutical industry, since
otherwise I’d be paying full freight for one of their products.  All it
does for the pharma firms is buy them a seat at the table–a chance to
win my business.  But it’s a great deal for me, and millions of
consumers like me who get a chance to try multiple products before we
commit to one. 

One of the things that bugs activists about this practice is that the
pharmaceutical companies record the cost of the marketing as the full
price of the product, not the cost of producing it.  But this is
actually the right accounting rule, precisely because of what I
outlined above:  the samples cost them a full price sale.  One could
argue that it should be slightly lower, because I might have insurance
which would pay a discounted rate for the product.  But whatever the
exact right price is, it’s closer to the market price of the product
than to the production cost.  Keep that in mind the next time you hear
someone complaining that pharma spends more on marketing than
development; if it weren’t for all those free samples, and the reps who
bring them to the doctors, they’d spend considerably less.

I continue to be unconvinced by the arguments for walking away from a mortgage.  The arguments run in one of several directions:

Companies act like faceless automatons, so we should too.  This is not actually true.  Imagine a bank that actually did only what is specified in their contract with you, and not an inch more.  That would be a bank you’d like a lot less than any existing bank, and with good reason.  They are restrained by various norms, and competitive pressure.  This is not to say that they always behave well.  But they do not, in fact, simply live by the letter of the contract, and if you think they do, I invite you to read me the part in your contract where they have to provide a customer service person who speaks adequate English and doesn’t burst into violent profanity when you ask for a mortgage modification. 

Moreover, the way to punish them for behaving badly is either to regulate the bad behavior, or refuse to patronize banks that behave badly, not to simply walk away from your house loan.

Morgan Stanley walked away from its loans  Really?  Really you want me to be indignant about Morgan Stanley’s egregious maltreatment of . . . other financial professionals who saw this coming months ago?  Companies borrow money under different expectation than people do, which is why it’s hard for a lot of companies to borrow money, as you’ll find if you ever try to start your own business.  The question is B2C and C2B norms, not what businesses do to each other, for the same reasons that I am much more tolerant when stock brokers rip off each other than I am when they do it to their clients.  If anyone else had ripped off the greedy financial professionals, the same people angrily demanding that I condemn Morgan Stanley’s actions would probably be cheering.

Banks need to be taught a lesson for their stupid lending  It all sounds very emergent and spontaneous and Hayekian:  a nation of freelance bank regulators.  Every man his own bankruptcy judge!

All well and good, except that if you are walking away from a mortgage simply because the house is underwater, you have no authority to punish them.  After all, the reason it was stupid to lend money to you is not that they were lending money to someone who probably couldn’t pay it back; you can.  The reason that it was stupid to lend money to you is that you’re a deadbeat–a foolish deadbeat, who thought that house prices are a magic route to free money.  That’s not something they could reasonably have been expected to know.  Also, “banks need to be punished for being almost as stupid and greedy as I am” doesn’t have much of a ring to it. 

Moreover, those cheerleading such behavior seem to be under the misimpression that this will somehow be targeted at banks that made stupid loans.  But the people who are walking away simply because the price dropped are not going to distinguish between good, sound credit unions with a conservative loan book, and big, greedy pension funds and charity endowments that bought residential mortgage backed securities.  They’re going to walk away from anyone holding the loan on a house where the price has dropped by more than the downpayment–which in places like California and Florida, is probably any house purchased between 2004-2007, no matter how conservative the underwriting.

It would actually be a good thing if credit was tighter.  Okay, first of all, nothing would have stopped people from writing awful loans at the height of the bubble, because they didn’t think the loans were going to go bad like they did.  Nay, not even outfits like Countrywide, which, last time I looked, were usually required to take back loans that went bad too quickly, since they are presumed to have been fraudulently originated. (This is why so many subprime lenders are now out of business, and thus not around to be punished by the Andrew Cuomo wannabes busily walking away from their underwater mortgages).  Contrariwise, no amount of good faith by borrowers could now persuade anyone to offer credit on such easy terms . . . which is why the FHA, which is still willing to write low-downpayment loans, is now puffing up like one of those toads that can take a deep breath and instantly grow to three times its actual size.

While it is true that tighter credit would probably be a result of more people walking away from their mortgages, it would certainly not be the only result, nor would it simply mean better underwriting.  A high rate of discretionary default probably means more points and really huge downpayments to protect the banks.  Coming up with 25-50% of the purchase price of your house is fine for bankers buying Manhattan co-ops, but a tetch tricky for most normal people.  It probably also means higher interest rates.  Naturally, this means lower house prices, which means that we can prepare for a rather extended vicious cycle. 

Except that banks would probably flood DC and state capitols with lobbyists trying to change the rules.  There hasn’t really been much value, up until now, in changing the recourse rules–I mean, banks probably prefer one to the other, but it’s not their top priority, because people almost never default on their house unless things are so dire that there’s no hope of recovering much anyway.  If that changes, tougher rules become a top priority–and eventually, they’ll probably get them, if the alternative is tougher underwriting, higher interest rates, and bigger downpayments.

A system that relies on norms against default actually allows us to be very legally and contractually easy on those in need, because most (not all, but most) of the people that we let off will be those in deepest hardship.  We’d be swapping that for a system which punishes them harder in order to deter excessive default rates.

What people want, I think, is simple:  to take money from banks and give it to people they like better, ones they consider more deserving.  But while that would be the immediate effect, there’s no particular reason to think that the banks would suffer most.  As long as you can’t make them lend money, they have the power to share their pain with customers, and as usual, the most vulnerable customers are the ones who will bear the most pain . . . the exact opposite of what is supposed to be accomplished by this.

The bottom line for me is that just because we’re angry at banks, doesn’t mean that it’s okay to do anything and everything to get back at them–much less a good idea.  Our response should be targeted at the things they did wrong (like lending money to people who probably couldn’t pay it back), and should cause fewer problems for the general public than it solves.  Voluntary defaults fail on both counts.

I wish the Wall Street Journal wouldn’t publish things like a column arguing that the late 1990s surpluses stemmed from the capital gains tax cuts.  It’s just not true, for reasons that Bruce Bartlett ably outlines:  the increased revenues from the capital gains tax just aren’t great enough to account for the majority of the boost.  You might posit some sort of supply-side effect, but it would have to be implausibly large to generate the lion’s share of the surplus, plus some of the increase in capital gains revenue–perhaps all of it–was due not to cutting the tax rate, but to secular changes in the the equity markets.

I think that in a country with a low savings rate and a stiff corporate
income tax, a low capital gains rate is a good idea.  But this is a
position that can easily be supported with facts; it does not need a
lot of rubbish lies about raising tax revenues by lowering the tax
rate.  There are at best very few tax rates in the United States high
enough to generate the kind of deadweight loss (and widespread evasion)
that would allow us to generate higher revenues with lower rates; and
none of those arguable cases are significant sources of federal
revenue.  If Republicans want to be taken seriously when they complain
about the ridiculous things Democrats say in support of their policies,
they need to stop generating ridiculously lies of their own about the
benefits of tax cuts . . . which may be legion, but do not include
greater tax revenue for the government in any measurable time frame.

Apparently, the Obama administration wants to make up for losses in the TARP program by taxing banks.  This seemed eminently fair until I read about where the losses were actually taking place:

U.S. taxpayer profits from bank bailout investments are being offset by estimated losses from American International Group and automakers and mortgage payment cuts for struggling homeowners, a U.S. Treasury report showed on Monday.

The Treasury estimated net losses on its $700 billion bailout program at $68.5 billion for the fiscal year ended September 30, 2009.

The December report for the Troubled Asset Relief Program, or TARP, showed that the fiscal 2009 net loss included estimated losses of $30.4 billion for AIG and $30.4 billion for automakers, with $27.1 billion in losses from the Home Affordable Modification Program.

These were much larger than a $15 billion profit registered from the Capital Purchase Program for banks and $4.4 billion in profits from other bank investments, asset guarantee and lending programs.

So we ought to tax bank profits because . . . GM is losing money just like everyone said it would.

I am all for regulation which prevents banks from taking on too much leverage–or encouraging others to do so by offering stupid loans. I would very much like to find a system of financial regulation which results in a financial structure that isn’t so utterly dominant (and bloated) as it has been for the last two decades.  But I’m failing to see why the banks in particular–or rather the customers of the banks who will enjoy higher fees and lower interest rates–ought to bear the financial cost of the administration’s ill-advised bailout of the UAW.

One argument is that a financial transactions tax would actually shrink the sector.  But it would actually shrink one very small piece of it, the high frequency traders, and that’s not the part that’s problematic.  Indeed, most economists think that this sort of micro-arbitrage enhances price discovery, helping the market to more rapidly incorporate new information.  It would do nothing to impact the part where banks spend increasing amounts of time dreaming up methods of regulatory arbitrage or ways to game the ratings agencies.  Plus it doesn’t look like a financial transactions tax is really on the table, presumably because ordinary Americans do a surprising number of financial transactions.

If we want to shrink the banking sector, we should be looking for a regulatory regime which doesn’t offer quite so many rewards for financial innovation (this might mean a regulatory regime that did less in some ways, giving fewer bankers outsized incentives to game the system).  But if we want to bail out GM, we should pony up out of the income tax, not cast about for the least popular group we can find.  That’s no way to run a tax code, or an economy.

One of the hallmarks of a regime in financial trouble is a complicated regime of “special” exchange rates aimed at getting around the problems caused by financial mismanagement.  The devaluation that Venezuela announced last week may have been a good idea, given the country’s recession, and the problems of declining oil revenues.  But the way Chavez has gone about the thing is typically ham-fisted.  By Sunday, he was threatening to deploy the military against . . . shopkeepers who raised prices in response to the devaluation, as if fiat were the main component of import prices.

I doubt that this will work any better than Chavez’s earlier attempts at price control and economic management.  The black market will considerably attenuate his power to mandate exchange rates.  Though the move will ease the government’s fiscal problems, it will not enable Chavez to keep inflating the level of government spending . . . and as a colleague at the Economist once remarked to me, Chavez’s popularity varies pretty much directly with how much social spending he’s able to eke out of oil revenues.

This is not to knock Chavez in particular for being left wing.  One can imagine a regime that made some moderate blunders while making real improvements to both economic productivity, and the safety net; in an era of higher oil prices, Venezuela could have diverted a lot of extra government revenue to the poor.  But Chavez managed the oil fields for political gain rather than revenue, and spent every dollar he could find, right up to the very edge of his nation’s swelling oil revenues. As he underinvested in oil production and got into a showdown with those who managed the output, he created a situation where falling yields meant that for his political coalition to prosper, the price of oil needed to not merely stay high, but keep rising, forever.  When the oil money faltered and the inevitable cracks appeared in the economy, Chavez has tried to replace the laws of supply and demand with government fiat, which has had the usual results.  The more desperate the measures he has to resort to, the more one suspects that his administration is entering into its senescence. 

I doubt that this will work any better than Chavez’s earlier attempts at price control and economic management.  The black market will considerably attenuate his power to mandate exchange rates.  Though the move will ease the government’s fiscal problems, it will not enable Chavez to keep inflating the level of government spending . . . and as a colleague at the economist once remarked to me, Chavez’ popularity varies pretty much directly with how much social spending he’s able to eke out of oil revenues.

This is not to knock Chavez in particular for being left wing.  One can imagine a regime that made some moderate blunders while making real improvements to both economic productivity, and the safety net; in an era of higher oil prices, Venezuela could have diverted a lot of extra government revenue to the poor.  But Chavez managed the oil fields for political gain rather than revenue, and spent every dollar he could find, right up to the very edge of his nation’s swelling oil revenues. As he underinvested in oil production and got into a showdown with those who managed the output, he created a situation where falling yields meant that for his political coalition to prosper, the price of oil needed to not merely stay high, but keep rising, forever.  When the oil money faltered and the inevitable cracks appeared in the economy, Chavez has tried to replace the laws of supply and demand with government fiat, which has had the usual results.  The more desperate the measures he has to resort to, the more one suspects that his administration is entering into its senescence.

One of the many obstacles to resolving the housing mess is that so many people during the boom used their houses as piggybanks, taking out second mortgages and helocs that were often originated by different banks from the originator of the first lien mortgage.  In order to do a short sale–or much of anything short of foreclosure–you need to get the second lien holder on board.  This is even harder than getting your first mortgage holder to help you, since there’s usually nothing in it for the second guy in line except a sure and certain loss.  The Obama administration has made some efforts to pull the second lien servicers into the process, but the results have been even more pitiful than the single-loan modification process.

This was a problem in the Great Depression, too, though the conflict was less between banks than between individuals who often issued or bought individual mortgages as investments.  No good way to resolve the problem was found, and thus it is still with us.  I’m toying with the notion that we should ban second mortgages by any except the first mortgage holder, but this would turn the first mortgagee into an effective monopolist, and also effectively kill securitization.  Plus I don’t know what you do with an insolvent bank if all the first and second loans have to be sold as packages.

Still, it would be nice if we could figure out something to do.  We need to figure out how to resolve the housing mess sometime before the turn of the next century.

MIT economist Jonathan Gruber has become the go-to economist for fans of the health care reform wending its way through congress.  He regularly produces analyses showing how great reform is going to be for people buying insurance in the individual market, and has been a vocal advocate for the excise tax.  His prominence made him a natural lead-in for Ron Brownstein’s recent piece on the health care bill for Atlantic Politics:

When I reached Jonathan Gruber on Thursday, he was working his way, page by laborious page, through the mammoth health care bill Senate Majority Leader Harry Reid had unveiled just a few hours earlier. Gruber is a leading health economist at the Massachusetts Institute of Technology who is consulted by politicians in both parties. He was one of almost two dozen top economists who sent President Obama a letter earlier this month insisting that reform won’t succeed unless it “bends the curve” in the long-term growth of health care costs. And, on that front, Gruber likes what he sees in the Reid proposal. Actually he likes it a lot.

“I’m sort of a known skeptic on this stuff,” Gruber told me. “My summary is it’s really hard to figure out how to bend the cost curve, but I can’t think of a thing to try that they didn’t try. They really make the best effort anyone has ever made. Everything is in here….I can’t think of anything I’d do that they are not doing in the bill. You couldn’t have done better than they are doing.”

He shows up in the work of the left-half of the health care commentariat so often that if I tried to round up representative cites, this piece would be published sometime next month, and you’d die of old age before you made your way through it.

But he probably wouldn’t have been cited with quite the same authority–particularly by mainstream media–if he’d been more upfront about the fact that he’s being paid almost $300,000 by the Obama Administration for “special studies and analysis” of the health care bills, as a blogger on Firedoglake revealed last night.  Ben Smith has the rundown; apparently most of the health care beat reporters were as unaware of the relationship as I was.

I certainly would not have written about him the same way, even though I am sure that what Gruber is saying comports with what he believes.  My guess is that like me, most journalists would have treated him as an employee of the administration, with all the constraints that implies, rather than passing along his pronouncements as the thoughts of an independent academic.  Christina Romer is a very, very fine economist.  But her statements about administration policy are treated differently from statements by, say, her colleague Brad De Long.

Given how influential Professor Gruber’s work has been during the health care debate, that’s rather a large problem.

Gruber’s explanation that “he disclosed this to reporters whenever they asked” is not very compelling.  I don’t see how anyone even tangentially connected to policy work could fail to realize that this was a material conflict of interest that should have been disclosed, and reporters cannot take up all their interview time going through all the sources who might have been paying or otherwise influencing their interviewee. 

The standard is even higher for people who are taking public funds, and not only Professor Gruber, but the administration had a responsibility to disclose the relationship.  Yet a post on the OMB blog signed by Peter Orszag cited Brownstein’s Gruber quotes without mentioning the relationship. 

To be clear, I’m sure that Jonathan Gruber is in favor of passing this health care bill, and thinks it will do a lot of genuine good.  I don’t think that funding automatically discredits the message; his work should stand on its own merits.  But journalists and academics are granted a presumption of independence that is not given to most other professions, and that gives them a special duty to make it clear whenever there is a relationship that people might reasonably think has affected their views.  Lefties were rightly furious when journalists turned out to have been taking money from the Bush administration, and I’m glad to see that at least some of them are holding Obama to the same standard.

My latest column for the Atlantic looks at the commercial real estate crash and comes to the conclusion that it effectively undermines the major narratives that many people have adopted to explain the residential bubble.   Though the commercial real estate bubble was smaller in scope than the residential one, it was characterized by essentially the same pathologies:  rising prices, stupid banks, and stupid borrowers.

Yet we can’t blame this on predatory lenders tricking the unsophisticated into unwise loans, because these were basically all professionals.  Nor can we argue that banks were willing to write toxic loans because they were just going to sell the garbage off to investors; a much smaller percentage of commercial mortgages were securitized (though that percentage did increase as the bubble inflated).  And we certainly cannot blame them because they “should have known better” than their borrwers, who usually had more experience than the banks in pricing commercial real estate. 

Somehow, everyone got stupid all at once.

To see just how tightly linked the bubbles were, look at this graphic posted by Paul Krugman:

Krugman points out that this also gives the lie to the theory that the gubmint dunnit with some combination of the CRA and implicit guarantees to Fannie and Freddie.  Everyone went crazy all at once, for reasons that aren’t entirely clear, but neither the “evil banks” or “evil government” theory has much explanatory power when you look at the residential and commercial trends together.

In the continuing saga of my debate with Mike Konzcal over the “libertarian litmus test” of the other day, he writes that the solution is a mandated vanilla financial option:  one for which there is no opportunity for tricks or hidden fees, but the up-front payment is probably higher.

It’s not a terrible idea, necessarily, but if it’s an actual option, I doubt it would accomplish much.  Banks will find ways to steer you into the more lucrative product–unless, of course, you’re the sort of highly informed, financially disciplined consumer who doesn’t need a vanilla option, and is in fact better off in the current system.

If it’s not an option so much as the only option, then it’s deeply problematic.

– Legally, it’s would mean outlawing broad classes of services

– The up-front fees might push more marginal consumers out of the banking system entirely, which would not in general make them better off.

– Single option financial services aren’t so good, which is the reason we no longer have the simple, folksy banking system of yore that so many bloggers have been pining for:  when inflation took off, that model spectacularly imploded and required, you may remember . . . a gigantic financial bailout.  That’s not an argument for the craziness we often now have, but either extreme is probably bad.

– Single-option financial products would shut large numbers of people out of the mortgage market, and no, not just people who shouldn’t be getting loans.  “Option ARM” products are actually a good product for the small number of consumers who have good but highly variable income; it lets them match payment to cash flow during lean months and make it up later.  “No doc” loans were originally for small business people with good expected income they couldn’t document.

Better-designed transparency is probably a better solution–but has its problems too, which I’ll address in a post tomorrow.

If you followed the financial collapse of Iceland at all, you’ll know that before the crash, Icelandic bank accounts became quite popular in Europe, particularly in Britain.  By virtue of paying extremely attractive interest rates, Icelandic banks enticed foreign savers to put billions of dollars into their savings account.

When the crash came, unfortunately, Iceland didn’t have a depository insurer capable of covering the losses.  The governments of Great Britain and the Netherlands decided to bail out their own citizens . . . and then, in a nice touch, to strongarm the Icelandic government to pay them back.  This is beyond shameful, as if America decided to send Mexico a bill for its border enforcement.  The Icelandic government is not responsible for the financial committments of larger (and at this point, better heeled) states.

Clive Crook is as disgusted as I am:

Iceland, a country of  300,000 people, is being asked to assume a debt of $6bn (that’s $20,000 apiece). It is an outrageous imposition. Iceland’s president is right to repudiate the deal.

Britain and the Netherlands were wrong in the first place to reimburse depositors beyond the capacity of the Icelandic insurance fund. Since they did, British and Dutch taxpayers should be on the hook for this, not Icelandic taxpayers. And regardless of that, the means by which pressure has been applied to Iceland–including, believe it or not, the UK’s briefly designating it a terrorist state–are an outrage. If Iceland is wondering whether it still wants to be a member of European Union after this, who can blame it?

More to the point, shouldn’t other countries be wondering if it isn’t time to block capital coming from Britain and the Netherlands?  After all, their governments seem to believe that accepting foreign investment creates some sort of unlimited taxpayer liability for the recipient country.  Iceland, sadly, is not in a very good position to resist this bullying.  But other countries are, and should make it clear that there are even bigger potential bullies on the block.

Update:  Daniel Davies makes a reasonably persuasive case for the defense.  The problem is, I think, that comparisons between countries and companies never stand up very well.

Yesterday I blogged about Mike Konzcal’s query as to whether banks should be allowed to identify customers with dementia and target them for tricky fees and other hidden charges.  I answered that it’s wrong, but it might actually be hard to craft legislation that prevented it.  But of course, this actually assumes that targeting customers with dementia would work.  Today, an employee of a major bank emails:

About Andrew’s post on ripping off old, demented, credit card customers I’d like to point out that this would be not so much evil as really REALLY stupid.  Since credit card debt is unsecured, the credit losses on this scam would be enormous and would definitely lose  a lot of money.  Nevermind the moral aspect of this, the financials for such a program would fail miserably and anyone suggesting such a program would be scorned not just for being an immoral jerk but for having zero business sense.

I’d say it would also be evil, but yes, probably really stupid too.  Which invites the question:  what if we turn it around?  Should banks be allowed–nay, encouraged–to use such a quiz to pick out customers they no longer care to do business with?  After all, we’d be protecting potentially demented customers from hurting themselves.

Of course, we’d also be potentially preventing non-demented customers from getting credit–given my work schedule, I not infrequently forget which day of the week it is, and when you’re retired, one day can easily shade into another. 

Too, the AARP would freak out the way they do when anyone suggests that maybe people over seventy should face a little extra scrutiny over their driving abilities–which is why a few years ago, I got hit by a fairly clearly demented 80-year old man in a Target parking lot.   He still had a driver’s license and car insurance even though the cops told me he’d had two accidents in the same parking lot over the last few months.  But (as in my case) there were never any witnesses, and he always accused the other driver of fault, so the accidents always got judged no fault, and he kept his ability to drive even though his wife, his insurance company, and his township all clearly knew that he shouldn’t be behind the wheel.

There would complaints from consumer activists, and angry articles about “credit discrimination” against the elderly, featuring spry eighty year olds with no obvious mental disease or defect.  Left-leaning bloggers would complain that banks were protecting their profits at the expense of old people who had paid their bills all their lives, and showed no sign of imminent default–all the complaints that have been leveled at banks that cut the credit lines of people they judged likely to run up debts and/or default.

Yet this is the logic of paternalism:  you discommode a large number of people in order to save other people, possibly a smaller number of other people, from financial distress.  Methinks, however, that many people who like government paternalism would view it differently if it were done spontaneously by banks out of profit motive.

It’s surprising how often Europeans comment on the relative awfulness of American chocolate.  They are, of course, entirely correct.  My personal favorite is Belgian chocolate, but almost any European chocolate is better than the waxy substance available here.  When I was at the Economist, my trips to Britain always meant I’d be eating at least one Cadbury’s candy bar a day.

So it’s a little amusing to see that Cadbury may be running from Kraft’s takeover bid into the arms of . . . Hershey, the most quintissentially American of the American chocolate companies.

Any port in a storm, I suppose, and at least if they ruin the brand
they’ll do it by importing American chocolate-making techniques, rather
than the strategic thinking and know-how behind Velveeta.  Hershey and
Cadbury already cross-distribute each other’s products, as I understand
it, so at least there’s some relationship there. 

But boy, does a Cadbury/Hershey deal seem unlikely.  Cadbury is more than twice the size of Hershey, and the Hershey board is said to be split,
with some of the directors concerned about the implications of the debt
they’d need to take on.  As well they should be.  Taking on big debt to
buy another company is risky in the best of times, and these are not
the best of times.  Though perhaps candy bars are countercyclical, as
the world rushes to drown its sorrows in chocolate.

Andrew characterizes this scenario as a “libertarian litmus test”:

I want to pitch to the credit card and financial industry a new innovative online survey. It is targeted for older, more mature long-time users of our services. We’ll give a $10 credit for anyone who completes it. Here is a sense of what the questions will look like:

– 1) What is your age?
– 2) What day of the week are you taking this survey?
– 3) Many rewards offered are for people with more active lifestyles: vacations, flights, hotels, rental cars. Do you find that your rewards programs aren’t well suited for your lifestyle?
– 4) What is the current season where you live? Are any seasons harder for you in getting to a branch or ATM machine?
– 5) Would rewards that could be given as gifts to others, especially younger people, be helpful for what you’d like to do with your benefits?
– 6) Would replacing your rewards program with a savings account redeemable for education for your grandchildren be something you’d be interested in?
– 7) Write a sentence you’d like us to hear about anything, good or bad!
– 8 ) How worried are you you’ll leave legal and financial problems for your next-of-kin after your passing?

Did you catch it? Questions 1,2,4,7 are taken from the ‘Mini-mental State Examination’ which is a quick test given by medical professionals to see if a patient is suffering from dementia. (It’s a little blunt, but we can always hire some psychologist and marketers for the final version. They’re cheap to hire.) We can use this test to subtly increase limits, and break out the best automated tricks and traps mechanisms, on those whose dementia lights up in our surveys. Anyone who flags all four can get a giant increase in balance and get their due dates moved to holidays where the Post Office is slowest! We’d have to be very subtle about it, because there are many nanny-staters out there who’d want to coddle citizens here.

I’m not sure why this is supposed to be a hard question for libertarians.  I mean, I might argue that preventing people from ripping off the marginally mentally impaired would, in practice, be too difficult.  Crafting a rule that prevented companies from identifying people who are marginally impaired might well be impossible–I’m pretty sure that if I wanted to, I could devise subtler tests than “What day of the week is it?”  And while the seniors lobby is probably in favor of not ripping off seniors, they’re resolutely against making it harder for seniors to do things like drive or get credit, which is the result that any sufficiently strong rule would probably have.

But it’s pretty much standard libertarian theory that you shouldn’t take advantage of people who do not have the cognitive ability to make contracts.  Marginal cases are hard not because we think it’s okay, but because there is disagreement over what constitutes impairment, and the more forcefully you act to protect marginal cases, the more you start treating perfectly able-minded adults like children.

The elderly are a challenge precisely because there’s no obvious point at which you can say:  now this previously able adult should be treated like a child.  Either you let some people get ripped off, or you infringe the liberty, and the dignity, of people who are still capable of making their own decisions.

Konzcal is, I take it, in favor of more paternalism.  But the objection that I have to paternalism is not that it prevents companies from more effectively ripping off their customers.  The presumption that a majority of American adults are essentially children puts the state in loco parentis, which hands too much power to people who are not nearly as clever and wise as they believe themselves.  It is morally wrong for companies to attempt to capitalize on dementia, just as I believe it is morally wrong for casinos to attempt to identify, and monetize, their customers with serious gambling problems.  But giving that moral belief force of law is not necessarily a good idea, particularly if it involves eroding the presumption that we are adults capable of, and responsible for, running our own lives.

A lot of the resistance I’ve gotten for saying that people ought to pay their debts comes from people angrily declaring that after all, the banks are vicious predators.  In some cases this is true . . . certainly, in the case of Tom Vellucci, which I debated with Felix Salmon last week, the servicer seems to have offered him an unsustainable modification in the hopes of squeezing the last drop of savings from a dying man.

But I don’t think this is an adequate argument.  Steve Waldmann, for example, seems to view walking away from your mortgage as a sort of game theory move, a just retribution in our society-wide game of tit-for-tat with banks that aren’t behaving like good people.  I sense that he is not alone.

But this is awfully naive game theory.  A simple tit-for-tat strategy assumes a simple world in which there are only a few possible actions, all of which send clear signals.  What signal does walking away from your mortgage send?  Maybe it says, “People are mad at banks and they shouldn’t charge such rapacious fees.”  On the other hand, maybe it says, “People have stopped feeling any responsibility to pay their debts, so you should make it harder to get a mortgage, and more punitive to walk away from one.”

The other problem with this notion is that tit-for-tat, and indeed every related strategy, requires that you can target the punishment at the bad actors.  But in many of the cases we’re disputing, there’s no evidence that the banks or investors who are getting shafted are the same banks or investors that are shafting others.  It’s like ripping off Korean grocers because a waiter at a sushi place once overcharged you.

If we think bankers are, say, being abusive with their overdraft fees, we have better ways to fix it than turning into a nation of deadbeats.  We could, umm, regulate their overdraft fees.  Or we could publicize the banks that charge outrageous fees, and try to do business only with the ones that pay better.  If banks made stupid loans, they’ll suffer by losing money.  But I find it hard to say that anyone is entitled to voluntarily default just to punish a bank for . . . being stupid enough to lend you money.  I mean, it’s sort of elegantly self-referential, but one cannot do it without indicting oneself right along with the bank.

Of course, there’s quite a bit of populist anger at the feeling that bankers haven’t suffered–that they’ve just gone right along making money.  This is not actually true; many bankers have lost their jobs, and the job losses were heaviest in the sectors that performed worst.  RMBS is not exactly a hot line of business right now. 

But of course, many other bankers are still minting it hand over fist, which especially rankles because we, the taxpayers, are the only reason that they’re not pricing refrigerator cartons and prime real estate under bridges.  It’s one thing to pump money into the banks, if that’s the only thing standing between us and the Great Depression, but no one wants to pump it into the bankers’ pockets.

But still, the answer is not to gratuitously walk away from mortgages.  Much of that paper isn’t held by banks, but by pension funds and similar institutions that did nothing to anyone. 

Unfortunately, I’m not sure what the answer is.  As long as banks are both extremely profitable, and competing for talent, they’ll continue to pay huge salaries.  There is no direct way to intervene without gross violations of our legal system, or severely impairing the few banks we do have control over–banks who, let us remember, still owe us a great deal of money. A few months ago, I asked why banker salaries are so high, and ultimately I ended up with the fact that they’re so high because so few people can make so much money.  When that’s the case, no one wants to risk getting a “deal” on second best–which is why managers pay a lot to the firms that do their IPOs, and those firms pay so much to the bankers.

But that doesn’t really answer the question of why, over the last thirty years, it became possible to make so much money in the financial sector–or why that sector became so grossly bloated.  Some of that activity was just regulatory arbitrage that added no value to society, like the leasing deals that allowed municipalities to transfer depreciation to taxable entities able to take advantage of it.  Much more of it was . . . well, I don’t want to definitively say that it had no value, but I’d like to hear the authors of much of this activity explain to me what value, exactly, it added to society.

My libertarian readers are no doubt writhing, but the fact is, financial activity takes place in a web of law, and during periods of financial innovation, that law is often inadequate.  We’ve had a couple centuries to work out the kinks in stocks.  We’ve had thirty years of experimentation with mortgage-backed securities, and at the very least, they clearly need some work.

I don’t think it’s particularly left wing to say that our financial sector clearly became too large and well-remunerated–particularly when we note that at least some of that was due to our increasingly sclerotic taxation and regulation schemes in the rest of the economy.  But I’m not sure what to do about it.  It sounds fun to take a wrench, wade into the shadow banking system, and start banging heads.  But that’s tricky to do without imposing great costs in terms of both liberty, and economic activity.

Or like I said earlier:  a system in which people just walk away from their mortgages is not a system in which the little guy prospers.  It’s a system in which the little guy can’t get a mortgage.  Our current combination of laws and social sanction does a remarkably good job of combining access to credit, with relief for those who need it.  There are many potential equilibria in this game scenario which are much worse than the current one.  

Waldmann, and I think Salmon, view the tightening of credit as a feature rather than a bug, of course–they’d like to return to the days of paternalistic credit markets.  But I’d like to suggest first, that fifties economic nostalgia is highly overdone, and extremely colored by the fact that the narrators of that economic history were overwhelmingly the children of the relatively educated, affluent, and successful.  And also, that the price of tighter credit and more punitive default terms will fall hardest on those who really, really can’t afford to pay it.  Damon Runyon didn’t just make up the crowded living conditions, the loan sharks, the reliance on pawnbrokers.  Those are relics of that golden bygone era when bankers didn’t extend credit to people without solid incomes, substantial assets, or affluent relations.  Fewer people got themselves into trouble with a bank, it is true.  But there are a lot of worse ways to get into trouble.  And as with the War on Drugs, I’m pretty strongly averse to more paternalistic policies which improve the lives of the middle class while making poorer people worse off.

Our own Derek Thompson thinks it does.  As longtime readers know, I’m a huge afficionado of gadgets in general, and the Kindle in particular.  And I don’t think that the still-mythical Apple tablet in any way replicates the key features of a Kindle.

For me, the benefits of a Kindle are that it’s extremely lightweight, is not backlit (meaning it’s both easier on the eyes, and can be read in full sunlight), and has an extremely long battery life.  I can charge up my Kindle at home, take it on vacation, and unless I’m using the wireless, have it all week on one charge.  If my experience with other Apple products is anything to go by, the Apple tablet will not even survive a moderate plane ride.  I’m certainly not going to sling it in my purse, the way I do my Kindle, and whip it out in odd moments. 

I’m not exactly an Apple tablet skeptic–maybe the thing will turn out to not only exist, but also be awesome.  But like Matt Yglesias, I’m having a hard time figuring out how I’ll use it.  Unless I’m going out somewhere social, I basically have a laptop with me at all times.  I don’t need another computer that is less powerful and harder to type on.  Nor am I seeing any benefit to replacing my Kindle, which already fits comfortably in my purse or laptop bag, and does exactly what I need it to do, which is carry around large amounts of text in a compact space.  How much extra would I be willing to pay to be able to read Vanity Fair in glorious full color?  Not much, especially since the print magazine is available on newstands everywhere–and, like my Kindle, has excellent battery life.

But perhaps I’m missing something.

Is the mortgage modification program making things worse?  An article in the New York Times gives voice to fears that by encouraging homeowners to stay in homes that they cannot really afford, Obama’s Making Home Affordable program is actually increasing the agony of homeowners, who pour money down the rathole of their mortgage rather than recognizing the loss and starting over.  In the meantime, the modification programs disguise the true condition of bank balance sheets (because modified mortgages are not yet non-performing mortgages), and slow down the process of recovery.

How much truth is there to this story?  Some, at least.  I found myself talking to my father about this after I exchanged blog posts over the tragic case of Tom Vellucci, a Floral Park resident who lost his job and wound up with a non-paying tenant, then drained his savings trying to keep up with a modification that got him current, but didn’t lower his payment.  We’re both longtime New Yorkers, so there’s a certain local interest in what happened.  We were mystified by why anyone would think that Mr. Vellucci would qualify for a modification–and more importantly, why Mr. Vellucci would have thought so.

Reading between the lines in his story, Mr. Vellucci had virtually no savings (making his house payments tapped him out in four months).  His income was moderate at the best of times, and his house payment was so large that everything had to go right for him.  If he was out of work or lost a tenant for any length of time, he was going to end up in defaulting.  As of the story’s publication, he was still on the dialysis that cost him his job, meaning he is not going to regain his income any time soon.  There was no way that any imaginable mortgage modification was going to clean up this mess.  Yet he gave the last of his savings to a skeezy servicer in some sort of tragic Hail Mary pass.

Why would he do something so patently insane?  Apparently he was hoping that he could get a second modification under MHA.  But his interest rate wasn’t his problem.  He had a mortgage principal that probably ran into the mid six-figures, and no job, and probably required a modification that slashed his payment in half.  The Obama program clearly raised ridiculous, unrealistic hopes in at least a few people.

That said, the people pushing the notion that MHA is making everything worse have their own vested interests:  people who want to pin political blame on Barack Obama; hedge fund managers and other financial types who presumably have taken bets that will pay off quicker and easier if foreclosures pick up; people pushing for more aggressive modifications that write down principal as well as interest rates.  With few permanent modifications yet approved, and no data, it’s not clear to me that this is a significant problem, rather than an occasional tragedy.

But I think that the so far lackluster results from MHA do point to something important, which is that we don’t have the kind of mortgage crisis we thought we had when we passed the modification.  This represents not only a shift in our thinking about how to fix the housing markets, but a major shift in our national narrative about the housing bubble.  Six to nine months ago, the major story we told in connection with the financial crisis was the homeowner suckered–by either fraud or greed–into a teaser loan with an artificially low interest rate that was going to turn disastrous when it reset.

We’ve seen some of that, to be sure, particularly with the “Option ARM” or “negative amortization” loans on which homeowners weren’t even making the full interest payment.  But that hasn’t turned out to be our biggest problem, largely because we are in a very low interest rate environment right now, so many people saw their rates reset downward rather than up.  Instead, we are plagued by negative home equity, and unemployment.  We have a modification program designed to avert a threat that never materialized.

Now we have a choice between two more stories.  One presents the negative equity as the major problem.  Negative home equity is a bigger predictor of default than job loss; so, the reasoning goes, we must be seeing something akin to the infamous “jingle mail”, in which people hand over their keys rather than keep making payments on a house that isn’t appreciating.

Obviously, this happens.  But I doubt it’s particularly common.  Most bankruptcy experts believe that while there are a handful of grossly irresponsible jerks who deliberately borrow as much as they can get away with before defaulting, or otherwise abuse the process, the majority of people who default try really really hard to find some way to make their payments.  (Interestingly/oddly, this does not seem to be as true of student loans and utility bills.)

My story is a little more complicated.  People who lose their jobs, but have positive equity, sell the house when money gets tight. (Five years ago, they probably would have refinanced).

People who lose their jobs, but have negative equity, lose the house.  So do people who get divorced and have negative equity, people who are whacked with unexpected medical or legal bills and have negative equity, people who get hit with back taxes and have negative equity, people who develop a gambling problem or a drug habit and have negative equity.  The negative equity is better correlated–but that doesn’t mean that people are deciding to walk away from houses just because they’re underwater.

My story is kinder to the debtors, but it also makes modifications more problematic.  If the negative equity is the main problem, you can solve the mortgage crisis by switching to modifications with “cramdowns”–i.e., get a judge or a banker to write off the portion of the principal that exceeds what the house is worth.  This has unpleasant side effects–it would probably pretty much instantly return us to the days of 20+% down payments on every house, and likely cause house prices to fall farther.  But it at least has some hope of solving the immediate foreclosure problem.

But if negative equity is merely exacerbating an untenable situation, it’s not clear how much good even a cramdown will do.  Proponents of cramdowns have begun a recent love affair with the pre-1977 bankruptcy code.  They are blissfully oblivious to the fact that the pre-1977 code was in many ways much less debtor-friendly, which is why it was reformed.  But that is neither here nor there, really.  Even the pre-1977 code did not view the cramdown as a sort of magical gift to the homeowner. 

At least as I understand it, cramdowns were then, as they are now, part of a Chapter 13 bankruptcy–in other words, part of a court-ordered repayment plan, not a Chapter 7, in which the debtor sheds their past debts.  If a Chapter 7 debtor wants to keep an asset that is securing a loan, he has to reaffirm the debt. 

In a Chapter 13 cramdown, the loan is “stripped” or bifurcated into two portions:  the secured part, in the amount of the asset’s current value, and an unsecured part, which is paid after other obligations have been satisfied.  (In practice, this usually means “never”; they’re generally discharged if the plan is completed successfully).  You have to pay the bank on time, every month, for a number of years; if you don’t, your Chapter 13 fails, and the loan reverts to its old terms.  Which, among other things, means that you now owe all the money you didn’t pay the bank while the modification was in effect, plus the interest that compounded on the unpaid portion.  Since most Chapter 13 plans fail, this should give advocates of mortgage cramdowns pause.

There is no precedent or procedure that I am aware of for letting homeowners get a modification in order to sell the house; that’s what a short sale is for.  But if people really are defaulting out of desperation, then selling the house is probably what they need to do.  Unless they’re very poor, people don’t lose the house because they got a 5-10% pay cut; lower taxes mitigate some of the effect, and people will do a lot before they’ll allow themselves to be foreclosed on.  No, by the time most people are looking at foreclosure, they’re in one of three situations:

• They were irresponsible borrowers who have amassed an essentially unpayable amount of debt
• They have had a dramatic loss of income (business failure, bad investments, furlough/job loss/new job at lower pay)
• They have had a dramatic increase in expenses (lawsuit, medical bills, back taxes, gambling problem, etc.)

The first group may be helpable, but if someone has $50,000 in credit card debt, no responsible banker would agree to modify their loan outside of a bankruptcy court; you’d essentially be making a free gift to other creditors who ought to share the pain. 

The second group is not helpable, because outside of a few frothy markets like California, writing the house down to market value will not provide enough of a decrease to cushion the kinds of income decline that push people into foreclosure.  A 10% writedown on a $400,000 mortgage at 6.25% nets you a little over $250 a month in savings.  If you make enough money to have a $400,000 mortgage, you are not defaulting because you suddenly developed a $250 shortfall in your monthly budget.

This arithmetic is also a problem for the third group, plus one hopes that no sensible banker would modify the loan of anyone whose other major creditor was Harrah’s. 

So to answer the question I posed at the beginning:  there’s not much evidence that the current scheme of mortgage modification is making things worse.  But there’s also not much evidence that any differently designed system would have made things any better.  We may have to look for other ways to ease the pain of those whose houses are more than they can afford. 

And we might start by trying to make it easier to get out of houses, as well as stay in them.  Instead of encouraging people to throw their savings into hopeless modifications, maybe the government should be trying to streamline the process of arranging for a short sale so that people can walk away with a little savings in the bank (and on their credit report) to help them get a fresh start.

Join the conversation about this story »

See Also:

• Loan Mods Are Still A Disaster
• Bank Of America Is The Worst Major Bank When It Comes To Mortgage Mods
• Why Mortgage Mods Aren’t Working

Is the mortgage modification program making things worse?  An article in the New York Times gives voice to fears that by encouraging homeowners to stay in homes that they cannot really afford, Obama’s Making Home Affordable program is actually increasing the agony of homeowners, who pour money down the rat hole of their mortgage rather than recognizing the loss and starting over.  In the meantime, the modification programs disguise the true condition of bank balance sheets (because modified mortgages are not yet non-performing mortgages), and slow down the process of recovery.

How much truth is there to this story?  Some, at least.  I found myself talking to my father about this after I exchanged blog posts over the tragic case of Tom Vellucci, a Floral Park resident who lost his job and wound up with a non-paying tenant, then drained his savings trying to keep up with a modification that got him current, but didn’t lower his payment.  We’re both longtime New Yorkers, so there’s a certain local interest in what happened.  We were mystified by why anyone would think that Mr. Vellucci would qualify for a modification–and more importantly, why Mr. Vellucci would have thought so.

Reading between the lines in his story, Mr. Vellucci had virtually no savings (making his house payments tapped him out in four months).  His income was moderate at the best of times, and his house payment was so large that everything had to go right for him.  If he was out of work or lost a tenant for any length of time, he was going to end up in defaulting.  As of the story’s publication, he was still on the dialysis that cost him his job, meaning he is not going to regain his income any time soon.  There was no way that any imaginable mortgage modification was going to clean up this mess.  Yet he gave the last of his savings to a skeezy servicer in some sort of tragic Hail Mary pass.

Why would he do something so patently insane?  Apparently he was hoping that he could get a second modification under MHA.  But his interest rate wasn’t his problem.  He had a mortgage principal that probably ran into the mid six-figures, and no job, and probably required a modification that slashed his payment in half.  The Obama program clearly raised ridiculous, unrealistic hopes in at least a few people.

That said, the people pushing the notion that MHA is making everything worse have their own vested interests:  people who want to pin political blame on Barack Obama; hedge fund managers and other financial types who presumably have taken bets that will pay off quicker and easier if foreclosures pick up; people pushing for more aggressive modifications that write down principal as well as interest rates.  With few permanent modifications yet approved, and no data, it’s not clear to me that this is a significant problem, rather than an occasional tragedy.

But I think that the so far lackluster results from MHA do point to something important, which is that we don’t have the kind of mortgage crisis we thought we had when we passed the modification.  This represents not only a shift in our thinking about how to fix the housing markets, but a major shift in our national narrative about the housing bubble.  Six to nine months ago, the major story we told in connection with the financial crisis was the homeowner suckered–by either fraud or greed–into a teaser loan with an artificially low interest rate that was going to turn disastrous when it reset.

We’ve seen some of that, to be sure, particularly with the “Option ARM” or “negative amortization” loans on which homeowners weren’t even making the full interest payment.  But that hasn’t turned out to be our biggest problem, largely because we are in a very low interest rate environment right now, so many people saw their rates reset downward rather than up.  Instead, we are plagued by negative home equity, and unemployment.  We have a modification program designed to avert a threat that never materialized.

Now we have a choice between two more stories.  One presents the negative equity as the major problem.  Negative home equity is a bigger predictor of default than job loss; so, the reasoning goes, we must be seeing something akin to the infamous “jingle mail”, in which people hand over their keys rather than keep making payments on a house that isn’t appreciating.

Obviously, this happens.  But I doubt it’s particularly common.  Most bankruptcy experts believe that while there are a handful of grossly irresponsible jerks who deliberately borrow as much as they can get away with before defaulting, or otherwise abuse the process, the majority of people who default try really really hard to find some way to make their payments.  (Interestingly/oddly, this does not seem to be as true of student loans and utility bills.)

My story is a little more complicated.  People who lose their jobs, but have positive equity, sell the house when money gets tight. (Five years ago, they probably would have refinanced).

People who lose their jobs, but have negative equity, lose the house.  So do people who get divorced and have negative equity, people who are whacked with unexpected medical or legal bills and have negative equity, people who get hit with back taxes and have negative equity, people who develop a gambling problem or a drug habit and have negative equity.  The negative equity is better correlated–but that doesn’t mean that people are deciding to walk away from houses just because they’re underwater.

My story is kinder to the debtors, but it also makes modifications more problematic.  If the negative equity is the main problem, you can solve the mortgage crisis by switching to modifications with “cramdowns”–i.e., get a judge or a banker to write off the portion of the principal that exceeds what the house is worth.  This has unpleasant side effects–it would probably pretty much instantly return us to the days of 20+% down payments on every house, and likely cause house prices to fall farther.  But it at least has some hope of solving the immediate foreclosure problem.

But if negative equity is merely exacerbating an untenable situation, it’s not clear how much good even a cramdown will do.  Proponents of cramdowns have begun a recent love affair with the pre-1977 bankruptcy code.  They are blissfully oblivious to the fact that the pre-1977 code was in many ways much less debtor-friendly, which is why it was reformed.  But that is neither here nor there, really.  Even the pre-1977 code did not view the cramdown as a sort of magical gift to the homeowner. 

At least as I understand it, cramdowns were then, as they are now, part of a Chapter 13 bankruptcy–in other words, part of a court-ordered repayment plan, not a Chapter 7, in which the debtor sheds their past debts.  If a Chapter 7 debtor wants to keep an asset that is securing a loan, he has to reaffirm the debt. 

In a Chapter 13 cramdown, the loan is “stripped” or bifurcated into two portions:  the secured part, in the amount of the asset’s current value, and an unsecured part, which is paid after other obligations have been satisfied.  (In practice, this usually means “never”; they’re generally discharged if the plan is completed successfully).  You have to pay the bank on time, every month, for a number of years; if you don’t, your Chapter 13 fails, and the loan reverts to its old terms.  Which, among other things, means that you now owe all the money you didn’t pay the bank while the modification was in effect, plus the interest that compounded on the unpaid portion.  Since most Chapter 13 plans fail, this should give advocates of mortgage cramdowns pause.

There is no precedent or procedure that I am aware of for letting homeowners get a modification in order to sell the house; that’s what a short sale is for.  But if people really are defaulting out of desperation, then selling the house is probably what they need to do.  Unless they’re very poor, people don’t lose the house because they got a 5-10% pay cut; lower taxes mitigate some of the effect, and people will do a lot before they’ll allow themselves to be foreclosed on.  No, by the time most people are looking at foreclosure, they’re in one of three situations:

– They were irresponsible borrowers who have amassed an essentially unpayable amount of debt

– They have had a dramatic loss of income (business failure, bad investments, furlough/job loss/new job at lower pay)

– They have had a dramatic increase in expenses (lawsuit, medical bills, back taxes, gambling problem, etc.)

The first group may be helpable, but if someone has $50,000 in credit card debt, no responsible banker would agree to modify their loan outside of a bankruptcy court; you’d essentially be making a free gift to other creditors who ought to share the pain. 

The second group is not helpable, because outside of a few frothy markets like California, writing the house down to market value will not provide enough of a decrease to cushion the kinds of income decline that push people into foreclosure.  A 10% write-down on a $400,000 mortgage at 6.25% nets you a little over $250 a month in savings.  If you make enough money to have a $400,000 mortgage, you are not defaulting because you suddenly developed a $250 shortfall in your monthly budget.

This arithmetic is also a problem for the third group, plus one hopes that no sensible banker would modify the loan of anyone whose other major creditor was Harrah’s. 

So to answer the question I posed at the beginning:  there’s not much evidence that the current scheme of mortgage modification is making things worse.  But there’s also not much evidence that any differently designed system would have made things any better.  We may have to look for other ways to ease the pain of those whose houses are more than they can afford. 

And we might start by trying to make it easier to get out of houses, as well as stay in them.  Instead of encouraging people to throw their savings into hopeless modifications, maybe the government should be trying to streamline the process of arranging for a short sale so that people can walk away with a little savings in the bank (and on their credit report) to help them get a fresh start.

Here’s some change we can believe in:  Turbo tax has apparently altered its software to prevent anyone in Timothy Geithner’s position from ever claiming they didn’t realize they had to pay the self-employment tax while working for a multilateral institution.

Felix Salmon discusses the sad case of a man who clearly cannot pay his mortgage and demands:

So this is what I’d like to ask Megan McArdle,
and others who like to extoll the moral virtues of paying one’s debts:
just how much of your life’s savings should you give these snakes
before they take your house?

I don’t really understand the question.  I am in favor of people are financially able to keep the house without getting foreclosed on, keeping the house rather than getting foreclosed upon.  The guy in question clearly cannot, given that he lost his job and has no tenant for the property in question.  Obviously he should have walked away immediately.

Indeed, I don’t understand why he didn’t, since the article makes no mention of any suggestion or promise that accepting a modification that didn’t reduce his payment, would later qualify him for one that did.  And since it’s pretty clear that Mr. Vellucci cannot afford much of any payment at all, it’s not clear why he–or Felix–thinks he should have gotten one.  Modifications are supposed to be a deal that makes both sides better off by avoiding the huge costs of foreclosure, not a vehicle for transferring wealth from bondholders or bank shareholders to people we like better.  The latter is what the progressive income tax is for.

Do I feel sorry for Mr. Vellucci?  Very sorry.  Illness is usually framed by complaints about large medical bills, but for most people income loss is at least as great a problem, and often a much bigger one.  And Mr. Vellucci seems to have been a financial naif who was given bad-to-fraudulent advice at every turn. What happened to him is tragic, and I wouldn’t be sorry to see the folks who defrauded him spend some time in the pokey. 

But the implied combination of tiny savings, minimal income, and inability to find a paying tenant in a real-estate market with a sub-2% vacancy rate, does not suggest that the solution to his problems is a mortgage modification.  I’m not sure what the servicer could have done, other than foreclosed outright.  Or what Felix thinks this has to do with people who decide to default on their mortgages so that they’ll have more money to spend on cruises and new furniture.

James Altucher has a lengthy column on why you should rent rather than buy.  Shorter version:  there are a lot of hidden costs, and outside of the bubble, housing has not historically been a great investment.  The phenomena that made it a great investment for some people (the emptying out and then filling up of cities, the introduction of self-amortizing mortgages, rising and then plummeting interest rates, and the special status of mortgage debt after 1986) will not indefinitely continue to push prices up; most of them have played out.  Over the long run, housing prices cannot grow much faster than incomes.

I agree with all of this.  You should not buy a house because “renting is throwing your money away” or because you expect the house to become a cash cow.  As an investment, housing is a good form of forced savings, but do not expect price appreciation to make you rich–nay, not even if it made your parents and all your neighbors rich.

But these articles, and the homeownership-skeptics (of which I am sort of one) often give short shrift to the benefits of owning.  Renting has hidden costs, too.  Outside of New York, with its massive stock of professional landlords hamstrung by restrictive rent rules, renting means you usually have to move every few years, because the landlord wants to live in the house again, or is selling it, or wants to raise the rent too much in the hope that you’ll be too lazy to move.  Moving costs a ton of money, between the movers (now that I’m getting old and creaky), the new furniture that is inevitably required, and the old furniture that cannot be fit into the new house and must be thrown away.  Moving also soaks up a month or so of your time on each side of the move, which needs to be factored in for both lost income and sheer misery.

Then there is the inability to have your house the way you want it.  Sure, it’s not like we could afford high-end appliances.  But if we owned our house, I might be able to hope that someday we would acquire a water heater bigger than a thimble, rather than hopelessly resigning myself to shallow, lukewarm baths.  I might also be able to sink screws into the ceiling for a hanging potrack, install blackout curtains so that I could sleep later than 6 am in the summer, and otherwise make the house over more to my specifications.  But the owners are fond of their home the way it is, so it stays.

For a long time, I didn’t care so much about this.  I liked the freedom renting gave me.  But once you’re committed to a city, and another person, that freedom starts looking overrated.

Join the conversation about this story »

See Also:

• Home Sweet Rental: The American Dream Is A Bunch Of Baloney
• 15 Huge Ideas That Flopped This Decade
• Case-Shiller: Housing Recovery Still Weak, October Decline Of 7.3% Slightly Worse Than Forecast