Preventing the Next Housing Crisis: Shared Responsibility Mortgages


It is now commonly agreed that the Financial Crisis of 2008 was caused by the collapse of the housing bubble beginning in 2007. There were three main aspects to the huge collapse of wealth caused by the Financial Crisis:

  • It Destroyed Mainly Middle Class Wealth. During the Great Recession housing values collapsed by $5.5 trillion, a large fraction of the total $14 trillion economy. As shown in the above chart, most of this loss of wealth came at the expense of middle- and lower-income families.
  • Foreclosures on Underwater Mortgages Lowered Housing Values across the Board. When foreclosed houses are sold at steeply discounted prices, the appraised value of all other houses in the area are lowered as well.
  • The Loss of Wealth of Indebted Households Forced Them to Cut Back on Their Overall Spending. The decline in aggregate demand due to wealth loss of the indebted then becomes a problem for everyone in the economy.

In a new book, the economists Atif Mian and Amir Sufi have proposed a new way to set up mortgages, called Shared Responsibility Mortgages (SRM), to protect holders of underwater mortgages during a housing crisis.
Consider a house bought for $100,000 with a 20% down payment and a 30 year mortgage of $80,000 at 5% interest.  The annual mortgage payment is $5,204 per year.  Suppose the value of the house drops 30% to $70,000.  With an SRM the owner’s equity drops to 20% of $70,000 or $14,000.  The annual mortgage payment would also drop 30% to $3,643.  It would continue to be adjusted each year until the house returns to 100% of original value at which point the payment would revert to and remain at the original amount unless the value again drops below 100% of original value.
In return for sharing in the loss caused by a drop in value, the mortgage holder would receive 5% of any capital gain realized whenever the house was sold or refinanced in the future.
Suppose that all mortgages in 2007 had been SRMs.  All three of the problems outlined above would have been avoided.  The financial crisis would have been much less severe!

What Is the Best Way to Boost the Economy and Create More Jobs?


The publication of two new books is causing a reevaluation of the financial rescue and its aftermath, e.g. “The Case Against the Bernanke-Obama Financial Rescue”.  The two books are “Stress Test” by Timothy Geithner, former Treasury Secretary, and “House of Debt” by the economists Atif Mian and Amir Sufi.
CaptureMr. Mian and Mr. Sufi maintain that the government’s response to the financial crisis should have focused less on saving the banking system and more on the problem of excessive household debt.  They discovered in their research that, during the housing bubble, less affluent people were spending as much as 25 – 30 cents for every dollar of increase in housing equity.  When the bubble burst, and housing prices started to fall, these borrowers cut way back on spending which caused many businesses to lay off employees.  The authors propose setting up a government program to help borrowers decrease what they owe in underwater mortgages.
Five years after the end of the Great Recession it would still be very helpful to speed up our lagging economy.  Here are three different possible ways to do this:

  • The Keynesians say the best way to stimulate the economy is with more government (deficit) spending. For example, spending several hundred billion dollars a year on infra-structure would create hundreds of thousands, if not millions, of new construction jobs. I think this is a good idea, but only if it’s paid for with a new tax (e.g. a carbon tax or a wealth tax).
  • The Mian/Sufi plan, as described above, would alleviate mortgage debt problems for millions of middle class homeowners who are still under water, encouraging them to spend more money which would in turn boost the economy. The problem is that the M/S plan creates a moral hazard for mortgage holders unless it’s paid for by mortgage insurance which would raise costs for borrowers.
  • Broad-based tax reform, with lower tax rates for everyone, paid for by closing loopholes and limiting tax deductions for the wealthy, would automatically put more income in the hands of the two-thirds of tax payers who do not itemize deductions. These middle class wage earners would tend to spend this extra money thereby boosting the economy.

The point is that there very definitely are ways to boost the economy, some better than others, and it should be a top priority of Congress and the President to get this done.