Nearly 3 in 10 U.S. homeowners with mortgages are now underwater

Simon Johnson, Bloomberg

Discussions around this weekend’s International Monetary Fund annual meetings in Washington made it clear that the standard macroeconomic toolkit has little more to offer the U.S. It’s time to try something else.

Monetary policy has reached its limits, and further fiscal stimulus isn’t in the cards. Three years into the financial crisis, the U.S. economy is still held back by weak consumer confidence. Meanwhile, the global financial system continues to face instability, most notably because of the persistent sovereign-debt crisis in Europe.

With roughly a quarter of all U.S. households with mortgages owing more on their loans than their homes are worth, it’s no surprise that consumption, which accounts for 70 percent of gross domestic product, is restrained.

The consequent lack of demand discourages business investment, which means job creation remains weak. People are afraid of losing their homes and that fear keeps spending down and thus prevents them — and their neighbors — from getting jobs.

What can be done to break this vicious circle? One suggestion from some officials this weekend — and of course many banks — is to accept a relatively small amount of money to settle the various robo-signing and other mortgage document cases that state attorneys general are pursuing. The claim is that this would put the banks back on their feet and spur lending. This is a complete illusion.

TARP Props

The biggest banks were propped up during the crisis by the Treasury Department using Troubled Asset Relief Program funds and by the Federal Reserve with huge loans in various forms. Some institutions, including Citigroup and Bank of America, were put back on their feet several times.

But this approach has proved insufficient to spur an economic recovery. Left to their devices, banks will always fail to restructure loans on a scale sufficient to make a macroeconomic difference. Negative equity or near negative equity weighs on consumers and depresses confidence, but no single private firm will ever take into account those broader consequences.

To date, the government’s efforts on mortgages have been lame — and much less than was done to save the biggest and worst managed banks. There’s also zero chance that this Congress would authorize the use of any public money to support mortgage relief. At the same time, it’s only fair and reasonable that there should be redress for homeowners who were tricked into mortgages they couldn’t afford, evicted without due process or otherwise mistreated by banks.

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