Demand Side Transcript

The Home Owners Loan Corporation
and other real answers to the impending crisis

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Today we have audio from Robert Kuttner, then I’ll give you some details on the Home Owners Loan Corporation, a New Deal model we could use today to clear the housing market. Kuttner will be back with observations on the political dangers to Democrats.

Remember to change your subscription on iTunes to demandside reborn one word lowercase. That link offers you the serialized version of Demand Side, the book, all at no cost or obligation. We’re moving through the history chapter and should be into economic performance by president, Chapter 4, by the first of next week. Look forward to consistent high marks for Democrats across the range of economic measures — growth, employment, investment AND profitability, all while borrowing trillions less.

Now Robert Kuttner, excerpted from an interview with Amy Goodman at Democracy Now on January 23.

ROBERT KUTTNER: ... the place to start is to recognize why this recession is different from all other recessions. This began and is continuing with a collapse in credit markets, and the collapse in credit markets is, in turn, the result of deregulation gone nuts. And it’s a repeat of a lot of things that happened in the 1920s, where there was too much speculation with too much borrowed money and a complete lack of transparency. The regulators, the public had no idea of what these bonds that had been created out of subprime mortgages really contained, what they were worth. The people who packaged them were not subject to any kind of regulatory scrutiny.

And when it turned out that a lot of these loans were never going to be paid back, the layer upon layer upon layer of bonds and then securities based on the bonds—you know, if you can picture the World Trade Center collapsing floor by floor or you can picture the collapse of the Ponzi schemes of the 1920s, that’s a good—or horrible—analogy. And when you have a credit contraction, it means that banks have less capital against which to make loans, and lowering interest rates doesn’t fix that.

There are two other things that lowering interest rates and an ordinary stimulus package won’t fix. One, you alluded to in your opening comments, Amy, and that’s the collapse in housing prices. At the current rate of decline in housing values, American homeowners—and that’s about 70 percent of Americans—are going to lose $2.2 trillion of net worth this year alone. Well, when you lose $2.2 trillion of savings, you’re not inclined to rush out and do home improvements, you’re not inclined to rush out and buy durable goods. And again, compared to that kind of a loss, a stimulus—and they’re talking about $140–$145 billion, that’s one percent of GDP—that’s a drop in the bucket.

Lastly, this occurs on top of thirty years of increasing insecurity on a whole bunch of fronts: the greater risk of losing your job, the greater risk of having your paycheck not keep pace with inflation, rising energy costs, rising tuition costs, rising health insurance costs. All of the things that make you middle class have become more difficult to attain in the past thirty years. So you’ve got a three-layer cake here. You’ve got this thirty-year history of flat or declining living standards for most Americans, you’ve got this terrible weakness in financial markets, and you’ve got this housing collapse.

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the great experiment in deregulation really started under Carter in the late 1970s. It was Carter who started the deregulation of trucking and natural gas and broadcasting. And the whole ideology of deregulation and the practice of deregulation was unfortunately bipartisan.

That’s Robert Kuttner, co-founder of the American Prospect, once an investigator for the Senate Banking Committee, and as good an economist as exists in Washington.

Let’s take the mortgage crisis. What is a way to clear the markets and keep people in their homes?

Kuttner suggests a resurrection of the Home Owners Loan Corporation of the New Deal era.

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During the 1920s a typical down-payment was 35 percent for mortgage loans lasting up to only ten years at interest of 8 percent. At the end of that period, borrowers had to hope they could refinance or somehow in some other way come up with the remaining cost of the property. The lending institutions did not offer loan mortgage insurance and were often dangerously under-funded.

The number of mortgages issued nationwide dropped from 5,778 in 1928 to a mere 864 in 1933, and many banks went under, dragging homeowners down with them.

There were three choices:

Marrner Eccles at the Fed urged the policies of the great John Maynard Keynes, public programs operating directly, shoring up the lagging building trades and producing the badly needed housing.

Herbert Hoover preferred to support the banks, the lenders in the private market. In 1932 he created the Federal Home Loan Bank. The number of mortgages let was nationwide under Hoover’s programs was fewer than ten. Total.

Franklin Roosevelt, in his New Deal, in the summer of July 1933, created the Home Owners Loan Corporation, which was authorized to issue new loans to replace the existing liens of homeowners in default.

Of the almost two million applicants, half were accepted, those who could demonstrate a determination to meet their financial obligations and a history of doing so. Existing lenders had to accept losses from lower appraisals, and they were happy to do it. A government guarantee of four percent interest was worth far more than the zero percent they were getting, even if the zero percent applied to a higher valuation.

The HOLC was short-term. It actively issued loans for only three years, between 1933 and 1936. It was liquidated in 1951 at a small profit.

The situation is starkly similar to adjustable rate mortgages of today, which like the short-term loans of the 1920s, are tenable only when refinancing is available on favorable terms.

The HOLC offered full amortization, meaning when the last payment was made the house was owned free and clear. This was built into most future mortgage instruments, until recently. It offered below market interest rates and close counseling and assistance for borrowers. The result was extremely low default rates for what were the subprime borrowers of the day.

As envisioned by Kuttner, the 2008 HOLC would purchase at a deep discount, perhaps 30 to 40 cents on the dollar, the securities that hold the mortgages. At present many of these securities m are valued at zero, since there is no other market for them. There may be tens of billions at the Fed, however, which has taken the shakiest paper as collateral in its special auction facility.

The HOLC program would repopulate homes by offering below market terms. It seems to us that these terms ought to include adjustments should market prices fall further. One very understandable reason for softness in the current market is that would-be buyers are on the sidelines. If these buyers could be insulated from the risk of falling prices, they would come into the market. If they came into the market sufficiently, prices would cease to fall.

We should be clear, falling equity values in the presence of a federal program to rescue the housing market is going to create stresses among those who behaved responsibly over the past half dozen years.

We should also be clear that this just clears up part of the mess. Regulation of the financial sector is likewise essential, as is a forward-looking recovery program — built on infrastructure, green technology and jobs — not one-time, short-term stimulus.

ROBERT KUTTNER:

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.. let’s bring this back to politics. There’s a big risk that the Democrats, trying to be realists, trying to help out in a crisis, enact something that President Bush can sign, and then their fingerprints are on a piece of legislation that is obviously not going to solve the problem. There’s a time for bipartisanship, and there’s a time for a partisan difference. It seems to me the duty of an opposition party is to oppose, and this is one of those moments when the Democrats would be well-advised to really clarify the differences between themselves and President Bush.

But I want to bring it back to politics in a broader sense. This did not just happen. This was not an accident. This was the agenda of business, particularly Wall Street, going back thirty years. And if you look at the history of this, the Great Depression discredited free-market ideology, because it was such a colossal practical failure. Nobody in the 1930s could argue with a straight face that free markets worked. And so, we had a whole mixed economy, a regulatory structure invented during the New Deal, that really lasted thirty or forty years. By the ’70s, for a variety of reasons, big business had recovered a lot of the political power that it had lost in the Depression. And both parties, beginning with Carter, continuing with Clinton, became enablers of the kind of deregulation that finally has come home to roost in this crisis.

So now we’re learning, painfully, for a second time a lesson that we never should have had to learn twice, that markets don’t regulate themselves. Markets, left to their own devices, create grotesque inequality, ruin the environment and ruin the economy. And we’re seeing that unfold.

Robert Kuttner, American Prospect, author of The Squandering of America, once a chief assistant to Senator William Proxmire.

The political dangers are real. It will be a sad day for Democrats if they underestimate the potential of current slowing to become a real and deep recession. Stagflation. Or if they overestimate the effectiveness of the Fed and its interest rates or their own economists and the stimulus package.

We will need the crisis to unfold, of course, in order to offer the conditions needed to mobilize public support, but a crisis will not provide other necessary elements — like competent political leadership and workable strategies. We’re hoping Democrats spend their political capital to put in place the reconstruction of the middle class economy, to spend it on success, rather than watching it erode through failure.

Tomorrow is five minutes with Bush One in the next section of Demand Side, the book, and we’re back on Wednesday, with a parable from Luke chapter 18, about a man whose debt ran into millions and who was on his way to being sold into slavery when his master relented. The same man went to a person who owed him only a few denarii, and the man would not relent, but had him put into prison until he should pay. It reminds me of certain banks, Bank of America, for example, who have been getting below zero real interest rates from the Fed and have now turned on their cash-strapped borrowers with new and steeply higher rates. In the Bible and the parable, when the master finds out about this, there is hell to pay for the hypocrite. We’ll discuss the terms on Wednesday.

Until then, this is Alan Harvey, from the Demand Side.


The full interview with Kuttner by Amy Goodman

More is available below

AMY GOODMAN: And what could the Democrats do right now as an opposition party?

ROBERT KUTTNER: Well, I think there are three things they ought to be doing. First of all, there’s the housing mess. We need something like the Home Owners’ Loan Corporation of the 1930s, where a government agency, financed by government bonds, would buy these bonds back from Citigroup and Merrill and whoever at a steep discount, maybe thirty or forty cents on the dollar—they’ve already been written down to zero, because nobody wants to buy them—and turn them back into affordable mortgages, turn them into mortgages that would have a rate below market instead of the kind of predatory rate that subprime mortgages had. And you could then repopulate these houses. People on the brink of foreclosure would be able to keep their houses. Other people could become homeowners. So you need a much bolder approach to the housing crisis.

Secondly, I don’t even think “stimulus” is a good word. You need a recovery program. And a recovery program means not just a quick shot in the arm, it means reversing all of the things that make it harder to be middle class in this country. It means everything from a massive program of infrastructure repair to energy independence to good jobs in the service sector, reversing the whole thirty-year trajectory of ordinary people finding that their personal economic situation is insecure, they can’t keep up with the cost of living. And a “stimulus” implies a kind of a quick jolt to get us out of a temporary problem. This is not a temporary problem, this is a long-term problem. It’s going to require long-term solutions. And that doesn’t even get at some of the harder stuff, like the dependency on foreign borrowing that was caused by chronic trade deficits that in turn were the result of bad trade policies.