Voodoo Economics Behind Government Demand for Mortgage Write-Downs by Big Banks

In 2010, Obama administration allies proposed a trillion-dollar bailout for those lucky mortgage borrowers whose loans were owned by the government-backed mortgage giants Fannie Mae and Freddie Mac — including wealthy borrowers who have no difficulty paying their mortgage — in order to increase their disposable income and temporarily pump up the economy through the next election. Now, Obama administration officials such as Associate Attorney General Tom Perrelli are trying to achieve the same goal on a much smaller scale in settlement talks with the nation’s four biggest banks. Perrelli is demanding that they reduce the mortgages of certain favored underwater borrowers (many of whom are underwater because they didn’t make a substantial downpayment, the way thrifty people do), using the banks’ unrelated foreclosure paperwork violations as a pretext (benefiting lucky borrowers who were never foreclosed upon, much less treated improperly in any way).

But as Mark Calabria notes, this demand makes no sense at all economically. Any mortgage write-off that increases the disposable income of borrowers will reduce the disposable income of investors whose mortgage-backed securities are worth less after mortgages are partly written off. The government’s demand reflects irrational, magical thinking, a kind of voodoo economics. This  proposed rip-off of investors would not create any wealth or income, but rather merely redistribute wealth and income from investors to borrowers (reducing the disposable income of the suddenly poorer investors), discouraging future investment.

Earlier, Calabria explained why the Obama administration’s use of “TARP funds to pay for modifications of loans not owned by the federal government” exceeds its “legal authority under TARP.”

Behind the administration’s mortgage bailout proposals is the false assumption that the economy remains weak due to “a collapse” in private consumption. But as Mark Calabria notes, it’s investment that’s low now, not consumption: by the middle of last year, “private personal consumption” had already risen “higher than at any point during the boom, after reaching bottom in the Spring of 2009.” Meanwhile, “unlike consumption, which has largely rebounded, investment today is about 20% below its peak.” It’s investment that needs to increase dramatically, not consumption. The administration’s extortionate demands to the nation’s banks discourage such investment.