December 6, 2024

Today’s Economist: Casey B. Mulligan: Forgiveness Formulas

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Casey B. Mulligan is an economics professor at the University of Chicago. He is the author of “The Redistribution Recession: How Labor Market Distortions Contracted the Economy.”

In an ideal world, collecting debts would be as simple as asking debtors to pay their obligations when they are able to. But in reality most businesses have found that they need to obtain other assurances, such as collateral or the option to shut off services to a delinquent payer. Otherwise it is too easy for debtors to claim hardship and walk away without paying.

Today’s Economist

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On the other hand, many families and other debtors do experience genuine hardship. In those cases it can be compassionate and even efficient to at least partly forgive the debts of people who have fallen on hard times. Many economists see loan defaults as (sometimes) an efficiency-enhancing form of risk-sharing.

Even the most hard-hearted lender may choose to partly forgive loans because too much lender effort is required to elicit full payment. Just as you cannot squeeze blood from a stone you cannot get much revenue from someone who does not have it.

One approach would be for lenders to develop and disclose a “forgiveness formula” that would clearly define “hard times” and indicate precisely what kind of forgiveness is possible. The advantage of forgiveness formulas is that distressed borrowers can be certain where they stand with the lender and can readily evaluate whether they were treated “fairly.”

Forgiveness formulas are also consistent with the idea that agreements should be clearly specified in writing, so the parties to the agreement fully understand each other and never have to argue about what the agreement really meant. Carefully specified written agreements are sometimes found in employment relationships, tenant-landlord relationships and even marriages.

This is the approach that the Federal Deposit Insurance Corporation took during the George W. Bush administration to restructure home mortgages that had fallen under water (that is, when home prices had fallen so much that selling the home would no longer provide enough proceeds to pay the mortgage in full). Borrowers were told what new mortgage terms would be affordable and under what net-present-value conditions those terms should be considered acceptable to lenders.

The clarity of forgiveness formulas is also their weakness, because they make it easier for debtors to “game the calculation” and can ultimately make loans more costly for borrowers who pay in full. The Internal Revenue Service has long been secretive about its procedures for auditing returns and restructuring delinquent tax payments, and the Treasury maintained that approach when it became involved with restructuring home mortgages (the Congressional Oversight Panel discusses this matter on Page 41 of this report).

Hospitals are also known to partly forgive medical debts incurred by the uninsured, while they make no accommodation for many others. Some states require hospitals to explain in writing how they go about discounting charges for hardship patients (as we can see in New York’s policy), but you might guess that hospitals worry that patients will game those calculations in order to pay less.

One advantage of health reforms that get more people on health insurance is that by getting people to pay for their health care before they get sick, the reforms reduce the number of cases in which clear forgiveness has to be traded off with formula gamesmanship.

Article source: http://economix.blogs.nytimes.com/2013/03/20/forgiveness-formulas/?partner=rss&emc=rss

Attorneys General Press White House to Fire F.H.F.A. Chief

WASHINGTON — Prominent state attorneys general are calling on President Obama to fire the acting director of the Federal Housing Finance Agency and name a new permanent director, arguing that current policies are impeding the economic recovery.

Under its current leader, Edward J. DeMarco, the F.H.F.A., which oversees the bailed-out mortgage financiers Fannie Mae and Freddie Mac, has refused to put in place a White House proposal to reduce the principal on so-called underwater mortgages — a move that might prevent foreclosures and thus save the mortgage giants money, but also might expose taxpayers to additional losses.

Led by Eric T. Schneiderman of New York and Martha Coakley of Massachusetts, the attorneys general argue that writing down the principal on underwater mortgages — those where the outstanding mortgage is greater than the current value of the home — would aid the recovery. They note that write-downs were a central part of a multibillion-dollar mortgage settlement that 49 state attorneys general negotiated with five major banks a year ago. And they say the White House should name a director to take that action.

“Our nation’s economy will never fully recover until we address this foreclosure crisis,” Ms. Coakley said in a statement. “Fannie Mae and Freddie Mac have been an obstacle to progress for far too long, and it is time for new leadership and a new direction to ensure that homeowners receive this important relief.”

Mr. DeMarco has held the position at the head of the F.H.F.A for more than three years. In the last year, especially, he has clashed with the administration over the issue of write-downs, also called principal forgiveness.

The Treasury Department has argued that write-downs would save money by reducing the chances homeowners would default. An F.H.F.A. analysis released last year seemed to show that a carefully directed program could save Fannie and Freddie money. But Mr. DeMarco has rejected the idea on the grounds that it would expose taxpayers to more losses. Fannie and Freddie have already required tens of billions of dollars of taxpayer aid.

The administration has frequently criticized Mr. DeMarco’s decision. “F.H.F.A. is an independent federal agency, and I recognize that, as its acting director, you have the sole legal authority to make this decision,” Timothy F. Geithner, who stepped down as Treasury secretary in January, wrote Mr. DeMarco last year. “However, I do not believe it is the best decision for the country.”

Yet the White House has failed to replace Mr. DeMarco.

That decision has troubled some members of Congress. “Ensuring that F.H.F.A. implements Congressional directives to support the most liquid, efficient, competitive and resilient housing finance markets is a matter of national urgency,” said a letter to Mr. Obama signed by 45 members of the House last month. “We strongly urge you to nominate an F.H.F.A. director who is ready to fulfill this mission and address the many challenges still facing the nation’s housing finance markets.”

Some housing advocates suggest the White House has not named a new director in order to keep Mr. DeMarco as a scapegoat for what they perceive as a failed housing policy.

The administration has struggled to find a qualified person to take the job. There is speculation that the White House may finally be close to naming a director. The Wall Street Journal reported that officials were considering nominating Representative Mel Watt, Democrat of North Carolina, perhaps next month.

The White House declined to comment on personnel policy.

Any director would probably be named as a recess appointment because he or she would be unlikely to win Congressional approval. Many Republicans concerned about the cost of Fannie and Freddie to the taxpayer have said the two agencies should not adopt principal-reduction policies. In 2010, the White House nominated Joseph A. Smith Jr., a North Carolina banking commissioner, for the position, but his nomination died in the Senate.

Attorneys general who have signed the letter also include Kamala D. Harris of California, Beau Biden of Delaware, Lisa Madigan of Illinois, Douglas F. Gansler of Maryland, Catherine Cortez Masto of Nevada and Bob Ferguson of Washington.

Article source: http://www.nytimes.com/2013/03/18/business/economy/attorneys-general-press-white-house-to-fire-fhfa-chief.html?partner=rss&emc=rss