The Wall Street Journal reports that the White House is considering nominating Janice Eberly to the Federal Reserve Board of Governors, to fill the seat vacated by former Vice Chair Lael Brainard when she became director of the National Economic Council. These days, Eberly teaches finance and economics at Northwestern University. But from 2011 to 2013, she served as assistant secretary of the Treasury for economic policy.
Her boss was Treasury Secretary Timothy Geithner, who allowed mortgage lenders to throw millions of indebted homeowners out of their houses to, in his words, “foam the runway” for Wall Street banks. The banks caused the 2007-2008 financial crisis by irresponsible mortgage lending on an epic scale. When it all blew up, they got directly bailed out through the Troubled Asset Relief Program in 2008. Then, when it came time to eat the losses on all of those irresponsible mortgage loans, Geithner gave the banks another bailout through the back door.
Eberly defended this policy after leaving office. In fall of 2014, she co-wrote a paper for the Brookings Institution titled “Efficient Credit Policies in a Housing Debt Crisis,” which claimed to “develop a framework to guide government policy in response to crises in cases when government may intervene to support distressed mortgages.” Shocker of shockers: Eberly and her co-author, fellow economist Arvind Krishnamurthy, find that Geithner’s policies were excellent, and his biggest critics should shut up.
Here’s why they were wrong, and why Eberly’s judgment should be a serious question as Biden makes his Fed selection.
The HAMP Debate: To Free or Not to Free (From Unfair Mortgage Debt)
To understand Eberly’s paper, you first have to know about the Home Affordable Modification Program (HAMP). This stemmed from the original TARP bailout, which thanks to Democratic pressure had up to $100 billion earmarked for homeowner assistance. The worst-off homeowners were “underwater” on their mortgages, meaning they owed more than the homes were worth.
Many independent onlookers thought the best thing for borrowers would have been principal reduction. This would have erased part of the loans, bringing borrower indebtedness down to what the house was worth. One plan, devised by Federal Deposit Insurance Corporation chair Sheila Bair, would have had government share in the upside if home values returned to strength. A primary goal of this plan was to prevent a situation where negative net worth dragged down borrower credit rating and spending.
The policy would also have kept many Americans in their homes. But principal reduction would have meant that the banks to which the borrowers owed their mortgage debt would lose out on a ton of future payments, harming their balance sheets. Especially since these same banks had just totaled the world economy, most onlookers thought that was a fair trade. Plus, many of these homeowners were so deeply underwater that mortgage lenders would never see those theoretical payments anyway.
But the idea of principal reduction was untenable to the banks, and thus untenable to Geithner. (He also convinced President Obama to renege on his promise to support “cramdown,” a legal reform that would allow homeowners to write off their underwater debt during a bankruptcy proceeding, also because it would have hurt bank balance sheets.)
Instead, Geithner set up HAMP. The supposed goal of HAMP was to rejigger the borrowers’ monthly payments into something acceptable to both the borrower and the bank, at least in the short term. In most cases, the borrower would still owe huge amounts on some inflated mortgage, but their payments would go down.
HAMP had strict eligibility requirements, and bent over backwards to placate the industry. Most importantly, the mortgage company had full discretion over whether to give borrowers a loan modification. The government offered “investor incentive payments” to entice the companies, but it was far more profitable for them to string borrowers along and then foreclose on them anyway, sucking out a few extra payments first. In the end, few borrowers were helped, especially in the critical first few years, and many more ended up being tricked into foreclosure. To call HAMP poorly managed is a gross understatement.
This is the policy Eberly and Krishnamurthy set out to defend in their 2014 Brookings paper. They rarely directly reference HAMP, TARP, Geithner, or any of the real-world stakes of their paper—it’s all framed as a theoretical exercise. But if you’re familiar with the actual policies, you’ll recognize that their theoretical set of policies looks suspiciously similar to what the Obama Treasury Department actually did. Obama economist Austan Goolsbee, in a commentary after the paper, even makes this explicit.
We Just Can’t Afford to Keep You Housed
Eberly and Krishnamurthy have a few main arguments for why lower monthly payments are better than the government erasing debt outright. First, if the government simply doesn’t have enough money to pay down everyone’s mortgage debt, then a HAMP-style program offers the best bang for their buck. “The government has a range of possible policy interventions and a limited budget,” they write.
It’s true that Congress didn’t appropriate nearly enough funds in TARP for Treasury officials to just pay down everyone’s mortgage debt during the crisis. What they don’t mention is that Geithner’s dithering and his terrible HAMP design meant the administration had failed to spend all that had been authorized under TARP, prompting Congress to cut its size by $225 billion in June 2010—enough for, say, 4.5 million fully paid principal reductions of $50,000. By contrast, in the first five years of HAMP, the government spent a little over $10 billion on incentive payments for modifications, only a fraction of what it had available.
Even setting that aside, Eberly and Krishnamurthy effectively assume that to do a principal reduction, the government would need to pay the mortgage lenders the difference between the old and new balances. But this is not necessarily true. The lenders could just not be made whole, and take the hit to their expected future revenue.
In the early 2010s, federal officials convinced themselves this was impossible. “The banks, grappling with issues of insolvency, could not recognize an additional $800 billion in losses on their balance sheets,” Austan Goolsbee, a White House economist just before Eberly’s tenure, writes in a commentary on Eberly’s paper. Officials were fresh off a slew of bailouts to keep the whole financial sector from capsizing. Asking the banks to take a financial hit so that people could stay in their homes—in other words, asking the banks to take responsibility for their own bad bets—might have triggered even more panic on Wall Street. The fear of that was why Geithner designed HAMP to “foam the runway” for Wall Street, and screw over homeowners instead.
But it’s far from obvious that the banks couldn’t have afforded to take responsibility for their actions. “By mid-2009, the acute part of the crisis is over, and by 2010, banks are again making big profits. If you force them to eat a bunch of foreclosure losses, maybe a few hundred billion over several years, it probably wouldn’t have been that bad,” the Prospect’s Ryan Cooper points out in a thorough video essay on the topic.
Moreover, there were other options for handling the debt losses instead of just having the banks eat it directly. “If you wanted to be safe, you could have set up a garbage bank, stuffed all of this trash debt into it, and then disconnected it from the rest of the financial system and let it go bankrupt,” Cooper argues. Obama even ordered Geithner to look into doing exactly that with Citigroup. Geithner just disobeyed, and Obama never followed up.
When a bad loan is made, it is both prudent and fair for the lender to bear the most responsibility. They are supposed to be wise stewards of their own capital. Instead, ordinary homeowners who did the least of any actor to cause the financial crisis ended up eating the losses.
Why Let the Facts Ruin a Good Theory?
But Eberly and Krishnamurthy argue there’s actually no need for government help. They claim that it is actually in lenders’ best interest to offer principal reduction themselves to struggling borrowers. “Lenders, who bear the credit default risk, have a direct incentive to partially write down debt and avoid greater loan losses due to default,” they write. In other words, better to take half a loaf from a written-down loan than no loaf at all from a defaulted loan.
Eberly and Krishnamurthy spend 40 pages of their paper on mathematical proofs that supposedly show how everyone’s interests align in a HAMP situation. But they give the game away in one sentence in one short paragraph: “[S]ervicer incentives and capacity may also have reinforced delay and timing discreteness.”
What Eberly and her colleague don’t want to understand is that the key actors making loan modification decisions were the mortgage servicers, who collected payments on behalf of investors. They had incentives to foreclose thanks to the structure of their contracts. So they went to incredible lengths to get that done.
Eberly and Krishnamurthy only mention mortgage servicers glancingly, since servicers don’t fit into their tidy, theoretical model of the mortgage market. After referencing more empirical papers that offer ideas for changing servicer incentives, they write, “The efficacy of these proposals is outside our present scope …”
A 13-page report from the California attorney general’s office in October 2012—two years before Eberly and Krishnamurthy’s paper was published—explains how servicers were “dual tracking” their relationship with homeowners. If someone was underwater on their mortgage and tried to refinance their monthly payments—in other words, if they tried to do what Eberly and Krishnamurthy claim is in the banks’ interest—servicers would instead slow-walk the refinancing application and fast-track the foreclosure process.
Incidentally, that report was written by an obscure California law professor named Katherine Porter. Today, her constituents know her as Rep. Katie Porter, the iconic progressive from the state’s 47th Congressional District.
“Dual tracking” was one of the banks’ comparatively more moral practices. Chain of Title by the Prospect’s David Dayen shows how the banks didn’t just play a rigged game to evict borrowers: They committed forgery, a federal crime, at an industrial scale.
During Wall Street’s housing mania in the 2000s, banks often didn’t bother filling out their required paperwork when offering someone a mortgage, instead moving quickly to sell the loans off to investors as fast as possible, without the added costs of proper procedure. This lack of documentation meant that in the 2010s, when the ultimate owners of the mortgage debt wanted to foreclose on a house, they often couldn’t prove that they had the right to do so. Without that paperwork, there was nothing legally proving that the homeowner owed money to the debt-investor.
To get at those homes, the banks paid floors of workers about $13 an hour to spend all day falsely attesting that they’d read massive files of mortgage documents, or forging documents or signatures, hundreds of times per day.
All of this was publicly reported in 2012, while Eberly was at the Treasury Department.
Won’t Someone Think of the Efficiency!
Eberly and Krishnamurthy’s other main argument in favor of HAMP-style refinancing is an old economist standby: efficiency.
“Principal reduction can be helpful, but it is a less efficient use of government resources, since it back-loads payments to households that cannot borrow against these future resources to support consumption today, and also because it is most helpful in reducing strategic default, rather than payment-distress-induced default,” they write.
Let’s take each of those clauses in turn. Lowering someone’s payments will indeed put money in their pockets, but this would also logically happen during a principal reduction, as payments reset with the new loan value. Plus, removing someone from a state of negative net worth will also improve their credit rating and hence ability to borrow.
Second, Eberly and Krishnamurthy’s judgment about which underwater borrowers are more or less deserving of aid is questionable. Even if one accepts their view that “strategic defaulters” are less deserving of aid, that means the one downside to principal reductions—the policy outcome so horrible that we had to have an eviction crisis to prevent it—is that the government might help a desperate person who just wasn’t quite desperate enough.
This is impossible to square with both the bank bailout and bankruptcy law generally. How can anyone say that the banks that totaled the world economy “deserved” the billions of dollars in aid they received throughout the crisis? Moreover, rich people like Donald Trumproutinely use strategic default to walk away from bad debts while pocketing huge profits.
It’s only when ordinary homeowners might theoretically take advantage of debt write-offs to benefit themselves that this type of economist suddenly has objections. Incidentally, the evidence shows that there were almost no borrower strategic defaults during the foreclosure crisis, except for one: when the Mortgage Bankers Association defaulted on its headquartersin Washington in 2010.
In summary, Eberly helped Geithner operate a system of deliberately throwing millions of people out of their homes so that the same Wall Street banks that tricked them into awful mortgages in the first place could turn another quick buck after they cratered the world economy. And the only part of her defense for doing so that isn’t empirically falsifiable is that she doesn’t think the government should help people who haven’t earned the charity.
All this informs us whose interests Eberly would serve on the Fed. The overriding priority of Geithner’s eviction policies was to protect Wall Street, right after it caused the greatest economic calamity since the Great Depression. Eberly’s willingness to justify the pain her boss inflicted on millions of average people in order to keep the financial sector thriving indicates a preference for Wall Street’s interests over the average person’s.
The Fed’s monetary policies are hugely important to the financial sector. It’s also the key regulator for the biggest banks. This means that, if made a Fed governor, Eberly would be asked to independently oversee an industry she and her boss coddled at the cost of throwing millions of people onto the street.
Are these the values Biden believes in? Is this the kind of person he wants as a part of his legacy?
PHOTO CREDIT: “Geithner” by Medill DC is licensed under CC BY 2.0.