Chapter 16: Executive Summary – Mortgages and Households

From the book “Restoring Financial Stability: How to Repair a Failed System”. Section VI: The Bailout

Background

The damage caused by the collapse of the housing and housing finance sectors of the economy is spreading at an alarming rate. Foreclosure activity jumped 81 percent in 2008, with more than 3 million foreclosure filings on 2.3 million properties. The ever increasing number of households who are upside down on their mortgages poses a growing threat to the financial system and the economy as the actual losses, and the uncertainty about their extent, pass through the financial system to the holders of the underlying mortgages and mortgage-backed securities.

Restoring Financial Stability: How to Repair a Failed System

In 18 short, targeted and definitive White Papers – each tracing the core of the problem, the policy alternatives, and a specific course of action – 32 academics, combining a solid understanding of financial economics with the practice of modern finance, suggest solutions, in the public interest, to the central issues of today’s financial crisis.This overview contains the Executive Summaries of these White Papers, to be published in their entirety by John Wiley & Sons in March 2009 and will be posted here at RGE Monitor in the following days.

Preface

As 2008 was drawing to a close, we were reflecting on the dramatic and often unprecedented events of the past year in financial markets and the broader economy. Nothing like this had occurred in our lifetimes. In our academic world, few events had as much potential for providing us and our colleagues with a rich source of raw material for good research and teaching for a long time to come.  This is the ultimate teachable moment and it is essential to teach it. We were in the middle of a financial and economic hurricane that was certain to leave behind massive financial and economic damage. It will eventually blow over, as all hurricanes do, but it is not too early to begin to think about what changes to the system can mitigate the damage and hopefully make future financial storms less likely.

Another Great Depression?

What’s the difference between a financial crisis and a Depression? At least initially, the symptoms appear similar. Banks won’t lend to one another, even overnight. Strong and respected businesses cannot borrow short-term money in the commercial paper market even though their default rates are negligible.

The banking systems in many countries have ceased functioning and required major government intervention. It is like a patient experiencing multiple organ failure because the basic circulatory system has gone kaput. Despite urgent measures, the patient appears unresponsive.