Part VIII: The Mortgage Crisis

The overall picture of the economy over the dozen years from 2007 to 2019 before the latest crash last year is very clear. It has been clear for decades. As Michael Spence, the Nobel-winning economist has written about the current situation, “the results of congressional and state elections were driven by different factors. Among them were most likely fast-rising income and wealth inequality – undoubtedly a major contributor to today’s economic, social, and political polarization – and distrust of elites on both sides.”  

Obama recognized that inequality and that it kept growing. “To this day, I survey reports of America’s escalating inequality, its reduced upward mobility and still-stagnant wages, with all the consequent anger and distortions such trends stir in our democracy, and I wonder whether I should have been bolder in those early months, willing to exact more economic pain in the short term in pursuit of a permanently altered and more just economic order.” (305)

Obama also recognized that the causes were structural (176):

• Shifting jobs overseas to take advantage of lower cost labour
• Automation
• The new digital economy requiring extensive training to use and improve
• Those controlling financial and human capital (those with highly specialized skills) “could leverage their assets, market globally and amass more wealth than any group in human history”
• The compounding effect because of commanding services to improve the human capital of one’s children through accessing the best schools, obtaining tutoring, attending special classes, test preparations, unpaid internships
• The steady diet of tax cuts for the wealthy since the Reagan era (which Obama perpetuated in the need to get Congressional votes as documented in a previous blog in spite of promising the opposite) (177)

But Obama read the economic crisis as fundamentally a moral failure much more than a product of structural distortions. One of the results of the misreading of the crisis – viewing it as a problem of moral turpitude on the part of both residential purchasers, real estate agents, mortgage brokers and financial gurus – was to limit the options available in tackling the crisis. The risky mortgage imbroglio should have been viewed as a very beneficial system of increasing capital available, lowering residential costs and making access to home ownership easier, but one misunderstood and undermined by a combination of complexity, ignorance and an inability to recognize and evaluate assets.

The consequences were politically catastrophic. The Republicans won big in the midterm 2010 elections even as economic inequality continued to grow. To reverse this trend over time, government could employ many instruments, including more progressive income taxes, low-cost delivery of high-quality public services (such as education and health care), a higher minimum wage, and greater wage-setting power for labor.” One omission – greater access for more people at lower cost to home ownership.

If, “A more equitable distribution of income between capital and labor is needed,” if “value creation is heavily skewed toward intangible capital” (algorithms not only for faster and much better information storage and exchanges, but ones that enhance the capital available for the residential real estate market), if this enhancement of intangible capital “is supported by public investment in science and technology, government could retain an equity interest in the value that is created.”

Again, quoting Spence, “Over the last several decades, as economies and financial systems have become increasingly interconnected, they have also become increasingly complex. Today, not even the most educated and experienced experts can pretend to comprehend fully these systems’ workings. Amid such complexity – and, indeed, opacity – questions about whose interests are really being represented abound, fueling mistrust and creating fertile ground for misinformation and conspiracy theories.” In other words, the result is a political crisis that led to the catastrophe of Donald Trump piled on top of a chronic and increasing economic crisis.

Let me examine the economic crisis at a deeper level that looks at increasing income disparities, mortgage debt and defaults, and student debt. (I will not examine credit card debt.)  The first indicator to look at is the percentage of people in America that live in poverty. Poverty status is determined by comparing annual income to a set of poverty thresholds that vary by family size, number of children, and the age of the householder. If a family’s before-tax money income is less than the dollar value of its threshold, then that family and every individual in it is considered to be in poverty. The Annual Poverty Rate (APR) averaged 21.3% between 2005-2009, 27.7 from 2010-2014 following the Great Recession, and 21.1% between 2015 and 2019 just before COVID-19 hit. In 2020, it is estimated that the poverty rate jumped back up to 28% or so. In sum, as far as poverty is concerned, the U.S. no sooner showed signs of progress than it was plummeted back again to a state where over one in four households would live in poverty without government assistance. After each economic cycle, the differentiation seemed to worsen.

When the Supplementary Poverty Measure (SPM) of government programs designed to lift low-income families out of poverty status (social security, refundable tax credits, etc.) are taken into account, we get the net effective poverty rate. In the 5-year period between 2005–2009, it was 13.5%. In the years following the Great Recession from 2010–2014, it rose to 15.6%. For the years from 2015–2019, it fell back to 13.4%. In other words, the differences between the period 20005-2009 and 2015-2019 were statistically insignificant.

What about another economic indicator, this one more applicable to the middle class, namely missed mortgage payments. On 1 August 2020, 32% of Americans carried outstanding mortgage payments, up from 30% in June. Further, the percentage of mortgages considered to be delinquent jumped from 3.8% in July 2019 to 6.6% in July 2020. Mortgages in default (over 90 days) rose to 4.1% on 2020 from 1.3% a year earlier. This relatively low figure given the circumstances was a consequence of the government legal measures to pause payments and legalize delays for up to 180 days. By September, 7.1% had missed mortgage payments. Note that in 2008, the percentage of mortgages that were delinquent over 30 days was over 4%. That had declined steadily until 2019 when it was less than 1%.

Compare this current situation to the 2008-2010 economic crisis. There are three classifications of foreclosure filings: default notices, scheduled foreclosure auctions and bank repossessions (called repos). The figures here cluster all three and do not differentiate between homeowner foreclosures and those against contractors or builders. On 15 January 2009, data showed that a total of 861,664 families lost their homes to foreclosure the previous year according to RealtyTrac, In 2009, the total number of foreclosure filings was 3,957,643, involving 2,824,674 properties. 2010 was an even worse and record year; 2.9 million properties received foreclosure filings — an increase of 2 percent from 2009 and 23 percent from 2008.

This suggests that the COVID-19 crisis compared to the Great Recession has hit the Middle Class with even greater force than the Great Recession, but its effects has been over a much shorter period and, therefore, affected a smaller percentage of the population and of homeowners. It is estimated that at least six million homeowners lost their homes from 2008-2010 affecting about twenty million Americans, or about 1 in 7 Americans who owned their own homes. The catastrophe was massive. The victims of the subprime mortgage crisis of 2008-2010 came largely from the lower middle working class attempting to climb into the middle class via home ownership.

Look at one of two other economic indicators – student loan totals. (I will not deal with credit card debt, a very important, but also very large issue in its own right.) By 2020, American student loan debt by 45 million borrowers, almost 1 in 7 Americans, had reached $1.6 trillion dollars. 3 million borrowers owed more than $100,000 each, 800,000 of them with debt exceeding $200,000. When Barack Obama was first elected to the Senate of the United States, he and Michele, two highly educated professionals, were still burdened with large student debts.

In 1964, the Canadian Universities Foundation in Canada set up a commission headed by Dean Vincent Bladen of the University of Toronto to estimate the financial requirements of Canadian universities and to recommend means of supplying them. One source was increased student fees. Another source was enhanced government grants if the quantity and quality of university graduates were to be increased, an increase that would be absolutely critical to the digital revolution that was then just in its infancy. In 1966, the Education Support Branch of the Department of the Secretary of State was established to coordinate assistance given to universities. Even before the Bladen Commission tabled its report, the Canada Student Loan Program (CSLP) was established.

In 1963-64, I was the Finance Commissioner for the Student Administrative Council (SAC) at the University of Toronto. I had been recruited to represent the graduate students and was elected Finance Commissioner because the SAC wanted to raise student fees from $8 to $12 per student to provide funds for students to engage in social activism. My recruitment was motivated by my social activism in the sixties as well as a seeming acquaintance with large scale financing because of my involvement in expanding student housing. I reviewed the budget and found ways to shift the cost of The Varsity, the student newspaper, to which students contributed $2 of their fees, to enhanced advertising income to make The Varsity a self-sufficient publication.

This was simply an early version of what became the American legislated PAYGO system whereby new expenditures had to be matched by cuts elsewhere. (Of course, this Republican conservative, both policy and principle, was simply set aside when it suited them.) In another application of this conservative economic approach, I also shifted the costs of the Blue and White Society of $2 per student for social activities, that largely seemed to benefit sororities and fraternities, to those who attended such events. As a result, we were able to avoid a student fee increase and shift half of the use of student fees to a budget for social activism.

As a result, I had gained enormous credit from very different ideological political camps so that when I proposed that we go before the Bladen Commission and propose raising student fees 400%, the student council went along and supported the proposal. Who had ever heard of students proposing to raise their own fees? What I had proposed was funding university educational (not research) costs entirely through student fees instead of by direct subsidies to universities. University education was an investment in human capital; higher education was not a consumer commodity. I, thus, also recommended that fees be recognized not as an expense but as a capital investment. Students would be enabled to borrow monies to invest in their own human capital and would repay the monies borrowed. That part of the proposal was eventually adopted far and wide and the proposal was greeted with front page headlines in the Toronto newspapers at the time, if only because of the shock value of students proposing to raise their own fees by 400%. The Bladen Commission also received our proposal with accolades and the statement that it was the most original proposal they had received.

However, they had ignored the second part of the proposal in which the debt incurred was to be repaid based on the return on investment. The higher the subsequent earnings of the student, the more they would repay. After all, if it was a capital investment and not an expense, the investor had to expect a return on the investment beyond the cost of the monies and sufficient to cover those cases where the student’s income fell below a certain level. Thus, if a student chose to become a Christian medical missionary in Africa, effectively his debt would be written off over time while students who went on to become CEOs or hedge fund managers would return much more than 100% over the initial investment.

I point this out to show how conventional Barack Obama’s economic thinking was, and not just about the financial system. He never recognized the huge importance of either human capital investment or the importance of supporting rather than undermining new complex financial instruments rooted in algorithms, the use of which needed to be recognized and regulated rather than perceived as a witch’s brew endangering the whole economy. Further, this failure also led to developments that eventually endangered the political system as well.