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"This risk has the potential to cause a global financial crisis"
Roubini:
Any solution to deal with economic overindebtedness must entail a reduction in the face value of the debt outstanding especially for households on the ropes and who have a strong incentive to just walk away which would be the worst outcome for borrowers, lenders, and investors
When a country (say Russia, Ecuador or Argentina) has too much debt and is insolvent it defaults and gets debt reduction and is then able to resume fast growth; when a firm is distressed with excessive debt it goes into bankruptcy court and gets debt relief that allows it to resume investment, production and growth; when a household is financially distressed it also needs debt relief to be able to have more discretionary income to spend. So any unsustainable debt problem requires debt reduction.
http://messages.finance.yahoo.com/Stocks_(A_to_Z)/Stocks_Y/threadview?m=tm&bn=25934&tid=160350&mid=160359&tof=13&off=1
The risk of a downward spiral of house prices is the primary danger facing the American economy.
Because of the structure of securitised mortgage finance, this risk has the potential to cause a global financial crisis.
Both of these problems will remain until a new policy brings stability to house prices.
Martin Feldstein, Financial Times, August 26, 2008
For decades, people had continued to pay down mortgages until their last cent was spent.
Now, increasing numbers were giving up their homes even as they continued to service other debts.
The practice has been given a name in the industry – “jingle mail” –
Financial Times, August 17, 2008
More people will post the keys to their lender and walk away.
The Economist print - Searching for Plan B - 28/2 2008
For decades, people had continued to pay down mortgages until their last cent was spent.
Now, increasing numbers were giving up their homes even as they continued to service other debts.
The practice has been given a name in the industry – “jingle mail” –
and there are even companies specialising in helping people with the decision
Financial Times, August 17, 2008
"They will focus on necessities, such as eating or paying for heating fuel.
To pay for those, they need to keep their credit cards open.
Credit cards have become an essential item for many people.”
“What if you could live payment-free for up to eight months or more and walk away without owing a penny?” the website asks.
http://youwalkaway.com/
The risk of a downward spiral of house prices is the primary danger facing the American economy.
Because of the structure of securitised mortgage finance, this risk has the potential to cause a global financial crisis.
Both of these problems will remain until a new policy brings stability to house prices.
Martin Feldstein, Financial Times, August 26, 2008
The current decline of house prices is the natural result of the bubble that by 2006 had raised house prices to 60 per cent above their long-term trend.
The sharp decline since then means that today’s prices are about 15 per cent above the trend level.
But while a further 15 per cent decline may be inevitable, there is nothing to stop prices declining even further. House prices that could overshoot by 60 per cent on the way up could also overshoot substantially on the way down.
A policy is needed that will permit the appropriate 15 per cent additional decline in house prices but end the risk of a further downward spiral.
Because of the uncertain values of mortgage-backed securities, financial institutions lack confidence in the liquidity and solvency of counterparties and even in the value of their own capital. Without that confidence, there cannot be adequate credit flows and without credit there cannot be economic activity and growth.
Negative equity mortgages are a big source of instability because US home mortgages are generally “no recourse” loans, implying that if an individual defaults on his mortgage the creditor can take the property but cannot claim other assets or income to pay the remaining loan balance.
The large and growing number of homeowners with negative equity will increase the rate of defaults and foreclosures and therefore drive the downward spiral of prices
It is this spiral that threatens the American economy and the global financial system.
The policies adopted until now will not stop the downward price spiral.
I have proposed a programme of “mortgage replacement loans” that I believe would stop the downward spiral of house prices. The basic idea is to provide an incentive to stop defaults among those who now have positive equity but are vulnerable to a further price decline.
With the mortgage replacement loan, people who now have a mortgage equal to 90 per cent of their house value would see that mortgage fall to just 72 per cent of the house value, implying that it would take a very unlikely price fall of more than 28 per cent to push those individuals into negative equity.
There may be better ideas for stopping the downward spiral of house prices, but I have not heard them.
The economy will continue to decline and the financial markets to deteriorate unless a policy is adopted to stop the downward spiral of house prices.
"The critical issue on the whole subprime, and by extension, the international financial system
rests very narrowly on getting rid of probably 200,000-300,000 excess units in inventory,"
Alan Greenspan, CNN 2007-11-06
Because US mortgages are “no-recourse” loans (lenders have no recourse to the house’s owner beyond the value of the house),
individuals with negative equity have an incentive to default.
There are now an estimated 8m negative-equity mortgages – more than 15 per cent of all outstanding mortgages.
Defaults are rising and foreclosures are now at twice the rate of a year ago.
Martin Feldstein, FT May 7 2008
A key cause of the present slowdown and potential recession was not a tightening of monetary policy
but the bursting of the house-price bubble. The Fed therefore will not be able to end the recession as it did previous ones by turning off a tight monetary policy.
Martin Feldstein, Wall Street Journal, February 20, 2008
Is the US heading into a recession?
December 16, 2007
America's economy risks mother of all meltdowns
The connection between the bursting of the housing bubble and the fragility of the financial system
has created huge dangers, for the US and the rest of the world.
Martin Wolf, Financial Times, February 19 2008
The German example shows that Britain's decision about adopting the euro is not a question of whether the time to do so is now right.
Adopting the euro is a permanent commitment with permanent consequences.
My judgment is that it would not be in Britain's long-term economic interest to accept the constraints of the single currency
Martin Feldstein, April 21, 2003