Munich Personal RePEc Archive

Collective Household Economics: Why borrowers rather than banks should have been rescued!

De Koning, Kees (2016): Collective Household Economics: Why borrowers rather than banks should have been rescued!

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In a series of lectures Dr. Ben S. Bernanke , the former Chairman of the Federal Reserve, discussed the two main responsibilities of central banks-financial stability and economic stability. Financial stability is achieved by central banks standing ready to act as lenders of last resort by providing short-term liquidity to financial institutions, replacing lost funding. For economic stability, the principal tool is monetary policy; in normal times that involves adjusting short-term interest rates.

Dr. Bernanke admits that when the U.S. financial crisis occurred in 2007-2008, no government entity was in overall control of the measures that needed to be taken to counteract the crisis. This was seen as a managerial shortcoming.

There were various other factors at play, which made it difficult for governments to deal with and contain the crisis. The demand for new homes seemed to be out of touch with reality. The shift in borrowing patterns for new homes was taken for granted rather than being scrutinized. The freedom to introduce poor quality mortgage products was left unchallenged. The widespread conversion of long-term mortgage debt into daily liquidity products through securitization was also left to market forces. However what resulted in the financial crisis being unduly prolonged and at much greater expense was that, in sharp contrast to the focus on support for lenders, no serious consideration was given to help the legions of mortgage borrowers who found themselves in trouble.

Financial stability won over economic stability; put simply, there was no plan ready to be implemented to assist the 21.3 million households who were faced with foreclosure proceedings during the period 2006-2013. There was also no plan for the homeowners of the 5.8 million homes that were repossessed. Financial stability measures were not for the short term either. The balance sheet of the Federal Reserve as at 7th January 2016 still shows a holding of $1.747 trillion in mortgage-backed securities and $2.461 trillion in U.S. Treasury securities; several years after they were acquired. For the mortgage sector this still represents 18.5% of all outstanding mortgages as at same date.

In September 2007, a few members of Congress pushed for direct federal aid to help homeowners in trouble, but most members did not want to spend substantial taxpayers funds on the problem. With the benefit of hindsight, the latter view may be regarded as a serious error of judgment. As this paper will show, the total costs of helping homeowners in trouble would have been $1.173 trillion over the period 2007-2013, which is less than the $1.747 trillion in mortgage bonds still on the books of the Fed. More importantly the U.S. government debt increase would have much lower than the nearly $9 trillion over the period 2007-2014. The only choice on the table should not be between economic growth or inflation, but between individual households’ income stability or instability. Income instability is a major cause of recessions.

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