Helicopter money or a risk sharing approach?

De Koning, Kees (2016): Helicopter money or a risk sharing approach?

Abstract

The U.S. financial crisis of 2007-2008 clearly illustrated that some mortgage borrowings became not only a curse for investors, but equally for individual households with a mortgage and for all homeowners; for the employed who lost their jobs, for pension funds and last but not least for the U.S. government which saw its debt levels skyrocket.

Money invested in U.S. mortgage-backed securities came from around the world and this resulted in a crisis in the U.S. becoming an international financial pandemic.

Why did the crisis occur, how did it happen and what could have been done to avoid it happening?

The prevailing wisdom in the years 1997-2007 was that house prices in the U.S. were the result of supply and demand factors and therefore should not be subject of government intervention. The 2007-2008 financial crisis disabused the world of that notion in a dramatic fashion.

The main driver of the crisis was the use of borrowed funds to acquire homes. Buyers’ (and bankers’ funding) sentiment was to buy in the expectation that the rise in house prices would compensate for the interest costs. The prevailing interest matted less than the potential gains.

Table 1 in the paper shows how fast both the outstanding mortgage level and the annual increase in household real estate values grew over the period 1997-2005.

What was overlooked, however, was what the economy could bear in terms of borrowed funds as compared to its National Income (or its near equivalent of GDP).

A dynamic yet stable debt-to-income level offers the best prospects for economic growth, not just in one year, but also in the long run.

No effective action was taken to stop the excessive mortgage lending growth over the period 1997-2006; no effective action was taken to stop the deterioration in the quality of mortgage products on offer, especially from 2004 onwards; no effective action was taken to stop or diminish the risks from the securitization and internationalization of mortgages.

In the paper a number possible policy options will be explored: a “traffic light system, a “mortgage quality control system” dealing with subprime mortgages and their securitization and a “lender of last resort for individual households” option.

The suggestion is that some “helicopter money” is used in the lender of last resort option. The risk sharing approach is an option when banks individually do not follow what is required in macro-economic terms.

• Item Type: MPRA Paper
• Language: English
• Keywords: Federal Reserve, financial crisis, mortgage lending in U.S., an early warning traffic light system, a mortgage quality control system, helicopter money, National Mortgage Bank, macro-economic mortgage risk assessments, a Macro-economic Reserve policy system.
• Subjects: E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles; E - Macroeconomics and Monetary Economics > E3 - Prices, Business Fluctuations, and Cycles > E32 - Business Fluctuations ; Cycles; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E51 - Money Supply ; Credit ; Money Multipliers; E - Macroeconomics and Monetary Economics > E5 - Monetary Policy, Central Banking, and the Supply of Money and Credit > E58 - Central Banks and Their Policies; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook; E - Macroeconomics and Monetary Economics > E6 - Macroeconomic Policy, Macroeconomic Aspects of Public Finance, and General Outlook > E61 - Policy Objectives ; Policy Designs and Consistency ; Policy Coordination

References

• Federal Reserve Bank of St. Louis: Balance Sheet of Households and Non-profit Organizations, period 1996-2015, Liabilities in Home Mortgages;

• Federal Reserve Bank of St. Louis: Balance Sheet of Households and Non-profit Organizations: period 1996-2015, Owners Equity in Real Estate;

• Ben S. Bernanke: The Courage to Act, W.W.Norton & Company, New York, ISBN 978-0-393-24721-3; published 2015;

• Federal Reserve Statistical Release: Factors Affecting Reserve Balances, Thursday 2nd June 2016;

• Congressional Research Service: The Increase in Unemployment Since 2007 by Linda Levine, January 24 2013, Congressional Research Service, 7-5700, www.crs.gov, R41785

• Treasury Direct; U.S. Government: Historical Debt Outstanding 31st December 2007 and 31st December 2015

• Kees De Koning: “Are Countries Prepared for the Next Recession?” 20th March 2016; IDEAS Repec Org. MPRA 70209