What is needed, they argue, is to make debt contracts more flexible, and where possible, replace them with equity. Courts should be able to write down the principal of mortgages as an alternative to foreclosure. They recommend “shared-responsibility mortgages” whose principal would decline along with local house prices. To compensate for the risk of loss, lenders, they reckon, would have to charge a fee equal to 1.4% of the mortgage, or receive 5% of any increase in the value of the property.
Pointer from Mark Thoma. “They” are Mian and Sufi, in House of Debt. Avent argues similarly that student loans should have an equity component.
What these forms of bad debt have in common, in my view, is that they reflect clumsy social engineering. Public policy was based on the idea that getting as many people into home “ownership” with as little money down as possible was a great idea. It was based on the idea of getting as many people into college with student loans as possible.
The problem, therefore, is not that debt contracts are too rigid. The problem is that the social engineers are trying to make too many people into home “owners” and to send too many people to college. Home ownership is meaningful only when people put equity into the homes that they purchase. College is meaningful only if students graduate and do so having learned something (or a least enjoyed the party, but not with taxpayers footing the bill).
As long as we still have these sorts of public policies, monkeying around with the nature of the loan contract is simply doubling down on clumsy social engineering.
Why not simply require home buyers to take a short futures position in a Case-Shiller index for their city? I understand this is only possible if there is an index for the city in question, but it seems to be an idea worth exploring further.
The futures position would hedge against city-wide price risk (unrelated to how the owners improve the house–or fail to do so), leaving only house-specific, idiosyncratic risk. (The latter important to avoid moral hazard problems.)
> Why not simply require home buyers to take a short futures position in a Case-Shiller index for their city?
1. Market distortion. What does this index market look like beforehand, and who is taking the other side of these bets?
2. Implementation. Government mandate? Or gradual self-adoption by banks as a mortgage requirement? Or?
Reynolds’ Law: “Subsidizing the markers of status doesn’t produce the character traits that result in that status; it undermines them.”
http://philoofalexandria.wordpress.com/2010/09/25/reynolds-law/
If the public policy goal of student loans is to increase the education level of the society as a whole, then I don’t see why can’t after a time let student loans be discharged in bankruptcy with the surrender of the underlying credential, as well as sealing the record of it being conferred. Society has gained a more “educated” member, but the former student does not reap the benefits of the credential they defaulted on. The student could, as those who fail to graduate, trade on the knowledge they gained in their college career.
Now, if the public policy is to increase the number of individuals holding credentials, that seems to me to have a lot of negative impacts on society and few overt positive ones.
Why do you think that too many students are going to college? Maybe default rates are high because it’s a risky investment, not because educating marginal students yields little return. Indeed, “the United States now ranks 12th in the world in the percentage of young people who have earned a college degree”.
http://www.nytimes.com/2014/05/18/magazine/who-gets-to-graduate.html?_r=0
It seems like you are referring to a different “the problem” than Sufi and Mian, who seem focused upon the recent recession. From their perspective, while social engineering may produce adverse outcomes, it doesn’t necessarily explain the last decade unless society became MORE engineered. The second derivative discussion is why otherwise valid criticism of GSEs could be largely dismissed as a cause of “The Great Recession.”