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Economic Reality Check
Critiquing three popular claims about housing, spending, and taxes.


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In the raucous debate over how to boost U.S. economic growth and prevent a fiscal tsunami, it is not difficult to find politicians who subscribe to one or more of the following beliefs: (1) The depressed housing market should be allowed to reach its bottom without further government intervention. (2) Making large cuts to discretionary spending is vital to future American prosperity. (3) Comprehensive tax reform must not, under any circumstances, involve the adoption of a federal value-added tax (VAT).

Three claims: each of them popular among a hefty chunk of the political class, and each of them either misguided or misleading or both.

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Start with housing. CoreLogic estimates that more than 22 percent of all U.S. residential mortgages were in negative equity (or “underwater”) as of September, and that another 5 percent were “near negative equity.” This massive debt overhang is severely hampering investment (both residential and nonresidential), business creation (because home equity is a major source of early-stage financing), and labor mobility (domestic migration has plummeted to “the lowest level since the government began tracking it in the 1940s,” according to the New York Times). After examining every U.S. economic recovery since World War II, Cleveland Fed analysts Timothy Bianco and Filippo Occhino determined that “weak household balance sheets have been an important factor behind the slower recoveries, especially the current one.”

Indeed, economists Atif Mian of Berkeley and Amir Sufi of the University of Chicago argue that household debt represents the single biggest obstacle to a stronger recovery. According to their recent survey of economic data from 238 U.S. counties with 100,000 or more residents, those counties that racked up the most household debt (relative to income) between 2002 and 2006 are now experiencing much slower growth in auto sales, residential investment, and employment than those counties that accumulated the least household debt. For example, the high-household-debt counties have seen residential investment fall by anywhere from 40 percent to 60 percent since the recession, whereas the low-household-debt counties “have almost completely avoided a decline in residential investment.”

Thus far, the Obama administration has very little to show for its efforts to stem the foreclosure crisis. As journalist Clive Crook wrote in the Financial Times earlier this year, “The administration’s housing market policies have failed because, through bad design and pitiful execution, they have modified loans mostly by cutting interest rates and extending repayments, not by reducing debt.” That must be the paramount objective — slashing household debt.

But how to do it? American Action Forum economist Ike Brannon has suggested allowing a mortgage cramdown via the bankruptcy process. Economists Glenn Hubbard and Chris Mayer of Columbia Business School (along with Absalon Project CEO Alan Boyce) have outlined a massive refinancing scheme for homeowners with government-guaranteed mortgages, predicting that it could yield up to $70 billion in annual mortgage savings. Writing in the New York Times, Harvard economist Martin Feldstein has touted a mortgage-principal-reduction strategy that would aid most underwater homeowners and purportedly cost less than $350 billion (if all eligible Americans participated).


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