Historically, Sufi said, “places that have bigger recessions usually have stronger comebacks.” But his calculations showed that since the end of the recession, places with high levels of debt have not had robust recoveries.
Other economists — from both political parties — were making the same point around the time Obama came to office. Blinder, a Clinton administration official, and Martin Feldstein, a Reagan administration official, developed plans calling on the government to commit hundreds of billions of dollars to restructure millions of mortgages with lower interest rates and principal balances.
Said John Geanakoplos, a Yale economist who proposed a plan to reduce principal: “I think the missed opportunity to forgive principal at the end of 2008 and beginning of the 2009 was the biggest mistake the administration made in trying to deal with the crisis.”
The Obama view
The architects of the Obama administration’s response to the recession — Summers and Geithner — knew all too well the problems of a debt overhang.
The two had begun their public service careers — Geithner at the Treasury Department, Summers at the World Bank — in the shadow of the Latin American debt crisis. A tough-minded rescue plan by Treasury Secretary James A. Baker III had failed and been replaced by a more generous one by Baker’s successor, Nicholas F. Brady, that finally helped Latin America shed its debt.
As Obama took office, Summers would note how the Brady plan had succeeded where the Baker plan failed. But although the new Obama administration had hundreds of billions of dollars in unspent financial bailout money available to use, it decided against any significant program to reduce the debt of underwater homeowners.
“No one was in doubt that debt overhangs were an important problem,” Summers said recently at a conference. But despite exploring many proposals, the administration did not see a plan that did not have the potential to cause “effects worse than the cure,” he said, such as cratering the financial system by forcing banks to absorb huge losses.
At a more basic level, officials simply did not believe that a big program of debt forgiveness was a smart investment, costing hundreds of billions of dollars — money that it preferred to spend on a massive economic stimulus package that could much more quickly lift the economy. The administration also announced a more modest program designed to avert foreclosures by reducing mortgage payments but not the total debt balance.
In late 2009, the economy started to grow at a pace of 4 percent per year — fast enough that employment would have returned to normal by just about now. But in 2010, growth sputtered to 2 percent. The administration responded with more stimulus. But the pattern repeated itself in 2011 and this year.
Today, administration officials say they do not see the mortgage debt overhang primarily at work. Rather, they say, foreign shocks, cuts in local and state spending, and other factors dragged down the economy.
Still, in the past year, Obama has expanded programs to try to better tackle mortgage debt, announcing more federal funding to write down loans and an expanded program to allow underwater homeowners to refinance.
The efforts seem to have had positive effects. A greater number of underwater borrowers have reduced their principle balances and been able to refinance, and the housing market has had a modest recovery.
Not everyone is impressed, though. “I don’t see the kind of aggressive approach that could make a big difference,” Romer said in September at Hofstra University.
Many people still have a long way to return to normal, pre-boom levels of debt. Although Americans racked up $5 trillion in new mortgage debt before the crisis, they have erased only about $1 trillion of it, according to the Federal Reserve. Research by Karen Dynan of the Brookings Institution shows more than 10 percent of families would have to save all of their income for six months to pay down the debt they accumulated in the boom years.
“The housing sector is far from being out of the woods,” Federal Reserve Chairman Ben S. Bernanke said last week. “We should not be satisfied with the progress we have seen so far.”