The Big Question: Is the US Housing Hangover Wearing Off?

(upbeat piano music)

Hal Weitzman: Subprime mortgages, questionable lending practices, and household debt were at the heart of the Great Recession. So do they also explain why the recovery since has been so relatively sluggish? Is housing still the main factor holding back the US economy, or is there something else going on, and how can we shake off the housing hangover?

Welcome to The Big Question, the monthly video series from Capital Ideas at Chicago Booth. I’m Hal Weitzman, and with me to discuss the issue is an expert panel.

Amir Sufi is the Chicago Board of Trade Professor of Finance at Chicago Booth. He’s the coauthor along with [Princeton’s] Atif Mian of House of Debt: How They (and You) Caused The Great Recession and How We Can Prevent It from Happening Again.

Matthew Notowidigdo is the Neubauer Family Assistant Professor of Economics at Chicago Booth. A former associate at Lehman Brothers, he’s an expert on labor economics, public finance, and health economics.

And Diane Swonk is chief economist of Mesirow Financial, the financial services firm with about $85 billion under management. She’s served as an advisor to the Federal Reserve Board and the Congressional Budget Office, and she’s a frequent commentator in the financial media.

Panel, welcome to The Big Question.

Amir Sufi, let me start with you because you just got this new book out, House of Debt, in which you argue that household debt kind of fueled the Great Recession. So are we still suffering from the same problem now?

Amir Sufi: Yeah, so, I mean, I think what you want to understand in the context of what usually happens after recessions is research has pretty consistently shown that housing is a main driver of economic activity

coming out of recessions. So for example, building, what we call residential investment. And what’s happening in this recovery is that it has not been nearly as strong as it has been after other recessions.

So even though it’s now finally positively contributing to GDP growth, it’s still much weaker than we have had in past recoveries from severe recessions. So in that sense, it’s a drag on GDP relative to where it traditionally is in this part of the economic cycle.

Hal Weitzman: And to what extent does it have to do with debt specifically?

Amir Sufi: Yeah, you know, so, I mean, I think we have this huge hangover, both in terms of the physical overhang of just properties and debt overhang in the household sector. We kind of went through an experience from 2002 to 2007, which was totally unprecedented in terms of the increase in homeownership rates, in terms of the increase in leverage in the household sector. And I think households very much are still recovering from that.

Add to that the growing burden of student debt on younger Americans, the fact that many people have moved back in with their parents, household formation is very low. All of those things are kind of contributing to this very weak housing market, which is definitely holding back the economy.

Hal Weitzman: But when we think of the performance of the economy overall, housing is just one element. What about unemployment, which is a key indicator used by the Fed and everyone else?

Amir Sufi: Yeah.

Hal Weitzman: To what extent does housing, and specifically housing debt, which is the subject of your book . . .

Amir Sufi: Yeah.

Hal Weitzman: . . . drive the unemployment rate?

Amir Sufi: Right, so unemployment’s actually trickier to study with our kinds of methods because when people in one area of the country who have got hit by a hard housing shock start cutting back spending, it actually affects employment throughout the entire country, not just in that one part of the country. But what you do see, very clearly—

Hal Weitzman: Because in your book, you drill down right to—

Amir Sufi: Right. So we’re trying to look at a county. And say in Cook County, house prices fell a certain amount, and how much did employment go down? It’s a little tricky because some people make stuff in Cook County that gets shipped over to California or Florida.

So what you do see in the data, very clearly, even to this day, is that jobs in the retail sector—people working at restaurants, people working at grocery stores—those tend to be depressed, even today, in areas of the country that had really bad housing busts. So think Nevada, California, Florida, Arizona. You still, even to this day, see the unemployment rate much higher in these states, and that’s primarily driven by workers who used to work in selling goods, and because no one’s buying goods anymore in those states, at least not to the degree they were, you see higher unemployment even today.

Hal Weitzman: OK, and Matthew Notowidigdo, this is more your area as well. You’re a labor economist. Does that make sense, that housing is kind of such an important driver of unemployment, or is there maybe something else going on in these very same areas that Amir’s talking about?

Matthew Notowidigdo: Well, I think it’s an important part of the story. I’d probably be skeptical that it’s the whole story, but I don’t think that’s what they would claim either, because I think the fact of the matter is there’s a lot of other things going on in the economy that probably are contributing to the fact that we’re experiencing this very slow recovery, another jobless recovery. I mean, this is the third straight recession where many, many months after the recession has officially ended, we still see very sluggish employment growth. And I think housing is definitely an important contributor to that, but I think there’s a lot of other things that potentially are playing a major role too, such as rising trade with China, other structural changes in the economy, such as technological change that’s routinizing and automating jobs. I think these kinds of forces are also contributing to the sluggish economic growth following the end of the recession.

Hal Weitzman: OK, that all sounds very good, and we talked, of course, on the last The Big Question, we talked about exactly this issue of structural unemployment because of technology.

Diane Swonk, let me bring you in. How do we kind of gauge the extent of housing and how important housing is right now on the US economy?

Diane Swonk: Well, I think, I mean, it really is important to the extent that we’ve already pointed out that it’s holding back the recovery. It’s not going on all cylinders or anywhere near all cylinders right now. And you really see that younger, the first-time buyers are not coming in. I mean, somehow people are sort of looking at it and saying, Well, we can just sell a bunch of homes to affluent buyers. We can only build homes for affluent buyers. That’s not how our housing model is built in this country.

And without first-time buyers, which are running about 28 percent of home sales, existing home sales in the first four months of the year, that’s down from a 40 percent norm. And in what should be the most affordable housing market we have out there—it’s still highly affordable—we don’t have those young, first-time buyers coming in, both because of the overhang of student debt—they’re locked out of the market.

If they default on federally guaranteed debt, they can never qualify for a mortgage again. And on the flip side of it, we also are beginning to see something a little—and I don’t wanna make too big of a point of this—reminiscent of the Great Depression, of young people saying they’re no longer just renting because they’re saving for a home. They’re just renting because that’s where they think they’re gonna be. They don’t necessarily have their sights on a home.

And that’s changed in the last couple of years, in terms of some of the surveys that some of the places like Fannie and Freddie have done, have shown sort of the shift in what young people are thinking about and whether or not they want to buy a house, because they’ve also seen the devastation of what’s happened to their families when a foreclosure happened, or people had to stack up in a home, or they had to stay at home longer.

So there’s a real thing—

Hal Weitzman: Are you suggesting that’s a permanent thing?

Diane Swonk: I never say anything is permanent because nothing’s ever permanent in the economy. It’s always a moving target, as we know. Full employment is a moving target. Structural unemployment’s a moving target. In the 1990s, if you had a pulse, in fact—you know, when people say people aren’t getting jobs because they can’t pass a drug test, drug tests are harder in labor markets where you’ve got a lot of extra labor. Back in the 1990s, they didn’t care what you were taking. If you had a pulse, you got a job, and they didn’t screen for anything. They screen much tougher now.

So nothing’s permanent, but it does have a more lasting impact, and it certainly is shaping the contour and pace of the recovery, as we have already talked about, both in labor markets, it’s interacting with a lot of things. I think there’s a lot of state and local government issues on the labor-market issue that’s not showing up in employment that usually shows up as well. But, in general, this is having feedthrough effects that you’re not seeing the churn in a market that you once did.

Hal Weitzman: OK. Amir Sufi, let’s go back to this point about technology, secular stagnation, you know. Some of the research that Matthew Notowidigdo has done with Erik Hurst shows this trend that was sort of masked by the housing boom. How should we think about the effect of housing as opposed to some other effect?

Amir Sufi: Yeah, so I mean, I think all of these things are intertwined. I think that the stuff EriK and Matt have done with [University of Chicago’s] Kerwin Charles has been fantastic about just showing these longer-run trends. Really, it all started in the 1980s in my opinion, where you saw a big rise in inequality, and a lot of the labor-market issues that Matt basically touched upon. And what you’ve seen since the 1980s, which I think lends support to the secular stagnation idea, is a fall in real interest rates that’s been pretty dramatic throughout all of the developed world, to a point where every single economic cycle that we see, we see lower average real interest rates.

That, in some sense, is a signal that people in some sense are saving a lot. That’s what kind of drives the interest rate down. And I think the housing boom is very intimately related to this because essentially what the housing market kind of hid—and I think Matt’s research shows this quite well, and we also show that it really did drive spending. It got a segment of the population spending from 2002 to 2006 that really didn’t have great income growth, but they were able to spend to get out of that.

And so when that kind of gain, which in some sense was artificial—it wasn’t related to fundamental income productivity growth—when that gain ended, you kind of saw an even worse downturn than probably you would have seen had that gain never gone on.

And so these two ideas, this idea that the economy is struggling to continue to prop up demand and how housing markets interact with demand, I think they’re very closely related actually, and I think it’s something we gotta think of going forward because we’re not hitting the kind of real GDP growth that we should see after such a severe recession, and we got to start thinking foundationally: What’s going on? What’s wrong with the economy, and is it related to this idea of secular stagnation or inadequate demand? It should be at least on the table as a potential issue.

Hal Weitzman: Absolutely, because presumably, I mean the outlook right now is that the growth in house prices is going to slow down pretty dramatically over the next few years.

Matthew Notowidigdo, does that mean that, I mean, what does that mean for US growth generally? If house prices are rising by 4 percent, much lower than they have been the past few years, what is that gonna mean for the economy?

Matthew Notowidigdo: I think we have to turn to these other factors that we’re talking about. I mean, we’ve seen in the last few recessions that there’s an enormous decline in what we call these routine jobs. The decline in employment in the routine employment sectors has been heavily concentrated in the last three recessions, and there’s been no sign that those jobs come back after recessions end.

So if we’re looking for sources of GDP growth, we have to look for sources of employment growth in other sectors outside of what I keep calling routine employment sectors, which is manufacturing but also other occupations outside of manufacturing.

What are those sectors going to be? I mean, I tend to talk about education and health care, state and local governments, I think, is a major source. I think we need to look at these areas for potentially the source of employment growth going forward.

Hal Weitzman: OK.Diane Swonk, what’s your view on this issue?

Diane Swonk: Well, you know, it certainly is complex. I would argue we’re doing pretty well given the magnitude of the crisis we had, given the financial crisis. So yes, we had a severe recession, but of course we weren’t going to bounce back because we don’t have a financial foundation. Credit markets are still very tight. I mean, the fact that there’s another aspect that’s going on with the housing-price issue and that is we’ve got about 10 million homeowners that are still underwater, but only marginally underwater on their loans, but they can’t sell their homes or list them because they can’t cover the closing costs.

We have a lot of other homeowners that are maybe, you know, 7 percent equity in their homes, less than 10 percent? That means they also can’t make a profit and cover closing costs by listing their home.

So you don’t have first-time buyers, and then you don’t have trade-up buyers, and you don’t have churn in the market. And that churn has a lot of powerful implications for the rest of the economy. And our whole model was based on a lot of heavy churn. And so that’s one aspect. The other aspect, on innovation, I think, as we move forward, the health-care industry is now seeing, since about 2012, the bending of the cost curve in health care has been more structural rather than just cyclical.

And what we’re seeing is the composition of jobs in health care, one, they’re slowing dramatically. It’s no longer the hirer of last resort, which had been a big player of very low-educated and higher-paying jobs for a long time. That’s shifting as well.

And we also have now the movement from inpatient to outpatient, and that means you’re hiring more people that are lower wage, if you’re hiring at all. We’ve actually had months of declines on health care, and that’s what’s highly unusual in the last year. And so this is another structural shift that as you start putting innovation into health care and get rid of some of those back-office jobs, the information-technology jobs, all of a sudden you’re gonna see a lot more changes.

So you get the productivity growth and the income gains for people that are very, very highly educated that designed the programs. But like you said, some of these more traditional types jobs—

Hal Weitzman: People are left behind.

Diane Swonk: It’s a very difficult equation to break.

Hal Weitzman: It does certainly seem to feed into the whole, this big debate that’s been happening about inequalities. It seems to be kind of the other side of that debate. I wanted to ask you, though, if house-price growth slows down, as it’s expected to, is that a good thing because it means people aren’t taking on a lot of debt, or is it a bad thing because, as you described, people are trapped?

Amir Sufi: Yeah. I mean, I think we’ve kind of undergone this big transformation in the housing market. For example, homeownership rates have declined, as Diane mentioned. We don’t know whether that’s a permanent change. If it is a permanent change, you start to have to ask yourself the question, well, if house prices go up in a city where the people who kind of are at the margin where their budgets are tight enough that it might affect their spending, if they’re renters, usually increases in house prices are followed quickly by increases in rents. And so one of the points that we’ve made, my coauthor and I, on our blog very many times is that we’ve gotten so used to cheering for higher house-price growth because we think it has these benefits for the economy, both through construction and through people borrowing against their home equity to spend.

It’s not so obvious to me anymore that we want to be cheering higher house-price growth, because as Diane mentioned, it’s going to price a lot of people out of the market from buying homes that may want to buy homes.

We don’t see a lot of borrowing against home equity anymore, so that channel of kind of consumption growth is no longer there. And further, it doesn’t seem to be translating into, kind of, really robust construction growth. So we’ve actually seen a reasonably sharp rise in house prices over the last two years. There has been a rise in residential investment and construction, but it hasn’t been that large really to bring us back to kind of steady-state levels that we were at before.

So I am kind of the opinion now that we need to rethink. As a macroeconomist, I kind of need to think a little bit more about what are the ancillary benefits of house-price growth. It’s no longer so obvious now to me that we should be cheering house-price growth, and that if they level off at 4 percent growth that it would be such a bad thing for the economy.

Hal Weitzman: Diane Swonk?

Diane Swonk: I just wanted to add onto that. One of the things we haven’t really thought out is what are the collateral damage of people renting single-family homes on a much higher pace than they did in the past?

Many of them were pushed out because of foreclosure. There was the flip to rent instead of the flip to sell. And that was in many of these subprime markets. The problem is you now have many more rentals in neighborhoods that once were almost entirely dominated by ownership. And over the longer haul, what is the collateral damage to having people who don’t put sweat equity or any equity into their homes because they’re renters on the rest of home values?

It’s kind of like, you know, you don’t want to buy a rental car because people treat them really horribly. If you’re gonna buy a used car, buy my old used car, I just sold it. (laughing) But, you know, you want a car that’s taken care of well. You don’t want something that’s not taken care of well.

And I actually—you can’t make this stuff up. My brother-in-law is in the epicenter of the subprime crisis in California, in Northern California, in the Modesto area. And he had a bunch of homes they built, they rented them out, were making great margins renting them out. When the people moved out, they took all the high-end appliances, and they literally tried to pry out the kitchen sink to get the granite countertop. I mean, you can’t make that up. And they ended up putting a bunch of cheap stuff in to replace it because they took everything with them when they left.

Amir Sufi: Yeah, and that’s . . . so one question I’m really interested in—

Hal Weitzman: They call that the sharing economy, I believe.

(laughing)

The sharing, yeah. So it’s more communistic economy.

Hal Weitzman: It’s a millennial term, I believe.

(laughing)

Amir Sufi: And I’ve been actually encouraging a PhD student to work on an issue, which I think is fascinating, and that is precisely if you have higher rentership ratios, if more people are renting, what is kind of the response of the real economy—employment, you know, GDP, consumption—what is the response of those outcomes to an increase in house-price growth? So you can imagine, for example, if you have more renters, you know, at the end of the day, my washing machine is broken. I own a home, well, I may go out and buy a new washing machine. But my landlord probably isn’t gonna buy a new washing machine. They’re instead just going to fix it up and try to get it to last until the end of my contract. So I think it’s still kind of an open question from a research perspective about how big these knock-on effects are when you have high homeownership rates.

But that’s a question I think is going to be crucial for thinking about. If this is a permanent change to higher renter ratio, how it’s going to affect the economy in the long run.

Hal Weitzman: Your book makes some pretty radical proposals about how to change lending contracts. So tell us briefly, just tell us what you’re proposing.

Amir Sufi: Yeah, so I mean, one of the fundamental problems we view of debt is that the way debt works is when someone makes you a mortgage and you put in your equity, your equity is in some sense much riskier than the mortgage because you take the first loss.

And we show that that dynamic not only helps to fuel asset price booms, housing booms, but then when house prices crash, it makes it much worse because usually the people who have the equity are much more vulnerable in the sense that when they have a dollar loss in their home value, they cut spending dramatically.

So the idea we have is to try to promote better risk sharing, meaning mortgage contracts that provide lenders both some upside if house prices go up—so in some sense, if you sold your house at 10 percent capital gain, then they would get a small cut of that capital gain—and likewise, if house prices crash in your city or your neighborhood, then you would actually have your principal balance interest payments automatically reduced. It’s in some sense an automatic renegotiation and restructuring that wouldn’t rely on all these frictions that are out there that make it difficult to renegotiate when you’re underwater. So that’s the basic idea that we think could really help. It could help stop big bubbles from forming and also help to make downturns less painful in terms of their effect on the real economy.

Hal Weitzman: And you and Tim Geithner have had a conversation about whether this would really have worked.

(laughing)

Give us some sense of what would have happened had we done that.

Amir Sufi: Well, so our debate with Tim Geithner is not so much on this shared-responsibility mortgage idea, but just on the idea of what we should have done in response to the Great Recession.

And our view is that we believe that Mr. Geithner and many who think like him had too singular, narrow focus on saving the banking system. And don’t get us wrong; we didn’t think banks should fail. I mean, we think that you do need to provide strong liquidity support. But we think that this very narrow view of viewing banks as being absolutely crucial and that we needed to save banks no matter what, the way we put it in the book is “save the banks and we save the economy,” we think that view was too narrow. You needed a more well-rounded approach where you more directly took on the looming, huge household debt crisis, the foreclosure crisis.

And so what we’re basically saying is that when you start viewing the world as save the banks no matter what, then you start to see the zero-sum game, which is that if I help a homeowner, I’m hurting a bank, and I don’t want to hurt a bank, no matter what.

Our view is that actually it’s in everybody’s interests to help homeowners because ultimately it’s not a zero-sum game. We are leaving money on the table because we’re leaving so many households drowning underwater on their mortgages. And that by forgiving some debt, restructuring debt, you could actually get higher growth, which ultimately would be good for the lenders as well. So that’s the basic argument that we had.

Hal Weitzman: But what does that mean? We would have prevented the Great Recession?

Amir Sufi: So we make the argument that if you had done pretty aggressive restructuring from the beginning, you would not have been able to avoid the recession altogether, but it would have been much less severe. And, in fact, I mean, I think we need to make sure we always understand cause and effect.

The financial crisis was the effect of, fundamentally, a housing problem, which emerged way before the financial crisis really became tremendously acute. So, for example, there was legislation passed in the summer of 2008, before Lehman Brothers, that was trying to restructure debt more aggressively. It was essentially written by bankers and it was written in a way that everything was voluntary, so nothing got done. Had that policy actually been enforced, strictly, I think that we could have avoided a really severe downturn. Probably a recession was inevitable given the excesses in the housing market, but it didn’t need to be so severe.

Hal Weitzman: OK. And Matt Notowidigdo, given your research on labor markets and the automation of these routine jobs that you talk about, would that have been enough? I mean, if we just said to—

Matthew Notowidigdo: No, like Amir said, it wouldn’t have been enough. We still would’ve had a recession; it might’ve just looked like a ’90s recession instead of the Great Recession.

Hal Weitzman: But what you’re identifying is a slightly different problem. This is about technology and certain kinds of jobs. So how do you address that problem?

Matthew Notowidigdo: I mean, I think that’s a very challenging problem. Let me just praise Amir first, because I think it’s important to recognize that this view that households need to be helped, and that there’s big macroeconomic benefits from doing that, I think he deserves a lot of credit for that because a lot of policy makers were not thinking that way during the crisis, and I think it would have helped a lot. Would it have been sufficient? No, because we talked about these other structural forces in the economy, but the household balance sheets matter, and I think the economic logic is very clear here. The extent to which people cut back on consumption when their wealth falls depends a lot on what kind of household you are. And I think the way that I think about this is, why did the housing crisis look so different from the dot-com bust? I think that when you look—

Diane Swonk: There’s leverage.

Matthew Notowidigdo: . . . at the wealth distribution and leverage, and I think that starts to matter a lot. And I think Amir should get a lot of credit for pointing that out.

Hal Weitzman: Diane.

Diane Swonk: I would just push back a little bit in terms of what could be done, ’cause I know that the administration and the Fed and a lot of policy makers . . . it’s almost like a joke: “I had Hank Paulson, Barney Frank, and Chris Dodd in a room,” it starts out, but that actually was the case. And they were saying, they’re talking about, they talked about this issue, and there was no way publicly to get to the principal reduction that a lot of us thought would have been necessary. And banks would have actually welcomed that if they could have just forgiven it.

Hal Weitzman: You mean there was no way politically.

Diane Swonk: Politically! And this is one of those issues where I’m servicing my mortgage, why should they get, my neighbor get, who bought a house when they shouldn’t have bought a house and is driving around with a car that they leveraged to buy the house with? And the political outrage, you know, what Tim refers to in his book as the Old Testament, you know, an eye for an eye, sort of wanting justice out there, just did not allow for that to happen.

And there was all the talk of more moral hazard, and this, and that, but it’s kind of interesting because there is a limit to what could be done. And although I agree that, you know, I mean, they focused on the banks, and banks still aren’t lending. Let’s just call it what it is. So it didn’t work all the way they wanted it to work. That said, there is a limit, unfortunately, to deal with Washington versus, as we know, I mean, one of my worst things that I have to deal with in the world is that I spend a lot of time in Washington because they’ve not passed a psychological let alone an economics class and they don’t think that way. And they also have to deal with the populous view. And the population, as much as I agree, theoretically, with what you’re saying, and say yes, I think that would have helped, I’m not sure it would’ve gotten you quite as far as you think.

But I do think it was politically impossible to do.

Hal Weitzman: And Amir Sufi, you’re not challenging the politics, right?

Amir Sufi: No, I mean, I’m not. That’s not what our research focuses on. I do think that—

Diane Swonk: Well, it’s good policy. It’s just . . . it’s bad politics.

Amir Sufi: I think what’s interesting about this argument, which I think definitely has support in terms of you just look at the polling on the issue, is the timing is absolutely crucial. I mean, we have to remember the Rick Santelli famous rant against helping the losers with the mortgages, as he called it. The Tea Party, yeah.

Diane Swonk:That was a turning point

Hal Weitzman: The whole Tea Party—

Diane Swonk: . . . unfortunately.

Amir Sufi: That did occur in the February of 2009. And we have to remember that the TARP legislation had passed already in October of 2008. And so this sequencing of policies is surely related to the populous backlash, right? I mean, it wasn’t easy politically to pass TARP either. And that was done, and there was a lot of force put behind that.

So I agree that, of course, politically, as of 2009, these ideas didn’t have much political support, but I don’t think we should forget the sequencing of how everything happened.

I can easily understand why members of the Tea Party and Rick Santelli were, in some sense, fed up because they had already witnessed such a major bailout legislation for bankers.

And so I think, let’s hope this doesn’t happen again, but the next time this happens, I think we do have to start to think about the sequencing of how we do government intervention to see how the politics work.

Hal Weitzman: Incidentally, in a sense, you argue that this would be good for lenders and borrowers.

Amir Sufi: Yeah, I mean—

Diane Swonk: Right, no, if it was a better structure.

Hal Weitzman: So what response have you had from, I mean, from the financial world—

Amir Sufi: I think behind closed doors, a lot of lenders agree with that, and in fact, for things like Chapter 13, allowing judges to write down mortgages, I’ve heard from both people heavily involved and I think even in the press, you do see accounts of lenders actually admitting that they would be willing to go for that legislation.

But I think Diane’s right, at that point, the politics became a little bit difficult. There are, of course, and again, this is not my expertise, but based on reading the newspaper, you do see a lot of arguments in the press that the Obama administration did not put their full support behind the Chapter 13 mortgage cramdown legislation, and a lot of Democrats in the house are on record saying, we were kind of abandoned at crucial times.

Again, that’s not my expertise in understanding the nitty-gritty of the politics, but I do have some problem . . . if it’s true, then we have to think about it. But I think this notion that I’m less willing to bail out my neighbor than I am to bail out a bank, politically, I don’t know. It just doesn’t make sense to me. I think we have to think a little bit about that. If that’s actually the case, then it seems like we’ve changed a lot, for example, since the Great Depression, when it was exactly the opposite. I had less of a problem bailing out my neighbor, but I hated those bankers. So something seems to have changed.

Diane Swonk: Well, everyone still hates the bankers, I think.

(laughing)

That’s sort of a comment. No, but actually it is interesting because the cramdown to get the TARP through, it was not politically popular. Here you are, right before an election. It was kind of amazing that they got it through at all. And I mean, you know, people get upset when Tim says, well, they paid it back. They did pay it back.

That said, they’re not exactly skinny and starving right now. And I think that juxtaposition of some of the opticals of the crisis: when AIG received bonuses because they were contractually there and the government didn’t wanna revoke contracts because they couldn’t. They felt that was wrong. But there was this sort of sense of, where are we on Main Street? How can you do this to us?

And I think there’s also just a really difficult to link to people what it means to lose a credit system, even though they’re tapped into it as much as we were. They don’t really realize the intersection between Main Street and Wall Street. And so politically that’s always difficult.

But the way the legislation—well, who knows, it’s not all written yet with Dodd-Frank, but a lot of the tools that were used to do these bailouts are now gone. So that may not happen again. But the question is, what will happen the next time? Because there’s not the kind of tools you’re talking about either. And that’s really worrisome.

Hal Weitzman: So apart from these renegotiations, what could we actually do now, today, to help people who are underwater? What would you be proposing that we do?

Yeah, I mean, one obvious thing to me is just to help underwater homeowners that are solvent on their mortgage payments refinance into lower interest rates. There’s finally been a lot of success on that front with the HARP 2.0, which was basically the government’s effort to help underwater homeowners refinance. And I don’t think it’s coincidental, like I don’t think it’s just by chance that we did start to see a pickup in some durable-goods purchases right around the time HARP 2.0 came in.

I still think there are probably a sizable group of people that for whatever reason are not refinancing into the lowest interest rate that they can possibly refinance into. So there may be some room on the policy front for thinking about that.

At this point, in terms of things like eminent domain and people have been talking about doing a lot of different policies to try to write down mortgage debt more aggressively, while in principle I kind of agree, we should have done it a long time ago. It’s not obvious to me there’s a huge bang for the buck at this point. I mean, we’re far along enough in this that the people who stayed in their homes have probably adjusted their behavior.

Hal Weitzman: So it’d be no big macroeconomic effect—

Amir Sufi: Right, I think there would have been in 2009, of course. But today, it’s not obvious if five years later it would matter so much.

Hal Weitzman: Matt Notowidigdo, what should we be doing, do you think, to be, if anything, to be helping people who kind of were victims of this?

Matthew Notowidigdo: Well, the new mortgage contracts that Amir’s talking about seem really intriguing to me. The idea of limiting your gains on the upside but also not punishing you as much on the downside. But that’s not going to help today. That’s going to help the next time we have a housing boom and a housing bust. I don’t think we should lose sight of that. I mean, the cliché that you never want to let a crisis go to waste I think applies here. I mean, it’s good to set a foundation for the next time we have a major boom and bust, in either the housing market or something else.

The idea of having these sorts of mortgages that could protect people on the downside sound like a great idea to me. And I don’t want us to lose sight of that just because it might not have a big bang for the buck.

Hal Weitzman: So just to come back right now to the Geithner point, and I wonder if the moment has passed, you know? We might be already building, you’ve talked about student debt, we might be already building whatever the next crisis is, housing or otherwise.

Diane Swonk: This might be a solution though, to the next crisis, because that change in attitudes among young people about not wanting to buy, well that’s because they saw the collapse. Now, if they thought they were more hedged, they might be more willing to go back in again. And these are not just . . . there is the overhang of student debt. We have to deal with that that you can’t restructure your federal student debt.

You can never have a do-over into this economy, graduating in this economy. A lot of them with graduate-school debt. We’re not talking about just people with undergraduates. Graduate-school debt that used to be a path to not only homeownership and higher wages, but wealth accumulation. So really kind of a big change here.

That said, this could bring in some of those people who are on the margins, sort of straddling it. We don’t know if it’s like the Great Depression, where people didn’t take on debt again for awhile, but this could bring them back in. And I think whenever you’re talking about reengaging a group of people that’s a potential of would-be buyers, that’s something you wanna do, would-be buyers that are able to actually afford this rather than just renting. I think that’s an important thing.

Amir Sufi: Let me just add one final thing. You know, student debt is an excellent example, actually, of the main thesis of our book. And that is just think—and Diane hinted at this—just think about how crazy student debt works. That if you graduated in 2009, through no fault of your own, you’re facing an unemployment rate of like 20 percent. And, you know, when you took on that debt in 2005, you thought for sure—

Diane Swonk: Your clock ticks and immediately you gotta—

Amir Sufi: Right, you thought—

Diane Swonk: . . . start paying.

Amir Sufi: . . . this was gonna be good for me. And yet, the way debt works is that it doesn’t care. It doesn’t care that you graduated in this horrible job market. Your interest payment’s the same, your principal payment’s the same, and renegotiating it is almost impossible. So it’s crazy to make young Americans bear that risk.

And the ultimate consequence is young Americans are gonna start saying, look, it’s not even worth it going to college, which of course is a horrible outcome. And it’s really a product where our financial system just isn’t really working.

Diane Swonk: Or it gets into undermining the whole labor-market issue that you’re looking at. And immigration policy, which is another whole issue of keeping people that we do train here, at the higher levels, here.

But the debt issue. And also, you know, there are some people who go to college that aren’t meant to go to college. I think there are some trade skills that we don’t train for anymore. That said, we really are talking . . . people have this misconception that it’s someone with a four-year communications degree that just didn’t get a job. It’s actually a lot of people with law degrees and doctors that their wage compression has been fairly substantial and what they thought they would earn—in fact, some lawyers tried to sue, of course, their law schools because—

Hal Weitzman: Shock.

Diane Swonk: Yeah, because they didn’t—.

Yeah, shock! And they failed. Because they didn’t earn what they thought they’d earn. But yes, they went in thinking they would do one thing or stayed in school thinking they were adding on to their ability to earn going forward. And in fact, they got more indebted and still were unable to earn anything. That’s a catch-22 that you don’t wanna really—

Hal Weitzman: OK. Well, I’m sure we all feel very sorry for all our lawyer and doctor friends.

(laughing)

On that note, my thanks to our panel, Amir Sufi, Matthew Notowidigdo, and Diane Swonk.

For more research, analysis, and commentary, visit us online at chicagobooth.edu/capideas, and join us again in September for another The Big Question.

Goodbye.

(upbeat piano music)