Cleaning up balance sheets

By Dave Anderson:

The big problem in the US economy right now is consumers are cleaning up their balance sheets.  People are either dealing with debt overhangs from the previous consumption binge or they fear for their future incomes due to either wage cuts or job loss and thus they pay down debt and increase their savings.  On an individual level this may be good, but in aggregate, this is a recession. 

I know my family is using our marginal dollars to improve our balance sheet.  Assuming no significant negative shocks in the next eighteen months, my family's balance sheet will be the cleanest since our wedding.  At that point, several deferred purchases will be contemplated, and our net consumption will increase. 

A few months ago, I reiterated a proposal from several dirty fucking hippy bloggers to use the Federal government's core competencies of borrowing money, writing checks, and collecting money to accelerate balance sheet clean-up:

The New
York Times has an interesting Op-ed that echoes what some 'Hog guest writers were saying in February 2009 on
a way to stimulate the economy, improve consumer cash flow and balance
sheets as well as generate some short term federal revenue... offer
consumers a chance to refinance high interest revolving debt with lower
interest debt offered by the federal government....

Going from 18% to 8% interest, the individual with $10,000 in credit
card debt would see their initial monthly payment go from $250 a month
to $167 per month.  Using a declining minimum payment formula  (monthly
interest expense +1% of current balance), the debt burden at the end of
the year is still $9,000 but the interest expense declines from $1,570
to $700.  That gap of $870 is greater than the ARRA Making Work Pay tax
credit...

This debt would be relatively secure and low-risk for the US
government to issue as the IRS could be made the collection agency for
the debt.  Long term risk could be lowered by changing the minimal
monthly payment formula so that the monthly minimum would be interest
expenses plus 1% of principal + half the savings from the interest
arbitrage.  That change would accelerate the repayment of debt while
also freeing up cash flow for consumers to either spend or save....

Since I wrote that piece, long term Federal interest rates have dropped another 45 basis points, so it would be even cheaper and profitable for the federal government to offer a one time debt restructuring deal.  It would have the advantage of increasing short term consumer cash flow so either consumption is increased in the short term, or the balance sheet clean-up efforts take significantly less time. 

The Very Serious People are coming around to this idea.  Bill Gross of PIMCO wants to use the federal government's backing of Fannie and Freddie Mac to leverage a massive refinancing scheme for fixed rate mortgages that are federally backed and where the borrowers are current on payments:

Bill Gross, who runs Pacific Investment Management Co.'s $239 billion
Total Return Fund, said that policymakers "should quickly re-engineer" a
plan that would refinance all non-delinquent mortgages backed by the
federal government. The rate on a 30-year fixed-rate mortgage averaged a
record-low 4.44 percent in the week ending Aug. 12, according to
taxpayer-owned mortgage giant Freddie Mac....

Greenlaw estimates about 18.5 million taxpayer-backed mortgages are at
rates higher than 5.75 percent interest.

This idea is structurally similar to the credit card idea.  It would free up current cash flow that could be used for either increased balance pay-down and thus balance sheet clean-up accelerates or that cash flow would be used primarily for current consumption. It would also marginally reduce the number of mortgages that go bad as the carrying cost of a house that is marginally underwater would significantly decrease.  The big losers under this proposal would be the MBS tranche holders who are only making significant money on newly purchased securities if the payback occurs over several years instead of very quickly. 

Either of these proposals would accelerate balance sheet clean-up, and right now acceleration is needed.