Economist Dean Baker shares thoughts on what went wrong and how to fix it
By Ted Henson, board member
Economist Dean Baker is co-founder and co-director of the Washington, D.C.-based Center for Economic Policy Research, a progressive think tank dedicated to the study of economic and social problems and to the education of the public about issues at the center of major policy debates. Baker is the author of several books including “Taking Economics Seriously” (MIT Press) and his analyses have appeared in numerous major publications.
Recently, Street Sense co-founder Ted Henson met Baker for an interview about everything from the impact of the nation’s mortgage crisis to the dilemma of homelessness to the long journey out of the recession. Here is a sampling of that interview.
Street Sense: When Street Sense began in 2003, homeless individuals were marginalized in many ways and not covered in the daily press. The foreclosure crisis has changed that. On May 31, the New York Times had an article on people who stopped paying their mortgages, which are worth way more than the actual value of their home, and decided to instead spend their money on their businesses, making ends meet, etc. What would you say to people who are facing foreclosure or who are underwater in their mortgages, and the bank is unwilling to work with them on modifying their loan or lowering their rate? Should they stop paying their mortgage and walk away?
Baker: People do have to recognize that there is a cost if you do decide to walk away because it hurts your credit rating if you want to buy a home again in three or four years. It’s going to be hard to buy a car or to borrow money to get a car. There’s definitely going to be a cost to that. So I wouldn’t suggest that people be cavalier on it. On the one hand, you have this moral worldview that we should honor our contracts. At the same time, you have this business worldview. Now, the businesses are playing by the business worldview.
I think people should approach their mortgages as a business proposition. What the contract says is that if you don’t pay the mortgage, they get the house. If you are following the law and the law is that if you don’t pay your mortgage, they can go to court and say that they are taking the house back from you, then you’ve followed through on the terms of the contract. In many circumstances, what you might be paying on the mortgage far exceeds what you’d pay in rent for a comparable place. If you owe much more than what the house is worth or might be worth in the foreseeable future, then it might very well make sense to walk away from it.
Street Sense: You have been advocating for some time now on passing legislation that would allow people facing foreclosure the right to rent their house from the bank at a fair market value. Could you describe how this strategy is better than forcing banks to modify loans through lower interest rates or lowering the principal amounts, as is being encouraged through the Making Homes Affordable program?
Baker: That strategy is not better in any and all cases. I don’t think that all loan modification programs are bad. But the issues you have to look at are who is getting the money at the end of the day, what it looks like for the homeowner and what it looks like for the bank. If you have a modification where the homeowner is still paying more on their mortgage than they pay to rent a comparable unit and they’re not likely to end up with equity in their home, then whatever the government has put up there really is money to the bank and not to the homeowner. If, on the other hand, you are getting a real principal write-down, the person has a reasonable hope of having equity and they are paying something comparable to what they’d pay to rent a similar unit, then that’s a good thing.
In terms of the right to rent, there are a few things that it does. Right away, it gives people housing security. There is the presumption that you have to be able to pay market rent, but in many of the areas there is a huge difference between what people might be paying on a mortgage and what would be the market rent for a comparable unit.
The right to rent is also a great bargaining chip because you’ve immediately handed a great stick to the homeowner that says the bank cannot just throw them out on the street. For the bank, foreclosure is now a much less attractive option.
Finally, the right to rent prevents the downward spiral that we see in many communities where you get vacancies that bring down the property values because they aren’t kept up, are drug houses or whatever it might be.
The programs helps to keep the homes occupied, which is something that is very valuable. So, I think that it’s a way of doing three very useful things immediately. If you change the law, it can help everyone in the jurisdiction. It can be done at the state level and a lot of states are already considering it.
Street Sense: So much of this conversation has been focused on how to help homeowners. Have we gone too far down the road of pushing homeownership at the expense of housing policies, i.e. rent control or affordable housing?
Baker: Yes, absolutely. People keep saying that it’s the American Dream. That’s fine if people have that dream, but I think that the policy should be focused on giving people good housing and recognize that we are going to have a lot of renters. If you look through this whole bubble period, we started back in the early 1990’s with about 64 percent ownership rates and we peaked in 2006 at around 69.7 percent.
So, even at the peak, we had over 30 percent of households who were renters. Going from 64 percent to 69 percent was a big change in the scheme of things. But, you still had more than 30 percent being renters. So, if we have a policy that says “if you are a renter you are no one,” that’s a large chunk of the population that we are writing off. So, I think what we have to do is recognize that we’re always going to have a large number of renters.
For a lot of people, it makes sense to rent because they are in unstable family situations or unstable employment situations. Therefore, it doesn’t make sense to spend all of the money associated with buying a home because of all the transactions costs, the closing fees, etc…and then, you know, to be in a situation where you might be selling two or three years later. That’s just a waste. So it makes perfect sense for these people to be renters. And we should make it so that renting is a good housing option and not “you’re a second class citizen.”
Street Sense: As an economist, what are the main causal factors that you see behind the growing epidemic of homelessness?
Baker: I think that there are two major factors going on. One is on the income side. You’ve had a deterioration in income for people with less education. They haven’t exclusively suffered, but basically people without college degrees have been falling behind for the last 30 years. They are much less likely to have substantial savings. Even during the years that they are working, they are unlikely to have substantial savings.
So, if they get a setback, such as an illness that keeps them from working, or they get laid off, they are much more vulnerable because they don’t have money sitting in the bank. It’s a family situation, too. They’re less likely to have a friend or relative who can lend them money because the people they hang out with are also going to be in the same situation. So, I think that you have a lot more people living much closer to the edge.
The other part of the story is that you’ve had a run up, which is particularly true in the bubble years, in housing prices. In many areas in inner cities, land has become much more valuable. So the idea of using it for transitional housing, something that would be a relatively low-valued commercial proposition, it’s much less appealing. You have developers who are going to want to fight and say, “No, we want this land to put up condos.”
That’s certainly been the story in D.C. where you have seen that. You’ve had a lot of areas that might have offered relatively low-cost housing options but are now empty. But they are still very expensive condos, or at least they are trying to sell them for very high prices.
Street Sense: It seems like there could be more policy solutions to bring in affordable housing if that’s really what we valued.
Baker: Right. People talk about this being the market. Let’s say that you have someone who is in the 33 percent tax bracket and they have a million-dollar home and an $800,000 mortgage on it. Say they are paying 6 percent a year interest. So, you’re paying almost $50,000 a year in interest and you are writing off $17,000 a year on your taxes.
So, imagine we had an idea where we wanted the government to subsidize low-income units at the rate of $17,000 a unit,.People would go nuts. But how about onetenth of that? The idea that maybe we should have some subsidy here shouldn’t be so outrageous. But when it gets thrown out there politically, people just jump up and down because the subsidies for higher-end housing are less transparent – or at least people don’t realize that they are there – but they are very,very real.
Street Sense: In past periods of great economic turmoil, leaders have often promoted sweeping progressive reforms and legislation. During the Great Depression, the New Deal gave rise to massive public works projects, labor reform that lead to a dramatic increase in unionization, Social Security and other reforms.
In the 1960’s was the Great Society, which led to Medicare and Medicaid, and most notably, the War on Poverty, which spawned many programs, including food stamps, Head Start, Job Corps and the Volunteers in Service to America (VISTA). Over the past two years we have seen a collapse in the financial system. The housing bubble has decimated individual wealth and sent millions of homes into foreclosure. State and local budgets are hemorrhaging which is resulting in a severe contraction in social safety net spending. Why have we not seen a similar scope of sweeping reform as we saw in the ‘30s and the ‘60s—even though Democrats have had huge majorities in Congress—particularly on jobs, labor reform, a public option in the health care bill and continuation of the stimulus? Have we moved too far to the right?
Baker: It is interesting. I often wonder what would have happened had McCain been elected rather than Obama because I think Obama has been a force stemming more action from the left. I think part of it is that there really is disarray on the left side of the spectrum in the sense that…I don’t think that many people feel confident that we know what to do. You go back to the ‘30s, and…I think labor was better positioned going into that that.
And you had the Communist Party which was an important force in a lot of these movements, especially union organizing. So you still had that tradition. Whereas right now I think that there is this real kind of disarray, like, “What is the progressive position?”
I think there’s a lack of three things. One, a lack of organization. Two, not a clear idea of where we want to be going because I don’t think that there’s any type of consensus. And three, the whole lack of confidence.
Street Sense: What do you see as our most pressing policy priorities to continue our trek out of the recession?
Baker: Getting back to something close to full employment really should be the first priority. My personal favoriteis the workshare program because it is successful and relatively cheap in the scheme of things. Germany and the Netherlands have effective workshare programs.
The idea is that if we can’t increase output enough to fully employ people, at least not quickly, then why don’t we have everyone work fewer hours so that everyone can be working. The joke I make about this is that here in the United States we’re experiencing the downturn with double digit unemployment, and in Germany they are experiencing it with shorter work weeks and longer vacations. You can talk about having a society where your income isn’t dependent on employment, but realistically we’re not there and we’re not likely to be there any time soon.
People are dependent on their jobs for their income, and in many cases, their self-respect or their self-esteem. Again, maybe they shouldn’t be, but they are. So I think that whatever we can do to get back to full employment quickly should be the top priority.
Street Sense: You predicted the housing bubble in 2002. Why did so many other economists miss it?
Baker: I think that it’s a few things. One is that there is remarkably little independent thought among economists. There are very few people who feel confident enough in their views to sort of say, “Oh, here’s something out in the world that’s a big deal,” because they are looking at what the other person, who they think is very well respected, is saying.
They don’t want to say something that’s very different from what that person is saying. I’m sure that happens in every profession, but I think that clearly happens a great deal among economists.