In response to the New York Times article "Matters of Principle" co-authored by Professor John Geanakoplos and Professor Susan P. Koniak. The article appeared on Thursday, March 5, 2009
Dear Professors Susan P. Koniak and John Geanakoplos:
I am writing in response to your joint article, "Matters of Principle", in today's edition of the New York Times. As my response, I would like to refer you to the 5th question on my "FAQ on Current Financial Crisis", which I had sent out to economists at several top schools, including Yale, Berkeley, Stanford, Harvard, Columbia and Chicago in October 2008:
"Q5. Why have the markets for mortgage securities continued to remain illiquid?
A. The main reason that the markets for mortgage securities have been illiquid for a prolonged period of time is that the home-owner who is the only party with a credible and serious interest as a buyer of the mortgage securities has been shut out of the market. Instead of directly involving the home-owner, Wall Street has been peddling bizarre theories about risk management that has resulted in this huge mis-allocation of this $700 billion recently. By providing the information for a direct match-up of the home-owners on Main Street and the security-owners on Wall Street, the government could implement a low-cost eBay-type bidding system that would enable the home-owners to bid for the various tranches in the mortgage securities issued on their homes -- those tranches that the banks want to get rid of. This way the home-owners stand to benefit from a reduction in their debt obligations. The security-owners gets a floor on the prices of the mortgage securities and because of the decent prices, their capital gets replenished. Moreover, the home-owners' debt reduction can be structured in a way that encourages good behavior, and timely re-payment of the rest of the mortgage loan. This process would cost less than $1 billion for the government and achieves the objectives of liquidity and re-capitalization stated in the $700 billion bill. In addition, this direct match-up plan reduces foreclosures by reducing the home-owner's debt. Professor Martin Feldstein has also proposed a plan to reduce foreclosures. In his plan the government re-negotiates the home-owners' loans to provide debt reduction through low-interest loans, in return for enhanced claims on the home-owner. In my plan, the government's role is solely to provide reliable information."
(Written in October 2008)
Please note that, unlike your solution, my solution does not suffer from the moral hazard problem. (The moral hazard is that homeowners who had sincerely paid all their mortgage dues are ignored and the irresponsible homeowners are being bailed out).
My solution also has the unique feature that it helps to unwind the complexity of the financial products in a natural and smooth manner. One of the major problems about the current economic crisis was that the financial industry had created financial instruments that were so complicated and arcane, and that these instruments had been used so pervasively that there was a huge systemic risk even if the status quo is altered slightly. In my solution, I connect the security-owner directly with the home-owner in a win-win deal, so that the unwinding of the complex financial system happens automatically.
Professor John Geanakoplos had proposed solutions twice earlier and had appeared on CNBC television channel each time to explain his solutions. I must say his solutions, along with Professor Martin Feldstein's, were more thoughtful than the others I have seen so far. But none of the solutions proposed in public come close to my solution for solving the mortgage crisis.
When I proposed my solution in October 2008, there were three prevailing views at that time. Professor Paul Krugman was writing in his New York Times blogs that the government not doing anything is not a solution, which I took to mean that the government must spend hundreds of billions of dollars to solve this crisis. Professor Nouriel Roubini went further and actually said that trillions of dollars would be required by way of fiscal deficits to avoid the Great Depression. Professor Kenneth Rogoff was writing that America has a lot of money to spend, and a lot more things must go wrong before the America economy would suffer serious damage.
I suppose that because of these prevailing views, my solution (which spends only $1 billion) was ignored. So, now that trillions of dollars has been spent in the five months since October 2008, and with no end to the mortgage crisis in sight, I am hoping that my solution would be taken more seriously. Thank you.
Sincerely,
T V Selvakumaran
Note:
(i) There is a correction to my e-mail. I had mentioned that Professor John Geanakoplos had written two earlier articles on the mortgage crisis. In fact, on at least one of them as well, Professor Susan P. Koniak was his co-author. However, I only saw Professor John Geanakoplos appearing on CNBC on the two earlier occassions following the publications of his articles on the mortgage crisis.
(ii) I had copied the above e-mail message to the following list of professors of economics:
Martin Shubik, Yale University
Philippe Aghion, Harvard University
Kenneth Rogoff, Harvard University
Martin Feldstein, Harvard University
Paul R. Krugman, Princeton University
Avinash K. Dixit, Princeton University
George Akerlof, University of California, Berkeley
Robert J. Shiller, Yale University
Kenneth J. Arrow, Stanford University
Gary S. Becker, University of Chicago
Edmund S. Phelps, Columbia University
Vernon L. Smith, Chapman University
Nouriel Roubini, New York University
Robert Engle, New York University
Joseph Stiglitz, Columbia University (e-mail bounced)
Dear Professors Susan P. Koniak and John Geanakoplos:
I am writing in response to your joint article, "Matters of Principle", in today's edition of the New York Times. As my response, I would like to refer you to the 5th question on my "FAQ on Current Financial Crisis", which I had sent out to economists at several top schools, including Yale, Berkeley, Stanford, Harvard, Columbia and Chicago in October 2008:
"Q5. Why have the markets for mortgage securities continued to remain illiquid?
A. The main reason that the markets for mortgage securities have been illiquid for a prolonged period of time is that the home-owner who is the only party with a credible and serious interest as a buyer of the mortgage securities has been shut out of the market. Instead of directly involving the home-owner, Wall Street has been peddling bizarre theories about risk management that has resulted in this huge mis-allocation of this $700 billion recently. By providing the information for a direct match-up of the home-owners on Main Street and the security-owners on Wall Street, the government could implement a low-cost eBay-type bidding system that would enable the home-owners to bid for the various tranches in the mortgage securities issued on their homes -- those tranches that the banks want to get rid of. This way the home-owners stand to benefit from a reduction in their debt obligations. The security-owners gets a floor on the prices of the mortgage securities and because of the decent prices, their capital gets replenished. Moreover, the home-owners' debt reduction can be structured in a way that encourages good behavior, and timely re-payment of the rest of the mortgage loan. This process would cost less than $1 billion for the government and achieves the objectives of liquidity and re-capitalization stated in the $700 billion bill. In addition, this direct match-up plan reduces foreclosures by reducing the home-owner's debt. Professor Martin Feldstein has also proposed a plan to reduce foreclosures. In his plan the government re-negotiates the home-owners' loans to provide debt reduction through low-interest loans, in return for enhanced claims on the home-owner. In my plan, the government's role is solely to provide reliable information."
(Written in October 2008)
Please note that, unlike your solution, my solution does not suffer from the moral hazard problem. (The moral hazard is that homeowners who had sincerely paid all their mortgage dues are ignored and the irresponsible homeowners are being bailed out).
My solution also has the unique feature that it helps to unwind the complexity of the financial products in a natural and smooth manner. One of the major problems about the current economic crisis was that the financial industry had created financial instruments that were so complicated and arcane, and that these instruments had been used so pervasively that there was a huge systemic risk even if the status quo is altered slightly. In my solution, I connect the security-owner directly with the home-owner in a win-win deal, so that the unwinding of the complex financial system happens automatically.
Professor John Geanakoplos had proposed solutions twice earlier and had appeared on CNBC television channel each time to explain his solutions. I must say his solutions, along with Professor Martin Feldstein's, were more thoughtful than the others I have seen so far. But none of the solutions proposed in public come close to my solution for solving the mortgage crisis.
When I proposed my solution in October 2008, there were three prevailing views at that time. Professor Paul Krugman was writing in his New York Times blogs that the government not doing anything is not a solution, which I took to mean that the government must spend hundreds of billions of dollars to solve this crisis. Professor Nouriel Roubini went further and actually said that trillions of dollars would be required by way of fiscal deficits to avoid the Great Depression. Professor Kenneth Rogoff was writing that America has a lot of money to spend, and a lot more things must go wrong before the America economy would suffer serious damage.
I suppose that because of these prevailing views, my solution (which spends only $1 billion) was ignored. So, now that trillions of dollars has been spent in the five months since October 2008, and with no end to the mortgage crisis in sight, I am hoping that my solution would be taken more seriously. Thank you.
Sincerely,
T V Selvakumaran
Note:
(i) There is a correction to my e-mail. I had mentioned that Professor John Geanakoplos had written two earlier articles on the mortgage crisis. In fact, on at least one of them as well, Professor Susan P. Koniak was his co-author. However, I only saw Professor John Geanakoplos appearing on CNBC on the two earlier occassions following the publications of his articles on the mortgage crisis.
(ii) I had copied the above e-mail message to the following list of professors of economics:
Martin Shubik, Yale University
Philippe Aghion, Harvard University
Kenneth Rogoff, Harvard University
Martin Feldstein, Harvard University
Paul R. Krugman, Princeton University
Avinash K. Dixit, Princeton University
George Akerlof, University of California, Berkeley
Robert J. Shiller, Yale University
Kenneth J. Arrow, Stanford University
Gary S. Becker, University of Chicago
Edmund S. Phelps, Columbia University
Vernon L. Smith, Chapman University
Nouriel Roubini, New York University
Robert Engle, New York University
Joseph Stiglitz, Columbia University (e-mail bounced)
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