Dean Baker of the Center for Economic and Policy Research delivers a strong reproof to those (like me!) who believe that reducing consumer debt is the key to accelerating recovery.
The total amount of underwater equity is estimated at around $700 billion. Suppose that we wiped that out tomorrow. If our underwater homeowners spent 15 percent of their equity each year, more than twice as large as the wealth effect more generally, this new equity would generate $105 billion a year in additional consumption, about 0.7 percent of GDP. That's helpful, but not close to enough to get us back to full employment.
Furthermore, this impact is probably not even realistic. Let imagine someone with a median home, worth roughly $180k. We'll give $60,000 a year in income, roughly 20 percent more than the overall median. (Homeowners have higher income on average.)
Let's assume that they are 25 percent underwater, which means that they have a mortgage of $225,000. We now wipe that out, in effect giving them $45,000 of additional equity. If they spend 15 percent of this equity, it would translate into $6,750 a yearin additional consumption. Did this family earning $60,000 a year have $6,750 in annual savings that they now can divert to consumption since we set their mortgage above water? That seems unlikely. Perhaps they will borrow to support additional consumption, but how much and for how long?
