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The Mod Squad: Why Conservative Economists Back Mortgage Modification

By Zachary Roth and Daniel Gross

It's hard to remember now, but Rick Santelli's famous February 2009 rant, credited with launching the Tea Party movement, was an attack on the idea of using mortgage modifications to help struggling homeowners. "In terms of modifications," Santelli asked, "how many people want to pay for your neighbor's mortgages that has an extra bathroom and can't pay their bills?"

The rest is history.

So why is it that, 32 months later, a growing list of prominent conservatives are touting the idea of large-scale, taxpayer-funded modifications? An ancient journalistic rule holds that three instances of a given occurrence constitutes a trend. If so, we've definitely got a trend of right-leaning economists pushing for borrowers who got in way over their heads to be bailed out.

Ladies and gentlemen, meet The Mod Squad.

Kenneth Rogoff, the Harvard economist who advised John McCain in the 2008 campaign, has become something of an oracle on dealing with the overhang of debt crises, in part because he's co-author of the encyclopedic This Time is Different: Eight Centuries of Financial Folly. As he wrote in an August Financial Times op-ed: "We need to either find a way to reduce what [underwater borrowers] owe or to raise the value of the homes securing the loans, or some of both."

Martin Feldstein, the Harvard economics professor who served as President Reagan's top economics adviser, last week penned an op-ed in the New York Times that contained a bold solution. The plan: cut underwater mortgages down to 110 percent of home value, "with the government absorbing half of the cost of the reduction and the bank absorbing the other half." In the case of the huge number of loans owned by Fannie Mae and Freddie Mac, he notes, "the government would just be paying itself." Borrowers who take up the offer would have to accept responsibility for the mortgage—i.e., the loans would become "full recourse" and the borrowers could no longer walk away from them. Total estimated cost: $350 billion.

Then there's Columbia Business School Dean Glenn Hubbard, who served as Chairman of the Council of Economic Advisers from 2001 to 2003, and currently advises GOP candidate Mitt Romney. Writing in the Financial Times on Tuesday, Hubbard says it would be a good thing "if every homeowner with a mortgage through Fannie Mae and Freddie Mac who makes payments on time were allowed to refinance their mortgage rates at the current low rates."

Even Romney himself sounds open to the notion. "I think the idea of helping people refinance homes to stay in them is one that's worth further consideration," he told the Las Vegas Review-Journal in an interview Tuesday. "But I'm not signing on until I find out who's gonna pay, and who's gonna get bailed out."

Mortgage modifications have been a key pillar of the progressive response to the economic downturn--and they've been one focus of the Occupy protests that have sprung up across the country. The Obama administration offered its own such program in 2009, though it has helped far fewer homeowners than anticipated, thanks to a flawed design. But until lately, conservatives had by and large opposed the idea, arguing, as Santelli did, that taxpayers shouldn't be forced to pay for borrowers' bad decisions, and that banks shouldn't have their actions constrained by government.

So what's changed? By and large, policy hands and political leaders alike recognize that the economy isn't going to get better on its own, at least not any time soon. There's a widespread consensus that until the United States tackles the massive overhang of housing debt -- American homeowners' wealth has fallen by a stunning 40 percent since 2006 -- the economic recovery won't gain steam. As Feldstein wrote: "The fall in house prices is not just a decline in wealth but a decline that depresses consumer spending, making the economy weaker and the loss of jobs much greater." Rogoff, too, views the crushing volume of personal debt as an unaffordable drag on growth. "Simply put, you can't operate an economy where huge numbers of people are desperately in debt and have no real way out," he argues.

Hubbard originally offered a modification plan in 2010 as a way to avoid another "costly stimulus package" designed to spur consumer demand. But he, too, may also recognize that mortgage modification, though necessary for the health of the economy, is likely to be politically unpopular. If so, better to have President Obama take the hit, rather than a future Republican president — like, say, President Romney.

Of course, right and left don't see entirely eye-to-eye on the issue. Dean Baker, an economist with the liberal Center for Economic and Policy Research, last week slammed Feldstein's plan as too soft on banks and a bad deal for struggling homeowners. And it's hard to imagine that Republicans in Congress would react favorably to an aggressive mortgage modification proposal from the Obama administration.

But these days, even baby steps toward unity count as a good thing. And as the elections drag closer and the economy continues to slog along, expect the Mod Squad to grow in numbers.

Zachary Roth co-wrote this piece. He is a senior national affairs reporter with Yahoo! News, The Lookout.

You can email him at zacharyiroth@yahoo.com; follow him on twitter @zackroth.

Daniel Gross is economics editor at Yahoo! Finance.

Email him at grossdaniel11@yahoo.com; follow him on twitter @grossdm.