Edward Gramlich, a former member of the Federal Reserve System’s Board of Governors (1997-2005), recently became the Urban Institute's first Richard B. Fisher Senior Fellow. An expert in macroeconomics and public finance, he got involved in affordable housing issues at the Federal Reserve. He has written America's Second Housing Boom, a new brief on the benefits and risks of the subprime mortgages offered to lower-income buyers. Dr. Gramlich's book, The Rise and Fall of the Subprime Mortgage Market, will be released by Urban Institute Press in May.

Five Questions Archives

February 1, 2007

1. What are your priorities after a decade in government?

Asset building and ownership, for one. In the past, people zeroed in on how much incomes figure into welfare. That's great. But asset building matters too because that's the way that people develop wealth.

My first project on housing fits right in because low- and moderate-income people generally build wealth through owning a house. Housing is a predominate form of wealth for all families, even into the top echelon.

The housing situation is complicated greatly by a serious debt-burden problem. Families with high debt levels are in a risky position already, and many of them took out even more debt to buy their house. There's evidence that the foreclosure rate may jump, causing big social problems as families lose homes and plunge more into debt.

With some assets, like IRAs [Individual Retirement Accounts], you just put money in and that's it. If you miss a few payments, it just means that there's less money in the account. With housing, it doesn't work that way—if you miss too many payments and get foreclosed on your house, you lose virtually all of the equity you had accumulated in the house.

The stakes are much higher for housing. The foreclosure problem, and where that may lead, is what got me interested in this issue at the Federal Reserve.

I also may do a project for the World Bank on urbanization for emerging market countries. Workers earn more in the cities than in the country. That sets up a very difficult social problem because, without careful planning, the population will flood to the cities and have trouble getting housing and jobs. It puts a strain on the social services. Not that you want to keep people down on the farm, where they don’t make any money.

2. How will affordable housing play out in this year's budget?

Rent subsidy programs will probably be level funded, so that won't help much or hurt much. The fundamental problem is that these programs aren't structured very well.

The other problem with housing is the subprime mortgages. Many of them have been taken out under very risky circumstances. The subprime mortgage of choice is an adjustable rate mortgage. Short-term rates have been very low. So adjustable rate mortgages on very good terms have been available. But that period is over.

The short rates have gone up and a lot of these mortgages are in for a big payment shock. Many people have borrowed to the end of their resources. Groups studying this issue are projecting pretty significant increases in foreclosures. There's not too much the federal budget has historically done about that. It really is a question of restructuring personal debt.

Now I do have some ideas on changing the rules of the game of subprime credit markets. It's very important and I hope Congress will get interested. [House Financial Services Chairman] Barney Frank already plans to hold hearings.

3. What should people watch as the budget process unfolds?

There are several critical issues to watch. One is the deficit. The deficit problem is not one of imminent financial collapse. It is one of long-term appropriate macroeconomic management. Everyone here would love to see Congress get the deficit under control, particularly over the long run. But I'm a bit dubious that it will happen.

There is always the entitlement problem. Short-term, there is going to be a war of numbers. If you want a guide on this war of numbers, you have to keep your eye on two things. One is whether the military costs are fully priced in. The administration funds Iraq on a series of supplemental spending bills, so it's hard to see the real costs.

The other thing is the alternative minimum tax [AMT]. If you leave it alone, it brings in a huge amount of revenue. But the AMT affects millions of people. This is a very large tax bill. Congress has typically indexed it so it brings in about the same amount of revenue as it did the previous year. It's often not counted in the budget, so you have to be careful about how it's treated.

In terms of whether anyone is serious about budget change, you have to just wait and see. But in terms of honest budgeting, I'd keep my eye on the AMT.

4. What big-ticket items might be tackled in the next two years?

We may not be far from thinking about national health insurance. We've got 47 million people without insurance. Of course, they really are covered. If they go into hospitals, they get treated. Then it gets loaded onto everyone else in a very inefficient way. Our health system is breaking down in some fundamental sense.

What's happening is that states like Massachusetts and California are starting to establish universal health care. The last thing we need is to have 50 different state programs. We aren't that far away from the time that we really have to confront this as a nation.

It will be costly. Whether the aggregate costs go up is not that clear. It will bring costs out into the open, and will certainly seem costly.

But the country can't go on much longer without confronting health care. Every year we sweep it under the rug. At some point, we can no longer do that.

With Medicare and the prescription drug program, it's certainly possible to do some fine-tuning. But I'm pessimistic about doing anything in Social Security. I do think that President Bush poisoned that debate a couple years ago with his push for private accounts.

A lot of people would accept individual accounts if they came on top of regular Social Security benefits. But if you carve them out of Social Security, no Democrat will support the plan.

Solving Social Security needs presidential leadership and the Democrats and Republicans in a room—and you have to get them to agree to hold their noses and come out with something. That was done in 1983, and it can be done again.

The preconditions don't strike me as being there right now for a compromise. Social Security is a wonderful issue to demagogue your opponent with. Somehow you have to change the dynamics. Frankly, I think the next president will have a better chance.

5. What's your advice for the new Congress?

I would love to see them do something about the budget. I would love to see them work toward honest budgeting—on the AMT and military. I would love to see them go to some pay-go rules so if there is some measure that busts the budget, attention gets paid to financing. And I would really love to see them make some reforms in entitlement spending.

The most we can hope for is that we get back some fiscal responsibility. I'm a little skeptical, but I would love to see it.

I also think Congress is going to have to confront health insurance—some sort of universal benefits plan. We can't keep letting all the states do it without at some point thinking that the national government should do this. It will happen, not because anyone wants it to happen, but because the issue is forced by rising health care costs and state action.

Health care may not necessarily get done in the next couple years, however, because Congress is facing such highly divisive issues as Iraq. It may not be the time to get together and compromise on things like health insurance or Social Security.

Congress might be able to help with housing. I could see measures against predatory lending and perhaps payment shocks in subprime mortgages passing without huge budget implications. But these issues definitely are not center stage.

Monetary policy is one thing in pretty good hands. After a century of working at it, I think the Fed is operating well. Of all the problems that we have, there is one that we don't have—inflation. We've actually gotten that under control.