Economists tend not to be very good at arithmetic. That's why almost all of them failed to recognize the $8 trillion housing bubble and to understand that it's collapse would wreck the economy.
Unfortunately their arithmetic (or logic) skills have not improved in the wake of the crash. Hence we have many economists telling us that the economy's problem is a debt overhang. This gets picked up endlessly (e.g. Joe Nocera's column today).
Let's think this one through for a moment. As a result of the ephemeral wealth created by the housing bubble, people ran up far more debt than would have otherwise been the case. This means that people have far less equity in their homes than in a counter-factual where house prices had never diverged from trend.
Let's say that collective indebtedness is $5 trillion greater than if there had never been a bubble. Now let's have the great god of economic correctness clap her hands and eliminate the $5 trillion in excessive debt. Do we now see a consumption boom that gets the economy back on course?
If you answered yes, you get a PhD from a prestigious economic department and flunk basic logic. Our god just destroyed $5 trillion in wealth. Any increase in consumption from this act would be the result of the difference in the propensity of the debtors to spend out of wealth as opposed to lenders. If this is even 2 percent, that would be surprising. While $100 billion in additional consumption would be a nice boost to growth, it would still leave us far from full employment. (btw, anyone who bothers to look at the data would know that consumption is still unusually high relative to disposable income, not low.)
The reality is that we need some new source of demand to replace the demand generated by the housing bubble. In the short-run, this can only be the government. This is true regardless of how much we hate or love the government. In the longer run it will have to be net exports. People who know logic and arithmetic understand this fact. Others work as economists.
I thought I would add a bit more on the ownership of mortgage debt. The vast majority of debt is held in mortgage backed securities. The holders of this debt would be comparable to the ownership of government debt, albeit with a somewhat smaller presence of foreign owners. The debt would show up in the portfolios of many individuals with 401(k)s and other retirement accounts. It would also be included in most pension portfolios. Losses in the latter would have to be made up with larger contributions in future years.
On the other side, not all the underwater borrowers should be viewed as low or even middle class. There are plenty of people who bought homes for $600k at the peak of the bubble that are today worth $300k. These people may have substantial other wealth, so they need not have reduced their consumption substantially as a result of the drop in housing values.
And of course our disappearance of $5 trillion in mortgage debt would mostly be for people who are not underwater, since there is only a bit more than $1 trillion in underwater debt. Most of the vanishing debt would be for people who owe $200k on a $300k home. Our god of economic correctness will have reduced this to $100k by extinguishing $5 trillion in mortgage debt.
Again, I would not doubt that the underwater homeowners have a higher average propensity to consume out of wealth than owners of their debt, but there is no reason to believe the latter is close to zero. I think a gap of 2 percentage points would be on the high side of the plausible.
(Only one link allowed per comment)