Esther Gibbons, Flickr

Forgiving portions of underwater mortgage loans could reverse the deleveraging process that locks the US in an “economic quagmire,” according to a USA Today article quoting SFI External Professor and Yale economist John Geanakoplos.

He says the economy is trapped in a deleveraging cycle, which is a collapse of credit, or leverage. “Deleveraging is a painful process that takes a long time to get out of because everyone is paralyzed,” he says, and one of the “only ways to get out of it is to find a way to forgive some of the debt.”

This paralysis is exemplified in the broken housing market, which originally precipitated the downturn. Unfreezing the housing market could reverse the leverage cycle, and to do so, Geanakoplos suggests that lenders rewrite mortgage debts to reflect current market values. Forgiving the portion of a mortgage that holds homeowners “underwater” would allow those currently trapped by their mortgages to sell their homes at reduced prices and begin spending again.

Geanakoplos is best known for his research and proposals suggesting revisions of economic theory to account for behavioral dynamics and other complex mechanisms that influence world financial markets.

Read the USA Today article (August 8, 2011)

Geanakoplos’s August 2010 paper on leverage cycles