There’s actually legislation to incentivize the blowing of whistles where tipsters can get back as much as 30% of what the IRS recovers from their tips (and, of course, the agency shields their reputation).  But as Drucker reports:

The IRS whistle-blower program — created by Congress in 2006 to boost tax revenue by giving incentives to tipsters — has become the place where allegations of tax avoidance go to die. Over the past five years, more than 1,300 claims have been filed against almost 10,000 companies and individuals, alleging tax underpayments of at least $2 million apiece.

Just three awards have been paid. The IRS won’t disclose the total dollar amount. Taxpayers annually owe $385 billion more than the IRS is able to collect, the agency said.

How can this be?  We desperately need revenue but we’re leaving hundreds of billions on the table.  How “Greek” of us.

There are numerous reasons, some of which come out in Drucker’s piece.

First, most of the bucks owed in the tax gap are from income sources that are very tough for the IRS to identify, like sole proprietorships, which could be a one-person, cash-only operation.  The Obama administration goes after a bunch of this compliance stuff in their budget, but it only scores as collecting an extra $10 billion over 10 years.

But the flavor of Drucker’s piece gets at a number of deeper problems, ones that could be fixed if we had the political will to fix them.  First, Congress doesn’t always want the IRS to get tough with tax cheats.  If they did, they’d give them the resources they need.  Just last year, staff were cut 6%, including tax collectors, auditors, and customer service reps.  A recent report by the national taxpayer advocate concluded that the IRS is “woefully understaffed” to efficiently deal with a newly demanding problem: identity theft.

And the tax code isn’t exactly getting simpler.  In fact, one expert I know who has focused on these issues for years called the code “almost unenforceable.”  For example, in one of the cases reviewed in the Drucker piece, questions were raised as to whether a firm in question was abusing the research tax credit by claiming the credits for workers not engaged in actual research.  A former employee pointed out that “…it was common to shoehorn employees’ job descriptions into positions that would help generate credits.”  And that’s just one of the hundreds if not thousands of activities privileged by the tax code.

Then there’s the institutional reluctance by the whistleblower unit to go after cases like the one featured in the piece regarding a firm named Alliantgroup.

The reluctance of the IRS to talk directly to whistle-blowers is common, according to lawyers who file such claims.

The IRS generally doesn’t permit its most knowledgeable examiners — field agents handling audits — to speak to the whistle-blowers at all, the agency says. That is because of fears of accidentally sharing confidential information with whistle-blowers, said Marty Basson, an attorney who retired last year from the IRS office that handles those claims.

As the agency debated what to do about Alliantgroup, one IRS official expressed misgivings, according to internal correspondence.

“On one hand it makes sense to reject” the claim, [she wrote]. “On the other, they’re (Alliantgroup) getting just what they want because they know we probably won’t audit these mid-size” companies.

When the foxes know the farmer isn’t guarding the henhouse don’t expect to collect a lot of eggs.

We’re not Greece, but the more we ignore the tax gap and the less we invest in and strengthen an IRS that can collect taxes owed, the more we share that one very troubling characteristic with them.

This is the same Jamie Dimon who chose London as the place to make highly-risky derivatives trades that have lost the firm upwards of $2 billion so far – and could leave American taxpayers holding the bag if JPMorgan’s exposure to tottering European banks gets much worse.

Dimon’s foreign affair is itself proof that unless the overseas operations of Wall Street banks are covered by U.S. regulations, giant banks like JPMorgan will just move more of their betting abroad – hiding their wildly-risky bets overseas so U.S. regulators can’t control them. Even now no one knows how badly JPMorgan or any other Wall Street bank will be shaken if major banks in Spain or elsewhere in Europe go down.

Call it the Dimon loophole.

This is the same Jamie Dimon, by the way, who at a financial conference a year ago told Fed chief Ben Bernanke there was no longer any reason to crack down on Wall Street. “Most of the bad actors are gone,” he said. “[O]ff-balance-sheet businesses are virtually obliterated, … money market funds are far more transparent” and “most very exotic derivatives are gone.”

One advantage of being a huge Wall Street bank is you get bailed out by the federal government when you make dumb bets. Another is you can choose where around the world to make the dumb bets, thereby dodging U.S. regulations. It’s a win-win.

Wall Street would like to keep it that way.

For two years now, squadrons of Wall Street lawyers and lobbyists have been pressing the Treasury, Comptroller of the Currency, Commodity Futures Trading Commission, SEC, and the Fed to go easier on the Street for fear that if regulations are too tight, the big banks will be less competitive internationally.

Translated: They’ll move more of their business to London and Frankfurt, where regulations are looser.

Meanwhile, the Street has been warning Europeans that if their financial regulations are too tight, the big banks will move more of their business to the US, where regulations will (they hope) be looser.

After the Basel Committee on Banking Supervision (a global financial regulatory oversight body) came up with a new set of rules to toughen bank capital and liquidity requirements, European officials threatened to get even tougher. They approved a new system of European regulatory bodies with added powers to ban certain financial products or activities in times of market stress.

This prompted Lloyd Blankfein, CEO of Goldman Sachs, to issue — in the words of the Financial Times — “a clear warning that the bank could shift its operations around the world if the regulatory crackdown becomes too tough.”

Blankfein told a European financial conference that while Europe remains of vital importance to Goldman, with less than half of the bank’s business now generated in the U.S., the introduction of “mismatched regulation” across different regions (that is, tougher regulations in Europe than in the U.S.) would tempt banks to search out the cheapest and least intrusive jurisdiction in which to operate.

“Operations can be moved globally and capital can be accessed globally,” he warned.

Someone should remind Dimon and Blankfein that a few years ago they and their colleagues on the Street almost eviscerated the American economy, and that of much of the rest of the world. The Street’s antics required a giant taxpayer-funded bailout. Most Americans are still living with the results, as are millions of Europeans.

Wall Street can’t have it both ways – too big to fail, and also able to make wild bets anywhere around the world.

If Wall Street banks demand a free rein overseas, the least we should demand is they be broken up here.

In the upside-down world of regressive Republicanism, McConnell thinks proposed legislation requiring companies to disclose their campaign spending would stifle their free speech.

He describes the current push to disclose the sources behind campaign contributions as a “political weapon,” used by the Democrats, “to expose its critics to harassment and intimidation.”

Harassment and intimidation? It used to be called accountability to shareholders and consumers.

Five members of the Supreme Court think corporations are people. Mitt Romney agrees. And now the minority leader of the Senate – the highest-ranking Republican official in America – takes this logic to its absurd conclusion: If corporations are people, they must be capable of feeling harassed and intimidated if their shareholders or consumers don’t approve of their political expenditures.

Hell, they might even throw a tantrum. Or cry. Corporations have feelings.

This isn’t just whacko. It also defies law and logic. What are corporations anyway, separate and apart from their shareholders and consumers? Legal fictions, pieces of paper.

And whom do corporations exist for if not the people who legally own them and those who purchase the products and services they sell?

Clearly, McConnell doesn’t want corporations to be forced to disclose their political contributions because he and other Republicans worry that some shareholders and consumers would react badly if they knew – and thereby constrain such giving.

And the reason McConnell and other Republicans don’t want any constraint on corporate political giving is most CEOs are Republicans who want to use their firms – and the money their shareholders legally own – as secret slush funds for the Republican Party, funneled through front groups like the U.S. Chamber of Commerce and Crossroads GPS.

Such nonprofits have spent significantly more than Super PACs on elections since 2010, according to the Center for Public Integrity and Center for Responsive Politics. Nonprofits have spent $95 million on elections since 2010, while Super PACs, which are required to disclose their donors, have spent $65 million, the Centers found.

Crossroads GPS has disclosed on its tax returns that 23 donors to it have each given $1 million or more to finance its campaign activities so far this year. But Crossroads claims status as a nonprofit under IRS rules – a “social welfare” organization” that doesn’t have to disclose its donors – even though anyone with half a brain knows its overriding purpose is to influence elections.

McConnell and other Republicans conveniently forget secret campaign money was at the heart of the Watergate scandals forty years ago. And that even the Supreme Court in its heinous “Citizens United” decision upheld the constitutionality of disclosure requirements on corporations and other outside groups.

Mitch McConnell wants to give some cover to his Republican colleagues who will be voting later this month or early next month on the bill to force full disclosure of corporate political expenses. But his speech at the American Enterprise Institute doesn’t provide cover. It cloaks the whole Republican enterprise in hypocrisy.

Before the vote, they all tried to assuage investors, saying in essence that they had big guns ready to deal with the uncertainty of a victory by the anti-bailout Syriza party. The important thing to watch is whether such guns — loans not just to banks but to sovereigns themselves, a lower borrowing rate from the ECB, less punishing austerity requirements, larger backstop funds — go back in holsters. If they do — if Europe’s policymakers go back to the same muddling strategies that have prevailed thus far — then the answer to what’s changed is: nothing.

Re 2, if nothing’s changed then Europe continues to be a threat to our already wobbly recovery. My guesstimate is that the e-zone recession is currently sucking 25-50 basis points off of U.S. GDP growth on an annual basis. So if GDP ends up growing around 2 percent this year, absent the e-zone recession, it might have grown as much as 2.5 percent. A Greek exit would have probably made that impact worse sooner, so I don’t think the election outcome hurts us more than we’re already hurting.

Next, a thoughtful treatise on the fiscal cliff from the NYT editorial page. I think the process they lay out is the right one. Don’t panic, but start planning now for a quick trip down the fiscal slope that is reversed with a compromise involving the partial can-kick I describe here.

We should all be aware, however, that this sensible plan assumes that the politics of January 2013 are considerably better — where “better” means more open to compromise — than the politics of today.

Next, a nutty attack on the Affordable Care Act by Robert Samuelson at the Washington Post. None of it makes sense — reverse the polarity of almost every bullet point in there and you’ll have it right. But for now, let me just hit on the claim that healthcare reform is a jobs killer.

The ACA /jobs question has far more moving parts than Samuelson’s lazy “If you increase the price of labor, companies will buy less of it. Requiring employers to buy health insurance for some workers makes them more expensive, at least in the short run.” There are parts of the bill that raise costs, parts that lower them (subsidies for low-income families and small employers), parts that have no impact (firms with fewer than 50 workers are exempt from the coverage mandate), and important from a labor demand perspective, parts that significantly raise health coverage.

This very non-lazy analysis by Holahan and Garrett suggests these are all likely to offset each other re jobs impact, but we won’t know until we see how things pan out. Which leads me to this particularly germane analysis of which Samuelson is apparently unaware (though HuffPo has it). It’s a case study of a natural experiment of sorts: since Massachusetts has implemented a version of healthcare reform quite similar to the ACA, the study asks how has job growth fared in Massachusetts relative to neighboring states that presumably faced similar economic conditions. And the answer is: no differently at all.

Massachusetts has achieved its goal of near-universal health insurance coverage under its 2006 health reform initiative, with no indication of negative job consequences relative to other states as a result of health reform.

I’ve often disagreed with Bob Samuelson but I’ve also often found his arguments to be well-researched. The fact that he either didn’t bother to do the requisite research on this question or is ignoring the best work to date on the topic suggests ideology over empirical evidence. And that’s exactly what we don’t need right now.

Years ago, students discovered a loophole in the system. The first round of bidding for the fall quarter took place before the first-year students showed up on campus — we wanted to give second-year students time to plan. As long as first-year students were bidding for first-year courses and second-year students for second-year courses, no problem arose. But second-year students soon realized that they could bid for popular first-year courses before the first-year students arrived and then “sell” them back at higher prices. This increased their number of points, which they could use to bid for other courses.

When this tactic — arbitrage, an economist would call it — became known, the faculty was divided on how to treat the students who had taken advantage of it. Some were furious and wanted to punish the students who gamed the system. Others thought that the students should be not punished but congratulated for their cleverness. I was not so sanguine. I thought it was unfair to punish the students, since they hadn’t broken any rule. But their opportunistic behavior had undermined the system, creating no benefits for the rest of the business school community and in fact producing a net loss.

This apparently simple question — Should we, as teachers, condemn, condone, or praise their behavior? — raises a broader one. Should economists be ivory-tower scientists who teach facts and not morals? Or should we take a moral stand — and if so, which one?

Most successful firms tend to develop a corporate culture that centers on key values that are shared by the employees and enforced throughout the organization. Integrity, for example, is a value identified by 70 percent of the companies belonging to the Standard and Poor’s 500 Index.

In part, these values are meant to make companies look good, but there is more to them than that. Employees often face trade-offs between the company’s interests and their own. Should I push for higher sales at the end of the quarter to make my yearly bonus, even if this reduces the quality of the product? Should I overlook the declining value of the company’s assets, so that the reported profits are not affected, leading to a higher bonus? Should I discount my product so that I can temporarily boost sales and sustain the perception of high growth that supports my stock price (and thus my stock options)? While incentives can be designed to minimize these problems, they can hardly eliminate them; the problems are inevitable, short of a complete identification between the individual goals and the corporate goals. So companies create values that draw the line beyond which trade-offs aren’t acceptable. When a company touts excellence as a value, for instance, it communicates to its employees that no compromises will be allowed in the pursuit of excellence. The same could apply for integrity and other values.

The role of these values is twofold. First, they establish a rule of behavior for employees who might not know how to operate in certain situations. Second, they make it easier to screen out employees whose own values are most at odds with the company’s. It is much easier for a firm to enforce a zero-tolerance policy than a more nuanced one. Thus the corporate world does recognize the benefits of internal norms.

When it comes to market-wide norms, however, no company is big enough to reap the benefits of creating a better market system. Why should any company care about making norms that enhance the functioning of the whole market? Companies, as we saw earlier, prefer to consolidate their market power. So who does have an interest in creating market-wide norms?

Business schools. They have the greatest interest in the long-term survival of capitalism, especially the superior American version of capitalism. They are — or should be — the churches of the meritocratic creed. So they should lead the effort to impose some minimal norms for business — norms that discourage behavior that is purely opportunistic even if highly profitable. For this reason, we should have frowned on the Booth students who exploited the loophole in the bidding system. We should likewise frown on behavior that we recognize as detrimental to the long-term survival of the free-market system.

Asking business schools to stigmatize all behavior that does not maximize welfare would be absurd. They shouldn’t be expected to shame or criticize a company for using the market power that it has legitimately acquired through innovative patents. They also shouldn’t be expected to denounce a company for taking advantage of the tax loopholes present in the system. I regularly teach my students how to exploit the tax benefits associated with corporate borrowing, and I don’t consider it unethical. The preferential tax treatment of debt is —  at least in principle — designed to stimulate companies to borrow more, just as the deductibility of mortgage interest is designed to subsidize people who borrow to buy a house. While I do not consider it a good law, I do not feel bad about advocating its use as long as it is on the books.

There is a difference, however, between taking advantage of existing tax loopholes and lobbying aggressively to have those tax loopholes created or expanded. What about marketing policies targeted to prey on addiction or to induce young customers to smoke? Is making money the only metric we should reward and admire in business leaders?

Business schools have a powerful enforcement mechanism: the way they treat their alumni. The schools celebrate their most prestigious alumni, for instance, and they reward the others by providing access to a valuable network of connections. In awarding prizes to outstanding alumni who adhere to economically useful norms, and by expelling from the network those who do not, they could send a powerful message. But they generally choose not to do so. In fact, they often seem to tolerate, if not foster, business behavior that is immoral and sometimes even illegal.

Consider the insider trading case involving the Galleon hedge fund. Raj Rajaratnam was convicted and sentenced to eleven years in prison; McKinsey director Anil Kumar pleaded guilty, and Rajiv Goel, a managing director of Intel, pleaded guilty too. They had all been classmates in the same business school earlier in their lives. Was this just a coincidence?

Unfortunately, academic research seems to suggest that university friends, such as Kumar, Goel, and Rajaratnam, may well share confidential information. The research shows that portfolio managers place larger bets on firms with directors who are their college friends and acquaintances, earning an 8 percent higher annual return on these investments. A benign interpretation of these results is that college friends know each other well; thus a portfolio manager would have an advantage in judging the quality of a CEO he went to school with. But this benign interpretation is difficult to reconcile with the finding that the positive returns are concentrated around corporate news announcements. Why would your intimate knowledge of the CEO’s personal qualities help you earn a better return  … right around the time of a corporate news announcement? Isn’t it more likely that some information has leaked your way? Business schools should do more to eradicate such behavior.

While insider trading is illegal and should be punished by the law, behaviors that are legal but not socially desirable could be effectively stamped out with a shaming from the business community, including the business school alumni network. Money should not be the only criterion of success by which alumni are recognized. A business school would never honor a businessman who made his fortune selling pornographic movies. Why should it honor somebody who has become wealthy preying on people’s addictions or marketing a financial instrument designed to dupe unsophisticated investors? In fact, business schools should actively shame this kind of behavior by criticizing it publicly.

Most business schools do offer ethics classes. Yet these classes are generally divided into two categories. Some classes simply illustrate ethical dilemmas without taking a position on what people are expected or not expected to do. It is as if students were presented with the pros and cons of racial segregation, leaving them to decide which side they wanted to take. Other classes hide behind corporate social responsibility, saying that social obligations rest on firms, not individuals. I say “hide” because a firm is nothing but an organized group of individuals. As the 2010 Supreme Court decision Citizens United v. Federal Election Commission affirms, we should not impose burdens on corporations that we do not want to impose on individuals. So before we talk about corporate social responsibility, we need to talk about individual social responsibility. If we do not recognize the latter, we cannot talk about the former. Business schools should stand up for what they think is the individual responsibility of a good capitalist.

Adapted with permission from “A Capitalism for the People: Recapturing the Lost Genius of American Prosperity,” by Luigi Zingales.  Available from Basic Books, a member of The Perseus Books Group.  Copyright © 2012.

Don’t push that snooze button! The jargon might be thick, but in the middle of a massive foreclosure crisis, Mayopoulos’ comments spoke directly to the most contentious issue in housing finance policy today: how to keep Americans in their homes. It’s a question that divides not just Democrats and Republicans, but also the executive branch of the government itself. Because you can make a good case that for all practical purposes Mayopoulous works for the federal government; and yet, his position on “principal reduction” is at direct odds with President Obama’s. That’s a big deal. The collapse of the housing sector precipitated the economic crash. Fixing it is crucial to enabling a sustainable recovery. And yet, despite years of effort, in the all-important domain of housing finance, the White House has proven itself unable to execute its agenda.

Principal reduction (or, as it is sometimes more coarsely known, “cramdown”) allows homeowners who are “underwater” on their mortgage — i.e., they owe more to the bank than their home is worth — to get real relief and avoid possible foreclosure. Simply put, the owner of the mortgage agrees to “write down” the amount owed by the borrower, so the mortgage shrinks in size to match what the house can be sold for.

One out of every five Americans with a mortgage owes more than their home is worth — that’s 10.7 million mortgage holders with a total negative equity of $700 billion. When you’re underwater on your mortgage, it is very difficult to refinance. Many housing activists — joined relatively recently by the White House — have long believed that the best way the government can end the housing crisis and ease mass economic hardship would be to convince — or force — mortgage-owners to grant large-scale principal reduction to millions of underwater homeowners.

Estimates vary widely on the economic impact of principal reduction, but an aggressive effort to ease the burden of negative equity by Fannie Mae could affect millions of homeowners. Fannie Mae is the largest owner of mortgages in the United States. Along with its sibling mortgage giant, Freddie Mac, it accounts for about half of all the mortgages in the U. S. — a massive amount of loans worth around $5 trillion. Which means Tim Mayopoulos’ opinion carries serious weight. If he steered Fannie Mae in the direction of principal reduction he could help bring an end to the ongoing foreclosure nightmare and spur a true housing sector recovery. But right off the bat, Mayopoulos made clear that principal reduction is not on his to-do list.

And here’s the rub. The Obama administration wants — or says it wants — principal reduction. And for all intents and purposes, the government owns Fannie Mae. Originally a quasi public-private entity referred to with the weasel words “government-sponsored enterprise,” Fannie Mae was essentially nationalized during the housing crisis in a bailout that cost taxpayers hundreds of billions of dollars.

You buy it, you own it, right? So how is it possible that the new CEO of an institution that is basically a fully taxpayer-funded government agency can be directly at odds with White House policy?

Over the past year, a narrative has emerged, fueled by White House leaks and congressional denunciations, that holds one person responsible for the Obama administration’s failure to get Fannie Mae and Freddie Mac to engage in principal reduction. His name is Edward DeMarco, a lifelong career government bureaucrat who currently serves as the director of the Federal Housing Finance Agency — the regulator charged with overseeing Fannie and Freddie.

DeMarco has been steadfast in his opinion that principal reduction is a bad idea. His reasoning is straightforward: Principal reduction, he argues, would mean further financial losses for Fannie and Freddie, which would then have to be made up by taxpayers. Since the FHFA is not only Fannie and Freddie’s regulator, but their conservator as they try to emerge from bankruptcy and pay back the government for its bailout, DeMarco’s legal responsibility, as he sees it, is to steer Fannie and Freddie back to profitability.

DeMarco’s numbers have been challenged; many housing activists argue that, in the long run, foreclosures cost more to administer than renegotiating mortgages with principal reduction. Furthermore, they argue, taxpayers will benefit more from an improving economy spurred by significant housing relief than from a profitable Fannie Mae and Freddie Mac.

The details get pretty wonky. But the big picture is this: By his own account, DeMarco is very pleased with the choice of Mayopoulos to run Fannie Mae. So the most significant aspect to Mayopoulos’ ascension to the CEO position and his ensuing comments is in how they bolster DeMarco’s apparent ability to resist pressure from the White House and congressional Democrats. That pressure has been fierce. Led by Elijah J. Cummings, the ranking Democratic member of the House Committee on Oversight and Government Reform, and with support from Shaun Donovan, secretary of Housing and Urban Development, DeMarco’s critics have, over the last few months, pressed him vigorously. On May 1, Cummings released documents that purported to show that FHFA’s own research had concluded that principal reduction would save Fannie and Freddie money. But so far, the attacks have made little impact.

In this narrative, congressional Republicans play a supporting role aiding and abetting DeMarco’s supposed obstructionism. DeMarco is only the acting director of the FHFA. In 2010, President Obama nominated his own pick for the job, North Carolina banking regulator Joseph Smith, but Senate Republicans blocked it. Richard Shelby, R-Ala., the ranking member of the Senate Banking Committee, based his opposition specifically on his belief that Smith would force banks to offer principal reduction. In the conservative ethos, principal reduction is just another bailout for homeowners who have only themselves to blame for getting in over their heads.

Sound familiar? Obama wants to do right by the country, but is blocked by Republicans protecting banks. We’ve seen this before, right?

But there are some problems with this narrative. First off, there’s the niggling issue that for the first two years of his administration, during which Obama had the greatest latitude to execute his agenda, the White House did not vigorously support principal reduction as a way of addressing the crisis. Mortgage lenders hated the idea of “cramdown” and the administration did not press the issue. Indeed, Obama is actually technically responsible for appointing DeMarco to his position as acting FHFA director in August of 2009. It was only after the 2010 midterms, when Obama lost his ability to push legislation through the House, that his administration started to take a more aggressive tone on principal reduction.

As for Republican obstructionism, Obama’s critics argue that he could have replaced DeMarco with a recess appointment, or simply fired him for not following administration policy. This is another contentious point. The director of an independent regulator like FHFA is supposed to only be firable for “cause” and it’s not clear that a disagreement on housing policy finance fits that category. But the critics say that’s just quibbling. Bruce Judson, a former senior faculty fellow at the Yale Management School, who writes frequently on housing issues in a regular column for the Roosevelt Institute, believes Obama could get his way, if he really tried.

“If he wanted DeMarco out, he would be out,” said Judson. “But Obama has never said ‘this man is not serving the country, I am asking for his resignation.’ Do you think DeMarco could last a minute in Washington after that?”

DeMarco has even flipped the table on Obama, and argued that the real problem with principal reduction is that it would be another big giveaway to the banks, a theory that has gotten some prominent media play. The four biggest banks own a massive amount of secondary loans on underwater properties, and according to DeMarco’s reasoning, it will be easier for them to collect on those loans if the principal involved in the primary mortgage gets written down.

Some circumstantial support for DeMarco’s position can be found in the fact that William Dudley, president of the New York Federal Reserve Bank, supports principal reduction, as does Treasury Secretary Timothy Geithner, who himself was once president of the New York Fed. Both men are not known for their willingness to go against banking industry interests. But the plot gets muddled here: Republicans are opposing Obama on principal reduction because they worry that the White House will force banks to take losses on their loans, while DeMarco is suggesting that principal reduction is yet another bank bailout? They both can’t be right at the same time.

The explanation that seems the most likely is that as it became clear over the course of the Obama administration that White House efforts to help homeowners avoid foreclosure were not working very well — and the results of the midterm elections sent a strong message that Democrats needed to get more populist — Obama and his advisers decided to get a little more aggressive on housing finance. But in classic Obama fashion, they didn’t get aggressive enough to do themselves, or homeowners, any good. They didn’t pick a real fight. They’ve made incremental changes in their various foreclosure avoidance plans that increase the incentives for banks and mortgage lenders to make loan modifications and perhaps even offer some principal reduction, but not enough to make a significant difference in the lives of enough Americans to end the foreclosure nightmare.

There’s even a nightmare scenario in which the entire fight over principal reduction becomes, in Judson’s words, “irrelevant.”

That’s because, says Judson, tax law historically treats principal reduction as income to the homeowner who gets it. In other words, if you have a $300,000 mortgage on a house that is now only worth $200,000, and your bank gives you a $100,000 break to bring the mortgage and the home value in line with each other, the IRS will consider that $100,000 break taxable income.

Congress recognized this obvious insanity in 2007 and passed a provision that gave homeowners a waiver from that liability, but the waiver will expire on Jan. 1. Not only would the change in tax law mean that getting a principal reduction would make no sense for a beleaguered homeowner, but it would also destroy the market for “short sales” — in which banks allow homeowners to get out of their mortgage by selling their property for less than the mortgage is worth. Judson believes some 30 percent of home sales are currently short sales. Knock the legs out of that market, and you’re asking for serious trouble.

“If we hit a train-wreck on Jan. 1,” says Judson, “it will take the housing market and any economic recovery down with it.”

Sounds bad — but right now, not only are very few people even warning about the possibility; Republican legislators are saying they oppose extending the waiver.

So the morass continues — and the more you know about how housing finance policy works, the more screwed up our economy’s chances of ever fully recovering seem to become.