Two verities of real estate investment

Over the past few days, I have been in San Francisco, and have had the privilege of meeting with four real estate executives whom I am trying to interest in participating with the Lusk Center in one way or another. They are all doing remarkably well, all things considered, and some of the things they said to me explain why. Two things stand out:

(1) When investing in real estate, underwrite the real estate without consideration for financing. Unless the deal earns an acceptable unlevered internal rate of return, don't do the deal.

(2) If a deal depends on a going-out (i.e. exit) cap rate that is lower than the going-in (i.e., purchase) cap rate, don't do the deal.

Are the Average SATs for your school really that high?

Have you ever wondered how so many Universities can have such intimidatingly high SAT scores? Well, perhaps they can't. I was reading one of the many brochures colleges are sending to my kids nowadays, and I noticed that the SAT range it presented was for those who were admitted, not for those that matriculated. So I looked at another. And another. And what I found was that in their literature, almost all schools report SATs of admitted students.

Self-sorting on the part of students should mean that in general, average scores for matriculants will be lower than average scores for admits.

If you really want to know how students who enter a university performed on the SAT, look to see whether it publishes a "Common Data Set" (here is University of Nebraska-Lincoln: http://irp.unl.edu/pdfs/CDS2015-07.pdf). It reports only scores of entering degree candidates.

Understanding the Mortgage Interest Deduction

Homeowners get a tax advantage relative to rents. But those with mortgage are not at an advantage relative to those who finance with equity. From an article I wrote for the Encyclopedia of Tax Policy (Cordes and Gravelle, eds.):

In the popular press, the mortgage interest deduction
is often characterized as being the principal tax
benefit accruing to homeowners. This is certainly
not correct. First, fewer than 50 percent of homeowners
itemize on their tax returns; the remainder
use the standard deduction. This is because the value
of itemized deductions for low- to moderate-income
homeowners in states with low marginal tax rates
will almost certainly be less than the value of the
standard deduction, which in 2003 was $9,500 for
married couples filing jointly. Also, according to tabulations from
the Survey of Consumer Finances, many households
with elderly heads own their homes entirely with
equity (i.e., do not have mortgages), and for these
households, the mortgage interest deduction has no
value.

Second, even for those who do itemize, the
mortgage interest deduction does not necessarily
produce the largest tax benefit arising from owning.
The imputed rent that households earn from their
owner-occupied housing (i.e., the rents that households
are not required to pay anyone else because
they own) goes untaxed. This rent is therefore
favored relative to most other types of income,
including ordinary income, taxable bond income,
dividend income, and capital gains income, which,
while favored and deferrable, is still generally taxed.
The average loan-to-value ratio in the United States
is less than 50 percent. Thus, even if all owners with
mortgages itemized on their tax returns, the value of
the nontaxation of imputed rent would be larger than
that of the mortgage interest deduction.

Effect of the benefit on choice of financing

One could argue that the effect of the mortgage interest
deduction is to put debt on a level playing
field with equity as a way to finance housing. This
contrasts with the tax treatment of corporate income,
where interest is deductible and the opportunity cost
of equity capital is not. Many analysts have shown
that the U.S. tax system encourages corporations to
take on debt. Capozza et al. (1996) have shown
how the combination of nontaxation of imputed rent
and the absence of a mortgage interest deduction
would discourage households from financing housing
with debt. In Australia, imputed rent is not taxed
and mortgage interest is not deductible, and households
there generally pay off their mortgages more quickly than in the United States.

Robert Van Order on Fannie and Freddie

When I left Madison for Washington six years ago, it was to follow my wife, who was offered a terrific job practicing geriatric medicine for under-served communities at the Washington Hospital Center. I decided to go to Freddie Mac at the time, in large part because I admired many people there, including Ed Golding, who was in charge of financial research, and Bob Van Order, who was the chief economist for many years.

Bob wrote the following on the raison d'etre for Fannie and Freddie, and with his permission, I am passing it along:

UNDERSTANDING FANNIE AND FREDDIE
By Robert Van Order
University of Aberdeen and University of Michigan
July 2015
Financial markets are different from other markets. They deal intensively in information and misinformation. Most of the time information is good enough and financial markets work fine, but when there are serious doubts about the quality of information entire blocks of investors, e.g., institutional investors who are not confident about information, exit and markets break down. In the case of lending markets borrowing rates go up abruptly and some borrowers have trouble getting loans at any price. Something like this has been happening in mortgage markets, especially subprime markets, and it seems to be spilling over into other markets.
Since the Great Depression when financial markets really went crazy we have developed institutions to try to control financial panic. A big part of this development has been deposit insurance, which provides bank depositors with assurance that they can get their money no matter what their bank does. Most of the time deposit insurance has served us very well. We don’t see bank runs to any great extent; in 1987 when the stock market crashed in a way that was not that different from 1929 we saw not a whiff of a bank panic. Of course the security has come at a cost. Banks can use deposit insurance as a basis for risk-taking and cause large costs to tax payers and distort resource allocation, as was the case with the Savings and Loans in the 1980s.
Fannie Mae and Freddie Mac (FF) are a part of this apparatus. They are usually referred to as Government Sponsored Enterprises or “GSEs.” That is, they are enterprises (they are privately owned), but they have special charters and benefits primarily in the form of implicit guarantees, for which they do not pay, and regulation (for instance, FF are limited to the mortgage markets and have regulations on their capital and on lending to targeted groups) which constrain their operation. They buy mortgages from lenders and they fund the purchases by issuing their own debt and (most often) mortgage backed securities (securities backed by particular pools of mortgages). They take credit risk because they are responsible for paying off investors in their securities in the event of default. They also take interest rate risk to the extent their debt funding is out of sync with their assets’ cash flows. Interest rate risk has not been the issue recently, but credit risk certainly has.
The GSEs have several purposes. Much of the recent focus has been on subsidizing homeownership, but the really important function has been to provide “liquidity” to the mortgage market, which basically means that they keep the market open even when times are tough, like now. Along with this they provide an element of standardization, which helps lenders and investors better understand what they are originating and buying. They can do this in part because their implicit guarantee allows them to raise money in bad times in the same way that deposit insurance allows banks to raise money even when they are in trouble.
Guarantees involve a subsidy, if they are not paid for. In FF’s case their debt has been rated AAA or AAA+ because of the government connection; whereas on its own it has been rated in the low AA range. The difference in borrowing rates between the two is around a quarter of a percent to .40%, which is a rough measure of their subsidy. Banks get a similar subsidy, which varies from bank to bank. The subsidy is probably larger now.
The analogy with deposit insurance is deliberate. Banks are de facto GSEs. Indeed, so are most major financial institutions around the world, which is in part why we have had relatively stable financial markets for decades. That does not mean that all GSEs are good things or that regulation can’t be improved on, but we’re not in uncharted water here. Nor are we looking at unprecedented support for mortgage markets. Since at least the 1950s almost all U.S. mortgages have benefited from guarantees: initially direct insurance like FHA and deposit insurance, especially via the Savings and Loans, and more recently via GSEs. The only part of the market without substantial government presence has been the subprime market.
What we have is a trade off. The GSEs provide stability. A measure of some of the current benefit from having FF in the market can be seen from a natural experiment that comes from the way the GSEs are regulated. There is a limit on the size of loan that FF can buy (It has been changed recently; at the beginning of this year it was $417,000. The limit is indexed to house prices over time). For years the loans above this cutoff (so called “jumbo” loans) paid rates about a quarter of a per cent higher than on loans below the limit (on 30 year fixed rate mortgages). The loans above the limit are not much different from those below; they are prime loans (the borrowers have good credit histories) with similar characteristics. However, at the end of last summer, as the subprime news hit the fan, the spread rose by over 1% and has stayed in that neighborhood. Again there is nothing in the data to suggest anything like that big a difference in credit risk on these loans. The difference is due to the existence of FF as liquidity providers in their part of the market. There is every reason to believe that without FF interest rates would have gone up in a comparable manner in most of the market.
The trade off is that the GSE structure, particularly the implicit guarantee, invites risk-taking in the same way that deposit insurance invites it. This distorts resource allocation (in this case diverting resources toward housing and homeownership). Perhaps more important, politically, it risks bail-outs (like with the S and Ls in the 1980s). Both the benefits and costs of GSEs are real and need to be balanced.
Right now the two GSEs are in trouble, and it is important to understand why. We can think of their business as having two parts: the “core” business of buying and funding prime mortgages, mostly 30 year fixed rate mortgages, and a portfolio of other “non Agency” mortgage-backed securities, which are not backed by prime loans, but rather by riskier loans like subprime and “Alt-A” mortgages. FF bought pieces of subprime and Alt-A deals that had insurance and subordination (meaning there were other investors in the loan pool that took risks first (e.g., the first 15% of the pool losses), which were supposed to protect them, so their parts of the deal (tranches) were rated AAA. These have performed worse than AAA and have fallen sharply in value. The non Agency portfolio is less than 10% of the combined $5 trillion in mortgage related assets held by the two, but it has been most of the recent controversy.
The core business of FF has been experiencing large defaults, almost certainly larger than either has ever experienced. This does not appear to have been due to changes in risk-taking or growth in the companies: the prime mortgages they bought have not changed much over time, and their performance has actually been better (lower delinquency rates) that those for prime mortgages in general. Nor was excessive growth a problem; the FF market share and level of purchases dropped sharply after 2003, as the subprime share rose. As far as one can tell so far the answer to “why?” is mostly that house prices have declined faster than at any time since these two have been around (It may have been worse in the 1930s). Both companies have taken write downs from this and more is likely to come. However, while this will certainly cut sharply into profits for several years it is likely that the two will weather the storm.
How do we know this? Well, we don’t know for sure, but we can get some ideas from history. Comparable declines in prices in some recent bad regional declines suggest that there is room for quite high default rates without collapse. An underappreciated tool that the FF regulator uses to assess FF capital is a series of “stress tests, which simulate the companies’ performance under stressful (in this case large credit loss situations). While the tests are a bit complicated the principle is simple: take the worst regional experience in recent history (for which we have data; this is the “oil patch” states in the 1980s) and project it nationwide and ask if the institution has enough capital reserve to survive ten years (leaving positive capital behind). The tool has not gotten much publicity because the institutions have generally (this includes the first quarter this year) had no trouble passing . It is important in part because the stress test appears to be actually happening. It looks like the two still pass (they had considerable excess in the first quarter of this year) but not without considerable pain. They will need added capital cushions both to make sure they get through the stress and so that they can grow. This part of their problem is a little controversial, but not a lot.
It is the non agency portfolios that are the big issue. A problem in assessing the non Agency portfolio, and the economic position of the two GSEs in general, is that the two standard measures of their position—two measures of their net worth- are both wrong. Standard accounting measures are almost always wrong because they are (generally) too slow to adapt to changing economic conditions. Hence, while accounting net worth of the two has worsened as they have set aside reserves for future losses, accounting rules do not do this fast enough to anticipate the full extent of future losses, so accounting (GAAP) net worth is probably too big.
The other measure, “mark to market” net worth, which estimates the market value of assets and liabilities of the two and takes the difference as their net worth, errs in the other direction. Right now mark to market net worth is around zero or negative for the two companies, primarily because the mark to market value of the non Agency securities has fallen sharply. This has been the genesis of much of the recent news about the two. It is certainly the case that if FF had to liquidate their portfolios they would be in trouble. However, they don’t have to; they are in a position of being able to hold them and fund their assets. Normally the mark to market value would also reflect the value of holding the assets as well as the value if sold; that is how competition in the market among buyers of securities works. But that only works if the market is working.
The problem is that there has been a liquidity crunch in the “non Agency” markets for mortgage-backed securities that is worse than the one we know about and can measure in the “Jumbo” market. The market for buying these has more or less evaporated, so it is hard to get the kind of clear read on the value of the securities that we would get in a market like the one for Treasury bonds. This is what is most controversial: the argument is that the senior, would-be AAA, subprime pieces are being priced at discounts that are way above any reasonable estimate of default loss. If that is the case, then holding the securities and using the proceeds to pay off the debt that funded them has a good chance of working—certainly it is better than selling the securities into a very thin market and trying to use the proceeds to pay off the debt.
Should we worry about this? Of course, but we should not overdo. Stress test tests run by FF and by outside analysts suggest that these securities are certainly not AAA, but they are not junk bonds either, and losses will be manageable. This is probably why the Congressional Budget Office opined recently that there probably will be no cost to the recently passed “bailout” bill.
But the “probably” part matters. Things could turn south, and that could be costly. Indeed, a problem right now is that FF would get most of the upside if things improve, but Treasury (taxpayers) would be stuck with a large part of the downside. This is the balance part. Guarantees, both for GSEs and banks, give financial institutions incentives to take risks because they get the upside benefits, but not all of the downside costs, and the market does not make them pay for it. On the other hand, the situation we are facing now, a possible financial meltdown, happens infrequently, but when it does it can cause a great deal of damage, a small glimpse of which we are seeing in the Jumbo market.
The short run response, in the recent Housing Bill, to this has been to shore up the perception of a guarantee, so that it is more or less certain that FF can continue to raise money. That is what the so-called line of credit is about (Ditto for opening the Fed discount window). It gives Treasury authority to extend its ability to make secured loans to FF (at Treasury’s discretion, not FF’s). Right now it is not necessary; FF are liquid and raising money easily, but knowing that the line is there probably makes it less likely that it will be used (for the same reason that the existence of deposit insurance mitigates bank runs). A separate part of the Bill allows Treasury to buy FF stock. This makes less sense. From a public policy perspective the issue is keeping the market open, and the line of credit can do this without helping shareholders. If FF fail, the line of credit will be the main vehicle for paying off the implicit guarantee.
Longer term, the balance will most likely come from limits on risk-taking and on capital reserves. The risk-taking of FF has not been a major issue, but the capital reserve has. Reforms going forward will probably raise the minimum levels of capital. The stress tests have not been mentioned much. That is unfortunate for two reasons: One is that as house prices fall and losses get paid out the ability to withstand the stress test going forward will diminish and there will be built in need to raise capital. Second the stress tests can be revised. The 1992 law that set up FF regulation required taking the stress test from the worst regional downturn in the data. We shall surely have a region (the southwest? Florida?) from the current period that will best the oil patch states. As a result simply updating the stress test will increase required capital, and it will do it the right way—related to the risk the institutions take.
If you want to get an idea of how the two are doing, forget the accounting net worth and the mark to market net worth and look at what is happening with stress tests.
A dimension of the problem that has not been seriously addressed is that FF, like banks, do not pay for the insurance they get. A way of solving this is via user fees. Charging fees would really solidify the guarantee and take it out of the conjecture box. To some extent this is a question of the extent to which taxpayers want to subsidize mortgage rates. It is not likely to be as good a way of controlling risk as are capital requirements and stress tests.
More broadly: there are four likely ways that housing finance will get done in the U.S:
1. GSEs.
2. Non Agency (“private label”) securitization.
3. Banks (and S and Ls)
4. Government owned institutions like FHA and Ginnie Mae
These all have benefits and costs. The second is the only 100% private (without guarantee) model. It runs the risk of fragility—probably not as bad, going forward, as the subprime debacle, but at least like the current Jumbo market. The third has many similarities to the GSEs. In principle the GSEs and banks are hard to separate; in practice the GSEs have won the market, but innovations like “covered bonds” can allow banks to do almost the same thing as securitization. Both have incentives for risk-taking and risk of bail out. The fourth presents the problems of government management and inflexibility (For instance, pricing by both FHA and Ginnie Mae are fixed by statute), and it is not clear that there is less risk.
Going forward, there is no doubt that there are risks, but not the sorts of catastrophes that have been floating around the press, blogs and newsrooms. The current zero or negative mark to market net worth is more a figment of a broken market than a judgment about future prospects. In any event the last thing we should want to do now is take away the liquidity role of FF. Around 90% of all adults are homeowners at some time in their life and almost all homeowners take out a mortgage at some time. The mortgage market is important, and keeping it open is important. Sometimes you need someone to bring the punch bowl back to the party when the guests are threatening to leave.

The Truth About Amsterdam, RE: Bill O'Reilly loves Amsterdam

Amsterdam has a great orchestra, too.

Rental Stress in New England

I was disturbed but not surprised to learn that the top three, and four of the top ten, electorates in NSW suffering rental stress were in New England. Rental stress is defined as paying more than 30 per cent of gross income in rentals.

The top ten expressed as a proportion of the population suffering rental stress are:

• Richmond 57.5%
• Cowper 51.5%
• Lyne 50%
• Blaxland 48.7%
• Watson 47.6%
• Gilmore 47.1%
• Dobell 46.9%
• Fowler 46.6%
• Shortland 46%
• Robertson 44.4%

Michael Lacour-Little says it's all about the refinances

He points me to:

Why are so many homeowners underwater on their mortgages?

In crafting programs to prevent foreclosures, policymakers have assumed that the primary reason homeowners owe more on their home than it is worth is that they bought at the top of the market. In other words, they’ve lost equity primarily through forces beyond their control.

A new study challenges this premise and finds that excessive borrowing may have played as great a role.

Michael LaCour-Little, a finance professor at California State University at Fullerton, looked at 4,000 foreclosures in Southern California from 2006-08. He found that, at least in Southern California, borrowers who defaulted on their mortgages didn’t purchase their homes at the top of the market. Instead, the average acquisition was made in 2002 and many homes lost to foreclosure were bought in the 1990s. More than half of all borrowers who lost their homes had already refinanced at least once, and four out of five had a second mortgage.


The original loan-to-value ratio for these borrowers stood at a reasonable 84%, but second and third liens left homeowners with a combined loan-to-value ratio of about 150% by the time of the foreclosure sale date.

Borrowers, meanwhile, took out around $2 billion in equity from their homes, or nearly eight times the $262 million that they put into their homes. Lenders lost around four times as much as borrowers, seeing $1 billion in losses.

“[W]hile house price declines were important in explaining the incidence of negative equity, its magnitude was more strongly influenced by increased debt usage,” writes Mr. LaCour-Little. “Hence, borrower behavior, rather than housing market forces, is the predominant factor affecting outcomes.”

If other housing markets across the country offer similar findings, then the study argues that current “policies aimed at protecting homeowners from foreclosure are misguided” because lenders, and not borrowers, have born the lion’s share of economic losses.

Borrowers that bought homes without ever putting any or little equity in their homes could have seen huge returns on investment simply by extracting cash through refinancing. “Why such borrowers should enjoy any special government benefits such as waiver of the income taxation on debt forgiveness or subsidized loan modifications to reduce their borrowing costs is at best unclear,” the authors write.

Michael is a co-author of mine (and was a student at Wisconsin while I taught there), and has a gift for slicing up mortgage data. On the policy question, we might think about treating the half who did not refinance differently, as they were drowned by the flood.

A web site for bridge geeks who grew up near the Mississippi River

John Weeks provides a treasure trove of pictures and stories about bridges that cross the Mississippi River.

He dedicates one page each to the two highway bridges at La Crosse. He notes quite correctly that the Dresbach Bridge is remarkably pedestrian given its spectacular location (it is just south of the widest spot for the upper-Mississippi). The dual bridges five miles further south are far more interesting.

I think all government capital projects should be subject to cost-benefit analysis. But there is something to be said for spending something to make such permanent fixtures as bridges beautiful.

Closure of the Inverell Supercoat Petcare facility - 168 jobs gone

Many New England regional centres have suffered from major job closures. Often these go unremarked by the metro media. I was reminded about this by a story from the Inverell Times reporting on the closure of the Supercoat Petcare facility.

The story is simple enough.

Nestle Purina Petcare has announced it is closing the Inverell Supercoat Petcare facility and moving it to Blayney, about 650km away in the state’s Central West.

Nestle Purina purchased the business in March 2015 and general manager David Grant said since then the company has conducted a review of its long-term manufacturing and sourcing needs for its Australian pet care business.

“Since purchasing the business we have run it largely as we found it and we have been very pleased with the factory’s performance,” Mr Grant said.

“It was a very difficult decision to make but when looking at the review, our Blayney factory can make all that we produce at the Inverell factory.

“To put all our product into Inverell, however, would require significant capital investment. The factory in Blayney is double the size of this place.”

Mr Grant said the review had been ongoing and the decision was made at the end of last week.
“We then advised staff and suppliers as soon as possible,” he said.

Closure of any facility is always a difficult issue, more so when it is located in a regional centre.

At least in this case another regional centre will benefit, while Nestlé Purina will provide redundancy payments and financial counselling, job-seek training and career counselling.

An Interview with Kenneth Arrow, Part One - Conor Clarke

An Interview with Kenneth Arrow, Part One - Conor Clarke

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Cities as Museums

When I was a kid, my father told me that the way to get to know cities was to walk and take the bus. I have followed his advice ever since, which I think explains why I like thinking about cities, and about why some are more successful than others.

In any case, I had an afternoon to kill in San Francisco the other day, and managed to take in a wide variety of sites and people by simply taking the N car to the beach, walking on the beach, walking from the beach along Lincoln Way to 19th Street, taking the 71 bus through the Haight, getting off at Larkin and Market, walking north up Larking to Clay, and then east to near the top of Nob Hill, and then down through North Beach and back to the financial district where I was staying.

The whole thing took around 3-4 hours, and yet enabled me to observe and enjoy the many different and idiosyncratic aspects of San Francisco.

New to the top of the reading list

I need to go get Rick Perlstein's Nixonland. It is not just that Brad Delong recommends it (and I think the most valuable service Brad Delong provides is reading recommendations--if only I could read as voluminously as he). I have long had something of a Nixon obsession. According to my parents, when I was one, during the Kennedy-Nixon debates, Nixon's presence on TV would make me cry. And then he went and died on my birthday in the city where I was born.

I have read a lot of Nixon books--I think Wills' Nixon Agonistes is my favorite to this point. But I need to read Perlstein.

Stanley Fish and Chris Rock make the same point

Fish writes about Henry Louis Gates' time at Duke:

I flashed back 20 years or so to the time when Gates arrived in Durham, N.C., to take up the position I had offered him in my capacity as chairman of the English department of Duke University. One of the first things Gates did was buy the grandest house in town (owned previously by a movie director) and renovate it. During the renovation workers would often take Gates for a servant and ask to be pointed to the house’s owner. The drivers of delivery trucks made the same mistake.

The message was unmistakable: What was a black man doing living in a place like this?

At the university (which in a past not distant at all did not admit African-Americans ), Gates’s reception was in some ways no different. Doubts were expressed in letters written by senior professors about his scholarly credentials, which were vastly superior to those of his detractors. (He was already a recipient of a MacArthur fellowship, the so called “genius award.”) There were wild speculations (again in print) about his salary, which in fact was quite respectable but not inordinate; when a list of the highest-paid members of the Duke faculty was published, he was nowhere on it.

The unkindest cut of all was delivered by some members of the black faculty who had made their peace with Duke traditions and did not want an over-visible newcomer and upstart to trouble waters that had long been still. (The great historian John Hope Franklin was an exception.) When an offer came from Harvard, there wasn’t much I could do. Gates accepted it, and when he left he was pursued by false reports about his tenure at what he had come to call “the plantation.” (I became aware of his feelings when he and I and his father watched the N.C.A.A. championship game between Duke and U.N.L.V. at my house; they were rooting for U.N.L.V.)

And now Chris Rock:

I will give you an example of how race affects my life. I live in a place called Alpine, New Jersey. Live in Alpine, New Jersey, right? My house costs millions of dollars. [some whistles and cheers from the audience] Don't hate the player, hate the game. In my neighborhood, there are four black people. Hundreds of houses, four black people. Who are these black people? Well, there's me, Mary J. Blige, Jay-Z and Eddie Murphy. Only black people in the whole neighborhood. So let's break it down, let's break it down: me, I'm a decent comedian. I'm a'ight. [applause] Mary J. Blige, one of the greatest R&B singers to ever walk the Earth. Jay-Z, one of the greatest rappers to ever live. Eddie Murphy, one of the funniest actors to ever, ever do it. Do you know what the white man who lives next door to me does for a living? He's a f**king dentist! He ain't the best dentist in the world...he ain't going to the dental hall of fame...he don't get plaques for getting rid of plaque. He's just a yank-your-tooth-out dentist. See, the black man gotta fly to get to somethin' the white man can walk to.

I have a question for Senator Grassley

Does he really believe that all the white guys he has voted for "set aside [their] personal preferences and prejudices?"

Featured on today's USC Home Page

A story on Dr. Patricia Harris, who makes house calls.

Is William Poole kidding?

He gets some things right in his op-ed piece in today's New York Times. Fannie and Freddie should have higher capital requirements and they should stop lobbying. Beyond this, I think something should be done about executive compensation for senior management at both institutions. But when Poole says:

In fact, there has already been a test case for how the mortgage market would function without Fannie and Freddie. After an accounting scandal in 2005, regulators severely constrained their activities. The nation’s total residential mortgage debt outstanding rose by $1.176 trillion in that year, even though Fannie’s and Freddie’s stakes rose by only $169 billion, just 14.4 percent of the total. In essence, the market barely noticed that the two agencies’ private competitors were providing 85 percent of the increase in mortgage debt in 2005.

The market barely noticed???? I think we have been noticing quite a lot about mortgages generated in the "pure" private market over the past 18 months or so. And of course, the non-conforming (i.e., private) market for 30-year fixed rate mortgages is, shall we say, problematic at the moment.

I was on Bloomberg TV today

I have to admit it is fun. The clip is at http://tinyurl.com/GreenHousing.

Program Note

I will be on KPCC's Airtalk with Larry Mantle at 10:05 today.

Fixed rate mortgages vs ARMS

Floyd Norris's NYT column today is good:

http://select.nytimes.com/2015/07/27/business/27norris.html

I have long held a view that hosueholds should look at themselves as financial intermediaries, and match the duration of assets and liabilities. Houses are an asset of long duration, and as such, have values that are sensitive to changes in interest rates. Thus people who plan on living in a house for a long time should match it with a liability that has long duration--a long-term fixed rate mortgage.

If people know they will be in a house for five years, a hybrid 5 year ARM is fine. But it all cases, households should make sure they can afford a house based on a long-term mortgage before they buy. If the only thing that gets them into the house is a variable rate interest only loan, they are looking for trouble (FWIW, these thoughts occured to me at the time Chairman Greenspan was recommending ARMs to people in 2004).

Manuel Adelino, Kristopher Gerardi, and Paul S. Willen are skeptical...

...that the paucity of loan modifications is a function of securitization.

There is widespread concern that an inefficiently low number of mortgages have been modified during the current crisis, and that this has led to excessive foreclosure levels, leaving both families and investors worse off. We use a large dataset that accounts for approximately 60 percent of mortgages in the United States originated between 2005 and 2007, to shed more light on the determinants of mortgage modification, with a special focus on the claim that delinquent loans have different probabilities of renegotiation depending on whether they are securitized by private institutions or held in a servicer’s portfolio. By comparing the relative frequency of renegotiation between private-label and portfolio mortgages, we
are able to shed light on the question of whether institutional frictions in the secondary mortgage market are inhibiting the modification process from taking place.

Our first finding is that renegotiation in mortgage markets during this period was indeed rare. In our full sample of data, approximately 3 percent of the seriously delinquent borrowers received a concessionary modification in the year following their first serious delinquency, while fewer than 8 percent received any type of modification. These numbers are extremely low, considering that foreclosure proceedings were initiated on approximately half of the loans in the sample and completed for almost 30 percent of the sample. Our second finding is that a comparison of renegotiation rates for private-label loans and portfolio loans, while
controlling for observable characteristics of loans and borrowers, yields economically small, and for the most part, statistically insignificant differences. This finding holds for a battery of robustness tests we consider, including various definitions of modification, numerous subsamples of the data, including subsamples for which we believe unobserved heterogeneity to be less of an issue, and consideration of potential differences along the intensive margin of renegotiation.

Since we conclude that contract frictions in securitization trusts are not a significant problem, we attempt to reconcile the conventional wisdom held by market commentators, that modifications are a win-win proposition from the standpoint of both borrowers and lenders, with the extraordinarily low levels of renegotiation that we find in the data. We argue that the data are not inconsistent with a situation in which, on average, lenders expect to recover more from foreclosure than from a modified loan. At face value, this assertion may seem implausible, since there are many estimates that suggest the average loss given foreclosure is much greater than the loss in value of a modified loan. However, we point out that renegotiation exposes lenders to two types of risks that are often overlooked by
market observers and that can dramatically increase its cost. The first is “self-cure risk,” which refers to the situation in which a lender renegotiates with a delinquent borrower who does not need assistance. This group of borrowers is non-trivial according to our data, as we find that approximately 30 percent of seriously delinquent borrowers “cure” in our data without receiving a modification. The second cost comes from borrowers who default again after receiving a loan modification. We refer to this group as “redefaulters,” and our results show that a large fraction (between 30 and 45 percent) of borrowers who receive modifications, end up back in serious delinquency within six months. For this group, the
lender has simply postponed foreclosure, and, if the housing market continues to decline, the lender will recover even less in foreclosure in the future.

We believe that our analysis has some important implications for policy. First, “safe harbor provisions,” which are designed to shelter servicers from investor lawsuits, are unlikely to have a material impact on the number of modifications and thus will not significantly decrease foreclosures. Second, and more generally, if the presence of self-cure risk and redefault risk do make renegotiation less appealing to investors, the number of easily “preventable” foreclosures may be far smaller than many commentators believe.

Ideally, a lender would like to know whether a borrower will either (1) self-cure; (2) be cured by a loan modification that has no reduction in balance; (3) be cured by a loan modification that has a balance reduction or (4) is beyond help. If anyone can figure out how to write a contract that induces the borrower to reveal their type, they will have the solution to the crisis. The closest I can think of is one that allows borrowers to short-sell their houses (a la Hancock and Passmore) with reference to some sort of price index, so as to prevent gaming of the sales process.

Means and medians

The popular press seems to have a hard time understanding when a median (the 50th percentile) is better, and when to use a mean (the sum of everything in a population divided by the size of the population) is better. Both are measures of central tendency.

If one worries about large mistakes exponentially more than small mistakes, means are better. To give one example, if one is underwriting an 80 percent loan-to-value ratio loan, a small mistake in valuation matters little, but a big mistake matters a lot. Predicting house values based on a mean (likely a conditional mean, i.e., a mean based on knowlege about the characteristics of this house) thus makes more sense for underwriting than predicting house values based on a median. But if one just wants to know what someone in the middle of the homebuying pack would pay, the median is far better.

Median income is a much better reflection of middle class living standards than mean income. Reporters seem to have a hard time understanding this. But then so do some business school professors I know...

Trigger events

During past mortgage default spikes, having an "in-the-money" default option (that is, having a house that was worth less than the mortgage balance) was not always sufficient to bring about default. Usually, households that defaulted had also faced a "trigger event:" a job loss, a divorce, or a serious health issue. The high default rates in Michigan and Ohio in the late 1970s and in Texas in the mid-1980s were a function of both falling house prices and high unemployment.

The open question is whether people have become more ruthless about default. We'll know for sure after the next few years...

Praise be to the NYT On Language Column (h/t Patricia Harris)

A brief history of singular pronouns:

One tweeter asked plaintively, “Can we just accept that ‘they’ can be used as singular?” But another wrote, “I HATE it when people make improper use of plural pronouns for gender neutrality!” Several suggested writing around the problem (“Sometimes I try to alternate he and she, but bleh”). One tweet seemed to sum up the general attitude: “Damn you, English language!”

Traditionalists, of course, find nothing wrong with using he to refer to an anybody or an everybody, male or female. After all, hasn’t he been used for both sexes since time immemorial? Well, no, as a matter of fact, it hasn’t. It’s a relatively recent usage, as these things go. And it wasn’t cooked up by a male sexist grammarian, either.

If any single person is responsible for this male-centric usage, it’s Anne Fisher, an 18th-century British schoolmistress and the first woman to write an English grammar book, according to the sociohistorical linguist Ingrid Tieken-Boon van Ostade. Fisher’s popular guide, “A New Grammar” (1745), ran to more than 30 editions, making it one of the most successful grammars of its time. More important, it’s believed to be the first to say that the pronoun he should apply to both sexes.

The idea that he, him and his should go both ways caught on and was widely adopted. But how, you might ask, did people refer to an anybody before then? This will surprise a few purists, but for centuries the universal pronoun was they. Writers as far back as Chaucer used it for singular and plural, masculine and feminine. Nobody seemed to mind that they, them and their were officially plural. As Merriam-Webster’s Dictionary of English Usage explains, writers were comfortable using they with an indefinite pronoun like everybody because it suggested a sexless plural.

If it is good enough for Chaucer it is good enough for me. I will from now on use "they" as my gender neutral singular pronoun.

Mark Thoma thinks housing supply elasticities may be assymetric

The basic point is that in markets with lots of land, housing may be supplied elastically during booms, but takes a long-time to adjust during price declines. I have reason to think Mark is right.

My 2005 paper with Mayo and Malpezzi found evidence of this; cities that appeared inelastic included Pittsburgh, Toledo, Albany, Buffalo and Providence. None of these cities had upward pressure on housing production; rather, they were losing population and the housing stock took a long time to adjust to the loss.

New England - Northern Tablelands Wine Region

I have drawn this map from the New England wine site. It shows the boundaries of the new GI area. The site contains a range of useful material on this re-emerging wine region.

Brad Delong channels Jared Bernstein who channels Timothy Egan

http://delong.typepad.com/sdj/2015/07/the-minimum-wag.html

I was eating at the bar of a restaurant in San Francisco a few weeks ago. The bartender, a Russian, had moved from New York to SF. I asked her why she moved (and figured she would say something about weather). She said it was because the minimum wage in California was higher. I wondered then and there whether this anecdote revealed anything about the larger economy. Perhaps it does.

Never mind

From the National Association of Realtors today:

Total housing inventory at the end of June rose 0.2 percent to 4.49 million existing homes available for sale, which represents an 11.1.-month supply2 at the current sales pace, up from a 10.8-month supply in May.

Have Existing Home Sales Started to Rise?

NAR reported that Existing Home Sales rose 3.6 percent in June. In response to this, MSNBC notes:

"The turnaround in the housing market appears finally to be here and indeed may be gaining some speed," wrote Joel Naroff, president of Naroff Economic Advisors Inc.

Stocks jumped on the news, with the Dow Jones industrial average rising above 9,000 for the first time since early January.

The NAR numbers suggest that sales have stopped falling, and this is doubtless a good thing. But the numbers really don't support the idea that sales are rising--yet.

The reason is that the NAR Existing Home Sales number is a seasonally adjusted annualized number. This is a correct method for reporting (or at least I have reasons to think it is correct, as I am partly responsible for the development of the Existing Home Sales Methodology). But a seasonal adjustment is a statistical measure, and as such cannot be known with precision. June is a month that requires lots of adjustment, because June sales are always higher than sales in the average month. I am guessing that 3.6 percent is inside the 95 percent confidence interval of seasonally adjusted sales, so the best interpretation of the NAR release is that sales were flat or better in June.

The really good news in the report is the fact that the share of sales that are non-distressed sales is rising.

What is it with these people?

I happened upon a poll on CNN last night. 79 percent of say they are Americans are OK with a woman president, 86 percent (I think) say they are OK with a black president. This means that somewhere between 21 and 35 percent of Americans think race or sex is a disqualification for President. Who are these people????

The Excellent Ken Small on Transportation Policy

This is really good:



I think his points about more heterogeneous urban highways (not all arterials need to be freeways; not every highway needs to be designed to carry trucks) are particularly good.

Stocktakes on Posts

It has taken me a lot longer to complete the Hinton story than expected. I need a solid block of time. In the meantime, I have not been writing.

Some time ago I began a series of stocktake posts, posts that pulled together previous writing on a particular topic. So while I am thinking about the Hinton story, I thought I might take the opportunity to start updating the stocktake series.

What is normalcy?

gaius marius writes:

fwiw -- and i realize this is but anecdotal, but it is illustrative of the general condition -- i live in suburban chicago, renting a house. i pay $2000/mo, property taxes are $550/mo. my rental payment then would support (ignoring upkeep/insurance/etc) a $1450/mo payment.at today's 30-year fixed rate (~6.5%), that would support a $230,000 loan. with 20% down, call the purchase price $290,000 -- and generously, as we are excluding all expenses but taxes.this house sold in 2005 for $460,000. houses in the neighborhood still list for $410,000.

Actually, this suggests to me that houses in your area are priced at something like fundamentals. Let us say the marginal tax rate of the typical buyer is 25 percent, that property taxes (which are deductible for most people) are at 1.5 percent, that maintenance costs about 2 percent, and that expect rent growth is 2.5 percent (i.e., a little less than recent CPI growth). Then the user cost of owning would be
410,000*(.065*.75 + .015*.75+ .02 -.025) = 22,550, or a little less than the $24,000 you are paying in rent right now.
Two financial advantages of owning that you are not considering are the tax benefit and the immunization from future rent increases. Of course, should interest rates rise to 8 percent, or tax policy change, these calculations change.

OFHEO HPI and long term trends.

The new OFHEO house price index came out yesterday. At the moment, I like OFHEO better than Case-Shiller (I worry that Case-Shiller is now giving too much weight to REO properties in its index). In any event, it is fun to play with some long term trends.

According to yesterday's OFHEO press release, since 1991, house prices have risen about 4.5 percent per year; since 2000, they have risen by 5.5 percent per year, even taking into account the recent decline. This means that between 1991-2000, prices rose about 3.6 percent per year (take (1.045^17/1.055^8)^(1/9)-1).

Suppose that 3.6 percent is the long-term nominal house price growth trend. By how much are house prices overvalued? The answer is (1.045^17)/(1.036^17)-1= .158. So house prices would have to fall by about another 13.6 percent immediately to stay in line with the long term nominal trend, after which they should rise by 3.6 percent per year.

Alternatively, if house prices just stayed flat for four more years, they would return to their long-term trajectory--assuming that the trajectory before the year 2000 was the long-term trajectory.

New history of Inverell's Byron Arcade

Photo: Inverell Times. Inverell District family History Group Inc members Julie Regan, Joselyn Griffey and Muriel Resta talk about the new history of Inverell's Byron Arcade.

The Inverell Times reports that the Inverell District Family History Group Inc. has produced Our Place, a comprehensive and colourful account of the history of Byron Arcade on the corner of Otho and Evans Streets.

Construction of the magnificent building began in early 1902 and was built for George Cruickshank, MP for Gwydir.

Named after his property, Byron Station, the arcade cost 13,000 pounds Sterling to erect and included 32 shops. Over the years it has seen dentists, photographers, music teachers and a myriad of other businesses operate under its roof.

Our Place is available through the Inverell District Family History Group Inc at a cost of $30 and contains a full history of the building and every resident and business that has occupied it since its erection in 1902.

There are full colour pictures of the beautiful building and old black and white images taken around the time of its erection.

To obtain a copy of Our Place, contact the Inverell District Family History Group on (02) 6721 1487 or (02) 6722 1893.

Postscript

For those interested in Inverell's history, Inverell On-line has a very useful local history page.

What does it mean?

Obama has 1.1 million fans on facebook.

McCain has 170,000 fans on facebook.

Of course, McCain doesn't know what facebook is.

Two ideas for appraisal reform

Lawrence Yun of NAR is complaining that appraisals are preventing legitimate real estate transactions from occurring. Because of the way appraisers sometimes choose comparables, I have some sympathy for this view. And as I noted in an earlier post, Rhonda Porter says the Home Value Code of Conduct is nothing more than a way to line the pockets of Appraisal Management Companies. I have some sympathy for this view as well.

But we should not go back to the days when appraisers were basically paid to stay out of the way of the consummation of a deal. So let me suggest two proposals:

(1) Appraisers should not be allowed to see the offer price of a house. This is the only way their valuation will be truly independent.

(2) Appraisers should use valuation techniques that allow them to report a standard deviation of their estimate. Subdivision tract houses will have small standard deviations; architect designed villas will have large standard deviations.

We could then move to a pricing rule where Mortgage Insurance will be required if (1) the LTV based on appraised value is greater than 80 percent or (2) there is a greater than five percent chance that the true value of the house implies an LTV of 95 percent.

Step (1) would be easy to implement, and I think would help a lot. Step (2) will require lots of training (and perhaps different parameters from those that I am suggesting).

We need to stop kidding ourselves that we can measure house prices precisely. We need to start measuring the level of imprecision.

Rethinking California's Revenue Structure

California Assembly Speaker Karen Bass, who has no particular allergies to progressive taxes, cites an astonishing statistic about California Income Taxes: that 144,000 Californians (out of 38 million) pay half the state's income taxes. As I will discuss below, this does not necessarily imply that California taxes are, overall, too progressive, but it does mean that state income tax revenue is too undiversified. When such a small share of the population makes up such a large share of the revenue base, the fiscal conditions of the state will swing wildly with the fortunes of a few. This is what we have been witnessing here in California.

On the other hand, California has a very high sales tax as well, and everyone pays it. The best evidence I know suggests that the sales tax is regressive over the short term, but is more or less proportional over the life cycle. There is no question that the size of California's sales tax dampens the overall progressiveness of state revenue collections.

Finally, there is the property tax, which is completely detached from the ability to pay it, because of Proposition 13. Within a condominium complex, one can find two identical units that pay extraordinarily different levels of property taxes (sometimes by a factor of 10 to 1), because taxes are based on the price a property owner pays at the time of acquisition.

For California to have stable fiscal conditions going forward, it will need to broaden its income tax base and equalize its property tax base. I am not holding my breath.

Perspective on Fannie and Freddie (update)

I should have looked at the 10Qs (duh) for the first quarter. Credit losses for both companies were around 12bp (although survivable), which is high by historical standards (see below). Still, the first quarter financial statements came out in May, so it is hard to understand exactly what happened a couple of weeks ago.

Perhaps we can start looking for a bottom

I have long said that so long as the months supply of housing available for sale is rising, it is not possible to know then the housing market will reach bottom (in terms of price). But the months supply measure has fallen pretty substantially since this winter, from a peak of 11.4 months to a current rate of 9.4 months. The inventory needs to get down to 5-6 months before inflation adjusted prices become stable. But the derivative finally has the right sign.

New England Stories - the Hinton Bequest

Howard Hinton

Preamble

This story is a work in progress.

In response to a post I wrote in May, Marcel Proust aka marcellous kindly gave me a link to a court case involving the Hinton Collection, one of the finest collections of Australian art. Now this was a case in which I have a direct personal interest, one that combines different elements in New England's history.

As it happened, I was having lunch around that time with Annette McCarthy.

Annette and I come from different sides of New England politics.

My grandfather was the Country Party member for Armidale and then New England. He was NSW Minister for Public Instruction, now Education, at the time of the Hinton bequest to the Armidale Teacher's College.

Annette's dad Bill was the Labor Party member for Armidale. He and his wife Thelma played a key role in the establishment of the New England Regional Art Museum, the place where the Hinton collection is now held. Despite political differences, Bill was punctilious in recognising my grandfather's achievements.

Annette and I disagree on many things. Yet we also share many things. We both know what it is like to grow up in public families. We both share a concern about the decline in New England, although we may disagree to some degree about the causes and solutions. Both of us want to see the achievements of the past preserved and built on. All this meant that were both very interested in this court case.

Against this background, I wanted to write the story of the Hinton Collection from a personal perspective. In the first instance, the post that follows should be regarded as a work in progress, collecting information including visuals. This means that it will be messy for some time. I will tidy it up as I go along.

The Story

Hinton ... conceived the idea of endowing the Teachers' College, Armidale, with an art collection—S. H. Smith, director of education, co-operated with him. The first picture 'The Lock Gates' by Sir Adrian Stokes,. R.A., arrived in 1929. He gave over 1000 works to the college and an art library of some 700 volumes. He hoped to illustrate the development of Australia art from 1880, and the collection is widely recognized as a priceless anthology of the artistic impulse in nineteenth and early twentieth-century Australia. Norman Lindsay described it as the only complete collection of Australian art in the country. Jock Elphick, Australian Dictionary of Biography.

It is the only collection of its kind in Australia. He [Howard Hinton] developed his collection for the purpose of encouraging artists, educating students, and for the benefit and enjoyment of the public. Former NERAM Curator Caroline Downer (source).

J. R. McGregor (now Sir James), Howard Hinton OBE, Sydney Ure Smith and myself were having lunch one day, the topic under discussion, as one could readily guess, being art. Suddenly J. R. turned to me and said, "I have a few pictures I would like to present to some educational institution. What about the Armidale Teachers' College?" Before I could reply, Howard Hinton jovially interjected - "No, you don't Jim, that's my preserve, find a College of your own!" D H Drummond, A University is Born, Angus & Robertson 1959 pp 66-67.

History

• Australian Dictionary of Biography entry on Howard Hinton
• Sydney Morning Herald, 7 December 2005, Back to the wellspring's of inspiration

Court Case

• judgement
• Armidale Express 18 May 2005 Financial Pressure Building for Years
• Armidale Express 22 June 2005, Business Guru called in to turn NERAM around
• Armidale Express 29 May 2006, Sound Business Footing Top Priority for NERAM
• Armidale Express, 26 June 2006, Information Session on Proposed Art Sale
• Armidale Express, 14 July 2006, Alliance cool on bankrolling NERAM
• Armidale Express, 28 July 2006, Options open for NERAM with three offers on the table
• Armidale Express, 11 August 2006, Enjoy a great night out and help save Mosman's Bay
• Armidale Express, 19 January 2015, Gallery trade-off: an icon for an icon
• Armidale Express, 26 January 2015, Storm forces NERAM closure
• Armidale Express, 19 March 2015, Friends support half sale
• Armidale Express, 30 April 2015, Call to arms for 'Australia's best regional gallery'
• Armidale Express, 7 May 2015, End game for art sale
• Armidale Express, 21 May 2015, Friends dig in on art sale
• Armidale Express, 28 May 2015, Business as usual for Art Gallery
• Armidale Express, 20 June 2015, Another Round in Fight for NERAM
• Armidale Express, 13 July 2015, Frustration as Council fails to get numbers
  
  

Illustrations

Arthur Streeton's McMahon's Point Ferry (1890), another painting in the Hinton Collection.

Tom Robert's Mosman's Bay, the painting at the centre of the storm

A luncheon given to Mr Julian Ashton on the occasion of his 90th Birthday (1941) (National Library). Group portrait from left to right: Professor E.G. Waterhouse M.A., Mr Charles LLoyd Jones, Sir Lionel Lindsay, Sir Marcus Clark, Mr Howard Hinton O.B.E., Mr Ure Smith O.B.E., Will Ashton, Mr G.V.F. Mann C.B.E., Mr J.S. Watkins (standing), Mr Howard Ashton (standing), Mr Sydney Long A.R.E., Mr W. Lister Lister, Mr W.H. Ifould O.B.E., Mr Julian Ashton C.B.E., Mr B.J. Waterhouse O.B.E., F.R.I.B.A., The Hon. D.H. Drummond M.L.A.

The Joy of Great Cities

Last night, at the invitation of friends of ours, my wife and I went to a concert of the Pasadena Pops at Descanso Gardens. I wasn't quite sure what to expect: I am always suspicious of "pops" concerts (I love the Rolling Stones, but really don't want to hear Satisfaction played by a 100 piece orchestra) and community orchestras vary tremendously in terms of quality and spirit. I can enjoy music that is less than perfectly polished, but I find indifference difficult to take.

The punchline, of course, is that the concert was a gas. In the first place, the band has a conductor named Rachael Worby, who introduces the pieces with charm and who, more importantly, knows how to make an orchestra sparkle. Her beat and cues were so clear that even the most obtuse player would know what she wants. Second, the program, featuring Saint Saens, Gershwin, and Chansons sung by Karen Akers, was delightful.

But the really extraordinary thing was the caliber of the playing; one does not expect such precision in rhythm and tuning from an orchestra in a city of 150,000 people. But of course, the orchestra is drawing on a population of musicians who are drawn to Los Angeles because of opportunity, but also because they can find lots of other good musicians. I went to the Pasadena Symphony Web Site, and alas could not find a list of the players. My suspicion is that a number of the players are studio musicians (or people hoping to become studio musicians). And so it is throughout the region. One can go to free student recitals around LA, and hear music, from Palestrina to Riley, performed well.

I suspect that this is an example of agglomeration at its best (I can only suspect because I know of no formal test), and is a reason why the Londons, Parises, New Yorks and Los Angeleses of the world retain their special places for long periods of time.

Research and Teaching

A smart colleague of mine, James Bailey, argues that teaching excellence and research excellence are uncorrelated. Specifically, he cites work that shows that research productivity is not a good predictor of teaching evaluations or peer review. That doesn't particularly surprise me. But I do think there is both reason behind and evidence for the idea that a research environment produces a richer intellectual environment for students.

For starters, those who do research are being kept honest on a regular basis. When one sends a paper off to be refereed or presents a paper at a conference, he is exposing himself to the possibility of getting beaten up intellectually. But if one's ideas can survive scrutiny, and have foundation in evidence (there I am, going all positivist on you), then one is probably reasonably well qualified to teach.

Second, research almost forces one to keep current. I am not saying that everyone needs to print a refereed paper every year--but one every five years is not unreasonable, and would help people stay current (BTW, my mother was an English professor at a "comprehensive" teaching university, and she still managed to crank out an article every now and then. She wasn't particularly rewarded for doing so, it was just important to her.)

Third, I don't think it is an accident that the greatest University in England was home to Newton and Keynes, among others; nor is it an accident that MIT, Stanford, Berkeley, Chicago, etc. attract the best motivated and brightest students from all over the world.

So I am curious about what the (likely small number of) people who look at this blog think. Do (did) they get a better classroom experience from faculty who produce research. Or at least from those that produce well-known research?

Why the consequences of past discrimination persist over generations

I just read President Obama's most recent speech on race. It is another extraordinary speech--his ability to be at once sophisticated and accessible never ceases to amaze me.

To oversimplify, the speech has two themes: that individuals, whether discriminated against or not, must take control of their owns lives as best they can, but that the legacy of Jim Crowe will not go away quickly--that there are structural conditions in society that to place impediments in the paths of success for minority children.

The point reminded me of an award winning thesis by Kate Antonovics I read while I was at Wisconsin. One of the papers she generated from the thesis has the following summary:

Thus, initially disadvantaged groups may become trapped even though there is always a
unique within-generation equilibrium. That is, in contrast to standard models of statistical discrimination, repeated coordination failures are not needed to generate persistent discrimination.

Rather, statistical discrimination changes the transmission of earnings across generations by leading parents’ investment behavior to depend upon the distribution of income in the parents’ racial group. Thus, statistical discrimination and racial inequality are self-reinforcing, and multiple equilibria can arise.

When parents have limited resources to invest in their children, it becomes harder for children to migrate to a higher income class than their parents. In a world that was truly characterized by equal opportuntiy, children's fortures would be independent of their parents. We should at least strive to move to the point where children's fortunes are independent of their parents' race.

A little perspective on Fannie and Freddie

Above are charts of 90-day delinquencies (based on the Monthly Volume Summaries and the OFHEO Report to Congress) through the first quarter of this year and credit losses through 2015 (these are the most recent public data that I can find).

Like many others, I eagerly await the companies' first quarter financial statements. But what do
others know that we don't?

Newcastle's busy airport

Recently I have flown in and out of Newcastle a number of times. I have been meaning for a little while to record my impression of Newcastle's airport. In simple terms, I was amazed at just how busy it has become.

I have always felt that Newcastle should become more of a hub. Truncated at it is from its natural New England heartland, it is still a natural rival to Sydney.

Well, based on my recent experience it seems to be getting there. Obviously Kingsford Smith dwarfs Newcastle and how. But the place is still growing!

It's the ARMS, stupid

Aleablog cites the Fed:

http://www.aleablog.com/?p=329

Prime mortgages are doing fine; fixed-rate subprime mortgages are doing fine. ARMS with rate resets are not. Many 2/28 and 3/27 ARMs, that started with low teaser rates, have prepayment penalties, meaning borrowers can't get themselves out of trouble by refinancing into a FRM. Prepayment penalities are, in principle, fine--they allow borrowers to get mortgages with lower coupon rates. But in current practice, they may be a leading source of a lot of problems in the next few years...

Inflation and the Development of Mortgage Markets in Emerging Economies

Rising commodity prices have not just placed upward pressure on inflation in the US. In emerging markets, the impact is, in many cases, larger, with double digit inflation returning to places such as South Africa and Russia.

Inflation harms mortgage markets. Because nominal interest rates are high during periods of high inflation, payment-to-income ratios for even modest houses move beyond the means of what households can afford (and what lenders are willing to lend) in the short run. This problem is known as mortgage "tilt."


There are workarounds--for instance, price level adjustable mortgages (or PLAMS) charge real interest rates and then adjust the loan balance each period to reflect inflation. Unless these mortgages are carefully constructed, however, and unless the "correct" price index is known (and it rarely is), they are highly risky, because they have a negative amortization feature by construction. They are particularly problematic when house prices do not rise as rapidly as the general price level. The current US experience (as well as the 1980s) show that gaps between consumer prices and house prices can at times be large.


So the mortgage market is a case where nominal price changes can have real effects. It is no accident that the American mortgage market nearly disappeared during the late 1970s--a period of double digit inflation in the US.

Unhappiness (again)

From Greg Ip:

For decades, the typical college graduate's wage rose well above inflation. But no longer. In the economic expansion that began in 2001 and now appears to be ending, the inflation-adjusted wages of the majority of U.S. workers didn't grow, even among those who went to college. The government's statistical snapshots show the typical weekly salary of a worker with a bachelor's degree, adjusted for inflation, didn't rise last year from 2015 and was 1.7% below the 2001 level.

The Great Divide

I liked this piece in Slate:

http://www.slate.com/id/2170561/nav/tap3/

I was struck by the divide while in San Francisco last weekend (I was there teaching in the Wharton Executive MBA program). One the one hand I talked to a waitress who had moved to California because of its (relatively) high minimum wage and a bartender who was extolling the virtues of an employer who paid $15 per hour before tips. On the other hand, I was at a party where a woman was saying how her mother would find it hard to get by on a nest-egg of $3-4 million. If I were more creative, I could weave these vignettes into a novel about contemporary America.

John Y. Campbell, Stefano Giglio, and Parag Pathak estimate that Foreclosed houses sell at a 28 percent discount

The results imply two problems with thinking about house prices through the lens of the Case-Shiller Index.

In Southern California, somewhere in the neighborhood of 40 percent of sales are distressed sales. If lenders make decisions that are based on Case-Shiller, they will underestimate the value of transactions that are taking place in the absence of distress. Appraisers seem to be taking a Case-Shiller view of the world right now, and so deals are getting undone. There is reason to believe that when buyers are willing to place 20 percent down on a house, they actually believe the house is worth the offer price.

On the other hand, let's say we move to a world where only, say, 20 percent of sales are distressed. This will produced an observed increase in the index Case-Shiller Index of 6 to 7 percent--even if nothing is really changing about underlying house prices. This could lead markets to become too optimistic too quickly.

Cap Rates and the Ten-year Treasury Rate

The current 10 years treasury rate is 5.1 percent; Cap Rates on San Francisco office buildings are running around 5.5 percent.

On the one hand, rents rise, meaning that the expected IRR on a San Francisco office building is higher than 5.5; on the other hand, buildings depreciate and need to be recapitalized, meaning that net stablized net cash flow growth will be less than market rent growth. While office rents in San Francisco rose smartly last year, they had been stagnant for serveral years before, and office buildings always have the potential for substantial vacancy. So would I buy an office building at a 40 basis point spread over Treasuries? I don't think so...

Belshaw's obsession with New England sapphires

Photo: Australian sapphires

I have recently been on a bit of a sapphire trip.

Growing up in a gold and precious stones mining area, stories of prospecting and discovery were all around me.

Then I had a girlfriend who told me all about the gully on her place where raw sapphires could be found.

A little later I started buying sapphires in Armidale, getting Evan J Lewis (a local jeweller) to make them into rings. The cost wasn't too high, and they made a nice local present.

Then life changed and I forgot about all this. Now it's back!

So I have just put up a number of posts:

• Fossicking in New England
• New England Sapphires - a note
• Mining in New England - working bibliography
• Sapphires in New England - historical notes

Never let it be said that I am not an obsessive!

The rigors of the USC Masters in Real Estate Development Program

A student of ours emails:

I just wanted you to know that this assignment got me out of a traffic ticket this morning.

La Cienega was shutdown to due an accident and I was trapped. So, I made a u-turn which included driving over a curbed median. A motorcycle cop pulled me over and gave me a lecture about how this isn't Texas (I have texas plates) and "cowboy driving" is not acceptable....whatever that means. So I told him that I had to get to campus for the mid- term and I had a limited amount of time to complete the homework assignment. I pulled out assignment #3 to make my story credible and he took it with him when he went back to his motorcycle.

When he came back he told me that it seemed like the assignment was going to be enough punishment and he let me go.

Greg Mankiw's Economics Platform

He tries to list the things for which there is a consensus among economists. It is actually quite good.

I have two problems with the list. First, raising the retirement age for people like me (i.e., those who have cushy jobs) makes a lot of sense. But I think we need to treat truck drivers, miners, linemen, etc. differently. They are often physically incapable of continuing work until an old age. And to ask a 60 year old to retrain is, I think, naive.

Second, I would like to see something about fiscal responsibility. Deficit spending during recessions is fine. But it would be nice to go back to the good old days of the late '90s and run surpluses when the economy is surging.

A Modest Proposal for Richard Syron and Dan Mudd

The two CEOs would take compensation of $1 per year plus restricted stock that doesn't vest for, say, two years. By doing this, whey would show that they have confidence in the long term futures of their companies, and that they are willing to risk-share with taxpayers.

Mark Zandi says the Price-Rent ratio is returning to the fundamentally correct level

He is quoted in today's WSJ.

Also coming into balance, though not there quite yet, is the ratio of home prices to rents. The lower the ratio, the more people are likely to buy a home than rent one. Mr. Zandi estimates that this ratio dropped to 20.02 in the second quarter from a high of 24.90 during the boom. The average ratio from 1985 to 2002 was 14.44. "If you just look at affordability indices, we would say we are probably close to a bottom," says Ivy Zelman, a housing and homebuilding analyst. "But these are not normal times."

FWIW, I am in the middle of buying a house in Pasadena (when it is a done deal, I will write a little history of the transaction). It is because owning looks like a very fair deal relative to renting; also, LA is likely the place we will live for the next 20+ years, so short term house price fluctuations don't mean much to us.

Now that I will be driving to work most days

I will swap my minivan for a Toyota Corolla. I love the Prius, but the price premium in California is too high--assuming you can even get one.

It does bring to mind my first car that was not a hand-me-down from my parents--a Honda Civic that my wife and I bought in 1985. It had a 76 hp engine mated to a 5-speed manual transmission. It seemed adequately fast to me. It had no gadgets on it--riders rolled up the windows by hand, and I had to install the radio by myself. It got 30 mpg around town, and between 35 and 40 on the highway.

Here's the thing--it was not a "sacrifice:" I loved the car. It was fun to drive, and pretty much flawless--we spent very little on maintaining the car. We kept it for 12 years, and only then replaced it because Wisconsin winters took their toll on its body (and Hondas tended to rust back then). But the engine and drive train still ran beautifully.

So my question is--why is it not easy to buy cars like the middle-80s vintage Civic anymore? It seems like a great solution for reducing emissions and congestion. And no new technology is necessary.

Paul Krugman on the GSEs

He writes:

But here’s the thing: Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S.& L. fiasco. In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble.

Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Fannie and Freddie that curtailed their lending just as housing prices were really taking off. Also, they didn’t do any subprime lending, because they can’t: the definition of a subprime loan is precisely a loan that doesn’t meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income.

So whatever bad incentives the implicit federal guarantee creates have been offset by the fact that Fannie and Freddie were and are tightly regulated with regard to the risks they can take. You could say that the Fannie-Freddie experience shows that regulation works.

In that case, however, how did they end up in trouble?

Part of the answer is the sheer scale of the housing bubble, and the size of the price declines taking place now that the bubble has burst. In Los Angeles, Miami and other places, anyone who borrowed to buy a house at the peak of the market probably has negative equity at this point, even if he or she originally put 20 percent down. The result is a rising rate of delinquency even on loans that meet Fannie-Freddie guidelines.

Also, Fannie and Freddie, while tightly regulated in terms of their lending, haven’t been required to put up enough capital — that is, money raised by selling stock rather than borrowing. This means that even a small decline in the value of their assets can leave them underwater, owing more than they own.

Ex post it would appear that Fannie-Freddie should have had higher capital requirements, if for no other reason than to bolster confidence during periods of stress. But ex ante, stress-testing models showed that Fannie was well capitalized and that Freddie was very well capitalized. Ironically, most of us who followed the companies worried a lot more about interest rate/prepayment risk than default risk.

This is not to say that past Fannie/Freddie senior management did not behave badly with respect to financial reporting, and I find it maddening that some of the worst actors wound up walking away with millions of dollars. While I made good friends at Freddie and learned a lot, the moral obtuseness of company leaders at the time (2002-03) made me very uncomfortable and I looked for a way out (I also discovered within about a week of being there that I really missed being a professor). Daniel Mudd's current silence also makes me wonder if there is a shoe to drop that has not yet appeared in the monthly volume summaries.

But for the reasons Krugman gave, moral hazard did not produce lax underwriting at Fannie-Freddie--regulation (and to be fair, I think corporate culture at Freddie) prevented that from happening. To the extent they are in trouble, it is because of market conditions outside the realm of historical experience. It is, after all, their job to be in the market at all times--no matter what. They is why they have their charters. A government backstop will not it their cases reward bad behavior; it will assure that they can do a job that purely private participants are unwilling to do at the moment.

We have a new Census Director!

Robert Groves was confirmed. The vote to invoke cloture was 78-15. Why did this take so long? Why is the Senate so.....Senatorial?

I spent the afternoon flying back to DC from California

I just read the Paulson press release. Tomorrow will be an interesting day. I'll be watching the repo market.

Jan Hatzius has a Great Sense of Humor

His GDP forecast for 2015 goes four places right of the decimal point. (it is - 2.8753%).

The Savior of Capitalisim, or its End?

Marx argued for the tendency of the rate of profit to fall:

The progressive tendency of the general rate of profit to fall is, therefore, just an expression peculiar to the capitalist mode of production of the progressive development of the social productivity of labour. This does not mean to say that the rate of profit may not fall temporarily for other reasons. But proceeding from the nature of the capitalist mode of production, it is thereby proved logical necessity that in its development the general average rate of surplus-value must express itself in a falling general rate of profit. Since the mass of the employed living labour is continually on the decline as compared to the mass of materialised labour set in motion by it, i.e., to the productively consumed means of production, it follows that the portion of living labour, unpaid and congealed in surplus-value, must also be continually on the decrease compared to the amount of value represented by the invested total capital. Since the ratio of the mass of surplus-value to the value of the invested total capital forms the rate of profit, this rate must constantly fall. - Karl Marx, Capital Volume 3, chapter 13.

At the Wynn Hotel in Macao, the rooms have a copy Wynn magazine, which gives evidence that Marx was wrong about profits. Exhibit A was an advertisement for a pair of $700 Puma sneakers.

I will confess to liking nice things. I am, for examble, the rare Ph.D. economist who likes neckties, and I own way too many of them (my only defence is that I only buy them when they are on sale, but even so). But there are things that are just grotesque in their conspicuousness. It is hard to believe such things are good for social stability.