A quote from Tony Blair's last day as PM

I think of Blair very much the same way as I think of LBJ--as a great man of many important accomplishments who made a tragic mistake with respect to a war whose implications he didn't understand. On his last day in office, he said:

"Some may belittle politics but we who are engaged in it know that it is where people stand tall. Although I know that it has many harsh contentions, it is still the arena that sets the heart beating a little faster. If it is, on occasions, the place of low skulduggery, it is more often the place for the pursuit of noble causes."

I have been thinking about yesterday's vote in the House. Like Paul Krugman and Brad Delong and Mark Thoma, all of whom I admire, had I been in Congress, I would have held my nose and voted for the deal, which has many aspects I didn't like.

But the press today has been about the venality of members who were afraid to vote for the plan because it is unpopular with voters. Having had some conversations today with friends who are to the left of me, and who opposed the plan, I think that the votes against the plan may well have been sincere votes, dictated not by expediency but by principle. Many Democrats view the plan as having insufficient consideration for consumers, and many Republicans genuinely find the idea of socializing risk to be anathema. As it happens, I disagree with this Republican point of view, but in this instance it is honest and defensible (although I think the business about cutting capital gains taxes is nonsense).

So while I think Congress made a mistake yesterday, I find it entirely plausible that the vast majority of members, on this one particular occasion, voted with their heads and hearts,

Coleman, Lacour-Little and Vandell argue that house prices made sense until 2004

The abstract of their new paper:

The cause of the "housing bubble" associated with the sharp rise and then drop in home prices over the period 1998-2015 has been the focus of significant policy and research attention. The dramatic increase in subprime lending during this period has been broadly blamed for these market dynamics. In this paper we empirically investigate the validity of this hypothesis vs. several other alternative explanations. A model of house price dynamics over the period 1998-2006 is specified and estimated using a cross-sectional time-series data base across 20 metropolitan areas over the period 1998-2006. Results suggest that prior to early 2004, economic fundamentals provide the primary explanation for house price dynamics. Subprime credit activity does not seem to have had much impact on subsequent house price returns at any time during the observation period, although there is strong evidence of a price-boosting effect by investor loans. However, we do find strong evidence that a credit regime shift took place in late 2003, as the GSE's were displaced in the market by private issuers of new mortgage products. Market fundamentals became insignificant in affecting house price returns, and the price-momentum conditions characteristic of a "bubble" were created. Thus, rather than causing the run-up in house prices, the subprime market may well have been a joint product, along with house price increases, (i.e., the "tail") of the changing institutional, political, and regulatory environment characteristic of the period after late 2003 (the "dog").

This result is hardly consistent with the charge that the GSEs were the principal source of the problem. It also says something about having a purely private mortgage market.

New England Australia - end month review September 2015

As part of my end months review, I looked at the last eighteen posts to come to this blog.

One, a very small number, came as a direct hit. Three came from my other blogs. That left 14 from search engines. So what can we tell here?

The first search, on Google Australia whole web was on patrice newell. This brought the searcher in at 17 to In praise of Patrice Newell. I like this post, which was triggered by my reading of Patrice's book The River.

Patrice lives at Elmood at Gundy. Here there were two Google searches using identical search terms - elmswood gundy nsw. Both searches brought them at number 10 to Secrets of New England - along the Fossickers Way 2, another good post. Mind you, I need to continue this series since everyone has been stuck at Nundle for many months!

Then came a search on Google UK - judith wright aborigine. This brought the visitor in at 6 to The Poetry of Judith Wright - Bora Ring. Another searcher on Google Switzerland on bora ring rider's heart found the Bora Ring post at number one. Then there was a third search on Google Australia, this time on judith wright poetry. This found both the Bora Ring post, this time at 29 and then at 28 The Poetry of Judith Wright - South of My Days.

The Judith Wright posts are a major source of traffic on this blog. Just checking, three of the most recent ten searches were also on Judith Wright. I suspect the traffic will die down once the year 12 exams are over. In the meantime, it is nice to think that at least some of my writing is being read.

The next search was on blogscope -Armidale - and found at 3 Armidale 1945 VJ parade. This is a short photo post.

Then came a search on a search engine that I had never heard of, SweetIM. This search on landscape new england australia brought in at 3 The past is always present - the Country Party. I hope that the searcher was not too disappointed because this post deals with the political landscape!

Then came a search on Google Australa, whole web, death at copeton dam. This brought up the blog front page simply, I think, because I had a story on New England dam levels, although I have run a story on fishing at Copeton dam since. In similar vein, a Google Australia, whole web search on glenbawn dam history brought up the front page at number 12.

A Google Australia, whole web search on nsw new england railway brought up the Great Northern Railway - End of the Line Continued: Wallangarra Railway Station at number 3.

Then came a post on Google Australia, whole web, armidale white bull. This brought up at number 2, The End of Armidale's Club Hotel, a story of the rebuilding and renaming of the pub.

Finally, a search on Google - Golden Heart Contest Dallas Texas - brought up at 3, New England writer wins Golden Heart Award, the story of Bronwyn Clarke's victory.

In all, a mixed bag!

It's a good thing Texas Tech coach Mike Leach is not a professor

I ran across this item where he banned a player for using twitter. Apparently he didn't like the fact that the player pointed out that he was late for practice.

I thought coaches were supposed to be tough, but I am guessing that Mr. Leach would have a tough time with course evaluations and peer review of his work; if you don't have a thick skin, you will not be happy in the academic game.

More important, we keep being told that football players are student athletes (in my experience, most try hard to be so). Students need to be allowed, indeed encouraged, to express themselves freely--that is part of what a university education is supposed to be about.

I guess I think markets are more efficient than does Robert Lucas

I was astonished to read the following in Brad Delong's blog today:

Thus the thing to focus on is that the prices of risky financial assets are very low—not as low as they were last March, when the S&P 500 kissed a level of 667, but still very low. Why are they so low? The answer is that the risk tolerance of the private market has collapsed. For example, consider what the University of Chicago’s Nobel Prize-winning economist Bob Lucas told Tom Keene of Bloomberg last March 30—that he was 100% in cash:

LUCAS: [T]here is no question that fear is what this liquidity crisis is. I mean the reason I got into money [with my portfolio] is that I got afraid to leave my pension fund in other securities. So I’m sitting there with a portfolio full of zero-yield stuff just because I’m afraid to do anything else. I think there are millions of people like me.

KEENE: What will be the signal for Robert Lucas to go back into the markets...?

LUCAS: I don’t know. Robert Rubin made a joke about that in the first session today. Nobody knows...

My personal investment strategy for retirement has been (and continues to be) to diversify across a set of passive index funds: some equities, some fixed income, some in the US, some abroad. I do not think I can forecast interest rates, nor can I pick stocks (although I try to pick REITS, mostly for fun, because I do, after all, teach real estate). I know that over my investment horizon (I expect to retire in something like 20 years), stocks and bonds will perform better than cash. I did not change my allocations last year, because, well, once the value of stocks fell, buying new ones seemed cheap. I never take short positions, because when it comes to investment, I am a coward, just not so much of one that I would ever think to put everything in cash (or even worse, gold).

The irony, of course, is that my investment strategy reflects a greater belief in efficient markets than Lucas'. To be fair, though, he is older than I, and so has more about which to be afraid.

LA House Prices again

Brad Delong has the Case-Shiller house price index for LA going back to 1987 on his blog today. Nominal house prices are now about double what they were in 1987, for an annualized growth rate of about 3.3 percent. Sounds reasonable to me.

The Fannie/Freddie Conservatorship seems to be working OK

Let' see:

-Interest rates on conforming loans have dropped substantially, helping both homebuyers and sellers in the conforming market. Underwriting standards, though., remain more stringent (good in the long run, perhaps not so good in the short run).

-Senior management got removed without golden parachutes

-Shareholders get largely, but not entirely, wiped out

-The taxpayer, holding 80 percent of the company, gets susbstantial particiation in any upside (which in F&F's case, I think likely).

On net, this looks pretty good. It also looks kind of like Sweden's temporary nationalization of its banking system in 1992, which worked pretty well.

Can't anyone play this game?

A few years back, I reads Robert Caro's Master of the Senate. The thing about the book that most stuck with me was the political genius of Richard Russell. While he was a racist old bastard, he knew how to count votes, and he knew not to showboat in order to get votes. We could use his skills (if not his worst attitudes) right now.

The Great Inland Fishing Festival 2015

Photo: That's a fish!

In an earlier post I talked about New England dam levels. While water levels are down, there is still some good fishing.

The Great Inland Fishing Festival at Lake Copeton has established a reputation among regional anglers as one of the best, with more than 800 anglers expected to vie for a prize pool of $20,000 over the weekend of November 30, December 1 and 2.

Lake Copeton is regarded as one of the nation’s best inland fisheries, with plentiful Murray Cod, as well as Yellow Belly, Catfish and Silver Perch.

In 2003 the rules were changed to make it a catch and release contest (rather than catch and kill). The proceeds were then used to put fish back in the water in an effort to further develop Inverell's claim to be the Inland Fishing Capital of Australia.

Festival organiser Darrel Kachel says while the Lake Copeton level is at 15%, the fish are still plentiful. He attributes the high level of fish to the catch and release policy of the surrounding fishing clubs in recent years.

“There’s certainly a healthy supply on hand and our sponsorship has really improved since we introduced the catch and release policy,” he said.

Mr Kachel said the festival is designed to be a family event which promotes the district and sustainable fishing.

At least three measuring stations will be set up on the dam foreshores during the competition, as well as 20 flag boats for measuring out on the water.

A highlight of the weekend is the Fishermens’ Dream Raffle – with a prize of boat, motor, trailer, and safety equipment.

The Australian Inland Fishing Champion will be awarded a major prize of $1,000.

FURTHER INFORMATION

The Great Inland Fishing Festival at Copeton Dam runs from November 30 to December 2. Lake Copeton is between 17 and 35 kilometres south west of Inverell, depending on which area of the Dam you choose to go. It is three times the size of Sydney Harbour and offers cabins, bunkhouses and campsites.

Entry fees for the Festival are $20 for adults, $8 for pensioners and children and $30 for a family. For festival enquiries, phone Darrel Kachel (02) 67224410 BH or (02) 67221054 AH

For accommodation enquiries at Lake Copeton, phone the Recreation Area on (02) 6723 6269.

Inverell is 569 kms (7 hours 35 minutes) north west of Sydney if you travel by Thunderbolt's Way. The New England Highway route is longer. If you are travelling from Brisbane it is 433 kms (5 hours 20 minutes), from Armidale 126kms (one hour 43 minutes).

Is Lincoln Forecasting its own Demise?

So I'm watching the Bears-Eagles game, and I see this ad for a Lincoln featuring the David Bowie song, "A Space Oddity," a song that I really like. The idea is that the driver of the Lincoln is just like Major Tom. Of course, in the end, ground control says to Major Tom, "your circuit's dead, there's something wrong."

Note to Self: Always listen to Warren Buffett

During my brief stint at Freddie, an occasional question for discussion at lunch was the company's vulnerabilities. I think it is fair to say that those of us who were worker bees wanted to be sure that the taxpayer would never be on the hook for Freddie Mac debt and/or guarantees.

This was 2002 and 2003, so default risk was not a great worry: the company's underwriting practices at the time were sound, and mortgages were protected either by 20 percent downpayments or mortgage insurance, and property values were still rising, but not yet at a bubble like pace in places like Las Vegas and Florida. As for interest rate risk, the company purchased hedges so that its balance sheet would always have duration of less than a month, and so that duration risk was quite small too--although while hedging duration is pretty straightforward, convexity is more complicated (duration is basically the first derivative in how capital value changes with respect to interest rates; convexity is the second derivative). FWIW, I also thought the people who executed risk management at Freddie were very good at their jobs.

In these discussions, we failed to predict the principal reason the company got into trouble: we had no idea that senior management would recklessly gamble the charter through accounting that was both misleading and (it turned out) incompetent. I have arguments with William Poole, but when he said that management risk was a huge problem with having institutions like Fannie and Freddie, he was right.

But one among us (whose name I will reveal if he/she gives me permission to do so) did predict a major source of the current problem: counterparty risk. For example, Freddie Mac would buy instruments called swaptions, which would give the company the option to swap floating rate debt for fixed rate debt, and vice versa. These swaptions would allow Freddie to manage its balance sheet when interest rates changed in the future. Suppose, for instance, Freddie borrowed long-term in order to finance fixed rate mortgages. Now interest rates fall and borrowers refinance. Swaptions allowed Freddie to trade its expensive fixed rate debt into less expensive floating rate debt to match the lower return on its portfolio (and the converse when interest rates rise). But of course, swaptions would be useless if the institution with which Freddie contracted could not make good on its part of the bargain when interest rates changed.

In 2003, Warren Buffett called derivatives (such as swaptions) weapons of mass financial destruction. Like everyone else, I have long admired Buffett, but I though he got this one wrong. Derivatives allowed institutions to hedge and therefore reduce risk! Or at least, I thought this was the purpose of derivatives.

But of course, investors can also use derivatives to speculate, and when they do so (and particularly when they do so using leverage), derivatives become very dangerous. AIG, for instance, guaranteed against mortgage default. This meant that when defaults rose to levels not seen since the Great Depression, it didn't have enough capital to meet its responsibility to its counterparties. So the counterparties who thought they had hedged their risk found themselves exposed, which in turn ate into their capital position, and so a cascade was on.

Derivatives can be used for good, or for evil. Buffett understands human nature far better than I, and I should always remember that.

The Future of the GOP?

Data from the US Census. Population Projections.

Couldn't help but think about this while I watched the debate for a few minutes last night.

New England Australia Demography - Stocktake of posts as at 28 September 2015

Now that the results of the latest Australian census are out and I want to write some more on New England's demography, it seems sensible to do a stocktake of previous posts linked in some way to that demography.

A list follows in more or less chronological order.

Friday 7 July 2006. The past is always present - the Country Party discusses the enduring influence of different European settlement patterns on politics in different parts of NSW.

On 14 November 2006 I began a series of posts examining the NSW State Government's new ten year plan from a New England perspective. Assumptions about demography are central to the plan.

In NSW Ten Year Plan - New England's Needs I set out my perceptions of the needs the plan might meet. This post includes supporting demographic data. My next post, Does the NSW Ten Year Plan Meet New England's Needs?, looked at the structure and objectives of the plan against the needs as I saw them. My conclusions were not positive. This was followed by a concluding post, NSW Ten Year Plan and New England - Conclusions, drawing the analysis together.

On 18 January 2015 in Sydney Government releases draft Mid-North Coast strategy I reported the release of the the Government's strategy for this area as defined by them. Assumptions about population growth are central to this strategy.

I followed this with a post on 23 January, Sydney Government's Coastal Planning Strategies, looking at the coastal strategies as a whole. I was again very critical of the demographic assumptions.

On 5 August 2015 in Sydney's Sluggish Population Growth, I commented on Sydney's growth compared to the other capital cities, querying again the Sydney Government's planning assumptions.

New England's indigenous people spread across many posts.

New England's indigenous population is significantly higher than the national average, with the distribution of the population affected not just by natural increase, but by migration within and beyond New England. All this makes, or should make, issues relating to Aboriginal economic and social development a key policy concern.

In Australia's Aborigines - a Note on Demography (21 December 2006) I looked in a preliminary way at migration patterns. On 7 March 2015 in NSW's Aboriginal Population I provided some data on the regional distribution of Aboriginal people.

One of the points that I made in my analysis of the NSW Government's Ten Year Plan was the need for economic development if New England's problems, including those of its Aboriginal people, were to be properly addressed.

On 4 March 2015 in New England's Poor Towns - a failure in public policy I commented on work done by Professor Vinson that nearly all the poorest and most socially disadvantaged towns and villages in NSW could be found in New England. I followed this in quick succession a second post on the same day - New England and the Immiseration of Public Policy - that extended my argument in a somewhat angry fashion.

On 31 July, in Rental Stress in New England I reported that the top three, and four of the top ten, electorates in NSW suffering rental stress were in New England. The census data provides an opportunity to extend my economic and social analysis in a more rigorous fashion.

Finally, I have yet too look properly at the various ethnic and national groups that have contributed to New England's evolution, although I have referred to it in passing in various posts. However, I have made an in initial foray here with New England's Chinese - Introductory Post (26 February 2015).

Previous Stocktakes

• Aborigines: New England's Aborigines - Stocktake on Posts as at 24 March 2015. Updated 7 June 2015
• Education - The Armidale School (TAS) - collected posts entry page
• Education - University of New England: University of New England - Stocktake of Posts as at 5 November 2006.
• Food & Wine: Stocktake Food & Wine Posts up to 24 September 06
• History: Historical posts up to 7 September 06. See also New England's History blog
• Transport: New England Australia - Stocktake on Transport Posts 24 October 06
• Writing: The poetry of Judith Wright - entry page

When leaving the Ukraine

Don't wear a sportscoat or a suit or anything that might make it appear that you have money. The following conversation more or less happened immeidately after passport control:

Guy in Border Guard Uniform: How much money do you have with you

Me: I don't know, maybe $400 and 200 Euros

Border Uniform: Let me see it

Me (opening wallet): here it is

Border Uniform: I want to count it

Me (handing over money): OK

Border Uniform (fans out money like cards, and then unfans): OK, here is is back. You can go.

Me (assuming I am $20-$40 lighter): thank you sir.

Lots of people are posting this

So I will join them:

http://www.etc.cmu.edu/global_news/?q=node/42

Pausch is magnificent. He is also about my age (he's six months younger). His children are considerably younger than mine; I can't imagine how much it would sadden me not to have been able to see my kids grow up.

Kudos to Morris Davis..

..for organizing the most stimulating housing/urban conference I have been to in some time.

Arthur Nelson, call Irina Telyukova

I saw Irina (UCSD) give a nice paper (joint with Makoto Makajima) on home equity withdrawal at the UW-Atlanta Fed Conference. While not the basic point of the a paper, she found evidence in the Health and Retirement Survey that a little over one percent of elderly households decided to downsize for the sake of downsizing--over the course of a decade,

A few months ago, I posted my skepticism about Arthur Nelson's claim that boomers will downsize en mass when they age. Irina and Makoto find that the elderly take equity of of their house so they may continue to live in them, We like our houses!

A readers asks where to get data about Fannie Mae loan performance

Every month, Fannie Mae (as well as Freddie Mac) puts out a monthly volume summary. The most recent summary, for July, has 90 day loan delinquencies at 1.36 percent. This compares with the Mortgage Bankers Association national delinquency number of 2.35 percent for prime loans, and 17.35 percent for subprime loans for the second quarter of 2015. In case you were wondering, the 90 day loan delinquency number for Freddie was 1.11 percent in August.

The comparisons are not exactly apple-to-apples, but because the MBA data are a little older than the FF data, it is actually likely the case that the GSEs have performed relatively better than the comparison above would suggest.

The Argumentative Indian

About a year ago, my Senior Associate Dean recommended Sen's book to me; my wife bought it for me the other day. It is so far very good. I am particularly taken with this passage.

"The nature of [western descriptions of the Indian intellectual tradition] has tended to undermine an adequately pluralistic understand of Indian Intellectual traditions. While India has certainly inherited a vast religious literature, a large wealth of mystical poetry, grand speculation on transcendental issues,
and so on, there is also a huge--often pioneering--literature, stretching over two and a half millennia, on mathematics, logic, epistemology, astronomy, physiology, linguistics, phonetics, economics, political science and psychology, among other subjects concerned with the here and now.

Even on religious subjects, the only world religion that is firmly agnostic (Buddhism) is of Indian origin, and further the atheistic schools of Varvaka and Lokatay have generated extensive arguments that have been studied by Indian religious scholars. themselves...

...What is in dispute here is not the recognition of mysticism and religious initiatives in India, but the overlooking of all other intellectual activities that are also abundantly present. In fact, despite the grave sobriety of Indian religious preoccupations, it would not be erroneous to say that India is a country of fun and games..."

I have been privileged to visit many places in my life. I am gaining a better understanding about why India has been among my favorite.

Long-term interest rates again

This morning's Wall Street Journal reports that long-term interest rates are at their lowest levels in months, with the ten-year Treasury at 4.55 percent. They also note:

Recent data from the Mortgage Bankers Association suggests that some families have taken advantage of a decline in long-term mortgage rates to refinance their mortgages and lock in lower payments. The association's index of mortgage refinancing applications has risen 27% since mid-July, and now stands at its highest level since February.

The MBA has been ahead of the curve in figuring out how the inverted yield curve would affect refinancing. This should help soften price declines in the housing market, particularly in markets away from the coasts.

Nevertheless, yesterday's news on prices and inventories out of NAR was ugly: prices are falling a bit, and inventories are at a high for the decade.

Full Disclosure

In light of some of my recent posts, I should repeat my disclosure that I worked at Freddie Mac between September 2002 and January 2004. I also own something like 200 shares of stock in the company (if it is important to anyone, I can check the exact amount). Those shares are of course not worth very much right now.

I made many close friends at Freddie, and learned more about mortgages that I could have possibly learned had I never left academia. I also found myself very disappointed with the company in all kinds of ways, which is why I didn't stay very long (although I also didn't stay long because I missed being a professor). I think senior management there has made a series of awful decisions.

Readers may draw their own conclusions about how seriously to take my views in light of this.

A Key to a Soft Landing in Housing

As I have already mentioned, the Chicago Merc housing futures market is predicting a decline in nominal house prices in several markets over the next year. While the market is still very thinly traded, it likely reflects a prevailing view among many investors and observers of the housing market.

One of the reasons for the softening of in some markets has been the increase in the federal funds rate. Some work in progress among Chris Redfearn, Stuart Gabriel and me is showing that the short end of the yield curve migh have a substantial impact on house prices in many of the coastal cities. The reason: in expensive markets, borrowers slide down to the short end of the yield curve where the cost of borrowing is generally lower. This allows borrowers to buy houses with "affordable" initial payment-to-income ratios.

The problem, of course, is that short term interest rates have been driven up by the Federal Reserve, from one percent in late 2003 to 5.25 percent today. If an Adjustable Rate Mortgage's spread over the fed funds rate is three percent (not usually the way ARMs are calculated, but lets give the example to make a point), and it amorizes over 30 years, the payment on an ARM would rise more than 50 percent per dollar of mortgage balance. This means people who could get into the housing market in a place like Los Angeles before can no longer do so, and it means many people in Los Angeles are facing payment shock. The situation is even worse for those who used "option ARMs" to finance their houses--these products allow people to pay less than the interest they owe on their mortgage every month, meaning that their loan balances are rising over time.

The good news is that long-term fixed rate mortgages, while not at rock bottom rates, remain at very low rates by the standard of the past 25 years: 30 year-fixed rate conforming mortgages last week hast week at an average rate 6.4 percent, according to Freddie Mac's survey. This means the ARM borrowers can refinance out of their ARM into a fixed rate product that is pretty reasonable. This should place a floor under house prices, particularly in an economy where unemployment is pretty low.

I think the early part of the '00s should have taught an important lesson to homebuyers--if they can't afford a house with a 30 year fixed-rate mortgage, they probably shouldn't buy a house. That is not to say the ARM isn't a good product--it is, if households use it as part of a portfolio strategy. For instance, is someone knows she is only going to live in a city for five years, it is perfectly reasonable for her to borrower with a 5/1 ARM, where the rate is fixed for only five years. Her liability, the mortgage, now matches her asset, the house, where she expects to live for five years. But when people use ARMs--especially option ARMS--to make payment-to-income ratios acceptable for a limited period of time, they are liekly looking for trouble.

I am looking forward to seeing this paper at the Atlanta Fed-University of Wisconsin conference tomorrow

Andra C. Ghent and Marianna Kudlyaky
Federal Reserve Bank of Richmond Working Paper No. 09-10

July 7th, 2015

Abstract

We analyze the impact of lender recourse on mortgage defaults theoretically and
empirically across U.S. states. We study the effect of state laws regarding deficiency
judgments in a model where lenders can use the threat of a deficiency judgment to deter
default or to shorten the default process. Empirically, we found that recourse decreases
the probability of default when there is a substantial likelihood that a borrower has
negative home equity. We also found that, in states that allow deficiency judgments,
defaults are more likely to occur through a lender-friendly procedure, such as a deed
in lieu of foreclosure.

Morris Davis writes to me

Morris is currently at Wisconsin-Madison, and was formerly at the Fed.

Why I am opposed to the bailout, by Morris A. Davis

First, I've decided it is bad economics. Suppose the bailout costs 500 billion. Suppose the bailout is effective in avoiding a recession -- The bailout itself costs 3-1/2 percent of GDP. I think you have to go back to 1982, maybe further, to get that kind of contraction in GDP during a recession.

Second, Paulson and Bernanke have proven, repeatedly, they have no idea what is going on. For example, here is a published quote from Bernanke on June 5, 2007, available on the Federal Reserve Board web site: "At this point, the troubles in the subprime sector seem unlikely to seriously spill over to the broader economy or the financial system." I can find similar quotes from Paulson.

If Bernanke and Paulson have been wrong, every time, why would they be right about the effectiveness or cost of a bailout now.

The reason I have no faith in Bernanke or Paulson is that they have no simple theory to explain what is going on. They know all the bits and details of current events, but they have no simple unifying underlying theory for events.

Third, what assets should be bought in a bailout? Mortgages? How about underperforming stocks? How will the government decide which markets are illiquid and which ones aren't? Forget the adverse selection problem for the moment. Just ask: Why would the government know which class of assets to buy and why?

Fourth and Fifth, the precedent this sets is terrible. This bailout means we have lost faith in free markets to allocate scarce capital to its most productive use. It also tells punishes responsible investors (who did not underwrite or hold high yield junk mortgages) and rewards exp-post the participants in financial markets who took the riskiest bets.

Program Note

I will be on Airtalk with Larry Mantle on KPCC at 11 am PDT tomorrow.

Charles Calomiris and Peter Wallison blame Fannie Mae for the Subprime Mess

Hmmmm. The loan performance on Fannie's book of business is substantially better than the overall mortgage market. And starting in 2002, Fannie Freddie (pink line) lost market share to ABS (light blue line). The data underlying the graph is from the Federal Reserve,

Table 1173. Mortgage Debt Outstanding by Type of Property and Holder.

Why hasn't Broadway (the Los Angeles one) been redeveloped?

Broadway in downtown Los Angeles has among the most beautiful art deco buildings in the United States (for a nice photo, go here).

Yet while the buildings are filled with ground floor retail, many of the floors above sit empty; my understanding is that they don't comply with current earthquake codes. But given that land is so valuable in LA, and that the bones of the buildings are so good, it is a bit of a mystery that the buildings haven't been retrofitted and leased out.

The answer, apparently, is that the ground floor leases are very valuable--so much so that one can't justify replacing the current ground floor retail with a functional mixed-used building. The retailers are not high end shops, either, but rather are immigrants who cater to other immigrants. This is a beautiful example of Alonzo's bid rent theory, where low income uses incorporate density to outbid high income uses.

Moree mentoring attracts interest - congratulations to Peter Strang

Back in June I wrote a short post on the work of Dick Estens and his colleagues in creating employment opportunities for Moree's Aboriginal young.

I see from an article in the Moree Champion that this work has continued. My congratulations to Peter Strang for receiving the initial AES award for his work in Moree's mentoring program.

I think personally that this type of action is very important. Whatever the issues and approaches may be at state or national level, action at local level to improve opportunities for New England's Aboriginal kids is critical. Without this, other things will fall over.

Could we please stop saying that it was the hybrid feature of Fannie/Freddie that caused them to fail?

I think we have enough failures across enough different types of financial institutions (Investment Banks, Commercial Banks, Thrifts,Insurance Companies and GSEs), and sufficiently (ahem) large rescue packages for them that we can say that the US financial system has very few purely private financial institutions (sorry Lehman Brothers).

Perhaps the new rule going forward is going to have to be that any financial institutions with assets of greater than $X billion will be required to have paid-in capital of greater than Y percent. I have no idea what X and Y should be, but the costs of making X a little too small and Y a little too big are almost surely smaller than the costs of the converse.

Demanding some Accountability is not Partisan Squabbling

The TED Spread (still above 200 bp at this writing) tells me that something must be done quickly to restore investor confidence. But something doesn't have to exclude oversight of the Treasury Secretary or the elimination of golden parachutes for executives whose companies have failed.

As I read the debate over the stimulus...

...I can't help but think of George Akerlof's AEA Presidential Address. The conclusion:

This lecture has shown that the early Keynesians got a great deal of the working of the economic system right in ways that are denied by the five neutralities. As quoted from Keynes earlier, they based their models on “our knowledge of human nature and from the detailed facts of experience.” They used their intuitions regarding the norms of how consumers, investors, and wage and price setters thought they should behave. There is systematic reason why such knowledge and experience is likely to be accurate: by their nature norms are generated and known by a whole community. They are known to those who abide by them, and those who observe them as well.

We have shown ways in which macroeconomic variables will be affected by norms. The neutralities say that consumption should have no special dependence on current income; investment should be independent of current cash flow; wages and prices should not depend on nominal considerations. The very construction of those neutralities denies the possibility that peoples’ decisions might be influenced by their views regarding how they, and how others, should behave. However, in practice, the neutralities are systematically violated. Insofar as economists have felt it necessary to explain these violations they have appealed to a variety of different frictions, such as myopia and credit constraint. In so doing they have failed to consider that those violations would occur even in the absence of those frictions: they will occur because of decision-makers’ norms.

The incorporation of norms based on careful observation imparts an appropriate balance to macroeconomics. The New Classical research program was correct in viewing models of the early Keynesians as too primitive. They had not been sufficiently attentive to the role of human intent in choices regarding consumption, investment, wages and prices. But that research program itself has failed to appreciate the extent to which the Keynesians’ views of macroeconomics were also reflective of reality, since they were based on experience and observation.

A macroeconomics with norms in decision makers’ objective functions combines the best features of the two approaches. It allows for observations regarding how people think they should behave. It also takes due account of the purposefulness of human decisions.

As I have said in past posts, I am not a macroeconomist. Part of the reason for this, I think, is that Charles Manski has an enormous influence over how I think about economic issues, and so I worry about the reflection problem and identification. When I see Chicago-style macro-analysis, I see reflection problems and identification issues everywhere. I also see excuses ("it's all about frictions") when totemic hypotheses are tested against data, and fail. And when I see Chicago macroeconomists defending themselves now, the argument takes the form of "all reputable economics agree," which to me sounds very much like "every one I agree with agrees with me."

Keynes' analysis had a richness that is missing from much modern macro, and let's face it, he probably made the most spot-on macroeconomic forecast of the 20th Century.

Has the Detroit Housing Market Disappeared?

I was looking at the NAR median house price series for metropolitan areas today, and noticed the following line for Detroit:

19820

Detroit-Warren-Livonia, MI

151.7

140.3

N/A

N/A

N/A

N/A

N/A

N/A

N/A

The first two numbers are median prices for 2006 and 2007. 2015 and after: zip.

Is the Ukraine the most efficient country in the World?

In one respect, it appears to be. The bid-ask spread for currencies is less than .5 percent. It is hard to imagine how the small cambios in this business make a profit. I don't think there are price controls either, because there are dozens (if not more) currency exchamge businesses within a 20 minute walk of my hotel.

Now if only the passport lines at the airport were faster...

Is this really a success?

Jennifer Steinhauer thinks that light rail in Phoenix is a success. Her evidence is that while projected daily ridership was 26,000, it has clocked in at 33,000. The reason that ridership is better than forecast is because of weekend riders--people are using the line for pub crawls, among other things.

But ridership of 33,000 per day translates to about 12 million per year. The system cost $1.4 billion to build, not including lost revenue to businesses located along the line (which was probably largely displaced to other business). Let's assume that the cost of capital to Phoenix is 6 percent and that the system depreciates at 2 percent per year. Therefore, the capital costs of the system are about $110 million per year.

Assuming fares cover operating costs (and they almost certainly don't), this means that each ride is subsidized to the tune of more than $9, and according to the article much of the subsidy is going to entertainment.

I think it is great that some people in Phoenix are leaving their cars at home when they go out drinking. But I would guess that a free shuttle service going from bar to bar would have cost the taxpayers of Phoenix a lot less money.

How big could a new RTC be to remain comparable to the old RTC?

When the Resolution Trust Corporation was created in 1989, nominal GDP was about 40 percent of what it is currently. That RTC took over about $400 billion in assets. So a current RTC could take over around $ 1 trillion and would be the same relative to the economy as the old RTC.

We did manage to get through the early 90s with a fairly mild recession.

Degrees of Freedom

I am reluctant to weigh in on proposed solutions to the financial crisis, because Ben Bernanke and Henry Paulson are a lot smarter than I and have a lot more information than I. Based on publicly available information, I thought Fannie and Freddie would be OK (and in the end, I think there is still a chance that the conservatorship will actually benefit taxpayers), but it is now clear that public information was not sufficient for making a judgment.

But while Bernanke/Paulson have more information than the rest of us, they have no foundation for calibrating a model to inform them how to move forward. We are completely outside the support of the data. As Charles Manksi describes it so simply and eloquently, because we are in a world of Xs we haven't seen before, we cannot possibly know how to relate those Xs to Ys. And so at the end of the day even our smartest policy makers must rely heavily on judgment. I am not reasurred when I remember that Isaac Newton lost a bunch of money in the South Sea Bubble .

I do think I support the RTC type plan that Paulson is proposing. My worry with it, however, is political more than financial. If we get the wrong sort of people (say those who went to grade school with the Vice-president, or those who were until recently running the interior department) running it in the future, it could produce cronyism and kleptocracy unlike anything we could have before imagined.

Freddie seems materially different from Fannie right now.

Both companies (or perhaps I should say, wards of government) put out financial disclosures each month called monthly volume summaries. Freddie's most recent summary shows a serious delinquency rate of 2.95 percent for single family borrowers and 0.11 (!) percent for multifamily. Fannie, on the other hand, has a delinquency rate of 3.94 percent for single family borrowers and 0.51 for multifamily. Fannie's credit enhanced book (i.e., book of mortgages that had loan to value ratios of less than 20 percent at origination) is performing very poorly.

The difference in single family performance may reflect differences in the mix of loan originators from whom the two companies purchase mortgages. But the difference in multifamily performance puzzles me.

Multifamily performance is still good well because apartments continue to produce reasonably good cash flow. But when multifamily loans come due, rising cap rates and falling rents will make them difficult to refinance, so we will start seeing defaults in this sector increase in the next few years.

America the Spacious

While those of us who live on the Eastern seaboard of the United States feel hemmed in, the fact is that by World urban standards, we have a lot of space.

One of my favorite websites is http://alain-bertaud.com/. Alain has a wonderful gathering of information on urban environments around the world. Among his many great graphs, a particularly revealing one is the one to the left: it gives average urban densities for large cities around the world.

Note that American cities are in red: the densest of this, of course, is New York. But New York is less dense than European cities, and is much less dense than Asian and African cities. My home city of Washington is practically rural compared with most large cities around the world. But then, I am sure that someone from Mumbai would consider suburban Maryland and Virginia to be the countryside.

One of the reasons American cities have so little density is that the United States has a lot of land (only about five percent of which is developed) ; another reason is that the US is a rich country, and rich people buy more stuff, including land. But these reasons are only part of the story. More to come....

Are we at the Bottom in SoCal?

For the second month in a row, Dataquick shows pretty robust sales growth for housing sales in Southern California--along with sharply lower prices. I think this may be a bottom (despite what is going on more generally this week) because:

(1) From a user cost perspective, owning really does look pretty good in many SoCal markets right now, especially for houses that are inexpensive enough to use conforming loans. Mortgage rates are down about 75 basis points on Fannie-Freddie loans since they were placed into conservatorship. People have to live somewhere.

(2) Lots of sales are distressed sales (around 40 percent). This means the prices we are observing are not arms-length transactions, and may be below equilibrium market prices.

(3) While I am wary of anecdotal evidence, I have been getting a lot of anecdotes about bidding wars for modestly priced houses (modestly priced by California standards, anyway).

But there are a number of cautions:

(1) After rising sharply for the past four years, rents in Southern California are stagnant, and perhaps are falling a little bit.

(2) Unemployment has risen sharply in San Bernardino, Riverside, Orange and Los Angeles Counties.

(3) The overall sense of pessimism arising from the financial market crisis could keep buyers from buying.

Altogether this suggests to me that house prices won't be going up a lot anytime soon, they won't be falling much more either.

Underemployment

The other night, I was on a panel sponsored by the UC-Berkeley Alumni Association, the UCLA Anderson School and the USC Lusk Center and Marshall School of Business. One of the panelists was a business economist, and he claimed that the employment picture wasn't as dire as the media suggested. He also scoffed at the notion that there was underemployment, arguing that people generally consider themselves underpaid, and therefore, by extension, underemployed (most people in the audience did not agree that they were underpaid). He also scoffed at the concept of discouraged workers.

In light of this, I wish I had had the following graph on my flash drive:




The employment to population ratio has fallen to less than 60 percent; it peaked at nearly 65 percent at the end of the Clinton Administration. The share of us working has dropped precipitously in the last two years to levels not seen since the Carter-Reagan recessions.

This panelist also complained about comparisons to the Great Depression. The only common comparison I know is that this is the worst recession since the great depression. Given that California's unemployment rate has just reached its highest level since 1940, the comparison seems apt.

Hunter Valley Walks

Photo: Sundara Rajagopalanm, Tranquil setting. Photo from ABC Newcastle Radio breakfast.

I found by accident a rather nice if still incomplete story on ABC Newcastle on Hunter Valley walks, especially around Newcastle. I must try some of them on my next visit.

At a dinner party in Sydney recently I was arguing to friends that Newcastle must now be one of the most civilised places to live in Australia. I was pleased to find that a number agreed with me. Even with those who did not, I think that I have actually encouraged some to visit.

Clawbacks and Capital

The two Cs will go a long way toward preventing future catastrophes. If people (and firms) have their own money at risk, and if short term windfall compensation based on short term profits can be wiped out in the event of longer term catastrophe, risk will be priced appropriately.

Jon Stewart on Social Foment

We saw Jon Stewart at Merriweather Post Pavillion last night. He articuated well why many of us can't get organized about expressing our frustration at policy and policy makers. The rallying cry of "be reasonable" somehow does not have an inspirational ring to it.

Credit to Francois Ortalo-Magne

It occurs to me that I might never have come up with the idea in the previous post had it not been for a conversation I had with Francois Ortalo-Magne at an NBER conference around a month ago. Francois pointed out the selectivity problem in Levitt's work.

I should write something about Lehman...

... and I will, but probably not for a few days. There is a lot I need to think through.

I also dropped my younger (by 45 minutes) daughter off at college today. It has been wonderful to see my self-confident, hard-working girls just bubble over with joy while starting out at great universities in great cities. But it has also left me, for the moment, profoundly sad. I am a little surprised at this. Some wisdom does indeed come only through experience.

Bethesda House Prices

Forgive the selfishness of reporting a price index for my neighborhood, but I was just looking at Zillow data.

The top line (light blue) is my zip code; the bottom line (dark blue) is the zillow estimate of my house.

The last year is likely all inside the zillow confidence interval, but it does suggest that prices, after declining, have firmed this year.

Silly things.

There are blogs that blame the National Association of Realtors for the run-up in house prices, saying that without their cheer leading of the housing market, prices never would have risen so much. I give people more credit than that--most people can guess that Realtors like houses as much as Steve Jobs likes ipods.

On the other hand, NAR is saying it's the media's fault that the housing market is so lousy now. The media have little to do with it--the housing market is bad because there is excess supply and because credit outside of the conforming prime loan market has gotten relatively expensive. Until inventories begin to fall, it won't matter what either the media or NAR say.

Not to be snarky, but...

Leslie Stahl, in introducing a section of her 60 minutes interview with Alan Greenspan, said, "Alan Greenspan will give his economic predictions for the future." Not his predictions for the present or past?

New England Dam Reports

With all the talk of drought, I thought that I should start a regular series of New England dam reports. You can find the original source data here. The percentages that follow may not be exactly correct since they come from graphs. I have drawn supporting information especially from sweetwater fishing.

Toonumbar Dam was built across Iron Pot Creek 31km west of Kyogle and completer in 1972. It holds 11 000 mega-litres of water and has a surface area of around 400 hectares when full. It is currently around 90 per cent full.

Pindari Dam is located on the Severn River 63 kms from Inverell, 22 kms upstream from Ashford. Pindari comes from an aboriginal word meaning 'high rocks' and is the name of an early pastoral run which adjoined the dam. Construction of Pindari began in 1967 with completion in 1969. Key facts:

• Storage capacity - 312,000 million litres or over half the volume of Sydney Harbour.
• Catchment area - 1,994 square kilometres.
• Surface area - 10.5 square kilometres.
• Maximum spillway discharge - 21,900 cubic metres/second (1.89 million ML/day).
• Maximum outlet discharge - 58 cubic metres/second (5,000 ML/day).

Pindari is currently around 35 per cent full, with a recent increase in water levels.

Copeton Dam is located approx 30km south west of Inverell. The dam is almost three times the size of Sydney Harbour when full and was built across built across the Gwydir River in 1976. I have started a series on the Gwydir River Valley.

In recent weeks dam levels have increased slightly to around 13 per cent.

Split Rock Dam lies on the Manilla River, a tributary of the Namoi, 31k from Barraba and 15 k from Manilla and was constructed in 1987 for irrigation. It has a water storage capacity of 397,370 mega-litres, a surface area of 2150 hectares and a maximum depth of 60 meters.

Split Rock has been flatlining at around 3 per cent full.

Lake Keepit lies on the Namoi River 13km upstream from the junction with the Peel River. The Dam was constructed in 1961 and has a storage capacity of 425 000 mega-litres when full.

In recent weeks, dam levels have increased from around 6 to 14 per cent.

Chaffey Dam lies on the Peel River on the edge of The Fossickers Way, 16km to the north of Nundle and 44Km south of Tamworth. The Dam has a capacity of 62,000 mega-litres and is the main water supply for Tamworth. Over the last few months, storage has increased from around 14 to 44 per cent.

Lake Glenbawn lies on the Hunter River around 15 kilometres east of Scone. Construction of the Glenbawn Dam was finished 1958, with a major upgrade in 1986. The Dam now holds 750 000 mega-litres at full supply capacity.

Since May, dam levels have increased from around 28 to 38 per cent.

Glennies Creek Dam lies 25 km north of Singleton and has a storage capacity of 283,000 million litres. Since May capacity levels have risen from around 25 to 35 per cent.

Lostock Dam was built across the Paterson River in 1971 for irrigation and town water storage and has a capacity of 20,230 mega-litres. The dam is currently full.

Arizona has Chutzpah

The Daily Show last night featured the sale-leaseback deal that Arizona is trying to get for its capitol. Sales price of $735 million, lease payments of $60 million for 20 years, property reverts to state at end of the 20 years.

The IRR for the investor: 5.2 percent. Hmmm.

David Byrne is better at music than math

In his piece in the Wall Street Journal on what makes a perfect city, David Byrne extols the virtues of San Francisco--and then complains that Los Angeles isn't dense enough.

The problem: metropolitan Los Angeles is denser than metropolitan San Francisco, and considerably denser than the San Francisco Bay area (and no, the Bay itself is not in the denominator).

Los Angeles is a real, live city where people from all over the world seek their fortunes. When they do so, they double-up and triple-up in housing, meaning that more people get crammed into lower buildings. Koreatown is as dense a place as there is in the US outside of Manhattan, and the length of Wilshire Blvd is very dense (by US standards).

If the lead head wants not to like LA, it is no skin off my nose. But dislike it for a correct reason.

Blocking and Tackling and Transit

When I lived in Washington, I took Metro to work nearly every day--I took it so often that I didn't have a parking space at GW.

Now that I live in LA, I take transit about once a week, and part of the trip (a bus from Union Station to Campus)is subsidized by USC.

Before you yell sprawl, let me point out that in Washington I lived 9.3 miles from work while in LA I live 12 miles from work. So what is the difference?

For all that people complain about it, Washington Metro is well run. Connections are good, the buses and trains are clean, and the web site works great.

Transit in LA is not well run. The timing of the connections is often awful, and th web site is nearly useless. Many drivers on the Gold Line have a hard time figuring out where to stop in stations.

Could better management improve ridership in Los Angeles? Perhaps not, but it sure would be worth trying.

Do Real Estate Brokers Shirk?

Steve Levitt is an incredibly smart guy (he has a Clark Medal, the prize for best economist under 40, to prove it) and, according to the people I know who know him, a very nice guy. Freakonomics is fun to read, and I liked it enough to use it for a seminar I taught last summer.

A reason the book is so much fun is that it is provocative, and challenges us to think about things from perspectives we had not before considered. It asks why drug dealers live with their mothers; whether Roe v Wade was responsible for the falling crime rate in the 1990s; whether Sumo Wrestlers cheat; and whether real estate agents shirk.

Levitt sets up the real estate agent-house seller relationship as a classical principal-agent problem: the agent is like anyone else: he has an incentive to do as little work as possible in exchange for as much commission as possible. Therefore, Levitt conjectures that real estate agents have an incentive to get sellers to take the first offer they receive from buyers. Because commissions are based on the entire price of the house, the fact of a sale gives agents a large benefit. If the seller refuses an offer, the agent has to do more work, but gets very little added compensation. For example, if there is a $490,000 offer on a house that could ultimately sell for $500,000, and the agent gets a 1.5 percent cut, from the standpoint of the agent, the benefit of waiting is only $150. The agent will almost certainly have to do a lot more work for the $150, and so has an incentive to encourage the buyer to take the $490k.

This would be a powerful argument for an incentive problem if agents were playing a one-shot game. But they are not--they are playing a repeated game. Agents rely on listings to make money, and listings come from referrals. Agents--good ones anyway--have an incentive to make sellers very happy, because happy sellers drive future business.

So now let's get to the evidence that Levitt provides to show that agents shirk: he shows that agents leave their own houses on the market longer and sell them for higher prices than the houses that they sell for others. This is an interesting fact, but is not necessarily explained by agents' shirking. Rather, it could be that the houses agents own themselves are different in unobserved characteristics from the houses that they sell to others. Or it could be that agents are different as human beings--they are more risk taking, and more entrepreneurial. For all we know, sellers ignore the advice of their agents and sell more quickly than they should, because they are relieved at the prospect of a sale and don't care so much about the marginal benefit they would get for waiting. In order to disentangle this, we would need to know something about the unobserved characteristics of people who become real estate agents--and of people who don't.

Full disclosure: while I was writing my dissertation in the late 1980s, I worked doing research for the Wisconsin Realtors Association. I had fun while I was there. Believe me, the Realtors are different with respect to their attitude toward risk taking from the rest of us.

This is Disheartening

http://www.latimes.com/news/local/la-me-ucilaw13sep13,0,5893599.story?coll=la-home-center

I thought UC-Irvine was a school on the rise. I now know not to take it seriously until it gets a new Chancellor.

Lists

Planetizen http://www.planetizen.com/topthinkers has produced a list of 100 "top urban thinkers." While the list has some sensible names (Don Schoup, Tony Downs, Ed Glaeser, Joel Garreau, my USC colleague Manuel Castells, and even though I am not sold on everything he says, Richard Florida*), it also consists of a poseur (Prince Charles), a hater of cities (Thomas Jefferson) and a whole bunch of people who like to attend salons at which they put down the "banal" people who chose to live in "nowhere," including a man whose most famous project became the set for the movie "The Truman Show."

The list lacks some of the most important analysts of urban form and urban problems: Von Thunen, Ed Mills, John Kain, and Reynolds Fairly come immediately to mind. For us to better understand cities, we must understand externalities, and we must understand preferences, and that doesn't mean our own.

*I root for Buffalo to win football games, but I don't think it is coming back as a city. But Florida has provocative ideas worth investigating, and has had a profound and wonderful influence on his students.

Why I remain a New England New Stater 5 - the case of Tasmania

Note to readers: This post is one in a series using personal examples to illustrate why I continue to support both agitation for New England self-government and self-government itself. Agitation, because its very existence forces forces the Sydney Government to consider New England interests. Self-government, because there are some things that we cannot achieve without this.

As I write the Federal election is raging. As always, Tasmania is receiving a fair bit of attention. And cash. Senator Harradine showed what could be done to extract benefits for a state from a position of power

New England is far bigger than Tasmania, yet receives almost no attention. Not for us the Harradine largess .

This is a very clear case where statehood would improve our position through increased bargaining power.

Now one could argue - I have often heard this argument - that Tasmania should not receive these benefits. That is small consolation to those concerned with New England and its neglect.

Return to introductory post

Why we need consumer protection for mortgage borrowers: a story

A few years ago, I went to a Joint Center for Housing Studies sponsored conference at the Harvard Business School. While my memory may be faulty, the broad outlines of the following story are true.

During a discussion for the need for consumer protection, a Harvard Law Professor (it may have been Elizabeth Warren, but I am not sure) asked those in the room with an Adjustable Rate Mortgage to stand up--perhaps half the room did so. The professor then asked how many of those standing could name the index to which their loan rate was tied. Those who didn't know were asked to sit down, at which point half of the original group remained standing. The next question was about the size of the margin between in the index rate and the loan rate, at which point another half sat down. Finally, those who remained standing were asked if they knew roughly the maximum payment that they could make on their mortgage--only one person remained standing (and the person sitting next to me said, "I know that guy--he would never admit that he didn't know something in public anyway.")

So here is the point: a crowd of Harvard, Yale, Michigan, Princeton, etc professors and top policy makers did not fully understand the mortgages they had. How can we expect someone armed only with a high school diploma and no consumer finance training to knowledgeably negotiate the world of mortgages?

I used to cringe at the thought of imposing "suitability standards" on lenders. No more.

Greatest Conductor of the last 100 Years?

I love music, and especially symphonies. There are only a few things that thrill me as much as a great orchestra playing a great symphony (such as Beethoven 3, Schubert 9, Bruckner 7 or Mahler 6) really well.

I've been listening to a wonderful recording of Brahms 2 tonight. It features the London Symphony, with a conductor who is distinctly unglamorous, and who is not particularly famous in the US. But compared to him, Bernstein (who I really like, by the way) is too fussy; Karajan is too slick, Solti and Toscanini are too driven, Furtwangler is too sloppy, and Abbado is too slack.

Bernard Haintink has been making extraordinarily satisfying recordings for more than 40 years now, before with the Concertgebouw Orchestra of Amsterdam, and now with the London Symphony. His Brahms, Beethoven, Schubert, Mahler and Bruckner are all great. He did a wonderful Zauberflaute, too. Now if only he'd get around to Haydn, Berlioz and Sibelius, but I guess we have Colin Davis to take care of that.

Time to Return to TRA 1986?

I am fine with the current fiscal deficit--the evidence is pretty clear to me that we would be worse off in the absence of the stimulus, and so long as we can borrow cheaply, and build projects cheaply (because contractors are eager to get work), there are positive NPV opportunities for the public sector.

But the long term fiscal position worries me a lot (and it bothers me when people I respect as much as Paul Krugman soft-peddle it). The question is how to we get out from under?

The good news is that we have gotten out from under budget shortfalls before. The Obama administration proposes raising taxes on high earners, and that is fine, but it is not enough. More fruitful, I think, would be to go after the tax expenditures.

Leonard Burman, Eric Toder, Christopher Geissler estimate the size of tax expenditures. It is huge: depending on the modeling strategy they employ (they look at tax expenditures with and without interaction effects, and with different assumptions about the Alternative Minimum Tax), they estimate tax expenditures for 2007 of 700 billion to 760 billion. The largest expenditures are for retirement plans (126 billion), employer contributions for health insurance (138 billion), the mortgage interest deduction (92 billion), and preferential treatment of capital gains (84 billions).

If we were to eliminate tax expenditures, the overall effect on the tax code would be largely progressive. Pretty much everyone would take a hit, but those at the top would take a bigger hit. If the earned income tax credit (about 43 billion) were left alone the impact would be more progressive.

According to CBO, the long-term fiscal deficit is somewhere in the neighborhood of 600 billion per year. Elimination of tax expenditures other than the EITC would put us back into fiscal balance in a progressive manner without raising rates. It would also make the tax code simpler and less distortionary.

Just a thought.

Ofheo House Price Index Flattens

See http://www.ofheo.gov/media/pdf/2q06hpi.pdf. House prices rose only 1.17 percent in the second quarter, according to the index. This is an increase that more or less keeps pace with inflation.

The Ofheo house price index is not, however, completely representative of the housing market. Ofheo tracks prices on houses financed by Fannie Mae and Freddie Mac; Fannie and Freddie may only finance "conforming" loans, which are in 2015 defined as loans whose value is less than 417,000. This limit shuts Fannie and Freddie off from large parts of the California, Boston, New York and Washington housing markets; consequently, should these large markets go into the tank, their impact on the index will be muted.

The Case, Shiller, Weiss (http://www2.standardandpoors.com/servlet/Satellite?pagename=sp/Page/PressSpecialCoveragePg&c=sp_speccoverage&cid=1143857726920&r=1&l=EN&b=4index ) doesn't have this issue; nor, presumably, do the indexes that one can find in Zillow. The CSW Composite Index for 10 cities was completely flat in June.

If not a hybrid, then what?

I kind of liked the hybrid model of mortgage funding. The pure public sector doesn't do that well (FHA underwriting is not all it should be); the pure private sector also doesn't do so well (beyond the subprime mess, there is very little liquidity even in the prime jumbo market right now).

Where I was mistaken was to think 2.5 percent capital was sufficient backing for the GSEs--I thought home mortgages were so safe, that 2.5 percent plus a stress test would be OK. I was wrong. And it is becoming increasingly clear that the GSEs' managements were reckless with the charters, which gives evidence that Robert Van Order's powerful argument that GSE management would never want to screw up a wonderful franchise was also incorrect.

So maybe the correct answer is a hybrid with more capital--say 5 percent. After all, thanks for FDIC and the Federal Home Loan Bank System, Banks are really hybrids too.

The Power of Simplicity

I gave a talk in New York yesterday morning, and then spent the afternoon/evening with my daughter. We were walking down Park Avenue, and caught the two light beams arising from Ground Zero. We both felt our throats catch at the sight.

The Democratic Party and Subprime

I am a Democrat. Some people who are close to me are not. They they are not has always been something of a mystery to me; as a railroad worker and an executive secretary, they would surely benefit from Democratic policies relative to Republican policies. But I think the sub-prime crisis has given me some insight into why they are Republicans.

This couple, while not affluent, have always been financially responsible. As such, it is not difficult for them to find credit at a cheap price. They would also never think to sign a piece of paper that represented their income to be something other than what it actually was.

Let me stipulate that among sub-prime borrowers, there are many who were harmed by unscrupulous lenders who engaged in deceptive practices. We know, for instance, that many sub-prime borrowers would have qualified for prime mortgages. That they did not receive such mortgages is a problem that need to be remedied. Policy should make it easy for them to refinance out of their subprime mortgages into something more favorable.

But there are also borrowers in the sub-prime market who speculated on the housing markets, and there are borrowers who misrepresented their income and assets. For many of those of have followed the rules, anything that might smack of of a bail-out of those who speculated or borrowed fraudulently will induce anger. My friends are such people, and they believe that the Democratic Party has long been in the vanguard of diverting resources away from them toward those who don't, in Bill Clinton's phrase, "play by the rules." As we seek to solve this problem, and to remedy that harm that was done to those who were victimized by truly bad actors, we Democrats need to remember those who have always played by the rules.

Best article title I have seen in some time

Repugnance as a Constraint on Markets, by Alvin Roth, Journal of Economic Perspectives, Summer 2015.

A Paper on Market Reaction to 9/11 by Kallberg, Liu and Pasquariello

I really like this paper:

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=716721

Abstract:

This study analyzes how three groups of market participants - insiders, analysts, and investors - revised their expected returns on New York Real Estate Investment Trusts (REITs) in response to the catastrophic events of September 11, 2001. The attack on the WTC represents a unique experimental setting to evaluate financial markets' reaction to external shocks for several reasons. First, these events, of a totally unanticipated and unprecedented nature, could not have been built into the market's expectations; hence, market participants had to learn something new rather than just recalibrate their expectations on past occurrences. Second, unlike other studies of market reactions, the impact of the terrorist attacks on REIT returns was ambiguous, since it was uncertain if the effect of reduced supply of office space in New York would outweigh the impact of the negative shocks to the local and national economy on its demand. Finally, the period of market closure that followed 9/11 gave these players ample opportunity to reassess their expectations. Our analysis reveals that, on the day when markets reopened, REITs with significant exposure to the New York area outperformed a broad REIT office index by 4.1%. However, we find that, according to several metrics of real market behavior, this anticipated superior performance of New York office properties did not materialize. Consistent with notions of market efficiency, we find that insiders were the first to lower their expectations (99.9% of their trades in REITs with New York exposure were sales in the month following 9/11), followed by analysts (the vast majority of them revised downward their expectations of NY REIT performance in the first weeks of November 2001), and finally market prices adjusted to reflect the underlying real market behavior; indeed, abnormal REIT returns had disappeared by mid November 2001.

While the paper is principally about information diffusion, it also presents some very nice data on the resiliency of the New York employment market in the wake of 9/11. New York's refusal to be cowed may be the greatest victory we have had over Al-Qaeda. But that refusal also speaks volumes about why New York became a great city in the first place.

A Rising not a Setting Sun

h/t Brad Delong

Whilst the last members were signing it, Doctr. FRANKLIN looking towards the Presidents Chair, at the back of which a rising sun happened to be painted, observed to a few members near him, that Painters had found it difficult to distinguish in their art a rising from a setting sun. "I have," said he, "often and often in the course of the Session, and the vicisitudes of my hopes and fears as to its issue, looked at that behind the President without being able to tell whether it was rising or setting: But now at length I have the happiness to know that it is a rising and not a setting Sun."

Median Incomes and Economic Obsolescence of Large Homes

One thing that has led me to believe that the housing market in Southern California is largely at bottom is the fact that many houses are selling at less than replacement cost. While such a discrepancy can exist for a long time in places with declining population, replacement cost is a pretty sound fundamental for determining the minimum sustainable house price in areas with growth.

The report on median incomes released yesterday, though, suggests to me a flaw with my line of reasoning. While the average new house has grown about 20 percent in size over the past ten years, median household incomes have actually fallen a bit. If house size is a proxy for house quality (and we have good statistical evidence to think that it is), then house quality has outstripped the ability of people to pay for it.

When comparing market prices to replacement cost, we really need to think about depreciated replacement cost. Depreciation comes in three flavors: physical, functional and economic. Physical depreciation happens because things wear out as they age--it is what Congress is thinking of when it allows depreciation deductions for investment property and plant and equipment.

Functional depreciation happens when a component of a capital asset does not perform its function well by current standards. Think of a furnace that uses lots of energy, and could be replaced by something more efficient. It is possible that it could work as a furnace for years, but it still would be best replaced by something more efficient.

Finally, there is economic depreciation, which happens when the demand for something (like Detroit real estate) disappears. It is possible that large houses have incurred economic depreciation because people lack sufficient income to afford them. If this is true, values can fall below original construction cost and stay there for some time.

Such considerations do not, of course, apply to reasonably well located, modest homes--I continue to believe that 1500 square foot houses in the San Fernando Valley and the central part of the San Gabriel Valley are reasonably priced now. But the market for larger houses may be troubled for some time yet to come.

One other implication: builders should construct smaller houses in the years to come. This vindicates a prediction I once made. Unfortunately, I made it in 1990.