Friday, November 30, 2007

I was waiting for this

From this morning's Wall Street Journal

Even as the national housing market has been hit by slow sales and falling prices, Manhattan has continued to shine. But now its light may be dimming.
Upper East Side townhouse was listed in July for $24.5 million. Current asking price: $19.5 million.

Fewer apartments are being sold -- 858 went into contract in September, a 9.9% drop from a year ago and the lowest total in two years, according to brokerage Corcoran Group -- and the inventory of unsold apartments is increasing. Prices are also leveling off. The median price of a Manhattan apartment fell 3.4% in the third quarter from the previous one, according to the research firm Radar Logic. The firm says properties are sitting on the market longer, too, an average of 123 days, up from 94 days at the peak of the market in 2005.

Developers used to seeing yet-to-be-built apartments get snapped up sight-unseen are increasingly offering incentives, from help with closing costs to museum memberships, to jump-start sales. "Buyers are more hesitant," says Hall Willkie, president of brokerage Brown Harris Stevens.

I wrote a paper some years ago on the effect of the tech stock market on house prices in California. Short answer: none in LA, lots in San Jose. I am guessing that the stock value of investment banks (and the bonuses of their employees) has the impact on Manhattan real estate that the stock value of tech companies has on Silicon Valley real estate.

Thursday, November 29, 2007

Harvard Joint Center for Housing Conference on Understanding Consumer Credit

I have spent the past two days participating in a conference at Harvard Business School on Consumer Credit (so it became a conference about subprime). Some impressions:

(1) When it comes to mortgages, very few of us are really informed about what we are doing. Of the people in the audience who had an adjustable rate mortgage, no one could say what their payment would be if it rose to the fully indexed amount next year. And the audience was filled with law professors and economists who teach at places like, um, Harvard. This has pretty profound implications about the meaning of consumer choice in the mortgage market.

(2) John Campbell noted that competitive pressures lead lenders to offer products that rely on somebody being stupid (the stupid subsidize the savvy). The 2-28 ARM may be just such a product. While I couldn't imagine myself saying this a year ago, it may be welfare improving to reduce mortgage choice. A menu that contains 30-year fixed mortgages, and fully indexed one, three and five year ARMS may be enough (although I reserve the right to change my mind on this).

(3) Amy Cutts showed (I think) that when lenders can foreclose more rapidly, there is a greater tendency for both cures and mortgages.

(4) Everyone involved in the mortgage process needs to have some capital at stake--including borrowers (i.e., no down payment mortgages just don't make sense).

(5) The housing market may be getting bad enough that some sort of bail-out might not create serious moral hazard problems--that is, many people who did nothing wring are now at risk, and for the sake of the macroeconomy, we need to think about how to help them.

(5) They regulate the mortgage chain far more in the UK and the Continent than in the US. Good news: defaults are much rarer. Bad news, consumers have much less mortgage choice. Borrowers in the UK can't get fixed-rate mortgages; borrowers in Germany can't prepay their loans.

(6) I love visiting Cambridge (I know, HBS is in Alston, but close enough).

Monday, November 26, 2007

Fareed Zakaria's column this week is worth reading

It is here:

The point is that America is shooting itself in the foot by making it difficult for foreigners to come here for tourism and short business meetings. I did a paper last year on the importance of airports as engines of growth, and the results are sufficiently powerful that I really believe them (see Airports and Economic Development, Real Estate Economics, Spring 2007).

We seem to have made it a national policy to make visiting here as unpleasant as possible. Among other things, our airports are not good (Singapore, Hong King Dubai and Frankfort have our airports beat hands down; thank goodness that Narita, Charles de Gaulle, and Heathrow are as bad as anything we have). And I guess that dealing with the INS is just no fun for foreigners. While I find Dubai and Singapore somewhat oppressive, their immigration processes are remarkably efficient. Put all this together, and we are losing business meetings (and world-class graduate students) to other countries.

If any of this was really preventing terrorism, one might make the cost-benefit calculation and decide that the cost to us economically was worth it. But I am skeptical of the utility of our hostility to foreign visitors. I also think nothing does a better job of instilling good feelings about the United States among foreigners like allowing them to have pleasant visits here. And we need all the sympathy we can get.

Hoisted from Mark Thoma's comments

Mark Thoma was kind enough to refer to my post on forecasting housing prices. ONe of the comments came from Fishy Math:

Fishy math says...

Wait a second! This formula is based on a perpetuity! Of course you are going to get huge swings resulting from relatively modest changes in assumptions. If you believe that housing prices will decrease by 5% per year INDEFINITELY, then you're correct. More likely, we will experience sharp depreciation for a couple of years, followed by a resumption of whatever the normal level of appreciation in housing in perpetuity.

Assuming 2 years of 10% declines followed by a resumption of 5% annual increases, I get a multiple of about 16x capitalized rents.

I want to make it clear that I am NOT forecasting declines of 5 percent in perpetuity. My point was that expectations, which overshot on the upside before, could now overshoot on the downside, and that we have rather poor estimates of what expectations are--although the CSW housing futures index suggests that those who are putting money on the line think that prices are going to fall for quite awhile. People also seem to be myopic when they form expectations.

The most important point, as Mark notes, is that small changes in expectations can lead to big changes in prices. To use a less extreme example, if expected appreciation drops from five percent to two percent per year, values would fall by about 40 percent. I think that is quite enough.

Three principles for avoiding future subprime messes

Changes in policy should accomplish three things:

(1) It should make sure that all parties in the lending chain have “skin in the game.” While reputational risk mitigates against bad behavior, there is no substitute for financial incentives.

(2) It should make sure that all parties in the lending chain are subject to federal supervision. This will reduce regulatory arbitrage.

(3) It should do what it can to improve disclosures throughout the lending chain. Borrowers must be better informed as to the consequences of their lending choices (although this will be difficult); ratings must be consistent, and securities must be more transparent.

Long run vs Short run

I should follow us my earlier post by noting that while expectations can be ideosyncratic in the short run, they are probably about right in the long run.

With that in mind, let me point out that in 2002 I thought that house prices in most cities (with the possible exceptions of Boston, San Diego and San Jose) were tied pretty well to fundamentals. So if you want to know long-run house prices in most places, look at values in 2002 and add around 3 percent per year. Alas, many places had double-digit increases per year between then and now...

Pleasant memories

One of my cousins got married this weekend, and in the course of the festivities, my family (all my immediate and some of my extended) went to the MIT museum. It was there that I was reminded of one of the most exciting experiences of my life.

The MIT museum has an exhibit dedicated to the work of Harold, or Doc, Edgerton, "the man who made time stand still." When I was 16, I made a campus visit to MIT. I wanted to go to college there, as my very smart Aunt and Uncle had Ph.Ds from the place, and my very smart cousin, who worked on Apollo rockets, was an engineering alum (since then, yet another cousin got at Econ Ph.D. there--he now teaches at Northwestern). During the campus visit, I was taken to Doc Edgerton's lab, where the man himself was working (playing?) with his strobe. He asked if I wanted to see how it worked! And so it was for the first time that I saw milk drops falling and eggs smashing at a speed at which every detail was visible (it was like watching CSI for real, only not so bloody).

Boy, did that make me want to go to the Institute! In the end, they made the wise decision not to take me (I am really not good enough at math), so I spent four nice years a couple of miles down the street. But I hadn't thought about that day for a long time, and it was nice to have it returned to me.

Brad Delong cites the FT on The Arnold and Subprime

By bringing together four large subprime lenders and getting them to cooperate, Schwarzenegger has done something incredibly important--he has gotten lenders out of the prisoner's dillemma and onto a welfare-improving cooperative equilibrium.

Unless everyone agrees to modify their loans, everyone has an incentive not to modify (if there are going to be lots of defaults,one might as well get a high coupon rate for each mortgage that stays current). But now all the players have an incentive to modity, so long as everyone else modifies. This will prevent some defaults, and thus reduce the inventory of houses for sale relative to what it might have been.

But if any one of the four lenders starts fooling around, the whole thing will come unglued. It is important that the Terminator use his ability to intimidate to keep the deal together.

The problem with forecasting house prices

The value of a house should, in equilibrium, be its capitalized rents. Its capitalization rate is (roughly) the after-tax required rate of return, plus depreciation and expenses less expected appreciation. We may write this out as:

r + m - pi.

The r and the m are relatively easy to measure. Households in the conventional conforming market can borrow at an after-tax mortgage rate of about 5 percent right now, and with very little equity, they can borrow at around 6 percent (the cost of interest plus mortgage insurance). Let's add a risk premium and put the total around 7 percent (this is probably a bit high). Depreciation and expenses will run around 2 percent of house value. So the value of a house is the value of its rent divided by 9 percent less expected appreciation.

Now let's see what happens when we let expectations about future prices rangs from an increase of 5 percent in a year to a decrease of 5 percent in a year. If expected prices increase five percent, values are 25 times rent (rent/.04); if the decrease 5 percent in a year, values are about 7 times rent. So a ten percentage point deline in expectations could cause house prices to fall by two-thirds.

I think this is part of the current problem. On the one hand, after roughly 2002, prices in many markets shot up well past the 25 to 1 point (on a quality adjusted basis), in part because of very low interest rates, and in part because of unrealistic expectations. Now that prices are falling (as inevitably they would), expectations have reversed, although it is not yet clear by how much.

Some months ago, when others were writing that the bottom was coming, I wrote that I didn't know when the bottom of the housing market was coming, and neither did anyone else. I wish I had been wrong.

Wednesday, November 21, 2007

Happy Thanksgiving!

Let's hope nothing too eventful happens this weekend. See you on the Mass Pike!

Oy vey

On July 16 I wrote:

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...

The good news: 10 years Treasuries are now at around 4 percent. The bad news: see Commercial real estate values are falling. Just what we need.

Freddie Mac's Earnings

Yesterday was not a good one for Freddie Mac: its earnings were substantially more negative than nearly everyone was expecting, and the value of the stock slid by 30 percent.

I am not entirely sure yet why earnings were so poor, but press accounts suggest that the heart of the problem was the mark-downs the company took on delinquent loans that it had repurchased from loan pools. The losses on these loans have not actually been realized in a cash-flow sense (Freddie has not sold them at below market value), but in light of the fact that these are by definition problem loans and that losses conditional upon default seem to be rising, the write-down seems appropriate.

The episode brings home several points. First, it was not long ago that Fannie and Freddie were criticized for having returns on equity that were "too high" and for charging guarantee fees that were also "too high." Guarantee fees are the insurance premium the GSEs charge to sellers of loans to guarantee timely payment of principal and interest. The reason ROES were so high for years is because house prices rose everywhere, and so default losses were nearly non-existent. The companies faced an environment analogous to a casualty company with a book of business in Florida that didn't face a serious hurricane for five years. It one looks at the long term history of default in the United States, Fannie/Freddie G-fees were not excessive (fwiw, I made this point at least as far back as 2005).

Second, as Freddie is confined to conventional/conforming loans, and focuses on prime loans, the markdown at which the market is pricing its non-current loans reflects the fact that the market is building in a high risk-premium for all loans. One thing we know about prime mortgages from the past is that people actually rarely defaulted on them, unless they were facing job loss, divorce or illness, regardless of house price movements. It is possible that attitudes toward default among prime borrowers have changed--we are in the middle of an experiment that will allow us to find out.

Finally, it is an important and open question as to what the role of the companies should be going forward. If the regulatory climate (such as capital requirements) remains tight, the inability of the companies to purchase loans could make housing conditions worse. On the other hand, if house prices overshot up, they will likely overshoot down regardless of credit market conditions. Congress and regulators need to ask themselves whether they are willing to hang on tight if they allow Fannie and Freddie to increase lending in such an environment.

We went through a ride like this in the early 1980s, where because of interest rate changes, Fannie Mae was technically insolvent (and bleeding cash flow). The government decided to forbear, and once interest rates fell, Fannie was OK again.

Tuesday, November 20, 2007

144 years ago yesterday

Brad Delong's blog reminds me that this was spoken:

Four score and seven years ago our fathers brought forth on this continent, a new nation, conceived in Liberty, and dedicated to the proposition that all men are created equal.

Now we are engaged in a great civil war, testing whether that nation, or any nation so conceived and so dedicated, can long endure. We are met on a great battle-field of that war. We have come to dedicate a portion of that field, as a final resting place for those who here gave their lives that that nation might live. It is altogether fitting and proper that we should do this.

But, in a larger sense, we can not dedicate -- we can not consecrate -- we can not hallow -- this ground. The brave men, living and dead, who struggled here, have consecrated it, far above our poor power to add or detract. The world will little note, nor long remember what we say here, but it can never forget what they did here. It is for us the living, rather, to be dedicated here to the unfinished work which they who fought here have thus far so nobly advanced. It is rather for us to be here dedicated to the great task remaining before us -- that from these honored dead we take increased devotion to that cause for which they gave the last full measure of devotion -- that we here highly resolve that these dead shall not have died in vain -- that this nation, under God, shall have a new birth of freedom -- and that government of the people, by the people, for the people, shall not perish from the earth.

Gary Wills' book on the Gettysburg Address is among my all-time favorites. Lincoln used the occasion to replace the Constitution with the Declaration of Independence as the document that declared our principles (as opposed to out legal structure). We have been better as a country ever since. The Declaration declared that all men are created equal, while the Constitution as is existed at that time condoned slavery. It was only when the 13th, 14th and 15th amendments came into being that our laws began to match our aspirations.

How to reform Division I sports?

This is from Gregg Easterbrook's TMQ column today. I don't care that much for his "serious" stuff, but he has the best football column going. And today, he reported on a beauty of a suggestion from his brother:

Thus Lewis' article gives me an opening to repeat the reform proposal made by Official Brother Neil Easterbrook, a professor at TCU -- for every year a Division I football or men's basketball player performs, he receives an additional year of tuition, room and board at the school. That way, when NCAA eligibility expires and the player realizes no NFL or NBA payday will ever happen, he can buckle down, get serious about studying and obtain the college education that will help him advance in life. Neil's rule would ensure that Division I football and men's basketball players are not used up and tossed away by the sports-factory schools; would create a strong incentive for those schools to be serious about teaching their athletes, so they graduate on time and don't represent extra years of costs; and would create a campus presence of once-star players who didn't make the NFL or NBA and are now at the library studying, radiating the message that you'd better study. How about it, NCAA? Why not use your billions of dollars to set up a system that would allow revenue-sport athletes who have brought you cash and glory on the field to remain in school until their degrees are complete?

Monday, November 19, 2007

Worthwhile reading on Wamu vs Cuomo

Tanta On WaMu vs. Cuomo

There was a great post by Tanta on Calculated Risk's blog about a legal battle involving Cuomo, Fannie Mae, and Washington Mutual.

For background information on the lawsuit please see WaMu Collapses Under Appraisal Probe. My ending comment was "If Washington Mutual has to buy back those loans from Fannie Mae, the patient will die."

Tanta took things further, looking at the entire appraisal industry itself, including some legal repercussions of what might happen depending on how the lawsuit progresses.

Tanta's must read post is called WaMu and The Rep War.
Following are a few snips:

Fannie Mae is saying that WaMu will take back any loans with dubious appraisals this "independent examiner" digs up. WaMu is saying that it will "rigorously" avoid doing so.

WaMu is also saying, in effect, that it signed a contract with eAppraiseIT that puts all liability for inflated appraisals on eAppraiseIT.

Fannie Mae is saying, in effect, that it signed a contract with WaMu that puts all liability for inflated appraisals on WaMu.

This is very interesting precisely because it isn't going to be about inflated appraisals. It's going to be about how far anyone can get away with two practices that are the lynch-pins of the mortgage industry: outsourcing regulatory liability to a third party bag-holder and doing business on a representation and warranty basis without pre-sale due diligence.


Trust me; all of that stuff is detailed and specific enough that it isn't that hard to find contractual grounds to declare breach and demand repurchase of a loan.


Anyway, this is why the whole flap is scaring the panties off everyone in the mortgage industry, far, far beyond any worry over stiffer appraisal regulation. The core issue here is a cornerstone of the whole "originate and sell" model that has created such a crisis.

If Cuomo's suit makes any headway at all, it will put eAppraiseIT out of business one way or the other. That's because if appraisal management companies are no longer willing or able to write these liability swaps into their contracts, they won't be able to offer what the lenders really want from them. The advantage of doing business this way isn't really about saving a few dollars on outsourcing administrative work for the lenders, it's about getting out from under a huge expensive compliance and legal risk.

No wonder Cramer's head is exploding again. This thing really isn't about appraisals, it's about stopping the game of risk-layoff.

Yes, WaMu (WM) will collapse if it has to take back those loans, but the bigger picture is the entire "originate and sell" model might collapse along with it. Won't that be fun?

The originate to sell model has taken a reputational hit as a result of subprime. Nevertheless, the old-fashioned retail-depository model had had its share of problems throughout its history; we shouldn't forget that securitization helped solve the savings and loan crisis. It would be a shame if in the midst of our current troubles we forgot about how the ability to sell mortgages has deepened the liquidity of prime mortgages, and enabled households to become attached to capital markets in a positive manner.

A Clue as to Why Goldman is So Good

The Times this morning has a flattering piece on Goldman-Sachs. And no wonder: they took hedge positions that have increased the company's profitability at a time when other investment banks are having, shall we say, serious problems.

The Times gives some reasons about why the company is so good, but let me suggest another. My limited exposure to people in the company suggests to me that part of the culture is actually to encourage reflective study. Instead of making decisions coming "straight from the gut," people at the company read current literature and appreciate the history of financial markets. Unlike its competitors, Goldman has people who understood that house values could not go up forever in all markets. This simple insight was fundamental to the company having a very sensible (and in the end) profitable risk management strategy.

It is often the case that ex post high payoffs result from nothing more than a favorable draw from a distribution of outcomes. But every now and then, one sees an institution that gets the favorable draw time-after-time. Berkshire-Hathaway seems to be one of these institutions, GS is another. The probability of getting great draws at random again and again becomes vanishingly small. I am willing to believe that Goldman Sachs is just plain smarter than its competitors.

Sunday, November 18, 2007

Manski and Identification

I am teaching Charles Manski's great book on Identification Problems in the Social Sciences right now (I must say that I find his writing much clearer than the class I had with him as a grad student).

One of this important points is that one cannot evaluate the counter factual or a persons' life. Suppose we find that children who come from in fact families graduate from high school at an 87 percent rate. Then without assuming a lot of structure, all we can know is if children in non-intact families could magically be transported to intact families, the children's graduate rate would lie between 0 and 100 percent. It is only if we assume that kids got randomly picked into intact and non-intact families that we can assert that all kids in in-tact families will graduate at the 87 percent clip. But this assumptions seems hardly reasonable. More on this tomorrow...

Suburbs Separated at Birth?

I live in Bethesda, Maryland a suburb immediately outside of Washington. My in-laws live in S. Pasadena, CA, a suburb immediately outside of LA. I was comparing rents and prices on a per square foot basis in both towns, and they seem remarkably similar. I will need to investigate this more carefully (making adjustments for housing quality etc.), but still...

Bethesda and Pasadena have a couple of things in common. They have always had town centers, and as such have long had a greater sense of identity than the typical cookie-cutter suburb. They have also seen their downtowns develop remarkably in recent years. In fact, Pasadena is one of the great urban renewal stories of the post-War era. Twenty-five years ago, the heart of downtown Pasadena, the corner of Fair Oaks and Colorado, was a dump. It is now very beautiful, with nice retail and many interesting restaurants. Bethesda never got as down-in-the-mouth as Pasadena, but it was pretty dull when I first lived in the DC area immediately after college. Downtown Bethesda is now lively. Both downtowns have lots of street life. Both towns have nice residential districts with some distinguished houses architecturally (I particularly like the craftsmen bungalows in Pasadena).

They are also convenient to many employment centers within thriving metropolitan areas.

Why we get in this business

GW inaugurated its new president last week, and I attended or was involved with a number of events surrounding the festivities. The highlight for me was a lunch, where the new President, the President of the Alumni Association, and a Senator who is an alum spoke. It wasn't the speeches, however, that made the lunch.

The lunch was rather made by the two undergraduates who sat at my table--one was a freshman, and one a junior. They were engaged, curious and highly intelligent, and just lots of fun to talk with. We spoke largely about potential opportunities for real estate development in China and India. The conversation centered around the fact that the challenges facing developers in these fast growing places are more grounded in politics than economic feasibility: if one can build a block of flats in Mumbai, they will sell. The issue is getting the government to give permission to build them. We also discussed the problems of property rights in China, and the remaining suspicion of foreign investment in India.

Other than a few seminars, I think the last time I taught undergraduates was 2004, when I taught 120 undergrads at Wharton. I need to get back into undergraduate teaching....

Wednesday, November 14, 2007


From this morning's WSJ:

Among the nation's 100 largest metropolitan areas, Stockton, Calif.; Detroit; and Riverside-San Bernardino, Calif., posted the highest third-quarter foreclosure rates, RealtyTrac said Wednesday. Stockton had one foreclosure filing for every 31 households; Detroit had one for every 33 households; and Riverside-San Bernardino had one for every 43 households. Riverside-San Bernardino also had the most foreclosure filings overall -- 31,661 -- followed by Los Angeles, Detroit and Atlanta.

Other cities with top foreclosure rates were Fort Lauderdale, Fla.; Las Vegas; Sacramento, Calif.; Cleveland; Miami; Bakersfield, Calif.; and Oakland, Calif.

The Stockton, Detroit and Riverside numbers are truly astonishing. They mean that nearly everyone in these areas knows someone who is in foreclosure. That can't help but undermine confidence in the housing market, and therefore produce greater expectations of future house price declines. My best guess is that house prices in these places will overshoot downward, so it is going to be a long time before we see a bottom.

Tuesday, November 13, 2007

Should Academics Blog?

A class post from Dan Drezner on this is here:

I am lucky, in that I am past tenure. But the question is whether blogging detracts from doing "serious" work. The answer is perhaps, but not necessarily.

First, one can't help but note that some great academics, such as Gary Becker, Richard Posner, Brad Delong and Jim Hamilton, blog regularly. I learn a lot from these blogs (much more than I do from Atrios or Dailykos or Huffingtonpost), and am grateful that they are out there. Among other things, they help inform my choice of reading, and therefore lead me to knowledge I care about more efficiently.

Second, unlike, say, Ed Glaeser and John Quigley, who are seemingly incapable of intellecutaly exhaustion, I am not able to do "serious academic work" 24/7. Sometimes I just like to put ideas out there and see if I get any response. When I do, it helps me think things through, and therefore makes me a better professor.

Menzie Chen on the Credit Crunch

A couple of points. First, the fact that the yield curve is upward sloping again is probably good for the mortgage market (at least the prime market), because short borrowers can earns returns on the term structure. When I did my recent paper with Wachter, it was striking to me how bad an inverted yield curve seems to be for the mortgage market.

Second, while lots of home equity has been destroyed, I am not sure how important this is to the macroeconomy. I never bought the idea that home equity loans had a long term effect on aggregate demand, because they did not generally improve the household balance sheet (in exchange for cash, the household took on a new liability). Moreover, people tend not to sell their houses and cash out home equity until they are old. Consequently, the "wealth" effect arising from high house prices should largely have an impact on the elderly. For those who continue to consume the same quantity of housing, house prices are not so important.

The problem as I see it is largely from spillovers. To the extent credit spreads in general widen because of an absence on confidence, the economy will be slowed.

Edward Elgar is 150 this year

Colin Davis' new recording on the Enigma Variations is something to behold.

Should you be near Rockville, MD this Friday

Go see the Richard Montgomery High School production of Lend me a Tenor. It is great--seriously. The kids' sense of comic timing is remarkably mature--I was reminded of Preston Sturgis' movies.

Ok--full disclosure, my daughter is in it (as Diana) but...she actually surprised me with her brilliance, and I have lived with her for 17 years.

Thursday, November 08, 2007

Cuomo, WAMU and Fannie/Freddie (cont.)

I have it on reliable authority that Fannie/Freddie do in fact use automated valuation systems to place a reality check on appraisals. So Cuomo is grandstanding (and not for the first time). In the meanwhile, he may be doing genuine harm to the mortgage market when it is already crippled enough.

Fudged Appraisals

From Calculated Risk:

Here is the press release from NY AG Cuomo. A couple of excerpts:

“Our expanding investigation into the mortgage industry has uncovered that Washington Mutual improperly pressured appraisers to provide inflated values that best served the lender’s interest. Knowing this, Fannie Mae and Freddie Mac cannot afford to continue buying Washington Mutual mortgages unless they are sure these loans are based on reliable and independent appraisals.”
Attorney General Cuomo, Nov, 7, 2007
And from the Appraisal Institute:
“I wish I could say I am shocked by the discoveries made by the Attorney General and his staff. Sadly, what allegedly happened between First American and Washington Mutual is not an isolated incident. Rather, it is symbolic of a problem that has plagued the appraisal industry for years. As the allegations against First American show, the mortgage industry’s dirty secret has been that banks exert tremendous pressure to extort appraisers.”
Terry Dunkin, President of the Appraisal Institute Nov 7, 2007.

One thing puzzles me about this. Cuomo wants Fannie and Freddie to verify that the WAMU loans they buy do not have inflated appraisals underwriting them. But I thought that when Fannie/Freddie bought loans, they used an automated valuation model to keep the appraisals honest. I could be wrong about this, but if I am not, Cuomo's calling the GSEs on the carpet is grandstanding. But this whole episode also shows why home mortgages should be underwritten using automated valuation models. They are not perfect, and they are what they are, but they can't be fudged.

Monday, November 05, 2007

Rhetoric and Success in Economics

This is a seriously cool paper by Hugo Mialon:

The abstract:

Is economics an art? I address this old, but important, question empirically by examining the impact of rhetorical features of the titles of published economics articles on the ultimate success of these articles, as measured by their cumulative citations over the six-year period following their publication. Twenty-eight percent of articles in the sample have a fresh figure of speech in their title. Surprisingly, adding a rhetorical device to the title of an empirical article adds more than four citations to the article's "lifetime" count, which represents about twenty percent of the lifetime citations of the average empirical article. This result testifies to the continuing power of rhetoric and poetry in economics science.

Robert Shiller's recommendations on mortgage policy

From testimony he gave to Congress

The FHA, the GSEs, private mortgage investors and mortgage servicers should be
incentivized to further assist the lower-income and minority borrowers and others who
have been victimized by fraudulent and predatory lending practices in the recent boom.
We should create, along lines advocated by Harvard Law professor Elizabeth Warren, a
Financial Product Safety Commission, patterned after the Consumer Product Safety
Commision, to deter poor lending practices in the future. Formal safeguards against the
practices and influences that generate systematic home appraisal inflation are also long
overdue in the mortgage lending industry. We should, at the same time, promote other
risk managing innovations in housing, such as home equity insurance, shared equity
mortgages, home price warranties, and down-payment-insured home mortgages. All of
these risk-management vehicles will help mitigate the severity of impact on individual
homeowners when we next encounter a boom-bust cycle in home prices.

The Financial Product safety commission might be worth a try, but I am skeptical about how effective it would actually be. It would run into exactly the same problems that regulators have faced over the past decade: how does one develop mortgages that are "safe" without shutting certain categories of people (low-FICO borrowers, the elderly) out of the housing market altogether?

Shared equity mortgages and home price warranties are ideas that have been around for a long time, but run into practical difficulties when people attempt to implement them. For instance, people in a house do not want to have to get permission from the shared equity partner to redo the kitchen.

The call for appraisal reform is long overdue, however.

Friday, November 02, 2007

The Presiden't Commission on Tax Reform and Housing

Andy Reschovsky and I just wrote a paper on this. Here is part of the conclusion:

The United States government currently spends about $175 billion per year to subsidize homeownership. The lion’s share of these subsidies operate through the tax system, with the largest single tax subsidy being the mortgage interest deduction. Despite these subsidies, ho-meownership rates for certain groups of Americans, notably African Americans, Hispanics, and households with modest incomes, are substantially below the average homeownership rate. For several decades now, economists have argued that the use of a mortgage interest credit instead of the current deduction would both encourage homeownership and more equitably distribute ho-meownership tax subsidies across the income distribution. In fact, in their final report, issued in November 2005, the President’s Advisory Panel on Federal Tax Reform recommended eliminat-ing the mortgage interest deduction and replacing it with a non-refundable 15 percent mortgage tax credit.

In this paper, we estimate a model of housing tenure choice and housing expenditures using data from the one-percent PUMS from the 2000 Census. The model allows us to determine the impact of alternative tax policies on the user cost of owning relative to renting. Because of our large sample size, we are able to estimate quite precise effects for individual racial/ethnic groups. Our results are very robust, with the tax variable proving to be highly significant in re-gressions using data for both 1990 and 2000, for recent movers, and for various racial/ethnic groups. The results of our housing model are used in a tax simulation model that we have con-structed based on 2004 federal and state tax law. Our simulation model allows us to calculate federal income tax liabilities of all taxpayers under existing tax law and under a variety of alter-native tax policies aimed at increasing the rate of homeownership.

Specially, we simulate the impact of the housing credit proposal made by President Bush’s Advisory Panel on Federal Tax Reform. Because we are convinced that the elimination of the mortgage interest deduction is politically impossible, we also simulate a plan that involves a refundable mortgage interest tax credit that provides every household with the option of utilizing the credit or the existing mortgage interest deduction, whichever one provides the largest tax savings.

The striking thing about the housing proposals of the President’s Tax Reform Panel is how little they do beyond redistributing the homeowner tax subsidy. The net result of replacing the mortgage interest deduction with a credit would actually be a decrease in the overall ho-meownership rate (by half a percentage point). This decrease would occur because the additional homeownership among low- and moderate-income households would be insufficient to offset the decrease in homeownership among middle- and high-income households, some of whom would choose to rent in response to a reduction in the size of the mortgage tax subsidy they would re-ceive, Although a credit is more beneficial than a deduction for low- and moderate-income families, its impact on the homeownership rate is limited because the proposed credit is non-refundable, and therefore provides no homeownership incentive to households who pay no in-come tax.

On the other hand, because many homeowners who are not itemizers become eligible for the credit, the Tax Reform panel’s proposal does not do very much to increase federal income tax revenue. Much of the benefit of the proposed plan flows to households who are already owners in the form of reduced housing costs. We estimate that if there were no changes in how households finance their housing, the Treasury would gain $4.9 billion in revenue, about 1.6 per-cent of total 2004 income tax revenue. However, if there is a substantial shift away from debt toward equity for the financing of homes, the net revenue impact of the proposal will be much smaller.

Statistics and the WSJ Op-ed page

There is an embarrassingly bad piece in today's WSJ op-ed page:

The two writers follow the number of executions and the number of murders across time, conclude that there is a strong correlation between executions one year and number of murders the next, and then say the fact that they haven't controlled for anything is probably OK, because of Occam's razor.

Aside from the fact that they don't deal with the special issues presented by time series data (correlations produced by two series of data with strong trends in them will be spuriously high), their Occam's razor approach pretty much ignores how serious people do social science research. Richard Freeman, the Harvard Labor economist, says something like: "it had better be there in the correlation, it has better be there in the OLS regression, it had better be there in the IV regression, and it had better be there in the high-tech Maximum Likelihood estimate.

I am open minded about the possibility that the death penalty is a deterrent. But this morning's piece does nothing to pursuade me; worse, by polluting social science, it undermines social science.