Tuesday, March 31, 2009

Highest per capita Restaurant Quality in the Country?

Brad Delong today wrote about the virtues of Caribou Coffee in Washington. This reminded me of how much I missed Victors Coffee in Madison when I lived in Washington. And it in turn brought back memories of all the great tastes in Madison.

For me, Madison has the country's best ice cream (Michael's Frozen Custard), hamburger (Dotty Dumpling's Dowery), beer (New Glarus Spotted Cow) and coffee (Victor Allen's). It also features the best bagel outside of NYC (Bagel's forever). For special occasions, L'Etoile was, to me, a match for Chez Pannise in Berkeley. Madison had two very good Italian restaurants (Pasta par Tutti and Wild Iris) and two very good Mexican restaurants (La Hacienda and El Dorado Grill). Monte's blue plate diner always served delicious, creative food, and was fun. Needless to say, prices at these places were much lower than prices in New York, Washington or even Chicago.

So while LA and San Francisco and New York have more good restaurants than Madison, or a per capita basis, Madison may well beat them all.

Monday, March 30, 2009

Property Rights and Property Values in Asia

Global Property Guide is a wonderful web site with lots of fun facts about property markets around the world. I was looking through its data this morning in order to get information for a project I am doing at the moment, and I couldn't help but draw a plot:

The X axis is a measure of property rights by country: property rights are weakest in Vietnam and strongest in Singapore and Hong Kong. Note the correlation. Even though the property rights index is only ordinal, it has a correlation of .78 with the price per square meter of a 120 square meter flat in the national and or financial capital of each country.

On the one hand, one would expect freer property rights to encourage productivity, and therefore produce higher incomes which would leads to higher prices. On the other hand, stronger property rights should also make housing supply more elastic, and therefore reduce property values.

India is (as is often the case) the outlier here: property rights are not strong, but prices are very high. Indeed, the price of a flat in Mumbai, where per capita PPP income is at about 1/6 the US's, is comparable to Manhattan, and much more expensive than Los Angeles. But Indian policy has fettered housing construction over the years, and Mumbai is the financial and cultural capital of India, so its very high prices (especially in context) should not be surprising.

Monday, March 23, 2009

One person's perspective on bonuses

When I followed my wife from Madison to Washington in 2002, I thought it would be a great opportunity to try something different from academia. While I enjoyed being a professor very much, it struck me that I could learn more from doing something else for awhile. I hence wound up at Freddie Mac--where in about 16 months I learned more about mortgages and human nature than I ever thought possible.

Money was actually not much of a motivation for the move. My salary at Freddie was slightly higher than my nine-month salary at Wisconsin's School of Business. But at Wisconsin I could get two-months of summer research support (or 22 percent), whereas at Freddie I might get a bonus (typically 15 percent). So in the end, total compensation in the two places was pretty much even--although Freddie's cafeteria was much better.

That said, I can't say that I ever counted on getting the bonus. Indeed, I figured that if the company did badly, there would be no bonus. As it happens, during the one full year I was at Freddie, 2003, the company did very badly indeed, not financially, but ethically. In the wake of an earnings smoothing scandal, most senior management was fired. I suppose this wasn't the fault of we worker bees, but it occurred to me that I should have seen it coming. Before I joined Freddie, I asked a Senior Vice President how Freddie could continue to make good on its promise of double digit earnings growth, given that the mortgage market was finite and that Fannie and Freddie together good gain no more than 100 percent of the conventional conforming market. Has answer was, "that is a good question."

I asked a good question, but I was too naive to consider the implications of a reasonable answer. So while I wasn't responsible for the company's troubles, I should have known enough to avoid the company, and having gotten myself into it, I shouldn't have been surprised if there were no bonuses.

It turned out we did get bonuses. The amount was not the full 15--I don't remember anymore exactly what it was--but it was substantial. I have to admit this mystified me until it dawned on me--workers tend to think of bonuses as an entitlement, rather than, well, a bonus.

Mortgages and Uncertainty

My understanding of the Obama-Geithner plan for restoring financial institutions is that it rests on a hope and a prayer: a hope that no more mortgages will go underwater, and a prayer that underwater mortgages will get paid back at something close to par.

FWIW, my view is this sort of dithering is similar to what the Japanese did in the 1990s, and what we did with the Savings and Loans through the 1980s. The argument is that the mortgages on bank balance sheets are worth more than their current market value, and that by basically forbearing, the financial system can wait out (sweat out?) the problem.

I fear that part of the problem is that Geithner doesn't have mortgage experts on his team. Many people who are brilliant at finance do not understand the behavioral aspects of mortgages (a year or so ago, Eugene Fama called mortgages uncomplicated). The problem is that mortgages have lots of embedded options, and that borrowers do not always exercise them ruthlessly. They exercise the call (prepayment) option when it is out of the money because they have to move. They fail to exercise the call option when it is in the money because they can't be bothered. They fail to exercise the put (default) options when it is in the money, because they care about their reputation for paying their bills, or because they don't know the real value of their house. They do exercise the put option when it is in the money because they lose their job, or they get sick, or they have marital difficulty. And the option can move in and out of the money with remarkable swiftness.

Modeling all of this is hard work, because financial models--such as those used to value callable corporates--are just not sufficient. If we set up something like a home owners loan corporation, we could recognize losses at their likely maximum, and keep mortgages current going forward. It seems to me that this would do the least harm and allow the financial system to reset.

Friday, March 20, 2009

For Excellence in Film Reviewing

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How big a tax advantage do owners have relative to renters?

Bill Wheaton's comment at UCI a few weeks ago continues to haunt me.

Let's ignore financing for a moment (because interest is deductible for both owner-occupants and landlords). According to Morris Davis, Gross Imputed Rent is about 4.6 percent of house value. One is functionally allowed to deduct the value of that income for determining taxes.

The depreciation schedule for rental property is 27.5 years/ straight line, or 3.6 percent of value. Only buildings are depreciable, and in the US, this is about 80 percent of value, so 3.6 percent x .8 = 2.9 percent. Owner-occupants may not deduct operating expenses, while landlords are allowed to do so. Figure this adds another one percent to the deduction. We are at a 4.6 percent deduction for owners, and 3.9 percent for landlords. This is a pretty small difference

But the average owner occupant is almost surely in a lower marginal tax bracket than the average investor in apartments. If the average owner pays a 20 percent marginal tax rate, and the average landlord pays 25 percent, the tax deduction to landlords is actually a little higher than the tax deduction to owners.

Neither owner-occupants nor landlords pay much in the way of capital gains taxes (owner-occupants get a large exemption, while landlords can use exchanges to defer capital gains taxes forever).

The tax treatment of housing still encourages high income people to buy bigger houses than they otherwise might (because the value of the subsidy increases with one's tax bracket), and this is distributionally obnoxious. But given the magnitudes we are talking about, I am guessing the deadweight loss created is pretty small.

I don't think the depreciation allowance for rental housing is unreasonably high: building that are not recapitalized will wear out before age 27.5 (try going without a new roof or furnace for 27 years). So it is not clear to me how the tax code particularly favors housing relative to other investments.

Thursday, March 19, 2009

US Housing Policy is about to get better

From today's Washington Post:

Raphael Bostic
Department of Housing and Urban Development
Assistant Secretary for Policy Development and Research
Announced: March 18, 2009

Education: Harvard University, AB; Stanford University, PhD
From: Los Angeles, CA
Ethnicity: Black
Bostic is a professor at the University of Southern California's School of Policy, Planning, and Development. He studies the roles that credit markets, financing and policy play in enhancing household access to economic and social amenities.

Last Job
University of Southern Çalifornia, professor at School of Policy, Planning and Development
Other Job
University of Southern Çalifornia, director of Master of Real Estate Development degree program

Wednesday, March 18, 2009

Morris Davis' Rent-to-Price Ratio is rising

Go to this page. Click on the word "here."

At 4.67% (based on Case-Shiller) it is it at its highest point since 2000. With mortgage rates as low as they are, this implies people think rents are going to fall for awhile.

I am doubtful Obama's MID cut-back would affect California much

President Obama has proposed reducing the rate at which households with incomes above $250,000 would benefit from the Mortgage Interest Deduction. The value of the deduction would be reduced from as much as 35 percent to 28 percent.

But here in California, where state income taxes are very high, I calculate that the vast majority of those with incomes in excess of $250,000 pay the Alternative Minimum Tax, which has a top marginal tax rate of 28 percent. (I base this claim on using the NBER TAXSIM model). This means most Californians would not be affected by the proposed change.

Perhaps I am missing something here--if so I would appreciate enlightenment.

Comments on William Fischel on Property Taxes and School Finance

Comment on William Fischel, “The Median Voter and School-Finance Reform:
How Tax-Base Sharing Undermines the Efficiency of the Property Tax”
Richard K. Green
University of Southern California
February 12, 2009

In the course of 18 years as an academic, I don’t think I have ever had an assignment as intimidating as discussing a paper by William Fischel on the property tax. The only thing worse would be to discuss a paper by Professor Fischel on zoning.

So let me begin by agreeing with many of the points Professor Fischel argues in his paper:

o The median voter in most instances makes pretty smart decisions. The anecdote about the general correctness of majority answers to his multiple-choice exams illustrates the point quite vividly.

o A tax price of unity for school funding produces good outcomes. Districts with tax prices of less than unity will spend more on schools, sometimes for good, and sometimes not. Districts with tax prices of greater than unity might well underspend on schools. Certainly, when tax prices are higher for schools, households are willing to spend less on schools.

o Redistributive funding mechanisms that raise the tax price of schools in some districts can be counter-productive.

In the end, though, this is not entirely satisfying. The fact is that differences in property values, and in tax prices (before redistribution) produce unequal outcomes for school children. As Oates (1970) showed, in a regime where schools are funded locally, higher school spending produces higher property values. The inference we may draw from this is that the net benefits of schools were greater than the net costs of funding them. At the same time, the inequality may be self-reinforcing, as I will discuss below.

To illustrate the problem, let me use as examples two places where I have lived: Wisconsin, and Metropolitan Washington. Wisconsin nicely illustrates two dilemmas about using the property tax to finance schools. First, the distribution of property values per pupil is both highly dispersed and skewed (Figure 1). The average school district in Wisconsin has taxable property per pupil of $664,000, while the standard deviation of property values is $773,000. The dispersion is not driven just by outliers: at the top quartile of the property value distribution, property value per pupil is roughly double the value at the lowest quartile of the distribution.

At the same time, the tax price of schools varies dramatically. In the Town of Brookfield, more than 50 percent of property value comes from commercial property, so the tax price is quite low. In the city of Wisconsin Rapids, on the other hand, substantial chunks of manufacturing property are exempt from the property tax, and farm land is taxed at use value. Because of this, residential property makes of a disproportionately large share of the tax base, and the tax price for schools is higher there than elsewhere.

Turning to Metropolitan Washington, we see the correlation between school quality and house prices, when we look at four suburban counties: Montgomery and Prince Georges Counties in Maryland, and Arlington and Fairfax Counties in Virginia. Average SATs in three of the four counties (Montgomery, Arlington and Fairfax) were above 1600, while the SAT in Prince George’s County was 1283 in 2007. At the same time, the median price of a house in Montgomery County was $475,000, and in Fairfax and Arlington Counties was above $500,000 in 2007, while in Prince George’s County it was $340,000. While house prices in Washington, DC are high (the median price was $450,000), the city has a shockingly small number of married couple families with children. Moreover, the parts of the city with the worst schools—the area east of the Anacostia River—have median house prices in the $250,000 range.

I don’t want to push this too far: Montgomery County is closer to the job centers of metropolitan Washington than Prince George’s County, but Montgomery’s network of roads is actually not as well developed. We of course cannot draw any statistical inferences about capitalization in the DC area, but we can certainly have suspicions.

If school quality gets capitalized into prices, we get both a current and intergenerational dilemma. Because house prices are so high in the areas around DC except for Prince George’s County, the best public schools in the region are not accessible to low-income students. This places these students, already at a disadvantage because of the circumstances of their households, at a disadvantage in accumulating human capital, leading to increasing income inequality across generations.

Because Professor Fischel related personal anecdotes, I will relate one too. My kids went to a magnet high school in Montgomery County, Maryland. Both the students with whom they went to school and their teachers were extraordinary. I often thought it must be both a pleasure and pain to be a teacher or principal in Montgomery County: a pleasure because the students are generally so serious; a pain because the parents are heavily involved with the schools, sometimes to the point of annoyance. The upshot was that my kids got a lot out of their school, and their parents were content with the education they received.

But I couldn’t help but think about the unfairness of it all. The schools (particularly the high schools) in Prince George’s County and Washington DC were dysfunctional, and the kids who were stuck there had much less promising futures than the kids who got to go to schools in one of the strong districts. While it may be a coincidence that recent data show increasing persistence in intergenerational wealth inequality—who your parents are seems to matter more now than it did a generation ago—my prior is that it is not.

Of course, there is a more direct method than redistributing resources across districts for putting children on a level playing field—vouchers that do not tie children to their local schools. Tom Nechyba argues that it makes no policy sense for geography to determine child outcomes. I tend to like vouchers myself. And yet it is the nexus of geography and schools that leads to the positive outcomes Professor Fischel attributes to property tax based school funding. At the same time, as a practical matter, it would be difficult for parents in Anacostia to transport their children to Rockville, Maryland or Falls Church Virginia, for school.

Compounding the dilemma is the fact that the evidence, much of it cited by Professor Fischel, suggests that central government funding of education does not work very well. Public school systems in California used to be jewels of the state. Over the years in which most school funding has flowed through Sacramento, public schools in California have deteriorated. So where does this leave us?

Perhaps an answer arises from a simple insight of microeconomics: that marginal things matter more than average things. The best policy (or perhaps I should say second best policy) might be one in which all schoolchildren had access to the minimum level of resources necessary to receive an adequate education. I think there might be a great deal of consensus about what constitutes this minimum: proficient reading and math test scores at the grade school level; sufficient numbers of classes to prepare students for college at the high school level.
Each school district would receive the funding necessary to provide the minimum level of education necessary. This might not include such things as AP courses.

From an efficiency standpoint, the ideal tax would be a lump-sum tax leveled at the state—or perhaps even federal—level. Such a tax would, of course, be politically infeasible and regressive. The least distortionary tax I can think or is a sales tax of a value added tax. Any spending a community did beyond the bare minimum would be determined and financed by the community. By doing this, the marginal tax price of marginal improvements in education would be close to unity. Such plans exist, and are known as foundation plans. Many of the people in this room have worked on such plans.

One final point. While the median voter model works well for Dartmouth economics students and New Hampshire Villages, it is not entirely clear that it works well everywhere. Alienation is a serious problem in some places. According to the Los Angeles County register’s web site, only 23.6 percent of registered voters in Compton voted in the last school board elections there. Perhaps more problematic for Los Angeles County is that a very large share of its residents are not even eligible to vote.

Do I suffer from NIMBY creep?

Revealed preference tells me I like living in older, close-in, suburbs. While in Madison, I technically lived near the middle of the city in a neighborhood called University Heights, from which I could walk to work (although if it dropped below -10 F, I would drive). But Madison is pretty small, so the neighborhood felt suburban. My house was built in 1927. From there I moved to Bethesda, MD and lived in a house built in 1936: a rare vintage for the US but not so much for the DC area. Now I live in a house built in 1911 in the south central part of Pasadena. Pasadena is unusual among suburbs, in that it is very much a stand alone city, with lots of employment and center-city amenities. But it is still a suburb.

The neighborhood in Madison has a number of tri-deckers; the neighborhood in Bethesda has nothing other than detached single-family units, but the houses, while nice, were kind of dull. Had someone suggested rezoning the neighborhood to allow denser development, I would have not objected.

Here in Pasadena, land values are sufficiently high that rezoning would doubtless produce an increase in multi-family housing. I think a four story, 16 unit building would fit on my lot rather easily. More than that would be a problem because of the street infrastructure around here.

This would allow Southern Californians of average means to live near shopping and schools and (perhaps) close to work who might otherwise live in the far eastern reaches of the San Gabriel Valley. It would allow more people to have access to the Gold Line, which is within walking distance. The economist in me thinks that the neighborhood should be rezoned to allow for higher density, and land values suggest that such rezoning would produce redevelopment when the market comes back.

The non-economist in me thinks this would be a shame. The neighborhood is filled with Arts and Crafts houses from around 100 years ago, most of which are lovingly maintained. As I walked home this morning from Peet's coffee (where I was discussing land use issues with my colleague Chris Redfearn), I marveled at the beauty of the old suburban landscape. Does this have policy implications? What are they?

Monday, March 16, 2009

Program Note

I will be on KPCC tomorrow at 11:07, talking about Obama's plan to reduce the mortgage interest deduction for those making more than $250K. I am for it: those making that kind of income are going to be homeowners anyway, and it will slightly increase the incentive to own with equity instead of debt. There will be someone else on who is against the proposal.

How much context should Newspapers provide?

This past weekend, the Washington Post asked three finance gurus, Peter Lynch, Burton Malkiel and Bill Gross, for investment advice. All three are wonderfully smart and have different takes on the world. As such, the Post performed an important service by getting the opinions of the three.

But...Bill Gross advised against owning stocks at all. He runs a fixed-income fund. Do readers understand that he therefore directly benefits when bonds outperform stocks? Should this be explained to people? A few years ago, I had much more of a caveat emptor attitude toward investing, but the world has changed. I am not saying that Bill Gross doesn't believe in the advice he is giving--I have little doubt that he does. But his beliefs are, just like the rest of us, surely shaped in part by his own interests.

Long live the 767

The one daily non-stop flight between LAX and Lima takes about eight hours. The carrier is LAN, and the plane is a refurbished 767.

LAN seems to be nothing special--airline food at its typical worst and slightly surly service people--but the 767 is great. It is the only plane (I think) with 2-3-2 seating in coach. The combination of this seating plan and high ceilings make the plane feel more spacious than any other, and so makes long trips more tolerable. But 767s are getting old; I will miss them when they disappear.

Fight on!

The hardest adjustment to joining the USC faculty has been learning to root for the football team. When I was a kid, I would root for the Trojans against Notre Dame, but otherwise I have been a Big Ten guy my whole life, and USC was just too good.

But it has been a great pleasure to root for the Trojan Basketball team in the PAC-10 Tournament; particularly sweet was the victory over UCLA, with which I will always associate the magnificent and insufferable Bill Walton.

I think USC is underseeded in the NCAAs, and I look forward to further surprises.

What is wrong with this picture?

I gave a couple of lectures at the Central Bank of Peru last week. The driver who picked me up at the airport had returned to Lima after living in the United States for more than 15 years. The reason? he had prostate cancer and couldn't afford to get it treated in the US, so he moved back to Peru to get treated.

Saturday, March 14, 2009

My question to Ken Rosen is then, what is wealthy?

He is quoted in today's LA times:

"The problem with this [Obama's plan to cut back on the mortgage interest deduction for those earning more than $250k] is households earning more than $250,000 in New York or California may not be what we call wealthy."

According to the Census, median household income in California is about 60K (in 2007), and in LA County is about 53K. If 4-5 times median income is not sufficient to be deemed wealthy, at what point does a household become wealthy?

Monday, March 09, 2009

Programming note

I will be on KPCC's 'Airtalk' at 10:40 tomorrow morning. The topic is the commercial real estate market in Southern California.

Sunday, March 08, 2009

The Oriole Way asks me to try GDP growth and lagged taxes

Pleased to oblige:

The correlation now goes up to .11. [update: I cleaned up the chart a little. On the right side of the oval are Clinton tax years; the left are GWB tax years.]

[Second update. I added the three most recent years. Correlation now rises to .17!]

Saturday, March 07, 2009

Fun with Charting Tax Rates and Growth

Just for fun, I plotted the top marginal federal tax rate from 1947 through 2006 against real GDP growth for each year. Here is what I get:

GDP data come from BEA; Federal Tax Data from Brookings and the Urban Institute. The correlation is actually slightly positive (about .098). I am not suggesting that higher marginal tax rates cause economic growth. But it is awfully hard for me to see where a ten percent increase in marginal tax rates for the wealthiest among us will bring about economic ruin.

Friday, March 06, 2009

What is his evidence?

Michael Boskin writes in today's Wall Street Journal:

Increasing the top tax rates on earnings to 39.6% and on capital gains and dividends to 20% will reduce incentives for our most productive citizens and small businesses to work, save and invest -- with effective rates higher still because of restrictions on itemized deductions and raising the Social Security cap. As every economics student learns, high marginal rates distort economic decisions, the damage from which rises with the square of the rates (doubling the rates quadruples the harm). The president claims he is only hitting 2% of the population, but many more will at some point be in these brackets.

I know Boskin is one of my betters, but I am having hard time with this statement. These were the tax rates during the Clinton years, and people seemed to work awfully hard then. I also wonder if it is necessarily the case that our highest paid citizens are in fact our most productive. Given what we now know about the decisions taken by investment bankers, does Boskin really want to argue a strong correlation between productivity and very high pay?

[Update. David Barker in the comments paper points me to an Ed Prescott paper arguing that taxes affect the labor supply. He uses a cross country comparison to do so. But so far as I can tell, his results derive from a simulation model with some assumed parameters about the size of the capital stock across countries and the value of leisure. There are no controls for the relative size of the social safetuy net by country. I can't find a standard error in the paper, so it is hard to know what the results really mean. I certainty don't see firm evidence supporting Boskin's quadratic rule.]

Wednesday, March 04, 2009

Why not just reduce the principal?

Details of the Obama plane to help mortgage borrowers were released this morning. The order in which the mods will happen: interest rate reduction, term extension, principal reduction.

This is backward. Suppose a $100,000 loan has a 7 percent coupon, and its rate is modified down to 4 percent. The payment drops from $665 per month to $477 per month. This helps, but leaves the borrower underwater, making it difficult for her to sell if she needs to move to a new job.

But a $477 payment, at 7 percent annual interest, has a present value of $71,759. So if the interest rate remained the same and the loan balance was written down by 28 percent, the payment would be the same as an interest rate write-down to 4 percent, but the borrower would have her head above water. If she later sells for more than $72K + selling costs, she can split the proceeds with the lender, who would now basically be a shared equity owner.

I think the people in the Obama Administration are very smart. Why aren't they doing this?

Tuesday, March 03, 2009

The Amtrak Problem

Passenger rail subsidies make sense in small parts of the United States: Washington to Boston for sure, and perhaps Southeastern Florida, Chicago to Detroit, and LA to San Diego (sorry for being provincial).

Yet Amtrak continues to run far-flung rail lines that make no sense economically. The losses from these lines undermine Amtrak's ability to take on the projects it really needs--like a new tunnel through Baltimore.

Why does it do it? It's web site gives the answer: it runs through 255 Congressional Districts. Amtrak must always run through at least 218 Congressional Districts, whether it makes any sense or not.

Such is the fundemental problem with nationally owned companies.

Monday, March 02, 2009


NPR's Susan Stamberg had a nice piece this morning on typewriters.

In my first job after graduating from college, I worked for the Department of Energy. We GS-7s were not supposed to type for ourselves--secretaries were supposed to do that. But my handwriting is illegible, and my job required me to write a lot (something like two 10-20 page Decision and Orders a week), so to keep our secretaries from going mad, I needed to be able to type first drafts.

In a supply closet, I found an IBM selectric that nobody else seemed to be using, so I accidentally placed it on my desk. No one said anything, so it stayed there for the remainder of my time at DOE. I loved that thing--before or since, I have never encountered anything on which I could type as quickly or accurately.

Last Dust-up Point Counterpoint

First Chris Thornberg--then me.

Point: Christopher Thornberg

The homeowner rescue plans so far have been failures. Either few troubled borrowers have signed up or, more significantly, within just a few months of having their loans modified a shockingly large portion of the borrowers are back in default. The entire rescue process has accomplished little more than increasing the cost to the banks by extending the foreclosure process that much longer.

There are two possible explanations for this re-default problem. One is that the programs simply don't acknowledge that with loans sharply underwater, folks have little incentive to maintain their mortgages even when payments are being lowered to something more affordable.

It has been claimed that past studies have shown that being underwater is a necessary but not sufficient condition for foreclosure. I would argue that we have never had a housing downturn as dramatic as this one, with people so desperately underwater, and we have never had so many families with such small stakes in the game (witness no-money-down mortgages with initially negative amortization payment levels). As such, past data points offer little in terms of comparison to the current situation. From this perspective, borrowers go along with the mortgage modification plans simply to maintain their housing situation for a few extra months.

The second potential explanation is that these mortgage programs do not screen their applicants for other potential issues, such as the loss of income due to the downturn, debt burdens outside the mortgage or perhaps even verifying income to see if the new "affordable" payment is in fact affordable. As we now know, even with mortgages where incomes were supposedly verified, brokers quickly learned how to game the system in such a way as to not trigger further verification efforts. In other words, many of those prime loans were not.

President Obama's plan is another one-size-fits-all scheme without much effort to distinguish between those who have a reasonable chance of having a workout succeed and those for whom the workout represents little more than a few extra months of free rent. It relies on one streamlined effort to reduce payments with little effort made to try to distinguish those who might be helped from those for whom help is useless.

Is there a better way? Should we study these mortgages on a case-by-case basis? Perhaps -- but the industry has little incentive to make the investments to deal with such complexities. Remember that during the bubble, a mortgage company earned 2% or 3% of the value of the loan for closing a mortgage. This amounts to $5,000 to $10,000 per mortgage in higher-priced markets with little cost to the broker, given all the rapid computerized systems being used to place the money. With this revenue flow gone, the industry has rapidly shrunk. Now the administration is offering a paltry $1,500 per mortgage to servicing companies that try to work things out. This time, however, the cost to mortgage companies will likely be much higher because more individual verification is needed. This simply isn't realistic.

The other option is to have the government pony up even more cash to facilitate the process, with the intent of simply shrinking the potential pool of applicants. And of course we will still have the legal and ethical minefield to negotiate as we work to rescue people from their own really bad financial decisions.

If this sounds like a hopeless situation, you know what? It is! And it is about time we have an honest and open discussion that acknowledges the hopelessness and stops using expensive knee-jerk policies in place of rational approaches. As a nation, we need to allow this process to take place naturally.

Do we need to worry about empty homes and depressed neighborhoods? Sure. But this process is much easier on the back end than the front. How about a national tax break for buying not just any home, but only a foreclosed property? How about generating a new group of potential buyers by simply not allowing current defaults to be recorded on people's credit reports? How about streamlining the foreclosure process, making it quicker and easier for banks to clear properties and find a new buyers, thus reducing their losses?

And most important, we need to think ahead to the changes that need to be made so that we never end up with such a mess again.

Christopher Thornberg is a founding partner with Beacon Economics.

Government inaction would only prolong the pain
Counterpoint: Richard K. Green

I disagree with you on a number of points, Chris.

First, we do have precedent for what is happening now: the Great Depression. While data from that time aren't as good as we would like, we do know that during the early 1930s, home prices fell at a rate similar to today and unemployment was considerably higher. Housing construction declined by 90% from peak to trough (if January's construction number is representative for the year to come, we are at about an 80% peak-to-trough decline now). Despite this, the federal government at the time developed a mortgage modification program that worked rather well, about which I will say more soon.

Second, I continue to think some of the older models of mortgage default are informative. University of Michigan economist Robert Van Order and National University of Singapore economist Yongheng Deng (among others) calibrated sophisticated models of default that looked at markets (such as Texas in the 1980s and California in the early 1990s) that went through substantial price declines. Although I agree that the new world in which we live means we should be modest about how much we actually know, it doesn't mean we should ignore the work that has been done before. The idea that families will not default if they have an equity stake in their house remains compelling to me.

Third, for the government to largely stand back and let nature take its course is, in my view, a really bad idea. Prices have fallen enough in many places that the cash-flow cost of owning now looks very favorable relative to renting -- at least by historical standards. Yet existing and new home sales in January were abysmal. Why? People lack confidence in the future. The Reuters-University of Michigan consumer confidence index is near a 28-year low. Even people who once considered themselves to be recession-proof fear they will be laid off. Under such circumstances, I am not sure we can expect people to run and buy homes whose occupants are in default.

I have long been an admirer of John Maynard Keynes, who talked about the importance of animal spirits to economic health. I do not see Americans' animal spirits recovering until house prices stop dropping. Prices will not stop declining until inventories stop rising. While home builders are doing their part (they have stopped building), allowing many more foreclosures to occur will not help this process.

During the Great Depression, the Roosevelt White House rolled out the Federal Housing Administration to insure mortgages and the Home Owners' Loan Corp. to buy defaulted mortgages. The HOLC bought the mortgages from lenders at prices below the value of the houses that were collateralizing the mortgages. It then modified payments, changing interest-only mortgages with balloon payments into 20-year self-amortizing mortgages. The HOLC worked: It bought mortgages from only 1933 to 1936, but it bought a large number during these years. It put itself out of business when the last mortgage it bought was retired in 1951. The program reduced the default rate on these mortgages by 90%. Because the government could borrow so cheaply, the HOLC actually turned a small profit for taxpayers.

To me, the HOLC (perhaps modified to include a claw-back provision) is the model for going forward.

Redistribution is happening

According to the 2004 SCF, those in the top tenth percentile of the income distribution had about 50 percent of their financial assets in equities (inlcuding mutual funds and retirement funds). Equity values are now down around 50 percent. So...