The Real Value Added of Fannie and Freddie?

Mark Thoma has a nice post on adverse selection and mortgages. Adverse selection can only happen, of course, in the presence of unobserved heterogeneity.

Fannie and Freddie, owing to their market power, could require loan originators to collect a long checklist of information and documentation about borrowers: everyone who obtains a conforming, conventional, prime mortgage fills out the same forms. Much of the information on these forms is not particularly useful for estimating probit or logit models of loan default; however, they are filled out only by borrowers who are willing to reveal a lot of information about themselves. This alone will reduce unobserved borrower heterogeneity, and therefore reduce adverse selection problems. Borrowers once were willing to fill out the forms (along with associated documentation) because they HAD to do so in order to get a mortgage. Now they fill them out is they want to get the pass-through benefit of the of the Fannie-Freddie subsidy. I think one of the lessons of the current crisis is that we need to return to the day when only well-documented borrowers get loans.

This doesn't mean we need to go back to a rationed market (which i what we had in the pre-subprime days). In fact, by requiring borrowers to disclose sufficient information, the market might be able to price mortgage risk better in the future.

Dick Cavett gives Public Speaking Advice

I really enjoyed this.

Tip #1. Change all “I wills” and “I shalls” from the speech to “I’ll’; Also, “I haves” and “I ams” to “I’ve” and “I’m,” etc. You’d be surprised how much this cuts down on the oratory tone.
Tip #2. Pretend you are speaking to one person. One single person. Because that’s what everybody is. No one watching or sitting in the audience is an “all of you” or an “everyone” or a “those of you” or a “Hi, everybody,” and no one is a “ladies and gentlemen.” You, out there, are a “you.” So, speaker, think of yourself as being viewed by only two eyes. (Presumably on the same person.) The most magical word you can use, short of a person’s name, is “you.”
The great Arthur Godfrey practiced this invariably. “How are you?” he said, is all-important. “Ladies and gentlemen of the radio audience,” he said, “is bull and reaches no one.” With emphasis on “one.” On radio he had millions of listeners, largely adoring women in the daytime, each convinced he was speaking to her personally. Including my grandmother. (You knew it worked because in a ruthless Nebraska summer, when all the windows were open, I could hear Arthur uninterruptedly as I passed one house after the other.)
Tip #3. I feel almost silly when I do this one, but it works. Grab a bunch of words off the prompter and, instead of staring straight ahead, glance down and to one side as you do — in real life — when thinking just what to say next. Then look back and deliver those snatched-up words to the camera. It works like a charm. (As a beloved childhood magic catalogue of mine used to say — with unintended ambiguity — “We cannot recommend this trick too highly.”)
If I were McCain’s adviser I would shock everyone by having him come out carrying his script, and saying — not “ladies and gentlemen,” as we just learned, but launch right into, “You know, I don’t use these teleprompters very well. I guess I’m just not one of those people who can fool you into thinking I’m making it up as I go along . . . which these things are supposed to do. I don’t even fool myself. I cringe when I watch myself trying to bring off that ‘electronic deception,’ you might call it . . . Anyway, here’s my

This couldn't help but remind me of the teachings of my high school speech/debating coach, Michael Sipe. The two tips I learned from him that I will never forget:

(1) Don't use a podium. It's a crutch, and it puts distance between you and your audience. If you need notes, better to hold them in your hand. Remember how good Elizabeth Dole was at the RNC in '96? I don't mean what she said (I actually don't remember much about that, except that her husband was a war hero); I mean how well she came across. I don't think Daniel Webster used a podium.

(2) Never say, "in conclusion" at the end of a speech. You don't say, "in beginning" at the beginning of a speech!

Mr. Sipe had an important impact on my life. I heard some time ago that he died at a rather young age. I feel sorry for the younger Wisconsin debaters who never got to know him

Ed Glaeser has a nice essay on John Kenneth Galbraith

Reading this is a pleasant way to spend five minutes on an early evening Sunday.

I have three comments. First, I don't think Americans (or others, for that matter) nowadays have much sense of how poor the country was in the 1930s. I was teaching students here in India about the New Deal Institutions that under girded the development of the modern housing finance system. While doing so, I pointed out that many people in the US went hungry in the 1930s, and that little more than half of households had indoor plumbing in 1940, the first year the census kept track. It was not until after WWII that the US did in fact become an affluent society.

Second, on the issue of wealth vs distribution, I can't help but think that the GDP standings focus too much on means and medians, and not enough on quintiles and deciles. Some time I ago, I took the World Bank World Development Report and looked at PPP Incomes by quintile. If I remember correctly The US was the number one country for the top three quintiles, but fell to something like 20 for the bottom quintile (as soon as I get back to Washington I will find the spreadsheet where I did this). Now lots of people in the bottom quintile go to work every day, so it is not as if perverse incentives could somehow explain the US's relatively lackluster performance. It is also possible that many Americans are comfortable with their country's relatively low rank for this group of people. But it is important that we go beyond means and medians when we debate social welfare policy. I know there are also GINI coefficients that say pretty much the same thing, but try explaining a GINI coefficient to a politician.

Finally, Ed says that much of the housing mess has arisen from overregulation. I think he is talking about the regulation of land markets, and with this I agree. But we did not have excess regulation in financial markets, and I would guess that the lack of regulation in the mortgage market was more important for explaining the housing bubble than was overregulation in the land market.

Worth rereading: Deng, Quigley and Van Order from 13 years ago

Mark Thoma tries to unravel the mystery of why house prices matter more than rate resets. The paper by D, Q and VO is Mortgage Default and Low Downpayment Loans: The Costs of Public Subsidy, and I think it helps answer the question. The abstract:

This paper presents a unified model of the default and prepayment behavior of homeowners in a proportional hazard framework. The model uses the option-based approach to analyze default and prepayment and considers these two interdependent hazards as competing risks. The results indicate the sensitivity of default to the initial loan-to-value ratio of the loan and the course of housing equity. The latter is a measure of the extent to which the default option is in the money. The results also indicate the importance of trigger events, namely unemployment and divorce, in affecting prepayment and default behavior. The empirical results are used to analyze the costs of a current policy proposal -- stimulating homeownership by offering low downpayment loans. We simulate default probabilities and costs on zero-downpayment loans and compare them to conventional loans with conventional underwriting standards. The results indicate that if zero-downpayment loans were priced as if they were mortgages with ten percent downpayments, then the additional program costs would be two to four percent of funds made available -- when housing prices increase steadily. If housing prices remained constant, the costs of the program would be much larger indeed. Our estimates suggest that additional program costs could be between $74,000 and $87,000 per million dollars of lending. If the expected losses from such a program were not priced at all, the losses from default alone could exceed ten percent of the funds made available for loans.

When households have equity in their house, they don't default. This is why the unprecedented drop in nominal house prices nationally is so calamitous. At the same time, households don't usually default unless they face a trigger event, such as unemployment, divorce and illness. A large rate reset may also constitute such a trigger event, but as three Boston Fed economists show, these are not all that common. Trigger events, moroever, are not sufficient conditions for default, and negative equity is a necessary condition for default.

The first two points of Obama's plan for Regulating Financial Institutions

I think these are right on the nose:

1. Provide the Federal Reserve with basic supervisory authority over any financial
institution to which it may make credit available as a lender of last resort. The Federal Reserve does not exist to bail out financial institutions, but rather to ensure stability in our financial markets. For that reason, it is essential to make clear that while the government may step in during times of crisis to prevent instability, financial institutions must play by the rules. Any institution that has access to the sacred trust of the American government when everything else goes wrong — the ability to use the Federal Reserve as the lender of last resort — must be subject to prudential oversight to ensure it is not taking excessive risks with the American taxpayer's money. Barack Obama believes that we should not give
access to the discount window or similar facilities as a favor to banks. It is entirely for the benefit of the American people and their interest in the safety and soundness of credit markets. The nature of such oversight should be commensurate with the degree and extent of contingent exposure for the Federal Reserve to specific institutions. At a minimum, it should include liquidity and capital requirements.

2. Capital, liquidity and disclosure requirements should be developed and strengthened for all financial institutions. Barack Obama believes that capital requirements should be reexamined and strengthened, especially with respect to complex financial instruments such as many of the mortgage-backed securities that lie at the heart of current problems. New standards for managing liquidity risk, which has been neglected in the past, must be developed and rigorously applied. And the events of the last year have also highlighted the need for more disclosure. Though transparency cannot rectify everything that has gone wrong, it is imperative that we enhance information flows to shareholders and counterparties of financial institutions in order to increase market discipline, as well as greater disclosure of off-balance sheet risks such as exposure to Structured Investment Vehicles. Finally, Obama believes we need to look into the issue of the rating agencies. This problem was illustrated in the subprime market crisis in which credit rating agencies
strongly rated subprime mortgage securities even as there were significant indications of large numbers of foreclosures and a weakening housing market.

Yes I am supporting the man--I have even done a (very) small amount of work for the campaign. But even if I weren't, I would be impressed with the level of sophistication that these points demonstrate. And as I have said in many previous posts, capital is THE crucial issue.

The Inventors of Popeye's Fried Chicken and the Egg McMuffin have died

I read the news today, oh boy.

These past few weeks in India have been for me a nearly meatless experience, and I was doing fine until I read the story. I actually haven't done Popeye's in a long time, but it sure is good. Maybe I'll have some when I get home on Sunday.

Arthur Anderson Redux?

The New York Times on KPMG and New Century:

New Century Financial, whose failure just a year ago came at the start of the credit crisis, engaged in “significant improper and imprudent practices” that were condoned and enabled by auditors at the accounting firm KPMG, according to an independent report commissioned by the Justice Department.

I remember when Arthur Anderson was considered unassailable (all you had to do was talk to someone who worked there). I also wonder how accounting played into the Beat Stearns debacle...

David Leonhardt's piece in today's NYT reminds me of one of my favorite papers on housing economics

The headline is: Be It Ever So Illogical: Homeowners Who Won’t Cut the Price

The story reminded me of a QJE paper by David Genesove and Chris Mayer: Loss Aversion and Seller Behavior: Evidence from the Housing Market

The abstract:

Data from downtown Boston in the 1990s show that loss aversion determines seller behavior in the housing market. Condominium owners subject to nominal losses 1) set higher asking prices of 25-35 percent of the difference between the property's expected selling price and their original purchase price; 2) attain higher selling prices of 3-18 percent of that difference; and 3) exhibit a much lower sale hazard than other sellers. The list price results are twice as large for owner-occupants as investors, but hold for both. These findings are consistent with prospect theory and help explain the positive price-volume correlation in real estate markets

If today my voting choice was between Mike Huckabee and Hillary Clinton...

Today (and today alone), I would vote for Huckabee.

Here is Huckabee (via James Fallows)and many others:

And one other thing I think we've gotta remember. As easy as it is for those of us who are white, to look back and say "That's a terrible statement!"...I grew up in a very segregated south. And I think that you have to cut some slack -- and I'm gonna be probably the only Conservative in America who's gonna say something like this, but I'm just tellin' you -- we've gotta cut some slack to people who grew up being called names, being told "you have to sit in the balcony when you go to the movie. You have to go to the back door to go into the restaurant. And you can't sit out there with everyone else. There's a separate waiting room in the doctor's office. Here's where you sit on the bus..."
And you know what? Sometimes people do have a chip on their shoulder and resentment. And you have to just say, I probably would too. I probably would too. In fact, I may have had more of a chip on my shoulder had it been me.

Here is Clinton:

"He [Wright] would not have been my pastor...you don't choose your family, but you choose what church you want to attend."

What is more, as Tim Noah points out, she said this said this to the Pittsburgh Tribune-Review, a newspaper owned by Richard Mellon Scaife, who was, in Tim's phrase, the CEO of the Vast Right-Wing Conspiracy.

The thing that is particularly sad is that Senator Clinton knows better...

Small Addictions

My daughters joined me last Sunday for my final week in India. Besides having the pleasure of their company, I again have the pleasure of drinking Victor Allen's coffee in the morning. Victor's is a Madison roaster: my wife and I (and now the kids) liked it so much that when we moved to Washington, we started mail ordering it. If you like good coffee, you should too.

A Bear Stearns Bailout

I thought it was fine when the Fed agreed to back Bear Stearns' obligations in exchange for a near liquidation of the company ($2 per share was close enough). But it now continues to back Bear's liabilities, and shareholders will get quintuple the price. To me, this amounts to a transfer from the US government (i.e., taxpayers) to Bear Stearn shareholders.

I have written in the past of my reluctance to award haircuts to homeowners in trouble, but I find such policies far preferable to taxpayer transfers to Investment Bank executives.

A LIttle Good News

According to NAR, existing home sales are up a little, and inventories are down a little, meaning that the months supply measure is down a little. It could all be within the confidence interval of the estimates, but still, it is the first decent news in awhile. Lawrence Yun's commentary is pretty much on the mark.

The big drop in the Case-Shiller Index is not so bad either. As prices fall, the rent-to-price index rises to a point where it is fundamentally wise to buy a house. The sooner this happens, the better.

Mickey Kaus and Bill Kristol want us all to shut-up about race

Kristol, in fact, "cringes" that Obama brought up the subject. But while my fellow white guys Kaus and Kristol (perhaps we need to find a third K?) think it is time to get over race, the problem is that many white people have yet to do so. Consequently, the best empirical evidence shows that while there is far less discrimination now than there was in the past, discrimination remains substantial, and arises from prejudice.

Here in an abstract from Zao, Ondrich and Yinger (2006):

This study examines racial and ethnic discrimination in discrete choices by real estate brokers using national audit data from the 2000 Housing Discrimination Study. It uses a fixed-effects logit model to estimate the probability that discrimination occurs and to study the causes of discrimination. The data make it possible to control for auditors’ actual demographic and socioeconomic characteristics and characteristics assigned for the purposes of the audit. The study finds that discrimination remains strong but has declined in both the scope and incidence since 1989. The estimations also identify both brokers’ prejudice and white customers’ prejudice as causes of discrimination.

Before any of us white folks who have never suffered meaningful discrimination or prejudice, or who have never even suffered the little indignities of being stopped by the police for no reason, or been followed by a security guard in a store, or been looked at suspiciously or altogether avoided on the street, tell the world that we don't need to talk about or think about race anymore, perhaps we need to try to walk in the shoes of someone who has suffered all these things.

Things are getting better. All I have to do is see how kids behave at my daughters' high school to know so; who knows, by the time my generation is dead, race may no longer be a problem. But we are not there yet. We are not even close. I think Obama's speech nailed where we are with remarkable precision.

Austin Kelly finds that Zero Down Mortgages perform really badly

His paper is here.

The abstract:

Previous research has focused on equity as a prime determinant of mortgage default propensities. This paper extends the analysis of mortgage default to include mortgages that require no down payment from the purchaser. A continuous time hazard model is used to estimate the conditional probability of a serious delinquency, or a claim, as a function of a host of standard control variables, and indicators for the presence and source of the down payment. The data consist of a nationally representative random sample of about 5,000 FHA insured single family mortgages endorsed in Fiscal Years 2000, 2001, and 2002, observed through September 30, 2006, and samples of about 1,000 FHA loans each from the Atlanta, Indianapolis, and Salt Lake City MSAs in the same time period. The results indicate that borrowers who provide down payments from their own resources have significantly lower default propensities than do borrowers whose down payments come from relatives, government agencies, or non-profits. Borrowers with down payments from seller-funded non-profits, who make no down payment at all, have the highest default rates. Additionally, borrowers who do not make down payments from their own resources tend to have higher loss given default in the small subset of loans that had completed the property disposition process.

No more no money down mortgages from Fannie and Freddie

Rhonda Porter says the 100 percent LTV products are history. This is a good thing. Owners with no equity in their houses from the beginning--are renters.

The mortgage market periodically tries zero down payment and negative amortization mortgages. They never seem to work. The HUD 235 program (little down, negative amortization) had default rates of around 35 percent. Graduated payment loans (which had negative amortization) got the not so kind nickname of "gypems." Skin in the game, people, skin in the game. I don't know that it needs to be a lot, but there has to be some.

Housing Bubble Hyderabad?

According to students here at ISB, the rent to price ratio in Hyderabad is between 2 and 3 percent. Mortgage rates are 12 percent; mortgage interest is tax deductible here, and the marginal tax rate for most buyers is 33 percent, so the after-tax cost of capital is 8 percent. Add to that maintenance costs and a risk premium on housing equity, and the housing market needs to appreciate something like ten percent a year to be sustainable. But of course this will not happen forever.

One surprise--in the formal market for housing in India, homebuyers can get mortgages with LTVs of up to 90 percent.

A positive expected value bet

Fannie Mae and Freddie Mac's regulator is loosening their capital requirements. This is, I think, the correct call. It is possible that Fannie and Freddie can stablize mortgage credit markets by refinancing loans--particularly Jumbos--and mitigate house price declines in coastal markets (I don't think Florida and Inland California can be helped much).

I am not saying this will work, but if OFHEO had done nothing, we could be sure of a taxpayer bailout. At worst, the reduction in capital requirements will leave taxpayers no worse off. At best, the reduction could make everyone better off. This means that the expected impact of the policy decision is positive.

That said, Fannie and Freddie should now have their feet held to the fire about meeting their mission of liquidity provision.

Benighted policy of the Day

Ethanol subsidies. Ethanol does little to improve the environment--in fact some scientists have argued that it makes things worse. But one thing it manifestly does do is raise grain prices.

I was thinking about this because here in India, while incomes are generally rising, caloric intake among the lowest 30 percent of the income distribution in rural areas is falling. Making grains more expensive doesn't help any. So allowing Archer-Daniels-Midland to feed at the Federal trough is not only bad economic policy, it is making the World's hungriest hungrier.

It's not just the mean, it's the distribution

David Brooks this morning says that house prices have fallen by 10 percent from peak and that "experts" think it will fall another 20. Actually, the biggest national peak-to-trough number I have seen is negative 8.9 percent (Case-Shiller), and I, for one, guess house prices nationally will fall but another 5-10 percent in nominal terms.

But that doesn't mean I am much more sanquine than Brooks. Around those mean changes are distributions, and I am wondering whether the distribution of house price outcome is getting larger--i.e., whether the standard deviations of the house price indexes is getting larger. If they are, from the standpoint of mortgage performance, the increased number of houses with large price declines will not be offset by an increased number of houses with rising prices.

Much to my surprise, when I look up my wife's and my house on Zillow, its value continues to increase; not by much, but nevertheless it is increasing. And it doesn't matter from a mortgage performance standpoint: we have a lot of equity in the house, so more won't do anything to improve our contribution to default performance. But of course if our house is holding its own in value, there is another house in the DC area that is doing much worse than a declining average, and therefore is very likely to default.

To really characterize this, it would be nice for Case-Shiller and Ofheo and NAR to not just give means and medians, but also quintiles or even deciles of house price performance. Then we would know what we are up against.

Jonathan Laing of Barrons says that Fannie may fail

He says so here:
The article came out while I was on my way to India, and I just picked it up. In any event, three aspects of the piece suggest to me that he is a little aggressive in his forecast of Fannie's demise.

First, he says that 40 percent of subprime mortgages in Fannie's book will default. This is an extraordinary number (20 percent seems to be closer to consensus), unless his view is that the good subprime stuff has already refinanced, and what remains in the portfolio is toxic. In any event, it would be nice to see how he came up with the number.

Second, he says that 4 percent of the prime book will default. This would be four times the long-term historical average; moreover, most of the defaults would be covered by mortgage insurance, meaning that for Fannie, they would be prepayment events rather than credit loss events (unless the MI companies fail too--that is another story).

Finally, he says that the company's Low Income Housing Tax Credits have little value, because it will be awhile before it will have taxable income against which to apply them. But so far as I know, tax credits are resellable (word?), and there has always been a hefty demand for them. If Fannie can't use the credits, they should be able to sell them at market value to an entity that does (if I am wrong about this, I would appreciate the correction. I am not a tax attorney).

Change these three assertions in the article, and Fannie's capital position looks fine.

Jonathan Laing is a fine reporter. He is also the reporter who in 1989 wrote an article that gave credence to Mankiw and Weil's forecast of a 47 percent decline in real house prices between 1987 and 2007. In the next year or two, we'll see whether his prediction errors are negatively or positively correlated.

Where's Fannie?

Rhonda Porter writes:

New Conforming Loan Limit Won't Help Refi's w/2nds...FHA May Save the Day

Fannie Mae's underwriting guidelines for the temporary conforming loan limits have been released and it looks like the new loan amounts are not going to be as helpful as many had hoped. The new guidelines for loan amounts between $417,001 - $567,500 in King, Snohomish and Pierce Counties are far more strict.

The biggest whammy is that if you were hoping to combine your first and second mortgage (or heloc) into one new conforming-jumbo mortgage, you're out of luck. Fannie is not allowing any "cash out" refinances. This means that even if you were just paying off the two mortgages and not receiving a nickle back at closing--it's not going to fly.

You must have a minimum of 660 credit scores for a fixed rate purchase for a LTV of 80% or less for a purchase using a fixed or adjustable rate.

Limited cash out refinances are allowed up to 75% loan to value with a minimum 660 credit score. Limited cash-out means that you are allowed to roll in the closing costs to the refinance and receive no more than $2000 cash back at closing (no second mortgages/helocs can be included in the refinance).

BTW, Rhonda's blog is one of the most useful tools I know for understanding what is really going on in the mortgage market. And if all originators were as well informed as Rhonda, we would almost certainly not be in this current mess.

My justification for the GSE subsidy has long been that it allows the institutions to provide liquidity to mortgages when it is drying up in other credit markets. In fact, I have always thought this role has been much more important than any role "encouraging homeowing" or "affordable housing." My interpretation of the evidence to this point is that GSEs have done a good job of liquidity provision, but have had a marginal impact on ownership and a not particularly large impact on affordability.

The underwriting policy that forbids refinancing of second and HELOCs, even when the total LTV is below 80 percent, means that Fannie is backing away from its mission to provide liquidity, just when we need it to embrace that mission most.

Charles Dickens would support the Estate Tax

From Our Mutual Friend, Chapter 1.

'And what if I had been accused of robbing a dead man, Gaffer?'
'You COULDN'T do it.'
'Couldn't you, Gaffer?'
'No. Has a dead man any use for money? Is it possible for a dead man to have money? What world does a dead man belong to? 'Tother world. What world does money belong to? This world. How can money be a corpse's? Can a corpse own it, want it, spend it, claim it, miss it? Don't try to go confounding the rights and wrongs of things in that way. But it's worthy of the sneaking spirit that robs a live man.'

Predatory Lending in India?

I am currently in Hyderabad, visiting for a few weeks at the India School of Business. This morning's newspaper contained an item about how farmers in India obtained mortgages with very high interest rates, fell behind in their payments, and ultimately lost their properties to lenders.

The government of Maharashtra (the state that includes Mumbai) is contemplating legislation that would require the lenders to return title to the borrowers. The sentiment is understandable, but could undermine the ability of India to develop its fledgling mortgage market. The dilemma is depressingly familiar.

Richard Florida thinks that Rustbelt Cities can come back

He says so here.

His basic argument is that all it would take is high-speed intercity transport and revitalized downtowns to do this job. I am skeptical.

I should begin by saying I like the Midwest a lot--I grew up in a small city in Western Wisconsin, and spent most of my professional life in Madison. I have always rather liked cities like Cleveland, Milwaukee, St. Louis, and Duluth. I think Pittsburgh is absolutely lovely (you read that right) and is a terrific university town.

But these places (along with Detroit, Buffalo, Syracuse, etc.) have a history of concentrated manufacturing employment, which in turn created labor markets where workers had few incentives to become well eductated (for the classic article on this, see Benjamin Chinitz, Contrasts in Agglomeration: Pittsburgh and New York, AER (1961). All these places are, moreover, cold. Two of the most important predictors of population growth since World War II have been education levels of the population, and climate.

Cities in the Midwest with higher educational attainment levels, such as Minneapolis, Chicago and Columbus, have done better. I doubt downtown condos and high speed rail will turn Scranton into Floreance.

Gipsy Kings Hotel California 1990

Income, Happiness....and Democracy?

Mark Thoma has a very nice post summarizing recent work on Income and Life Satisfaction. In the post he includes a graph from Angus Deaton:


A couple of things stand out to me (beyond the correlation between income and life satisfaction that others discuss). First, people in India have remarkably high life satisfaction in light of their economic condition--Indians are much happier than Chinese and Russia, and about as happy as people in Hong Kong. I believe this: despite the fact that one encounters appalling and widespread poverty in India, the place is vibrant, friendly and fun.

But more important, it appears that once one controls for income, democracy and transparency are important predictors of happiness (of course, one would have to run some sort of regression with some sort of proxy for openness of government institutions to figure this out). This really stands out at the $30,000 level; on the other hand, people in Venezuela and Saudi Arabia are happier than average for their income classes, and they are hardly democratic.

Putting our Mortgage Problems in Proper Perspective

I had lunch yesterday with Elena Panaritis, who does work on housing finance in emerging countries. She was telling me that it is difficult to develop a mortgage market in Botswana, because people there don't live long enough to pay off mortgages. Life expectancy in Botswana has dropped from 65 to 40 over the past fifteen years. HIV/AIDs is the culprit.

Why I like Obama

It's not just that his Facebook page tells me his tastes are almost exactly like mine. It's not just that he was right about going into Iraq when I (along with a few hundred million others) was wrong. It's not just that he wants to get us closer to where we should be on health care while understanding that there is a limit as to what will get through Congress (LBJ wanted a lot more than Medicare--according to Joe Califano, he took what he could get). It's not just that Austin Goolsbee let us know that he will be OK on trade.

It's that he could have someone as remarkable as Samantha Power, as opposed to a political type, in a very senior position in his campaign; someone smart enough to write A Problem from Hell, and someone honorable enough to resign when she said one dumb thing.

Should lenders take haircuts to stave off default?

It is a tempting solution to the current problem: for those whose mortgage balance is greater than their house value, cram down the loan owed to the value of the house. This will presumably reduce the probability of default substantially, and losses will (largely) be borne by those who took on the lending risk. Ben Bernanke likes the idea, and he knows a lot more about financial crises than I.

But two serious problems stand out. First, future investors could respond by requiring higher spreads for mortgages. If these spreads get capitalized into values, the borrowers whose loans got crammed down could find themselves under water again, and the problem will remain.

Second, there is an issue of fairness. Consider two borrowers, one of whom has a 20 percent down payment, and the second of whom has a 5 percent down payment. If house prices decline by 10 percent, the second borrower gets debt forgiveness, while the first one doesn't. Perhaps the first casualty of financial crises is fairness, but as a policy matter, it is hard to ignore the problem.

Speaking of Chicago

Among my favorite books is Bill Cronon's Nature's Metropolis. It is up there with Braudel's stuff when it comes to carefully done, and breathtakingly beautiful, economic history.

Greatest American City is 171 years old today

Happy Birthday, Chicago!

William F. Buckley was right about two things.

I remember reading a column of his in the Washington Star many years ago extolling the virtues of peanut butter.

I learned in this morning's New York Times that his favorite piece of music was the Beethoven 4th Piano Concerto.

A subprime cartoon

Warning: contains language inappropriate for a family blog.

Mark Thoma points us to Ed Glaeser on how Cities are treated Unfairly

Mark posts Ed's comments here.

Ed (with whom I often disagree on politics) is completely on the mark here. The question is, then, what to do about it? The core problems, as Ed sees it, are that driving is heavily subsidized, and that central cities are disproportionately responsible for providing services for the poor.

Solving the driving problem is not, in principle, difficult. Governments could use taxes and fees to internalize the cost of driving. Economists across the ideological spectrum agree that Pigou taxes (such as gasoline and carbon taxes) and congestion pricing of roads is a good idea. Politicians claim that people would rebel against such policies, but they have been implemented and are popular in Singapore and London. Michael Bloomberg would be willing to put such policies in place in New York, but he has not been able to get the permission of the New York State Legislature to do so. Washington, DC, which has to serve more workers per capita than any other large American city, should be allowed to put in place a commuter tax, but Congress forbids it from doing so. Funds from such fees and taxes could go to creating better transit.

The government services problem is more difficult. It might be appealing to set up metropolitan government structures, such as they have for Canadian cities, so that suburbs cannot use zoning to eliminate affordable housing and thus shirk their responsibilities to the poor. Toronto long ago merged with its suburbs, and it is a very successful city: economically dynamic and culturally vibrant.

But metropolitan government creates problems too. First, there is something to be said for having a myriad of municipalities compete with each other: such competition promotes efficiency and variety. For instance, here in the Washington area, there is a rich variety of suburbs, from urban places with town centers (such as Bethesda and Arlington) to places with large lots and large houses (such as Potomac). I like the former sort of places, but not the latter; there are people whose tastes are the opposite of mine. At the same time, when mayors and city councils are competing for tax bases, they have an incentive to do their job well.

Perhaps the best method for helping central cities is a shared revenue system whereby they get a foundation amount of revenue from an entity capable of redistribution (such as a state) but then pay their own way at the margin. The foundation amount should not just take into account differences in taxable land per capita (it is often lower in central cities than it is in suburbs), but also differences in required service provision.

A great subprime paper from Sufi and Mian

You can download it here.

The paper shows that places that had high mortgage rejection rates in the middle 1990s had higher than average price increase in the first half of this decade. The reason: the development of subprime enabled those who were preciously shut out of the housing market to enter the housing market. An important inference: looser credit standards got capitalized into house prices. This is an important lesson for the development of mortgage finance around the world: liberalizing credit not only increases the ability of people to buy houses, it makes houses more expensive.

I Had a Very Nice Day at the Central Bank of Peru

The staff there are very smart and nice. I learned a number of interesting things: among them, the Central Bank invests in only sovereign and "agency" securities. I asked whether they would invest in a AAA corporate bond, and I was told no. Hence Fannie Mae and Freddie Mac, which do not have standalone AAA ratings, are preferred investments to, say, GE.

All of this makes it difficult for me to understand a quote from Daniel Mudd, CEO of Fannie Mae, in a Michelle Singletary story in the Washington Post recently. The relevant paragraphs are:

I

n an effort to help lower rates for borrowers needing jumbo loans, the recent economic stimulus bill included a provision to allow Fannie Mae and Freddie Mac to buy mortgages above the $417,000 limit.

The new jumbo loan limits won't be the same for all areas. The limits will vary but can't be more than $729,750.

Many jumbo loan holders are certainly anxious to know if rates will fall soon. However, Mudd wasn't sure that many homeowners with jumbo loans would actually see lower rates anytime in the near future.

"There will be some benefit," Mudd said. "How much? I don't know."

Mudd questioned whether investors would buy bundles of jumbo loans. Given the current mortgage crisis, investors might fear that these larger loans would be more risky, he said.

I am guessing that the reason that the Central Bank of Peru buys Fannie Mae notes is that the company has special status. I have gotten grief from many of my friends over the years because I have defended this status on the grounds that it is important to have the companies provide liquidity in times of mortgage market stress. If Mudd is arguing that his company is limited in its ability to restore liquidity to a rather important segment of the mortgage market (basically the entire East and West Coasts), one begins to wonder about the utility of his company's special status.