Illness and Foreclosure (h/t Vanessa Perry)

Christopher T. Robertson , Richard Egelhof, and Michael Hoke have a paper:

Abstract:
In recent years, there has been national alarm about the rising rate of home foreclosures, which now strike one in every 92 households in America and which contribute to even broader macroeconomic effects. The "standard account" of home foreclosure attributes this spike to loose lending practices, irresponsible borrowers, a flat real estate market, and rising interest rates. Based on our study of homeowners going through foreclosures in four states, we find that the standard account fails to represent the facts and thus makes a poor guide for policy. In contrast, we find that half of all foreclosures have medical causes, and we estimate that medical crises put 1.5 million Americans in jeopardy of losing their homes last year.

Half of all respondents (49%) indicated that their foreclosure was caused in part by a medical problem, including illness or injuries (32%), unmanageable medical bills (23%), lost work due to a medical problem (27%), or caring for sick family members (14%). We also examined objective indicia of medical disruptions in the previous two years, including those respondents paying more than $2,000 of medical bills out of pocket (37%), those losing two or more weeks of work because of injury or illness (30%), those currently disabled and unable to work (8%), and those who used their home equity to pay medical bills (13%). Altogether, seven in ten respondents (69%) reported at least one of these factors.

If these findings can be replicated in more comprehensive studies, they will suggest critical policy reforms. We lay out one approach, focusing on an insurance-model, which would help homeowners bridge temporary gaps caused by medical crises. We also present a legal proposal for staying foreclosure proceedings during verifiable medical crises, as a way to protect homeowners and to minimize the negative externalities of foreclosure.

Did California Overbuild its Housing Stock?

It all depends on the relevant time frame. If we look at the 00's in isolation, California overbuilt.

But California has grew by 7 million people between 1990 and 2008 and added about 2.43 million housing units (all data are from US Census-- assume that 98 percent of units permitted are actually built). The average household in California has 2.9 people (which is the second highest in the country, and compares with 2.5 nationally), which means that even without removals from the stock and no change in household size, the state needed 2.41 million new housing units. So if we look at the 18 year horizon, California did not overbuild--there we almost surely more than 20,000 demolitions over an 18 year period.

What if we go back to 1980? California grew by 13 million people and added 4.4 million housing units. At 2.91 people per unit, California demanded 4.46 million units. Again, it is safe to assume 60,000 demolitions over 28 years, so it is hard to make a case for long-run overbuilding.

Certainly, some housing was built in the wrong places, or was the wrong type of housing for the place (Lancaster and Beaumont come to mind). But it is hard to make a case that in aggregate California now has too many housing units.

Memorial for Arthur Goldberger at AEA meetings.

Sunday, January 3, 2010: 10:15 am, Atlanta Marriott Marquis, Atrium Ballroom A Remembering Arthur S. Goldberger Presiding: James Heckman (University of Chicago) Speakers:
Lawrence Klein (University of Pennsylvania)
Glen Cain (University of Wisconsin)
Kate Antonovics (University of California-San Diego)
Gary Chamberlain (Harvard University)
Charles Manski (Northwestern University)
with remarks from Harry Kelejian (University of Maryland) read by James Heckman

It's A Wonderful Life Fan Trailer

News item on Fannie/Freddie CEO pay

Bob Hagerty in the Wall Street Journal says they will make $6 million each. This is absurd--they are now government agencies. It would not be unreasonable to cap GSE CEO pay at the President's pay (by that I mean the US President). I would even let them have a rent-free house. I could even see giving them a bunch of shares, so if by some miracle the GSEs became going concerns again, the CEO would benefit. But the current arrangement is bizarre.

Paul Krugman should know better

Civility is important to me. I am all for fighting the other guys' arguments tooth and nail, but try not to engage in name calling, because name calling devolves into the sort of ugly spectacle we just saw in the US Senate, where a member (physician!) from Oklahoma encouraged prayer for the illness or death of a colleague.

I was thus disappointed when Paul Krugman, whose work I admire, encouraged the left to hang Joe Lieberman in effigy, and then issued a non-apology-apology is his column the other day. I am not crazy about Lieberman--he seems to have the Tartuffe-like combination of sanctimoniousness and naked ambition (ok, now I am name calling a bit)--but using violent imagery as part of a policy debate is not acceptable.

The real problem with John Taylor's paper...

...is that it asks the wrong question. The issue is not what would happen to rates without the Fed backstop to Fannie/Freddie, but whether there would be fixed rate mortgages at all.

30-year-fixed rated-80-percent-loan-to-value mortgages beyond the conforming loan limit basically do not exist at the moment [update: by conforming loan limit, I mean the high cost area loan limit, which in some places is now $729,750]. A conversation I had today with two bank executives confirmed this. Some would argue that 30-year fixed rate mortgages are over-rated, but not I.

John Taylor says that the Fed could sell its MBS without having a material impact on interest rates

His blog post is here. I will download the paper when I get into the office tomorrow ( I can only download NBER papers while on campus).

But one thing from the blog post strikes me as strange: he uses spreads on agency debt as his measure of credit risk. But the very fact that the Fed has purchased MBS could produce a perception that the government is standing behind the debt--as the Fed exits, so too might this perception. I would also imagine that the low current interest rates mean expectations about prepayment are unusual at the moment, and that the most common methods for pricing the mortgage call option might not be appropriate either.

The point is that it is very difficult to separate total mortgage interest rates into the term-adjusted risk-free interest rate, the credit spread and the prepayment spread. More after I actually read the paper.

[update: I just read the paper. Taylor describes it well in his blog post, which means that I have not seen anything to change my mind that it is not very convincing. More to come soon].

Paul Carrillo, Stephanie Cellini and I have a new paper

Surfing for Scores:
School Quality, Housing Prices, and the Changing Cost of Information

The abstract:

I

n this paper we investigate the relationship between school quality and information disclosure in
housing markets. When presented with the option of identifying their local public school in a
real estate listing, we find that sellers with homes assigned to higher-performing schools are
more likely to provide this information, an effect that is driven by sellers of large single-family
units. Further, we find that controlling for school quality, information disclosure has no
independent effect on housing prices for single-family homes, implying that buyers with a high
willingness-to-pay for school quality will seek out information on school quality on their own.
On the other hand, we find that sellers’ disclosures about schools have a large positive impact on
the sale price of small multi-family residential units in 2001-02, but the effect disappears by
2006-07. Presumably, the increasing ubiquity of the Internet and the availability of new data
under No Child Left Behind dramatically reduced the cost of gathering information on school
quality over this period. Taken together the results reveal substantial heterogeneity in buyers’
willingness-to-pay for information on school quality, they support the findings of the education
literature on the importance of school quality in housing markets, and they confirm the
“unraveling” theory of information disclosure found in other markets.

Will post to SSRN soon.

Very Sad News from Wisconsin--RIP Arthur Goldberger.

We lost one of our most influential econometricians and teachers of econometrics this week--Arthur Goldberger. The econ department's obit is here:

http://www.econ.wisc.edu/Goldberger%20remembrance.pdf

A week doesn't pass without me being grateful for my econometrics education at Wisconsin--in fact, there are times even now when it just starts to dawn on me what Charles Manski and Gary Chamberlain were trying to teach me. Professor Goldberger's (I never had the nerve to call him Art) class sticks with me whenever I even glance at data. His clarity of presentation allowed us to internalize thoroughly classical and "neoclassical" regression theory.

When I go to conferences on policy analysis, I am always struck by (and proud of) how many of the presenters are Wisconsin Ph.D.'s, and by how much of the work that they present is good. Arthur Goldberger deserves a large part of the credit for this. Professor Goldberger didn't only teach a terrific and influential class (his textbook, A Course in Econometrics, is essentially a set of his lecture notes). He infused the economics department at Wisconsin, along with its students, with an ethos that refused to tolerate sloppy empirical work. He shall be missed very much.

[Austin Kelly adds: "I never met the gentlemen, but I can't tell you how many times I have referred people to his classic pages on "micronumercy" - his slam at people who blame everything on multicollinearity."

He also taught me not to place too much faith in R-squared.]

How pro-transit people shoot themselves in the foot.

I read the following on the Seattle-based Alaska Viaduct project in the Infrastructurist:

McGinn’s statements suggest that this megaproject may still be defeated. For the sake of a city with exciting light rail plans and big-city potential, we hope this happens, since the tunnel is too expensive and will only advance the interests of car commuters, rather than encourage them to try transit.

Let me stipulate that the project may very well not pass a cost-benefit test. But the line "will only advance the interests of car commuters" reflects both snobbishness and detachment from reality. According to this blog, more than four-fifths of commuter trips and 85 percent of all trips in Seattle are made in private automobiles. Complaining that something advances the interest of auto commuters is like complaining about advancing the interest of, say, children--pretty much every one of us is one, or loves someone who is.

As the Onion so wisely headlined, "98 percent of US commuters favor public transportation for others."

Gregg Easterbrook has a good piece on college sports this week

It begins:

Charlie Weis and Bobby Bowden had to go -- Notre Dame and Florida State weren't winning every game! Get rid of the bums! All we heard from sports commentators, and from alums and boosters, was get rid of the bums, we gotta win, win, win. Sorry to interject, but why? Why does Notre Dame or Florida State or any university need to win every game? Is it now official that big colleges care more about sports than education?

If an NFL team, which is strictly a commercial enterprise in the business of providing entertainment, doesn't win, get rid of the bums. But a university exists to educate; winning football games is a secondary concern. Don't get me wrong. I attend way too many college football games, and I always like it when the school I'm rooting for wins. But I am not so misguided as to think that a college's winning games means more than a college's educating students, including athletes. Why is this distinction practically absent from sports commentary?....

I was harsh with him last week, so when I think his work is good...

Inquiry about Hyderabad

I will be making my second visit to the Indian School of Business this coming January. If anyone out there has expertise in the Hyderabad real estate market, I would very much appreciate hearing about it. richarkg@usc.edu.

Sameulson stands alone

From the time I was in high school, I was told of a symmetry in economics: that the world had two leading economists, one on the right (Milton Friedman)and one on the left (Paul Samuelson). But once I started reading their works in college and graduate school, I came to the view that there was no symmetry: that Friedman was a brilliant economist, but that Samuelson was at a different level altogether. Friedman was more like Gershwin, whereas Samuelson was more like Mozart.

Friedman's two masterpieces were A Monetary History of the United States 1867-1960 (which he coauthored with Anna Schwartz) and Essays in Positive Economics. The former is an astonishing work of scholarship,and rigorously uncovers data to make an important point about the quantity theory of money. The latter reads like a series of clever puzzles to be solved--it challenges you to figure out the underlying assumption that drives the result.

But Samuelson's Foundation of Economic Analysis was like Don Giovanni and the Magic Flute--it changed everything. I do not think it is an exaggeration to say that all economic thought since then has its (if you will excuse me for saying so) foundations in that work. At the same time, he was, like Mozart, astonishingly prolific, and had influence in pretty much every field of economics (macro, micro, public economics, trade, industrial organization, etc.), and at pretty much every level (as a scholar of original research, textbook author, popular press writer).

We will miss Paul Samuelson

Mark Thoma picks out a couple of nice articles.

How lending decisions produce sub-optimal social outcomes

The New York Times reports that many people who would like to refinance their mortgages into lower interest rate 30 year fixed rate mortgages are unable to do so.

Of course, were households able to refinance their mortgages, their probability of default would fall, because the present value of their mortgage balance would fall (effectively lowering the loan-to-value ratio) and payment-to-income ratios would also fall. At the same time, because the cost of capital for lenders is low, financial institutions would find the refinanced loans profitable.

But when a lender holds an underwater loan, it wants to earn as much profit as possible, and so hasn't sufficient incentive to lower the interest rate. The judgment of these lenders is that the profit gained by continuing to charge a high interest rate is greater than the potential losses from the increased probability of default. At the same time, other lenders do not want to take out a loan that is underwater. Hence, people are stuck.

This is surely socially less than optimal--keeping foreclosures as low as possible is in everyone's best interest at the moment. So here is a policy proposition--if a borrower has always been current on repaying their mortgage, they get to refinance at the current low rate of interest. Financial institutions are being subsidized with unnaturally low interest rates. Borrowers should get their share of those subsidies.

Case’s career rewarding by any measure - The Boston Globe

Case’s career rewarding by any measure - The Boston Globe

Posted using ShareThis

The USC Casden forecast is on line

It is at
http://www.usc.edu/schools/sppd/lusk/casden/reports/pdf/2009-USC-Casden-Industrial-and-Office-Report.pdf

We handed it out today on flash drives instead of hard copy reports. The audience seemed to like this. Kudos to Lusk staffer Jennifer Frappier for coming up with the idea.

When Gregg Easterbrook writes about something I know about, he almost always gets his facts wrong

In his football column (which I like), he writes:

A generation ago -- a decade ago! -- home buyers were expected to have a 20 percent down payment; that made them unlikely to try to buy something they could not afford, and banks wouldn't be exposed if something went wrong, since they were lending only 80 percent of the value of the property. Now requiring 3.5 percent down is viewed as "toughening" standards. Isn't this an invitation for yet another cycle of mortgage problems?

Low downpayments for FHA loans have been around for awhile. When President Eisenhower signed the 1957 housing bill, Time Magazine reported:

The Federal Housing Administration, aiming to attract money for homebuilding, increased maximum interest rates on FHA-backed mortgages from 5% to 5¼%. And to woo more buyers from middle—and even low —income groups, it slashed down-payment requirements from 5% on the first $9,000 to 3% on the first $10,000 of a mortgage.

Yes, one could buy a house for $10K in 1957. A brand new 3-bedroom in Mansfield Ohio cost $15k at the time, so used homes would have cost less.

Buyers have also been able to use private mortgage insurance to buy houses with five percent down-payments for many years (at least since the 1980s--if any one has history on PMI down-payments before that, I would love to hear about it). VA loans have always had very low downpayment requirements.

Do I worry about FHA? Sure. But let's not pretend that we lived in some virtuous world before this decade in which everyone put 20 percent down on their house. It was just not true.

USC Student Jonathan Shum sends me to a Green Street Report on Capital Structure in the REIT Sector

Its summary:

A Cultural Affinity for Leverage: Until about twenty years ago, the structural make-up of the real estate industry (i.e. small players, fragmented ownership, no outside equity sources, etc.) dictated that debt, not equity, serve as the primary source of external capital. As a result, market participants grew accustomed to operating with far more leverage than is found in virtually any other industry. Now that financing options for major real estate companies are very similar to what
is available to other large corporations, there are several reasons to believe that less debt and more equity should be the norm going forward.

Financial Theory: There is no reason why a non-taxable entity (e.g. a REIT) should have any debt, yet the costs associated with credit crunches (both in the form of distress and missed opportunities) provide ample reason to limit leverage to relatively low levels. These costs have proven to be so high that optimal leverage targets for most REITs likely fall in the 0-30% (debt/
asset value) range.

Best Practices in Corporate America: Most corporations have a strong incentive to utilize debt –interest expense helps minimize their corporate tax bill – yet it represents less than one-quarter of the typical corporation’s capital structure. REITs, by contrast, have no reason to use debt, yet it typically comprises about half the capital structure. There is no justifiable reason why financing
practices should differ as much as they do.

The Real World Lab Experiment: Higher leverage should be accompanied by higher returns in order to compensate for its added risk. This has not been the case, however, in the REIT sector, as more levered REITs failed to provide meaningfully better returns even in the ten-year period preceding the peak of the asset valuation bubble. Lower levered REITs have substantially outperformed over the last fifteen years.

De-leveraging & Value Creation Ahead: The REIT sector has commenced what is likely to be a multi-year de-leveraging process. It should unfold in three stages: 1) de-lever to ensure survival; 2) de-lever to return to prior leverage targets; and 3) acknowledge that prior leverage targets were too high and de-lever to achieve new, lower targets. Much progress has been made on the first phase, yet most companies are not yet entirely out of the woods. The subsequent stages will entail
massive amounts of equity issuance, as leverage ratios need to decline by more than 1500 bps to return to prior norms, and a substantial reduction beyond prior targets is appropriate. At a time when other real estate market participants lack access to capital, REITs that aggressively de-lever as they articulate thoughtful strategic objectives with regard to their long-term capital structures will be well-rewarded.

For Universities, Leaders Matter

Steven Sample is retiring as president of USC this year. He is one of the reasons I wanted to join the USC faculty. I am guessing that no university president has done more over the past three decades or so to transform his institution than Sample; the only comparable academic leaders I can think of are Theodore Hesburgh at Notre Dame and John Sexton at NYU.

One indicator of Sample's influence is USC's ranking based on Avery, Glickman, Hoxby and Metrick's measure of student preferences. Their measure is simple: after controlling for such things as cost and legacy, they look at the propensity of students to choose one college over another. Based on this measure, USC is the 29th most favored college in the country. Every college ahead of USC based on this measure is an excellent institution (the places immediately above USC in this ranking are Chicago and Johns Hopkins). For those that get into both Berkeley and USC, 72 percent go to Berkeley, but for those that get into both USC and UCLA, 89 percent go to USC (once again, controlling for costs). When Sample took over as President, this would have been unimaginable.

Sample also writes gracefully about higher education.

Ann Schnare and I write about the Rise and Fall of F&F

The paper is here and here.

Has anyone done a paper on network effects and restaurant ordering?

Some years ago, I was awaiting a flight from LA to Washington (I think). It was winter, and so the flight was delayed, so I went to the bar to have a drink. I ordered a Ketel One Dirty Martini; after I did so, the man two stools down from me said, "that sounds good," and ordered one, and then a women across the bar also said, "that sounds good," and ordered one, and so on, until 5 or six people at the bar had Ketel One Dirty Martinis in front of them.

I thought about this while in a restaurant last night, when one order of gumbo seemed to lead to a cascade of gumbo orders around the room. So I would like to know whether these were isolated incidents, or whether one order generally influences the surrounding orders. In the case of married couples (or significant others) who like to share, one order might have a negative influence on the probability of a similar order. When the boss is buying lunch, perhaps her order places a ceiling on the price of other orders.

Anyway, it seems like there is a paper in this, but until I finish the half-dozen papers that are currently between 10 percent and 80 percent done, I am not working on it.

My AEA Economists Calendar has Arrived!

While I need to double check this, it would appear that Locke is the oldest economist listed; Saez is the youngest.

Why it is hard to imagine consumption reigniting.

Mark Thoma wonders about whether consumption will come back any time soon.

A graph making the rounds uses the Federal Flow of Funds data to look at the ratio of Household Debt to GDP--the ratio rose from around 60 percent as recently as 15 years ago to more than 100 percent now. If households begin reducing their leverage back toward the long-term average, it will depress consumption for three reasons:

Debt service payments will rise when interest rates rise, and so discretionary income will be lower than it was when households had less leverage ( we are getting some relief right now because of very low interest rates on debt tied to LIBOR or the prime rate).

Households will not take on new borrowing to support spending.

Households will in fact be amortizing their current debt (meaning they won't spend).

The counter-argument is that average household net worth relative to GDP remains quite normal by historical standards. But here is where the skewed distribution of wealth is a problem. I am reasonably sure that when the next Survey of Consumer Finances is released for 2010, median household net worth will be down. Corelogic says that one in four households with mortgages has negative home equity--this would be about 18 percent of owner households (about 30 percent of owners have no mortgage). If we combine this with the fact that 1/3 of the country rents, this means that the median households has little or no home equity. The median household is not loaded with financial assets, either. According to the 2007 Survey of Consumer Finances, only half of families have a retirement account, and only 21 percent owned stocks. Put this all together, the median household is not in great shape financially, and the median household consumes a higher share of its income than higher income households.

One more back of the envelope calculation on getting us back to a steady state: suppose the steady state household debt to GDP ratio is 70 percent. If the national economy uses 5 percent of its income to pay down that debt (which is about 7.5 percent of current consumption), at an interest rate of 8 percent, it would take 9.2 years to de-lever down to the steady state ratio.

[Update: the above back of the envelope assumes six percent nominal growth. If nominal growth is less, it will take longer].

Homeowners Associations contribute to Global Warming

Over the holidays, I have learned from my parents that there are homeowners associations that ban drying clothes on clotheslines and make it difficult to place solar panels on houses. I did a google search on the issue, and learned to such hostility toward environmentally friendly practices is fairly widespread.

This sort of thing has got to stop. While apparently some states have passed laws that ban homeowners associations from prohibiting solar, the laws are sufficiently vague that they can be circumvented.

Dubai, Academic Freedom, and Real Estate

Sometime around 2006, when I was an Associate Dean at George Washington University, I was asked to be part of a team to go to Dubai to explore the possibility of opening a degree program there. After spending three or four days there and running some financials, our team decided that unless GW got a heavy subsidy from Dubai, it was economically a non-starter for us to set up something. Our team's judgments is looking pretty good right now.

The more interesting part of the story, though, is a conversation I had with a professor at one of the universities there. I asked about academic freedom in Dubai, and he said there was plenty. I then asked whether it would be OK to raise in class a discussion about whether the Emir had shown good judgment in building Burj Dubai, the still incomplete tallest skyscraper in the world. The look on his face told me all I needed to know.

The Pleasures of Teaching

Last night, I heard 10 presentations from my MBAs on TARP, TALF, PPIP and HAMP. I learned at least one thing from every one of them.

Shiraz Allidina (attribution corrected) creates a nice indicator of over-leverage in commercial real estate.

He uses the Federal Flow of Funds to look at Commercial Real Estate Loans Outstanding as a fraction of GDP. When the share goes well above the long term mean, bad stuff in commercial real estate seems to ensue.

Eichholtz, Kok and Quigley find Economic Value from Green Buildings

This is forthcoming in AER:

This paper provides the first credible evidence on the economic value of the certification of green buildings-- value derived from impersonal market transactions rather thanengineering estimates. For some 10,000 subject and control buildings, we match publicly available information on the addresses of Energy Star and LEED-rated office buildings to the characteristics of these buildings, their rental rates and selling prices. We find that buildings with a green rating command rental rates that are roughly three percent higher per square foot than otherwise identical buildings - controlling for the quality and the specific location of office buildings. Ceteris paribus, premiums in effective rents are even higher - above six percent. Selling prices of green buildings are higher by about 16 percent. For the Energy-Star-certified buildings in this sample, we subsequently obtained detailed estimates of site and source energy usage from the U.S. Environmental Protection Agency. Our analysis establishes that variations in the premium for green office buildings are systematically related to their energy-saving characteristics. For example, an increase of ten percent in the site energy utilization efficiency of a green building is associated with a two percent increase in selling price - over and above the 16 percent premium for a labeled building. Further calculations suggest that a one dollar saving in energy costs from increased thermal efficiency yields roughly eighteen dollars in the increased valuation of an Energy-Star certified building.

I find the value results compelling; the rent results less so (the t-stat on their best specification is not that impressive given their large sample size). But in any event, an important contribution.

Is there room for more than one Chicago?

Last weekend, for the first time since leaving the Midwest in 2002, I spent time enjoying Chicago. The best part was visiting my daughter, but the second best part was seeing Millennium Park, the New Modern Wing of the Art Institute, and just plain walking around and eating in Chicago.

Within one-half mile of Lake Michigan, from Cermak Road on the South to the Evanston city limit on the North, Chicago is an Urbanist's dream. It is walkable, it has more impressive urban landscapes than any other city I know, transit is good, there is well-tended and contiguous green space, and, of course, the magnificent lakefront.

So why don't we have more Chicagos? Part of the reason is that countries have systems of cities, whose size seems to kind-of-sort-of follow Zipf's law, and so there is room for a limited number of cities of Chicago's size. But one could ask why we don't see Chicago in miniature more often. To the extent that it is preferences--that there are only a limited number of us who like the features of places like Chicago--the fact that there are few Chicagos is nothing to worry about.

But I suspect that it has to do more with policies--zoning that requires separation of uses, low densities, large setbacks, etc. Particularly problematic is the hostility many communities show toward multi-family housing, and the silliness of greenspace requirements that encourages many little playgrounds but fails to develop large parks. The again, policies are put into place by elected officials, so maybe the absence of Chicagos does reflect preferences (or prejudices). And that's too bad.

If only we knew ...

The basic problem with valuing underwater loans is that borrowers are heterogeneous. Some borrowers are going to walk away from their mortgages; from the standpoint of financial institutions, it would be better to simply write down their mortgage balance, swap the value of the debt above the mortgage balance for equity, and avoid foreclosure.

But other borrowers insist on paying their mortgages, no matter what. These mortgages continue to be worth something like their par value. Financial institutions do not want to modify their loans. But if those who pay their mortgages know that those who don't will get a modification, they will change their behavior.

So the optimal program (from the lender's perspective) would be one that identifies those who wouldn't repay, and then grant those people a secret modification. I can't figure out how to either (1) how to do the identification or (2) write to contract binding the borrower to secrecy.

Does the MIT transactions based commercial real estate index imply that commercial real estate is at bottom?

I was surfing the MIT CRE web site this afternoon, and the following picture caught my eye:



The MIT index is a hedonic transactions based index based sales from the NCREIF index, and it attempts to find price movements of a "typical" property. The interesting thing is that the Moody's Commercial Property Index is still falling:



So the question is whether the MIT TPI is a leading indicator. My sense is actually that Apartments and Industrial Real Estate will come out of this thing earlier than other generic types, but I am not sure that anything is really at bottom yet. In particular, the MIT folks are showing that demand and supply are coming closer to lining up, but there is still excess supply nationally in the industrial, office and retail sectors.

The problem with Goldman bonuses

Beyond the generic problem that bonuses are usually based on an un-risk-adjusted IRR, the problem with bonus for banks in general, and Goldman in particular, is that the government is backing short-term bank borrowing, and so banks can borrow at very depressed rates and make a lot of money on spreads. This seems more like playing the government than playing the market.

Fighting the last war

At the ULI meetings, I am hearing that banks are not willing to repeat their behavior in the last down market (the early 1990s): they are afraid that if they sell their assets--commercial real estate loans--at a discount, they will miss out on upside opportunity. Instead, they are "extending and pretending," in the hope that values will rebound to levels above mortgage balances. I overheard one person say, "cap rates have to go back down again. right?"

Not necessarily. This paper by Phillip Connor and Yougo Lang shows that cap rates tend to stay in the eight range over the long term--to think they will return to the fives is almost certainly unrealistic. Even if net operating income had stayed constant--and it has fallen--the increase in cap rates from 5 to 8 implies a 37.5 percent reduction in value. It is going to be a long time before loans with LTVs at origination in excess of 75 percent will be right-side-up again.

We may be in bad shape fiscally, but at least we're happy (h/t Richard Florida)

According to Gallup, six of the country's 10 happiest congressional districts are in California. The happiest, the California 14th, is between San Francisco and Silicon Valley.

I live in the 49th happiest district; the least happy is the Kentucky 5th, in Appalachia. Makes sense.

Never thought I would live to see the day...

..that a politician would present a powerpoint that included a slide on the "lemons problem."

The Vice-President of Taiwan, Vincent Siew, was discussing the problem of trying to get that country's financial institutions to disgorge their bad assets. Amazing. No wonder it is such an impressive place.

Taipei has among the best public transit systems in the world

The MRT (heavy rail) system is fast, comprehensive and clean. It is busy in the middle of the day, suggesting feasibility.



The buses are very good too, and cost only about $0.45 US to ride. There are also lots of reasonably priced taxis. Of course, the fact that Taipei is among the world's densest cities helps make this all work.

Ten Facts about California

For pictures, go here. Thanks to Matt Moore for research assistance.

(1) Family of four median income in California ranks 15th among the states. Regardless of how income is measured, in California it is somewhat above average, but not extraordinarily so.

(2) Among the 50 states, California ranks 4th in per capita spending; add DC, and it ranks 5th.

(3) Per capita spending on K-12 education is about average.

(4) California's high school graduation rate is 10th from the bottom.

(5) This can be explained partially by the fact that California leads the nation in foreign born population.

(6) But even after controlling for foreign born population, educational attainment in California is average.

(7) California's incarceration rate is a bit above average, but not extraordinary by US standards.

(8) California relies less on property tax revenue to finance its government than the average state. Economists generally find the property tax to be less distortionary and unstable than other types of taxes.

(9) in 2005-06 (the last year for which I have data), California had more net business creation than any other state. After scaling for size, California's business creation was comparable to Texas'.

(10) California relies disproportionately on Information Technology and Professional and Technical Services for employment. These are high paying jobs that require a well educated labor force.

Is the Tax Credit + FHA a toxic combination?

It would be churlish not to think today's strong existing home numbers were good. But there is an aspect of it that worries me.

The tax credit is $8000. FHA loans require 3.5 percent down payments. Consider the position of an unscrupulous investor in housing. He gets someone to front for him as a first time buyer on a $200,000 house. He puts $7,000 down, and then collects the $8,000 credit. He pays the front person a commission of $500. So the investor gets $500 plus the house. If the house goes up in value, he sells; if not, he walks.

Of course, we have no recent experience with this kind of behavior....

I guest post at Paul Romer's charter city blog

The post begins:

Hong Kong, Singapore and Korea experienced great economic success: all have per capita GDP that is at least seven times higher than in 1960 (see Penn World Table for more information). All three economies also came to be relatively well housed. While we cannot draw a uniform lesson from their experiences, it is worthwhile to examine each case for clues about successful housing development...

Why government spending makes people angry

I was listening in to some proposals for building Section 42 Low Income Housing Tax Credit housing the other day. I heard three proposals: the construction cost per unit being proposed was between 400K to 500k.

It is expensive to build in LA, but downtown has luxury condos selling for less than 400K right now. The median price of a house in Southern California is around $275,000. I am all for providing poor people with good housing, but we could do it a lot more cheaply by buying existing houses and renting them out then building new units whose prices are beyond what a median income household in LA could ever expect to afford.

The reason this sort of thing bothers me is because I do think there is a role for government to do things, such as provide education, health care and networks (roads, sewers, etc.). But for this to happen, government must demonstrate that it spends money well. Building "low-income" housing for $400K a unit does not inspire confidence.

Can Corporate CEOs justify private jet travel?

The Washington Post had a story today about CEO perks at rescued banks. Among the most common, of course, is the use of a private jet for private purposes. But this begs a more fundamental question: is it possible to justify the use of private jets for business purposes?

I picked one CEO at random to try to figure it out. Dieter E. Zetsche, the CEO of Damler Benz, gets paid about $3 million per year (which actually seems reasonable to me, in light of his responsibilities). Let's say the typical CEO works 60 hours a week, 50 weeks per year. This means Zetsche earns about $1000 per hour.

I am going to take as a given that it is worth upgrading the CEO to first class on a commercial flight--it is hard to work while flying in coach, so on a round trip cross country flight, giving the CEO a reasonable environment for work is worth about $10K. The marginal cost of round trip first class tickets is a lot less than that.

Most of the time saving from flying a private jet comes at the airport. I got to fly on a corporate jet once (confession: it is fun). One drives right up to the plane and walks on--no ticket counter, no security. So let's say time saved at the airport on both ends of a round trip is 4 hours: $4000. According to one source, the cost of flying a private jet ranges from $1800 to $5000 per hour. Let's just use $2500. It takes about 5 hours to fly from LA to New York, so round trip, that it $25,000. Let's say the CEO take someone with him/her. Now the cost is down to $12,500 per person.

I just checked on Kayak, and first class airfare from NY to Los Angeles is $2250 on Virgin and Delta. So the marginal cost of the private plane is about $8,000, and the benefit is around $4,000. And of course the cost benefit calculation for the second person is even worse.

I do understand that CEO's on occasion need to go places without commercial airports, and that the time spent driving from a commercial airport to these places might make the private jet pencil out. But they could use shared ownership, or net jets, to take care of those cases. Most of the time, they should fly with the rest of us.

USC planning student Alexene Farol writes about why public transit is hard for LA

Lex Rail writes (h/t Lisa Schweitzer):

The biggest complaint I repeatedly hear about L.A. is that it has a poor public transportation system. News flash: that's true, we're not New York or Tokyo by any means. Yet I often feel compelled to protect L.A. from empty criticism. The people who complain about L.A.'s public transportation system are complaining due to what I see as three major factors: 1) the effect of hearing other people complain (to which I have nothing truly helpful to contribute), 2) the absence of a transportation culture, like the subway-state-of-mind of New York City or even the let's-take-BART-to-the-Giant's-game compulsion in San Francisco, and finally, 3) the feeling of disorder and general lack of safety surrounding the systems we already have. Here's my take on those things.

So let's face it: in Los Angeles, we drive our cars. Everywhere, all day, every day. We jam up our freeways and complain about commutes and argue about congestion but still, we drive our cars. Historically speaking, there is a reason for this. East Coast cities were designed with pedestrians in mind; they are planned to some extent, but largely that American grid pattern wasn't implemented until we started growing westward. People still had few options but to walk when those cities began to develop and subsequently explode in population; hence those cities have easily identifiable centers. Like many European cities, the center is actually in the middle, creating a smaller but more concentrated radius of things-that-are-important-to-get-to: financial buildings and offices, cultural offerings, commercial centers, etc. Los Angeles, however, is a totally different breed of city. Most significantly, by the time L.A. took off in terms of population, Americans were falling in love with the automobile. (Isn't it just like a bad romance novel? The honeymoon period is magical and then we find out that the objects of our affections are shredding the ozone layer. Typical.) This city is not designed for pedestrians but for vehicles, which explains our lack of green space and, obviously, our general difficulties with creating a truly cohesive transportation network. Additionally, L.A. is a highly stratified city, partially because it contains so many levels of specialization and industry. L.A. has many centers - Westwood, the financial district, etc. - and subsequently has a harder time connecting them except by vehicle lanes. Given that information, it's hardly surprising that our public transportation appears subpar. Do you realize how much harder that task is for L.A. than for New York? The concept of reducing VMT (vehicle miles traveled) is a very new concept that is miles away from what L.A. was really planned for. Oh and while we're facing facts, don't lie: those of you who are complaining, you wouldn't ride public transportation anyway.

And why wouldn't you ride public transportation in L.A.? Because there's no guarantee that you'll be as safe as you would be if you were driving. Many of the complainers are students I go to school with, and further, many of those are members of my sorority. This is where the AYF (Attractive Young Female, or as Michael Jackson might say, PYT) factor comes in. Pretty girls are the best way to judge the success of a public transportation system, because they are a) the most noticeable and b) the most vulnerable, for either real or imagined reasons. Pretty girls will not ride public transportation if they don't feel safe. So here we reach another issue with L.A. public transportation: the pretty girls don't trust it. Now part of that, I think, is that these PYTs are expecting the hip subway culture that is not typical of Los Angeles, and as I said earlier, there's nothing we can do about that. They're also expecting fancy light rails with Starbucks and Yogurtland in them. Here's the problem with that, though: who rides public transportation in L.A.? Largely it's the low-income minority population, and they're not riding the fancy light rails. They're riding the derelict, overcrowded buses - the non-glamorous option, and thus, the one with less funding. There are no PYTs on these, nor are there likely to be while they remain in that state. And L.A., in all its innovative glory, continues to invest in highway expansions that don't work or rail lines with low ridership because that's what the PYTs - and higher income residents - want. In the meantime, we force our bus riders to suffer inadequate resources while we develop for the people who complain and yet do not provide ridership.

I've talked for a while now, so in conclusion: to the city of L.A., please put more money into the bus systems. Make the bus stops safer, clean them up - throw in a Yogurtland if you want - invest in better, more fuel-efficient buses, and make sure the buses are always reliable. Maybe you'll attract more people to them; but even if you don't, at least we won't shove the majority of our population into grimy

outdated machines.

What is the optimal Rock Star status for a professor?

Greg Mankiw's blog led me to a piece in the Harvard Crimson on three of Harvard's most popular professors: Mankiw himself, Robert Lue and Niall Ferguson. The opening paragraph:

When History Professor Niall C. D. Ferguson begins his lecture at 10:07 a.m., he abandons the podium, choosing instead to pace in a slow, deliberate loop around the lectern. He speaks with the kind of proper British accent that makes Anglophiles swoon. As he makes an argument about the French Revolution, his throat wraps around certain words with a silky aggression that he punctuates by cocking an eyebrow or gesturing with his left hand, index finger and thumb closed into an “o” around a stub of chalk. His words are actually improvised. His paper schedule book, full of cross-country speaking engagements, is not.

The article also makes clear that Mankiw and Lue are around and available for students all the time, and they are well known. But from the perspective of undergraduate education, what is better--to have a famous professor who gives good lectures who is rarely around, or to have a not so famous professor who gives good lectures who is always around?

My friend Suzanne Gillespie sends me a story on the Las Vegas Housing Market.

CNBC reports that houses in Las Vegas are falling apart, and that at least one buyer went to a homebuilder for a new house because she couldn't find any existing home that was acceptable.

This is actually a good example of what Ed Olsen was writing about in his seminal paper, "A Competitive Theory of the Housing Market." When prices fall below replacement cost, housing deteriorates until its depreciated cost equals price. Once this happens, housing markets are in equilibrium. The fact that the inventory of houses available for sale in Las Vegas has dropped to four months suggests that it is near its equilibrium level.

We could just be happy that the market in Vegas had returned to normalcy where it not for the fact that the deodorization of houses has almost certainly produced negative externalities--i.e., blight. (I was last in Vegas late last spring, and it looks pretty awful). But it is amazing how quickly markets adjust.

Crooked Timber on Elinor Ostrom

Henry writes:

Lin’s work focuses on the empirical analysis of collective goods problems – how it is that people can come up with their own solutions to problems of the commons if they are given enough room to do so. Her landmark book, Governing the Commons, provides an empirical rejoinder to the pessimism of Garret Hardin and others about the tragedy of the commons – it documents how people can and do solve these problems in e.g the management of water resources, forestry, pasturage and fishing rights. She and her colleagues gather large sets of data on the conditions under which people are or are not able to solve these problems, and the kinds of rules that they come up with in order to solve them.

This is, as Kieran suggests, a vote in favor of detailed, working-from-the-ground-up, empirical work, which doesn’t rely on sharply contoured theoretical simplifications and flashy statistical techniques so much as the accumulation of good data, which reflects the messiness of the real social institutions from which it is gathered. Quoting from Governing the Commons:

An important challenge facing policy scientists is to develop theories of human organization based on realistic assessment of human capabilities and limitations in dealing with a variety of situations that initially share some or all aspects of a tragedy of the commons. … Theoretical inquiry involves a search for regularities … As a theorist, and at times a modeler, I see these efforts [as being] at the core of a policy science. One can, however, get trapped in one’s own intellectual web. When years have been spent in the development of a theory with considerable power and elegance, analysts obviously will want to apply this tool to as many situations as possible. The power of a theory is exactly proportionate to the diversity of situations it can explain. All theories, however, have limits. Models of a theory are limited still further because many parameters must be fixed in a model, rather than allowed to vary. Confusing a model – such as that of a perfectly competitive market – with the theory of which it is one representation can limit applicability still further. (pp.24-25)

One plausible characterization of her life’s work is that it is about demonstrating the empirical weaknesses of a ‘cute’ economic model (the Tragedy of the Commons) that assumed a role in policy discussions far out of proportion to its actual explanatory power, and replacing it with a set of explanations that are nowhere near as neat, but are far more true to the real world. It is also worth pointing out in passing (as an email correspondent has brought to my attention) that she has received roughly a dozen grants under the NSF program that Senator Tom Coburn wants to abolish. Tom Coburn vs. the Nobel committee as a judge of scholarly quality – you decide.

It is also a vote in favor of supplementing quantitative work with qualitative understanding...

It is important that the Nobel Committee recognizes that there is more than one approach to science in general, and social science in particular. It strikes me that Darwin used "detailed, working-from-the-ground-up, empirical work, which doesn’t rely on sharply contoured theoretical simplifications and flashy statistical techniques so much as the accumulation of good data," and he moved our understanding of how life on earth works. Real scientists tell me that an awful lot of his specific predictions have stood up, as well.

Jan Brueckner and Bob Helsley find that subsidized sprawl produces urban blight

Jan presented the paper at the first annual UCLA-UCI-USC real estate research day. The finding was straightforward but still interesting: if congestion for commuting to the suburbs is not priced at marginal cost, the urban center will be maintained at less than the social optimum, so the housing stock in the center will deteriorate below the social optimum.

For those who worry about whether this implies that taxing sprawl will reduce the stock of affordable housing, Jan points out that the mechanism for making housing cheaper is greater residential density: with optimal taxation of congestion, one gets very small high quality housing units in the center city.

Bob Shiller wonders what the turnaround in house prices means

He concludes:

WHAT should we conclude? Given the abnormality of the economic environment, the sudden turn in the housing market probably reflects a new home-buyer emphasis on market timing. For years, people have been bulls for the long term. The change has been in their short-term thinking. The latest answers suggest that people think the price slide is over, so there is no longer such a good reason to wait to buy. And so they cause an upward blip in prices.

At the moment, it appears that the extreme ups and downs of the housing market have turned many Americans into housing speculators. Many people are still playing a leverage game, watching various economic indicators as well as the state of federal bailout programs — including the $8,000 first-time home-buyer tax credit that is currently scheduled to expire before Dec. 1 — in an effort to time their home-buying decisions. The sudden turn could signal a new housing boom, but is more likely just a sign of a period of higher short-run price volatility.

My take is different: I wonder if we have actually seen a sudden turn. The mix of sales has recently included fewer distressed sales. If distressed sales are fundamentally different from others, changes in the mix will influence the index. I suspected before that prices for non-distressed transactions before fell somewhat less than CSI; for the same reason, they may not be rising quite as quickly as CSI now.

Paul Romer's radical idea: Charter cities

I like the idea of Canada turning Guantanamo Bay into Hong Kong.

William Brock, Cars Hommes and Florian Wagener show how hedging instruments can destabilize markets.

More hedging instruments may destabilize markets:

This paper formalizes the idea that more hedging instruments or derivative securities may destabilize a market when traders are heterogeneous and learn from experience based on realized returns. Here is a sketch of the idea. Consider a heterogeneous agent intertemporal asset market where risk averse agents are learning the structure of asset prices in the economy by using, for example, different prediction strategies of future asset prices under some kind of reinforcement or evolutionary learning, for instance as in Brock and Hommes (1997).

Let there be S states of the world and a finite number n of contingent claims or risk hedging instruments available. If n < S − 1 the market is incomplete. We model the risk hedging instruments as “Arrow” securities for state s, 1  s  n < S − 1, each paying 1 if state s occurs and 0 otherwise. Elementary Arrow securities are used here as a convenient analytical device, and a suitable combination of Arrow securities may serve as a proxy of more realistic financial instruments such as futures, derivatives or recently introduced collateralized debt obligations. Now
suppose that n < S − 2 and that a new risk hedging instrument, that is, a new Arrow
security, is added for state n + 1 < S − 1. Then, since agents are risk averse, and
since they can use the new Arrow security to hedge out “extra” risk, they will now
tend to place bigger positions on the market. Thus if an agent’s forecasting tool turns out to be on the “right side” of the market, it will return a larger profit (because a larger position has been placed on the market), and therefore it will receive a stronger reinforcement and more individuals will switch to using that particular forecasting tool. This, in turn, implies that the learning system is now more likely to “overshoot”, i.e. to become unstable, and consequently market volatility increases. This intuitive idea will be formalized in a stylized model.

On the other hand it has been argued that an increasing multitude of derivative securities has made it possible for rational speculators to help stabilize markets since they can take bets on market imperfections and hedge their risk. A second contribution of our paper is to investigate the potential stabilizing role of rational traders in a market with co-existing non fully rational traders. Can a perfectly rational trader employ a growing number of hedging instruments to stabilize the market? It turns out that, when the information gathering costs for full rational expectations are large, rational traders can not prevent destabilization.

In the mortgage context, information gathering is expensive. One either needs to set up a good underwriting model, which can take years of experience, or at least to careful loan-by-loan due diligence. Many of us believed that hedges (such as Credit Default Swaps) helped distribute risk better and mitigate against systemic risk. How I wish we had this paper then. (BTW, I took two classes in grad school from Brock. I learned maybe 1/3 of what he was trying to teach, because I am not that good at math. I still learned more from him than pretty much anyone).

Robert Solow on what is needed for growth

From an interview with the MIT Times.

Q. Your research made clear how much technology can contribute to economic growth. To what extent might we see technology driving growth now?
A. I actually think the situation of the economy calls for a surge in technologically oriented investment. We have to expect consumer spending to be weak in our economy, not just for six months, but for the next few years. It will not be as strong a driving force as it has been the past several years. Something has to take its place. Government spending can't, since government will have a hard time financing the inevitable deficits and is not in a position to aggressively increase its deficit spending.

That leaves two sources of expenditure to replace the pullback of consumers. One of those is net exports. That's a long story. The other is business investment. We need business investment to support the economy. We have every reason to want to divert our resources toward secure and renewable sources of energy, new materials and environmental improvement. It's our job, a place like MIT, to produce those new technologies, then it's the job of private industry to grab them, but I also think it's the job of the federal government to shift incentives, from incentives to consume more to incentives to invest more. Obama ran on this kind of platform, and if he can put some money behind that fundamentally correct view, he might generate something. It's going to take more than that to replace 5 percent of GDP, but that would be a neat place to start.

This is also why I really worry about the reduction in funding for our great public universities. Michigan, Wisconsin, Berkeley, UT-Austin, etc. have long been wellsprings of ideas. Once upon a time in Wisconsin, I think the broader population understood why research was so important, particularly when the Ag School was discovering innovations that were useful for farmers. As a political matter, universities must connect to the broader community so that it understands why their research matters so much. Continuing American dominance in Noble Prizes certainly helps, but I don't think the connection is sufficiently concrete for most taxpayers.

One of Mark Thoma's Best Posts

On how to think about research on modifications to the Efficient Markets Hypothesis:

http://economistsview.typepad.com/economistsview/2009/10/capital-market-theory-after-the-efficient-market-hypothesis.html


Principal agent problems (particularly involving asymmetric information) have been an enormous part of the problem, but as Mark notes, are likely not enough to by themselves explain the crisis. I think we also need to look carefully at prospect theory and norms, and the mechanisms households use to make decisions (for instance, the marketing literature shows us that many households make credit decisions based on initial monthly payment).

A first step toward making California governable?

Last week I discussed a talk by Isaac Martin (UCSD) on the political durability of Proposition 13. Isaac pointed out that Proposition 13 contains a whole set of policies: a cap on the property tax rate, assessments based on acquisition value, rather than market value, limits on the growth of the property tax levy , and a 2/3 legislative supermajority for raising state taxes and a 2/3 popular vote supermajority for raising some local taxes.

The point of Isaac's talk was that most people look at Prop 13 as a monolith, when it is not. In particular, he showed that levels of support for each part of the proposition vary. While people are vociferously opposed to any change in the treatment of residential property taxes, they are not so opposed to reducing the supermajority requirement from two-thirds to 55 percent.

Reducing the supermajority requirement would make California more governable. The problem, however, is there seems to be no prospect of reattaching local spending to local revenue sources. This prevents the efficiency mechanisms of the Tiebout model, which predicts that local government compete based on services and their costs, from working in California.

Paul Harris of the Guardian writes that California may be a failed state

I found one paragraph especially disturbing:

Yet California is currently cutting healthcare, slashing the "Healthy Families" programme that helped an estimated one million of its poorest children. Los Angeles now has a poverty rate of 20%. Other cities across the state, such as Fresno and Modesto, have jobless rates that rival Detroit's. In order to pass its state budget, California's government has had to agree to a deal that cuts billions of dollars from education and sacks 60,000 state employees. Some teachers have launched a hunger strike in protest. California's education system has become so poor so quickly that it is now effectively failing its future workforce. The percentage of 19-year-olds at college in the state dropped from 43% to 30% between 1996 and 2004, one of the highest falls ever recorded for any developed world economy. California's schools are ranked 47th out of 50 in the nation. Its government-issued bonds have been ranked just above "junk".

Yet Harris writes something else that doesn't make sense to me: he says California may lose a congressional district after the 2010 census. But census estimates show that California's population has risen a little bit more than the country's (in percentage terms) over the course of this decade, so unless he has special insight into problems with census estimates, this statement does not make sense to me.

But the broader point still holds. California is currently engaged in an experiment testing whether a place with lots of advantages (including some of the most talented people in the world) can overcome disfunctional government. It would appear that the answer is no.

Nancy Franklin points out serious sex-discrimination in the joke market

In her New Yorker review of the Jay Leno show, she writes:

In other diversity news, Leno’s and the rest of the nighttime comedy shows are bizarrely lacking in women writers. Did a bomb go off and kill all the women comedy writers and leave the men standing? The other night on the Emmy Awards broadcast, the names of the nominees for best writing on a comedy or variety series were read, and, out of eighty-one people, only seven were women. Leno has no women writers on his show. Neither does David Letterman, and neither does Conan O’Brien. Come on.

My wife noticed the same thing (I think I did too, independently, but I can't be sure, because she voiced it before I did). The question is, why? This situation for women in comedy is even worse than for women trying to become tenured faculty at universities. I have no evidence that women are not as funny as men: my mother is funny, my wife is funny, my daughters are funny. I have worked at eight places as an adult. The sex of the funniest person I knew at each place? (1) man (2) woman (3) tie (4) man (5) woman (6) woman (7) woman (8) not positive yet. That's four women, two men, one tie, one where the jury is still out.

Why do cities want the Olympics?

It puzzles me, given that Vancouver is facing serious financial issues for its forthcoming Olympics, why major cities care so much about getting them. Olympic games also make life inconvenient for those living and working in the cities where they take place. It is not like Chicago, Madrid, Rio and Tokyo aren't high profile cities. Do we really think more highly about Atlanta because it had an Olympics?

I get permanent sports franchises--they become a source of common conversation in communities, and Carlino and Coulson show that people value this (although free agency and high ticket prices might screw this up). But the Olympics? I hear people talk around here about the 1988 Dodgers and Kirk Gibson's home run all the time; I almost never hear about the 1984 Olympics.

Madison has many things for which to be proud; being the birthplace of The Onion may top the list

Poll: Happy, Healthy Obamas Out Of Touch With Miserable Americans

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

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

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

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

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

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

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

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

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

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

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

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

Kudos to Morris Davis..

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

Arthur Nelson, call Irina Telyukova

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

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

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

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

July 7th, 2009

Abstract

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

Program Note

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

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

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

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

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

As I read the debate over the stimulus...

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

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

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

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

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

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

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

Has the Detroit Housing Market Disappeared?

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

19820

Detroit-Warren-Livonia, MI

151.7

140.3

N/A

N/A

N/A

N/A

N/A

N/A

N/A

The first two numbers are median prices for 2006 and 2007. 2008 and after: zip.

Is this really a success?

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

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

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

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

Freddie seems materially different from Fannie right now.

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

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

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

Underemployment

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

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




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

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

Clawbacks and Capital

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

Arizona has Chutzpah

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

The IRR for the investor: 5.2 percent. Hmmm.

David Byrne is better at music than math

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

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

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

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

Blocking and Tackling and Transit

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

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

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

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

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

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

Lists

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

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

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

Why we need consumer protection for mortgage borrowers: a story

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

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

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

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

Time to Return to TRA 1986?

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

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

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

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

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

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

Just a thought.

A Rising not a Setting Sun

h/t Brad Delong

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

Median Incomes and Economic Obsolescence of Large Homes

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

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

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

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

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

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

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