Favorite Line of the Week (h/t Bob Van Order)

The difference between a theorem and a tautology is how fast you think.

The William Cohan fallacy

William Cohan the other day complained that Elizabeth Warren fallaciously claimed borrowers did not know what they were getting themselves into when they took out exotic loans. Cohan suggests instead that the vast majority of borrowers knew what they were signing up for when they took out exotic mortgages.

This was certainly the case for some borrowers (particularly speculators), but I am not sure "vast majority" is correct. Understanding the intricacies of, say, a pay-option ARM requires a degree of mathematical sophistication that I would guess is beyond the capabilities of many borrowers. My former GW colleague Vanessa Perry has found that many borrowers do not understand anything about credit beyond their next monthly payment. In the case of pay-option ARMS, this payment was often low relative to income and stayed low for some time, so a potential borrower/homebuyer could be "advised" by a mortgage broker lender and/or real estate broker that an expensive house was indeed "affordable."

Should such borrowers have known better? I don't know. I do know that even though I really wanted to dunk a basketball, it was never going to happen, because I am short and can't jump. Similarly, no matter how much they try, there will be potential borrowers with generally good life skills who will never be able to understand an amortization schedule, and who are susceptible to a good sales pitch. To suggest such people are "responsible" for their plight is akin to suggesting that I am "responsible" for never being able to dunk a basketball.

Might Elizabeth Warren's idea of sufficient consumer protection go too far? Sure. But the events of the past eight years or so strongly suggest to me that consumer protection was insufficient.

Lisa Schweitzer on Transportation funding

She bring nuance to an issue that is often argued about with slogans (go to her post for graphs).

One of the common arguments I hear is that transit is underfunded. Now, this is a subjective question. For those who believe that having transit is absolutely vital to cities, no amount would be enough. So that’s not the point.

The other argument that I hear is that we spend too much on highways rather than transit. Again, subjective. There’s no way to suss this question easily enough for a blog post.

But we can take a look at what people seem to believe is a disparity in funding.

This is the graphic you are most likely to see when we discuss differences between highway and transit funding:

Ok, so of the total, highways get about 55 to 60 percent and transit gets 17 percent on average over the time period, but by the end of the time period, transit’s share has risen to about 20 percent and highways has gone to about 54 percent.

So that’s a pretty big difference in funding. But when you factor in the passenger miles served, the calculus changes. In the following graphic, I have assigned 100 percent of the spending on highways to passenger cars–a major overstatement, but it serves the point. It’s an overstatement because highways also serve trucks (a big deal), motorcycles and some transit (less of a big deal.)




My transit advocate friends will patronize me at this point and lecture me about how I’m not factoring in the external costs of the cars–and that’s true.

But I am not sure that external costs are relevant to expenditure fairness. Whether we factor in external costs or not is relevant to tax policy, for sure, but it’s probably not relevant to the budget equity arguments often made. It’s one thing to talk about optimum investment, which would require marginal social cost: it’s another to try to figure out if transit exists is “David” to auto’s “Goliath”.

Here, we’re trying to figure out if transit riders are getting the shaft. Are they getting the shaft (the transit advocate side)? Or are they rolling in dough they don’t need (the Reason foundation argument)?

This is one of the few times I actually might believe the apples and oranges arguments about comparing. Transit is in a building stage, but highways, for the most part, are in the maintenance phase. We could argue ourselves in circles: to reach investment parity, we’d need to double the transit numbers per passenger mile, etc, etc.

I just don’t know what I think. I need to fiddle with the numbers more.

All these data are from BTS, btw.

Hannah Green blogs from an NGO School in India

She writes:

On Tuesday afternoon, we could either take a nap or go to the Pragnya School, a K-10 NGO school in the village. I said that I wouldn’t go and got into bed, only to realize that I was not really committed to napping. My roommate Christina said that she would go but decided that she was too tired. We sat indecisively on the daybed outside our room, and Jesse said, “Come on, we’re going!” and I said “ugh” and we left.

Outside the Vihar gates, eight of us piled into a single autorickshaw. As soon as the rickshaw got going, I was glad that we hadn’t stayed in. The driver saw that we were having fun and put on some Indian pop. We grinned and jerked our heads to the music and felt the breeze coming in through the bars that held the ceiling to the floor. Music isn’t allowed in the Vihar, although we can hear it from the pujas outside all the time (and we’re allowed iPods). Still, we could never listen together like we could in the rickshaw.

When we arrived, we were surprised to find an assembly waiting for us. Girls with plaits in their hair and uniforms filled rows of benches facing a concrete stage with staircases set in three corners, in very Indian style. There were boys in the audience, too, but fewer of them. Sister Shoba, who wore a conservative pink sari and a large crucifix, showed us to a group of folding chairs in the shade.

The first dance was for the Goddess Dergah, which surprised me because of Sister Shoba’s crucifix. There were many dances. The small girls did a dance for the sun god with a lot of dainty marching and raised arms. Their movements were sweet and easy, even when they moved out of step. The boys did wild acrobatic dances which the girls’ clothing and cultural boundaries would not have allowed. In one dance five boys wore camoflage hats to show that they were soldiers in Pakistan. They died dramatically, doing backlfips and jerking along the ground. When they came back to life, one boy bent over backwards and kissed the ground between his feet. In the dance for the goddess Dergah, a teenage boy danced alone wearing only low-rise jeans and a white kerchief around his waist. He danced with two real torches, twisting his body and tracing his torso with the flames. I was a little envious of all the dancing. In America, you don’t learn to move that way. I also felt that it had been too long since I’d danced because dancing isn’t allowed at the Vihar.

When all the organized dancing was over, one girl got up and danced by herself, then the boys got up and danced and tried to take us with them. At first we hesitated. Robert had told us that once some American girls had started dancing in the street during Dergah Puja, and a crowd of five hundred men gathered within five minutes. But we were within the school walls, and that girl had been dancing alone earlier. Someone said, “Come on! If we all do it, it won’t be that bad!” We danced on the stage in the hot sun.

The boys had moves, and we tried to copy them, bouncing our knees, raising our arms and spreading our fingers. I tried to bend back and touch the ground like one of the boys did, but I tripped up, and one boy said “Is good! You try, you try!” Every time we tried to leave the stage, they said “five more minutes!” until finally Sister Shoba lead us back to the chairs. She looked a little embarrassed for us. “If you had not stopped them, it would have gone on all evening,” she said.

She told us that all the performance had been planned for us that day. I wondered what they’d have looked like if they’d had time to practice.

Sister Shoba and the teachers answered our questions about the school and showed us around. The school was founded in 1991 and now has five hundred students. A group of mediation teacher at the Thai temple had wanted to start a school, and they asked our abbot, the abbot of the Burmese Vihar, to run it because he has helped build and run so many monasteries. Most of the students are younger because a lot of them drop out early for marriage or other reasons. All the students attend for free, but admission is somewhat competitive. The poorest students are given preference, but some higher-caste students are accepted so that the classes can mix. Once the students are in school, the teachers to their best to keep caste hidden. All the students wear uniforms, but on the first day many come very dirty. When that happens, all the dirty students are forcefully sent home to take a bath. “Very soon they begin to come very smartly on their own,” Sister Shoba said. The school tries to teach religious acceptance as well. The students say all the different prayers: Hindu, Muslim, Christian and Buddhist. Of the 500 students, most are Hindu or Muslim. The are five Christians and no Buddhists. Sister Shoba told us that she was Catholic.

“‘Tis a very rare thing, for a Catholic nun to run a school like this,” she said.

Inside the school, we saw tiny classrooms painted blue. We saw the three or four computers that all the students use to learn. The ceiling fans had “World Peace” written in Hindi on each blade. From the upper stories and the roof, we got a good view of nearby rice fields and the Chinese and Tibetan temples.

Sister Shoba said that the school’s main problems are financial. Someone asked if they got money from the government.

“No. And we wouldn’t want because then we have to follow government rules.”

Bill Gross says don't expect double-digit returns anymore

He could very well be right. Part of returns come from inflation, which is currently running at an annual pace of 1.2 percent. If "normal" inflation is 3 percent, a 10 percent return in normal times is equivalent in real terms to 8 percent now. There is nothing necessarily wrong with that.

A modest step toward untangling housing markets

One of the impediments to housing transactions is appraisals. If appraisals (which are backward looking) don't support the offer price of a house, the financing for the house can disappear.

For low down payment deals, this is frustrating, but appropriate. But for deals involving a minimum of 20 percent down, it is hard to see how appraisers have a better sense of value than the potential buyer who is actually putting a lot of money at risk. It may make sense to allow buyers who put 20 percent down, and whose source of funds is well documented, to get a loan even if the appraisal comes in a little low.

At what point will short sales become meaningful to restarting the housing market?

The Washington Post today forecasts 400,000 short sales this year. Lawrence Yun says there will be 2.5 million foreclosures in 2010. So while short sales have have increased substantially, they will still be only about 1/6 the number of foreclosures.

Don't get too excited

Nick Timiraos retweets Brad Hunter: Census numbers: Single family starts up 4.3% (+/- 12.4%) Plus or minus 12.4%!! It's in the fine print of their release!

I actually try my best not too make too big a deal out of any monthly number.

To my macroeconomist friends: if you are going to do urban economics, please read the urban economics literature first.

I saw a paper from a famous macroeconomist a week or so ago that proposed that cities with high incomes relative to house prices produce more utility than those cities with low incomes realtive to house prices. Using this metric, he concluded that Flint was among the five highest utility cities in the US. This might have been a clue that there was something wrong with his utility measure.

The systems of cities literature (see Jan Brueckner's chapter in the Handbook of Urban Economics) and the quality of life literature (see Stuart Gabriel Joe Mattey & William Wascher's RSUE paper) shows that in a country with mobility, utility tends to get equalized across cities, and so that places with high house prices relative to income have more non-housing amenities than places with lower house prices. I can testify to the reasonableness of of this, as while Los Angeles is expensive (as well as congested), I do not find myself tempted to move anywhere else, suggesting that I, at least, derive a great deal of utility from living here (I recognize that lots of people are not so enamored of LA, but enough of us are to keep the price of housing high relative to other places). Other places like LA include New York, London, Paris, Singapore, Tokyo, Hong Kong, Sydney, etc.

This produces an efficient outcome, for if Los Angeles were less expensive, it would be even more congested. On the other hand, St. Louis' cheap house prices should eventually attract people back to it. But it also produces an unfair outcome, because it is very difficult for low income people in Los Angeles to find reasonably priced housing in reasonable locations. Perhaps the goal of housing policy should be to allow everyone to be able to choose the city in which to live, while at the same time distorting the relative prices of cities as little as possible. I am not sure how one does both.

While Arrow showed the impossibility of a well defined ordering of social preferences...

...we tend to act as if there is one anyway. That is, we place a lot of focus on GDP per capita when evaluating economic success. By this measure, the US is, of course, successful. By a slightly different measure from the OECD (go to page 37), average disposable income per household, the US ranks second after Luxembourg among the nations measured. Luxembourg has about the same population of Long Beach, so it is hard to worry too much about it.

But a social welfare function that looks at the lowest decile of income is just as legitimate (or perhaps I should say, illegitimate). By this measure, the US ranks 20th among countries measured, which places it toward the bottom of the OECD pack, with levels similar to Greece and Italy.

On the other hand, the top 40 percent of American household are better off than their counterparts in all other countries (with the exception of Luxembourg), reflecting a great deal of affluence across a large number of people. So where to pick? As Arrow would say, that is really impossible.

When assumptions drive the result

I have spent the past few days at the Wisconsin-St Louis Fed conference on Housing, Urban, Labor and Macroeconomics; it is a third in a series that Morris Davis had organized, and the papers were thought-provoking and well done.

The macro paper, however, was about whether government can effectively counteract negative shocks to one sector of the economy. To the standard macro model it added a friction where workers had to retrain in the event of a shock to one sector of the economy so as to be able to work in another sector. This is clever and important.

But while the model allowed for frictions, it failed to allow for involuntary unemployment, and so it found that government interventions were ineffective. Well, duh...

Is it housing or is it Boston?

David Leonhardt's excellent piece on house prices in the New York Times this morning asks a fundamental question about how to think about the future of house prices. If houses are a staple, they are currently overvalued by historical standards; if they are a luxury good, they are not.

Mr. Leonhardt's definition of a luxury good is one with an income elasticity equal to one (i.e., a good where the share of income spent on the good remains constant), whereas technically speaking, luxury goods have income elasticities greater than one (think nice vacations). But the point is still a good one--the income elasticity of demand for housing should tell us a lot about where house prices "should be" right now.

National house prices did follow income closely between 1970 and 2000, while according to Robert Shiller, they grew only by the rate of inflation before that. I wonder if the reason for the change is not that people wanted to spend a constant fraction of their income on housing, but rather that they wanted to spend a constant (or even increasing) fraction of their income on certain cities, such as Boston, New York, San Francisco and Los Angeles. These are all high amenity places, chock full of luxury goods, that have inelastic housing supply. It is possible that housing in, say, Wichita (sorry to the Kansans out there) is a staple, while Santa Barbara is a luxury.

LA commutes? Not so bad.

The average one-way LA commute is 29 minutes. This compares with 45 minutes for the UK (the whole country, not just urban areas) and 38 minutes for the EU. A variety of sources suggests that the median commuting time in Japan is greater than 30 minutes and the average is longer (because of skewed data).

European cities are great for vacations, and wealthy people in such cities can live in places that allow them to walk to work. But for average people, LA is a easier place to get around.

Ryan Avent of The Economist gets it right (h/t to Mark Thoma)

He writes:

"...it's simply not true that the administration has rolled out every programme it can think of. Economists with which administration officials are very familiar have proposed measures to deal with the real problem in housing markets: negative equity. Promising policies like mortgage cramdowns and own-to-rent programmes have yet to get a serious look from Washington leaders. But ultimately, a real fix for housing markets must address underwater mortgages. Absent some attempt to deal with negative equity, a rush of buyers into the market will accomplish little; the problem is that underwater homeowners can't afford to sell at prevailing prices. Driving those prices lower won't change that fact.

The truth is that the trouble in housing is not, for the most part, a demand-side issue. The problem is the millions of homeowners stuck in houses they can't afford to sell. These households represent a significant shadow supply of foreclosures-in-waiting. I agree that it would be silly for the administration to try to support housing prices by offering more goodies to potential homebuyers. But it doesn't follow that letting prices go their own way will magically get housing markets moving again."

John Quigley, Alan Blinder (and I for that matter) have been advocating something like a Home Owners Loan Corporation, and/or a debt equity swap for underwater mortgages for some time. We also need to deal with second liens--investors in such liens are holding up renegotiated mortgages because they will get wiped out--which is of course what is supposed to happen when one interest is subordinate to another.

(Thanks to Jim for filling me in on who RA is).

A downpayment factoid

Canada allows 95 percent LTV loans. Borrowers must get mortgage insurance, either from the government or the private sector, if the LTV exceeds 80 percent. Yet 90 day delinquencies there remain under 50 basis points. All home lenders in Canada are subject to strong regulatory oversight.

My favorite Art Goldberger quote

I saw a paper today on heritability and savings. It made me think of my econometrics teacher, Art Goldberger, who once wrote:

Professor Hans Eysenck was so moved by the twin study that he immedi- ately announced to Hodgkinson that it "really tells the [Royal] Commis- sion [on the Distribution of Income and Wealth] that they might as well pack up" (The Times, 13 May 1977). (A powerful intellect was at work. In the same vein, if it were shown that a large proportion of the variance in eyesight were due to genetic causes, then the Royal Commission on the Distribution of Eyeglasses might as well pack up. And if it were shown that most of the variation in rainfall is due to natural causes, then the Royal Commission on the Distribution of Umbrellas could pack up too.)

From "Heritability," Economica, 1979, 46, 327-47.

Do low rates make house prices more volatile?

Over at the FT blog, Cardiff Garcia has a nice summary of three papers that attempt to explain the run-up in house prices before 2007. It particularly approves of the work of my friend and co-author Susan Wachter and Andrew Levitan, who argue that a supply-side credit bubble produced the housing bubble.

As I read the piece, though, I couldn't help but think that while it is unlikely that low interest rates would explain prices, they might explain volatility. When nominal interest rates are low, a small change in price expectations can lead to a large change in prices.

Consider the Gordon Growth model, where Value = dividend/(i-g), where in this case the dividend is the value of living in a house, i is the interest rate and g is the expected growth rate of the dividend. Let everything be real (i.e., not nominal) Consider two worlds: 2 percent real interest rate world and a 4 percent world. Now let expectations about growth vary from negative one percent to positive one percent. In the two percent world, the upside scenario produces three times the value of the downside scenario. In the four percent world, the upside produces 67 percent greater value than the downside. Hence small changes in expectations have a much larger impact in a low interest rate environment than a high interest rate environment. It may be hard to pick this up because expectations are so difficult to measure.

Just a thought.

The wonders of academia

I became a full professor at the University of Wisconsin-Madison in 2001. Among the responsibilities of full professors are (1) to evaluate whether professor at schools other than ours merit promotion and (2) to chair and serve on promotion committees at our own schools.

So far as I can tell, senior faculty take these responsibilities very seriously. The strange part is that we take promotions of people at other schools very seriously, even though we compete with those very schools. I suppose one could make an argument that we at USC should try to blow up the cases of those who we deem to be good at other schools in California, while also waxing enthusiastic about weaker faculty at these schools. It is as if Honda were telling Toyota who to promote, and vice versa.

In the end, though, faculty at one school tend to recommend that faculty they deem meritorious at another receive promotion. While the process is certainly less than perfect, the good faith that most faculty show in these affairs helps explain why the US still has the best research universities in the world.

Did Californians break their contract?

Mark Thoma, whom I admire, approvingly posts Michael O'Hare's letter to his students. Professor O'Hare says something that really bothers me:

...for a variety of reasons, California voters realized that while they had done very well from the existing contract, they could do even better by walking away from their obligations and spending what they had inherited on themselves. “My kids are finished with school; why should I pay taxes for someone else’s? Posterity never did anything for me!”

As Professor O'Hare correctly notes in the header to his blog, "everyone is entitled to his own opinion, but not his own facts."

So before we accuse middle-aged Californians of being greedy, we should consider four things. First, California ranks 4th in state and local per capita spending in the country (and number one is Alaska, where the tax price of government service is essentially zero). Second, about 2/3 of California bond referenda that go to the public receive the 2/3 super-majority necessary to get passed. Third, we in Los Angeles County voted two years ago, in the middle of a recession, to tax ourselves to pay for transportation infrastructure. Finally, we absorb more people from the rest of the world relative to our population than any other state. These facts are more consistent with generosity than greed.

I understand Professor O'Hare's frustration with California's state budget process and with the threats against the wonderful UC and Cal State systems. Those who know me know that I enthusiastically support all kinds of public spending. But Professor O'Hare's rhetoric could well alienate many whom he wants on his side, and may actually give aid and comfort to the Sarah Palins and Glenn Becks of the world.

Maybe we are more like Homer Simpson than Spock

I saw Juan Carrillo of the USC economics department present a very nice paper testing auction theory using experimental data. The only problem was that the people in the experiment were Cal Tech students, who are not exactly representative. But even Cal Tech students, while likely more rational than the general population, and who certainly understand experiments better than the general population, are still far less than perfectly rational.