Worthwhile reading on Wamu vs Cuomo

http://globaleconomicanalysis.blogspot.com/2007/11/tanta-on-wamu-vs-cuomo.html

Tanta On WaMu vs. Cuomo

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

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

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

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

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

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

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

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

....

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

...

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

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

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

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

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

A Clue as to Why Goldman is So Good

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

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

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

Manski and Identification

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

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

Suburbs Separated at Birth?

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

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

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

Why we get in this business

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

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

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

Foreclosures

From this morning's WSJ:

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

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

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

Should Academics Blog?

A class post from Dan Drezner on this is here:

http://www.danieldrezner.com/archives/001936.html

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

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

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

Menzie Chen on the Credit Crunch

http://www.econbrowser.com/archives/2007/11/the_credit_crun.html

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

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

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

Edward Elgar is 150 this year

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

Should you be near Rockville, MD this Friday

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

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

Cuomo, WAMU and Fannie/Freddie (cont.)

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

Fudged Appraisals

From Calculated Risk: http://calculatedrisk.blogspot.com/2007/11/ny-ag-wamu-improperly-pressured.html

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

“Our expanding investigation into the mortgage industry has uncovered that Washington Mutual improperly pressured appraisers to provide inflated values that best served the lender’s interest. Knowing this, Fannie Mae and Freddie Mac cannot afford to continue buying Washington Mutual mortgages unless they are sure these loans are based on reliable and independent appraisals.”
Attorney General Cuomo, Nov, 7, 2007

And from the Appraisal Institute:

“I wish I could say I am shocked by the discoveries made by the Attorney General and his staff. Sadly, what allegedly happened between First American and Washington Mutual is not an isolated incident. Rather, it is symbolic of a problem that has plagued the appraisal industry for years. As the allegations against First American show, the mortgage industry’s dirty secret has been that banks exert tremendous pressure to extort appraisers.”
Terry Dunkin, President of the Appraisal Institute Nov 7, 2007.

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

Rhetoric and Success in Economics

This is a seriously cool paper by Hugo Mialon:

http://userwww.service.emory.edu/~hmialon/Poetry.pdf

The abstract:

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

Robert Shiller's recommendations on mortgage policy

From testimony he gave to Congress

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

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

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

The call for appraisal reform is long overdue, however.

The Presiden't Commission on Tax Reform and Housing

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

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

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

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

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

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

Statistics and the WSJ Op-ed page

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

http://online.wsj.com/article/SB119397079767680173.html?mod=opinion_main_commentaries

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

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

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

A paper on Homeowner's beliefs and how they affect behavior

This is by Sumit Agarwal in the most recent issue of Real Estate Economics.

Using a unique dataset of 81,943 house value estimates by the homeowners and their financial institution, I find that homeowners overestimate their house value by 3.1%. After controlling for homeowners’ socioeconomic characteristics, I find that ex-ante homeowners who rate (cash-out) refinance an existing loan to increase savings (consumption) are significantly more likely to underestimate (overestimate) their house value. Moreover, overestimators (underestimators) are more likely to increase (reduce) their spending ex post. Finally, I also find that underestimators are more likely to prepay their loans and overestimators are more likely to default on their loans.

Yet something else to worry about...

James Baughman has a new book

It is on the history of the infancy and adolescence of television. It gets a nice review here in the New Yorker:

http://www.newyorker.com/arts/critics/books/2007/04/30/070430crbo_books_lemann

Jim was a dear colleague of mine when I was at Wisconsin. His two earlier books, Republic of Mass Culture and Henry R. Luce and the Rise of the American News Media, are absolutely terrific--Jim is a wonderful scholar and a wonderful story teller. If you want to learn about "old" media, you should read his stuff.

I hope he writes a book about the blogosphere someday...

Housing and Leverage

As they try to sell houses in a poor market, some real estate brokers are advising that housing is a good investment because on a leveraged basis, its return is higher than the stock market. This is true, but it is also true that when levered, housing is more risky than the stock market.

If someone takes a long position in a Vanguard Blue-chip fund, the chance of losing his entire investment is remote. Of he buys a house with just ten percent down, however, and house prices fall ten percent, he loses his entire investment.

I would still not discourage someone from buying a house if they know they will live in the same place for more than five years. There is a cash-flow benefit to owning (the fact that you don't pay rent) and there is a real benefit to having control over one's living environment. But if I were to move right now, the chances would be pretty good that I would rent out the house I now own (I wouldn't want to give up my very low-interest rate mortgage) and then rent for awhile in the place I am going.

A stunningly bad Existing Home Sales Number

The September Existing Home Sales number came out yesterday, and it is off by roughly 20 percent from a year ago (it is a little less than that when seasonably adjusted, a little more when not seasonally adjusted). At the same time, inventories and the month's-supply measures continue to rise.

There is also a chance things will get worse. I was at a Homer Hoyt conference that I helped organize on subprime yesterday. Two participants, Dave Crowe and Marsha Courchane, made the point that of the subprime loans that have gone into default, 91 percent did so without a rate reset.

Mark Zandi and Steve Westley both presented data that showing subprime originations from the first quarter of '07 were performing even worse than the '06 book, although that could be because of changing housing market conditions, rather than deteriorating credit quality per se. In any event, it is possible we will see a lot more inventory dumped on the market through the REO process, which will further depress demand.

My colleague Vanessa Perry (as well as others) have an intriguing idea--simply let everyone with an ARM about to reset refinance into a reasonably priced (what this means is not clear) fixed rate mortgage. Among other things, this might separate out those who really want to stay homeowners from speculators (who will want to dump houses they were planning to flip anyway). But no matter what, it is hard to see where a housing recovery is going to happen over the next three years.

No one is better at defending himself than...

Paul Krugman. David Kennedy had a silly review of his book in the NYT. Krugman's pithy response,

http://krugman.blogs.nytimes.com/2007/10/20/continuing-the-tradition/

was perfect.

I am sometimes told I am a good writer...for an economist. That is kind of like saying I am a good basketball player...for a slow guy who can't jump with a lousy outside shot. Krugman is a terrific economist AND a terrific writer.

I remember reading in my second year of grad school his wonderfully innovative paper (with Helpman) on increasing returns and patterns of trade. It was elegant, easy to follow for anyone with a small grasp of calculus, and profound: it showed that country size by itself could explain part of why countries traded goods with others. It was a major step beyond the classic Ricardian model. That someone can do scholarship that well and write the best column in the New York times inspires admiration...and envy.

Cost-Benefit Analysis: What is the correct discount rate? Growth rate?

I was working on a paper with Chris Redfearn last week, and he raised one of the most interesting puzzles in economics: how to we think about environmental/infrastructure issues in the presence of discounting? With a real discount rate of, say, 3 percent, a dollar of benefit to our great-great-grandchildren, who might be born 100 years from now, is worth only 5 cents to us in present value terms, assuming that a benefit to our progeny is equal to a benefit to ourselves.

This creates all kinds of policy problems. The example Chris gave is that on an ex-ante basis, removing lead from gasoline did not pass the cost-benefit test. Yet I think almost all of us are grateful for unleaded gasoline. Similarly, I find myself puzzled every day when I ride the Washington Metro that the system does not pass the cost-benefit test. Washington is becoming an increasingly difficult place to live as it is; it would be hard to imagine what traffic would be like in the absence of Metro (where the cars are jammed to capacity during rush hours).

Maybe the problem is that we get potential growth wrong. If people's earning potential increases 2 percent per year, then maybe the way to do cost-benefit properly is to use a Gordon Growth setup with an r-g term: we discount net of growth. Such a change would increase the present value of the dollar to our great-great grandchild from 5 cents to 37 cents.

Forecasting the Housing Market

I was reading the NAR forecast this morning. They say that improvements in the mortgage market will cause a turnaround in the housing market. If I were them, I wouldn't say anything.

I do admire the REALTORs for putting out numbers every month that play it straight down the middle (full disclosure, I helped the group design their benchmarking system: see http://www.realtor.org/Research.nsf/files/FinalDocumentationForWebsite_reviewed.pdf/$FILE/FinalDocumentationForWebsite_reviewed.pdf)
Particularly useful is the pending sales index as well as the month's inventory supply measure.

Both of those numbers are not encouraging at the moment: pending sales continue to decline, and month's supply continues to increase. I understand why people whose business is selling homes do not want to hype these numbers, but for credibility sake, they should avoid making pronouncements that fly in the face of their numbers. REALTORs want to be thought of as professionals, and trusted advisors, rather than sales people. This means telling people about the reality of the market. In fact, if they could use market information to convince sellers that they need to lower their prices (admittedly, a difficult task), they could help the market reach bottom faster.

I am not saying that the market won't recover next year. As Bob Shiller pointed out in his Jackson Hole paper, prices in London began to dip a few years ago, only to start back up soon after. What I am saying is I don't know when the market will begin its recovery--and neither does anyone else.

Where is the Greatest Research University Agglomerationin the US?

One would think it is in Boston, and in a sense, one would be right: there is nothing comparable to having MIT and Harvard down the street from each other.

But if one looks at the top 50 research Universities as measured by The Center for Measuring University Research Performance at Arizona State, the leading metropolitan area for number of top research institutions is not Boston, nor is it Chicago, Philadelphia, or New York. It is LA, which has four in the top 50 (UCLA, USC, Cal Tech and UC-Irvine). If one stretches another 100 miles or so, UC-San Diego and UC-Santa Barbara get added to the mix.

Southern California rarely gets credit for being an intellectual mecca, but after spending a pleasant morning at UCLA and a pleasant afternoon at USC last week, I couldn't help but think that it is. Then again, Thomas Mann, Arnold Schoenberg and William Faulkner all managed to enjoy life in LA. Randy Newman might have been onto something...

Matthew Kahn has a blog

And it is good:

http://greeneconomics.blogspot.com/

Research University Rankings

Here is a nice compendium of fun facts about research Universities:

http://mup.asu.edu/research_data.html

One thing the surprised me is that in 2005, my old University, Wisconsin-Madison, raised half-a-billion dollars, placing it second among all universities in the US.

I am not surprised that people show the place a lot of love--it is a very wonderful place that I think has transformed many lives for the better. But I am curious as to how it happened to have such a great year.

This paper is a lot of fun

It ranks concert halls by acoustical quality. Concert halls are, after all, a type of real estate.

http://www.leoberanek.com/pages/eightyeighthalls.pdf.

I agree with the Boston ranking. But I think San Francisco (now) has a nice hall, and am surprised it does so badly. Three halls I like not mentioned here are the new Strathmore Hall in North Bethesda, Maryland (so shoot me, I'm a homer, but it really is good), Uihlein Hall in Milwaukee, and Orchestra Hall in Minneapolis. Perhaps I am especially fond of the last, because it was my first "real" concert hall. I was 15, I think, and I remember hearing Martha Argerich play the Chopin F-minor Piano concerto with the Minnesota Orchestra. It was amazing.

The Future of the GOP?

Data from the US Census. Population Projections.

Couldn't help but think about this while I watched the debate for a few minutes last night.

When leaving the Ukraine

Don't wear a sportscoat or a suit or anything that might make it appear that you have money. The following conversation more or less happened immeidately after passport control:

Guy in Border Guard Uniform: How much money do you have with you

Me: I don't know, maybe $400 and 200 Euros

Border Uniform: Let me see it

Me (opening wallet): here it is

Border Uniform: I want to count it

Me (handing over money): OK

Border Uniform (fans out money like cards, and then unfans): OK, here is is back. You can go.

Me (assuming I am $20-$40 lighter): thank you sir.

Lots of people are posting this

So I will join them:

http://www.etc.cmu.edu/global_news/?q=node/42

Pausch is magnificent. He is also about my age (he's six months younger). His children are considerably younger than mine; I can't imagine how much it would sadden me not to have been able to see my kids grow up.

The Argumentative Indian

About a year ago, my Senior Associate Dean recommended Sen's book to me; my wife bought it for me the other day. It is so far very good. I am particularly taken with this passage.

"The nature of [western descriptions of the Indian intellectual tradition] has tended to undermine an adequately pluralistic understand of Indian Intellectual traditions. While India has certainly inherited a vast religious literature, a large wealth of mystical poetry, grand speculation on transcendental issues,
and so on, there is also a huge--often pioneering--literature, stretching over two and a half millennia, on mathematics, logic, epistemology, astronomy, physiology, linguistics, phonetics, economics, political science and psychology, among other subjects concerned with the here and now.

Even on religious subjects, the only world religion that is firmly agnostic (Buddhism) is of Indian origin, and further the atheistic schools of Varvaka and Lokatay have generated extensive arguments that have been studied by Indian religious scholars. themselves...

...What is in dispute here is not the recognition of mysticism and religious initiatives in India, but the overlooking of all other intellectual activities that are also abundantly present. In fact, despite the grave sobriety of Indian religious preoccupations, it would not be erroneous to say that India is a country of fun and games..."

I have been privileged to visit many places in my life. I am gaining a better understanding about why India has been among my favorite.

Is the Ukraine the most efficient country in the World?

In one respect, it appears to be. The bid-ask spread for currencies is less than .5 percent. It is hard to imagine how the small cambios in this business make a profit. I don't think there are price controls either, because there are dozens (if not more) currency exchamge businesses within a 20 minute walk of my hotel.

Now if only the passport lines at the airport were faster...

Bethesda House Prices

Forgive the selfishness of reporting a price index for my neighborhood, but I was just looking at Zillow data.

The top line (light blue) is my zip code; the bottom line (dark blue) is the zillow estimate of my house.

The last year is likely all inside the zillow confidence interval, but it does suggest that prices, after declining, have firmed this year.

Silly things.

There are blogs that blame the National Association of Realtors for the run-up in house prices, saying that without their cheer leading of the housing market, prices never would have risen so much. I give people more credit than that--most people can guess that Realtors like houses as much as Steve Jobs likes ipods.

On the other hand, NAR is saying it's the media's fault that the housing market is so lousy now. The media have little to do with it--the housing market is bad because there is excess supply and because credit outside of the conforming prime loan market has gotten relatively expensive. Until inventories begin to fall, it won't matter what either the media or NAR say.

Not to be snarky, but...

Leslie Stahl, in introducing a section of her 60 minutes interview with Alan Greenspan, said, "Alan Greenspan will give his economic predictions for the future." Not his predictions for the present or past?

This is Disheartening

http://www.latimes.com/news/local/la-me-ucilaw13sep13,0,5893599.story?coll=la-home-center

I thought UC-Irvine was a school on the rise. I now know not to take it seriously until it gets a new Chancellor.

Greatest Conductor of the last 100 Years?

I love music, and especially symphonies. There are only a few things that thrill me as much as a great orchestra playing a great symphony (such as Beethoven 3, Schubert 9, Bruckner 7 or Mahler 6) really well.

I've been listening to a wonderful recording of Brahms 2 tonight. It features the London Symphony, with a conductor who is distinctly unglamorous, and who is not particularly famous in the US. But compared to him, Bernstein (who I really like, by the way) is too fussy; Karajan is too slick, Solti and Toscanini are too driven, Furtwangler is too sloppy, and Abbado is too slack.

Bernard Haintink has been making extraordinarily satisfying recordings for more than 40 years now, before with the Concertgebouw Orchestra of Amsterdam, and now with the London Symphony. His Brahms, Beethoven, Schubert, Mahler and Bruckner are all great. He did a wonderful Zauberflaute, too. Now if only he'd get around to Haydn, Berlioz and Sibelius, but I guess we have Colin Davis to take care of that.

The Democratic Party and Subprime

I am a Democrat. Some people who are close to me are not. They they are not has always been something of a mystery to me; as a railroad worker and an executive secretary, they would surely benefit from Democratic policies relative to Republican policies. But I think the sub-prime crisis has given me some insight into why they are Republicans.

This couple, while not affluent, have always been financially responsible. As such, it is not difficult for them to find credit at a cheap price. They would also never think to sign a piece of paper that represented their income to be something other than what it actually was.

Let me stipulate that among sub-prime borrowers, there are many who were harmed by unscrupulous lenders who engaged in deceptive practices. We know, for instance, that many sub-prime borrowers would have qualified for prime mortgages. That they did not receive such mortgages is a problem that need to be remedied. Policy should make it easy for them to refinance out of their subprime mortgages into something more favorable.

But there are also borrowers in the sub-prime market who speculated on the housing markets, and there are borrowers who misrepresented their income and assets. For many of those of have followed the rules, anything that might smack of of a bail-out of those who speculated or borrowed fraudulently will induce anger. My friends are such people, and they believe that the Democratic Party has long been in the vanguard of diverting resources away from them toward those who don't, in Bill Clinton's phrase, "play by the rules." As we seek to solve this problem, and to remedy that harm that was done to those who were victimized by truly bad actors, we Democrats need to remember those who have always played by the rules.

Best article title I have seen in some time

Repugnance as a Constraint on Markets, by Alvin Roth, Journal of Economic Perspectives, Summer 2007.

Tyler Cowen on Economics Education

"Teaching economics. Give students open-ended problems, no answer, want students to struggle, argue with their classmates, write them up on their own. But many don't, and are comforted when they just hear the answer in class. Hard to get students—and ourselves—to do the hard work necessary to learn. Generally, teaching that way is not popular. Painful to have to defend your own propositions in the face of being challenged. We don't understand very well how education works. Can you replace teachers with DVDs of the great lecturers? Probably wouldn't work, but why not? What makes education effective? Reading a blog may be as good a way to learn economics as reading a book. Hearing people chat, tell stories. Talking about each other's ideas is intrinsically valuable, valuable to be part of a small discoursing community. Emulates the dinner table. Anecdote: Alfred Marshall was teaching a class, and Pigou was only student. Pigou sits down, Marshall just reads his lecture notes."

A long interview with him is at:

http://www.econtalk.org/archives/2007/09/cowen_on_your_i.html

Housing and the Business Cycle

Ten years ago, I wrote this: Follow the Leader: How Changes in Residential and Non- residential Investment Predict Changes in GDP

RICHARD K. GREEN George Washington University REAL ESTATE ECONOMICS, Vol. 25 No. 5, Summer 1997

Abstract: This paper examines the effect of different kinds of investments on the business cycle. Specifically, it examines whether residential and non-residential investment Granger cause GDP, and whether GDP Granger causes each of these types of investments. The paper uses quarterly National Income and Products Data for the period 1959 to 1992. Under a wide variety of time-series specifications, residential investment causes, but is not caused by GDP, while non-residential investment does not cause, but is caused by GDP. Thus, housing leads and other types of investment lag the business cycle. The results also suggest that policies designed to funnel capital away from housing into plant and equipment could produce severe short-run dislocations. About a month ago, Ed Leamer wrote this: http://www.kc.frb.org/publicat/sympos/2007/PDF/2007.08.03.Leamer.pdf Where he showed that declines in the housing cycle are remarkably strong predictors of recessions. I have a ($1) bet with my boss, Susan Phillips, about whether we are heading into recession this year: I say yes and she says no. She was a Fed Governor, and so has insight that I don't begin to have. I would also prefer to lose the bet. By after last Friday's jobs numbers, I like my chances.

Joe Morello

Joe Morello never ceases to amaze me. Listen to how he keeps the 5/4 signature alive through is complicated solo.

Why Private Equity?

Last month, Hamid Moghadam, CEO of AMB, spoke to my Wharton West class. He was a remarkable speaker.

AMB is an industrial REIT that has a private subsidiary whose existence is a puzzle to me. The REIT and the subsidiary share profits until the subsidiary reaches a return target, after which the public company gets the lion's share of the profit. In other words, the public and private companies split the risk, but the public company has more upside potential. This makes no sense in a Modigliani-Miller world (or any reasonable world, for that matter).

The benefit of the private company in this context is that it is not priced every day. Managers of institutional portfolios like this, because they don't have to report losses until they are realized. With stocks, managers can be measured on a minute-to-minute basis. Chris Mayer at Columbia, who knows more about this stuff than I, confirms that this can be a motivator for how fund managers choose their investments.

How big is the Subprime mess?

Let's figure this out. Subprime and Alt-A Mortgage Debt outstanding is something like $1.5 trillion. Let's say 20 percent default (double the default rate during the great depression). That is $300 billion in bad loans. If the loss that is 70 percent (probably an overestimate), that leaves $210 billion to clean up.

The S&L Crisis cost around $150 billion in present value terms (see http://www.erisk.com/Learning/CaseStudies/USSavingsLoanCrisis.asp). But the economy in 1995, which was pretty much when the clean-up ended, was half the size in nominal terms as it is now. So in the context of its economy, the subprime crisis is smaller than the S&L crisis, which was one of a number of events that led to a relatively mild, short-lived recession.

But there is an important difference. This crisis appears to have done serious reputational harm to rating agencies, which is turn means that lenders have less confidence about their ability to get repaid. This is turn means that non-residential lending is being affected by the subprime crisis. How much these spillovers matter will determine how much the crisis matters to the macroeconomy.

Professor John Taylor of Stanford presented a graph at Jackson Hole that suggested that the spillover from the subprime market to US credit markets was large, but that credit markets in other countries have to this point been immune from contagion. Let's hope this continues abroad, and that the non-subprime debt market in the US returns to normal reasonably soon.

The paper I have with Wachter at the Jackson Hole Symposium

http://www.kc.frb.org/publicat/sympos/2007/PDF/2007.08.21.WachterandGreen.pdf

Still needs a little cleaning up, but it is basically what we will submit for the symposium issue.

The Theme that runs through the Bourne movies

Is it me, or does it sound an awful lot like the prelude to Die Walkure?

BTW, if you like action movies at all, The Bourne Ultimatum is about as good as it gets.

An Interesting Idea from Andrew Samwick and Dean Baker

http://www.projo.com/opinion/contributors/content/CT_baker31_08-31-07_8G6SA6I.1c1d9dc.html

Allow those who defaulted stay in their homes at fair market rent. Only houses at less than median value would qualify. This is an interesting idea. I'll need to think it through at greater length...

House Price Indices: Case-Shiller and OFHEO

Two house price indices came out this week--the Case-Shiller and the OFHEO. Case-Shiller is down, while OFHEO is flat (quarter-to-quarter). It is natural enough to wonder why.

The two indices have three principal differences:

OFHEO has only houses financed with conforming mortgages (those with balances of less than $417,000). CS uses all sales.

OFHEO includes appraised values for refinance loans. CS looks only at sales.

OFHEO includes houses that may have been substantially improved from one sale to the next. CS throws those houses out.


In short, CS is better. The only advantage OFHEO has is that it covers the whole country--CS only covers the 20 largest metropolitan areas.

You know you're travelling too much when

You actually look forward to getting the Lemon-pepper Tuna in the $5 United snack box.

I know people hate United, but I don't think they are any worse than any other US airline (save one), and if you fly them a lot, you get seats with more legroom. You also get to listen to Air Traffic Control, and they have the tasty tuna.

Lots of people seem to love Southwest--I am not sure why. But Jetblue is really great. They just don't go enough places yet.

Jim Hamilton writes from Jackson Hole about GSEs

One of the (many) great things about getting to participate in the Jackson Hole conference was getting to meet Jim Hamilton, along with his wife, Marjorie Flavin, both of whose work I have admired for some time.

Jim makes a connection between the GSEs and the current mortgage crisis.

http://www.econbrowser.com/cgi-bin/mt-tb.cgi/633

The problem is that we really need the GSEs to step in and help right now (I think Jim's comments suggests that he agrees with this), but we don't want to write a big fat check to Fannie and Freddie.

Perhaps the thing to do is embodied in a comment I wrote on a paper by the USC gang for a Brookings Volume:

"The United States has idiosyncratic institutions whose purpose is to provide capital to mortgage markets while not originating loans. Two of these institutions, Fannie Mae and Freddie Mac, are among the largest financial intermediaries in the world, with assets of about $800 billion each.[i] Each company guarantees well over $1 trillion of off-balance-sheet mortgages.[ii]

Beyond being large, both of these companies are highly profitable, with typical book returns on equity of 25 percent.[iii] Critics of the firms argue that, on a risk-adjusted basis, they are too profitable.[iv] Specifically, they argue that shareholders whose debts are implicitly guaranteed by the U.S. government should not earn such large returns.

The size and profitability of the companies are likely the reason that they are required to meet affordable housing goals. The original charters of the companies were silent on the issue of affordability. Rather, they emphasized stability, liquidity, and ubiquity.[v] It was not until 1992, with passage of the Federal Housing Enterprises Financial Safety and Soundness Act, that Fannie Mae and Freddie Mac faced a regulatory requirement to target mortgage funding to “low- and moderate-income” borrowers, to “underserved” census tracts, and to “very low-income” borrowers or low-income borrowers in “low-income” areas. It is not a stretch to think that Congress felt that, in light of the companies’ special status and profitability, they had a special obligation to help those at the margins of the housing market. These targets became known as the “affordable housing goals.”

The paper by An, Bostic, Deng, and Gabriel asks a very simple question: Did the regulatory requirements put in place in 1992 work...

...[An, Bostic, Deng, and Gabriel’s] results taken as a whole imply that the affordable housing goals have accomplished little in terms of directing mortgage capital to the “underserved.” One could look at the goals as a classic outcome predicted by the public choice literature, which argues that government attempts to cure distortions that it created itself with other distortions.[i] In this particular case, regulators are trying to “cure” a distortion that arises from the existence of Fannie Mae and Freddie Mac: an unnaturally high return on equity to the shareholders of these two companies. This distortion arises from the perceived backing that the two companies receive from the federal government.[ii]

The purpose of the goals is to tax the companies and send shareholder benefits to underserved borrowers and neighborhoods. Structured as they are, however, the goals may simply shift profits from Fannie and Freddie shareholders to mortgage originators. An unusually explicit example of this happened in 2003, when Freddie Mac paid Washington Mutual $6 billion to “borrow” mortgages for goal-counting purposes.[iii] This transaction did nothing to add liquidity to the mortgage market anywhere and yet was a perfectly rational reaction by both parties to the goals.

The problem with the goals is that they do not tackle the distortion created by the existence of Fannie Mae and Freddie Mac in a head-on manner. The companies earn large profits because they are allowed to borrow at low risk-adjusted interest rates. Moody’s, for example, notes that it gives Freddie Mac an Aaa rating in part because of “dependence between Freddie Mac and the U.S. government.”[iv] In fact, Moody’s states that the default risk of Freddie Mac’s portfolio is at the level of an Aa1-rated financial institution. This is an excellent credit rating and reflects well on the management of the company, but it is still lower than Aaa: the company thus borrows at a lower rate than its credit characteristics warrant.

Congress could tackle this problem directly in one of two ways. It could raise the capital requirements for both companies, or it could follow the suggestion of Glaeser and Jaffee or Jaffee and Quigley and tax Fannie Mae’s and Freddie Mac’s issuance of new debt.[v] The second solution is particularly appealing, because it preserves the ability of Fannie and Freddie to guarantee mortgages—something that has been good for mortgage consumers in the United States—while reducing, if not completely eliminating, the ability of the companies to arbitrage their favorable borrowing position. The money raised via a debt tax could, in turn, be funneled into the Section 8 rental voucher program and, as such, could directly assist those facing the greatest housing needs.

To make this concrete, consider the impact of a 20-basis-point fee on the issuance of new debt. If the companies have at any one time $1.5 trillion in debt outstanding and turn debt over every three years, such a fee would produce $1 billion in revenue each year. This would allow for a $2,000 housing subsidy for 500,000 low-income renter families. Compared to what is currently in place, this is surely a more effective and efficient policy.


[i]. Neither Fannie Mae nor Freddie Mac has issued current financial statements. According to their most recent restated financial statements, each of the companies has more than $800 billion in assets on its balance sheet. For Freddie Mac’s consolidated financial statement for 2006, see freddiemac.com/investors/ar/ [March 2007]. For Fannie Mae’s 2003 consolidated financial statement, see www.fanniemae.com/ir/annualreport/index.jhtml?s=Annual+Reports+%26+Proxy+Statements [March 2007]. [ii]. For Freddie Mac, see freddiemac.com/investors/volsum/pdf/0107mvs.pdf [March 2008]. For Fannie Mae, see www.fanniemae.com/ir/pdf/monthly/2007/013107.pdf [March 2007].[iii]. The current five-year average return on equity is 24.1 percent for Freddie Mac and 28.9 percent for Fannie Mae. For Freddie Mac, see finapps.forbes.com/finapps/jsp/finance/compinfo/Ratios.jsp?tkr=FRE [March 2007]. For Fannie Mae, see finapps.forbes.com/finapps/jsp/finance/compinfo/Ratios.jsp?tkr=FNM [March 2007].[iv]. See, for example, Frame and White (2005).[v]. For the text of Freddie Mac’s original 1970 charter, see www.freddiemac.com/governance/pdf/charter.pdf [March 2007]. For the text of Fannie Mae’s original charter, see www.fanniemae.com/global/pdf/aboutfm/understanding/charter.pdf [March 2007].


[i]. See Tullock (1965) for the classic argument.
[ii]. I have argued that, on balance, this backing has been a good thing, because it creates liquidity in the market for conventional conforming mortgages. See Green (2005).
[iii]. See Berenson (2004a).
[iv]. Moody’s Investor Services (2006).
[v]. Glaeser and Jaffee (2006) and the paper by Jaffe and Quigley in this volume.

Off to Jackson Hole on Thursday

I am going to this year's Kansas City Fed symposium, where I am giving a paper with Susan Wachter called the Housing Finance Revolution. I have pretty much wanted to do something like this since I was a kid (I know, I'm a strange kid).

Preliminary Syllabus for Finance 397

Finance 397

Applied Microeconomic for Business

Professor Richard K. Green

Office: 507 Funger

drgreen@gwu.edu

Keynesian.richard@gmail.com

202-994-2377

202-994-9141

301-467-3582

Office Hours: 1-3 Tuesday or by Appointment

This is a course in the application of microeconomic theory to academic business disciplines. As such, it is not a traditional graduate microeconomics course, such as Economics 301. All business disciplines—even management and marketing—contain some economic theory in their literatures. For example, papers in marketing are often applications of industrial organization theory, and papers in management often deal with principal-agency and asymmetric information issues.

The class will contain four requirements: two exams (25 percent each), an 8-10 page critical review paper (30 percent), and a 15 minute presentation, such as one would give at an academic meeting (20 percent).

Texts: (*)-ed readings are required.

1. Introduction to Economic Analysis, by R. Preston McAfee, (an open source principles text downloadable from http://www.introecon.com/). (*)

2. Game Theory for Applied Economists, by Robert Gibbons, Princeton University Press (1992, paperback). ISBN 0-691-00395-5. (*)

3. Identification Problems in the Social Sciences, by Charles F. Manski, Harvard University Press, (1995, paperback). ISBN 0-674-44284-9.(*)

4. Iowa State Economics 500 and 501 Lecture Notes. http://www.econ.iastate.edu/classes/econ501/Hallam(*)

Week 1: Introduction to Optimization and the Robinson Crusoe Economy

http://www.econ.iastate.edu/classes/econ500/hallam/documents/Opt_Simple_Multi_000.pdf

http://www.econ.iastate.edu/classes/econ500/hallam/documents/opt_con_gen_000.pdf

http://www.econ.ucla.edu/doepke/teaching/resources/e102ch1.pdf

Week 2: Optimization and Theory of the Firm

McAfee Chapter 4 and 6

Griliches, Zvi and Jacques Mairesse (1995) Production Functions: The Search for

Identication, NBER Working Paper No.w5067.

Week 3: Industrial Organization I

http://www.econ.iastate.edu/classes/econ501/Hallam/documents/Competition_000.pdf

Borenstein, Severin, Hubs and High Fares: Dominance and Market Power in

the U.S. Airline Industry, Rand Journal of Economics, 2(3) (1989), 344-365.

Week 4: Theory of the Consumer

McAfee Chapter 5

http://www.econ.iastate.edu/classes/econ501/Hallam/documents/FunctionalForms.pdf

Laurits R. Christensen; Dale W. Jorgenson; Lawrence J. Lau, Transcendental Logarithmic Utility Functions, The American Economic Review, Vol. 65, No. 3. (Jun., 1975), pp. 367-383

Week 5 Industrial Organization II

http://www.econ.iastate.edu/classes/econ501/Hallam/documents/Oligopoply.pdf

.

Zettelmeyer, Florian, Fiona Scott Morton, and Jorge Silva-Risso (2005) Cowboys

or Cowards: Why are Internet Car Prices Lower?

Akerloff, GA The Market for "Lemons": Quality Uncertainty and the Market Mechanism

The Quarterly Journal of Economics, Vol. 84, No. 3. (Aug., 1970), pp. 488-500

Week 6 Topics in Game Theory I

Gibbons Chapter 1

McAfee Chapter 7

Week 7 Exam I

Week 8 Topics in Game Theory II

Gibbons Chapter 2

Shapley, L. S. and M. Shubik (1972) The Assignment Game I: The Core, Interna-

tional Journal of Game Theory, 1: 111-130.

Week 9 Adverse Selection

Gibbons Chapters 3 and 4.

Week 10 Moral Hazard

Stoughton, Neal, Moral Hazard and the Portfolio Management Problem, The Journal of Finance, Vol. 48, No. 5. (Dec., 1993), pp. 2009-2028

Week 11 Identification I

Manski 1,2

James J. Heckman (2000) Causal Parameters and Policy Analysis In Economics:

A Twentieth Century Retrospective, The Quarterly Journal of Economics, 115(1),

45-97.

Week 12 Identification II

Manski 3-7

Week 13 Student Presentations of Applied Microeconomic Papers (choose from list)

Week 14 Exam II

Papers to choose from for presentation

Avery, Christopher, Mark Glickman, Caroline Hoxby and Andrew Metrick, A Revealed Preference Ranking of US Colleges and Universities, Working Paper.

Borenstein, Severin and Andrea Shepard (1996) Dynamic Pricing in Retail Gasoline

Markets, Rand Journal of Economics, 27(Autumn): 429-51.

Donohue, J.J. and Steven Levitt, The Impact of Legalized Abortion on Crime." Quarterly Journal of Economics, 2001, 116(2), pp. 379-420.

Gandal, Neil, M. Kende and Rafael Rob (2000) The Dynamics of Technological

Adoption in Hardware/Software Systems: The Case of Compact Disk Players, Rand

Journal of Economics, 31(1): 43-61.

Graddy, K. (1995) Testing for Imperfect Competition at the Fulton Fish Market,

Rand Journal of Economics, 26 (Spring): 75-92.

Green RK and MJ White, Measuring the Benefits of Homeowning: Effects on Children, Journal of Urban Economics,

Krugman, Paul, Scale Economies, Product Differentiation, and the Pattern of Trade

The American Economic Review, Vol. 70, No. 5. (Dec., 1980), pp. 950-959.

Mankiw, G and D Weil, The Baby Boom, the Baby Bust and the Housing Market, Regional Science and Urban Economics

If you want to be scared about subprime...

Read this:

http://bigpicture.typepad.com/comments/2007/08/cdo-insiders-we.html

The story I heard from a bond trader is that the Chinese were willing to buy paper at very low spreads just to keep the RMB from appreciating. I have no idea whether this is really true, but it makes for a good story.

Subprime--I was probably wrong

I long have taken a caveat emptor view about mortgage lending. I assumed borrowers understood that loan brokers where in sales, and they would therefore try to get as much money out of borrowers as possible. Just as one should be wary with a car salesman, so too should he be wary of a mortgage saleman.

The problem is that borrowers did not understand what the sales people where selling them. Loans are complicated--even the "sticker price," the APR, doesn't really tell the story. And so borrowers, particularly those without any financial training, are at a disticnt disadvantage when dealing with lenders.

I am not sure what to do about this. I have long thought that the sub-prime market could give borrowers access to cheaper credit than they would get elsewhere; nevertheless, the market also led people to make what were clearly bad decisions. I am not sure how reasonable it was to expect borrowers to understand how bad their decisions would turn out to be.

And so we must figure out a mechanism for helping borrowers navigate the mortgage waters better. I am not sure what that is. One possibility: tie loan broker compensation not just to loan origination, but loan performance. They don't get fully paid until the loan is fully paid. This would reduce the incentive for them to make loans that will turn into defaults.

Teaching and Research Again

I just read the introduction to Richard Feynman's Six Not So Easy Pieces. In it is a wonderful exposition of how great research can lead to great teaching.

Dhaka's getting worse

Students are protesting continuing military rule in Bangladesh. The military took power last January, allegedly in order to prepare the country for unrigged elections. Alas, this has not happened. http://news.bbc.co.uk/2/hi/south_asia/6958206.stm

When I visited Dhaka in 2004, it was a place of unspeakable poverty, and according to Transparency International, had among the world's worst corruption. But so far as I could tell, people could move, speak and organize reasonably freely. The press was certainly vigorous and regularly criticized the government. It was hardly a paragon of human rights. To me, human rights include the right to have enough to eat and the right of all children to go to school. But among all the world's poor countries, its human rights record was not too bad.

Still, I left Dhaka thinking that life would get better there. It has actually shown itself capable of competing in the textile business in the absence of the multifibre agreement. The people there were also remarkably gracious. I thought there was a chance for corruption to be reduced, and for the middle-class to grow. I hope that I will someday be proved correct, but today I don't have a lot of hope.

How does the NFL get away with charging for the Preseason?

I've spent the past three days writing, and needed to zone out, so I turned on the Colts-Bears pre-season game. It absolutely stunk, and after the first quarter most of the starters were gone.

As it happens, a student of mine, Jason Berkowitz, did some regressions of how well the preseason predicted the real season. The answer is that it doesn't--a team's winning percentage in the preseason has almost no predictive power of regular season fortunes.

So the question is--why do fans pay full ticket prices to see these fake games? It is not like spring training in baseball, when going to games in in part an excuse to get away from the cold north. I know this is not the most important issue facing the NFL today, but after watching that game, I just had to wonder....

Sub-prime returns.

I just did a little experiment on a 2-28 with the following assumptions:

Five year life (stiff prepayment penalties before year five), after which everyone who survives refinances.

Coupon rate starts at 6 for two years, goes to 9 for a year and then 12 for two years.

10 percent default rate over five years with 70 percent loss severity.

Mortgage is tranched into two pieces. Piece A gets the first 80 percent of the equity and a six percent coupon; Piece B gets all the rest.

The IRR on this set up fro the B-piece comes in around 9 percent. Not great, given the risk, but not bad either. It should be enough to pay any leverage taken on to buy it. So...where am I going wrong? I will be happy to share the spreadsheet with anyone who can help me out.

The Jumbo Market and House Prices

Spreads on Jumbo mortgages rose about 50 basis points in the past week. This is likely a market over-reaction: 80 percent LTV loans to borrowers with high FICO scores remain low risk mortgages.

But the impact on prices could be serious. Consider what happens when the cost of capital increases quickly by 50 basis points, from 6.5 to 7 percent. The cost of capital has gone up 7.7 percent. But lets say that expectations are for 2 percent house value growth. Then the cap rate for houses goes from 4.5 percent to 5 percent--an 11.1 percent increase. This translates into a ten percent decline in house prices (CF/5)/(CF/4.5) =4.5/5 = .9.

But this phenomenon could change expectations about futue house price expectations. As expectations worsen, the cap rate will rise further, and house prices will fall further. The next few months might be pretty ugly for the coasts.

Can Las Vegas Keep Building Apartments?

Metropolitan Las Vegas has about .6 percent of the US population. Last year, about 2.9 percent of units in buildings with more than five units built in the US were built in Las Vegas. The pace has slowed considerably this year, but it suggests an interesting question: how much growth does Las Vegas have left in it?

The answer is: a lot. The basic industry is, of course, accomodation. Las Vegas has around 140,000 hotel rooms (http://cber.unlv.edu/stats.html) with an cccupany rate in excess of 90 percent. Hotels are profitable at occupancy rates of around 65 percent, meaning that Las Vegas could support something like 50,000 more hotel rooms with no increase in demand.

Let's cut that to 25,000 rooms to be conservative. There are roughly two jobs in the hotel business for every room in Las Vegas, meaning that 25,000 rooms will directly create about 50,000 jobs.

Economic base analysis (http://faculty.washington.edu/krumme/350/econbase.html) for Las Vegas predicts that every basic job produces an additional 2.5 non-basic jobs. So the Las Vegas market has room for another 175,000 jobs over the near-to-medium term (say 5 years).

The ratio of jobs to population in Las Vegas is .47; let's round and say population growth produced by hotel room growth will be 350,000. The average Household Size is a little more than 2.5 (census) and about 35 percent of households live in multifamily buildings (again, census). Put this all together, and there will be demand for about 50,000 multi-family units over the medium term--again assuming no growth in demand for hotel rooms. Vacancy rates for apartments in Las Vegas is a little less than 7 percent--this is close to a natural vacancy rate, meaning that the market is currently in equilibrium. The fact that inflation adjusted rents have risen by a bit more than inflation in the past year also indicates that the apartment market is not oversupplied. Assuming hotel developers respond to demand, there should be strong demand for apartments for some years to come.

There are issues, of course, not the least of which is water (although if people would stop watering their lawns, there would be plenty of water for awhile). But it is remarkable how much Las Vegas' strong population growth (and therefore demand for housing construction) is grounded in fundamentals.

A nice mortgage blog by Rhonda Porter

This is worth a look:

http://www.mortgageporter.com/

Are the Average SATs for your school really that high?

Have you ever wondered how so many Universities can have such intimidatingly high SAT scores? Well, perhaps they can't. I was reading one of the many brochures colleges are sending to my kids nowadays, and I noticed that the SAT range it presented was for those who were admitted, not for those that matriculated. So I looked at another. And another. And what I found was that in their literature, almost all schools report SATs of admitted students.

Self-sorting on the part of students should mean that in general, average scores for matriculants will be lower than average scores for admits.

If you really want to know how students who enter a university performed on the SAT, look to see whether it publishes a "Common Data Set" (here is University of Nebraska-Lincoln: http://irp.unl.edu/pdfs/CDS2006-07.pdf). It reports only scores of entering degree candidates.

Understanding the Mortgage Interest Deduction

Homeowners get a tax advantage relative to rents. But those with mortgage are not at an advantage relative to those who finance with equity. From an article I wrote for the Encyclopedia of Tax Policy (Cordes and Gravelle, eds.):

In the popular press, the mortgage interest deduction
is often characterized as being the principal tax
benefit accruing to homeowners. This is certainly
not correct. First, fewer than 50 percent of homeowners
itemize on their tax returns; the remainder
use the standard deduction. This is because the value
of itemized deductions for low- to moderate-income
homeowners in states with low marginal tax rates
will almost certainly be less than the value of the
standard deduction, which in 2003 was $9,500 for
married couples filing jointly. Also, according to tabulations from
the Survey of Consumer Finances, many households
with elderly heads own their homes entirely with
equity (i.e., do not have mortgages), and for these
households, the mortgage interest deduction has no
value.

Second, even for those who do itemize, the
mortgage interest deduction does not necessarily
produce the largest tax benefit arising from owning.
The imputed rent that households earn from their
owner-occupied housing (i.e., the rents that households
are not required to pay anyone else because
they own) goes untaxed. This rent is therefore
favored relative to most other types of income,
including ordinary income, taxable bond income,
dividend income, and capital gains income, which,
while favored and deferrable, is still generally taxed.
The average loan-to-value ratio in the United States
is less than 50 percent. Thus, even if all owners with
mortgages itemized on their tax returns, the value of
the nontaxation of imputed rent would be larger than
that of the mortgage interest deduction.

Effect of the benefit on choice of financing

One could argue that the effect of the mortgage interest
deduction is to put debt on a level playing
field with equity as a way to finance housing. This
contrasts with the tax treatment of corporate income,
where interest is deductible and the opportunity cost
of equity capital is not. Many analysts have shown
that the U.S. tax system encourages corporations to
take on debt. Capozza et al. (1996) have shown
how the combination of nontaxation of imputed rent
and the absence of a mortgage interest deduction
would discourage households from financing housing
with debt. In Australia, imputed rent is not taxed
and mortgage interest is not deductible, and households
there generally pay off their mortgages more quickly than in the United States.

Fixed rate mortgages vs ARMS

Floyd Norris's NYT column today is good:

http://select.nytimes.com/2007/07/27/business/27norris.html

I have long held a view that hosueholds should look at themselves as financial intermediaries, and match the duration of assets and liabilities. Houses are an asset of long duration, and as such, have values that are sensitive to changes in interest rates. Thus people who plan on living in a house for a long time should match it with a liability that has long duration--a long-term fixed rate mortgage.

If people know they will be in a house for five years, a hybrid 5 year ARM is fine. But it all cases, households should make sure they can afford a house based on a long-term mortgage before they buy. If the only thing that gets them into the house is a variable rate interest only loan, they are looking for trouble (FWIW, these thoughts occured to me at the time Chairman Greenspan was recommending ARMs to people in 2004).

Means and medians

The popular press seems to have a hard time understanding when a median (the 50th percentile) is better, and when to use a mean (the sum of everything in a population divided by the size of the population) is better. Both are measures of central tendency.

If one worries about large mistakes exponentially more than small mistakes, means are better. To give one example, if one is underwriting an 80 percent loan-to-value ratio loan, a small mistake in valuation matters little, but a big mistake matters a lot. Predicting house values based on a mean (likely a conditional mean, i.e., a mean based on knowlege about the characteristics of this house) thus makes more sense for underwriting than predicting house values based on a median. But if one just wants to know what someone in the middle of the homebuying pack would pay, the median is far better.

Median income is a much better reflection of middle class living standards than mean income. Reporters seem to have a hard time understanding this. But then so do some business school professors I know...

Trigger events

During past mortgage default spikes, having an "in-the-money" default option (that is, having a house that was worth less than the mortgage balance) was not always sufficient to bring about default. Usually, households that defaulted had also faced a "trigger event:" a job loss, a divorce, or a serious health issue. The high default rates in Michigan and Ohio in the late 1970s and in Texas in the mid-1980s were a function of both falling house prices and high unemployment.

The open question is whether people have become more ruthless about default. We'll know for sure after the next few years...

Brad Delong channels Jared Bernstein who channels Timothy Egan

http://delong.typepad.com/sdj/2007/07/the-minimum-wag.html

I was eating at the bar of a restaurant in San Francisco a few weeks ago. The bartender, a Russian, had moved from New York to SF. I asked her why she moved (and figured she would say something about weather). She said it was because the minimum wage in California was higher. I wondered then and there whether this anecdote revealed anything about the larger economy. Perhaps it does.

What is it with these people?

I happened upon a poll on CNN last night. 79 percent of say they are Americans are OK with a woman president, 86 percent (I think) say they are OK with a black president. This means that somewhere between 21 and 35 percent of Americans think race or sex is a disqualification for President. Who are these people????

The Excellent Ken Small on Transportation Policy

This is really good:



I think his points about more heterogeneous urban highways (not all arterials need to be freeways; not every highway needs to be designed to carry trucks) are particularly good.

Research and Teaching

A smart colleague of mine, James Bailey, argues that teaching excellence and research excellence are uncorrelated. Specifically, he cites work that shows that research productivity is not a good predictor of teaching evaluations or peer review. That doesn't particularly surprise me. But I do think there is both reason behind and evidence for the idea that a research environment produces a richer intellectual environment for students.

For starters, those who do research are being kept honest on a regular basis. When one sends a paper off to be refereed or presents a paper at a conference, he is exposing himself to the possibility of getting beaten up intellectually. But if one's ideas can survive scrutiny, and have foundation in evidence (there I am, going all positivist on you), then one is probably reasonably well qualified to teach.

Second, research almost forces one to keep current. I am not saying that everyone needs to print a refereed paper every year--but one every five years is not unreasonable, and would help people stay current (BTW, my mother was an English professor at a "comprehensive" teaching university, and she still managed to crank out an article every now and then. She wasn't particularly rewarded for doing so, it was just important to her.)

Third, I don't think it is an accident that the greatest University in England was home to Newton and Keynes, among others; nor is it an accident that MIT, Stanford, Berkeley, Chicago, etc. attract the best motivated and brightest students from all over the world.

So I am curious about what the (likely small number of) people who look at this blog think. Do (did) they get a better classroom experience from faculty who produce research. Or at least from those that produce well-known research?

It's the ARMS, stupid

Aleablog cites the Fed:

http://www.aleablog.com/?p=329

Prime mortgages are doing fine; fixed-rate subprime mortgages are doing fine. ARMS with rate resets are not. Many 2/28 and 3/27 ARMs, that started with low teaser rates, have prepayment penalties, meaning borrowers can't get themselves out of trouble by refinancing into a FRM. Prepayment penalities are, in principle, fine--they allow borrowers to get mortgages with lower coupon rates. But in current practice, they may be a leading source of a lot of problems in the next few years...

The Great Divide

I liked this piece in Slate:

http://www.slate.com/id/2170561/nav/tap3/

I was struck by the divide while in San Francisco last weekend (I was there teaching in the Wharton Executive MBA program). One the one hand I talked to a waitress who had moved to California because of its (relatively) high minimum wage and a bartender who was extolling the virtues of an employer who paid $15 per hour before tips. On the other hand, I was at a party where a woman was saying how her mother would find it hard to get by on a nest-egg of $3-4 million. If I were more creative, I could weave these vignettes into a novel about contemporary America.

Cap Rates and the Ten-year Treasury Rate

The current 10 years treasury rate is 5.1 percent; Cap Rates on San Francisco office buildings are running around 5.5 percent.

On the one hand, rents rise, meaning that the expected IRR on a San Francisco office building is higher than 5.5; on the other hand, buildings depreciate and need to be recapitalized, meaning that net stablized net cash flow growth will be less than market rent growth. While office rents in San Francisco rose smartly last year, they had been stagnant for serveral years before, and office buildings always have the potential for substantial vacancy. So would I buy an office building at a 40 basis point spread over Treasuries? I don't think so...

The Savior of Capitalisim, or its End?

Marx argued for the tendency of the rate of profit to fall:

The progressive tendency of the general rate of profit to fall is, therefore, just an expression peculiar to the capitalist mode of production of the progressive development of the social productivity of labour. This does not mean to say that the rate of profit may not fall temporarily for other reasons. But proceeding from the nature of the capitalist mode of production, it is thereby proved logical necessity that in its development the general average rate of surplus-value must express itself in a falling general rate of profit. Since the mass of the employed living labour is continually on the decline as compared to the mass of materialised labour set in motion by it, i.e., to the productively consumed means of production, it follows that the portion of living labour, unpaid and congealed in surplus-value, must also be continually on the decrease compared to the amount of value represented by the invested total capital. Since the ratio of the mass of surplus-value to the value of the invested total capital forms the rate of profit, this rate must constantly fall. - Karl Marx, Capital Volume 3, chapter 13.

At the Wynn Hotel in Macao, the rooms have a copy Wynn magazine, which gives evidence that Marx was wrong about profits. Exhibit A was an advertisement for a pair of $700 Puma sneakers.

I will confess to liking nice things. I am, for examble, the rare Ph.D. economist who likes neckties, and I own way too many of them (my only defence is that I only buy them when they are on sale, but even so). But there are things that are just grotesque in their conspicuousness. It is hard to believe such things are good for social stability.

When agglomeration makes things worse

I have just returned from the Asian Real Estate Society conference in Macao. The conference was very good, as was the food. The small, historic center of Macao, is very beautiful.

But Macao is largely about gambling--the claim is that it has higher gambling revenue than Las Vegas. There are already lots of glitzy casino-hotels. The conference venue was at one of them--the Wynn. Given the construction cost of the place and the posted room rates, it must be the case that it makes its money on the casino.

I have a (small) libertarian streak in me; that streak tells me it is none of my business is people want to blow their money on gambling. I myself go to Santa Anita every other year or so and bet as much as $18 on horse races. But there is a well established literature (http://scholar.google.com/scholar?hl=en&lr=&q=addictive+gambling) that there are gambling addicts--and it is here that there is an agglomeration problem.

Around the casinos of Macao, one finds large numbers of two kinds of retail outlets: pawn shops, and ATM machines. This makes complete business sense--if people need to feed the gambling beast, places that provide money should cluster near casinos. The problem is that it is like putting free booze into the hands of an alcoholic. Even worse is the fact that some casinos have ATM machines on the premises.

I have no illusions about the possibility of eliminating problem gambling, but it might be worthwhile to make it a little less easy to do. Limiting the number of ATM machines and banning pawn shops within a certain radius of a casino might be a start.

Brad Delong on Academic Blogging

The hope of all of us who blog is that we will become smarter, do more useful work, be happier and more productive, and will also impress our deans so they will raise our salaries. The first three hopes are clearly true: Academics who blog think more profound thoughts, have a bigger influence on the world — both the academic and the broader worlds — and are happier for it. Are we more productive in an academic sense? Maybe. We will see when things settle down.
Are our deans impressed? Not so far, but they should be. A lot of a university's long-run success depends on attracting good undergraduates. Undergraduates and their parents are profoundly influenced by the public face of the university. And these days, a thoughtful, intelligent, well-informed Web logger like Juan Cole or Dan Drezner is an important part of a university's public face. Michigan gains in reputation and mindshare from having a Cole on its faculty. Yale loses from not having an equivalent.
A great university has faculty members who do a great many things — teaching undergraduates, teaching graduate students, the many things that are "research," public education, public service, and the turbocharging of the public sphere of information and debate that is a principal reason that governments finance and donors give to universities. Web logs may well be becoming an important part of that last university mission.

You know you're a mortgage geek when...

You are taking a walk with your wife on a beautiful Sunday morning:

You: deep sigh

Wife: what's the matter?

You: just thinking about the subprime market

Wife: geez--from that sigh I thought something was wrong with one of the girls...

A really awful SCOTUS decision

The decision overturning the Seattle and Louisville desegregation plans, plans that used race as a tiebreaker after many other considerations for school assignments, reflected a naiveté about the state of residential segregation in the United States that is appalling.

In Seattle, nearly 60 percent of black households would need to move for the community to be integrated; in Louisville, the percentage is nearly 70 percent. (see http://www.censusscope.org/us/m4520/chart_dissimilarity.html for details, which come from the fine work of Frey and Myers).

Moreover, the best evidence we have is that these patterns of segregation arise from continuing discrimination in the housing market (John Yinger, Marge Turner and Reynolds Farley do the heavy lifting on demonstrating continuing discrimination). Given that SCOTUS has ruled out the ability of school districts to remedy the fact that housing discrimination leads to school segregation, the only way to move forward is to enforce fair housing laws far more rigorously--sending rental agents and Realtors who discriminate to jail for a Paris Hilton type sentence might not be the worst way to start. Not that I expect to see this anytime soon...

At least when people of my generation and older are dead and gone, things should get better. A Pew poll on attitudes toward race shows that Gen Xers are far more enlightened than the rest of us--91 percent think inter-racial dating is OK, while only 77 percent of my generation (boomers) think so (who are those other 23 percent?) . Those older than I are are even less likely to think it is OK.