(Vertical) transportation and urban form:

Nick Paumgarten in the New Yorker:

In New York City, home to fifty-eight thousand elevators, there are eleven billion elevator trips a year—thirty million every day—and yet hardly more than two dozen passengers get banged up enough to seek medical attention. The Otis Elevator Company, the world’s oldest and biggest elevator manufacturer, claims that its products carry the equivalent of the world’s population every five days. As the world urbanizes—every year, in developing countries, sixty million people move into cities—the numbers will go up, and up and down.

Two things make tall buildings possible: the steel frame and the safety elevator. The elevator, underrated and overlooked, is to the city what paper is to reading and gunpowder is to war. Without the elevator, there would be no verticality, no density, and, without these, none of the urban advantages of energy efficiency, economic productivity, and cultural ferment. The population of the earth would ooze out over its surface, like an oil slick, and we would spend even more time stuck in traffic or on trains, traversing a vast carapace of concrete. And the elevator is energy-efficient—the counterweight does a great deal of the work, and the new systems these days regenerate electricity. The elevator is a hybrid, by design.

Admissions Advice

This week I read Susan Coll's Admissions, which reminded me of my time as MBA Dean at GW. We had an excellent admissions staff with fine judgment, but they would sometimes ask my opinion about close calls. I remember one mediocre candidate who began his essay with something along the lines of "when people work for me." He then proceeded to describe what everyone would do for him--nothing about what he would do for them. He basically showed himself to be the sort of person with whom no one would wish to work.

So my advice to those writing admission essays: don't be a putz.

The New York Times is (some days) a National Treasure

Barry Bearek's story of his imprisonment for trying to cover the elections in Zimbabwe is both harrowing and informative. The final two paragraphs:

I had left the cells with a case of scabies, an infestation of microscopic mites that swelled my hands and wrists to nearly twice their size. But I am better now, back in Johannesburg, with Celia, with our sons, Max, 17, and Sam, 12.

In the meantime, Zimbabwe is beset with paroxysms of violence. Thuggery, torture and murder are familiar implements in Robert Mugabe’s tool kit. Political opponents are being brutalized, as are everyday people whose voting defied him. The presidential election results are still unannounced.

A blogger whom I esteem often entitles his posts "New York Times Death Spiral," and then gives examples of the paper's shortcomings. But all journalism is compromised by tight deadlines; journalists also need to play a repeated game with sources, which means they cannot be heroic and write whatever they are thinking every day.

To me, the Times balances the need for timeliness and access against its moral obligation to be courageous as well as any newspaper. It gets the balance wrong from time-to-time. But I remain grateful for its existence.

A Pox on All Three (but the biggest, grossest on McCain)

All three candidates are pandering about gasoline prices. McCain is the worst, having called for a gas tax holiday in the summer, when pollution is at its worst.

Now comes a story from Businessweek that suggests that, contrary to the findings in David Austin's work, higher gas prices are leading to less driving. It would be hard to list all the policy benefits that result from this.

We do need to be careful about the association here--people may be driving less because they are less likely to be working, or because they are not going shopping or out to eat as much. If the reduction is driving owes more to the likely recession than to the price of gasoline, the effect will not be permanent. We won't be able to figure out which it is until and unless the economy bounces back at the same time that the price of gas remains high.

The regressive nature of high gas prices is also a problem. But this would be better solved through increases in the minimum wage and/or the earned income tax credit than a reduction in the federal gasoline tax.

It is going to be awhile before the economy recovers

From the Washington Post:

Sales of New Single-Family Homes at 16-Year Low

I wrote ten years ago that residential construction was THE leading indicator. And Ed Leamer says housing IS the business cycle. Yikes!

dilemmas

My Wall Street Journal subscription is about to expire. I don't know whether to renew. One the one hand, I hate sending money to Rupert Murdoch. On the other, I would miss Greg Ip, David Wessel and Scott McCartney. And the editorial page is one of two places I allow myself to be exposed to right-wing nuttery (Bill Kristol's column is the other).

[update: I've decided to renew].

Polonius on Subprime

Hamlet, Act I Scene III

Neither a borrower, nor a lender be;
For loan oft loses both itself and friend,
And borrowing dulls the edge of husbandry.

Of course, Polonius was an ass.

Twelfth Night Commercial 3

With the Green sisters. Successors to the Coen Brothers.

Diane Swonk Waxes Poetically about Falling House Prices

She writes:

[The housing downturn] not only represents a hit to the American economy, but it represents a hit to the American psyche. It is a straw that breaks the back of working class households who feel they have already given more than their fair share in an economy that penalizes manual labor relative to educational attainment.

A more prosaic way to put it is that home equity is often the only wealth that people in the lower half of the income distribution have. According to the 2004 SCF, 40 percent of those in the bottom quintile of the income distribution have some home equity; only 12 percent own stock.

The prescience of JM Keynes

This via Brad Delong:

The outstanding ground for cheerfulness lies, I think, in this -- that the system has shown already its capacity to stand an almost inconceivable strain. If anyone had prophesied to us a year or two ago the actual state of affairs which exists to-day, could we have believed that the world could continue to maintain even that degree of normality which we actually have? This remarkable capacity of the system to take punishment is the best reason for hoping that we still have time to rally the constructive forces of the world.

Remarkable.

Schools and Property Values

One of my good GW friends, knowing that my daughters had just finished navigating the college admissions process, lent me her copy of Acceptance, a novel about crazed parents and their slightly less crazed children going through the college application process in a fictitious Maryland county that just happens to contain the National Institutes for Health. The novel is quite funny, and one passage stood out:

Her public school might as well have been a private school, and in a way, it was. There was no tuition, per se, but irrational real estate prices served to filter out most of the rabble and ;end it a somewhat exclusive air, or so she'd heard her mother say.

This paragraph summarizes why I support school choice. Affluent people have school choice--they can pay for private school, or they can move to places with excellent public schools (whose excellence is capitalized into land prices). Meanwhile, kids of poor families are stuck in dysfunctional school districts with no place to go. Just spending money on these schools doesn't seem to solve the problem--DC has among the highest expenditures per pupil of any school district in the country, yet by any reasonable measure, their performance, particularly at the high school level, is dreadful. Kids in DC should be allowed to attend schools in Montgomery and Fairfax Counties.

Mark Thoma gives George Will a deservedly hard time, but..

I agree with Mark that for George Will to accuse someone else of elitism is too rich. For Bill Kristol also to do so is the ultimate in Chutzpah (I would call Will guilty of Chutzpah too, but I would guess George doesn't know what it means).

But Will's basic point about the Fed is not as ridiculous as it might seem. Will says:

The Fed's mission is to preserve the currency as a store of value by preventing inflation. ... The Fed should not try to produce this or that rate of economic growth or unemployment

My problem is with the use of the word "should." The more interesting question is whether the Fed can influence long-term economic growth or unemployment. Kydland and Prescott's model of credible commitment and central bank behavior (Journal of Political Economy 1977), which produced a Nobel prize in 2004, suggests that the Fed can only credibly commit to fighting inflation; that issues of time consistency prevent it from both fighting inflation and maximizing employment, and that if it commits to something other than zero inflation, it will produce socially undesirable levels of both inflation AND unemployment. This has spawned a literature on credible commitment on the part of central banks. And while I am not a macroeconomist (and won't play one on TV--when reporters ask me to forecast interest rates, I tell them to go away), my reading of the literature suggests that it is within the realm of possibility that Kydland and Prescott are correct.

Twelfth Night Commercial 1

TWELFTH NIGHT

ACT I

SCENE II The sea-coast.



[Enter VIOLA, a Captain, and Sailors]

VIOLA
What country, friends, is this?

Captain
This is Illyria, lady.

VIOLA
And what should I do in Illyria?
My brother he is in Elysium.
Perchance he is not drown'd: what think you, sailors?

Captain
It is perchance that you yourself were saved.

VIOLA
O my poor brother! and so perchance may he be.

Captain
True, madam: and, to comfort you with chance,
Assure yourself, after our ship did split,
When you and those poor number saved with you
Hung on our driving boat, I saw your brother,
Most provident in peril, bind himself,
Courage and hope both teaching him the practise,
To a strong mast that lived upon the sea;
Where, like Arion on the dolphin's back,
I saw him hold acquaintance with the waves
So long as I could see.

VIOLA
For saying so, there's gold:
Mine own escape unfoldeth to my hope,
Whereto thy speech serves for authority,
The like of him.

Twelfth Night Commercial 2

Directed by Morgan Green. Starring Hannah Green as Olivia. Shakespeare at his comic best. And it's free. What could be better?

Jumbo Conforming Spread

I was looking at the Wells Fargo mortgage web page this morning. The jumbo conforming spread for prime mortgages is around 125 basis points. The spread implies an expected default probability for jumbos, and so I started fooling around with a few simulations.

I used the following assumptions: 12 percent prepayment each year, 30 year term, jumbo rate of 7.35 percent; conforming rate of 6.1 percent, constant conditional default rate (this is the least realistic); loss rate conditional on default of 35 percent. Given these assumptions, the implied conditional default rate is in excess of 3 percent per year, which is extraordinarily high for prime mortgages.

If I raise loss conditional on default to .5, the implied expected default rate becomes 2.5 percent per year. I will do further refining of this, but it seems to me that prime jumbo mortgages are a good investment opportunity.

Greg Mankiw Writes about Education and Income Inequality

But in doing so, he focuses on the top end of the education and income distribution. It seems to me that the problem lies on the bottom end, where according to Heckman and LaFontaine, educational attainment levels are falling.

Americans without high school diplomas simply cannot compete in the global economy.

Novels about Academia

I just finished On Beauty by Zadie Smith. It reminded me that my little professional world makes a good backdrop for novels. Others that I have liked include Moo by Jane Smiley, Gaudy Night by Dorothy Sayers, most novels by Robertson Davis, and Talk Talk by TC Boyle.

The economics professor in Moo hits a little to close to home for me sometimes; among Davis' stuff, I especially like the Lyre of Orpheus.

I couldn't say it better myself

http://economistsview.typepad.com/economistsview/2008/04/an-open-letter.html

And why did ABC think it was OK to let a Clintonista referee a debate that included HRC?

A more recent article on Rail Transit in the US

Abstract from Clifford Winston and Vikram Maheshrim
On the social desirability of urban rail transit systems, Journal of Urban Economics Volume 62, Issue 2, September 2007, Pages 362-382

Despite a decline in its mode share, investment to build new urban rail transit systems and extend old ones continues. We estimate the contribution of each U.S. urban rail operation to social welfare based on the demand for and cost of its service. We find that with the exception of BART in the San Francisco Bay area, every system actually reduces welfare and is unable to become socially desirable even with optimal pricing or physical restructuring of its network. We conclude rail’s social cost is unlikely to abate because it enjoys powerful political support from planners, civic boosters, and policymakers.

When I have a little time, I will produce a more comprehensive bibliography. My reading of (a fairly extensive) literature is that rail makes sense only in the densest places, such as New York, Boston, Tokyo, Paris, London, Seoul, etc. I would build metros in Indian cities that do not have them. But I have never seen a socially compelling case for light rail.

BTW, I personally love rail. One of the best things about living in Bethesda and working in Foggy Bottom is that I almost never drive to work. Metro is great for me. But should low income taxpayers in Kansas (or Frederick, Maryland, for that matter) be paying for a professor to be able to read in comfort on the way to work in Washington?

My Problems with Light Rail

(1) It is the worst of two public transportation technologies; it has the inflexibility of rail, and the speed of buses. It also has low capacity.

(2) The capital cost alone per passenger mile is very high.

(3) In practice, light rail systems cannibalize bus systems, and so lower overall transit use.

My guru on this was John Kain. A short article of his on the topic is: John F. Kain, The Use of Straw Men in the Economic Evaluation of Rail Transport Projects, The American Economic Review, Vol. 82, No. 2, Papers and Proceedings of the Hundred and Fourth Annual Meeting of the American Economic Association (May, 1992), pp. 487-493. You need a subscription to get to it.

An Anonymous Comment on Meaurement of CPI Owner Rents

Thus just came in:

Both the Rent and OER indexes of the CPI are moved by inflation in market rents. As long as "location-location-location" holds, rent on owned properties will rise at about the rate as rent on nearby rental properties, after controlling for differential effects of aging, which the BLS does. The "how much would your home rent for" question is only used in generating weights

Whoever sent this in: I would like to know more. What do you mean by weights? How exactly is the OER calculated? I want to fix this if I got Turley's comments wrong.

Reverse Snobbery

Having just bashed intellectuals (see below), I now feel the need to bash Maureen's Dowd's column today on what it takes to be a "regular guy (gal)." Apparently John Kerry's disdain for Cheez-Wiz and Barack Obama's concern for the healthfulness of the food he eats disqualify them from relating to working class people, whereas Hillary Clinton's ability to toss down a boilermaker gives her street cred.

Leave aside for a second whether or not the President needs to be "regular." People--including Presidential Candidates--should be able to eat what they want without fear of ridicule and condemnation. It is my observation, moreoever, that lots of different kinds of people like lots of different kinds of food.

The Chinese think they can learn from US Suburbs

There is a nice piece about it in USA Today.

One line in the story, though, really caught my eye.

"Most intellectuals say [suburbanization is] horrible. Most environmentalists say the same thing," says Nora Libertun de Duren, urban planning professor at Columbia University and an expert on suburbs in developing countries. "But developers say it's good business, and architects say it's good business."

And so we see a congenital weakness on the part of intellectuals: the need to look down on how other people choose to live (I am afraid I suffer this weakness myself from time-to-time, although my family does a good job of calling me on it when I display it). The fact is that many people enjoy the privacy, greenary, and sense of order that comes with suburban living, and there is nothing wrong with that. Moreover, as the Chinese have figured out, suburban planned communities often can self-finance infrastructure, and therefore provide a technique for community upgrading.

The environmental issue is more serious, but is solvable. If people were required to pay the social cost of driving, the settlement patterns that would emerge would be environmentally sustainable too. In many places, private automobiles would be very efficient forms of transport if (1) they got reasonable gas mileage and (2) if someone would sit in the front right seat everyday. The idea that light rail will solve environmental problems is just silly.

Paul Krugman has a good point about Big Cities

This is so nice:

OK, actually I was born in Albany, and grew up on Long Island. But here’s my question: I understand why it’s political poison to show disrespect for small-town values — dignity is precious to all of us, and often trumps material interest. But why is it OK to disrespect big city values, even to suggest — as Bush has — that big-city dwellers aren’t part of the “real America”?

I mean, I get a lump in my throat when visiting the Lower East Side Tenement Museum. The big-city immigrant experience is as much a part of what made America as the rural, small-town experience. It deserves the same degree of respect.

I'll go a step further (and BTW, I grew up in a small Midwestern town called La Crosse, Wisconsin--the epitome of the "heartland"). Cities are where things get accomplished, and where people need to learn to get along with others who may be different from themselves. New Yorkers have to cooperate more with others every day than any other place in the US (with the possible exception now of Los Angeles). This reflects values that we should celebrate.

The Trouble with House Prices.

A few months ago, I wrote this:

Now comes a story from the AP saying that people's expectation of PI is negative 1/4 of the time. This all by itself will substantially decrease house prices, and may cause them to overshoot below their fundamental values. Ed Leamer has a proposal to use the tax code to prop up values, but because it is temporary, I am not sure it would be sufficient. More important is the rapid expansion of the FHA program, which explicitly places the US Treasury behind housing markets. We'll see whether it is sufficient...

Ivory Park, Gauteng, South Africa

This is one of the 40 square metre houses. I am on the right.

Planning type just can't seem to get behind suburbs

Yesterday I gave a presentation at a World Bank workshop in Pretoria on urban spatial structure and housing (yeah, I'm a lucky SOB). My job was to talk about successful models of housing development for low income workers, and I gave praise to the evolution of housing development in Hong Kong, Singapore and the post WWII United States. No one complained about the first two examples, but a planner complained that I would praise "sprawl" development.

But the fact is that houses in places like the Levittowns offered veterans returning home from war inexpensive, sanitary housing that could be modified and upgraded as their incomes rose. Density patterns in South Africa are also more similar to the largest American cities than to East Asian cities, and I met a group of women who were developing detached single family 40 square meter houses for around $4000 in construction costs, so to rule the detached house model out of hand does not make sense to me. I do think some Americans are needlessly fearful of density at times, but there is nothing wrong per se with constructing lower density houses in places with relatively ample land. And the snobbery some planning types show toward suburbs is just as disturbing to me as the fear some suburban types show toward dense cities.

Alice Rivlin has sold me

In previous posts I have expressed skepticism about bail-outs. Then along came this via Mark Thoma:

The Fed’s Money Well Spent, by Alice Rivlin, Commentary, NY Times: One benefit of the Federal Reserve’s rescue of Bear Stearns is that public outrage has aroused the political system to action in mitigating the foreclosure crisis.

Never mind that the supposed conflict between Wall Street and Main Street is a false one — Main Street runs on credit and cannot prosper if the financial system is in shambles and credit dries up. Never mind that the supposed Fat Cat “bailout” was a disaster for Bear Stearns stockholders, and that the idea of a “moral hazard” risk — that other investment banks will be tempted to emulate Bear Stearns — is preposterous. Never mind that if markets head back up and the collateral can be sold at a profit, taxpayers may lose nothing.

In the end, the Fed’s action was not aimed at rescuing those who made bad decisions out of greed or stupidity, but at protecting the rest of the country — and indeed the world — from the possibly devastating consequences of a financial meltdown.

Nevertheless, the outrage is both understandable and useful. Public money has been put at risk...

Like the failure of a financial behemoth, spreading foreclosures engulf the innocent as well as the imprudent and unwise. To be sure, many homeowners were shortsighted and greedy. Like their Wall Street counterparts they borrowed too much and got caught when the music stopped. Like the Bear Stearns shareholders, they should take losses. But putting them out of their homes does not merely harm them and their children, it endangers whole neighborhoods and drags down the assets of their more prudent neighbors.

Congress and the Bush administration should move quickly ... to enact laws to ease the renegotiation of mortgages and keep homeowners who are able to pay the new charges in their homes. Public money will have to be put at risk, but it is worth it. The deals should be structured so that the taxpayer shares in the gains if markets recover...

When the immediate crisis is past, however, we must turn to the difficult task of reducing the chances of a replay. It will not be easy to design regulations that do more good than harm, but at the very least all financial institutions that stand to benefit from Federal Reserve help in a crisis must be subject to regulatory scrutiny to make sure they are managing their risk prudently. There must be higher capital requirements and limits on excessive leverage. ...

After that, we must take on the even harder job of sorting through the explosion of financial instruments ... and deciding which belong in our kit of tools and which should be relegated to the waste heap. If they genuinely spread risk and help move capital into more productive uses, they should stay. But some exotic derivatives ... may entail more systemic risk than social value.

The folks who devise these exotica are talented enough to create something useful. We would all be better off if they were productively employed in the “real” economy — or pursued wealth in Las Vegas, where the risks the smartest gamblers pose to the house are carefully controlled.

The world is a second best place. Sometimes I still need to learn to live with it.

Paul Krugman and Brad Delong have an argument about Rents

Krugman argues that house prices are fundamentally still too high, because CPI real rents have been flat. Delong says he is not sure what to make of CPI Rents. As I noted in a previous post, Ralph Turley, who knows more about these things than most all of us, argues that CPI rents are in fact measured incorrectly.

In a paper I did with Cutts and Chang (for which I must get around to doing the final revision), we performed hedonic regressions showing that quality adjusted rents during the 1990s in many cities did rise more rapidly than the CPI suggested. And when I look at rent to price ratios for comparable properties (i.e., condos and apartments) in, say, Los Angeles, the financial argument for owning seems pretty reasonable right now. Again, because we don't know how people are forming their expectations at the moment, it is difficult to say when a bottom is coming. But I do think equilibrium house prices are higher than Krugman thinks.

Rachmaninov - 2nd suite

Other than an untidy beginning, this is remarkable....

Whence Systemic Risk?

William Poole's departure from the St. Louis Fed calls to mind a speech he gave in 2003 on Fannie Mae, Freddie Mac and systemic risk. In Poole's view, the concentration of mortgage risk in the two institutions was per se dangerous. I think it is fair to say that Poole's view was at least partly grounded in the idea that the implicit subsidy the two institutions received created alarming moral hazard issues. It was (is) a view shared by many fine economists, including Dwight Jaffee and Larry White, both of whose work I admire.

My view--and it is one that has led me to feel lonely at times in the company of other economists--is that the benefits of the GSE subsidies outweigh their costs, and that the GSE subsidies are not materially larger than those received by, say, Citigroup. Indeed, the pool of financial institutions with an implicit guarantee has recently moved beyond GSEs and commercial banks to include investment banks.

I think it is worth noting that Fannie and Freddie's core business--prime mortgages--is doing ok. To the extent the companies are having trouble, it is because they were pushed into buying subprime and Alt-A loans by a set of misguided regulations known as affordable housing goals. I don't know whether it is a coincidence or not, but Fannie and Freddie market share of mortgages declined dramatically between 2002 and 2007; they gave up their market share to private label institutions. So if Poole was correct, systemic risk should have declined between 2002 and 2007. The prediction didn't work out too well.

I should disclose that I worked at Freddie for 15 months in 2002 and 2003. While I learned a lot there and met some wonderful people who remain my friends, I pretty much knew I wanted to leave the place within a month of arriving. How this biases my views on GSEs is not entirely clear to me. But I do sometimes wonder if some of the GSE's most vociferous opponents, such as the American Enterprise Institute and the Wall Street Journal Editorial page, just can't stand the idea that government created institutions have spread the benefits of capital markets to a broad swath of ordinary people in a very responsible way.

The Real Value Added of Fannie and Freddie?

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

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

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

Dick Cavett gives Public Speaking Advice

I really enjoyed this.

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

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

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

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

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

Ed Glaeser has a nice essay on John Kenneth Galbraith

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

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

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

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

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

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

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

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

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

I think these are right on the nose:

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

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

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

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

I read the news today, oh boy.

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

Arthur Anderson Redux?

The New York Times on KPMG and New Century:

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

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

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

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

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

The abstract:

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

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

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

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

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

Here is Clinton:

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

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

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

Small Addictions

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

A Bear Stearns Bailout

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

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

A LIttle Good News

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

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

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

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

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

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

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

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

Austin Kelly finds that Zero Down Mortgages perform really badly

His paper is here.

The abstract:

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

No more no money down mortgages from Fannie and Freddie

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

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

Housing Bubble Hyderabad?

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

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

A positive expected value bet

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

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

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

Benighted policy of the Day

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

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

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

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

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

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

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

Jonathan Laing of Barrons says that Fannie may fail

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

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

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

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

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

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

Where's Fannie?

Rhonda Porter writes:

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

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

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

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

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

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

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

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

Charles Dickens would support the Estate Tax

From Our Mutual Friend, Chapter 1.

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

Predatory Lending in India?

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

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

Richard Florida thinks that Rustbelt Cities can come back

He says so here.

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

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

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

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

Gipsy Kings Hotel California 1990

Income, Happiness....and Democracy?

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


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

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

Putting our Mortgage Problems in Proper Perspective

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

Why I like Obama

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

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

Should lenders take haircuts to stave off default?

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

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

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

Speaking of Chicago

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

Greatest American City is 171 years old today

Happy Birthday, Chicago!

William F. Buckley was right about two things.

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

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

A subprime cartoon

Warning: contains language inappropriate for a family blog.

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

Mark posts Ed's comments here.

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

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

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

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

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

A great subprime paper from Sufi and Mian

You can download it here.

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

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

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

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

I

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

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

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

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

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

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

One of my favorites lines from Bugs Bunny

is, "Daddy, you're back from Peru."

My kids will actually be able to say this to me on Wednesday night--I am going down to Lima to give a lecture at the Peruvian Central Bank. I am really looking forward to it.

Alan Blinder and Mark Thoma want to bring back the HOLC

Mark's post is here.

I am myself a fan of the HOLC, and have said so in articles I wrote with Susan Wachter for Journal of Economic Perspectives and for the Jackson Hole conference last summer, as well as a comment I just wrote for Housing Policy Debate. Yet I am not sure it is alone the medicine for the current crisis.

When the Home Owners Loan Corporation was invented, it was in response to an economic tsunami that swamped lenders and homeowners. Moral hazard was not much of an issue, as loans were stringently underwritten (typical LTVs were 50 percent at origination). But loans had short terms, and therefore were vulnerable when people were forced to refinance in the teeth of the great depression. The HOLC allowed for massive loan modification and helped get incentives for borrowers and lenders aligned correctly.

Now, however, we are in the midst of a crisis that has arisen in part because of agency problems throughout the lending chain. To bail out lenders through some sort of HOLC setup could very well encourage excessive risk taking in the future, which is of course problematic.

I think if we are going to go the HOLC route, it needs to be accompanied by a regulatory structure that will prevent the sort of bad practices that led to the current crisis going forward. As I have noted before, such regulatory changes would require greater transparency, a requirement that everyone who touches a mortgage be subject to federal supervision, and a requirement that everyone who touches a mortgage have some capital at risk.

10 percent of Homeowners Upside Down???!!!

That was the headline in yesterday's NYT, based on calculations from economy.com. Because the article doesn't describe how the calculations were done, it is not possible to agree or disagree with them, but I don't find the number on its face implausible.

Let us say for the sake of argument that the number is correct. It means that for 10 percent of owners, the put option contained in their mortgage (i.e., the option to put their house back to the lender) is in the money. If all these households default, the mortgage market will be cooked: Fannie and Freddie, who put 45 basis points of capital behind each mortgage they guarantee, would likely not be able to withstand so many defaults. Moreover, if ten percent of the market becomes REO, inventories will swell further, putting more downward pressure on house prices, which in turn will lead to more borrowers being underwater.

It is unlikely, however, that all such households will default. Past work by people such as Bob Van Order and Yongheng Deng has shown that people in the past usually needed to face a trigger event, such as divorce, job loss or sickness, before they default. The question is whether things are different this time: that because people are so aware of the declining housing market, they will understand more quickly that their house value is less than their mortgage balance, and will therefore default. After all, in principle, if one observes that her house is less valuable than her mortgage balance, she could default one day and buy the house back the next, and be better off.

But default doesn't actually work that way. When a borrower defaults, she trashes her credit score, and therefore reduces her options for either owning or renting going forward: people like having a roof over their heads. Beyond that, houses are idiosyncratic and can be more valuable to their dwellers than they are to the market. Houses become associated with memories, neighbors, gardens, strange paint colors, and other characteristics that make them valuable to their occupants in a way that cannot be reflected in the market. These things prevent people from defaulting (or selling when it makes more sense financially to rent). Finally, many households still feel an obligation to pay their bills. The fact that so many mortgage borrowers in Louisiana continued to make payments for homes Katrina destroyed is quite remarkable, and quite germane to the situation in which we find ourselves now.

How much these phenomena will prevent defaults in the next few years is an open and interesting question. I suspect we will know the answer pretty soon.

Testing Micky's Kaus' Election Hypothesis

I don't care much for Kaus' stuff, but he puts forward an interesting hypothesis: that every time Hillary Clinton does well in a primary, there is a backlash in the following primary, and that when she does badly, she generates sympathy and does better in the following primary.

I took her primary percentages each week since Iowa (using this handy dandy web site.)

The finding? There is a negative correlation of about .65 in her share of the primary vote from one date to the next.

Why an Interest Rate Freeze won't solve the Subprime Problem

I. Freezing interest rates on Adjustable Rate Mortgages would have little impact on the current mortgage crisis.

As I noted in a previous post, a recent paper by Federal Reserve Bank of Boston economists Kristopher Gerardi, Adam Hale Shapiro, and Paul S. Willen take a careful look at the characteristics of 2-28 ARM mortgages. Among its findings are that interest rate resets have little if anything to do with the large number of defaults we are observing. For the vast majority of subprime loans, defaults or refinances happen before resets take place. Moreover, the size of the resets is smaller than most of us think, because the initial teaser rates are pretty high. Also, because the Federal Reserve Board has cut interest rates so aggressively, reset rates will not be as high as people have feared.

The authors also note that while ARMs have higher default rates than FRMs, putting ARM borrowers into FRMs (which is what a freeze would effectively do) will not necessarily reduce defaults. The difference in default performance between the two instruments may reveal more about the borrowers than the instruments themselves. ARM borrowers by their very nature are more prone to risk-taking that FRM borrowers.

Finally, some of the most potentially explosive mortgage products, such as Option-ARMS, have negative amortization features—that is, borrowers actually accrue interest, so their mortgage balance rises each month for awhile. These features produce default incentives independent of changes in interest rates; an interest rate freeze will not help home borrowers who are under water because early payments did not pay for all interest due.

II. Freezing Rates on all Adjustable Rate Mortgages could reduce the availability of mortgage credit in the future.

Sometimes in the search to find the source of a tragedy, people try to settle on a villain. There have been lots of villains to go around in the sub-prime tragedy: unscrupulous brokers, speculative borrowers and lax rating agencies among them. But to the extent that investors in mortgages are villains, they are already being punished pretty severely, as they have taken on billions upon billions of dollars of losses.

It is therefore not surprising that investors—some of whom include the pension funds that provide the retirement incomes for schoolteachers and firefighters—are being frightened away from mortgages. The upshot is that the subprime market has nearly vanished for the time being, and mortgage credit more generally has become more expensive and scarce in high cost areas such as the coasts.

In light of this, policy responses that add to the perceived risk of investing in mortgages—including safe mortgages – would be counter-productive. A policy whereby the government freezes interest rates is a policy in which the government changes the terms of contracts, and thereby adds both to the perceived and real risk of investing in mortgages. This will make it harder and more expensive for borrowers to obtain mortgage credit, and could spill over to the point where it becomes more difficult for all entities in the US—including the U.S. Government—to borrow.

Other countries around the globe, such as India and Korea, have experimented with major government intervention in the enforcement of mortgage terms. These have produced stunted mortgage markets. We need to remember that the United States had until quite recently the most robust mortgage market in the world. We also need to remember that the adjustable rate mortgage saved the mortgage market in the 1980s, when macroeconomic conditions were unstable. Had it not been for the adjustable rate mortgage (along with investor confidence that those mortgage rates could reset with the market), housing conditions in the US in the 1980s would have been far worse.

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What is wrong with this picture?

I read the following in today's Slate about Clinton and Obama sending representatives to the AAAS meeting this year:

About 400 science researchers, policy wonks, and journalists packed into a meeting-room to see the surrogates duke it out. In the Clinton corner was Tom Kalil, a ruddy, thick-necked bureaucrat armed with a PowerPoint presentation and a full clip of obscure facts about academe. (Did you know that the average age for receiving your first NIH R01 grant is 41?) Representing Obama was Alec Ross, a smarmy and pandering thirtysomething in shirtsleeves. “I'm one of those guys who’s deeply moved by data,” he said, and then failed to adduce a single obscure fact about academe through the course of the session.

Let me say that I think either candidate would make a fine President, although personally I prefer Obama. I am glad that they at least sent representatives to talk to scientists (the other party's hostility to science is an important reason why I don't support it). But I looked up both Kalil and Ross--and neither of them is a scientist! JFK and LBJ used Jerome Wiesner, who would later become President of MIT, for science policy advice. It occurs to me that there are lots of articulate, policy-minded, honest-to-goodness scientists out there. It would be good to hear from them.

Airline Mergers and Urban Dynamics

Apparently there is a very good chance that Delta and Northwest will merge. Delta's three domestic hubs are in Atlanta, Cincinnati and Salt Lake City; Northwest's are in Minneapolis, Detroit and Memphis.

The distance between Atlanta and Memphis is only 380 miles. It is hard to see both hubs survive: Pittsburgh couldn't survive as a hub given its proximity to Philadelphia for US Airways (even though Allegheny, US Airway's predecessor) was originally a Pittsburgh company)and St. Louis couldn't survive as a hub after TWA's merger into American given its proximity to Chicago. Jan Brueckner and I have done separate papers showing that this is very bad news indeed for Memphis. My paper, moreover, shows that air cargo has little impact on local economic development, so the presence of FedEx at Memphis won't do much to soften the blow of a likely dehubbing there.

Sometimes Harvard Really is Great

I really like this policy that was just approved by the Faculty of Arts and Sciences there.

David Wessel has a Nice Piece on House Price Indexes in today's WSJ

It is here.

Let me repeat something I wrote here last September:

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.

I think the last of these three points is especially important in partially explaining the difference between price indexes.

GREEN CHIMNEYS PT. 1

I like the name of the tune.

Postal Experiments

One of my students, Jocelyn Leitzinger, forwarded this to me. It is fun.

Some hope on housing from Pasadena

I was running some rent to price ratio stuff there. I basically get that rent near Cal Tach and Downtown Pasadena is about $18 per square foot per year, and condos sell for about $400 per square foot. This give a ratio of 4.5 percent, or a price to rent ratio of 22. For purchasers requiring mortgage of less than $417K (an amount that will soon go up), mortgage rates are in the mid-fives right now, so the appreciation one would need to make one indifferent between renting and buying is between 3 and 4 percent (I will share my spreadsheet that does these calculations with anyone that is interested). This is not an unreasonable expectation.

Remarkable

I am teaching in Hyderabad for a few weeks in March. Fortunately, my kids' spring break coincides with some of the time I will be there, so they will fly over and join me. The cost of a roundtrip ticket on Qatar Airlines (change in Doha) is $1350. The Great Circle distance between Washingon and Hyderabad is about 8500 miles, or 17,000 miles round trip. This means that the cost of getting from Washington to Hyderabad is about 8 cents a mile.

Favorite Variations

Bach, Goldberg Variations

Beethoven, Diabelli Variations

Brahms, Handel Variations

Schumann, Symphonic Etudes

Rzewski, The People United will Never be Defeated!

The last is good regardless of your politics. The recording I link to is by Stephen Drury, my good friend and piano teacher from college. It is also the best recording of the piece.

It was cold in Washington today

So it is good to think of spring in Paris.

Is Everything we "Know" about Subprime Wrong?

Yesterday I saw a great talk by Paul Willen of the Boston Fed. An earlier version of the paper he gave is here.

I don't think I am caricaturing what he said to say when I describe the following takeaways from his talk:

(1) Falling house prices lead to defaults more than defaults lead to falling house prices. In the early
part of the decade, when delinquencies reached record levels, default rates remained extremely low, because house prices were rising (see his graph on Page 48).

(2) Interest rate resets have little if anything to do with the large number of defaults we are observing. For the vast majority of subprime loans, defaults or refinances happen before resets take place. It is moreover the case that the size of the resets is smaller than most of us think, because the initial teaser rates are pretty high.

(3) While ARMs have higher default rates than FRMs, putting ARM borrowers into FRMs will not necessarily reduce defaults. In the first place, as people move out of ARMs into FRMs, the denominator in the default proportion ratio will decline for ARMs, while increasing for FRMs, meaning that if the number defaults stay constant, the default share in ARMs will still rise.

Beyond this last point, a working paper I have with Cutts and Ramogopal shows that ARM borrower are fundamentally more likely to be risk-takers than FRM borrowers, so the difference in loan performance between the two products may say more about the distributions of the different borrowers, rather than the products themselves.

In any case, all of this means that many of the policies being pushed at the moment (such as interest rate freezes) may not be particularly helpful in resolving the crisis.

Couldn't help but notice

It is almost certain that a sitting Senator will be elected President. Hasn't happened since JFK.

John Dickerson in Slate has a Great Line

On Romney:

"He was a PowerPoint candidate who was all points and no power."

A thought all business school professors should take to heart.

How houses are like movies

Brad Delong has a nice piece on selectivity bias and the quality of movies. His basic point is that when people say "they don't make them like they used to," they are comparing the best movies from past generations with average movies from ours. There is a natural enough reason that we do this: the only movies from the past we still watch are Hitchcock/Wilder/Huston/Capra type movies; we don't watch the mediocre stuff from the past anymore. The same is true for novels: Dickens was not the representative novelist of the 19th century.

Houses are like this too. In many markets, a hedonic regression will yield a U-shaped relationship between house vintage and value. Here in Washington, houses built in the 1920s and 30s are especially valuable. An important reason for this is that the typical house is removed from the stock between age 70 and 80 (Jack Corgel did the definitive work on this some years ago); the houses that remain are those that were especially well constructed, or have unusual and desirable design features.

Ahem

On December 11, I wrote this.

I would have mentioned it had I gotten it wrong, too.

Experts

I have not written for the last few days, because I was in Chicago with my daughter, who was visiting colleges and auditioning for a theater program. I stayed with my cousin, Jonathan, who teaches at Kellogg. Jon, Hannah and I had a nice lunch at a deli in the loop, and had a really nice time talking about his recent paper on experts.

The point of Jon (and Nabil I. Al-Najjar's) paper is that the best way to determine expertise is to compare predictions in some meaningful way. It is not sufficient to call someone an expert for choosing some mean outcome (if it rains 20 percent of the time, and a weatherman predicts a 20 percent chance of rain everyday, he will, in a sense, be right, but he adds no information, no expertise).

This got me thinking about Macroeconomic forecasting models. The Wall Street Journal will celebrate an economist's forecast if it is the best for a particular quarter. This is a strange metric: if someone predicts 6 percent GDP growth (an unusually high but not unheard of number) every quarter, in the unusual quarter where growth is that fast, he or she will be lionized in the pages of the country's leading financial newspaper.

A possibly better way to measure macroeconomic forecasts is to look at the mean squared error of forecasts over a reasonable time horizon--say 20 quarters. Perhaps someone has performed the exercise--it would be fun to know how it would shake out. My guess is that the eternal optimists and doomsayers wouldn't look so good.

My favorite cities that have lost more than 10 percent of peak population

1. Chicago (my favorite American City)
2. Duluth (incredibly nice people; incredibly nice lake shore)
3. Boston
4. Philadelphia
5. Washington
6. Minneapolis
7. Pittsburgh (great college town!)
8. Cleveland (great art museum, even greater orchestra)
9. New Orleans (authentically tawdry, as opposed to Las Vegas)

Music for 18 Musicians Piano Rehearsal 01