Is it a bottom? Or just one strange month?

Last week, the California Association of Realtors put out the July EHS numbers for the state. Prices had fallen 40 percent from a year ago, and sales increased by 43 percent. Inventories were whittled down to about six months, which is very close to an equibilibrium level (a nice rule for real estate--when inventories for a type of building are about equal to the length of time it takes to build that type of building, the market is more or less in equilibrium). I have talked to people at CAR to make sure that there isn't some quirk in the data to explain the extraordinary change.

As I have written before, prices in California have fallen so rapidly that in many markets it is now just as sensible financially to own as it is to rent--assuming one can get her hands on financing. There are, moreover, many cash buyers in places like the Inland Empire right now, and cash buying is a powerful indicator of a bottoming market. Finally, I am hearing lots of anecdotes about multiple offers on properties for sale.

The problem is that a very large number of the sales are foreclosure sales or short sales--properties that lenders are trying to dispose of, and are therefore selling at extremely low prices. Whether this tendancy will extend to the rest of the market is very much an open question. But if the next few months are similar to July, we may well be at bottom out here.

Just dropped a kid off at NYU--and thought about the real estate.

So we just had the first one leave the nest for Greenwich Village (second one leaves in two weeks for Evanston). Two real estate thoughts hit me:

(1) NYU dorms are the bargain of the century. They are very nice (four young women share two bedrooms, a living room and a kitchenette) and have views that would command double the price per square foot in the standard, un-rent-stabilized NYC housing market. The hallway gives a great view up Lexington Avenue (you can see the Chrysler Building) and over the Williamsberg Bridge.

(2) People need to get over considering price-to-household-income as the key fundamental. Density in lower Manhattan is so much greater than nearly anywhere else in the country, it will of course be the case that the relative price of housing to anything else--including wages--will be higher there than elsewhere.

Getting a California Mortgage in 2008

My wife and I close on a house here today. It is our fourth house--we bought two in Madison, and one in Washington, and then one here in LA.

The first three houses were a piece of cake to buy; this one was a lot harder. In the process of doing it, I think I spoke with half a dozen lenders, including CNB, the bank that is funding the mortgage. The experience included:

(1) a broker who tried to get my business by trashing his competitors

(2) a broker who dangled an impossibly low interest rate loan from a lender whose balance sheet is in such bad condition, it is likely not able to make loans anymore

(3) a bank that told me that investors are not much interested in California

(4) lenders are reluctant to count any income beyond salary income for underwriting purposes.

The last point is almost certainly true, as rates on California mortgages seem to be about 50 bp higher than in other parts of the country.

In the end, CNB was quite professional, but I have to say that the level of scrutiny--particularly with respect to the appraisal--was mich higher than I had ever experienced before. Perhaps in general this is a good thing. But if conditions remain this way, potential homebuyers are going to have to understand the need to keep excellent documentation about their income (keep those W-2s!) and buyers and sellers are going to need to understand that transactions will take longer than it did a couple of years ago. And to get the housing market unstuck, lenders are going to have to think about how to underwrite self-employed people, rather than just rejecting them.

The Mystery of Airlines

Other than Southwest (which hedged its fuel costs), they are all losing money. Yet every flight I take is packed. The obvious solution is for them to raise prices, except that they fear losing market share--in a market that loses money. Perhaps there is some sort of Nash game that explains this behavior...

Alan Greenspan has an Idea

In an interview in today's Wall Street Journal:

He also offers a novel suggestion to bolster the housing market: Increase the number of potential home buyers by admitting more skilled immigrants.

I have actually wondering whether enforcement of immigration laws within the last year has worsened the housing situation in Arizona, Nevada, and the California Inland Empire. While overbuilding, undisciplined lending, and speculation are all at fault for the mess we are in, I can't help but wonder if lower levels of immigration in the Southwest haven't matter as well.

Neither McCain nor Obama seems particularly interested in keeping immigrants out of the country, so it will be interesting to see what happens to housing absorption in 2009.

How much should gas prices be capitalized into SUV values?

Let us say that the baseline car gets 20 mpg, and an SUV gets 13 mpg (this is for in-town driving). If the average person drives 15,000 miles per year, this means the SUV driver uses about 400 gallons per year more than the baseline car. Let us suppose the equilibrium price was determined when gas was $2 per gallon.

Now that gas is $4 per gallon, the SUV driver is paying $800 per year more relative to the baseline car than expected. Suppose the real discount rate for a car is .05, and that cars depreciate on a straight-line basis over 10 years. This means that SUV values should fall by $800/.15 or about $5300. Seems to work....

Just thinking out loud

Wells Fargo has a market cap of about $100 billion; Freddie Mac's is under $4 billion.
Wells Fargo has been well managed for years; Freddie, not so much.
Wells Fargo has long had a higher standalone credit rating than Freddie.

Might it make sense to allow a GSE to become a subsidiary of a bank? As I said, just thinking out loud...

In LA

I suppose it is time to resume blogging...

Bldgblog on my new town

I like his take:

I got back from Los Angeles last night and my head is still spinning. I'd move there again in a heartbeat.
There are three great cities in the United States: there's Los Angeles, Chicago, and New York – in that order.
I love Boston; I even love Denver; I like Miami; I think Washington DC is habitable; but Los Angeles is Los Angeles. You can't compare it to Paris, or to London, or to Rome, or to Shanghai. You can interestingly contrast it to those cities, sure, and Los Angeles even comes out lacking; but Los Angeles is still Los Angeles.

[Image: L.A., as photographed by Marshall Astor].

No matter what you do in L.A., your behavior is appropriate for the city. Los Angeles has no assumed correct mode of use. You can have fake breasts and drive a Ford Mustang – or you can grow a beard, weigh 300 pounds, and read Christian science fiction novels. Either way, you're fine: that's just how it works. You can watch Cops all day or you can be a porn star or you can be a Caltech physicist. You can listen to Carcass – or you can listen to Pat Robertson. Or both.
That's how we dooz it.

L.A. is the apocalypse: it's you and a bunch of parking lots. No one's going to save you; no one's looking out for you. It's the only city I know where that's the explicit premise of living there – that's the deal you make when you move to L.A.
The city, ironically, is emotionally authentic.
It says: no one loves you; you're the least important person in the room; get over it. What matters is what you do there.

I agree with his assessment about the three great American cities--San Francisco and Boston are wonderful, but then so is Madison. None of them are as consequential as the big three. I think he gets Washington right--it is perfectly pleasant, and has become far more international in the years I have been coming and going to and from it, but I have never been able to fall in love with it, as I have Madison--and Chicago, New York and Los Angeles (and Rome and Tokyo and Hong Kong and Mumbai, but that is for another time).

In any case, Randy Newman's song is not ironic, and neither am I--I love LA, and am looking forward to many happy years there.

Wow

I wake up this morning to read:

In an interview, Freddie Mac’s former chief risk officer, David A. Andrukonis, recalled telling Mr. Syron in mid-2004 that the company was buying bad loans that “would likely pose an enormous financial and reputational risk to the company and the country.”

I left Freddie at the beginning of 2004. At that time, I believed that it excelled at mortgage underwriting--it had very serious people who constructed careful, sophisticated models of default prediction.

Dave A. was among the most highly respected people in the company. Apparently, things changed after I left.

I hope this is a quiet week

I move to California on Thursday. My guess is that I will not be posting again until after I get out there.

Robert Van Order on Fannie and Freddie

When I left Madison for Washington six years ago, it was to follow my wife, who was offered a terrific job practicing geriatric medicine for under-served communities at the Washington Hospital Center. I decided to go to Freddie Mac at the time, in large part because I admired many people there, including Ed Golding, who was in charge of financial research, and Bob Van Order, who was the chief economist for many years.

Bob wrote the following on the raison d'etre for Fannie and Freddie, and with his permission, I am passing it along:

UNDERSTANDING FANNIE AND FREDDIE
By Robert Van Order
University of Aberdeen and University of Michigan
July 2008
Financial markets are different from other markets. They deal intensively in information and misinformation. Most of the time information is good enough and financial markets work fine, but when there are serious doubts about the quality of information entire blocks of investors, e.g., institutional investors who are not confident about information, exit and markets break down. In the case of lending markets borrowing rates go up abruptly and some borrowers have trouble getting loans at any price. Something like this has been happening in mortgage markets, especially subprime markets, and it seems to be spilling over into other markets.
Since the Great Depression when financial markets really went crazy we have developed institutions to try to control financial panic. A big part of this development has been deposit insurance, which provides bank depositors with assurance that they can get their money no matter what their bank does. Most of the time deposit insurance has served us very well. We don’t see bank runs to any great extent; in 1987 when the stock market crashed in a way that was not that different from 1929 we saw not a whiff of a bank panic. Of course the security has come at a cost. Banks can use deposit insurance as a basis for risk-taking and cause large costs to tax payers and distort resource allocation, as was the case with the Savings and Loans in the 1980s.
Fannie Mae and Freddie Mac (FF) are a part of this apparatus. They are usually referred to as Government Sponsored Enterprises or “GSEs.” That is, they are enterprises (they are privately owned), but they have special charters and benefits primarily in the form of implicit guarantees, for which they do not pay, and regulation (for instance, FF are limited to the mortgage markets and have regulations on their capital and on lending to targeted groups) which constrain their operation. They buy mortgages from lenders and they fund the purchases by issuing their own debt and (most often) mortgage backed securities (securities backed by particular pools of mortgages). They take credit risk because they are responsible for paying off investors in their securities in the event of default. They also take interest rate risk to the extent their debt funding is out of sync with their assets’ cash flows. Interest rate risk has not been the issue recently, but credit risk certainly has.
The GSEs have several purposes. Much of the recent focus has been on subsidizing homeownership, but the really important function has been to provide “liquidity” to the mortgage market, which basically means that they keep the market open even when times are tough, like now. Along with this they provide an element of standardization, which helps lenders and investors better understand what they are originating and buying. They can do this in part because their implicit guarantee allows them to raise money in bad times in the same way that deposit insurance allows banks to raise money even when they are in trouble.
Guarantees involve a subsidy, if they are not paid for. In FF’s case their debt has been rated AAA or AAA+ because of the government connection; whereas on its own it has been rated in the low AA range. The difference in borrowing rates between the two is around a quarter of a percent to .40%, which is a rough measure of their subsidy. Banks get a similar subsidy, which varies from bank to bank. The subsidy is probably larger now.
The analogy with deposit insurance is deliberate. Banks are de facto GSEs. Indeed, so are most major financial institutions around the world, which is in part why we have had relatively stable financial markets for decades. That does not mean that all GSEs are good things or that regulation can’t be improved on, but we’re not in uncharted water here. Nor are we looking at unprecedented support for mortgage markets. Since at least the 1950s almost all U.S. mortgages have benefited from guarantees: initially direct insurance like FHA and deposit insurance, especially via the Savings and Loans, and more recently via GSEs. The only part of the market without substantial government presence has been the subprime market.
What we have is a trade off. The GSEs provide stability. A measure of some of the current benefit from having FF in the market can be seen from a natural experiment that comes from the way the GSEs are regulated. There is a limit on the size of loan that FF can buy (It has been changed recently; at the beginning of this year it was $417,000. The limit is indexed to house prices over time). For years the loans above this cutoff (so called “jumbo” loans) paid rates about a quarter of a per cent higher than on loans below the limit (on 30 year fixed rate mortgages). The loans above the limit are not much different from those below; they are prime loans (the borrowers have good credit histories) with similar characteristics. However, at the end of last summer, as the subprime news hit the fan, the spread rose by over 1% and has stayed in that neighborhood. Again there is nothing in the data to suggest anything like that big a difference in credit risk on these loans. The difference is due to the existence of FF as liquidity providers in their part of the market. There is every reason to believe that without FF interest rates would have gone up in a comparable manner in most of the market.
The trade off is that the GSE structure, particularly the implicit guarantee, invites risk-taking in the same way that deposit insurance invites it. This distorts resource allocation (in this case diverting resources toward housing and homeownership). Perhaps more important, politically, it risks bail-outs (like with the S and Ls in the 1980s). Both the benefits and costs of GSEs are real and need to be balanced.
Right now the two GSEs are in trouble, and it is important to understand why. We can think of their business as having two parts: the “core” business of buying and funding prime mortgages, mostly 30 year fixed rate mortgages, and a portfolio of other “non Agency” mortgage-backed securities, which are not backed by prime loans, but rather by riskier loans like subprime and “Alt-A” mortgages. FF bought pieces of subprime and Alt-A deals that had insurance and subordination (meaning there were other investors in the loan pool that took risks first (e.g., the first 15% of the pool losses), which were supposed to protect them, so their parts of the deal (tranches) were rated AAA. These have performed worse than AAA and have fallen sharply in value. The non Agency portfolio is less than 10% of the combined $5 trillion in mortgage related assets held by the two, but it has been most of the recent controversy.
The core business of FF has been experiencing large defaults, almost certainly larger than either has ever experienced. This does not appear to have been due to changes in risk-taking or growth in the companies: the prime mortgages they bought have not changed much over time, and their performance has actually been better (lower delinquency rates) that those for prime mortgages in general. Nor was excessive growth a problem; the FF market share and level of purchases dropped sharply after 2003, as the subprime share rose. As far as one can tell so far the answer to “why?” is mostly that house prices have declined faster than at any time since these two have been around (It may have been worse in the 1930s). Both companies have taken write downs from this and more is likely to come. However, while this will certainly cut sharply into profits for several years it is likely that the two will weather the storm.
How do we know this? Well, we don’t know for sure, but we can get some ideas from history. Comparable declines in prices in some recent bad regional declines suggest that there is room for quite high default rates without collapse. An underappreciated tool that the FF regulator uses to assess FF capital is a series of “stress tests, which simulate the companies’ performance under stressful (in this case large credit loss situations). While the tests are a bit complicated the principle is simple: take the worst regional experience in recent history (for which we have data; this is the “oil patch” states in the 1980s) and project it nationwide and ask if the institution has enough capital reserve to survive ten years (leaving positive capital behind). The tool has not gotten much publicity because the institutions have generally (this includes the first quarter this year) had no trouble passing . It is important in part because the stress test appears to be actually happening. It looks like the two still pass (they had considerable excess in the first quarter of this year) but not without considerable pain. They will need added capital cushions both to make sure they get through the stress and so that they can grow. This part of their problem is a little controversial, but not a lot.
It is the non agency portfolios that are the big issue. A problem in assessing the non Agency portfolio, and the economic position of the two GSEs in general, is that the two standard measures of their position—two measures of their net worth- are both wrong. Standard accounting measures are almost always wrong because they are (generally) too slow to adapt to changing economic conditions. Hence, while accounting net worth of the two has worsened as they have set aside reserves for future losses, accounting rules do not do this fast enough to anticipate the full extent of future losses, so accounting (GAAP) net worth is probably too big.
The other measure, “mark to market” net worth, which estimates the market value of assets and liabilities of the two and takes the difference as their net worth, errs in the other direction. Right now mark to market net worth is around zero or negative for the two companies, primarily because the mark to market value of the non Agency securities has fallen sharply. This has been the genesis of much of the recent news about the two. It is certainly the case that if FF had to liquidate their portfolios they would be in trouble. However, they don’t have to; they are in a position of being able to hold them and fund their assets. Normally the mark to market value would also reflect the value of holding the assets as well as the value if sold; that is how competition in the market among buyers of securities works. But that only works if the market is working.
The problem is that there has been a liquidity crunch in the “non Agency” markets for mortgage-backed securities that is worse than the one we know about and can measure in the “Jumbo” market. The market for buying these has more or less evaporated, so it is hard to get the kind of clear read on the value of the securities that we would get in a market like the one for Treasury bonds. This is what is most controversial: the argument is that the senior, would-be AAA, subprime pieces are being priced at discounts that are way above any reasonable estimate of default loss. If that is the case, then holding the securities and using the proceeds to pay off the debt that funded them has a good chance of working—certainly it is better than selling the securities into a very thin market and trying to use the proceeds to pay off the debt.
Should we worry about this? Of course, but we should not overdo. Stress test tests run by FF and by outside analysts suggest that these securities are certainly not AAA, but they are not junk bonds either, and losses will be manageable. This is probably why the Congressional Budget Office opined recently that there probably will be no cost to the recently passed “bailout” bill.
But the “probably” part matters. Things could turn south, and that could be costly. Indeed, a problem right now is that FF would get most of the upside if things improve, but Treasury (taxpayers) would be stuck with a large part of the downside. This is the balance part. Guarantees, both for GSEs and banks, give financial institutions incentives to take risks because they get the upside benefits, but not all of the downside costs, and the market does not make them pay for it. On the other hand, the situation we are facing now, a possible financial meltdown, happens infrequently, but when it does it can cause a great deal of damage, a small glimpse of which we are seeing in the Jumbo market.
The short run response, in the recent Housing Bill, to this has been to shore up the perception of a guarantee, so that it is more or less certain that FF can continue to raise money. That is what the so-called line of credit is about (Ditto for opening the Fed discount window). It gives Treasury authority to extend its ability to make secured loans to FF (at Treasury’s discretion, not FF’s). Right now it is not necessary; FF are liquid and raising money easily, but knowing that the line is there probably makes it less likely that it will be used (for the same reason that the existence of deposit insurance mitigates bank runs). A separate part of the Bill allows Treasury to buy FF stock. This makes less sense. From a public policy perspective the issue is keeping the market open, and the line of credit can do this without helping shareholders. If FF fail, the line of credit will be the main vehicle for paying off the implicit guarantee.
Longer term, the balance will most likely come from limits on risk-taking and on capital reserves. The risk-taking of FF has not been a major issue, but the capital reserve has. Reforms going forward will probably raise the minimum levels of capital. The stress tests have not been mentioned much. That is unfortunate for two reasons: One is that as house prices fall and losses get paid out the ability to withstand the stress test going forward will diminish and there will be built in need to raise capital. Second the stress tests can be revised. The 1992 law that set up FF regulation required taking the stress test from the worst regional downturn in the data. We shall surely have a region (the southwest? Florida?) from the current period that will best the oil patch states. As a result simply updating the stress test will increase required capital, and it will do it the right way—related to the risk the institutions take.
If you want to get an idea of how the two are doing, forget the accounting net worth and the mark to market net worth and look at what is happening with stress tests.
A dimension of the problem that has not been seriously addressed is that FF, like banks, do not pay for the insurance they get. A way of solving this is via user fees. Charging fees would really solidify the guarantee and take it out of the conjecture box. To some extent this is a question of the extent to which taxpayers want to subsidize mortgage rates. It is not likely to be as good a way of controlling risk as are capital requirements and stress tests.
More broadly: there are four likely ways that housing finance will get done in the U.S:
1. GSEs.
2. Non Agency (“private label”) securitization.
3. Banks (and S and Ls)
4. Government owned institutions like FHA and Ginnie Mae
These all have benefits and costs. The second is the only 100% private (without guarantee) model. It runs the risk of fragility—probably not as bad, going forward, as the subprime debacle, but at least like the current Jumbo market. The third has many similarities to the GSEs. In principle the GSEs and banks are hard to separate; in practice the GSEs have won the market, but innovations like “covered bonds” can allow banks to do almost the same thing as securitization. Both have incentives for risk-taking and risk of bail out. The fourth presents the problems of government management and inflexibility (For instance, pricing by both FHA and Ginnie Mae are fixed by statute), and it is not clear that there is less risk.
Going forward, there is no doubt that there are risks, but not the sorts of catastrophes that have been floating around the press, blogs and newsrooms. The current zero or negative mark to market net worth is more a figment of a broken market than a judgment about future prospects. In any event the last thing we should want to do now is take away the liquidity role of FF. Around 90% of all adults are homeowners at some time in their life and almost all homeowners take out a mortgage at some time. The mortgage market is important, and keeping it open is important. Sometimes you need someone to bring the punch bowl back to the party when the guests are threatening to leave.

A web site for bridge geeks who grew up near the Mississippi River

John Weeks provides a treasure trove of pictures and stories about bridges that cross the Mississippi River.

He dedicates one page each to the two highway bridges at La Crosse. He notes quite correctly that the Dresbach Bridge is remarkably pedestrian given its spectacular location (it is just south of the widest spot for the upper-Mississippi). The dual bridges five miles further south are far more interesting.

I think all government capital projects should be subject to cost-benefit analysis. But there is something to be said for spending something to make such permanent fixtures as bridges beautiful.

Cities as Museums

When I was a kid, my father told me that the way to get to know cities was to walk and take the bus. I have followed his advice ever since, which I think explains why I like thinking about cities, and about why some are more successful than others.

In any case, I had an afternoon to kill in San Francisco the other day, and managed to take in a wide variety of sites and people by simply taking the N car to the beach, walking on the beach, walking from the beach along Lincoln Way to 19th Street, taking the 71 bus through the Haight, getting off at Larkin and Market, walking north up Larking to Clay, and then east to near the top of Nob Hill, and then down through North Beach and back to the financial district where I was staying.

The whole thing took around 3-4 hours, and yet enabled me to observe and enjoy the many different and idiosyncratic aspects of San Francisco.

New to the top of the reading list

I need to go get Rick Perlstein's Nixonland. It is not just that Brad Delong recommends it (and I think the most valuable service Brad Delong provides is reading recommendations--if only I could read as voluminously as he). I have long had something of a Nixon obsession. According to my parents, when I was one, during the Kennedy-Nixon debates, Nixon's presence on TV would make me cry. And then he went and died on my birthday in the city where I was born.

I have read a lot of Nixon books--I think Wills' Nixon Agonistes is my favorite to this point. But I need to read Perlstein.

Is William Poole kidding?

He gets some things right in his op-ed piece in today's New York Times. Fannie and Freddie should have higher capital requirements and they should stop lobbying. Beyond this, I think something should be done about executive compensation for senior management at both institutions. But when Poole says:

In fact, there has already been a test case for how the mortgage market would function without Fannie and Freddie. After an accounting scandal in 2005, regulators severely constrained their activities. The nation’s total residential mortgage debt outstanding rose by $1.176 trillion in that year, even though Fannie’s and Freddie’s stakes rose by only $169 billion, just 14.4 percent of the total. In essence, the market barely noticed that the two agencies’ private competitors were providing 85 percent of the increase in mortgage debt in 2005.

The market barely noticed???? I think we have been noticing quite a lot about mortgages generated in the "pure" private market over the past 18 months or so. And of course, the non-conforming (i.e., private) market for 30-year fixed rate mortgages is, shall we say, problematic at the moment.

Mark Thoma thinks housing supply elasticities may be assymetric

The basic point is that in markets with lots of land, housing may be supplied elastically during booms, but takes a long-time to adjust during price declines. I have reason to think Mark is right.

My 2005 paper with Mayo and Malpezzi found evidence of this; cities that appeared inelastic included Pittsburgh, Toledo, Albany, Buffalo and Providence. None of these cities had upward pressure on housing production; rather, they were losing population and the housing stock took a long time to adjust to the loss.

Never mind

From the National Association of Realtors today:

Total housing inventory at the end of June rose 0.2 percent to 4.49 million existing homes available for sale, which represents an 11.1.-month supply2 at the current sales pace, up from a 10.8-month supply in May.

What is normalcy?

gaius marius writes:

fwiw -- and i realize this is but anecdotal, but it is illustrative of the general condition -- i live in suburban chicago, renting a house. i pay $2000/mo, property taxes are $550/mo. my rental payment then would support (ignoring upkeep/insurance/etc) a $1450/mo payment.at today's 30-year fixed rate (~6.5%), that would support a $230,000 loan. with 20% down, call the purchase price $290,000 -- and generously, as we are excluding all expenses but taxes.this house sold in 2005 for $460,000. houses in the neighborhood still list for $410,000.

Actually, this suggests to me that houses in your area are priced at something like fundamentals. Let us say the marginal tax rate of the typical buyer is 25 percent, that property taxes (which are deductible for most people) are at 1.5 percent, that maintenance costs about 2 percent, and that expect rent growth is 2.5 percent (i.e., a little less than recent CPI growth). Then the user cost of owning would be
410,000*(.065*.75 + .015*.75+ .02 -.025) = 22,550, or a little less than the $24,000 you are paying in rent right now.
Two financial advantages of owning that you are not considering are the tax benefit and the immunization from future rent increases. Of course, should interest rates rise to 8 percent, or tax policy change, these calculations change.

OFHEO HPI and long term trends.

The new OFHEO house price index came out yesterday. At the moment, I like OFHEO better than Case-Shiller (I worry that Case-Shiller is now giving too much weight to REO properties in its index). In any event, it is fun to play with some long term trends.

According to yesterday's OFHEO press release, since 1991, house prices have risen about 4.5 percent per year; since 2000, they have risen by 5.5 percent per year, even taking into account the recent decline. This means that between 1991-2000, prices rose about 3.6 percent per year (take (1.045^17/1.055^8)^(1/9)-1).

Suppose that 3.6 percent is the long-term nominal house price growth trend. By how much are house prices overvalued? The answer is (1.045^17)/(1.036^17)-1= .158. So house prices would have to fall by about another 13.6 percent immediately to stay in line with the long term nominal trend, after which they should rise by 3.6 percent per year.

Alternatively, if house prices just stayed flat for four more years, they would return to their long-term trajectory--assuming that the trajectory before the year 2000 was the long-term trajectory.

What does it mean?

Obama has 1.1 million fans on facebook.

McCain has 170,000 fans on facebook.

Of course, McCain doesn't know what facebook is.

Perspective on Fannie and Freddie (update)

I should have looked at the 10Qs (duh) for the first quarter. Credit losses for both companies were around 12bp (although survivable), which is high by historical standards (see below). Still, the first quarter financial statements came out in May, so it is hard to understand exactly what happened a couple of weeks ago.

Perhaps we can start looking for a bottom

I have long said that so long as the months supply of housing available for sale is rising, it is not possible to know then the housing market will reach bottom (in terms of price). But the months supply measure has fallen pretty substantially since this winter, from a peak of 11.4 months to a current rate of 9.4 months. The inventory needs to get down to 5-6 months before inflation adjusted prices become stable. But the derivative finally has the right sign.

A little perspective on Fannie and Freddie

Above are charts of 90-day delinquencies (based on the Monthly Volume Summaries and the OFHEO Report to Congress) through the first quarter of this year and credit losses through 2007 (these are the most recent public data that I can find).

Like many others, I eagerly await the companies' first quarter financial statements. But what do
others know that we don't?

Inflation and the Development of Mortgage Markets in Emerging Economies

Rising commodity prices have not just placed upward pressure on inflation in the US. In emerging markets, the impact is, in many cases, larger, with double digit inflation returning to places such as South Africa and Russia.

Inflation harms mortgage markets. Because nominal interest rates are high during periods of high inflation, payment-to-income ratios for even modest houses move beyond the means of what households can afford (and what lenders are willing to lend) in the short run. This problem is known as mortgage "tilt."


There are workarounds--for instance, price level adjustable mortgages (or PLAMS) charge real interest rates and then adjust the loan balance each period to reflect inflation. Unless these mortgages are carefully constructed, however, and unless the "correct" price index is known (and it rarely is), they are highly risky, because they have a negative amortization feature by construction. They are particularly problematic when house prices do not rise as rapidly as the general price level. The current US experience (as well as the 1980s) show that gaps between consumer prices and house prices can at times be large.


So the mortgage market is a case where nominal price changes can have real effects. It is no accident that the American mortgage market nearly disappeared during the late 1970s--a period of double digit inflation in the US.

Unhappiness (again)

From Greg Ip:

For decades, the typical college graduate's wage rose well above inflation. But no longer. In the economic expansion that began in 2001 and now appears to be ending, the inflation-adjusted wages of the majority of U.S. workers didn't grow, even among those who went to college. The government's statistical snapshots show the typical weekly salary of a worker with a bachelor's degree, adjusted for inflation, didn't rise last year from 2006 and was 1.7% below the 2001 level.

Greg Mankiw's Economics Platform

He tries to list the things for which there is a consensus among economists. It is actually quite good.

I have two problems with the list. First, raising the retirement age for people like me (i.e., those who have cushy jobs) makes a lot of sense. But I think we need to treat truck drivers, miners, linemen, etc. differently. They are often physically incapable of continuing work until an old age. And to ask a 60 year old to retrain is, I think, naive.

Second, I would like to see something about fiscal responsibility. Deficit spending during recessions is fine. But it would be nice to go back to the good old days of the late '90s and run surpluses when the economy is surging.

A Modest Proposal for Richard Syron and Dan Mudd

The two CEOs would take compensation of $1 per year plus restricted stock that doesn't vest for, say, two years. By doing this, whey would show that they have confidence in the long term futures of their companies, and that they are willing to risk-share with taxpayers.

Mark Zandi says the Price-Rent ratio is returning to the fundamentally correct level

He is quoted in today's WSJ.

Also coming into balance, though not there quite yet, is the ratio of home prices to rents. The lower the ratio, the more people are likely to buy a home than rent one. Mr. Zandi estimates that this ratio dropped to 20.02 in the second quarter from a high of 24.90 during the boom. The average ratio from 1985 to 2002 was 14.44. "If you just look at affordability indices, we would say we are probably close to a bottom," says Ivy Zelman, a housing and homebuilding analyst. "But these are not normal times."

FWIW, I am in the middle of buying a house in Pasadena (when it is a done deal, I will write a little history of the transaction). It is because owning looks like a very fair deal relative to renting; also, LA is likely the place we will live for the next 20+ years, so short term house price fluctuations don't mean much to us.

Now that I will be driving to work most days

I will swap my minivan for a Toyota Corolla. I love the Prius, but the price premium in California is too high--assuming you can even get one.

It does bring to mind my first car that was not a hand-me-down from my parents--a Honda Civic that my wife and I bought in 1985. It had a 76 hp engine mated to a 5-speed manual transmission. It seemed adequately fast to me. It had no gadgets on it--riders rolled up the windows by hand, and I had to install the radio by myself. It got 30 mpg around town, and between 35 and 40 on the highway.

Here's the thing--it was not a "sacrifice:" I loved the car. It was fun to drive, and pretty much flawless--we spent very little on maintaining the car. We kept it for 12 years, and only then replaced it because Wisconsin winters took their toll on its body (and Hondas tended to rust back then). But the engine and drive train still ran beautifully.

So my question is--why is it not easy to buy cars like the middle-80s vintage Civic anymore? It seems like a great solution for reducing emissions and congestion. And no new technology is necessary.

Paul Krugman on the GSEs

He writes:

But here’s the thing: Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S.& L. fiasco. In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble.

Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Fannie and Freddie that curtailed their lending just as housing prices were really taking off. Also, they didn’t do any subprime lending, because they can’t: the definition of a subprime loan is precisely a loan that doesn’t meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income.

So whatever bad incentives the implicit federal guarantee creates have been offset by the fact that Fannie and Freddie were and are tightly regulated with regard to the risks they can take. You could say that the Fannie-Freddie experience shows that regulation works.

In that case, however, how did they end up in trouble?

Part of the answer is the sheer scale of the housing bubble, and the size of the price declines taking place now that the bubble has burst. In Los Angeles, Miami and other places, anyone who borrowed to buy a house at the peak of the market probably has negative equity at this point, even if he or she originally put 20 percent down. The result is a rising rate of delinquency even on loans that meet Fannie-Freddie guidelines.

Also, Fannie and Freddie, while tightly regulated in terms of their lending, haven’t been required to put up enough capital — that is, money raised by selling stock rather than borrowing. This means that even a small decline in the value of their assets can leave them underwater, owing more than they own.

Ex post it would appear that Fannie-Freddie should have had higher capital requirements, if for no other reason than to bolster confidence during periods of stress. But ex ante, stress-testing models showed that Fannie was well capitalized and that Freddie was very well capitalized. Ironically, most of us who followed the companies worried a lot more about interest rate/prepayment risk than default risk.

This is not to say that past Fannie/Freddie senior management did not behave badly with respect to financial reporting, and I find it maddening that some of the worst actors wound up walking away with millions of dollars. While I made good friends at Freddie and learned a lot, the moral obtuseness of company leaders at the time (2002-03) made me very uncomfortable and I looked for a way out (I also discovered within about a week of being there that I really missed being a professor). Daniel Mudd's current silence also makes me wonder if there is a shoe to drop that has not yet appeared in the monthly volume summaries.

But for the reasons Krugman gave, moral hazard did not produce lax underwriting at Fannie-Freddie--regulation (and to be fair, I think corporate culture at Freddie) prevented that from happening. To the extent they are in trouble, it is because of market conditions outside the realm of historical experience. It is, after all, their job to be in the market at all times--no matter what. They is why they have their charters. A government backstop will not it their cases reward bad behavior; it will assure that they can do a job that purely private participants are unwilling to do at the moment.

I spent the afternoon flying back to DC from California

I just read the Paulson press release. Tomorrow will be an interesting day. I'll be watching the repo market.

I was going to say this, but...

Brad Delong said it first:

The chance that American taxpayers will actually lose any money if Ben Bernanke and Henry Paulson decide that Fannie and Freddie need government support is very low:

* The interest payments they have coming in are greater than the interest payments they have going out.
* Their government guarantee is itself a very valuable asset that they have made a lot of money off of in the past and will make more off of in the future.
* They are not even in liquidity trouble--unless they begin to have problems rolling over their discount notes...
* As long as it is generally understood that they are too big to fail, they should not even have liquidity problems--absent a depression that bankrupts many currently-solvent homeowners, that is.

I would like to mention three other things based on the 15 months or so that I worked at Freddie.

(1) One reason Freddie got in trouble about how it reported its earnings is that Senior Management did not believe that GAAP treatments of earnings reflected the economics of the company, and so it needed to fudge (the company's self-investigation, called the Baker-Botts report, made this quite clear). This does not excuse its behavior--publicly traded companies must comply with GAAP. The correct thing would have been for management to explain the problems with GAAP in the MD&A Statement.

But Senior Management was correct that GAAP earnings did not (and does not) give meaningful metrics of GSE corporate performance.

(2) Just my two cents, but I don't think the company's mortgage underwriting could be characterized as reflecting moral hazard. The company was quite conservative about loans that qualified for purchase, and perhaps would have been more conservative were it not for the Affordable Housing Goals (and BTW, there is no evidence that the Affordable Housing Goals in any way helped channel mortgage credit to underserved communities or families). In any event, the people running Freddie were not the Savings and Loan cowboys who would lend to anyone for anything.

(3) It is very hard to measure corporate cash flow at Fannie-Freddie, because funding and amortization are both happening constantly.

One other disclosure, I own something like 300 shares of Freddie stock that I received as compensation when I worked there. Feel free to discount anything I say about these matters as a result of this.

I don't get it

The last real "news" about Freddie Mac is the May Monthly Volume Summary, which came out more than 2 weeks ago. Delinquencies on their book have been rising, but at .81 percent are not at anything like an alarming level.

Could the word of a former Federal Reserve Bank President really have such a strong impact on the market?

Christopher Mayer, Tomasz Piskorski and Alexei Tchistyi Show that Prepayment Penalties Benefit Borrowers with Poor Credit Histories

Their paper find there is a separating equilibrium under which borrowers with blemished credit want prepayment penalties, while those with perfect credit do not. More particularly, they show:

Subprime borrowers with FICO scores below 620 obtain rates as much as 0.7%
lower than similar borrowers with fully prepayable mortgages and default at a lower rate (13% default rate) than comparable borrowers with no prepayment penalties (18% default rate). Our …findings suggest that regulations banning re…financing penalties might have the unintended consequence of raising interest rates, increasing mortgage default, and limiting available credit for the riskiest borrowers.

The paper does only look at fixed rate mortgages, and so it is not clear whether the argument applies to 2-28s. But the finding is well worth considering in light of the current policy debate.

Shopping for Mortgages

I am currently shopping for a California Mortgage. It is a little weird--the best pricing relative to the yield curve seems to be a 5-1 ARM. 30-year fixed rates are absurd--around 350 bp above 30 year CMT. While part of this is pricing the prepayment option, it also implies a truly implausible default probability for a prime mortgage.

One would think five-year ARMS would have higher default risks, so it must be about interest rate risk--perhaps buyers of 30-year Treasuries are not so worried about duration matching as buyers of 30-year mortgages? Anyway, the mortgage market in California currently strongly resembles the Canadian Mortgage market.

Jefferson had his problems, but boy could he write

When in the Course of human events, it becomes necessary for one people to dissolve the political bands which have connected them with another, and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature's God entitle them, a decent respect to the opinions of mankind requires that they should declare the causes which impel them to the separation.

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. --That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, --That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness. Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn, that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security. —Such has been the patient sufferance of these Colonies; and such is now the necessity which constrains them to alter their former Systems of Government. The history of the present King of Great Britain [George III] is a history of repeated injuries and usurpations, all having in direct object the establishment of an absolute Tyranny over these States. To prove this, let Facts be submitted to a candid world.

He has refused his Assent to Laws, the most wholesome and necessary for the public good.

He has forbidden his Governors to pass Laws of immediate and pressing importance, unless suspended in their operation till his Assent should be obtained; and when so suspended, he has utterly neglected to attend to them.

He has refused to pass other Laws for the accommodation of large districts of people, unless those people would relinquish the right of Representation in the Legislature, a right inestimable to them and formidable to tyrants only.

He has called together legislative bodies at places unusual, uncomfortable, and distant from the depository of their public Records, for the sole purpose of fatiguing them into compliance with his measures.

He has dissolved Representative Houses repeatedly, for opposing with manly firmness his invasions on the rights of the people.

He has refused for a long time, after such dissolutions, to cause others to be elected; whereby the Legislative powers, incapable of Annihilation, have returned to the People at large for their exercise; the State remaining in the mean time exposed to all the dangers of invasion from without, and convulsions within.

He has endeavoured to prevent the population of these States; for that purpose obstructing the Laws for Naturalization of Foreigners; refusing to pass others to encourage their migrations hither, and raising the conditions of new Appropriations of Lands.

He has obstructed the Administration of Justice, by refusing his Assent to Laws for establishing Judiciary powers.

He has made Judges dependent on his Will alone, for the tenure of their offices, and the amount and payment of their salaries.

He has erected a multitude of New Offices, and sent hither swarms of Officers to harass our people, and eat out their substance.

He has kept among us, in times of peace, Standing Armies without the consent of our legislatures.

He has affected to render the Military independent of and superior to the Civil power.

He has combined with others to subject us to a jurisdiction foreign to our constitution and unacknowledged by our laws; giving his Assent to their Acts of pretended Legislation:

For Quartering large bodies of armed troops among us:

For protecting them, by a mock Trial, from punishment for any Murders which they should commit on the Inhabitants of these States:

For cutting off our Trade with all parts of the world:

For imposing Taxes on us without our Consent:

For depriving us, in many cases, of the benefits of Trial by Jury:

For transporting us beyond Seas to be tried for pretended offences:

For abolishing the free System of English Laws in a neighbouring Province, establishing therein an Arbitrary government, and enlarging its Boundaries so as to render it at once an example and fit instrument for introducing the same absolute rule into these Colonies:

For taking away our Charters, abolishing our most valuable Laws, and altering fundamentally the Forms of our Governments:

For suspending our own Legislatures, and declaring themselves invested with power to legislate for us in all cases whatsoever.

He has abdicated Government here, by declaring us out of his Protection and waging War against us.

He has plundered our seas, ravaged our Coasts, burnt our towns, and destroyed the lives of our people.

He is at this time transporting large Armies of foreign Mercenaries to compleat the works of death, desolation and tyranny, already begun with circumstances of Cruelty and perfidy scarcely paralleled in the most barbarous ages, and totally unworthy the Head of a civilized nation.

He has constrained our fellow Citizens taken Captive on the high Seas to bear Arms against their Country, to become the executioners of their friends and Brethren, or to fall themselves by their Hands.

He has excited domestic insurrections amongst us, and has endeavoured to bring on the inhabitants of our frontiers, the merciless Indian Savages, whose known rule of warfare, is an undistinguished destruction of all ages, sexes and conditions.

In every stage of these Oppressions We have Petitioned for Redress in the most humble terms: Our repeated Petitions have been answered only by repeated injury. A Prince whose character is thus marked by every act which may define a Tyrant, is unfit to be the ruler of a free people.

Nor have We been wanting in attentions to our British brethren. We have warned them from time to time of attempts by their legislature to extend an unwarrantable jurisdiction over us. We have reminded them of the circumstances of our emigration and settlement here. We have appealed to their native justice and magnanimity, and we have conjured them by the ties of our common kindred to disavow these usurpations, which, would inevitably interrupt our connections and correspondence. They too have been deaf to the voice of justice and of consanguinity. We must, therefore, acquiesce in the necessity, which denounces our Separation, and hold them, as we hold the rest of mankind, Enemies in War, in Peace Friends.

We, therefore, the Representatives of the united States of America, in General Congress, Assembled, appealing to the Supreme Judge of the world for the rectitude of our intentions, do, in the Name, and by the Authority of the good People of these Colonies, solemnly publish and declare, That these United Colonies are, and of Right ought to be Free and Independent States; that they are Absolved from all Allegiance to the British Crown, and that all political connection between them and the State of Great Britain, is and ought to be totally dissolved; and that as Free and Independent States, they have full Power to levy War, conclude Peace, contract Alliances, establish Commerce, and to do all other Acts and Things which Independent States may of right do. And for the support of this Declaration, with a firm reliance on the protection of divine Providence, we mutually pledge to each other our Lives, our Fortunes and our sacred Honor.

See The Visitor

A movie about an economics professor, music and immigration policy. It is a powerful and poignant indictment of how America's government treats those whose only "crime" is a desire to live here.

It is bad enough that where we happen to be born has so much to do with how life turns out for us. It is worse when something as artificial as national frontiers prevent those born into bad circumstances from improving their lots in life.

Perhaps some hope on California's Housing Market

According to the California Association of Realtors, existing home sales in May were up 18 percent from a year earlier. At the same time, my colleague Delores Conway is showing that the gap between house payments and rents is returning to its historical norm for Los Angeles.

But perhaps more interesting are anecdotes I heard at the Pacific Coast Builders Conference in San Francisco last week--buyers are going on REO "bus tours" and purchasing multiple homes--with their own money. It is not all all clear how widespread this phenomenon is, but if we see large numbers of vultures in a market using equity to sweep up REO properties and short sales, we have seen the bottom of the market.

Superior Classical Music Blogging

So I am listening to Perahia's Goldbergs, and I run across this: http://jessicamusic.blogspot.com/. Jessica is clearly witty and informed. I'll enjoy reading through the archives.

Was the "Northwest" in North by Northwest the first example of product placement?

One commenter thinks it is perhaps so. You see the red tail when Carey Grant and Leo G. Carroll are headed for a plane from Midway to Rapid City. I don't know whether the coincidence of the airline name (actually Northwest Orient at the time) and the movie title was intentional or not.

I did forget to list NW among airlines. It is funny, because I think after United I have flown on it more than any other. There must have been a traumatic experience that made me want to forget....

More on airlines

I didn't mean to pick on United in my last post, it just happened to be the airline that the woman worked for. I hear people complain a lot about United, but as I have said before, I don't think they are too bad. They give frequent fliers extra room (an excellent loyalty program benefit), and you can hear the pilots communicate with ATC. I find this calming. The ground staff and flight attendants are generally very nice.

So here is my list, best to worst, of domestic airlines I have flown:

Jetblue
Midwest Express
The Old TWA (RIP)
United
Delta
Continental
Southwest
American
US Airways

The bottom two tie for worst--I try to avoid them.

Among international carriers, my list is

Singapore (in my egalitarian dream, everyone gets to fly it at least once)
Lufthansa
Cathay Pacific
KAL
ANA
Emirates
KLM
Air France
Thai
Air Canada
Alitalia
Air India
The Ukrainian National Airline--soviet era plane smelled of oil

Framing

When I was in Philadelphia last week, I met a woman who had worked in the HR department at United Airlines. As one might expect, the employees at United are not a happy group, but they also don't want to leave. I asked the woman why, pointing out that people such as flight attendants are quite intelligent, and could presumably make more money doing something they might like better.

She said the issue is that the flight attendants love the travel benefit (talk about your busman's holiday!). I asked the HR woman whether the travel benefit compensated for the pay lost not working in other areas. She said no--that many workers could make tens of thousands more, which would, of course, suffice to pay for a large number of plane tickets. But beyond this, people could use the money to buy things other than plane tickets, were they to chose.

This seems like a classic example of framing. Flight attendants see their travel benefit as an entitlement, and they would have to be paid something more than the value of the entitlement to let it go. Economics needs to get better at figuring this stuff out.

Stuart Thiel knows why people are unhappy (about George Bush)

Stuart (my Econometrics TA in Graduate School) has been tracking this relationship for some time. Looks pretty robust to me.

Great Piano Moments I have heard

Martha Argerich playing the Chopin F-minor with the Minnesota (I was 16 and I think I fell in love)

Duke Ellington at Interlochen. His technique was not all it once was, but who cared...

Count Basie accompanying Ella Fitzgerald at Carnegie Hall.

Maurizio Pollini playing the Wanderer Fantasy at the Kennedy Center.

Two Rudolph Serkins: Beethoven Op. 81 and Schubert B-flat at Symphony Hall in Boston, Beethoven Op 53 at the Kennedy Center.

Ivan Morevic playing the Appasionata in Jordon Hall in Boston. He just exploded into the coda.

Bobby Short at the Cafe Carlyle, and at the Kennedy Center

Mitsuko Uchida playing Mozart (in particular the C-minor Fantasy and Sonata)at Strathmore, our magnificent new hall in Montgomery County, Maryland.

Alfred Brendal playing the List Sonata at the Kennedy Center

Strangely, I have never heard my favorite piece (The Goldberg Variations, with which I have something of an obsession) in concert. I can't wait to hear the Disney Hall.

If we have hit peak oil, what won't I mind giving up.

I don't mind driving a small car (especially now that we don't need a minivan to cart around the kids, their friends, and their props for their various shows). I never have minded walking and using public transport. I'm willing to eat less meat so we use feed grains more disparately and efficiently. I don't mind living in a small house close to transit. I would still own a car, but just for those days when I need to get around town more than the commute in and the commute home. I would keep my heat off almost all the time in Southern California, and use AC lightly.

For me, the only hard thing to give up would be travel. Walking the streets of London, Paris, Florence, Rome, Stockholm, Amsterdam, Kiev, Krakow, Hong Kong, Tokyo, Seoul, Cairo, Dubai, Mumbai, Hyderabad, Singapore, Quito, Lima Dhaka and even TJ has taught me as much about urban and real estate dynamics as any spreadsheet or map--and I love spreadsheets and maps. If environmental conditions require us to do less of this kind of thing, I will cooperate. But I won't be happy about it.

NME says the youtube Lhevine recording of La Campanella is authentic

The commentary is here.

I myself am befuddled--but this recording is quite wonderful--the phrasing during the first 40 seconds is magic, and the ability of the pianist--whoever it is--to articulate while playing quite rapidly is remarkable.

Jumbo Conforming Spreads widen again

I looked at the Wells-Fargo web site this morning: the difference on APRS between jumbo and conforming 30-year fixed rate mortgages was 156 basis points.

I looked at the Citibank web site this morning: they were requiring five (five!) points to get a 30-year fixed rate mortgage; the difference in APRs was more than 200bp (and this assumes points are amortized over the full term of the loan--the real gap is actually larger).

I looked at the National City web site this morning: they are not quoting rates on jumbos.

Historically, the jumbo-conforming spread is less than 50 basis points. It is going to be very difficult for coastal markets to get unstuck so long as so much fear is gripping the market.

Mark Thoma explains why people are unhappy

For the past four or five years, I have gone to a meeting that the CFO of DC convenes to get views on the state of the area real estate market. At the most recent of these meetings, a hack "economist" declared that people were (I am paraphrasing here) pessimistic without reason about the economy.

Neil Irwin in The Washington Post had a similar complaint, and argued that people's pessimism arose from the fact that the indicators they see on a regular basis, such as gas prices, have been alarming to them.

But I think Mark Thoma has the real answer:

Part of the problem is the presumption in the question, which has been around for several years now and is basically "why are people so gloomy when the economy is doing so well?" If you ask instead, "why are people so gloomy when the economy has all these problems, reduced economic security, stagnant real wages, rising health care costs, falling home values, rising college costs, rising food costs, loss of employer based retirement programs, rising energy costs, worries about the future, etc., etc.," there's really no mystery.

I think both the "economist" at the meeting and the Washington Post reporter have limited capacity to think about what it must be like to be the median income household now. The median income household has now had (at best) many years of stagnant living conditions and worsening economic security.

La Campanella Liszt-Busoni Performed by Lhevinne

My freshman year college roommate introduced me to Lhevine's playing. I didn't much care for my freshman roommate, and when I for some unaccountable reason googled him, I saw that he gave money to Swift Boat Veterans for the Truth. But, he both motivated me to find great roommates (Curt, Harry, John and Jon) for my remaining college years; he also had great taste in pianists.

Natural Experiments in the Marginal Productivity of Labor

Tiger Woods made everyone in my family a golf fan. Before Tiger, I might watch the last round of the British Open, but that was about it (I know the Masters is the truly great tournament, but even when Tiger plays in it, it is too stuffy for me to enjoy).

My suspicion is that we are not alone. So the first difference in television ratings between last year's British Open and this year's might help establish a lower bound for Woods' marginal productivity. A robustness check will be the first difference between this year and next year. (I have tried to find how ratings points translate into advertising rates per minute, so far without success).

Bumsoo Lee, Peter Gordon, James E. Moore, II, and Harry W. Richardson tell us how many trips we take, and the reasons we take them.

My soon-to-be colleagues do so here: RESIDENTIAL LOCATION, LAND USE AND TRANSPORTATION: THE NEGLECTED ROLE OF NONWORK TRAVEL.

They find that less than one out of five trips is for work, and that in 2001, the average person made more than four trips per day (reinforcing my point in my last post on gas prices and urban land).

I should also mention that according to Zillow, for the Washington area, house prices in nearby Montgomery County have fallen by 7 percent in the last years, while in exurban Prince William County they have fallen by 24 percent. Paul Carrillo and I have done preliminary estimates that show that prices in the District have not fallen at all.

As for changing urban form, it will take awhile, but it could happen. Houses in the exurbs will likely not be torn down, but they will depreciate rapidly, while houses near employment centers and amenities will increase in relative value, meaning there will be incentives for dense redevolopment. For a good treatise on "filtering," see Ed Olsen's classic AER paper.

When Turtle talked about "Cheap money," we should have known there was a bubble

As part of my *ahem* research for living in Southern California, I started watching the first season of Entourage. In the second episode, Vince decides to buy a $10 million house after he has turned down a $4 million movie contract. Drama tells him it is OK, because it is, after all, California, where a house worth $10 million this year will be worth $20 million next year. And Turtle tells Vince "he can get money cheap."

The show's first year was 2004. Should have tipped us all off....

A little more on Gas and Urban Land

Yesterday, I made an assumption that each household made five trips per day--this was pulled out of thin air, because I couldn't find an estimate.

I have found one here: in 2001, the average American made four trips per day. The average household has a little more than 2.5 people, meaning that the average household made ten trips per day. According to the US Census, 77 percent of these trips involve a driver without passengers; 11 percent involve carpooling. If the average car pool has two passengers (that is probably too high), then car trips per day per household is more like eight than five. From a static standpoint, I underestimated the impact of gas prices on urban form. But as one commenter noted, dynamics will tend to attenuate some of the impact (on the other hand, close in places where transit is a choice will now be at a greater advantage than places on the fringe).

People often wonder why European densities are so much higher than US densities. Part of it is history (Paris and London largely developed before automobiles); but part of it is that Europeans have been paying high prices for gasoline for a long time, and that they have had transit as an alternative. That said, the dynamics of European cities has been toward sprawl--central Paris has been losing population to its suburbs for the past fifty years. But I will leave the discussion of that to another post.

My Upcoming Industry Talks

June 25, Real Estate Capital Markets After the Credit Crisis, UBC Center for Urban Economics, Vancouver.

June 26, Pacific Coast Builders Conference, San Francisco

September 11, Commercial Property News Conference, New York

September 18, Multihousing World, Denver

$4 per gallon gasoline and the urban land market

Over the past six years, the price of gasoline has risen about $2 per gallon. What does this mean for relative urban land prices?

Let's say the average household makes five one-way trips per day--for work, shopping, entertainment, etc. Let's also say that the average car gets 20 mpg in city driving. Each mile of distance to work, shopping, etc. is therefore now 50 cents per day per household more expensive than before. A household living immediately adjascent to work and shopping should then be willing to pay $5 per day more in rent than a household 10 miles away compared with six years ago, all else being equal. This becomes $150 per month, or $1800 per year. Assuming a five percent cap rate for owner occupied housing, this translates to $36,000 in relative change in value. Given that the median house price in the US is about $220k, this is kind of a big deal.

The assumptions here are pretty crude (particulalry the ceteris paribus assumption), but if gas remains at its current real price, we will see the shape of US cities change.

He looked things up

Which for me, is the ultimately tribute. RIP, Tim Russert.

Brendan O' Flaherty notes a problem with Hanna Rosin's piece on Section 8

In an email, he writes:

The Rosin article advances a fascinating hypothesis about why murder or crime rose in Memphis and in the rest of the country. It gets one important detail wrong. Crime did not rise in Memphis or in the rest of the country.

Here is a fairly long time series for UCR murders in Memphis (UCR excludes justifiable homicide, law enforcement, and murders that did not occur in the jurisdiction of the Memphis Police Department):

1990 195
1991 189
1992 176
1993 198

1994 159
1995 181
1996 161

1997 138 Rosin says the trouble started here
1998 115
1999 118
2000 147

2001 158
2002 149
2003 126
2004 107

2005 138 they stopped moving people out of the projects here
2006 149
2007 129 preliminary

If you treat murders as Poisson variables, only the 2004-2005 and 1999-2000 increases approach 2 se, but murders are really stuttering Poisson, which has greater variance. So going from 1996 until today, which is the natural comparison for the effect of project demolition, you have a decrease from 161 to 129. You can slice it many different ways, but my reading is essentially nothing happened. Remember also that the projects get emptied out long before demo. Since the title of the article is murder, i think it's very fair to look at murder.

What about nationally? Everybody knows that murders have come down a lot since the mid 90s nationally. The national rate stabilized around 2000 and has had only minor random blips since. The new data for 2007 show a small drop of 2.7% from 2006, but this is not significant to me. Rosin makes a big deal of the increase in cities 500k-1 m. Again, murders went down in these cities 2006 to 2007.

Rosin also cites the Police Executive Research Foundation report. This was about the change in murder in a non-random sample of large cities 2005 to 2006. Murder went up in about half of those cities, it went down in the other half, and the authors chose to report on all the increases. Half go up and half go down is what you expect from pure white noise.

Brendan says more, including the fact that Jens Ludwig has a regression that more convincingly ties the crime rate in New York to the success of the Yankees than the work that ties murder in Memphis to Section 8.

Transit and "Broken Windows"

I like taking transit--it allows me to read and/or listen to my ipod while getting from one place to another. Driving is a waste of time and in Washington is quite frustration.

So last April, when I made a visit to USC to prepare for my move this coming August, I used transit to get around LA to see what it was like. In terms of convenience, it is actually not too bad--buses go nearly everywhere, and the routes are sensible. It is also very cheap. Yet there was one huge difference between DC and LA transit--and I am not referring to the fact that Washington's Metro rail system excellent and LA's Metro rail system doesn't go enough places to be all that useful. Rather, it is the fact that one sees all economic classes on transit (including buses) in Washington, but not in Los Angeles (perhaps I am making too much of an assumption based on people's attire, but I don't think so.) A conclusion one might reach is that people who don't have to take transit in Washington do so anyway, while only people who have no choice but to take transit do so in Los Angeles.

Perhaps a reason for the difference is that Washington Metro rigorously enforces its rules prohibiting eating, drinking and loud noises. While I long thought the eating and drinking rules were extreme (especially when I really want a coffee during my ride in), I have to admit that one of the reason Metro is so pleasant is that it remains very clean. On the other hand, when I rode transit in LA, I encountered three winos drinking out of brown paper bags. And the vehicles themselves were no where near as clean and pleasant as their DC counterparts. I must confess that such conditions make me less likely to use transit.

It is important for transit to be considered an acceptable option for travel for all economic classes--it is one of the ways to develop a political consensus behind it. While once upon a time I couldn't imagine myself saying this, perhaps all transit systems should consider adopting Washington's rules--and enforcing them.

Witold Rybczynski Presents an Eero Saarinen Slideshow

Rybczynski's slideshows are marvelous, and this one is no exception. But it also inadvertantly underscores the problem with architecture.

Ryncsynski supports Saarinen's own view that the Finnish architecht's best building is Dulles Airport. When one drives up to Dulles, it is indeed magnificent--particularly at dawn and dusk. Its large mass is made human by its airiness.

But as a functional airport, Dulles is pretty much a disaster, in part because of the mobile lounges that are Saarinen's invention. I use Dulles between once and twice a month (Reagan National, a wonderful airport, doesn't do international flights or frequent flights to the West Coast, and Baltimore is too far away), and it is even more irritating than most airports. When one departs, the security lines move slowly, and when one arrives, it takes about 45 minutes to get from the airplane to one's car in daily parking. Among large airport terminals in the United States, O'Hare, San Francisco, Dallas and the new Detroit airport, while not as astehtically attractive as Dulles, work far better (note that I am talking about the buildings, not the air traffic sitution).

A visiting ghost?

Statcounter lets me know more or less from where my blog visitors come, and it is fun to see I have visitors from Singapore to Duluth. But a weird one turned up when I looked tonight--Arthur Anderson. I didn't think it existed anymore, unless Accenture has the url of the old accounting business.

Judge Glock Corrects me

He writes:

HUD has actually eliminated the old "take one, take all" Section 8 policy as well as the "endless lease" policy, since, I believe 1994. The change has made landlords more willing to accept vouchers, but, as the problems with the "Moving to Opportunity" program show, it is difficult to convince receipents, even with counseling and even with landlord consent, that they should move away from high-poverty neighborhoods. Maybe that is because they understand what the empirical evidence now shows: the benefits are minimal at best.

Update: Congress repealed the "take one, take all" provision in 1998. Some states, however, maintain the provision; there is currently an argument over whether federal law preempts the right of states to have such a provision. Courts in New York and New Jersey have order landlords to keep Section 8 tenants after their leases have expired (see Rosario v Diagonal Realty, LLC for NY, and Franklin Tower One v. N.M for NJ).

I will try to find out more, but so far as I can tell, Tennessee (the subject of The Atlantic piece) respects the repeal provisions.

Hanna Rosin writes about the spread of murder in Memphis

It is in the most recent Atlantic, and it reports on recent work of Phyllis Betts (among others) on how crime has spread out from central city Memphis. I have asked Professor Betts for her papers, and am looking forward to reading them.

One passage in the Rosin piece, though, really hit me:

Studies show that recipients of Section 8 vouchers have tended to choose moderately poor neighborhoods that were already on the decline, not low-poverty neighborhoods. One recent study showed that...voucher recipients seemed not to be spreading out, as they had hoped, but clustering together.

I have for some years argued that Section 8 has been the country's most successful housing subsidy program. The program, which provides recipients a voucher that fills the gap between 30 percent of family income and area market rent, has been a far more efficient mechanism for providing subsidy than public housing or Low Income Housing Tax Credits. Yet the piece's point is likely correct.

It may also be a product of the program's design: on the one hand, landlords can refuse to take any Section 8 tenants; on the other, once a landlord takes one Section 8 tenant, he needs to take any Section 8 tenant. Perhaps a rule that would require all landlords to accept Section 8, but would also allow them to cap any one building to, say, 30 percent Section 8, would help reduce the problems described in the Rosin piece.

Will Rogers said...

"I belong to no organized party. I am a Democrat."

Perhaps he will (finally) be wrong this fall.

Federalism and Taxis

Taxicabs in the Washington area are regulated by various jurisdictions--DC cabs may not pick up fares in Virginia and Maryland, Virginia cabs can't get passengers in the District and Maryland, and District Cabs are forbidden from pick ups in Maryland and Virginia.

This produces a perverse and wasteful outcome, especially at our airports. My family and I were dropping off a visiting friend at Dulles today, and on the way back I noticed a bunch of empty DC and Maryland cabs on the Dulles access road. The distance from Dulles to DC is about 25 miles--this implies substantial time is wasted and greenhouse gases emitted every day for no good reason. Once upon a time this might have been a small thing, but that is no longer the case.

The right House Price Index for Analyzing Fannie/Freddie's Finances

In this month's Atlantic, Bob Shiller has a thought-provoking piece on how to attenuate the mortgage meltdown. In that piece, however, he juxtaposes Freddie Mac Chief Economists' Frank Nothaft's statement that the company has modeled the company's financial health assuming a 13.8 percent decline in house prices with his own that real house prices have fallen by 15 percent from peak to trough.

From the standpoint of mortgage performance, it is nominal, not real, house prices that matter, because mortgage balances do not adjust to changes in the price level. So long as nominal prices rise, the incentive to default is low, because home equity will be increasing.

Just as problematic, Shiller is applying the Case-Shiller Index to make conclusions about Fannie/Freddie performance. But for evaluating Fannie/Freddie, the OFHEO purchase index is best, because it only contains loans that Fannie/Freddie actually fund, and because it is based only on transactions. This index has fallen 3.1 percent from peak so far. This is nothing to celebrate, but it is well within the realm of what Freddie modeled.

My Daughters Graduate from High School Today

One is off to NYU this coming fall; the other is off to Northwestern. I am wistful...

Brad Delong Directs me to Rick Perlstein on Chicago in the 1960s

Perlstein writes:

Long story short: Douglas soldiered on, imploring his constituents to remember the favors they had received from the Democratic Party—entree, for one thing, into the world's first mass middle class of factory workers. To no avail. Percy won in an upset. Pundits said it was because Percy's daughter had just been brutally murdered; it was a sympathy vote. But if people voted for Percy because he was a grieving father, the ratio of the sympathetic to the callous was suspiciously high in the Bungalow Belt neighborhoods where Martin Luther King had marched. A ward analysis demonstrated that in Chicago neighborhoods threatened by racial turnover, new Percy voters were enough to account for Douglas's 80 percent decline in the city since 1960. Pundits also pointed to people's unwillingness to vote for such an old man. But in the backlash wards younger Democrats declined almost as significantly.

No, it was voters like this, from 4315 W. Crystal:

A few years ago I had written you a letter stating how I and my family would welcome the opportunity to vote you in to the highest office in the land--The Presidency. Since that time however your support of the open occupancy bill has caused me to change my support of your candidacy for senator of Illinois, and believe me sir there are many more in my category who are changing in their support of you.

Here is the fundamental tragedy of the backlash: Voters like this empowered a party that decided they didn't need protection against predatory subprime mortgage fraud. Didn't need affordable, universal health insurance; made it easier for companies to rape their pensions; kept on going back to the well to destroy their Social Security; worked avidly to shred their union protections. Fought, in fact, every decent and wise social provision that made it possible in the first place for mere factory workers to live in glorious Chicago bungalows, or suburban homes, in the first place.

Now a black man from the city King visited in 1966 and called more hateful than Mississippi is running for president, fighting for all those things that made the mid-century American middle class the glory of world civilization, but which that middle class squandered out of the small-mindedness of backlash.

This post is for Chicago. This post is for America. This post is for our future. This post is for our history—that we may redeem it. This post is for a man who, had he walked down the wrong street in his own city 42 years ago, might well have been beaten to death.

This passage brought back to me a long suppressed memory: that when I was a boy growing up in Wisconsin, I was brought up to despise Richard Daley's Chicago. When my parents (who brought me up to be a non-knee-jerk liberal, and who gave volunteers for Gene McCarthy a place to sleep in our finished basement) introduced my brother and me to big cities, it was to New York and Boston (our roots) and Minneapolis that we went. I am pretty sure my first visit to the Art Institute came while I was in college, and I think the first time I heard the Chicago Symphony live was the summer before college (actually, I remember that quite well--James Levine conducted, Stephen Bishop played piano, Mozart K 467, Tchaikovsky 4).

Now Chicago is my favorite American city, in part because it seems so...diverse. And it is a place that has reinvented itself from being a manufacturing city to a business services center, and that has among the most diversified economies in the country. Somehow, when I think of Chicago now, I think only of the city that it has become, and of the city depicted in Bill Cronon's Nature's Metropolis and in Wytold Rybczynski's City Life.

But Rybczynski writes about how Chicago's reconstruction out of brilliant white stone after the Great Fire led it to be known as "White City." Unfortunately, until much too recently, many of its residents took that sobriquet all too literally.

Lawrence Yun Writes

in response to my statement that he should apologize to Robert Shiller:

Perhaps I should have been more careful in my wording when I referred to Dr. Shiller having an incentive to "scare" the market. Dr. Shiller has been one of the most pessimistic prognosticators regarding the housing market forecast for the next several years - with U.S. home prices falling to the tune of 40 percent over the next decade. Who in their right mind would buy a home if such predictions are to be believed? When people ask me if Dr. Shiller is purposely trying to scare the market for his financial benefit, I reply that he is a well-respected scholar and I believe he genuinely believes that home prices will deeply contract. I further add that I do not think he wants to personally profit from people using hedging strategies as offered by his company MacroMarkets. It is a financial innovation that may indeed bring many societal benefits at some point by spreading risks to those who can presumably better handle them. However, one key element that has been missing in this discussion is disclosure.

Bob Shiller has never hidden his relationship with MacroMarkets. In fact, nowadays when he writes paper and goes on TV, he is identified as being with Yale and MacroMarkets. I am not sure there is much more that he could do to disclose.

So that I disclose fully, I worked for the Wisconsin Realtors Association when I was a graduate student from 1987-1990, and consulted with NAR on their existing home sales rebenchmarking. I think the EHS series is well done, but of course I have every reason to think so.

This, alone, means there will be improvement

From Barack Obama last night:

"I face this challenge with profound humility, and knowledge of my own limitations."

From John McCain yesterday:

"They might think me an imperfect servant of our country, which I surely am."

I very much prefer one to the other, but I have to ask, when is the last time we had a President would would say something along these lines?

The Problem with Motorcycles

Uncle Billy thinks I should ride a motorcycle to work. The problem is that according to the Insurance Institute, the fatality rate for motorcycles is 35 times that rate for automobiles. And while I have enough life insurance to get my kids through college, I would like to think that they would miss me.

Looking for Auto Advice

When I move to California late this summer, I will need to drive to work (ugh--I have only had to do this for about four years out of my entire adult life). I do NOT want to drive my Odyssey minivan to work everyday; I think I have narrowed it down to buying a Cooper Mini or a Prius. I welcome any and all thoughts.

Vanessa Gail Perry says that People Overestimate their own Credit Quality

My colleague Vanessa Perry has a study on people's perceptions of their own credit quality:

ScienceDaily (Jun. 2, 2008) — A new study examined consumers’ self-assessments of their credit rating and found that respondents were more likely to believe they had average or above average credit and those who overestimated their credit quality were less likely to budget, save, and invest regularly.

The study's author, Vanessa Gail Perry, Assistant Professor at the George Washington University School of Business, concludes that "Overestimating credit ratings is partly a function of a lack of financial sophistication. In addition, it appears that people who have overestimated their credit rating take less care in managing their finances.”

Professor Perry analyzed data from the Freddie Mac Consumer Credit Survey. The survey collected data on attitudes, behaviors, knowledge and experiences with credit and financial management from around 23,000 people. Results indicate that approximately 32 percent of respondents overestimated their credit ratings, while only four percent underestimated their credit ratings. The findings support previous studies in judgment and decision-making that show that individuals are more likely to be overconfident about their knowledge or abilities.

Those who overestimated their credit ratings had lower incomes, less formal education, and were less likely to own their homes. They were also more likely to be African-American, Hispanic, or female. One possible explanation for these results is that minority consumers in general have less experience with financial markets which in turn affects their tendency to overestimate their credit rating.

Matt Carter has a good piece on House Price Indexes on Inman News

He notes:

1) Case-Shiller and OFHEO look at repeat purchases and exclude new home purchases, but OFHEO also throws in appraisals that are generated when people refinance their homes. As we have all become very cognizant of lately, what a house will appraise for and what a house will actually sell for on the market can be very different things.

2) OFHEO doesn't consider transactions involving loans that are too big or too risky to be guaranteed by Fannie and Freddie, and acknowledges that homes with these mortgages on the upper and lower price ranges are seeing bigger price declines than the homes it tracks.

3) NAR looks sales of existing homes listed by MLSs, and reports median home prices, which reduces the impact of price volatility in upper price ranges.

The result is that the Case-Shiller index can show more extreme swings in price -- both up and down -- than NAR or OFHEO's numbers.

There are actually three Case-Shiller indexes -- monthly 10- and 20-city surveys, and a quarterly report that looks at all nine U.S. Census regions. The monthly survey is the one people tend to get the most worked up about, because it looks at 20 metropolitan statistical areas that include hard-hit areas like Detroit, Las Vegas, L.A., Miami, Phoenix, San Diego and Washintgton D.C. -- all of which have experienced double-digit price declines in the last year.

To the extent that the monthly Case-Shiller index can mistakenly be interpreted -- by a cursory reading of a headline, perhaps -- as representing the state of the nation's housing markets, that's a problem. And Ross is not alone in pointing out that Case-Shiller can also miss trends in micro-markets, like Manhattan, because it doesn't track sales of condos and co-ops.

He also points out that Lawrence Yun, Chief Economist of NAR,

...goes after Robert Shiller, the Yale economist who helped develop the Case-Shiller index, claiming that as a co-founder of MacroMarkets LLC, he profits from the trade of housing and futures options on the Chicago Mercantile Exchange and has a financial incentive to "scare" the market."

"The more hedging of bets that occur, the more profits go into Dr. Shiller’s bank account," Yun claims. "And more hedging of the bets will take place if people believe there will be a crash in housing values."

This is a disgraceful smear. I don't always agree with Shiller (I thought and still think he called the housing bubble prematurely), but he is a great and scrupulous scholar. His work has been cited on google scholar more than 10,000 times; Lawrence Yun has been cited twice. Despite this, I have seen Shiller express becoming modesty about his attempts to get a futures market going--something that would very much benefit consumers, were it to work, and that could reduce volatility. I am actually skeptical about whether futures markets can work in the housing market, and people actually hedge themselves pretty well by using mortgages (which are essentially a short position). But I very much admire Shiller's efforts to get one going--it is rare that such a first rate academic tries to create something so useful. As for Lawrence Yun's potential conflict of interest, let's not go there. But he owes Case and Shiller both apologies.

Reflections on the Real Estate Market from a meeting in California

I have just returned from my first Lusk Center Retreat, which took place in gorgeous Santa Barbara. The group at the retreat included among the most successful real estate developers and financiers in California, as well as guests from Wall Street. The weather was sunny; the mood of the group was not. Some takeaways:

(1) Every person in the room but one thought that the country was either in or headed into a recession. This may have reflected more about current conditions in California--and in particular in the Inland Empire--than the country as a whole. Then again, California is by itself an awfully large part of the country.

(2) Commercial real estate transactions have dropped precipitously. One person did report closing on a deal with a 4.9 percent capitalization rate, but many in the room were saying that transactions were off by as much as two-thirds from a year earlier. The story: bid-ask spreads are very wide, and because market fundamentals are good, sellers do not feel pressure to sell at a fire sale price.

The implication to me is that capitalization rates have risen. Given that spreads have risen in other financial markets, it seems to me that cap rates should be at least 100 basis points higher than a year ago, and perhaps 200 basis points higher. This would imply shadow values falling by between 15 and 40 percent. This will begin to create a problem when commercial mortgages, which usually feature balloon payments, begin getting refinanced in large numbers over the next few years.

(3) Raw land in the inland empire has less than zero value.