Property Rights and Property Values in Asia

Global Property Guide is a wonderful web site with lots of fun facts about property markets around the world. I was looking through its data this morning in order to get information for a project I am doing at the moment, and I couldn't help but draw a plot:





The X axis is a measure of property rights by country: property rights are weakest in Vietnam and strongest in Singapore and Hong Kong. Note the correlation. Even though the property rights index is only ordinal, it has a correlation of .78 with the price per square meter of a 120 square meter flat in the national and or financial capital of each country.

On the one hand, one would expect freer property rights to encourage productivity, and therefore produce higher incomes which would leads to higher prices. On the other hand, stronger property rights should also make housing supply more elastic, and therefore reduce property values.

India is (as is often the case) the outlier here: property rights are not strong, but prices are very high. Indeed, the price of a flat in Mumbai, where per capita PPP income is at about 1/6 the US's, is comparable to Manhattan, and much more expensive than Los Angeles. But Indian policy has fettered housing construction over the years, and Mumbai is the financial and cultural capital of India, so its very high prices (especially in context) should not be surprising.

One person's perspective on bonuses

When I followed my wife from Madison to Washington in 2002, I thought it would be a great opportunity to try something different from academia. While I enjoyed being a professor very much, it struck me that I could learn more from doing something else for awhile. I hence wound up at Freddie Mac--where in about 16 months I learned more about mortgages and human nature than I ever thought possible.

Money was actually not much of a motivation for the move. My salary at Freddie was slightly higher than my nine-month salary at Wisconsin's School of Business. But at Wisconsin I could get two-months of summer research support (or 22 percent), whereas at Freddie I might get a bonus (typically 15 percent). So in the end, total compensation in the two places was pretty much even--although Freddie's cafeteria was much better.

That said, I can't say that I ever counted on getting the bonus. Indeed, I figured that if the company did badly, there would be no bonus. As it happens, during the one full year I was at Freddie, 2003, the company did very badly indeed, not financially, but ethically. In the wake of an earnings smoothing scandal, most senior management was fired. I suppose this wasn't the fault of we worker bees, but it occurred to me that I should have seen it coming. Before I joined Freddie, I asked a Senior Vice President how Freddie could continue to make good on its promise of double digit earnings growth, given that the mortgage market was finite and that Fannie and Freddie together good gain no more than 100 percent of the conventional conforming market. Has answer was, "that is a good question."

I asked a good question, but I was too naive to consider the implications of a reasonable answer. So while I wasn't responsible for the company's troubles, I should have known enough to avoid the company, and having gotten myself into it, I shouldn't have been surprised if there were no bonuses.

It turned out we did get bonuses. The amount was not the full 15--I don't remember anymore exactly what it was--but it was substantial. I have to admit this mystified me until it dawned on me--workers tend to think of bonuses as an entitlement, rather than, well, a bonus.

Mortgages and Uncertainty

My understanding of the Obama-Geithner plan for restoring financial institutions is that it rests on a hope and a prayer: a hope that no more mortgages will go underwater, and a prayer that underwater mortgages will get paid back at something close to par.

FWIW, my view is this sort of dithering is similar to what the Japanese did in the 1990s, and what we did with the Savings and Loans through the 1980s. The argument is that the mortgages on bank balance sheets are worth more than their current market value, and that by basically forbearing, the financial system can wait out (sweat out?) the problem.

I fear that part of the problem is that Geithner doesn't have mortgage experts on his team. Many people who are brilliant at finance do not understand the behavioral aspects of mortgages (a year or so ago, Eugene Fama called mortgages uncomplicated). The problem is that mortgages have lots of embedded options, and that borrowers do not always exercise them ruthlessly. They exercise the call (prepayment) option when it is out of the money because they have to move. They fail to exercise the call option when it is in the money because they can't be bothered. They fail to exercise the put (default) options when it is in the money, because they care about their reputation for paying their bills, or because they don't know the real value of their house. They do exercise the put option when it is in the money because they lose their job, or they get sick, or they have marital difficulty. And the option can move in and out of the money with remarkable swiftness.

Modeling all of this is hard work, because financial models--such as those used to value callable corporates--are just not sufficient. If we set up something like a home owners loan corporation, we could recognize losses at their likely maximum, and keep mortgages current going forward. It seems to me that this would do the least harm and allow the financial system to reset.

For Excellence in Film Reviewing

Go to:

http://filmlinc.wordpress.com/

How big a tax advantage do owners have relative to renters?

Bill Wheaton's comment at UCI a few weeks ago continues to haunt me.

Let's ignore financing for a moment (because interest is deductible for both owner-occupants and landlords). According to Morris Davis, Gross Imputed Rent is about 4.6 percent of house value. One is functionally allowed to deduct the value of that income for determining taxes.

The depreciation schedule for rental property is 27.5 years/ straight line, or 3.6 percent of value. Only buildings are depreciable, and in the US, this is about 80 percent of value, so 3.6 percent x .8 = 2.9 percent. Owner-occupants may not deduct operating expenses, while landlords are allowed to do so. Figure this adds another one percent to the deduction. We are at a 4.6 percent deduction for owners, and 3.9 percent for landlords. This is a pretty small difference

But the average owner occupant is almost surely in a lower marginal tax bracket than the average investor in apartments. If the average owner pays a 20 percent marginal tax rate, and the average landlord pays 25 percent, the tax deduction to landlords is actually a little higher than the tax deduction to owners.

Neither owner-occupants nor landlords pay much in the way of capital gains taxes (owner-occupants get a large exemption, while landlords can use exchanges to defer capital gains taxes forever).

The tax treatment of housing still encourages high income people to buy bigger houses than they otherwise might (because the value of the subsidy increases with one's tax bracket), and this is distributionally obnoxious. But given the magnitudes we are talking about, I am guessing the deadweight loss created is pretty small.

I don't think the depreciation allowance for rental housing is unreasonably high: building that are not recapitalized will wear out before age 27.5 (try going without a new roof or furnace for 27 years). So it is not clear to me how the tax code particularly favors housing relative to other investments.

US Housing Policy is about to get better

From today's Washington Post:

Raphael Bostic
Department of Housing and Urban Development
Assistant Secretary for Policy Development and Research
Announced: March 18, 2009


Bio
Education: Harvard University, AB; Stanford University, PhD
From: Los Angeles, CA
Ethnicity: Black
Bostic is a professor at the University of Southern California's School of Policy, Planning, and Development. He studies the roles that credit markets, financing and policy play in enhancing household access to economic and social amenities.

Last Job
University of Southern Çalifornia, professor at School of Policy, Planning and Development
Other Job
University of Southern Çalifornia, director of Master of Real Estate Development degree program

Morris Davis' Rent-to-Price Ratio is rising

Go to this page. Click on the word "here."

At 4.67% (based on Case-Shiller) it is it at its highest point since 2000. With mortgage rates as low as they are, this implies people think rents are going to fall for awhile.

I am doubtful Obama's MID cut-back would affect California much

President Obama has proposed reducing the rate at which households with incomes above $250,000 would benefit from the Mortgage Interest Deduction. The value of the deduction would be reduced from as much as 35 percent to 28 percent.

But here in California, where state income taxes are very high, I calculate that the vast majority of those with incomes in excess of $250,000 pay the Alternative Minimum Tax, which has a top marginal tax rate of 28 percent. (I base this claim on using the NBER TAXSIM model). This means most Californians would not be affected by the proposed change.

Perhaps I am missing something here--if so I would appreciate enlightenment.

Comments on William Fischel on Property Taxes and School Finance

Comment on William Fischel, “The Median Voter and School-Finance Reform:
How Tax-Base Sharing Undermines the Efficiency of the Property Tax”
Richard K. Green
University of Southern California
February 12, 2009

In the course of 18 years as an academic, I don’t think I have ever had an assignment as intimidating as discussing a paper by William Fischel on the property tax. The only thing worse would be to discuss a paper by Professor Fischel on zoning.

So let me begin by agreeing with many of the points Professor Fischel argues in his paper:

o The median voter in most instances makes pretty smart decisions. The anecdote about the general correctness of majority answers to his multiple-choice exams illustrates the point quite vividly.

o A tax price of unity for school funding produces good outcomes. Districts with tax prices of less than unity will spend more on schools, sometimes for good, and sometimes not. Districts with tax prices of greater than unity might well underspend on schools. Certainly, when tax prices are higher for schools, households are willing to spend less on schools.

o Redistributive funding mechanisms that raise the tax price of schools in some districts can be counter-productive.

In the end, though, this is not entirely satisfying. The fact is that differences in property values, and in tax prices (before redistribution) produce unequal outcomes for school children. As Oates (1970) showed, in a regime where schools are funded locally, higher school spending produces higher property values. The inference we may draw from this is that the net benefits of schools were greater than the net costs of funding them. At the same time, the inequality may be self-reinforcing, as I will discuss below.

To illustrate the problem, let me use as examples two places where I have lived: Wisconsin, and Metropolitan Washington. Wisconsin nicely illustrates two dilemmas about using the property tax to finance schools. First, the distribution of property values per pupil is both highly dispersed and skewed (Figure 1). The average school district in Wisconsin has taxable property per pupil of $664,000, while the standard deviation of property values is $773,000. The dispersion is not driven just by outliers: at the top quartile of the property value distribution, property value per pupil is roughly double the value at the lowest quartile of the distribution.

At the same time, the tax price of schools varies dramatically. In the Town of Brookfield, more than 50 percent of property value comes from commercial property, so the tax price is quite low. In the city of Wisconsin Rapids, on the other hand, substantial chunks of manufacturing property are exempt from the property tax, and farm land is taxed at use value. Because of this, residential property makes of a disproportionately large share of the tax base, and the tax price for schools is higher there than elsewhere.

Turning to Metropolitan Washington, we see the correlation between school quality and house prices, when we look at four suburban counties: Montgomery and Prince Georges Counties in Maryland, and Arlington and Fairfax Counties in Virginia. Average SATs in three of the four counties (Montgomery, Arlington and Fairfax) were above 1600, while the SAT in Prince George’s County was 1283 in 2007. At the same time, the median price of a house in Montgomery County was $475,000, and in Fairfax and Arlington Counties was above $500,000 in 2007, while in Prince George’s County it was $340,000. While house prices in Washington, DC are high (the median price was $450,000), the city has a shockingly small number of married couple families with children. Moreover, the parts of the city with the worst schools—the area east of the Anacostia River—have median house prices in the $250,000 range.

I don’t want to push this too far: Montgomery County is closer to the job centers of metropolitan Washington than Prince George’s County, but Montgomery’s network of roads is actually not as well developed. We of course cannot draw any statistical inferences about capitalization in the DC area, but we can certainly have suspicions.

If school quality gets capitalized into prices, we get both a current and intergenerational dilemma. Because house prices are so high in the areas around DC except for Prince George’s County, the best public schools in the region are not accessible to low-income students. This places these students, already at a disadvantage because of the circumstances of their households, at a disadvantage in accumulating human capital, leading to increasing income inequality across generations.

Because Professor Fischel related personal anecdotes, I will relate one too. My kids went to a magnet high school in Montgomery County, Maryland. Both the students with whom they went to school and their teachers were extraordinary. I often thought it must be both a pleasure and pain to be a teacher or principal in Montgomery County: a pleasure because the students are generally so serious; a pain because the parents are heavily involved with the schools, sometimes to the point of annoyance. The upshot was that my kids got a lot out of their school, and their parents were content with the education they received.

But I couldn’t help but think about the unfairness of it all. The schools (particularly the high schools) in Prince George’s County and Washington DC were dysfunctional, and the kids who were stuck there had much less promising futures than the kids who got to go to schools in one of the strong districts. While it may be a coincidence that recent data show increasing persistence in intergenerational wealth inequality—who your parents are seems to matter more now than it did a generation ago—my prior is that it is not.

Of course, there is a more direct method than redistributing resources across districts for putting children on a level playing field—vouchers that do not tie children to their local schools. Tom Nechyba argues that it makes no policy sense for geography to determine child outcomes. I tend to like vouchers myself. And yet it is the nexus of geography and schools that leads to the positive outcomes Professor Fischel attributes to property tax based school funding. At the same time, as a practical matter, it would be difficult for parents in Anacostia to transport their children to Rockville, Maryland or Falls Church Virginia, for school.

Compounding the dilemma is the fact that the evidence, much of it cited by Professor Fischel, suggests that central government funding of education does not work very well. Public school systems in California used to be jewels of the state. Over the years in which most school funding has flowed through Sacramento, public schools in California have deteriorated. So where does this leave us?

Perhaps an answer arises from a simple insight of microeconomics: that marginal things matter more than average things. The best policy (or perhaps I should say second best policy) might be one in which all schoolchildren had access to the minimum level of resources necessary to receive an adequate education. I think there might be a great deal of consensus about what constitutes this minimum: proficient reading and math test scores at the grade school level; sufficient numbers of classes to prepare students for college at the high school level.
Each school district would receive the funding necessary to provide the minimum level of education necessary. This might not include such things as AP courses.

From an efficiency standpoint, the ideal tax would be a lump-sum tax leveled at the state—or perhaps even federal—level. Such a tax would, of course, be politically infeasible and regressive. The least distortionary tax I can think or is a sales tax of a value added tax. Any spending a community did beyond the bare minimum would be determined and financed by the community. By doing this, the marginal tax price of marginal improvements in education would be close to unity. Such plans exist, and are known as foundation plans. Many of the people in this room have worked on such plans.

One final point. While the median voter model works well for Dartmouth economics students and New Hampshire Villages, it is not entirely clear that it works well everywhere. Alienation is a serious problem in some places. According to the Los Angeles County register’s web site, only 23.6 percent of registered voters in Compton voted in the last school board elections there. Perhaps more problematic for Los Angeles County is that a very large share of its residents are not even eligible to vote.

Do I suffer from NIMBY creep?

Revealed preference tells me I like living in older, close-in, suburbs. While in Madison, I technically lived near the middle of the city in a neighborhood called University Heights, from which I could walk to work (although if it dropped below -10 F, I would drive). But Madison is pretty small, so the neighborhood felt suburban. My house was built in 1927. From there I moved to Bethesda, MD and lived in a house built in 1936: a rare vintage for the US but not so much for the DC area. Now I live in a house built in 1911 in the south central part of Pasadena. Pasadena is unusual among suburbs, in that it is very much a stand alone city, with lots of employment and center-city amenities. But it is still a suburb.

The neighborhood in Madison has a number of tri-deckers; the neighborhood in Bethesda has nothing other than detached single-family units, but the houses, while nice, were kind of dull. Had someone suggested rezoning the neighborhood to allow denser development, I would have not objected.

Here in Pasadena, land values are sufficiently high that rezoning would doubtless produce an increase in multi-family housing. I think a four story, 16 unit building would fit on my lot rather easily. More than that would be a problem because of the street infrastructure around here.

This would allow Southern Californians of average means to live near shopping and schools and (perhaps) close to work who might otherwise live in the far eastern reaches of the San Gabriel Valley. It would allow more people to have access to the Gold Line, which is within walking distance. The economist in me thinks that the neighborhood should be rezoned to allow for higher density, and land values suggest that such rezoning would produce redevelopment when the market comes back.

The non-economist in me thinks this would be a shame. The neighborhood is filled with Arts and Crafts houses from around 100 years ago, most of which are lovingly maintained. As I walked home this morning from Peet's coffee (where I was discussing land use issues with my colleague Chris Redfearn), I marveled at the beauty of the old suburban landscape. Does this have policy implications? What are they?

Program Note

I will be on KPCC tomorrow at 11:07, talking about Obama's plan to reduce the mortgage interest deduction for those making more than $250K. I am for it: those making that kind of income are going to be homeowners anyway, and it will slightly increase the incentive to own with equity instead of debt. There will be someone else on who is against the proposal.

How much context should Newspapers provide?

This past weekend, the Washington Post asked three finance gurus, Peter Lynch, Burton Malkiel and Bill Gross, for investment advice. All three are wonderfully smart and have different takes on the world. As such, the Post performed an important service by getting the opinions of the three.

But...Bill Gross advised against owning stocks at all. He runs a fixed-income fund. Do readers understand that he therefore directly benefits when bonds outperform stocks? Should this be explained to people? A few years ago, I had much more of a caveat emptor attitude toward investing, but the world has changed. I am not saying that Bill Gross doesn't believe in the advice he is giving--I have little doubt that he does. But his beliefs are, just like the rest of us, surely shaped in part by his own interests.

Long live the 767

The one daily non-stop flight between LAX and Lima takes about eight hours. The carrier is LAN, and the plane is a refurbished 767.

LAN seems to be nothing special--airline food at its typical worst and slightly surly service people--but the 767 is great. It is the only plane (I think) with 2-3-2 seating in coach. The combination of this seating plan and high ceilings make the plane feel more spacious than any other, and so makes long trips more tolerable. But 767s are getting old; I will miss them when they disappear.

Fight on!

The hardest adjustment to joining the USC faculty has been learning to root for the football team. When I was a kid, I would root for the Trojans against Notre Dame, but otherwise I have been a Big Ten guy my whole life, and USC was just too good.

But it has been a great pleasure to root for the Trojan Basketball team in the PAC-10 Tournament; particularly sweet was the victory over UCLA, with which I will always associate the magnificent and insufferable Bill Walton.

I think USC is underseeded in the NCAAs, and I look forward to further surprises.

What is wrong with this picture?

I gave a couple of lectures at the Central Bank of Peru last week. The driver who picked me up at the airport had returned to Lima after living in the United States for more than 15 years. The reason? he had prostate cancer and couldn't afford to get it treated in the US, so he moved back to Peru to get treated.

My question to Ken Rosen is then, what is wealthy?

He is quoted in today's LA times:

"The problem with this [Obama's plan to cut back on the mortgage interest deduction for those earning more than $250k] is households earning more than $250,000 in New York or California may not be what we call wealthy."

According to the Census, median household income in California is about 60K (in 2007), and in LA County is about 53K. If 4-5 times median income is not sufficient to be deemed wealthy, at what point does a household become wealthy?

Programming note

I will be on KPCC's 'Airtalk' at 10:40 tomorrow morning. The topic is the commercial real estate market in Southern California.

The Oriole Way asks me to try GDP growth and lagged taxes

Pleased to oblige:




The correlation now goes up to .11. [update: I cleaned up the chart a little. On the right side of the oval are Clinton tax years; the left are GWB tax years.]

[Second update. I added the three most recent years. Correlation now rises to .17!]

Fun with Charting Tax Rates and Growth

Just for fun, I plotted the top marginal federal tax rate from 1947 through 2006 against real GDP growth for each year. Here is what I get:



GDP data come from BEA; Federal Tax Data from Brookings and the Urban Institute. The correlation is actually slightly positive (about .098). I am not suggesting that higher marginal tax rates cause economic growth. But it is awfully hard for me to see where a ten percent increase in marginal tax rates for the wealthiest among us will bring about economic ruin.

What is his evidence?

Michael Boskin writes in today's Wall Street Journal:

Increasing the top tax rates on earnings to 39.6% and on capital gains and dividends to 20% will reduce incentives for our most productive citizens and small businesses to work, save and invest -- with effective rates higher still because of restrictions on itemized deductions and raising the Social Security cap. As every economics student learns, high marginal rates distort economic decisions, the damage from which rises with the square of the rates (doubling the rates quadruples the harm). The president claims he is only hitting 2% of the population, but many more will at some point be in these brackets.

I know Boskin is one of my betters, but I am having hard time with this statement. These were the tax rates during the Clinton years, and people seemed to work awfully hard then. I also wonder if it is necessarily the case that our highest paid citizens are in fact our most productive. Given what we now know about the decisions taken by investment bankers, does Boskin really want to argue a strong correlation between productivity and very high pay?

[Update. David Barker in the comments paper points me to an Ed Prescott paper arguing that taxes affect the labor supply. He uses a cross country comparison to do so. But so far as I can tell, his results derive from a simulation model with some assumed parameters about the size of the capital stock across countries and the value of leisure. There are no controls for the relative size of the social safetuy net by country. I can't find a standard error in the paper, so it is hard to know what the results really mean. I certainty don't see firm evidence supporting Boskin's quadratic rule.]

Why not just reduce the principal?

Details of the Obama plane to help mortgage borrowers were released this morning. The order in which the mods will happen: interest rate reduction, term extension, principal reduction.

This is backward. Suppose a $100,000 loan has a 7 percent coupon, and its rate is modified down to 4 percent. The payment drops from $665 per month to $477 per month. This helps, but leaves the borrower underwater, making it difficult for her to sell if she needs to move to a new job.

But a $477 payment, at 7 percent annual interest, has a present value of $71,759. So if the interest rate remained the same and the loan balance was written down by 28 percent, the payment would be the same as an interest rate write-down to 4 percent, but the borrower would have her head above water. If she later sells for more than $72K + selling costs, she can split the proceeds with the lender, who would now basically be a shared equity owner.

I think the people in the Obama Administration are very smart. Why aren't they doing this?

The Amtrak Problem

Passenger rail subsidies make sense in small parts of the United States: Washington to Boston for sure, and perhaps Southeastern Florida, Chicago to Detroit, and LA to San Diego (sorry for being provincial).

Yet Amtrak continues to run far-flung rail lines that make no sense economically. The losses from these lines undermine Amtrak's ability to take on the projects it really needs--like a new tunnel through Baltimore.

Why does it do it? It's web site gives the answer: it runs through 255 Congressional Districts. Amtrak must always run through at least 218 Congressional Districts, whether it makes any sense or not.

Such is the fundemental problem with nationally owned companies.

Nostalgia

NPR's Susan Stamberg had a nice piece this morning on typewriters.

In my first job after graduating from college, I worked for the Department of Energy. We GS-7s were not supposed to type for ourselves--secretaries were supposed to do that. But my handwriting is illegible, and my job required me to write a lot (something like two 10-20 page Decision and Orders a week), so to keep our secretaries from going mad, I needed to be able to type first drafts.

In a supply closet, I found an IBM selectric that nobody else seemed to be using, so I accidentally placed it on my desk. No one said anything, so it stayed there for the remainder of my time at DOE. I loved that thing--before or since, I have never encountered anything on which I could type as quickly or accurately.

Last Dust-up Point Counterpoint

First Chris Thornberg--then me.

Point: Christopher Thornberg

The homeowner rescue plans so far have been failures. Either few troubled borrowers have signed up or, more significantly, within just a few months of having their loans modified a shockingly large portion of the borrowers are back in default. The entire rescue process has accomplished little more than increasing the cost to the banks by extending the foreclosure process that much longer.

There are two possible explanations for this re-default problem. One is that the programs simply don't acknowledge that with loans sharply underwater, folks have little incentive to maintain their mortgages even when payments are being lowered to something more affordable.

It has been claimed that past studies have shown that being underwater is a necessary but not sufficient condition for foreclosure. I would argue that we have never had a housing downturn as dramatic as this one, with people so desperately underwater, and we have never had so many families with such small stakes in the game (witness no-money-down mortgages with initially negative amortization payment levels). As such, past data points offer little in terms of comparison to the current situation. From this perspective, borrowers go along with the mortgage modification plans simply to maintain their housing situation for a few extra months.

The second potential explanation is that these mortgage programs do not screen their applicants for other potential issues, such as the loss of income due to the downturn, debt burdens outside the mortgage or perhaps even verifying income to see if the new "affordable" payment is in fact affordable. As we now know, even with mortgages where incomes were supposedly verified, brokers quickly learned how to game the system in such a way as to not trigger further verification efforts. In other words, many of those prime loans were not.

President Obama's plan is another one-size-fits-all scheme without much effort to distinguish between those who have a reasonable chance of having a workout succeed and those for whom the workout represents little more than a few extra months of free rent. It relies on one streamlined effort to reduce payments with little effort made to try to distinguish those who might be helped from those for whom help is useless.

Is there a better way? Should we study these mortgages on a case-by-case basis? Perhaps -- but the industry has little incentive to make the investments to deal with such complexities. Remember that during the bubble, a mortgage company earned 2% or 3% of the value of the loan for closing a mortgage. This amounts to $5,000 to $10,000 per mortgage in higher-priced markets with little cost to the broker, given all the rapid computerized systems being used to place the money. With this revenue flow gone, the industry has rapidly shrunk. Now the administration is offering a paltry $1,500 per mortgage to servicing companies that try to work things out. This time, however, the cost to mortgage companies will likely be much higher because more individual verification is needed. This simply isn't realistic.

The other option is to have the government pony up even more cash to facilitate the process, with the intent of simply shrinking the potential pool of applicants. And of course we will still have the legal and ethical minefield to negotiate as we work to rescue people from their own really bad financial decisions.

If this sounds like a hopeless situation, you know what? It is! And it is about time we have an honest and open discussion that acknowledges the hopelessness and stops using expensive knee-jerk policies in place of rational approaches. As a nation, we need to allow this process to take place naturally.

Do we need to worry about empty homes and depressed neighborhoods? Sure. But this process is much easier on the back end than the front. How about a national tax break for buying not just any home, but only a foreclosed property? How about generating a new group of potential buyers by simply not allowing current defaults to be recorded on people's credit reports? How about streamlining the foreclosure process, making it quicker and easier for banks to clear properties and find a new buyers, thus reducing their losses?

And most important, we need to think ahead to the changes that need to be made so that we never end up with such a mess again.

Christopher Thornberg is a founding partner with Beacon Economics.


Government inaction would only prolong the pain
Counterpoint: Richard K. Green

I disagree with you on a number of points, Chris.

First, we do have precedent for what is happening now: the Great Depression. While data from that time aren't as good as we would like, we do know that during the early 1930s, home prices fell at a rate similar to today and unemployment was considerably higher. Housing construction declined by 90% from peak to trough (if January's construction number is representative for the year to come, we are at about an 80% peak-to-trough decline now). Despite this, the federal government at the time developed a mortgage modification program that worked rather well, about which I will say more soon.

Second, I continue to think some of the older models of mortgage default are informative. University of Michigan economist Robert Van Order and National University of Singapore economist Yongheng Deng (among others) calibrated sophisticated models of default that looked at markets (such as Texas in the 1980s and California in the early 1990s) that went through substantial price declines. Although I agree that the new world in which we live means we should be modest about how much we actually know, it doesn't mean we should ignore the work that has been done before. The idea that families will not default if they have an equity stake in their house remains compelling to me.

Third, for the government to largely stand back and let nature take its course is, in my view, a really bad idea. Prices have fallen enough in many places that the cash-flow cost of owning now looks very favorable relative to renting -- at least by historical standards. Yet existing and new home sales in January were abysmal. Why? People lack confidence in the future. The Reuters-University of Michigan consumer confidence index is near a 28-year low. Even people who once considered themselves to be recession-proof fear they will be laid off. Under such circumstances, I am not sure we can expect people to run and buy homes whose occupants are in default.

I have long been an admirer of John Maynard Keynes, who talked about the importance of animal spirits to economic health. I do not see Americans' animal spirits recovering until house prices stop dropping. Prices will not stop declining until inventories stop rising. While home builders are doing their part (they have stopped building), allowing many more foreclosures to occur will not help this process.

During the Great Depression, the Roosevelt White House rolled out the Federal Housing Administration to insure mortgages and the Home Owners' Loan Corp. to buy defaulted mortgages. The HOLC bought the mortgages from lenders at prices below the value of the houses that were collateralizing the mortgages. It then modified payments, changing interest-only mortgages with balloon payments into 20-year self-amortizing mortgages. The HOLC worked: It bought mortgages from only 1933 to 1936, but it bought a large number during these years. It put itself out of business when the last mortgage it bought was retired in 1951. The program reduced the default rate on these mortgages by 90%. Because the government could borrow so cheaply, the HOLC actually turned a small profit for taxpayers.

To me, the HOLC (perhaps modified to include a claw-back provision) is the model for going forward.

Redistribution is happening

According to the 2004 SCF, those in the top tenth percentile of the income distribution had about 50 percent of their financial assets in equities (inlcuding mutual funds and retirement funds). Equity values are now down around 50 percent. So...

In the LA Times Dust-up this week

A discussion with Christopher Thornberg

More on the relative tax breaks for owning and renting

Anonymous comments:

What's missing from this argument is that the lander is taxed on the rental income (after the deductions mentioned) but the homeowner is not taxed on the imputed rental income from the home.

The real tax break that homeowners get is not the interest deduction, but the fact that the imputed rental income (what the home would rent for) is not taxed.

This is because I did not write clearly, not because I hadn't considered it. Bill Wheaton's point was that the deduction for depreciation for rental units (about 3.3 percent per year) offsets the non-taxation of imputed rent. Most owners who get lots of net income from imputed rent are the elderly, who have paid off their mortgages. Because they generally have low cash incomes, they are in low tax brackets, which means that the value of the tax benefit are small. Owners of rental units are often in higher tax brackets, which means the value of the depreciation deduction might be high.

How it all washes out is an empirical question, of course...

Principal Reduction or Interest Reduction?

A concern raised with the Obama housing plan is it focuses on payment reduction instead of principal reduction. But a payment reduction based on a cut in interest rates has a de facto impact on principal. While par remains the same, the present value of the remaining payments falls. For anyone who doesn't need to move, this has the effect of reducing the amount owed (the mortgage) relative to the amount owned (the house).

As for those who do have to move, they are still stuck with the par value of the mortgage. On the other hand, a lower interest rate allows for more rapid amortization. An 8 percent 30-year mortgage with a 100,000 balance amortizes by about $835 in its first year, while a 5 percent mortgage amortizes by $1475. Not a huge difference, but every little bit helps.

Are Owner and Renter Housing treated equally under the federal tax code?

UC-Irvine, The MacArthur Foundation and the Rockefeller Foundation sponsored a conference this week on "Housing after the Fall."

The conference featured a number of interesting papers, but one of the most interesting conversations happened in the aftermath of Marge Turner and Denise DiPasquaule's talks on rental housing. They both pleaded for equal treatment of owner and renter housing (as did Stuart Gabriel the day before). But Bill Wheaton and John Weicher made provokative and possibly correct arguments about why the two house tenure are basically treated equally.

The biggest benefit of owner relative to renter housing is that imputed rent is not taxed. But as John points out, those who own their homes with equity are largely the elderly, many of whom have low cash incomes, which means that they have low marginal tax rates a so get small after tax benefits from owning. Both owners and landlords get to deduct interest and property taxes (although owners who pay the AMT cannot deduct property taxes). Landlords can deduct depreciation and maintenance; owners cannot. Landlords are probably in higher tax brackets than renters. Owners are (largely) exempt from capital gains taxes, but so are landlords, who can use like-kind exchanges to defer capital gains taxes forever.

Bill said he did a back of the envelope calculation that shows that the tax code treats the two tenure types about the same. The topic merits further research, but it may mean that those who think owner housing gets treated preferably may be wrong.

Brad Delong (and I) on Robert Barro

Evidence, Logic, and Robert Barro

Hoisted from Comments: Richard Green writes:

Grasping Reality with Both Hands: Council on Foreign Relations Wingnut Watch: Benn Steil: I am glad that Barro's logic escaped you, as well. As I am not a macroeconomist, I figured that it was I who was dense. But it seemed to me that the facts presented in the article showed that even an enormous stimulus that burned a lot of resources (building tanks and ships that will be destroyed are kind of like bridges to nowhere, economically) had very little crowding out effect.

The context is Benn Steil's claim that Robert Barro's January 22, 2009 Wall Street Journal op-ed "provides logic and offers evidence" to support Steil's claim that the interest elasticity of money demand is zero and thus that the fiscal multiplier is zero too.

As I said before, the evidence that Barro presents suggests a multiplier for temporary government purchases not of Steil's zero but instead of 0.8:

Robert J. Barro: Government Spending Is No Free Lunch: Because it is not easy to separate movements in government purchases from overall business fluctuations, the best evidence comes from large changes in military purchases that are driven by shifts in war and peace. A particularly good experiment is the massive expansion of U.S. defense expenditures during World War II.... I have estimated that World War II raised U.S. defense expenditures by $540 billion (1996 dollars) per year at the peak in 1943-44, amounting to 44% of real GDP. I also estimated that the war raised real GDP by $430 billion per year in 1943-44. Thus, the multiplier was 0.8 (430/540).... We can consider similarly three other U.S. wartime experiences -- World War I, the Korean War, and the Vietnam War.... Combining the evidence with that of World War II (which gets a lot of the weight because the added government spending is so large in that case) yields an overall estimate of the multiplier of 0.8 -- the same value as before...

But it is the logic that most puzzles me. Barro writes:

The [Keynesian] theory... assumes that the government is better than the private market at marshaling idle resources.... Unemployed labor and capital can be utilized at essentially zero social cost, but the private market is somehow unable to figure any of this out. In other words, there is something wrong with the price system. John Maynard Keynes thought that the problem lay with wages and prices that were stuck at excessive levels. But this problem could be readily fixed by expansionary monetary policy, enough of which will mean that wages and prices do not have to fall. So, something deeper must be involved -- but economists have not come up with explanations, such as incomplete information, for multipliers above one...

If I read this paragraph correctly, Barro thinks (a) there are theoretical reasons to think that the fiscal multiplier cannot be greater than one, and (b) there are theoretical reasons for thinking that if you believe in positive fiscal multipliers you should also believe that expansionary monetary policy that raises the flow of nominal spending will also raise employment and production--which people do, for it is only when they fear that monetary policy is tapped out and cannot raise the flow of nominal spending any more that they fear that monetary policy may be ineffective.

So I don't understand how Barro gets to his very next sentence:

A much more plausible starting point is a multiplier of zero...

A good plan, except...

I just watched the President outline his mortgage plan. I think it has two of the three key elements necessary: it will get people's loan balance below the value of their houses, and it will reduce payments to a sustainable level. What is missing (or at least I think it is missing), is a clawback provision for those homeowners who get a subsidized loan and then profit on sale later. I think this is critical for fairness. But perhaps I have just not digested the details of the plan yet.

It was so refreshing to see a President explain things so well, though...

Gary Kamiya says the Newspaper Business Model won't work anymore

I have said something like this too, but I think he says it better:

But the real problem isn't that newspapers may be doomed. I would be severely disheartened if I was forced to abandon my morning ritual of sitting on my deck with a coffee and the papers, but I would no doubt get used to burning out my retinas over the screen an hour earlier than usual. As Nation columnist Eric Alterman recently argued, the real problem isn't the impending death of newspapers, but the impending death of news -- at least news as we know it.

....

If newspapers die, so does reporting. That's because the majority of reporting originates at newspapers. Online journalism is essentially parasitic. Like most TV news, it derives or follows up on stories that first appeared in print. Former Los Angeles Times editor John Carroll has estimated that 80 percent of all online news originates in print. As a longtime editor of an online journal who has taken part in hundreds of editorial meetings in which story ideas are generated from pieces that appeared in print, that figure strikes me as low.

There's no reason to believe this is going to change. Currently there is no business model that makes online reporting financially viable. From a business perspective, reporting is a loser. There are good financial reasons why the biggest content-driven Web business success story of the last few years, the Huffington Post, does very little original reporting. Reported pieces take a lot of time, cost a lot of money, require specialized skills and don't usually generate as much traffic as an Op-Ed screed, preferably by a celebrity. It takes a facile writer an hour to write an 800-word rant. Very seldom can the best daily reporters and editors produce copy that fast.

I have one little suggestion for those who want papers to survive. When you are on their website, if you see an ad for anything that remotely interests you, click on it. It is not much, and almost certainly not enough, but it at least will show advertisers that you are reading the site.

Fannie and Freddie must be making large profits on their new business

According to Ken Harney, even if borrowers have a 20 percent down payment, if their FICO score is less than 740, they will pay hefty fees to obtain a Fannie Freddie mortgage. Given how far prices have already fallen, and given that borrowers are required to have a lot of their own money at risk, it is hard to see how the GSEs will lose on these loans, while at the same time they will collect a lot of money in fees.

Of course, they have lots of losses to make up for, so new borrowers are being charged for the mistakes of old management. But this seems neither forward looking nor productive to me.

It should have been Lincoln Institute of Land Policy

And I should have known better...

The Trouble with Washington

I was back at GW the last few days for a conference the George Washington Institute for Public Policy put on with the Lincoln Institute for Land Policy on Local Government Autonomy in the United States.

Overall, it was a great event. I was priveleged to discuss a Bill Fischel paper (Bill knows more about property taxes than just about anyone), and the quality of the discussion was excellent. But when people asked me whether I missed Washington, I had to say "no," but I couldn't quite put my finger on why. Washington is a beautiful city, with wonderful cultural amenities. It is diverse, it has many people there I like very much (and whom I do miss), and I got to read while riding Metro to work in the morning, afther which I would have a pleasant walk from Dupont Circle to Foggy Bottom.

I then came across the following quotes on mydd (h/t to atrios) this morning:

"It's eerie -- I read the news from the Beltway, and there's this disconnect with the polls from the Midwest that I see all around me," said Ann Seltzer, the authoritative Iowa pollster who works throughout the Midwest.

[...]

"I don't think he's lost anything in terms of overall job approval or favorability," said Andy Smith, a pollster at the University of New Hampshire. "That's just the a perception inside the Beltway that everybody outside Washington pays attention to politics and eats and lives politics the way you guys do down there."

I think these quites sum up the trouble with Washington quite well. It is a city full of self-important naval gazers. The biggest difference between DC and LA is that the first question you get asked in DC is "what's your title," while the first question you get asked in LA (outside of Hollywood, anyway) is "how bad was the traffic on your drive here?"




http://mydd.com/story/2009/2/14/1597/39888

Airports are Infrastructure too

Patrick Smith writes in Salon:

"Americans haven't figured out how to build a proper terminal. We fail at aesthetics, we fail at amenities, and we fail at the relatively simple task of moving people efficiently from A to B. The newest terminals across Europe and Asia are attractive, spacious, quiet and efficient, abounding with passenger-friendly touches. Ours, by comparison, often seem engineered for inconvenience and stress. In Amsterdam, Frankfurt, Hong Kong and Kuala Lumpur, Malaysia, passengers step from commuter trains directly into the check-in hall. At Kennedy, getting to or from Manhattan, or just getting from one (brand-new) terminal to another, is like mounting an expedition."

Airports and the air traffic control system are important to economic growth. And yet among the discussions of the stimulus and infrastructure spending, I have heard little about the air traffic control system (or for that matter, the freight rail system and the water ports, all of which have insufficient capacity--and all of which should have higher priority than passenger rail, aside from the Northeast Corridor and perhaps the Great Lakes and Southern California).

Two of our most important international airports, LAX and JFK, are embarrassing. SFO's runway configuration slows traffic dramatically in the face of mild degradations in weather. Atlanta and Dallas are just unpleasant. We have a few good large airports (MSP, IAH and the new DTW come to mind), but most of them are far behind their counterparts in Europe and Asia. The best I can say for us is the French and (remarkably) the Japanese can be just as bad as we are: Charles De Gaulle and Narita are also astonishingly unpleasant.

Would 4 percent mortgages get capitalized into house prices?

I don't know--and neither does anyone else.

I am in the middle of a project with Chris Redfearn and Stuart Gabriel that looks precisely at this issue. Our finding is that capitalization varies a lot by time and place. The coasts are different from the middle of the country; the period before 1997 is different from the period after. When we do rolling regressions across time to attempt to identify capitalization effects, we get very unstable coefficients.

This is not to say borrower relief is a bad idea--I have come around to the view that we need to do it (although I would like to see clawbacks). But let's not kid ourselves--we have no good model to predict the effectiveness of any policy right now.

Ads I can live without

So I am watching one of the best Super Bowl 4th quarters ever, and this ad comes on with an obnoxious baby advising us to stop being passive about our 401(k)s and (basically) to try to pick individual stocks on our own. Does the company that made this ad really think this can work?

On the GSEs (again)

This is an excerpt from my commentary at the Berkeley-UCLA conference on the mortgage meltdown:

Fannie and Freddie’s management teams did unseemly things with respect to accounting, it is very hard to argue that they behaved worse with respect to risk management than investment banks or regulated commercial banks. According to the firms’ monthly volume summaries, their delinquency rates on single-family mortgages remain below 1.6 percent as of November 2008; according to the Mortgage Bankers Association, the overall delinquency rate for that time for the single-family market was 3.93 percent for prime loans, and more than 18 percent for subprime loans. Again, this does not necessarily reflect virtuous management, but rather the fact that the GSEs’ regulator, then the Office of Federal Housing Enterprise Oversight, while often accused of being a weak regulator, actually prevented the firms from engaging in the worst sorts of underwriting behavior. Also quite remarkable is the fact that the delinquency rate for Fannie and Freddie multi-family loans remains at around a basis point.
Among the consequences of this regulation is that the firms lost market share (Figure 1). The pink line in the graph is Fannie and Freddie’s share of mortgage debt outstanding. Note that while it declined sharply from 2002 to 2006, the private label market gained the market share that the GSEs lost. Under the circumstances, it is hard to make the case that the GSEs were the fundamental cause of the mortgage crisis, although many critics would like to think so.
I should disclose that I worked at Freddie Mac for around 15 months. One of the things about the place that was quite striking to me is how seriously its staff took mortgage underwriting. The credit models for the prime book (the business Freddie should have stuck to) were sophisticated, and the arguments about how to do underwriting were at once passionate and scientific. The people responsible for modeling credit risk were, by any standard, well qualified to do so. The chief risk officer of the company at the time discouraged senior management from expanding beyond the prime mortgage business. The GSEs arguably performed their job better than FHA, which has always had limited resources for developing underwriting models.
Senior management of the GSEs was under tremendous pressure to expand their business lines beyond prime mortgages because of the above documented loss of market share. This led both companies, and particularly Freddie Mac, to expand investment into Alt-A mortgages, and it was these mortgages that caused Freddie Mac so much trouble. Had OFHEO been a stronger regulator, or had Freddie Mac been statutorily prohibited from making Alt-A mortgages, the company would still be solvent.
This phenomenon had nothing to do with Freddie Mac’s portfolio per se; even if the GSEs had been in the guarantee business alone, they still would have been under pressure to increase their business. Securitizers in the pure private market put fee generation ahead of due diligence when determining whether to fund mortgages. Keys et al. (2008)showed that loans that were more easily securitized received less lender scrutiny than those that were more likely to be held in portfolio.
If we are going to have GSEs, their re-emergence should rest on four pillars. First, as Jaffee and Quigley suggested in an earlier paper, their cost of funds should reflect the risk they take. This could be accomplished through a tax on new debt issuance. Second, GSEs should be stringently regulated so their products do not depart from high standards of underwriting. Third, to assure one and two happen, GSEs should be forbidden from lobbying. Finally, minimum capital requirements need to be higher, although this (along with the tax on new debt) will raise mortgage costs.
This does not mean the end of GSEs as we know it, but rather a roll-back to where they were in the middles 1990s. Recent events make it clear that the economy cannot rely on the purely private sector to fund 30 year fixed rate mortgages.

The Surprise
If one looks at commentary from the earlier part of this decade on the GSEs, one finds that most of the concerns about them involved market (interest rate) risk, rather than credit risk. Because nominal house prices rose nationally every year between the end of World War II and last year, it was hard to imagine that mortgages would induce a credit crisis. Certainly no empirical model could have predicted the events of the past few years.
This has powerful implications for how we think about capital going forward. Among other things, it suggests that the model-based capital standards proposed in Basel II are not sustainable. It also suggests that there is no substitute for rigorous and admittedly somewhat arbitrary minimum capital ratios for all institutions that lend. This will inevitably mean that the economy will lose out on some positive net present value opportunities. But it also means we will be far less likely to find ourselves in the current situation

John Quigley's solution to the mortgage crisis

But for two things, I like it:

The foreclosure crisis is at the heart of the more general economic crisis. Protecting homeowners at risk of foreclosure is therefore an obvious priority. Here I outline a plan to ameliorate the foreclosure crisis, using the FHA’s mortgage authority to force lenders to recognize the actual values of homes and thus to restructure loans accordingly. The plan has four basic elements.

1) All those who purchased homes after a specified date are eligible, period. There is no distinction between those in arrears and those current in payment. There is neither time nor reason for a fight about moral hazard.

2) Participating homeowners will pay a small amount to register and receive an appraisal of current house value from the Federal Government.

3) If the household is able to make payments on a new first mortgage with a 40 year term for this appraised value, using standard underwriting criteria, then the household will be offered a new FHA mortgage. This new mortgage will be structured as interest-only for an initial period of years. This mortgage will be guaranteed, and premiums will be paid into the existing Mutual Insurance Fund administered by FHA.

The mortgage under these new terms will be reported to the master servicer, who will replace the existing contract with the new contract. Servicers will inform the owners of securities in any pool containing parts of the previous mortgage, and servicers will continue to pass on payments made by homeowners under the new contract to owners of existing mortgage pools or other securities.

4) In addition, when the new contracts mature or are terminated, any capital gain, net of costs, will be divided, with a small fraction accruing to the homeowner. The residual gain, net of costs, will be transmitted to the servicer who will distribute it to the owners of securities or pools in which the mortgage is bundled.

The Big Picture:

The most important thing is that the government force these revised mortgage contracts to be marked to market quickly, to reflect the actual value of the underlying housing.

There also doesn’t need to be a fight over securing the agreement of lenders or owners of securities. Some financial gurus claim that the sanctity of contracts requires agreement. This is nonsense. Terms of contracts are changed all the time by legislation. All this legislation does is to recognize the current market value of the contract. Finally, the biggest contractual change ever in American financial history, the abrogation of the gold standard, was made unilaterally by FDR. If this plan were adopted tomorrow, it would still take a lot of time to gear up a Home-Owners-Loan-Corporation (HOLC)-like appraisal process for hundreds of thousands of appraisals. And time is of the essence. So we need a simple program that can be implemented as soon as you are able to move.

And the cost? With 12M households currently holding underwater mortgages, we can safely assume that the average writedown would be less than $100,000. With a 1 percent default rate on new loans, and a loss on default of $100,000, this might add up to $12B. I used to think this was a lot of money. If the average write down were $100K, and housing prices did not increase at all before the new contracts were terminated or matured, the total private write down would be $1.2T.

This figure does not represent a new loss to the lenders, but rather is a recognition that the underlying asset is less valuable. Each lender or servicer will be given a coupon entitling him to some percentage (perhaps even 100%?) of the gain in value between the date of the new contract and the date of contract termination or maturation.

In effect, we force holders of this paper to mark these assets to market today, and preserve their right to any capital gain on the assets which have been marked to their current value. (But don’t let the bastards securitize these coupons.)

Details:

1) Eligibility is not based on delinquency in payments, and those who have struggled to make payments are not disadvantaged relative to those who are in arrears. The “right” –utterly arbitrary — date of eligibility might be January 1, 2004. (Subprime mortgages increased from about 9 percent of originations in January 2003 to 18 percent a year later, and to almost 22 percent in January 2005.)

2) Participation costs are meant to be small, a hundred or two hundred dollars. The appraisal will be some average of estimates of replacement cost, rental value, and current selling price. This is the same procedure used by the HOLC, and it will not underestimate the current value of the house.

3) The “standard underwriting criteria” could involve the 38 percent payment-to-income ratio of the New Hope Alliance, or Sheila Bair’s number. (I prefer Bair, but I also like vanilla.)

4) The interest-only aspect of the mortgage is not essential, but we are in a recession. That period could be limited to two years.

5) The new mortgage will be structured just like “regular” FHA mortgages with a payment by the household into the FHA’s mutual insurance pool.

6) The owners of the existing mortgages will share in any capital gains realized during the term of the new contract, perhaps in proportion to the writedown in asset value under the new contract. As a result, this is not a constitutional “taking,” and claims to the contrary are incorrect.

My two quibbles:

(1) John is a terrific, admirable economist (there is a difference between the two adjectives) and has long been an intellectual hero of mine. That said, he is not a lawyer, and so I am not sure we can be so sanguine about mass contract modification. Then again, I am not a lawyer either...

(2) I think cap gains should be split at something like 50-50 between homeowners and lenders. If nearly all the cap gains go to lenders, owners will have less incentive to maintain, to expend effort when selling, etc.

Blocks

Daniel Solomon, in his book, Global City Blues, makes a nice point about city blocks: of you want to have a vibrant street life, you need short blocks. San Francisco provides a nice natural experiment. Below is a Google Earth picture of San Francisco:



Notice that there are two grids: one is north of Market Street, and the other is south of Market (SOMA). The area north of Market is among the most inviting urban places I know for a walk; the area south of Market is more intimidating and, in some places, rather sketchy (although it must be said that the Tenderloin, which is north, is rather sketchy too--in the movie Milk, someone points out that among San Fracisco's leading problems is the smell of urine in the Tenderloin). In any event, there is no question that the street life in the northern grid is more vibrant.

What's the difference? It is fairly obvious that the grid north of Market is much tighter. For some reason, this makes it more humane.

I worry that this phenomenon will inhibit downtown Los Angeles from ever becoming a destination for pedestrians. The blocks are extremely long. Once a street grid is in place, it is hard to change it.

Are we calming?

The TED Spread is under 100 bp (just). And my colleague Raphael Bostic points out that intra-day stock price volatility has dropped precipitously. Perhaps soon-to-be- President Obama is soothing us?

One way to define bubble cities

I gave a paper (with Chris Redfearn and Stuart Gabriel) at ASSA last week on how interest rates and income get capitalized into house prices. Our preliminary results show that the following cities had house price elasticities with respect to income of less than one before 1997, but greater than one thereafter:

Albuquerque
Allentown
Amarillo
Appleton
Atlanta
Austin
Baltimore
Barnstable Town
Baton Rouge
Beaumont
Binghamton
Bismarck
Bloomington
Boise City
Boulder
Bridgeport
Canton
Cape Coral
Cedar Rapids
Charleston-SC
Charlotte
Chattanooga
Chicago
Cincinnati
Columbia
Columbus
Corpus Christi
Cumberland
Dallas
Davenport
Deltona
Denver
Des Moines
Detroit
Durham
Elmira
El Paso
Erie
Eugene
Fargo
Farmington
Gainesville
Glens Falls
Grand Rapids
Green Bay
Greensboro
Greenville
Gulfport
Hagerstown
Houston
Jackson
Jacksonville
Kansas City
Kennewick
Kingston
Knoxville
Lansing
Las Vegas
Lincoln
Little Rock
Louisville
Madison
Memphis
Miami
Milwaukee
Minneapolis
Mobile
Norwich
Ocala
Orlando
Palm Bay
Pensacola
Philadelphia
Phoenix
Pittsfield
Portland-OR
Raleigh
Reno
Richmond
Rockford
Salem
Salt Lake City
San Antonio
Sarasota
Shreveport
Sioux Falls
Spartanburg
Spokane
Springfield-MO
Syracuse
Tallahassee
Tampa
Toledo
Topeka
Tucson
Virginia Beach
Washington
Youngstown

This may be one way to define bubble cities. In cities such as Boston and Los Angeles (where the elasticity is always greater than one), large price swings might reflect the fact that the short run supply curve is strongly inelastic.

My friend Stuart Gabriel (UCLA) sends me a petition

And I signed it. I encourage other scholars to do so:

Scholars For Peace in the Middle East

*Promoting Academic Integrity and Honest Debate*

*Petition to Protest Canadian Union of Public Employees (CUPE) Proposed
Boycott of Israeli Academics*

/Written by: SPME Board of Directors/
*January 8, 2009* *To: Academic Colleagues From Around The World to
Protest Canadian Union of Public Employees (CUPE) Proposed Boycott of
Israeli Academics*

We, the undersigned university faculty members from around the world
call upon the members of the Canadian Union of Public Employees (CUPE)
to oppose any resolution to ban Israeli academics from teaching in
Ontario or anywhere else. The current resolution invokes, as
justification for the proposed ban, bombing that damaged the Islamic
University in Gaza on December 29. Sid Ryan of CUPE's Ontario University
Workers Coordinating Committee says: "Israeli academics should not be on
our campuses unless they explicitly condemn the university bombing and
the assault on Gaza in general." No other country's academics have been
the targets of such union action before, whether or not their country
was at war. Israel is engaged in a war to defend its people against an
enemy that has been firing missiles at Israeli civilians for years. The
enemy, Hamas, had been using the Islamic University as a training camp,
launching pad, and weapons depot. Oth! er universities in Gaza were not
Hamas facilities and were therefore not bombed.

The proposed ban clearly represents ethnic discrimination, and the
proposed ideological litmus test is a violation of free speech. The
members of the University and College Union in England recently rejected
a similar proposal because of its discriminatory nature, and we urge the
Ontario CUPE members to reject the proposal now before them.

To show our solidarity with our Israeli academics in this matter, we,
the undersigned, hereby declare ourselves to be Israeli academics for
purposes of any academic boycott. We will regard ourselves as Israeli
academics and decline to participate in any activity from which Israeli
academics are excluded.
*? *Visit Scholars For Peace in the Middle East website
*http://www.spme.net*

*? *To Sign this petition go to
*http://www.spme.net/cgi-bin/display_petitions.cgi?ID=15&Action=Sign
*

*? *To see current signatures go to
*http://www.spme.net/cgi-bin/display_petitions.cgi?ID=15&Action=View
*

Hope from Lutz Kilian?

He has the lead article in the new Journal of Economic Literature on the Economic Effects of Energy Price Shocks. He calculates a one year elasticity of consumer expenditures with respect to retail energy prices of
-.15. The energy component in CPI was down 13 percent from a year ago in November. If the coefficients on his model are stable, this implies consumption growth of 2 percent over the next year. Then again, one of the points of the paper is that the coefficients on such models are not particularly stable.

Syllabus for PPD 437

University of Southern California
School of Policy, Planning, and Development
PPD 437 Advanced Finance and Investment for Planning and Development
Course Syllabus – Spring 2009

Instructor name: Richard K. Green
Instructor phone: (213) 740-4093
Instructor email: richarkg@usc.edu

Course Objectives
This course is an introduction to the fundamental concepts and analytical methods used in making investment and financing decisions. During the course we will begin with single unit residential (single family homes or condominiums) finance and work our way to income producing property finance. By the end of the semester, you will be able to evaluate an income producing property and use pro forma analysis to estimate a value and forecast an investment return. This course will provide you with the basic financial analytic tools for understanding the determination of prices and values in the real estate investment, finance and development arena. Topics will include valuation techniques (especially discounted cash flow analysis) and the relationships among them, as well as issues relating to the uses of debt and equity, leases, taxes, and risk analysis.

At the core of the course is the notion of property valuation. We will begin with a very basic, stylized model and gradually add real-world complexity throughout the semester. We will consider investment in both “stabilized” (fully operational) income producing properties as well as development projects as time permits. We will build our models upon the modern corporate finance and investment curriculum, focusing in particular upon discounted cash flow methodology and the tradeoffs between risk and reward.

Reading Materials
The required text for this course is: Brueggeman and Fisher: Real Estate Finance and Investments, Thirteenth Edition. There will also be numerous reading assignments and financial models/templates available on the Blackboard system.

Required Course Materials
All students must have a calculator with financial functions: HIGHLY recommended model is the Hewlett Packard 12C, which will be used for all in-class examples. All other calculators will need to be learned independently. Students must bring calculators to all classes and exams. Students will be at an extreme disadvantaged if they do not have calculators for exams.

Students will need to have access to Excel in order to complete many of the assignments later in the class. Bringing a notebook computer is also recommended.

You must have access to the Wall Street Journal, LA Business Journal, and a business weekly, such as Businessweek. Students should keep abreast of local and national news and trends in the real estate market. The first 5-10 minutes of class will be spent discussing real estate issues in the news. Each of you will be responsible at some point for leading this discussion.

Course Requirements and Grading
The Course is divided into 16 weeks. Everything done in the class is quantified, including attendance, participation, homework, exams, presentations and final project. There are 502 total points that can be earned during the semester. Students will be graded on their performance on a take-home mid-term (75 points or 15.0%), in class mid-term (125 points or 25.0%) and final project (200 points or 40.0%); homework assignments (60 points or 12.0%) and in-class participation, including demonstrating an understanding of the week’s homework assignments and attendance (42 points or 8.0%).

Class meets once weekly, from 6 pm to 9:30 pm on Tuesday, beginning January 13, 2009 and continuing through April 28, 2008. The final project will be due on Tuesday, May 5, 2009.


Homework
Homework will consist of sets and case assignments, which are designed to give the student the opportunity to employ the techniques of valuation and market analysis in a practical context. These assignments will be graded on a full-credit/no credit basis. To receive full credit, the student should have made a reasonable attempt to solve every problem assigned. All homework assignments earn 10 points to each student.

Take-Home Exam
Students will be tested on class material via one take home exam. Students may work independently or in groups of no more than 3 to complete the exam. Students may choose their teammates.

The exam is worth a total of 75 points.

In-Class Exam
Students will be tested on class material via one mid-term. There will be no final exam. Example problems and study guides will be distributed near the date of the exam to familiarize the student to test formats and expectations.

The exam is closed book and is worth a total of 125 points.

Final Project
The culminating learning experience of this class will be a project requiring you to seek out an actual real estate investment opportunity in the Los Angeles area, evaluate that opportunity, and present your findings to the class. Students will be required to work in groups of 3 to 4 for this project, no exceptions. Further details on acceptable property types, deliverables, etc will be discussed later in the semester.

The final project is worth a total of 200 points and will be based upon the report, presentation and internal group evaluation.

Participation
Lectures will take place once a week and attendance is mandatory. You should arrive on time and should not leave until class is dismissed. Students are awarded 3 points for each class attendance. Only verified personal emergencies will be considered excused absences. If a student is absent more than 3 classes then student shall receive zero credit for attendance for the semester and may be subject to an incomplete for the semester. Total attendance represents 8.0% of your total grade.

Disability Services
Any student requesting academic accommodations based on a disability is required to register with Disability Services and Programs (DSP). A letter of verification for approved accommodations can be obtained from DSP. Please be sure that the letter is delivered to me as early in the semester as possible. DSP is located in STU 301; their phone number is 213-740-0776.

Academic Integrity
The use of unauthorized material, plagiarism, communicating with fellow students during an examination, attempting to benefit from the work of another student, allowing another student to benefit from one’s own work, and similar behavior that defeats the intent of an examination or other class work is unacceptable. Where a violation has occurred, the student will receive an F in the class and may be subject to disciplinary action at the University level. Examples of violations include (but are not limited to) copying off another student, allowing another student to copy off your paper, using a “cheat sheet” in any form during an exam, and refusing to stop when time is called.


Week 1: January 13, 2009
Lecture Topics:
• General Introductions
• Introduction to the course, syllabus and expectations
• Introduction to the Real Estate Industry. “Where to find a job?”
o Developers, Builders, Financing, Consultants, Government
• State of the Market lecture.
• Discussion on Legal Concepts (Chapter 1)

Reading assignments: B&F: Chapters 1 & 2

Homework assignment: None


Week 2: January 20, 2009
Lecture Topics:
• Market Topic (RG presents)
• Discussion of Notes & Mortgages (Chapter 2)
• Calculator Tutorial
• Discussion on Time Value of Money and Fixed Rate Mortgages (Chapter 3)
o Notes & Mortgages
o Present Value (PV)
o Future Value (FV)

Reading Assignments: B&F: Chapter 3 & 4


Week 3: January 27, 2009
Lecture Topics:
• Market Topic (Group 1)
• Recap Week 2
• Review PV, FV and Fixed Rate Mortgages (Chapter 4)
• Begin discussion on Adjustable Mortgages (Chapter 5)

Reading assignments: B&F: Chapter 5


Week 4: Feb 3, 2009
Lecture Topics:
• Market Topic (Group 2)
• Recap Week 3
• Adjustable Rate Mortgages (Chapter 5)
• Sample Problem work

Homework assignment #1: Problem Sets (handed out in class)


Week 5: Feb 10, 2009
Lecture Topics:
• Market Topic (Group 3)
• Review Homework Assignment
• Recap Week 4
• Residential Financial Analysis (Chapter 6)
o When to refinance, what loan term to select, what loan structure to choose?
o Current financing failures
• Singe Family Housing: Pricing, Investment and Tax Considerations (Chapter 7)

Reading assignments: B&F: Chapter 6 & 7


Week 6: Feb 17, 2009
Lecture Topics:
• Market Topic (Group 4)
• Residential Financial Analysis (Chapter 8)
o When to refinance, what loan term to select, what loan structure to choose?
o Current financing failures
• Singe Family Housing: Pricing, Investment and Tax Considerations
• Underwriting and Financing Residential Properties
• Key real estate terms/concepts

Reading assignments: B&F: Chapter 8

Take Home Mid-Term Handed Out and DUE WEEK 7

Week 7: Feb 24, 2009
Lecture Topics:
• Market Topic (Group 5)
• Mid Term Review
• Introduction to Income-Producing Properties: Lease Types, Rents, Expense Reimbursements and the Market for Space
• Creating the Static Pro forma (you will need to build a pro forma on the mid term and come to a value)

Reading assignments: B&F: Chapter 9


Week 8: March 3, 2009

Mid Term

Week 9: March 10, 2009
From this point we’ll be using Excel
• Quick Excel Tutorial (if you have notebooks bring them. We may be able to secure a computer lab)
• Offering Memorandum (OM)
o Property Description
o Location Analysis
o Market Analysis
• Three Methods of Value
o Cost Approach

Homework assignment #2: Individually find an income producing property on Loop Net (www.loopnet.com) that is currently for-sale and write-up a Property Description and Location Analysis for the property. Remember, you are pitching this property to potential investors or debt sources so make it sound good.


Week 10: March 24, 2009
Lecture Topics:
• The Three Methods of Valuation
o Cost Approach Review
o Sales Comparison Approach

Homework assignment #3: Find 5 sale comparables on Loop Net or equivalent (actual sales or listings) and use the template found on Blackboard. Adjust your property to the comparables using the adjustment chart found on Black board. Provide a narrative justifying the adjustments and conclude with a Sales Value for your project.


Week 11: March 31, 2009
Lecture Topics:
• Guest Lecturer – Los Angeles area Appraiser
• Income Approach to Value (continued)
o Direct Capitalization Approach to Value (static pro forma)
o Income & Expenses
o Capitalization Rates
• Creating a Discounted Cash Flow (continued)
o Internal Rate of Return (IRR)
o Discount Rate
o Residual Value (Exit Capitalization Rate)
o Net Present Value (NPV)

Homework assignment #4: Individually, pull 5 rent comparables (actual leases or listings) use the template found on Blackboard. Adjust your property to the comparables using the adjustment chart found on Black board. Provide a narrative justifying the adjustments and conclude with a Market Rent for your property.


Week 12: April 7, 2009
Lecture Topics:
• Guest Lecturer – Equity Broker
• Form Final Project Groups
• Analyzing the capital stack
o Sources of capital
o Debt vs. equity
• Calculating Leveraged Returns
• Modigliani-Miller

Homework assignment #5: In your group, go out and find an income producing property (this is the start of your Final Project). Property must be submitted with property and location descriptions along with photos and a brief paragraph explaining why the property was selected. Additional information will be provided in class. Assignment will be due the beginning of Week 15.


Week 13: April 14, 2009
Lecture Topics:
• Guest Lecturer – Los Angeles area Equity Investor (Chris Chee, Blackstone)
• Case Studies

Reading assignment: A case study will be handed out for review. We will discuss in detail following week.


Week 14: April 21, 2009
TBD

Week 15: April 28, 2009
Lecture Topics:
• Primer on the Development Process and financing
• Review and question answer session


Week 16: May 5, 2009
• Presentations (20 Minutes each)

Syllabus for FBE 589

University of Southern California
Marshall School of Business
Department of Finance and Business Economics

Professor Richard K. Green
Spring 2009
Mortgages, Mortgage-backed Securities and Real Estate Capital Markets
FBE 589 (15473)

Tuesdays and Thursdays


A. COURSE OVERVIEW

This course provides graduate-level exposure to theory and analytical methods used for valuing and pricing mortgages, mortgage-backed securities, and derivatives. In doing so, this course provides insight into not just how mortgage-backed securities and real estate capital markets operate, but also why. It provides a broad overview of mortgage-backed security, in-depth discussion of specific structure finance products, and hands-on exercises to enhance learning of key concepts.

The growth in the scale and complexity of the U. S. mortgage market since the securitization revolution of the 1980s has been enormous. The volume of outstanding mortgage related securities has grown to $7.4 trillion as of the first quarter of 2008. In comparison, the volume of outstanding marketable Treasury securities was about $5 trillion, total corporate debt securities was about $5.9 trillion. The Federal agency mortgage-backed securities outstanding has increased by more than ten times over the last two decades, from about $348 billion in 1987 to over $3.5 trillion by the end of 2007.

At the same time, the market also witnesses the unprecedented turmoil in the secondary mortgage market led by the meltdown of the subprime market starting in late 2006 and early 2007. As one of the most recent fatalities of the subprime fallout, on July 12, 2008, FDIC seized IndyMa
Bank, which had $32 billion in assets and over 10,000 employees, in what regulators called the
second-largest bank failure in U.S. history. FDIC's insurance fund has assets of about $52 billion. The House (on July 23, 2008), and the Senate (on July 26, 2008), overwhelmingly passed a landmark housing bill – the Housing and Economic Recovery Act of 2008 – that will offer up to $300 billion in loans to rescue some 400,000 homeowners at risk of foreclosure in the current crisis, as well as restoring investor confidence in the government-sponsored enterprises (GSEs) Fannie Mae and Freddie Mac. Since then, Fannie and Freddie have been placed into receivership, and Congress has passed the Trouble Asset Relief Program (TARP). We live in interesting times.

The primary objective of this course is to combine the theory of finance with the practice of real estate capital markets to enable you to make intelligent business decisions in increasingly complex and turbulent real estate markets.

B. COURSE ORGANIZATION AND REQUIREMENTS

The course is a combination of lectures, guest presentations, and discussions. There are several
assignments which will not be graded, but suggested answer to the assignments will be posted on
tBlackboard. There is also a group project to be completed by two-student teams. A list of topics for the group projects will be distributed during the semester. Each team will pick a topic and work together to complete their project before April 21. Each team should prepare a 15-minute PowerPoint presentation of the highlights of the project in classes on April 23 and April 28. Each team will also read and prepare comments on one project prepared by another team. Each project group should deliver a draft report to their discussant team by April 21. The report may not exceed 15 pages (double-spaced). The final project report is due on December 3rd.

There will be three quizzes but no final exam. You must have a financial or programmable calculator that can compute annuities and present values. You are responsible for knowing how to use these functions. You will be very unhappy if you take the quizzes without one.

C. COURSE GRADING

Each Quiz: 20%
Project 30%
Class Participation 10%

D. TEXTBOOKS AND READINGS
Textbook:
Andrew Davidson, Anthony Sanders, Lan-Ling Wolff and Anne Ching, (2003) Securitization:
Structuring and Investment Analysis, Wiley Finance. ISBN: 978-0-471-02260-2.
Optional Reference Books:
Anjan V. Thakor and Arnoud W. A. Boot, (2008) Handbooks In Finance: Handbook of Financial
Intermediation and Banking, North-Holland. ISBN: 978-0-444-51558-2.
Danny Ben-Shahar, Charles Ka Yui Leung and Seow Eng Ong, (2008) Mortgage Markets
Worldwide, Blackwell Publishing. ISBN: 978-1-4051-3210-7.

E. BLACKBOARD COURSE INFO WEB SITE
Lecture notes, assignments, solutions, your grades and other communications will be posted on a
Blackboard Course Info web site at http://blackboard.usc.edu under “20091_FBE_589_15473: MORTGAGES AND MORTGAGE-BACKED SECURITIES AND MARKETS (20091_FBE_589_15473).”
Your login ID to the FBE 589 course web site is the first part of your USC email ID before
@usc.edu. Your password is your USC e-mail password. Please make sure you can access the
course web site and download the course materials there.

F. INSTRUCTOR ACCESS
I will hold office hours on Tuesdays 1:00pm - 3:00pm or by appointment. Appointments are
recommended even during office hours as meeting schedules may occasionally conflict with
office hours. E-mail is a dependable way to communicate with me. I will respond to all emails within 24 hours.

Professor Richard K. Green
Office: Lewis Hall (RGL) 331A
Tel: (213) 740-4093
E-mail: richarkg@usc.edu

G. ACADEMIC DISHONESTY
The Use of unauthorized material, communication with fellow students during an examination,
attempting to benefit from the work of another student, and similar behavior that defeats the
intent of an examination, or other class work is unacceptable to the University. It is often
difficult to distinguish between a culpable act and inadvertent behavior resulting from the nervous
tensions accompanying examinations. Where a clear violation has occurred, however, the
instructor may disqualify the student’s work as unacceptable and assign a failing mark on the
paper.

H. DISABILITY STATEMENT
Any student requesting academic accommodations based on a disability is required to register
with Disability Services and Programs (DSP) each semester. A letter of verification for approved
accommodations can be obtained from DSP. Please be sure the letter is delivered to me (or to
TA) as early in the semester as possible. DSP is located in STU 301 and is open early 8:30 a.m. -
5:00 p.m., Monday through Friday. The phone number for DSP is (213) 740-0776.
4
I. CLASS MEETINGS (Note: speaker dates might change)
Date Topics and References
1. January 13 and 15 Introduction: Course mechanics. Overview of Real Estate Capital Markets.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 1-4.

Green and Wachter (2007), The Housing Finance Revolution, Proceedgins of the 31st Annual Economic Conference of the Federal Reserve Bank of Kansas City

2. Jan 20 and 22 Credit Risks in the Mortgage and Mortgage-Backed Security Markets.
Guest Speaker: Anthony Sanders, Bob Herberger Arizona Heritage Chair in
Real Estate Finance, Professor of Finance, Arizona State University (date may be changed)

• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 15, Ch 17.

3. Jan 27 and 29 Mortgage Basics.

• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 5.

4. Feb 3 and 5 Fixed-Income Basics: Yield Curve and Term Structure of Interest Rates, Term Structure Models and Bond Pricing Models. Guest Lecture: Amy Crews Cutts, Deputy Chief Economist Freddie Mac
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 7, Ch 10.

5. Feb 10 Pricing of Mortgage Prepayment Options, Option-adjusted Spreads and Monte-
Carlo Simulation.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 12-13.

Feb 12 Quiz 1

6. Feb 17 and 19 Mortgage Pass-Through Securities.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 6, Ch 8.

7. Feb 24-26 Stripped Mortgage-Backed Securities, CMOs, and REMICs.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch. 9, Ch 11.

8. March 3 and March 5 How the Securities Markets Affect the Value of Real Estate, Transaction Volume and the Business Decisions by Investment and Financial Institutes.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 10, Ch 14.

9. March 10 Introduction to Commercial Mortgages

March 12 Quiz 2


10. March 24 and 26 Commercial Mortgages, Prepayment Protections and Defeasance.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 22.

11. March 31 and April 2 CMBS and CDO Markets.

• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 23.

12. April 7 and April 9 REITs Case Study, Public vs. Private REITs.
Guest Speaker: TBA
.
• Davidson, Sanders, Wolff and Ching. (2003) Securitization, Structuring and
Investment Analysis, Ch 24.

13. April 14 What went wrong?

April 16 Quiz 3.

April 21 and 23 Group Project Presentations.
6
H. USEFUL WEBSITE LINKS
Lusk Center for Real Estate (http://www.usc.edu/schools/sppd/lusk)
Glossary of Finance and Economic Terms
(http://www.freddiemac.com/finance/smm/a_f.htm#A)
REMIC & SMBS Securities Glossary
(http://www.fanniemae.com/markets/mbssecurities/product_info/remic/r_glossary.html)
Bloomberg Market Rates (http://www.bloomberg.com/markets/rates/index.html)
U.S. Census Bureau (http://www.census.gov/pub)
NAHB Economic and Housing Data (http://www.nahb.org/facts/default.htm)
Financial Services Facts (http://www.financialservicefacts.org/index.html)
Office of Federal Housing Enterprise Oversight (http://www.ofheo.gov)
FannieMae (http://www.fanniemae.com)
FreddieMac (http://www.freddiemac.com)
National Association of Real Estate Investment Trusts (http://www.nareit.org)
Mortgage Bankers Association of America (http://www.mbaa.org)
The Bond Market Association (http://www.bondmarkets.com)
National Mortgage News (http://www.nationalmortgagenews.com)
American Real Estate and Urban Economics Association (http://www.areuea.org)
Urban Land Institute (http://www.uli.org)
Journal of Real Estate Finance and Economics (http://www.jrefe.org)
Real Estate Economics (http://www.areuea.org/publications/ree/)

Thoughts from the Rose Parade

Yesterday was another gorgeous Jan 1 in Pasadena, and the parade was especially enjoyable. A couple of thoughts:

(1) The Ballou (Washington, DC) High School Marching Band was amazing. The kids in the band were remarkably accomplished. This surely has something to do with its band director, Darrell Watson.

Ballou High School has proficiency rates on its standardized math and reading scores of less than 10 percent. The students there show that they can excel--if they have a caring teaching showing them the way.

(2) The National Association of Realtors had a float in the parade. There were lots of snarky comments in the crowd about the theme of the "dream" of homeownership. While the other floats got lots of applause, the silence as the NAR float went by was eerie.