An Admission (Officer's) Essay

USC has become a selective school, and so when parents find out that I teach here, they ask me the trick for getting their kids in. I tell them, "have your kid take hard classes and get good grades."

Anyway, such questions remind me of the following:

Kid comes into an admissions office, says, “I’ve got an act for you.” Admissions guy says, “What kind of act?” Kid says, “A family act.” “OK, how does it go?” Kid says, “High-school junior spends $4,000 on a Princeton Review class and SAT scores go up 120 points—now he figures he doesn’t have to go to Nos. 10–15 on the U.S. News list but can get into 1–10, so the mother takes a second job to pay off the Princeton Review and buys the Platinum Package from an independent college counselor for $30,000 so Junior can be advised about when to help his fellow man and how best to package the experience, and when to take power naps. Father, meanwhile, talks to the accountant, finds out that even a home-equity loan won’t bring enough cash to get the kid into the right summer program to help repair castles in Carcassonne as a community-service project, without which Junior won’t get into colleges 1–10, to say nothing of having the money to send the boy to Tibet to practice spinning prayer wheels as proof of his spirituality and concern for diversity and international harmony, and besides there is the tuition for sophomore daughter’s harp camp in Maine. So he decides to sell the car, which means mom and dad have to use the Metra to get the younger brother to his 2 a.m. hockey practice, which he’ll need if he wants to use the athletic hook to get into an Ivy or at least a Little Three, a trip that takes one parent away from Junior’s homework—the family has a pact that at least one parent will write at least one draft of each required paper due senior year, and Junior has carefully chosen the “most challenging” senior coursework—AP stats as his math, AP psych as his science, History of the Vietnam War as the social science, Literature of the Vietnam War as the English elective, and Reading a Balance Sheet as preparation for his college internship, which he means to be the culmination of his liberal-arts education.

Parents are working so many extra hours and spending so much time on the Metra train on the way to hockey practice that sister is ignored and stops practicing the harp, thereby settling for a future without a prestigious college education, hence, perdition, has herself heavily tattooed, drops out of the Key Club, joins a heavy-metal harp band, and spits venomously whenever Junior pulls out his SAT word list and adds another entry to his online collection of homonyms. Metra goes on strike, little brother can’t get to hockey practice, is kicked off the team, begins to think of a future at the community college or emigration to Germany where he can join an apprentice program for tool and die makers, and Mom and Dad begin to feel strains in the marriage but vow to stay together to see Junior through the second round of the SAT IIs, because they know that with support, and coaching, he will be able to get an 800 on the writing exam unless he is tempted to be either original or imaginative, which would result in a lower score and his having to settle for, heaven forbid, a state university, which means no job at Goldman Sachs, so why bother to go to college at all?

Father finds that he begins to daydream of the time when he carried Junior’s egg on his toes beneath a flap of his own skin during the long Antarctic winter and vows that the boy will never go to college in a windy and frigid Midwestern city where, if the egg drops, cracks will reveal the icicles that had been his not-yet fledgling son, and in his identification with the fragile frosty egg decides that we will only apply to Duke, Emory, UVA, and, of course, Dartmouth if we can get in—damn the cold, they are rated 7th in U.S. News. All the while, the mother swims under the ice eating enough chum to regurgitate meals for her newly hatched chick to make him strong enough for cross-country practice, which should look pretty good on the application despite the fact that his little webbed feet limit his speed, and he finds that flopping on his belly to slide along the ice doesn’t really improve his time. Family meets and decides to prune away younger brother and sister to help foster the blossom that they wish Junior actually had turned out to be, they sell the home and move to Kazakhstan, hoping that geographical diversity might work the trick at any, please, just any, top-ten college or university, and they are last seen deciding to which school they will apply Early Decision.”

The admissions guy looks at him and says, “Wow! That’s quite an act—what do you call it?”

“The Meritocrats.”

Mark Thoma on Moving and Economic Development

Around 18 months ago he wrote:

…I struggle with this one a little bit. Should we, as official policy, expect people to move when things get bad - to leave their family and friends, to move away from the place they grew up and put their kids into new schools - or should government try to find a way to attract new business and provide enough jobs for residents? The latter strategy isn't always feasible, sometimes changes are permanent and nothing can be done about that, and attracting business is difficult in any case. When it isn't feasible, when change that is out of their control forces people to uproot and relocate, shouldn't we do what we can to help with the transition?

But I'm not sure what role the government should play in these cases. The difficulty that comes from leaving a place where you've lived a long time isn't just from home ownership, though that certainly contributes, so simply promoting more renting or even making it easier to sell a home won't fully resolve this "stickiness". If we want to encourage faster adjustment, then to help ease the transition I'd certainly be in favor of generous tax advantages for middle and lower income households who are willing to relocate if we can structure the policies to avoid the distortions that tax breaks for relocating create (e.g., we don't want people moving just to get tax breaks).

But tax breaks aren't the only possibility. Many families won't even move across town while their kids are in school because even if they are willing to provide transportation, the kids cannot stay at the same school due to residency requirements. Reexaming rules such as these could help promote labor market flexibility without costing taxpayers much. The point is that we can do a lot more than we do now to facilitate the transition for families willing to relocate for economic reasons and hopefully, when the administration changes after the next election, domestic issues such as these will receive much more attention than they have in recent years.

The problem of Flint (and East St. Louis, and the Mississippi Delta...)

Yesterday, I watched four or five holes where Tiger Woods methodically held onto his lead in the Buick Open (I missed his daring miss and masterful up and down on the 13th). The coverage was elegiac, because this will probably be the last year for a PGA event that is either sponsored by Buick or held near Flint.

I found myself carried along by the mood, because Flint has so little now, and the place the tournament might be moving--the Greenbriar--is a place of plenty (although to be fair, it is in West Virginia). When not rooting for my own teams, I tend to root for those from places like Buffalo, Pittsburgh and Cleveland: places that have fallen on hard times and were once great centers of making things.

One wants to figure out policies that would help these places, but no one knows what they are. We do know that people-centered policies--such as access to education and health care--help people improve their lot in life. But I know of no example of a place-based economic development program that has been broadly successful. When neighborhood vitalization is attempted in one part of a metropolitan area, it usually simply chases problems to another part of the area. A series of works by Tim Bartik and Helen Ladd shows that place based economic development programs create very few jobs and are very expensive. So the solution to the problems of economically depressed regions would seem to be to educate the kids and train the adults so they can move to economically robust places. This is a view I have long taken myself. When I visited the Mississippi Delta some years ago in the course of doing a project for the Ford Foundation, I was shocked at the amount and level of poverty one could still see within the United States, and I wanted to tell every adult to move their kid to Atlanta or Nashville, where opportunities are much greater.

But people feel a passion for their places. The intensity of these feelings have struck me twice in the past month. When I visited Cleveland around a month ago, it was clear that people cared deeply about that struggling city. When I watched the Buick Open yesterday, there was something special about how much the gallery appreciated that Tiger would play in their tournament. While economists prefer for the best of reasons to be bloodless when thinking about urban policy, people have deep ties to family and friends in their communities, and these ties are important--often more important to them than economic opportunity. And so I struggle with the policy implication--should we require people to leave their nearest and dearest in order to have a decent job?

Perhaps there is no alternative. Certainly, schemes for economic revitalization have not generally been successful. But that doesn't mean we should stop searching for something that might be.

Two verities of real estate investment

Over the past few days, I have been in San Francisco, and have had the privilege of meeting with four real estate executives whom I am trying to interest in participating with the Lusk Center in one way or another. They are all doing remarkably well, all things considered, and some of the things they said to me explain why. Two things stand out:

(1) When investing in real estate, underwrite the real estate without consideration for financing. Unless the deal earns an acceptable unlevered internal rate of return, don't do the deal.

(2) If a deal depends on a going-out (i.e. exit) cap rate that is lower than the going-in (i.e., purchase) cap rate, don't do the deal.

The Truth About Amsterdam, RE: Bill O'Reilly loves Amsterdam

Amsterdam has a great orchestra, too.

Michael Lacour-Little says it's all about the refinances

He points me to:

Why are so many homeowners underwater on their mortgages?

In crafting programs to prevent foreclosures, policymakers have assumed that the primary reason homeowners owe more on their home than it is worth is that they bought at the top of the market. In other words, they’ve lost equity primarily through forces beyond their control.

A new study challenges this premise and finds that excessive borrowing may have played as great a role.

Michael LaCour-Little, a finance professor at California State University at Fullerton, looked at 4,000 foreclosures in Southern California from 2006-08. He found that, at least in Southern California, borrowers who defaulted on their mortgages didn’t purchase their homes at the top of the market. Instead, the average acquisition was made in 2002 and many homes lost to foreclosure were bought in the 1990s. More than half of all borrowers who lost their homes had already refinanced at least once, and four out of five had a second mortgage.


The original loan-to-value ratio for these borrowers stood at a reasonable 84%, but second and third liens left homeowners with a combined loan-to-value ratio of about 150% by the time of the foreclosure sale date.

Borrowers, meanwhile, took out around $2 billion in equity from their homes, or nearly eight times the $262 million that they put into their homes. Lenders lost around four times as much as borrowers, seeing $1 billion in losses.

“[W]hile house price declines were important in explaining the incidence of negative equity, its magnitude was more strongly influenced by increased debt usage,” writes Mr. LaCour-Little. “Hence, borrower behavior, rather than housing market forces, is the predominant factor affecting outcomes.”

If other housing markets across the country offer similar findings, then the study argues that current “policies aimed at protecting homeowners from foreclosure are misguided” because lenders, and not borrowers, have born the lion’s share of economic losses.

Borrowers that bought homes without ever putting any or little equity in their homes could have seen huge returns on investment simply by extracting cash through refinancing. “Why such borrowers should enjoy any special government benefits such as waiver of the income taxation on debt forgiveness or subsidized loan modifications to reduce their borrowing costs is at best unclear,” the authors write.

Michael is a co-author of mine (and was a student at Wisconsin while I taught there), and has a gift for slicing up mortgage data. On the policy question, we might think about treating the half who did not refinance differently, as they were drowned by the flood.

An Interview with Kenneth Arrow, Part One - Conor Clarke

An Interview with Kenneth Arrow, Part One - Conor Clarke

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Stanley Fish and Chris Rock make the same point

Fish writes about Henry Louis Gates' time at Duke:

I flashed back 20 years or so to the time when Gates arrived in Durham, N.C., to take up the position I had offered him in my capacity as chairman of the English department of Duke University. One of the first things Gates did was buy the grandest house in town (owned previously by a movie director) and renovate it. During the renovation workers would often take Gates for a servant and ask to be pointed to the house’s owner. The drivers of delivery trucks made the same mistake.

The message was unmistakable: What was a black man doing living in a place like this?

At the university (which in a past not distant at all did not admit African-Americans ), Gates’s reception was in some ways no different. Doubts were expressed in letters written by senior professors about his scholarly credentials, which were vastly superior to those of his detractors. (He was already a recipient of a MacArthur fellowship, the so called “genius award.”) There were wild speculations (again in print) about his salary, which in fact was quite respectable but not inordinate; when a list of the highest-paid members of the Duke faculty was published, he was nowhere on it.

The unkindest cut of all was delivered by some members of the black faculty who had made their peace with Duke traditions and did not want an over-visible newcomer and upstart to trouble waters that had long been still. (The great historian John Hope Franklin was an exception.) When an offer came from Harvard, there wasn’t much I could do. Gates accepted it, and when he left he was pursued by false reports about his tenure at what he had come to call “the plantation.” (I became aware of his feelings when he and I and his father watched the N.C.A.A. championship game between Duke and U.N.L.V. at my house; they were rooting for U.N.L.V.)

And now Chris Rock:

I will give you an example of how race affects my life. I live in a place called Alpine, New Jersey. Live in Alpine, New Jersey, right? My house costs millions of dollars. [some whistles and cheers from the audience] Don't hate the player, hate the game. In my neighborhood, there are four black people. Hundreds of houses, four black people. Who are these black people? Well, there's me, Mary J. Blige, Jay-Z and Eddie Murphy. Only black people in the whole neighborhood. So let's break it down, let's break it down: me, I'm a decent comedian. I'm a'ight. [applause] Mary J. Blige, one of the greatest R&B singers to ever walk the Earth. Jay-Z, one of the greatest rappers to ever live. Eddie Murphy, one of the funniest actors to ever, ever do it. Do you know what the white man who lives next door to me does for a living? He's a f**king dentist! He ain't the best dentist in the world...he ain't going to the dental hall of fame...he don't get plaques for getting rid of plaque. He's just a yank-your-tooth-out dentist. See, the black man gotta fly to get to somethin' the white man can walk to.

I have a question for Senator Grassley

Does he really believe that all the white guys he has voted for "set aside [their] personal preferences and prejudices?"

Featured on today's USC Home Page

A story on Dr. Patricia Harris, who makes house calls.

I was on Bloomberg TV today

I have to admit it is fun. The clip is at http://tinyurl.com/GreenHousing.

Program Note

I will be on KPCC's Airtalk with Larry Mantle at 10:05 today.

Manuel Adelino, Kristopher Gerardi, and Paul S. Willen are skeptical...

...that the paucity of loan modifications is a function of securitization.

There is widespread concern that an inefficiently low number of mortgages have been modified during the current crisis, and that this has led to excessive foreclosure levels, leaving both families and investors worse off. We use a large dataset that accounts for approximately 60 percent of mortgages in the United States originated between 2005 and 2007, to shed more light on the determinants of mortgage modification, with a special focus on the claim that delinquent loans have different probabilities of renegotiation depending on whether they are securitized by private institutions or held in a servicer’s portfolio. By comparing the relative frequency of renegotiation between private-label and portfolio mortgages, we
are able to shed light on the question of whether institutional frictions in the secondary mortgage market are inhibiting the modification process from taking place.

Our first finding is that renegotiation in mortgage markets during this period was indeed rare. In our full sample of data, approximately 3 percent of the seriously delinquent borrowers received a concessionary modification in the year following their first serious delinquency, while fewer than 8 percent received any type of modification. These numbers are extremely low, considering that foreclosure proceedings were initiated on approximately half of the loans in the sample and completed for almost 30 percent of the sample. Our second finding is that a comparison of renegotiation rates for private-label loans and portfolio loans, while
controlling for observable characteristics of loans and borrowers, yields economically small, and for the most part, statistically insignificant differences. This finding holds for a battery of robustness tests we consider, including various definitions of modification, numerous subsamples of the data, including subsamples for which we believe unobserved heterogeneity to be less of an issue, and consideration of potential differences along the intensive margin of renegotiation.

Since we conclude that contract frictions in securitization trusts are not a significant problem, we attempt to reconcile the conventional wisdom held by market commentators, that modifications are a win-win proposition from the standpoint of both borrowers and lenders, with the extraordinarily low levels of renegotiation that we find in the data. We argue that the data are not inconsistent with a situation in which, on average, lenders expect to recover more from foreclosure than from a modified loan. At face value, this assertion may seem implausible, since there are many estimates that suggest the average loss given foreclosure is much greater than the loss in value of a modified loan. However, we point out that renegotiation exposes lenders to two types of risks that are often overlooked by
market observers and that can dramatically increase its cost. The first is “self-cure risk,” which refers to the situation in which a lender renegotiates with a delinquent borrower who does not need assistance. This group of borrowers is non-trivial according to our data, as we find that approximately 30 percent of seriously delinquent borrowers “cure” in our data without receiving a modification. The second cost comes from borrowers who default again after receiving a loan modification. We refer to this group as “redefaulters,” and our results show that a large fraction (between 30 and 45 percent) of borrowers who receive modifications, end up back in serious delinquency within six months. For this group, the
lender has simply postponed foreclosure, and, if the housing market continues to decline, the lender will recover even less in foreclosure in the future.

We believe that our analysis has some important implications for policy. First, “safe harbor provisions,” which are designed to shelter servicers from investor lawsuits, are unlikely to have a material impact on the number of modifications and thus will not significantly decrease foreclosures. Second, and more generally, if the presence of self-cure risk and redefault risk do make renegotiation less appealing to investors, the number of easily “preventable” foreclosures may be far smaller than many commentators believe.

Ideally, a lender would like to know whether a borrower will either (1) self-cure; (2) be cured by a loan modification that has no reduction in balance; (3) be cured by a loan modification that has a balance reduction or (4) is beyond help. If anyone can figure out how to write a contract that induces the borrower to reveal their type, they will have the solution to the crisis. The closest I can think of is one that allows borrowers to short-sell their houses (a la Hancock and Passmore) with reference to some sort of price index, so as to prevent gaming of the sales process.

Praise be to the NYT On Language Column (h/t Patricia Harris)

A brief history of singular pronouns:

One tweeter asked plaintively, “Can we just accept that ‘they’ can be used as singular?” But another wrote, “I HATE it when people make improper use of plural pronouns for gender neutrality!” Several suggested writing around the problem (“Sometimes I try to alternate he and she, but bleh”). One tweet seemed to sum up the general attitude: “Damn you, English language!”

Traditionalists, of course, find nothing wrong with using he to refer to an anybody or an everybody, male or female. After all, hasn’t he been used for both sexes since time immemorial? Well, no, as a matter of fact, it hasn’t. It’s a relatively recent usage, as these things go. And it wasn’t cooked up by a male sexist grammarian, either.

If any single person is responsible for this male-centric usage, it’s Anne Fisher, an 18th-century British schoolmistress and the first woman to write an English grammar book, according to the sociohistorical linguist Ingrid Tieken-Boon van Ostade. Fisher’s popular guide, “A New Grammar” (1745), ran to more than 30 editions, making it one of the most successful grammars of its time. More important, it’s believed to be the first to say that the pronoun he should apply to both sexes.

The idea that he, him and his should go both ways caught on and was widely adopted. But how, you might ask, did people refer to an anybody before then? This will surprise a few purists, but for centuries the universal pronoun was they. Writers as far back as Chaucer used it for singular and plural, masculine and feminine. Nobody seemed to mind that they, them and their were officially plural. As Merriam-Webster’s Dictionary of English Usage explains, writers were comfortable using they with an indefinite pronoun like everybody because it suggested a sexless plural.

If it is good enough for Chaucer it is good enough for me. I will from now on use "they" as my gender neutral singular pronoun.

Have Existing Home Sales Started to Rise?

NAR reported that Existing Home Sales rose 3.6 percent in June. In response to this, MSNBC notes:

"The turnaround in the housing market appears finally to be here and indeed may be gaining some speed," wrote Joel Naroff, president of Naroff Economic Advisors Inc.

Stocks jumped on the news, with the Dow Jones industrial average rising above 9,000 for the first time since early January.

The NAR numbers suggest that sales have stopped falling, and this is doubtless a good thing. But the numbers really don't support the idea that sales are rising--yet.

The reason is that the NAR Existing Home Sales number is a seasonally adjusted annualized number. This is a correct method for reporting (or at least I have reasons to think it is correct, as I am partly responsible for the development of the Existing Home Sales Methodology). But a seasonal adjustment is a statistical measure, and as such cannot be known with precision. June is a month that requires lots of adjustment, because June sales are always higher than sales in the average month. I am guessing that 3.6 percent is inside the 95 percent confidence interval of seasonally adjusted sales, so the best interpretation of the NAR release is that sales were flat or better in June.

The really good news in the report is the fact that the share of sales that are non-distressed sales is rising.

Two ideas for appraisal reform

Lawrence Yun of NAR is complaining that appraisals are preventing legitimate real estate transactions from occurring. Because of the way appraisers sometimes choose comparables, I have some sympathy for this view. And as I noted in an earlier post, Rhonda Porter says the Home Value Code of Conduct is nothing more than a way to line the pockets of Appraisal Management Companies. I have some sympathy for this view as well.

But we should not go back to the days when appraisers were basically paid to stay out of the way of the consummation of a deal. So let me suggest two proposals:

(1) Appraisers should not be allowed to see the offer price of a house. This is the only way their valuation will be truly independent.

(2) Appraisers should use valuation techniques that allow them to report a standard deviation of their estimate. Subdivision tract houses will have small standard deviations; architect designed villas will have large standard deviations.

We could then move to a pricing rule where Mortgage Insurance will be required if (1) the LTV based on appraised value is greater than 80 percent or (2) there is a greater than five percent chance that the true value of the house implies an LTV of 95 percent.

Step (1) would be easy to implement, and I think would help a lot. Step (2) will require lots of training (and perhaps different parameters from those that I am suggesting).

We need to stop kidding ourselves that we can measure house prices precisely. We need to start measuring the level of imprecision.

Rethinking California's Revenue Structure

California Assembly Speaker Karen Bass, who has no particular allergies to progressive taxes, cites an astonishing statistic about California Income Taxes: that 144,000 Californians (out of 38 million) pay half the state's income taxes. As I will discuss below, this does not necessarily imply that California taxes are, overall, too progressive, but it does mean that state income tax revenue is too undiversified. When such a small share of the population makes up such a large share of the revenue base, the fiscal conditions of the state will swing wildly with the fortunes of a few. This is what we have been witnessing here in California.

On the other hand, California has a very high sales tax as well, and everyone pays it. The best evidence I know suggests that the sales tax is regressive over the short term, but is more or less proportional over the life cycle. There is no question that the size of California's sales tax dampens the overall progressiveness of state revenue collections.

Finally, there is the property tax, which is completely detached from the ability to pay it, because of Proposition 13. Within a condominium complex, one can find two identical units that pay extraordinarily different levels of property taxes (sometimes by a factor of 10 to 1), because taxes are based on the price a property owner pays at the time of acquisition.

For California to have stable fiscal conditions going forward, it will need to broaden its income tax base and equalize its property tax base. I am not holding my breath.

The Joy of Great Cities

Last night, at the invitation of friends of ours, my wife and I went to a concert of the Pasadena Pops at Descanso Gardens. I wasn't quite sure what to expect: I am always suspicious of "pops" concerts (I love the Rolling Stones, but really don't want to hear Satisfaction played by a 100 piece orchestra) and community orchestras vary tremendously in terms of quality and spirit. I can enjoy music that is less than perfectly polished, but I find indifference difficult to take.

The punchline, of course, is that the concert was a gas. In the first place, the band has a conductor named Rachael Worby, who introduces the pieces with charm and who, more importantly, knows how to make an orchestra sparkle. Her beat and cues were so clear that even the most obtuse player would know what she wants. Second, the program, featuring Saint Saens, Gershwin, and Chansons sung by Karen Akers, was delightful.

But the really extraordinary thing was the caliber of the playing; one does not expect such precision in rhythm and tuning from an orchestra in a city of 150,000 people. But of course, the orchestra is drawing on a population of musicians who are drawn to Los Angeles because of opportunity, but also because they can find lots of other good musicians. I went to the Pasadena Symphony Web Site, and alas could not find a list of the players. My suspicion is that a number of the players are studio musicians (or people hoping to become studio musicians). And so it is throughout the region. One can go to free student recitals around LA, and hear music, from Palestrina to Riley, performed well.

I suspect that this is an example of agglomeration at its best (I can only suspect because I know of no formal test), and is a reason why the Londons, Parises, New Yorks and Los Angeleses of the world retain their special places for long periods of time.

Why the consequences of past discrimination persist over generations

I just read President Obama's most recent speech on race. It is another extraordinary speech--his ability to be at once sophisticated and accessible never ceases to amaze me.

To oversimplify, the speech has two themes: that individuals, whether discriminated against or not, must take control of their owns lives as best they can, but that the legacy of Jim Crowe will not go away quickly--that there are structural conditions in society that to place impediments in the paths of success for minority children.

The point reminded me of an award winning thesis by Kate Antonovics I read while I was at Wisconsin. One of the papers she generated from the thesis has the following summary:

Thus, initially disadvantaged groups may become trapped even though there is always a
unique within-generation equilibrium. That is, in contrast to standard models of statistical discrimination, repeated coordination failures are not needed to generate persistent discrimination.

Rather, statistical discrimination changes the transmission of earnings across generations by leading parents’ investment behavior to depend upon the distribution of income in the parents’ racial group. Thus, statistical discrimination and racial inequality are self-reinforcing, and multiple equilibria can arise.

When parents have limited resources to invest in their children, it becomes harder for children to migrate to a higher income class than their parents. In a world that was truly characterized by equal opportuntiy, children's fortures would be independent of their parents. We should at least strive to move to the point where children's fortunes are independent of their parents' race.

John Y. Campbell, Stefano Giglio, and Parag Pathak estimate that Foreclosed houses sell at a 28 percent discount

The results imply two problems with thinking about house prices through the lens of the Case-Shiller Index.

In Southern California, somewhere in the neighborhood of 40 percent of sales are distressed sales. If lenders make decisions that are based on Case-Shiller, they will underestimate the value of transactions that are taking place in the absence of distress. Appraisers seem to be taking a Case-Shiller view of the world right now, and so deals are getting undone. There is reason to believe that when buyers are willing to place 20 percent down on a house, they actually believe the house is worth the offer price.

On the other hand, let's say we move to a world where only, say, 20 percent of sales are distressed. This will produced an observed increase in the index Case-Shiller Index of 6 to 7 percent--even if nothing is really changing about underlying house prices. This could lead markets to become too optimistic too quickly.

The rigors of the USC Masters in Real Estate Development Program

A student of ours emails:

I just wanted you to know that this assignment got me out of a traffic ticket this morning.

La Cienega was shutdown to due an accident and I was trapped. So, I made a u-turn which included driving over a curbed median. A motorcycle cop pulled me over and gave me a lecture about how this isn't Texas (I have texas plates) and "cowboy driving" is not acceptable....whatever that means. So I told him that I had to get to campus for the mid- term and I had a limited amount of time to complete the homework assignment. I pulled out assignment #3 to make my story credible and he took it with him when he went back to his motorcycle.

When he came back he told me that it seemed like the assignment was going to be enough punishment and he let me go.

We have a new Census Director!

Robert Groves was confirmed. The vote to invoke cloture was 78-15. Why did this take so long? Why is the Senate so.....Senatorial?

Jan Hatzius has a Great Sense of Humor

His GDP forecast for 2009 goes four places right of the decimal point. (it is - 2.8753%).

Peter Wallison calls Consumer Protection Elitist

He writes:

Traditionally, consumer protection in the United States has focused on disclosure. It has always been assumed that with adequate disclosure all consumers -- of whatever level of sophistication -- could make rational decisions about the products and services they are offered. No more. If the administration's plan is adopted, many consumers will be told that they cannot have particular products or services because they are not sophisticated, educated or perhaps intelligent enough to understand what they have been offered.

Conservatives have always argued that liberals are elitists who do not respect ordinary Americans; this legislation seems to prove it. For example, the administration's plan would allow the educated and sophisticated elites to have access to whatever financial services they want but limit the range of products available to ordinary Americans.

This unprecedented result comes about because, under the proposed legislation, every provider of a financial service (a term that includes organizations as varied as banks, check-cashing services, leasing companies and payment services) is required to offer a "standard" product or service -- to be defined and approved by the proposed agency -- that will be simple and entail "lower risks" for consumers. These standard products are called "plain vanilla" in the white paper that the administration circulated in advance of the legislation.

Such protection is actually not unprecedented. For example, people must be deemed to be "accredited investors" or (for more complicated products) "qualified purchasers" in order to invest in certain types of hedge funds. And stock brokers have an obligation to make sure their clients' investments are "suitable."

But beyond the issue of precedence, there is a broader issue of safety. We reasonably forbid or require a variety of actions in the interest of safety. We require people to wear seatbelts. Be don't allow people to buy certain type of narcotics over the counter. Perhaps Mr. Wallison thinks such protections are a bad idea too, in which case he is consistent, if not also ridiculous. Mortgages can be dangerous products. Let's turn it over to Richard Thaler:

Fast forward to 2008, and the world of mortgage shopping had become a much more complicated place. Borrowers were quoted low initial “teaser” rates that would jump later to some higher level, depending on market interest rates at the time, and there were prepayment penalties for paying off the loans early. For such mortgages, an A.P.R. was no longer an adequate measure of the loan’s cost.

How can we help people make sense of all this?

One extreme approach would be to ban complex mortgages entirely: we could just go back to the world of uniform fixed-rate mortgages. But the cost of simplicity is an end to innovation. Shopping for televisions was easier in the 1970s, when we did not have to decide between plasma and L.C.D. technology — but who wants to go back to those hulking old TV sets?

A better approach is to strive for maintaining diverse options but helping consumers make smart choices and avoid the most common pitfalls.

For mortgages, the specific plan proposed by the administration appears to be strongly influenced by Michael S. Barr, an assistant Treasury secretary. Mr. Barr is a former law professor at the University of Michigan who wrote an important article sketching out these ideas with Sendhil Mullainathan, an economist at Harvard, and Eldar Shafir, a professor of psychology and public affairs at Princeton. As the administration plan describes it, lenders could be required to offer some mortgages they call “plain vanilla,” with uniform terms. There might be one vanilla 30-year, fixed-rate mortgage and one five-year, adjustable-rate mortgage. The features of these plain mortgages would be uniform, much as in a standard lease used in most rental agreements.

Lenders would also be free to offer other exotic mortgages — perhaps called “rocky road” mortgages? — along with the vanilla variety, but these offerings would receive more intense scrutiny from regulators.

I am not sure what is so elitist about this, other than the fact that those who are hostile to regulations tend to like to use elitist as an epithet for their opponents. So I guess I have two questions for Mr. Wallison:

(1) If I gave him an HP12C calculator, assumptions about an interest rate path, and the terms of an option-ARM mortgage, would he be able to tell me the payment on that mortgage in, say, month 62? Perhaps he could, but I don't know too many lawyers (and he is a lawyer) who could do that calculation. If highly education lawyers are generally flummoxed by this calculation, it is hard to see how ordinary Americans could understand it. The point is not to disparage ordinary Americans, but to emphasize a fact--most of us do not have the equipment to make informed judgments about complex financial products.

(2) I am curious how often Mr. Wallison hangs out with those who are not elite. Does he socialize with, say, median income people? With people whose eduction is at the median (i.e., high school graduates?). Perhaps he does, in which case he is entitled to refer to "the elite" as an other. But I have my doubts.

President Obama, please be bolder

Both Brad Delong and Mark Thoma have it right today, when they suggest the need for another round of stimulus--with particular aim at helping states--right now.

But President Obama needs to be bolder when it comes to solving the mortgage mess too. Last March I wrote:

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 President's rescue program has not taken off. The redefault rate on modified mortgages is high--because they don't solve the negative equity problem. I am not alone in thinking some wort of debt-for-equity modification would make sense. John Quigley has supported such an idea. The Milkin Institute has supported the idea. I was on a radio program with Ken Rosen last week, and I am pretty sure he supported the idea.

Moliere saw 345 years ahead of his time.

Two quotes from Tartuffe:

Although I am a pious man, I am not the less a man.

and

To create a public scandal is what's wicked;
To sin in private is not a sin.

To which I should add a quote attributed to Jean Baptiste Alphonse Karr -

"plus ça change, plus c'est la même chose"

(p.s., I don't speak French, but this is how it appears, and I think we can all figure it out.)

Home news from the USC Lusk Center for Real Estate

My colleague and friend Raphael Bostic was today confirmed as Assistant Secretary for Policy Development and Research at the Department of Housing and Urban Development. This is a good thing for the country, but we shall miss him while he is gone.

We will also be joined by a new colleague, Jenny Schuetz, late of NYU and CCNY. She does wonderful work on (among other things) land use regulation and the impacts of various policy interventions on neighborhood outcomes. We are very excited that she will be joining us in August.

Lisa Schweitzer on Cities and the Stimulus

From her blog:

One of my fantastic students from Virginia Tech, Eric Howard, posted this piece from today’s New York Times on Facebook. The NYT author argues that:

Two-thirds of the country lives in large metropolitan areas, home to the nation’s worst traffic jams and some of its oldest roads and bridges. But cities and their surrounding regions are getting far less than two-thirds of federal transportation stimulus money.

The reporter goes on to quote outrage from mayors. They also get information from one of my favorite experts, Rob Puentes at Brookings. As usual, Rob has a very good point here: this package isn’t just about business as usual revenue allocation–which has always had a strong rural bias due to the structure of the Federal representative system (as Owen D. Gutfreund points out). This rural strength made way more sense 150 years ago than it does now.

So, of course all of these smart people are right in that cities aren’t treated very well in the stimulus, as they aren’t treated very well in Federal politics in general.
However, we have to ask ourselves: would it really be sensible to hand out this money on a per capita basis either? The main argument for cities and against suburbs and small towns is an economy of scale argument. Those arguments underpin the “costs of sprawl” research. Urbanization and density of human settlement lower the cost of providing infrastructure because of all the sharing we city folk do: the same sidewalk can serve thousands per day instead of a handful of people per day, as in a low-density settlement.

Thus, cities should somewhat expect to receive less per person than other places. The key point is just how much less per person should we expect urban infrastructure to cost, given all this sharing. The problem with sharing, of course, is that sharing leads to congestion after a certain point in population growth, thereby raising costs for everybody and requiring either dispersal of population or additional infrastructure.
While planning and planners are hard-wired to think in terms of increasing density, building duplicate systems (ie increasing capacity) in congested areas is only one means of cost sharing: the other, more macro-scale approach is to direct more growth to areas with excess capacity or price congested facilities and shift more of the revenue generation burden back onto users instead of looking for Federal funds.
This latter approach is, I think, where we are ultimately heading with infrastructure finance in the new urban world. Do we have compelling arguments for why the Federal government should be involved in urban infrastructure if all they going to do is return revenues to source (the per capita/population distribution argument). Anti-federalists can and do make strong arguments for local funding of intracity systems, like metro rail systems, while Federal dollars should go to intercity and interstate projects.

So while the NYT and urban mayors are probably right in that this distribution of funding is skewed, they haven’t really told us what the right distribution would look like, other than to say that cities are important and they need more money. Of course they are and they do, but it isn’t as though some of the poorest places in this country aren’t places like the Central Valley rather than places like Los Angeles, and it’s not as though Boston doesn’t depend on connectivity between rural Florida and Boston for all parts of the freight and US food system.

Debra Johnson points us to the relative dearth of recent household formations.

She has a nice graph:







The graph illustrates an important change; after a secular decline in average household size in the US (from about 3.5 people per households after World War II to around 2.6 now), households are getting (slightly) larger. This matters for housing demand, of course, because households are the source of such demand (recent event have taught us that not a whole lot of people can afford to own more than one home). It is important to note that this change happened before the current economic calamity.

She does have some good news, though: age induced household formations should be rising over the next three years. The question is whether there will be sufficient numbers of jobs for young adults to leave the family nest on schedule.

Why some columnists make my head want to explode

Ross Douthat:

In this sense, she really is the perfect foil for Barack Obama. Our president represents the meritocratic ideal — that anyone, from any background, can grow up to attend Columbia and Harvard Law School and become a great American success story. But Sarah Palin represents the democratic ideal — that anyone can grow up to be a great success story without graduating from Columbia and Harvard.

But the point about Palin is not that she didn't go to Columbia and Harvard. She graduated from her state's flagship school, and I personally am very fond of such places. The point is that she went to five different colleges before graduating. Two, ok, but at three you start to wonder. But doesn't the fact that she went to five tell us something about her ability to follow through--to finish something? Hasn't her past behavior been a pretty good predictor of current behavior, and therefore likely of future behavior?

Program Note

I will be on KPCC at 2 today.

Krugman on Franken

To reinforce the point that funny people are often smart:

David Broder has a column this morning calling for bipartisanship. I know, you’re shocked. But what struck me was this bit about Al Franken:

Franken, the loud-mouthed former comedian, will be the 60th member of the Senate Democratic caucus …

Two points.

First, implicit in this characterization of Franken is the notion of the Senate as a decorous gentlemen’s club. I doubt that club ever existed in reality; but in any case, these days the World’s Greatest Deliberative Body is, not to put too fine a point on it, chock full o’ nuts. James Inhofe: I rest my case.

Second, Al Franken’s dirty secret is that … he’s a big policy wonk.

I used to go on Franken’s radio show, all ready to be jocular — and what he wanted to talk about was the arithmetic of Social Security, or the structure of Medicare Part D.

In fact, the only elected official I know who’s wonkier than Al Franken is Rush Holt, my congressman — and he used to be the assistant director of Princeton’s plasma physics lab. (The campaign’s bumper stickers read, “My Congressman IS a rocket scientist.”)

So what will Franken do to the level of Senate discourse? He’ll raise it.

Franken writes quite well. The only times he really bothers me is when he loses his sense of humor and becomes sanctimonious. For instance, he loves to point out that while many in the family values crowd are serial adulterers and divorcees (a point that is certainly worth some emphasis), he is a devoted husband and father. I think that is great Al, but let someone else say so.

William Adelman deserves props for pointing out that Krugman can actually be quite funny himself.

Anne-Sophie Mutter's Top Ten Record List

It is a nice list. I think Previn is her husband, which may explain why he is on it three times. But the Bruckner, Ella, Korngold are all wonderful, and the La Boheme is a guilty pleasure of mine. My mind tells me it is schmalz--but I love it anyway.


Anton Bruckner

Symphonies
Berliner Philharmoniker
Herbert von Karajan
DGG

Ella Fitzgerald

The Complete Ella Fitzgerald Song Books
Verve

Erich Korngold

The Sea Hawk
The Private Lives of Elizabeth and Essex
Captain Blood
The Prince and the Pauper
London Symphony Orchestra
André Previn
DGG

Wolfgang Amadeus Mozart

Concerto for Piano and Orchestra no. 21 in C major, K 467
Clara Haskil

André Previn

A Streetcar Named Desire
(Complete)
Fleming · Futral · Gilfry · Griffey · Forst · Lord · Gayer · San Francisco Opera Orchestra
André Previn
DGG

André Previn

Honey and Rue
Text by Toni Morrison
Kathleen Battle
Orchestra of St. Luke's
André Previn
DGG

André Previn

Live at the Jazz Standard
With David Fink
Decca

Giacomo Puccini

La Bohème
Mirella Freni, Luciano Pavarotti
Berliner Philharmoniker
Herbert von Karajan
DGG

Josef Strauss

Delirien Walzer, Sphärenklänge, Kaiserwalzer
Wiener Philharmoniker
Herbert von Karajan
Decca

Sergey Rachmaninov

Piano Concertos No.1 in F sharp minor, Op.1 and No. 2 in C minor, Op. 18
Krystian Zimerman
Boston Symphony Orchestra
Seiji Ozawa
DGG

Can't help but blog a bit about Health Care

I have not commented on health care because it is not my area of expertise. But my wife is a primary care physician, is head of the Geriatrics Section at Keck Medical School, and was a Health Policy Fellow at the Department of Health and Human Services, so I learn a lot through osmosis and by reading various stuff she puts in front of me.

The most recent thing she put in front of me was from the New England Journal of Medicine. The following reported quote from a Parke-Davis executive really made the hair on the back of my neck stand up:

...We can't wait for physicians to ask, we need to get out there and tell them up front. Dinner programs, CME programs, consultantships all work great but don't forget the one-on-one. That's where we need to be, holding their hand and whispering in their ear, Neurontin for pain, Neurontin for monotherapy, Neurontin for bipolar, Neurontin for everything. I don't want to see a single patient coming off Neurontin before they've been up to at least 4800 mg/day. I don't want to hear that safety crap either...

Economics is supposed to respect evidence; to me, economists who oppose even thinking about a public option (or single-payer option) show no respect for evidence. Medical outcomes in this country are, at best, the equal of any other in the world, but we spend twice as anyone else to get care that is no better than many others'. Spare me stories of queues for elective surgery; when we spend 75 percent more per person than Canada and 2.5 times more per person than Japan on health care, we should get better outcomes. The sort of corruption documented above is at least one reason why we don't.

What's wrong with being funny?

A Minnesota Republican today said something to the effect that Norm Coleman should not run for governor of Minnesota, because he could not even beat Al Franken--i.e., a comedian.

Some of the smartest and wisest people in history, though, have also been very funny. Shakespeare was funny. Benjamin Franklin was funny. Mark Twain was funny. Will Rogers was funny. Jon Stewart is funny. My wife is funny. And I would take any one of them over the vast majority of current Senators. Of the Senate's many problems, one near the top of the list is how seriously Senators take themselves; how utterly bereft of humor they are (and this is a bipartisan affliction). I hope very much that Franken takes his job seriously, and I think he will. But I also hope he stays funny.

[Update: I somehow forgot to mention that Abe Lincoln was very funny. Enough said.]

My Brother and John Norquist are happy

After many years of population decline, the city of Milwaukee has seen a (small) increase in population since the beginning of the decade.

Some other old central cities (not metropolitan areas) where population has increased: New York, San Francisco, Boston, Washington DC, Denver (not so old, but a city with tight municipal boundaries), Atlanta (see Denver), St. Louis (!!) and Newark.

Continuing to lose: Detroit (of course), Chicago (a little--but still surprising in light of what a great city it is), Philadelphia, Memphis, Baltimore, Cleveland, Pittsburgh, Buffalo (which may in 50 years pass Green Bay as having the smallest population of any NFL city), and Birmingham.

San Antonio has had remarkable growth, and is now the country's 7th largest city.

Nitpicking Brad Delong on Fannie/Freddie

He writes (in response to Greg Mankiw):

The problem is that in the past year and a half the Federal government has stood behind the debts of not just Fannie and Freddie, but AIG, Bear Stearns, Merrill Lynch, Bank of America, Morgan Stanley, and Goldman Sachs--none of which bear any resemblance whatsoever to a "public plan." The government has stood behind Fannie and Freddie not because they were, before 1968, public enterprises but because they were--like AIG, Bear Stearns, Merrill Lynch, Bank of America, Morgan Stanley, and Goldman Sachs--too big to fail. The Treasury staff would have loved to have let Fannie and Freddie default on their bonds had they not feared the systemic consequences.

The fact that Mankiw can't find an example of his argument (2) makes me think that it is very weak, and that the real reason people oppose the public plan is (1).

I agree that the Mankiw's Fannie/Freddie example is emblematic of a weak argument against a public health insurance plan. But, I actually seriously doubt that Fannie/Freddie would have been allowed to fail their creditors under any circumstances.

Foreign central banks bought FF debt and MBS at least in part because FF securities were called agency securities. Subordinated debt on FF debt was not AAA, and so it is highly unlikely that foreign central banks would have invested in FF debt/MBS were it not for the ambiguous government guarantee, an ambiguity that arose at least in part because Fannie's debt was public before 1968 (Freddie was born in 1970). LBJ wanted Fannie debt off the government balance sheet so that the apparent Vietnam War deficit would be lower. Had FF been allowed to default on debt held by foreign central banks, Treasuries themselves might have been much less appealing. And if the government is going to make the Bank of China whole, it is also going to make grandma whole. It is striking that FF debt continued to trade at favorable prices even when they couldn't produce timely financial statements.

I have in this space argued that FF were not the primary causes of the crisis--they turned out to be slow followers of the "purely private" market in funding unsustainable mortgages. But let's not kid ourselves: the enterprises long have had an implicit subsidy, and they took advantage of it when they could.

Confirm Robert Groves as Census Director

From his first page of scholar.google.com:

B

OOK] Survey errors and survey costs
RM Groves - 2004 - books.google.com
WILEY SERIES IN SURVEY METHODOLOGY Established in Part by WALTER A. SHEWHART AND
SAMUEL S. WILKS Editors: Robert M. Groves, Graham Kalton, JNK Rao, Norbert
Schwarz, Christopher Skinner The Wiley Series in Survey Methodology covers ...
Cited by 1104 - Related articles - Web Search - Library Search - All 2 versions

[BOOK] Nonresponse in household interview surveys
RM Groves, M Couper - 1998 - Wiley-Interscience
Cited by 584 - Related articles - Web Search - Library Search

[BOOK] Surveys by telephone: A national comparison with personal interviews
RM Groves, RL Kahn - 1979 - Academic Pr
Cited by 334 - Related articles - Web Search - Library Search

Understanding the decision to participate in a survey - ►uiuc.edu [PDF]
RM Groves, RB Cialdini, MP Couper - Public Opinion Quarterly, 1992 - AAPOR
Abstract The lack of full participation in sample surveys threat- ens the
inferential value of the survey method. We review a set of conceptual
developments and experimental findings that appear to be informative about ...
Cited by 300 - Related articles - Web Search - BL Direct - All 5 versions

Consequences of Reducing Nonresponse in a National Telephone Survey* - ►pollcats.net [PDF]
S Keeter, C Miller, A Kohut, RM Groves, S Presser - Public Opinion Quarterly, 2000 - AAPOR
Abstract Critics of public opinion polls often claim that method- ological
shortcuts taken to collect timely data produce biased results. This study
compares two random digit dial national telephone surveys that used ...
Cited by 318 - Related articles - Web Search - BL Direct - All 10 versions

[BOOK] Survey nonresponse
RM Groves, DA Dillman, JL Eltinge, RJA Little - 2001 - Wiley-Interscience
Cited by 149 - Related articles - Web Search - Library Search

[BOOK] Telephone survey methodology
RM Groves - 1988 - books.google.com
WILEY SERIES IN SURVEY METHODOLOGY Established in Part by WALTER A. SHEWHART AND
SAMUEL S. WILKS Editors: Robert M. Groves, Graham Kalton, JNK Rao, Norbert
Schwarz, Christopher Skinner Wiley Seríes in Survey Methodology covers ...
Cited by 178 - Related articles - Web Search - Library Search - All 2 versions

Advances in strategies for minimizing and adjusting for survey nonresponse
RC Kessler, RJA Little, RM Groves - Epidemiologic Reviews, 1995 - Soc Epidemiolc Res
INTRODUCTION The decrease in survey response rates since the 1950s (1, 2) has
sensitized survey researchers to the importance of studying the effects of
nonresponse bias, of developing procedures to minimize the mag- nitude of ...
Cited by 207 - Related articles - Web Search - BL Direct - All 4 versions

Leverage-Saliency Theory of Survey Participation: Description and an Illustration* - ►ohio-state.edu [PDF]
RM Groves, E Singer, A Corning - Public Opinion Quarterly, 2000 - AAPOR
The literature on survey participation contains scores of alternative hypotheses
about influences on cooperation with survey requests. Unfortunately, there is an
embarrassing lack of replication of experimental findings (incentives some- ...
Cited by 132 - Related articles - Web Search - BL Direct - All 7 versions

[PDF] ►Frequency-independent equivalent-circuit model for on-chip spiral inductors
Y Cao, RA Groves, X Huang, ND Zamdmer, JO … - IEEE Journal of solid-state circuits, 2003 - vergina.eng.auth.gr
( ) characteristics beyond the self-resonant frequency. Using
frequency-independent RLC elements, this new model is fully compatible with both
ac and transient analysis. Verification with measurement data from a SiGe ...
Cited by 131 - Related articles - View as HTML - Web Search - BL Direct - All 15 versions

It would be hard to find someone more qualified--because he/she doesn't exist.

I am surprised the rate is so low

Luigi Guiso, Paola Sapienza and Luigi Zingales find in a working paper that once the value of a family's house falls to below 50 percent of its mortgage balance, the default rate rises to 17 percent, even among those who can afford to make payments. This to me shows how un-ruthless people are about default--about how responsible they feel to make their payments.

(ht to Leigh Ann Coates for pointing out the paper to me).

Models and Agents teach(es) us about Bank Capital

She writes:

So the first blunder comes early on when Greenspan talks about what he sees as a virtuous circle of rising stock markets, leading to improved credit conditions, higher lending and the resumption of economic activity… which in turn supports higher stock prices and so on.

While the idea that improved confidence can generate a virtuous circle has merits, what is questionable is Greenspan’s road to get there: The “newly created equity” in banks’ balance sheets as the prices of banks’ stocks go up.

Well that’s plain wrong. Regulatory capital, which is what matters for a bank’s ability to increase its lending, is not marked to market but at the price paid up originally to purchase equity in a bank. (Regulatory capital also includes other stuff, like retained earnings, which again are not marked to market but at the price when they were booked).

In other words, the increase in stock prices does NOT provide a “capital buffer that supports the debt issued by financial and non-financial companies” and does NOT “supply banks with the new capital that would allow them to step up lending.”

If there is one way higher stock prices help is if banks actually see it as an opportunity to raise new capital and expand their operations. Indeed, some banks have done so recently, but the main motivation was their urge to pay back the TARP money and rid themselves of the government’s watch. So new private capital replaced old government capital, without a meaningful improvement in banks’ ability to lend.

The problem with equity is that it is not as liquid as tier-one capital: if a bank tries to sell a bunch of its equity to raise cash, the value of the equity will fall.

Foreclosures up, but not that high -- GazetteXtra (HT to Kris Hammergren)

Morris Davis explains how RealtyTrac gets foreclosure numbers wrong. As households are trying to figure out what to do about their housing, getting numbers that are accurate is especially important.

Foreclosures up, but not that high -- GazetteXtra

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Identification Problem

Traffic has been moving remarkably smoothly on the 110 Freeway for the past week or so. Is it summer? Unemployment? Gas north of $3 per gallon? It seemed before that $4 was something of a magic threshold.

Austin Kelly adds to my brief explanation of the origin of Freddie

He writes:

The Federal Home Loan Bank System, chartered in 1932, was created to provide a national source of funds for local thrifts. Any thrift could borrow from their FHLB (cooperatively owned by the thrifts) and the FHLBs borrowed collectively in a national market.

Freddie was created as part of the Home Loan Bank System (owned by the Home Loan Banks, which were, in turn, owned by the thrifts) to get into the securitization game. A small thrift couldn't really expand its volume if it had to hold all its loans on balance sheet. But if it could sell them off like the mortgage banks could ...

Significant Features of the Property Tax is Live On-line

This is a new, valuable tool for those interested in property taxes.

http://www.lincolninst.edu/subcenters/significant-features-property-tax/

It is a joint project between the Lincoln Institute for Land Policy and George Washington Institute for Public Policy. My former GW colleague Nancy Augustine spearheaded it.

Rhonda Porter asks why we have both Fannie and Freddie

Back in 1987, when I started working on housing finance issues, I wondered this very thing. So I spoke with the person in charge of secondary market business for a Wisconsin Savings and Loan called First Financial (I wish I could remember his name now).

He had a crisp explanation: Fannie Mae was a Savings and Loan for Mortgage Bankers, while Freddie Mac was a mortgage banker for Savings and Loans. This was in fact the reason for their original existence. Fannie has been around since 1938, and it became private in 1968, and its purpose was to raise money from capital markets to fund mortgages originated by mortgage bankers. Between 1938-68, its business was entirely FHA and VA loans; thereafter it could fund private sector loans.

Freddie was chartered in 1970 at least in part in response to regional differences in the availability of mortgage credit. At that time, around 60 percent of mortgages were held by Savings and Loan Associations. These S&Ls were local businesses, who could not lend outside of their communities (I will need to double check, but my recollection is that they could not lend more then 150 miles away from their front door).

As young people migrated from the Northeast and Midwest to the sunbelt, leaving their parents and grandparents behind, there was a geographic mismatch between the location of deposits and the demand for mortgage credit. Freddie was invented to buy loans from S&Ls, turn them into securities, and sell them in the secondary market. This allowed money to flow where it was needed.

The distinction between the two institutions disappeared in 1992, with the passage of the Federal Housing Enterprises Financial Safety and Soundness Act (FHEFSSA). I am guessing that the reason we kept two around was to have some competition in the MBS issuance market.

The Blessings of Product Variety

A SoCal phenomenon I don't understand is In n' Out Burger. People around here rave about their burgers; to me they are not worth the calories and fat.

Don't get me wrong--I like lots of food that is bad for me. Tommyburger sends me to the moon. But while others find consumption of In N' Out puts them on indifference curves that are tangent to their budget constraints, it leaves me on an indifference curve that cuts the budget constraint.

Why 15 percent is a magic number for office vacancies

From Businessweek last April:

Stan Ross, chairman of the Lusk Center for Real Estate at the University of Southern California in Los Angeles. He estimates that 15% of all office space across the U.S. is currently vacant. "We can live with 10% to 12%, but we start really feeling it at 15% to 18%," he says. "And we could get [to 18%]."

One metric for commercial mortgage underwriting is the "break-even" ratio, which is (Debt Service + Operating Expenses)/(Potential Gross Income). The most aggressive commercial loans have break-even ratios in the neighborhood of 85 percent. Thus when vacancies rise past 15 percent, some office buildings will have insufficient cash flow to cover their expenses and debt service. And in an environment where rents are falling, a 15 percent vacancy rate is worse than it looks.

Office vacancies in Manhattan are now around 13 percent--and Manhattan has about 25 percent of all Central Business District office space in the country--at least according to Cushman and Wakefield. Hang on to your hats.

Mark Thoma thinks Ben Bernanke should be reappointed

He writes:

I'd reappoint him. If forced to choose between Yellen and Summers, I'd choose Yellen.

I agree. I think Bernanke has done a remarkable job, and I think his temperament is much better suited to the job than Summers' (not that it matters, I suppose, but I also prefer Bernanke's academic work to Summers'). I also worry about the appearance of having a Fed Chair who has taken such large speaking fees from companies that he would be regulating.

The USC Graduate Real Estate Association has a Blog!

http://trojangrea.blogspot.com/

FWIW

I have spoken recently with a couple of real estate brokers that I trust (i.e., those who tell me when the market is bad). In the western San Garbriel Valley, stuff in the 500K range is selling very quickly--often receiving multiple offers within a week of listing. They are not distressed sales, either.

I still worry about shadow inventory of REOs that have not yet been placed on the market. But it is hard to ignore the change in activity over the past four or five months.

I have nothing to add...

...to Brad Delong and Paul Krugman's posts on the firing of Dan Froomkin from the Washington Post. Except to say that I once thought that Brad was too harsh with the Post. I was wrong.

A Sharpe Rule for Compensation?

As we think about the extent to which compensation incentives caused the financial mess, we might start with a basic fact: annual internal rate of return is a bad metric for evaluating performance. The largest problem with it is that it rewards return without punishing risk.

When firms use leverage to invest, they increase the risk they are taking on. The value of a firm's assets divided by its equity gives a rough multiple of risk created by leverage.

Suppose a firm has $100 in assets, and its return in one year can be either -$5 or $15, each with 50 percent probability. The expected return to the firm is 5 percent, with a standard deviation of 10 percent.

Now suppose it can borrow half the money to purchase the assets at an interest rate of 3 percent. Its expected return is now higher, because it will expect to earn $3.50 (13.50*.5+(-6.50)*.5) on a $50 investment, or seven percent. Thus positive leverage gooses the return.

But now the standard deviation or risk) of the investment is 20 percent (the investment produces a return swing of plus or minus $10 on a $50 investment). So while the return has improved, so too has the risk of the investment. Compensation strategies based on return would fail to recognize the risk.

This would not be the case if compensation were tied to a company's Sharpe Ratio. The Sharpe Ratio is corporate return less a risk free rate divided by the standard deviation. In our case, in the first instance, the sharp ratio is .2 (.05-.3)/.1. In the second case, it is also .2 (.07-.03)/.2). If the Sharpe Ratio were used to determine compensation, managers would not be rewarded for goosing returns via leverage. And we could avoid all kinds of future trouble.

Paul Krugman on the how the Obama Financial Reform Plan is Insufficient

He writes:

True, the proposed new Consumer Financial Protection Agency would help control abusive lending. And the proposal that lenders be required to hold on to 5 percent of their loans, rather than selling everything off to be repackaged, would provide some incentive to lend responsibly.

But 5 percent isn’t enough to deter much risky lending, given the huge rewards to financial executives who book short-term profits. So what should be done about those rewards?

Tellingly, the administration’s executive summary of its proposals highlights “compensation practices” as a key cause of the crisis, but then fails to say anything about addressing those practices. The long-form version says more, but what it says — “Federal regulators should issue standards and guidelines to better align executive compensation practices of financial firms with long-term shareholder value” — is a description of what should happen, rather than a plan to make it happen.

Two things:

First, one of the things that got investment banks in trouble is that they did hold on to part of the securities they created. Indeed, they held the riskiest stuff--the lowest rated tranches of subprime and commercial MBS. The reason: so long as they performed, they captured the margin between the rate on the underlying debt instrument and the rates paid to the higher tranches. They borrowed short term at low interest rates to invest in these high risk, high margin securities, and earned spectacular rates of return, for awhile.

Investment bankers had incentives to take risks, because while they were earning spectacular returns (IRRs), they got paid huge bonuses. But when their investments fell apart, they only lost their jobs--there was no claw back. While their companies failed, their total compensation for the time they worked remained high.

So, point two is that compensation schemes must align long-term company interests with pay. There are two ways to do this: through clawbacks (which are complicated) and through long-term restricted stock (which is how employees at Google get paid).

I should note, however, that I am very pleased with the administration's proposal for financial institution capital. That by itself will solve a lot of problems.

The Wisdom of Paul Samuelson

Two nuggets from an interview with Conor Clarke

Last thing. Mea culpa, mea culpa. MIT and Wharton and University of Chicago created the financial engineering instruments, which, like Samson and Delilah, blinded every CEO -- they didn't realize the kind of leverage they were doing and they didn't understand when they were really creating a real profit or a fictitious one.

and

Well, I'd say, and this is probably a change from what I would have said when I was younger: Have a very healthy respect for the study of economic history, because that's the raw material out of which any of your conjectures or testings will come. And I think the recent period has illustrated that. The governor of the Bank of England seems to have forgotten or not known that there was no bank insurance in England, so when Northern Rock got a run, he was surprised. Well, he shouldn't have been.

But history doesn't tell its own story. You've got to bring to it all the statistical testings that are possible. And we have a lot more information now than we used to.

Mark Thoma Points us to Robert Shiller on Unlearned Lessons

Did the false belief that land suitable for building houses was becoming scarce help to drive the housing bubble?:

.Unlearned lessons from the housing bubble, by Robert J Shiller, Project Syndicate: There is a lot of misunderstanding about home prices. Many people all over the world seem to have thought that since we are running out of land in a rapidly growing world economy, the prices of houses and apartments should increase at huge rates.

That misunderstanding encouraged people to buy homes for their investment value – and thus was a major cause of the real estate bubbles around the world whose collapse fuelled the current economic crisis. This misunderstanding may also contribute to an increase in home prices again, after the crisis ends. Indeed, some people are already starting to salivate at the speculative possibilities of buying homes in currently depressed markets.

But we do not really have a land shortage. Every major country of the world has abundant land in the form of farms and forests, much of which can be converted someday into urban land. ...

I think Shiller is largely right but for two things.

First, there are a small number of places on earth for which there is no close substitute: Santa Barbara, Aspen, Paris come to mind. Rich people will always outbid the rest of the world for these places, whose fundamentals are more similar to those of Monet paintings than real estate. But these are a very small number of places indeed, and we can argue about what they are.

Second, I think Shiller underestimates the power of NIMBYIsm to prevent housing construction. He should visit places like Mumbai and Johannesburg, where regulations limiting residential density have driven values well beyond what middle-income people in those places can afford. I agree that land shortages are an artificial, rather than a natural, phenomenon. But it remains a powerful phenomenon nevertheless.

The Miracle of Southwest Airlines

I am sitting in the Tucson airport awaiting a flight home to LA. I just watched a Southwest 737 stuffed with passengers load and unload in about 20 minutes.

United Airlines can't turn around a regional jet in less than 40 minutes (they always claim they are "cleaning" the plane, but I never see much evidence of cleaning). It is little wonder that Southwest has performed better financially over the long haul.

What's the matter with Rich Liberals?

Derek Thompsonn, in an Atlantic blog, argues that rich people who support higher taxes are just a befuddling as Thomas Frank's Kansans, I am not so sure.

If people are at all introspective, they will recognize that fortune can be fleeting--that anyone can get a bad draw. Catastrophe call befall anyone, because of illness, because of natural disaster, because of unexpected changes in business conditions. For example, while it is possible that the demise of the newspaper industry was foreseeable many years ago, I am not sure that it is likely. As a result, many people who thought themselves secure in their work are now being laid off.

We can think of taxes as being both user fees and as insurance premiums. Social Insurance helps the rich--as well as their parents and children--survive at a minimum living standard even if the world turns on them. While we all like to think we have some control over our lives--and to some extent we do--we are also all subject to chance, and for some of us, it is good to know there is a society that cares about the misfortune of others should we encounter a bad draw.

Certainly some rich people are also motivated by altruism and their desire to repay a country that had given them so many great opportunities. But people pay all sorts of insurance premiums; to some extent, taxes are another.

University of Wisconsin Union Terrace

One my favorite chunks of real estate (especially in summer!).

One Mortgage GSE?

At the Wisconsin Housing Conference in Madison last week, Curt Culver of MGIC forecast that Fannie and Freddie would be merged into one public sector entity for mortgage funding. I am not so sure...

Blogging from 7 miles up

First internet connection off the ground, on Airtran flight 226. It works really well!

Housing/Community Development Focus of 2009 Policy Summit ::

Housing/Community Development Focus of 2009 Policy Summit ::


Federal Reserve Bank of Cleveland

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Some random thoughts on Cleveland

The day before yesterday, I participated in a conference at the Cleveland Fed (I will post the slides in a bit). I got into Cleveland the afternoon before the conference, and so had a chance to walk around its downtown and take in a ball game at Jacobs Field. It was my second visit to Cleveland, and it confirmed my impressions from around 10 years ago: it is a very pleasant city. The Midwest has four declining cities that I quite like--the others are Milwaukee, St.Louis and Pittsburgh--and so it pains me that they are in decline.

The way to explain decline is in one sense easy: lots of literature has shown that since World War II, cities in cold climates have had a very difficult time competing with warmer cities, and cities that relied on manufacturing have been at a disadvantage. Yet some cold climate cities (Boston, Chicago and Minneapolis) have done quite well, and Cleveland has remarkable assets, including one of the World's great medical centers, a first rate university, and among the finest orchestras and art museums anywhere.

Cleveland is also, distinguished, however, by an eye-popping number: a high school graduation rate that is, according to Jay Greene of the Manhattan Institute, 28 percent. High school graduation rates are difficult to calculate, but even if Greene's estimate is off by 10 percentage points, Cleveland's educational system resembles that of a developing country, and its kids are not equipped to be productive.

The poor performance also explains an anomaly: a city with lots of vacant houses has suburbs with newly constructed houses. Its not that the old houses are good--they are not--but given Cleveland's infrastructure, it would be more sensible to raze the vacant houses in the central city, assemble the parcels, and encourage new development rather than have development on the periphery. But one could hardly blame parents looking for houses for avoiding a school district with a high school graduation rate of less than 1/3.

Rhonda Porter writes about the Home Value Code of Conduct

She writes:

You may or may not have heard about HVCC. You'll have the opportunity to learn about it first hand if you obtain a conventional mortgage. In a nutshell, mortgage originators and processors (anyone considered to be in "production") are no longer allowed to order appraisals or know who the appraiser willbe until AFTER they receive the appraisal. HVCC just went into effect in May, I wrote a post about my experience at Rain City Guide where a Real Estate Agent asked me:

If I understand you correctly:

1. We don’t know who the appraiser is
2. We cannot contact the appraiser even if we knew. [Note: the real estate agent CAN contact the appraiser if they somehow know who it is...the loan production staff cannot].
3. We have no idea when the appraisal will be done.

The Home Value Code of Conduct was created as a result of the New York Attorney General investigating Washington Mutual (once a large bank) and eAppraiseit (an appraisal management company) for manipulating appraisers to produce higher values.

HVCC was suppose to create a professional distance between mortgage originators and appraisers so that an appraiser could perform their task without pressures to produce a higher value. Appraisals now go through an appraisal management company (which take on average 40% of the appraisal fee from the appraiser) to create this distance and supposedly reduce any conflicts of interest. However, the code was amended to allow AMCs (appraisal management companies) to be owned by the very banks who are ordering the appraisals.

From Fannie Mae's HVCC FAQs update on May 9, 2009 (Question 36):

Q. May an AMC Affiliate with, or that owns or is owned in whole or part by the lender or a lender-affiliate, order appraisals?

A: Yes, an AMC affiliated with, or that owns or is owned in whole or part by the lender or a lender affiliate, may order appraisals...

This smacks of the WaMU eAppraiseit scenario all over again!

So big bank owns an AMC where they order all their appraisals through and if a mortgage originator is brokering a loan to that big bank, the appraisal may be ordered through that AMC. Big bank/title company collects an average of 40% of the appraisal fee from the appraiser just for ordering the appraisal. If an appraisal cost $500; the AMC keeps $200 just for controlling and placing the order. The appraiser, who once collected $500 for producing the report now receives $300. Many appraisers are having to increase appraisal fees in order to make a living since AMCs are stripping them of 40% of their income.

Instead of being able to select an appraiser by their qualifications, experience or expertise in a certain area; it's a crap-shoot based on which appraisers are participating (agreeing to lower compensation) with the AMCs.

From CNBC's Diana Olick on the impact of HVCC:

"As many brokers expected, the HVCC is also resulting in some lower appraisals. Since the appraisers now may be unfamiliar with the local market, they will err on the lower side. Of course it may also be that the lack of a relationship with the lender is removing the 'expectation' of a certain appraised value. If the appraisal comes in lower than the sale price, then the deal is off."

HVCC does not allow second appraisals to be ordered due to low appraisal as it's considered "value shopping".

With a refinance, no value can be provided to the appraiser--I can't even let the appraiser know what the home owner thinks the value of their home may be. The home owner, if the appraisal comes in low, is out the appraisal fee (typically around $500). Prior to HVCC, my appraiser could call to give me a heads up that the home was not going to appraise high enough--providing an option for the client to cancel the appraisal before it's complete and saving them some of the appraisal fee or I could contact my appraiser to ask for a value check prior to ordering the appraisal. Not so anymore.

The National Association of Mortgage Brokers has been trying to battle this code with strong political opposition. (NOTE to Mortgage Originators: NOW is the time to belong to your local chapter of NAMB if you care about the future of your industry).

The intentions of HVCC to stop the strong-arming of appraisers to create false values are good. The results are terrible and many of us are trying to have this reversed. I encourage you to please sign this petition and to contact your representatives in Congress.

HVCC is going to hurt the consumer and will only help pad the pockets the owners of the Appraisal Management Companies.

I read Rhonda's blog all the time: she is a straight shooter and keeps me informed of the real world mortgage market. But here I think the policy idea behind the HVCC is correct, and that it needs tweaking instead of repeal. The fact is that lenders and appraisers were in cahoots to get deals done, and that appraisals were basically useless. A paper I wrote with Michael Lacour-Little back in 1998 found that appraisals came in at or above offer prices about 94 percent of the time in Boston, and I have little reason to doubt that the figure was similar elsewhere.

But the more general problem is that even honest appraisers cannot know property values with precision. When I read residential appraisals, they are ridiculous. For instances, they make adjustments from comparables that appear to have no foundation in statistical modeling; they weights the place on the comparables also have no particular foundation. Kerry Vandell showed that comparables can improve valuation relative to using regression along (because they can help control for characteristics that are difficult to observe in data), but I know of no appraiser who actually uses the techniques developed in Kerry's work.

But even if they did, it is likely the standard deviation of valuations would be something like 10 percent. This means that we can be 95 percent sure that actual values would be within 20 percent of appraised value. In neighborhoods where there is lots of homogeneity, one could do better; in neighborhoods with lots of variety, one could do worse. But the point is that to have one number determine collateral value makes little sense.

A rational scheme for mortgage underwriting would look at a combination of down payment size, amortization speed and confidence interval for valuations. I am not holding my breath.

Next Thursday in Madison

I will be speaking at the annual Wisconsin Housing Conference. I am really looking forward to returning to Madison.

My Colleague Lisa Schweitzer writes about GM

From her blog:

I opened my Facebook this morning to see a few environmentalists crowing about GM’s bankruptcy. If nothing else, this is uncharitable, as the company plans to lay off 21,000 more people. Way to combat the idea that environmentalists are a bunch of Birkenstock-wearing privileged bobos who don’t care about working class people, folks. At least there was some protection for workers’ retirement benefits in the restructuring.

But more to the point, crowing is also inaccurate. The car company will retain its four signature lines–Cadillac, Buick, GMC, and Chevrolet. It is cutting its Saturn and Hummer lines, or more accurately, selling them. It isn’t as though its cars on the road will vanish magically simply because of its economic hardship. If anything, this is probably bad news for the environment because these kinds of economic hardships give companies more evidence to argue against new, potentially capital-intensive changes needed to implement technology standards like the ones environmentalists were celebrating a few days ago or new engine technologies.

If this stuff were as easy as striking a strident normative stance , the planet would be sustainable already.

How would one best manage a university portfolio?

It would be complicated. The biggest asset for most places is tuition paying students. For selective universities (those with excess demand), undergraduates are more or less a long asset: one can expect a steady cash flow stream that is hedged against inflation. Masters student demand seems more volatile, and therefore shorter in duration. Ph.D. students lose money for universities in the short run, but might make money (via their ability to enhance a university's reputation) in the long run.

As for liabilities, it is again a mixture. Tenured faculty (and to some extent, unionized staff)are long liabilities; adjuncts have much shorter duration. Into this mix are financial assets and liabilities. It seems to me that the best portfolio strategy would use financial assets and liabilities to hedge the business of the university. I would be curious as to whether those in charge of managing university portfolios do this.

Speaking of Duration Mismatch

I wonder if we are setting ourselves up for another set of problems for Fannie and Freddie. They are purchasing large number of mortgages with 5 percent interest rates; so long as the yield curve remains steeply sloped, this is OK. But if short term rates rise to 5 percent, the GSEs and investors in their MBS who are borrowing short will be in trouble.

The problem is that the GSE disclosures are not very helpful. They look at the effect of changes in interest rates and the slope of the yield curve on value, but the changes are quite small. They also disclose how much of their debt is one year and how much is longer than one year, but again, one year is not that helpful a cut-off point. It is possible that everything is fine from a duration perspective, but with so much current focus on credit issues (and just getting through the next year), we may be taking our eye off the ball on interest rate risk.

I once felt good about having Larry Summers run the economy

Now I am not so sure. From Boston Magazine:

Further squeezing Harvard was a transaction Summers had pushed it into in 2004, when he successfully argued that the university should engage in a multibillion-dollar interest rate swap with Goldman Sachs and other large banks. Under the terms of the deal, Harvard would pay Goldman a long-term fixed rate while Goldman paid Harvard the Federal Reserve rate. The main goal was to lock in a low rate for future debt, and if the Fed had raised rates, Harvard would have made hundreds of millions. But when the Fed slashed rates to historic lows to try to goose stalled credit markets, the deal turned equally sour for Harvard: By last November, the value of the swaps had fallen to negative $570 million. The university found itself needing to post more collateral to guarantee those swaps, and would ultimately buy its way out of them at an undisclosed cost.

If this story is true, Summers basically created balance sheet duration mismatch, with short assets and long liabilities. This creates negative duration, which is just as risky as more traditional positive duration (i.e., the S&L problem). I wonder if Summers plotted out a worst-case scenario for this transaction, or if he just thought he was really good at forecasting interest rates.