Thoughts from 37,000 Feet

I am on a Virgin America flight that includes, among other things, Wifi. The plane is nicely lit and very clean (because it is new). And it makes me wonder whether the airline business will ever be a sustainable long-term business. There are reasons why it is difficult for the legacies to match the Virgins and Jetblues for amenities.

How many loans are non-recourse?

In California (and other states), purchase money home mortgages are non-recourse loans--if a bank accepts the keys from a borrower, it cannot then go after the borrower for any difference in value between the house and the loan outstanding.

But as I learned from Paul Willen this weekend, once a loan is refinanced, it is no longer a non-recourse loan. For borrowers who have no assets to speak of, the difference doesn't matter much. But for others, the difference is large.

Is it better to model or to converse?

It amuses me when on occasion someone in the real estate business complains that I am "too academic." For starters, given the career I have chosen, I don't exactly consider than an insult.

But it does raise a question: would academics who study real estate be better off spending less time modeling and more time talking to practitioners? As someone who enjoys talking to people in the business, I would say the answer is no. While models have their problems--particularly with respect to precision--well specified models should be free of bias. To give one example, modeling drove me to conclude three years ago that capitalization rates for commercial real estate were unsustainably low. I wasn't sure when they would rise, I was just sure that they would--and as a consequence drive down commercial real estate values. My views were treated with derision by practitioners, who were convinced that we had entered a "new paradigm" wherein cap rates would always stay low and values would forever stay high.

Jim Shilling summed up the issue in his AREUEA Presidential Address. Here is the abstract:

This paper is based on my Presidential Address to the American Real Estate and Urban Economics Association delivered at Washington, D.C., in January 2003. The paper asks whether there is a risk premium puzzle in real estate. I examine this question by reporting on an empirical investigation of real estate investors' expectations over the last 15 years. The results suggest that ex ante expected risk premiums on real estate are quite large for their risk, too large to be explained by standard economic models. Further, the results suggest that ex ante expected returns are higher than average realized equity returns over the past 15 years because realized returns have included large unexpected capital losses. The latter conclusion suggests that using historical averages to estimate the risk premium on real estate is misleading.

I actually do learn a lot by talking to people who do real estate. I just don't learn a lot about future returns.

Small Ironies

I was culling my books over the weekend, and decided to pitch out Milton and Rose Friedman's Free to Choose. This is striking me today as ironic, because I doubt that the West Virginia miners were free to choose much of anything.

At best, they made a choice based on misinformation--they thought they were working at a mine that met safety standards. Those of us who are tenured professors have indeed been free to chose; we can even say whatever we want without fear of losing our jobs. But to think everyone has such freedom is just delusional.

Good Reading

Yannis Ioannides Journal of Economic Literature review of Scott Page's The Difference: How the Power of Diversity Creates Better Groups, Firms, Schools and Choices.

My disappointment with Ted Koppel

I was listening to NPR's Talk of the Nation while driving home tonight: the topic was the federal deficit. They brought in Ted Koppel to talk about it, and he was asked the difference between the national debt and the deficit--and he couldn't answer.

It did not so much disappointment me that he didn't know (although the distinction is pretty easy--the debt is a stock and the deficit is a flow). It disappointed me that given that he knew he didn't know, he still thought he had something worthwhile to say about the issue.

I wonder if we will see a discontinuity in mortgage rates tomorrow

It should only happen if the market didn't believe the Fed would stop buying. Otherwise expectations should have already been built into pricing.

A little more on Mortgage Debt and Aging

I did a quick comparison of average household income for 1989 and 2007 (using the census) and average mortgage debt for those that has mortgage debt (using Survey of Consumer Finances data). In both cases I looked at 45-54 year olds.

In 1989, average household income among 45-54 year olds was $39,934; average mortgage debt outstanding among those who had debt was $39,300, so the ratio was about one-to-one.

In 2007, average household income among 45-54 year olds was $83,100; average mortgage debt outstanding among those who had debt was $154,000, so the ratio was just under two-to-one.

In 1989, the share of households in the age group with a mortgage was 58.3 percent; in 2007 it was 65.5 percent.

The only good news: interest rates have dropped from about 10.5 percent to 5 percent. So in 1989, an average income household that wanted to amortize an average mortgage in 15 years would need to pay 14 percent of gross income to do so; in 1989 it would need to spend 19 percent. So putting this all together, the ratio of debt service to income for amortization by retirement has increased by (.19*.655/.14*.583)-1 = 52 percent. Not good, but not quite as bad as I thought, either.

The long-term impact of the mortgage crisis--and why it keeps me awake

My parent's generation behaved differently than mine in all sorts of ways. A paper of mine with Hendershott shows that they spent less, controlling for education, etc., throughout their life cycle than any other generation. One of the reasons for this is that they paid off their mortgages. According to the American Housing Survey, 70 percent of households headed by someone over the age of 65 have no mortgage at all. Loan amortization became a mechanism for forced saving, and as a a result, those born during the depression are in pretty decent shape financially. A Pew Survey shows that those over the age of 65 feel much more in control of their finances than younger people.

My generation is different. Even under the most benign circumstances, we refinance in a manner that slows amortization. I refinanced in Madison twice to take advantage of lower interest rates--this was, of course, the right thing to do financially. But each time, the amortization schedule reset, and so it extended the period at which the mortgage would pay off. Now yes, one can take the money one doesn't put into home equity and put it in other savings vehicles, but it is not clear that everyone does that. Forced saving is slowed.

But this is not the worst of how people have handled their mortgages. A substantial fraction of borrowers pulled equity out of their houses, putting themselves on a lower savings path even in the absence of falling house prices.

I am going to run some American Housing Survey data on this, but it is hard for me to imagine that 70 percent of my generation will have no mortgage debt when we are elders. My parents' generation has used housing wealth to, among other things, finance long-term care. I hope I am missing something here, but the lack of housing wealth in the future could become yet another challenge as we seek to fund the needs of the elderly.

My Colleague Gary Painter writes about the Impact of Immigration on Midsize City Housing Markets

The abstract:

The recent trend of immigrants arriving in mid-size metropolitan areas has received growing attention in the literature. This study examines the success of immigrants in the housing markets of a sample 60 metropolitan areas using Census microdata in both 2000 and 2005. The results suggest that immigrants are less successful in achieving homeownership and more likely to live in overcrowded conditions than native-born whites of non-Hispanic origin. The immigrant effect on homeownership differs by geography and by immigrant group. Finally, we find evidence that immigrant networks increase the likelihood of becoming a homeowner.

Those who thought the housing tax credit would simply shift sales forward....

...rather than increase sales are probably being vindicated. February was another bad month for existing home sales.

The ultimate in branding?

I was recently at a meeting where all were instructed to turn off their Blackberries. Not iphones. Not cell phones. Blackberries. Everyone knew what was meant, though.

Has Blackberry become the new Kleenex? If so, they need to be careful. Aspirin was once a brand, but it became such a strong part of the lexicon, that Bayer lost the ability to retain it.

Clarification on Sprawl and Zoning

Zoning is not the only reason we are spreading out--as my colleague Peter Gordon shows (go to minute 50), people are spreading out around the globe. Our increasing affluence and rise of the automobile have also led us to spread out. The fact that gasoline is so much cheaper in the US than other places has led us to spread out faster.

But our particular brand of single-use zoning has doubtlessly had an impact on settlement patterns. At minimum, we have insufficient land zoned for apartments. We know this because land zoned for multifamily use often sells for more (controlling for location) than land zoned for single-family use. This is not the market--this is local government holding back the supply of a certain type of land use. Moreover, minimum lot size, set back and street width requirements mean we use more land than necessary to build even single-family housing.

US sprawl is not a market outcome.

A discussion is going around the internet about John Stossel's "libertarian" piece on the virtues of sprawl. John Norquist, on the other hand, labels sprawl a "communist plot," and Matthew Yglesias notes how bulk zoning requirements promote sprawl.

A point John likes to make is sprawl is at least in part the result of government housing finance policy. The New York Times this morning:

I.R.S. requirement keeps the agency from acquiring mortgages made in buildings where more than 20 percent of the square footage is commercial — space that is used for, say, a hotel or a doctor’s office.

Mixed use development is not going to happen if it can't get financed. Most of Paris, London, large swaths of San Francisco (i.e., some of our best urban places) would not qualify for US housing finance rules. And of course, single use zoning would ban them all.

But most insidious is that zoning is used as a tool to keep low-to-moderate income people out of suburbs. The town next door to mine--San Marino--has zoning requirements so onerous that it is not possible to build small housing there. Even my town, Pasadena, which at least has a bunch of apartments, prevents construction of granny flats on lots smaller than 15,000 square feet. These rules keep out the poor, which reduces expenditures on social services, which makes property values higher, which keeps out the poor, which...

Of course poor people must live somewhere, and so they live in cities with old housing stock that was built before the era of stringent zoning. So cities with old housing stock are placed at a fiscal disadvantage, which induces people with means to leave, which puts them at a greater fiscal disadvantage, etc....

My Colleague Lisa Schweitzer wonders whether anyone understands the Macro Economy

She says so in a note at the bottom of a blog posting.

Macroeconomics is unsatisfying to me, as well. In one sense, we can't really understand it, because our degrees-of-freedom (number of data points) are limited. We have had ten business cycles since WWII, and if we think seriously about these things, that means we have had only ten data points from which to draw inferences. Leaving aside Manski's issues about identification in general, this means we can only estimate the impacts of at most nine casual factors on economic performance, and only then with an enormous amount of imprecision.

Unfortunately, those making policy need to do the best they can anyway. It seems reasonable to me that when private sector demand falls off a cliff, the public sector should fill in the gap. It also makes sense to me in times of high unemployment to help the unemployed eat and stay in their house. But that has less to do with macroeconomics than it has to do with decency, an issue too many macroeconomists seem to be uncomfortable with considering.

I continue to like micro a lot, though.

Business Schools do teach Modigliani-Miller and Sharpe Ratios. Why does no one remember them?

The New York Times had a disturbing story about pension fund investments the other day. One paragraph is typical:

Wisconsin, meanwhile, has become one of the first states to adopt an investment strategy called “risk parity,” which involves borrowing extra money for the pension portfolio and investing it in a type of Treasury bond that will pay higher interest if inflation rises.

Officials of the State of Wisconsin Investment Board declined to be interviewed but provided written descriptions of risk parity. The records show that Wisconsin wanted to reduce its exposure to the stock market, and shifting money into the inflation-proof Treasury bonds would do that. But Wisconsin also wanted to keep its assumed rate of return at 7.8 percent, and the Treasury bonds would not pay that much.

We teach that IRR rules are bad rules because they don't take into account risk. Net present value rules, where one needs to explicitly pick a risk adjusted discount rate, can prevent the sort of woe we have seen over the past few years.

Whenever I meet a senior executive from a company that got in trouble because of too much leverage, I ask (nicely, I hope) whether they know MM, which implies that investment decisions should not be made based on capital structure. Most say no, but they are very interested to hear about it.

This is stuff that has been known for a long time. One would think the most recent crisis would teach pension funds not to go down the same path they and others followed before. Alas this seems not to be the case.

Tracy Gordon says that the Total Government Spending (Local, State And Federal) did not grow very much.

She writes:

M

eanwhile, Joshua Aizenman and Gurnain Kaur Pasricha showed in a National Bureau of Economic Research paper that, using either measure, ARRA’s “net fiscal impact” was zero.

What gives? Did Paul Krugman’s prognostications about Fifty Little Hoovers come true? Not so fast. The NBER study asked not whether ARRA boosted the economy but merely whether it stimulated government spending. (Tax cuts are completely out of the story.)

There is no doubt federal outlays grew – to the tune of about $160 billion through last December according to the CBO. But, the NBER authors say, belt tightening by state and local governments almost completely offset this increase.

As the NBER authors note, “the counterfactual of the performance of the US economy in the absence of the fiscal stimulus is hard to ascertain.” In other words, no one knows what would have happened to government spending without the stimulus. They assume it would have chugged along at typical post-World War II levels, while others think we were headed for The Great Depression 2.0. In any event, it’s certainly not hard to find a governor who says that, but for those extra federal funds, their budget situation would be a lot worse.

So was ARRA a flop? No more so than usual. States and localities generally save federal dollars for a rainy day if they can get away with it, much like individuals save tax cuts. This tendency also frustrated Washington architects of General Revenue Sharing during the 1970s and 1980s.

Tracy is on target, but my take is a little different in one respect: almost every state has a balanced budget requirement, which means that all the Feds did was allow states to cut less spending than they otherwise might have. And as it is, they still cut a lot.

My Father sends me to Alan Tonelson and Kevin L. Kearns

He asks me whether their op-ed, Trading Away Productivity, in the New York Times this past week was correct.

I'm pretty sure that they are not correct, for reasons I am about to give. But the topic is really not within my wheelhouse, so I went searching for critiques on line. The only one I could find is on CafeHayek; the fact that it is there doesn't exactly reassure me. I also wasn't crazy about the argument.

Anyway, Tonelson and Kearns argue that labor productivity in the US has not gone up, because much more manufacturing assembly is done abroad, and that therefore the division of GDP by US work hours to get productivity is misleading.

But the only aspect of output that goes into GDP is value added. GDP is thus measuring value created in the US divided by hours worked in the US, which is as good a measure of average labor productivity as I an think of. Indeed, the whole point of trade is that different nations produce different things based on what they are comparatively good at doing. This even works within nations, within states and within cities.

Let me stipulate that I have long thought that trade was a good thing, and impediments to trade were generally bad things. My dissertation was on US commercial policy in the 1970s, and to me the evidence showed that protectionism created a lot of bad outcomes without a whole lot of good ones. I can't help but notice that a lot of places over time have become rich because of trade, from the Hanseatic League of Cities in the 13th century to Singapore today. I should note that Swati Dhingra, a Ph.D. student who is finishing her dissertation at Wisconsin, has done sophisticated work merging industrial organization theory with trade theory to show the benefits of trade might not be quite so large was we think. But Tonelson and Kearns seem quite crude by comparison.

But I have not studied these issues in depth for some time, so if I am fundamentally wrong, I would welcome correction.

Another Book for the Pile: Scott Patterson's The Quants

One of the problems with quantitative analysis in finance is that a lot of it relies on calculus. Calculus is a beautiful thing, but it also involves small changes--and when I say small, I mean infinitesimal.

This makes for a good approximation when analysts are dealing with movements of a few basis points. It becomes a big problem, however, when the economy goes through major structural shifts. The point came home to me some years ago, when I was trying to estimate the impact of changes in the tax code on house prices. I was using regression coefficients (which are essentially first derivatives), and got changes in prices that seemed way too big. The problem is that the relationship between house prices and taxes is non-linear, so simulations involving large changes in tax policy cannot be approximated with a linearization.

California employers add 32,500 jobs in January - latimes.com

California employers add 32,500 jobs in January - latimes.com

Posted using ShareThis

Why we need an independent consumer financial protection agency, and why Elizabeth Warren should run it

I know it is too late now, but I want to make the point anyway.

I remember the first time I heard Elizabeth Warren speak. It was at a conference on consumer credit hosted by Georgetown and the estimable Mike Staten--I think it was in 2002. Elizabeth Warren spoke about consumers getting steered into mortgages--and in particular high balance mortgages and long-term mortgages. She argued that this was bad for consumers; she argued low balance, short maturity mortgages would mean consumers would pay less interest, and that this would leave consumers better off.

My reaction was that she was nuts. After all, my economist's brain told me, present value is present value. She was ignoring the opportunity cost of equity. She was, I thought, offering consumers horrible advice.

Now her advice looks pretty good. Lower leverage means lower risk, and households--particularly those without financial assets--are not in a good position to manage risk. Moreover, low balance short amortization mortgages nudge people into saving, and may explain why people of my parents' generation (who paid off their mortgages by the time they were in their 50s) are in better shape financially than people of my generation (who kept taking equity out of their houses).

The problem with the Fed is not that people there aren't smart and well-intentioned--they are. The problem is that most people there were trained to think like me. I hate to say it, but there may be times when a smart, caring lawyer understands how the world really works better than a smart, caring economist.

Chile, Earthquakes and Los Angeles

An explanation (and probably a correct explanation) for why the earthquake in Chile did not produce even more fatalities is that it is a relatively rich country with decent building codes.

This prompts a few thoughts about Los Angeles. First, many of us who worry about the cost of housing worry that land use regulations and building codes drive up the price of houses to a point where low-to-moderate income households can't afford them.

But clearly making housing seismically appropriate is important in LA, and this will drive up the cost of housing for good reason, and in particular will drive up the cost of high rise buildings, which in turn means that unit density in Southern California will be low relative to population density (and so it is). To some extent, then, our sprawl reflects an appropriate allocation of resources. It also explains (among other reasons) why housing will also be somewhat more expensive here than other places.

According to my colleague Lisa Schweitzer, our sprawl might do even more good. Specifically, a spread-out city such as ours is more "diversified" with respect to natural disasters, because no more part of the metropolitan area dominates economically, There is no one central job center here--there are many: downtown, Century City, Santa Monica, Pasadena, Burbank, Santa Ana, Newport Beach, Long Beach etc.

Finally, the need to prepare against earthquakes has strong implications for the ability to redevelop downtown. Broadway has magnificent buildings that are empty above street level. One of the most important reasons for this is that seismic retrofitting is so expensive, redeveloped old buildings are not competitive with new buildings. This is sad, but likely appropriate.

Megan McArdle writes: Jim Bunning Plays Chicken with Unemployment Benefits - Business - The Atlantic

Megan McArdle says it perfectly:

Jim Bunning Plays Chicken with Unemployment Benefits - Business - The Atlantic

Unfortunately, Bunning's mind doesn't seem to work so well any more (which is why even the GOP wanted him to step down from his Senate seat), so he is immune to persuasion.

Yet another study I wish I could do

I was listening to rap while driving down the 210 on Saturday. I don't listen to rap very often, but when I do, it is always while I am in the car. I notice that something always seems to happen when I do--my speed gets faster--sometimes much faster--and I need to slow down (because I do not wish to incriminate myself with the CHP, I will not get any more specific than that). On the other hand, when I listen to, say, Winton Marsalis, I seem to drive more slowly. I have noticed no clear pattern when I listen to news or classical.

So the study is--do people drive different speeds depending on what they are listening to in the car? It would be fun to test.

The Cluelessness of Harvard

Tim Noah sent me to:

Super-active students are over-scheduled | Harvard Magazine Mar-Apr 2010

The article is, to me, horrifying, in that it suggests that Harvard has, with respect to undergraduates, completely lost its liberal arts roots (I am sure the Ph.D. programs in Arts and Sciences are another matter). But two passages in particular bother me. The first is from Admissions Dean Fitzsimmons:

"....but there’s no question that this place has many more people from the bottom quarter and bottom half of the American income distribution. Now, about a quarter of the class comes from families earning less than $80,000 per year.”

But median household income in the US is $50,000 per year; at $80,000, a household is somewhere in the second highest quintile (and about the same distance to the top of the quintile as the bottom). A more accurate statement, then, is that 75 percent of Harvard students come from the top 25 percent of the income distribution, which is better than 90 and 10, but is still hardly an indicator that Harvard is an engine of social mobility. For that, one needs to turn to places like that Cal State schools.

Even more annoying is

Harvard may or may not be the greatest university in America,” says Howard Gardner, “but it is clearly the greatest one in the world” in that it’s known from Malaysia to Chile to Sri Lanka, whereas references to Yale, Stanford, and Princeton draw only blank stares even in western Europe.

I want to know where in Western Europe Yale, Stanford and Princeton draw blank stares. Hell, in most places I go, people have even heard of the University of Southern California.

Harvard has so much wealth and such extraordinary faculty and students, it survives its insularity. But to see such insularity put on display in its own alumni magazine...

Some Hollywood Facts I learned yesterday at the Lusk Rena Sivitanidou Research Symposium

From Elizabeth Currid Halkett I learned that the two most strongly connected cities (in terms of propensity to show up in Getty Images) are LA and New York, with LA and London second.

From Michael Storper (UCLA), I learned that while film production is increasingly outsourced, creative film talent is increasingly concentrated in LA.

From Matt Kahn I learned that movie stars get no more when they sell their houses than anyone else.

I will report on non-Hollywood related issues later.

Yesterday's lousy new home sales number and the supply effect

New homes available for sale are at their lowest level since 1971.

The data come from http://www.census.gov/const/www/newressalesindex_excel.html


Population in the US in 1971 was about 2/3 the current population. Maybe nothing is selling because there is nothing to sell. It is hard for me to see how construction doesn't make a come-back this year.

Today's New Home Sales number...

...was awful. But it may be a supply effect as well as a demand effect. The gap between a used home and the cost of building a new home is large, meaning that people would rather pick something up in the used market. And in the spec market, builders have not built much of anything recently, meaning that the new stuff available for sale is quite low.

Just a thought...

The banality of Mitch McConnell

I heard him on NPR this morning saying we need to cut taxes more. Here are all federal revenues as a share of GDP going back to 1995:

1995 0.183
1996 0.185
1997 0.190
1998 0.196
1999 0.195
2000 0.208
2001 0.198
2002 0.174
2003 0.160
2004 0.158
2005 0.175
2006 0.180
2007 0.187
2008 0.178
2009 0.148
2010 0.148

The Bush Tax cuts pushed revenue down by about 20 percent relative to GDP; the recession has pushed them down another 7 or 8 percent. The American people like their spending (any reduction in entitlements or defense spending elicits howls. And the American people are not particularly greedy about what they want from their government--relative to other OECD countries, our social safety net is pretty small. At the same time, the average tax burden in the US relative to GDP is about 3/4 of the average tax burden for the OECD.

So, Senator McConnell, if you really think taxes are too high here, what would you cut? Don't tell me waste and fraud.

The brilliance of FDR

He made us confront our problems while making us feel good about ourselves:

But here is the challenge to our democracy: In this nation I see tens of millions of its citizens—a substantial part of its whole population—who at this very moment are denied the greater part of what the very lowest standards of today call the necessities of life.

I see millions of families trying to live on incomes so meager that the pall of family disaster hangs over them day by day.

I see millions whose daily lives in city and on farm continue under conditions labeled indecent by a so-called polite society half a century ago.

I see millions denied education, recreation, and the opportunity to better their lot and the lot of their children.

I see millions lacking the means to buy the products of farm and factory and by their poverty denying work and productiveness to many other millions.

I see one-third of a nation ill-housed, ill-clad, ill-nourished.

But it is not in despair that I paint you that picture. I paint it for you in hope—because the nation, seeing and understanding the injustice in it, proposes to paint it out. We are determined to make every American citizen the subject of his country’s interest and concern; and we will never regard any faithful law-abiding group within our borders as superfluous. The test of our progress is not whether we add more to the abundance of those who have much; it is whether we provide enough for those who have too little.

If I know aught of the spirit and purpose of our Nation, we will not listen to comfort, opportunism, and timidity. We will carry on.

Overwhelmingly, we of the Republic are men and women of good will; men and women who have more than warm hearts of dedication; men and women who have cool heads and willing hands of practical purpose as well. They will insist that every agency of popular government use effective instruments to carry out their will.

Government is competent when all who compose it work as trustees for the whole people. It can make constant progress when it keeps abreast of all the facts. It can obtain justified support and legitimate criticism when the people receive true information of all that government does.

If I know aught of the will of our people, they will demand that these conditions of effective government shall be created and maintained. They will demand a nation uncorrupted by cancers of injustice and, therefore, strong among the nations in its example of the will to peace.

If this is happening, the Administration is Pretty Clever

I heard a real estate investor this morning claim that as banks are making profits because of the spreads over their cost of money, regulators are forcing them to liquidate bad assets and realize the losses. If this is really going on, somebody really smart is behind the idea.

Is this growing up?

I still like to listen to records. For years, I have had a British Belt Drive Turntable--a Linn Sondek LP12. When it worked, it sounded great, but it was extremely fussy, and repairs for it were astronomically expensive.

I now have a Technics 1200Mk2. I will stipulate that it does not sound as good as a Linn, but it sounds quite good to my aging ears--and it works all the time. So instead of spending time tweaking my turntable, I am spending time with family and friends--and actually listening to music.

Environmental Regulation can Leave the Economy Better off (h/t Elizabeth Vivian)

From the EPA:

The direct benefits of the Clean Air Act from 1970 to 1990 include reduced incidence of a number of adverse human health effects, improvements in visibility, and avoided damage to agricultural crops. Based on the assumptions employed, the estimated economic value of these benefits ranges from $5.6 to $49.4 trillion, in 1990 dollars, with a mean, or central tendency estimate, of $22.2 trillion. These estimates do not include a number of other potentially important benefits which could not be readily quantified, such as ecosystem changes and air toxics-related human health effects. The estimates are based on the assumption that correlations between increased air pollution exposures and adverse health outcomes found by epidemiological studies indicate causal relationships between the pollutant exposures and the adverse health effects.

The direct costs of implementing the Clean Air Act from 1970 to 1990, including annual compliance expenditures in the private sector and program implementation costs in the public sector, totaled $523 billion in 1990 dollars. This point estimate of direct costs does not reflect several potentially important uncertainties, such as the degree of accuracy of private sector cost survey results, that could not be readily quantified. The estimate also does not include several potentially important indirect costs which could not be readily quantified, such as the possible adverse effects of Clean Air Act implementation on capital formation and technological innovation.

One of the foundations of Meg Whitman's gubernatorial campaign is the gutting of California's environmental laws. Anyone who remembers what LA was like before the Clean Air Act will have to wonder whether this is a good idea.

An Update on my Sunk Cost Paper with Rosenblatt and Yao

In the earlier version, we found that Loan-to-Value at origination predicted default probability, even after controlling for market-to-market (i.e., contemporaneous) LTV. We now find that the results are robust to whether we look at LTV at origination, dollar amount of the down-payment, or down-payment relative to income. This is consistent with prospect theory--borrowers show aversion to [realizing the loss] on their down-payments, even when walking away seems to make sense financially.

The paper is on SSRN.

[Thanks to Tstockmann for more correct wording on prospect theory].

California's budget picture is improving (h/t Andrew Leonard)

Comptroller John Chiang's January budget report puts tax revenues at 18 percent above expectations.

It doesn't bother me that Sarah Palin writes on her hand

It bothers me what she writes on her hand.

Useless (but fun) fact of the day

The densest zip code in the US is on the Upper East Side of New York, with a density of about 580 people per hectare. Metropolitan Mumbai has a density of about 400 people per hectare (h/t/ Alain Bertaud). But the UES is filled cheek-by-jowl with high-rises. Mumbai is not.

Some facts from Thad Kousser on California

I went to a very nice talk by Thad Kousser (UCSD) yesterday on whether California is "ungovernable." Some of the takeaways I got (and if I screwed any of this up, it us my fault, not Thad's):

(1) The California legislature really has gotten more polarized over the years.

(2) The people of California have not.

(3) Politically, California has changed from a North-South state (D's north and R's south) to a West-East state (D's west and R's east).

(4) For non-budget legislation, California actually is governed quite well.

(5) For budget legislation, it is not.

(6) The difference is that the budget requires 2/3 approval, whereas other types of
legislation only requires a majority.

(7) The 2/3 rule is not a Prop-13 phenomenon--it has been around since the 1930s.

Housing and the Macroeconomy in India

Some years ago, I wrote a paper that showed how housing construction in the United States led the business cycle. The paper included a large number of econometric specifications (detrended levels, first differences, error correction, etc.), and the finding was robust to all specifications: residential investment Granger caused GDP.

For the Jackson Hole conference two years ago, Ed Leamer did a similar exercise, and found that the results held up: indeed the title of his paper was "Housing is the Business Cycle." An interesting question, then, is whether the result holds for other countries.

For at least one other, it appears not to. One student of mine from Wisconsin, Shampa Bhattacharya, performed the exercise for India, and could not find a relationship between housing and GDP. Another student of mine from India School of Business, Katyayini Krishnamoorthy, updated Shampa's work with fresh data and found the same thing.

The difference in results may reflect the fact that Indian data has lower frequency than US data (it is annual instead of quarterly), but it was striking how they got absolutely nothing. Among other things, it means that in India housing is not an effective transmission mechanism for monetary policy. This may have something to do with the fact that housing finance in India is not well developed--a fact that may have kept that economy out of trouble over the past few years. I will be posting more about this soon.

Ugliest sentence I have seen in a long time.

I wake up this morning to an email with this following sentence:

CATALYZING THE POWER OF HARVARD TO IMPACT HEALTH

Sunk Costs and Mortgage Default

A paper with Eric Rosenblatt and Vincent Yao. The abstract:

In this paper, we estimate default hazard functions that include standard variables along with borrowers sunk cost: i.e., down payment at loan origination. After testing large numbers of specifications, we find that after controlling for mark-to-market loan-to-value, initial combined loan to value remains an important predictor of default. We also find, contrary to Guiso, Sapienza and Zingales, that there is not a specific point at which one observes a discontinuous default probability, but that it is rather that default is smooth in mark-to-market LTV.

Paul Goldberger on Dubai

The architecture critic writes:

The Burj Khalifa, like most super-tall skyscrapers, looks best from afar, and, certainly, it can’t do much to mitigate the real horror of Dubai, which isn’t the fact that most of the towers look gaudy on the sky line but that they are wretched at street level. This is a city that has grown with utter hostility to the idea of the street. The main commercial thoroughfare, Sheikh Zayed Road, lined with skyscrapers, is a twelve-lane highway. It’s impossible to get anywhere here without a car, and there is no place to walk except inside a mall. The city is completing a transit system, and there are some strikingly handsome, glass-enclosed elevated stations, but it is an idealized version of a Western-style metro, dropped onto an urban plan designed solely for the automobile; it’s hard to believe that it will make much difference. The biggest group of pedestrians I saw in five days was on the promenade outside the Dubai Mall, where people gather to look across an artificial lagoon at the Burj Khalifa while watching fountains dance to Middle Eastern music. To them, the Burj is a backdrop for a show.

I couldn't say it better myself.

Why does NBC do this?

NBC blocks its shows from streaming in India, but Viacom (Comedy Central, CBS) doesn't. So I have been able to watch the Daily Show and Letterman, but I couldn't watch Conan's last show.

Why do they do this? Students here seem pretty hooked on Jon Stewart; it seems to me this might translate to DVD revenue somehow.

Richard DeKaser says only 87 of 299 US cities now have overvalued housing markets

His list seems quite reasonable to me. And his 2006 list pretty much nailed overvalued markets.

Economists need to do a better job of explaining Pigouvian Taxes

I am actually surprised that there is much of an argument about taxing large banks in order to recover TARP funds. We certainly have adequate evidence that "too large to fail" financial institutions impose social costs on the economy. We also have ample evidence that bank managers, knowing that they are managing "too big to fail" institutions, will take on excessive risk, unless they are actively discouraged from doing so.

Textbook economics says that when an action creates social costs, it is optimal to tax it. It is, of course, difficult to know what the precisely correct tax rate should be, but we can probably come up with a reasonable approximation. And getting taxes slightly wrong is probably less distortionary than getting regulation wrong/

I long thought that if Fannie and Freddie had to pay a Pigou tax on their debt, they would avoid getting into trouble. Alas...

Inexpensive Capital Stock that might increase productivity in India

Hyderabad does not have many sidewalks--even where it is building wide roads. Lots of streets in Europe don't have sidewalks either, but they are so narrow that cars drive slowly, meaning that cars and pedestrians can co-exist without separation.

But here, walking can be down right scary. I will upload some pictures later. While I understand that resources are scarce here (investments in water, sanitation and education likely dominate everything else), I really do wonder where, from a capital budgeting perspective, sidewalks would rank.

California has less than four months of housing inventories

The California Association of Realtors sales report puts inventories at 3.8 months. Perhaps more interesting is that even inventories in the $1 million + range are half what they were a year ago, and at 7.8 months are just slightly higher than the equilibrium level of 5-6 months.

The market is now tight enough that it could even handle some foreclosures (the shadow inventory) without getting whacked too badly. And because lenders seem more willing to do short sales, there is a chance that the number of foreclosures will be somewhat smaller than previously forecast.

Once again, if not Bernanke, who?

So I see names out there. I think lots of supporters of Paul Volcker would be disappointed with his policies--he was, after all, the guy who allowed interest rates to rise into the stratosphere in order to break the back of inflation. I actually admire his helmsmanship of the Fed a lot, but I am not sure that many of those throwing out his name understand what they might be getting.

Paul Krugman is certainly more than smart enough and has made remarkably accurate forecasts over the past nine years, and I like his politics a lot--I am guessing I agree with him about 95 percent of the time. But his comments have at times been immoderate--and Federal Reserve Chairs need to have even temperaments. I also would guess he would have a tough time getting confirmed, although I am terrible at political forecasts. As PK also notes, Alan Blinder and Janet Yellin, who would also be good choices, might have tough confirmation battles.

John Taylor, William Poole and Charley Plosser are all smart but are ideologues. I have never seen any evidence that they care in the least about the social costs of unemployment. I suppose Martin Feldstein would be OK, but I am not sure why a Democratic President would nominate him.

In short, I keep coming back to the fact the Bernanke is smart (or, as Krugman says, brilliant), honest, is willing to listen and learn, and has an even temperament. Did he not see the magnitude of the crisis coming? Sure. But neither did a lot of us (I thought the subprime meltdown would be a problem on the order of the Savings and Loan crisis--it was Nouriel Roubini who ultimately woke me up). I just don't see anyone better out there.

Next on the reading pile: Louis Menand's The Marketplace of Ideas

I loved the Metaphysical Club (especially the stuff on Oliver Wendell Holmes); Menand has a sharp eye and a winning style. But he purports (apparently) to solve a mystery which isn't all that much of a mystery: why is the academy so liberal? To me the answer is obvious--if you are willing to become an English professor, you have revealed that you don't care much about money.

One survey I just found put the average English assistant professor's starting salary at $47K; a full professor makes on average 74K. Given how grueling it is to get a Ph.D., and given how few tenure track jobs are out there in English, this means the expected monetary value of going to graduate school relative to effort is small.

So why do people do it? Because they love Dickens or Austin or Shakespeare or Conrad or Toni Morrison or Zadie Smith, and they want to spend their lives reading and thinking about such. Clearly, money wages do not have a particularly large place in their utility functions. If money is not important to you, then maybe you will be less prone to complain about taxes.

Conversely, people who care a lot about money should look elsewhere. Even within fields this is true: academic physicians tend to earn less than private practice docs, but they get to play with state-of-the art treatments and probably provide better medical care. So once again, money is not top priority.

I do not think I am going out on a limb when I posit that the correlation between how much someone cares about money and their propensity to vote Republican is highly correlated. So I suppose if Republicans want more conservative English Professors, they should advocate paying them better!

Brad Delong takes down the execrable Charles Murray

The only reason to mention a reference to Murray is that it gives me an excuse to recommend Goldberger and Manski vivisection of "The Bell Curve."

If not Ben, then who?

I wish that those who are trying to block Bernanke would let us know a better alternative--I can't think of one. Bernanke is smart, honest, and while he made mistakes, he showed a great deal of flexibility (and a willingness to learn) in response to the crisis. The best evidence suggests to me that we were indeed on the brink, and he gets a lot of credit for pulling us back. I guess that I am especially mystified that the Republicans would oppose him, unless they are hoping to put the country on a new downward spiral before the midterms (I like to think they even they are not that cynical).

Full disclosure: I briefly met Bernanke once, and I really liked him as a person. But I don't think that has any influence on my views of him as a central banker.

Does how little we know about other countries matter? Probably.

I am currently in India, and went out for beer last night with a number of people, all of whom seemed very engaged in the outcome of the Massachusetts Senate race; there was in particular a lot of curiosity about what it meant for US policy going forward.

Yet I would guess that very few Americans know the name Jyoti Basu (I know that if it weren't for the fact that I have now visited India 4-5 times, I would not know who he is). Basu died a few weeks ago, and it is fair to say that he was at least as important to India as Ted Kennedy was to the US, and probably more so.

It seems to me that as India and China's influence continue to grow, it will become increasingly important that more of us in the US know more about their politics and their leaders--beyond heads of state. But then again, maybe I am just getting on my high horse, which I am known to do from time to time.

George Harrison - Bangladesh

Lunch conversation today turned to the many intractable problems (still) facing Bangladesh, and it reminded me of the great George Harrison song--which doesn't seem to get much play anymore.

My Cousin Jonathan Weinstein quotes George Washington on Speculators

"[They] work more effectually against us, than the enemy's arms. They are a hundred times more dangerous to our liberties, and the great cause we are engaged in. It is much to be lamented that each State, long ere this, has not hunted them down as pests to society, and the greatest enemies we have to the happiness of America."

Of course Jon also points out that Alexander Hamilton was backstage, telling bankers that they really had nothing to worry about.

The estimable Joseph Stiglitz complains about the social cost of securitization, but doesn't acknowledge possible social benefits

In Mother Jones he writes:

Securitization epitomized the process of how markets can weaken personal relationships and community. With securitization, trust has no role; the lender and the borrower have no personal relationship. Everything is anonymous, and with those whose lives are being destroyed represented as merely data, the only issues in restructuring are what is legal—what is the mortgage servicer allowed to do (see "Mortgage Shark Attack")—and what will maximize the expected return to the owners of the securities. Enmeshed in legal tangles, both lenders and borrowers suffer. Only the lawyers win.

This is an issue. But let's not get too sentimental about the days in which we relied on relationship lending. In those times, if one was white or male, his relationship with lenders was automatically better than anyone else's. When lending decisions were made based on borrower "character," it re-enforced the ability of well-connected people to get access to capital, while others were shut out.

There was something to be said for a model where measurable credit-worthiness--rather than personal relationships--determined loan outcomes. The problem was not the securities, but rather the fact that lenders did away with all underwriting--measurable and unmeasurable.

Arturo Toscanini

Haven't listened to anything from AT in while. Shame on me.

Having dumped on Mickey Kaus, I have to give him props for:

this (you have to scroll, I can't find a permalink):

Funny, I would think health care reform would be judged effective if, say ... all Americans, however rich or poor, can get the health care they need, including the latest advances in life-saving and life-enhancing treatments. If reform accomplishes that, but the health care sector winds up as 20 percent of GDP, will it really be a failure? Why? As long as it's paid for who is Al Hunt to tell Americans how much of their GDP they should spend keeping themselves alive?

I think that is about right.

Is it a bubble?

I am spending January visiting at the Indian School of Business in Hyderabad--it is a lovely part of India here, with hills, lakes and a (relatively) mild climate. The atmosphere is at once laid-back and hard working--kind of like California!

So here is the mystery. After talking to people and having students here gather data from web sites, it appears that rents for apartments in Banjara Hills--a nice part of town--go for about Rs 100-120 per year per square foot; they sell for about Rs 10,000. Thus the gross rental yield is about one percent.

Given that mortgage interest rates here are in eights, and that owning property involves expenses, for owning to be a break even proposition implies that rents (and values) need to increase by at least 10 percent per year forever. This suggests a bubble.

Yet typical loan-to-value ratios here are low, and many buyers purchase with cash only. As best as I can tell, people don't flip property here, in part because the stamp (transfer) tax at ten percent is very high. So the characteristics of a bubble--lots of leverage and flipping--don't seem to be present here.

Some people here have suggested that real estate here benefits from "black money"--income that is unreported so as to evade taxes. Those who have such money park it in real estate--they buy at an "official" transactions price that is well below the actual price. But it seems to me that the minimum reasonable dividend yield here is 4-5 percent (there might be a lot of growth for while), which implies values should be about one-quarter of what they actually are. That is an awfully big black money premium.

The biggest stretch I have yet seen for blaming Fannie for the world's problem

Micky Kaus, who seems to have trouble sleeping at night for fear that some below median income person somewhere might actually benefit from government, attacks Jim Johnson, former CEO of Fannie Mae, for contributing to our current woes.

The problem is that Johnson ran the company from 1991-1998; I am guessing that few mortgages from his tenure are even around anymore, and if any are, their balance is so much lower than the value of the house supporting them (house prices are still nuch higher than in 1998, and the loan would have amortized a lot), that the incentive to default is non-existent.

Of course, in the piece he approvingly quotes Peter Wallison, an AEI "scholar" who never met a bank he didn't like.

Over the years, Fannie has done plenty of things not to like. But jeez!

The Risk Culture at Freddie Mac pre-2003

I am in the middle of writing a default paper (I know, who isn't); in the course of looking up references, I Googled (Bob) Van Order and (Chet) Foster, who wrote two of the seminal papers on mortgage default modeling. The first entry that shows up is this very good blog post from Arnold Kling from about a year ago. He finishes the post with:

I was "present at the creation" of Freddie Mac's risk management culture--all of those people who had absorbed the Foster-Van Order approach to pricing mortgage default risk. That was the culture that Syron rejected. I was proud to be part of that culture, and I would have felt hurt no matter how Syron's new policy turned out. But the new policy drove Freddie Mac to the brink of bankruptcy, if not beyond. As a result, I believe that the risk-assessment models that we so proudly developed will die along with the company.

I read the post when Arnold first wrote it, but it struck me as especially poignent now. As it happens, when I was at the ASSA meetings, the people I went to dinner with on both nights all either once worked at or currently still do work at Freddie. This was not by design--they were just all people I like hanging out with, because they are all caring and exceedingly competent people. They are the sort of people that led me to want to work at Freddie during my brief absence from academia. That culture that Arnold writes about was pretty special, and it would be nice if somehow we could get it back.

The best tip I got at the ASSA meetings

I went to a wonderful memorial session celebrating the work and life of Arthur Goldberger, and a number of speakers referred to Nicholas Kiefer's interview with him in Econometric Theory. A copy is here. Read it.

Don Haurin gave a very nice AREUEA Presidential Address

He tries to explain the increase in the homeownership rate over the 90s and 00s. He finds:

Demographics don't
Income and wealth don't
Interest rates don't
Local house prices don't
National house prices do!

We finds that when the moving average of national house prices rises, the propensity to own goes up. While one would think tat only local house prices are relevant, they do not have explanatory power for tenure choice--only national house prices have such power. Perhaps the frenzy was driven by national media reporting. I look forward to seeing Don's paper.

More evidence that economists are cheap

The Wall Street Journal reports on the strange band of people converging on Atlanta over the next three days: We have our conventions after the New Year, because that is when hotel rates are cheapest.

Two personal anecdotes on the penurious nature of economists:

(1) Many years ago, I went to the ASSA meeting in New Orleans. My plane arrived late, and I hadn't eaten, so I went into a bar to get a burger. Once I sit down, the bartender says to me, "you're not one of those as****e economists, are you." I said, "no sir, not me." He said, "good, those as****e economists are so cheap that all they'll drink is beer. Now what will you have."

(2) There was an chain Italian restaurant where I would sometimes go to lunch with colleagues. It was one of these places that gives you all the salad and rolls that you can eat if you order an entree--they just put a couple of salad bowls on the table, and refill them when they're empty. When one of our colleagues would learn a group was going, he would come along, eat the salad and rolls, and not order anything.

Florida did overbuild

Doing the same exercise as I did for California: since 1980, population in Flordia has grown by about 8.7 million--average household size is 2.46 people, for increased demand of 3.6 million units. About 4.6 million units were built, or one million more than necessary to meet full-time residential demand. Florida has a large second home market, but really...Florida's population is about half of California's.

Illness and Foreclosure (h/t Vanessa Perry)

Christopher T. Robertson , Richard Egelhof, and Michael Hoke have a paper:

Abstract:
In recent years, there has been national alarm about the rising rate of home foreclosures, which now strike one in every 92 households in America and which contribute to even broader macroeconomic effects. The "standard account" of home foreclosure attributes this spike to loose lending practices, irresponsible borrowers, a flat real estate market, and rising interest rates. Based on our study of homeowners going through foreclosures in four states, we find that the standard account fails to represent the facts and thus makes a poor guide for policy. In contrast, we find that half of all foreclosures have medical causes, and we estimate that medical crises put 1.5 million Americans in jeopardy of losing their homes last year.

Half of all respondents (49%) indicated that their foreclosure was caused in part by a medical problem, including illness or injuries (32%), unmanageable medical bills (23%), lost work due to a medical problem (27%), or caring for sick family members (14%). We also examined objective indicia of medical disruptions in the previous two years, including those respondents paying more than $2,000 of medical bills out of pocket (37%), those losing two or more weeks of work because of injury or illness (30%), those currently disabled and unable to work (8%), and those who used their home equity to pay medical bills (13%). Altogether, seven in ten respondents (69%) reported at least one of these factors.

If these findings can be replicated in more comprehensive studies, they will suggest critical policy reforms. We lay out one approach, focusing on an insurance-model, which would help homeowners bridge temporary gaps caused by medical crises. We also present a legal proposal for staying foreclosure proceedings during verifiable medical crises, as a way to protect homeowners and to minimize the negative externalities of foreclosure.

Did California Overbuild its Housing Stock?

It all depends on the relevant time frame. If we look at the 00's in isolation, California overbuilt.

But California has grew by 7 million people between 1990 and 2008 and added about 2.43 million housing units (all data are from US Census-- assume that 98 percent of units permitted are actually built). The average household in California has 2.9 people (which is the second highest in the country, and compares with 2.5 nationally), which means that even without removals from the stock and no change in household size, the state needed 2.41 million new housing units. So if we look at the 18 year horizon, California did not overbuild--there we almost surely more than 20,000 demolitions over an 18 year period.

What if we go back to 1980? California grew by 13 million people and added 4.4 million housing units. At 2.91 people per unit, California demanded 4.46 million units. Again, it is safe to assume 60,000 demolitions over 28 years, so it is hard to make a case for long-run overbuilding.

Certainly, some housing was built in the wrong places, or was the wrong type of housing for the place (Lancaster and Beaumont come to mind). But it is hard to make a case that in aggregate California now has too many housing units.

Memorial for Arthur Goldberger at AEA meetings.

Sunday, January 3, 2010: 10:15 am, Atlanta Marriott Marquis, Atrium Ballroom A Remembering Arthur S. Goldberger Presiding: James Heckman (University of Chicago) Speakers:
Lawrence Klein (University of Pennsylvania)
Glen Cain (University of Wisconsin)
Kate Antonovics (University of California-San Diego)
Gary Chamberlain (Harvard University)
Charles Manski (Northwestern University)
with remarks from Harry Kelejian (University of Maryland) read by James Heckman

It's A Wonderful Life Fan Trailer

News item on Fannie/Freddie CEO pay

Bob Hagerty in the Wall Street Journal says they will make $6 million each. This is absurd--they are now government agencies. It would not be unreasonable to cap GSE CEO pay at the President's pay (by that I mean the US President). I would even let them have a rent-free house. I could even see giving them a bunch of shares, so if by some miracle the GSEs became going concerns again, the CEO would benefit. But the current arrangement is bizarre.

Paul Krugman should know better

Civility is important to me. I am all for fighting the other guys' arguments tooth and nail, but try not to engage in name calling, because name calling devolves into the sort of ugly spectacle we just saw in the US Senate, where a member (physician!) from Oklahoma encouraged prayer for the illness or death of a colleague.

I was thus disappointed when Paul Krugman, whose work I admire, encouraged the left to hang Joe Lieberman in effigy, and then issued a non-apology-apology is his column the other day. I am not crazy about Lieberman--he seems to have the Tartuffe-like combination of sanctimoniousness and naked ambition (ok, now I am name calling a bit)--but using violent imagery as part of a policy debate is not acceptable.

The real problem with John Taylor's paper...

...is that it asks the wrong question. The issue is not what would happen to rates without the Fed backstop to Fannie/Freddie, but whether there would be fixed rate mortgages at all.

30-year-fixed rated-80-percent-loan-to-value mortgages beyond the conforming loan limit basically do not exist at the moment [update: by conforming loan limit, I mean the high cost area loan limit, which in some places is now $729,750]. A conversation I had today with two bank executives confirmed this. Some would argue that 30-year fixed rate mortgages are over-rated, but not I.

John Taylor says that the Fed could sell its MBS without having a material impact on interest rates

His blog post is here. I will download the paper when I get into the office tomorrow ( I can only download NBER papers while on campus).

But one thing from the blog post strikes me as strange: he uses spreads on agency debt as his measure of credit risk. But the very fact that the Fed has purchased MBS could produce a perception that the government is standing behind the debt--as the Fed exits, so too might this perception. I would also imagine that the low current interest rates mean expectations about prepayment are unusual at the moment, and that the most common methods for pricing the mortgage call option might not be appropriate either.

The point is that it is very difficult to separate total mortgage interest rates into the term-adjusted risk-free interest rate, the credit spread and the prepayment spread. More after I actually read the paper.

[update: I just read the paper. Taylor describes it well in his blog post, which means that I have not seen anything to change my mind that it is not very convincing. More to come soon].

Paul Carrillo, Stephanie Cellini and I have a new paper

Surfing for Scores:
School Quality, Housing Prices, and the Changing Cost of Information

The abstract:

I

n this paper we investigate the relationship between school quality and information disclosure in
housing markets. When presented with the option of identifying their local public school in a
real estate listing, we find that sellers with homes assigned to higher-performing schools are
more likely to provide this information, an effect that is driven by sellers of large single-family
units. Further, we find that controlling for school quality, information disclosure has no
independent effect on housing prices for single-family homes, implying that buyers with a high
willingness-to-pay for school quality will seek out information on school quality on their own.
On the other hand, we find that sellers’ disclosures about schools have a large positive impact on
the sale price of small multi-family residential units in 2001-02, but the effect disappears by
2006-07. Presumably, the increasing ubiquity of the Internet and the availability of new data
under No Child Left Behind dramatically reduced the cost of gathering information on school
quality over this period. Taken together the results reveal substantial heterogeneity in buyers’
willingness-to-pay for information on school quality, they support the findings of the education
literature on the importance of school quality in housing markets, and they confirm the
“unraveling” theory of information disclosure found in other markets.

Will post to SSRN soon.

Very Sad News from Wisconsin--RIP Arthur Goldberger.

We lost one of our most influential econometricians and teachers of econometrics this week--Arthur Goldberger. The econ department's obit is here:

http://www.econ.wisc.edu/Goldberger%20remembrance.pdf

A week doesn't pass without me being grateful for my econometrics education at Wisconsin--in fact, there are times even now when it just starts to dawn on me what Charles Manski and Gary Chamberlain were trying to teach me. Professor Goldberger's (I never had the nerve to call him Art) class sticks with me whenever I even glance at data. His clarity of presentation allowed us to internalize thoroughly classical and "neoclassical" regression theory.

When I go to conferences on policy analysis, I am always struck by (and proud of) how many of the presenters are Wisconsin Ph.D.'s, and by how much of the work that they present is good. Arthur Goldberger deserves a large part of the credit for this. Professor Goldberger didn't only teach a terrific and influential class (his textbook, A Course in Econometrics, is essentially a set of his lecture notes). He infused the economics department at Wisconsin, along with its students, with an ethos that refused to tolerate sloppy empirical work. He shall be missed very much.

[Austin Kelly adds: "I never met the gentlemen, but I can't tell you how many times I have referred people to his classic pages on "micronumercy" - his slam at people who blame everything on multicollinearity."

He also taught me not to place too much faith in R-squared.]

How pro-transit people shoot themselves in the foot.

I read the following on the Seattle-based Alaska Viaduct project in the Infrastructurist:

McGinn’s statements suggest that this megaproject may still be defeated. For the sake of a city with exciting light rail plans and big-city potential, we hope this happens, since the tunnel is too expensive and will only advance the interests of car commuters, rather than encourage them to try transit.

Let me stipulate that the project may very well not pass a cost-benefit test. But the line "will only advance the interests of car commuters" reflects both snobbishness and detachment from reality. According to this blog, more than four-fifths of commuter trips and 85 percent of all trips in Seattle are made in private automobiles. Complaining that something advances the interest of auto commuters is like complaining about advancing the interest of, say, children--pretty much every one of us is one, or loves someone who is.

As the Onion so wisely headlined, "98 percent of US commuters favor public transportation for others."

Gregg Easterbrook has a good piece on college sports this week

It begins:

Charlie Weis and Bobby Bowden had to go -- Notre Dame and Florida State weren't winning every game! Get rid of the bums! All we heard from sports commentators, and from alums and boosters, was get rid of the bums, we gotta win, win, win. Sorry to interject, but why? Why does Notre Dame or Florida State or any university need to win every game? Is it now official that big colleges care more about sports than education?

If an NFL team, which is strictly a commercial enterprise in the business of providing entertainment, doesn't win, get rid of the bums. But a university exists to educate; winning football games is a secondary concern. Don't get me wrong. I attend way too many college football games, and I always like it when the school I'm rooting for wins. But I am not so misguided as to think that a college's winning games means more than a college's educating students, including athletes. Why is this distinction practically absent from sports commentary?....

I was harsh with him last week, so when I think his work is good...

Inquiry about Hyderabad

I will be making my second visit to the Indian School of Business this coming January. If anyone out there has expertise in the Hyderabad real estate market, I would very much appreciate hearing about it. richarkg@usc.edu.

Sameulson stands alone

From the time I was in high school, I was told of a symmetry in economics: that the world had two leading economists, one on the right (Milton Friedman)and one on the left (Paul Samuelson). But once I started reading their works in college and graduate school, I came to the view that there was no symmetry: that Friedman was a brilliant economist, but that Samuelson was at a different level altogether. Friedman was more like Gershwin, whereas Samuelson was more like Mozart.

Friedman's two masterpieces were A Monetary History of the United States 1867-1960 (which he coauthored with Anna Schwartz) and Essays in Positive Economics. The former is an astonishing work of scholarship,and rigorously uncovers data to make an important point about the quantity theory of money. The latter reads like a series of clever puzzles to be solved--it challenges you to figure out the underlying assumption that drives the result.

But Samuelson's Foundation of Economic Analysis was like Don Giovanni and the Magic Flute--it changed everything. I do not think it is an exaggeration to say that all economic thought since then has its (if you will excuse me for saying so) foundations in that work. At the same time, he was, like Mozart, astonishingly prolific, and had influence in pretty much every field of economics (macro, micro, public economics, trade, industrial organization, etc.), and at pretty much every level (as a scholar of original research, textbook author, popular press writer).

We will miss Paul Samuelson

Mark Thoma picks out a couple of nice articles.

How lending decisions produce sub-optimal social outcomes

The New York Times reports that many people who would like to refinance their mortgages into lower interest rate 30 year fixed rate mortgages are unable to do so.

Of course, were households able to refinance their mortgages, their probability of default would fall, because the present value of their mortgage balance would fall (effectively lowering the loan-to-value ratio) and payment-to-income ratios would also fall. At the same time, because the cost of capital for lenders is low, financial institutions would find the refinanced loans profitable.

But when a lender holds an underwater loan, it wants to earn as much profit as possible, and so hasn't sufficient incentive to lower the interest rate. The judgment of these lenders is that the profit gained by continuing to charge a high interest rate is greater than the potential losses from the increased probability of default. At the same time, other lenders do not want to take out a loan that is underwater. Hence, people are stuck.

This is surely socially less than optimal--keeping foreclosures as low as possible is in everyone's best interest at the moment. So here is a policy proposition--if a borrower has always been current on repaying their mortgage, they get to refinance at the current low rate of interest. Financial institutions are being subsidized with unnaturally low interest rates. Borrowers should get their share of those subsidies.

Case’s career rewarding by any measure - The Boston Globe

Case’s career rewarding by any measure - The Boston Globe

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The USC Casden forecast is on line

It is at
http://www.usc.edu/schools/sppd/lusk/casden/reports/pdf/2009-USC-Casden-Industrial-and-Office-Report.pdf

We handed it out today on flash drives instead of hard copy reports. The audience seemed to like this. Kudos to Lusk staffer Jennifer Frappier for coming up with the idea.

When Gregg Easterbrook writes about something I know about, he almost always gets his facts wrong

In his football column (which I like), he writes:

A generation ago -- a decade ago! -- home buyers were expected to have a 20 percent down payment; that made them unlikely to try to buy something they could not afford, and banks wouldn't be exposed if something went wrong, since they were lending only 80 percent of the value of the property. Now requiring 3.5 percent down is viewed as "toughening" standards. Isn't this an invitation for yet another cycle of mortgage problems?

Low downpayments for FHA loans have been around for awhile. When President Eisenhower signed the 1957 housing bill, Time Magazine reported:

The Federal Housing Administration, aiming to attract money for homebuilding, increased maximum interest rates on FHA-backed mortgages from 5% to 5¼%. And to woo more buyers from middle—and even low —income groups, it slashed down-payment requirements from 5% on the first $9,000 to 3% on the first $10,000 of a mortgage.

Yes, one could buy a house for $10K in 1957. A brand new 3-bedroom in Mansfield Ohio cost $15k at the time, so used homes would have cost less.

Buyers have also been able to use private mortgage insurance to buy houses with five percent down-payments for many years (at least since the 1980s--if any one has history on PMI down-payments before that, I would love to hear about it). VA loans have always had very low downpayment requirements.

Do I worry about FHA? Sure. But let's not pretend that we lived in some virtuous world before this decade in which everyone put 20 percent down on their house. It was just not true.

USC Student Jonathan Shum sends me to a Green Street Report on Capital Structure in the REIT Sector

Its summary:

A Cultural Affinity for Leverage: Until about twenty years ago, the structural make-up of the real estate industry (i.e. small players, fragmented ownership, no outside equity sources, etc.) dictated that debt, not equity, serve as the primary source of external capital. As a result, market participants grew accustomed to operating with far more leverage than is found in virtually any other industry. Now that financing options for major real estate companies are very similar to what
is available to other large corporations, there are several reasons to believe that less debt and more equity should be the norm going forward.

Financial Theory: There is no reason why a non-taxable entity (e.g. a REIT) should have any debt, yet the costs associated with credit crunches (both in the form of distress and missed opportunities) provide ample reason to limit leverage to relatively low levels. These costs have proven to be so high that optimal leverage targets for most REITs likely fall in the 0-30% (debt/
asset value) range.

Best Practices in Corporate America: Most corporations have a strong incentive to utilize debt –interest expense helps minimize their corporate tax bill – yet it represents less than one-quarter of the typical corporation’s capital structure. REITs, by contrast, have no reason to use debt, yet it typically comprises about half the capital structure. There is no justifiable reason why financing
practices should differ as much as they do.

The Real World Lab Experiment: Higher leverage should be accompanied by higher returns in order to compensate for its added risk. This has not been the case, however, in the REIT sector, as more levered REITs failed to provide meaningfully better returns even in the ten-year period preceding the peak of the asset valuation bubble. Lower levered REITs have substantially outperformed over the last fifteen years.

De-leveraging & Value Creation Ahead: The REIT sector has commenced what is likely to be a multi-year de-leveraging process. It should unfold in three stages: 1) de-lever to ensure survival; 2) de-lever to return to prior leverage targets; and 3) acknowledge that prior leverage targets were too high and de-lever to achieve new, lower targets. Much progress has been made on the first phase, yet most companies are not yet entirely out of the woods. The subsequent stages will entail
massive amounts of equity issuance, as leverage ratios need to decline by more than 1500 bps to return to prior norms, and a substantial reduction beyond prior targets is appropriate. At a time when other real estate market participants lack access to capital, REITs that aggressively de-lever as they articulate thoughtful strategic objectives with regard to their long-term capital structures will be well-rewarded.

For Universities, Leaders Matter

Steven Sample is retiring as president of USC this year. He is one of the reasons I wanted to join the USC faculty. I am guessing that no university president has done more over the past three decades or so to transform his institution than Sample; the only comparable academic leaders I can think of are Theodore Hesburgh at Notre Dame and John Sexton at NYU.

One indicator of Sample's influence is USC's ranking based on Avery, Glickman, Hoxby and Metrick's measure of student preferences. Their measure is simple: after controlling for such things as cost and legacy, they look at the propensity of students to choose one college over another. Based on this measure, USC is the 29th most favored college in the country. Every college ahead of USC based on this measure is an excellent institution (the places immediately above USC in this ranking are Chicago and Johns Hopkins). For those that get into both Berkeley and USC, 72 percent go to Berkeley, but for those that get into both USC and UCLA, 89 percent go to USC (once again, controlling for costs). When Sample took over as President, this would have been unimaginable.

Sample also writes gracefully about higher education.

Ann Schnare and I write about the Rise and Fall of F&F

The paper is here and here.

Has anyone done a paper on network effects and restaurant ordering?

Some years ago, I was awaiting a flight from LA to Washington (I think). It was winter, and so the flight was delayed, so I went to the bar to have a drink. I ordered a Ketel One Dirty Martini; after I did so, the man two stools down from me said, "that sounds good," and ordered one, and then a women across the bar also said, "that sounds good," and ordered one, and so on, until 5 or six people at the bar had Ketel One Dirty Martinis in front of them.

I thought about this while in a restaurant last night, when one order of gumbo seemed to lead to a cascade of gumbo orders around the room. So I would like to know whether these were isolated incidents, or whether one order generally influences the surrounding orders. In the case of married couples (or significant others) who like to share, one order might have a negative influence on the probability of a similar order. When the boss is buying lunch, perhaps her order places a ceiling on the price of other orders.

Anyway, it seems like there is a paper in this, but until I finish the half-dozen papers that are currently between 10 percent and 80 percent done, I am not working on it.

My AEA Economists Calendar has Arrived!

While I need to double check this, it would appear that Locke is the oldest economist listed; Saez is the youngest.

Why it is hard to imagine consumption reigniting.

Mark Thoma wonders about whether consumption will come back any time soon.

A graph making the rounds uses the Federal Flow of Funds data to look at the ratio of Household Debt to GDP--the ratio rose from around 60 percent as recently as 15 years ago to more than 100 percent now. If households begin reducing their leverage back toward the long-term average, it will depress consumption for three reasons:

Debt service payments will rise when interest rates rise, and so discretionary income will be lower than it was when households had less leverage ( we are getting some relief right now because of very low interest rates on debt tied to LIBOR or the prime rate).

Households will not take on new borrowing to support spending.

Households will in fact be amortizing their current debt (meaning they won't spend).

The counter-argument is that average household net worth relative to GDP remains quite normal by historical standards. But here is where the skewed distribution of wealth is a problem. I am reasonably sure that when the next Survey of Consumer Finances is released for 2010, median household net worth will be down. Corelogic says that one in four households with mortgages has negative home equity--this would be about 18 percent of owner households (about 30 percent of owners have no mortgage). If we combine this with the fact that 1/3 of the country rents, this means that the median households has little or no home equity. The median household is not loaded with financial assets, either. According to the 2007 Survey of Consumer Finances, only half of families have a retirement account, and only 21 percent owned stocks. Put this all together, the median household is not in great shape financially, and the median household consumes a higher share of its income than higher income households.

One more back of the envelope calculation on getting us back to a steady state: suppose the steady state household debt to GDP ratio is 70 percent. If the national economy uses 5 percent of its income to pay down that debt (which is about 7.5 percent of current consumption), at an interest rate of 8 percent, it would take 9.2 years to de-lever down to the steady state ratio.

[Update: the above back of the envelope assumes six percent nominal growth. If nominal growth is less, it will take longer].

Homeowners Associations contribute to Global Warming

Over the holidays, I have learned from my parents that there are homeowners associations that ban drying clothes on clotheslines and make it difficult to place solar panels on houses. I did a google search on the issue, and learned to such hostility toward environmentally friendly practices is fairly widespread.

This sort of thing has got to stop. While apparently some states have passed laws that ban homeowners associations from prohibiting solar, the laws are sufficiently vague that they can be circumvented.

Dubai, Academic Freedom, and Real Estate

Sometime around 2006, when I was an Associate Dean at George Washington University, I was asked to be part of a team to go to Dubai to explore the possibility of opening a degree program there. After spending three or four days there and running some financials, our team decided that unless GW got a heavy subsidy from Dubai, it was economically a non-starter for us to set up something. Our team's judgments is looking pretty good right now.

The more interesting part of the story, though, is a conversation I had with a professor at one of the universities there. I asked about academic freedom in Dubai, and he said there was plenty. I then asked whether it would be OK to raise in class a discussion about whether the Emir had shown good judgment in building Burj Dubai, the still incomplete tallest skyscraper in the world. The look on his face told me all I needed to know.

The Pleasures of Teaching

Last night, I heard 10 presentations from my MBAs on TARP, TALF, PPIP and HAMP. I learned at least one thing from every one of them.

Shiraz Allidina (attribution corrected) creates a nice indicator of over-leverage in commercial real estate.

He uses the Federal Flow of Funds to look at Commercial Real Estate Loans Outstanding as a fraction of GDP. When the share goes well above the long term mean, bad stuff in commercial real estate seems to ensue.

Eichholtz, Kok and Quigley find Economic Value from Green Buildings

This is forthcoming in AER:

This paper provides the first credible evidence on the economic value of the certification of green buildings-- value derived from impersonal market transactions rather thanengineering estimates. For some 10,000 subject and control buildings, we match publicly available information on the addresses of Energy Star and LEED-rated office buildings to the characteristics of these buildings, their rental rates and selling prices. We find that buildings with a green rating command rental rates that are roughly three percent higher per square foot than otherwise identical buildings - controlling for the quality and the specific location of office buildings. Ceteris paribus, premiums in effective rents are even higher - above six percent. Selling prices of green buildings are higher by about 16 percent. For the Energy-Star-certified buildings in this sample, we subsequently obtained detailed estimates of site and source energy usage from the U.S. Environmental Protection Agency. Our analysis establishes that variations in the premium for green office buildings are systematically related to their energy-saving characteristics. For example, an increase of ten percent in the site energy utilization efficiency of a green building is associated with a two percent increase in selling price - over and above the 16 percent premium for a labeled building. Further calculations suggest that a one dollar saving in energy costs from increased thermal efficiency yields roughly eighteen dollars in the increased valuation of an Energy-Star certified building.

I find the value results compelling; the rent results less so (the t-stat on their best specification is not that impressive given their large sample size). But in any event, an important contribution.

Is there room for more than one Chicago?

Last weekend, for the first time since leaving the Midwest in 2002, I spent time enjoying Chicago. The best part was visiting my daughter, but the second best part was seeing Millennium Park, the New Modern Wing of the Art Institute, and just plain walking around and eating in Chicago.

Within one-half mile of Lake Michigan, from Cermak Road on the South to the Evanston city limit on the North, Chicago is an Urbanist's dream. It is walkable, it has more impressive urban landscapes than any other city I know, transit is good, there is well-tended and contiguous green space, and, of course, the magnificent lakefront.

So why don't we have more Chicagos? Part of the reason is that countries have systems of cities, whose size seems to kind-of-sort-of follow Zipf's law, and so there is room for a limited number of cities of Chicago's size. But one could ask why we don't see Chicago in miniature more often. To the extent that it is preferences--that there are only a limited number of us who like the features of places like Chicago--the fact that there are few Chicagos is nothing to worry about.

But I suspect that it has to do more with policies--zoning that requires separation of uses, low densities, large setbacks, etc. Particularly problematic is the hostility many communities show toward multi-family housing, and the silliness of greenspace requirements that encourages many little playgrounds but fails to develop large parks. The again, policies are put into place by elected officials, so maybe the absence of Chicagos does reflect preferences (or prejudices). And that's too bad.

If only we knew ...

The basic problem with valuing underwater loans is that borrowers are heterogeneous. Some borrowers are going to walk away from their mortgages; from the standpoint of financial institutions, it would be better to simply write down their mortgage balance, swap the value of the debt above the mortgage balance for equity, and avoid foreclosure.

But other borrowers insist on paying their mortgages, no matter what. These mortgages continue to be worth something like their par value. Financial institutions do not want to modify their loans. But if those who pay their mortgages know that those who don't will get a modification, they will change their behavior.

So the optimal program (from the lender's perspective) would be one that identifies those who wouldn't repay, and then grant those people a secret modification. I can't figure out how to either (1) how to do the identification or (2) write to contract binding the borrower to secrecy.

Does the MIT transactions based commercial real estate index imply that commercial real estate is at bottom?

I was surfing the MIT CRE web site this afternoon, and the following picture caught my eye:



The MIT index is a hedonic transactions based index based sales from the NCREIF index, and it attempts to find price movements of a "typical" property. The interesting thing is that the Moody's Commercial Property Index is still falling:



So the question is whether the MIT TPI is a leading indicator. My sense is actually that Apartments and Industrial Real Estate will come out of this thing earlier than other generic types, but I am not sure that anything is really at bottom yet. In particular, the MIT folks are showing that demand and supply are coming closer to lining up, but there is still excess supply nationally in the industrial, office and retail sectors.

The problem with Goldman bonuses

Beyond the generic problem that bonuses are usually based on an un-risk-adjusted IRR, the problem with bonus for banks in general, and Goldman in particular, is that the government is backing short-term bank borrowing, and so banks can borrow at very depressed rates and make a lot of money on spreads. This seems more like playing the government than playing the market.

Fighting the last war

At the ULI meetings, I am hearing that banks are not willing to repeat their behavior in the last down market (the early 1990s): they are afraid that if they sell their assets--commercial real estate loans--at a discount, they will miss out on upside opportunity. Instead, they are "extending and pretending," in the hope that values will rebound to levels above mortgage balances. I overheard one person say, "cap rates have to go back down again. right?"

Not necessarily. This paper by Phillip Connor and Yougo Lang shows that cap rates tend to stay in the eight range over the long term--to think they will return to the fives is almost certainly unrealistic. Even if net operating income had stayed constant--and it has fallen--the increase in cap rates from 5 to 8 implies a 37.5 percent reduction in value. It is going to be a long time before loans with LTVs at origination in excess of 75 percent will be right-side-up again.

We may be in bad shape fiscally, but at least we're happy (h/t Richard Florida)

According to Gallup, six of the country's 10 happiest congressional districts are in California. The happiest, the California 14th, is between San Francisco and Silicon Valley.

I live in the 49th happiest district; the least happy is the Kentucky 5th, in Appalachia. Makes sense.