Downtowns

A reporter yesterday asked me to name some keys to successful downtown redevelopment. Two places I have lived provide some clues (Sorry for being a homer).

When I moved to Madison in 1984, the downtown there wasn't much--despite the fact that it has lots of worker density from state government and the University of Wisconsin. But the city--and in particular its chief planner, George Austin--had the sense to see that Euclidean zoning was not compatible with downtown redevelopment. Downtown zoning was essential replaced with Planned Urban Developments. Ironically, I remember some environmentalists--people who want transit oriented development--opposed some of the plans on the grounds they would bring too much density to downtown. Oh well.

In any event, the transformation of downtown Madison has been astonishing. It now has very attractive condos, and a restaurant scene that is remarkably strong (I was going to add the caveat "for a city of Madison's size," but the caveat is actually unnecessary). The area is now lively, with people strolling even in cold that is now, well, beyond my personal limit of tolerance (I have gotten soft since leaving). The city also built a beautiful Frank Lloyd Wright inspired convention center that provides an anchor to the south end of downtown. Unlike many such places, it was designed to be a gathering place for the community, and it has worked magnificently.

When I first saw Pasadena in the early 1980s, it was actually a pretty unattractive place, with dilapidated commercial areas and an under-maintained housing stock. The air quality was terrible--I remember my nostrils stinging the whole time I was there--and I wondered why anyone would live there.

Two important changes have since happened. First, the air quality, while still not good enough, is much, much better. I can see the San Gabriel Mountains pretty much every day now; in the 1980s, it was hard to know that the place even had mountains. My colleague Chris Redfearn maintains that once air quality improved, people began reinvesting in the very beautiful pre-World War II houses that make up a good chunk of Pasadena (more evidence that environmental regulations that target real externalities are economically beneficial).

Second, the city set up a business improvement district in Old Town that operates much like a mall operating agreement. This allowed anchors such as Crate and Barrel to internalize some of the external benefits that they create by being a draw. An advantage regional shopping malls have had over traditional downtowns is that mall operators can create lease structures such that anchors can recover benefits from the traffic they generate for other stores. This is why anchors pay lower rents than in-line stores. In general, local government subsidies to businesses are not wise, but subsidies for anchor department stores may be an exception. Ideally, governments will set up districts in which merchants whose traffic is driven by anchors will subsidize the anchors, but to get downtowns started, governments themselves might need to give the subsidy.

BP Spills Coffee

I get as frustrated as anyone when government performs poorly. But could we please stop the narrative that the private sector always does better?

How New Urbanist Jeff Speck would fit into the Bush Adminstration

My colleague Lisa Schweitzer points me to Jeff Speck's screed against those who would question some of the tenants of the New Urbanist movement.  This line stands out in particular:

To this group [libertarians], which is quite skilled at mustering facts in support of its utterly counterintuitive claims, the only rebuttal is to revert to common sense and a single question: How, by any possible stretch of the imagination, could it be considered efficient, healthy, or even acceptable to have spent the better part of a society’s wealth constructing a national landscape in which most citizens require a one-ton, poison-belching prosthetic device to satisfy their daily needs? (Slap forehead and continue … )

Yes, Jeff, let us ignore facts and respond to them with common sense.  The most recent administration didn't like facts much, and clearly neither do you.  If you don't like the evidence, just ignore it.  Because we all know that like George W Bush, Duany knows all, and can't be bother with facts--such as the fact that people all over the world really, really like their cars.

Why do high income people feel so put upon?

A mystery to me is why households earning $250,000 per year seem to resent being called rich.  This income is roughly five times the median US household income.

So it occurred to me that perhaps the marker basket upon which high earners spend has risen in price more rapidly than the CPI.  So for fun (and only for fun--this is not a systematic price index), I looked at four items: income taxes, the price of a BMW 3-series, houses in Los Angeles, Santa Barbara and New York, and Harvard tuition, all going back to 1988.

It is hard to do an apples-to-apples comparison on taxes, but based on the NBER Taxsim Model, wage income for high earners is taxed at about the same level, and capital income is taxed less relative to 1988.

CPI has not quite doubled since then.  While the BMW 3-series is not the same car as it was in 1988 (it is almost certainly better), its price has not quite doubled.  House prices in the California are about 2.7 times higher than in 1988; in New York they are 2.2 times higher (these are MSAs--Malibu and Manhattan are probably different stories).  Harvard tuition is three times higher.

People really notice how much they are paying for their houses and how much it costs to put their kids through school.  So while I continue to think it is silly for people who earn five times the national median to feel anything other than extremely well off, it is possible that those right at the 250k level perceive their living standards to be no better than they were 20 years ago.

D-Day...Landing On Omaha Beach: Should have posted yesterday

: Should 

When does a regulatory taking become a physical taking?

Slate has a piece today on Jay Bybee's 9th circuit opinion that rent control is per se unconstitutional.  The reporters argue that the opinion is silly--that the courts have long upheld the right of municipalities to regulate land use (Euclid v Ambler being the iconic case that enshrined the rights of communities to zone).  But the Supremes have also maintained that when a regulation deprives owners of property of all economic value, it consitutes a taking under the 5th amendment and thus is either impermissible or must be accompanied by compensation to the property owner (Lucas vs South Carolina Coastal Commission).

It is pretty clear that rent control (something that I dislike based on both equity and efficiency grounds) is consistent with the ability of communities to regulate property for a public purpose.  On the other hand, if rent control were set at zero, then it us pretty clear that it would amount to a regulatory taking.  The question is the level at which rent control would require a taking.  For instance, if cities told landlords that they had to cut their rents by 50 percent, I think one could make a pretty good case that the takings rule would apply.  But this is a legal issue and not an economic one--I am not sure whether one could draw a bright line at which a regulation consistutes a taking.

Why most economic forecasts are useless

Worthwhile Canadian Initiative writes:

Suppose instead that the model has a consistent one period lag, so Y(t)=R(X(t-1)). And suppose that Statistics Canada reports all data on X immediately. Now we can use the model for genuine forecasting of the future. Statistics Canada tells us what X is today, and we use the model to tell us what Y will be one period in the future. But the model can tell us nothing about what Y will be two periods in the future, because Statistics Canada can't tell us what X will be one period in the future. And yet I keep hearing about model-based forecasts for one, two, three, four, etc., periods in the future.

Steve Malpezzi, Walter Barnes and I wrote a paper some years ago that tried to come to grips with this very issue.  The context was office market forecasts, and we worked on developing confidence intervals for estimates of future office demand for a number of metropolitan areas.   In developing the confidence interval, we used a technique from a 1971 Martin Feldstein Econometrica paper that takes into account the fact that to forecast Ys, one needs to forecast Xs as well.

To make a long story short, after a couple of quarters, the confidence intervals blow up (I don't have the paper at home, but when I go in to the office this week I will scan some pictures from it), meaning that after a few quarters, metropolitan office demand could be just about anything.  Local office markets are much less complicated than an entire national economy.

Scariest thing I have learned over the past 48 hours.

Sometime within the next five years, half of LA's city budget will go to pensions.

Ugly University Buildings I have Known

I have spent a fair amount of time at six universities as a student or faculty member.  Five have astonishingly ugly buildings.

We begin with Mather Hall (below left) at Harvard: the Robert Taylor Homes of college dorms.  On the right is USC's Hoffman Hall, which was actually designed by a great architect, IM Pei.  It shows we all have bad days.

Next we have the Academic Center at George Washington (below left).   The photo makes it look nicer than it is.  Huntsman Hall at Penn is the new Wharton Building.  It is a little, er, out of scale for the surrounding neighborhood, but if Philadelphia ever returns to an agriculture based economy, it will have a really nice silo.  

Finally we have the Humanities Building at Wisconsin.  My understanding is that this ironically named building will soon be torn down.  That will certainly produce addition from subtraction.




The Indian School of Business was designed by John Portman, and is simply beautiful.

Housing Inventories

The bad news for the US housing market: despite strong resales in April, the country had about 8.2  months of inventory. For real house prices to stay stable, inventories need to be in the four to six month range, and because inflation is nearly non-existent for the moment, downward pressure on real prices means downward pressure on nominal prices as well. This could be a problem for a housing market that had relied so heavily on FHA loans, which have lax downpayment requirements.

Things here in California are better:

The data come from CAR.  Inventory under $500K is pretty thin, meaning that even if there is a shadow inventory that comes on line, California should be able to avoid much in the way of further price declines.  Just as interesting to me is that while the $750K+ inventory is still pretty large, it has shrunk pretty dramatically.  I actually wonder how these houses are getting financed--are there that many affluent buyers with cash?  When I talk with lenders, they are telling me that to get a decent rate at $1 million+, buyers need at least 25 percent down, and sometimes more.

Sarah Ritchie reminds me that today the Brooklyn Bridge is 127 years old.

Every time I visit New York, I am stunned at what a remarkable human accomplishment it is. I think there is a pretty good chance that among the most important contributors to that accomplishment are its bridges and tunnels.

I cannot think of any city in the world with remotely as many impressive bridges. The names roll off the tongue: Brooklyn, Manhattan, Williamsberg, 59th Street, George Washington, Verrazano, Throg's Neck and Whitestone. London, Paris, Rome and Seoul have very nice bridges, too, but because their rivers are so much narrower than the East (yes, I know it's not really a river) and Hudson, the bridges don't quite so stir my imagination. San Francisco's bridges span great distances, but there are only two that are impressive (the San Matao and Dumberton bridges are just strips of pavements on pillars, and the Richmond Bridge is, well, "interesting").

So happy birthday to Brooklyn Bridge, the first of a wonderful family.

Annoying anti-car headline of the day

From Richard Florida's twitter feed, I get:

One Hour Spent Driving = 20 Minutes Lost Life Expectancy:

So let us think what this means for people who drive one hour per day every day for 60 years. Expected life expectancy is reduced by 60 years times 365 days per year times one hour times 1/3 hour of life lost per hour of driving. This all comes to 7227 hours, or about 300 days. So driving every day for one hour means we lose 10 months of life expectancy (move these numbers around as you wish).

But what if we weren't able to drive at all (and buses and shared-rides vans count as forms of driving)? I am guessing we would be much poorer--mobility has at least something to do with our affluence. Maybe we wouldn't be as well nourished. Maybe we would face more economic stress. I can't be certain, but I would be willing to bet that if we stopped driving altogether, our life expectancy would fall.

I have long supported Pigou taxes on the negative externalities created by automobiles. I support subsidies for transit as a matter of social justice. But do I think cars have provided a net benefit to living standards and life expectancy? Sure!

David Barker comments on the growth path of GDP

He writes:

I just did a quick Chow test to see if there is a structural break in per capita GDP growth between 1935 and 2009 and there is not.

This is just a growth over time model (log GDP on time), and I also checked consumption and disposable income. If I did it right, there are no breaks - not even close. So you are right about Wallison, but one can't draw the opposite conclusion either.

I think in general it is difficult to draw casual inferences about macroeconomic data. More specifically, I agree with David that there is not sufficient statistical evidence to ascribe a cause to the relatively weak performance in growth after 1980. I do think rampant deregulation of financial institutions has been on net harmful (we seem to have financial crises more frequently now), but we haven't sufficient numbers of data points to establish that fact scientifically.

But it is also true that what Wallison wrote is demonstrably false. Life was not barren in the pre-Reagan years, and it has not been the land of milk-and-honey since. The evidence, limited thought it may be, is consistent with the idea that the New Deal was a good thing. On the other hand, Wallison wears very nice suits.

Peter Wallison: Opinions without Data

He writes in his screed against financial regulation:

In the rapturous days after Barack Obama's victory and the Democratic congressional sweep that accompanied it, House Financial Services Committee Chairman Barney Frank declared that the new Congress would enact a "new New Deal." Few people really thought at the time that he or his party meant this seriously. After all, the original New Deal—as anyone who has read history knows—failed to revive the economy.

Indeed, the modern era of rapid economic growth commenced after both Democratic and Republican presidents undertook to lift costly and stultifying New Deal regulations.

Using the National Income and Products Account, I looked at real annual GDP growth between 1933 and 1980 (the stultifying years) and 1980 to 2009 (the "rapid economic growth" years). Between 1933 and 1980, GDP grew by about 8-fold, or more than 4 percent per year (actually 4.5 percent per year). Between 1980 and 2009, real GDP did slightly better than doubling, or 2.7 percent per year.

I try to respect people whose points-of-view differ from mine, but who decides to let this guy waste ink?

USC: The Spirit of Transformation

The frustrations of Academic Life

Was about to ship a paper off for journal consideration and discovered a mistake. I am just hoping it turns out not to be material.

A little experiment in house price indexes

Among my favorite web site's is Morris Davis'. One feature of the site is a page of data that Morris and his colleagues have developed: among them is an estimate of land prices in the United States.

This morning, I looked at the change in real land prices in the United States. Between 1980 and 1997, real land prices (as deflated by the CPI) increased by 4.4 percent per year. I chose 1980 because Morris told me the data has some problems previous to that year, and 1997 because that was the year of the first inflection point in the movement of house prices (an even more impressive inflection began around 2002). The 4.4 percent rate is thus almost certainly fundamental, and does not reflect any bubble.

The question I wanted to ask is whether land is now over-valued or under-valued based on a 4.4 percent long-term real growth path. Unfortunately, Morris' data ends with 2007. For land values to have returned to a 4.4 percent long-term growth path, land values would have needed to have fallen about 1/3 since the end of 2007.

Actually, it is plausible that they have fallen more than this. From the end of 2009 to the end of 2009, the Case-Shiller house price index fell by 20 percent. But the value of structure changes very slowly, while the value of land changed quite rapidly. Land makes up about 1/3 of house values, implying that for house prices to fall by 20 percent, land prices must have fallen around 60 percent. Let's say that falling labor costs and commodity prices meant that construction costs fell a little bit, and that land value fell by only 40 percent. This still means that relative to its long term fundamental trend, land values overshot on their way down.

[Update. Morris has more recent data on the Lincoln Institute Web Site. His estimate is that land prices fell by 53 percent just between the end of 2007 and the beginning of 2009. This suggests that relative to long term trends, land prices overshot downward.]

Stunning Overbuilding Fact of the Day

I am listening to a presentation at the Homer Hoyt meetings on the condo meltdown in South Florida. Developers planned on building 95,000 units in the city of Miami between 2002 and 2007. In the 2000 census, the whole city had 163,000 units.

How do you produce a 63 day winning streak?

Here is how I have been trying to figure this out. Suppose we wanted to figure out what a daily winning percentage had to be in order to observe a 50 percent probability of a 63 day winning streak. It would be (.5)^(1/63), because the probability of 63 straight wins would be Pr(one win)^(63). It turns out that (.5)^(1/63)=.989, which I will round to .99.

Now lets say a firm has a proprietary trading model that is correct 51 percent of the time. This means that on the average day, it will come out ahead (suppose all trades are $1 trades). But if a trader makes one trade a day, he will close the day ahead only 51 percent of the time. If he makes 100 trades a day, however, while his winning percentage per trade remains the same, put his winning percentage per day goes up a lot. Specifically, the standard error for a daily outcome goes down by 1/10, from sqrt(.51*.49) to sqrt(.51*.49/100), or from about .25 to .025. The chance of finishing the day losing on average is based on how many standard deviations away .5 is from .51. In this case, it does from .01/.25 (or not far at all) to .01/.025, or .4 standard deviations away. In a normally distributed world, this means there is a 65 percent chance of finishing the day ahead, assuming each trade has a .51 batting average and 100 trades per day.

To get to winning 99 percent of days, we need to get the standard error for the day to be sufficiently low that .5 is more 2.4 standard deviations away from .51, so the standard error needs to be .01/2.4 or about .004. So we need to find X such that sqrt((.49*.51)/X)=.004. or X=.25/(.004^2)=15,625 trades per day.

Three big assumptions go into this calculations. First, it assumes a stable model. Over the course of one quarter, this may be reasonable. Second, it assumes a model with a 51 percent winning percentage. This is a huge assumption (I do not know what a reasonable number might be). Third, it assumes normality. This is probably not too bad; we do know that Chebyshev's Inequality says that (1-1/k^2) share of any distribution must be within k standard deviations of the mean. This means that 99 percent of any distribution is within 10 standards deviations, but that is an extreme outcome.

Virginia AG Cuccinelli is not only trying to kill Academic Freedom, he is trying to kill America's economic advantage

Mark Thoma sends me to Barkley Rosser:

This is in today's daily links, but I think it deserves a bit more notice:

Virginia AG Cuccinelli Out To Kill Academic Freedom, by Barkley Rosser: Friday's WaPo reports that Virginia Attorney General Ken Cuccinelli, following up on his efforts to end efforts by state universities and colleges to avoid discriminating against GLBT folks, has decided to interfere directly in scientific research in a criminal way. In particular, Cuccinelli is claiming that climate scientist, Michael Mann of hockey stick fame, engaged in billing fraud with the state while working on this subject while a professor of environmental sciences at the University of Virginia, where he has not been located for some years (now at Penn State). Cuccinelli is demanding all kinds of emails and other materials from the university, apparently attempting to imitate the climategate gang that did this over at East Anglia, only to end up with no fraud being discovered.

I think that some of the critics of Mann's work were correct, but this is an outrage. There is no evidence at all of fraud (and those claiming the email in which he spoke of using a "trick" as evidence for this do not understand or are willfully misrepresenting how this term is used in these situations) on his part, whatever errors he may have made in his study of the hockey stick (and it really does not matter exactly what the temperature was 1000 years ago; I have posted on this here previously). ...

Beyond the fact that I find Cuccinelli's attacks to be morally repugnant, they are also aiming for the heart of what remains of America's economic advantage: its ability to innovate. One of the reasons we are so good at innovation is because we have a research culture like no other nation, a culture that comes from universities that are, by world standards, intellectually free and well supported. The smartest people from all over the world come to the US for its universities, and then they stay to do research and to start businesses. Does the Ayatolla Cuccinelli really want to undermine this? Wait, don't answer that...

Two items in this morning's LA Times bring out my inner conservatism (small though it may be)

(1) The LA City Council is considering forbidding landlords of rent stabilized property from raising rents at all. I am certainly not a Friedmanite, but all credible evidence suggests to me that rent control leads to under-provision and under-maintenance of rental housing, and is distributionally unjust (Henry Pollakowski has shown that the benefits of rent control in New York accrue largely to high income people). But what LA is contemplating is even worse: to tell landlords that they can expect to be allowed to raise their (well-below-market) rents by 3 percent and then renege sends potential investors in Los Angeles the message that they can't rely on anything the city tells them. It may help explain why the city (as opposed to the region) has been unable to create jobs for a long time now.

(2) Al Gore bought a 6500 square foot vacation house in Montecito. I get why he might need to own one large house--if he uses his house for business purposes and has large receptions at it, he needs the space. I even get why a former Vice-President may not be able to fly commercial--the security problems are just too large. But for Al to own two large houses is just rank hypocracy. One of the reasons I can't take the GOP seriously is that it seems permeated by holier-than-thou hypocrites. Even though I generally agree with Al Gore on policy, he does at times make it hard to take him seriously.

Yet another reason why real estate is so interesting

I was listening to the BBC last night on the general election in the UK. One commentator stated that the reason coalition government wouldn't work in the UK is because of the design of the House of Commons: the government is on one side of the house; the opposition directly across on the other. It is all about the building!

What Milton Friedman got wrong

Friedman had two fundamental problems with business regulation. His first is that the business would capture the regulator, and therefore use regulation to establish monopoly power. My field leads me to find this line of argument compelling: real estate developers love (regulatory) barriers to entry that keep competitors from building.

His second, though, is just wrong. He argues that in order to preserve their reputations, businesses will self-regulate. Among other things, this ignores that managers often have short-term horizons. It also ignores that when large businesses implode, they leave victims with whom they never engaged in a transaction in their wake. BP did nothing illegal--how's that reputation thing working out? And having now read a whole lot on Goldman-Abacus (including the SEC complaint, the response on GS's web site, the offering circular, and excellent commentary from James Surowiecki, Yves Smith and others), it is not clear to me that Goldman did anything illegal or actionable (but I could be persuaded to change my mind). It is just that what it did (including investing long in CDS) should be unambiguously illegal and actionable. I can't think of anyone who had a bigger reputation franchise than Goldman.

Could we finally get a Pigou Tax on gasoline now?

Lisa Margonelli in this morning's New York Times.

The Deepwater Horizon spill illustrates that every gallon of gas is a gallon of risks — risks of spills in production and transport, of worker deaths, of asthma-inducing air pollution and of climate change, to name a few. We should print these risks on every gasoline receipt, just as we label smoking’s risks on cigarette packs. And we should throw our newfound political will behind a sweeping commitment to use less gas — build cars that use less oil (or none at all) and figure out better ways to transport Americans.

I think it is safe to say that economists across the political spectrum approve of gasoline taxes. To the extent they are regressive, the revenue they raise could be used to provide better mass transport subsidies for low income people. Maybe now there will be political cover to do something.

Path Dependence?

I am currently in Minneapolis. It is, to me, a great city. My feelings may reflect that it was the large city nearest to me when I was growing up, but they also reflect that it has the attributes of a great city: innovative companies, such as 3M, and Medtronic, wonderful arts, including an orchestra that Alex Ross of the New Yorker wrote,"[sounds] to my ears, like the greatest orchestra in the world," and a vibrant, walkable downtown. The only other Midwestern city with such a jewel of a downtown is Chicago, which is also, of course, a much larger city.

The question is why. Bill Cronon wrote a great book about Chicago, explaining how it became and remains an epic city. The remain part is a function of path dependence--once Chicago made a set of choices about how it would connect with the nature that surrounded it, both physically (through, for instance, railroads) and intellectually (through, for instance, exchanges), it set itself on a self-perpetuating path.

I know of no similar book about the Twin Cities (that doesn't mean it doesn't exist). But it is an interesting question as to why Minneapolis has done so much better than other Midwest metropolitan areas: it terms of educational attainment, income, and population growth, it has substantially outperformed Kansas City, St Louis, Milwaukee, Cleveland, Cincinnati, Toledo, Dayton, Pittsburgh and Buffalo (I could go on, but you get the point). I don't think it is the weather.

Did Arizona just help California's Housing Market?

My colleague Dowell Myers points out that for the housing market in the US to remain healthy, we must "cultivate new immigrant residents." Arizona's new law, which would require immigrants (legal or otherwise) to "carry papers" creates what I would consider to be an atmosphere of hostility to immigrants--all immigrants. I am also awaiting the spectacle of a police officer demanding the "papers" of a native-born Latino.

In any event, people have a propensity to go where they feel welcome, and avoid places where they are not. Hostility to immigrants in general and Latinos in particular seems to be a political loser in California, so Arizona's policies may lead to higher demand for houses in California.

Should Berkshire Hathaway be required to post collateral on underwater positions?

Yes.

(BTW, I own a few Class B shares and am a big fan of Warren Buffett).

A simple financial reform

If an investment instrument has never been through a down-cycle, rating agencies should be forbidden from giving the instrument a grade of BBB (or in Moody's case, Baa) or higher. Instruments that lack history are, by definition, speculative.

Trying to figure out whether synthetic CDOS add value

In principle, I think they could, because they allow investors to invest in a combination of mortgages that are not actually available in the market (the combination, that is), and as such, make markets a bit more complete.

But does the efficiency benefit synthetics create exceed the cost of their opaqueness? Would creating an exchange deliver sufficient transparency to overcome the opaqueness problem?

Bill Wheaton says housing is a sleeping giant that is about to wake up

He says so in a short paper. I think he is right.

What people don't know about household income

I spoke at a Hanley-Wood Conference in Ft.Lauderdale today to a group of Apartment operators. It was a very nice audience.

I asked members of the group to raise their hands when they thought I hit the number at which median income for renters in the US was higher. I started at $60K; nobody raised their hand. But at $50K, a number raised their hands; at $40K, nearly everyone had a raised hand. According to the American Housing Survey from 2007, median income among renters was $28,921. It is possible that number is even lower now. If 30 percent of income paid for rent is "affordable," this means the median renter can afford to pay no more than about $750 per month.

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.