Steve Malpezzi's Reading for Life

It is on the Wisconsin Real Estate blog:

13. Ahamed, Liaquat. Lords of Finance: The Bankers Who Broke the World. Penguin Press, 2009.

12. Akerlof, George A. and Robert J. Shiller. Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. Princeton Unversity Press, 2009.

11. Bartik, Timothy J. Who Benefits from State and Local Economic Development Policies? Kalamazoo: W.E. Upjohn Institute for Employment Research, 1991.

10. Cronon, William. Nature's Metropolis: Chicago and the Great West. W.W. Norton, 1991.

9. Gomez-Ibanez, Jose A., William B. Tye and Clifford Winston (eds.). Essays in Transportation Economics and Policy: A Handbook in Honor of John R. Meyer. Brookings, 1999.

8. Green, Richard and Stephen Malpezzi, A Primer on U.S. Housing Markets and Policy. The Urban Institute Press for the American Real Estate and Urban Economics Association, 2003.

7. Hulme, Mike. Why We Disagree About Climate Change: Understanding Controversy, Inaction and Opportunity. Cambridge University Press, 2009.

6. Lewis, Michael. The Big Short: Inside the Doomsday Machine. W.W. Norton, 2010.

5. Reinhardt, Carmen M. and Kenneth S. Rogoff. This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises. Princeton University Press, 2009.

4. Slemrod, Joel and Jon Bakija. Taxing Ourselves: A Citizen's Guide to the Debate over Taxes. MIT Press, 2008.

3. Tufte, Edward R. The Visual Display of Quantitative Information. Chesire, Connecticut: Graphics Press, 1983.

2. Wessel, David. In Fed We Trust: Ben Bernanke's War on the Great Panic. Crown Business, 2009.

1. http://wisconsinviewpoint.blogspot.com/

Ken Rogoff thinks the BP spill might produce a groundswell for a carbon tax...

...but Mark Thoma is not so sure [Rogoff's take is here].

I am actually more inclined to agree with Rogoff on this one. When environmental problems are easily visible, they seem to generate political consensus for action. The air quality in Los Angeles, which was obviously awful 30 years ago, is much better currently--the vast majority of days are quite clear now(although we still have the problem of invisible small particulates). The 1952 smog disaster led to major policy changes in the UK. The BP disaster could similarly mobilize policy.

Mark could still be right about this--I just hope he is not.

I am putting Michael Lewis' The Big Short on my FBE 589 reading list for this fall

So many great lines. Perhaps my favorite (from pp 151-152):

The only interested parties missing from the conference were the ultimate borrowers, the American home buyers, but even they, in a way, were on hand, serving drinks, spinning wheels, and rolling dice. "Vegas was booming," said Danny. "The homeowners were at the f**king tables."

A couple of thoughts. First, I would bet (forgive the word) that gambling habits would be a good underwriting variable for predicting mortgage default. If lenders could know whether someone gambled more than one percent of their annual income in casinos, at the race track, or on lottery tickets, it might say something about propensity to repay a mortgage [full disclosure, I bet $18 once or twice a year at Santa Anita].

Second, I do remember being mystified at what happened to house prices on my street in Bethesda, Maryland. When my wife and I moved there in 2002, we thought it was awfully expensive, but decided that the schools and proximity to metro made it worth while. We swallowed hard and got a mortgage where our mortgage payments + property taxes were about 20 percent of our gross income. My wife was an attending physician at a large medical center, and I was a finance professor at George Washington.

By 2005 or so, the price of houses on our street had increased by about 2/3 (because all houses were 30s vintage colonials, every sale we observed was a good comp). The mysterious part was the buyers were young one-earner households. I wondered how on earth they were "affording" their houses. Now we know.

I don't blame Goldman Sachs for taking 100 cents on the dollar of its Credit Default Swaps from AIG....

....I blame the government for offering it. I understand that there was a need to keep Goldman stable, but jeez.

Justice

On Wed, I am having the screening procedure that Katie Couric so vividly demonstrated some years ago. Basically the story is that if you have this procedure at age 50, any colon cancer that might be detected will be at a sufficiently early stage for it to be quite curable. So because I have good health insurance, I can be sure I will not die of colon cancer.

Those without insurance are not so fortunate. Such patients can only get the screening if they pay out of pocket ($2000-$3000) or, if they are patients at places like the LA County hospital, if they are symptomatic, which means the cancer might not be caught early. For the median family, $2000 is a lot of money; for those who occupy the netherworld of having too much money to get medicaid but not enough to afford health insurance, it is even more so.

I hope the new health care system rectifies this. Under the old system, this difference in service delivery was unjust.

[Updates: First, I misspelled "colon," which shows that I should never write things while being reflective at midnight. Second, it is worth saying something about cost benefit analysis and screening--according to this source, the cost per life year is about $45,000, which seems like a good deal to me].

One more take on Kartik Athreya's critique of economics bloggers

Athreya is arguing that the blogosphere's various critiques of modern macro are being made by insufficiently expert bloggers using insufficiently rigorous arguments. As is often the case, the best rejoinder comes from Mark Thomaand I suppose I don't have much to add myself. (I would link to the essay, but it seems to be broken right now)

But George Akerlof did [have a lot to add], way back in 2006, during his American Economic Association Presidential Address. which was entitled "The Missing Motivation in Macroeconomics." I remember finding the piece enthralling (I know, we economists aren't supposed to use such emotion laden words), because it made the very simple but devastating case that when the foundations of modern macro (the independence of consumption and current income (given wealth); the independence of investment and finance decisions (the Modigliani-Miller theorem); inflation stability only at the natural rate of unemployment; the ineffectiveness of macro stabilization policy with rational expectations; and Ricardian equivalence) are tested against data, they generally fail the test. I remember at the time that some economists thought that Akerlof had taken leave of his senses (and some friends of mine thought I had taken leave of mine because I so admired the address).

But in the end, we should be respecting evidence more than clever theoretical edifices. And yes, Kartik, while I am not an expert in macro, I did have to slog through lots of OLG models and rational expectation models and real business cycle stuff in graduate school, and pass prelim questions on them, so I have at least some idea of what it is that I find intellectually unsatisfying. Akerlof's view, expressed before we had the financial meltdown, that we really need to start over with modern macro, has, I think, largely been vindicated.

Hard to believe

I was on the radio the other day, discussing the future of Fannie and Freddie, when another guest said that all we had to do was fully privatize the mortgage market for all to be well. I know that I can't expect everyone to be aware of the 1920s, but the period 2002-2006 was a period in which the "pure" private sector took away substantial market share from Freddie-Fannie, and look how well that turned out.

Of course in the end there is no such thing as a pure private market, because when large financial institutions get in trouble, the government comes to the rescue, either through an injection of funds or through extremely low interest rates. We are all GSEs.

Jack Guttentag found that mortgage rates in the 1940s were in the low fours.

Here is the link. [update: of course these were typically 20 year loans, so the comparison is not perfect].

Lisa Schweitzer on time-service quality trade-offs for transit and autos

She writes:

.

..People tend to like to separate travel time and service quality based on the arguments, like Litman uses, that the time in transit or walking is more pleasurable and productive than being in a car. But they are only right for people whose preferences align with theirs. For other segments of the mobility market, they are wrong. Moreover, it’s wrong to assume that these are the only things being traded: yeah, you hate to drive and you’d be happier not driving, but the extra half an hour that transit takes you means a half an hour you’re not with your kids, cooking, drinking wine with your spouse at home, watching the game, or any number of things you can’t do on transit, either. So yeah, I’d prefer to get the exercise walking than driving, but I prefer to spend the time cooking so that my kids aren’t sitting around hungry after school more than I prefer the exercise.

As she wrote this yesterday, I couldn't help thinking about it yesterday during my transit trip home. I take transit in LA every now and then, in part because that it the sort of guilty liberal I am. But yesterday, when all the stars were aligned (I arrived at bus from USC to Union Station at exactly the time in left; I only had to wait a minute or two for the Gold Line connection from Union Station to Pasadena), it took me just less than one hour to get from my office door to my front door. When I drive to work in the morning (at a strategic time), it takes me 20 minutes. When I return home in the afternoon (using surface streets until Hill or Figueroa meets the Pasadena Freeway), it rarely takes more than 35, and never more than 45. So my worst days in the car free up about an hour relative to transit. In case you are wondering, it is 11 miles from home to campus.

But don't I find driving unpleasant? Not really, I can plug my i-pod into my car stereo, or listen to NPR or the BBC, or a CD...In the morning, when traffic is clear, I get pleasure from driving my car at freeway speeds. I do miss the walk that I get when I use transit.

To some extent, the problem is that the street system in Los Angeles, with lots of redundancy, works too well. In Washington DC, Metro was a viable alternative to driving--it would often get me to work faster than taking my car. The street lay-out in Washington, set as it was in the late 18th century, was not designed to keep auto traffic moving. Metro is also very good--when people in DC complain how how awful it is, I want to laugh.

At the same time, I don't think a transportation system whose principal mode is people driving alone is sustainable. We need to think about some system in between driving alone and fixed route transit. It seems eminently doable to me, but it will take some imagination to make it work.

One more point about fixed-rate mortgages

They seem to be safer. From the Mortgage Bankers Association of America:

On a seasonally adjusted basis, the delinquency rate stood at 6.17 percent for prime fixed loans, 13.52 percent for prime ARM loans, 25.69 percent for subprime fixed loans, 29.09 percent for subprime ARM loans, 13.15 percent for FHA loans, and 7.96 percent for VA loans. On a non-seasonally adjusted basis, the delinquency rate fell for all loan types.

The foreclosure starts rate increased for all loan types with the exception of subprime loans. The foreclosure starts rate increased six basis points for prime fixed loans to 0.69 percent, 17 basis points for prime ARM loans to 2.29 percent, 18 basis points for FHA loans to 1.46 percent, and eight basis points for VA loans to 0.89 percent. For subprime fixed loans, the rate decreased nine basis points to 2.64 percent and for subprime ARM loans the rate decreased 39 basis points to 4.32 percent.

Some of this may just be that people who take less risk select themselves into fixed-rate loans, but even so....

Bob Hagerty blogs about Patrick Lawyer on Fixed Rate Mortgages:

He writes, in part:

Allotted only about 10 minutes to share his vision, Mr. Lawler....first made the obligatory statement that he was expressing his own views and not those of his federal agency. Yeah, right, I thought, and reached for my triple espresso.

But then Mr. Lawler launched a frontal assault on the most sacred element in U.S. housing-policy dogma: the 30-year fixed-rate mortgage loan, providing the right to refinance at any time, with no prepayment penalty. If more members of the audience had been fully awake at this moment, I feel sure that their gasps would have been audible.

Now, Americans are very attached to their 30-year fixed-rate freely prepayable mortgages. They like not having to fuss about the possibility of 28% interest rates in 2032, even though most of us will move or die long before then. They love to refinance every time rates drop and then brag to their neighbors about how much they are saving per month.

What they don’t stop to realize often enough is that they are paying a very large price for that privilege– twice.

The context is important.  One of the reasons the 30 year fixed rate mortgage is ubiquitous is the United States may be the existence of Fannie and Freddie.  If we do away with FF, we may also do away with the 30-year fixed rate mortgage.  So let me defend the 30-year fixed a bit with something I wrote about 3 years ago:

The problem with advising people to use adjustable rate mortgages, however, is that ARMs give households liabilities that have short duration--that is, liabilities whose market value remains close to face value at all times. This is because the rates on ARMs by definition change to meet market rates on a regular basis. Houses, on the other hand, are assets with lots of duration. The services they give to homeowners (shelter and a set of amenities) is pretty much invariant to market conditions. Consequently, house values change with market conditions, such as changing interest rates.

Good financial management practice suggests that to minimize risk, the duration of of assets and liabilities for any institution, including households, should be matched. In the case of houses, this means that households looking to minimize risk should use a fixed rate mortgage to finance their house. There are exceptions--if one buys a house and expects to sell it in five years, a five year ARM makes lots of sense, because the duration of the asset (housing services over five years) and the liability would match.

This is not to say there is anything wrong per se with people getting ARMS, so long as they explicitly understand the risk embedded in them. But a principle I have been pushing for years is that if people can't afford a house with a fixed-rate mortgage, they probably shouldn't buy a house. It is one thing to have the option of the FRM, and then decide to take the risk of the ARM anyway. One of the nice things about the United States is that FRMs are easy to come by--this is not true in most countries around the world. It is something else to be forced into taking a risk in order to buy. Under these circumstances, buying probably isn't worth it. 

Everything involves real estate: music edition

I went to hear the Concertgebouw Orchestra in the Concertgebouw last Friday night.  There is no experience like it--the hall is remarkably intimate, and the sound washes over listeners without being blurry.  Bass notes in particular both rumble and have great pitch definition.  Not even Symphony Hall in Boston, Orchestra Hall in Minneapolis, or Disney Hall here in LA (all of which are terrific venues) compare.  One of the reasons the orchestra has a consistent and unique sound (beyond, of course, the magnificent players) is its building--real estate creates sound character.

Yet buildings need to be renovated from time to time, otherwise they just wear out.  Yet any change to the Concertgebouw--the upholstery, the wood on the stage, maybe even the paint--has the potential to change those special acoustics.  What does one do to preserve such a place?

p.s., a young woman name Susanna Malkki took over from an ill Jansons.  She was really, really good.  Perhaps I saw an early performance from a future superstar?

Detroit has not had the largest peak-to-trough decline in percentage terms among American large cities

Although it is getting close.  Detroit has lost about 58 percent of its 1950 population; St. Louis has lost about 59 percent.  And Detroit's population is much bigger than it was in 1900; St. Louis has lost about 30 percent of its population since 1900 (just prior to the 1904 World's Fair, when 20 million people visited St. Louis).

Detroit Shrinking

The New York Times has a good story about it this morning.  It reminds me of the Talking Heads song Nothing but Flowers:

Where, where is the town

Now, it's nothing but flowers

The highways and cars

Were sacrificed for agriculture

I thought that we'd start over

But I guess I was wrong

Once there were parking lots

Now it's a peaceful oasis

you got it, you got it

This was a Pizza Hut

Now it's all covered with daisies

you got it, you got it

I miss the honky tonks,

Dairy Queens, and 7-Elevens

you got it, you got it

And as things fell apart

Nobody paid much attention

you got it, you got it

I dream of cherry pies,

Candy bars, and chocolate chip cookies

you got it, you got it

We used to microwave

Now we just eat nuts and berries

you got it, you got it

This was a discount store,

Now it's turned into a cornfield

you got it, you got it

Don't leave me stranded here

I can't get used to this lifestyle

Does The Greatest Trade Ever produce evidence of prospect theory?

There is a statement in Gregory Zuckerman's terrific book that really struck me: he notes that people hate negative carry, and far prefer positive carry (I don't had the book in front of me right now, so I need to paraphrase).  In Paulson's context, he was able to buy credit insurance very cheaply--this limited his downside risk in a way shorting would not, while allowing him to invest consistent his bearish views on the housing market. But it also meant he was paying out cash flow and not gettting anything in return until subprime mortgages and other instruments began failing.

To some extent, there is a discounting issue here: if investors take losses on the negative for several periods, the gains they receive in the future will be discounted.  But still, it is an interesting question whether investors discount negative carry trades too much--whether the typical Wall Street investor sold Paulson insurance that was, under reasonably discounting, an ex ante positive NPV bet for Paulson.  I am not sure how one would go about testing this, though....

A line in Clark Hoyt's final column bothers me

He writes:

There is also no question that The Times, though a national newspaper, shares the prevailing sensibilities of the city and region where it is published. It does not take creationism or intelligent design as serious alternatives to the theory of evolution.

This is not sharing "prevailing sensibilities."   This is simply reporting overwhelming scientific evidence.  It is no more about sharing sensibilities than not taking flat-earthers seriously is about sharing sensibilities.

 

How to punish universities without punishing students

I understand that when universities violate rules (NCAA or otherwise), they need to be punished, so that rules have credibility.  But it seems unfair to punish current students for past misdeeds.  In the current context, a fair sanction would be to allow current students to play in bowl games, but forbid the university from taking any money for them.  Just a thought.

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

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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.