Four quick points about Fannie-Freddie Reform

(1) Why have an explicit guarantee?  If TARP should have taught us anything, it is that there are implicit guarantees everywhere; it is better to be up-front about the fact that the government does provide backstops in times of crisis.

(2) How to price the guarantee?  Mark Zandi has a good explanation.  The hard part is going to be to keep fees up in times of low defaults.  In the early part of the last decade, Fannie and Freddie were criticized for earning excess profits on their guarantee fees, for the simple reason that defaults on prime mortgages essentially didn't exist in the 1998-2005 period.  Complaining about Fannie-Freddie's g-fees at that time would be akin to complaining the State Farm enjoys excess profits when Florida goes a year without a hurricane.

(3) In the absence of government intervention in the market, the long-term fixed-rate prepayable mortgage will likely go away.  These mortgages are expensive to households, but they also provide a level of certainty that helps households manage risk.  Households are already facing more risk than before (defined benefit pensions, anyone?), so I am not sure it is a good idea to add even more.

(4) I worry about high downpayment requirements.  It is clear that households need to put some of their own money into a house for a mortgage to be safe (gifts and grants don't count).  But while the overall homeownership rate for the US is fine, the substantial gap between whites and minorities, more than 20 percentage points, is not.  Minorities have far less wealth than whites, and across the generations, have had wealth systematically expropriated; minorities have also been discriminated against by the government in credit markets.  Massey and Denton:

In rating the home, the FHA established minimum standards for lot size, setbacks and separation from existing structures that essentially eliminated many inner-city dwellings....in the late 1940s, the FHA recommended the use of application of racially restrictive covenants...per capita mortgage spending was 6.3 times greater [in St. Louis County relative to the city of St. Louis].

I suppose in light of history, direct payments to the heirs of those who have had wealth systematically stripped away makes more sense than trying to close the homeownership gap.  But the latter seems more politically doable than the former.

SIngapore Envy

Tom Friedman rhapsodizes too much about Singapore.  While it is hardly the least free society in the world, the People's Action Party for all intents and purposes has a political monopoly.  Singapore's GINI coefficient is higher than the United States for income, as is its ratio 90th percentile to 10th percentile income.

Nevertheless, every time I pass through the city-state (I just did for the third time), I am awed by its transportation infrastructure: beautifully landscaped expressways, congestion pricing for automobiles, and well-operated bus and trail transit.  Transit is very clean, fast and efficient, and runs frequently.  The trains are often crowded but somehow not too crowded.  Changi airport is a public works project of the sort that once filled American's with pride--it is to airports what Hoover Dam is to, well, dams.  Changi is also profitable.

So when I come home to Los Angeles, I find LAX to be a little embarrassing.  When I use transit from the airport, the Flyaway Bus, I find it to be unreliable and less than spotless.  The process of buying a ticket (at the end of the journey) is cumbersome.  It would be one thing if LA were unusually bad about such things for US cities, but it is not.  The fact that New York is having a hard time getting a second rail tunnel built under the Hudson also reflects America's seeming inability to provide necessary public works.

Homeownership and Social Justice

I am reading and enjoying Simon Johnson and James Kwak's 13 Bankers. Like a lot of recent stuff (including an OECD report), it takes a swipe, if a mild one, at the virtues of homeownership.   If people think homeownershipp is overrated, I can live with that (even if I disagree with it. Where I do have a problem is when people argue that government "pushes" homeownership on people, whether they really want it or not.

I am not sure that the pushing matters that much--it is entirely possible that people, for reasons beyond financial reasons, want to own houses in particular and real estate in general.  Two things stick with me:

(1) I was talking yesterday with a developer here in India who is trying to building market-rate affordable housing.  He faces a number of hurdles, one of which, he said, is "Indians' obsession with homeownership."

(2) Years ago, when I was in Madison, the guy who cut my hair loved to talk about the rental property he owned in Florida.  It would, he said, be the source of his retirement income.  I asked him why he was so undiversified--why he didn't sell his place and put the money in an index fund.  His reply was that he didn't trust Wall Street, and that he needed an investment that he could "touch" as well as control.  I told him his mistrust of Wall Street was misplaced--shows what I knew at the time.

The point is that there is something about real estate that reduces agency problems,  One may not be able to control markets, but one can control the management of real estate that one owns.  I do remember when I left the rental market for the owner market, I was very happy, not because I thought I would make out financially (house prices in Madison had been stagnant for years), but because I disliked my landlord, and was relieved that I would no longer have to write a check to him. 

This is not to say putting people in houses they cannot afford is a good idea, and I have long been dubious of very low downpayment schemes (I do think homeowners who put no equity into their houses are not really owners).  But it is a little too easy for people who own houses (or have the choice to do so) to say it is not important to make the option available to others.  Freedom to some extent means the ability to take control of one's own life, and to avoid agency issues as much as possible. 

I freely confess that this is all supposition based on informal observation.  Some work has been done on how ownership solves some agency issues, but I think it is an understudied phenomenon.  If anyone wants to help me think about how to model such things formally, I would welcome the assistance.

According to an informal vote of Indian School of Business MBAs...

...the cities with the most potential for real estate investment in India are Pune and Ahmedabad. 

How much freedom to choose?

Ed Glaeser argues that the "moral heart of economics" is "freedom" and in particular the "freedom to choose:"

Improvements in welfare occur when there are improvements in utility, and those occur only when an individual gets an option that wasn’t previously available. We typically prove that someone’s welfare has increased when the person has an increased set of choices.

When we make that assumption (which is hotly contested by some people, especially psychologists), we essentially assume that the fundamental objective of public policy is to increase freedom of choice.

I will leave it to others to dispute the notion that more choices are always better than fewer.  But I can't help but think that it is to easy for those of us who are tenured professors to extoll the virtue of free choice, for the simple reason that we get so many, well, choices.  We get to choose what we write, we to a large extent get to choose what we teach inside our classes, and we can piss our deans off and pay fairly little in the way of consequences.  We might not get a raise or we might have to teach a class that we would rather not, but this is all small beer.  We can make an awful lot of choices and still be economically secure.

Now consider the administrative assistant at a corporation who has a boorish boss and a sick kid.   The company she (he) works for has a good health insurance plan, but if she were to leave, she would find herself unable to get coverage at a reasonable price.  Does she really have choice?

Consider the West Virginia coal miner who goes into a dangerous mine every day, and whose life expectancy is shortened with each hour worked underground.  Now consider the fact that the miner grew up in a West Virginia town with a poor school in an environment where going to college was a rare phenomenon.  Does that miner have a choice?

I could go on, but I think the point is fairly clear.  There are times when government intervention could expand the choice set up a large number of people.

Ed does point out how government can improve choice sets, and for that he deserves credit.  But the more fundamental problem is that market economies produce large institutions that have limited markets inside of them, and therefore sometimes have hierarchies that can be as inhospitable to personal liberty as government bureaucracies.  Elinor Ostrom's Nobel win in 2009 shows that the economics profession is beginning to recognize this problem,  but I am not sure Ph.D. students are broadly encouraged to study it.    

Uh-oh

I met with a large developer here in India.  He told me that "rent models," (i.e., discounted cash flow models) don;t work in India--that everyone wants to own property in India, and so India is different.  I remember a Japanese real estate guy telling me the same thing about Japan in the late 1980s.

At least there isn't a lot of leverage here, so the systemic risk of a collapse in prices is lower.  But still....

Mark Thoma passes on terrible news about Maxine Udall, girl economist

To all Maxine Udall Girl Economist Readers

I didn't know who she was, but I felt like I knew her.  She was smart and wise.

Land use regulation and the cost of housing, Indian style

Mumbai is among the densest cities in the world: as a metropolitan area, it is roughly ten times denser than New York (h/t Alain Bertaud).  Yet residential zoning codes typically have FSIs (the equivalent of a floor-area ratio) of between 1 and 1.33.  This compares with typical central business district FSIs of between 5 and 15 in other cities around the world, and there are places in Hong Kong, which is a very attractive city, where it reaches 20.  

So what happens when the most crowded large city in the world forbids intense development?  Prices get very high.  The most expensive parts of Mumbai are more expensive than Manhattan; the least expensive are comparable to the American Midwest, but people's "middle-class" incomes are perhaps 1/8 as large in Mumbai.

A developer I spoke with last night told me that if FSIs were raised to 4 (still low by world standards), prices would fall by about 50 percent.  While this is not an econometrically determined elasticity, it does make a certain amount of sense.  It would be worth at least doing the policy experiment of raising FSI uniformly.

As for services, well, there are already plenty of people using services.  The average person in Mumbai consumes about 30 square meet of residential floor space, so allowing more vertical development might, if anything, alleviate crowding, both inside and out.  

The present value relationship still doesn't work in India

I had students here in Hyderabad gather data on rents, and then we put together a valuation pro forma.  We determined that the present discounted value of flats here is roughly 40 percent of their sale price.

I have been doing this sort of exercise since I first visited south Asia seven years ago, and I get about the same outcome every time.  It is not credit that is driving this market--many people buy property with cash.  People tell stories about "black money" financing property--this is untraceable, and therefore untaxed, money.    But our calculations imply an implicit tax rate of 60 percent--taxes in India are not that high (in fact, other than an eight percent transfer tax, they are fairly similar to the US).

So the story must be about expectations, and indeed, that is the story I hear.  But current yields are well under 3 percent, and if values rise faster than rents, those yields will get even lower.  Something has got to give.  I just have no idea when.

The OECD says imputed rent should be taxed

When homeowners own their property with equity, they get a tax benefit as important as the mortgage interest deduction: the imputed rent they pay to themselves goes untaxed.  To think about how this works, consider two nieghbors who own their houses free and clear.  Suppose the houses are identical, and that the nieghbors swap houses, paying rent to each other.  They now have a tax liability that they would not have had they remained in their houses.  Avoiding this liability is tantamount to a tax expenditure--a benefit to those who own their houses without debt.  The OECD is correct that countries rarely tax imputed rent, and argues that this lack of taxation has tilted investment toward housing to the detriment of more productive uses.  It also argues that the benefits to homeownership are overstated.  I am not sure that this is true (see here and here), but I will leave that for another time.

The question is how does one go about taxing imputed rent?  It is not easy.  One could start by imposing an ad valorem tax on property values (such as a local property tax), but that doesn't tax imputed rent per se, because it does not take into account expected inflation (if one person expects her house to go up in value, and another does not, the rent the first person pays is lower than the second).  Alternatively, one could find comparables in the rental market and attribute rents found there to the owner market.  But owner and rental markets are so segmented that this would be difficult to do.

This has implications for fairness; if we don't know what we are taxing, it is hard to know how much to tax it. 

Amy Chua and the Reflection Problem

I saw Amy Chua speak some years ago (at the World Bank, I think) about her book, World on Fire. She was an excellent, witty and provocative speaker, so much so that I read the book as a result. And while the book was indeed thought-provoking, it was not convincing. Her basic point was that democracies can produce instability: minorities in democracies can amass economic wealth, which in turn leads to resentment, which in turn leads to political scapegoating and instability and all other kinds of bad things. The problem is she never presented to me a convincing counterfactual; she never showed me how a world devoid of democracy would also be devoid of resentment and instability.

As a result of reading World on Fire, I will not read Battle Hymn beyond the excerpt in the Wall Street Journal (although I understand that the excerpt is not representative of the book). If the book is only a memoir, then it is almost certainly fine, but this is not how it is being represented. Instead, it is being characterized as a comparison between "Chinese parenting" and its results and "Western parenting" and its results. Again, this may be unfair to Ms. Chua, but the book has spurred myriad commentary about the virtues and deficiencies of various parenting styles.

What is lost in all of this is how difficult it is to actually draw inferences about the effects of parenting styles on outcomes. Charles Manski calls this "the reflection problem." Here is Manski:

Here is an identification problem from everyday life: Suppose that you observe the almost simultaneous movements of a person and of his image in a mirror. Does the mirror image cause the person's movements, does the image reflect the person's movements, or do the person and image move together in response to a common external stimulus? Empirical observations alone cannot answer this question. Even if you were able to observe innumerable instances in which persons and their mirror images move together, you would not be able to logically deduce the process at work. To reach a conclusion requires that you understand something of optics and of human behavior.

A like inferential problem, which I have called the reflection problem (Manski 1993a), arises if you try to interpret the common observation that individuals belonging to the same group tend to behave similarly. Two hypotheses often advanced to explain this phenomenon are endogenous effects, wherein the propensity of an individual to behave in some way varies with the prevalence of that behavior in the group; and correlated effects, wherein individuals in the same group tend to behave similarly because they face similar environments and have similar individual characteristics.

Similar behavior within groups could stem from endogenous effects (e.g., group members could experience pressure to conform to group norms) or group similarities might reflect correlated effects (e.g., persons with similar characteristics might choose to associate with one another). Empirical observations of the behavior of individuals in groups, even innumerable such observations, cannot per se distinguish between these hypotheses. To draw conclusions requires that empirical evidence be combined with sufficiently strong maintained assumptions about the nature of individual behavior and social interactions.

Why might you care whether observed patterns of behavior are generated by endogenous effects, by correlated effects, or in some other way? A good practical reason is that different processes have differing implications for public policy. For example, understanding how students interact in classrooms is critical to the evaluation of many aspects of educational policy, from ability tracking to class size standards to racial integration programs.

Suppose that, unable to interpret observed patterns of behavior, you seek the expert advice of two social scientists. One, perhaps a sociologist, asserts that pressure to conform to group norms makes the individuals in a group tend to behave similarly. The other, perhaps an economist, asserts that persons with similar characteristics choose to associate with one another. Both assertions are consistent with the empirical evidence. The data alone cannot reveal whether one assertion or the other is correct. Perhaps both are. This is an identification problem.

Whatever one thinks about Ms. Chua's parenting, we have no firm evidence whether her kids' outcomes are a function of Chinese parenting, Chua-specific parenting, or just her kids' endemic talents. It is a serious problem when we forget that.

Some evidence about state government spending multipliers.

Three abstracts. The findings should give the pain caucus some pause.

Daniel Shoag:

The effect of government spending on income and employment is a central unresolved question in macroeconomics.

This paper employs a novel identification strategy to isolate exogenous and unexpected variation in state government spending. State governments manage large defined-benefit pension plans for which they bear the investment risk. Using a newly-collected dataset on the returns and portfolios of these plans, I show that the idiosyncratic component of their returns is a strong predictor of subsequent
state government spending. Instrumenting with this ‘windfall’ component of returns, I find that state government spending has a large positive effect on income and employment. Baseline estimates indicate that each dollar of spending raises in-state income by 2.12, and that 35,000 of spending generates one
additional job. These effects are not due to in-state investment bias, are concentrated in the non-traded sector, and are larger during times of labor force ‘slack.’ Finally, I consider how these results compare with the predictions of a standard macroeconomic model and outline which features in the model are
consistent with the empirical findings.

Nakamura and Steinsson:

We use rich historical data on military procurement spending across U.S. regions to estimate the e ffects of government spending in a monetary union. Aggregate military build-ups and draw-downs have diff erential e ffects across regions. We use this variation to estimate an open economy government spending multiplier of approximately 1.5. Standard closed economy estimates of the government spending multiplier are highly sensitive to how strongly monetary policy \leans against the wind." In contrast, our estimates "diff erence out" these eff ects because diff erent regions in a monetary union share a common monetary policy. This allows us
to better distinguish between alternative business cycle models. We show that our estimates are consistent with a New Keynesian model with GHH preferences. They are consistent with a small closed-economy multiplier when monetary policy is highly responsive (as in the Volcker- Greenspan era) and a substantially larger closed-economy multiplier when interest rates are less responsive (as at the zero lower bound).

Clemens and Miran:

Balanced budget requirements lead to substantial pro-cyclicality in state government spending outside of safety-net programs. At the beginnings of recessions, states tend to experience unexpected deficits. While all states ultimately pay these deficits down, differences in the stringency of their balanced budget requirements dictate the pace at which they adjust. States with strict rules enact large rescissions to their budgets during the years in which adverse shocks occur; states with weak rules make up the difference during the following years. We use this variation to identify the impact of mid-year budget cuts on state income and employment. Our baseline estimates imply i) a state-spending multiplier of 1.7 and ii) that avoiding $25,000 in mid-year cuts preserves one job. These cuts are associated with shifts in the timing of government expenditures rather than differences in total spending over the course of the business cycle. Consequently, our results are informative about the potential gains from smoothing the path of state government spending. They imply that states could reduce the amplitude of business-cycle fluctuations by 15% if they completely smoothed their capital spending and service provision outside of safety-net programs.

ASSA Interviewing Etiquette

Here is a suggestion for freshly-minted Ph.D.'s looking for Assistant Professor jobs: take time to at least glance at the web sites of the places to which you are applying.  Even in academia, people who are hiring you want to know that you have at least a little interest in the place where they work.

Apologies to Mark Thoma

I was sloppy in characterizing Mark's comments about Gene Sperling.  He writes:

I think this misstates what I have said. I posted something defending Sperling, and the claim that 

"their grounds are basically that he is a protege of Robert Rubin and that he took money to work (essentially) as a consultant for Goldman Sachs."

I didn't say he was a protege, and said nothing about the money, etc.

I did say that from a political view I thought the administration would be better off breaking its ties with the Clinton administration personnel, just as I said the same thing about Summers. But that is different from saying there is something wrong with Gene in particular other than the political baggage that comes with him.

Here is what I said specifically. First, I echoed a post defending him. Then, I said "I still think a break from the Wall Street connected side of the Clinton administration would have political value."

See: 

http://economistsview.typepad.com/economistsview/2010/12/who-should-replace-summers.html

Tim Duy had much more to say, but those are his words, not mine.

Goldman Sachism?

I enjoy Felix Salmon and Mark Thoma's blogs a lot.  In the last day, both have lamented the possibility that Gene Sperling might replace Larry Summers; their grounds are basically that he is a protege of Robert Rubin and that he took money to work (essentially) as a consultant for Goldman Sachs.

I suppose I should disclose that I once got to sit next to and talk with Gene Sperling on an airplane from Jackson Hole to Denver, and he struck me as a person of great intelligence and even temperament.  That doesn't particularly matter--it does matter, however, that the people who I know who know him also regard him as a person of great intelligence and even temperament.  Let me emphasize the temperament part.  He also pushed for the very good idea of imposing Pigou taxes on banks.

So far as I know, his critics do not suggest that he is really personally deficient, but that he is a problem because (1) he worked in the Clinton Administration under Robert Rubin and/or (2) he received money from Goldman Sachs.  To me, the first part is actually a recommendation, but I feel the need to comment on the second.

Goldman Sachs has done things for which it should not be proud.  Does that mean that anyone who worked at/for the place should be disqualified from government?  In its history, the Ford Motor Company has done unlovely things; Boeing has done some not-so-great things; I am not please at some of the things my one-time employer, Freddie Mac, has done.  This does not mean people who worked at Ford, Boeing and Freddie Mac should be disqualified from government.  All these places, as well as Goldman Sachs, have many intelligent, honest, capable people.

If you have a beef with the substance of Sperling, fine.  If you think Furman would be better in the job, that is fine too.  But guilt by association is just too easy, and has its own ugly history.

Top Ten Cities for Real Estate Investment (h/t Wisconsin Graaskamp Center and Francois Ortalo-Magne)

The Association of Foreign Investors in Real Estate surveyed real estate investors from around the world about places and property types.  Among other questions, they asked respondents to list cities that had the best prospects for commercial real estate.  The list:

1. New York
2. Washington
3. London
4. Paris
5. Shanghai
6. Singapore
7. Hong Kong
8. Madrid (!!!)
9. Sydney
10. Los Angeles

Urban recovery: Pareto improvement is hard

The first time I visited Pasadena, in 1980, the place was a bit down-in-the mouth.  The corner of Fair Oaks and Colorado (the heart of what would become Old Town) featured disreputable establishments, and many beautiful old houses had fallen into disrepair.  Air quality was dreadful.

Now, 30 years later, Pasadena is among the loveliest and most lively cities I know (it also happens to be where I live).  New Urbanists should love the place: pedestrians fill Old Town and, to a lesser extent, Lake Avenue.  The craftsman bungalows--the sort of houses that people like Andres Duany like to copy--have been restored to their former glory, and range in size from modest to obscenely large.  Air quality, while still not great, is much, much better.  One can see the San Gabriel Mountains every day.

This produces unhappiness on the part of Occidental College sociologist Peter Drier.  He writes:

New US Census data reveal a troublesome reality about the Rose City. Pasadena’s has become a tale of two cities — one that welcomes affluent residents and another in which middle-class and poor families are pushed out by rising housing prices. 

Pasadena officials like to boast about the city’s recent “renaissance,” pointing to the major (and expensive) renovations of City Hall ($117 million) and the Convention Center ($150 million), and the just-approved $152 million facelift for the Rose Bowl, as well as the addition of new condominium complexes and upscale stores. 

 But who, exactly, is benefiting from the city’s renaissance?...

...At the very top, the wealthiest 5 percent of Pasadena households — those with household incomes above $249,841 — have almost one-quarter (22.7 percent) of city residents’ total income. Only five cities – Los Angeles (25.9 percent), Glendale (25.8 percent), Rancho Cucamonga (25.2 percent) San Francisco (23.4 percent) and Oakland (23.1 percent) — have a higher concentration of income among the richest 5 percent.

 In contrast, the poorest one-fifth of Pasadena households — those with incomes below $23,042 — combined have only 2.6 percent of all residents’ income. As Table 2 reveals, only in San Francisco do poor households have a smaller share of citywide income.

In Pasadena, those in the next poorest one-fifth — those with household incomes between $23,043 and $45,174 — bring home only 7.6 percent of residents’ incomes. Together, the poorest 40 percent of Pasadena’s households have only 10.2 percent of Pasadenans’ total income.

...Pasadena lost 2,420 households with incomes below $50,000 — an 8.8 percent drop. By far the biggest losses were among households earning under $10,000. The number of these households fell from 5,273 to 4,094 — a 22.9 percent decline.

None of this should be surprising in light of spiraling rents and house prices, the accelerating conversion of affordable apartments to expensive condominiums, the predominance of new luxury units among the condos approved by city officials and the paucity of affordable housing in Pasadena’s development pipeline. 

So Peter underscores a fundamental problem.  We want out cities (and inner ring suburbs, such as Pasadena) to improve.  But when cities get better, they become more desirable places to live.  To use a metaphor, 30 years ago, Pasadena was a K-car, and now it is an Acura (one needs to travel south to San Marino for the BMW).  Consequently, when cities become successful, they tend to attract richer people and push out poorer people.  This is true in New York, San Francisco, London, Paris, and so on.


So whom does this help?  It certainly helps homeowners, regardless of income, because it leads to greater wealth.  The median person in Pasadena is a homeowner, but just barely; nearly 50 percent of Pasadenans are renters.  Because rents are higher, renters might appear to be worse off.  On the other hand, rents reflect desirability.  If the change of the value of the bundle of amenities arising from living in Pasadena is greater than or equal to the change in rents, renters are at least as well off as before.  Pasadena is cleaner, safer and healthier than in was 30 years ago, and these things are valuable.


The exception is those people who are forced to move because wealth prevents them from choosing to live in Pasadena.  Those who are forced out of their homes are worse off than before, and so a revived Pasadena is not a Pareto improvement (in the strict sense of the phrase) over dowdy Pasadena.


So what should we do?  Discourage the kind of renaissance that Pasadena has produced?  I think not.  I can think of three policy responses that might help.  First, make Section 8 vouchers and entitlement, so that people can choose to live in whatever city they like.  That is a federal responsibility.  Second, use Pasadena's relatively high property values (relative to other communities; not to five years ago) to improve social services.  But that is not possible to do without changes to Proposition 13 (parcel taxes are not as efficient or equitable as ad valorem taxes).  Third, get rid of regulations that make in extremely difficult to build inexpensive units, such as granny flats, in Pasadena.  This is the only lever than is in Pasadena's hands.


It is difficult to get around a very uncomfortable question: should all people have financial access to all communities?  As an economist, I tend to think the answer is no.  As a human being, I am not sure at all.

Looking for Information on Real Estate Market Conditions in Hyderabad

I will be spending a few weeks visiting the Indian School of Business at the end of January; in the past, I have gotten welcome comments on the market environment in Hyderabad.  Anything that gives me more context is helpful.

Sewell Chan: Economists consider ethics code

It's about time.  I do think it is a good thing when economists participate in both business and policy--such things inform both teaching and research.  But disclosure is important.  We may all think of ourselves as forthright and objective, but we are in fact shaped by experiences (and as economists never cease to remind us, by our paychecks).  Gary Becker's line in Chan's piece about replicability curing all ethical problems doesn't really hold up, because lots of economic theory has never been or has been inadequately tested against data (George Akerlof does a very good job demonstrating this in his AEA Presidential Address from 2007).

We seem as a profession to have a difficult time dealing with ethics--it makes us squeamish, because mainstream economics often celebrates avarice.  But one of Adam Smith's earth shattering works was called The Theory of Moral Sentiments, so he wasn't squeamish about thinking about such things as all.

I have within this blog from time-to-time disclosed my relationships when such things might matter to what I am writing.   The two most important are with Realtors (when I was a graduate student I worked for the Wisconsin Realtors Association, and I was a consultant on Existing Home Sales in the late 1990s and early 2000s) and with Freddie Mac (where I worked for less than a year and a half in 2002-03).  My center at USC has a large number of donor members.   I have also consulted for the World Bank.  These relationships have been rewarding to me financially and intellectually, and while I like to think I play things straight, I would be foolish to pretend that these experiences have had no influence on my outlook.  I leave it to readers to determine the impact of such influence on the validity of what I write.

How the NCAA undermines the academic enterprise

I love major college sports; I have enjoyed having athletes in class--they actually tend to run the gamut in terms of how well they do, and I appreciate the time management skills required to be a varsity athlete while performing well in class.

But part of the academic enterprise is instilling in students the importance of not bullshitting.  The NCAA undermines this when it states things like:

Money is not a motivator or factor as to why one school would get a particular decision versus another. Any insinuation that revenue from bowl games in particular would influence NCAA decisions is absurd, because schools and conferences receive that revenue, not the NCAA.

But who are the members of the NCAA?  The schools!  This statement meets Harry Frankfurt's criteria for bullshit, and is an example of why bullshit is harmful.  Frankfurt:

Someone who lies and someone who tells the truth are playing on opposite sides, so to speak, in the same game. Each responds to the facts as he understands them, although the response of the one is guided by the authority of the truth, while the response of the other defies that authority and refuses to meet its demands. The bullshitter ignores these demands altogether. He does not reject the authority of the truth, as the liar does, and oppose himself to it. He pays no attention to it all. By virtue of this, bullshit is the greater enemy of the truth than lies are.

It seems to me that those of us who have anything to do with colleges and universities have an obligation to avoid bullshit.

My colleague Lisa Schweitzer gently scolds me, and then teaches me something about LA Metro project management

In response to my post, she starts by writing:

First off, it’s a bad idea to conclude anything about work effort based on what you observe by walking by. That’s like the people who judge professors by saying we “only teach two hours a week.” It’s not a valid sample, and it’s very had to evaluate other people’s work effort when you have never done the job yourself— and that’s particularly true of white collar workers passing judgment on blue collar workers engaged in dangerous and often tiring work–during a recession, no less, where anything that extends their work hours has direct implications for their family’s ability to eat and pay rent (unlike salaried work).


More to the point, Richard is mistaken when he concludes that people are not upset. The LA Weekly recently published a story called L.A.’s Light-Rail Fiasco which eviscerates the CEO of the Exposition Metro Line Construction Authority, Rick Thorpe, for salary and his conduct. Rick Thorpe is exactly the sort of transit guy who becomes a free agent and CEO: relentlessly self-promotional and confident, any previous successes get attributed to his leadership. So he picks up stakes, gets recruited away, commands an enormous salary, and builds a brand for himself that he delivers projects on time and on budget.

It is worth reading the whole thing.

Suddenly, some members of the GOP realize they actually will be part of the government

Alan Zibel writes in the Wall Street Journal:

Earlier this year, leading House Republicans proposed to privatize mortgage giants Fannie Mae and Freddie Mac or place them in receivership starting in two years.


Now, as Republicans prepare to assume control of the House next week, they aren't in as big a rush, cautioning that withdrawing government support in the housing market should be gradual.

"We recognize that some things can be done overnight and other things can't be," said Rep. Scott Garrett (R., N.J.), incoming chairman of the House Financial Services subcommittee, which oversees Fannie and Freddie. "You have to recognize what the impact would be on the fragile housing market as it stands right now."

I actually don't think the mortgage market will ever be truly a private sector enterprise.  Suppose Fannie and Freddie were to go away: the most likley entities to step into the residential finance market would be banks.  Would this be privitization?  Not really.  Banks receive explicit guarantees (FDIC) and, as we know from recent events, implicit guarantees as well (TARP was nothing if not the execution of an implicit Federal guarantee). 

The conservative complaint about Fannie and Freddie is that they privatized profit while socializing risk.  This is doubtless true.  I just don't see how it is any less true for banks.

[update: just to be clear, I am all for FDIC, and I think on net TARP left the country better off.  The point is that we will always rely on the public sector to some extent, whether some people like it or not].

Keynes on the "Psychology of Society"

My wife gave me a Kindle for Christmas.  The first thing I should say is that it is really great: my eyesight isn't what it once was, and I find it very easy to read..  The second is that I will continue to buy books at Vroman's (a Pasadena bookstore), because I want them to stay in business.  Third, I downloaded the Economic Consequences of the Peace, which I hadn't read in four or five years.  It has a section early on that really struck me:

Europe was so organized socially and economically as to secure the maximum accumulation of capital.  While there were some continuous improvements in the daily conditions of life of the mass of the population, Society was so framed to to throw a great part of the increased income into the control of the class least likely to consume it.  The new rich of the 19th century were not brought up to large expenditures, and preferred the power which investment gave them to the pleasures of immediate consumption.  In fact, it was precisely the inequality of the distribution of wealth which made possible those vast accumulations of fixed wealth and of capital improvements which distinguished that age from all others.  Herein lay, in fact, the main justification of the Capitalist System.  If the rich had spent their new wealth on their own enjoyments, the world long ago would have found such a regime intolerable.  But like bees they saved and accumulated, not less to the advantage of the whole community because they themselves held narrower ends in prospect.

The immense accumulations of fixed capital which, to the great benefit of mankind, were built up during the half century before the war [WWI], could never have come about in a Society where wealth was divided equitably.  The railways of the world, which that age built as a monument to posterity, were, not less than the Pyramids of Eqypt, the work of labor which was not free to consume in immediate enjoyment the full equivalent of its efforts.

Thus this remarkable system depended for its growth on a double bluff or deception.  On the one hand the laboring classes accepted from ignorance or powerlessness, or were compelled, perusade or cajoled by custom, convention, authority, and the well-established order of Society into accepting a situation in which they could call their own very little of the cake that they and Nature and the capitalists were co-operating to produce.  And on the other hand the capitalist classes were allowed to call the best part of the cake theirs and were theoretically free to consume it, on the tacit underlying condition that they consumed very little of it in practice.

Is the Mortgage Interest Deduction a "Middle-class" benefit?

Yesterday, I was on the Larry Mantle program on KPCC debating Lawrence Yun about the merits of the mortgage interest deduction.  Lawrence is the chief economist of NAR, and is, as such, not disinterested about the issue, but he is an honest advocate (full disclosure: when I was a graduate student, I worked for Wisconsin Realtors, and I consulted on benchmarking the Existing Home Sales series in the late 90s and around 2002 or so ).

He said a couple of things, however, that bothered me.  He sort of dissed renters, by saying they pay only five percent of federal income taxes, ignoring the fact that they pay FICA, state and local taxes.  One would think Realtors would like renters, since they do, after all, pay rent to property owners.  But he also characterized the mortgage interest deduction as being a "middle-class" deduction.  This all depends on the defintion of "middle-class."

Let me turn to Eric Toder and colleagues:

The percentage reduction in after-tax income from eliminating the deduction would be largest for taxpayers in the 80th to 99th percentiles of the distribution. These upper-middle-income households would be affected more than tax units in the bottom four quintiles because they are more likely to own homes and itemize deductions and because the higher marginal tax rates they face make deductions worth more to them than to lower-income taxpayers. The very highest income taxpayers, however, will experience a relatively small drop in income (about 0.4 percent on average) because, at the very highest income levels, mortgage interest payments decline sharply as a share of income.

So it is probably correct to characterize the mortgage interest deduction as an "upper-middle-class" deduction.  The very rich don't benefit that much from it, because they don't really need mortgages.  The bottom 80 percent don't benefit much, because their marginal tax rates are low, they are more likely to be renters and perhaps don't itemize their tax deductions.  My guess is that people between the 80th and 99th percentile don't need a lot of encouragement to become homeowners.

Small reasons that government drives people crazy

A light rail line going by USC--the Exposition Line--has been under construction for some time now.  For a considerable time, the site featured a sign that said the line would open in 2010.  Now the estimates are that it will open some time in 2011 or 2012.  At the same time, when I walk by the project, I can't say that the workers building it show a great deal of, shall we say, urgency about getting the thing done.

At the same time, I don't hear a lot of people who are upset about how far behind schedule the project is. Maybe this is because no one is planning to take the Expo Line.  Maybe it is because peoople have such low expectations of LA Metro that they are not surprised, and therefore not outraged.  Either way, it suggests a problem.

I continue to believe that we need government to do certain things (rail tunnels under the Hudson and a more modern power grid, for starters) for the economy to perform well.  But when government doesn't perform well, it turns positive NPV projects into negative NPV projects, and it undermines political consensus for the necessity of government.

Bethany McLean on the GOP "primer" on the financial crisis

She writes:

This narrative isn't completely wrong—but it is shockingly incomplete, which makes it, in the end, a ludicrous distortion of what happened.

Three points.  First, I have never, ever, seen Peter Wallison suggest that banks are ever anything by morally upright and wise, despite lots of evidence to the contrary (I would welcome a correction on this point). 

Second, to say that the Affordable Housing Goals were major contributors to the crisis is silly, because as people like Wallison liked to point out, the GSE's continually lagged the market when it came to advancing mortgages to low income borrowers and underserved areas.  Wallison specifically said in 2006 that GSEs were "not doing the job they should for low income borrowers.  Finally, the Community Reinvestment Act did not cover many of the financial institutions that originated the most toxic loans.

What bothers me about the entire Republican narrative is that it continues a pattern of argument that suggests that when it comes to finding fault, borrowers are always more culpable than lenders; low income people are always more culpable than high income people; and underrepresented minorities somehow have gotten an unwarranted good deal. 

Update: Barry Ritholtz has 10 questions for the GOP members of the commission.

Jonathan Weinstein on Fairness in Tax Policy

It is worth reading the whole thing; here is the conclusion:

As a 1st approximation, someone in a highly scalable profession would keep roughly

half their income, since they enter the game with, on average, half the population

present. (See a more carefully worked out example in the appendix.) There are

many possible adjustments to this estimate; for one, if the inventor or entertainer

is extracting rents from network e ects and they are not actually much better than

a replacement, their Shapley value might be much less than half their income. On

the other hand, someone in a non-scalable profession creates roughly the same value

regardless of the size of society, so they would keep more of their income. Whether

these considerations re
ect fairness is, of course, ultimately a value judgment, but a

50% top marginal tax rate is well within the historical range, so such an outcome

would not be radical.

The great intellectual advances that illuminated the enormous bene ts of the free

market, starting with Adam Smith and continuing into the 20th century, have long

since been assimilated into our political discourse. The danger is that in some circles

the lessons have been learned just a bit too well. The free market then becomes a

21st-century deity whose dictates are perfectly fair and should not be questioned,

lest its manna of prosperity cease to rain down upon us. Warning about this is, of

course, unnecessary for economists, who, whatever their political stripe, understand

perfectly the limits of core equivalence and welfare theorems. Keeping any nuance

is very di cult when intellectual advances are distilled for a larger population, so

responsible academics always have to be very careful in how they discuss the practical

impact of abstract results.

(Full disclosure: Jon is my cousin).

Yves Smith gives Five Rules for Private Label Mortgage Securitization

They are:

1. Mortgages must be seasoned 12 months before they can be securitized

2. The originator must retain at least a 5% interest in the credit risk of the assets sold

3. The interest of all parties to a transaction must clearly be disclosed, along with their fees

4. Re-securitizations (meaning CDOs) are severely restricted (note a disconnect here; the e-mailed and verbal reports suggested they were banned entirely; the language at the FDIC website seems to indicate that they are allowed in limited circumstances, but any use of synthetic assets, meaning credit default swaps, in a asset-backed CDO is verboten)

5. Compensation to servicers will include incentives for loss mitigation

The mortgage securitization industry apparently opposed this, which is odd, in light of the fact that it is doubtful securitization will return in the absence of such rules.

Yesterday's NYT: A Secretive Banking Elite Rules Trading in Derivatives

In the aftermath of The Big Short, one would think we would try to stop this kind of thing.  It is one thing to be OK with some people making a lot of money; it is another thing to think it is OK for people to make lots of money because of a rigged game in their favor.  I worry that the extraordinary increase in unevenness in wealth is not the result of merit, but the result of the game being more and more rigged.

Density and the use of public transportation

I am grading papers from students in my Advanced Urban course, and a number are reviewing literature on density and use of public transport.  The literature suggests that doubling density is associated with something like an eight percent increase in public transit use, but of course, it is difficult to tease out cause and effect: I suspect those who like living densely are also more likely to want to use public transportation.

I can't help but think about a trip I made to a UN conference on urban issues.  The conference took place in Barcelona, which has among the easiest to use transit systems in the world--more than half the people there live within walking distance of a metro stop.  As it happens, I went to dinner with some officials from the Bush Administration, and when I suggested we use the metro instead of cabs, my companions were, well, stunned at the very idea.  I pursuaded them to go, and learned that a bunch of people who lived in a city which has an excellent metro, Washington, never used public transportation.

I could be wrong, but my sense was that taking the metro in Barcelona was a foreign adventure for them in all kind of ways, and one that they did not particularly wish to repeat at home.

Some facts about Wisconsin: Presentation to Wisconsin Realtors Executive Conference

I see that the Adminstration's deal on taxes is being characterized as a "compromise"

It is not a compromise.  It is a capitulation.

The Residences at LA Live may become LA's icon

After the Hollywood sign, of course.  I heard Victor McFarlane give a talk last night; MacFarlane Partners did the Residences at LA Live:

The picture comes from the LA Architecture Awards web site.  I drive by this building every day, and enjoy it every day.  The place still needs to stand the test of time, but I love the fact that the building is distinctive and doesn't relay on mass or extreme height to be striking. 

Should house prices still be falling?

I'm not sure.  According to the National Association of Realtors, the median house price in the US is $170,500.  The most recent American Housing Survey data from 2008 shows median rent at $ 808 per month, and the CPI-Rent index is essentially flat since 2008.  This means the cash flow cost of renting is $9696 per year.

If we assume the mortgage interest rate on a 30-year fixed rate mortgage  is 4.5 percent, the cost of home equity is 10 percent, a buyer puts 20 percent down on a house, property taxes are one percent of house value, marginal income tax rates (state and local) are 25 percent, maintanence costs are one percent per year, and amortized closing costs are another one percent per year, the cash cost of owning is $12,162 per year.

But the median rental unit is 1300 square feet and the median owner unit is 1800 square feet, so owning the median owner unit costs about 10 percent less per square foot than renting the median rental unit.  This means house prices could fall and, in some places at least, still leave the owner better off than renters.

Neither renter nor owner markets are national, but I am hard pressed to think of a time when owning on a cash-flow basis looks so reasonable relative to renting. 

Ingrid Ellen, John Tye, and Mark Willis on Covered Bonds replacing GSES

They write:

Covered bonds have three potential advantages over MBSs as a method of mortgage finance.

First, they have the potential to reduce principal-agent problems, because the banks themselves

would hold the loans underlying covered bonds, giving them an interest in originating better

loans. Second, because the mortgage loans would simply remain on bank balance sheets and not

be put into special trusts subject to the incentives of servicers, banks could modify failing loans

far more easily than MBS trusts can. This could reduce foreclosures and maximize loan value.

Third, depending on how they are implemented, covered bonds also hold the possibility of

improving the options available to homebuyers who find themselves underwater. In Denmark,

covered bonds operate according to the “balance principle.” The balance principle requires a

match between each mortgage written and every bond issued. It permits homebuyers two options

for paying off their debt: they may either pay off their mortgage at par, or they may repurchase

their lender’s bonds on the open market, in an amount corresponding to the size of their

mortgage, and return those bonds to the lender. Falling house prices will often depress the

corresponding bond prices (though this may not always happen). When house and bond prices

fall together, homeowners can sometimes refinance their homes at the new, lower house price,

by buying back their bonds at the lower bond prices, and surrendering the bonds to the original

lender. This new option for refinancing could reduce foreclosures in the event of a widespread

decline in housing prices.

There is uncertainty, however, in the extent to which covered bonds would deliver the same level

of liquidity as GSE MBSs, because in a covered bond system, mortgage loans remain on bank

balance sheets. Moreover, it may be difficult for covered bonds to achieve the minimum efficient

scale to compete with government-backed GSE MBSs. As in Denmark, an effective covered

bond market would require standardized bond forms, and a high-volume market that could

demonstrate liquidity to potential buyers. If covered bonds were issued by hundreds of banks

across the country, each with different underwriting standards and bond structures, the extensive

market fragmentation would seriously reduce trading volume and liquidity for any particular

covered bond issue. The Danish covered bond system is effective because the market is highly

structured and homogenized, with only a few participating banks.

Me again: one of the selling points of covered bonds is that they remain on bank balance sheets, and, in Denmark anyway, have no explicit of implicit backing from the government.  But do they really lack such backing?  If the government is willing to inject liquidity into banks (and in Denmark, it is), do the bonds really lack a guarantee?  I am not so sure.

A thought experiment on airport screening and jobs

As noted in earlier posts, my students and I discussed Bill Cronon's Nature's Metropolis this past week.  One of Cronon's explanations for Chicago's extraordinary growth was its role as a distribution center: railroads had both eastern and western terminals in Chicago, and so lots of stuff got collected and moved in the city.  Chicago is not the only city whose development came about in part because of transshipments; one could tell such stories about Hong Kong and Singapore as well.

Coincidentally, Nate Silver had a blog post this week where he estimates that extra post-9-11 security screening reduced air travel by 6 percent.  This begs the question as to how much impediments to movement are also impeding the broader economy.

I wrote a paper a few years back that linked passenger traffic at airports to employment.  The finding was that an increase of one passenger per capita per year produced a 3 percent increase in jobs.  A typical large city has four boardings per year per capita, so let's run the math: -.06*4*.03 is a .72 percent reduction in jobs.  The US has about 139 million jobs, so a .72 percent reduction is about a million jobs.  So it is possible that impediments to travel mean we have a million fewer people working than we otherwise would.

This is very much a first cut, rough kind of number, but it does give one pause.  Is what we are doing at our airports worth sacrificing a meaningful number of jobs?  Perhaps.  But we should still think about the trade-offs explicitly.

Is US success a product of bailouts?

Hamilton "cemented" the Union by getting congress to agree to assume the states' debts from the American Revolution; in exchange, he gave up his desire to have New York be the federal capital.  Ron Chernow's recounting of Hamilton's genius at getting assumption done.

These thoughts cross my mind as I hear people say that the solution to our mortgage problems is to get rid of non-recourse loans.  We have long been more generous about bankruptcy than Europe, and it may explain why our economy is more dynamic and innovative.  The US is a country about second chances in so many ways (including education); it is a country where it is OK to fail and then come back.  We need to be careful about messing with that.

More BIll Cronon

I just finished my third reading of Nature's Metropolis, which I am teaching tomorrow.  It is among the best works on central place theory and aggomeration that I know. 

He also paints vivid pictures of wheat being harvested and shipped to the White City's great grain elevators, the lumbermills of Marquette and Marrinette, of timber sliding down ice flows and floating down rivers and lakes; we can smell the entrails from the slaughtered cattle and pigs, and imagine how the Chicago River South Branch bubbles with potions not even the Weird Sisters could have imagined.  He established how it became a metropolis by not becoming a new center of the center, but rather the center of the periphery. 

We can see how the city raised living standards--standards that 130 years later we would (rightfully) deem appalling.  His picture of Chicago, warts and all, is far more entralling than Sinclair's picture. 

Couldn't we get him to do Tokyo now?  Mexico City?  How about Los Angeles?  Kevin Starr has written a great history of California, but Cronon's angle would be different.

As I read Bill Cronon's Nature's Metropolis on the development of Chicago's abattoirs, I can't help but think of ....

http://www.amazon.com/Natures-Metropolis-Chicago-Great-West/dp/0393308731

One hand clapping for the Deficit Commission Co-chairs' powerpoint

It is not much of a report, but it emphasizes two things that do matter:

(1) Tax expenditures are about $1.1 trillion, and deficit reduction requires scaling them back.  While there has been gnashing of teeth about a proposed top marginal tax rate of 23 percet, the powerpoint contemplate this only in the context of full elimination of tax expenditures.  This would surely be more efficient--it is also possible that it would be more progressive, as the biggest tax expenditures (exclusion of the employer contributions for health care, exclusion of employer contributions to pension contributions, and the mortgage interest deduction) tend to go to those with higher incomes.  It is an empirical question as to how these things net out, but it is an empirical question worth answering (a similar analytical exercise was done in the middle-1990s, but the world is now different).  If someone can create a tax code that brings in more revenue under static assumptions (i.e., is not projecting revenue based on Voodoo economics), is more progressive, and has lower rates because of the phase out of tax expenditures, I am all for it.  FWIW, as someone who has a California mortgage and pays California state income taxes, this is probably not in my personal self-interest.

(2) I do think we need to do something about the retirement age, but it should somehow be linked to occupation.  I have a cushy job, and there is no reason why I can't keep doing it until I become demented.  But those who do physical labor just wear out, and it is not reasonable to ask a 60 year old lineman (the telephone kind, not the football kind) to "retrain."   

Paul Willen says self-amortizing mortgages were abundant before the 1930s

He sends me the following table:

It has long been "established" that self-amortizing mortgages were rare before the existence of the Home Owners Loan Corporation, whereas this source suggests they made up 40 percent of loan originations between 1925-1929.  What this table doesn't tell us is how long the amortization period was.  So the importance of the HOLC may have been the establishment of long-term self-amortizing mortgages.

I would love to get actual mortgage contracts with their terms from the 1920s.

A really nice paper on the Home Owners Loan Corporation

This morning I read a July 2010 NBER paper from Charles Courtemanche and Kenneth Snowden.  The abstract:

The Home Owners’ Loan Corporation purchased more than a million delinquent mortgages from private lenders between 1933 and 1936 and refinanced the loans for the borrowers. Its primary goal was to break the cycle of foreclosure, forced property sales and decreases in home values that was affecting local housing markets throughout the nation. We find that HOLC loans were targeted at local (county-level) housing markets that had experienced severe distress and that the intervention increased 1940 median home values and homeownership rates, but not new home building.

Unfortunately, the paper is behind the NBER firewall, but if you belong to a subscribing university, you can get a link to a downloadable version sent to you.

The change in time today reminds me of one of the many things I learned from William Cronon's Nature's Metropolis

Until the railroads came to prairie towns after the Civil War, each town set its clock using the sun.  It was  impossible to run railroads under such circumstances, and so railroads developed "standard time zones," for the United States.  They became the standard well before they were codified into law.

I comfort myself with the opening of Adam Smith's Theory of Moral Sentiments

How selfish soever man may be supposed, there are evidently some principles in his nature, which interest him in the fortune of others, and render their happiness necessary to him, though he derives nothing from it except the pleasure of seeing it. Of this kind is pity or compassion, the emotion which we feel for the misery of others, when we either see it, or are made to conceive it in a very lively manner. That we often derive sorrow from the sorrow of others, is a matter of fact too obvious to require any instances to prove it; for this sentiment, like all the other original passions of human nature, is by no means confined to the virtuous and humane, though they perhaps may feel it with the most exquisite sensibility. The greatest ruffian, the most hardened violator of the laws of society, is not altogether without it.

I have started a classical music blog

It is here:

http://richardsmusicblog.blogspot.com/

This is just fun for me--we will see how it works.

Please make it stop

A friend of mine posts a query to my Facebook Wall:

I was listening to an Economist this AM on the radio [who is] part of a group of Economists who believe FDR's policies prolonged the Depression, rather than helped it. This goes against everything I learned in my vast High School and Community College experience. What's the real deal, Green?

Just to make sure, I calculated four year GDP growth by presidential term, going back to Hoover.  I count as a term as the period from inauguration to inauguration, so 1929-1933, 1933-1937, etc.

The three terms in which GDP grew fastest: FDR III, FDR I and FDR II.  Even if one removes III because of the special circumstance of World War II, he still gets the best two four year periods.  Do people really want to argue the counterfactual?  [BTW, #4 is Truman II, and # 5 is JFK-LBJ].

On the theme of personal responsibility

Investors in second (and third, fourth, fifth...) lien mortgages knew that they were subordinate to first liens.  Such investors bet that the higher rates paid to such mortgages more than compensated for taking a first loss position.  They bet wrong.

People in a position to know such things tell me that one of the impediments to private renegotiation of first lien mortgages is second lien mortgage investors.  If there is a place we could use a reckoning, it would be a recognition that such liens have been wiped out.

Should everyone get debt relief?

Paul Krugman in his column this morning argues that debt relief is crucial to economic recovery.  I think he is basically right, but it is not clear to me to whom he would extend debt relief.  If we don't draw any distinctions between those who actively put themselves in trouble and those who are victims of circumstances beyond their control, we will leave the whole concept of the responsibility to repay debt in tatters.  Even if we don't care about the moral implications of this, we should care that if we do blanket discharges of debt, it will be much harder for consumers to obtain debt in the future.

With this is mind, we should probably draw distinctions among different types of borrowers.  Here is a rough ranking of borrowers in some sort of difficulty from most to least culpable for their misfortunes:

(1) Those who committed fraud: for example, those who willfully overstated their income on a loan application.

(2) Speculators who put little or no money down on a house, and then walked the instant house prices fell.

(3) Borrowers who used cash-out refinances or second liens to buy stuff--vacations, televisions, boats, etc.  Michael Lacour-Little estimates that about half of underwater borrowers in Southern California took equity out of their houses.

(4) Borrowers who used cash-out refinances or second liens to pay for education or health care.  Am I drawing a distinction between (3) and (4)? Yes.

(5) Borrowers who had adequate income to repay their purchase money mortgage, did not take money out of their house, lost a job (or took a serious pay cut), and are underwater.

(6) Borrowers who are current on their mortgages and are underwater.  People in buckets (5) and (6) may well be equally responsible; people in (6) may have just gotten a better draw.

As a policy matter, I cannot see providing debt relief to (1)-(3).  While I agree with Krugman that we cannot let worries about moral hazard prevent us from engaging in all debt relief, we cannot just ignore moral hazard altogether.  The tough part, from a policy perspective, is distinguishing between (3) and (4).  I am not sure how we do that, but it is worth thinking about.

As for (5) and (6), at minimum we could allow such borrowers to refinance into today's low interest rates without any fuss: this would both lower payments and the present value of the mortgage, and hence reduce the amount by which people are under water on a mark-to-market basis.

If I had my druthers, people in (5) would be offered a debt equity swap, where the amount owed (the bond) would be reduced, but a large share of any future profit would be shared with the lender.  The Wisconsin Foreclosure and Debt Relief Plan is also worth considering.

Those who were treated fraudulently by lenders (particularly those who had equity stripped via fees) are in another group altogether, and deserve relief.  I am not sure what the correct policy lever is for delivering it.