Never mind

From the National Association of Realtors today:

Total housing inventory at the end of June rose 0.2 percent to 4.49 million existing homes available for sale, which represents an 11.1.-month supply2 at the current sales pace, up from a 10.8-month supply in May.

What is normalcy?

gaius marius writes:

fwiw -- and i realize this is but anecdotal, but it is illustrative of the general condition -- i live in suburban chicago, renting a house. i pay $2000/mo, property taxes are $550/mo. my rental payment then would support (ignoring upkeep/insurance/etc) a $1450/mo payment.at today's 30-year fixed rate (~6.5%), that would support a $230,000 loan. with 20% down, call the purchase price $290,000 -- and generously, as we are excluding all expenses but taxes.this house sold in 2005 for $460,000. houses in the neighborhood still list for $410,000.

Actually, this suggests to me that houses in your area are priced at something like fundamentals. Let us say the marginal tax rate of the typical buyer is 25 percent, that property taxes (which are deductible for most people) are at 1.5 percent, that maintenance costs about 2 percent, and that expect rent growth is 2.5 percent (i.e., a little less than recent CPI growth). Then the user cost of owning would be
410,000*(.065*.75 + .015*.75+ .02 -.025) = 22,550, or a little less than the $24,000 you are paying in rent right now.
Two financial advantages of owning that you are not considering are the tax benefit and the immunization from future rent increases. Of course, should interest rates rise to 8 percent, or tax policy change, these calculations change.

OFHEO HPI and long term trends.

The new OFHEO house price index came out yesterday. At the moment, I like OFHEO better than Case-Shiller (I worry that Case-Shiller is now giving too much weight to REO properties in its index). In any event, it is fun to play with some long term trends.

According to yesterday's OFHEO press release, since 1991, house prices have risen about 4.5 percent per year; since 2000, they have risen by 5.5 percent per year, even taking into account the recent decline. This means that between 1991-2000, prices rose about 3.6 percent per year (take (1.045^17/1.055^8)^(1/9)-1).

Suppose that 3.6 percent is the long-term nominal house price growth trend. By how much are house prices overvalued? The answer is (1.045^17)/(1.036^17)-1= .158. So house prices would have to fall by about another 13.6 percent immediately to stay in line with the long term nominal trend, after which they should rise by 3.6 percent per year.

Alternatively, if house prices just stayed flat for four more years, they would return to their long-term trajectory--assuming that the trajectory before the year 2000 was the long-term trajectory.

What does it mean?

Obama has 1.1 million fans on facebook.

McCain has 170,000 fans on facebook.

Of course, McCain doesn't know what facebook is.

Perspective on Fannie and Freddie (update)

I should have looked at the 10Qs (duh) for the first quarter. Credit losses for both companies were around 12bp (although survivable), which is high by historical standards (see below). Still, the first quarter financial statements came out in May, so it is hard to understand exactly what happened a couple of weeks ago.

Perhaps we can start looking for a bottom

I have long said that so long as the months supply of housing available for sale is rising, it is not possible to know then the housing market will reach bottom (in terms of price). But the months supply measure has fallen pretty substantially since this winter, from a peak of 11.4 months to a current rate of 9.4 months. The inventory needs to get down to 5-6 months before inflation adjusted prices become stable. But the derivative finally has the right sign.

A little perspective on Fannie and Freddie

Above are charts of 90-day delinquencies (based on the Monthly Volume Summaries and the OFHEO Report to Congress) through the first quarter of this year and credit losses through 2007 (these are the most recent public data that I can find).

Like many others, I eagerly await the companies' first quarter financial statements. But what do
others know that we don't?

Inflation and the Development of Mortgage Markets in Emerging Economies

Rising commodity prices have not just placed upward pressure on inflation in the US. In emerging markets, the impact is, in many cases, larger, with double digit inflation returning to places such as South Africa and Russia.

Inflation harms mortgage markets. Because nominal interest rates are high during periods of high inflation, payment-to-income ratios for even modest houses move beyond the means of what households can afford (and what lenders are willing to lend) in the short run. This problem is known as mortgage "tilt."


There are workarounds--for instance, price level adjustable mortgages (or PLAMS) charge real interest rates and then adjust the loan balance each period to reflect inflation. Unless these mortgages are carefully constructed, however, and unless the "correct" price index is known (and it rarely is), they are highly risky, because they have a negative amortization feature by construction. They are particularly problematic when house prices do not rise as rapidly as the general price level. The current US experience (as well as the 1980s) show that gaps between consumer prices and house prices can at times be large.


So the mortgage market is a case where nominal price changes can have real effects. It is no accident that the American mortgage market nearly disappeared during the late 1970s--a period of double digit inflation in the US.

Unhappiness (again)

From Greg Ip:

For decades, the typical college graduate's wage rose well above inflation. But no longer. In the economic expansion that began in 2001 and now appears to be ending, the inflation-adjusted wages of the majority of U.S. workers didn't grow, even among those who went to college. The government's statistical snapshots show the typical weekly salary of a worker with a bachelor's degree, adjusted for inflation, didn't rise last year from 2006 and was 1.7% below the 2001 level.

Greg Mankiw's Economics Platform

He tries to list the things for which there is a consensus among economists. It is actually quite good.

I have two problems with the list. First, raising the retirement age for people like me (i.e., those who have cushy jobs) makes a lot of sense. But I think we need to treat truck drivers, miners, linemen, etc. differently. They are often physically incapable of continuing work until an old age. And to ask a 60 year old to retrain is, I think, naive.

Second, I would like to see something about fiscal responsibility. Deficit spending during recessions is fine. But it would be nice to go back to the good old days of the late '90s and run surpluses when the economy is surging.

A Modest Proposal for Richard Syron and Dan Mudd

The two CEOs would take compensation of $1 per year plus restricted stock that doesn't vest for, say, two years. By doing this, whey would show that they have confidence in the long term futures of their companies, and that they are willing to risk-share with taxpayers.

Mark Zandi says the Price-Rent ratio is returning to the fundamentally correct level

He is quoted in today's WSJ.

Also coming into balance, though not there quite yet, is the ratio of home prices to rents. The lower the ratio, the more people are likely to buy a home than rent one. Mr. Zandi estimates that this ratio dropped to 20.02 in the second quarter from a high of 24.90 during the boom. The average ratio from 1985 to 2002 was 14.44. "If you just look at affordability indices, we would say we are probably close to a bottom," says Ivy Zelman, a housing and homebuilding analyst. "But these are not normal times."

FWIW, I am in the middle of buying a house in Pasadena (when it is a done deal, I will write a little history of the transaction). It is because owning looks like a very fair deal relative to renting; also, LA is likely the place we will live for the next 20+ years, so short term house price fluctuations don't mean much to us.

Now that I will be driving to work most days

I will swap my minivan for a Toyota Corolla. I love the Prius, but the price premium in California is too high--assuming you can even get one.

It does bring to mind my first car that was not a hand-me-down from my parents--a Honda Civic that my wife and I bought in 1985. It had a 76 hp engine mated to a 5-speed manual transmission. It seemed adequately fast to me. It had no gadgets on it--riders rolled up the windows by hand, and I had to install the radio by myself. It got 30 mpg around town, and between 35 and 40 on the highway.

Here's the thing--it was not a "sacrifice:" I loved the car. It was fun to drive, and pretty much flawless--we spent very little on maintaining the car. We kept it for 12 years, and only then replaced it because Wisconsin winters took their toll on its body (and Hondas tended to rust back then). But the engine and drive train still ran beautifully.

So my question is--why is it not easy to buy cars like the middle-80s vintage Civic anymore? It seems like a great solution for reducing emissions and congestion. And no new technology is necessary.

Paul Krugman on the GSEs

He writes:

But here’s the thing: Fannie and Freddie had nothing to do with the explosion of high-risk lending a few years ago, an explosion that dwarfed the S.& L. fiasco. In fact, Fannie and Freddie, after growing rapidly in the 1990s, largely faded from the scene during the height of the housing bubble.

Partly that’s because regulators, responding to accounting scandals at the companies, placed temporary restraints on both Fannie and Freddie that curtailed their lending just as housing prices were really taking off. Also, they didn’t do any subprime lending, because they can’t: the definition of a subprime loan is precisely a loan that doesn’t meet the requirement, imposed by law, that Fannie and Freddie buy only mortgages issued to borrowers who made substantial down payments and carefully documented their income.

So whatever bad incentives the implicit federal guarantee creates have been offset by the fact that Fannie and Freddie were and are tightly regulated with regard to the risks they can take. You could say that the Fannie-Freddie experience shows that regulation works.

In that case, however, how did they end up in trouble?

Part of the answer is the sheer scale of the housing bubble, and the size of the price declines taking place now that the bubble has burst. In Los Angeles, Miami and other places, anyone who borrowed to buy a house at the peak of the market probably has negative equity at this point, even if he or she originally put 20 percent down. The result is a rising rate of delinquency even on loans that meet Fannie-Freddie guidelines.

Also, Fannie and Freddie, while tightly regulated in terms of their lending, haven’t been required to put up enough capital — that is, money raised by selling stock rather than borrowing. This means that even a small decline in the value of their assets can leave them underwater, owing more than they own.

Ex post it would appear that Fannie-Freddie should have had higher capital requirements, if for no other reason than to bolster confidence during periods of stress. But ex ante, stress-testing models showed that Fannie was well capitalized and that Freddie was very well capitalized. Ironically, most of us who followed the companies worried a lot more about interest rate/prepayment risk than default risk.

This is not to say that past Fannie/Freddie senior management did not behave badly with respect to financial reporting, and I find it maddening that some of the worst actors wound up walking away with millions of dollars. While I made good friends at Freddie and learned a lot, the moral obtuseness of company leaders at the time (2002-03) made me very uncomfortable and I looked for a way out (I also discovered within about a week of being there that I really missed being a professor). Daniel Mudd's current silence also makes me wonder if there is a shoe to drop that has not yet appeared in the monthly volume summaries.

But for the reasons Krugman gave, moral hazard did not produce lax underwriting at Fannie-Freddie--regulation (and to be fair, I think corporate culture at Freddie) prevented that from happening. To the extent they are in trouble, it is because of market conditions outside the realm of historical experience. It is, after all, their job to be in the market at all times--no matter what. They is why they have their charters. A government backstop will not it their cases reward bad behavior; it will assure that they can do a job that purely private participants are unwilling to do at the moment.

I spent the afternoon flying back to DC from California

I just read the Paulson press release. Tomorrow will be an interesting day. I'll be watching the repo market.

I was going to say this, but...

Brad Delong said it first:

The chance that American taxpayers will actually lose any money if Ben Bernanke and Henry Paulson decide that Fannie and Freddie need government support is very low:

* The interest payments they have coming in are greater than the interest payments they have going out.
* Their government guarantee is itself a very valuable asset that they have made a lot of money off of in the past and will make more off of in the future.
* They are not even in liquidity trouble--unless they begin to have problems rolling over their discount notes...
* As long as it is generally understood that they are too big to fail, they should not even have liquidity problems--absent a depression that bankrupts many currently-solvent homeowners, that is.

I would like to mention three other things based on the 15 months or so that I worked at Freddie.

(1) One reason Freddie got in trouble about how it reported its earnings is that Senior Management did not believe that GAAP treatments of earnings reflected the economics of the company, and so it needed to fudge (the company's self-investigation, called the Baker-Botts report, made this quite clear). This does not excuse its behavior--publicly traded companies must comply with GAAP. The correct thing would have been for management to explain the problems with GAAP in the MD&A Statement.

But Senior Management was correct that GAAP earnings did not (and does not) give meaningful metrics of GSE corporate performance.

(2) Just my two cents, but I don't think the company's mortgage underwriting could be characterized as reflecting moral hazard. The company was quite conservative about loans that qualified for purchase, and perhaps would have been more conservative were it not for the Affordable Housing Goals (and BTW, there is no evidence that the Affordable Housing Goals in any way helped channel mortgage credit to underserved communities or families). In any event, the people running Freddie were not the Savings and Loan cowboys who would lend to anyone for anything.

(3) It is very hard to measure corporate cash flow at Fannie-Freddie, because funding and amortization are both happening constantly.

One other disclosure, I own something like 300 shares of Freddie stock that I received as compensation when I worked there. Feel free to discount anything I say about these matters as a result of this.

I don't get it

The last real "news" about Freddie Mac is the May Monthly Volume Summary, which came out more than 2 weeks ago. Delinquencies on their book have been rising, but at .81 percent are not at anything like an alarming level.

Could the word of a former Federal Reserve Bank President really have such a strong impact on the market?

Christopher Mayer, Tomasz Piskorski and Alexei Tchistyi Show that Prepayment Penalties Benefit Borrowers with Poor Credit Histories

Their paper find there is a separating equilibrium under which borrowers with blemished credit want prepayment penalties, while those with perfect credit do not. More particularly, they show:

Subprime borrowers with FICO scores below 620 obtain rates as much as 0.7%
lower than similar borrowers with fully prepayable mortgages and default at a lower rate (13% default rate) than comparable borrowers with no prepayment penalties (18% default rate). Our …findings suggest that regulations banning re…financing penalties might have the unintended consequence of raising interest rates, increasing mortgage default, and limiting available credit for the riskiest borrowers.

The paper does only look at fixed rate mortgages, and so it is not clear whether the argument applies to 2-28s. But the finding is well worth considering in light of the current policy debate.

Shopping for Mortgages

I am currently shopping for a California Mortgage. It is a little weird--the best pricing relative to the yield curve seems to be a 5-1 ARM. 30-year fixed rates are absurd--around 350 bp above 30 year CMT. While part of this is pricing the prepayment option, it also implies a truly implausible default probability for a prime mortgage.

One would think five-year ARMS would have higher default risks, so it must be about interest rate risk--perhaps buyers of 30-year Treasuries are not so worried about duration matching as buyers of 30-year mortgages? Anyway, the mortgage market in California currently strongly resembles the Canadian Mortgage market.

Jefferson had his problems, but boy could he write

When in the Course of human events, it becomes necessary for one people to dissolve the political bands which have connected them with another, and to assume among the powers of the earth, the separate and equal station to which the Laws of Nature and of Nature's God entitle them, a decent respect to the opinions of mankind requires that they should declare the causes which impel them to the separation.

We hold these truths to be self-evident, that all men are created equal, that they are endowed by their Creator with certain unalienable Rights, that among these are Life, Liberty and the pursuit of Happiness. --That to secure these rights, Governments are instituted among Men, deriving their just powers from the consent of the governed, --That whenever any Form of Government becomes destructive of these ends, it is the Right of the People to alter or to abolish it, and to institute new Government, laying its foundation on such principles and organizing its powers in such form, as to them shall seem most likely to effect their Safety and Happiness. Prudence, indeed, will dictate that Governments long established should not be changed for light and transient causes; and accordingly all experience hath shewn, that mankind are more disposed to suffer, while evils are sufferable, than to right themselves by abolishing the forms to which they are accustomed. But when a long train of abuses and usurpations, pursuing invariably the same Object evinces a design to reduce them under absolute Despotism, it is their right, it is their duty, to throw off such Government, and to provide new Guards for their future security. —Such has been the patient sufferance of these Colonies; and such is now the necessity which constrains them to alter their former Systems of Government. The history of the present King of Great Britain [George III] is a history of repeated injuries and usurpations, all having in direct object the establishment of an absolute Tyranny over these States. To prove this, let Facts be submitted to a candid world.

He has refused his Assent to Laws, the most wholesome and necessary for the public good.

He has forbidden his Governors to pass Laws of immediate and pressing importance, unless suspended in their operation till his Assent should be obtained; and when so suspended, he has utterly neglected to attend to them.

He has refused to pass other Laws for the accommodation of large districts of people, unless those people would relinquish the right of Representation in the Legislature, a right inestimable to them and formidable to tyrants only.

He has called together legislative bodies at places unusual, uncomfortable, and distant from the depository of their public Records, for the sole purpose of fatiguing them into compliance with his measures.

He has dissolved Representative Houses repeatedly, for opposing with manly firmness his invasions on the rights of the people.

He has refused for a long time, after such dissolutions, to cause others to be elected; whereby the Legislative powers, incapable of Annihilation, have returned to the People at large for their exercise; the State remaining in the mean time exposed to all the dangers of invasion from without, and convulsions within.

He has endeavoured to prevent the population of these States; for that purpose obstructing the Laws for Naturalization of Foreigners; refusing to pass others to encourage their migrations hither, and raising the conditions of new Appropriations of Lands.

He has obstructed the Administration of Justice, by refusing his Assent to Laws for establishing Judiciary powers.

He has made Judges dependent on his Will alone, for the tenure of their offices, and the amount and payment of their salaries.

He has erected a multitude of New Offices, and sent hither swarms of Officers to harass our people, and eat out their substance.

He has kept among us, in times of peace, Standing Armies without the consent of our legislatures.

He has affected to render the Military independent of and superior to the Civil power.

He has combined with others to subject us to a jurisdiction foreign to our constitution and unacknowledged by our laws; giving his Assent to their Acts of pretended Legislation:

For Quartering large bodies of armed troops among us:

For protecting them, by a mock Trial, from punishment for any Murders which they should commit on the Inhabitants of these States:

For cutting off our Trade with all parts of the world:

For imposing Taxes on us without our Consent:

For depriving us, in many cases, of the benefits of Trial by Jury:

For transporting us beyond Seas to be tried for pretended offences:

For abolishing the free System of English Laws in a neighbouring Province, establishing therein an Arbitrary government, and enlarging its Boundaries so as to render it at once an example and fit instrument for introducing the same absolute rule into these Colonies:

For taking away our Charters, abolishing our most valuable Laws, and altering fundamentally the Forms of our Governments:

For suspending our own Legislatures, and declaring themselves invested with power to legislate for us in all cases whatsoever.

He has abdicated Government here, by declaring us out of his Protection and waging War against us.

He has plundered our seas, ravaged our Coasts, burnt our towns, and destroyed the lives of our people.

He is at this time transporting large Armies of foreign Mercenaries to compleat the works of death, desolation and tyranny, already begun with circumstances of Cruelty and perfidy scarcely paralleled in the most barbarous ages, and totally unworthy the Head of a civilized nation.

He has constrained our fellow Citizens taken Captive on the high Seas to bear Arms against their Country, to become the executioners of their friends and Brethren, or to fall themselves by their Hands.

He has excited domestic insurrections amongst us, and has endeavoured to bring on the inhabitants of our frontiers, the merciless Indian Savages, whose known rule of warfare, is an undistinguished destruction of all ages, sexes and conditions.

In every stage of these Oppressions We have Petitioned for Redress in the most humble terms: Our repeated Petitions have been answered only by repeated injury. A Prince whose character is thus marked by every act which may define a Tyrant, is unfit to be the ruler of a free people.

Nor have We been wanting in attentions to our British brethren. We have warned them from time to time of attempts by their legislature to extend an unwarrantable jurisdiction over us. We have reminded them of the circumstances of our emigration and settlement here. We have appealed to their native justice and magnanimity, and we have conjured them by the ties of our common kindred to disavow these usurpations, which, would inevitably interrupt our connections and correspondence. They too have been deaf to the voice of justice and of consanguinity. We must, therefore, acquiesce in the necessity, which denounces our Separation, and hold them, as we hold the rest of mankind, Enemies in War, in Peace Friends.

We, therefore, the Representatives of the united States of America, in General Congress, Assembled, appealing to the Supreme Judge of the world for the rectitude of our intentions, do, in the Name, and by the Authority of the good People of these Colonies, solemnly publish and declare, That these United Colonies are, and of Right ought to be Free and Independent States; that they are Absolved from all Allegiance to the British Crown, and that all political connection between them and the State of Great Britain, is and ought to be totally dissolved; and that as Free and Independent States, they have full Power to levy War, conclude Peace, contract Alliances, establish Commerce, and to do all other Acts and Things which Independent States may of right do. And for the support of this Declaration, with a firm reliance on the protection of divine Providence, we mutually pledge to each other our Lives, our Fortunes and our sacred Honor.