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.

Where does hard-headedness end and nastiness begin?

I have been arguing with a friend of mine, someone whose work I admire and whom I like personally, about the election.  In one email, he wrote to me:

All this administration has done, in effect, is additionally regulate banks and businesses (in the middle of a deep recession) and transfer resources from high skill to low skill.  That's what the health care plan and the extension of unemployment benefits has done.

There are a few large presumptions here: that wealth is a function of skill, and that skill is the most important criterion for determining whether one "deserves" resources.   I have no doubt that there is a strong correlation between skill and wealth, but I also have no doubt that a regression where wealth is on the left hand side and skill is on the right would have a large residual.

But even if skill translated perfectly to wealth, I am uncomfortable with the idea that the unskilled are unworthy of having a decent standard of living, particularly in a country as rich as the United States.  I also think that income distribution data from OECD calls into serious question whether rewarding the "highly skilled" leads to better outcomes for the lower income parts of society.  Thus I recoil at the idea that extending unemployment insurance periods in times when there are far more job seekers than jobs is a good idea.

That said, the hard-headed aspects of economics do lead to important insights.  For example, when the country is at full-employment (or something like it), the duration of unemployment insurance should be limited, because we do want people to work.  Similarly, we should always make it better for people to work than to receive government assistance.  I could also go on about the evils of rent control, etc.

This is where I feel conflicted about my discipline on a regular basis.  So much of what we put out there strikes me as being on its face inhumane and arrogant.  Yet I would hate to see what policy would look like in our absence.

Sampling

If my friends were a representative sample of the US population, there will be 30 million people at the Rally to Restore Sanity. (Putting the subjunctive together with the future tense sure is awkward!).

The real reason why a foreclosure moratorium would be a bad idea

I was on Marketplace the other day debating Mike Konczal about whether a foreclosure moratorium  would be a good idea.  I took the no position for two reasons:

(1) A moratorium would slow down the eventual resolution of the housing crisis;

(2) A moratorium would add yet another level of uncertainty about the ability to foreclose going forward, which would discourage the private sector from returning to the mortgage market.  If lenders can't take away the houses of people who don't make their payments, they will not advance mortgage money in the first place.

But last night it occurred to me why I have such a visceral reaction to such things as moratoriums: they strip property rights without due process.  If a borrower agrees to repay a mortgage, and everything about the mortgage is legitimate, and the borrower ceases to make payments, the lender has a property right to take the house.

I am at times a card-carrying member of the ACLU, because I think the rule of law and due process should apply to everyone.  Many lenders have behaved badly and appear to still be behaving badly.  That doesn't mean that all of them should lose their well-defined rights--even temporarily.

Why to avoid motorcycle riding in India

Hannah in Bodh Gaya: the most dangerous thing you can do » North by Northwestern

I

saw someone die in the street last night.

During orientation, Robert explained the five Buddhist Precepts to us, and he explained why our experience and that of others would be better if we agreed to follow them during our time here. Then he said that if we broke one, we shouldn’t beat ourselves up, but that we should try not to do it again. When a few students were caught drinking and smoking on the roof, he said at lunch that he’d heard about it, and that if we had any intoxicants in our room we should go get them and flush them down the toilet. He didn’t say to go get them and bring them to him. He understands that he can’t make us do anything.

The only thing that he forbade expressly was riding motorcycles.

“Riding a motorcycle in India is the most dangerous thing you can do,” he said. “There is no trauma ward. If you get into an accident, everyone will stand and watch while you bleed to death in the street.

I saw the crowd before I saw the body. I was walking with a couple of French people I’d met the night before. They saw the crowd and didn’t wish to walk that way. One man told me it was OK for us to pass, so I went because otherwise I would be late to mediation. For just half a second I saw the man lying exactly on his back in a pool of blood with a thick stream of blood draped across his face and body. It could not have been more red. His motorcycle was behind him. I turned my head away and touched the wall next to me, but the image has not left my mind. This body was not like a body prepared for cremation in Varinassi. They were supposed to be dead. This man was still fresh. He should have been alive. At the moment I saw him, maybe he was alive.

I walked back the way I’d come and saw my fellow students coming toward me in rickshaws. I looked at them and said “there’s a dead man in the street.” I expected them to stop or something, but the rickshaws just went past. Only Wanda and Heidi got out. I didn’t want to walk alone, so I had to walk past the same place to catch up with them. The body was being carried up the hill on a woven stretcher, and I had to see the pool of blood mixed in the gravel and rainwater again as I walked past.

When we got to mediation we were having a group photo taken. We had to wear our Zen robes. I thought “I can’t figure out the strings on these robes, I just saw a dead man,” and “I can’t smile for this photo, there was so much blood,” and “I can’t get up for walking mediation, he was lying right on his back like he was in bed,” but I managed to do all those things anyway.

It was our final meditation session in the Japanese temple, so afterward one of the monks spoke to us. He told us that “Arigato” means more than thank you in Japanese. It means, these circumstances were difficult to come by, and we are so happy that you can be here. You are not just thanking the person you are speaking to, but you are thanking every circumstance that lead you to be together. He said we should all call or e-mail our families to say “arigato”. He said that it might confuse them, but he didn’t care. Maybe it’s wrong, but it’s true that seeing death like that makes you understand how rare it is that so many of the people you love are still healthy and fine. Arigato.

The Fannie-Freddie Problem is not as severe as the headlines would suggest

Page 10 of the FHFA report, gives forward expected losses under three scenarios.  The third is really awful--it assumes a further reduction in house prices by 1/4, which would be a lot.  But under the other two scenarios, the net cost to taxpayers (draws less dividends owed to Treasury) would be $6 to 19 billion.  This is real money, but hardly cataclysmic.  It does suggest that the vast majority of the losses are already behind us.