What to think of Obama’s housing plan

by  Tyler Cowen in

The ever-worthy Mark Thoma rounds up reactions and analyses, including some critical remarks from CalculatedRisk and some praise from Felix Salmon.  Willem Buiter is negative (worth a read).  Simon Johnson says it's not enough.  WSJ surveys a few reactions as well.  I'll add some observations:

1. Housing prices ought to be lower, and as quickly as possible.  So aiding homeowners cannot be justified on the grounds of propping up prices, which is difficult to accomplish anyway.  Such aid has to be justified in some other way.  The main argument is that our ex post procedures for foreclosures are not what we would have chosen ex ante, had we known that such a severe housing and financial crisis could be possible.  That opens up some room for beneficial intervention, but a good plan it still hard to pull off.

2. When it comes to refinancing the Fannie and Freddie loans, and expanding those agencies, how many foreclosures will this avoid?  We should be reducing the size of the mortgage agencies rather than putting another $200 billion into them.   

3. We should not be helping people stay in their homes if their mortgage payments are at 43 percent of their income.  (The bill requires banks, in such cases, to lower interest rates until monthly payments are at 38 percent of income.  The government then steps in to lower payments to 31 percent of income.)  I don't feel moral outrage (although it is morally outrageous), I just don't think it is a good use of money.  I also wonder how it works when your income is quite variable year to year.  Are they sure there is no way to game this?

It will in the short run prevent some (enough to matter?) foreclosures.  But it won't keep up the long-term price of homes or prevent eventual foreclosures when the home has negative equity.  It adjusts interest rates on the payments, not principal on the loans (thank goodness).

Most of all it is a bad precedent which we will live to regret.  It is a significant move away from the idea of commercial decisions based on contract. 

One source,
by the way, suggests that lenders will have veto rights over these
"renegotiations" by choosing to foreclose instead of accepting the lower payments.  But foreclosure is quite costly for the bank, so I don't feel so much better.

By the way, aren't we trying to help the banks?

4. Sellers receive various bonuses for modifying eligible mortgage loans.  This is ideally a Pareto improvement if more of these contracts could be modified than is currently the case.  My doubt is whether the subsidy will affect many modification decisions; so far I don't see that lenders are putting a lot of effort into renegotiations.  Here is a good article on when modifications work and when they do not.  I doubt if an extra 1k will make much difference.

5. Guidelines for modifying eligible mortgage loans are established.  Ideally this could give more scope to the Coase theorem, but see my reservations under #4.

Felix Salmon, who likes the plan, nonetheless offered up a scary bit:

But really nobody has a clue how much it will cost: that's entirely
dependent on whether or not the plan succeeds in arresting the fall of
house prices.

The bottom line: #3 is a deal-killer for me.  Just say no, and you don't even need a moral hazard argument (they are overrated, anyway) to see why this is troubling.  I'd like to see the plan's proponents predict how many foreclosures it will forestall and be willing to take their lumps if they are wrong.

How $8 a week can best boost the economy

by  Tyler Cowen in

Here are answers from many economists, here was mine:

In my view, fixing the banking sector is more important than getting
the stimulus right. So if you can afford to lose the money, go to a
large bank (more likely to be insolvent), find their most overpriced
service, and buy as much of it as you can. That way you are doing your
part to recapitalize our banking system.

If you’re stuck for ideas, just keep on using ATM machines, owned by
other banks, so you can pay large fees to take out small sums of money
from your checking account. When you need to, take all of your
withdrawals and deposit them back in the account once again and start
all over with the process.

The economic collapse of Japan and the Phoenix Suns

by  Tyler Cowen in

Most of you have heard about the Japanese gdp report; it implies an annualized rate of decline of almost 13 percent.  OK, they depend on exports but why is it so dire there? 

You also may have heard that the Phoenix Suns have been trying to unload All-Star players Amare Stoudemire and Shaquille O'Neal.  They are not hoping to get equal talent in return but rather they need to lower their payroll.  (Why pay $75 million a year for a fringe playoff club?)  And the New Orleans Hornets, former contenders, traded center Tyson Chandler simply to unload his salary.

I think of the Suns or Hornets as similar to a highly leveraged institution.  I don't know the debt level of their corporate structure but that is not the point.  The Suns have been spending lots in recent years toward the goal of ever-rising prices for season tickets and corporate boxes.  Does that strategy sound familiar?  If the future price hikes don't come on the main asset, they can't afford their obligations and so they will try to shed illiquid and hard-to-value assets into an unwilling market.  Sound familiar?  (As an aside, I wonder if barter is one way to jump start trading in illiquid financial assets.)

Does this sound familiar?:

"You've got a market loaded with motivated sellers and only a very
small group of buyers," one NBA executive told ESPN.com. "It's really
ugly. Owners are scared to death right now."

Institutions can have receipts and obligations which require growing revenues even if they don't have much explicit debt on their books.  I think also of the artistic non-profits which invested in expensive facilities, in the hope of ever-rising donations from their investment banker patrons.  Many other parts of the economy may be "leveraged" in this fashion, with or without high levels of debt.

Japan, of course, has high levels of government debt and also a demographic problem.  I wonder whether their future-oriented export strategies make them even more leveraged, de facto, in a manner resembling the (former) business strategy of the Phoenix Suns.

One lesson of this crisis will be how deep the concept of leverage extends.  That's another reason why this is fundamentally a crisis of sectoral shifts.

Targeted? Infrastructure Spending by Unemployment Rate

by  Alex Tabarrok in

The ProPublica site maps/graphs infrastructure spending per unemployed worker against the unemployment rate but in effect that puts the number of unemployed people on both sides of the regression/graph and if there is any measurement error this can result in bias.  The graph with spending per unemployed worker is similar to the above but with a slightly more negative slope.

Our deflationary recovery from the Great Depression?

by  Tyler Cowen in

Frank Steindl reports:

During the
depression, both output and prices fell, as was their usual behavior in
depressions. The bottom of the depression was May 1938, one year after it
began. Thereafter, output began growing quite robustly, rising 58 percent by
August 1940. Prices, however, continued to fall, for over two years. Figure 8
shows the depression and revival experience from May 1937 through August 1940,
the month in which prices last fell. The two shaded areas are the year-long
depression and the price "spike" in September 1939. Of interest is that the shock
of the war that spurred the price jump did not induce expectations of further
price rises. Prices continued to fall for another year, through August 1940.

Here are some graphs (see Figure 8) and more.  Steindl concludes:

The economic phenomenon that was driving the recovery was probably increasing
productivity.

In his view that also explains why it was a "jobless recovery" in the 1938-1940 period, namely that the demand for labor did not need to rise so much.  It also has been argued that the technological innovations of the Great Depression were labor-saving ones and that 1930s unemployment cannot be understood apart from this fact.

I do not mean to present these opinions as definitive (by the way here is more by Steindl); I hope to read more in the area and report back to you.  Most generally, I would like to stress how poorly we understand the economics of the 1930s and 40s.

Free Market Bank Nationalization

by  Alex Tabarrok in

I believe that bank nationalization is now very likely.  It may even be desirable.  The term nationalization, however, clouds judgment on both sides of the debate.  It's better to think of what we want to do as bankruptcy.  Many of the major banks are insolvent.  When the liabilities of an ordinary firm exceed its assets the firm enters one of a variety of types of bankruptcy procedure during which management is often removed, the firm is sold or reorganized and liability holders take ownership or are paid off at a discount.  Notice that we do not call a bankruptcy procedure, nationalization, even though it typically occurs under the auspices of a government employed judge. 

When it comes to the banks the issue is more complicated than with an ordinary firm because the major liability holders are depositors whom the government has guaranteed.  As a result, the ultimate liability holder is the government.  But now, as a thought experiment, imagine that we had private deposit insurance.  What would a private insurance firm do in this situation?  Would it pander to the current bank management and carry the zombie banks on its books, hoping and waiting for a miracle?  Or would it step in, remove current management, pay off the depositors, reorganize and then sell the banks to recoup its losses?  I believe a private insurer would follow the second path, the fact that the government is not yet ready to do this indicates how powerful bankers are in Washington.  Thus, given deposit insurance the procedure most consistent with free market principles is bankruptcy, preferably a speed bankruptcy procedure under the auspices of the FDIC which has significant expertise in this field.

A speed bankruptcy;  1) punishes current management reducing moral hazard, 2) will be less politicized if done under the auspices of the FDIC than if done piecemeal with congressional involvement and 3) will get the banks working again as soon as possible.

Notice how the term nationalization confuses the issue.  First, it suggests government ownership of the banks which would indeed be a disaster.  People in favor of free markets will rightly want to avoid any such outcome but ironically it's the current situation of "wait and see," and "protect the banker," which is likely to lead to an anemic recovery and eventual government ownership.  Second, it confuses people on the left who think that nationalization is a way to insure that taxpayers get something on the upside.  That idea is a joke – there is no upside.  Taxpayers are going to have to pay through the nose but the critical point is that the taxpayers must pay the depositors whom they have guaranteed not the banks.

The debate so far has been framed between a "bailout" and "nationalization." But the public rightly sees the bailout as a way to protect bankers and thus we get pressure for government ownership, which has already happened in part through government control over banker wages.  Bankruptcy in contrast is a normal free market procedure, it emphasizes that the firm has failed and current management should be removed.  Framing the issue in this way, for example, makes it clear that only the depositors should be protected and under reorganization there should be no control over wages on future management (wages are going to have to be high to get anyone to take on the task).  Finally the idea of bankruptcy makes it clear that the goal is to get banks solvent, under new management, and back under private control as quickly as possible.

Addendum: Garett Jones nicely lays out the case for doing the normal thing.

Mexico fact of the day

by  Tyler Cowen in

This is what happens when your country doesn't have a sufficiently well-developed middle class:

The country’s Federal Competition Commission is looking into Mr. [Carlos] Slim’s
companies. But the agency is outspent and outmanned by Mr. Slim. His
companies “spend more on a single case than our entire annual budget,”
said an official at the commission, who insisted on anonymity because
he was not authorized to speak publicly about agency matters.

Here is the full story.

What if all the smart people are in one party?

by  Tyler Cowen in

Ross Douthat thinks through liberaltarianism and the new spatial equilibrium has him worried:

What could happen, instead, is a bigger-tent liberalism – somewhat
chastened, perhaps, by some big-government failures in the Obama era –
that makes libertarian intellectuals feel welcome, engages them in
conversations about smarter regulations and more efficient tax policy,
and generally woos them away from their culturally-dissonant alliance
with people who attend megachurches and Sarah Palin rallies. This would
make for a smarter left-of-center in the short run, but I think in the
long run it would be pernicious. It would further the Democratic
Party's transformation into a closed circle of brainy meritocrats, and
push the Republican Party in a yet more anti-intellectual direction.
And it would produce an elite consensus more impervious to structural
critiques, and a right-wing populism more incapable of providing them.
The Democratic Party would hold power more often, and become more
sclerotic as a result; the GOP would take office less often, and behave
more recklessly on those rare occasions when it did manage to seize the
reins of state.

Put aside your views on the R, D, and L people and think in terms of an abstract argument.  There is an optimal distribution of smart people across political parties and it need not be all in the same party.  For one thing, the marginal product of a smart person in a stupid party might be very high.  For another, being in power all the time may corrupt the thinking processes of smart people and we want to have some smart people insulated from this corruption.

So should a smart person attempt to move the world toward an optimal distribution of smart people across parties?  Or should a smart person join the party he or she most wishes to belong to?  Should a smart person advise others according to the same standard she uses to regulate herself?  In general does the world "cluster" smart people too much or too little?

You'll notice that many of these questions apply to fun parties and not just political parties. 

The excellent Arnold Kling adds insightful comment.