Fear

by  Alex Tabarrok in

We have nothing to fear but fear itself, but
fear itself can be pretty scary.

…Fear is ruling the
financial markets. Billions of dollars have been lost in mortgage-related
investments. The Federal Reserve worked madly over the weekend to
engineer a takeover of Bear Stearns and avert a systemic meltdown. But
the big fear remains. How low will house prices go?

If prices continue to fall, mortgage defaults will move well beyond the
subprime sector. Trillions of dollars in losses for investors are not
impossible. But that doesn’t mean they are inevitable.

That’s me in today’s New York Times.  Believe it or not, my piece is one of the more optimistic pieces you are likely to read on the housing crisis.

I think that housing prices went beyond the fundamentals sometime around 2004 (and I said so in 2005, see here and also note my warning that prices could fall dramatically here).   But 2004 levels are still well above long run trend.  Thus my optimism stems from thinking that unlike Japan, our housing prices need not fall back to long run trend (see my piece for graphs).

But the problem is that we can overshoot the fundamentals going down as well as going up and the United States now faces two potentially
self-fulfilling prophecies.


If the financial markets can predict where and when house prices will
stabilize, then credit conditions can quickly return to normal, the
economy can expand and house prices will indeed stabilize.


But if the financial markets remain uncertain about when the decline in
house prices will end, then fear will tighten credit even further, which
would strangle the housing market and generate even more fear.

Unfortunately, I do not know what will push us into the right prophecy (but read my piece, that will help!)  Thus, I am more optimistic than Paul Krugman, who thinks that we may have slipped into the state where no prophecy can bring us back to a good equilibrium, but I’m not that much more optimistic.

Claims about Spanish banks

by  Tyler Cowen in

…perhaps the most important reason why the Spanish financial system is
unlikely to suffer a meltdown is the virtual absence of Special
Investment Vehicles (SIV) and conduits. These animals allow banks to
move mortgage-backed securities off their balance sheets, thus
obscuring the exposure of individual institutions and escaping capital
requirements.

There is much more here.  Note also that Spanish originators keep a share of each mortgage they securitize.  In case you didn’t know it, Spain too has had a bursting of its real estate bubble, although so far they have not had comparable troubles with their banks.

gdp vs. gdp per capita

by  Tyler Cowen in

Using growth in GDP per head rather than crude GDP growth reveals a strikingly different picture of other countries’ economic health. For example, Australian politicians often boast that their economy has had one of the fastest growth rates among the major developed nations–an average of 3.3% over the past five years. But Australia has also had one of the biggest increases in population; its GDP per head has grown no faster than Japan’s over this period. Likewise, Spain has been one of the euro area’s star performers in terms of GDP growth, but over the past three years output per person has grown more slowly than in Germany, which like Japan, has a shrinking population.

Some emerging economies also look less impressive when growth is compared on a per-person basis. One of the supposedly booming BRIC countries, Brazil, has seen its GDP per head increase by only 2.3% per year since 2003, barely any faster than Japan’s. Russia, by contrast, enjoyed annual average growth in GDP per head of 7.4% because the population is falling faster than in any other large country (by 0.5% a year). Indians love to boast that their economy’s growth rate has almost caught up with China’s, but its population is also expanding much faster. Over the past five years, the 10.2% average increase in China’s income per head dwarfed India’s 6.8% gain.

Here is more.  Of course it is wrong to think that one measure is necessarily better than the other.  And immigration and more births both raise absolute gdp though you may not view the gdp gains in each case as having the same moral status.  One simple adjustment that could be made is to subtract the income an immigrant would have earned, had he or she not moved to a new country.

My podcast on macro and monetary policy

by  Tyler Cowen in

It is with Russ Roberts and it covers the roots of our current crisis, why things are far more troublesome than most people expected (and that is the really tough question; real estate bubbles have burst before), why monetary policy matters at all, the tricky balancing act played by the Fed, why a gold standard isn’t the answer, and many other macroeconomic topics.  My core attitude, in case you don’t already know it, is that monetary policy is both an art and a science and there are no secret ways of getting it right, understood by only a few.  The podcast is here. 

Addendum: Arnold Kling summarizes.

Surely you all wondered the same

by  Tyler Cowen in

Not all investors are expected to be pleased with the deal. A
conference call with investors and analysts on Sunday night was broken
up when a Bear Stearns shareholder sought an explanation of why he
would be better off approving this transaction rather than seeing Bear
Stearns file for a Chapter 11 bankruptcy.

The JPMorgan executives
demurred, instead referring the investor to Bear Stearns executives for
an explanation. The shareholder declared that he would vote against the
deal.

Afterward, Mr. Cavanaugh said JPMorgan felt comfortable in
pulling the trigger despite the short due-diligence process. “We’ve
known Bear Stearns for a long time,” Mr. Cavanaugh said.

Vis-a-vis that last sentence, last year the stock price was $170, late Friday it was $30 a share, yesterday the deal was done at about $2.  Here is the story.  From published accounts, the nature and extent of the Fed and Treasury obligations is not yet clear.

Common Wealth: Economics for a Crowded Planet

by  Tyler Cowen in

That’s the new Jeff Sachs book.  It promotes resource pessimism, Nordic-style social democracy, foreign aid, and a fundamental rethinking of U.S. foreign policy.  Most of all it expresses a faith in global cooperation.  Sachs is very smart and, though I do not agree with him, there is often more to his views than his critics admit.  But my browsing of this book never gave me the feeling that I had access to the mind of Jeffrey Sachs.  It doesn’t even read like a popularization.  Imagine a smart and diligent but not insightful or self-reflective person doing a "color by numbers" version of what a Jeffrey Sachs book should read like.

Chicken

by  Tyler Cowen in

Suppose that Monday morning, Ben Bernanke is presented with a deal,
under which a buyer gets Bear assets on the cheap, Bear stockholders
get paid out, and the Fed (implicitly or explicitly) bears residual
risk. If the Fed doesn’t approve, executives say, Bear will file for
bankruptcy. Dr. Bernanke will then have an unappetizing choice. He can
say yes, and hope that there aren’t any more rumors out there about any
other firms. Or he can say no, and make it very clear that if Bear
Stearns files for bankruptcy despite the Fed’s continuing provision of
liquidity, he will do everything in his power to hold Bear executives
personally responsible for the crisis that results.

Who do you think has more bargaining power in this game?  The firm with the reputation for obnoxiousness and recklessness, or a charming, intelligent and indeed gentlemanly central banker?  We may know soon enough.  Here is more, and here, and don’t forget this.  Here is a news report, if you are interested in the background.

Update: Seems to be a deal…at about $2 a share.  Book value of about $80 a share. 

Cop in the Hood

by  Tyler Cowen in

Motivated primarily by a desire for court overtime pay, police officers want arrests on their own terms, ideally without victims, complaints, or unnecessary paperwork.  Young officers make more arrests than veteran officers.  These officers believe that making arrests is police work.  In my squad, the top three officers in arrest totals were three officers with the least experience.  An arrest-based culture can exist in a low-drug environment, but without a limitless supply of arrestable criminal offenders, an arrest-based culture cannot make a lot of arrests.  Neighborhoods, without public drug dealings will not produce a high number of arrests.

That is from Peter Moskos’s truly excellent Cop in the Hood: My Year Policing Baltimore’s Eastern District.  This is one of the two or three best conceptual analyses of "cops and robbers" I have read.  It is mandatory reading for all fans of The Wire and recommended for everyone else.

How many books should be facing out?

by  Tyler Cowen in

To boost sales, retailer Borders Group is taking a simple but radical approach, our colleague Jeff Trachtenberg reports in today’s Wall Street Journal.
Borders is increasing the number of books that it displays with the
cover facing out (rather than the spine facing out), even though this
shelf-space-eating approach will require cutting inventory at each
store up to 10%. Says one analyst: “Breakfast cereals are not stocked
end-of-box out. […] It’s a little bizarre that it’s taken booksellers
this long to realize that the point of self-service is to make the
product as tempting as possible.”

The link is here.  I understand the basic model as follows.  Superstores first invest in high inventory and a tony reputation.  You start thinking of them as "the place to go" for books, or in an earlier era, for music.  They then devote more and more of their space to non-book items.  The number of greeting cards and chocolates stocked by my Borders has risen steadily over time, as have the size of the coffee shops.  Having more books "face out" — at least they are books — is one of the lesser aspects of this more general problem.  It’s related to why most trendy restaurants peak in the first year and a half of their operation, followed by decline and then stagnation.  Once they have a high enough (and sticky enough) reputation, it is time to cash in and lower the quality of the product to the informed and more sophisticated buyers.

The N word

by  Tyler Cowen in

No, not that N word, the other N word.  Nationalize.  As in nationalize a financial institution here and there.

Do you know how Paul Krugman is following the TED spread as an indicator of current financial troubles?  I’ll be following how many times the N word pops up in Google News.  Right now the top mentions all concern other countries, of course including Northern Rock in Great Britain.  So far this is the closest I’ve found to hints of nationalization for the United States; in the blogosphere Nouriel Roubini is saying nationalization is better than bailouts.

The Swedes, of course, nationalized Nordbanken, their #2 bank at the time, in the early 1990s, during their financial crisis.  They also nationalized Gotabanken and supplied funds to several other institutions.  The belief at the time was that loan liquidation would have been even worse.  And since Nordbanken was on life support anyway, and the government had to limit systematic risk by paying off creditors anyway, why not just control the bank directly?  The bank was subsequently re-privatized.  You’ll find more background on the Swedish experience here.  Of course in these situations none of the options are pretty.  But keep in mind that the Fed (and ultimately, the taxpayer) is already residual claimant on the Bear Stearns deal and then read Mises on the dynamics of interventionism.

There are many things we do not do as well as the Swedes.  In any case, if use of the N word remains spotty or non-existent in the U.S., you’ll know that things are going OK, at least relative to what might have happened.

Addendum: Brad DeLong has much to add, including some policy recommendations.  Arnold Kling doesn’t agree.