Finally, someone has spoken the unspeakable on the foreclosure crisis. In today's WSJ there's an op-ed titled, "Why Be a Nation of Mortgage Slaves?" (subscription req'd).
The politicians have been spouting off for months on this--how it's horrible that homeowners have been the victims of the mortgage crisis and how they need a bailout or foreclosure moratorium to stay in their homes. These pols are blowing smoke. Nobody, I mean nobody, in their right mind wants to be forced to pay an oversized mortgage for an undersized house for the next 30 years. The question is who takes the haircut on these white elephants? The homeowner, the lender, the investor, or the taxpayer? Morally, I think the taxpayer should be absolutely last on this dance card.
I wrote on this before in my blog on Foreclosure Myths. Hopefully we can move the public conversation towards some kind of economic logic. If we want to make houses affordable, all we need to do is stop subsidizing them and let prices fall to a natural level based on comparable rents. We've got a long way to go.
Saturday, January 31, 2009
Friday, January 16, 2009
Mass Confusion in Washington
Perhaps Washington's policy confusion will take a brief 2-day holiday next week, but then it's back to the hair of the dog that bit us. The confusion seems to be about what to do about the economy. All the talk is about which "stimulus" plan will give the most bang for the buck. Should we spend big on infrastructure? Pump up the private credit markets? Save homeowners? Increase social insurance payments? Increase tax cuts to business? Subsidize "green" energy? Bail out failing industries? Drop dollars from helicopters? All of the above? (If you're expecting our new president to magically come up with the right answers, you're living on a whim and a prayer.)
These folks seem to be missing the lesson the market has taken great pains to teach us. Almost all these options focus on pumping up collapsed demand - yet the demand collapsed because it was running on hot air. The real problem is that quibbling over whether a dollar of infrastructure spending or unemployment insurance yields more than a dollar of tax cuts is like rearranging the deck chairs on the Titanic. Now the Fed is even considering targeting a positive rate of inflation, so people can be assured that their balance sheets will gradually strengthen as their real wealth slowly vanishes.
Instead we should be focusing on how to get people back to acting on their risk-taking animal spirits. (People, mind you, private individuals--not government or its servants.)
We need to reexamine some simple economic truths:
1. Governments don't create jobs, private entrepreneurs and businesses do.
2. Governments don't create industries either, risk-taking investors and businesses do.
3. Inflating demand that is not built upon increased productivity and production is a form of illusion. Giving people money they can never pay back to buy stuff they don't need isn't going to fill anyone's coffers with profits, only losses.
4. National economies grow when people work more, produce more, save, consume and invest. Government can't accelerate this train by pumping up one or another of these activities.
5. The best any government can do is set up the rules of the game and the playing field so private citizens can produce wealth. Then get out of the way.
We can see that very few of the policy proposals square with these fundamental economic truths. The problem we face now is that we've allowed behavioral incentives to become distorted to favor some actors over others. We bred excess and then fed it. Now government is leaving its big paw prints over everything. This only counteracts any positive incentives that may arise from this financial correction.
Asset prices, especially housing, have been totally distorted by the vicissitudes of policy. Public pronouncements of what prices "should" be can only add to the uncertainty. Some corporate and private balance sheets are flush with cash, but as long as the distortion and uncertainty goes on, the longer they will stand on the sidelines and wait. The bigger danger of the housing market is that it will take years to reach economically rational prices, not that it will get oversold.
We should be providing clear positive incentives to all economic actors that directly bear upon their risk-return calculations and reduce their perceptions of uncertainty. Naturally, I favor tax cuts targeted to productive effort. No subsidies, bail outs or guarantees on outcomes. And it would be reassuring to know a dollar will still be worth a dollar next year.
As our policy-makers dither over different proposals to put Humpty back together again I hope they will focus on answering one question: will this policy encourage actors to take prudent risks without engendering moral hazard?
If the answer is not a resounding yes, let's skip it and leave well enough alone.
These folks seem to be missing the lesson the market has taken great pains to teach us. Almost all these options focus on pumping up collapsed demand - yet the demand collapsed because it was running on hot air. The real problem is that quibbling over whether a dollar of infrastructure spending or unemployment insurance yields more than a dollar of tax cuts is like rearranging the deck chairs on the Titanic. Now the Fed is even considering targeting a positive rate of inflation, so people can be assured that their balance sheets will gradually strengthen as their real wealth slowly vanishes.
Instead we should be focusing on how to get people back to acting on their risk-taking animal spirits. (People, mind you, private individuals--not government or its servants.)
We need to reexamine some simple economic truths:
1. Governments don't create jobs, private entrepreneurs and businesses do.
2. Governments don't create industries either, risk-taking investors and businesses do.
3. Inflating demand that is not built upon increased productivity and production is a form of illusion. Giving people money they can never pay back to buy stuff they don't need isn't going to fill anyone's coffers with profits, only losses.
4. National economies grow when people work more, produce more, save, consume and invest. Government can't accelerate this train by pumping up one or another of these activities.
5. The best any government can do is set up the rules of the game and the playing field so private citizens can produce wealth. Then get out of the way.
We can see that very few of the policy proposals square with these fundamental economic truths. The problem we face now is that we've allowed behavioral incentives to become distorted to favor some actors over others. We bred excess and then fed it. Now government is leaving its big paw prints over everything. This only counteracts any positive incentives that may arise from this financial correction.
Asset prices, especially housing, have been totally distorted by the vicissitudes of policy. Public pronouncements of what prices "should" be can only add to the uncertainty. Some corporate and private balance sheets are flush with cash, but as long as the distortion and uncertainty goes on, the longer they will stand on the sidelines and wait. The bigger danger of the housing market is that it will take years to reach economically rational prices, not that it will get oversold.
We should be providing clear positive incentives to all economic actors that directly bear upon their risk-return calculations and reduce their perceptions of uncertainty. Naturally, I favor tax cuts targeted to productive effort. No subsidies, bail outs or guarantees on outcomes. And it would be reassuring to know a dollar will still be worth a dollar next year.
As our policy-makers dither over different proposals to put Humpty back together again I hope they will focus on answering one question: will this policy encourage actors to take prudent risks without engendering moral hazard?
If the answer is not a resounding yes, let's skip it and leave well enough alone.
Wednesday, January 7, 2009
Comprehensive Election Analysis
Jay Cost and Sean Trende of RealClearPolitics posted the first installment of their 2008 election analysis today. You can find it here and it's pretty accurate in its interpretation. Their manipulation of the data cuts through most of the nonsense promoted by the media.
In short, there is still a significant urban-rural red-blue divide and Obama benefited mostly from the racial vote, both black and white. Thus, there is probably no real ideological shift within the electorate and Obama's fate will probably rest on the economy and any national security surprises. This is consistent with my own findings.
In short, there is still a significant urban-rural red-blue divide and Obama benefited mostly from the racial vote, both black and white. Thus, there is probably no real ideological shift within the electorate and Obama's fate will probably rest on the economy and any national security surprises. This is consistent with my own findings.
Friday, January 2, 2009
Party and Election Analysis
Excellent analysis in RCP on the current state of party politics in the US by David Paul Kuhn: "Democrats' Year: Less Change Than Chance." This is as close to the reality as I've seen as Kuhn points out the strengths and weaknesses of the Obama phenomenon.
Monday, December 22, 2008
Foreclosure Myths
Barron's recently published their proposed plan to solve the housing financial crisis: "Mortgage Relief for Everyone." Here is the four step plan summarized:
I've been reading a lot of this kind of nonsense in the popular press but was a little flabbergasted such a proposal was coming from a free market publication and was compelled to reply. They actually printed the letter below:
This kind of fuzzy thinking can only be cleared up if we burst a few myths about foreclosures. Let's say someone bought a house at $600K with 5% down plus closing costs and financed the rest with a $570K loan. After a 25% decline in housing prices that house is now worth $450K and the owner is looking at a $150K loss of which his/her equity is only $30K. Does this person want to avoid a foreclosure? I think not. If fact, they're begging to push that $120K loss off on somebody else - i.e., the banks and investors who underwrote the mortgage-backed securities - and walk away.
These investors and lenders in turn would also like to push the loss off on somebody else - say, back to the original owner or the taxpayer. This argument about saving peoples' houses is really an argument on how to stick them with a really bad housing investment for the life of their mortgage. This may sound like just deserts, but how are these buyers, many of whom came from the lowest income brackets, going to save for the future when an overpriced house sucks all their disposable income down a black hole? They are going to be even more dependent on government benefits in the future. This was not the way to promote "an ownership society." The political rhetoric about "helping poor folks stay in their houses" is no benevolent altruism. The better route would be to let people foreclose and then manage the losses across the financing chain. The sooner housing falls to a realistic level, the better off our economy going forward will be. And inflation is definitely the stupidest route out of this cul-de-sac.
In the next housing phase, where most homes will be looking like a capital loss rather than a gain, we need to return prices to an economically rational level ASAP. Housing is paid for out of incomes and rents. There is a reasonable multiple of income, usually roughly 4x to borrow against for residential home purchases. There is also a reasonable multiple of gross rents that imply a fair housing value. Living in a world where there is no rational connection between these fundamental cash flow values and the price of the underlying real estate means we will be living with a dysfunctional market for a long time to come. There's only one thing worse in real estate than owning a house you don't want - having it own you.
I've been reading a lot of this kind of nonsense in the popular press but was a little flabbergasted such a proposal was coming from a free market publication and was compelled to reply. They actually printed the letter below:
Dear Editors:
I must respectfully disagree with all four points of your plan. First, low, subsidized financing is what turned real estate investment into a financial asset akin to an option on a bond. Low mortgage rates recapitalized housing based on the debt service required to buy overvalued housing assets on the margin. The temptation of easy financing caused buyers to view housing as a sure thing with quick turnover. But all one-sided gambles soon end and now we’re saddled with a severe balance sheet problem where incomes and rents are insufficient to service outsized mortgages.
By reducing lending rates your plan merely addresses the balance sheet insolvency problem by artificially inflating the servicing of mortgage debt. This is like a little hair-of-the-dog to cure a hangover. But in the case of an asset bubble, this can only prolong the pain because your plan merely seeks to maintain these overvalued assets, while a functioning housing market going forward needs to correct them. Equity returns on overpriced housing will continue to be negative and buyers will choose to put their funds elsewhere, if they’re at all sensitive to yield. I, for one, do not want my most important asset to have a negative return for the next 5-10 years and I certainly wouldn’t borrow money at any rate to buy such overvalued assets.
It’s necessary to return housing prices to some rational level consistent with personal incomes and implicit rents. It’s time to manage the losses, not deny them. The only other option is to inflate incomes until the real value of housing equals the depreciated nominal value of mortgage debt. But this comes at the cost of all other investment alternatives, especially savings. It would also sacrifice the credibility of the dollar – an economic risk that may be incalculable.
This kind of fuzzy thinking can only be cleared up if we burst a few myths about foreclosures. Let's say someone bought a house at $600K with 5% down plus closing costs and financed the rest with a $570K loan. After a 25% decline in housing prices that house is now worth $450K and the owner is looking at a $150K loss of which his/her equity is only $30K. Does this person want to avoid a foreclosure? I think not. If fact, they're begging to push that $120K loss off on somebody else - i.e., the banks and investors who underwrote the mortgage-backed securities - and walk away.
These investors and lenders in turn would also like to push the loss off on somebody else - say, back to the original owner or the taxpayer. This argument about saving peoples' houses is really an argument on how to stick them with a really bad housing investment for the life of their mortgage. This may sound like just deserts, but how are these buyers, many of whom came from the lowest income brackets, going to save for the future when an overpriced house sucks all their disposable income down a black hole? They are going to be even more dependent on government benefits in the future. This was not the way to promote "an ownership society." The political rhetoric about "helping poor folks stay in their houses" is no benevolent altruism. The better route would be to let people foreclose and then manage the losses across the financing chain. The sooner housing falls to a realistic level, the better off our economy going forward will be. And inflation is definitely the stupidest route out of this cul-de-sac.
In the next housing phase, where most homes will be looking like a capital loss rather than a gain, we need to return prices to an economically rational level ASAP. Housing is paid for out of incomes and rents. There is a reasonable multiple of income, usually roughly 4x to borrow against for residential home purchases. There is also a reasonable multiple of gross rents that imply a fair housing value. Living in a world where there is no rational connection between these fundamental cash flow values and the price of the underlying real estate means we will be living with a dysfunctional market for a long time to come. There's only one thing worse in real estate than owning a house you don't want - having it own you.
Tuesday, December 2, 2008
Why Blue Needs Red (and Vice-Versa)
Pundits and casual observers have come up with all sorts of ‘theories’ to explain the red-blue divide in our politics. But the voting evidence tells a different story than the exit polls and media narratives. There are many cross-cutting divisions in our politics, but the red-blue divide is best explained by three coinciding factors: lifestyle, party and ideology. Since the 1960s the lifestyle differences between urban and rural have become aligned with liberal and conservative ideologies. This alignment has then been amplified by partisan electoral strategies and governing platforms that target these divisions. The result is that rural communities have become more conservative and Republican while urban communities have become more liberal and Democrat. Suburbs are now the tipping point, or battleground, if you prefer. Both election campaigns were well aware of this and Obama had considerably more resources to campaign in the suburbs nation-wide than did McCain. Money and the economic crisis is what delivered the election to Senator Obama.
So, will it be a battle that’s always going to be fought to a win-lose rather than win-win result? Last time country rubes, next time city slickers? The majority of the voters voiced their displeasure with this distraction and both candidates did their best to campaign on their bipartisan credentials.
But here’s the rub. The split between rural and urban values differs across many political issues and policies. These differences are eminently legitimate and beneficial to our national identity. However, our mainstream media and most of our commercial culture is heavily biased in one direction. These media industries are based in urban America and tend to reflect urban values. This is not necessarily malicious, but the reason we have few conservative reporters, TV news analysts or Hollywood script writers is because these professionals have predominantly come to reflect their urban liberal preferences.
“So,” liberals might ask, “what’s the problem?” The problem is that broad swaths of the country are founded on more traditional, conservative values. These Americans may enjoy entertainment fare from the city, but they have no desire to embrace the same values and lifestyles. Many of these traditional values are also shared by urban and suburban dwellers, but the small towns of America provide the roots from which American culture spreads its many diverse branches. Rural areas also offer a respite from the rat race, the impersonal and stress of urban living. They provide the necessary link to nature, our neighbors, and the land.
I would argue these traditional values provide an important touchstone for our national culture that promotes the diversity and colorful experimentation that goes on in the more fluid, progressive, urban environment. Americans are not really black-and-white conservative or liberal – they are tolerant and traditional. Our liberal ideology emphasizes the tolerant while our conservative ideology emphasizes the traditional. If either of these were to be snuffed out I'm sure we would be poorer in soul and spirit for it.
So, will it be a battle that’s always going to be fought to a win-lose rather than win-win result? Last time country rubes, next time city slickers? The majority of the voters voiced their displeasure with this distraction and both candidates did their best to campaign on their bipartisan credentials.
But here’s the rub. The split between rural and urban values differs across many political issues and policies. These differences are eminently legitimate and beneficial to our national identity. However, our mainstream media and most of our commercial culture is heavily biased in one direction. These media industries are based in urban America and tend to reflect urban values. This is not necessarily malicious, but the reason we have few conservative reporters, TV news analysts or Hollywood script writers is because these professionals have predominantly come to reflect their urban liberal preferences.
“So,” liberals might ask, “what’s the problem?” The problem is that broad swaths of the country are founded on more traditional, conservative values. These Americans may enjoy entertainment fare from the city, but they have no desire to embrace the same values and lifestyles. Many of these traditional values are also shared by urban and suburban dwellers, but the small towns of America provide the roots from which American culture spreads its many diverse branches. Rural areas also offer a respite from the rat race, the impersonal and stress of urban living. They provide the necessary link to nature, our neighbors, and the land.
I would argue these traditional values provide an important touchstone for our national culture that promotes the diversity and colorful experimentation that goes on in the more fluid, progressive, urban environment. Americans are not really black-and-white conservative or liberal – they are tolerant and traditional. Our liberal ideology emphasizes the tolerant while our conservative ideology emphasizes the traditional. If either of these were to be snuffed out I'm sure we would be poorer in soul and spirit for it.
Wednesday, November 19, 2008
Big Business + Big Labor + Big Government = Universal Health Care?
If history is any guide, Rahm Emanuel has revealed the Obama administration’s strategy to cajole big business into supporting universal health care as the foundation of a New New Deal (See the WSJ: “Emanuel Sets a Challenge,” Nov. 19). The strategy implies a radical expansion of the Federal government’s commitment to social insurance mandates. National unemployment insurance and public pensions, the harbingers (or Trojan horse) of the social welfare state, were passed with similar political strategies in almost every developed democracy during the crises at the end of the 19th century and in the 1930s.
Today, corporate CEOs’ first preference is to remove rising health care costs from their income statements and the attendant liabilities from their balance sheets. Their second preference is to have somebody else pony up to help pay for it. The Democrats’ gambit is to close off the first option and leave the second as the only alternative to doing nothing. Obviously the political architects believe the triumvirate of big business, big labor and big government can steamroll universal health care over special interest opposition. This at a time when the electorate has expressed the lowest approval ratings in history for large public institutions – a level of mistrust that applies to both parties’ stewardship.
Of course, these special interests include individual taxpayers, consumers, and anyone unaffiliated with the big three, which means small business, entrepreneurs and the self-employed--who’ll all get flattened in this scenario. Every taxpayer will be subsidizing the inefficient provision of corporate and public health care and we’ll be told it’s for our own good. The only possible consequence of mandates is the loss of consumer choice and control needed to contain costs. This makes little sense in an expanding world market for private health care. Costs are best reduced by maximizing consumer choice and providing incentives to economize all around. Social insurance should only play a limited role in cases of catastrophic illness or accident. It looks like it’s time to pay attention to what change in Washington will really mean.
Today, corporate CEOs’ first preference is to remove rising health care costs from their income statements and the attendant liabilities from their balance sheets. Their second preference is to have somebody else pony up to help pay for it. The Democrats’ gambit is to close off the first option and leave the second as the only alternative to doing nothing. Obviously the political architects believe the triumvirate of big business, big labor and big government can steamroll universal health care over special interest opposition. This at a time when the electorate has expressed the lowest approval ratings in history for large public institutions – a level of mistrust that applies to both parties’ stewardship.
Of course, these special interests include individual taxpayers, consumers, and anyone unaffiliated with the big three, which means small business, entrepreneurs and the self-employed--who’ll all get flattened in this scenario. Every taxpayer will be subsidizing the inefficient provision of corporate and public health care and we’ll be told it’s for our own good. The only possible consequence of mandates is the loss of consumer choice and control needed to contain costs. This makes little sense in an expanding world market for private health care. Costs are best reduced by maximizing consumer choice and providing incentives to economize all around. Social insurance should only play a limited role in cases of catastrophic illness or accident. It looks like it’s time to pay attention to what change in Washington will really mean.
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