Author Archive
It Is Less Important Who Pays Taxes Than What Government Does With Them
Often when surveying the political landscape here in Washington, one can’t help but be struck by the feeling “is this the most important thing we have to discuss”? That was my reaction to today’s Politico story on party differences with extending the payroll tax cut. The difference, as Politico would have us believe, are that Democrats want millionaires to pay, while Republicans want government employees to bear the costs. It seems to be the case with whatever the issue is, who pays?
Quite simply, this debate between Republicans and Democrats over who should bear the costs of government is completely misplaced. We should be asking ourselves why the government has such a deep involvement in our lives in the first place.
If the government should not be involved in an activity, how is said activity any more just if its paid for by millionaires or the middle class. Would the fact that we have the largest prison population in the world somehow be more just if only more of the cost of it was borne by millionaires? Would having our failed drug war funded solely by millionaires turn it into a success? How about the U.S. playing world policeman? Would we be more loved around the world if our military was funded more by millionaires? Would we be viewed as honest brokers in the Middle East if our foreign aid was funded by millionaires? Is having children struck in failing public schools more just if those schools are funded by millionaires?
Here’s my offer to both my Democrat and Republican friends, you let me decide what the size and scope of government is going to be, and I am happy to let you decide upon “who pays”.
Consumer Finance Nominee Cordray to Get Floor Vote?
Rumor is that Richard Cordray might just get a vote on his nomination to head the new Consumer Finance Protection Bureau (CFPB), created by the Dodd-Frank Act. Full Senate vote could come as early as Wednesday.
Given that 44 Republican Senators have said they will oppose his nomination, cloture on the motion to proceed seems likely to fail, dooming the vote. But as Bloomberg makes clear, this vote isn’t about protecting consumers, it is about protecting President Obama’s job.
The President plans to use the vote to argue that Republicans are hacks for Wall Street, while he fights for the middle class. Of course he never mentions that the new agency does NOT even cover Wall Street, which remains under the Securities and Exchange Commission. And if he is being so tough on banks, then why is his Treasury Secretary Tim Geithner going around saying that having Cordray in place would be good for banks? Which exactly is it? But then the fact that Geithner is still Treasury Secretary offers plenty evidence on who is really the “front” for Wall Street.
The CFPB already has plenty of power to go after banks. What it lacks is expanded authority over non-banks. For some bizarre reason Geithner believes it was check-cashiers and payday lenders behind the financial crisis. But then such a belief goes a long way in explaining his failed performance as NY Fed President.
I’ve written elsewhere on the structural changes Republicans are asking for, which would add some transparency and accountability to the new agency. Republicans are right to fight for these changes, using the only leverage they have. So far Republicans have only focused on the agency itself, saying little about Cordray. Even if Republicans were successful getting their changes, they should still question Cordray. During his thankfully short political career, Cordray showed himself to be a reliable friend of the trial bar. His nomination exposes what the CFPB has been really about all along: lining the pockets of the trial bar.
Housing Will Be the Last to Recover
The New York Times’ Floyd Norris repeats the same old tired argument that if only we could get the housing market going, everything would be swell. Maybe that works if somehow you believe our objective is to get back to 2005.
Don’t get me wrong; 2005 felt great in terms of the economy. But it was a BUBBLE, driven by false and misplaced beliefs about housing prices (not to mention lots of easy credit). The result? We built more housing than we now need or want. Norris never gets around to explaining how exactly building more housing would solve our current problem of oversupply.
Norris’ solution? Yes, the same tired, old proposal of writing down mortgage debt. Again, nowhere does he explain how forgiving mortgage debt helps to clear the oversupply of housing—because it doesn’t. As I argued before, the notion that forced mortgage write-downs creates wealth, and hence increases spending, is false. But why let facts get in the way of a blind devotion to theft as a manner of creating wealth?
The solution is not to hope our housing market turns around (if you actually want to, try these). Counter to Norris’ bias against markets, letting prices fall and the market clear is the most workable path to fixing the housing market. The real solution to getting our economy moving is helping to transition resources out of housing and into other sectors of the economy, where they can be used to create real wealth and not simply to bid up house prices. I cannot envision a situation where we put more than half of the 2 million unemployed constructions workers back to work in residential construction any time soon. Ain’t going to happen.
I particularly find these positions most puzzling when they come from the Left. We’ve had a decade of stagnant wages. Why? Because we invested in running up asset (house) prices, rather than investing in capital (plant and equipment), which would have increased labor productivity and ultimately wages. Running up house prices does not increase wages or benefit the working class. It’s just a horrible form of regressive theft that benefits those with assets (houses) at the expense of those without.
GSE Loan Limits Fell…and Home Sales Went Up
On October first, the Fannie Mae/Freddie Mac maximum loan limit fell (from around $729,000 to $625,000). The Senate later voted to extend that limit until December 2013. Some House members, such as Rep. John Campbell (R-CA) warned that if the loan limits were not raised back to their previous levels, our housing market would “crater.” And of course the special interests in the real estate industry all but implied that if the taxpayer did not remain on the hook, then we’d all be living in caves before too long.
It was easy enough to make such outlandish statements in the absence of data. Now we have some data, and from of all people, the real estate industry. According to the National Association of Realtors (full disclosure: I worked there about 10 years ago):
Total existing-home sales, which are completed transactions that include single-family, townhomes, condominiums and co-ops, rose 1.4 percent to a seasonally adjusted annual rate of 4.97 million in October from a downwardly revised 4.90 million in September, and are 13.5 percent above the 4.38 million unit level in October 2010. [emphasis added]
You read that correctly. The loan limits fell and then home sales actually rose, which is the opposite of crater. I’m not claiming that the decline in loan limits caused home sales to increase, but I am claiming that the housing market did not crater, as was predicted.
Apparently a Little Economics Education Does Work on Congress….
While most of my adult life has been devoted to simply imparting basic Economics to policymakers, I have to admit to being a little skeptical as to if they are actually listening. I’ve seen too many times, especially during my service as staff in the Senate, politicians support policies they have to know are harmful. So it always encouraging to see some evidence of Congress taking basic Economics into account.
The evidence is presented in a recent paper in the academic journal Public Choice. The paper examines the 2007 vote to raise the minimum wage. After controlling for a variety of factors, the “study finds that members who majored in economics as undergraduates were less likely to vote for the minimum wage increase than their colleagues.” Again this controls for party and others factors that might also influence a Representative’s decision. As you probably recall, the vote in question did pass. So while I’m not suggesting that a few more economists in Congress would solve all our problems, it might actually help.
‘Monstrous Moral Hybrids’
Sunday’s dinner of the Society for Development of Austrian Economics featured a keynote from George Mason University economics professor Richard Wagner. The talk brought back a lot of memories for me. Wagner was chair of my dissertation committee and it was in his graduate public finance class (back in 1992?) that I first gave any thought to Fannie Mae and Freddie Mac when I wrote a paper on government sponsored enterprises. Little did I know I’d spend much of the following years working to reform Fannie and Freddie.
During his talk, Wagner invoked a term first used by Jane Jacobs: “monstrous moral hybrids.” I suspect Jacobs used the term to describe how Robert Moses managed to wield unaccountable power over development in New York City (Caro’s account of Moses, Power Broker, still being the single best read on city government). Ms. Jacobs describes two distinct moral syndromes, commercial and guardian. Obviously commercial pertains to the market, while guardian can pertain to government. The monstrous moral hybrids are when we get the worst of both instincts combined in one entity. For instance, I generally view competition as a good thing; however, competition underwritten by government guarantees will almost always lead to disaster. Its competition without the discipline of failure.
I repeatedly watched, while working in Senate, Fannie/Freddie invoke their “private” nature in order to avoid regulation while invoking their “public” nature to gain protection and privilege. The result was little accountability from either the market or the government (our largest banks currently enjoy a smaller version). Of course, one of the primary differences in debates over financial regulation is the degree to which one believes that either the market or government provides accountability. Setting aside those debates, we should all be able to agree that companies should be either private or government. That the mixing of the two, government sponsored enterprises, is a recipe for avoiding accountability and transparency. But then I suspect that might have been the intent all along. Monstrous moral hybrids by design.
Firing Failed Employees Would ‘Harm’ Agency Says SEC Chief Schapiro
Over a year ago I asked a fairly simple question, why can’t we fire failed regulators? After all, lots of seemingly smart people had oversight of our financial markets, and regardless of whatever spin you might hear, our financial markets are, and have been, highly regulated. Sadly, “highly” is not the same as “well”.
Perhaps no failure was as avoidable as that of the Bernie Madoff scheme. After all outside parties basically put the case together and brought it to the Securities and Exchange Commission (SEC). Yet the SEC did nothing until it was far too late. Eventually the SEC’s human resources department and an outside law firm advised the agency on how to handle these regulatory failures. Their recommendation: fire the manager responsible. SEC Chair Mary Schapiro’s response? No, as such “would harm the agency’s work.” I’d think having incompetent employees would harm the agency’s work. But then we have yet to hear what happened to the many SEC employees that spent the crisis watching porn instead of doing their job.
This is just another example, in a long list, of why relying on the relatively weak incentives of government regulatory oversight is inferior to relying on the strong incentives contained in market participants having their own wealth on the line. But then for such incentives to be effective, we need to end bailouts and have real market discipline. Sadly we are currently stuck in the worst of both worlds: incompetent and unaccountable regulators coupled with a neutering of market discipline by these very same regulators.
Just How Much of the Mortgage Market Is Over $625,000?
On October 1st the maximum loan limit for Fannie Mae and Freddie Mac declined from around $729,000 to just over $625,000. Not surprisingly the real estate industry and Fannie apologists are claiming that this would cause the housing market to crater. It would seem to me that this claim would greatly depend upon just how much of the market will be impacted.
Fortunately one can try to answer that question. According to Federal Reserve data, collected under the Home Mortgage Disclosure Act (HMDA), the percent of home purchase mortgages between $729,000 and $625,000 is less than 1% of the market. So we are arguing over increasing mortgage rates for only 1% of the market? I fail to see how such is going to have much of an adverse impact on the mortgage market.
If we were to go back to the pre-crisis loan limits of $417,000, we’d only have about 8% of the mortgage market not under the conforming loan limit. So instead of talking about a decrease to $625.000 we should be at least talking about a decrease to $417,000. Going even further to just over $200,000 would still leave Fannie and Freddie with a majority of the market.
For those that believe that declining loan limits unfairly hit “high cost” areas, then the solution to me would be to abandon any loan limits altogether and base eligibility on income, as we do in the Rural Housing Programs (which I believe have a limit of 115% of state median income). Of course this sets aside the fact that many “high cost” areas are expensive because of their harmful and misguided land use policies.
Raising Interest Rates to Help the Housing Market
Last week I offered a few proposals to help move along the housing market. Given the need for brevity, the rationales for each were short. As almost all of them were counter to the conventional wisdom, they do merit a little more explaining, in particular the suggestion to raise interest rates.
Before I could offer a further discussion of the fact that the mortgage market is driven by both demand and supply, Daniel Indiviglio at the Atlantic was quick enough to provide much of that detail. Rather than repeat his analysis here, which I agree with, let’s focus on a few other points.
David argues that “at rates like 4 percent, those loans had better be pristine if the bank wants to ensure that its default risk is covered by the small amount of interest it receives.” Let’s dig a little deeper. What lenders care about are real rates. With inflation running approximately 2 percent, the real return on a prime mortgage today, before credit cost, is around 2 percent. But today about 3.5 percent of prime loans are in foreclosure. Assuming a 50 percent recovery rate, 1.75 percent is needed to cover credit losses. Even in good times, prime loans foreclosure at about a 0.6 percent rate. With subprime foreclosures running about 14 percent, you’d need to charge at least 9 percent to break-even in real terms. At today’s rates, lenders are barely breaking even on prime loans, they’d bleed money if they charge similar rates to subprime borrowers.
But then why don’t lenders just charge higher rates for the higher risk borrowers? After all that’s what they did during the bubble years. Well a lot has changed since then. For instance, in 2008 the Federal Reserve, under the Home Ownership and Equity Protection Act (HOEPA), lowered the threshold for what is considered a “higher-cost” mortgage, from treasury +8 percent, which excluded much of the market, to prime mortgage +1.5 percent, which under current rates makes anything over 5.5 percent a “high cost” mortgage. When Congress passed HOEPA in 1994, it shut down that segment of the market, due to what is tremendous litigation risk. Now the Fed’s extension of HOEPA has done the same for much of the mortgage market. According to the Fed, 22 percent of the market was “higher-cost” in 2005. After the new regulation, that share had fallen to 2.4 percent in 2010. Yes the housing bubble and credit crisis would have shrunk that market, but by almost 90 percent? And yes, many of those loans we didn’t want to come back, but many we did.
The point here is that the Fed actually does impose, via legal risk, a de facto ceiling on mortgage rates. If we want to bring back housing/mortgage demand among higher risk borrowers, which were a significant source of demand, then the Fed would be wise to suspend its current HOEPA rules. If we don’t want to bring that demand back, then fine, just stop complaining about a weak housing market. As an aside, I was of the view in 2008 and still today that the Fed lacked legal authority for its 2008 HOEPA rule, but then the Fed has rarely let a lack of legal authority get in its way.
Occupy the Elderly
The Pew Research Center released a study today on the growing “age gap” in economic well-being. Based largely on Census’ Survey of Income and Program Participation, the study compares household income trends, by age, from 1984 to 2009.
The main result is that those households headed by someone 65 and older did pretty well for themselves, while those under 35 did pretty badly. The number one driver of this trend? The housing bubble. Seems the elderly, in general, purchased long before the bubble and didn’t take a lot of equity out, while the young bought near the peak and took a bath.
The paper’s results suggest two policies messages to me (perhaps it will suggest different ones to you): given how well most of the elderly have done, relative to younger households, where’s the justice or even need for the young to continue to subsidize the elderly via medicare, social security, etc. These trends in wealth provides considerable justification for means-testing these programs. Secondly the Federal Reserve’s constant attempt to make us wealthier via a series of asset bubbles is actually adding to income inequality. Asset booms make those with assets, usually older and wealthier households, even more wealthy while doing little or even real harm to those without assets. If you really want to see more equal wealth, then demand that the government stop trying to push up home prices.
Of course there are other factors that also drive the difference in age wealth trends. Recall the data is for households, so the declining household size (rise of single parents, delay of marriage) will generate difference across cohorts.
Helping to Move the Housing Market Along
As I spend a lot of time pointing out how various government proposals are either useless or outright harmful, some of my friends get the impression that I am against ever doing anything. Keeping in mind that I do firmly believe nothing should always be an option (ever hear of “first do no harm”), here’s what we should do to help correct the housing market:
1. Speed up the foreclosure process. The massive shadow inventory of homes yet to hit the market, numbering in the millions, is keeping potential buyers on the sidelines. Why buy now when a future massive increase in supply will likely depress prices more? It is best to get that supply to the market now. We also, by my estimate, have about 500,000 borrowers still in their homes that have not made a single payment in over 2 years. These borrowers will likely never get current.
2. State Attorneys General need to either put-up or shut-up. Holding back lending by depressing bank equity values, and not to mention dragging out the foreclosure process, is a massive 50 state targeting of bank foreclosure practices. If the state AGs have some real evidence, then why aren’t we in court? Either the AGs should go to court, where we can all see the facts, or they should drop what only looks like a shakedown.
3. The Fed should start raising rates. First, what bank wants to make a mortgage at 4% when their cost of funds in a few years will easily be above that? Just like any price ceiling, artificially low rates cause shortages. In this case current Fed policies are reducing the supply of credit, making it harder for potential borrowers to get mortgages (yes, if you can get a mortgage, the price is great). When rates do go up, which they will, such will put downward pressure on prices, better to take that hit now.
4. Subsidize moving on, not staying put. While I am against spending any more tax dollars trying to delay the adjustment of the housing market, if we are going to spend billions, we’d be better off helping to pay households’ rents in a new unit, preferably in a new city where they might have a better chance at finding a job. We should be helping families adjust, not remain stuck in limbo.
5. Exercise recourse when possible. Many federal loans, like FHA, have a recourse option. In the case where borrowers can pay, but simply don’t want to (due to price declines or otherwise), they should be held to account. When FDR did mass re-fis and modifications in 1930s, he also demanded strong recourse, which was regularly exercised. If its harmful for a bank to start a foreclosure, then it’s also harmful for a borrower, who can avoid it, to also do so.
For the sake of brevity, I will continue this list in the future. I suspect I’ve given interested parties plenty here already to debate.
Want to Stick It to the Rich, Get Rid of Fannie and Freddie
There’s an interesting new NBER working paper out this week on the impacts of Fannie Mae and Freddie Mac on the mortgage market and the overall economy. I have to admit I’m still working through some of it (my matrix algebra is a little rusty).
To summarize the paper’s findings:
First, comparing stationary equilibria with and without the policy, a tax-financed interest rate subsidy of 40 basis points leads to a significant increase in mortgage origination, but has little effect on investment in housing assets or in the equilibrium construction of real estate. The mortgage subsidy does not significantly change the share of households with positive holdings of real estate, because on one hand the subsidy makes real estate ownership more attractive, but on the other hand the higher required taxes lower net of tax income and thus discourage homeownership for low-income and low-asset households. However, the subsidy does significantly affect the distribution of leverage in the economy by increasing both the fraction of households that have positive mortgage debt and the level of leverage. This suggests that the GSE’s may have led to over-investment in mortgages and excess household leverage, which may have exacerbated the response to the recent drop in house prices.
Using a steady state utilitarian social welfare functional we find that the aggregate welfare implications of the subsidy are negative, in the order of 0f 0.8% of consumption equivalent variation. However, since households are heterogeneous, there is disagreement over the desirability of the subsidy. Low-wealth households prefer to live in a world without the subsidy, whereas high wealth households prefer to live in a world with the subsidy. This can be explained by the fact that low-wealth households hold little or no housing, and thus do not benefit from the subsidy, as compared to high wealth households that have large homes and mortgages.
Of course you can always read the paper and decide for yourself. I didn’t need to work out all the equations to prove that Fannie and Freddie have been a massive regressive theft from all of us to a narrow segment of higher-income homeowners (and bankers).
Cato on Facebook
Cato on Twitter
Cato on Google+
Cato on YouTube
