Archive for the ‘Finance, Banking & Monetary Policy’ Category
Questions and Thoughts on the Mortgage Settlement
If you missed the news (Obama actually made a “big” speech about it), the federal government, along with 49 state AGs, reached a settlement with the largest mortgage servicers over servicing violations. In some ways, what little detail has been offered raises more questions than answers.
Perhaps the biggest question is how much of the actual losses will be borne by the banks and how much will be passed along to investors, who were not even represented at the table. One hears that both first and second mortgages would be written down “in proportion” so that if the first loan is reduced 10%, then the second is also reduced 10%. Obviously this flies in the very face of what a first and second loan are. The first shouldn’t take any loss until the 2nd is completely wiped out. But since investors often hold the first while banks hold the second, it looks like Obama has blessed the banks sticking a good deal of their losses to the investors, which include pension funds, retirement accounts etc.
And while I was of course moved by the touching picture of a couple and their child featured so predominantly on the settlement’s website, I was also left wondering, what is the process for determining which foreclosed homeowners receive assistance. The settlement is actual quite clear that “$1.5 billion will be distributed nationwide to some 750,000 borrowers” but that such borrowers need not have actually been harmed. This really seems little more than a lottery trying to pass as consumer protection. But then I suspect your chances for getting a piece are bigger if you happen to live in a swing state (sorry California).
What really worries me is the massive payment to states. Of course they claim this is going to help “fund consumer protection” but then we also told that the tobacco settlements would help smokers; it instead turned into state government slush funds. Even more troubling is the high probability that such funds will flow to various non-profits, whatever the current incarnation of ACORN is calling itself.
Fortunately the entire settlement has to be approved by a federal judge. Given that these issues really should have been decided in the courts in the first place (separation of powers, anyone?), this is the opportunity for the courts to ask for the AGs and Obama to actually produce some evidence of wrong-doing. And also to ask that parties actually harmed be the ones compensated. Anything else would be a perversion of justice.
Which Way Is Inflation Headed?
First let me admit I do not have a crystal ball, nor does anyone I know, so given the limitations of economic forecasting, one can only attempt educated guesses as to the direction of any economic variable. That said, I found the chart below, taken from the most recent Bureau of Labor Statistics’ Consumer Price Index release, to be interesting in terms of the clear trend.
The lower line is core CPI, the Federal Reserve’s preferred measure of inflation, the upper line is the full CPI, which includes food and energy prices. The good news is that while still higher than I’d prefer, food and energy prices started to moderate in the fall of 2011. That moderation in food/energy prices, however, did not translate into a lower core CPI. In fact the core CPI continued its fairly steady increase. Since September 2011, core CPI has been, on an annualized basis, above the Fed’s target of 2 percent (let’s set aside, for the moment, whether this is the right target or if it is even measured appropriately). Remembering that monetary policy works with “long and variable lags” the time to worry about inflation is before it hits, not after. Given the clear upward trend in the government’s own charts, I’d say we are already past the point where we should start worrying.
Bernanke’s Anti-Stimulus
One of the direct results of the Federal Reserve’s zero interest rate policies has been a massive reduction in interest income going to households. Since 2008, household interest income has fallen by about $400 billion annually. That’s $400 billion each year that families have not had to spend.
Now of course you can also argue that families interest expenses have also fallen, and that would be true, but that just serves to illustrate that much of monetary policy is not about creating wealth, but re-distributing it. Since interest payments are one’s person expense and another’s income, Fed driven changes in the interest rate should not increase household income in the aggregate.
As interest income/expense is not the only item on the household balance sheet, the Fed does try to make us feel richer via changes in asset prices. The problem, however, is that the change in many asset prices can also have little more than distributional effects. If owners feel richer because their house prices have gone up, or not fallen as much as they would have otherwise, then renters are poorer as they need to save more to by the same house. The same holds for commodity prices. Monetary driven increases in the price of food might be great for farmers, or speculators, but it makes households poorer by the same amount it increases the wealth of commodity holders. If the Fed truly wished to help our economy get back to “normal” then it would allow the free choices of individual borrowers and savers to determine the interest rate. It would also end its implicit practice of picking winners and losers in our economy. Unlike Fed driven changes in asset prices and interest payments, voluntary exchange between savers and borrowers increases the welfare of all parties involved.
The Case for Gold — Again
In the New York Times, Floyd Norris reminds us:
The 1980 presidential election was fought by a Democratic incumbent weakened by a poor economy amid worries that the United States had lost its ability to compete in the world. Gold prices had risen to unprecedented levels as the election approached, and the Republican nominee hinted he might propose a return to a gold standard.
That Republican, Ronald Reagan, won the election and soon appointed a commission to study the role of gold in monetary systems.
And now:
Last month, Newt Gingrich, seeking to widen his support in the days leading up to the South Carolina primary, promised that he would appoint a new gold commission. “Part of our approach ought to be to re-establish something Ronald Reagan did in 1981 and that is to have a commission on gold to look at the whole concept of how do we get back to hard money,” he said in a speech.
Whatever the likelihood of Gingrich’s ever being in position to appoint a presidential commission, the minority report of the U.S. Gold Commission, by Rep. Ron Paul and Lewis Lehrman, still makes for worthwhile reading. And conveniently enough, it’s available right here at the Cato Institute. Download a pdf or epub here.
For a more recent analysis, read “Is the Gold Standard Still the Gold Standard among Monetary Systems?” by Lawrence H. White.
Chinese Currency and the U.S. Financial Crisis
Some people might have been surprised to read in Sunday’s New York Times magazine that I believed “that all that easy money from China helped make the housing bubble much bigger and last longer, which created a far bigger crisis when the bubble finally burst.” As you might suspect, it was only those two little words “from China” that gave me pause. But I’m very grateful to Adam Davidson and his colleagues at NPR’s Planet Money for giving me a chance to elaborate on their blog. Here’s a brief excerpt:
China was eager to buy our debt, both Treasury bonds and Fannie and Freddie’s debt. But it was Congress that ran the deficits, and the Fed that kept interest rates artificially low. We don’t need to go to Beijing to find the villains in this piece….
Our economy could use plenty of reforms – lower, flatter, simpler taxes; a more stable monetary policy or even a move toward free markets in money; reduced regulatory burdens; the de-monopolization of services from education to mail delivery; and less government spending. In all those cases, the problem and the solution are right here in the USA.
Read it all! And special bonus links: Steve Hanke responds to the argument for a tougher policy toward China at Planet Money. And Adam Davidson talked with me about libertarianism in 2010 (plus a much longer version also featuring Mark Calabria).
Arlo Sings Bailouts
Only days after the president declared, “No more bailouts, no more handouts,” I see that Arlo Guthrie is touring the South in February and March. What’s the connection? If you have the good fortune to see him, be sure to ask for “I’m Changing My Name to Fannie Mae.” That 2008 song was itself a new version of Tom Paxton’s classic song “I’m Changing My Name to Chrysler,” sung here by Arlo: “When they hand a million grand out, I’ll be standing with my hand out….If you’re a corporate titanic and your failure is gigantic, Down in Congress there’s a safety net for you.”
The 2008 version is sung here by Arlo and here by Paxton. Besides the name of the company, they had to make a few other changes in the lyrics, like “When they hand a trillion grand out, I’ll be standing with my hand out.”
But that was October 2008. By the end of December, I was noting that it was a Merry Christmas for GMAC, which learned on Christmas Eve that the Federal Reserve had approved its application to become a bank holding company. That gave GMAC “access to new sources of funding, including a potential infusion of taxpayer dollars from the Treasury Department and loans from the Fed itself,” as the Washington Post explained. GMAC wasn’t the only company that suddenly became a “bank holding company” in order to cash in on the $700 billion financial bailout. Late one night in November, American Express was granted the same privilege, along with Morgan Stanley, Goldman Sachs, and CIT. Which was why I suggested then that Tom and Arlo needed a new version: “I’m Changing My Name to Bank Holding Company.”
For now, enjoy “I’m Changing My Name to Fannie Mae”:
EU Credit Rating Agency Hoax
Daniel Hannan’s post on the establishment of the European Credit Rating Agency makes some good points. The recent downgrade of a number of European countries is a consequence of low growth and massive debts and deficits.
Instead of implementing far-reaching structural reforms, however, an increasing number of European politicians talk about an Anglo-American conspiracy to sink Europe’s single currency, the euro. According to one of the most prominent EU parliamentarians, Elmar Brok of the German Christian Democratic Party, credit-rating agencies Standard & Poor’s, Moody’s and Fitch are part of the American economic war against Europe. The EU Commission president Jose Manuel Barroso implied as much some time ago.
So, naturally, what the EU needs is a European credit-rating agency that will provide an “objective” and “independent” analysis of the “true” state of the European economies. (The EU already has an “independent” think-tank called Bruegel that is largely funded by the European governments.)
Headline of the Week: “Consumer Chief Richard Cordray Promises Not to Abuse His Power”
From the Los Angeles Times.
It works on so many levels.
How to End a Depression
Great article in the Sunday Washington Post by James Grant on the depression of 1920-21 and how after President Warren G. Harding’s response, “the unemployment rate fell from 15.6 percent to 9 percent (on its way to 3.2 percent in 1923), while constant-dollar output leapt by 16 percent. After which the 1920s proverbially roared.”
And how did the administration of Warren G. Harding, in conjunction with the Federal Reserve, produce these astonishing results? Why, by raising interest rates, reducing the public debt and balancing the federal budget.
Pundits often accuse Herbert Hoover of “doing nothing” to counter the depression of 1929. Boy, are they wrong. Grant thinks Harding doesn’t get his due:
When he wasn’t presiding over a macroeconomic miracle cure, Harding convened a world disarmament conference and overhauled the creaky machinery of federal budget-making. For his trouble, historians customarily place him last, or next to last, in their rankings of U.S. presidents. Incredibly, they consign him near the bottom even in the subcategory of economic management, about 40 places behind Franklin D. Roosevelt, who inherited a depression that he didn’t actually fix.
The Hoover-Roosevelt-Bush-Obama do-something-anything-everything approach to economic recovery seems to result in elongated depressions. Take a look:
Maybe we should try the Harding do-nothing approach — which isn’t actually do-nothing; he cut taxes and spending and balanced the budget.
Cato scholars have written about how Harding ended a depression here and here.
Sorry EPI, It’s Credit, Not Race, that Drives Mortgage Pricing
One would think that after a housing boom driven by cheap credit, we would have heard the end of the “minorities charged higher rates regardless of credit” narratives. But our friends at the Economic Policy Institute continue to spin the myth that it is really race, and not credit history, that determines a borrower’s interest rate.
EPI cleverly starts out by lumping most borrowers into the same category: “In recent years, Latino and African American consumers with good credit scores of 660 and higher have too often ended up with high interest rate mortgages, mortgages which are supposed to go to risky borrowers.” First of all, 660 is not a good credit score. We can debate whether it’s poor or mediocre, but it isn’t good. According to the Federal Reserve, loans with a FICO of around 660 default at a rate of almost nine times that of loans with a FICO of 720 or higher (see table below). To mix the two and claim they are the same risk is misleading, at best.
So let’s start with some basic facts:
For a variety of reasons, including differences in age, Latino and black borrowers have lower credit scores than white borrowers. This still holds even when you exclude loans to borrowers with credit scores below 660 or 620. Second, defaults continue to vary, by large magnitudes, even for rates above 660. To imply 660 is equal to 700 or that 700 is equal to 780 is false.
There have also been a number of studies that reject the claim of large, or even any, differences in mortgage pricing by race, when one includes relevant variables. A recent NY Federal Reserve Bank study concludes:
we find no evidence of adverse pricing by race, ethnicity, or gender in either the initial rate or the reset margin. Indeed, if any pricing differential exists, minority borrowers appear to pay slightly lower rates.
A recent study in the peer-reviewed Journal of Real Estate Research concludes
that up to 90% of the African American APR gap, and 85% of the Hispanic APR gap, is attributable to observable differences in underwriting, costing, and market factors that appropriately explain mortgage pricing differentials. Although any potential discrimination is problematic and should be addressed, the analysis suggests that little of the aggregate differences in APRs paid by minority and non-minority borrowers are appropriately attributed to differential treatment.
FHA and the Foreclosures of Tomorrow
The recently released Federal Reserve White Paper on the Housing Market has received considerable attention, at least for its policy proposals. I found one of the more interesting pieces of data in the paper to be the number of mortgages with negative equity, reproduced below (Figure 3 in the Fed paper).
What I found both interesting and distressing is that despite the fact that the Federal Housing Administration (FHA) was only about 2 percent of mortgages at the height of the bubble in 2005/2006, FHA is now over a fourth of total mortgages with negative equity. Of course this was all predictable (I actually predicted it). If you decide, as did our federal government, to get lots of borrowers into loans with very little equity, at a time when prices are falling, you will create a whole lot of loans with negative equity. Thank you FHA for creating a mess that was completely 100% avoidable. But who cares when you’re ultimately just sticking it to the taxpayer, right?
It Was the Republican Banker on the Fed Board Raising Concern about Housing
If you’ve followed Obama’s nominations to the Federal Reserve, he’s been pretty consistent, displaying a strong preference for coastal academics or politicos. Not one of his nominations came from the private sector (or “flyover country”), despite the very clear requirements of the Federal Reserve Act.
Recently released Fed transcripts reveal an interesting fact: it wasn’t the all-knowing, impartial Ivy League academics (like Bernanke and Yellen) or the long-term bureaucrats (like Geithner) that expressed concern about the housing and mortgage markets, it was the Republican banker from Tennessee, Susan Bies. Unfortunately it appears that the academics and bureaucrats on the Board treated Governor Bies’s concerns with their usual contempt for anyone who’s actually had to make payroll (or didn’t do their graduate work at Harvard or Yale).
In Obama’s defense, we are talking about the Federal Reserve Board as it existed in 2006. Bush was almost as bad about filling important economic positions with either New Keynesian academics (Mankiw, Bernanke) or Wall Street insiders (Paulson). Bush, however, did occasionally bow to some voices outside the Cambridge-Wall Street-Washington echo chamber, with Fed appointments such as Bies and the current Fed governor Duke.
The relevance for public policy choices facing us today? First, while a Board is no panacea, it does mean alternative voices are at least heard before they are dismissed (think the Consumer Financial Protection Bureau) and second, having a bunch of arrogant (and ignorant of real markets) academics run our economy is a recipe for disaster. And I’m not suggesting we turn our government over to corporate America, I’m suggesting we return our economy to the control and choices of free individuals.
Cato on Facebook
Cato on Twitter
Cato on Google+
Cato on YouTube
