Archive for the ‘Finance, Banking & Monetary Policy’ Category
Do Liberals Oppose Affordable Housing?
I’m a little behind on my reading, so you’ll have to forgive that the paper I’m about to talk about has been out for over a year. We tend to associate the push for more affordable housing, whether it is direct subsidies like the Section 8 Voucher program or lending requirements like the Community Reinvestment Act, with those more of the liberal persuasion. A empirical analysis, published in the peer-reviewed Journal of Urban Economics, by UCLA economist Matthew Kahn (believe me, no conservative or libertarian is he), finds that:
across California metropolitan areas from 2000 to 2008…liberal cities grant fewer new housing permits than observationally similar cities located within the same metropolitan area. Cities experiencing a growth in their liberal voter share have a lower new housing permit growth rate.
Yes the analysis controls for income, so this isn’t just a NIMBY effect, but does seem to be the result of either ideology or political preferences. So it appears that while liberals push for more federal housing subsidies, they fight against more housing, and hence less affordable housing, at the local level. Now you might suspect that the hope is that one off-sets the other. I wouldn’t be surprised to believe the citizens of, say, San Francisco want the rest of us to subsidize their lifestyle and also believe more federal subsidies can take care of affordable housing needs. But the unfortunate truth is that the two, increased federal subsidies and local supply restrictions, end up driving up housing prices, contributing to housing bubbles and ultimately do little to provide affordable housing. The reason is that increased demand, which is what most federal housing subsidies do, simply drives up price in the presence of inelastic supply. If liberals truly cared about the poor and needy, they’d deregulate their local housing market and actually allow for the provision of affordable housing.
Ed DeMarco Deserves a Medal
The same people who helped create the $180 billion bailout of Fannie Mae and Freddie Mac are now demanding the head of Ed DeMarco, the acting director of the Federal Housing Finance Agency (FHFA), which regulates Fannie Mae and Freddie Mac. Some commentators have gone as far to say that the “single largest obstacle to meaningful economic recovery is a man who most Americans have probably never heard of, Edward J. DeMarco.” Of course, such a statement shows a stunning lack of understanding of both the mortgage market and the economy in general.
Why are so many upset with Mr.DeMarco? One simple reason: he is following the law. Some believe that broadly writing down the mortgages of underwater borrowers would turn the economy around, regardless of the cost to the taxpayer. While that assumption itself is highly questionable, it doesn’t matter. As I’ve detailed elsewhere, the current statutory language governing FHFA limits Mr. Demarco from doing so. Yes, some proponents have found language elsewhere in the statute they believe allows sticking it to the taxpayer for another $100 billion. But their argument relies on general introductory sections of the statute, not the powers and duties of FHFA as a conservator. Statutory interpretation 101 is that more specific sections trump general introductory sections. General sections have “no power to give what the text of the statute takes away” (Demore v. Kim, 538 U.S. 510, 535). One would expect senior members of Congress to understand that.
Of course, if some members of Congress believe we should spend $100 billion bailing out deadbeats, then why don’t they simply offer a bill on the floors of the House and Senate doing so? I’m sure House leadership would be happy to have a vote on the issue. The notion, instead, that an unelected, un-appointed, acting agency head should, in the absence of clear authority to do so, spend $100 billion is simply offensive to our system of government. Not to mention it probably violates the Anti-Deficiency Act, and would be hence subject to criminal prosecution.
Unfortunately, one of the common themes of the financial crisis was outright unlawful behavior by the financial regulators, such as the FDIC broad guarantee of bank debt, which lacked any statutory basis. Mr. DeMarco is to be commended for staying within the letter of the law. If Congress had wanted Fannie and Freddie to bailout underwater borrowers, they could have simply written that into the statute. Congress didn’t, regardless of whatever spin any current members of Congress might want to place on the issue.
Are Markets Pro-Gay?
In case you missed it, this past weekend the Public Choice Society was meeting in Miami. I missed it too, which is unfortunate as there were a number of great papers presented. A particularly interesting paper examined the question, does greater economic freedom, that is more market-based institutions, foster tolerance? The results show a strong impact on increasing economic freedom, as measured by the Economic Freedom of the World index, and tolerance for homosexuals, as measured by the World Values Survey. There was also a positive relationship found between economic freedom and tolerance for different racial groups, although the impact was much smaller in terms of significance.
The theory behind this relationship derives from Richard Florida’s work, specifically the author cites Florida’s argument:
Places that are open and possess low entry barriers for people gain creativity advantage from their ability to attract people from a wide range of backgrounds. All else equal, more open and diverse places are likely to attract greater numbers of talented and creative people – the sort of people who power innovation and growth.
On the other hand, another paper, also using data from the Economic Freedom of the World index, found that greater economic freedom was associated with increases in a country’s average body-mass index. That is, apparently economic freedom makes us fatter. If the trade-off is more tolerance, but also a few more pounds around the waste, that’s a trade-off I can live with.
Are Courts Dragging out the Housing Crisis?
Despite what looks like a national mortgage market, what we do not have is a national foreclosure process. Almost all the law that matters in terms of foreclosures is at the state level (which is both good and bad, and it is not clear to me which dominates). One of the biggest differences is whether a lender has to go before a court to seek a foreclosure, or whether such can be handled administratively. Although even in administrative states, borrowers do have redress to the courts when things go wrong (besides the actual fact of a foreclosure).
The following chart, put together by the Mortgage Bankers Association, lists states by percentage of loans in some stage of the foreclosure process. Also listed (color-coded) is which states have a judicial, that is court-driven, foreclosure process and that those that do not. The most noticeable difference is that, with a few exceptions, the states with the highest percentage of properties still in foreclosure are those with a judicial foreclosure process. Perhaps most surprising is that states like California and Arizona, which were ground-zero for the housing bubble, have foreclosure inventories, as a percent of loans, below the national average.
A common refrain for slowing the foreclosure process is that such is thought to slow the decline in housing prices. The facts, as they relate to judicial foreclosures which do take considerably longer, is just the opposite. Based on state-level price data from Zillow, non-judicial states saw prices fall 3.3% over the course of 2011, whereas prices fell 4.5% in judicial states. While there’s a lot driving house price declines, it doesn’t look as if the judicial process is helping. Similar results hold if you date back to the peak of the bubble. Judicial states have seen, on average declines of about 20%, whereas non-judicial have seen declines of about 17% (not population weighted).
Now, I am a big believer in respecting contracts, and the existing legal environment is part of the contract, so I’m not advocating that states change their foreclosure process for existing loans. For loans not yet made, however, there appears to me to be the case for at least examining the merits of judicial foreclosure (or even better let borrowers and lenders freely contract to choose their own rules).
Obama Fixes the Housing Market Again (and Helps the Troops)
Yesterday President Obama announced yet another set of programs intended to help the housing market. The majority of these are aimed at helping active service members of the military. For instance the proposal would compensate service members who were wrongly foreclosed upon and help re-finance into lower rates service members wrongly denied that opportunity. Assistance would also be provided to service members who suffered losses because they had to sell their homes due to a change in station (that is the military ordered them to move).
While some of these changes are likely to benefit service members, the impact on the overall housing market is likely to be very small. From what little details we have, it appears most benefits will be limited to currently active service members. Let’s start with the re-finance piece. There are just over 1 million active military living in the U.S. (another quarter million stationed overseas, who we lack data on), of those just over 300,000 both own their home and have a mortgage (about 80,000 own free and clear). Interestingly just over 2/3rds purchased their home since the housing bubble burst. During this time mortgage rates have been fairly low, so its probably reasonable to assume that these borrowers already have low rates and won’t benefit from a re-finance. I haven’t been able to find data on how many longer-term borrowers have already re-financed, but its sure to be a significant amount. So our upper-bound is that about 100,000 service members might be able to benefit from a re-finance, I suspect the actual number is much lower. And of course, who knows what “wrongly denied” means.
The “wrongly foreclosed” piece is a lot harder to estimate, so take this with a huge margin of error. First we don’t know how many active duty borrowers have even been foreclosed upon. If we assume foreclosure rates similar to the VA loan program (good reasons to think it could be higher or lower), then about 12,000 service members are likely to have been foreclosured upon since the bubble burst. The “wrongly” is even harder to figure out. If interpreted narrowly, then say 1%, gets us to just over 100 loans. Even 10% gets us to about 1,000 loans. Under any reasonable estimate a pretty small number compared to the overall housing market.
The permanent change of station piece is the other big piece. Setting aside that service members taking a loss on their home has long been an issue and just why it has become important now we will leave to the imagination (an election year perhaps?). Of those active duty service members who moved in the last year, about 100,000 had a mortgage, and so could have taken a loss. If they were underwater to the same extent as the general population (probably an under-estimate), then this program will help somewhere between 20,000 and 30,000 borrowers.
While it is important that anyone actually wronged be compensated (that’s what we have courts for), the impact of Obama’s latest plan, like his previous plans, is likely to be extremely small and do almost nothing to help the overall housing market.
Note: data are my estimates from Census’ American Community Survey. If you have better, please share.
New Bill to Reform the UK Banking System
On Wednesday February 29, UK Member of Parliament Steve Baker introduced a Bill to the UK Parliament to reform the UK banking system. The purpose of this Bill is to implement a series of measures to resolve the financial crisis in the UK. The underlying principle of this Bill is to minimize moral hazards within banking, by making those who make or preside over risk-taking as liable as possible for the consequences of that risk-taking. Since rules are usually gameable, the Bill also includes mutually reinforcing measures that minimize scope for evasion.
The key provisions of the Bill are as follows:
First, board members of banks would be subject to strict and unlimited personal liability for any bank losses. They would also be subject to stringent provisions to provide personal bonds that would be potentially forfeit in the event their banks posted losses.
These measures would create the strongest possible personal incentive for board members to ensure that their banks are managed responsibly. This is the most important requirement to resolving the crisis: with the key decision-makers’ own wealth most at risk, they would ensure that the excess risk-taking would soon disappear.
Second, the payments of any bonuses that are awarded in any given year would be deferred for a period of 5 years. The amounts involved (‘bonus pool’) would be invested on beneficiaries’ behalf in an escrow account.
Third, should a bank report losses over any period, these losses would be made good in the first instance by drawing from the bonus pool. Should a bank report losses that exceed the value of the bonus pool, then the whole of the bonus pool would be forfeit to the bank to make good the losses. The difference remaining – the difference between the reported loss and the value of the bonus pool – would then be made good by drawing from the board members’ personal bonds. Should their bonds prove insufficient to meet the whole of the remaining loss, then all their bonds would liquidated to offset that loss, and any subsequently remaining losses would be passed to shareholders.
Thus, the bonus pool and the personal bonds would provide additional levels of capital to protect shareholders and other stakeholders against losses, and the fact that both the bonus pool and the personal bonds would be at-risk before shareholders’ capital would provide a very strong incentive for key decision makers to ensure that the bank takes risks responsibly.
Fourth, for the purposes of this Bill, all relevant figures (measures of profit, loss, capital, bonuses, personal bonds posted, etc.) would be obtained using the parallel accounting rules (i.e., in effect, old UK GAAP under Companies Act legislation) proposed under the 2011 Baker Bill. This would put a stop to the manufacture of ‘fake profits’ and other accounting abuses that have become prevalent under the current International Financial Reporting Standards (IFRS) used in the UK.
Fifth, the Bill sets out a proposed solvency standard: a bank is deemed to be insolvent if its ratio of core capital to assets should fall below 3%, where its core capital is defined to be equal to the sum of the value of the bonus pool, directors’ personal bonds and shareholder capital. This definition of core capital is far better (and far less fiddleable) than the capital definitions in the Basel II capital adequacy regime, which have been widely abused by banks.
Sixth, the Bill calls for the government to bring before Parliament measures to create a fast track bankruptcy regime for banks and to end all state support for banks. This would include: all bailout support, all lender of last resort support, all public shareholdings in banks, all central bank holdings of any bank assets and any form of state-supported deposit insurance. Any future state or central bank support for financial institutions is also to be prohibited.
Finally, the Bill calls for the government to establish a new Financial Crimes Investigation Unit that will investigate financial crimes, and whose focus will be crimes committed by senior bankers and financiers. This new unit will also begin investigations into possible criminal offenses committed in all financial institutions that have failed since 2007 and/or been in receipt of state support (e.g., bailouts).
Taken together, these measures would remove the most flagrant abuses and restore the integrity of the UK financial system; they would also address the widespread indignation over bankers’ behavior and meet the public demand for accountability and justice in modern UK banking.
Why Is Massachusetts Trying to Ban Truthful Information About Hedge Funds?
The Massachusetts Uniform Securities Act prohibits general solicitation and advertising by anyone offering unregistered securities, ostensibly for the purpose of furthering state and federal disclosure schemes. Yet this ban on public communications has been applied so broadly that it has undermined those purported disclosure goals. For instance, the ban has prevented individuals who have no interest in investing in any security — such as journalists, academics, students, and others who are not wealthy or financially sophisticated — from receiving truthful, non-misleading information about hedge funds.
In Bulldog Investors v. Massachusetts, an investment company maintained an interactive website that provided information about its products. Because Bulldog was not registered in Massachusetts, however, the State filed an administrative action against the firm, demanding it take down its online content.
In response, Bulldog joined a group of other firms and individuals — including some who have no interest in investing but wish to read the website information — in a lawsuit claiming that the Massachusetts ban violates their First Amendment rights. The Supreme Judicial Court of Massachusetts upheld the ban, so the plaintiffs have asked the U.S. Supreme Court to take the case.
Cato, along with the Competitive Enterprise Institute and a group of journalists and academics, has now filed an amicus brief supporting that request and arguing that the Massachusetts law is an unconstitutional ban on free speech. We show that the state’s claim that the ban furthers a larger federal regulatory scheme ignores the judgment of many federal officials (from both parties) who have concluded that such bans undermine these goals.
The state’s alleged disclosure interest is just a pretext for coercing companies to register in Massachusetts, and is therefore an unconstitutional attempt at circumventing federal preemption. But even if the ban furthers a legitimate state interest, it is so broad that it is has substantially chilled both truthful, non-misleading commercial speech and noncommercial speech alike.
A law so repugnant to the First Amendment cannot stand.
Tim Geithner’s Amnesia
In case you missed Treasury Secretary Tim Geithner’s revisionist fiction in today’s Wall Street Journal, he takes the critics of Dodd-Frank to task for forgetting about the financial crisis and how it came about. Sadly it is Geithner who forgets (or willfully ignores) the causes of the crisis. Just a few highlights:
Geithner reminds us of the AIG bailout. He forgets that it was the NY Fed’s approval of using credit default swaps to lower bank capital that lead to so much bank counter-party risk being concentrated in AIG (see Gillian Tett’s Fool’s Gold), as well as increasing bank leverage. But then who was heading the NY Fed at this time? Tim Geithner.
Mr. Geithner goes on to complain about the growth of the shadow banking sector. Who was it that approved banks’ exemption from the Sarbanes-Oxley rules on off-budget entities, which lead to the growth of various bank off-budget, hidden liabilities? Again, Geithner’s NY Fed gave that approval.
Geithner raises the issue of “risky short-term financing” but does so without mentioning that the primary reason for such was the low interest rates and steep yield curve created by. . . again Geithner’s NY Fed (and the rest of the Federal Reserve System). There’s a reason that MF Global failed in basically the same way that Bear Stearns did, because monetary policy provided both with strong incentives for maturity mismatch. But since Geithner also acts shocked that “household debt rose to an alarming 130% of income” perhaps he needs a few lessons in monetary policy. Did he seriously not think that cheap credit, via the Fed, would result in increased debt?
Perhaps all this amnesia should not be surprising coming from the same guy who told Congress he had never been a bank regulator. He certainly never acted like one, despite the title of NY Fed President. The real amnesia is that despite about two decades of engineering one bank rescue after another, beginning with his role in the peso crisis, Mr. Geithner still does not understand the concept of moral hazard. When he complains about late night calls from “then giants of our financial system” I, for one, wish he had just stayed in bed. Would have saved us all a lot of money and we’d have a much more stable financial system.
I have no sympathy for bankers afraid to lose their subsidies. What our financial system needs is a dose of real market discipline. Mr. Geithner’s rants only serve to distract from the fact that Dodd-Frank will make the next crisis more severe and more likely. It fails to address the actual causes of the crisis while further extending the worst features of our regulatory system. Worst of all it distracts from having a conversation about fixing this system. Repeal and Replace.
Some Consequences of Government Ownership of Banks
Despite the substantial and continuing repayment of TARP bank assistance, the U.S. government maintains an equity interest in 371 banks. A small number of those banks actually have the government as a majority owner. For instance the former GM financing arm, now known as Ally Bank, has a government interest of 74 percent. Sadly the United States is not alone in this regard. The Royal Bank of Scotland (RBS) is still majority owned by the UK government. And of course the U.S. government owns Fannie Mae and Freddie Mac, even if the Office of Management and Budget denies that reality.
Should we be concerned about all this government ownership of financial institutions? The small body of empirical literature on the topic suggests a strong “yes.” Probably the most comprehensive research was published in the Journal of Finance by La Porta, Lopez-de-Silanes, and Shleifer. The authors find “that higher government ownership of banks is associated with slower subsequent development of the financial system, lower economic growth, and, in particular, lower growth of productivity.” Let’s keep in mind that the last one, productivity, is ultimately what drives wage growth. So for several very important reasons we should be doing our best to get the government out of ownership in the financial sector. Recent research in the Journal of Financial Intermediation confirms these findings, and also finds that political inference is what primarily drives these bad results.
As much as it pains me to say it, the recent suggestion by Paul Myners and Manus Costello in the Financial Times that, in the context of RBS, we are better off as taxpayers taking our losses and getting out of these companies rather than holding out for better returns, is probably correct. The damage to the greater economy from political interference in the financial system (witness the demands for Fannie and Freddie to take losses to support the housing market) is likely to outweigh the losses to the taxpayer from an early ownership withdraw.
Patriotism, Loyalty, Tax Competition, and ‘Tax Fugitives’
I fight to preserve tax competition, fiscal sovereignty, and financial privacy for the simple reason that politicians are less likely to impose destructive tax policy if they know that labor and capital can escape to jurisdictions with more responsible fiscal climates.
My opponents in this battle are high-tax governments, statist international bureaucracies such as the Organisation for Economic Co-operation and Development (OECD), and left-wing pressure groups, all of which want to impose some sort of global tax cartel—sort of an “OPEC for politicians.”
In my years of fighting this battle, I’ve has some strange experiences, most notably in 2008 when the OECD threatened to have me thrown in a Mexican jail for the supposed crime of standing in a public area of a hotel and advising representatives of low-tax jurisdictions on how best to resist fiscal imperialism.
A few other bizarre episodes occurred in Barbados, back when I was first getting involved in the issue. Here’s a summary of that adventure.
Read the rest of this post »
Local Governments Also To Blame For Housing Crisis
Most narratives of the financial-mortgage-housing crisis tend to focus on what are essentially demand-side factors. Whether it is federal mortgage subsidies, like Fannie Mae, or reduced interest rates via loose monetary policy, these policies increase the demand for housing by allowing, and encouraging, more buyers to enter the market. As I’ve written in more detail elsewhere, this narrative ignores the supply side of the market.
If housing supply could easily adjust to the increased demand that arises from other policy interventions, then prices would be unlikely to increase. In fact, if supply increased more than demand, we could see falling house prices, despite the various federal subsidies. The point is that for a price boom to develop, you need some sort of rigidity in supply (inelastic supply, as we economists would say).
So who has the most influence over housing supply? Local governments. A recent article in the January 2012 issue of the Journal of Urban Economics provides empirical evidence ”that more restrictive residential land use regulations and geographic land constraints are linked to larger booms and busts in housing prices. The natural and man-made constraints also amplify price responses to the subprime mortgage credit expansion during the decade, leading to greater price increases in the boom and subsequently bigger losses.” A similar argument has been made by Cato scholar Randal O’Toole.
The lesson here is that if we want to avoid future property booms and busts, with their devastating impact on financial institutions, we also need to reform our local land use controls to allow for the more rapid response of supply to changes in demand. Again, it wasn’t a lack of regulation that caused the crisis, but too much regulation, particularly of the land/housing market.
Dumb Government Intervention in the Housing Market of the Day
With the continuing bailout of Fannie Mae and Freddie Mac, along with the impending bailout of the Federal Housing Administration, it is easy to think that the federal government has a near monopoly on misguided and harmful housing policies. Sadly local governments manage, on regular basis, to give the federal government some real competition in terms of just plain dumb.
The last entry is this category comes from Winona, Minnesota. The great folks at the Institute for Justice summarize Winona’s recent actions pretty well:
“In Winona, only 30 percent of homes on a given block may receive a government-issued license entitling the owner to rent them out. As soon as 30 percent of the properties on a block obtain rental licenses, no other property on that block may receive a rental license.”
There are just so many reasons why this policy is harmful. First, if you happen to care about the poor and needy, this policy directly reduces the stock of available rental housing. It benefits existing landlords at the expense of renters and potential landlords, a policy that is likely to be very regressive.
Second the policy reduces the value of homes that don’t get the license. By reducing what you can do with a property, you reduce its value. You also end up leaving foreclosures vacant that could otherwise be rented out. That may also depress the value of near-by homes. Not to mention you may increase foreclosures, because absent owners, such as IJ’s client Ethan Dean who owns a home in Winona and is currently serving in Afghanistan, may not be able to cover the mortgage without renting out the property.
The good news is that the Institute for Justice is litigating to have this misguided policy overturned. Best of luck to them.
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