Russell Roberts's Blog, page 1487

Chicago and Camelot

Here's a letter to the Washington Post:

Unlike E.J. Dionne, I neither admire nor find inspiration in JFK's famous line "Ask not what your country can do for you – ask what you can do for your country" ("Kennedy's inaugural address presents a challenge still," Jan. 20).  The late Milton and Rose Friedman explained best why that statement is detestable:

"Neither half of the statement expresses a relation between the citizen and his government that is worthy of the ideals of free men in a free society. The paternalistic 'what your country can do for you' implies that government is the patron, the citizen the ward, a view that is at odds with the free man's belief in his own responsibility for his own destiny.  The organismic, 'what you can do for your 'country' implies the government is the master or the deity, the citizen, the servant or the votary."

Free men and women abhor the very thought of being either wards or servants of the state, and are not charmed out of this attitude by soaring slogans.

Sincerely,

Donald J. Boudreaux

UPDATE: I love Steve Landsburg's translation of Kennedy's famous line: "Ask not what I can do for you – ask what you can do for me."

The crazy housing market

From a talk by Erik Hurst of the University of Chicago's Booth School:

Starting around 1997, there was a massive run-up in housing prices that we haven't seen at least in the measured country's history. We had this big run up in prices. Now why was that? There are lots of stories. Interest rates were really low. Cheap capital from the world. People had expectations about the housing market. Maybe a bubble-type story, people wanted to get in on the bubble. Whatever was going on, people started re-allocating a lot of resources to the purchases of housing.

If you watch the talk or even read the words I've transcribed above, you can tell that Hurst isn't particularly interested in the reason for the run-up in housing prices. He's more interested in the effects and the after-shocks from the run-up. And these are the standard stories you hear–low interest rates, capital inflows, and animal spirits–if people think housing prices are going to go up, then there is a self-fulfilling prophecy as people bid to get access to an appreciating asset.

But are these good answers? Are they reasonable? Do they pass the sniff test? Again, I'm agnostic about whether Hurst really believes these answers as plausible or whether he just wanted to get on to the rest of his talk. But I think it's important to consider whether these are good answers. If housing markets are prone to crazy behavior because of these three things on their own or in tandem, there are important implications for public policy toward housing and the Fed.

First, lets look at a measure of housing prices and how they changed over time:

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So yes, housing prices did start to accelerate around 1997. And then around 2001 or 2002, they seem to start increasing at an even faster rate.

Now let's look at the three explanations that Hurst mentions–low interest rates, capital flows, and animal spirits.

First interest rates. Here is a picture of different mortgage rates from 1992 to the present.

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Reproduced with the permission of Mortgage-X.com

The first thing to note is that nothing apparently happens before 1997 that might explain the launching point of housing prices then. There is a drop in interest rates starting around 2000 that might help explain the acceleration in housing prices starting around then. But the path of interest rates cannot easily explain the take-off that began in 1997.

What about foreign capital flows? To be honest, I have never really understood this argument. There's always lots of capital in the world looking for yield and facing the trade-off between risk and reward. Even if capital flows surged during this time period, why did they flow into housing? What is the underlying cause? After all, foreigners weren't buying houses–they were at best financing them. Why would foreigners find it suddenly profitable to invest in financing houses?

One answer is that there were suddenly more investment vehicles for investing in houses such as mortgage-backed securities. Again, let's look at the data:

[image error]Click on this picture to make it bigger. Look at it. Then look at it again. Ignore the Ginnie Mae line. Look at the red line, which is Fannie and Freddie, and the lime green line, which is private. The private category is mortgage backed securities issued by Bear Stearns and Lehman Brothers and other investment banks. The Fannie and Freddie line is Fannie and Freddie–mortgage backed securities issued by Fannie and Freddie with the implicit backing of the US government. That implicit backing became explicit in fall 2008.

There is an increase in Fannie and Freddie's activity between 1997 and 2000. It's hard to notice because the vertical scale is so stretched to accommodate the even bigger increase after 2000. But between 1995 and 1998, Freddie and Fannie's issuance of MBS more than doubled. There is also a big percentage increase in the private label MBS between 1995 and 1998, but it is dwarfed by Fannie and Freddie. Also note that in 2004, Fannie and Freddie's issuance fell sharply. But don't get fooled when Krugman and DeLong tell you that Fannie and Freddie were "small players" after 2003 or that they withdrew from the market. As you can see, they were still massively large by any historical standard and still almost as large as the private label MBS. Between 2004 and 2006, they still issued over two TRILLION dollars worth of MBS. That's not withdrawing. That's not small. That's not insignificant. They also bought a lot of that private MBS which was subprime.

So again, most of the action is in the post-2000 period. But there is some action between 1997 and 2000. Is it enough to get housing prices to take off as they did?  Perhaps. But my point is that foreign capital flows are at best a proximate cause. The underlying cause is whatever made it possible for Fannie and Freddie to issue increasing amounts of MBS post-1995.

So what allowed Fannie and Freddie to expand? One answer, and it might be the only answer you need, is that starting in the mid-1990s, Fannie and Freddie were encouraged by the President and Congress to relax their previous standards for which mortgages they could buy. They were encouraged to buy loans from low-income individuals and the percentage of their business accounted for by such borrowers was required to grow steadily. See the two charts at the end of this HUD paper, written in 2001. Fannie and Freddie started buying loans with low down payments and loans with incomplete documentation. Is this enough to explain what happened? I don't know, but it's a good place to start. More details in the first half of my essay on the crisis. Here.

The other thing that happened in 1997 was the government made it a lot easier for people to avoid capital gains taxes on homes. Before 1997, you had to buy another house of equal or greater value. After 1997, you didn't have to roll the gain over. Did this increase the demand for housing? I haven't seen a careful analysis of this but there is an unambiguous effect of the 1997 tax change: you could avoid the capital gains on a second home as long as you lived in it for three of the previous five years. This encouraged the purchase of second homes.

And what about those animal spirits? What do you need them for? What got them started? Why did people all of a sudden in 1997 start thinking housing was a better investment than they had thought before? Certainly once prices began appreciating people might buy houses for the investment return. But what gets them started? The animal spirit theory isn't much of a theory.

So if you want to know why housing prices accelerated in 1997 and then racheted upward once more in the early 2000s, I would focus on government's bipartisan attempt to engineer an increase in home ownership that ratcheted upward in the 1990′s and extended through the 2000′s. Then add the implicit backstopping of the creditors from large financial institutions. Large financial institutions that lent money to others to buy AAA-rated MBS were very leveraged. This leveraging allowed enormous sums of money to flow into MBS. Those creditors should have been wiped out in 2008. But almost none of them were. Just as they had been protected in the past, they anticipated being protected again. So they lent money recklessly and allowed the funneling of trillions of dollars into housing. Bad idea. Bad allocation of capital. Bad result for the taxpayer. Bad effects on future incentives. Again, the whole story is here. But the point I want to emphasize here is that when we talk about why the housing went crazy between 1997 and 2007, let's not stick with interest rates, capital flows, and animal spirits. Let's remember the role of bad economic policy in the housing market and the financial sector.

Who's 'Outcompeting' Who?

Here's a letter to the Programming Director of WTOP news radio in DC:

During today's 11am hour your anchors interviewed a "trade expert" with the AFL-CIO who asserted that "China, with its low wages, will outcompete the U.S. for investments and customers unless Congress intervenes."

Forget that this "trade expert" seems to be unfamiliar with the principle of comparative advantage.  Let's look at some relevant empirical evidence – namely, the amount of foreign direct investment (FDI)* that China has received over the past decade compared to the amount that the U.S. has received.  If the "expert's" claim is correct, China should be receiving more FDI than is America as investors swarm into that Asian nation to take advantage of its low wages.

But in fact, over the ten-year span 2000 through 2009, the total amount of FDI received by China was $685.8 billion, while the total amount of FDI received by the U.S. was $1,799.1 billion.  That is, America's inward FDI was 162 percent higher than was China's.  On a per-capita basis, the figure is even greater: America's per-person inward FDI during these years was ten times (!) greater than was China's.**

So much for the case that low-wage countries suck investments away from high-wage countries.

Sincerely,

Donald J. Boudreaux

* As defined by Richard Caves, Jeffrey Frankel, and Ronald Jones on page 285 of the 9th edition of their widely used textbook World Trade and Payments (Addison Wesley, 2002), "Foreign direct investment occurs when the residents of one country acquire control over a business enterprise in another country.  The acquisition may involve buying enough stock in an existing enterprise to become a controlling shareholder…., taking over the enterprise outright, or building a new factory or enterprise from scratch…."

** FDI figures were calculated using this very helpful database from UNCTAD.

Old time religion

Obama's recent anti-regulation stance isn't fooling David Harsanyi. Read it here. Excellent.

Macro vs. Micro Thinking

Here's a letter to the New York Times:

David Leonhardt says that unemployment remains high in the U.S. largely because "American employers operate with few restraints….  Many companies can now come much closer to setting the terms of their relationship with employees" ("In Wreckage of Lost Jobs, Lost Power," Jan. 19).

Only six paragraphs later, though, Mr. Leonhardt reports that "In this country, average wages for the employed have risen faster than inflation since 2007, which is highly unusual for a downturn."

If American employers are so powerful, why are real wages rising despite high unemployment?  One explanation is that employers magnanimously pay more than they must to get the workers they need.  A better explanation is that competition for workers remains intense.  If true, this fact suggests that workers are not so interchangeable as they are believed to be by Mr. Leonhardt and others who advocate simplistic programs to "share" existing jobs.

Unemployment will fall only when new jobs – new opportunities – are created for the specific talents of workers now unemployed.  Surely if businesses were as powerful as Mr. Leonhardt asserts, they would already have jumped at the opportunity to profit by tapping into the talents of today's millions of unemployed Americans.

Sincerely,

Donald J. Boudreaux

It's important always to keep in mind the perspective suggested by Arnold Kling's acronym PSST: patterns of sustainable specialization and trade

They're Only Human

If only Hizzoner Bloomberg and the rest of NYC's government were as good at removing snow from city streets as they are at from removing entrepreneurs from city streets….. (HT Perry Eidelbus)

Any Color as Long as It's Black

This five-minute video offers an interesting history of Henry Ford's Model-T.  (HT Whit Whitman)

Dem Catfish Farmers is Jumpin'

Here's a letter to CBS News.com:

You write that "Back in 2003, 3 percent of U.S. catfish sales came from foreign countries.  In 2009, that grew to 57 percent.  CBS News Correspondent Mark Strassmann reports that farmers in Alabama are fed up and want the government to do something about it" ("Catfish Imports Worry U.S. Fish Farmers," Jan. 17).

Translation: "Audaciously spending their own money as they choose, more and more American consumers are buying catfish from foreign suppliers.  CBS New Correspondent Mark Strassmann reports that catfish farmers in Alabama are fed up and want the government to stop each of these consumers from spending his or her money as that consumer sees fit and, instead, to spend his or her money in ways that American catfish farmers see fit."

Sincerely,

Donald J. Boudreaux

(HT Tim Townsend)

Some Links

Fred Foldvary makes the case for free banking.

Paul Jacob – commenting upon a plan by Doug Bandow – explains why black markets can make our lives brighter.

Tibor Machan analyzes Paul Krugman's moral stance.

Scott Lincicome helps put the hysteria over the dollar-renminbi exchange rate in perspective.

Ronald Coase was recently interviewed on the role of the journal that he edited so expertly for many years: the Journal of Law & Economics (HT Josh Wright)

Bryan Caplan discusses immigration with an angry Republican.

Corrupt cronies

In the old days, when we pretended Fannie and Freddie were private, profit-maximizing organizations, banks and other originators who sold them bad mortgages that did not conform to Fannie and Freddie's requirements would be on the hook for those mortgages if they ended up not paying off. In other words, Fannie and Freddie guaranteed payment unless a bank or an originator violated Fannie and Freddie's rules.

It turns out that many of the mortgages that failed did not comply with Fannie and Freddie's rules. That gives Fannie and Freddie the right to demand payment from the originators that defrauded them. But now Fannie and Freddie are under government "conservatorship" and they are negotiating settlements. Rather than demand the whole amount they (or should I say "we" now that they are publicly managed) are owed.

Bank of America, for example, recently agreed to pay us Fannie and Freddie $2.8 billion. Sounds like a lot of money. But as the Washington Post reports, this is not a lot of money relative to what it could have been:

Bank of America said its $1.3 billion payment to Freddie Mac extinguishes all outstanding and potential repurchase claims on 787,000 mortgages that had total unpaid principal balances of $127 billion.

What a good deal for Bank of America. What a lousy deal for you and me. Ally Bank also got a good deal:

The Bank of America agreement is Fannie Mae's second recent settlement over mortgage issues. On Dec. 27, Ally Financial, formerly known as GMAC, announced that its mortgage unit agreed to pay Fannie Mae $461.5 million to eliminate its liability for loans with unpaid principal of $84 billion. Under that deal, the FHFA agreed to withdraw subpoenas it issued last year in a probe of industry practices.

It gets worse. CitiGroup is STILL MAKING BAD LOANS AND SELLING THEM TO YOU AND ME FANNIE AND FREDDIE! When I say "bad loans" I don't mean loans that turn out badly. That is an inevitable part of lending. I'm talking about loans that violate the underwriting requirements of Fannie and Freddie. Bloomberg reports (HT to Tim Townsend):

Three years after bad home loans helped trigger the recession and six weeks after the government cashed in the last of its $45 billion Citigroup investment, the New York-based bank is still selling mortgages that violate quality standards, according to an internal Freddie Mac review obtained by Bloomberg.

Fifteen percent of the performing loans Citigroup sold to the government-owned mortgage-finance company in the second half of 2009 and the first half of 2010 had such flaws as missing appraisals or insurance documents or income miscalculations, according to the review of 375 mortgages. The target for defects should be about 5 percent, said Tim Rood, a former executive with Freddie's sister agency, Fannie Mae, and now managing director at Washington-based advisory firm Collingwood Group LLC.

Bloomberg couldn't get the CEO of Citi, Vikram Pandit, to comment on the story. But they did manage to get a fantasy quote from one executive:

Sanjiv Das, New York-based chief executive officer of CitiMortgage Inc., the Citigroup unit that originates loans and buys them from smaller lenders, declined to comment on the Freddie Mac findings. He said the bank's own quality control reviews show an improvement in underwriting that "is one of the most outstanding stories in our business." Freddie Mac has no published standard for defect levels.

"My own information based on our defect rates tells me we are doing a fantastic job," Das said.

I love that word–fantastic. If you're going to go out on a limb, go all the way out, baby. So when your defect rate is THREE TIMES what it should be, just claim you're doing not just an acceptable job or a decent job or that the job is difficult and mistakes are inevitable. No. Claim you're doing a FANTASTIC job. And what justifies that claim. Your own information. Perfect.

Here is some more data that is not from Citi:

In Freddie Mac's review of Citigroup's performing loans — those on which borrowers were still paying — the portion rated as "Not Acceptable Quality" fell to 9 percent in the third quarter's sample from 32 percent in the fourth quarter of 2009, according to the Freddie Mac memo. The average defect rate in the 12 months through Sept. 30 was 15 percent.

But don't worry:

Mortgage buyers such as McLean, Virginia-based Freddie Mac, which packages the loans into securities for sale to investors, can ask for their money back if they find that Citigroup or other originators sold them mortgages that failed to meet underwriting standards.

Doesn't that inspire confidence, given the story on Bank of America?

And here's a nice summary of how generous the government has been with my money and yours already:

Citigroup received $45 billion in investments from the U.S. government in 2008 and $301 billion in asset guarantees, making the bank the biggest recipient of U.S. taxpayer bailout support. The investment has been paid back and the guarantees canceled. Last week, the government, which still owns warrants to buy 465 million of the bank's shares, announced a plan to auction them off before the end of March.

What we are living through now is the continuing of the looting process. Get the government out of the banking business. The process is corrupt. The cronies are winning. You and I are losing.