Welcome to California, Elliot Hirshman

San Diego State University, a place I admire a lot, just hired Elliot Hirshman as its new president, at a controversial salary. I am not exactly sure what I believe about how much public university presidents and provosts should be paid, but I do know that Elliot was an excellent hire for SDSU, and therefore for California.

Elliot was Chief Research Officer at George Washington when I was there, and I served on a university committee that he chaired.  He was and am sure still is a good leader, good listener, and problem solver.  Research service for faculty at GW improved considerably during his tenure.  

If I am reading the deal correctly...

....this is not a compromise, this is a capitulation.  I am starting to think that Cornell West's characterization of Obama was correct.

Jenny Schuetz, Elizabeth Currid-Halkett and I have a new paper that has nothing to do with the debt crisis

It is here.

Abstract:     

The art market is famous – or notorious – for auctions at Sotheby’s and Christie’s at which works by well-known artists are sold for stratospheric prices. Researchers have argued that such prices are volatile and unpredictable based on economic fundamentals, implying that at least some segment of the art market behaves irrationally. In this paper, we examine whether the broader art market, composed mostly of small galleries, is more consistent with standard economic models. In particular, we ask whether the location patterns of art galleries exhibit behavior consistent with agglomeration economies, as would be predicted for retail firms selling highly differentiated and expensive products. Using a newly developed database, we find strong evidence of agglomeration economies among Manhattan art galleries from 1970-2003. Galleries locate in highly concentrated spatial clusters, and these clusters are more likely to occur in neighborhoods with affluent households and older, more expensive housing, consistent with locating near potential consumers. We find no evidence that galleries locate in cheap, “bohemian” neighborhoods. The highest quality tier of the art market, which has been most widely studied, contains a relatively small share of gallery establishments, although these “star” galleries have a longer average lifespan than non-star galleries. Locating near other galleries also increases the longevity of firms and establishments.

Are we a 15 percent society or an 18 percent society?

Over the long term, federal revenues as a share of GDP have averaged around 18 19 percent over the past 20 years.  Currently, federal revenues as a share of GDP are about 15 percent.  Some of the difference arises from lower tax collections because of the recession, but most is the result of the Bush Tax cuts.  Obama cut taxes even more (yes, he has cut taxes--payroll tax reduction, housing tax credit, etc.).

The question is, do we want to be a 15 percent society?  I guess the Teapartiers would say yes.  But this would not just mean that we need to do things like slowly extend the retirement age and bend the cost curve on health care--it would mean that to reach long run sustainability, we would have to cut current benefit levels.

Even Paul Ryan's budget plan presumes revenues would increase to 18 19 percent of GDP--it just doesn't specify how to get there.  Personally, I think we can afford to spend even more on the sick and the elderly (and children), but we need to be willing to pay for it.  For the time being, I would be happy to return to the long-term revenue average.

If we follow the 15 percent path, we will be kicking grandmothers out of their wheelchairs.  We will be allowing children to be malnourished.  This is not demagoguery.  This is the cost of not being willing to tax ourselves at the level we have for many years taxed ourselves.

This is probably a crazy, stupid idea for getting around the debt ceiling, but...

...here goes anyway. 

Consider a 30-year Treasury Bond with a coupon of 4 percent and a par value of $100.  Treasuries pay every six months, so this produces 60 cash flows of $2 and then $100 at the end of the 30 years.

To make things easy, assume for a minute that that market is discounting 30-year bonds at 4 percent per year (or 2 percent per six months).  Suppose the US government offers investors a swap of 4 percent coupon bonds for 8 percent coupon bonds.  If we don't worry about duration issues for a moment, and use Excel notation (I don't know how to get Greek symbols in blogger), investors would be indifferent between:

PV(.02,60,2)+100/(1.02^60)

and

PV(.02,60,4X)+100X/(1.02^60).

X is the face value of the new bond, and comes out to about $58.99.  So the face value of the debt is reduced by 41 percent, while the value to investors remains constant.  Nothing of substance has changed (and actually duration risk is a little lower), but the balance sheet looks better.

I am sure I am missing some institutional thing here, or maybe my simple finance is off somehow, but still...

Don't lump everyone together, Professor Summers

In his response to Mark Thoma's "Great Divide," post, Larry Summers writes:

Second, as Keynes’ comments on the advantages of being conventionally wrong rather than unconventionally right illustrate, it is a serious mistake to overstate the insights possessed by practitioners in any field.  Anyone in mutual funds will tell you that active managers regularly outperform the market.  Only economic scientists realized they do not.  Contrary to the the implications of Thoma’s column, the best calls on the real estate bubble came from academics like Bob Shiller and Nouriel Roubini, not from any economists involved with the home building or realty industries.

While Summers' point about Bob Shiller and Nouriel Roubini is correct (and what was particularly impressive is that they explained the mechanisms that would create the destruction), he does not acknowledge that non-academic economics, such as Dean Baker and Chris Thornberg, also called the bubble.  On the other hand, lots of academic economists did not see the crisis coming (I certainly did not see the magnitude of it).


It is, moreover, not fair to lump Realtors and homebuilders together.  The Realtors' Chief Economist at the time (whose name I shall not mention) was ridiculous.  But while Dave Seiders, Chief Economist at the time with the National Association of Homebuilders, did not get it right, he did not do badly either.  I remember being impressed with NAHB at the time, because they were not being cheerleaders--they seemed to me to be playing things pretty straight down the middle.

Homer Simpson, Spock, Reaction Functions, and the Debt Ceiling

Imagine a game between Spock and Homer Simpson.  Spock's utility is maximized by saving the galaxy from destruction.  Homer Simpson's utility function is maximized by beer.  Spock gets some disutility from the amount of beer Homer Simpson drinks, because drinking makes Homer obnoxious, but it is less than the disutility he would get from the galaxy being destroyed.  Homer Simpson gets no disutility from the galaxy being destroyed, because he doesn't think it is possible.

Homer thus ties himself to the mast--he must get his beer no matter what--if he doesn't, he will allow the galaxy to be destroyed.  Homer therefore has a stronger negotiating position than Spock.  Similarly, people who think the earth is 4000 years old, that dinosaurs lived with humans, and don't believe there would be consequences to government default are in a stronger negotiating position.

The Mortgage Professor is Worried

Jack Guttentag writes:

...“If a default had the horrendous consequences you describe, and these induce Congress and the Administration to agree finally on an increase in the debt ceiling, how long would it take financial markets to return to normal?”

 Markets would never return to a state where US Government obligations are viewed as riskless. We will pay for this loss of grace forever.

 Investors in fixed-income securities are worse-case oriented, and make a major distinction between the impossible and the unlikely. The current rates that the Treasury must pay investors are based on the assumption that default is impossible. Once a default occurs, it will NEVER again be viewed as impossible. The additional cost of carrying debt on which default is possible will be paid forever....

Read the whole post.

Bad belt-tightening metaphors

A commonplace among politicians that drives me crazy is that "government must live within its means, just like families."

The problem is that families don't, at least within the meaning implied by the above statement.  Personal income in the United States is about $12.9 trillion.  Mortgage debt outstanding is about $10.5 trillion.  Consumer credit outstanding is about $2.4 trillion.  So the ratio of consumer debt relative to consumer income is similar to US government debt to GDP.

I am not saying we needn't worry about long term fiscal balance--we do.  As I have said before, we must, among other things, return tax revenues to at least their long-term mean as a share of GDP, and bend the cost-curve for health care--something that Obamacare actually tries to do. But bad metaphors that basically dishonestly flatter people are not helpful.

Caltrans needs to fix this sign

Visitors to LA get misled by this old freeway sign on the Pasadena Freeway headed south:

The problem is that it is not an interchange with the 101 and the 5--it is just an interchange with the 101, which heads south a couple of miles to the 5.  People look for the 101 South and miss it, because it is nowhere to be found on signs.



  

Tastes in Tax Policy

I confess that I like the broad outlines of the Gang of Six plan.  I don't have a problem with people like me having to wait longer to retire, so long as people who do physical labor get held harmless. 

It occurs to me that I care about substantial progressivity at the bottom of the income distribution (and I am a big fan of the Earned Income Tax Credit).  To calculate progressivity, one needs to take into account ALL taxes, including FICA and state and local taxes.  I also need to think about Mark Thoma's point about the progeressivity of both taxes and benefits--maybe Europe is onto something in using regressive or proportional consumption taxes to finance a strongly progressive safety net.  I suppose the question is whether getting progressiveness out of taxes or spending produces less dead-weight loss.

But once income reaches a certain threshold ($100K per year?), proportional taxes are just fine with me.  A reasonablly flat rate structure with an earned income tax credit, few deductions, and a large exemption would do the trick.

 

Was it Murdoch who ditched the six columns?

This morning, James Taranto defends the Wall Street Journal against Joe Nocera's charges that the paper uses "Democrat" as an adjective.  Whatever.  But as I have been thinking about why I don't find the Journal as compelling as it used to be, it occurs to me that I loved its old lay-out: a lead news story in the left column and a deep feature story on the right.  Both stories would inevitably be rich with useful detail, and I think they made a lot of breakfast-time readers smarter.

I am not sure whether the front page was blown-up during the Murdoch era, but if it was, he has yet something else to answer for.

Lisa Schweitzer, again, writes something I wish I had written

She begins:

I think one of the reasons why there is a resistance to otherwise nice things like local foods and bicycling concerns the often terminally joyless way their advocates present the Great Social Good that The Better People Who Do These Things create, unlike you, you indolent, planet-killing dolt.

Read the whole thing.  

How does Michael Boskin do math?

He writes in the Wall Street Journal this morning:

The lower marginal tax rates in the 1980s led to the best quarter-century of economic performance in American history.

This didn't seem right to me, so I went to the National Income and Products Account web site.  For GDP growth after 1947 (the beginning of the quarterly NIPA data), the best 25 year period was between the first quarter of 1949 and the last quarter of 1973, when the economy grew by a multiple of 2.68.  This is well before Reagan took office.  The period of 25-year spells after Reagan took office is small, but the best period is the fourth quarter of 1982 until the third quarter of 2007, when the economy grew by a multiple of 2.26.

GDP growth likely overstates the benefit of the post Reagan era, because the benefits of the growth have been unevenly distributed.  If we look at median household income, it is really hard to figure out how to find a "best in history" 25 year period after Reagan.

Why can't we have them?

In Asian and European hotels, there is a master switch near the front door of each guest room that is triggered by the insertion of a hotel key--when then key is not in, neither the lights nor air conditioning works.  It allows: (1) to always remember where one put his key and (2) to shut down lots of energy use on departure.

It is such a hassle free way to save energy, I am not sure why these devices aren't everywhere.

Good bye Wall Street Journal.

I have been reading the Wall Street Journal pretty much every day since I was in high school (yes, I was that nerdy--in that, and so many other ways, too).  I disagree with Joe Nocera that the paper has deteriorated badly--it still has many terrific reporters. The team that works on mortgage finance, including Nick Timiraos and Bob Haggerty, is better informed than their counterparts at other papers.

On the other hand, after more than 30 years, the Journal has ceased to be a daily must read for me now.  The Wall Street Journal once would have attacked the News Corporation scandal as fiercely as it attacked the Orange County bankruptcy story and the Enron and Worldcom stories. 

More important, the Murduchs have proven themselves even more eggregious than I expected.  Unlike last time, when David Wessel flattered me into renewing my subscription, I won't do so anymore.  The FT will have to go it alone.

One reason HAMP failed

A remarkable interagency group of economists wrote a paper that investigated the NPV test that is at the heart of HAMP: for a borrower to get a loan modification, the value of the modification must be on net greater than zero (or in the case of Fannie-Freddie loans, greater than -$5000).  In other words, the losses from expected default must be greater than the losses from modification.

An upshot of this rule is that borrowers who are deeply under water get no modifications--because the chance their loan will in the end cure is very small.  This means that borrowers in places that need HAMP most--Las Vegas, Phoenix, Florida, etc.--are least likely to get it, all else being equal.

It also underscores a basic point: in places where values have fallen by more than, say, 50 percent, anything less than principal balance relief just delays the inevitable.  When households in, say, Central California want to move or retire, their house sale will not be sufficient to cover their loan balance.   Even moving to make short sales easier would help.  Otherwise, it is hard to see how we can restart the market anytime soon.

Why is reducing government jobs considered a free lunch?

Politicians love to brag about cutting government work forces.  This month, while the private sector added 57,000 jobs, government shed 39,000 jobs, for total job growth of 18,000, which is basically not different from zero statistically.

Cutting government jobs not only has consumption effects (people who don't get paychecks can't buy stuff), it also has productivity effects.  When the DMV is closed three days a month, people have to wait longer to get their drivers' licenses.  When there are fewer cops, crime increases.  When there are fewer high school teachers, the ability to offer AP courses drops, etc.

Is there waste in the public sector?  Sure.  But for those working in the private sector, particularly large institutions, ask yourself whether everyone you work with is productive.  I have no idea what the "correct" level of public sector employment is.  I also have no idea how much public sector employment crowds out the private sector, but if the crowding out effect is less than one (and with unemployment above nine percent, I am guessing the effect must be less than one), then reducing government employment reduces total employment.  But to think that cutting government employment is a magic pill for economic recovery makes no sense.

 

What is the incidence of the Fannie-Freddie bailout?

There is lot of rending of garments and gnashing of teeth that the FF bailout will cost something like $300 billion, including the implicit subsidy to mortgages that are guaranteed (the cash flow cost right now is something like $130 billion).  So for an economy whose GDP is roughly $14.5 trillion, this is a little more than two percent of GDP.

To whom does the money go?  Given that shareholders were essentially wiped out, it goes to largely three places: holders of Fannie and Freddie debt, the US Treasury (which owns preferred shares in the companies) and homeowners.  I am curious how this shakes out distributionally.  Clearly, homeowners are on average richer than renters, and bondholders are richer than non-bond holders, so the bail-out must have some regressive implications, but it is not clear to me how much so.  It is at least worth thinking about.

  

So Congressman, how do you get to 19 percent?

From Mark Thoma's blog, I pick up the following quote from Paul Ryan:

RYAN: What happens if you do what he’s saying, is then you can’t lower tax rates. So it does affect marginal tax rates. In order to lower marginal tax rates, you have to take away those loopholes so you can lower those tax rates. If you want to do what we call being revenue neutral … If you take a deal like that, you’re necessarily requiring tax rates to be higher for everybody. You need lower tax rates by going after tax loopholes. If you take away the tax loopholes without lowering tax rates, then you deny Congress the ability to lower everybody’s tax rates and you keep people’s tax rates high.

The Congression Budget Office did an analysis of the Ryan Budget plan, which anticipates revenues rising to 18.5 percent of GDP by 2022 and to 19 percent by 2030.  Revenue is currently at 15 percent (Table 1 on page 3).   The CBO followed the following instruction:

The path for revenues as a percentage of GDP was specified by Chairman Ryan’s staff.
The path rises steadily from about 15 percent of GDP in 2010 to 19 percent in 2028
and remains at that level thereafter. There were no specifications of particular revenue
provisions that would generate that path. (see page 11).

If Ryan will only accept closing loopholes in order to cut marginal tax rates, partcularly for the wealthiest Americans, I am hard pressed to see how we get from 15 to 19--would you care to specify Congressman Ryan?
 
I was on a panel last month with Ryan, and was impressed with how intelligent he is, particularly in contrast to Wisconsin's governor.  The fact that he is so intelligent tells me that he knows what a cynical game he is playing.

Kurt Paulson adds more evidence that FF were not leaders into the crisis

 ).

From comments:

I think there is at least one additional and important piece of data in support of your argument which, to my mind, has been underplayed in this whole discussion. FHFA released a research report in Sept. 2010 entitled "Data on the Risk Characteristics and Performance of Single-Family Mortgages Originated in 2001 - 2008 and Financed in the Secondary Market." Of particular importance is Figure 8 (page 16), entitled "Ever 90-Day Delinquency Rates on Higher Risk Single-Family Mortgages Originated from 2001 through 2008 and Sold into the Secondary Market, by Origination Year." While not a great title, the graph shows that for Higher Risk loans, PLS default rates were ALWAYS higher than GSE loans for vintage 2001-2007 loans. A frequently repeated claim is that the GSEs (whether or not through their "affordable" goals) caused a reduction in underwriting standards and therefore caused the crisis. As you point out, this is false - despite some bad actions by the GSEs. What this Figure 8 demonstrates is that it PLS defaults for similarly situated borrowers were substantially higher. Private securitization cannot be blamed entirely for the crisis: but it cannot be excused. These data seems to suggest that PLS underwriting was worse than the GSEs. The report and data can be found at: http://www.fhfa.gov/Default.aspx?Page=313 (but I can't seem to link to the Figure itself).

Mark Thoma and Dean Baker are correct: Fannie Mae and Freddie Mac did not start the crisis.

Rather they followed it.  The data showing how private label securities led us into the mess is here.  Mark Thoma and Dean Baker take down the Will-Brooks-Morgenstern-Rosner meme that in the absence of Fannie and Freddie, we would not have had a financial crisis.

Did Fannie and Freddie behave admirably?  In many respects no, but they did maintain underwriting discipline longer than most of the rest of the mortgage market.  On the other hand, their bad behavior from early in the decade prevented them from leading the market: accounting scandals (Freddie understated earnings while Fannie overstated them) led the companies' regulator, OFHEO, to require both companies to improve their capital ratios, which meant they needed to shrink their share of the mortgage business.

The most disturbing part of the attacks on the GSEs is that it is an indirect method for blaming minorities and the poor for the financial crisis, an argument that is at once ludicrous, disingenuous, and reprehensible. (Once again, I should disclose that I worked for Freddie from September 2002 until January 2004.  I should also note that the fact that I stayed there for such a short period reflects in part a lack of particularly warm feelings for the company.  I do own a few hundred worthless shares of Freddie Mac stock).

President Obama and Regulation vs. Pricing

I opened my New York Times this morning to see that President Obama wants to raise fuel economy standards by twofold over the next 14 years.  I have no doubt that the goal of reducing fuel consumption is a good one, but doing it using regulation is clumsy and could be counterproductive.

First, such regulations could hurt welfare in three ways: if it drives up production costs, it will reduce the number of cars sold and hence have an adverse impact on employment.  Second, it could lead to cars that people don't want, and so consumer welfare is reduced.  Third, if cars get high mileage, people will drive them more--not enough, in all likelihood, for total fuel consumption to go up, but enough to create other negative externalities, such as congestion.

But what of the fact that fuel consumption produces negative externalities?  That it leads to greenhouse gas emissions and  endangers our security?  The best way to deal with a negative externality is to impose a Pigou tax--one that requires consumers to pay for both the private and social costs of their actions.  If the US had gas prices more similar to what we observe in other parts of the developed world, it is likely that people would generally choose more fuel efficient cars, but that those who wanted big cars even in the face of higher gas prices would be able to buy them.  At the same time, such a policy would discourage driving (better fuel economy encourages driving), and would therefore help relieve congestion a bit.  The revenue raised by a gas tax could also be used to fund transit and provide a tax cut to those most hurt by higher gas prices--those at the lower end of the income distribution.

Sometimes even white guys overachieve