Connecting Household Balance Sheets to PSST

Interesting comment found by Glenn Reynolds. From Jeffrey Levin:

If you dig around and research start-ups you will find that the majority of start-ups are funded by second mortgages or HELOC draws. Due to the housing crash, that equity is just not there for the vast majority of people looking to start up a new business. Its one of the large reasons why commercial credit expansion has been so moribund. Without getting off the ground from seconds or HELOC’s all those startups that would have made it past year 1 and then been able to obtain standard commercial business loan never got off the ground and thus never graduated to commercial loan financing. You have to walk first before you can run. Startups don’t start in the commercial loan department (at least most of them don’t).

Recalculation means discovering new patterns of sustainable specialization and trade. Doing so requires entrepreneurial trial and error. As Levin points out, the stereotypical 20-year-old in a garage is actually atypical. Most entrepreneurs are like I was, forty years old and risking accumulated wealth. If my wealth had suddenly been halved in 1993, I doubt that I would have started a business in 1994.

And whose wealth got crushed by the housing crash? According to a paper by Edward Wolff, as cited in the WSJ blog:

The big drop in home prices between 2007 and 2010 meant a 59% loss in home equity for people under 35, compared with just 26% for people generally. That meant a massive loss of wealth, or “net worth” — what people own minus what they owe. People ages 35-44 saw a 49% fall in home equity.

Thanks to Mark Thoma for the pointer.

Home Ownership’s Negative Employment Externalities

David G. Blanchflower and Andrew J. Oswald write,

We explore the hypothesis that high home-ownership damages the labor market. Our results are relevant to, and may be worrying for, a range of policymakers and researchers. We fi nd that rises in the home-ownership rate in a US state are a precursor to eventual sharp rises in unemployment in that state. Th e elasticity exceeds unity: A doubling of the rate of home-ownership in a US state is followed in the long-run by more than a doubling of the later unemployment rate. What mechanism might explain this? We show that rises in home-ownership lead to three problems: (i) lower levels of labor mobility, (ii) greater commuting times, and (iii) fewer new businesses. Our argument is not that owners themselves are disproportionately unemployed. Th e evidence suggests, instead, that the housing market can produce negative externalities’ upon the labor market. Th e time lags are long. Th at gradualness may explain why these important patterns are so little-known.

Pointer from Steve Goldstein of the WSJ.

I would suggest viewing these findings as tentative at best. As the authors write,

We are unable, in this paper, to say exactly why, or to give a complete explanation for the patterns
that are found

There are many conceivable explanations for the findings. Bear in mind that conventional macro distinguishes between cyclical and structural unemployment. To aggravate structural unemployment, home ownership would have to result in permanent mis-matches between skills and labor demand. To aggravate cyclical unemployment, home ownership would have to make wages stickier, or somesuch. In a PSST framework, home ownership would have to make it more difficult for entrepreneurs to discover new forms of comparative advantage.

I personally would rate as low the probability that there is truly a causal relationship between home ownership rates and subsequent unemployment rates. Still, it is refreshing to see a paper that runs counter to the “home ownership is great” mantra.

My Testimony’s Impact

From a blog on title insurance.

Immediately after hearing the testimony, the American Land Title Association reached out to Financial Services Committee staff to correct the record and to serve as a resource to the Committee. During that conversation, staff confided that they “do not anticipate the Committee pursuing it any further…I really don’t see any momentum here on going deeper than Dr. Kling’s suggestion.”

Shock me, shock me.

If Economists had a PAC

It would not lobby for what one of Tyler Cowen’s readers calls

political solutions which represent common sense agreement on a variety of issues

My guess is that it would lobby for more NSF grants in economics and more college subsidies for students to take economics courses. Or for barriers to competition that might reduce the incomes of American economic professors.

To see what PACs are all about, follow my rants about housing policy (note that Tyler links to data saying that the realtors are the largest PAC, and they donate almost equally to both parties). Or John Cochrane’s rant on energy policy absurdities. Or follow the Washington Post editorial page as it discusses Montgomery County unions.

If libertarians are guilty of averting their eyes to economic inequality, then progressives are guilty of averting their eyes to the reality of public choice.

Questions Lifted from Comments

Why do we have the axes that we have and why do some people adopt one axis over another? Is it nature, nurture, free will or something else? Is it is more than just group identity and signalling?

I think that the oppressor-oppressed axis must have very deep roots in human nature. I look at the Passover story of Pharoah and the Jews as a story that is readily told in terms of that axis. I know, I know, it can be read in terms of freedom and coercion also, but it’s not as if the “happy ending” frees everyone.

I also think that the civilization-barbarism axis has roots that go deep, because it ties in with xenophobia. It is common to view “the other” as barbaric, and therefore to view the prospect of defeat by the other in cataclysmic terms.

Perhaps it is the freedom-coercion axis that is most unnatural. Most people think that government has existed and always will exist. They are not necessarily wrong. And my guess is that most Americans feel that, on balance, state power is exercised for them rather than against them. Again, they are not necessarily wrong. I would guess that while libertarians raised objections to the way the police in Boston handled the aftermath of the Marathon bombing, if you were to take a poll, the support for the authorities among the public at large would be overwhelming.

In answer to the third question, I think that the axes are most useful for group identity and signalling. Framing an issue in terms of the axes is a way to dog-whistle to those with whom you agree. Characterizing those who disagree with you as being at the opposite end of your preferred axis (“they only want to help the rich!” “they just want to tear down America!” “they just want a police state!”) is a way to reinforce your own group identity.

I don’t know how to predict your preferred axis based on some other characteristic. But I will predict that articulate, politically-engaged people in the U.S. will tend to gravitate toward one axis, and to use that axis for group-identity and signaling purposes. I do believe that it is human nature to take mental shortcuts and to pursue status within a tribe. As Brink Lindsey pointed out at lunch at Cato yesterday, the more we learn from experimental cognitive psychology, the more we see that we are prone to biased thought processes. Perhaps as more people become aware of these biases, they will be more willing to detach themselves from any particular axis.

What areas do the axes agree on and why? Do we at least agree on the liberal project (broadly defined) of individual rights, democracy and science, but disagree on the right mix?

I would not think of the axes as philosophical pillars. Again, I think they perform tribal functions, including group identity and signaling. Certainly, there are general areas of agreement among all three groups. But “individual rights” mean different things to different tribes: one tribe believes in a “right to health care” and the other ones don’t; One tribe believes in the “right to life” (vs. abortion) and the other ones don’t; One tribe believes in the “right to ingest whatever substance he or she wants” and the other ones don’t.

Do people change axes or moderate their views over time? What might cause a change or moderation?

I have changed axes over time. In 1970, I was with Noam Chomsky, who explained the Vietnam war in oppressor-oppressed terms, as driven by American corporations seeking to dominate Vietnamese markets. I think that if you are capable of realizing that your tribe’s position is silly (as this one was), you are capable of change or moderation. And I think every tribe has taken a silly position at one point or another (and by the way, I still think that the Vietnam War was a terrible mistake, but the process by which that mistake was made was complex.)

in what circumstances will the rent-seekers triumph over the technocrats in affecting policy? Virtually every time? Or can the technocrats rally enough support from their drummer pals to defeat them, and if so, in what circumstances?

My father, who unlike me was a political scientist, would have taken a hard line on this one. He would have said that the rent-seekers (he would have called them insiders or interest groups) win every time. The tribal drummers serve as “useful idiots,” creating drama that captures the imagination of the public, while in the back rooms the insiders divide up the goodies. I should note also that he did not feel outraged by this. He just thought it was the natural order of things. In fact, if you had asked him, “What should I personally do about this?” his answer probably would have been “Become an insider!”

The technocrats can operate along some margins, particularly in areas where rent-seekers give them some slack. But when the stakes in terms of rents are high, you should always bet on the rent-seekers. So the Fed has a little slack in terms of choosing to pursue slightly higher or lower inflation. It probably had a lot less slack in choosing whether to bail out Citi and Goldman.

Technocrats, Rent-seekers, and Tribal Drummers

Today at Cato, John Samples hosted a discussion of my e-book on the Three-Axes model. One of the interesting questions came from Matt Yglesias, who asked about the role of columnists who are less tribal, or even anti-tribal, in their orientation. My thinking is that their views receive less amplification (as measured, say, by blog citations) than the tribalists. However, as Matt points out, the tribal drummers may have less influence on policy setting, where technocrats and centrists hold more sway. This leads me to posit the following matrix, which captures my views of the relative significance of different types of players in the mediasphere, partisan election results, and policy setting.

Actors Mediasphere Partisan Elections Policy Setting
Tribal Drummers high medium* low
Technocrats low low medium
Rent-seekers medium low high

The Tribal Drummers are folks who can clearly be identified using the three-axis model as progressives, conservatives, or libertarians. I call them tribal drummers because they whip up enthusiasm among those who agree. If you want to have a lot of significance in the mediasphere, it is best to be a tribal drummer. Also, you may have some influence on partisan elections. By partisan elections, I mean the contests between Democrats and Republicans. It is probably easier to argue that the tribal drummers have influence on primaries than on partisan elections.

*Libertarian tribal drummers have a lower influence on partisan elections than progressive or conservative tribal drummers, because libertarians do not have a party.

Technocrats are pundits and policy wonks who tend to be centrist in orientation. I claim that they are not amplified much in the mediasphere. They do get involved in the policy game. I think of Ezra Klein as someone who wants to be both a technocrat and a tribal drummer, and in my opinion he would do better to close off the latter option.

Finally, rent-seekers are folks who know what they want from policy and focus on getting it. Thus, their influence on policy is high. Because they buy influence on both sides, their significance in partisan elections is low. The one exception that comes to mind would be teachers’ unions, who are both rent-seeking and strongly partisan. I also claim that rent-seekers have a lot of influence in the mediasphere, because I think that they are very good at shaping the battle space. What I have in mind is the housing lobby, which is amazing at shaping how housing issues are presented in the media.

This matrix might still leave out the sorts of columnists that Matt Yglesias mentioned, e.g., Thomas Friedman. Friedman is not a technocrat, tribal drummer, or policy wonk. In fact, the category I would put him in is suck-up (and, no, I am not being charitable). I think there is a niche for journalists who write to make important people feel even more important. These journalists go to places like Davos and admire the leaders with whom they rub elbows. The CEOs and politicians write warm blurbs for their books, and so they sell well, even while the tribal drummers and others in the mediasphere dismiss them as insipid.

The Illusion of Explanatory Depth

Philip M. Fernbach, Todd Rogers, Craig R. Fox and Steven A. Sloman write,

We hypothesized that people typically know less about such policies than they think they do (the illusion of explanatory depth; Rozenblit & Keil, 2002) and that polarized attitudes are enabled by simplistic causal models. We find that asking people to explain policies in detail both undermines the illusion of explanatory depth and leads to more moderate attitudes (Experiments 1 and 2). We also demonstrate that although these effects occur when people are asked to generate a mechanistic explanation, they do not occur when people are instead asked to enumerate reasons for their policy preferences (Experiment 2). Finally, we show that generating mechanistic explanations reduces donations to relevant political advocacy groups (Experiment 3). The evidence suggests that people’s mistaken sense that they understand the causal processes underlying policies contributes to polarization.

This paper was cited in a recent WSJ article by Daniel Akst, forwarded to me by a reader.

Capital Structure Arbitrage

James Hamilton looks at recent stock market behavior.

Fernando Duarte and Carlo Rosa of the Federal Reserve Bank of New York surveyed 29 different forecasters and models for their calculation of the expected return on stocks relative to that on bonds. Obviously you want to take anybody’s claim that they know where the stock market is headed with a rather large grain of salt. But it’s interesting that the consensus assessment of this group is that stocks will outperform bonds by as high or higher margin as ever would have been expected over the last half century.

Investment-grade corporate bonds yield about 3 to 3-1/4 percent these days in nominal terms. In real terms, that is something closer to 1-1/2 percent or less. Meanwhile, according to Hamilton, Shiller’s backward-looking P/E ratio on stocks is 23.4. Taking 1 over that, you get something like 4 percent as the real yield on stocks.

It would seem as though any corporation (such as Apple, which has been doing this) that can issue bonds at a real yield of 1-1/2 percent and buy back stock. Rinse and repeat until your bond investors get scared and drive up the yield. This lowers your cost of capital–it is nearly an arbitrage. So much for Modigliani-Miller.

There is something going on in financial markets that I do not understand. Is the Fed’s quantitative easing powerful enough to drive the real ten-year rate below zero? Could be, but I doubt it.

Pundits talk about a huge demand for safe assets. But for me, that does not explain ten-year bond yields. Ten-year bonds do not look like safe assets to me. They look dangerous as hell.

If I ran a hedge fund, my main bet would be deep out-of-the-money puts on bonds. I would keep enough cash to keep rolling over this bet for five years or until it pays off, whichever comes first.

Evaluating the Null Hypothesis in Education

Andrew Coulson links to a study in the UK. The study reports that

From the analysis of the available data, there is no clear correlation between funding and school average performance; for a given level of funding, there is significant variation in performance the calculated correlation coefficient between the two variables was less than 0.1. In our view, this suggests that the level of funding, per se, is almost irrelevant as a predictor of performance.

Having said that, the study does find a correlation between a measure of school quality and average student performance. That result would contradict the null hypothesis. However, the indicator that the researchers use for school quality is not convincingly exogenous.

the Ofsted ‘overall effectiveness’ indicator has been used as our measure of school quality. This is a combined assessment of schools’ performance that contains specific judgements on:
— pupils’ achievement and the extent to which they enjoy their learning;
— how well do learners achieve;
— pupils’ behaviour;
— the quality of teaching; and
— the effectiveness of leadership and management in embedding ambition and driving improvement.
The ‘overall effectiveness’ judgement is then made on a four-point scale: outstanding (1); good (2); satisfactory (3); and inadequate (4)

Coulson also supplies a chart demonstrating the null hypothesis in American education spending.