John Cochrane on Housing Finance

He writes,

Suppose that mortgages were bundled into securities, intermediated by mutual funds whose values float, just like those of equity mutual funds, and held around the world in retirement accounts, pension funds, and our endowments’ portfolios, without government guarantees at every step. This would be a terrific financial structure

I think that this would be an improvement. However, the household demand for risk-free assets might lead banks or money-market funds to offer fixed-rate instruments backed by these floating-rate securities. Add enough leverage and you have a very shaky financial structure. In any case, I continue to believe that if there were no government actions distorting the price differential between a thirty-year mortgage with an interest rate fixed for just five years and a thirty-year fixed-rate mortgage, the latter would cease to dominate the housing finance system in the U.S.

Burt Malkiel vs.John Cochrane on Investment Managers

In the Journal of Economic Perspectives, Malkiel writes,

The major inefficiency in financial markets today involves the market for investment advice, and poses the question of why investors continue to pay fees for asset management services that are so high. It is hard to think of any other service that is priced at such a high proportion of value.

Cochrane writes,

After all, active management and fees have survived 40 years of efficient-market disdain. Economists who would dismiss “people are stupid” as an “explanation” for a pricing anomaly that lasts 40 years surely cannot use the same “explanation” for the persistence of active management. Economists who think the evidence favors lots of “inefficiencies” in the market are even less well placed to deplore active management. They should conclude that we need more, or at least better, active management to They should conclude that we need more, or at least better, active management to correct the market’s inefficiencies. Their puzzle is the inability of existing managers correct the market’s inefficiencies. Their puzzle is the inability of existing managers to pick low-hanging fruit. to pick low-hanging fruit.

I suppose that one can believe that there are a lot of inefficiencies in the market and also believe that active managers are so bad at finding these inefficiencies that they actually make things worse.

Anyway, read the whole essay.

What I’m Reading

New books by Kevin Williamson and by Tim Kane and Glenn Hubbard. Both take as their premise the thesis that the U.S. is on an unsustainable fiscal course. In The End Is Near and It’s Going to be Awesome, Williamson treats this as an opportunity, while in Balance, Kane and Hubbard treat it as a threat. Perhaps it would be appropriate at some point to jointly review them at length.

If I might boil the Kane-Hubbard book down to one sentence, it would be that without a balanced budget amendment to avert fiscal collapse, America will lose its great power status. I can imagine conservatives, thinking in terms of the civilization-barbarism axis, nodding firmly in agreement. However, by the same token, I can picture progressives and libertarians shrugging with indifference.

Williamson appears to be in the latter category. So far (I am less than 1/3rd finished), the book is assembling a standard array of libertarian arguments. Anyone who already resonates to the freedom-coercion axis is bound to like it. My guess is that Williamson is headed toward an embrace of what I have called civil societarianism. So far, it looks as though he is arguing for views that I share, although he expresses them with greater certitude.

From Permanent Press to Permanent Clean

Walter Russell Mead writes,

A Kickstarter success story making the rounds of the Internet this week caused us to perk up our ears here at Via Meadia. A Brooklyn-based company called Wool & Prince has developed a dress shirt that doesn’t require ironing and can be worn for extended periods of time without it starting to stink.

Pointer from Nick Schulz, who reminds me that in our book we talked about the progress represented by permanent press and speculated that in the future we might see permanent clean.

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.