Some Institutional Knowledge

Posted on February 14, 2013 by Arnold Kling

the organizational capability of servicers could have played a very important role in determining the rate of modifications and foreclosures during a financial crisis — and such capability takes a long time to build.

The policy wonks thought that they could implement a mortgage refinance program just by snapping their fingers. In real organizations, planning, testing, and training are necessary.

I could have warned policy makers about this (indeed, I did, at a Congressional hearing). In my forthcoming online housing course, I plan to discuss the business processes involved in mortgage lending. I think that this is important information for policy makers to have. However, you will not see academic economists interested in these sorts of details. Piskorski and Seru seem to have stumbled onto reality by way of the data ex post, rather than through industry experience. This puts them way ahead of folks like Joe Stiglitz and Martin Feldstein, who style themselves as experts on housing finance but who I regard as ignoramuses on the topic.

At best, I hope to interest some mid-level government staffers and research assistants in my course. If they can communicate up to the policy makers, maybe the ignoramuses will do less damage.

The New Fraud Paper

Posted on February 14, 2013 by Arnold Kling

It is by Tomasz Piskorski, Amit Seru, and James Witkin.

We find that mortgages with misrepresented owner occupancy status are charged interest rates that are higher when compared with loans with similar characteristics and where the property was truthfully reported as being the primary residence of the borrower. Similarly, interest rates on loans with misrepresented second liens are generally higher when compared with loans with similar characteristics and no second lien. Given the increased defaults of these misrepresented loans, this suggests that lenders were partly aware of the higher risk of these loans. Strikingly, however, we find that the interest rate markups on the misrepresented loans are much smaller relative to loans where the property was truthfully disclosed as not being primary residence of the borrower and as having a higher lien. This suggests that relative to prevailing interest pricing of that time, interest rates on misrepresented mortgages did not fully reflect their higher default risk.

Pointer from Mark Thoma.

My thinking goes like this. There are some loan brokers who have a reputation for participating in fraud, so they have a smaller choice of lenders that will do business with them. Customers of those brokers end up paying higher rates as a result. The lenders who do not blacklist those brokers wind up being adversely selected. They think they are getting a higher profit margin on these loans than other loans, but in fact the reason that they can get away with (slightly) higher interest rates is that other lenders (rightly) will not touch loans from the same source.

As I said when I first heard about this paper from Luigi Zingales but did not know where to find it,

Zingales says that the bankers should be prosecuted. He makes it sound as if the lenders would record a loan internally as backed by an investment property and report it to investors as an owner-occupied home. That would require a much more complex conspiratorial action on the part of the lender, and until I learn otherwise, I will doubt that it happened.

Indeed, the authors of the paper looked at one infamous now-bankrupt subprime lender, New Century.

Of all loans in this sample that we identified as having misreported nonowner-occupied status, none was reported as being for non-owner-occupied properties in the New Century database. This evidence suggests that the misrepresentation concerning owner-occupancy status was made early in the origination process, possibly by the borrower or broker originating the loan on behalf of New Century.

The authors go on to write,

In contrast, of all mortgages identified as having misreported second lien status to investors, 93.3% had a second lien reported in the New Century database. This confirms that the lenders were often aware of the presence of second liens, and hence their underreporting occurs later in the process of intermediation.

Consider these possibilities:

1. New Century sold loans in the “TBA market,” meaning that investors committed to buy the loans before they were closed. New Century sold these loans as not having seconds, because it had no idea about them. Lo and behold, when the borrowers went to closing, they needed a second loan in order to make the down payment. New Century then recorded in its database the existence of the seconds, but there was no further communication with the investors.

2. New Century new darn well all along about the seconds, but they have two records in their database–a record that they made for internal purposes and a record that they gave to investors.

#1 is still fraud, but it is not as blatantly intentional as #2. I suspect it was #1.

When my online housing course starts (by the end of this month, I am now told), I want to share my knowledge of these institutional issues.

Did Jewish Genius Really Decline?

Posted on February 13, 2013 by Arnold Kling

Andrew Gelman summarizes some criticisms of the data that went into the Ron Unz article that I cited in this post.

Pointer from Tyler Cowen. Some of the criticisms seem powerful to me, others less so. Basically, it possible to come up with disparate measures for the proportion of Jews in a segment of the population. Unz appears to have over-estimated the proportion of Jews admitted to elite colleges and under-estimated the proportion with high achievement (such as wins in the Putnam math exam). Note, however, that the people proposing revised estimates may be stretching things in order to prove their point.

What Belongs on the Left-Hand Side?

Posted on February 13, 2013 by Arnold Kling

Business Week reports,

The rate of short-term unemployment—six months or less—is almost back to normal. In January it was 4.9 percent of the labor force. That’s only 0.7 percentage point above its 2001-07 average. But the rate of long-term unemployment, 3 percent in January, is precisely triple its 2001-07 average, according to a Bloomberg Businessweek calculation based on Bureau of Labor Statistics data. (Those two rates—4.9 percent and 3 percent—add up to the overall unemployment rate of 7.9 percent.)

Pointer from Tyler Cowen.

Beware of the interpretation that there is a clump of “long-term unemployed” that is separate and distinct from the short-term unemployed. That is, I would not assume that the causality runs from long-term unemployment to the unemployment rate, with the former boosting the latter.

Consider the alternative of putting total unemployment on the right-hand side. That is, the length of time to find a job is a function of the number of unemployed people with whom you are competing. As the unemployment rate goes up, the rate of long-term unemployment goes up.

How much long-term unemployment can be mathematically explained by the overall drop in the job-finding rate, and how much represents a drop in the job-finding rate for the long-term unemployed relative to that for the short-term unemployed? The article hints that perhaps some of the latter has taken place, but it is not clear how much.

A Housing Discrimination Rule

Posted on February 12, 2013 by Arnold Kling

From HUD.

the charging party or plaintiff first bears the burden of proving its prima facie case that a practice results in, or would predictably result in, a discriminatory effect on the basis of a protected characteristic. If the charging party or plaintiff proves a prima facie case, the burden of proof shifts to the respondent or defendant to prove that the challenged practice is necessary to achieve one or more of its substantial, legitimate, nondiscriminatory interests. If the respondent or defendant satisfies this burden, then the charging party or plaintiff may still establish liability by proving that the substantial, legitimate, nondiscriminatory interest could be served by a practice that has a less discriminatory effect.

So, suppose that a lender uses a credit-scoring algorithm produces scores below the approval cutoff for blacks more often than whites (step one). Then, the lender shows that the credit scoring algorithm predicts default probabilities accurately for both blacks and whites. Does that satisfy step two? And then what sort of can of worms is opened by step 3? Suppose a community-action group claims that “If you pay us to set up a lending diversity program, we can bring you minority loans with acceptably low default rates,” does it have to prove its claim? If so, then this is actually harder on community-action groups than the current situation, in which all they have to do is threaten to sue and a bank will pay them protection money to make them go away.

I am only sort-of kidding. I would put the burden of proof to HUD to show that in recent years there has not been a lot more suffering caused by anti-discrimination regulations than by actual discrimination. And I am talking about suffering by people with “a protected characteristic.”

Alexander Field vs. Scott Sumner (and others)

Posted on February 12, 2013 by Arnold Kling

Field writes,

The thesis that massive monetary accommodation in the early 1930s could have almost entirely eliminated the output cost of the Great Depression needs to be reconsidered. Balance sheet considerations were likely implicated in the slow recovery then as well as now, and might have resulted in persistent output losses, even in the presence of different monetary policy.

In fact, the analysis behind this claim is certain not to impress Sumner, because Field views monetary policy in the recent crisis as accommodative and Sumner does not.

Later, Field writes,

whereas the real economy appears to have largely shrugged off the end of the residential real estate bubble in 1926, that does not appear to have been the case with the stock market crash of 1929 and the slow, sickening slide to a trough in 1932, marked as it was by some of the largest one day percentage increases in stock prices. And whereas the real economy appears to have largely shrugged off the collapse of the Tech stock bubble in 2000-2001, that does not appear to have been the case with the real estate collapse that began in early 2006…This asymmetrical real economy response to asset price deflation is associated with almost diametrically opposed opportunities for leveraged asset acquisition in housing and equities during the run ups to the two crises.

In other words, there is a parallel between buying houses with little money down in the recent period and buying stocks on margin in the 1920s.

Some other points.

1. In both circumstances, the leverage created in the financial sector was even greater than that among households. Think of the thin capital margins that banks had for their mortgage security portfolios. Think of the stocks that were issued in the 1920s merely to buy other stocks.

2. Field’s view that the real estate collapse of the 1920s was relatively harmless runs explicitly counter to that of Steven Gjerstad and Vernon Smith.

3. Field notes that in the 1920s the housing collapse was larger in construction volume but much smaller in house prices than the recent collapse. I imagine that one explanation for this is that in the early 19th century there was much less land use regulation, so that the supply elasticity of housing was greater.

George Lakoff and the Three-Axes Model

Posted on February 11, 2013 by Arnold Kling

He writes,

These ideas are placed into public discourse via a sophisticated conservative communications machine: think tanks, messaging experts,Grover Norquist’s weekly meetings at Americans for Tax Reform and across the country, training institutes, booking agencies, talk radio, Fox News, Rupert Murdoch’s media empire, chambers of commerce, bloggers and the rest. This network puts those words and their frames, both political and moral, into the brains of a huge number of our citizens.

In my forthcoming e-book, I point out that each political tribe puts forth a narrative that blames the existence of the other tribe on a conspiracy of this kind. Lakoff lists the standard villains from the progressive point of view. For conservatives, it is “Hollywood” and the “mainstream media” that are to blame for people’s false consciousness.

In fact, Lakoff is most famous for Moral Politics, in which he argues that the difference between conservatives and progressives is that conservatives use a “strict-father” morality to evaluate public policy and progressives use a “nurturant parent” model. Never does Lakoff recognize that equating government-citizen and parent-child is a mistake.

Libertarians think that the false consciousness of people comes from academics such as Lakoff. For decades, we have hoped to change the narrative within universities.

Ralph Raico and the Three-Axes Model

Posted on February 11, 2013 by Arnold Kling

Don Boudreaux offers an hour-long video of a talk by Ralph Raico in 1986. I found it well worth watching.

In three-axis terms, Raico begins his talk by saying that we consistently are taught to think of the role of government during the Industrial Revolution along the oppressor-oppressed axis. He ends his talk by saying that the welfare state’s origins in Germany should be viewed along the freedom-coercion axis.

In my forthcoming e-book on the three-axis model (not sure when it will appear, because I have just begun the process), I point out that every partisan blames the media for pushing the (false) narratives of the other side. Thus, it is quite typical for libertarians to complain about the false narrative of the Industrial Revolution and to try to supply the “true” narrative.

Having said that, and keep in mind that I put myself in the libertarian camp, I think that Raico makes a very good case, at least in the first half of the talk. That is, progressives tell a story in which whenever laissez-faire breaks out for a while, it has horrible consequences in terms of oppression, until government rescues the common man. A quarter-century after his talk, that is exactly how progressives tried to frame the financial crisis. Concerning the Industrial Revolution, this oppressor-oppressed narrative with government as savior is, as Raico points out, a baloney sandwich.

A Development to Watch

Posted on February 10, 2013 by Arnold Kling

From a WSJ blog.

Wages rose 3.4% from 2011 to 2012 for full-time workers in computer and mathematical occupations, 5.1% for accountants and auditors, 7.5% for electrical engineers, and 4.4% for mechanical engineers.

…For job seekers across the occupational spectrum, bigger paychecks for the most sought-after workers could signal higher turnover and faster wage growth throughout the economy.

But the ratio of employment to the working-age population remains abysmally low, and unemployment among workers under 30 remains abysmally high. I would think that if you’re an aggregate-demand, Phillips-Curve type of guy, you have to forecast continued low wage growth. If instead we see bigger paychecks “across the occupational spectrum,” what sort of AD story could you tell?

Ronald Coase on the State of Economics