Thursday, October 23, 2008

To do nothing is sometimes a good remedy

In a crisis, leaders 'do something'. Thus, in the Great Depression, we passed laws making it hard to lower wages, which when aggregate prices were falling about 33%, meant wages had to rise in real terms. It helps current union members, but hurts everyone else. The only people favoring these laws are those too ignorant to grasp the inconsistency, those who are merely rationalizing (if subconsciously) their deeper desire for egalitarian redistribution (though this usually helps insiders), or if one of the Officially Designated Victim Groups, self-interest.

In today's WSJ, they note that Federal Deposit Insurance Corp. Chairman Sheila Bair suggested the government give banks a financial incentive to turn troubled loans into more-affordable mortgages. Under the proposal, the government would share in any future losses on the new loans with lenders. If there is anyone who does not have a claim of victimhood, it is someone who got a mortgage they could not pay, with little money down, who now wants to be subsidized so that they have no loss (with a loss, they walk away as US banking laws mean you can default on your mortgage and not worry about the bank coming after your other wealth such as savings; ie these are non-recourse loans). The effect is then to subsidize those who behaved most recklessly, who have the least skin in the game, and increases the number of zombie properties that are not maintained because the 'owner' has abandoned the property, and the lenders are forced to go threw a costly and lengthy process before they take hold of the property, fix it up and sell it at a market-clearing price.

Trying to subsidize X means, necessarily, you tax ~X. Further, it then creates incentives for people to game these new incentives. The key is to have many small groups, so you can parade various people from these groups so every week you can bring out the most sympathetic individual within the group who mentions how legislation allowed them to avoid the poorhouse or achieve their dreams. The net effects are complex, subtle, and spread around enough that it is usually impossible to statistically prove they caused any effect, like legislating that the government given me one million dollars: to prove that it makes others worse off looking at aggregate data is empirically impossible. My personal characteristics are such that my victimhood status is pretty much near the bottom of the vanguard's list of politically attractive groups to subsidize, so I see these actions as basically more things they have magnanimously decided I should pay for--though not directly. I can see why intellectual mandarins, the super rich, the super poor, and muck-raking community activists find these actions good, because it increases their power and status.

Note that in climate discussions, the presumption on the Left is that increasing man's footprint is bad, and while certain areas may benefit, the net effect is bad because our meddling are unnatural. Thus, even though my state (Minnesota) may benefit some from Global Warming, the cost to other areas is a bad trade. No one would suggest adding chemicals to wetlands to 'improve' their pH, or introduce new flora to improve the diodiversity, is a great way to save the environment, rather the objective is highly conservative: conserve energy, growth, and stop development. In the economy, however, Washington's footprint is considered an obvious corrective to an anarchic suboptimality, because we know legislation has the public welfare at heart, in contrast to the individuals making decisions on their own, who are driven by self-interest. Every problem invites a new top down solution, as if top-down meddling in the form of encouraging home ownership was not a large, if not the singular prime mover, of the crisis we are in. The economy is very complex system, just like the climate or the environment. The biosystems and the environment, are too complex for top down intervention; the economy, however, needs top down solutions NOW.

So we have screaming that we need to help homeowners to keep them in their housing; we also need to make housing more affordable. We address the high rates of medical spending by giving more state-insurance and tax subsidization of medical expenditures. We address the high costs of college by giving more subsidies and tax breaks on education spending. Did it ever occur to these geniuses that less intervention might be a solution, as opposed to more? Lowering the subsidies, eliminating tax breaks on targeted spending?

A neighbor down the street abandoned his house in my nice neighborhood, and its landscape was not maintained for months, creating an eyesore. The 'owner' also removed many of the nicer fixtures: marble counters, everything valuable you could take out. This tactic is only encouraged by giving defaulters more power, and this is a deadweight loss for society.


Anonymous said...


Unfortunately, it is hard for any ambitious politican to resist the self-interested imperative to "do something" in order to rationalize his/her position and utility.

$9,000,000,000 Write Off said...

If you want to help homeowners, let them take an ordinary deduction on a loss from sale of their home. Its much simpler than an inextinguishable bureaucracy built to liaise between guvment and homeowner and bank, because the tax code already segregates homeownership sales and costs.

People seem to refusing to lower prices and take losses out of pride or endowment bias, etc. This plugs up the necessary correction to the market. A $20,000 loss doesn’t sound so bad when you get to deduct it. Another example is how ordinary people make December sales to realize their $3,000 in capital losses that they can use against ordinary income.

This approach is consistent with the idea of the home as an investment or the “ownership society”; i.e., deductibility of mortgage, exclusion on some gain, etc (all bad policy, but the ones under which people have bought and maintained homes).

Seems simple, no more government bureaucracy, gooses the market, and is targeted only at homeowners who sell at a loss.

Anonymous said...

"encouraging home ownership was not a large, if not the singular prime mover, of the crisis we are in"

Is there any evidence of this. The numbers just don't add up.

* More than 84% of the subprime mortgages in 2006 were issued by private lending institutions.
* Private firms made nearly 83% of the subprime loans to low- and moderate-income borrowers that year.
* Only one of the top 25 subprime lenders in 2006 was directly subject to the CRA;
* Only commercial banks and thrifts must follow CRA rules. The investment banks don't, nor did the now-bankrupt non-bank lenders such as New Century Financial Corp. and Ameriquest that underwrote most of the subprime loans.
* Mortgage brokers, who also weren't subject to federal regulation or the CRA, originated most of the subprime loans.

via big Big picture

Eric Falkenstein said...

I think everyone was drinking the kool-aid, in that investors didn't think it mattered, nor did issuers, they were too short term oriented. But...without the legitimacy granted on the evaporation of standards from such respected groups as academics (American Economic Review, 1996), the Federal Reserve (Boston Fed), Pulitzer prizes looking at mortgage data, Fannie, Freddie, and many others. Important people, including regulators (and every financial institution other than hedge funds is pretty heavily regulated in their activity), were pushing lowering underwriting standards.

I think the 'good intentions gone awry' idea is basically that it gave legitimacy to a bad idea, that without it, would have been much less probable. After, all, a company like Moody's, which owes so much of its quasi-monopoly profits to its cozy government benefits (all vague, but all highly valuable), is not going to put out a piece saying that a new housing initiative targeted at poor people requires twice the subordination. Did you hear Kucinich lay into the rating agencies for their mention of the budget decifit, which he saw as a code word for getting the government to privatize social security?

CRA was one of many little 'reminders' of what a 'good lender' does. This aided and abetted the the frenzy, though I'm sure many at the bottom had no idea about the genesis for 'liar loans'.

Seth said...

I was listening today to Sheila Barr's suggestion to backstop Mortgages. Sounded like a horrible idea for the simple reason that it gives banks the incentive to just dump toxic debt on taxpayers.

I wish people would just understand the problem as a "sugary donut". When you eat a sugary donut for breakfast you get the sugar high for a while (peak) and then the post-donut trough around 9:30 a.m. The last thing you want to do in the trough is eat more sugar. It just creates a longer trough before lunch.

So, let's get through a sugar trough and eat some veggies for lunch by encouraging savings and investment.

Plamen said...

Anonymous at 5:41PM: Who originated the mortgages is rather inconsequential, since they were resold for a hefty fee to Fannie and Freddie [F&F] (mostly; also to the likes of Deutsche Bank, who were big in the MBS business) before the ink was dry. And F&F happily guaranteed their "product" against homeowner default. The structure was diabolo-shaped (roughly), with F&F at the juncture of the two funnels. Back in those days (2000) I took a graduate level class on real estate finance, and default was not mentioned even once in it, but the homework assignment right after the first class session was on prepayment tables and structures. Prepayment was the concern du jour, and once you had a grasp on that, the focus was on creating fanciful structures. These structures were all designed to sell the maximum volume of the top tranches, and concentrate as much of the risk as possible in as small an H-tranche as possible, with the understanding that the issuer will retain that tranche.

Bottom line: default risk on a DEBT instrument was totally ignored, even as early as 2000 - it was all assumed to lay safely with F&F and with the mortgage insurers. Who mandated F&F to buy crap and cook it into crap cakes, we all know.