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July 30, 2009

Economist's View - 7 new articles

What Caused Foreclosures?

Richard Green:

Michael Lacour-Little says it's all about the refinances, by Rickard Green: He points me to:

Why are so many homeowners underwater on their mortgages?

In crafting programs to prevent foreclosures, policymakers have assumed that the primary reason homeowners owe more on their home than it is worth is that they bought at the top of the market. In other words, they've lost equity primarily through forces beyond their control.

A new study challenges this premise and finds that excessive borrowing may have played as great a role.

Michael LaCour-Little, a finance professor at California State University at Fullerton, looked at 4,000 foreclosures in Southern California from 2006-08. He found that, at least in Southern California, borrowers who defaulted on their mortgages didn't purchase their homes at the top of the market. Instead, the average acquisition was made in 2002 and many homes lost to foreclosure were bought in the 1990s. More than half of all borrowers who lost their homes had already refinanced at least once, and four out of five had a second mortgage.

The original loan-to-value ratio for these borrowers stood at a reasonable 84%, but second and third liens left homeowners with a combined loan-to-value ratio of about 150% by the time of the foreclosure sale date.

Borrowers, meanwhile, took out around $2 billion in equity from their homes, or nearly eight times the $262 million that they put into their homes. Lenders lost around four times as much as borrowers, seeing $1 billion in losses.

"[W]hile house price declines were important in explaining the incidence of negative equity, its magnitude was more strongly influenced by increased debt usage," writes Mr. LaCour-Little. "Hence, borrower behavior, rather than housing market forces, is the predominant factor affecting outcomes."

If other housing markets across the country offer similar findings, then the study argues that current "policies aimed at protecting homeowners from foreclosure are misguided" because lenders, and not borrowers, have born the lion's share of economic losses.

Borrowers that bought homes without ever putting any or little equity in their homes could have seen huge returns on investment simply by extracting cash through refinancing. "Why such borrowers should enjoy any special government benefits such as waiver of the income taxation on debt forgiveness or subsidized loan modifications to reduce their borrowing costs is at best unclear," the authors write.

Michael is a co-author of mine (and was a student at Wisconsin while I taught there), and has a gift for slicing up mortgage data. On the policy question, we might think about treating the half who did not refinance differently, as they were drowned by the flood.

[I'm at a conference and posted this on my way out the door (hence the long, rambling introduction). I was running late and had to catch the shuttle bus to dinner and didn't have time to check the post after I hit the save button, and I left my iPhone in an airport so I couldn't check it en route. Of course, since I couldn't check it, that meant there'd be a problem. Sorry about the formatting - it has been fixed.]

To Page this Person, Press Five Now...

From my son Paul:

Take Back the Beep Campaign, Pogue's Posts: ...I've been ranting about one particularly blatant money-grab by U.S. cellphone carriers: the mandatory 15-second voicemail instructions.

Suppose you call my cell to leave me a message. First you hear my own voice: "Hi, it's David Pogue. Leave a message, and I'll get back to you"–and THEN you hear a 15-second canned carrier message.

  • Sprint: "[Phone number] is not available right now. Please leave a detailed message after the tone. When you have finished recording, you may hang up, or press pound for more options."
  • Verizon: "At the tone, please record your message. When you have finished recording, you may hang up, or press 1 for more options. To leave a callback number, press 5. (Beep)"
  • AT&T: "To page this person, press five now. At the tone, please record your message. When you are finished, you may hang up, or press one for more options."
  • T-Mobile: "Record your message after the tone. To send a numeric page, press five. When you are finished recording, hang up, or for delivery options, press pound."

(You hear a similar message when you call in to hear your own messages...)...

[UPDATE: iPhone owners' voicemail doesn't have these instructions--Apple insisted that AT&T remove them. And Sprint already DOES let you turn off the instructions message, although it's a buried, multi-step procedure...]

These messages are outrageous for two reasons. First, they waste your time. Good heavens: it's 2009. WE KNOW WHAT TO DO AT THE BEEP.

Do we really need to be told to hang up when we're finished!? Would anyone, ever, want to "send a numeric page?" Who still carries a pager, for heaven's sake? Or what about "leave a callback number?" We can SEE the callback number right on our phones!

Second, we're PAYING for these messages. These little 15-second waits add up–bigtime. If Verizon's 70 million customers leave or check messages twice a weekday, Verizon rakes in about $620 million a year. That's your money. And your time: three hours of your time a year, just sitting there listening to the same message over and over again every year.

In 2007, I spoke at an international cellular conference in Italy. The big buzzword was ARPU–Average Revenue Per User. The seminars all had titles like, "Maximizing ARPU In a Digital Age." And yes, several attendees (cell executives) admitted to me, point-blank, that the voicemail instructions exist primarily to make you use up airtime, thereby maximizing ARPU.

Right now, the carriers continue to enjoy their billion-dollar scam only because we're not organized enough to do anything about it. But it doesn't have to be this way. ... Let's push back... Send them a complaint, politely but firmly. Together, we'll send them a LOT of complaints. [List of addresses for complaints in full post.] If enough of us make our unhappiness known, I'll bet they'll change. ... I have a feeling that the volume of complaints will be too big for them to ignore. ...

Fed Watch: More Confirmation of Steady Monetary Policy

Tim Duy sees, among other things, the possibility of another bubble:

More Confirmation of Steady Monetary Policy, by Tim Duy: Green shoots - or, as President Obama says - the beginning of the end of the recession aside, the Fed will not be ready to reverse their accommodative policy stance anytime soon. New York Federal Reserve President William Dudley said as much in a speech today:

If the recovery does, in fact, turn out to be lackluster, the unemployment rate is likely to remain elevated and capacity utilization rates unusually low for some time to come. This suggests that inflation will be quiescent. For all these reasons, concern about "when" the Fed will exit from its current accommodative monetary policy stance is, in my view, very premature.

The Fed continues to expect that low levels of resource utilization will keep a lid on inflation. While some might object that emerging market economies can have both weak growth and high inflation, those economies still have an important transmission mechanism between higher prices and higher wages that appears to be missing in the US. Indeed, while the press focused on the old news "recession is ending" angle of the Beige Book, the money quote for policymakers was:

The weakness of labor markets has virtually eliminated upward wage pressure, and wages and compensation are steady or falling in most Districts; however, Boston cited some manufacturing and business services firms raising pay selectively, and Minneapolis said wage increases were moderate. Boston, Cleveland, Richmond, Chicago, Dallas, and San Francisco cited a range of methods firms are using to limit compensation, including cutting or freezing wages or benefit contributions, deferral of future salary increases, trimming bonuses and travel allowances, reducing hours, temporary shutdowns, periodic furloughs, and unpaid vacations.

Until economic growth is sufficient to propel wages upward, any residual price pressures are likely to be snuffed out by deteriorating real wage growth. Will the job market improve anytime soon? We get a fresh look at initial unemployment claims tomorrow morning, but the July consumer confidence report from the Conference Board indicates that households see a deteriorating jobs picture:

The share of consumers who said jobs are plentiful dropped to 3.6 percent, the lowest level since February 1983. The proportion of people who said jobs are hard to get climbed to 48.1 percent from 44.8 percent.

Lacking a story that leads to strong wage growth in the near - or even medium - term, the Fed is almost certainly on hold at least through this year and likely well into 2010, allowing the size of the balance sheet to adjust according to the needs of the financial markets while keeping interest rates at rock bottom levels. That doesn't mean all that easy money will not show up somewhere - technical analysts are looking for US equities to explode on the basis of recent market action. But will the Fed lean against such an explosion without clear and convincing evidence that the labor market is poised for strong, sustainable improvement? I doubt it - and for those looking for it, therein lies the ingredients for making the next big bubble.

Sluggish Wages and Employment

Following up briefly on part of Tim's post, once the economy turns the corner, for wages to increase two things must happen. First, there is a lot of expansion that can come from currently employed workers through expanded hours, reversing temporary shutdowns, eliminating forced furloughs, no longer allowing unpaid vacations, those sorts of things. These bring hours and other work conditions back to normal and hence do not place much if any upward pressure on wages. There is a lot of slack in hours alone that can be taken up before the existing workforce is fully utilized, and adding back hours that have been taken away does not require an increase in wages. (There are some cases where the wage rate was cut instead of hours, and even some cases where both happened, but because the proportion of firms that cut wages is relatively small, even if those wage cuts are reversed it would not have much of an effect on the overall wage rate, and it would be a one-time change in wages in any case, not continuous upward wage pressure).

Second, even if the existing workforce reaches normal (full) employment conditions, there are still a lot of workers who are unemployed, and they can be hired at the existing wage rate. It is not until the existing workforce returns to normal and the unemployed find new jobs that wages come under pressure. When the economy is at full employment, expanding the number of workers in a particular firm requires that they be bid away from other opportunities, and that pushes wages up. But when there is unemployment, there are no alternative opportunities and hence no upward pressure on wage rates.

Finally, note that when there is slack in the existing labor force due to a decline in hours worked, etc., there will be a delay between the time the economy turns around and the time when employment begins increasing. This isn't the only reason there is a delay in the response of employment, but it contributes to it.

"Some Thoughts on Wages and Competitiveness"

Another follow-up to Tim's post gleaned from a post by Karl Whelan at The Irish Economy:

Some Thoughts on Wages and Competitiveness, by Karl Whelan: There's a lively debate going on about ... competitiveness and recovery...

Despite what seems to me to be an exceptionally strong attitude in this country [Ireland] of calling on the government to solve every possible problem, we are largely a market economy and wage rates are set in a relatively decentralised fashion compared with other European countries. And despite the faith of many that unregulated labour markets should always clear to produce full employment, we have plenty of macroeconomic evidence that this is not the case.

The reality is that, in all economies, negative macroeconomic shocks tend to raise unemployment because wages never adjust quickly enough to get the labour market back to full employment. This has been a mainstream theme in macroeconomics since, at least, the General Theory.

In more recent decades, New Keynesian macroeconomic theorists have put forward a plethora of models to explain why the labour market does not operate according to the simple market-clearing fashion (efficiency wages, implicit contract theory, bargaining models based on "holdups"). More recently, behavioural economists have documented the importance of "money illusion'' which makes workers particularly resistant to cuts in nominal wages. The result is a significant amount of empirical evidence demonstrating the existence of nominal and real wage rigidity.

This is not to argue that wages are completely rigid or that the labour market does not have mechanisms to bring unemployment down after a negative shock. Macroeconomic data generally show good fits for Phillips Curve relationships such that wage growth is low when unemployment is high. But governments will generally not want to rely only on this mechanism to restore macroeconomic equilibrium because the pace of recovery will be too slow. Instead, they prefer, where possible, to use countercyclical fiscal and monetary policy. ...

I should note that the argument in the full post gives more credence to wage cuts as a recession fighting strategy that I would. Here's Paul Krugman on the topic:

[W]e may be facing the paradox of wages: workers at any one company can help save their jobs by accepting lower wages, but when employers across the economy cut wages at the same time, the result is higher unemployment.

Here's how the paradox works. Suppose that workers at the XYZ Corporation accept a pay cut. That lets XYZ management cut prices, making its products more competitive. Sales rise, and more workers can keep their jobs. So you might think that wage cuts raise employment — which they do at the level of the individual employer.

But if everyone takes a pay cut, nobody gains a competitive advantage. So there's no benefit to the economy from lower wages. Meanwhile, the fall in wages can worsen the economy's problems on other fronts.

In particular, falling wages, and hence falling incomes, worsen the problem of excessive debt: your monthly mortgage payments don't go down with your paycheck. America came into this crisis with household debt as a percentage of income at its highest level since the 1930s. Families are trying to work that debt down by saving more than they have in a decade — but as wages fall, they're chasing a moving target. And the rising burden of debt will put downward pressure on consumer spending, keeping the economy depressed.

Things get even worse if businesses and consumers expect wages to fall further in the future. John Maynard Keynes put it clearly, more than 70 years ago: "The effect of an expectation that wages are going to sag by, say, 2 percent in the coming year will be roughly equivalent to the effect of a rise of 2 percent in the amount of interest payable for the same period." And a rise in the effective interest rate is the last thing this economy needs.

Concern about falling wages isn't just theory. Japan — where private-sector wages fell an average of more than 1 percent a year from 1997 to 2003 — is an object lesson in how wage deflation can contribute to economic stagnation.

"Surprising Comparative Properties of Monetary Models"

I need to read this paper:

Surprising Comparative Properties of Monetary Models: Results from a New Data Base, by John B. Taylor and Volker Wieland, May 2009 [open link]: Abstract: In this paper we investigate the comparative properties of empirically-estimated monetary models of the U.S. economy. We make use of a new data base of models designed for such investigations. We focus on three representative models: the Christiano, Eichenbaum, Evans (2005) model, the Smets and Wouters (2007) model, and the Taylor (1993a) model. Although the three models differ in terms of structure, estimation method, sample period, and data vintage, we find surprisingly similar economic impacts of unanticipated changes in the federal funds rate. However, the optimal monetary policy responses to other sources of economic fluctuations are widely different in the different models. We show that simple optimal policy rules that respond to the growth rate of output and smooth the interest rate are not robust. In contrast, policy rules with no interest rate smoothing and no response to the growth rate, as distinct from the level, of output are more robust. Robustness can be improved further by optimizing rules with respect to the average loss across the three models.

links for 2009-07-30

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