Tuesday, November 30, 2010

Unintended Consequence Of Reconciliation Of Obamacare: No Severability Clause

From "Severability and Obamacare" by Ben Domenech on RedState Blog:
Some people have claimed the severability clause is absent from Obamacare because the writing process of the bill was such a cluster, the clause was just forgotten. But the reality, I’m told, is that a severability clause would’ve been added in conference between the House and Senate. Except that as you know, no such conference happened — everything had to be done via reconciliation after the House passed the Senate bill. Hence, no severability clause.

Achieving Parity With Bankruptcy Under Dodd-Frank

From the online version of the Harvard Business Law Review "One Way That Dodd-Frank’s Liquidation Authority Could Achieve Parity With The Bankruptcy Code" November 29, 2010, by Harvey R. Miller, Partner at Weil, Gotshal & Manges LLP, and Maurice Horwitz, Associate, at Weil, Gotshal & Manges LLP:
One of the criticisms of Title II [of the Dodd-Frank Wall Street Reform and Consumer Protection Act], however, is that creditors lack the same degree of certainty with respect to their probable treatment under an FDIC receivership as compared with the bankruptcy process. The FDIC’s typical response to this concern is that the statute guarantees creditors no less than the amount they would have received if the covered financial company had been liquidated under chapter 7 of the Bankruptcy Code.

This response is inherently flawed because it assumes that one could state objectively what a creditor’s probable recovery would be in a hypothetical chapter 7 case. All judgments of value are subjective, even if based to some extent on objective facts. It is for this reason that valuation disputes are among the most common forms of litigation in Bankruptcy Courts. However, Title II does not appear to provide any recourse to creditors who disagree with the FDIC’s determination of value in most contexts.
If,through the rulemaking process, value determinations ... can be placed in the hands of independent third party arbiters, Title II may yet achieve parity with the Bankruptcy Code.
Read the complete Harvard Business Law Review article here.

Connecting Smart Risk Takers: A Better Formula for Economic Growth

From "A Better Formula for Economic Growth: Connecting Smart Risk Takers" by Vivek Wadhwa in the Chronicle of Higher Education:
Build a magnificent technology park next to a research university; provide incentives for chosen businesses to locate there; add some venture capital. That is the common recipe for harnessing higher education and industry to spur economic growth as prescribed by management consultants touting the "cluster theory" developed by Harvard Business School's Michael E. Porter.
It simply doesn't work that way. It takes people who are knowledgeable, motivated, and willing to take risks. Those people have to be connected to one another and to universities by information-sharing social networks.
One way to understand what works and why no one has been able to replicate Silicon Valley is to compare it with the Route 128 ring around Boston.
By the 80s, Silicon Valley and Route 128 looked alike: a mix of large and small tech firms, world-class universities, venture capitalists, and military financing.
Yet, today, most people don't even know where Route 128 is. Silicon Valley raced ahead because of its dynamism, which overwhelmed the slow pace of technological change in the Boston area. What gave Silicon Valley its advantage were its high rates of job hopping, new-company formation, and a culture of information exchange and risk taking. Silicon Valley firms understood that collaborating and competing at the same time is a recipe for success in the tech world, where complex products often comprise chunks of technology harvested from many organizations. In addition, failure was tolerated and often worn proudly.
Read Wadhwa's complete commentary here.

Economic Growth Causes Consumer Spending, Not the Other Way: YouTube Video

Video by Hiwa Alaghebandian of the American Enterprise Institute on economic growth causes increased consumer spending and not the reverse:

New Economic Research Finds Tax Cuts And Not Stimulus Spending Promote Economic Growth

From "Why the Spending Stimulus Failed: New economic research shows why lower tax rates do far more to spur growth." by Michael Boskin in the Wall Street Journal:
economic theory, history and statistical studies reveal that more taxes and spending are more likely to harm than help the economy. Those who demand spending control and oppose tax hikes hold the intellectual high ground.[Emphahsis Added].
Macroeconomics since Keynes has incorporated the effects of longer time horizons, expectations about future incomes and policies, and incentives (including marginal tax rates) on economic decisions.
based on the best economic evidence, we should reject increased spending and increased taxes.

If anything, we should lower marginal effective corporate and personal tax rates further (for example, along the lines suggested by the bipartisan deficit commission's Erskine Bowles and Alan Simpson). We should quickly enact an enforceable gradual phase-down of the spending explosion of recent years.
Read the complete Wall Street Journal article here.

$25 Billion Tarp Costs Way Below Initial Estimates

From the "Report on the Troubled Asset Relief Program—November 2010" prepared by the CBO:
CBO estimates that the cost to the federal government of the TARP's transactions (also referred to as the subsidy cost), including grants that have not been made yet for mortgage programs, will amount to $25 billion (see Table 1). That cost stems largely from assistance to American International Group (AIG), aid to the automotive industry, and grant programs aimed at avoiding foreclosures. Other transactions with financial institutions will, taken together, yield a net gain to the federal government, CBO estimates.

CBO's current estimate of the cost of the TARP's transactions is substantially less than the $66 billion estimate incorporated in the agency's latest baseline budget projections (issued in August 2010) and the $109 billion estimate shown in the agency's previous report on the TARP (issued in March 2010). The reduction in estimated cost over the course of this year stems from several developments: additional repurchases of preferred stock by recipients of TARP funds; a lower estimated cost for assistance to AIG and to the automotive industry; lower expected participation in mortgage programs; and the elimination of the opportunity to use TARP funds for new purposes (because of the passage of time and the provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L. 111-203). CBO's current estimate is also well below OMB's latest estimate, $113 billion, because the market value of assets held by the government has increased and several recipients of TARP funds — most notably General Motors and AIG — have significantly restructured the Treasury’s investment since May 31, 2010, the date used as the basis for OMB's analysis.
The complete report is available from CBO here or on Scribd here or embedded below.

CBO Report on the Troubled Asset Relief Program November 2010

Sunday, November 28, 2010

Increasing The Top Tax Rate Does Not Increase Tax Revenues: Lowering The Top Tax Rate Increases Tax Revenues

From The Wall Street Journal, "There's No Escaping Hauser's Law: Tax revenues as a share of GDP have averaged just under 19%, whether tax rates are cut or raised. Better to cut rates and get 19% of a larger pie" by W. Kurt Hauser:
Over the past six decades, tax revenues as a percentage of GDP have averaged just under 19% regardless of the top marginal personal income tax rate. The top marginal rate has been as high as 92% (1952-53) and as low as 28% (1988-90). This observation was first reported in an op-ed I wrote for this newspaper in March 1993. A wit later dubbed this "Hauser's Law."

On average, GDP has grown at a faster pace in the several quarters after taxes are lowered than the several quarters before the tax reductions. In the six quarters prior to the May 2003 Bush tax cuts, GDP grew at an average annual quarterly rate of 1.8%. In the six quarters following the tax cuts, GDP grew at an average annual quarterly rate of 3.8%. Yet taxes as a share of GDP have remained within a relatively narrow range as a percent of GDP in the entire post-World War II period. 
Read the complete Hauser piece here.

Reducing the deficit and debt will not be as easy as passing legislation to increase taxes.

As Hauser describes in his article and as known from other economic research, raising the tax rate produces lower than expected tax revenues and also lowers future GDP. People shift their actions to reduce tax payments, increase tax deductions and generate more tax free income from tax free investments. Higher tax rates lower the rate of capital investment, which reduces future GDP and taxable income.

The Bowles-Simpson draft deficit reduction plan envisions tax revenue rising to 21 percent of GDP. As Hauser notes, 19 percent of GDP is the norm as tax rates rise and fall over the last six decades.

The only way to substantially increase tax revenues is through strong economic growth and strong economic growth is more likely in a low top marginal income tax environment.

The US is unlikely to solve its deficit problems through higher tax rates. The US will find itself needing to make substantial cuts to its spending programs in order to get its fiscal house in order. Simultaneously it will need to lower tax rates to spur economic growth.

Cutting government programs and government spending while lowering top tax rates will not be an easy sell for politicians, but it is the right way to eliminate the deficit and increase GDP growth.

Friday, November 26, 2010

Comment On Airline Safety And The TSA

A short comment I posted to The Wall Street Journal article, "The TSA Is Keeping the Skies Safe" by Gabriel Schoenfeld:
Let's test the system to see if it really does work.

Hire an outside independent evaluation firm to put fake explosives on testers with a bonus if they can get past TSA. If they can get past then jettison the system we have. If they get caught, give bonuses to those employees who found the fake explosives on the evaluators. Do this regularly to keep TSA on its toes, and quickly publish the results to show the public that the system we have is either effective or ineffective.

The English Queue, Americans Do Not: Why US Healthcare Will Never Be Like England's: Why The New Health Law Will Be Repealed Or Modified Beyond Recognition

Implementation of the new US health care law is underway. Unlike the British who culturally accept and respect lining up, Americans do not stand still in lines for things and services they need and want.

Just picture an amorphous blob of people outside a Wal-Mart on Black Friday (the big sale day after Thanksgiving) pushing and shoving to be the first to get into the store and you will realize Americans do not queue. In Britain, a line would naturally form.

If the new health law results in queues as expected, i.e. waiting in line, taking a number, rationing, delays or the equivalent, the law will fail, and it will be modified into something unrecognizable from its original form or be repealed to do away with the queuing.

On top of all the many major economic weaknesses of the new health care law (and there are many), the cultural difference between Americans and the British relating to queuing will be the new law's Achilles' heal and downfall.

Thursday, November 25, 2010

Monday, November 22, 2010

Video: Peter Wallison of the Financial Crisis Inquiry Commission On How the Financial Crisis Happened

A nine minute Wall Street Journal video opinion interview of Peter Wallison of the Financial Crisis Inquiry Commission On How the Financial Crisis Happened. Wallison discusses the financial crisis effect of the GSEs' subprime lending, US housing policy, the Fed's failure to save Lehman and AIG.

Saturday, November 20, 2010

Higgs Boson Intrade Price Jumps 46 Percent

The Intrade price for finding a Higgs Boson particle before December 31, 2013 jumped from 15 to 22, almost 47 percent. The Intrade price of finding a supersymmetry particle remains unchanged at 21.2.

It is now a neck and neck race as to which particle is more likely to be found.

The below chart is updated once per day and may not reflect latest prices. Check Intrade Scientific grouping pricing for most recent price.
Price for Observation of the Higgs Boson Particle at intrade.com

Friday, November 19, 2010

Banking For The Poor: McKinsey Strategy

From McKinsey Quarterly [free but registration required], "A new idea in banking for the poor: By teaming up with retail outlets in low-income, often hard-to-reach areas, financial institutions can create value both for themselves and their new customers" November 2010, by Alberto Chaia, Robert Schiff, and Esteban Silva:
Correspondent banking has become one of the most promising strategies for offering financial services in emerging markets. In this model, financial institutions work with networks of existing nonbank retail outlets—such as convenience stores, gas stations, and post offices—to deliver financial services. This approach can be especially powerful when serving the unbanked poor because of its ability to reduce banks’ cost-to-serve and reach low-income workers where they live. In Brazil, where the strategy has enjoyed its greatest successes, about 1,600 municipalities (approximately one-third of the total) are served solely by correspondent-banking outlets.
Read the complete McKinsey & Co. article here.

Bill Gates Chides Teachers Unions And Education Establishment

From "Gates Urges School Budget Overhauls" by Sam Dillon in The New York Times, November 19, 2010:
Mr. Gates — who is gaining considerable clout in education circles — plans to urge the 50 state superintendents of education to take difficult steps to restructure the nation’s public education budgets, which have come under severe pressure in the economic downturn.

He suggests they end teacher pay increases based on seniority and on master’s degrees, which he says are unrelated to teachers’ ability to raise student achievement. He also urges an end to efforts to reduce class sizes. Instead, he suggests rewarding the most effective teachers with higher pay for taking on larger classes or teaching in needy schools.
Bill Gates understands that educational success requires focusing on results and not process, that teachers are overpaid for what their students' learn and that increases in pay without student results are undeserved.

Unfortunately, the existing education establishment is part of the problem, but not the whole problem. Cultural changes have to be made in low performing education student groups and families to raise educational expectations, so success, graduation and learning are looked upon favorably, become the norm and are not considered inappropriate and selling out.

Thursday, November 18, 2010

Change Medicare To A Health Insurance Voucher Or Unrestricted Elderly Tax Credit?

My comment on Econlog blog, "Voucherization of Medicare" by Arnold Kling about The Washington Post article about Rep. Paul Ryan and Alice Rivlin's proposal to switch Medicare to a health insurance voucher system, "Deficit commission debates overhaul of Medicare" by Andrew Taylor:
More fundamentally, why a limited purpose voucher just for health insurance instead of an unspecified use tax credit for people over 65 years old.

By specifying a medical insurance use for the voucher, it acts an health insurance subsidy and increases the cost of elderly health insurance while minimizing industry competition.

An unspecified use elderly tax credit would force health insurers to more vigorously compete for the elderly consumers' dollars on price and quality among all consumer consumption choices. It would broaden competition for the dollars, which would force greater efficiencies in the medical sector and allow the medical sector to shrink as a percentage of US GDP.

New And Improved Tax Calculator 2.0 For Proposed Tax Changes From Tax Policy Center

In response to user comments, the Tax Policy Center has revised its online tax calculator to see the income tax effects of proposed tax changes. The TPC tax calculator is available at this weblink.

A Bias Towards Tax Increases In NY Times, CBO, JTC Budget Calculators

New York Times' readers, bloggers, economists and others are having fun with the NY Times, "You Fix The Budget" interactive budget calculator. Unfortunately, there are hidden assumptions and biases in the calculations that lead readers to favor tax increases and to understate the extent of the cuts needed to government program spending to close the short and long-term budget gaps.

The most significant bias in the calculator is that it assumes changes in tax rates do not affect the growth rate of the US economy (GDP).

The calculations assume a 'static' as opposed to a 'dynamic' economy. In reality, many tax increases will lower capital investment, the growth of the economy, labor force participation and hours worked. These changes can affect unemployment levels, tax revenue and government program participation rates, which will understate the projected costs and overstate the budgetary effects of program cuts in the budget calculators.

The NY Times calculator is based on the model of economists Alan Auerbach and William Gale mentioned in their paper "DÉJÀ VU ALL OVER AGAIN: ON THE DISMAL PROSPECTS FOR THE FEDERAL BUDGET." The economists' paper and model use CBO's projections of the President's budget. CBO does not model tax revenues. It uses the projections of the Joint Committee on Taxation (JCT). JCT uses a static model of the economy when modeling the effects of tax rates on tax revenue. JCT assumes individuals and corporations minimize taxes and modify behavior, but tax law changes do not change the projected growth rates of the US economy.

From page 19 of "Inside the JCT Revenue Estimating Process" CBO JCT states:
"Macroeconomic" Revenue Estimates
  • standard JCT estimate incorporates behavioral responses in projecting tax revenues, but assumes that these tax and behavioral changes do not in turn ‘move the needle' of the entire US economy
  • This is termed the "Fixed GNP Constraint"
    • Generally assumes that total labor supply and investment are fixed
    • For example, we assume that a surtax on labor income will not cause taxpayers to retire early, or simply to work less hard
Many of the proposed changes that NY Times readers' input into the interactive budget calculator will not in real life close the budget gap. Many tax increases will not produce the revenue inputted into the calculation. Many tax and program changes will increase individual, household and family participation rates in government programs, which will drive up program expenses faster than anticipated in the calculator's model.

The budget calculator appears to work similarly to JCT and CBO's calculation, but the inputted tax and program changes will not in real life produce the anticipated benefits.

Tax increases will produce lower amounts of revenue than anticipated even if tax rates are further increased. Program costs will be higher than expected.

The result is that program cuts will need to be deeper than planned unless the US economy grows much faster than currently projected.

Congress will be able to pass a package of tax increases and program cuts than that produce a CBO projection of a closed budget gap. Unfortunately, as the years roll out, it will become clear that the budget gap will not disappear due to negative economic effects from the plan and another round of cuts and tax increases will be required.

Tuesday, November 16, 2010

High GPA African American Adolescents Do Not Feel Accepted

From "Social costs of achievement vary by race/ethnicity, school features" on ScienceBlog:
“This is the first study to clearly show that for adolescents, there are measurable differences in the social costs of academic success across racial and ethnic groups,” notes Thomas E. Fuller-Rowell, postdoctoral research fellow in the Institute for Social Research at the University of Michigan; Fuller-Rowell led the study when he was at Cornell. “By doing so, it points to the significance of race and ethnicity in understanding the achievement gap, and can be helpful to those developing programs and policies to address this gap.”

The researchers carried out their work using a nationally representative sample of almost 14,000 7th through 12th graders,....

The researchers found that for African American and Native American teenagers, the higher their GPAs at the start of the study, the more their feelings of social acceptance decreased over the one-year period. In contrast, for White teens and teens of other races and ethnicities, the higher their GPAs at the start of the research, the more their feelings of being socially accepted increased over the year.
An ungated pre-publication version of the research paper, "The social costs of academic success across ethnic groups" by Thomas E. Fuller-Rowell and Stacey N. Doan is available here.

Monday, November 15, 2010

Without A Productivity Measure, Government-Private Pay Comparisons Are Misleading

A comment I posted on "Are Government Employees Overpaid? Still No." by Mike Konczal on Rortybomb:
Without a productivity measure, pay measurements are meaningless. For example, if three government engineers are needed to do the same work of two private sector engineers, then even at the same salaries and benefits, the government employees are overpaid.

In the private sector, it is fairly common to hear about someone skipping lunch, working late, coming in on a day off or postponing vacation to finish a project. How often does that happen in government?

Robot Actors In Plays And Performing Arts Likely One Day

It is easy to envision a not to distant day when computer controlled robotic actors are performing plays and musicals as well as many live performers. Computer encoded performances of previously live events can be persevered and performed identically in different theaters in different locations simultaneously or at later times, as well as original works.

Since the stage is a well defined, confined area and the other robot actors' actions are known and predictable, the actual engineering and computer programming effort should not be too difficult, once a data set of programmed human emotions is established. The dialogue can be prerecorded like the movie industry does for animated works, or computer synthesized.

Saturday, November 13, 2010

Healthier Eating Will Hurt Developing Economies

From "Eat a carrot, hurt the economy? Sometimes" by Maria Cheng, AP Medical Writer, November 10, 2010:
British researchers modeled what could happen if people in Britain and Brazil adopted healthier diets as defined by the World Health Organization, including more fruits and vegetables and less meat and dairy products.

In Britain, experts estimated that fixing the country's bad eating habits might prevent nearly 70,000 people from prematurely dying of diet-related health problems like heart disease and cancer. It would also theoretically save the health system 20 billion pounds ($32 billion) every year.

In Brazil, however, the rates of illnesses linked to a poor diet are not as high as in the U.K. So Brazilians would get relatively few health benefits while their economy might lose millions.
Read the complete AP article here.

The news article is based on a paper published in the Lancet, Volume 376, Issue 9753, Pages 1699 - 1709, 13 November 2010, Published Online 11 November 2010, "Health, agricultural, and economic effects of adoption of healthy diet recommendations" by Karen Lock PhD, Prof Richard D Smith PhD, Alan D Dangour PhD, Marcus Keogh-Brown PhD, Gessuir Pigatto PhD, Corinna Hawkes PhD, Regina Mara Fisberg PhD, Zaid Chalabi PhD.

The full text of the Lancet paper is available free with registration for a username at the Lancet website.

Friday, November 12, 2010

US Budget Financial Data For Understanding The US Debt Problem

Some key US financial numbers to help a reader understand the magnitude of the US debt problem.

Below is 2010 data excerpted from the US budget data summary tables from the complete US FY 2011 budget document:
  • Total 2010 US government receipts are $2.2 trillion (about $1 trillion is from US income tax).

  • Total 2010 US government outlays are $3.7 trillion.

  • Total 2010 US government deficit is $1.5 trillion.

  • Total 2010 US debt held by the public is $9.3 trillion.

  • Total 2010 US debt is about $14 trillion, including US debt held by other US government agencies.

  • Total 2010 US GDP is $14.6 trillion.
Other miscellaneous budget data from various sources follows.
  • State and local government total receipts for 2010 are about $2.4 trillion.
Also, there are outside the budget future US government dollar payment commitments not included in the yearly budget, sometimes known as off balance sheet or unfunded liabilities. These items are future Medicare and Social Security payments, US government guarantees and other US government payment commitments, such as federal employee pensions, etc.
  • Future Medicare and Social Security payments are estimated to be around $60 trillion.
Total US payment commitments in unfunded liabilities is estimated from various unofficial sources as over $100 trillion. The accuracy of this later number is unknown, but there is some dollar amount that should be added to future payment commitments for Social Security and Medicare to include these other US government commitments.

Other US budget documents and data is available here.

Wednesday, November 10, 2010

Groundwater Depletion Causing 25% Of Sea Level Rise

From "Is Groundwater Depletion Causing Sea-level Rise?" by Lakis Polycarpou on state of the planet blog:
depletion of groundwater may be contributing to as much as 25 percent of observed sea-level rise in recent years.

What does this mean? Try to imagine it this way: human beings have stuck giant straws into the ground all over the world and are sucking out ancient water that has been there for, in some cases, millennia. That water is initially used to irrigate crops, water lawns, etc, but then it has to go somewhere, eventually into the sea. Or to put it another way, as Duke University’s Bill Chameides puts it, “Mankind is moving buckets and buckets of water from land to the ocean.”
Read the complete post here.

Obama's Lasting Negative Legal Legacy: GM, Chrysler Bankruptcies

From "GM, Chrysler bankruptcies created troubling legacy, legal scholars say" on November 10, 2010:
The Chrysler and General Motors bankruptcy reorganizations represented a sea change in corporate restructuring, one that could portend the end of our current system of bankruptcy reorganization, according to a published article by two University of Illinois experts in bankruptcy law.

Law professors Charles J. Tabb and Ralph Brubaker argue that the legal principles applied in the GM and Chrysler bankruptcies — two of the largest in U.S. history at $83.5 and $39.9 billion, respectively — were misguided, and ultimately have undermined the distributional norms of bankruptcy reorganizations.
Read the complete post here.

The complete paper is available here.

Draft Proposal Of Obama's Debt Commission Released With $200 Billion Illustrative Savings

President Obama's bipartisan commission on reducing the federal debt, officially known as the National Commission on Fiscal Responsibility and Reform, released it draft proposal for government fiscal responsibility on November 10, 2010.

The draft report is available here, on Scribd or embedded below.

The Commission also provided illustrative examples of $200 billion of fiscal savings. The examples are available here, on Scribd, or embedded below the Draft Proposal below.

Fiscal Commission Draft Proposal Nov 10 2010

Fiscal Commission Illustrative Fiscal Savings

Tuesday, November 9, 2010

Unincorporated, Non-Employer Business Startups Increase During Recessions

From "Entrepreneurs of necessity" post in the Atlanta's Fed Macroblog:
Importantly, [Robert] Fairlie's [Department of Economics University of California] measure of new businesses picks up new nonemployer businesses, many of which are not incorporated.

What is particularly interesting about Fairlie's research is that he shows not only that this measure of entrepreneurial activity has surged, but that it is closely related to movements in local unemployment rates. That is, he has potentially uncovered an "entrepreneur of necessity" effect caused by high unemployment. For many unemployed workers, the benefits of starting a business during a weak economic environment outweigh the costs. It is noteworthy that the largest proportionate increase in this measure of entrepreneurial activity is by people with less than a high school diploma. This group has been especially hard hit by the recession and weak recovery, and it appears that many have responded by starting their own business.
Read the complete Atlanta Fed Blog post here.

Fairlie's research paper is available here.

Politicians' Public Statements Extended NewsCorp Cablevison Blackout

Politicians' public statements, not just their legislation, can have negative unintended consequences.

From Bloomberg.com, "Man Who Blacked Out World Series Blames Politicians" By Sarah Rabil:
News Corp.’s Chase Carey, the man who oversaw Fox’s talks with Cablevision Systems Corp. during a two- week blackout, has advice for government officials who want to keep more TV channels from going dark: Stop meddling.

News Corp. last month cut off World Series games and shows including “Glee” to Cablevision’s 3 million customers after the two sides couldn’t agree on how much Cablevision should pay Fox. One problem, Carey said, was that the government wasn’t clear about whether it would intervene, leading Cablevision to think it might get better terms if it held out until the U.S. weighed in.

“This process would have been resolved more easily, more quickly,” said Carey, chief operating officer and second-in- command to Rupert Murdoch. “I would actually contend we wouldn’t have gone off the air at all.”
Read the complete article here.

Sunday, November 7, 2010

How Much Extra Is A Homeowner Willing To Pay For Future Home Price Appreciation?

Since homeowners in normal economic environments expect house prices to appreciate, how much extra are buyers willing to pay for that future appreciation?

With reasonable assumptions, in a heated housing market, homeowners are willing to pay about 23 percent more for a home to benefit from future price increases.

Option pricing theory allows us to make a reasonable guess about the amount in the purchase price that is attributable to future price appreciation.

For most of the period from World War II until about 2006, homebuyers expected to sell their houses for more than the original purchase price.

Almost everything else we buy and use is either thrown away, given away or sold for less than the purchase price. Homes are an exception to a general rule for things we use.

According to the National Association of Realtors, http://www.realtor.org/press_room/news_releases/2010/11/survey, the average length of homeownership is eight years.

The value of the expected price appreciation of a house can be modeled by looking at the cost of buying an eight-year call option on a home. The owner of the call option will benefit from any appreciation in the home's price without having to purchase the home. Any purchaser of a home also benefits from price appreciation. The purchase price of a home therefore includes the cost of an embedded call option.

One can use the well-known Black-Scholes option pricing model to compute a price accurate enough for the purposes of this post (it is not the only mathematical way to compute the price of an option but it is simple, relatively easy to use, and many free online Black-Scholes option pricing calculators are available).

Using 20 percent as a reasonable amount for the standard deviation input of the price change in the Black-Scholes model in a heated housing market, the value computed for an eight-year call option of a house is about 23 percent of the fundamental home price.

A homebuyer would have to pay about $369,000 for a home that is fundamentally worth $300,000 because of the extra benefit of price appreciation conferred on homeownership.

The negative side of paying for expected appreciation is that when there is no market expectation of home price appreciation, the price will drop by the amount of the embedded option for future price increases. A call option with no expectation of future price increases will approach zero value.

A home that is worth $369,000 in a heated housing market, such as leading up to the recent financial crisis, will drop back to close to the $300,000 fundamental value for almost a 20 percent decline.

In using option pricing, I am assuming that any benefit to the homeowner from the elimination of the need to pay a landlord any rent payment is completely offset by taxes and maintenance costs.

Residential home price to rent rations are typically in the range of 15 to 20, which makes the yearly rent about 5 to 6 percent of the price of a home. The elimination of rent represents the equivalent of a dividend to a homeowner.

Homeowners also have costs that offset the elimination of rent benefit.

I assumed home structures represent about 75 percent of the purchase price with land the other 25 percent and that home structures need repair, maintenance and replacement and have an average structure life of about 20-25 years. Over 20-25 years, these depreciation costs are about 4-5 percent (1/25-1/20) of the structural costs or about 3-4 percent of the total purchase price (structure price is ¾ of the total price). Real estate taxes and other non-rental costs such as heat, water, etc. are easily around the 2 percent range. The total cost of home ownership is about equal to the rental benefit of 5-6 percent. It is a reasonable assumption without precise data to view costs as completely offsetting benefits.

For those familiar with options, I used the 8-year future value (using the T-note rate) of the current price as the exercise or strike price since the call option owner has the benefit of investing the full fundamental home price in Treasuries until expiration of the call option.

House buyers increase the amount they are willing to pay for a home due to the value of future price appreciation. Option pricing is one way to model the extra cost to a purchaser of buying a home when there is a market expectation of future price appreciation. The computed option value also represents that amount of price decline when the market stops expecting house prices to increase.

Also, see my February 23, 2009 post, "Determinates Of Home Prices."

Thursday, November 4, 2010

Americans Sicker But English Die Quicker

From Reuters "Americans sicker but English die quicker says study" by Kate Kelland and Julie Steenhuysen:
"If you get sick at older ages, you will die sooner in England than in the United States," said James Smith, an economist with RAND in Santa Monica, California, who co-authored the study with James Banks and Alastair Muriel of the IFS.

"It appears that at least in terms of survival at older ages with chronic disease, the medical system in the United States may be better than the system in England."
Read the complete article here.

Wednesday, November 3, 2010

The Power Of 'Exit' In The 2010 Election

As I said in "The Hubris Of Government Healthcare Reform: Exit, Voice, and Loyalty" on October 7, 2009:
Politicians would do well to learn the concepts in the book, "Exit, Voice, and Loyalty" by the economist Albert O. Hirschman. Our elected officials confuse the voice of dissatisfaction with the current healthcare system with a mandate to change our healthcare system. They should become fearful, if they are not already, of the power of 'exit'.

The more our politicians include mandates in the change to current medical care in the US, the more they limit individuals' abilities to go outside the government legislated system. The more Congress reduces the electorate's ability to choose an alternative to Congress's vision of healthcare, the more likely it is for US citizens to 'exit' the Congressional system by voting against those who favored the medical system change.

In private enterprises, consumer choice is visible in a business's profits and losses, acts as a check and a powerful force against bad business ideas. The only equivalent in public enterprises is to vote the officials out of elected office. Healthcare is too much of the US economy, people's daily lives, household costs and concerns not to be a significant impact on the next election...

Tuesday, November 2, 2010

Popular History Ignores Government Created Subsidy Distortions

From Mises Daily, "The Myth of the Great Railroad Meetup" by Mark A. Pribonic:
[Promontory Summit, Utah] is the place where the railroads of the Central Pacific and the Union Pacific met completing the transcontinental rail line.
It has been well noted in history that these two railroads were given land grants, low interest-rate loans, and direct subsidies by the federal government. The subsidies were graduated according to the difficulty of the terrain being traversed with $16,000 paid for construction over an easy grade and up to $48,000 for grades in the mountains.
...the perverseness caused by the subsidies was in full view. At that moment we were standing on the grade built by the Central Pacific and there less than fifty yards below was the grade built by the Union Pacific. The grades did not meet but ran parallel to each other and had continued that way for 250 miles — almost a year's work.

...these two railroads had no intention of meeting. The purpose of grading and laying tracks was not to meet the demand for transcontinental passenger service, but simply to collect, risk-free of any market forces, the federal subsidies.
Read the complete article here.

Possible Antibiotic Equivalent Found For Viruses

From The Independent, "A cure for the common cold may finally be achieved as a result of a remarkable discovery in a Cambridge laboratory" by By Steve Connor, Science Editor:
In a dramatic breakthrough that could affect millions of lives, scientists have been able to show for the first time that the body's immune defences can destroy the common cold virus after it has actually invaded the inner sanctum of a human cell, a feat that was believed until now to be impossible.

The discovery opens the door to the development of a new class of antiviral drugs that work by enhancing this natural virus-killing machinery of the cell. Scientists believe the first clinical trials of new drugs based on the findings could begin within two to five years.
Read the complete article here.

Monday, November 1, 2010

Home Sellers Using Real Estate Brokers Do Not Get A Higher Price

From Kellogg Insight, "The Superfluousness of Realtors: Homes sold through Realtors don’t garner a price premium over ones sold by owners" based on the research of Igal Hendel, Aviv Nevo And François Ortalo-Magné:
Their research spans the years 1998 to 2004, and its conclusions up-end the received wisdom passed on by real estate agents themselves, whose trade groups have in the past argued that agents’ commissions are justified by their ability to achieve a higher sale price.

“Our key finding is that Realtors do not offset the cost of their commission; they do not get you a higher price,” says Nevo. “Your cost for the Realtor is your full commission.”
The complete article is available here.