A very interesting study [Updated Weblink] from the St. Louis Federal Reserve Bank on subprime mortgages from 2001 through 2006. The researchers found that 20, 50 and 80 percent of subprime mortgages are terminated after 1, 2 or 3 years, respectively. There are three ways to end a subprime mortgage; prepayment, refinance, or default.
The researchers found that subprime mortgages are intended to be temporary with 80 percent ended within three years after inception.
The study found that if there was house price appreciation after the mortgage was originated, it was more likely to be refinanced than defaulted. If there was no home price appreciation, then there was an increase in defaults of the subprime mortgages.
Once home prices stopped increasing and actually decreased, the risk of default on subprime mortgages increased, as the actual, recent data has shown
Other factors also contributed to the higher default rates, such as FICO scores and loan to value ratios and are discussed and in the study.
Tuesday, March 10, 2009
Monday, March 9, 2009
Another Economic Prof For Monetary Expansion Over Stimulus
Tyler Cowen, another economic professor who has studied business cycles, calls for additional monetary expansion. In his blog, Cowen refers to the work of Harold Vatter that showed that the growth in industrial production during the World War II years was due to monetary expansion and not fiscal spending.
Sumner For More Monetary Expansion
Scott Sumner, another great economic expert on the Depression, questions why Obama and his economic team are not doing more with monetary expansion to turn our economy around. It worked great for Roosevelt within the first 100 days of his first term. Read the comment on Sumner's blog. Industrial output rose 57 percent in the first four months of Roosevelt's term.
New Keynesian Multipliers Much Smaller
Greg Mankiw's recent post on New Keynesian multiplier research.
The gist of the research is that Government spending multipliers in an widely-cited new Keynesian model are much smaller than in the old Keynesian models; the estimated stimulus is extremely small with GDP and employment effects only one-sixth as large and with private sector employment impacts likely to be even smaller.
New Keynesian economics takes into account Rational Expectations, i.e., people adjust their behavior based on what they expect to happen in the future. Very similar to Efficient Markets.
The gist of the research is that Government spending multipliers in an widely-cited new Keynesian model are much smaller than in the old Keynesian models; the estimated stimulus is extremely small with GDP and employment effects only one-sixth as large and with private sector employment impacts likely to be even smaller.
New Keynesian economics takes into account Rational Expectations, i.e., people adjust their behavior based on what they expect to happen in the future. Very similar to Efficient Markets.
Tuesday, March 3, 2009
Where Are The Rational Expectation Economic Theorists In The Public Media?
One does not find Paul Krugman in his NY Times column or other economists with newspaper articles writing about expectation theory, rational expectations, and efficient markets. There is little widespread mention in public media about Lucas, Prescott, and others who have laid the foundation for expectations in economics. Consumer and business expectations are the Achilles heel of Keynesian economics. Expectations were the objection to Keynesian economics even in the 1930s. In addition, Keynes was writing for his own country, England, which was heavily unionized with extremely sticky wages that would not let the labor market clear and increase employment. That is not the current US problem. Wages could not go down and jobs were not created so the only option Keynes thought was to have the government increase its spending to increase total wages and employment. Similar to the problem that Roosevelt created in the 1930s through wage and price controls. However, Keynesian economics did not work in the 1930s.
Government stimulus spending does not change consumer and business behavior and expectations to cause a permanent increase in demand. The government's stimulus spending only increases demand by at most the amount of government spending and its small if any secondary effects. Unless the public modifies its expectations and increases its own demand, the economy will not improve and government spending by itself will not shift consumer demand and cause a permanent increase to turn our economy around.
Government stimulus spending does not change consumer and business behavior and expectations to cause a permanent increase in demand. The government's stimulus spending only increases demand by at most the amount of government spending and its small if any secondary effects. Unless the public modifies its expectations and increases its own demand, the economy will not improve and government spending by itself will not shift consumer demand and cause a permanent increase to turn our economy around.
Government Actions Depressed Toxic Asset Prices
Robert C Merton of Harvard at an October 2008 panel discussion at that university about the financial crisis said that modification to mortgage terms that increased consumer rights, such as giving bankruptcy judges greater power to modify mortgage terms, would increase the consumer's cost of a mortgage through a higher mortgage interest rate. A market's perception that a higher interest rate is required on an existing investment due to an after the fact modification of existing mortgage investment terms that increase the investor's risk of loss or delay of payments would cause existing mortgage securities to trade at a discount.
With Pelosi and Reid representing the two of the four states with the highest US foreclosure rates and with President Obama's populist stance against big business and banks, the markets, which are forward looking, excessively discounted the mortgage securities prices in 2008 in expectation of government interference with existing mortgage security contracts.
Congress, the President and the bank regulators have repeatedly pressured, cajoled, coerced and threatened the banks and investors to delay foreclosures, lower existing interest rates and payments, and decrease outstanding mortgage principal amounts. In addition, efforts are under way to increase a judge's power and discretion to modify the terms of a mortgage, including mortgage principal reduction to aid borrowers. Moreover, the current administration's programs and stance reward defaulting borrowers through lower mortgage payments and increase the likelihood of default to benefit from the program. Additionally, the administration repeatedly states that it expects underwater homeowners to walk away from their mortgage obligations, a fact not supported by studies of other times of underwater mortgages in periods of economic downturns in Boston and in Texas. The President's actions and plans have increased the number of homeowners likely to default on their mortgages beyond that expected by our current economic downturn through economic rewards and tolerance of default.
The decline in the prices of mortgage related securities, the toxic assets, to a significant discount below book value is only partially due to an increase in all homeowner foreclosure rates from about the normal 1 percent rate to an almost 2 percent rate and to the lowering of home prices. Part of the discount is also attributable to the government's tolerance of default and willingness to interfere after the fact in existing mortgage loan terms, which lowers the return to investors and increases their risk of loss and delayed payments. Cashflow projections of the toxic assets show that they have a value higher than their market prices and support the contention that a significant part of the price discount is due to factors other than default rates.
The President, his administration and the Democratic controlled Congress are responsible for part of the discount in prices of the toxic assets. The deep discount is contributing to bank capital insufficiency and insolvency problems and contributed to the collapse of Bear Stearns.
There is nothing stupid about the administration's plan to recognize that market prices of toxic assets are below market prices attributable to economic conditions. The administration wants to compensate the banks for the shortfall caused by government interference in the mortgage markets and subsidize part of the discount below book value through government action to purchase the assets at an above market price.
With Pelosi and Reid representing the two of the four states with the highest US foreclosure rates and with President Obama's populist stance against big business and banks, the markets, which are forward looking, excessively discounted the mortgage securities prices in 2008 in expectation of government interference with existing mortgage security contracts.
Congress, the President and the bank regulators have repeatedly pressured, cajoled, coerced and threatened the banks and investors to delay foreclosures, lower existing interest rates and payments, and decrease outstanding mortgage principal amounts. In addition, efforts are under way to increase a judge's power and discretion to modify the terms of a mortgage, including mortgage principal reduction to aid borrowers. Moreover, the current administration's programs and stance reward defaulting borrowers through lower mortgage payments and increase the likelihood of default to benefit from the program. Additionally, the administration repeatedly states that it expects underwater homeowners to walk away from their mortgage obligations, a fact not supported by studies of other times of underwater mortgages in periods of economic downturns in Boston and in Texas. The President's actions and plans have increased the number of homeowners likely to default on their mortgages beyond that expected by our current economic downturn through economic rewards and tolerance of default.
The decline in the prices of mortgage related securities, the toxic assets, to a significant discount below book value is only partially due to an increase in all homeowner foreclosure rates from about the normal 1 percent rate to an almost 2 percent rate and to the lowering of home prices. Part of the discount is also attributable to the government's tolerance of default and willingness to interfere after the fact in existing mortgage loan terms, which lowers the return to investors and increases their risk of loss and delayed payments. Cashflow projections of the toxic assets show that they have a value higher than their market prices and support the contention that a significant part of the price discount is due to factors other than default rates.
The President, his administration and the Democratic controlled Congress are responsible for part of the discount in prices of the toxic assets. The deep discount is contributing to bank capital insufficiency and insolvency problems and contributed to the collapse of Bear Stearns.
There is nothing stupid about the administration's plan to recognize that market prices of toxic assets are below market prices attributable to economic conditions. The administration wants to compensate the banks for the shortfall caused by government interference in the mortgage markets and subsidize part of the discount below book value through government action to purchase the assets at an above market price.
Monday, March 2, 2009
Reason For Excessive Discounting Of Mortgage Securities
One of the logical reasons for the apparently excessive market price discounting of mortgage securities is the market anticipated the Federal government's intervention into the mortgage contract which diminished the value of the securities. The Federal banking agencies and Congress are forcing the banks to extend mortgage life, decrease the interest rate, decrease monthly payments to a lower percentage of income, and delay foreclosure proceedings. Also, there are strong indications that banks will see the principal amounts of the mortgages lowered, either through bankruptcy judges or voluntarily. All of the above factors and others cause mortgage securities to be worth significantly less than originally anticipated based on default rates and cashflow.
As the data on the current mortgage crisis reveals itself, it is becoming increasing clear that four states were the cause of the current banking problem. California, Nevada, Arizona and Florida account for most of the subprime, no income verification, underwater, defaulting mortgages, and foreclosures. Much of it was caused by the above average and rapid house price appreciation in these states combined with lax state regulation of mortgage bankers and originators within these states.
While in all recessions there are always calls by some of our Congressional representatives to help homeowners in foreclosure, this time around we had the US Senate and the House of Representatives controlled by individuals whose states were at the forefront of the problem. Pelosi is from California and Reid is from Nevada. It was also clear during the 2008 presidential campaign that a Democrat was most likely to win the White House due to Bush's and the Republican's very high unfavorably ratings and that the Democratic winner would likely accede to a Democratic Congress on helping mortgage borrowers in trouble.
The depressed market prices for mortgage securities in early 2008, which led to the Bear Stearns collapse, were lower than many anticipated by the then actual and foreseeable cashflows on the mortgage securities. Even today, the payments are better on these mortgage securities than market prices would suggest. The disconnect between expected cashflows and market prices has caused the most problems in motivating banks to take write downs and in attempting to come up with a federal government solution.
If one uses the market prices of the mortgage securities instead of their book value then one would conclude that banks that hold them have assets that are less than liabilities and are insolvent. If one would use likely cashflow projections without government intervention then these banks are solvent.
Insolvency is the trigger for government intervention of the bank. So, the insistence by the banking regulators and the Treasury to use market prices instead of cashflow projection prices has caused the deterioration in banks' equity stock market prices and insolvency. However, Krugman and others should recognize that mortgage securities prices are excessively depressed due to the involvement of the Democratically controlled Congress and White House in coercing banks' to modify mortgage loans.
As the data on the current mortgage crisis reveals itself, it is becoming increasing clear that four states were the cause of the current banking problem. California, Nevada, Arizona and Florida account for most of the subprime, no income verification, underwater, defaulting mortgages, and foreclosures. Much of it was caused by the above average and rapid house price appreciation in these states combined with lax state regulation of mortgage bankers and originators within these states.
While in all recessions there are always calls by some of our Congressional representatives to help homeowners in foreclosure, this time around we had the US Senate and the House of Representatives controlled by individuals whose states were at the forefront of the problem. Pelosi is from California and Reid is from Nevada. It was also clear during the 2008 presidential campaign that a Democrat was most likely to win the White House due to Bush's and the Republican's very high unfavorably ratings and that the Democratic winner would likely accede to a Democratic Congress on helping mortgage borrowers in trouble.
The depressed market prices for mortgage securities in early 2008, which led to the Bear Stearns collapse, were lower than many anticipated by the then actual and foreseeable cashflows on the mortgage securities. Even today, the payments are better on these mortgage securities than market prices would suggest. The disconnect between expected cashflows and market prices has caused the most problems in motivating banks to take write downs and in attempting to come up with a federal government solution.
If one uses the market prices of the mortgage securities instead of their book value then one would conclude that banks that hold them have assets that are less than liabilities and are insolvent. If one would use likely cashflow projections without government intervention then these banks are solvent.
Insolvency is the trigger for government intervention of the bank. So, the insistence by the banking regulators and the Treasury to use market prices instead of cashflow projection prices has caused the deterioration in banks' equity stock market prices and insolvency. However, Krugman and others should recognize that mortgage securities prices are excessively depressed due to the involvement of the Democratically controlled Congress and White House in coercing banks' to modify mortgage loans.
Did The 2008 Democratic Election Wins Lead To The Current Economic Crisis?
It is not just Obama, but also the combination with Reid and Pelosi. The four states with the highest foreclosure rates, the most underwater mortgages and the most subprime and toxic mortgages are California, Nevada, Arizona and Florida. With Reid from Nevada, Pelosi from California and Arizona a neighbor, it was predictable that, with the Democrats in control, that Congress would do something to help homeowners, mostly flippers and speculators, who overextended themselves. Most of these were the mortgages securitized and held by the investment banks.
The Iowa experimental election markets are more accurate than election polls in predicting US Presidential elections and predicted a Democratic win way before Obama took the lead against McCain in the polls.
http://tippie.uiowa.edu/news/story.cfm?id=2047
The collapse of Bear Stearns, which was the forerunner of the crisis, was due to an inability of the firm to continue to fund itself because its mortgage securities had a sharp and excessive decline in value and were insufficient collateral. The loss in value of these securities was due to a much higher expectation that their actual cashflow would be much less than predicted. The banks that are currently holding these securities are finding that they are paying and not defaulting, which says that these securities should trade at a much higher price than they are. The decline in value and price of these securities, including at the time of Bear Stearns collapse, is due to an expectation that future, as opposed to current, cashflow will be modified and be less than anticipated.
In other words, the market anticipated the mortgage modification programs, bankruptcy cram downs, Democratic moral suasion and incentives to walk away from paying mortgages and the consequential results. This Democratic philosophy and programs led to excessive and unanticipated devaluation of mortgage securities. It also led to the inability of the investment banks and commercial banks to continue to fund themselves and impaired their capital base through write downs of the excessive devaluation of these securities. The impairment of the financial services sector would naturally lead to an increase fear by the consumers of a collapse of the US economy, which would cause consumers to be thrifty, increase savings and decrease consumer demand. As a result, unemployment would increase and further decrease the value of mortgage securities.
Of course, a collapse in the investment banking area, in banking capital and a fear of government intervention in rewriting banking lending contracts after the fact would and did lead to the current worldwide equity markets decline and economic crisis. Especially, since worldwide governments and central banks follow each other's actions.
The Iowa experimental election markets are more accurate than election polls in predicting US Presidential elections and predicted a Democratic win way before Obama took the lead against McCain in the polls.
http://tippie.uiowa.edu/news/story.cfm?id=2047
The collapse of Bear Stearns, which was the forerunner of the crisis, was due to an inability of the firm to continue to fund itself because its mortgage securities had a sharp and excessive decline in value and were insufficient collateral. The loss in value of these securities was due to a much higher expectation that their actual cashflow would be much less than predicted. The banks that are currently holding these securities are finding that they are paying and not defaulting, which says that these securities should trade at a much higher price than they are. The decline in value and price of these securities, including at the time of Bear Stearns collapse, is due to an expectation that future, as opposed to current, cashflow will be modified and be less than anticipated.
In other words, the market anticipated the mortgage modification programs, bankruptcy cram downs, Democratic moral suasion and incentives to walk away from paying mortgages and the consequential results. This Democratic philosophy and programs led to excessive and unanticipated devaluation of mortgage securities. It also led to the inability of the investment banks and commercial banks to continue to fund themselves and impaired their capital base through write downs of the excessive devaluation of these securities. The impairment of the financial services sector would naturally lead to an increase fear by the consumers of a collapse of the US economy, which would cause consumers to be thrifty, increase savings and decrease consumer demand. As a result, unemployment would increase and further decrease the value of mortgage securities.
Of course, a collapse in the investment banking area, in banking capital and a fear of government intervention in rewriting banking lending contracts after the fact would and did lead to the current worldwide equity markets decline and economic crisis. Especially, since worldwide governments and central banks follow each other's actions.
Saturday, February 28, 2009
No Surprise Mortgage Modifications Default Again
Experienced loan officers know that one of the best predictors of a loan default is a prior loan default. Therefore, the news that mortgage modifications have a very high rate, approaching 60 percent, of new defaults is not surprising.
Since defaulting on a mortgage is the requirement for qualifying for a mortgage loan modification, a high rate of new defaults after modification is normal. Tweaks to the government and the banks' loan modification programs will not decrease the rate of defaults unless mortgage modification programs allow people who did not default to qualify for a modification.
Since defaulting on a mortgage is the requirement for qualifying for a mortgage loan modification, a high rate of new defaults after modification is normal. Tweaks to the government and the banks' loan modification programs will not decrease the rate of defaults unless mortgage modification programs allow people who did not default to qualify for a modification.
Monday, February 23, 2009
Determinates Of Home Prices
House prices are composed of two primary components. The total value of a house is the combined value of the land that the structure sits on and the value of the physical structure. While there are regional differences in the cost of lumber and other materials primarily due to differences in transportation and storage costs and in the regional costs of labor, these do not account for the significant difference in regional prices of comparably built homes. The land's value is the primary cause of regional difference in comparably built homes. Over time, it is the value of a home's raw materials, labor, land and depreciation that determine a home's value.
The house structure as opposed to the land, depreciates over time due to the wear and tear of its components. For example, roofs will need replacement. The exterior will need repainting or need siding repair or replacement. Plumbing wears out and leaks. Weathering damage occurs to the structure, and many other parts of the house will need maintenance, repair or replacement. Any one who has ever seen an abandoned house recognizes that it will deteriorate over time without maintenance and repair.
A home's value will decline yearly due to this depreciation unless there is enough appreciation to compensate for the natural decline in a home's value or unless a potential buyer can assume that the current homeowner added back to the home's value the cost of the depreciation through repair and maintenance. In a robust economy, one can assume that the current owner is making the necessary repairs and maintenance and that the value of the replacement is equal to the depreciation value.
Assuming a 20-year average life for the combined house structure (it is just a reasonable guess to use as an example and not an actually computed value), the value of a home's structure will decline in value by 5 percent per year. Assuming that the land a house sits on is worth about 20 percent to the total house price (again just a reasonable guess for an average with the understanding that in some areas such as DC, San Francisco, NYC, etc it will be higher), the value of a home will decline by 4 percent per year (80 percent of 5 percent). A four percent increase in the total value of a home will be just enough to compensate for the loss due to depreciation and hold constant the total value of a home. To say that a home increases in value by the CPI is in effect to say its value increased by CPI plus 4 percent or that it increased by CPI and the homeowner added back to the home the 4 percent value of the depreciation. In recessionary times, homeowners will defer maintenance and repairs. Home prices will decline by their depreciation amount since the homeowner is not adding back the depreciation value, where in better times home prices will remain stable. Therefore, a 2-3 percent CPI increase in home prices will not be enough to compensate for the depreciation loss and lead to a 1-2 percent decline in home values. Currently, we are facing a deflationary price period and many of the raw materials needed for repairs have declined in price. For example, lumber prices are at a five year low. Due to the slow down in residential construction, labor costs are also low. Any repairs made by owners (if made) will cost less than anticipated and not compensate for the decline in a home's value due to depreciation. Plus, there is the increased likelihood that maintenance and repairs will be deferred.
Land value is set by supply and demand, which is determined by the desirability of an area and the availability of approved (or potentially approvable) buildable land in the area. Local government regulation determines if available land is approved for building a home. The availability of employment and the salaries paid for the jobs is a determinate of an area's desirability. The other is leisure, including retirement. When an area's total employment declines, the value of the residential land in that area will also decline causing a decline in a home's value. Likewise, in poor national economic times the value of leisure plus a delay in retirement decreases the value of land in leisure and retirement areas.
Therefore, home values will continue to decline due to two factors. Poor regional economies will cause a decline in land values in regional areas. The national downturn will cause a decline in retirement and leisure land areas. The decline in raw materials and labor for houses will also cause a decline in the replacement value of a home.
Home prices will not stabilize until regional employment stabilizes, until retirement and leisure return to normal levels and until raw material and labor prices recover to a level to compensate for the loss in value due to depreciation and homeowners add back the replacement cost of depreciation.
The house structure as opposed to the land, depreciates over time due to the wear and tear of its components. For example, roofs will need replacement. The exterior will need repainting or need siding repair or replacement. Plumbing wears out and leaks. Weathering damage occurs to the structure, and many other parts of the house will need maintenance, repair or replacement. Any one who has ever seen an abandoned house recognizes that it will deteriorate over time without maintenance and repair.
A home's value will decline yearly due to this depreciation unless there is enough appreciation to compensate for the natural decline in a home's value or unless a potential buyer can assume that the current homeowner added back to the home's value the cost of the depreciation through repair and maintenance. In a robust economy, one can assume that the current owner is making the necessary repairs and maintenance and that the value of the replacement is equal to the depreciation value.
Assuming a 20-year average life for the combined house structure (it is just a reasonable guess to use as an example and not an actually computed value), the value of a home's structure will decline in value by 5 percent per year. Assuming that the land a house sits on is worth about 20 percent to the total house price (again just a reasonable guess for an average with the understanding that in some areas such as DC, San Francisco, NYC, etc it will be higher), the value of a home will decline by 4 percent per year (80 percent of 5 percent). A four percent increase in the total value of a home will be just enough to compensate for the loss due to depreciation and hold constant the total value of a home. To say that a home increases in value by the CPI is in effect to say its value increased by CPI plus 4 percent or that it increased by CPI and the homeowner added back to the home the 4 percent value of the depreciation. In recessionary times, homeowners will defer maintenance and repairs. Home prices will decline by their depreciation amount since the homeowner is not adding back the depreciation value, where in better times home prices will remain stable. Therefore, a 2-3 percent CPI increase in home prices will not be enough to compensate for the depreciation loss and lead to a 1-2 percent decline in home values. Currently, we are facing a deflationary price period and many of the raw materials needed for repairs have declined in price. For example, lumber prices are at a five year low. Due to the slow down in residential construction, labor costs are also low. Any repairs made by owners (if made) will cost less than anticipated and not compensate for the decline in a home's value due to depreciation. Plus, there is the increased likelihood that maintenance and repairs will be deferred.
Land value is set by supply and demand, which is determined by the desirability of an area and the availability of approved (or potentially approvable) buildable land in the area. Local government regulation determines if available land is approved for building a home. The availability of employment and the salaries paid for the jobs is a determinate of an area's desirability. The other is leisure, including retirement. When an area's total employment declines, the value of the residential land in that area will also decline causing a decline in a home's value. Likewise, in poor national economic times the value of leisure plus a delay in retirement decreases the value of land in leisure and retirement areas.
Therefore, home values will continue to decline due to two factors. Poor regional economies will cause a decline in land values in regional areas. The national downturn will cause a decline in retirement and leisure land areas. The decline in raw materials and labor for houses will also cause a decline in the replacement value of a home.
Home prices will not stabilize until regional employment stabilizes, until retirement and leisure return to normal levels and until raw material and labor prices recover to a level to compensate for the loss in value due to depreciation and homeowners add back the replacement cost of depreciation.
Thursday, February 19, 2009
FDIC Procrastination Is The Way Around Pricing The Toxic Assets
The large banks, such as Citi, are not cash flow insolvent and are still in a position to lend. Some are likely book value insolvent or at least capital insufficient if the assets are repriced to market value, but on a cash flow basis, they can continue to operate and lend and honor normal deposit withdrawals.
Deposits are stable. Many of the toxic assets are receiving payments and are cash flow positive. Plus, these banks have liquid securities, such as Treasury securities, that can be converted to cash to further increase lending.
As long as these banks are not seeing a run on its deposits and as long as they can continue to lend, there is no functional need for the FDIC to step in and takeover Citi or the other large banks.
Buying or moving the toxic assets requires a repricing of the assets to a current market value and destroying much, if not all, of these banks' capital base. However, as long as the banks are receiving payments on the toxic assets, despite accounting rules, they can avoid writing down these assets until they default arguing that the assets are more like loans than securities. They may face some future shareholder and SEC lawsuits, but that potential liability will be small in comparison to a FDIC takeover.
Assuming that not all the assets will default at the same time and that Citi and the other banks will have positive earnings from the rest of their lending and investment portfolios, they can survive and come out of this crisis (although bruised) over the next few years. They will write down over the next few years its toxic assets (as they are already currently doing) as they default in their payments and these write downs will be offset by earnings from the remainder of the banks.
30 years ago, the large banks faced a crisis over sovereign debt until the Baker Plan and were technically insolvent, but were not required to write down those assets to a market value. Similarly, 20 years ago, there was a commercial real estate crisis and the banks took loan losses but not market value write-downs.
The current banking crisis with toxic assets is not like the S&L crisis. With S&L's there was a moral hazard because large shareholders controlled the bank and use the delay to take on very high risk as the only hopes of salvaging their wealth and many in effect bet the bank and lost. But many also survived.
Sometimes, banks have to wear the emperor's new clothes. Over time, the toxic assets will disappear through repayments and write-downs. Quick fixes are not always the best solutions. In the case of the large banks, procrastination is possibly the best answer.
Deposits are stable. Many of the toxic assets are receiving payments and are cash flow positive. Plus, these banks have liquid securities, such as Treasury securities, that can be converted to cash to further increase lending.
As long as these banks are not seeing a run on its deposits and as long as they can continue to lend, there is no functional need for the FDIC to step in and takeover Citi or the other large banks.
Buying or moving the toxic assets requires a repricing of the assets to a current market value and destroying much, if not all, of these banks' capital base. However, as long as the banks are receiving payments on the toxic assets, despite accounting rules, they can avoid writing down these assets until they default arguing that the assets are more like loans than securities. They may face some future shareholder and SEC lawsuits, but that potential liability will be small in comparison to a FDIC takeover.
Assuming that not all the assets will default at the same time and that Citi and the other banks will have positive earnings from the rest of their lending and investment portfolios, they can survive and come out of this crisis (although bruised) over the next few years. They will write down over the next few years its toxic assets (as they are already currently doing) as they default in their payments and these write downs will be offset by earnings from the remainder of the banks.
30 years ago, the large banks faced a crisis over sovereign debt until the Baker Plan and were technically insolvent, but were not required to write down those assets to a market value. Similarly, 20 years ago, there was a commercial real estate crisis and the banks took loan losses but not market value write-downs.
The current banking crisis with toxic assets is not like the S&L crisis. With S&L's there was a moral hazard because large shareholders controlled the bank and use the delay to take on very high risk as the only hopes of salvaging their wealth and many in effect bet the bank and lost. But many also survived.
Sometimes, banks have to wear the emperor's new clothes. Over time, the toxic assets will disappear through repayments and write-downs. Quick fixes are not always the best solutions. In the case of the large banks, procrastination is possibly the best answer.
Monday, February 16, 2009
Forget About Bank Recapitalization Or Nationalization
The US Treasury is worrying about the wrong problem.
The US is not any better off or richer if the government places its own stock in banks for the banks' toxic assets. It just moves the toxic asset problem from the right hand pocket of a potential FDIC liability to the left hand pocket of a potential US Treasury (or Federal Reserve) liability. In either pocket, US citizens still owned the potential liability and will have to make up any future shortfall through paying taxes. Furthermore, the capital base of the banks will be the same through a recapitalization as through a delay in writing down the toxic assets. Therefore, the total lending by these banks will be the same and the US economy will not be getting any economic benefit after the government's investment in these banks. Insolvency does not affect a bank's ability to be a lender, but does call into question its ability to survive as a corporate entity.
A recapitalization of the large banks is an optical trick that allows the US government to say it will not close these banks down. Unless the government reorganizes the bank and wipes out the private investors with the chance that the government becomes the sole investor, a recapitalization protects the banks' current shareholders and bondholders.
Insolvent banks pose a threat to debt holders and shareholders who face a complete loss of their investments. Insolvent banks, also, pose a threat to depositors only if the bank's income and positive cash flow are insufficient to continue paying deposit interest, deposit withdrawals and fund new lending. The large banks that the government is thinking about salvaging have sufficient positive cash flows to continue to operate. Many of the toxic assets continue to have a positive payment stream. These banks also have many cash equivalent assets such as US Treasuries, which can be converted to cash to fund lending without increasing the banks' leverage ratios and without increasing the banks' need for further capital to make loans.
Write downs of toxic assets decrease capital and accounting income, but do not decrease cash flow and sometimes actually increase cash flow because of the reduction in taxes. Capital amounts due to regulatory minimum capital requirements do impact the ability to lend. Simply allowing banks to delay writing down toxic assets (or allowing them to amortize the loss over a long time period such as on a asset cash flow matching basis), would obviate any need for the government to recapitalize these banks. It would allow banks with positive cash flows to remain sufficiently capitalized to continue to lend.
Banks were once, until about 40-50 years ago, the primary source of lending and deposit gathering in the US. With the advent of greater direct access by corporations to capital markets, private equity, hedge funds, insurance companies, non-financial lenders and with mortgage and loan securitization, bank lending has declined from 40 percent in 1980 to about 22 percent in 2008. The downward trend will continue, as banks no longer hold the monopoly on lending and are not the most efficient or knowledgeable source about borrowers.
Similarly, these days a much greater share of corporations and consumers place their funds in alternatives to FDIC insured bank deposit accounts, such as money market funds, muni and corporate bond funds, direct investment into US Treasuries, corporate bonds, municipal bonds and stocks. Like lending, banks have lost their monopoly as funds gatherers. In fact, without FDIC insurance, these large banks probably would not have been able to continue to gather and keep their deposits as the banks increased the riskiness of their assets. Either the deposits would have left these banks or demanded an interest rate higher than the return on the banks' assets.
Whatever the government decides to do with the large banks, it will not change the total bank lending in the US, but it can meaninglessly transfer potential liability from the FDIC to the US Treasury. The US government should just allow the importance of these banks to the US economy to continue to diminish. The government and the Federal Reserve should continue to focus on reinvigorating the non-bank lending and securitization in the US, which are now, as have been for a while, the primary sources for loans to the US economy. The government should just give the banks the OK not to write the down the toxic assets and then focus on the real economic problem in the US of the lack of non-bank lending and securitization. Over time, the large banks will continue to lose their importance to the US economy and whatever is done to them at a later date will no longer be a major concern.
The US is not any better off or richer if the government places its own stock in banks for the banks' toxic assets. It just moves the toxic asset problem from the right hand pocket of a potential FDIC liability to the left hand pocket of a potential US Treasury (or Federal Reserve) liability. In either pocket, US citizens still owned the potential liability and will have to make up any future shortfall through paying taxes. Furthermore, the capital base of the banks will be the same through a recapitalization as through a delay in writing down the toxic assets. Therefore, the total lending by these banks will be the same and the US economy will not be getting any economic benefit after the government's investment in these banks. Insolvency does not affect a bank's ability to be a lender, but does call into question its ability to survive as a corporate entity.
A recapitalization of the large banks is an optical trick that allows the US government to say it will not close these banks down. Unless the government reorganizes the bank and wipes out the private investors with the chance that the government becomes the sole investor, a recapitalization protects the banks' current shareholders and bondholders.
Insolvent banks pose a threat to debt holders and shareholders who face a complete loss of their investments. Insolvent banks, also, pose a threat to depositors only if the bank's income and positive cash flow are insufficient to continue paying deposit interest, deposit withdrawals and fund new lending. The large banks that the government is thinking about salvaging have sufficient positive cash flows to continue to operate. Many of the toxic assets continue to have a positive payment stream. These banks also have many cash equivalent assets such as US Treasuries, which can be converted to cash to fund lending without increasing the banks' leverage ratios and without increasing the banks' need for further capital to make loans.
Write downs of toxic assets decrease capital and accounting income, but do not decrease cash flow and sometimes actually increase cash flow because of the reduction in taxes. Capital amounts due to regulatory minimum capital requirements do impact the ability to lend. Simply allowing banks to delay writing down toxic assets (or allowing them to amortize the loss over a long time period such as on a asset cash flow matching basis), would obviate any need for the government to recapitalize these banks. It would allow banks with positive cash flows to remain sufficiently capitalized to continue to lend.
Banks were once, until about 40-50 years ago, the primary source of lending and deposit gathering in the US. With the advent of greater direct access by corporations to capital markets, private equity, hedge funds, insurance companies, non-financial lenders and with mortgage and loan securitization, bank lending has declined from 40 percent in 1980 to about 22 percent in 2008. The downward trend will continue, as banks no longer hold the monopoly on lending and are not the most efficient or knowledgeable source about borrowers.
Similarly, these days a much greater share of corporations and consumers place their funds in alternatives to FDIC insured bank deposit accounts, such as money market funds, muni and corporate bond funds, direct investment into US Treasuries, corporate bonds, municipal bonds and stocks. Like lending, banks have lost their monopoly as funds gatherers. In fact, without FDIC insurance, these large banks probably would not have been able to continue to gather and keep their deposits as the banks increased the riskiness of their assets. Either the deposits would have left these banks or demanded an interest rate higher than the return on the banks' assets.
Whatever the government decides to do with the large banks, it will not change the total bank lending in the US, but it can meaninglessly transfer potential liability from the FDIC to the US Treasury. The US government should just allow the importance of these banks to the US economy to continue to diminish. The government and the Federal Reserve should continue to focus on reinvigorating the non-bank lending and securitization in the US, which are now, as have been for a while, the primary sources for loans to the US economy. The government should just give the banks the OK not to write the down the toxic assets and then focus on the real economic problem in the US of the lack of non-bank lending and securitization. Over time, the large banks will continue to lose their importance to the US economy and whatever is done to them at a later date will no longer be a major concern.
Tuesday, February 3, 2009
Job Cut Announcements Overstate Job Losses
Losing ones job is horrible, but in previous periods of announced job cuts, the announced cuts at public companies significantly exceed the actual numbers that lose their jobs at those companies. Publicly traded companies often believe it is good for their stock price to announce a cost cutting effort, particularly when profits are low.
Companies will often include in announcements: (1) personnel included in a sale of a business unit or subsidiary who retain their jobs under the new owners; (2) people retained by the company and moved to a different job in the company when their old position is abolished; (3) abolishing a higher paying senior position to only rehire at a lower paying junior position; (4) normal job attrition due to retirement, quitting, taking a job at another company, etc., and (5) failure to follow through and actually lay-off the announced number of people for numerous business reasons.
Also, companies are often vague about the time frame in which the reductions will occur. The reductions at some companies are not immediate and they can take place over several years.
Companies will often include in announcements: (1) personnel included in a sale of a business unit or subsidiary who retain their jobs under the new owners; (2) people retained by the company and moved to a different job in the company when their old position is abolished; (3) abolishing a higher paying senior position to only rehire at a lower paying junior position; (4) normal job attrition due to retirement, quitting, taking a job at another company, etc., and (5) failure to follow through and actually lay-off the announced number of people for numerous business reasons.
Also, companies are often vague about the time frame in which the reductions will occur. The reductions at some companies are not immediate and they can take place over several years.
A Bank Toxic Assets Solution
A simple solution for dealing with the toxic assets on banks' books that goes to the core issue is to have the regulators use their inherent powers to create a new asset category on the banks' books. The new regulatory asset category will be for performing assets with a disputed market price that need not be written down to market price as long as the loan asset is substantially performing and current in its predicted and scheduled payments. The regulators can call these assets Disputed Market Price Performing Assets.
As long as these assets are receiving their scheduled payments or are fully paid off, the banks will receive over time their booked value of these assets plus interest and no write-downs due to mark to market will be necessary. If these assets go into arrears on their payments, the regulators can require, as they do for non-performing loans, that these assets be put into a non-performing category on the banks' balance sheets. If within a reasonable time, such as 120 days, these assets do not become current in their payments, then the bank will need to write down the value of the asset to a more realistic value based on the lower amount of payments that it is receiving. Banks and regulators are well versed in dealing with and valuing loan assets that are not performing as predicted and scheduled.
Having this additional asset category solves many problems. It allows banks to disagree with the current market price without immediately needing to write the asset down to current market value. The asset will be written down and lose value on the banks' books only when it stops receiving the scheduled payments. It avoids the difficult problem of valuing hard to value assets. It decreases the number assets that are potentially toxic on the banks balance sheet to those assets that actually go into default. It spreads the write-downs of the bad assets over their lifetime of many years.
If the banks and the administration are right, that these assets are incorrectly valued currently by the market, then no write-downs by the banks will occur. If these assets do need to be written down, it will be over time as they show their true diminished value through defaults in payments. Time will give banks opportunity to reserve against these losses and preserve their capital base.
As long as these assets are receiving their scheduled payments or are fully paid off, the banks will receive over time their booked value of these assets plus interest and no write-downs due to mark to market will be necessary. If these assets go into arrears on their payments, the regulators can require, as they do for non-performing loans, that these assets be put into a non-performing category on the banks' balance sheets. If within a reasonable time, such as 120 days, these assets do not become current in their payments, then the bank will need to write down the value of the asset to a more realistic value based on the lower amount of payments that it is receiving. Banks and regulators are well versed in dealing with and valuing loan assets that are not performing as predicted and scheduled.
Having this additional asset category solves many problems. It allows banks to disagree with the current market price without immediately needing to write the asset down to current market value. The asset will be written down and lose value on the banks' books only when it stops receiving the scheduled payments. It avoids the difficult problem of valuing hard to value assets. It decreases the number assets that are potentially toxic on the banks balance sheet to those assets that actually go into default. It spreads the write-downs of the bad assets over their lifetime of many years.
If the banks and the administration are right, that these assets are incorrectly valued currently by the market, then no write-downs by the banks will occur. If these assets do need to be written down, it will be over time as they show their true diminished value through defaults in payments. Time will give banks opportunity to reserve against these losses and preserve their capital base.
Sunday, January 18, 2009
Thoughts On Sheila Bair's Bad Bank Solution
Does FDIC's Sheila Bair's idea of using government funds to buy bad, toxic assets at banks at a 'fair value' price that is above current prices make economic sense?
If you believe that markets price assets at or close to fair value all or most of the time, then the only solution is for the government to overpay for the banks' assets. Having this idea is to align oneself with efficient, rational markets theorists.
If you believe markets can misprice assets and under or over value them for a sustained period and that the market will eventually correct itself, then purchasing the assets from banks above current prices will be the correct action. In this scenario, one sees the banks as unfairly penalized for market disruptions that are beyond their control.
If you believe that market prices are mostly right, then it is inconsistent to believe that there was a housing bubble. Then, the recent decline in house prices is a rational response to expected economic forces as yet not fully disclosed.
Bair, other government officials, many politicians, and more than a few economists believe there was a housing bubble and that house prices were not rational. Going from believing in mispriced house prices to mispriced mortgage and other bank assets is a tiny step.
If you believe that markets price assets at or close to fair value all or most of the time, then the only solution is for the government to overpay for the banks' assets. Having this idea is to align oneself with efficient, rational markets theorists.
If you believe markets can misprice assets and under or over value them for a sustained period and that the market will eventually correct itself, then purchasing the assets from banks above current prices will be the correct action. In this scenario, one sees the banks as unfairly penalized for market disruptions that are beyond their control.
If you believe that market prices are mostly right, then it is inconsistent to believe that there was a housing bubble. Then, the recent decline in house prices is a rational response to expected economic forces as yet not fully disclosed.
Bair, other government officials, many politicians, and more than a few economists believe there was a housing bubble and that house prices were not rational. Going from believing in mispriced house prices to mispriced mortgage and other bank assets is a tiny step.
Sunday, January 11, 2009
What Are The Expected Values Of the Stimulus Plans?
Every government stimulus spending or tax reduction plan has its own risks associated with it and probabilities that measure that risk. There is obviously a political risk as to whether Congress will pass the plan, will substantially modify it, or will fail to pass it. Likewise, there is an implementation risk as to whether the plan can be and will be set up as envisioned. Lastly, there is also obviously a results risk as to whether the plan will achieve its intended effect with the expected impact without negative unintended economic consequences. For example, a plan double the size of that proposed may have no additional impact on the economy in a reasonable time because the government will be unable to spend the extra funds sufficiently quickly to have a positive economic result. Additionally, there can be other economic risks to the proposed plan not discussed here, such as geopolitical risks from trade effects, military budget effects, etc.
Evaluation of different stimulus packages just by the final modeled effect on the economy, GDP and unemployment is misleading because it does not incorporate the chance of the success or failure of the different proposed plans. It would be like playing poker and assuming the odds of getting two of a kind are the same as getting four of a kind.
A much more meaningful and relevant discussion of the comparison of different stimulus packages, whether the packages are government spending, tax reduction or a blend, is to compute the expected value of each plan based on each plan's risk profile. Under economic theory, the plan with the highest expected value is the one to choose for the greatest economic impact. Without a computed expected value for the different plans, the discussions about the various economic plans in news articles, or in blogs shed no real light on what plan to choose.
Evaluation of different stimulus packages just by the final modeled effect on the economy, GDP and unemployment is misleading because it does not incorporate the chance of the success or failure of the different proposed plans. It would be like playing poker and assuming the odds of getting two of a kind are the same as getting four of a kind.
A much more meaningful and relevant discussion of the comparison of different stimulus packages, whether the packages are government spending, tax reduction or a blend, is to compute the expected value of each plan based on each plan's risk profile. Under economic theory, the plan with the highest expected value is the one to choose for the greatest economic impact. Without a computed expected value for the different plans, the discussions about the various economic plans in news articles, or in blogs shed no real light on what plan to choose.
Wednesday, January 7, 2009
Will Private Investment Follow Government Stimulus Spending
When the two years of government stimulus spending ends, what will there be to replace it unless we have concurrent private investment? The government does not have an obvious answer as to what will be a sustained replacement for the decline in the US housing component (construction, sales, etc.) of the last decade's GDP. Obama's plan to fix roads, bridges, build modern schools, pay teachers higher salaries, make government buildings energy efficient and green America will not provide the necessary historical and consistent long-term per capita US GDP growth that has given the US its high standard of living and has been the envy and despise of the world.
Sustainable high productivity is a sure long-term path to a better standard of living for a country's people and is the result of the technological innovations of private investment and fierce competition. US workers have the highest productivity in the world for many reasons: Ease of bankruptcy, low government share of GDP, low government ownership rate of business, low unionization rate, entrepreneurial wealth incentives, ability to amass wealth through hard work, accessibility to capital, ease of business start-ups, tough competition, lack of price controls, etc.
Recent government efforts to help the financial, automotive and other US industries are doing much to undermine the prospects for future US economic growth for the sake of appearing to help the voting worker, a lesson learned during the Franklin Roosevelt era and forgotten by our current politicians. It took until 1940 for the US economy to return to the height of its 1928-29 production levels and much of that was due to helping the war effort in Europe. Over the next two years, the US employable workforce is expected to grow at 1.1 percent a year, and the US needs to create 3.3 million new jobs in addition to replacing the 2.6 million jobs lost in 2008 and the yet unknown jobs lost in 2009 to have unemployment levels return to pre-recession levels. The US needs to create at least double the number of jobs promised by the new president. Obama's US employment rhetoric and goals of 3 million jobs falls far short of the needs of the US economy for the next two years.
Unfortunately, our politicians see the Roosevelt era through rose-colored glasses. While we call the 1930s, the period of the Great Depression, the slowdown in Europe was not called a Great Depression because it was not as severe and it was shorter lived. In England, it was much milder than in the US and their Great Depression occurred in 1907.
Predicting the future success of new businesses and of new technological innovation is impossible. The US needs a new commitment to fund basic scientific and technological research, a commitment to facilitate business start-ups and business growth and the least obvious, a commitment to allow businesses of all sizes in all industries to fail. Unfortunately, nothing in Obama's plans deal with helping the long-term per capita GDP growth of the US. His instincts, rhetoric and plans are more of the nature of a political animal already planning his reelection than of an economic man who will steer the US economy to long-term prosperity.
Sustainable high productivity is a sure long-term path to a better standard of living for a country's people and is the result of the technological innovations of private investment and fierce competition. US workers have the highest productivity in the world for many reasons: Ease of bankruptcy, low government share of GDP, low government ownership rate of business, low unionization rate, entrepreneurial wealth incentives, ability to amass wealth through hard work, accessibility to capital, ease of business start-ups, tough competition, lack of price controls, etc.
Recent government efforts to help the financial, automotive and other US industries are doing much to undermine the prospects for future US economic growth for the sake of appearing to help the voting worker, a lesson learned during the Franklin Roosevelt era and forgotten by our current politicians. It took until 1940 for the US economy to return to the height of its 1928-29 production levels and much of that was due to helping the war effort in Europe. Over the next two years, the US employable workforce is expected to grow at 1.1 percent a year, and the US needs to create 3.3 million new jobs in addition to replacing the 2.6 million jobs lost in 2008 and the yet unknown jobs lost in 2009 to have unemployment levels return to pre-recession levels. The US needs to create at least double the number of jobs promised by the new president. Obama's US employment rhetoric and goals of 3 million jobs falls far short of the needs of the US economy for the next two years.
Unfortunately, our politicians see the Roosevelt era through rose-colored glasses. While we call the 1930s, the period of the Great Depression, the slowdown in Europe was not called a Great Depression because it was not as severe and it was shorter lived. In England, it was much milder than in the US and their Great Depression occurred in 1907.
Predicting the future success of new businesses and of new technological innovation is impossible. The US needs a new commitment to fund basic scientific and technological research, a commitment to facilitate business start-ups and business growth and the least obvious, a commitment to allow businesses of all sizes in all industries to fail. Unfortunately, nothing in Obama's plans deal with helping the long-term per capita GDP growth of the US. His instincts, rhetoric and plans are more of the nature of a political animal already planning his reelection than of an economic man who will steer the US economy to long-term prosperity.
Saturday, December 27, 2008
Why Mortgages Are Expensive Compared To Treasuries
Why are current interest rates on 30-year mortgages so high given that 10-year treasuries are so low? In effect, the current difference in the interest rate of 30-year mortgages and 10-year treasuries is more than double its normal and historical average. 30 yr mortgages are normally compared to 10 year treasuries because both the duration and the average life of a 30 year mortgage is closer to 10 years then 30 years, making the spread over 10 year more appropriate then 30 yr. It is currently about 3 percent or 300 basis points.
Mortgage spreads over treasuries contain at least two components. One is the risk of default, including the risk that the collateral for the mortgage, i.e. the house will decrease in value below that of the mortgage amount.
The other is the cost of an implied option right that gives the mortgagor the ability to prepay the mortgage before the 30 years through sale, refinancing or through additional principal payments. The cost of the option is borne by the mortgagor through a higher spread since it is the mortgagor who owns and pays for the right to prepay.
The two work in opposite direction. The longer one expects to continue to pay a mortgage, the greater the risk of default and the higher the spread. The increase term increases the likelihood that the mortgagor will encounter economic difficulties, such as a job loss, unexpected large medical or other expenses, or a significant decrease in home value, etc. In the first 15 years of a mortgage, about 70 percent of the principal remains and after 20 years, almost half the mortgage principal remains.
The longer one initially expects to reside in the home and pay the mortgage, the less one is willing to pay for the option that gives right to prepay in the early years and this will decrease the spread.
The above average spread of mortgage rates over treasuries can mean either of two things. It can mean that the average life of new 30-year mortgages will be significantly less than 10 years and people are willing to pay a premium in the spread for the right to do so. It can also mean just the opposite, that people are expecting to stay in their homes way beyond ten years and that the average life of a mortgage will be significantly more than 10 years with a higher chance of default that historical average spreads suggest.
Both a longer term with a higher chance of default and a willingness to pay a premium for the right to prepay early for a shorter term will increase mortgage spreads above historical averages over treasuries. People who have worked in mortgage finance computing option adjusted spreads for mortgages could probably compute which effect is the dominate one in the current environment.
Any action the government takes to attempt to decrease the current mortgage spread must either decrease the risk of default on longer-term mortgages or decrease the cost of the likelihood of early payment of mortgages without interfering with people’s ability to refinance or move.
In either case, guaranteeing the GSEs debt with the full faith and credit of the US or having Treasury borrow on their behalf as Nobel prize winning economist Paul Krugman recommends in his December 26, 2008, NY Times article will not do the trick. His solution most likely will not impact the underlying factors that make up the mortgage spread over treasuries.
Mortgage spreads over treasuries contain at least two components. One is the risk of default, including the risk that the collateral for the mortgage, i.e. the house will decrease in value below that of the mortgage amount.
The other is the cost of an implied option right that gives the mortgagor the ability to prepay the mortgage before the 30 years through sale, refinancing or through additional principal payments. The cost of the option is borne by the mortgagor through a higher spread since it is the mortgagor who owns and pays for the right to prepay.
The two work in opposite direction. The longer one expects to continue to pay a mortgage, the greater the risk of default and the higher the spread. The increase term increases the likelihood that the mortgagor will encounter economic difficulties, such as a job loss, unexpected large medical or other expenses, or a significant decrease in home value, etc. In the first 15 years of a mortgage, about 70 percent of the principal remains and after 20 years, almost half the mortgage principal remains.
The longer one initially expects to reside in the home and pay the mortgage, the less one is willing to pay for the option that gives right to prepay in the early years and this will decrease the spread.
The above average spread of mortgage rates over treasuries can mean either of two things. It can mean that the average life of new 30-year mortgages will be significantly less than 10 years and people are willing to pay a premium in the spread for the right to do so. It can also mean just the opposite, that people are expecting to stay in their homes way beyond ten years and that the average life of a mortgage will be significantly more than 10 years with a higher chance of default that historical average spreads suggest.
Both a longer term with a higher chance of default and a willingness to pay a premium for the right to prepay early for a shorter term will increase mortgage spreads above historical averages over treasuries. People who have worked in mortgage finance computing option adjusted spreads for mortgages could probably compute which effect is the dominate one in the current environment.
Any action the government takes to attempt to decrease the current mortgage spread must either decrease the risk of default on longer-term mortgages or decrease the cost of the likelihood of early payment of mortgages without interfering with people’s ability to refinance or move.
In either case, guaranteeing the GSEs debt with the full faith and credit of the US or having Treasury borrow on their behalf as Nobel prize winning economist Paul Krugman recommends in his December 26, 2008, NY Times article will not do the trick. His solution most likely will not impact the underlying factors that make up the mortgage spread over treasuries.
Thursday, December 25, 2008
Possible Cause of Housing Decline
Could the collapse of mortgage securities, CDOs, and house prices have an efficient market, rational expectation explanation other than over building and subprime mortgage lending?
A December 2008 released Pew Research Center Social & Demographic Trend survey found; "Only 13% of Americans changed residences between 2006 and 2007, the smallest share since the government began tracking this trend in the late 1940s." The survey was conducted during October 2008 and released on December 17, 2008.
A decline in relocation would cause a decline in demand for housing and a decline in consumer purchases related to setting up a new house. It would also cause an increase in the expected life of mortgages due to a decline in mortgage payoffs caused by the sale of an existing mortgaged house. It would also cause a decline in the demand for employment by existing labor to the extent that two wage earning couple are willing not to relocate.
Pew attributes the decline to an older population which is less likely to relocate and to two career couples because it is difficult to coordinate a move when two wage earners are involved.
The Pew news release is available at
http://pewresearch.org/pubs/1058/american-mobility-moversstayers-places-and-reasons
and the full Pew report at
http://pewsocialtrends.org/assets/pdf/Movers-and-Stayers.pdf
A December 2008 released Pew Research Center Social & Demographic Trend survey found; "Only 13% of Americans changed residences between 2006 and 2007, the smallest share since the government began tracking this trend in the late 1940s." The survey was conducted during October 2008 and released on December 17, 2008.
A decline in relocation would cause a decline in demand for housing and a decline in consumer purchases related to setting up a new house. It would also cause an increase in the expected life of mortgages due to a decline in mortgage payoffs caused by the sale of an existing mortgaged house. It would also cause a decline in the demand for employment by existing labor to the extent that two wage earning couple are willing not to relocate.
Pew attributes the decline to an older population which is less likely to relocate and to two career couples because it is difficult to coordinate a move when two wage earners are involved.
The Pew news release is available at
http://pewresearch.org/pubs/1058/american-mobility-moversstayers-places-and-reasons
and the full Pew report at
http://pewsocialtrends.org/assets/pdf/Movers-and-Stayers.pdf
Tuesday, December 23, 2008
Job Growth
The US has approximately 145 million workers and the US population grows about 1.1 percent per year. The US needs to add about 3.3 million jobs over the next two years just to keep unemployment at current levels. President-elect Obama's plan to add 3 million jobs to the economy over the next two years will do little if anything to reduce unemployment.
Subscribe to:
Posts (Atom)