Kevin Drum

The Calm Before the Storm?

| Mon Apr. 5, 2010 11:32 AM EDT

So how's the housing market looking? Well, prices seem to have stabilized and foreclosure rates are down. Hooray! But Mark Gimein warns that the news is not actually as happy as the realtors' PR machine would like you to believe:

Consider, for instance, California. In the first quarter of 2009, according to the Mortgage Bankers Association, banks started foreclosures on 2.15 percent of all mortgages (that is, roughly one in 50). In the last quarter — the latest period for which data are available — that was down to 1.34 percent, a sizable drop....

But if you conclude from this that more folks have gotten their arms around their mortgages, think again. The number of new foreclosures may have dropped, but the number of people seriously behind on their mortgages has risen — from 4.75 percent of mortgage holders all the way up to 6.93 percent, an increase of close to 45 percent....Thanks to some combination of government pressure, genuine efforts at loan modifications, and reluctance to seize houses and try to sell them in a dismal market, banks are simply letting more debtors fall behind without foreclosing.

....The Realtors' association happily reports that housing prices are rising because of tightening “inventory” — the trade term for “fewer houses for sale” — but underneath this is the scary reality that there are ever more folks seriously behind on their loans and waiting for lenders to take their houses and condos. This is something that lenders are reluctant to do because they still have no one to sell them to. The housing market looks stable only because lenders are avoiding flooding it with foreclosed properties.

There's something more fundamental at work too: housing prices may have stablized recently, but they've done so at a level quite a bit higher than their pre-bubble value. Now, I've long thought that when the housing crash is finally over, prices might actually end up somewhat higher than their historical trend rate, but even if I'm right (never a sure bet) my guess is that prices might end up 10-20% higher, not 30-40% higher, which is where they are now. Bottom line: the housing market still has a ways to fall, and when the foreclosure moratorium finally ends it's likely to spark another 20% fall in housing values. Or maybe more. The fat lady hasn't sung yet.

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Strange Bedfellows

| Mon Apr. 5, 2010 11:08 AM EDT

In the LA Times today, Dean Baker has co-authored an op-ed with Kevin "Dow 36,000" Hassett. So a guy who was right about (almost) everything is paired up with a guy who's been wrong about (almost) everything. This has serious implications for the space-time continuum.

The Fed and the Bubble

| Mon Apr. 5, 2010 10:20 AM EDT

Should the Fed have done more to fight the housing bubble of the past decade? Dean Baker says yes, Brad DeLong says probably not, and Matt Yglesias comments:

I have no opinion on how much monetary policy influenced the bubble or could have counteracted it. I know economists don’t like to talk about this sort of thing, but if you ask me the biggest influence policymakers had on the bubble wasn’t so much what they did as to an extent what they said.....Throughout this period, Alan Greenspan and Ben Bernanke were extremely famous, very well-known public officials charged with economic policy. If Greenspan had said something like “seems to me that price:rent ratios are totally out-of-whack and bubbly, so even though I’m not convinced there’s anything the Fed can do to pop a bubble in the housing market, I’m going to put my house on the market and start renting while the going is good” I think that would have made a big difference in the common understanding of what was going on.

I think what's missing from this discussion is what else the Fed could have done. Yes, they could have raised interest rates earlier and faster, but as Brad points out, that's a blunt instrument that would have hurt the wider economy — and in any case, when they did finally raise short-term interest rates it had precious little effect on longer-term rates. Likewise, Greenspan and Bernanke could have jawboned more, but that might or might not have had any real effect.

But what about everything in between? After all, the Fed regulates banks and it regulates mortgage loans. Would commercial banks have been able to shovel so much leverage off their balance sheets if the Fed had glommed onto what they were doing and prohibited it? What if the Fed had decided to regulate overdraft fees as loans, putting a big dent in the credit/debit card frenzy of the aughts? What if the Fed had taken a tough stance against deceptive mortgage practices, as consumer groups continually begged them to do based on FBI reports that such practices were rampant? What if they had performed more vigorous oversight of bank affiliates — Wells Fargo Financial, CitiFinancial, Countrywide Home Loans, etc. — that played such a big role in the subprime bubble? And keep in mind too that the Fed also has considerable influence over other regulators. Would the SEC have lowered capital limits on investment banks if the Fed had vigorously opposed it?

I haven't read Dean's book yet, and it might go into all this stuff. But just for the sake of the immediate conversation, I want to point out that raising interest rates was far from the only possible response by the Fed to the credit bubble. They probably couldn't have stopped it completely, but if they had seen it coming they had plenty of tools in their toolkit to keep it from spiraling out of control the way it did.

False Profits

| Sat Apr. 3, 2010 6:25 PM EDT

In a review of Dean Baker's False Profits, Daniel Davies notes that although Wall Street's infamous financial legerdemain (along with dollops of occasional fraud) helped to amplify the financial bubble that crashed to earth in 2008, it wasn't the primal cause:

It’s necessary to be clear here — the original sin here was the real estate bubble, a bubble which could and should have been the object of anti-bubble policy, and which wasn’t, because of a massive, ghastly policy error on the part of the Federal Reserve. This is Dean’s thesis, and he names the guilty men.

....None of the arguments made by housing bulls during the bubble made a lick of sense, for the simple reason that the ratio of house prices to rents was constantly increasing — any fundamental change in the economics of housing ought to have shown up equally in the rental market as in the market for house purchase, and the “buy versus rent calculation” wasn’t an anomaly or a quirk — it was a simple and easily comprehensible piece of information showing that prices were in a bubble, which was almost universally ignored.

There's a lively debate in the economics community about whether it's possible to recognize bubbles as they're happening. For example, we still don't know for sure if the 2007-08 oil runup was a bubble or whether it was caused by fundamental issues of limited supply and rising demand. (Probably a bit of both, it turns out.) But as both Dean and Daniel point out, housing is different. In the housing market there are several well known and historically rigorous metrics that do a pretty good job of telling you whether prices have become untethered from reality. The ratio of price to rents is the most fundamental, but there's also price-to-median income and mortgage payments as a share of income. By 2002 all three had started to rise dangerously, and by 2004 they were plainly in bubble land. Even if it's true generally that bubbles are hard to distinguish reliably, this one was easy.

I've mentioned before that I sort of waffle about how important all the other stuff was (the overseas savings glut, the credit derivative free-for-all, reckless abuse of leverage, ratings agency corruption, etc.), but no matter how important it was, the housing bubble was plainly the ur-cause underlying everything else. The Fed should have been doing something about it, not egging it on.

Calorie Counting in the Gamma Quadrant

| Fri Apr. 2, 2010 10:02 PM EDT

In the Wall Street Journal today, Carl Bialik has some startling news about weight loss:

How many calories must a dieter cut to lose a pound? The answer most dietitians have long provided is 3,500. But recent studies indicate that calories can't be converted into weight through a simple formula.

....Consider the chocolate-chip-cookie fan who adds one 60-calorie cookie to his daily diet. By the old math, that cookie would add up to six pounds in a year, 60 pounds in a decade and hundreds of pounds in a lifetime.

But new research [suggests] the cookie fiend probably will see his weight gain approach six pounds, and then level off, pediatrician David Ludwig and nutrition scientist Martijn Katan wrote in the Journal of the American Medical Association earlier this year. The same numbers, in reverse, apply to weight loss.

There's a disturbing lack of common sense at work here. The handy illustration on the right, taken from the article, is for a 210-calorie cookie, not a 60-calorie cookie, but still: does anyone believe that adding a single cookie to your daily diet will take you from 200 pounds to 320 pounds in six years? Has anyone ever believed that? Of course not. It defies reason.

Not surprisingly, then, no one has ever suggested such a thing. Ceteris paribus, a certain number of calories will sustain a certain amount of weight. Take, for example, this calorie calculator from the fine folks at the American Cancer Society. It says that 2,818 calories per day will sustain a sedentary 200 pound man. Now add in that 210-calorie cookie. According to the ACS, 3,028 calories will sustain the same man at a weight of 215 pounds. It does not say that after 30 years he will weigh 830 pounds.

This is not based on dazzling new science. It's the same result you'll get from every calorie calculator in the world. It's possible that new research will change the simplistic formula this is based on, but it's going to be a rather more subtle change than 6 pounds vs. 600. Common sense should have sent this story back to rewrite.

Friday Cat Blogging - 2 April 2010

| Fri Apr. 2, 2010 1:58 PM EDT

I happen to like this picture a lot, so Friday Catblogging this week is turned over entirely to Inkblot, the great snoozeball himself. He is, perhaps, dreaming of tuna Easter eggs. Or something. I myself am dreaming of old school chocolate Easter eggs. Have a good weekend, everyone.

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China and Us

| Fri Apr. 2, 2010 12:32 PM EDT

So then, what's going on with China? Things have been testy for a while, but now suddenly we're hearing reports that U.S.-China relations may be on the mend. No currency war, a bit of agreement on Iran sanctions, and sort of a mini-detente over Taiwan and Tibet. Hooray! But Dan Drezner points us to the FT's Gideon Rachman, who says the long picture isn't quite so hunky dory, especially this:

The mega-trend in the background is the rise of China and the relative decline of the US — and the expression of this will be the gradual challenge to American military hegemony in the Pacific. This will not be a comfortable process.

Maybe not. But it presupposes that China is going to keep growing at the blistering rate we've seen for the past couple of decades — a pace they have to keep up just to keep from falling behind. Gordon Chang, writing in World Affairs, thinks they've already missed their chance to do that:

The analysts and the conventional wisdom they peddle are wrong. China’s economic model, which allowed the Chinese to take maximum advantage of boom times, is particularly ill suited to current global conditions. About 38 percent of the country’s economy is attributable to exports — some say the figure is higher — but global demand at this moment is slumping.

....Chinese technocrats, goaded by a multitude of analysts and foreign leaders, have known for years that they would have to diversify the economy — steer it away from investment and exports and toward consumption. Yet [Prime Minister Wen Jiabao], in office since 2003, has not made much of an effort to do so....So the Chinese economy, once in an upward super-cycle, is now headed on a downward trajectory. Beijing’s leaders had the opportunity to fix these problems in a benign period of growth, but they did not because they were unable or unwilling to challenge a rigid political system that inhibits adaptation to changing circumstances. Their failure to implement sensible policies highlights an inherent weakness in the system of Chinese governance, not just a single economic misstep at a particular moment in history.

Now, Chang is a longtime doomsayer about the Chinese economy. His book, The Coming Collapse of China, predicted that China would collapse in 2006. So like any good doomsayer proven wrong, he's just pushed out his prediction a bit.

In other words, take him with a big shaker of salt. Still, I think there's a germ of truth here that gets missed too often: Chang is right that China's economy is probably shakier than we usually give it credit for. Not only is it built on a foundation of booming exports, but its political system requires fantastic growth rates just to remain stable. As China's economy grows, however, its wage base will grow too and this will hurt their ability to keep up the flood of exports. Without internal demand to make up for it, growth rates will fall below the magic number of 8% per year. For them, that would be about as painful as a sluggish growth rate of 1-2% would be for us.

Now, maybe China will make the transition better than Chang thinks. And in any case, they'll certainly continue to grow both their economy and their influence even if they don't do it quite as manically as they have since the 80s. In other words, I'll leave the doomsaying to Chang. Still, I suspect that China is going to run into a few more hiccups on the way to domination of the Pacific than the alarmists think. Their brand of autocratic government is going to have a very hard time coping with a restive middle class once per capita income starts to bump up against $10,000 or so. That's still a ways off, but it's not that far off.

Healthcare and Hillary

| Fri Apr. 2, 2010 11:21 AM EDT

Bruce Bartlett makes a long argument today that conservatives should have (quietly, one presumes) supported Hillary Clinton during the Democratic primary because she would have governed more agreeably than Obama has. I'm not sure about that, but I'm especially not sure about this specific prediction:

I think the evidence suggests that Hillary Clinton could have won the Democratic nomination with just a little bit more support, and probably would be governing significantly more conservatively than Obama. For one thing, given her disastrous experience with health care reform in 1993-1994, it's reasonable to assume that she would have stayed away from that issue at all costs.

Well, we'll never know, will we? But my guess is just the opposite. I think Hillary was, if anything, more dedicated to healthcare reform than Obama, and I think she would have taken it on more vigorously than he did. What's more, my guess is that her better feel for the Senate and past failure with healthcare reform would have made her more effective at getting a package passed. It probably would have looked about the same as what we got (her position during the campaign was similar to Obama's and most of the work was done by Congress anyway), but I suspect that she would have been a little more aggressive about pushing it through more quickly. Contra Bruce, we might have gotten healthcare reform last fall instead of last month.

But! Who knows? Maybe the economy would have spooked her. Maybe Bill would have convinced her to wait until 2011. Maybe the townhall madness of summer would have stopped her short. But I think the conservative myth of the allegedly principle-less, endlessly calculating Hillary has led Bruce astray here.

Lambasting the Banks

| Fri Apr. 2, 2010 10:45 AM EDT

The first thing I do when I come down to the computer each morning is read the email that's piled up overnight. More precisely, I sort of mindlessly click through and delete the 90% of it that's either spam, PR drops, announcements from politicians, or other related dreck. I was doing that this morning when my eyes lit on the phrase "lambasted the tilted playing field that benefits Wall Street banks over Main Street banks." My fingers stopped. Tell me more, internet!

In a 45-minute interview this week, Federal Reserve Bank of Kansas City President Thomas M. Hoenig, who's emerged as one of the few influential voices calling for a fundamental redesign of a broken U.S. financial system:

  • Lambasted the tilted playing field that benefits Wall Street banks over Main Street banks;
  • Called the idea that the U.S. needs megabanks to compete globally a "fantasy";
  • Said Congress should mandate simple, easily understood and enforceable rules — rather than guidelines — so regulators can restrain financial firms and rein in the financial system;
  • Prodded the Senate to get tougher on permanently ending Too Big To Fail by enacting laws that would take away much of the discretion currently held by policymakers (who bailed out financial firms when confronted with these decisions in late 2008);
  • And criticized the Federal Reserve's ongoing policy to keep the main interest rate near zero because it "guarantee[s] a spread to Wall Street", enabling unearned profits and "encourag[ing] speculation."

....Hoenig isn't just any reformer — he's the longest-serving Fed policy maker; a voting member of the Fed's main policy-making body, the Federal Open Market Committee; and his credentials as a deficit- and inflation hawk are unparalleled.

I'm not so sure Hoenig is right about raising the interest rate — his inflation hawkery is too strong for my taste — but I definitely like his attitude toward leverage and how to rein it in:

"The simplest is: What is your total assets and what is your equity capital, and what's that ratio, and what's the maximum we should allow it to be? Should it be 12 or 14 or in some instances 15? We can have that debate either through the legislative process or though the regulatory process with comments and then come to a rule that is binding and cannot be exempted under any circumstance.

...."The max should be — and this is based on my experience, I haven't done the studies, so I have to put that caveat in there — if a bank has a 12-to-1 leverage ratio, total assets to equity, that's a fairly good operating level if you look across the country. So I would be inclined to put 15-to-1 as the max, so that in a growth environment you could get to 15, but not beyond that. That becomes a constraint, and I think it would work over time. You would get some blame during the boom that you're inhibiting growth, but that means you'd have to bring capital to the table and that would be strong.

"So I would start with 15. Let the debate go on — if that's not the right number — but that's where I would start."

Obviously Hoenig isn't exactly bowling over the world with his views yet, but it's nice to see that there are at least a few people in real policymaking positions who seem to get this stuff. Hoenig's approach to leverage, I think, is exactly right: keep it simple and keep it blunt. The only thing he doesn't mention here is the need to apply these kinds of blunt limits to the shadow banking system as well as the conventional banking system, but I'd be surprised if he doesn't believe that too. Is there any way we can appoint him dictator for a day?

Why Did Obama Decide to Drill, Baby?

| Fri Apr. 2, 2010 10:02 AM EDT

I should have posted this yesterday, but I forgot. On Tuesday night, responding to President Obama's decision to unilaterally open up new offshore drilling tracts, I asked, "Wouldn't he be better off holding this stuff in reserve and negotiating it away in return for actual support, not just hoped-for support?" Well, it turns out that something of a consensus answer has formed about this.

Basically, it goes like this. Sure, Obama could have held out on offshore drilling and used it as a bargaining chip to get some Republican support for an overall climate plan. But no Republican would have made the deal anyway, so it wouldn't have done any good. However, by doing it preemptively, Obama has (a) deprived them of an issue to sputter about this summer, (b) split their ranks, and (c) made himself look like a pretty reasonable guy to the general public. Long story short, this is mostly a long-term play for public opinion, not part of a short-term partisan negotiation.

I'm not sure if I buy this or not. But I just thought I should mention it since I asked the question in the first place.