Z: **Inactive:** Brad DeLong--Economics Only

Change of Format...

I am going to retire this backup and direct everybody to:

http://delong.typepad.com/sdj/econ_only_rss.xml

for a feed for economics-only posts...

The ATM on Turtle Ridge, Irvine, California

Felix Salmon sends us to Irvine Housing Blog:

Rudolph the Red-Nosed Reindeer: Address: 24 Shady Lane, Irvine, CA 92603. Beds: 3. Baths: 3.5. Sq. Ft.: 2,629. Lot Size: 5,053 sq. ft. Area: Turtle Ridge. County: Orange. MLS#: S512996: From Redfin:

Best deal around. Great plan 1 in private cul de sac location in the prestige Ledges at Turtle Ridge. Home shows as new very clean private location and great value for the Ledges estate. Nice rear yard area and great street appeal. Truly great deal here priced below most homes in area...

Let’s look at the loan history on this property.... The property was purchased in January 2005 for $1,157,000. The combined first and second mortgages totalled $1,156,730 leaving a downpayment of $270. Let’s just call it 100% financing. By April, they owners were able to find refinancing through Countrywide with a $999,999 first mortgage... Option ARM with a 1% teaser rate... a simultaneous second mortgage for $215,000 pulling out their first $58,000. So look at their situation: They are living in a million dollar plus home in Turtle Ridge making payments less than those renting, and they “made” $58,000 in their first 4 months of ownership.

Apparently, these owners liked how hard their house was working for them, so they opened a revolving line of credit (HELOC) in August 2005 for $293,000. Did they spend it all?... In December of 2005, they extended their HELOC to $397,990. In June of 2006, they extended their HELOC to $485,000. In April of 2007, the well ran dry as they did their final HELOC of $491,000. I bet they were pissed when they couldn’t get more money.

So by April 2007, they have a first mortgage (Option ARM with a 1% teaser rate) for $999,999, and a HELOC for $491,000. These owners pulled $333,000 in HELOC money to fuel consumer spending. Assuming they spent the entire HELOC (does anyone think they didn’t?), and assuming... negative amortization... the total debt on the property exceeds $1,500,000. The asking price of $1,249,000 does not look like a rollback, but if the property actually sells at this price, the lender on the HELOC (Washington Mutual) will lose over $300,000.

These owners will probably just walk away. I doubt they have any assets. They never put any money into the deal, they pulled out $333,000 in cash, and they got to live in Turtle Ridge for 3 years. Not a bad deal — for them...

Needless to say, this is not a typical case.

Herb Gintis Reviews Paul Krugman's "The Conscience of a Liberal"

Herb Gintis reveals that his years on the left have transformed him into a man who buys the substantive argument of how the world works made by the right. Herb writes that more progressive income taxes are bad for the middle class in the long run:

Krugman should know that if the wealth were redistributed to the middle class, the US investment rate would fall, since the rich save their money and it is translated into investment, whereas the middle classes would spend their gains on consumption, thus driving out investment. A "soak the rich" policy simply cannot work to the advantage of the middle classes...

Marty Feldstein could not put it better.

Here is the whole review, on Amazon:

Amazon.com: H. Gintis' review of The Conscience of a Liberal: "Being progressive,'' says Paul Krugman in the concluding pages of The Conscience of a Liberal, "means being partisan." Like Krugman, my training lies in economics, but unlike Krugman, I am not partisan. Rather, I take a policy orientation to social issues: there are problems to be solved in order to enhance the lives of citizens, and it is our job to discover and publicize solutions to these problems.

Krugman's partisan stance only clouds the issues. For Krugman there is a "union movement" rather than a "bureaucratic labor aristocracy," critics of the welfare states want to "turn back the clock," rather than streamline and curb the inequities of the welfare state, conservatives have won by "exploiting cultural backlash" rather than by mounting a principled opposition to the explosion of crime, drug abuse, and single-headed households in a manner that resonates with the voting public. Critics of the wealth tax are "financed by a handful of [super-rich] families," with the public being ignorant dupes of the slick politicians.

This book epitomizes what is wrong with American liberalism. Krugman was a fine, perceptive international trade theorist, but he is a political hack, with nothing new to offer. There is one problem as far as Krugman is concerned: inequality. But inequality is an intellectual abstraction, not a politically motivating issue. People hated the Robber Barons because they were robbers and barons, not because they were rich. Oprah Winfrey and Bill Gates do not send the Pinkerton men out to protect their ill-gotten gains; nor to the other super-rich.

Socialists' ringing political slogans dealt with fairness, social progress, and power to the people, not "inequality." Moreover, a truly progressive movement must built on technical progress that is impeded by the reigning powers that be (Sam Bowles and I call this efficiency-enhancing egalitarian redistribution), not the beggar-thy-neighbor, zero-sum-game sort of redistribution favored by Krugman.

I suspect Krugman is correct in saying that the degree of inequality in the USA today is the product of politics, not economic necessity. This is because some advanced industrial countries have more equal distributions of income and wealth that the USA (e.g., France, Germany). But, these countries are plagued by bureaucratic inefficiency and deeply threatened by the "lean and mean" up-and-coming countries like Poland, the Baltic States, Romania, India, et al. The USA has purchased a thriving economy and full employment at the cost of having a bunch of super-rich families. Not a bad deal, after all.

Krugman's vision for the future has three key premises, all wrong.

First, he believes progressives can win on a platform of redistributing from the rich. However, no one cares about inequality. People care about injustice, unfairness, poverty, sexual predators, family values, gay marriage, terrorism, and many other problems of everyday life. People don't care about Gini distributions and other abstractions. Moreover, Krugman should know that if the wealth were redistributed to the middle class, the US investment rate would fall, since the rich save their money and it is translated into investment, whereas the middle classes would spend their gains on consumption, thus driving out investment. A "soak the rich" policy simply cannot work to the advantage of the middle classes.

Second, Krugman would strengthen the labor unions, which he credits for their egalitarian effects. However, unions were strong only when industry was highly non-competitive in such areas as automobiles and steel. The oligopolistic character of mid-twentieth century industry, with a few countries in the lead, made fighting over the excess profits highly rewarding. With globalization, there are no excess profits to be fought over. Thus, it is not surprising that most successful unions in the USA are public service, not private (e.g., teachers, government employees). There is no future in unionism, period.

Third, Krugman believes that liberalism can be restored to its 1950's health without the need for any new policies. However, 1950's liberalism was based on southern white racism and solid support from the unions, neither of which exists any more. There is no future in pure redistributional policies in the USA for this reason. Indeed, if one looks at other social democratic countries, almost all are moving from corporate liberalism to embrace new options, such as Sarkozy in France (French socialists have the same pathetic political sense as American liberals, and will share the same fate).

I am sorry that we can't do better than Krugman. There are very serious social problems to be addressed, but the poor, pathetic, liberals simply haven't a clue. Conservatives, on the other, are politically sophisticated and hold clear visions of what they want. It is too bad that what they want does not include caring about the poor and the otherwise afflicted, or dealing with our natural environment. Politics in the USA is no longer Elephants and Donkeys; it is now conservative Pigs and liberal Bonobos. The pigs are smart but only care about what's in their trough. The Bonobos are polymorphous perverse and great lovers, but will be extinct in short order.

One final comment. Herb "conservatives... are politically sophisticated and hold clear visions of what they want... too bad that what they want does not include caring about the poor and the otherwise afflicted, or dealing with our natural environment... conservative pigs... are smart but only care about what's in their trough" claims that he is non-partisan?

Citigroup Replenishes Its Capital

Steve Goldstein and Greg Morcroft write:

Citigroup gets $7.5 billion infusion from Abu Dhabi investors: Citigroup said it has received a $7.5 billion injection from the Abu Dhabi Investment Authority, a much-needed shot in the arm as the financial-services giant weighs massive job cuts and slashing the value of debt securities on its balance sheet. "This investment, from one of the world's leading and most sophisticated equity investors, provides further capital to allow Citi to pursue attractive opportunities to grow its business," said Win Bischoff, acting chief executive of the Dow Jones Industrial Average component. Citigroup's shares rose 2% Tuesday morning, adding 59 cents to $30.39. The stock, which had dropped below $30 for the first time in more than five years on Monday, has lost 40% of its value this year.

Citigroup, in a statement issued late Monday, said the "long-term" investor will receive no more than 4.9% of its capital and won't get a seat on the board. This holding would exceed the 3.6% controlled by Prince Alwaleed bin Talal bin Abdul Aziz al Saud of Saudi Arabia. Abu Dhabi is getting bonds that must be converted and will yield 11% annually. They'll convert into stock priced at $31.83 to $37.24 a share, with the conversion to occur between March 2010 and September 2011. Stefan-Michael Stalmann, analyst at Dresdner Kleinwort, said that while the coupon rate of 11% looks high, the after-tax cost of funding is equivalent to Citi's current dividend yield of about 7.25%. Stalmann called the deal "relatively attractive" and said Citi is issuing delayed equity at a premium of 8% to 25% to the current share price -- thus avoiding the discount that a current rights issue would have required. "In exchange for being able to issue equity at a guaranteed premium, Citi only gives up the opportunity to issue straight equity at a higher share price in the future," he said...

Economic History Seminar: Jonathan Rose: "Hoover's Truce: Nominal Wage Rigidity in the Onset of the Great Depression"

ECONOMIC HISTORY SEMINAR: Jonathan Rose, UC Berkeley: "Hoover's Truce: Nominal Wage Rigidity in the Onset of the Great Depression": November 26, 2-4 p.m., 597 Evans.

• The sluggishness of wage declines during the Great Contraction
• Data from International Harvester
• David Romer: "Keynes's Keynesian model does not do too badly..."
• Hoover's conferences
  • Were they significant?
  • Did anybody comply with Hoover's pleas to firms not to cut wages?
  • Wage cuts in 1930-31 as compared to 1920-21
  • Herbert Hoover as corporatist crypto-socialist triangulating b------

Bernanke Effectively Brings Inflation Targeting to the Fed

Willem Buiter writes:

FT.com | Willem Buiter's Maverecon: It has taken a while, just under two years since Ben Bernanke took over from Alan Greenspan as Chairman of the Fed, but the deed now is done: the Fed has moved to de-facto inflation targeting... inside the twin Trojan horses of improved communications and greater transparency. An indeed, these proposals are likely to improve the clarity of the Fed’s communications to the market and the public at large and to enhance its transparency. But there is more....

The Fed’s modus operandi under Greenspan could be described as formally symmetric but in fact biased towards low unemployment, extremely flexible inflation targeting without a firm, let alone a numerical, inflation target.... There can be no doubt, however, about another asymmetry in the reaction function of the Greenspan Fed. With unemployment at or near the best guestimate of the natural rate, when faced with the choice between a rate cut that would reduce the likelihood of an increase in the unemployment rate at the expense of a higher risk of excessive inflation, or tighter monetary policy that would increase the likelihood of higher unemployment but would lower the risk of excessive inflation, the Greenspan Fed would opt for lower unemployment. 

This is no longer true for the Bernanke Fed.... [T]he new three-year horizon for the forecasts will provide the equivalent of a numerical point inflation target.... The Fed will no doubt continue to pay lip service to what is deemed (both by the Fed itself and by Congress) to be its official, legal dual mandate - maximum employment and stable prices. Congress will continue to insist on parity for these two objectives, and Fed officials and Governors will nod and agree....

During the 32-year period 1965-2007, the headline CPI increased 24 percent more than the headline PCE index, an average annual difference in inflation rates of around 0.67 percent.  the core CPI increased 28 percent more than the core PCE index, an average annual inflation rate difference of 0.77 percent. A core PCE target of 1.75 percent therefore would correspond to a core CPI target of 2.5 percent...

Leveraged Super Senior Trades and the Liquidity Put - Portfolio.com

Felix Salmon writes:

Market Movers: Today we're learning a lot about something known as leveraged super senior trades, or LSS.... In an LSS, investors made a leveraged bet on the super-senior tranches of mortgage-backed securities. But the leverage wasn't the kind of leverage that the Bear Stearns hedge funds used. The Bear Stearns funds simply went to their banks (or "prime brokers", as they're known in the hedge-fund world) and borrowed the money against the value of their portfolios. When those portfolios dropped in value, the prime brokers started making margin calls, forcing the funds to sell their paper at a loss.

An LSS, by contrast... borrowed the money to create its leverage by issuing asset-backed commercial paper, or ABCP... at very short maturities... [backed by] the assets of the LSS. And those investors had two reasons to be sure that they would get repaid in full. The first was that the assets of the LSS, being super-senior, were therefore super-safe... The second was that the banks which created these structures, like Citigroup, promised that they would step up and buy the ABCP if no one else would. That is the famous liquidity put...

Now the ABCP is asset-backed, so Citi could and presumably did take possession of the super-senior paper which was held by the LSS vehicle. The original investors in the LSS will have been wiped out, left with nothing. But the value of that super-senior paper as now fallen so far that it's worth much less than Citigroup paid for the ABCP...

I May Have to Regard Arnold Schwarzenegger Not as an Empty Suit but as a Man

Given the history I have lived through during the past five decades, it goes against the grain to regard any Republican at all as a sophont possessing functional organs of generation. But I may have to regard Arnold Schwarzenegger not as an overpromising empty suit but as a man. This looks well done--if it holds together. Matthew Garrahan and Krishna Guha report in the world's best newspaper, the Financial Times:

FT.com / In depth - California homes deal to avert defaults: Arnold Schwarzenegger is once again leading US states to action on policy reform ahead of lawmakers on Capitol Hill. The California governor... has now moved to slow the rate of home loan defaults brought on by the collapse in the subprime mortgage market. Mr Schwarzenegger’s deal with four of the state’s biggest mortgage lenders – Countrywide Financial, GMAC, Litton and HomeEq – is “nothing less than jaw-dropping in its ambition and implications.”... Under the scheme, the four lenders will extend for a “sustainable” period their low introductory rates on adjustable subprime loans to homeowners at risk of foreclosure. That would address a serious headache for policymakers – the large number of adjustable-rate home loans taken out at low introductory rates and due to reset at higher rates in the next few years.

Adjustable rate mortgages (ARMs) make up about 30 per cent of all US home loans and are more prevalent in the low-quality subprime market. More than $350bn (£170bn,€236bn) in ARMS will reset to higher rates in the next 18 months. Analysts and ratings agencies alike say these resets will increase the frequency of loan defaults as falling house prices leave borrowers with negative equity and no chance of refinancing. That could hit consumer spending, with knock-on effects on the US and world economies.

Attempts to avert such a scenario by encouraging mortgage lenders and servicers to renegotiate home loans have not gone as far as policymakers would hope. While investors generally agree that in many cases everyone is better off if a loan is restructured rather than going into default, there is great resistance to standardised work-outs based on simple criteria such as type of loan and status of borrower. Many investors feel such standardised solutions will benefit borrowers who can afford to make higher payments, and want to proceed instead on a case-by-case basis, albeit with the aid of standardised systems....

California has not promised any financial or legislative incentives to the lenders, says a spokeswoman for Mr Schwarzenegger. “This is a public-private partnership that does not involve public dollars.” Instead, the agreement is backed by “safety in numbers”. “If only one of these companies was modifying its loans . . . they would lose out to the competition and [house] prices would keep falling. It would be a double whammy,” she said. However, with four mortgage lenders representing 25 per cent of subprime mortgages signing up to the plan, the risk to the lenders has been minimised. The agreement with the lenders will cover only those homeowners “making timely payments”. Beneficiaries will also need to prove they cannot afford a rate rise.

A U.S. Recession Is Now Probable (but Not Yet Inevitable)

A U.S. recession is probable because sentiment now believes that a U.S. recession is probable. Gillian Tett, Jennifer Hughes, and Krishna Guha writing in the world's best newspaper, the Financial Times:

FT.com / World - Investors fear new round of turmoil: Investors fear the financial system is moving into new credit turmoil, which could create further losses for financial institutions – and potentially hurt sentiment in the “real” economy. Credit markets are trading at levels which imply that investors assume that the US is heading for a recession, bank analysts and economists have warned. “Recession is getting priced in,” said Jan Loeys, economist at JPMorgan, adding that markets went into “virtual panic mode” last week. “Pressure is building for central banks to become a lot more active and vocal [this] week if they want to avert a collapse in credit markets.” Swaps spreads rose sharply in UK gilts and US Treasuries, amid a flight to quality and fear of bank defaults. Spreads on high-yield corporate bonds and the yen-dollar exchange rate also leapt dramatically, while liquidity evaporated in many corners of the credit markets.

Peter Sutherland, chairman of both Goldman Sachs International and BP, joined those voicing concern. “The US economy is in a mess,” he told TV3, an Irish TV channel, yesterday. “There is a whole big issue...which has not fully played out in regard to providing credit and liquidity to institutions, so I think it is a dangerous period for the world. I think we are going to go through next year, certainly the first half of next year, with considerable traumas.” Rising market tension prompted the European Central Bank to announce on Friday that it would provide fresh emergency injections of liquidity from this week. In recent days, liquidity has evaporated in parts of the European credit markets, as banks have become nervous about trading with each other. Investors are watching to see whether the US Federal Reserve will also provide additional liquidity into the US system. Analysts speculate that the Fed could extend the scale or duration of long-term open market operations, lower the discount rate at which it lends directly to banks, or even announce more radical steps.

Ben Bernanke, Fed chairman, is also likely to reassure the market that the US central bank recognises the threat to growth posed by the relapse.

One factor undermining investor confidence is that the projected size of this year’s credit shock is now rising rapidly. The US government initially forecast $50bn losses on subprime securities. However, investment banks now expect $200bn-$500bn subprime losses – and additional massive losses in other debt markets, such as credit card loans. Lawrence Summers, former US Treasury secretary, writing in today’s Financial Times, says: “The odds now favour a US recession that slows growth significantly on a global basis.” A second problem is continued deep uncertainty about which institutions hold these losses...

The Glamour of Technology: Subnotebook Department

Gordon's Notes sends us to Charlie Stross, who promptly succumbs to the Glamour of Technology:

Charlie's Diary: Commoditizing our future: I've spouted off previously in this blog about my lamentable poor saving throw versus shiny! — not to mention my irritation at the refusal of the consumer electronics industry to render me bankrupt by actually giving me what I want. Trouble is, at long last they've turned around and done it. I have in my possession an Asus Eee subnotebook... £220... right now there's a certain scarcity value attached, and they haven't yet sunk to their real price, somewhere around thruppence ha'penny. But the process is becoming clear.

Back in 1998, I bought a notebook... Hewlett-Packard... 166MHz processor, 80Mb of RAM, a 4Gb hard disk, an external CDROM drive (reader, not writer), and a docking station... full-whack £1900 that bundle was going for a few months earlier.... Compare with the Eee. On processor and memory... 900MHz and 512Mb respectively. The disk space is the same, except the Eee uses solid state memory rather than a spinning mechanical thingy.... For an extra £80, I bought the Eee 8Gb of additional storage media (an SDHC card), an upgrade to 1Gb of RAM, and an external CD/DVD rewriter....

Moore's Law suggests that every component of a PC halves in price on a roughly 18-month cycle. A desktop PC today should be roughly 100 times as powerful as a desktop PC of similar price 10 years ago.... A naive soul with no prior experience of consumer capitalism might ask why, instead of doubling in power, the manufacturers don't concentrate on cutting prices? But that's not how the industry worked. Until now....

A couple of years ago Nicholas Negroponte of the MIT Media Lab launched the idea of a $100 laptop for education in the developing world. Well, the OLPC XO-1 is now out.... Intel's reaction was the Classmate reference design, their own purported rival to the XO-1; the Asus Eee is what you get when a large far eastern OEM thinks "hang on, can we commoditize this and sell it in bulk?" Microsoft... failed to make it onto the Eee bandwagon because they wanted $40 for a Windows XP license — on a machine that starts at $250 for the stripped-down version. Mine runs Linux perfectly well, thank you, and comes with the basic stuff you need to be productive; OpenOffice, Thunderbird for email, Firefox as a web browser, and some other gadgets (like Skype and a webcam).

The Eee... is close to an order of magnitude cheaper than previous ultra-lightweight subnotebooks. And I think I'm going to use it as a pointer to a future trend.... The Eee is about 8 times as powerful as that 1998 Omnibook, at a quarter the price.... The dirty little fact everybody in the consumer computer trade have been trying to ignore... is that the computer biz is overdue for commoditization. There is no intrinsic reason why a kilogram of plastic and metal with a couple of silicon chips in it should sell for more than its weight in silver.... Apple have staked out a boutique territory for themselves, and more power to them for noticing that they needed to do that in order to survive: but that's a small lifeboat, and not everyone can market themselves on being cooler than everyone else.

The Eee isn't quite the disposable computing resource I've been wanting — they'll have to shave a zero off the price tag for that — but it's close enough for now. It does the basics I need, runs portable cross-platform applications and editing open file formats, and if I leave it on a train or sit on it or something my immediate reaction will be to swear, check my backups, and buy another one, rather than to whimper and go talk to my bank manager...