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Nocera Largely Right on Fannie and Freddie Print
Thursday, 27 June 2013 07:26

Joe Nocera gets the story mostly right in his skepticism toward a bill put forward by Senators Mark Warner and Bob Corker that would replace Fannie and Freddie with a convoluted system of government guarantees. I would add three points.

First, the 30-year fixed rate mortgage is not necessarily dependent on a government guarantee. In the pre-bubble days banks did hold a substantial portion of the mortgages on their books. They also issued 30-year jumbo mortgages which could not be guaranteed by Fannie and Freddie, so apparently there is a market for these mortgages even without government guarantees.

Second, an important goal of policy in housing finance should be efficiency. In other words, the point is to make it possible for people to buy homes with as few moving parts as possible. This could probably be best accomplished with something like the old Fannie Mae.

In the pre-privatization period, Fannie was a publicly owned company that bought and held mortgages. There were no mortgage backed securities. There is little obvious purpose to move from a government company/agency holding mortgages to a government company/agency guaranteeing mortgage backed securities. In the latter case the government still has the credit risk, it only shields itself from timing risk (fluctuations in interest rates), but that is a risk the government has no problem bearing.

There are political reasons why the old Fannie system might be difficult to reinstate, but we can at least be clear that it would be the most efficient way to manage housing finance. Other methods are political compromises.

Which brings us to the third point, the waste created by these compromises is income to the financial industry: hence the argument for the sort of convoluted system of guarantees in the Warner-Corker bill.

So if we want the most efficient system that is politically feasible, it's probably best to just shut down Fannie and Freddie altogether. The 30-year mortgage will not disappear, although it may cost somewhat more.

Thomas Edsall on Richard Burkhauser and Inequality Print
Thursday, 27 June 2013 04:36

Thomas Edsall has a lengthy blogpost on a new measure of income developed by Cornell University Professor and AEI fellow Richard Burkhauser. Burkhauser's measure reverses the widely reported finding that inequality has increased substantially over the last three decades.

While Edsall went to great lengths to include extensive comments from other economists (including me) on Burkhauser's methodology and concluded himself that Burkhauser's methodology doesn't measure up, readers may still be led to believe that there is more ambiguity on this issue than is actually the case. This is because Burkhauser's measure is so peculiar and counter-intuitive, that it is unlikely that many readers would understand what he has in fact done.

Burkhauser does address a legitimate question -- the treatment of capital gains. Usually economists calculate inequality by both taking income without counting realized capital gains (sales of stock, houses, or businesses) and also including the gains. The latter will generally show higher degrees of inequality since wealthy people are likely to have realized capital gains, whereas middle and lower income people are not.

This approach does pose a problem since the decision to sell an asset is an arbitrary one and does not necessarily reflect when the gain actually took place. Also, a lower capital gains tax rate will encourage people to sell their assets more frequently, which by itself would lead to larger reported income. So a methodology that includes realized capital gains is problematic.

However Burkhauser's response, to include unrealized gains, makes no sense in a serious measure of income. The reason is that asset prices (especially stock, but in recent years housing as well) are hugely volatile. For people who have substantial assets, the movement in these prices in any given year will often swamp their other income. Gary Burtless and I both made this point in our comments.

An implication of Burkhauser's methodology is that our measure of inequality would depend hugely on the exact year we picked for our analysis. In his study, the base year for most of his analysis is 1989, a year in which the S&P 500 rose by more than 27 percent. This hugely increased the earnings of the top quintile in his base year. As a result, the change from 1989 forward would be guaranteed to be small. By contrast, if Burkhauser had chosen 1987, when the S&P fell more than 6 percent, he would have a much lower base. This would make the growth in income for the top quintile appear much larger.

To see this, imagine the average income, not counting capital gains, for the top quintile is $200,000 in both 1987 and 1989. Suppose they own $1 million in stock on average. In Burkhauser's methodology their income in 1989 is $470,000. Their income in 1987 is $140,000. (Number corrected, thanks Yoram.) We would be telling a very different story about the growth of income inequality over the next two decades if we opted to choose 1987 as our base year rather than the year picked by Burkhauser. (The year 1989 is often chosen as a base year because it is a business cycle peak. That makes sense in a measure that is primarily reflecting earnings growth which tends to peak at the peak of the cycle. It makes no sense when taking a measure that is moved primarily by capital gains.)

There could be an argument for taking unrealized capital gains averaged over a longer period, which is not the methodology that Burkhauser chose. By this methodology we would average the capital gains for households over the period being investigated and add the annual amount to their income. This would be a considerably more defensible methodlogy, but it still would give very misleading results because of the housing bubble.



Honest Piece by Casey Mulligan on Medicaid Expansion Print
Wednesday, 26 June 2013 05:15

Some applause please for Casey Mulligan. Mulligan has been a strong opponent of the Affordable Care Act and the expansion of Medicaid provided under the act. However he used his column today to dispel a misunderstanding of a study of the health impact of increased Medicaid enrollment in Oregon.

The study was written up in an article in the New England Journal of Medicine which noted that the study found no statistically significant impact of Medicaid enrollment on health care. However Mulligan makes the point that the study actually did find that the people enrolled in Medicaid had improved health by several important measures. While the improvements were not large enough to meet standard tests of statistical significance this does not mean that they were not important. As Mulligan notes, given the limited number of people in the study and the relatively short time-frame (2 years), it would have been highly unlikely that it could have found statistically significant gains in health outcomes.

Mulligan deserves credit for clarifying this point, especially when the implications seem to be directly at odds with his view of the policy. It would be great if debates on economic policy were always like this. 



I'm glad to see that I have people knowledgeable about statistics reading this blog. Since I guess I was too quick in my post and folks apparently did not read the Mulligan piece or the study, let me be a bit clearer. The study had very little power. There were not enough people in it. As a result you had relatively few people with any specific condition, which meant that it would be almost impossible to find statistically significant results.

To see this point, suppose we chose 100 people at random for a study to determine if drug X was effective in preventing heart attacks. We gave 50 people drug X and the other 50 got a placebo. After a year, 2 people in the placebo group got a heart attack but only one person in the treatment group. Okay, this is a nice result, but almost certainly not statistically significant. Since we had not selected people with heart conditions and heart attacks are relatively infrequent in the population as a whole, it would have been almost impossible to have a statistically significant finding.

That is the story of the Oregon study. It had some encouraging results. They were not statistically significant, but it would have been almost impossible given the design of the study to have statistically significant results. That was the point of Mulligan's piece -- and he is 100 percent right.

The Huge Variance in Wages of Male College Grads Discourages College Enrollment Print
Wednesday, 26 June 2013 04:55

Eduardo Porter's column on the drop in college graduation rates in the United States relative to other wealthy countries ignored the large variance in the wages of male college grads. While there is little dispersion for the wages of women who graduate college, this is not the case for men.

There are a substantial number of male college graduates who can anticipate wages that are less then the top quartile of men without college degrees. The marginal college graduate is presumably more likely to be in this group of low earners. If they recognize the risk of not being a high earner many men may opt not to take the time and incur the expense of getting a college degree even if on average it would make them better off.

Corker-Warner Plan for Replacing Fannie & Freddie Is a Jobs Killer Print
Wednesday, 26 June 2013 04:23

Okay, this is cheap line day, but in fact this is true. Even in a best case scenario, where there are no more hazard issues, the bill for a reshaped government mortgage loan guarantee put forward by senators Bob Corker and Mark Warner would be a job killer in standard economic models, like those used by the Congressional Budget Office and others. The logic is simple. The guarantee would subsidize loans to housing thereby steering more capital to housing and away from other forms of investment. The result is lower productivity growth, which would mean lower real wages and fewer jobs. It would have been worth including the views of an economist who could have explained this scenario to the Washington Post's readers.

It is also unlikely that the system will be able to escape the problem of moral hazard that has afflicted the current system. (Wall Street types are smart.) The real question that should be posed is whether this additional form of housing subsidy, on top of the mortgage interest deduction, is the best use of public money. Unfortunately the article never frames the issue this way.


Note: Warner's first name has been corrected -- thanks Barkley.

NYT Really Misses Housing Story Big Time Print
Tuesday, 25 June 2013 20:56

The NYT headlined an article on the release of the newest Case-Shiller housing price data, "housing market shrugging off rise in mortgage interest rates." This may or may not be true, but the new Case-Shiller data will not provide us much information on this question.

The data released today was for the three month period ending in April. This means that the typical home in the sample was sold in March. It is also important to remember that the index picks up closings. Since it typically takes roughly two months between contracting and closing, the Case-Shiller data released today is telling us about house sales that were contracted back in January. That is not going to give us much information about how the housing market is responding to a rise in mortgage rates that has mostly occurred over the last two months.

The piece also tells readers:

"If mortgage rates rise to 4 percent by the end of the year, as the Mortgage Bankers Association forecasts, they will still be much lower than the rates most Americans have experienced over the last few decades. In May, the average interest rate on a 30-year fixed mortgage stood at 3.5 percent."

This statement is bizarre because interest rates have already crossed 4.0 percent. The Mortgage Bankers Association reported that the average contracted rate two weeks ago was 4.17 percent. It is almost certain to be higher now since Treasury rates have risen substantially in the last two weeks.

Wow, the Wall Street Journal Still Has Not Heard About the Housing Bubble! Print
Tuesday, 25 June 2013 20:27

The Wall Street Journal seems to have completely missed the story of the housing bubble and the resulting economic collapse. It begins an article telling readers:

"After a slow start early in the economic recovery, consumer spending has begun to pick up. The question is whether Americans are ready to open their wallets more widely."

It is just mind-boggling to see this in the country's leading business newspaper. Umm, no actually wallets have been pretty wide open for a long time. The way that economists determine the width of the opening is by looking at the saving rate. In the good old days before the stock and housing bubbles, savings out of disposable income averaged more than 8.0 percent.

The savings rate began to fall in the late 1980s in the response to the beginnings of the stock bubble. It fell further in the late 1990s as the bubble peaked. The savings rate bottomed out at just over 2.0 percent in 2000. It rose again after the bubble burst but then fell back to 2.0 percent as a result of the wealth created by the housing bubble. (Actually the saving rate fell to near zero by some measures.)

Predictably, the saving rate rose again following the collapse of the housing bubble and the loss of $8 trillion in housing wealth. However it has remained unusually low, at less than 4.0 percent in recent quarters. This means that consumers are actually spending quite freely. It is not clear what data the piece is referring to when it complains that consumers have been reluctant to spend. Clearly the opposite is true.

More Thoughts on Patents and Copyrights Print
Tuesday, 25 June 2013 04:34

Since my comments on Greg Mankiw's defense of the one percent prompted so much response, I thought I should add some clarification on the treatment of patents and copyrights. First off, my main point is that these are government policies designed to meet a public purpose (i.e. promoting innovation and creative work), not natural rights that are an end in themselves. In this sense altering them does not raise questions of rights as would restricting the freedom of speech or assembly.

Those who like to point to the constitutional origin of these forms of property should note where patents and copyrights appear in the constitution. They are listed as a power of Congress along with other powers, like the power to tax. They do not appear in the Bill of Rights where rights of individuals are explicitly described.

The constitution authorizes Congress to create monopolies for limited periods of time "to promote the Progress of Science and useful Arts." In this sense, patents and copyrights are explicitly linked to a public purpose. If it were determined that patents and copyrights are not the most efficient means for promoting innovation and creative work, and therefore Congress decided to stop authorizing these monopolies, individuals would have no more constitutional basis for complaint than if Congress decided that it didn't need to raise taxes.

Once we recognize that patents and copyrights are policies to promote innovation and creative work then the question is whether they are best policy and if so, are they best structured now for this purpose. Neither assumption is obvious and I would argue that the latter is almost certainly not true.

In terms of whether these are the best policies, in my earlier post I was simply pointing out that alternative mechanisms already exist and support a great deal of work. I actually didn't advocate any specific policy, but I have written on alternatives to both. Here's a discussion of alternatives to patent supported drug research and here is a proposal modeled after the tax deduction for charitable contributions for supporting creative work. (By the way, the folks who were arguing for the merits of markets over central planning are in the wrong place. You were looking for Joe Stalin's blog, there is no proposal for central planning in my work.) 



Teaching Robert Samuelson About Supply and Demand Print
Monday, 24 June 2013 04:16

Last week we had to teach Robert Samuelson about inflation. He noted that the wealth of households was back to its pre-recession level, but spending was not. This led him to think that the wealth effect no longer applied. However, when we adjusted the data for inflation and then brought in Mr. Arithmetic it turned out that people were spending more than would be predicted by the wealth effect, not less.

This week it looks like we have to teach Mr. Samuelson about supply and demand. His column is a warning that "cheap money" (e.g. the quantitative easing and low interest rate policy pursued by the Fed) may do more harm than good. This comes in the context of the drop in world stock markets following Ben Bernanke's indication of a pullback from these policies.

Never mind that the drop in world stock markets is exactly what would be predicted if cheap money actually was helping the economy (in that case, the pullback would be expected to lead to lower growth and likely lower profits, therefore we would expect to see lower stock prices), let's deal with the rest of his story. The basic problem in the column is an inability to distinguish clearly between supply and demand.

This first comes up when he complains that in spite of cheap money:

"the speed of the U.S. recovery (about 2 percent annually) is roughly half the average of all recoveries from 1960 to 2007. As for the global economy, it grew 2.5 percent in 2012, down from the 3.7 percent average from 2003 to 2007, says IHS Global Insight."

This one is easily explained by lack of demand. Housing bubbles in the United States and elsewhere had been driving the economy prior to the downturn. Those bubbles have mostly burst, although Canada, Australia, and the UK have seen bubbles reemerge. The fact that the downturn was caused by a collapsed bubble instead of the Fed raising interest rates meant that the recovery would be much slower and more difficult than in prior recessions. There was no easy way to replace the consumption and construction demand created by these bubbles. Some of us were yelling this at the top of our lungs back at the start of the recession, but apparently Samuelson didn't hear us and is therefore surprised by the weakness of the recovery.



Tyler Cowen Goes Off the Track on China's Aging Print
Sunday, 23 June 2013 08:20

Tyler Cowen has an interesting piece on the problems facing developing countries going forward. As he notes, these will be different in the future than they were in the past. However the piece is strange due to one of the items it mentions, the aging of the population, and one it leaves out, intellectual property claims. (Btw, Cowen references a column by Dani Rodrick as raising the issue of new problems confronting developing countries. Rodrick does not mention aging in his list of concerns.)

On the former point, Cowen seems determined to apply the Peter Peterson financed obsession with cutting Social Security and Medicare to the whole world. He gives us the bad news:

"It is less well known that fertility rates in much of the Middle East and North Africa are also falling rapidly. In Iran, for example, it is now estimated at 1.86 per woman, which over time would mean that families are not replenishing themselves. And shrinking and older populations, of course, limit future economic growth."

Wow, back when I learned economics we cared about per capita income, not growth per se. Most people would think that Denmark is better off than Bangladesh, even though Bangladesh has a far higher GDP. Fewer people means fewer demands on resources of all types and less greenhouse gas emissions. I suppose Cowen is worried that the beaches will be less crowded and there will be smaller traffic jams. That prospect is not likely to be a major concern for most people in the developing world.

Cowen also gives us the bad news about China:

"Finally, many lower-income countries will be old before they are rich. China’s population, for example, is aging rapidly, given the government’s one-child policy and the decline in birthrates that accompanies rising income."

Let's think about this one for a moment. China has seen unprecedented growth in per capita income over the last three decades. Per capita GDP has risen by a factor of 13. This swamps the growth in almost every other developing country. While aging can impose some burden on the working population, it will not prevent both workers and retirees from enjoying much higher living standards than they did in the recent past.



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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.