Tuesday, September 30, 2008

US: More Text Messages Than Phone Calls

American cell phone users are sending more text messages than they are making phone calls, according to a Nielsen Mobile survey. For the second quarter of 2008, U.S. mobile subscribers sent and received on average 357 text messages per month, compared with making and receiving 204 phone calls a month (see chart above). In the first quarter of 2006, Americans sent and received 65 text messages per month. The number of messages sent and received today has increased 450%.

Gas Spotted Below $3 in Missouri


Bankruptcy, Not Bailout, Is The Right Answer

This bailout is a terrible idea. Here's why.

The current mess would never have occurred in the absence of ill-conceived federal policies. The federal government chartered Fannie Mae in 1938 and Freddie Mac in 1970; these two mortgage lending institutions are at the center of the crisis. The government implicitly promised these institutions that it would make good on their debts, so Fannie and Freddie took on huge amounts of excessive risk.

Worse, beginning in 1977 and even more in the 1990s and the early part of this century, Congress pushed mortgage lenders and Fannie/Freddie to expand subprime lending. The industry was happy to oblige, given the implicit promise of federal backing, and subprime lending soared.

This subprime lending was more than a minor relaxation of existing credit guidelines. This lending was a wholesale abandonment of reasonable lending practices in which borrowers with poor credit characteristics got mortgages they were ill-equipped to handle. Once housing prices declined and economic conditions worsened, defaults and delinquencies soared, leaving the industry holding large amounts of severely depreciated mortgage assets.

The fact that government bears such a huge responsibility for the current mess means any response should eliminate the conditions that created this situation in the first place, not attempt to fix bad government with more government. The obvious alternative to a bailout is letting troubled financial institutions declare bankruptcy. Bankruptcy means that shareholders typically get wiped out and the creditors own the company.

Bankruptcy does not mean the company disappears; it is just owned by someone new (as has occurred with several airlines). Bankruptcy punishes those who took excessive risks while preserving those aspects of a businesses that remain profitable.

In contrast, a bailout transfers enormous wealth from taxpayers to those who knowingly engaged in risky subprime lending. Thus, the bailout encourages companies to take large, imprudent risks and count on getting bailed out by government. This "moral hazard" generates enormous distortions in an economy's allocation of its financial resources.

The right view of the financial mess is that an enormous fraction of subprime lending should never have occurred in the first place. Someone has to pay for that. That someone should not be, and does not need to be, the U.S. taxpayer.

~Jeffrey A. Miron, Senior Lecturer in economics at Harvard University and Director of Undergraduate Studies

The Four Horsemen of the Financial Panic

From Americans for Tax Reform: No matter what one thinks of the financial bailout package, we ought to at least agree how we got here. Below are the real actors behind the mortgage panic of 2008:

1. Government-sponsored enterprises (GSEs). Fannie Mae, et al, bears a large share of the responsibility.

2. Easy money from the Federal Reserve. On January 3, 2001, the Federal Reserve cut the federal funds rate by 50 basis points, to 6.00%. They continued to do so until the rate hit a bottom of 1.00% on June 25, 2003.

3. Community Reinvestment Act (CRA). This legislation, first passed in 1977, gave federal regulators the power to encourage banks to issue loans to high-risk households and small businesses.

4. Mark-to-market accounting rules. This refers to an accounting practice that forces a balance sheet to value an asset at its current market price (that is, what it could be sold for at the time). Mark-to-market is an arbitrarily-restrictive accounting practice that should be scrapped for assets like securities which generate current income. Doing this alone would solve much of the problem.

Quote of the Day

The SEC's ban on short selling is a perfect illustration of the dangers of regulators taking a cartoon view of the world, where evil villains are responsible for all the chaos in fair Gotham. In their monomaniacal focus on the manipulative potential of short selling, Cox and his his minions have completely overlooked its benefits, and implemented policies that have inflicted substantial collateral damage on other portions of the financial market, including parts of the market that could facilitate fixing problems at the institutions allegedly protected by the regulations–banks.

This is particularly tragic given that the rationale for the policy is based on anecdote–to put it as charitably as possible. Remember what George Stigler said: The plural of “anecdote” is not “data.”

~Streetwise Professor

Gas Prices: $3 Per Gallon in MO and OK, $8 in GA

Gas prices are approaching $3 per gallon in Missouri and Oklahoma.

Meanwhile, in Georgia, "The state has received 1,300 complaints of gas gouging and has subpoenaed sales records from 130 gas stations to determine if they illegally jacked up prices in the wake of Hurricane Ike. There was one report that a station was charging $8.82 a gallon, but that report hasn’t been verified." (Another link here.)

To which columnist Neal Boortz replies "Don’t investigate them! Reward them! Price gouging is exactly what we need! It should be encouraged, not investigated."

HT: Larry Russell

Real Estate Roller Coaster

The Housing Bubble in 4 Easy Steps, from the Mises Institute:

1. Cut Fed Funds rate from 6.5% in 2000 to 1% by 2003.
2. 30-year mortgage rates fall to all-time low by June 2003.
3. Because of low interest rates, mortgage loans double between 2001 and 2006.
4. All these low-interest loans had to be extended to people with weak credit ratings and this increased the demand for homes and other real-estate assets. It should not be surprising that home prices skyrocketed. Click on the arrow below to the Real Estate Roller Coaster:

Fannie Mae, Freddie Mac, mortgage-backed securities, and credit derivatives were simply the conduit that made all these bad loans and investments seem less risky than they really were. In this manner the Federal Reserve can fool the market, at least temporarily. In the end the market always reasserts itself.

When Government's In Charge, Expect Shortages

WASHINGTON (AP)The U.S. Mint is temporarily halting sales of its popular American Buffalo 24-karat gold coins because it can't keep up with soaring demand as investors seek the safety of gold amid economic turbulence. Mint spokesman Michael White said Friday that the sales were being suspended because demand for the coins, which were first introduced in 2006, has exceeded supply and the Mint's inventory of the coins has been depleted.

The Mint had to temporarily suspend sales of its American Eagle one-ounce gold coins on Aug. 15 and then later that month announced sales of the American Eagle coins would resume under an allocation program to designated dealers. White said the Mint expected to soon start distributing available Buffalo gold coins through a similar allocation program.

NUMISMATIC NEWS - Coin dealers and collectors are still reeling from the U.S. Mint's announcement that it had run out of American Eagle gold coins. But what ought to surprise every American isn't that a government agency came up short. It's that the U.S. government should be making little metal discs at all.

Recall the plight of consumers under socialism: socialist governments tried to make everything and eventually ran out of everything. Now socialism is dead, but not when it comes to coining. So coin shortages keep breaking out, as they have ever since governments first monopolized coin making in ancient times.

Thomas Sowell On The Current Financial Crisis

As always, economist Thomas Sowell puts the current situation into perspective - here are some key points from his most recent column "Bailout Politics":

1. Nothing could more painfully demonstrate what is wrong with Congress than the current financial crisis. Among the Congressional "leaders" invited to the White House to devise a bailout "solution" are the very people who have for years created the risks that have now come home to roost.

2. The idea that politicians can assess risks better than people who have spent their whole careers assessing risks should have been so obviously absurd that no one would take it seriously. But the magic words "affordable housing" and the ugly word "redlining" led to politicians directing where loans and investments should go, with such things as the Community Reinvestment Act and various other coercions and threats.

3. If Fannie Mae and Freddie Mac were free market institutions they could not have gotten away with their risky financial practices because no one would have bought their securities without the implicit assumption that the politicians would bail them out. It would be better if no such government-supported enterprises had been created in the first place and mortgages were in fact left to the free market. This bailout creates the expectation of future bailouts.

Monday, September 29, 2008

Homeowners, Lenders Last Line of Defense: Denial

1. Looking backward, home buyers paid too much, and lenders wrote contracts that exposed them to the homeowners’ losses. With home values declining by something like $2 trillion, we are in a mad scramble to divide the loss between homeowners, lenders and taxpayers. In the meantime, homeowners and lenders are exercising their last line of defense: denial. Many homeowners are refusing to sell their homes at prices that can attract buyers. Many lenders are refusing to sell their mortgage-backed securities at prices that can attract buyers. All this denial gets in the way of the normal price discovery process, leaving stranded assets held by owners who think they are worth more than potential buyers.

2. Nonetheless, our financial institutions are doing a pretty good job. Our financial markets are supposed tell us how wealthy we are. This year the large drop in equity valuations is sending a pretty clear message: we are not as wealthy as we thought. That seems adequately accurate; no big problem there. Our financial markets also provide credit to consumers and businesses to help grow our economy. Outside of housing the economy is doing pretty well, and there is no clear evidence of a credit crunch seriously impinging on either business spending or consumer spending even though Wall Street pundits for more than a year have been ringing out loud alarm bells about an imminent credit contraction (see
related CD post). Though business spending and consumer spending are a bit weak, that weakness properly reflects the fundamentals of the economy and is not a symptom of a credit crunch. So what’s the problem, Mr. Secretary?

3. One honest way to transfer the losses directly to the taxpayers would have the Treasury buy homes directly at inflated prices and rent them to deserving Americans. Though the Treasury Plan involves buying mortgage backed securities at inflated prices, keep in mind that foreclosures will then turn the homes over to Uncle Sam. For $700 billion, the Treasury could purchase 2.3 million homes at an average price of $300,000. That is way more than is necessary. A half a million should be enough to unclog the system. Uncle Sam could purchase foreclosed homes, mow the lawns, fix the broken windows and rent them out to deserving families. That would help the other homes in the neighborhood sell at favorable prices.

Edward Leamer, UCLA economics professor

New Banking Data: Where's The Credit Crisis? Total Bank Loans and Leases Exceed $7T For First Time

New banking data were released today from the Federal Reserve on bank loan volume through September 17 (for weekly data and August for monthly data), showing that "Total Loans and Leases at All Commercial Banks" reached an all-time high of $7.026 trillion (reported weekly) in mid-September, going over $7 trillion for the first time in history (see graph below).

Consumer loans (reported monthly) hit an all-time high of $845 billion in August:

Real estate loans (reported monthly) peaked out this year at about $3.642 trillion, and increased slightly in August from July:

Commercial and industrial loans at large commercial banks (reported weekly) were close to an all-time in September, just slightly below record levels reached in July:

Q: Where's the credit crisis?

American Manufacturing Workers Are World-Class

To balance all of the bad news about the U.S. economy, here's some good news today from the BLS: Not only are American manufacturing workers probably the most productive in the world, they keep gaining on workers in other countries.

The top chart above lists the productivity gains for manufacturing workers from 2006 to 2007 (most recent data available) in 16 countries, and the U.S. gain of 4.1% in just one year was higher than the productivity gains in all countries except for Taiwan, Korea and Germany.

Over a longer period of time (1979-2007), American manufacturing workers had higher average annual gains in productivity (3.9%) than all countries except for Taiwan and Sweden during that period.

Bottom Line: One of the reasons that there are 6 million fewer U.S. manufacturing jobs today (13.428 million) than in 1979 (19.553 million), an average annual decline of 1.2%, is that American workers have become 4% more productive each and every year.

U.S. Consumers Are Being Taken to the Cleaners

In May, I posted about tariffs on hangers from China, enacted to protect the only remaining domestic supply of hangers, M&B Hangers in Leeds, Alabama, and to "punish" Chinese manufacturers for "dumping."

Economist Frank Stephenson now reports in The Freeman that hanger tariffs are responsible for doubling the price of hangers from $28 to $56 per box over the last year, which will cost each dry cleaner $4,000 or more per year.

Bottom Line: If you thought your dry cleaning bills were high in the past, well "hang on," because as surely as night follows day, higher hanger prices will be passed on to U.S. consumers in the form of higher dry cleaning prices. Tariffs, which are simply taxes on Americans buying imported goods, ultimately "punish" U.S. consumers and firms with higher prices more than they "punish" China.

Further, Stephenson cites this analysis that divides the total cost of the hanger tariff to U.S. dry cleaners ($4,000 x 30,000 dry cleaners = $120 million year), by the number of potential domestic jobs saved (564 jobs) in the U.S. hanger industry, indicating that each American job saved costs us about $212,765 per year. Since the typical full-time worker in this sector earns about $30,000 per year, it would be cheaper for the U.S. to eliminate the tariff, purchase cheaper hangers from China, let the domestic industry die, and pay each American hanger worker $30,000 per year to retire.

Like thousands of other examples, trade protection of inefficient American producers always imposes much higher costs to the country (measured in higher prices and jobs lost) than it generates in benefits (measured in jobs saved). And it's usually not even close, it's typically $2 in cost per $1 of benefits, or 2 lost jobs per job saved, when Americans are "punished" with trade protection.

Frank's Fingerprints Are All Over Financial Fiasco

Barney Frank: "The private sector got us into this mess. The government has to get us out of it."

Jeff Jacoby in yesterday's Boston Globe:

While the mortgage crisis convulsing Wall Street has its share of private-sector culprits, they weren't the ones who "got us into this mess." Barney Frank's talking points notwithstanding, mortgage lenders didn't wake up one fine day deciding to junk long-held standards of creditworthiness in order to make ill-advised loans to unqualified borrowers. It would be closer to the truth to say they woke up to find the government twisting their arms and demanding that they do so - or else.

The pressure to make more loans to minorities (read: to borrowers with weak credit histories) became relentless. Congress passed the Community Reinvestment Act, empowering regulators to punish banks that failed to "meet the credit needs" of "low-income, minority, and distressed neighborhoods." Lenders responded by loosening their underwriting standards and making increasingly shoddy loans. The two government-chartered mortgage finance firms, Fannie Mae and Freddie Mac, encouraged this "subprime" lending by authorizing ever more "flexible" criteria by which high-risk borrowers could be qualified for home loans, and then buying up the questionable mortgages that ensued.

HT: Cafe Hayek

Sunday, September 28, 2008

The High Cost of Living vs. The Cost of Living High

Based on a suggestion yesterday from a student in my MBA class (MGT 551 Business Economics), the graph above shows the declining share of disposable personal income (data) spent on food (data), clothing (data), and shelter (housing and household operation) since 1929. From a high of almost 59% in 1933, the percent of disposable income spent on food, clothing and shelter today has continually fallen, and today (2007) is only 33%.

Bottom Line: When people today talk about the "high cost of living," they’re usually talking about the "cost of living high" (see Dallas Fed), because they're certainly not spending very much on the basics: food, clothing and shelter - that spending is at an all-time low as a percent of disposable personal income.

Saturday, September 27, 2008

Hey, What About Wikipedia?

50 of the Most Dependable Web Resources for University Students, (minus one).

HT: Craig Newmark

If I had to guess whether Wikipedia or the median refereed journal article on economics was more likely to be true, after a not so long think I would opt for Wikipedia.

~Tyler Cowen

A Bad Bank Rescue

In the 1980s, the government did not need a strategy to decide which bad loans to take over; it dealt with anything that fell into its lap as a result of a thrift bankruptcy. But under the current proposal, the government would go out and shop for bad loans. These come in all shapes and sizes, so the government would have to judge what type of loans it wants. They are illiquid, so it's hard to know how to value them. Bad loans are weighing down the financial system precisely because private-sector experts can't determine their worth. The government would have no better handle on the problem.

In practice this means the government would make subjective choices about which bad loans to buy, and it would pay more than fair value. Billions in taxpayer money would be transferred to the shareholders and creditors of banks, and the banks from which the government bought most loans would be subsidized more than their rivals. If the government bought the most from the sickest institutions, it would be slowing the healthy process in which strong players buy up the weak, delaying an eventual recovery. The haggling over which banks got to unload the most would drag on for months. So the hope that this "systematic" plan can be a near-term substitute for ad hoc AIG-style bailouts is illusory.

~Sebastian Mallaby
in the Washington Post

Friday, September 26, 2008

Tragedy of the Commons and Economies of "Scales"

THE ECONOMIST -- Like most other fisheries in the world, Alaska’s halibut fishery was overexploited—despite efforts of managers. Across the oceans, fishermen are caught up in a “race to fish” their quotas, a race that has had tragic, and environmentally disastrous, consequences over many decades. But in 1995 Alaska’s halibut fishermen decided to privatize their fishery by dividing up the annual quota into “catch shares” that were owned, in perpetuity, by each fisherman. It changed everything.

In the halibut fishery the change in incentives that came from ownership led to a dramatic shift in behaviour. Today the halibut season lasts eight months and fishermen can make more by landing fish when the price is high. Where mariners’ only thought was once to catch fish before the next man, they now want to catch fewer fish than they are allowed to—because conservation increases the value of the fishery and their share in it. The combined value of their quota has increased by 67%, to $492m.

By giving fishermen a long-term interest in the health of the fishery, individual transferable quotas (ITQs) have transformed fishermen from rapacious predators into stewards and policemen of the resource. The tragedy of the commons is resolved when individuals own a defined and guaranteed share of a resource, a share that they can trade. This means that they can increase the amount of fish they catch not by using brute strength and fishing effort, but by buying additional shares or improving the fishery’s health and hence increasing its overall size.

Sadly, most of the rest of the world’s fisheries are still embroiled in a damaging race for fish that is robbing the seas of their wealth. Overfished populations are small, and so they yield a small catch or even go extinct.

For example, consider the situation of collapsing blue crab industry in Maryland, which was so bad this year that the "federal government is bailing out hard-pressed watermen with a disaster declaration."

Maryland lawmakers had sought the declaration by the Commerce Department since May, after Virginia posted a record-low harvest for the delectable crustaceans and Maryland had its lowest catch since 1945. Crabs remained the last thriving fishing industry in the Chesapeake until the 1990s, when pollution and overfishing finally took their toll. The stock is down by about 65% since 1990, according to Virginia and Maryland officials.

MP: Instead of another federal bailout for the blue crab industry ("too tasty to fail"?), maybe lawmakers should consider ITQs instead?

HTs: NCPA (halibut) and Peter Grose (blue crab)

See related
Economist story on privatizing fisheries.

We Turned Good Renters Into Bad Homeowners

For decades, starting with Jimmy Carter's Community Reinvestment Act of 1977, there has been bipartisan agreement to use government power to expand homeownership to people who had been shut out for economic reasons or, sometimes, because of racial and ethnic discrimination. What could be a more worthy cause? But it led to tremendous pressure on Fannie Mae and Freddie Mac -- who in turn pressured banks and other lenders -- to extend mortgages to people who were borrowing over their heads. That's called subprime lending. It lies at the root of our current calamity.

~Charles Krauthammer

Thursday, September 25, 2008

The Mind-Numbing Effects of Political Correctness

Uncovering the roots of the disastrous home mortgage bubble that popped last year will keep economic historians busy for decades. Yet, one factor has so far been largely overlooked: the bipartisan social engineering crusade to drive up the rate of homeownership by handing out more mortgages to minorities.

More than a negligible amount of the blame for the mortgage meltdown can be traced back to multiculturalism: government-mandated affirmative-action lending, demographic change, illegal immigration, and the mind-numbing effects of political correctness.

The chickens have finally come home to roost.

About half of all mortgages for blacks and Hispanics are subprime, versus roughly one-sixth for whites (see chart above). Not surprisingly, the biggest home price collapses have occurred in heavily Hispanic cities such as Las Vegas, Miami, Phoenix, and Los Angeles.

The mortgage bubble was essentially a bet on the purportedly increased creditworthiness of the bottom half of the American population. After three decades of the home ownership rate stalling at around 64%, a series of federal initiatives to increase minority and low-income ownership helped push the rate up to just below 70%.


HT: Juandos

Almost a 15 Point Lead for Obama: 56.5% to 41.8%

Intrade. Is it over for McCain?

Quote of the Day: The 20% Generation

Politicians will bend to any new wind that blows through, but this past week of financial turmoil has shown there's a strong whiff in the air for the values of the greatest generation. This was the 20% generation. In the post-war years, young couples knew they'd somehow have to save 20% of the down payment on a home mortgage. That's thrift, an archaic word I think is still in most dictionaries.

~Daniel Henninger in today's WSJ

The Smart Money Will Stay Bullish On America

So far, Main Street has shown a surprising amount of resiliency given the problems of Wall Street. Even if the economy eventually succumbs to recession, as now appears more likely, it will bounce back before long. It always has.

There have been plenty of crises in the past -- the stagflation and oil-price spikes of the 1970s, the savings and loan debacle and soaring trade and budget deficits of the 1980s, the popping of the dot-come bubble and the terrorist attacks in the early 2000s -- that led many observers to predict that the United States would soon go the way of Rome.

What the pessimists ignore is that the fundamentals of the U.S. economy remain strong. Indeed, the World Economic Forum has ranked the United States as the world's most competitive economy for the last two years. (The new survey comes out next month.) Its statistics show that per-capita gross domestic product in the U.S. consistently has grown faster than in other developed economies since 1980.

Given America's record of resiliency, it would be foolish to "short" our prospects based on recent turmoil. The smart money will stay "bullish on America," even if that was Merrill Lynch's slogan before its downfall.

~Max Boot in the LA Times

Spending on Food and Clothing At An All-Time Low

Using BEA data on annual expenditures for clothing and shoes (data), and annual disposable personal income (data), the chart above show spending on clothing as a percent of income from 1929 to 2007. From double-digit levels back in the 1930s and 1940s, average spending on clothing as percent of after-tax income was down to 3.68% in 2007.

The chart above shows spending on food and clothing as a percent of disposable personal income back to 1929, falling from more than 1/3 of personal income in the 1930s and 1940s to only 13.48% by 2007.

Bottom Line: The good old days are now, and it's nothing like the Great Depression. Nothing.

Spending on Food At An All-Time Historical Low; And It's Nothing At All Like The Great Depression

The chart above is based on data from the USDA's Economic Research Service showing "Food expenditures by families and individuals as a share of disposable personal income," from 1929 to 2007. In the entire history of the U.S., it's only been in the last eight years that the percent of income spent on food for Americans was in single digits - since 2000 it's been below 10%. In all previous years, spending on food was in double-digits, and in most years from 1929 to 1952 it was above 20%.

This amazing trend in lower food prices as a percent of income reflects the relentless and significant improvements in the productivity and distribution of food production, and doesn't even take into account the significant improvements in the quantity and quality of food products available for today's Americans compared to previous periods.

And perhaps this is another reason why comparisons of today's economic conditions to the Great Depression are hugely distorted - we are more than 7.5 times wealthier today compared to 1933 based on per-capita real GDP ($5,653 in 1933 vs. $42,707 in 2007), see chart below.

We Sacrificed Sound Credit Policies For Social Activism And Endangered Entire Mortgage Market

While many pundits are pointing to corporate greed and a lack of government regulation as the cause for the American mortgage and financial crisis, some analysts are saying it wasn't too little government intervention that cased the mortgage meltdown, but too much, in the form of activists compelling the government to pressure Freddie Mac and Fannie Mae into unsound – though politically correct – lending practices.

Stan J. Liebowitz, economics professor at the University of Texas at Dallas, in his forthcoming book, Housing America: Building out of a Crisis, puts forward an explanation that he admits is "not consistent with the nasty-subprime-lender hypothesis currently considered to be the cause of the mortgage meltdown."

In a nutshell, Liebowitz contends that the federal government over the last 20 years pushed the mortgage industry so hard to get minority homeownership up, that it undermined the country's financial foundation to achieve its goal.

"In an attempt to increase homeownership, particularly by minorities and the less affluent, an attack on underwriting standards was undertaken by virtually every branch of the government since the early 1990s," Liebowitz writes. "The decline in mortgage underwriting standards was universally praised as 'innovation' in mortgage lending by regulators, academic specialists, GSEs and housing activists."

"Although a seemingly noble goal, the tool chosen to achieve this goal was one that endangered the entire mortgage enterprise. As homeownership rates increased there was self-congratulation all around. The community of regulators, academic specialists, and housing activists all reveled in the increase in homeownership."

~From the WorldNetDaily article "Guess again who's to blame for U.S. mortgage meltdown? Analysts point not to greed, but to social activist politics"

Flashback to the 1990s: Origins of the Credit Crisis

It’s one of the hidden success stories of the Clinton era. In the great housing boom of the 1990s, black and Latino homeownership has surged to the highest level ever recorded. The number of African Americans owning their own home is now increasing nearly three times as fast as the number of whites; the number of Latino homeowners is growing nearly five times as fast as that of whites.

In 1992, [a majority Democratic] Congress mandated that Fannie and Freddie increase their purchases of mortgages for low-income and medium-income borrowers. Operating under that requirement, Fannie Mae, in particular, has been aggressive and creative in stimulating minority gains. It has aimed extensive advertising campaigns at minorities that explain how to buy a home and opened three dozen local offices to encourage lenders to serve these markets.

Most importantly, Fannie Mae has agreed to buy more loans with very low down payments–or with mortgage payments that represent an unusually high percentage of a buyer’s income. That’s made banks willing to lend to lower-income families they once might have rejected.

The top priority may be to ask more of Fannie Mae and Freddie Mac. The two companies are now required to devote 42% of their portfolios to loans for low- and moderate-income borrowers; HUD, which has the authority to set the targets, is poised to propose an increase this summer. Although Fannie Mae actually has exceeded its target since 1994, it is resisting any hike. It argues that a higher target would only produce more loan defaults by pressuring banks to accept unsafe borrowers.

~LA Times article on May 31, 1999

MP: Government policy turned millions of perfectly good renters into terribly bad homeowners.

Wednesday, September 24, 2008

Obama's Lead Up to 13.7 Points: 57% vs. 43.3%

Canada, Chile Now Economically Freer Than U.S.

Washington -- Economic freedom around the world remains on the rise but it has declined notably in the U.S. since the year 2000, according to the Economic Freedom of the World Report: 2008 Annual Report from the Cato Institute and Canada's Fraser Institute.

In 2000 the U.S. was the second-freest economy listed in Economic Freedom of the World, an annual report written by James Gwartney from Florida State University and Robert Lawson from Auburn University. This year the U.S. has fallen to 8th place, behind Hong Kong (ranked in first place), Singapore, New Zealand, Switzerland, the United Kingdom, Chile, and Canada.

More significant than the U.S.'s drop in the rankings is its fall in the freedom ratings: on a scale of 0-10, the U.S. fell from 8.55 in 2000 to 8.04. Only five countries have experienced a greater decline over the same time period: Zimbabwe, Argentina, Niger, Venezuela, and Guyana.

"The rule of law, government spending, and regulation are the areas where the United States saw the most troubling declines in its ratings this decade," observes Ian Vasquez, director of Cato's Center for Global Liberty and Prosperity.

MP: These ratings are for the year 2006, the most recent year for which comprehensive data are available (see top 20 most free countries above). What's going to happen to America's Economic Freedom rating when: a) the recent government takeover of Fannie and Freddie, b) the current proposal for a $700 billion bailout of the U.S. financial markets, c) the $85 billion AIG bailout, and d) the $25 billion in loans for the Detroit Three, are all accounted for?

Listen to Cato's Will Wilkinson's comments on NPR about now Canada, even with its socialized medical system, now ranks higher than the U.S. in its degree of overall economic freedom.

9-Point Lead: Obama: 54.4% vs. McCain: 45.2%


Cartoon of the Day

Credit Crunch? What Credit Crunch?

Based on data from the St. Louis Fed, Total Consumer Credit Outstanding reached an all-time high of $2.572 trillion in July (see chart above). The way the banking system is described in the media, you'd think the supply of commercial bank credit has completely dried up, e.g. do a Google News search for "credit crunch" and you get almost 45,000 results. At least for consumer credit, and at least through July, the supply of consumer credit has never been higher.

Lots of People Could Use A Cash Infusion

1. Barney "Big Un" Baumgartner of Windblown, Wyo., invited the Federal Reserve and the U.S. Treasury Department to take over his business, The Big Un 24 Hour Tow Service and Trophy Taxidermy. He'd be willing to let the government have 80% of his business for a quick cash infusion. He thought something in the neighborhood of $1.8 million should do the trick. That would be enough to gas up his two tow trucks, get some new taxidermy stuffing and clean up that overdue account at the Number 10 Saloon and Casino over in Deadwood, S.D.

2. A pawn shop in Reno, Nev., has an excess supply of eight-track cassette players, flower print shirts, broad white belts and Wayne Newton tapes, having gambled that the '70s would come roaring back. The owner pleaded for a Treasury take-over, arguing, "How can the government stand by and let such a rich part of our American culture simply fade away?"

3.The owner of an NFL poster shop in Green Bay, Wis., reports that he has given up on divine intervention and is now asking for Treasury to take over his business in a last-ditch effort to preserve the notion that whatever our differences, we're all Americans.

4. Darlene Dalrymple owner of the Shear Joy Hairstyling and Tattoo Salon in Rockhard, Vt., wrote Treasury Secretary Henry Paulson, inviting him and Federal Reserve Chairman Ben Bernanke to her shop for a free trim and tat if they'd also help with her balance sheet. Ms. Dalrymple said she's very busy, but her expenses somehow always exceed her income. She suspects her boyfriend, who likes to use a lot of Wall Street lingo he picks up watching business channels on TV, is shorting her cash register.

~Tom Brokaw in today's WSJ

If Banks Disappear, It Doesn't Mean Lenders Will

What's clear is that a bunch of financial institutions have made mistakes and lost money. What's unclear is why anyone (other than the owners and managers) should care. People make mistakes and lose money all the time. Restaurants fail, grocery stores fail, gas stations fail. People pick the wrong stocks, they buy the wrong cars, and they marry the wrong spouses without turning to the Treasury for bailouts.

So what's special about banks? According to what I keep reading, it's that without banks, nobody can borrow, and the economy grinds to a halt.

Well, let's think about that. Banks don't lend their own money; they lend other people's (their depositors' and their stockholders'). Just because the banks disappear doesn't mean the lenders will. Borrowers will still want to borrow and lenders will still want to lend. The only question is whether they'll be able to find each other.

That's one reason I feel squeamish about the official pronouncements we've been getting. They tell us bank failures will make it hard to borrow but never that bank failures will make it hard to lend. But every borrower is paired with a lender, so it's odd to state the problem so asymmetrically. This makes me suspect that the official pronouncers have not entirely thought this thing through.

In the 1930s, a wave of bank failures did make it hard for borrowers and lenders to find each other, and the consequences were drastic. But times have changed in at least two relevant ways. First, the disaster of the 1930s was caused not just by bank failures, but by a 30% contraction of the money supply, which is something today's Fed can easily prevent. Second, as any user of match.com can tell you, the technology for finding partners has improved since then. When a firm wants to raise capital, why can't it just sell bonds over the web? Or issue new stock? Or approach one of the hedge funds that seem to be swimming in cash? Or borrow abroad?

In other words, I'm not sure these big Wall Street banks are really necessary, and I'm not sure we'd miss them much if they were gone. Maybe there's something I'm missing, but if so, I think it should be incumbent on Messrs. Bernanke, Paulson and above all Bush to explain what it is.

~Steven E. Landsburg "Not Buying It" in The Atlantic

How Big Is One Trillion? (1,000,000,000,000)

Thomas Sowell breaks it down:

Many people have trouble even forming some notion of what such numbers as billion and trillion mean. One way to get some idea of the magnitude of a trillion is to ask: How long ago was a trillion seconds?

A trillion seconds ago, no one on this planet could read and write. Neither the Roman Empire nor the ancient Chinese dynasties had yet come into existence. None of the founders of the world's great religions today had yet been born.

That's what a trillion means. Put a dollar sign in front of it and that's what the current bailout may cost.

MP: One trillion seconds equals 16.667 billion minutes, 277.7 million hours, 11.574 million days, and 31,710 years.

Tuesday, September 23, 2008

LA Times: Give The Professor The Data

1. LA TIMES (9/26/2007) -- Affirmative action enables hundreds of minority law students to attend more elite institutions than their credentials alone would allow. Data from across the country suggest that when law students attend schools where their credentials (including LSAT scores and college grades) are much lower than the median at the school, they actually learn less, are less likely to graduate and are nearly twice as likely to fail the bar exam than they would have been had they gone to less elite schools. This is known as the "mismatch effect."

Data from one selective California law school from 2005 show that students who received large preferences were 10 times as likely to fail the California bar as students who received no preference. After the passage of Proposition 209, which limited the use of racial preferences at California's public universities, in-state bar passage rates for blacks and Latinos went up relative to out-of-state bar passage rates. To the extent that students of color moved from UC schools to less elite ones, the post-209 experience is consistent with the mismatch theory.

In general, research shows that 50% of black law students end up in the bottom 10th of their class, and that they are more than twice as likely to drop out as white students. Only one in three black students who start law school graduate and pass the bar on their first attempt; most never become lawyers. How much of this might be attributable to the mismatch effect of affirmative action is still a matter of debate, but the problem cries out for attention.

~UCLA Law Professor Richard Sander, "Does affirmative action hurt minorities? Racial preferences may be setting up many black and Latino law students for failure."

2. LA TIMES (9/8/2008) -- Two years ago, Richard Sander published research suggesting that racial preferences at law firms might be responsible for black lawyers' high rate of attrition and difficulty making partner. He hypothesized that in the interest of promoting diversity, law firms sometimes hired black lawyers who were underqualified, and that when there was a "credentials gap" between black and white lawyers at a firm, black lawyers often were less likely to advance and more likely to leave the firm.

The research stirred debate throughout the legal community, and Sander said he was surprised at the vehemence with which people attacked his motives. A former Volunteers in Service to America participant, fair-housing activist and campaigner for Chicago's first black mayor, Sander, who is white, insisted he was simply trying to examine an important question.

Now the professor has waded into another controversy. Sander says his goal this time is to examine whether law schools set up many affirmative action beneficiaries for failure by admitting them into rigorous academic environments in which they are ill-prepared to compete. He proposes to study almost 30 years of data on State Bar of California exam-takers. In the end, he hopes to explain why, as reported in a Law School Admissions Council study in the 1990s, blacks are four times as likely as whites to fail the bar exam on the first try.

The state bar has refused to facilitate his probe. Citing privacy concerns, the bar has denied him access to detailed demographic data collected from exam-takers since 1972.

~From the article "Does affirmative action help or hurt African American law students?"

3. LA TIMES EDITORIAL (9/17/2008) -- A California professor studying affirmative action should have access to law school performance statistics.

UAW Doesn't Discriminate, Why Should McCain?

Watch the Obama ad above blasting McCain for owning three foreign vehicles: a Lexus, a VW and a Honda (identified in the Detroit Free Press as a "2001 Honda sedan"). If it's a 2001 Honda Civic, it was built in East Liberty, Ohio, with higher domestic content (75%) than the Ford Escort (60%), see photo below (source: Dallas Fed):

MP: The 2008 Honda Pilot and Honda Civic are built in the U.S. with a higher domestic content (70%) than the 2008 Dodge Ram (68%).

In a related story about McCain's "foreign cars,"
BusinessWeek reports that "The United Auto Workers, already supporting Obama, really doesn’t like Toyota or its Lexus unit."

MP: Oh, really? On the
UAW's website, it provides information for "consumers who want to purchase vehicles produced by workers who enjoy the benefits and protections of a union contract," and lists the vehicles made in the U.S. by members of the UAW, including the TOYOTA COROLLA and the TOYOTA TACOMA, along with the Mazda 6, Mitsubishi Eclipse, Mitsubishi Galant, Isuzu i-Series Truck, Mazda B-series Truck, and Mitsubishi Raider Truck.

The UAW doesn't discriminate against foreign car companies, why should McCain or you?

Affordable Housing: Nobody Knows What It Means, But Politicians Never Want To Be On Wrong Side

Anyone who has not lived in a liberal inner suburb such as Arlington, Virginia may have a difficult time understanding the emotional freight that the phrase "affordable housing" carries in local politics. It is an issue on which candidates campaign, on which activists make officeholders feel guilty and on which a remarkably forceful social service coalition, anchored by churches and nonprofit organizations, can amass lots of political power. Nobody is ever sure exactly what "affordable housing" means, but nobody running for office ever wants to be on the wrong side of it.

~Alan Ehrenhalt's article in The Governing Magazine titled "The Magic Word: Affordable"

HT: Tim Wise

What Do New Yorkers Think About Free Trade?

HT: Division of Labour

Flashback to 1999: Origins of the Credit Crisis

From the NY Times on September 30, 1999: "Fannie Mae Eases Credit To Aid Mortgage Lending":

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990s by reducing down payment requirements,'' said Franklin Raines, Fannie Mae's chairman and CEO. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.''

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980s (MP: How prophetic!).

'From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the American Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

See Peter Wallison's article in today's WSJ

HT: Isaac Morehouse at Students for a Free Economy

Blame Fannie Mae and Congress For Credit Mess

How the political obsession with "affordable housing" and "home ownership" backfired:

The vast accumulation of toxic mortgage debt that poisoned the global financial system was driven by the aggressive buying of subprime and Alt-A mortgages, and mortgage-backed securities, by Fannie Mae and Freddie Mac. The poor choices of these two government-sponsored enterprises (GSEs) -- and their sponsors in Washington -- are largely to blame for our current mess.

In order to curry congressional support after their accounting scandals in 2003 and 2004, Fannie Mae and Freddie Mac committed to increased financing of "affordable housing." They became the largest buyers of subprime and Alt-A mortgages between 2004 and 2007, with total GSE exposure eventually exceeding $1 trillion. In doing so, they stimulated the growth of the subpar mortgage market and substantially magnified the costs of its collapse.

Beginning in 2004, their portfolios of subprime and Alt-A loans and securities began to grow. Subprime and Alt-A originations in the U.S. rose from less than 8% of all mortgages in 2003 to over 20% in 2006. During this period the quality of subprime loans also declined, going from fixed rate, long-term amortizing loans to loans with low down payments and low (but adjustable) initial rates. The hint to Fannie and Freddie was obvious: Concentrate on affordable housing and, despite your problems, your congressional support is secure.

Now the Democrats are blaming the financial crisis on "deregulation." This is a canard. There has indeed been deregulation in our economy -- in long-distance telephone rates, airline fares, securities brokerage and trucking, to name just a few -- and this has produced much innovation and lower consumer prices. But the primary "deregulation" in the financial world in the last 30 years permitted banks to diversify their risks geographically and across different products, which is one of the things that has kept banks relatively stable in this storm.

As a result, U.S. commercial banks have been able to attract more than $100 billion of new capital in the past year to replace most of their subprime-related write-downs. Deregulation of branching restrictions and limitations on bank product offerings also made possible bank acquisition of Bear Stearns and Merrill Lynch, saving billions in likely resolution costs for taxpayers.

~Charles Calomiris and Peter Wallison in today's WSJ

See related CD post below

Saints Are No More Common in D.C. Than Wall St.

Why then is there such a mess in the financial markets? Much of that mess is due to the very people we are now turning to for solutions-- members of Congress.

Past Congresses created the hybrid financial institutions known as Fannie Mae and Freddie Mac, private institutions with government backing and political influence. About half of the mortgages in this country are backed by these two institutions.

Such institutions-- exempt from laws that apply to other financial institutions and backed by the implicit promise of government support with the taxpayers' money-- are an open invitation to risky behavior. When these risks blew up in their faces, Fannie Mae and Freddie Mac were taken over by the government, costing the taxpayers billions of dollars.

Saints are no more common on Capitol Hill than they are on Wall Street. We can only hope that the political "solution" does not turn out to be worse than the problem.

~From Thomas Sowell's column A Political "Solution"

Monday, September 22, 2008

Great Depression:Not A Single Canadian Bank Failed

The McFadden Act of 1927 specifically prohibited interstate branch banking in the U.S., and only allowed banks to open branches within the single state in which it was chartered. Therefore, U.S. banks were forced to be small and local, with an undiversified loan portfolio tied to the local economy of a single state, or a specific region of a single state. The strict regulatory framework of the McFadden Act created a delicate and fragile banking system that could not easily withstand the shock of the Great Depression. Exhibit A: 9,000 banks failed in the U.S. in the early 1930s (see chart above).

Could it have been different? Could a different regulatory framework have enabled the U.S. banking system to withstand the Great Depression, thereby lessening its impact on the overall economy? Yes. Consider the following:

San Francisco Federal Reserve -- During the Great Depression years—1930 through 1933—5.6% (1,352 banks), 10.5% (2,294 banks), 7.8% (1,500), and 12.9% (4,000) of U.S. banks failed in each year; by the end of that four-year stretch, almost half of U.S. banks had either closed or merged. In all, 9,000 banks failed during the 19300s (see chart above).

Bernanke (American Economic Review, 1983) argues that this banking crisis worsened the magnitude of the downturn because credit supply fell as banks failed. Thus, many firms were unable to finance potential investments. Most of the failed banks were small and operated out of just a single office. In Canada, where not a single bank failed, branching was the rule; in fact, Canada had only ten large banks during the 1930s (see chart above). The Canadian economy fared much better than did the United States economy, in large part because of its better diversified and integrated banking system.

Bottom Line: Strict banking regulations are not always the answer to creating a sound and stable banking system. Exhibit A: The McFadden Act and The Great Depression, and the fact that 0 banks failed in Canada (due to a more sensible regulatory system) vs. 9,000 bank failures in the U.S. largely due to the repressive regulatory framework of the McFadden Act.