The Black Swan is a great book, and deserves the hype it has received. It also features lots of nasty comments about economics, most of which the profession deserves.
But economics training (or at least my Wisconsin economics training) teaches empirical skepticism (something Taleb advocates) all the time. We worry about mis-measurement of variables, omitted variables, selection, reverse causality, and distributions all the time. We think hard about things we don't observe--in my context, when I think about measuring house prices, I worry about the fact that we only observe houses that actually sell. We do non-parametric statistics, and we reject the assumption of normality on a regular basis.
As a result of all this, economics has actually helped us understand certain things better, at least within the realm of applied microeconomics. One a lighter note, let me state an untestable hypothesis--of all the "silent" music that has been written, none has been better than J.S. Bach's.
Saturday, 17 July 2010
Friday, 9 July 2010
Yves Smith on the Default of the Rich
She writes about this morning's story in the New York Times:
She slips in an important sentence--that refinanced mortgages lose their non-recourse status. Refinancings swamped purchase money mortgages in 2004 and were a substantial share of the market in 2005-2006. It would be interesting to see an estimate of the share of mortgage debt outstanding in "non-recourse" states that actually now come with recourse--I would imagine it is well over 50 percent. One might think that "sophisticated" investors are more likely to refinance than the general public (I did a paper with Lacour-Little some time ago that suggested that this was true), and so that "strategic" default could be particularly costly for this group. Certainly, if I were a lender and observed a borrower with a $1 million plus loan with recourse, I would go after the borrower for a deficiency judgment.
There is a broader point here as well. I have been reading arguments that America got itself into trouble because it is too borrower friendly, and that countries that avoided trouble, such as Canada and Germany, did so because of recourse. But the fact is that for all intents and purposes, the US is a recourse country too.
Another message here is that high income borrowers aren’t taking the Freddie/Fannie/bank bluster about strategic defaults seriously. Recall that the latest threat was that they would pursue deficiency judgments, as in sue borrowers who defaulted where the proceeds from the sale of the home, net of expenses, did not cover the mortgage debt. Now in some states that is not permitted (purchase money mortgages in many states are non-recourse, but refis never are). But independent of that, it is expensive to pursue defaulting borrowers, and if the borrower really is broke (say he had medical emergency, a business failure, or a costly divorce) litigation is just a costly wild goose chase. The most obvious group to pursue, nevertheless, would be defaulted owners of big ticket homes in affluent areas. They clearly regard the odds of legal action as low.
She slips in an important sentence--that refinanced mortgages lose their non-recourse status. Refinancings swamped purchase money mortgages in 2004 and were a substantial share of the market in 2005-2006. It would be interesting to see an estimate of the share of mortgage debt outstanding in "non-recourse" states that actually now come with recourse--I would imagine it is well over 50 percent. One might think that "sophisticated" investors are more likely to refinance than the general public (I did a paper with Lacour-Little some time ago that suggested that this was true), and so that "strategic" default could be particularly costly for this group. Certainly, if I were a lender and observed a borrower with a $1 million plus loan with recourse, I would go after the borrower for a deficiency judgment.
There is a broader point here as well. I have been reading arguments that America got itself into trouble because it is too borrower friendly, and that countries that avoided trouble, such as Canada and Germany, did so because of recourse. But the fact is that for all intents and purposes, the US is a recourse country too.
Thursday, 8 July 2010
Two more thoughts about The Big Short
(1) One of Hayek's most compelling arguments for the virtues of markets over government is that markets (via prices) reflect the constantly shifting preferences of millions of agents, and as such are both efficient and democratic. But the market for Collateralized Debt Obligations and Credit Default Swaps did not reflect the preferences of millions--they reflected the views of a very small number of people, some of whom had enormous market power (for awhile, anyway). A takeaway from the book is how large institutions could rig prices of over-the-counter investments for long enough periods to do substantial damage.
(2) While I loved the book, and will indeed use it in class, it may suffer a bit from ex-post thinking. The heroes of the book, Michael Burry, Steve Eisman, Greg Lippman, bet early and often against subprime mortgages, and made lots of money as a result. Ex post, their bets seem obvious, and perhaps ex ante, they should have seemed obvious. My strong suspicion is that Burry--who went to the bother of actually reading and analyzing offering circulars--really did know that he had a positive NPV bet ex ante. And loan originators surely knew they were underwriting junk, because documentation was so week. But perhaps not even Burry knew how big his pay-off would actually be.
(2) While I loved the book, and will indeed use it in class, it may suffer a bit from ex-post thinking. The heroes of the book, Michael Burry, Steve Eisman, Greg Lippman, bet early and often against subprime mortgages, and made lots of money as a result. Ex post, their bets seem obvious, and perhaps ex ante, they should have seemed obvious. My strong suspicion is that Burry--who went to the bother of actually reading and analyzing offering circulars--really did know that he had a positive NPV bet ex ante. And loan originators surely knew they were underwriting junk, because documentation was so week. But perhaps not even Burry knew how big his pay-off would actually be.
Friday, 2 July 2010
Steve Malpezzi's Reading for Life
It is on the Wisconsin Real Estate blog:
13. Ahamed, Liaquat. Lords of Finance: The Bankers Who Broke the World. Penguin Press, 2009.
12. Akerlof, George A. and Robert J. Shiller. Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. Princeton Unversity Press, 2009.
11. Bartik, Timothy J. Who Benefits from State and Local Economic Development Policies? Kalamazoo: W.E. Upjohn Institute for Employment Research, 1991.
10. Cronon, William. Nature's Metropolis: Chicago and the Great West. W.W. Norton, 1991.
9. Gomez-Ibanez, Jose A., William B. Tye and Clifford Winston (eds.). Essays in Transportation Economics and Policy: A Handbook in Honor of John R. Meyer. Brookings, 1999.
8. Green, Richard and Stephen Malpezzi, A Primer on U.S. Housing Markets and Policy. The Urban Institute Press for the American Real Estate and Urban Economics Association, 2003.
7. Hulme, Mike. Why We Disagree About Climate Change: Understanding Controversy, Inaction and Opportunity. Cambridge University Press, 2009.
6. Lewis, Michael. The Big Short: Inside the Doomsday Machine. W.W. Norton, 2010.
5. Reinhardt, Carmen M. and Kenneth S. Rogoff. This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises. Princeton University Press, 2009.
4. Slemrod, Joel and Jon Bakija. Taxing Ourselves: A Citizen's Guide to the Debate over Taxes. MIT Press, 2008.
3. Tufte, Edward R. The Visual Display of Quantitative Information. Chesire, Connecticut: Graphics Press, 1983.
2. Wessel, David. In Fed We Trust: Ben Bernanke's War on the Great Panic. Crown Business, 2009.
1. http://wisconsinviewpoint.blogspot.com/
13. Ahamed, Liaquat. Lords of Finance: The Bankers Who Broke the World. Penguin Press, 2009.
12. Akerlof, George A. and Robert J. Shiller. Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism. Princeton Unversity Press, 2009.
11. Bartik, Timothy J. Who Benefits from State and Local Economic Development Policies? Kalamazoo: W.E. Upjohn Institute for Employment Research, 1991.
10. Cronon, William. Nature's Metropolis: Chicago and the Great West. W.W. Norton, 1991.
9. Gomez-Ibanez, Jose A., William B. Tye and Clifford Winston (eds.). Essays in Transportation Economics and Policy: A Handbook in Honor of John R. Meyer. Brookings, 1999.
8. Green, Richard and Stephen Malpezzi, A Primer on U.S. Housing Markets and Policy. The Urban Institute Press for the American Real Estate and Urban Economics Association, 2003.
7. Hulme, Mike. Why We Disagree About Climate Change: Understanding Controversy, Inaction and Opportunity. Cambridge University Press, 2009.
6. Lewis, Michael. The Big Short: Inside the Doomsday Machine. W.W. Norton, 2010.
5. Reinhardt, Carmen M. and Kenneth S. Rogoff. This Time Is Different: A Panoramic View of Eight Centuries of Financial Crises. Princeton University Press, 2009.
4. Slemrod, Joel and Jon Bakija. Taxing Ourselves: A Citizen's Guide to the Debate over Taxes. MIT Press, 2008.
3. Tufte, Edward R. The Visual Display of Quantitative Information. Chesire, Connecticut: Graphics Press, 1983.
2. Wessel, David. In Fed We Trust: Ben Bernanke's War on the Great Panic. Crown Business, 2009.
1. http://wisconsinviewpoint.blogspot.com/
Ken Rogoff thinks the BP spill might produce a groundswell for a carbon tax...
...but Mark Thoma is not so sure [Rogoff's take is here].
I am actually more inclined to agree with Rogoff on this one. When environmental problems are easily visible, they seem to generate political consensus for action. The air quality in Los Angeles, which was obviously awful 30 years ago, is much better currently--the vast majority of days are quite clear now(although we still have the problem of invisible small particulates). The 1952 smog disaster led to major policy changes in the UK. The BP disaster could similarly mobilize policy.
Mark could still be right about this--I just hope he is not.
I am actually more inclined to agree with Rogoff on this one. When environmental problems are easily visible, they seem to generate political consensus for action. The air quality in Los Angeles, which was obviously awful 30 years ago, is much better currently--the vast majority of days are quite clear now(although we still have the problem of invisible small particulates). The 1952 smog disaster led to major policy changes in the UK. The BP disaster could similarly mobilize policy.
Mark could still be right about this--I just hope he is not.
Thursday, 1 July 2010
I am putting Michael Lewis' The Big Short on my FBE 589 reading list for this fall
So many great lines. Perhaps my favorite (from pp 151-152):
A couple of thoughts. First, I would bet (forgive the word) that gambling habits would be a good underwriting variable for predicting mortgage default. If lenders could know whether someone gambled more than one percent of their annual income in casinos, at the race track, or on lottery tickets, it might say something about propensity to repay a mortgage [full disclosure, I bet $18 once or twice a year at Santa Anita].
Second, I do remember being mystified at what happened to house prices on my street in Bethesda, Maryland. When my wife and I moved there in 2002, we thought it was awfully expensive, but decided that the schools and proximity to metro made it worth while. We swallowed hard and got a mortgage where our mortgage payments + property taxes were about 20 percent of our gross income. My wife was an attending physician at a large medical center, and I was a finance professor at George Washington.
By 2005 or so, the price of houses on our street had increased by about 2/3 (because all houses were 30s vintage colonials, every sale we observed was a good comp). The mysterious part was the buyers were young one-earner households. I wondered how on earth they were "affording" their houses. Now we know.
The only interested parties missing from the conference were the ultimate borrowers, the American home buyers, but even they, in a way, were on hand, serving drinks, spinning wheels, and rolling dice. "Vegas was booming," said Danny. "The homeowners were at the f**king tables."
A couple of thoughts. First, I would bet (forgive the word) that gambling habits would be a good underwriting variable for predicting mortgage default. If lenders could know whether someone gambled more than one percent of their annual income in casinos, at the race track, or on lottery tickets, it might say something about propensity to repay a mortgage [full disclosure, I bet $18 once or twice a year at Santa Anita].
Second, I do remember being mystified at what happened to house prices on my street in Bethesda, Maryland. When my wife and I moved there in 2002, we thought it was awfully expensive, but decided that the schools and proximity to metro made it worth while. We swallowed hard and got a mortgage where our mortgage payments + property taxes were about 20 percent of our gross income. My wife was an attending physician at a large medical center, and I was a finance professor at George Washington.
By 2005 or so, the price of houses on our street had increased by about 2/3 (because all houses were 30s vintage colonials, every sale we observed was a good comp). The mysterious part was the buyers were young one-earner households. I wondered how on earth they were "affording" their houses. Now we know.
I don't blame Goldman Sachs for taking 100 cents on the dollar of its Credit Default Swaps from AIG....
....I blame the government for offering it. I understand that there was a need to keep Goldman stable, but jeez.
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