Before we elected a new president 113 days ago and expected him to reverse a 15-year tsunami of misjudgment, miscreance, and missteps, we stored up confidence and trust in economists.
Bullish or bearish, notwithstanding, they managed our disappointment in their pronouncements and forecasts with a dismissive flourish and a slight adjustment to their predictive models.
In a story that just appeared in The Atlantic, Gregory Clark, a professor of economics at the University of California at Davis, described some of his concerns with the profession of Academic Economists.
In this story he also used a paper on online dating (one of mine) to show how economists are working on irrelevant topics. And while I think that the dating market is an important topic to study, and even more to try and improve, I think that his overall criticism is worth paying attention to.
Here is the text:
Dismal scientists: how the crash is reshaping economics With the chattering classes consumed by concern for the devastated value of their 401K funds, and their suddenly precarious lifestyles, there has been much anger and scorn directed at those former masters of the universe, financiers.
But the shock to the world of finance has been echoed by a shock to the world of academic economics that is just as profound.
In the long post WWII boom, as free market ideology triumphed, economists have won for themselves a privileged place inside academia.
First there is the cash. It astonished some when Washington University, a school with an economics department of modest prestige, hired economists David Levine and Michele Boldrin by offering salaries well in excess of $500,000. But most high ranked economics departments have professors earning in excess of $300,000. Not much by the pornographic standards of finance, but a fat paycheck compared to your average English or Physics professor.
It is not just the stars. Journeyman assistant professors in economics routinely come in at $100,000 or more. And, unlike the hard sciences, they do this fresh from their PhDs, without a publication to their name and without years of low pay as post-docs.
The high salaries have been accompanied by dramatic declines in the teaching burden. The research demands of our advanced science leave little time for the classroom. In good universities faculty typically teach only two courses a year – one of which has to be a graduate seminar. The masses in the Econ 1 classes are often abandoned to the tender mercies of graduate students.
Then there is the economics “Nobel” Prize. Not a real Nobel, but a prize funded by the Bank of Sweden in honor of Alfred Nobel, with all the royal trappings of the Nobel. That makes economics star players really attractive to universities. When Edward Prescott of Arizona State won the Nobel he was paraded at half time at a football game. There is nothing like a Nobel for luster and fund-raising.
Why did academic economics generate so much prestige? Sure, modern economics is technically demanding. But so, for example, are theoretical physics and archeology, and physics and archeology professors are (relatively) dirt poor.
The technical demands helped limit the supply of economists. But what drove demand was the unquenchable thirst for economists by banks, government agencies, and business schools – the Feds, the Treasury, the IMF, the World Bank, the ECB. Economics had powerful insights to offer the world, insights worth a lot of treasure. Economics was powerful voodoo. Any major university or research institute wanted to arm itself with this potency.
The current recession has revealed the weaknesses in the structures of modern capitalism. But it also revealed as useless the mathematical contortions of academic economics. There is no totemic power. This for two reasons:
(1) Almost no-one predicted the world wide downtown. Academic economists were confident that episodes like the Great Depression had been confined to the dust bins of history. There was indeed much recent debate about the sources of “The Great Moderation” in modern economies, the declining significance of business cycles.
Indeed as we have seen this year on the academic job market, macroeconomists had turned their considerable talents to a bizarre variety of rococo academic elaborations. With nothing of importance to explain, why not turn to the mysteries of online dating, for example.
I myself was so confident of the consensus of the end of the business cycle that I persuaded by wife after the collapse of Lehman Brothers to invest all her retirement savings in the stock market, confident that the Fed would soon make things right and we could profit from the panic of a gullible public. The line “Where is my money, idiot?” is her’s.
(2) The debate about the bank bailout, and the stimulus package, has all revolved around issues that are entirely at the level of Econ 1. What is the multiplier from government spending? Does government spending crowd out private spending? How quickly can you increase government spending? If you got a A in college in Econ 1 you are an expert in this debate: fully an equal of Summers and Geithner.
The bailout debate has also been conducted in terms that would be quite familiar to economists in the 1920s and 1930s. There has essentially been no advance in our knowledge in 80 years.
It has seen people like Brad De Long accuse distinguished macro-economists like Eugene Fama and John Cochrane of the University of Chicago of at least one “elementary, freshman mistake.”
It has seen Treasury Secretary Timothy Geithner, guided by Larry Summers, one of the most respected economists of our time, produce a bailout plan for the US financial system stunning in its faltering vagueness.
Bizarrely, suddenly everyone is interested in economics, but most academic economists are ill-equipped to address these issues.
Recently a group of economists affiliated with the Cato Institute ran an ad in the New York Times opposing the Obama’s stimulus plan. As chair of my department I tried to arrange a public debate between one of the signatories and a proponent of fiscal stimulus — thinking that would be a timely and lively session. But the signatory, a fully accredited university macroeconomist, declined the opportunity for public defense of his position on the grounds that “all I know on this issue I got from Greg Mankiw’s blog — I really am not equipped to debate this with anyone.”
Academic economics will no doubt survive this shock to its prestige.
Will we be as well paid? A recent article in the Wall Street Journal suggests the days of the $500,000 economics professor may have passed.
But more importantly, will the focus of academic economics change? That is hard to tell. But I would rate the chances of Chrysler producing once again a competitive US automobile at least as high as the chances of academic economics learning any lesson from this downturn. (What was the price of that Chrysler stock we bought, dear?)
Looks as if the asset value of economic analysis may be in flux, perhaps worth pennies on a 2006 dollar. We say, let’s learn more about dating.
10:00 a.m. Fed Chairman Ben Bernanke testifies befor the Senate Banking Committee; February consumer confidence
Noon Fed Governor Elizabeth Duke speaks
4:00 p.m. Stock Markets close
9:00 pm President Barack Obama addresses Joint Session of the Congress with the state of the union
Home Depot’s earnings came in, slightly better than analysts forecast. The operative phrase from Home Depot CEO Frank Blake:
“We expect the home improvement market in 2009 will remain just as challenging as 2008.”
ProSales Online reported yesterdaythat two more regional lumber yard operations have succumbed to the housing and economic crises, one of them a Missouri-based company that opened more than 150 years ago.
The two latest institutions to go out of business are Landreth Lumber, based in Bunker Hill, Ill., and Springfield Mill and Lumber in Missouri.
A spokesman for Landreth told ProSales today that its closure was involuntary–the result of Landreth’s bank deciding to stop providing credit to the 53-year-old southern Illinois institution. Shuttered were lumberayrds in Cottage Hills, Bunker Hill, and Jerseyville, Ill., as well as a manufacturing facility in Jacksonville, Ill. Roughly 60 employees lost their jobs.
…
In Missouri, the Springfield News-Leaderreported today that Springfield Mill & Lumber will be going out of business in about a month. Southern Supply Co. has purchased a majority of the LBM operation’s inventory and hired more than half of its 20-person workforce, M. Lloyd Wright, owner of Springfield Mill &Lumber, told the newspaper.
Not that there’s really good money around to go after the bad. However, as the federal government eyes converting Citigroup preferred shares into common and taking a 40% stake in the behemoth, folks who eat, sleep, and breathe economics and policy talk as if nationalization is inevitable, whether or not that’s what one calls it.
This video, from Sunday morning television on ABC’s “This Week,”has become the flashpoint of debate.
The Big Picture’s Barry Ritholtz comes acrossas if he smells blood on this issue. There’s nothing so gratifying in the thankless world of blogging than to have been roundly excoriated for going out on a limb on a theory, only to be proven 100% correct on it.
He draws on Miller Tabak + Co. equity strategist Peter Boockvar’s strong assertion about calling a spade a spade to further his pro-nationalization argument.
“The raging debate over whether to nationalize C and/or BAC is semantics at this point. With politicians in DC dictating executive pay, marketing expenses, employee trips, dividend policy, etc… with their tens of billions of pfd stock (which may now be common with an amazing sleight of hand with no new money) and the guarantee of almost a half trillion $s worth of assets, both are already wards of the state.
But, whatever step the government may or may not take, healing the banks directly is still only dealing with the symptoms and not the disease.
That disease is ‘an overleveraged consumer and falling home prices‘ — when its cured, it will heal the symptoms that is a troubled bank sector. Shifting bad assets from the banks to the govt is just a shell game as we’ll pay for it one way or another. The $64k question is what will happen to bond holders . . .
Talk about nationalizing some of the nation’s biggest banks is all the rage these days. Shares of major financial institutions tumbled further Friday as the chatter continued. The White House’s statement of support for private ownership — “a privately held banking system regulated by the government is what this country should have,” Obama’s spokesman put it — helped a bit, but not enough.
The government taking over a bank presents plenty of problems. Among the challenges, Federal Reserve Chairman Ben Bernanke said this week, is “that you tend to lose the franchise value, that the counterparties and others don’t want to deal with you because they don’t know your future.”
But if it’s necessary, how should it be done? Sweden is often seen as a model of bank nationalization that worked following its boom in real estate and consumer debt. Of course, the concept is always easier when you only have a few banks to worry about, rather than the 8,400 in the U.S. to sort through. (The count is 25 if you just consider the giant banks to probe, as U.S. regulators are preparing to do now.)
“Most of the criticisms that can be leveled at the Swedish crisis resolution are easy to make in hindsight,” write researchers O. Emre Ergungor and Kent Cherny. “Facing the prospect of imminent systemic collapse, incentive-skewing actions like blanket guarantees and liquidity provision can seem like surefire ways to restore confidence and avoid meltdown.”
(Blanket guarantees? Extensive liquidity provision? “Oops,” the American people might say after the U.S. government’s moves on that front last fall.)
The Cleveland Fed staffers, in a commentary this month, walk through the Swedish experience of the early 1990s and cite four key principles necessary in resolving troubled financial institutions:
1. Transparency. Fully disclosing banks’ losses “clears the uncertainty surrounding the institutions and makes it possible for the viable institutions to raise new funds.”
For the U.S., of course, the extent of banks’ losses is the big mystery. The government at least appears headed down that road, for its own analysis, by starting stress-testing of major banks to assess how they would fare in a weakening economy.
2. Political and financial independence. “If a government agency holds the purse strings, it can dictate policy and can also impede the process if emergency funding is needed,” they write.
Here, escaping political involvement entirely is a lost cause at this point. The Federal Reserve — an independent agency — oversees the major banks and is intimately involved, but the Obama administration is running the show
3. Maintenance of market discipline Investors must pay the price for missing signs of trouble, they say. “As past historical examples demonstrate, the stability of financial markets after crises largely depends on the incentive framework that is left in place.”
This is where the “blanket guarantees of uninsured depositors” comes into play to skew market discipline. It’s a form of the moral hazard argument — one that’s very much being discussed amid the U.S. response, though moral hazard of course has taken a back seat at times.
4. Restoration of credit flows Getting credit moving through the economy again, they acknowledge, is “a difficult task, given that the economic fallout from a crisis (such as rising unemployment) actually erodes credit quality further.”
With all the talk in Washington about getting banks to lend, that problem surely will stay front and center. But it’s likely to take years to work out.
One in five Americans say they’ve had trouble paying their rent or mortgage in the past year. That’s up from 14% a year earlier. That’s according to data from Pew Research Center, which offers insight into why stimulus and home affordability and stabilization program benefits have a below-$75,000 household income level cutoff point.
Click graphic to access Pew Research analysis.
While financial concerns have been rising among the relatively well-off, difficulty in making housing payments — as well as medical care payments, credit card concerns and pay cuts — is still concentrated among lower-income Americans. A third of Americans earning below $30,000 cite troubles making housing payments in the last year, compared with 21% of Americans earning between $30,000 and $75,000 and just 6% of Americans earning above $75,000. Still, only 8% of Americans say housing is the most important problem facing the economy. Jobs (42%) far surpass all other concerns regarding the economic crisis.
We’ve spent the better part of two decades polarizing population segments–redistributing wealth, if you will, from less-well-off and less-well-educated to a smaller, richer group with higher educational attainment.
What about this? Economically, is it smarter for the wealthy to hunker down and say to hell with the people who worked for lower wages and consumed items that turned into strong earnings for those with diversified stock portfolios and savvy real estate investments?
The administration has its work cut out for it to get people to see that cutting off their nose to spite their face is usually not an advisable strategy.
For those of us who are not economists, the intensity of the fiscal, monetary, financial, and economic subject matter makes it more and more difficult to get our minds around the ramifications for social responsibility and individual accountability.
If, like us, the math gets daunting there is recourse. Have a look. It’s four minutes that will make you feel smarter and bolder in the debates you engage in during parties you might attend this weekend.
Advertising everywhere is down. In many places, it’s out. Traditional print and broadcast media, whose lifeblood is generally advertisers, are taking it on the chin, not only because of inhospitable economic conditions, but also because of earth-shattering, structural secular change, i.e. people don’t consume media as they used to so traditional media is not as valuable as it used to be.
Now, there’s a third strike that media brands with cajones self-inflict. Their editorial goes after their advertisers with reportorial impunity, which doesn’t exactly earn the publication brownie points as the diminishing ad budgets get reallocated.
We actually thought the lobbying world had cleaned itself up a bit a few years ago.
Equally eye-opening is the amount that financial firms lobbies funnel to the campaigns of targeted elected officials.
Still, this brings us to our next question. We wonder whether the intrepid Business Week reportorial staff will be turned loose to sleuthe out a story of similar import: the debt ratings agencies’ [including McGraw-Hill Companies' Standard & Poor's unit] role in the financial crisis.
Imagine the charts porn they could do to accompany that piece!
Tally-ho. The Senate passes an $838 billion stimulus billthat now needs to get reconciled in conference with an $820 billion bill the House passed two weeks ago. Today Treasury Secretary Tim Geithner proposes a shock-and-awe program of spendinginto the trillions of dollars until lenders, investors, and mattress stuffers feel they can belly up with money pour into the ailing economic pipeline.
Housing industry players were angling for inclusion in these packages, but it seems they’ll get their day in the sun once TARP II and Stimulus 2.0 are water under the bridge.
Mr. Obama declined to detail the administration’s specific plans for the housing crisis, saying he didn’t want that strategy to get “buried” on the day U.S. Treasury Secretary Timothy Geithner announced his broad financial-market rescue. He said he would make an announcement on housing “in the next couple weeks.”
“Unless we address this in a serious way, we are not going to be able to get the economy back where it needs to be,” Mr. Obama said.
As debate continues about the best way to get home buyers off the sidelines even as layoffs pile up and consumer confidence plummets, a Harvard economics professor compares and contrasts a $15,000 tax credit vs. a 4% mortgage buy-down.
One of the great problems with any interest rate subsidy program is that costs accrue only over time, and initially reside off-balance-sheet. Remember the old fiction that Fannie Mae and Freddie Mac were providing a service to homebuyers at no cost to the government? Some proponents of interest-rate subsidies even suggest that as long as the subsidized lending rate is higher than the current Treasury rate, the government is actually making money off the deal. Such logic conveniently forgets default risks and other costs. Financing trillions of dollars of mortgages would require the government to borrow trillions, pushing interest rates up and raising the cost of the national debt. Borrowing to bet is generally not a good financial strategy for governments.
Standard economic reasoning tells us that if the market has priced 30-year mortgages appropriately, so that their rates reflects default risks and other costs, then the gap between the market rate and the subsidized rate reflects the cost of an interest rate subsidy program.
Current mortgage rates are about 5.35 percent, which is 135 basis points above one proposed subsidized rate. Americans today have about $10 trillion worth of mortgages. If everyone refinanced into the subsidized rate, this would mean an ongoing annual subsidy of $135 billion a year, which would last as long as the mortgages do. The great virtue of the tax credit over the interest rate subsidy is that a one-time cost of $35 billion or $50 billion is a lot less than a perpetual $135 billion annual subsidy stream.
One way or another, get the U.S. Mint printing presses in good working order.
Calculated Risk this morning steers us to smart, straightforward logic about the impact of a $15,000 tax credit for home buyers, which is part of the Senate’s stimulus plan but not part of the House’s.
The tip is to check out Econbrowser, where an analyst, Kash Mansori, maps a sales vs. prices vs. inventory level scenario that illustrates 1). part but not all of the excess inventory would turn thanks to the program; 2). part (but not all) of an expected deflation in home prices would be cushioned; and 3). sales would occur.
Here’s some of Mansori’s analysis–pristine in clarity and uncluttered rationale:
Now enter the tax credit. What will that do to the situation? Essentially, it gives each potential homebuyer an extra $15,000 to spend on houses. That doesn’t mean that they will necessarily buy a house that’s $15,000 more expensive than they would have without the tax credit… but it does mean that they would be willing to pay almost $15,000 more for a house that they were already willing to buy. We can depict this as a vertical bump up in the demand for houses of $15,000.
The beauty of Mansori’s piece is in his pictures, which plot his argument precisely along X and Y axis points with relatively few factors and variables to get one’s mind to manage.
The flaw of the piece, however, is in its opening assumption, which is that the intent of the program would be “to boost home prices.”
[Another possible flaw could be a miscalculation of the number of buyers who'll remain in the market even as unemployment rates soar toward double-digits and consumer confidence burrows to historic lows in the next leg of the economic crisis].
Sticking with the first flaw. Mansori’s assertion is that designers of the program want to prop up house prices. We don’t believe that’s actually the case. We believe both designers and beneficiaries of the program say the goal would be to start to stop home price deflation and stabilize house prices rather than to cause them to go up.
Here’s how one home builing executive articulates his hopes from the credit:
We all watch with interest what is happening in Washington.
This $15k is definitely something that appears it will help.
We simply need:
1. Stabilization in Home Values. Consumers need confidence in the value of their home to stop declining.
2. We need reduction of available inventory.
3. We need confidence in the job market. Consumers need to know they are not going to loose their job.
4. We need favorable Interest Rates. (We surely have this).
I see that we have 1 of the 4 today and need to gain ground on achieving the other 3. This $15k tax credit appears to me to be one of the ways to start achieving the other 3.
We think CR’s six-word kicker–”That is $35 billion for nothing.”–is less conviction and more provocation.
If you build it, you might be done; and if you don’t build it, you’re probably screwed anyway. Life on the flip-side of truisms is ugly business, especially when it’s costly. You recognize the truism in its adulterated inverse. Welcome to home building circa 2009, where no, housing has not turned a cornerwith an inflection point yet, but companies in housing may need to behave as if it already has in order to survive.
Per the December Census Bureau release last week, new homes are selling at an annualized rate of less than a thousand a day. Per what we’ve heard from home builders in the trenches, about half the homes selling these days are spec, and half are pre-orders.
Much if not all of that lore about buyers demanding the opportunity to customize their dream simply goes by the wayside. All of that theory about buyers insisting on bigger square footage, and more amenitized finishes also goes by the wayside. Their ranks diminished by 60% from their peak, half of the 331,000 hearty souls still in the market want their new home done and dusted now, and they want it more at the right price and terms than they want it to appeal to their sense of status in society.
Click for Wall Street Journal story link.
Status in society–for an individual, company, city, nation, etc.–is all about having a better balance sheet than the next guy, or organization, or municipality, or state, or government. In granular terms, you can see at least part of that in the picture here. Consumer spends less, and saves more. That’s good and it’s bad. It’s necessary because consumers overspent for too long, and didn’t save for too long. Homes as ATMs, home price appreciation, riskless debt, and all that.
It’s also horrible timing because all that sudden fiscal prudence has thrown the economy into cold turkey withdrawal. Saving on expenses happens when revenue can’t grow, and revenue can’t grow because everyone decided at the same time to save. Jobs go away, people are afraid more jobs [and their own] will go away, and they spend even less, so companies need to lay off more and preserve more cash.
“You could be talking about homes, about cars, about electronic appliances, about clothing, about nearly anything right now, and you’d have the same story,” said the CEO of one of the nation’s leading residential real estate companies just before the weekend. “When people don’t know if they’re going to have their job, they don’t spend. They save. It’s completely understandable.”
Briefly, an entire globe cash-preserving its way to a better balance sheet is what has set itself in motion, with varying time-released waves of consequence. All told, will the overreaction to fear wind up equal to the prior overreaction to greed? Do you guess that an overcorrection of 5% to 10% on the savings vs. spending continuum will occur?
For all the focus on multipliers, when will the turn in a dollar spend vs. a dollar saved at the household level turn into jobs, consumer confidence, spending, earnings, capital spending expansion, and revenue growth? It’s anyone’s guess.
Improved balance sheets, it turns out, will happen when a certain amount of the bubble profitability of land prices gets marked down to reality. In today’s business environment, we understand, this is not an easy thing to do, whether the asset is commercial paper or land.
Still, unless long-term household demographic growth estimates are off, it’s widely believed that the U.S. will add 1.3 million new homes a year. If you assume that even 65% of those new households are homeowners, there’s a demand base for more than 800,000 added home purchases each year.
Home builders need to keep working through their inventory, not only of already-started homes and completed homes, but finished lots to shrink, and possibly overly tighten supply.
They have to keep starts going for two reasons.
One is existential: If they don’t build, then they may not exist as company at all. The other reason is that if they don’t keep building, half of the scant total of customers out there will go to someone else for their ready-to-purchase home. Whether it’s half a million or 331,000 or even less, the one out of two of the ones who can get their loan and put their money down for a deal want their keys now.
If you want low-down on California dirt, Patrick Duffy is your guy. He’s a principal at MetroIntelligence Real Estate Advisors, a division of Beacon Economics. Better than that he can tell you who needs to sell prime lots right now, and why, right now.
He’s started contributing weekly for the Wall Street Journal’s “Developments” blog. Clearly, he’s starting off on an informed sources, provocative note. The kicker in his maiden contribution:
However, before jumping on any deals consumers should research the financial strength of potential home builders to ensure there’s someone around to address warranty issues. It’s about balancing some of the best deals on new homes we’ll see for a while — in which many builders are basically selling at or below cost — against your own comfort level that a builder may go out of business sometime after the sale closes.
At Housingcrisis, we feel that trust and confidence are at the core of the meltdown, and will be at the core of the recovery. Thing is, we can’t predict what will cause trust and confidence to swing back toward positive after the extreme yaw toward paralysis and dread.
Clearly, though, it’s an advantage to have knowledgeable veterans on the ground who’ll be the first ones to sense a sustainable turn in market trends. That’s Duffy, who also blogs at www.housingchronicles.com.
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