unlikely that the fall in mortgage interest rates during the early 2000s accounted for more than 20 percent of the increase in housing prices

From The Atlantic Business:

Richard A. Posner

A Failure of Capitalism

May 19 2009, 9:59PM

A Failure of Capitalism (IV): More on Bubbles

The housing bubble is so central to our current economic troubles, and such a mysterious phenomenon from an economic standpoint, that I want to elaborate on my brief remarks in the previous entry.

A few figures: At the beginning of 2000, the federal funds or overnight rate--the short-term interest rate that the Federal Reserve focuses on influencing through its purchase and sale of Treasury bonds--was 5.45 percent. Though short term, this rate influences long-term rates, because it is the rate at which banks borrow from each other, and the more (less) they borrow ,the more (less) they are able to lend to their customers; and the more (less) they lend, the lower (higher) their interest rates are. Also at the beginning of January 2000, the average interest rate for the standard 30-year fixed-monthly-payment mortgage was 8.21 percent.

By December 2003, when the overnight rate had fallen below 1 percent, the mortgage rate had fallen to 5.88 percent and housing prices had risen (since the beginning of 2000) by 42 percent. The overnight rate than gradually rose, to 5.26 percent in July 2007, by which time the mortgage interest rate had risen to 6.7 percent, yet housing prices had continued to increase and were more than 80 percent above their 2000 level. After that both interest rates, and housing prices, began to decline.

If low interest rates drive up housing prices, high interest rates should (and eventually do), drive them down. Yet we have just seen that housing prices continued rising after interest rates started to rise. Moreover, a leading housing economist, Edward Glaeser, has pointed out to me that, on the basis of studies of the responsiveness of housing prices to interest rates in other periods, it is unlikely that the fall in mortgage interest rates during the early 2000s accounted for more than 20 percent of the increase in housing prices.

What I think we are seeing in the numbers is the classic bubble phenomenon, a phenomenon that has been observed in a variety of markets in a variety of countries for centuries. The low interest rates of the early 2000s pushed up housing prices both directly and indirectly. Directly by reducing the cost of housing debt--and housing as I mentioned in my last entry is bought mainly with debt. Indirectly by pushing up the value of common stocks. The low interest rates, as I said, caused asset-price inflation. Common stock is an asset, and was affected by the inflation. As the market value of people's savings, increasingly concentrated in common stock (whether in brokerage accounts, retirement accounts, college savings plans, or health savings plans), rose, people felt (and were, for the time being anyway) wealthier, and this increased their demand for houses--for owning rather than renting, or for owning a bigger or fancier house than their present house. And banks, including mortgage banks, being able to borrow capital at low rates, for lending, were eager to encourage borrowing by relaxing their credit standards. So people who could not have qualified for a mortgage at any interest rate earlier were now able to borrow at affordable rates.

Once house prices started rising, moreover--and here is the bubble phenomenon at its purest--the increase acquired momentum. An increase in the price of an asset, after that increase has continued for a significant time, creates a belief that the asset is a good value. One sees other people bidding up the price of houses and assumes they know something that perhaps one does not. And when officials and economists, and not just brokers and bankers, say that housing prices are rising because of "fundamental" changes in demand and supply that are likely to continue, the belief that a house is a good value, even though it costs a good deal more than it would have cost just a year or two ago, is fortified. There is nothing irrational about such a belief, or about action on it, though there is always a risk that the apparent increase in value will turn out to be a bubble phenomenon.

That seems to be what happened, and the basic fault lies with the Federal Reserve in having pushed interest rates too far down, and kept them too far down for too long, during the early 2000s, and with the dismantling of regulatory controls that had formerly reduced the incentive and ability of banks to lend into a bubble."

Me:

Don the libertarian Democrat May 20, 2009 12:38 PM

I know that I must be wrong, but here's what I saw in the Central Valley of CA: As housing prices climbed, the wealth of the people buying the houses declined. In other words, the people in the worst economic shape were buying at the top of the market. Call me crazy, but that didn't, and still doesn't, sound right.

Now, when interest rates are first lowered, and people who have the means decide that this is a good time to buy, I can understand that. That's when people of limited means should be buying, if they have the savings and income. It should not take too great a rise for these marginal buyers to decide to wait and keep saving. That's my story.

I can, of course, concoct an asinine story for people to keep buying in such a scenario, but it doesn't have to do solely with interest rates: namely, you convince marginal buyers that, if they don't buy a house now, then they will never be able to buy a house. It's a story, a theory, a prediction, but, as Jeeves would say, it's unsound.

The interest rate story works for a bit at the beginning, but then it cannot account for what happens next. As rates started to rise, I can imagine hearing "you had better buy quick". I just don't see the evidence that anything less than a massive and quick increase would have saved us this misery, as long as people were buying into a story that had to have a bad ending for them.

Previewing your Comment

Don the libertarian Democrat May 20, 2009 7:20 PM

I want to add one more point on bubbles before you do another ten posts. For lower income people and many middle income people as well, the narrative was that you'd better buy now or you'll be out of luck. But there was another narrative that contributed to the bubble, and that was that you'll be a pauper when you retire.

There has been an endless warning that social security is iffy for people of a certain age, and that pensions are dying out. Events like Enron employees having their savings blown up contributed to this. Consequently, buying a house was considered by many to be the main option for providing for old age. Why was this so? Because you have to spend money for housing. Renting came to be seen as money down the drain, and the rest of people's wages really didn't allow for grand savings.

So people decided that, instead of paying rent, they needed to buy a house. It's hard to describe the sense of panic that many people have over retirement. I bought my house in 1991 in the Bay Area for just that reason. I did not particularly like the idea of owning a house. I sold it early last year. For me, this plan actually worked.

One reason that I'm for a guaranteed income, as proposed by Charles Murray, is precisely because I believe that it would alleviate much of this terror of a pauper's old age, by habituating people to a stable social safety net. In other words, I'm claiming that the bubble wouldn't have occurred without this life or death feeling that people had about buying a house to provide for their retirement. Being a novelist and philosopher, I've now done my part.

Servicers, who have a fiduciary duty to bondholders, actually have an obligation not to engage in loan modifications that lose money.

TO BE NOTED:

---

May 12, 2009, 7:02 am

Should the Government Subsidize Mortgage Modifications?

By Edward L. Glaeser

Edward L. Glaeser is an economics professor at Harvard.

Should the government be bribing mortgage servicers to modify loans and reduce payments?

Under the current housing plan, the federal government pays for one-half of the cost when lenders reduce mortgage payments to 31 percent of borrower income from 38 percent. When this plan was revealed, I was relieved because it seemed so much more reasonable than some of the extreme solutions being peddled, but a new paper by three Federal Reserve economists and a co-author has led me to reconsider my views.

There are two popular rationales for government action to increase mortgage modifications. One argument for supporting loan modifications is that foreclosures are bad for society, perhaps because they tear neighborhoods apart, and that the government should do all it can to reduce foreclosures. A second argument is that the securitization of mortgages broke the loan renegotiation process, and the government needs to fix the problem. The new Federal Reserve paper doesn’t address the first rationale for intervention, but it does leave the second argument in intellectual tatters.

Economists have long believed that dispersed property rights can lead to a breakdown in efficient bargaining. A developer trying to assemble a land parcel owned by 100 separate owners faces immense bargaining difficulties, because one recalcitrant owner can hold up a deal that would be good for everyone.

In the mortgage context, securitization has widely dispersed the rights to a mortgage’s cash flow across hundreds of bondholders. Dispersed ownership made it possible to believe that a similar breakdown in efficient bargaining might occur. Many observers took the view that the banks holding the mortgage, known here as servicers, were not engaging in sensible mortgage modification because they feared investor lawsuits. If that view is true, then there are win-win situations where loan modification can avoid foreclosure and benefit bondholders.

The new Federal Reserve paper challenges this conventional wisdom and argues that servicers are not missing sensible opportunities to avoid foreclosure by reducing payments or principal.

The first piece of evidence supporting their claim is that in their sample, among comparable mortgages, modifications appear to be equally common among loans held “in portfolio” and loans that are securitized. When banks hold loans in portfolio then property rights reside squarely with the bank and there can be no contracting difficulties. If bondholder suits were really restricting the modification of securitized loans, then there should be fewer modifications of such loans, but the rate of modification is roughly the same.

Their second piece of evidence is that “most contracts allowing modifications essentially instructed the servicer to behave as if it were the owner of a single loan.” If this is so, then it would explain why modifications are equally likely for securitized loans and for loans held in portfolio. The paper discounts the threat of investor lawsuits and asserts that “no servicer has yet been sued for making too many loan modifications.”

Perhaps they are right, and the threat of lawsuits has been made up by servicers themselves, because a phantom threat gives servicers an easy excuse for not modifying loans.

But what about the huge losses that servicers take when a foreclosure occurs? Surely the costs of foreclosure mean that renegotiation can be a win-win situation.

The problem with that logic is that it is hard to determine who is actually going to walk away from a house, and it is equally hard to determine whether a modification will permanently avoid a foreclosure. The paper shows that cutting payments has only a modest effect on the likelihood of default, which suggests that even if modification avoids a foreclosure today, a troubled borrower is likely to default again in the future. Moreover, a generous modification policy ends up cutting payments for plenty of borrowers who would never have defaulted.

If this evidence is right, then loan modifications aren’t a win-win situation made impossible by securitization. Servicers, who have a fiduciary duty to bondholders, actually have an obligation not to engage in loan modifications that lose money.

Does this mean that the government program is wrong? Not necessarily, but it needs to be justified by the social costs of foreclosure. Moreover, if these economists’ evidence is right and reducing payments does little to reduce defaults, then the government program will do little to reduce foreclosures.

If each foreclosure carries social costs grave enough to warrant using taxpayer money to subsidize servicers, then the United States also needs to stop encouraging poorer Americans to borrow to buy homes. Instead, the appropriate government policy would be a tax on risky borrowing that would discourage risky borrowing. I’m not quite in that camp yet, but I do believe that too many people, including myself, accepted the view that a contracting failure prevented the modification of securitized loans."

It's a good idea to encourage "safe" households to deploy their financial resources now, in the midst of recession.

From Free Exchange:

"Everything must go

Posted by:

Economist.com | WASHINGTON

Categories:

Consumption

AS MY colleague notes, economists find themselves in the position of Saint Augustine when addressing American consumers, asking for increased savings, but not yet. Ed Glaeser takes up the same topic today at Economix, where he writes that consumption in recession (for those with the means) isn't only virtuous, it could also be a good deal.

Mr Glaeser advocates inconspicuous or generous consumption (so as not to make others feel envious), including home improvements or gift-giving. Given a general decline in prices and wealth, this suggests that now is a good time to make reputational investments. Could your neighbourhood use new landscaping? Why not pay for it while materials and labour are cheap? You stimulate the economy, and your neighbours will be impressed by your philanthropy. Give heavily to local food shelters while food prices are low. Build a new basketball court in your backyard on the cheap, then invite the neighbourhood kids over to play. And so on. I think Mr Glaeser has it right in suggesting that calls to spend be framed as calls to generosity.

The potential problem, of course, is the depth of the recession. Consumers may be encouraged to hold off still longer, based on the expectation that prices will continue to fall. Or even those with ample savings may closely guard their reserves, based on fears that their jobs may be threatened. It's a good idea to encourage "safe" households to deploy their financial resources now, in the midst of recession. It's also important to recognise that in a severe enough crisis, only government will have the ability to overcome the paradox of thrift."

Me:

Don the libertarian Democrat wrote:

"It's a good idea to encourage "safe" households to deploy their financial resources now, in the midst of recession."

Are you suggesting that we go door to door? What about a sales tax decrease to be phased out? Wouldn't that be more likely to work than simple admonition? After all, some of us aren't Jedi's.

I'd be more likely to be a Sith anyway.

2/17/2009 7:16 PM GST

Recommend

the shift won't be enough to save most struggling borrowers, but it will be a nice payday for plenty of non-struggling homeowners.

From Free Exchange:

"Bring back the bubble

Posted by:

Economist.com | WASHINGTON

Categories:

Housing markets

LEGISLATORS of both parties seem excited by their plan to cut a $15,000 cheque to anyone buying a house in 2009, but they're not ending their attempt to bring back the housing bubble there. At the Wall Street Journal today, economist Ed Glaeser rips into Senate minority leader Mitch McConnell's stimulus "plan" to give borrowers government-backed mortgages at a 4% interest rate.

Mr Glaeser's big complaint, which he has made elsewhere, is that based on historical data, the proposed rate reduction will generate only a 6.2% increase in home prices (relative to their level in the absence of reduced rates). Considering that home prices nationally have fallen 18% in the past year alone, and 40% in the hardest hit markets, that's unlikely to do much good. It will also hand over billions of dollars to the relatively well off, many of which aren't in trouble on their mortgages but simply aiming to refinance. In other words, the shift won't be enough to save most struggling borrowers, but it will be a nice payday for plenty of non-struggling homeowners.

Tyler Cowen has interesting thoughts on Congress' penchant for homeowner subsidies, as well:

I wish to shift the economy out of housing, not into it again. I also believe that the supply of homes is relatively elastic right now. The tax credit will subsidize the new buyers without propping up the price of homes. Demand will go up, supply will go up, price will stay more or less on the same trajectory, and banks won't be any healthier. The subsidy goes to new home buyers and why should we be helping them above all others? Aren't they relatively wealthy on average? (Not that there's anything wrong with that.) Aren't some of them the dreaded "flippers" and speculators for that matter? (Can we really enforce the primary residence requirement?) Do we really want to push people into being less diversified and less geographically mobile in the labor market?

It really is stunning—almost to the extent that it's funny—that in the midst of an economic calamity brought on by the collapse of an epic housing bubble, policymakers are desperately adding to the array of homeownership incentives that created the distorted market in the first place. How do you argue with this level of obliviousness?"

And me:

Don the libertarian Democrat wrote:

I know that no one seems to buy my explanation, but I see these plans to help people buy homes or avoid foreclosure as an attempt to assuage the problem of having it appear that the government only helps the financial industry. After eight years of shameless cronyism, this seems like a reasonable worry to me.

I don't agree with the solutions being proposed, but I do believe, after we've announced to the whole world that banks or insurance companies or investment banks can be too big or powerful to fail,and we're going to lose a massive amount of money proving this, confining our resources to this financial bailout by saying that banks are essential, but other businesses aren't, begs the question of what is meant by "essential". Many people hear "essential to fund-raising". I think that the perception that there are possible social dislocations and disruptions coming from how government handles this crisis is well justified.

2/5/2009 6:54 PM GST

Intelligent land-use and zoning regulations can do much more for the cause of affordable housing with sustainable growth

From Felix Salmon:

"How to Fix America's Housing

Ed Glaeser's massive, 3,000-word TNR review of the new book by Robert Ellickson is a thought-provoking must-read for anybody interested in the dynamics of the housing boom and bust, and the policies which should be followed now. I'm not going to try to summarize it, but I do want to annotate a few passages.

As mortgages began to default, the owners of mortgage-backed securities became de facto homeowners, acutely sensitive to the price of housing.

This is very true, and quite obvious when you think about it, but it's a fact which I don't think has sunk in for many people in the policymaking world. Essentially the MBS market has priced in a massive debt-to-equity conversion, even as plans to buy up bad loans tend to value them not as home equity but rather as fixed-income instruments.

The current foreclosure crisis is an extreme example of an Ellicksonian fight over household space. Delinquent homeowners want to inhabit and to control their homes. Lenders want to get them out and to limit the damage done to the property. During the foreclosure process, home occupants have no reason to invest in their homes. Indeed, spite sometimes pushes them to abuse the property. Ellickson's logic suggests that such periods ensure an abuse of the housing stock, which is one reason why homes often lose close to half of their value when they go through foreclosure.
One current policy response to the housing debacle is to create lengthy foreclosure moratoria. Ellickson's analysis suggests that this is just about the worst of all possible policy responses. By drawing out the foreclosure process, these moratoria increase the time during which homes are no-man's-land. During such periods, homes and neighborhoods depreciate. A better policy would move the home quickly, either back into the hands of the owner with a new, more realistic mortgage, or into the hands of a new owner that can afford the house.

I'm not sure I buy this: it seems to be predicated on the notion that foreclosure proceedings start pretty much automatically as soon as a borrower becomes delinquent, and that once those proceedings have started, the main interest of the lender is to get the borrowers out of the house as quickly as possible.

In reality, however, banks are -- or should be -- generally reluctant to initiate foreclosure proceedings. And it's certain that if there's a foreclosure moratorium in place, then no bank is going to try to foreclose. Since homeowners who aren't subject to foreclosure don't mistreat their homes in the way that evicted homeowners do, I don't see how a moratorium would create entire neighborhoods of neglected housing.

Certainly if there's a chance of putting the house back into the hands of the owner with a new, more realistic mortgage, then the bank should always explore that option before initiating foreclosure proceedings, rather than afterwards, as Glaeser implies happens. On the other hand, he's quite right about this:

Mortgages are being handled by servicers, not by conventional banks, many of whom have little expertise at wisely handling delinquent loans. The servicers are scared of being sued by the security owners that they represent. For this reason, they follow rules of thumb that lead to evictions that could have been avoided...
Like Humpty Dumpty, the mortgages are in too many pieces to be put back together again.

Remember this fact -- that existing loan servicers are simply not up to the task of maximizing mortgage values. It'll be important when we get to bankruptcy in a minute.

The best that can be done, I think, is to create an as-if situation that gets servicers to act like local banks... If the government sets a series of rules that give servicers safe harbor from lawsuits, then the whole process can be made more efficient. For example, the rules might specify a simple test that determines whether the current occupant can plausibly support the home. If thirty percent or less of the current owner's income can pay for reasonable mortgage payments, marked down to the level implied by current housing prices and interest rates, then the owner can afford the house. If the owner can afford the house under those terms, then the loan should be renegotiated, since that is pretty much all that the house could generate in the best of circumstances. If the owner cannot afford the house, even at today's lower prices and interest rates, then the owner should be quickly moved out.

This is a extremely hazardous. If these simple tests are set in stone, then anybody currently paying more on their house than they would if they bought it at "current housing prices and interest rates" would have an enormous incentive to default. Unless there's some way of penalizing opportunistic defaults, it's going to be extremely hard to make this work, even if homeowners with renegotiated loans do lose some of the equity upside in their house. Most of us, at this point, would much rather have a lower mortgage payment and half the upside above say $200,000 than a higher mortgage payment and all the upside above $250,000.

To reduce the human suffering of speedy evictions, the government could give people who lose their homes a lump sum payment, perhaps $5,000, a relatively modest sum that would help at least to offset the costs of moving and finding a rental unit. For current foreclosures this sum would be paid for by taxpayers; it would be small beans relative to most proposed housing programs. In the future, this payment could be funded with an appropriate tax, tied to the riskiness of new mortgages. If the payment was contingent on the house being left in good order, this would reduce the incentives to abuse the housing stock.

Glaeser here is trying to get the government to do something the private sector already does perfectly well. If you're being foreclosed upon, the bank will quite happily and quite regularly offer you a few thousand dollars to move out quickly, cleanly and quietly. I'm not sure why we need a new tax to get the government to take over that role.

Simple rules, rather than judicial discretion, have the best chance of improving the foreclosure process. Some have suggested that bankruptcy courts should be able to re-write, or cram down, mortgage terms for primary homes. Ellickson's warnings about legal fees and transaction costs should scare us away from that idea. If individual judges adjust every mortgage on an ad hoc basis, the system will become more costly, less predictable, and less fair.

The problem is that when you get into the nitty-gritty, Glaeser's ideas are not nearly as simple as they seem at first glance. Meanwhile, bankruptcy judges are already looking at debtors' ability to pay in full, rather than using easily-gamed rules of thumb. They're in a very good position to take over the role which servicers have proved themselves incapable of performing. Mortgages should be adjusted on an ad hoc basis: indeed, that's a much better way of ensuring that the system is fair than trying to throw all mortgages into the same legislative bucket and dealing with them all en masse.

Since the New Deal, the government has promoted housing and homeownership by means of subsidizing borrowing. The Home Mortgage Interest Deduction makes it cheaper for wealthy itemizers to borrow to buy more expensive homes. Fannie Mae and Freddie Mac provide mortgage insurance at subsidized rates. The Community Reinvestment Act pushed banks to lend to lower income homebuyers. Subsidizing borrowing is so attractive to politicians because its looks like a free lunch. Borrowing at Treasury rates and then lending at slightly higher rates seems to allow the government to do well by doing good. Of course, this free lunch is an illusion. The government can only offer below-market rates by taking on the risks of defaults. Taxpayers are currently paying for the costs created by Fannie and Freddie.

I've long been an opponent of tax-deductible mortgage interest, which is a much greater villain in this story than the Community Reinvestment Act. What's more, the illusion of the free lunch is not mainly a function of mortgage default rates; instead, it's much more obvious, in the form of foregone tax revenue, and the increased taxes and borrowing elsewhere which are needed to make up for it.

Why is unaffordable housing now a national desideratum? The most recent housing boom made some of America's most economically dynamic and beautiful places unaffordable to ordinary Americans. Higher housing prices made it difficult for young and middle-income families to get by in America's costly coastal regions. There is much to like about housing's return to reality, not least its increased affordability, and much to dislike about artificially trying to make homes expensive.

This is absolutely true. Unaffordably expensive cities lose their dynamism, and more affordable cities are generally more vibrant. We might need to prop up house prices to try to deal with the present financial crisis, but expensive homes are not a desirous end in and of themselves.

Roughly 87 percent of all single-family detached homes are owner-occupied. Roughly 87 percent of all homes in buildings with five or more units are rented...
The connection between homeownership and structure type implies that when the federal government gets into the business of supporting homeownership, it also gets into the business of supporting single-family detached homes--and this means supporting lower-density living... You do not need to be an enemy of the suburbs to wonder why the government is implicitly urging Americans to drive longer distances and flee denser living.

Again, this is spot-on; Ryan Avent has more.

Ellickson notes that many lenders require that home-buyers pay for one-fifth of their home with their own cash. That cushion is thought to be enough to ward off the dangers of default, but that is not the case when we are at the top of a housing bubble. On average, for every dollar that prices rise over five years, relative to local and national trends, they go down by thirty-two cents over the next five years. In markets that have more than doubled over a five-year interval, lenders should expect declines that will wipe out any 20 percent margin.

I can't make the math work here. Consider a house which was worth $100,000 in 2001 and $200,000 in 2006. According to this rule of thumb, it should decline by $32,000 over the next five years -- which is less than a $40,000 20% downpayment if it was bought at the the top of the market. But still, it's a moot point: very few homes were bought at the top of the market with a 20% downpayment.

Rather than credit subsidies to increase borrowing, it would make more sense to re-think land-use controls. There are certainly legitimate reasons to regulate building, but it seems to me that many jurisdictions have gone too far, putting their own parochial interests first. Perhaps housing policy would do better to create real affordability by eliminating the barriers to building, rather than just inducing lower-income Americans to leverage themselves and bet more on housing.

This is absolutely right. Intelligent land-use and zoning regulations can do much more for the cause of affordable housing with sustainable growth than any number of desperate plans to buy up toxic mortgage-based assets. I hope that the Obama economic team listens to Shaun Donovan as much as it does to Sheila Bair."

Me:

I agree with your post, especially here:

Saturday, October 4, 2008
A Map Of Our Current Crisis
A map of our current crisis:

A) The rise in home prices:

Randal O'Toole on Cato:

"The credit crisis has led to numerous calls for bigger government. Yet the truth is that big government not only let the crisis happen, it caused it.

This truth is obscured by most accounts of the crisis. “I have a four-step view of the financial crisis,” says Paul Krugman. “1. The bursting of the housing bubble.”

William Kristol agrees. His account of the crisis begins, “A huge speculative housing bubble has collapsed.” “The root of the problem lies in this housing correction,” said Secretary of the Treasury Henry Paulson."

So it all started with the bubble. But what caused the bubble? The answer is clear: excessive land-use regulation. Yet while many talk about re-regulating banks and other financial firms, hardly anyone is talking about deregulating land."

Read the O'Toole post here:

http://www.cato-at-liberty.org/2008/09/22/blame-urban-planning/

By DonthelibertarianDemocrat Posted: Feb 03 2009 09:58am ET

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"This is prefectly consonant with the idea I think liberals ought to favor: the growth-maximizing welfare state."

I took the name libertarian Democrat in order to adumbrate some ideas on what such a beast might sound like. I didn't consider the name particularly controversial or hard to understand. That's because I consider myself a Whig or Classic Liberal. However, I thought that these terms might be too arcane, and since there was already a discussion begun in 2006 about being a libertarian Democrat, I would take that discussion as a starting point. Also, I had decided to become a Democrat. I should have chosen Classic Liberal.

Here's Matt Yglesias:

"Small-Government Egalitarianism

Ed Glaeser has an interesting post on what he terms “the case for small-government egalitarianism” which goes off into a stimulus detour, but which is more interesting on more enduring issues. He observes that “Political divisions have not always pitted big-government egalitarians against small-government conservatives” but today things are different, and not necessarily for good reasons:

Current American political discourse labels people as either anti-government or pro-equality, but wanting to help the poor should not require the abandonment of sensible skepticism about expanding the size of the state. Many of my favorite causes, like fighting land use regulations that make it hard to build affordable housing, aid the poor by reducing the size of government. In the wake of Hurricane Katrina, I also argued that it would be far better to give generous checks to the poor hurt by the storm than to spend billions rebuilding the city, because those rebuilding efforts would inevitably help connected contractors more than ordinary people.

These are well-taken points. And I think it’s both true that people who think of themselves as progressives (the kind of people who think industry shouldn’t just be allowed to pollute willy-nilly, the kind of people who think it would be smart to have a universal health care system) should give more emphasis to these issues and also true that people who think of themselves as conservatives (the kind of people who think income tax rates are too high) should give more emphasis to these issues.

Still, the idea of “small-government egalitarianism” strikes me as a slightly confused concept. The argument seems to go something like this:

1. Egalitarians often favor government programs that boost equality and regulations to reduce harmful externalities.
2. Some government programs and regulations are actually just the rich and powerful further enriching themselves.
3. Underpants gnomes.
4. Egalitarians should really be libertarians!

There’s something fishy happening in step three. Contrast “small-government egalitarianism” with ordinary modern American liberalism. When a modern American liberal thinks a government regulation or public spending endeavor would accomplish an important public purpose, he’s for it. But not otherwise! Dean Baker, for example, is one of our foremost defenders of Social Security but also the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer which you both can and should read for free online.

Baker’s book is full of ideas that a “small-government egalitarian” ought to be able to embrace—it’s all about policy proposals to eliminate or reform government interventions in the economy undertaken on behalf of the rich and powerful. He doesn’t happen to tackle the pet issue I share with Glaeser—land use regulations—but it’s very much in that spirit. At the same time, Baker’s just a regular-old liberal. Nothing about his egalitarian dislike of bad government programs forces him into dislike for good government programs. Modern American liberalism isn’t a mirror-image of modern libertarianism and it doesn’t have an a priori commitment to government intervention in the economy on a particular scale. I think it’s completely fair to charge that people who call themselves liberals are sometimes mistaken about the desirability of particular programs or regulations, but that’s a different issue—lots of people are mistaken about all kinds of things.

All that said, with the Cold War over and the conservative movement tending to take most of its emotional succor from a blend of militarism and homophobia these days, I hope that modern liberals and libertarians can find ways to cooperate on some of these economic issues where our interests may overlap."

Now, I agree with Dean Baker a lot. I think of him as a Classic Liberal. Why? Because he distrusts the power of government. Period. On any issue where I disagree with Baker, it comes down to empirical differences and nuances. My problems with Social Security have to do with how it actually works. In my own plan, with a guaranteed income, I would argue that the poorest seniors would be much better off. Nevertheless, I understand why Baker doesn't want to change this arrangement. From the point of Political Economy and Politics, he might even be correct. But I don't think that he would find my proposals illiberal, though he might raise real pragmatic objections. What about libertarians? My proposal is a lot like Charles Murray's, and I think that it is in the spirit of Hayek( Who loved Burke, who defended compromise and was always a Whig. ) and Friedman. If they would disagree with my particulars that's fine, but they would certainly understand them as similar to theirs.

The differences among Classic Liberals are accounted for in my view on Pragmatic grounds. No one who calls themselves a liberal of any kind should love the power of government. Rather, they should view government as necessary, and demand that it be run efficiently and well. Are there people who call themselves liberals who don't believe this? Yes. So what?

Let's look at the Yglesias list again:

The argument seems to go something like this:

1. Egalitarians often favor government programs that boost ( THIS WORD, "BOOST", IS THE PROBLEM WITH HIS "ARGUMENT". HE SEEMS TO QUALIFY EQUALITY HERE, AS SOMETHING TO BE REDUCED, NOT MANDATED. ) equality and regulations to reduce harmful externalities.( Liberals are willing to sacrifice some economic efficiency in order to reduce inequality and ensure social harmony. )
   
2. Some government programs and regulations are actually just the rich and powerful further enriching themselves.( YES )
   
3. Underpants gnomes.
4. Egalitarians ( WHO MANDATE EQUALITY ) should really be libertarians!

4 should be: Egalitarians who are willing to limit the power of government, even in the pursuit of equality, should be classic liberals.

I'm not much for theory, but I think that I've expanded the argument enough to allow much more discussion and cooperation between liberals and libertarians.

Also, from Will Wilkinson:

"Glaeser’s Libertarian Progressivism

by Will Wilkinson on January 22, 2009

I have no idea how I missed Ed Glaeser’s blog post on “small-government egalitarianism,” which he also dubs “libertarian progressivism.” By “egalitarianism” I don’t think Glaeser intends a view strictly oriented toward the equalization of economic holdings so much as he intends something like “prioritarianism,” as some political philosophers would call it: the view that the welfare of the least advantaged should be given a certain priority in policymaking. If we’re putting the poor first, we’ll want to note that big government generally redounds especially to the benefit of the rich and connected. As Glaeser puts it:

Libertarian progressivism distrusts big increases in government spending because that spending is likely to favor the privileged. Was the Interstate Highway System such a boon for the urban poor? Has rebuilding New Orleans done much for the displaced and disadvantaged of that city? Small-government egalitarianism suggests that direct transfers of federal money to the less fortunate offer a surer path toward a fairer America.

This is prefectly consonant with the idea I think liberals ought to favor: the growth-maximizing welfare state. Arrange our basic economic institutions to maximize productivity, and then directly transfer resources to those who fall below what we (through due democratic consideration) judge the threshold of sufficiency. You don’t need a big government for that( I AGREE ). Glaeser is right that something like this is the missing position in contemporary American politics. But he points out it wasn’t always this way, And it doesn’t have to be now.

Current American political discourse labels people as either anti-government or pro-equality, but wanting to help the poor should not require the abandonment of sensible skepticism about expanding the size of the state. Many of my favorite causes, like fighting land use regulations that make it hard to build affordable housing, aid the poor by reducing the size of government. In the wake of Hurricane Katrina, I also argued that it would be far better to give generous checks to the poor hurt by the storm than to spend billions rebuilding the city, because those rebuilding efforts would inevitably help connected contractors more than ordinary people.

Glaeser goes on to express skepticism about the both the effectiveness as stimulus and the distributive effects of big infrastructure spending, and argues for a means-tested cut in the payroll tax — not far from what I argued on Marketplace last week.

I declare Glaeser a liberaltarian in good standing! Anyway, read the whole, stimulating post."

I've already posted on this.

Libertarian progressivism distrusts big increases in government spending because that spending is likely to favor the privileged

From Economix. Doesn't this sound like a libertarian Democrat?:

"The Case for Small-Government Egalitarianism

By Edward L. Glaeser

Edward L. Glaeser is an economist at Harvard.

The stimulus debate badly needs the voices of that now-rare breed: Andrew Jackson’s intellectual descendant, the small-government egalitarian.( THE LIBERTARIAN DEMOCRAT )

Today, Franklin Roosevelt’s heirs — big-government liberals eager to right the wrongs of the world by expanding the size of the government — argue against small-government conservatives. The supposedly more progressive side wants the stimulus package to take the form of government spending, while their opponents want bigger tax cuts for businesses and more prosperous Americans.

The missing movement, small-government egalitarianism, would favor tax cuts, but only if they were aimed at ordinary Americans.( I AGREE TO AN EXTENT. THEY WOULD BE MY LARGEST CUTS, BUT CUTS FOR INVESTMENT MAKE SENSE. )

Libertarian progressivism distrusts big increases in government spending because that spending is likely to favor the privileged( THAT'S OUR SYSTEM, YES. ). Was the Interstate highway system such a boon for the urban poor? Has rebuilding New Orleans done much for the displaced and disadvantaged of that city? Small-government egalitarianism suggests that direct transfers of federal money to the less fortunate offer a surer path toward a fairer America.( THAT'S WHY I FAVOR A GUARANTEED INCOME. )

Political divisions have not always pitted big-government egalitarians against small-government conservatives.

At the start of the 19th century, the fans of big government, like Alexander Hamilton and Henry Clay, saw public projects as a means of strengthening the nation rather than reducing inequities. Their policies, such as tariffs and canals, often enriched the prosperous more than the poor. Conversely, the post-Era of Good Feelings Democratic Party was built around Andrew Jackson’s small-government egalitarianism. Jackson’s fight against the prosperous Philadelphian Nicholas Biddle and the Second Bank of the United States epitomized his desire to reduce privilege by reducing the size of government.

In the 20th century, President Woodrow Wilson campaigned on a “New Freedom,” opposing Teddy Roosevelt’s big-government Progressivism. While Roosevelt wanted the government to manage monopolies, Wilson wanted trust-busting and less protectionism. Wilson perceptively noted the dangers of too much government: “If the government is to tell big business men how to run their business, then don’t you see that big business men have to get closer to the government even than they are now?”

Current American political discourse labels people as either anti-government or pro-equality, but wanting to help the poor should not require the abandonment of sensible skepticism about expanding the size of the state. Many of my favorite causes, like fighting land use regulations that make it hard to build affordable housing, aid the poor by reducing the size of government. In the wake of Hurricane Katrina, I also argued that it would be far better to give generous checks to the poor hurt by the storm than to spend billions rebuilding the city, because those rebuilding efforts would inevitably help connected contractors more than ordinary people.( I AGREE ON BOTH POINTS )

Today, the New Deal’s heirs are vociferously arguing that more( I SAY SOME, BUT LESS. ) of the stimulus package needs to be spent on public works rather than tax cuts. The big-government skeptics point out that the government can’t spend hundreds of billions of dollars on infrastructure projects both wisely and quickly. Good infrastructure spending doesn’t happen on a dime, and applying a “use-it-or-lose-it” rule to speed up spending will lead to a lot of waste. The country could certainly invest more, in both human and physical capital, but that spending should follow the rule that benefits must exceed costs( THIS IS ESSENTIAL. ). Good investments need plenty of time to plan and implement, which pretty much rules them out as good fiscal stimulus. Moreover, since many of these projects will disproportionately benefit the prosperous, many of them can be financed with user charges( FINE ).

Yet skepticism about vast public works does not necessarily lead towards Alf Landon-like antipathy towards stimulus, or towards tax cuts for big businesses and the wealthy. A quite plausible alternative, which is partially present in the president-elect’s proposal, is for the fiscal stimulus to primarily take the form of payroll tax cuts for poor and middle-income Americans. Those are, after all, the people who are most likely to spend the money quickly.

Targeted tax aid for poorer Americans would be far more egalitarian than most kinds of infrastructure spending, such as broadband technology. Sensible infrastructure projects wouldn’t disproportionately employ the least-skilled Americans. Forgoing the payroll tax for households earning less than $75,000 a year is surer progressivism than bridge-building.

Economics has little say about how egalitarian society should be. That is a question for moral philosophers and the democratic process( POLITICAL ECONOMY ). However, economics does tell us to choose efficient means of redistribution, and cash transfers almost always involve less waste than the alternatives( I AGREE ). Reducing the payroll tax not only avoids the problems inherent in trying to spend infrastructure money quickly, but it can also directly target aid to the poor, who need help more and will spend the cash more quickly. Now that’s the kind of small-government egalitarianism that would have appealed to Andrew Jackson."

I disagree on two points:
1) I favor a sales tax cut over a payroll tax cut, but I do like the payroll sales tax cut over any other proposed option.
2) I favor tax cuts for investment. The primary problem we are currently fighting is the fear and aversion to risk, which such targeted tax cuts might help.

Otherwise, I'm in general agreement. Too bad he's never heard of a libertarian Democrat.

""I don't know anybody involved who thought he could predict these turning points."

Via Marginal Revolution, Drake Bennett on the Boston Globe discusses the current state of Economics:

"THE DEEPENING ECONOMIC downturn has been hard on a lot of people, but it has been hard in a particular way for economists. For most of us, pain and apprehension have been mixed with a sense of grim amazement at the complexity( CONNECTEDNESS ) of what has unfolded: the dense, invisible lattice connecting house prices ( A BUBBLE ) to insurance companies( POOR DECISIONS ) to job losses( MANY PREEMPTIVE ) to car sales( LIKE HOUSES, FINANCED THROUGH CREDIT WHICH IS NOW HARD TO GET ), the inscrutability of the financial instruments( VASTLY OVERSTATES THE COMPLEXITY ) that helped to spread( HIDE ) the poison, the sense that the ratings agencies and regulatory bodies were overmatched( TRY CONFLICT OF INTEREST ) by events, the wild gyrations( AMIDST THE WILD GYRATION'S OF GOVERNMENT POLICIES ) of the stock market in the past few months( NO MENTION OF FRAUD AND GOVERNMENT GUARANTEES ). It's hard enough to understand what's happening, and it seems absurd to think we could have seen it( WE MIGHT HAVE TRIED PREPARING FOR IT ) coming beforehand. The vast majority of us, after all, are not experts ( THANK GOD ).

	Discuss
	COMMENTS (8)

(Getty Images, Globe Staff photo illustration)

But academic economists are. And with very few exceptions, they did not predict the crisis, either( WERE THEY SUPPOSED TO? ). Some warned of a housing bubble, but almost none foresaw the resulting cataclysm. An entire field of experts dedicated to studying the behavior of markets failed to anticipate what may prove to be the biggest economic collapse of our lifetime. And, now that we're in the middle of it, many frankly admit that they're not sure how to prevent things from getting worse( THAT'S SIMPLY THE TRUTH ).

As a result, there's a sense among some economists that, as they try to figure out how to fix the economy, they are also trying to fix their own profession. The discussion has played out in blog posts and opinion pieces, in congressional testimony and at conferences and in working papers. A field that has increasingly been defined, at least in the public eye, by quirky studies explaining the economics of our everyday lives - most famously in the best-selling book "Freakonomics" - has turned decisively, in the last couple months, to more traditional economic turf. And at economics powerhouses like Harvard, MIT, and the University of Chicago, faculty lunch discussions that once might have centered on theoretical questions and the finer points of Bayesian analysis are now given over to dissecting bailout plans. Long-held ideas - about the stability of the business cycle, the resilience of markets, and the power of monetary policy - are being challenged ( GOOD ).

"Everyone that I know in economics, and particularly in the worlds of academic finance and academic macroeconomics, is going back to the drawing board( AGAIN, TRY A NOTEBOOK )," says David Laibson, a Harvard economist. "There are very, very, very few economists who can be proud( THAT'S SILLY )."

A few are suggesting, as well, that there are deeper problems in the discipline. Economists are asking aloud whether the field has grown too specialized, too abstract - and too divorced, in some sense, from the way real-world economies actually function( TRUE, BUT THAT HAS MORE TO DO WITH NOT RECOGNIZING OR CARING ABOUT THE DIFFERENCE BETWEEN ECONOMICS AND POLITICAL ECONOMY ). They argue that many of the models used to explain and predict the dynamics of financial markets or national economies have been scrubbed clean, in the interest of theoretical elegance( THERE'S A POINT TO THIS AT THE KANTIAN LEVEL OF EXPLANATION ), of the inevitable erraticism of human behavior( THAT'S WHY WE NEED HUMAN AGENCY EXPLANATIONS, WHICH ARE EXISTENTIAL ). As a result, the analytical tools of the trade offer little help in a crisis, and have little to say about the sort of collapses that led to this one( IF THEY TURNED TO POLITICAL ECONOMY, THEIR HELP WOULD BE QUITE USEFUL ).

"You can't just say, 'I have a model for tremors that works great, I just can't explain earthquakes,'( YOU JUST DID ) " says Kenneth Rogoff, a Harvard economist who has studied financial crises.

Historically, periods of severe economic distress have shaken up economics, and helped drive its evolution. And in the midst of the current crash, there is an urgent search for approaches and models that might better illuminate how to speed the recovery and forecast future meltdowns, and that might help us better understand the unruly flow of money.( UNRULY, ERRATICISM, GYRATIONS,INSCRUTABIlITY,DENSE,LATTICED,TREMORS, SCRUBBED CLEAN, DISSECTING, CATACLYSM, DEEPER PROBLEMS,BUBBLE, COLLAPSE, PREVENT, EARTHQUAKES, ETC. AND THAT'S JUST SO FAR )

The question of how well economists can model crises takes on an even greater importance because of the central role economic experts will play in Barack Obama's administration - not only at the Federal Reserve, the Council of Economic Advisors, and the Treasury, but in the Economic Recovery Advisory Board, a newly formed body created by the president-elect and headed by former Federal Reserve chairman Paul Volcker. Obama has a reputation as someone who places a great deal of stock in expertise and the power of data ( THAT'S GOOD. JUST MAKE SURE TO DIVERSIFY YOUR PORTFOLIO. SAY, BY ADDING THIS BLOGGER AS COURT JESTER FOR FINANCES ). For better or worse, the evolving understanding of economic breakdowns will have ample opportunity to test itself against the real thing( ISN'T THAT WHAT IT'S SUPPOSED TO DO? EVEN WITH MATH YOU SHOULD TRY ).

Along with everything else they have done, the financial meltdown and attendant economic slump have spurred unprecedented political attention and participation on the part of economists ( THEY'RE BETTER THAN MANY OTHERS ).

"In my lifetime as an economist I've never seen economists so engaged by what's going on," says Richard Thaler of the University of Chicago. "At the University of Chicago people always talk economics at lunch, but for the last three months they've all been talking about the crisis and the bailout, and writing op-eds( HAVE YOU TRIED STUDYING AT ALL? )."

This is something of a change. The topics economists study often have little to do with the average person's economic life - as in most any academic field, practical relevance can have little to do with what questions are deemed most interesting and rewarding. This divergence was exacerbated, many economists say, during the span of almost uninterrupted economic growth that began in the late 1980s, a period when many of the more practical questions in economic policy-making came to be seen as having been settled( NOTHING IS WRITTEN ). For years, leading economic figures like Larry Summers and Alan Greenspan argued that the United States had more or less( THE QUALIFYING SOUNDS A NOTE OF SKEPTICISM FOR ALL WHO CARE TO HEAR. I'M RATHER LIKE ODYSSEUS IN THAT REGARD, AND ONLY THAT ) brought the business cycle to heel ( THEY'RE LIKE TRAINERS IN THIS MODEL ).

Partly as a result, many bright young economists turned to questions that were quirkier, or more purely mathematical. To the wider public, the most visible ramification of this was the boom in papers and books about the economics of everyday life - the best-known practitioner was Steven Levitt of the University of Chicago, but economists like Ray Fisman of Columbia, Edward Miguel of UC Berkeley, and Justin Wolfers of the University of Pennsylvania also worked at least partly in this vein. In often ingenious studies, they used economics as a forensic tool to examine family dynamics, speed-dating, parking scofflaws, basketball games, or the life choices of street criminals.

For those who stayed on more traditional economic turf, however, the trend was toward narrower questions, and more abstract ones. Financial economists set out to figure out why it is that stocks earn more than bonds, or to devise better ways of calculating "beta," the correlation between the price of a single asset and the price of the market it was part of. Others took on the surprisingly difficult question of defining what, exactly, money is.

Wolfers, being an economist, describes these intellectually challenging but less policy-relevant questions as a sort of scholarly "luxury good." "During good times we all consume more luxuries," he says, "but during a bad economy, it feels to macroeconomists that what we should be doing is stuff to help today."

Some economists have suggested that this focus may account for why so many failed to see the warning signs of the financial crisis, and to predict the size and scope of its fallout.

Others see a broader problem in that the sort of behavior we've seen in everyone from home buyers to investment bankers in recent months is hard to fit into economists' analytical tools. The models that macroeconomists - those who study national and regional economies in their entirety - rely on do a poor job of describing the messiness of an actual market in flux( THAT'S WHY WE NEED A HUMAN AGENCY EXPLANATION ). Many, for example, only have one variable for an interest rate, even though in times of economic turmoil the gap between various rates often widens so far that it's difficult to say what "the" interest rate actually is. As a result, economists end up oversimplifying such situations when they model them - or simply avoid studying them at all.( THAT'S POLITICAL ECONOMY )

"We have a very restrictive set of language and tools, and we tend to work on the problems that are easily addressed with those tools ( THIS IS TRUE OF ALL HUMAN ENDEAVOR )," says Jeremy Stein, a financial economist at Harvard. "Sometimes that means we focus on silly questions and ignore greater ones( SO DOES MODERN PHILOSOPHY )."

Today there is a move to hone and rethink the models that describe the huge interlocking wheels of the economy, and to find a way to include the human tendencies that can bring them grinding to a halt. Some economists are looking to the methods and findings of psychology, others are applying themselves to the tricky task of modeling bubbles, a relatively neglected topic. Whatever the approach, the study of financial crises is likely to be a predominant question for the newest generation of economists. ( POLITICAL ECONOMY AND HUMAN AGENCY EXPLANATIONS ARE ALL THAT IS NEEDED,AND ALL THAT WE CAN EXPECT )

"I guarantee that over the next couple of years you are going to see lots of papers on banking crises and financial blowups," says Andrew Lo, a financial economist at MIT's Sloan School of Management.

In addition, others predict, there's likely to be a sharp migration among young economists into these fields. "Banking has been an incredibly important field that has not been hot for some time," says Edward Glaeser, a Harvard University economist. "What's happened is that banking is sexy again ( BECAUSE OF A CRISIS. NOW THAT'S PARADOXICAL )."

Already, the crisis is reshaping long-running debates. It has chastened believers in the self-correcting abilities of the free market - Alan Greenspan said as much before Congress in October - and emboldened those who see the need for more active government intervention( TRUE ).

In a sense, it's a debate that has been seesawing back and forth from crisis to crisis over the past century. Classical economics was devastated by the Great Depression, and in the years afterward gave way to the ideas of the British economist John Maynard Keynes: that individually rational economic decisions could add up to collectively disastrous consequences, that the "stickiness" of prices and wages could lead to long-term unemployment and stagnation, and that the government, as a result, has to step in to kick-start the economy.

The stagflation of the 1970s, while mild compared with the Depression, swung the pendulum back. It was Milton Friedman, a sharp critic of Keynesianism and a fervent advocate of unfettered free markets, who solved the seeming paradox of simultaneous inflation and high unemployment by realizing the deadening power of people's expectation of future inflation, and it was Friedman's proposed solution - sharply restricting the money supply - that eventually, albeit painfully, solved the problem.

Today's crisis has brought Keynes back to the center of the discussion, but some economists also see it driving the field into new territory. Up until very recently, the study of market bubbles was marginalized - there was no widely accepted definition of what a bubble was, and some economists, believers in the complete rationality of markets, argued that bubbles didn't even exist( BRILLIANT ). Today, however, there is a growing sense that understanding bubbles is vital to understanding markets - among those making the case is Federal Reserve chairman Ben Bernanke, who, as head of the Princeton economics department, made a point of hiring young economists interested in the topic( GOOD FOR HIM ).

Over the same time period, the field of so-called behavioral economics has risen to prominence, led by, among others, Thaler, Laibson, and Robert Shiller, a Yale economist who warned of both the housing bubble and, in 2000, the dot-com bubble. By borrowing the insights and methods of psychology, behavioral economics focuses on all the ways in which humans fail to act as the rational, self-interested beings that economic models call for - we aren't good at thinking about the future, we're susceptible to peer pressure, we overestimate our abilities and underrate the odds of bad things happening. It's a set of traits that describes perfectly the behavior of many of the people who, in a cascade of self-defeating decisions, helped create the subprime crisis. ( A GOOD APPROACH )

"People used to think that these behavioral effects were small anomalies that turned up in experiments but washed out in the real world," says Tyler Cowen, an economist at George Mason University not himself affiliated with behavioral economics. "But there's a sense( TRYING LOOKING AND IT WILL BE MORE THAN THAT ) in which they get multiplied in the real world."

For now, behavioral economics remains a critique without a real alternative. That may be starting to change: Lo has developed what he calls the "adaptive markets hypothesis," a model that he argues reflects both the rationality of the investor in good times and the blind panic of the bad( MIGHT HELP ).

Nonetheless, for some economists, the lessons of the crisis are likely to be smaller, though no less humbling. These scholars argue that they're facing not a new challenge but a familiar nemesis.

"What we're experiencing now is a good old-fashioned financial panic," says Jeffrey Kling, an economist at the Brookings Institution. "This is perhaps the biggest scale, but on some level it's not that different( A SLIGHT SIMILARITY )."

Robert Lucas, an economist and Nobel laureate at the University of Chicago and a champion of the rationality of markets, doesn't see much fundamental change coming out of the crisis, either. What it has reminded us of, he argues, is simply the impossibility of seeing these events in advance ( TRUE ).

"I don't know anybody involved who thought he could predict these turning points. Do macroeconomists know as much as we thought we did?" he asks. "Of course not( NO ONE DOES )."

By this logic, the problem isn't how economists see the world so much as it is what we expect of economics ( NOT MUCH ).

Laurence Ball, an economist at Johns Hopkins, makes a similar point. "Nobody ever sees anything coming," he says. "Nobody saw stagflation coming, nobody saw the Great Depression coming, nobody saw Pearl Harbor or 9/11 coming. Really big, bad things tend to be surprises( OTHERWISE THEY WOULDN'T HAVE HAPPENED )."

A little chastening isn't bad, but, please, no hand wringing.

"With prices plummeting, foreclosures soaring and the mortgage market in disarray, the country should rethink a federal housing policy that has failed

Two interesting posts about government intervention in the Housing Market, which is an issue we might want to consider given that the government is currently considering a massive intervention. It would seem prudent to have some goals or principles available with which to assess these various plans for dealing with housing crisis.

First, Dean Baker in the Guardian:

"The Bush administration is packing its bags and heading out the door. As they leave, we should insist they take the garbage with them. Among the items in the garbage pile should be the "ownership society".

With the collapse of the housing bubble throwing the economy into the worst recession in 70 years and the stock market deflating to levels not seen for more than a decade, the ownership society's proponents have not been anxious to talk about this concept lately. However, that shouldn't stop the rest of us from bringing up the topic.

Just to be clear on definitions, what distinguished the proponents of the ownership society from other people is that they argued for ownership as an end in itself. In the case of social security, the ownership crew wanted workers to take the risk of market fluctuations and bad investment choices, rather than having the guaranteed retired income provided by social security.

Their argument implied that these risks were ends in themselves. The returns from individual accounts could easily be beaten by the collective investment of social security money, which would lead to lower administrative costs than individual accounts. Incidentally, the higher administrative costs associated with individual accounts would mean higher income to the financial industry."

I think that there is still an argument for owning a home as opposed to renting, even, or especially for, people with less money. Namely, their money is being spent on an asset which they can sell at some point in the future, not going to a landlord. So, ownership, as opposed to renting, is a better investment, and an end in itself.

"When it came to housing, the ownership crew wanted everyone to be a homeowner. It is easy to show that in normal times it will not make sense for many people to own. There are large transaction costs associated with buying and selling. (Incidentally, these transaction costs are income for the financial industry.)

Typically, the round-trip cost of buying and selling a home, which includes realtor fees, points on mortgages, the cost of appraisals, title checks and other items, will be close to 10% of the sale price.

This is a substantial addition to housing costs for a family who will only be in a house for a short period of time. For a family buying a $300,000 house that incurs 10% round-trip transaction costs, the addition to their housing expenses will be $7,500 a year (more than $600 a month) if they live in this home for four years.

Tens of millions of families will live in their homes for less than four years. Changing employment and family situations or health factors often force people to move. For younger, less stable families, homeownership is likely to be a bad financial bet."

Yes, but that's a different point. Obviously, at least to me, the buyer needs to be able to afford the house. That doesn't mean that owning a house isn't an end in itself and a better investment than lending.

By the way, it's fine to point out that there are vested interests lobbying for any policy, but, remember, there are generally two sides to that lobbying. One can imagine Landlords lobbying against ownership by producing frightening scenarios against owning a home, trying to frighten away even qualified buyers. I don't know that such lobbying exists, but, in and of itself, lobbying or vested interests don't disqualify a policy. It's a version of Poisoning The Well, quite frankly.

"Of course that's the case in normal times. Encouraging people to buy homes as the bubble was pushing house prices to ever more unsustainable levels in the years 2003-2007 was the height of foolishness. This social engineering by the ownership society crew helped to inflate the bubble to ever more dangerous levels. The new homebuyers in these years, at least in the bubble markets, saw any wealth they had managed to acquire destroyed in the collapse."

Here we disagree as well. While government incentives can influence behavior, they cannot mechanically cause people to ignore sensible investment practices and procedures, or commit fraud, say. I can agree that these incentives helped justify some of the impetus for people buying houses, but not for the practices by individual human beings that caused this bubble.

"While we should not expect any mea culpas from the ownership gang, we should demand an end to their influence on public policy. In the case of retirement policy, the focus must be on providing mechanisms through which people can put aside money for a secure retirement. We don't have time for those who want to give people ownership at the cost of a secure retirement.

In the case of housing policy, the goal must be to give people good secure housing options. In some cases, this will mean homeownership. However, for many families, at certain points in their life, renting will be the better option."

I want to to stick to housing. Frankly, the only reason that I can see for Baker bringing up Social Security is to Poison The Well again, in the sense that he feels people's views on Social Security will positively effect his argument about housing. The two issues are not identical.

However, what he says about owning a house or renting is, again, obviously true. For some people, renting is the better option.

"A serious housing policy must ensure that good rental options exist. It should also seek to provide renters with some of the housing security that homeowners now enjoy. For example, restrictions on the grounds for which tenants can be thrown out of their homes (which exist in many cities) would provide renters with much greater security."

No sooner does he criticize housing policies, then he advances policies for renting. Surely we've learned to be dubious about government's good intentions as compared to its actual effects. Wasn't that the point?

"The disaster hitting the economy and the country's homeowners should force the Obama administration to rethink national housing policy. If progressives had been responsible for promulgating the same sort of disaster as the ownership society crew, they would not be allowed near the halls of power for the next half-century.

We don't have to banish the ownership crew, just their ideology. We need a serious discussion on housing policy that focuses on the goals that we want to achieve. We can't afford have the luxury of a housing policy that is driven by an ideology of homeownership."

It's a good idea to critique and justify all government intervention in the housing market, but it still seems to me to better, on the whole, to own a house rather than rent, if you can afford to do so.

Now Edward L. Glaeser and Joseph Gyourko on Economix:

"America shouldn’t waste the current housing crisis. With prices plummeting, foreclosures soaring and the mortgage market in disarray, the country should rethink a federal housing policy that has failed."

That's a very good idea. I don't like the use of the word "waste", which seems to be straining to find a benefit to the crisis. On the whole, I'd rather use less unnerving pedagogical tools.

"The policies that got us here, like Freddie Mac, Fannie Mae and the home mortgage interest deduction, put too much faith in subsidized borrowing.

Encouraging everyone to make highly leveraged bets on housing was patently a mistake. Housing policies of the past also erred by aiming at amorphous, often contradictory objectives, including higher homeownership rates, more affordable housing units and, most recently, higher prices. Those policies then mistakenly applied the same policy medicine to every housing market, whether housing was abundant and inexpensive or scarce and unaffordable. "

The incentives might have contributed to the problem, but they didn't cause the problem. An incentive is just that, a reason for doing something. There are always other possibilities and reasons to be considered in any action.

"The problems of old-style housing policy are well illustrated by the unwise proposal being considered to provide subsidized loans to home buyers at 4.5 percent interest. The historical, quite modest relationship between interest rates and housing prices suggests that this proposal will increase housing prices by at most 5 percent. A 5 percent price rise will do little to stem foreclosures in markets where prices have already fallen by 30 percent."

Here I agree, and said that we should let housing prices fall another 5 %, which would be a better deal for the buyers if rates remained roughly where they are now.

"Subsidized lending looks cheap, but isn’t.

When the government lends, taxpayers end up paying for the defaults that follow. Those people who claim that the plan will be cost-free seem to forget that this spurious argument was made to justify Freddie Mac’s and Fannie Mae’s credit guarantees. The policy will also encourage more overbuilding in Las Vegas and more over-borrowing in Detroit, neither of which is a good policy objective. "

Subsidies are not cost free. Although, one can imagine the government running a mortgage business that makes money. Here's where the contradiction comes in, because, in order for it to do so in the taxpayer's best interests, the terms would have to be very stringent, and wouldn't be possible for borrowers on the margin. If you decide to loan to more risky borrowers, then you have to state up front that possible losses are acceptable and justifiable.

Subsidies can effect the market in which they are used, often with unanticipated results. They should be used carefully.

"In our new book, “Rethinking Federal Housing Policy,” published by the American Enterprise Institute (and available for free download here), we argue that federal housing policy should ensure that our poorest citizens are able to live in decent housing ( I AGREE ), and should address the high housing costs facing many middle-income Americans ( DON"T AGREE, BUT THIS COULD BE DUE TO A DISAGREEMENT ABOUT MIDDLE CLASS ).

These are two distinct problems that require two different solutions — neither of which involves subsidized lending."

"The first problem, the shortage of housing for the poor, is best solved by providing more housing vouchers, not expensive tax programs aimed at stimulating construction of affordable housing. Subsidizing developers to build new housing for the poor makes no more sense that paying auto companies to provide a special line of poor people’s cars. Our current system, where the poor generally buy used cars, is a much more efficient way of providing cheap transportation. Section 8 vouchers can enable the disadvantaged to live in existing homes, which is much cheaper than new building.

The Low Income Housing Tax Credit, the primary tool for subsidizing housing supply, makes the mistake of trying to apply the same rules everywhere. It subsidizes new housing in Manhattan, which needs more building, and in Buffalo and Houston, which already have plenty of cheap homes. A better approach would be to scrap the tax credit and make Section 8 vouchers more available and portable across cities."

That's fine, but a voucher is a subsidy, isn't it? It could effect prices. Anyway, yes, I prefer a voucher.

"Section 8 vouchers aren’t going to do anything to ease the high housing costs facing middle-income Americans, though. That problem requires policies that reduce the barriers to building.

The current housing price slump shouldn’t disguise the fact that homes in San Francisco and New York remain extremely expensive by historical standards. Prices are far above construction costs because robust housing demand, fueled by rising economic productivity, has collided against barriers to supply, like minimum lot sizes and height limits.

Borrowing subsidies, including the home mortgage interest deduction, do little good when housing supply is constrained. In markets with limited supply, credit subsidies push up housing prices, and make housing less, not more, affordable.

Moreover, the benefits of the deduction go disproportionately to richer Americans who itemize on their tax returns and own bigger homes. Rather than a new round of credit subsidies, it makes more sense to gradually reduce the upper limit on the home mortgage interest deduction and shrink the public role in encouraging people to bet big on housing.

The only path towards widespread affordability is to build more, which requires reducing NIMBYist regulations. Localities tend to put their own interests ahead of the nation’s interest by restricting building in order to keep prices up and reduce congestion. The federal government should increase its efforts to counter this tendency. After all, stopping building in one area just leads to building and more congestion somewhere else. In other settings, when groups try to increase prices by restricting supply, the government sends in the antitrust police.

In the housing context, this means prodding restrictive, high-cost areas to permit more building. New York and greater San Francisco are the two most productive areas in the country, but people have increasingly moved to lower-wage Sun Belt cities because those areas have low housing prices created by unfettered supply.

It is bad economics to let local barriers drive people to less productive areas, and it is also bad environmentalism. The environmentalists who prevent building in temperate California are actually increasing carbon emissions, by driving people to build in the far more energy-intensive suburbs of Houston and Phoenix.

Expensive localities are never going to give up their growth controls on their own, but the stimulus package provides a natural tool for promoting affordability. If some aid to expensive states is made conditional on permitting more construction, then pricey places will face incentives to permit more units and promote affordability. Those incentives will encourage restrictive cities and towns to look beyond their borders, and to make America more affordable by permitting more construction in the high-price housing markets that are undersupplied and unaffordable even to the middle class."

Here I agree. If people really want housing prices to stay down, then they need to change the regulations on housing construction and use. It's a trade off, but it's the one sure way to lower housing costs.

In essence, I agree that we should reconsider our housing policy now. Baker makes a good point about the vacuousness or negative consequences of boldly declaring an "Ownership Society", not tied to sensible economic practices. But Glaeser and Gyourko have better ideas about how to deal with our housing policy.

"The goal of federal policy should be to eliminate the distortions that make housing unaffordable"

Via Greg Mankiw, Edward Glaeser doesn't like the Fed's GSE infusion either:

"THE GREAT housing cycle of the aughts - the 73 percent increase in housing prices between 2001 and 2006 and the 22 percent decline since then - was built on three illusions. Too many homebuyers thought housing prices would go up forever. Too many investors thought they could lend without risk to subprime borrowers. Too many policy makers thought the magic of subsidized credit could permanently achieve a vote-winning trifecta of bigger homes, rising prices, and more homeownership."

The Illusions ( Which are more like incorrect assumptions or false beliefs. Illusions are things perceived that aren't there, or not as they appear. Maybe this is close to what he means: the state or condition of being deceived; misapprehension. ) are:
1) Housing prices will rise forever ( False )
2) Subprime loans are viable ( False )
3) Subsidies for home ownership are good ( I don't agree with this, but it's a policy decision, not a simple true or false statement )

"The cruel reality of the market has shattered the first two illusions, but somehow the misconception persists that more lending subsidies can take us back to the housing markets of 2006. Yesterday, the Wall Street Journal reported: "The Treasury Department is considering a plan to revitalize the US home market" that "would temporarily use the clout of mortgage giants Fannie Mae and Freddie Mac to encourage banks to lend at rates as low as 4.5 percent." The plan's core idea violates basic economics and the hard-won wisdom gained over the last two years."

Tell us how.

"America's housing woes are, in part, the legacy of government policies that pushed consumers to borrow and banks to lend. The home mortgage interest deduction encouraged people to make leveraged bets on housing, which looks silly today amidst the wreckage of over-hyped housing markets. Since the New Deal, the federal government has thought that it was a nifty idea to use its borrowing power to encourage home buying through government-sponsored agencies like Fannie Mae and Freddie Mac. The political beauty of such policies was that they subsidized borrowing and buying in a way that could be kept off the balance sheet. For years, policy makers maintained the fiction that Freddie and Fannie didn't cost taxpayers anything."

This is true. The government has encouraged home ownership.

"One of the clearest lessons of the past year is that these lending policies are anything but cheap. To get banks to lend at below-market rates, the government must insure mortgages against default. When those mortgages do default, as they have in droves over the past two years, taxpayers are on the hook. Ordinary taxpayers are currently facing the prospect of paying for the last rash of government-subsidized lending. No one should be thrilled at the idea of a new government guarantee program that makes us liable for billions, or trillions, of dollars of new, bad mortgages."

No one is thrilled. Is he claiming that this is the main cause of the crisis? If so, he agrees with me, although I believe that this part of the government guarantees was much more explicit than the bank bailouts.

"Moreover, any benefits from a new round of subsidized lending are likely to be small. Over the past 25 years, when interest rates fell by 1 percent, housing prices increased by 4.6 percent. If this historical relationship continues to hold, the proposed plan would increase prices by about 5.25 percent. This modest increase would be barely noticeable at the epicenters of the housing bust where prices have fallen by over 30 percent. In many of those areas, like Las Vegas and Phoenix, land is cheap and building is unrestricted, and no credit market intervention in the world will keep housing prices permanently above the costs of supplying homes."

This was my main point. It won't even do much good.

"In fact, the government shouldn't really be in the business of making housing more expensive at all. Price supports are usually a bad idea, because they distort supply decisions and redistribute from buyers to sellers. Why, exactly, should the government be encouraging more overbuilding in Las Vegas? Why, in an age of global warming, should the government subsidize more McMansions? Some economists argue that price supports are needed because prices are below fundamentals, but prices today remain significantly higher than either historical norms or supply costs."

Indeed. But do you also include zoning restrictions as a government policy that raises the price of houses?

"In our new book "Rethinking Federal Housing Policy," Joseph Gyourko and I argue that housing should be more affordable rather than more expensive. We argue that credit subsidies, which artificially inflate prices and encourage over-borrowing, should be gradually reduced rather than increased. We argue that the federal government should lean against the tendency of many communities to block the construction of affordable homes. We also believe that the government should reduce the costs of the foreclosure process and make it easier for mortgage servicers to renegotiate delinquent mortgages."

So, he does seem to include zoning restrictions, etc. He does seem to want to encourage home ownership, only by reducing the price of homes. That's fine with me. I'm also fine with aiding the renegotiating of delinquent mortgages, and believe that a set of agreed upon procedures included in the mortgage would be very useful should the problem of delinquency arise.

"The goal of federal policy should be to eliminate the distortions that make housing unaffordable, not to bribe people to borrow and build."

Sounds good.