Tuesday, January 25, 2011

A Solution for Fannie Mae and Freddie Mac?

The twin giants in the mortgage industry, Fannie Mae (Federal National Mortgage Association) and Freddie Mac (Federal Home Loan Mortgage Corporation) are back in the news.   While the Republicans are pushing to limit the government's role in the housing market, a long time Republican ally is urging caution.

The housing industry is clamoring to maintain some form of government guarantee for mortgages - to keep the housing market from weakening further.  See WSJ  1-25-2011, GOP Feels Heat on Loan Guarantees by Alan Zibel and Nick Timiroas (link to article - scroll all the way to the bottom).

A bit of history: Fannie Mae was founded in 1938 in the midst of the depression to prop up the housing market. Fannie Mae was set up as a government agency to buy mortgages from banks, repackage them as securities, and sell those securities with guarantees. In 1968, Fannie Mae was rechartered as a GSE (government sponsored enterprise) with stockholders as owners - but its securities were still guaranteed by the government. In 1970, Freddie Mac (another GSE) was created to provide competition for Fannie Mae.

On September 6, 2008, after years of encouraging risky mortgages (in response to pressure from Congress) Fannie Mae and Freddie Mac were in such bad shape they were taken over by the FHFA (Federal Housing Finance Agency). To help place this in the financial crisis time line, recall Lehman Brothers filed for Chapter 11 on September 15, 2008 (see very useful Financial Crisis Timeline St. Louis Fed).

The share price of common stock in Fannie Mac fell from a local high of $68.52 on 2-27-2006 to $5.10 on 9-5-2008 as the market priced in the possibility of a government takeover. Once trading resume after the takeover on 9-8-2008, the shares fell to $.98. On 1-24-2011, shares traded over the counter for $.493 .

In addition to the shareholders being essentially wiped out, the taxpayer is also on the hook. According to David Wessel (the Economics Editor of the WSJ) "The single most expensive cost to the tax payer in this crises will be Fannie Mae and Freddie Mac...estimated over 300 billion total" (see http://online.wsj.com/video-center?mod=WSJ_formfactor). Fannie Mae and Freddie Mac now guarantee about 2/3 of U.S. mortgages (see Alistair Barr video).  This means bankers still have limited incentives to make sure mortgages are only given to borrowers likely to repay.

Treasury Secretary Tim Geithner and others say that without some sort of government guarantee, the 30 year fixed rate mortgage would go the way of the dinosaur. In most countries, only variable interest rate mortgages are available - and often for shorter periods than 30 years. Without a government guarantee, mortgages would be harder to get and more expensive.  Construction jobs would stay scarce.

Two possible solutions:

1. a quasi public/private market solution (WSJ 8-13-2010, Alistair Barr from WSJ MarketWatch) (3 minutes)

2. a non-profit solution - Prof. Vogel states that the U.S. non-profit sector is bigger than GDP of Russia.
Prof. John Vogel of Tuck School of Business of  Dartmouth (1-19-2011) - (3 minutes)

If you want to get angry, here is a CBS clip (9-8-2008) about management problems at the GSE's right before they were taken over,

Monday, January 24, 2011

Inflation Targeting, Best Option for the Fed?

Joseph Stiglitz (Economics Nobel Laureate) July 2009 on risks of relying solely on inflation targeting (1 min long)

Inflation made above the fold, front pages news today on the Wall Street Journal. Many countries around the world (Brazil, India, China and the Euro zone) are now facing inflation above 2% - the ideal level according to economic consensus. Increases in the prices of food, oil, and other raw materials are the prime sources of the current epidemic of inflation. The U.S. is recovering more slowly from the recession, and is still facing inflation below 2%.

From an economic policy perspective, today's article in WSJ outlook is more interesting. It discusses how the chairman of the Fed, Ben Bernanke, has long been a fan of inflation targeting. Many countries have already adopted an explicit inflation target of 2%. The key advantage of inflation targeting is that it simplifies the message for central banks, and makes their actions more predictable. Stiglitz (in the very short video above) highlights the dangers of relying solely on inflation targeting and ignoring the financial sector. Clearly things can still go wrong even if inflation is low and stable. If  the price increases of financial assets (like stocks and housing) were incorporated into a broader measure of inflation, perhaps this criticism could be overcome.

WSJ (1-24-2011) New Push at Fed to Set an Official Inflation Goal

WSJ (1-24-2011) Global Price Fears Mount

Wednesday, January 19, 2011

Health Care Repeal - Lies, Damned Lies, and Statistics

The CBO (congressional budget office) reports that the Affordable Care Act (ACA, or Obamacare) will save money over the next ten years. Closer inspection reveals, that the choice of time period and other assumptions matters crucially. Many costs don't kick in until four years from now (see WSJ article below). Supporters of the ACA should be cautious about justifying the ACA on the basis of economic savings.

If the Democrats have erred in too literal an interpretation of the CBO numbers, then Republicans have erred in too literal an interpretation of poll numbers. Many of those opposed to ACA wanted it to be bolder - to cover more people or to be a single payer system; they certainly would not want to repeal the ACA and return to the previous system (see article by Eugene Robinson below). Excluding the health care reform enthusiasts, the percentage of people opposed to the ACA drops to 37.5%.

As imperfect as the ACA is, at least the world's richest country is finally addressing the health needs of most of its citizens. In my opinion (students can feel to disagree), repealing ACA without replacing it with something better is unethical.

This July 14, 2008 clip from 60 minutes helps put a human face on the uninsured. It describes a program, Remote Area Medical, that was originally set up to provide health care to remote areas in developing nations. It has been adapted to help the uninsured and underinsured in the U.S.. Doctors, dentists, and optometrists volunteer for a weekend to treat as many patients as they can. During the 60 minutes episode, 920 people were treated in Nashville, TN - but 400 had to be turned away. The people lining up for service, as early as 7 hours before the gates opened, were predominantly working poor in middle life.


Unfortunately, our country does not have unlimited recourses to devote to health care. ACA is just round one - revisions will be made. The ACA includes provisions that allow states to experiment with cost control measures. Perhaps one of those will work and will be expanded nation-wide. Perhaps a complete overhaul will someday be adopted including: medical savings accounts, catastrophic insurance, and tiered plans (with no tax deduction).

Matt Miller (see Washington Post link below)  challenges the Republicans to come up with a better plan:

 "If Republicans are serious, they have to accept that it's a national priority to make sure that every American has basic health coverage. Thirty million [newly covered people] isn't enough, of course, because the ranks of the uninsured still hover around 50 million. But since Democrats could only muster the will to cover 30 million, that's all we can expect the GOP to match as a measure of seriousness. (Though I'd be happy to see them shame Democrats with a plan to cover more).

The reason Obama should frame the debate this way is that there is no chance the Republican House will pass such a bill..."

Let us hope Matt Miller is being too partisan, and the two parties can work together over the next decade to craft a better, more efficient health care system for all citizens.

WSJ (1-19-2010) Health Care Repeal Won't Add to the Deficit

Washington Post (1-19-2011) Yes, repeal health-care reform -- on one condition
by Matt Miller

Washington Post (1-18-2011) Americans don't want health care repeal
by Eugene Robinson

Tuesday, January 18, 2011

State Finances and the Muni Market

60 Minutes (12-19-2010)
State Budgets: Day of Reckoning (14 minutes long)

With tax receipts falling and bills piling up, many states and local governments are facing a severe fiscal crunch. Meredith Whitney and others are sounding the alarm about bond defaults.  However, no state in the U.S.  has ever defaulted. Even on the rare occasions when local government have defaulted, 90% of the debt is typically recovered (see CNN article below).

The WSJ suggests that the panic may create good investment opportunities for the astute investor.  Investors must do their homework - and perhaps not rely too much on the rating agencies. The rating agencies did a terrible job measuring the risk of housing financial instruments before the financial crisis - and have yet to earn back investors' trust.

Even if defaults don't increase - big adjustments are ahead for state and local taxation and spending. Pension reform looks inevitable.

Muni Bonds Run Wild Money.CNN.com (1-14-2011) - includes short video clip

"Municipal Bonds: What Investors Should Do Now", WSJ (1-15-2011)

Thursday, January 13, 2011

African Lions and Asian Tigers

Two recent articles discuss the good economic news coming from sub-Saharan Africa. In the next five years, seven of the ten fastest growing economies are likely to be in sub-Saharan Africa (see Economist article below). Much of the growth in investment and trade in Africa is linked to a rising Asia. 

The Economist (1-6-2011) A more hopeful continent: The lion kings? Africa is now one of the world’s fastest-growing regions

WSJ (1-13-2010) A Continent of New Consumers Beckons

Monday, January 10, 2011

New alternative to GDP?

In "Elusive Economic Indicator: Quality of Life Gauge" (WSJ, 1-10-11, p. A2),  Mark Whitehouse presents recent research on an alternative measure to GDP. Recall GDP is the value of all goods and services produced within a country's borders. Since GDP does not seem to correlate well with measures of happiness, alternative measures have long been sought. 

Stanford Professors Peter Klenow and Charles Jones created a "Well-Being Index" that adjusts GDP for  three other factors: life expectancy, leisure, and income inequality.  These three factors have the advantage of being easily measured.  Many other relevant factors like environmental depletion and desirability of spending (ex. investment spending is more desirable than hurricane relief spending, but show up the same in GDP) are not so easy to measure and are not included. 

Just incorporating these three factors is enough to alter the international ranking of well-being/GDP. The U.S. still holds onto number one spot (according to chart in WSJ) but many European nations almost close their gap with the U.S.. Many emerging economies fall down the list. 

To understand why an alternative to GDP should be considered watch:

1. EUXTV 9-8-2009: An increase in GDP (dollar value of national output)  does not imply increase in well-being.
http://www.youtube.com/watch?v=Ep4DWx1--sY&feature=related (3 min)

2. ForaTV 1-22-2008: Winner of Nobel Prize in Economics ,  Joseph Stiglitz: "information affects behavior"
http://www.youtube.com/watch?v=QUaJMNtW6GA&feature=related  (8 min)

Stiglitz notes that if GDP is the yard stick of political success, then politicians will seek to maximize GDP, even if it is a poor measure of a country's well being. Stiglitz highlights important factors not included in GDP: income of median citizen, environmental depletion, health, leisure, spending on bads (disasters and prisons), offshoring (GDP does not reveal how much of income from production gets shipped back to foreign owners).

Wednesday, January 5, 2011

Economics Games

Back when I was in college, one of my favorite classes was based on a simulated futures trading game. There are now many such games on the web. Here are nine to consider (all are listed on the far right under Top Economics Games):

1. Fix the Budget (NYT 11-13-2010)
This game lets you pick from the menu of choices to see how you would fix the budget. If only all government leaders played this game and posted their results.


2.  Fed Chairman Game
This game from the Federal Reserve Bank of San Francisco lets you try your hand as Chairman of the Fed.  My first round, I was not reappointed as Chair.


3. Game for Macroeconomists
This game is posted on Gregory Mankiw's site. Here you get to control both fiscal and monetary policy. It is also called the President's game - except in reality the President does not get to control monetary policy directly. To the chagrin of most Presidents, they don't even get to control fiscal policy directly, but must work with Congress.


One of the biggest knowledge gaps in freshman macro is that fiscal policy refers to taxation and spending and is conducted by Congress and the President (at the national  level). Whereas monetary policy typically refers to targets for money supply, interest rate, and/or credit and is conducted by the Fed.

4. The Economy Stupid (The Prime Minister's Game)
This game lets you choose fiscal policy for Great Britain. The game includes the VAT (value added tax - essentially a national sales tax that is designed to ensure collection).


5. Virtonomics Virtual Business
This game offers cash awards. It takes a substantial time investment to learn to play the game, but all aspects of running an international business are included. Players compete with other players around the globe.


6. Wall Street Survivor Stock Market Game
This is a top simulated stock market game. Cash Awards are given to the most successful players. Clubs or classes now can also win awards.


7. Investopedia Stock Simulator
Another top simulated stock market game. Cash awards are not given, but the game is integrated with Investopedia's vast pool of information for investors.


8. How to Trade Foreign Exchange
How the Market Works is yet another simulated stock market game. It also offers this game to practice trading in the foreign exchange markets.


9. Mock Futures Trading
This game offers practice trading in the futures/commodities markets.


End World Poverty?

Mexico's Oportunidades and Brazil's Bolsa Familia are two anti-poverty programs that are making a big difference - and are being copied world wide. Both of these programs focus on incentives. In exchange for small monthly payments, families are required to make sure their children are immunized and go to school.

The tiny monthly payments help alleviate poverty today, but perhaps more importantly, the extra education helps alleviate poverty and fuel growth in the future. The small payments replace what the children would have earned if they had dropped out of school to help support the family. 

In Brazil, this program has dramatically reduced poverty and inequality. Despite the program's relatively low cost and surprisingly efficient administration, not all Brazilian's support the program.  Wealthier Brazilian's object to the use of government funds to redistribute income. The key element of this program that makes it more than just redistribution - is that it aligns the incentives of poor families with the long run growth of the country - which depends on an educated labor force.

Newscast video about Bolsa Familia

NY Times article about these programs