Author: James Kwak

Made-Up Definitions

By James Kwak

Many commentators who want to blame Fannie and Freddie for the financial crisis base their arguments on analysis done by Edward Pinto. (Peter Wallison bases some of his dissent from the FCIC report on Pinto; even Raghuram Rajan cites Pinto on this point.) According to Pinto’s numbers, about half of all mortgages in the U.S. were “subprime” or “high risk,” and about two-thirds of those were owned by Fannie or Freddie. Last year I pointed out that Pinto’s definition of “subprime” was one he made up himself and that most of the “subprime” loans held by Fannie/Freddie were really prime loans to borrowers with low FICO scores. Unfortunately, I made that point in an update to a post on the somewhat obscure 13 Bankers blog that was mainly explaining what went wrong with a footnote in that book.

Fortunately, there’s a much more comprehensive treatment of the issue by David Min. One issue I was agnostic about was whether prime loans to people with low (<660) FICO scores should have been called “subprime,” following Pinto, or not, following the common definition. Min shows (p. 8) that prime loans to <660 borrowers had a delinquency rate of 10 percent, compared to 7 percent for conforming loans and 28 percent for subprime loans, implying that calling them the moral equivalent of subprime is a bit of a stretch. Min also shows that most of the Fannie/Freddie loans that Pinto classifies as subprime or high-risk didn’t meet the Fannie/Freddie affordable housing goals anyway — so to the extent that Fannie/Freddie were investing in riskier mortgages, it was because of the profit motive, not because of the affordable housing mandate imposed by the government.

Min also analyzes Pinto’s claim that the Community Reinvestment Act led to 2.2 million risky mortgages and points out that, as with “subprime” loans, this number includes loans made by institutions that were not subject to the CRA in the first place. Of course, the CRA claim is ridiculous on its face (compared to the Fannie/Freddie claim, which I would say is not ridiculous on its face) for a number of reasons, including the facts that only banks are subject to the CRA (not nonbank mortgages originators) and most risky loans were made in middle-income areas where the CRA is essentially irrelevant.

Mainly, though, I’m just glad that someone has dug into this in more detail than I did.

Lessons from the Oracle

By James Kwak

[I wrote this post a month ago but just realized I never clicked “Publish.” It’s about a book that was published more than two years ago, though, so it shouldn’t have gotten any more stale.]

I recently finished reading Snowball, Alice Schroeder’s 2008 biography of Warren Buffett. It wasn’t a bad read, although at over eight hundred pages it was on the long side and began to seem repetitive; the impression I got was that Buffett had the same kinds of relationships with his family and friends for a long time, and not much changed over the decades.

The big question about Buffett for people like me — people who invest in low-cost index funds, that is — is whether he is smart or lucky. After all, since Burton Malkiel’s Random Walk Down Wall Street, the main argument against stock-picking skill has been that in a coin-flipping tournament featuring thousands of players (and with survivorship bias), someone is bound to win time after time after time.

The answer, at least the one from the book, is that Buffett is smart. And that shouldn’t be too surprising. I recently read a pile of papers about active mutual fund management, mainly from the Journal of Finance, and I’d say that while there’s no consensus per se, the general trend has been that there are some mutual fund managers who can beat the indexes and can more than cover their costs.* There aren’t many of them, they are outnumbered by the ones who do worse than the indexes, and they are probably hard for you and me to find, but they exist. And I say this despite the fact I didn’t want it to be true.

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Comment Unthreading

By James Kwak

I’m sorry to those who liked it, but I decided to turn off threaded comments. There were just too many examples of people “responding” to the first comment with something that, while perhaps related to the original post, was not related to that comment, apparently to get their input up to the top of the comment list. I decided this was a simpler solution than trying to block those people.

Update: Many people use the “@” symbol to show that they are replying to a previous comment. So if you want to reply specifically to a comment by “agreenspan,” for example, put “@agreenspan:” at the beginning of your comment.

Not with a Bang

By James Kwak

In the Times, Neil Barofsky, Special Inspector General for TARP, performed the admirable feat of fitting a clear, comprehensive, sober critique of how TARP was implemented and what its long-term impact will be in fewer than 1,000 words. It’s a perspective I mainly agree with,* and it highlights the different priorities that the administration put on aid to large banks and aid to homeowners, even though both were goals of the bill.

Back in late 2008 and early 2009, there was a lot of talk about how a true solution for the problems of the banking system would require a solution for the problems of homeowners, since the banks’ losses were largely the result of mortgage defaults. One of the major technical achievements of the administration was showing that it was possible to stabilize the financial system and restore the banks to short-term profitability without doing much for homeowners. As Barofsky says, and as the Times reports in yet another article today, the administration’s programs to help homeowners obtain loan modifications had little impact on the behavior of the banks that service mortgages and foreclosures continue unabated. Real housing prices have fallen below the previous lows of 2009 and now look likely to overcorrect on the downside.**

Housing modifications are admittedly more difficult than bailing out banks. It’s administratively easier to write a few $25 billion checks and create unlimited low-interest credit lines for a few of the Federal Reserve’s existing customers than to intervene in millions of mortgages. But the financial crisis was a time of bold action on other fronts. Treasury and the Federal Reserve were willing to push the limits of the law, for example in J.P. Morgan’s takeover of Bear Stearns. (See the chapter in Steven Davidoff’s book Gods at War for the details.) Henry Paulson threatened to declare the nation’s largest banks insolvent if they didn’t agree to sell preferred stock to the government. By contrast, as law professor Katherine Porter says in the Times article, “The banks were so despised, and TARP was so front and center, you could have actually done something. In the midst of real boldness in bailing out the banks, we get this timid, soft, voluntary conditional program.”

The lesson we learned learned is that homeowners were only a priority insofar as their health mattered to the banks’ health. When those two things became unmoored, the administration was willing to declare victory.

* The main thing I don’t agree with is Barofsky’s implied criticism of the Bush administration for using TARP money to buy preferred stock from banks rather than buying mortgage-backed securities directly. While I have often criticized various aspects of the preferred stock purchases, I think it was a more direct way to stop the panic of September-October 2008, and at that point a program to purchase MBS would probably have been an even more blatant transfer to the banks.

** I’m all for prices falling from bubble levels, but the policy goal should have been preventing them from falling through the long-term trend.

Convenient Arguments

By James Kwak

Here’s my solution to our national debt. We have a one-time, 100 percent tax on all wealth (net worth) of all United States residents, with a $10 million per-person exemption. With household wealth at around $60 trillion, that should be plenty to pay off the accumulated debt and shore up Social Security and Medicare for the next century.* The government promises never to do it again. Since we only care about future behavior, a one-time wealth tax should have no impact on people’s incentives to work, and hence no distorting effect on the economy.

Don’t like that idea? How about this one. The Federal Reserve creates $20 trillion in money but, instead of crediting it to large banks’ accounts at the Fed, it credits it to Treasury’s account. Again, no more debt. Again, the Fed promises never to do it again.

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Incentives Don’t Work

By James Kwak

Driving home from school today, I listened to a Fresh Air interview from two months ago with Atul Gawande, by now perhaps the most famous doctor in the policy intelligentsia. The interview was based on a New Yorker article discussing how some doctors and even some health care payor organizations are trying to reduce health care costs for the most expensive people while improving outcomes. In Camden, New Jersey, one doctor found that one percent of people generate thirty percent of health care costs.

One refrain you heard incessantly during the health care reform debate was that we have high health care costs because of overconsumption and we have overconsumption because people don’t bear a high enough share of their marginal health care costs, so the solution is to increase copays and deductibles. This is what Economics 101 would tell you: people respond to incentives. But Gawande discussed one large company that tried this year after year, but only saw their costs going up. The problem was that while most members responded to the higher copays and kept their costs more or less steady, the 5 percent of members who generated 60 percent of the costs behaved differently. Or, rather, they also reduced consumption (of doctor’s visits and prescription medications), but as a result they often had catastrophic outcomes. These were people with heart disease on cholesterol-lowering medications, and when they went off their medications they ended up in the hospital with heart attacks and then with congestive heart failure.

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Two Cakes

By James Kwak

Eric Dash of DealBook reports on the latest stress tests conducted by the Federal Reserve, which apparently went swimmingly, at least for some of the healthier banks. I have no independent basis on which to assess the accuracy of those test results, so I won’t.

What I did notice is that JPMorgan Chase and Wells Fargo are using the green light from the Fed to start buying back stock: $15 billion for JPMorgan, 200 million shares (about $6 billion) for Wells. Does something seem wrong with this picture to you? Me, too.

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Important Matters

By James Kwak

I know you can’t wait to hear my thoughts on the NCAA basketball tournament, but I’ve put them on my personal blog. I used to have a personal blog, and one my friends said he preferred it to The Baseline Scenario, so I started a new one recently for things that don’t have to do with economics, politics, business, the law, or the like. I post to it occasionally — just whenever I have something I want to say that doesn’t feel like a Baseline Scenario post. You can visit it or not, as you choose.

Not Clear on the Concept

By James Kwak

From Congressman Spencer Bachus’s Media Center (these are the actual titles of four consecutive press releases):

Enough

By James Kwak

A friend passed on this article in The Motley Fool by Morgan Housel. It begins this way:

“Enough.

“That’s the title of Vanguard founder John Bogle’s fantastic book about measuring what counts in life.

“The title, as Bogle explains, comes from a conversation between Kurt Vonnegut and novelist Joseph Heller, who are enjoying a party hosted by a billionaire hedge fund manager. Vonnegut points out that their wealthy host had made more money in one day than Heller ever made from his novelCatch-22. Heller responds: ‘Yes, but I have something he will never have: enough.'”

The rest of the article discusses the cases of Rajat Gupta and Bernie Madoff, the former accused (but not criminally) and the latter convicted of illegal activity done after they had already been enormously successful, professionally and financially.

Housel asks, why do people push on — legally or illegally — when they have more of everything than anyone could possibly need? He summarizes the happiness research as follows:

“Money isn’t the key to happiness. What really gives people meaning and happiness is a combination of four things: Control over what they’re doing, progress in what they’re pursuing, being connected with others, and being part of something they enjoy that’s bigger than themselves.”

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How Dumb?

By James Kwak

In his latest column, “Dumbing Deficits Down,” Paul Krugman has harsh words for Republican nonsense about the budget deficit:

Today’s Republicans just aren’t into rationality. They claim to care deeply about deficits — but they’ve spent the past two years putting cynical, demagogic attacks on any attempt to actually deal with long-run deficits at the heart of their campaign strategy.

But he’s only slightly less harsh toward President Obama:

The president and his aides know that the G.O.P. approach to the budget is wrongheaded and destructive. But they’ve stopped making the case for an alternative approach; instead, they’ve positioned themselves as know-nothings lite, accepting the notion that spending must be slashed immediately — just not as much as Republicans want. . . .

the White House is aiding and abetting the dumbing down of our deficit debate.

In this context, this concluding passage from the book I just read seems appropriate:

U.S. political leaders now seem determined to follow Nero’s reputed example when setting budget policy. They dicker with trivial deficit reduction packages, and then on a regular basis stoke the fire by passing much larger tax cuts, while the long-term budget picture keeps getting worse. They know what is happening, as do the voters.

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For Profit or For Students?

This guest post is contributed by Mark Paul and Anastasia Wilson. Both are members of the class of 2011 at the University of Massachusetts-Amherst.

For-profit colleges are expanding enrollments at a rapid pace, but it is questionable whether these revenue-seeking universities give adequate consideration to students’ welfare, retention/graduation rates, and overall economic well-being alongside their bottom line profits.

A new post by Judith Scott-Clayton, a professor at Columbia Teachers College and new weekly contributor to the New York Times Economix blog, explores the merits of for-profit colleges, arguing that in many ways these schools are more efficient at seeking funding opportunities for students and adopting new teaching technologies. These schools procure more Federal dollars per student and employ more cost-saving technologies, in the classroom and online, than their non-profit public and private competitors.

However, the real question is not a matter of efficiency, but instead concerns students and the taxpayers funding Federal loans and grants consumed by for-profits. Are the relative merits of profit-oriented schools, including their comparative advantage in securing Federal funding, being used to improve the return on investment for students or for their shareholders? On the macro level, does the growth of for-profit higher education promote new risks in the economy, as drop-out and loan default rates continue to increase?

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Conventional Meaninglessness

By James Kwak

David Brooks may be a wonderful person, but I don’t like his columns (and I didn’t like Bobos in Paradise, either). It’s hard to put my finger on why, but he helped me out with yesterday’s column. For one thing, he has this annoying habit of trying to claim the reasonable center, often by making false equivalences between the two things he is trying to sound more reasonable than. So, for example:

“No place is hotter than Wisconsin. The leaders there have done everything possible to maximize conflict. Gov. Scott Walker, a Republican, demanded cuts only from people in the other party. The public sector unions and their allies immediately flew into a rage, comparing Walker to Hitler, Mussolini and Mubarak.”

Comparing the other side to Hitler is bad.* Pushing for legislation that hurts the other side is something else. In the abstract, that legislation may be justified; Walker did just win an election, after all. But it’s a completely different category from making stupid signs to hold at rallies, and it’s a classic David Brooks false equivalence.

But that’s just a minor peeve. It’s when Brooks adopts his pseudo-reasoned “everybody knows” tone that I get really mad.

“Everybody now seems to agree that Governor Walker was right to ask state workers to pay more for their benefits. Even if he gets everything he asks for, Wisconsin state workers would still be contributing less to their benefits than the average state worker nationwide and would be contributing far, far less than private sector workers.”

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February 18, 2011

By James Kwak

Thank you for all the suggestions about my post on the3six5. I decided to write about my favorite topic: my daughter. But at the suggestion of several people, here’s another one (also limited to 365 words and in diary style).

***

Today I spent another two hours in the car, mostly on Interstate 91.

The section between Amherst and Hartford is the stretch of highway I know best in all the world. For six years I went to the Hartford airport every week or two for business. For three years I’ve been driving to New Haven for school. And I recently accepted a job in Hartford.

The thing that makes it at all tolerable is the radio — more specifically, the podcasts I play from my phone. My favorite, loyal readers know, is This American Life, followed by RadioLab, Planet Money, Fresh Air, and TED Talks. (When I’m too tired for anything even remotely intellectual, I listen to embarrassing music on Pandora.)

Most of those shows come from NPR or its affiliates. The spending cuts just passed by House Republicans eliminate funding for the Corporation for Public Broadcasting, which according to Wikipedia provides about 17 percent of all funding for public broadcasting stations.

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Is Economics the Problem?

By James Kwak

For a class, I recently read “The Psychological Consequences of Money,” a 2006 article in Science by Kathleen Vohs, Nicole Mead, and Miranda Goode. It describes nine experiments testing how reminding people of money leads them to behave differently — in ways that we should not be proud of. You may have heard of these experiments.

In Experiment 5, participants first played Monopoly, after which the game was cleared except for a large or a small amount of play money; then they were asked to imagine a future with abundant finances or with strained finances (there was also a control group); then someone walked into the room and dropped a box full of pencils. People who saw more money and imagined having a lot of money picked up fewer pencils. In Experiment 7, participants saw a screensaver with currency symbols floating underwater or fish swimming underwater; then they were asked to move two chairs together for a conversation with another person. People who saw the currency symbols placed the chairs further apart than people who saw fish.

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