Renting and Buying Compared

By James Kwak

Loyal readers already know what I think of housing as an investment. The main issue, in my mind, is that it’s extremely risky as an investment: not only are most middle-class families putting more than their total net worth in a single asset class (and one with low average real returns compared to the stock market), but they are putting it into a single asset, which violates the most fundamental principle of investing.

That said, on a pure expectation basis (not considering risk), buying is probably better than renting. It’s not as simple as saying that “renting is throwing money away while paying a mortgage is building equity” because (a) homeowners usually pay more cash than renters on an ongoing basis (mortgage, homeowner’s insurance, maintenance, etc.) and (b) you have to consider the returns you could get by investing your capital (down payment and principal payments) in another asset class. But the tax deduction for mortgage interest probably tilts the scale toward buying.

So if you’re thinking about buying or renting, I recommend that you read “The Effectiveness of Homeownership in Building Household Wealth” by Jordan Rappaport, an economist at the Kansas City Fed (hat tip David Leonhardt). The most valuable part of the paper is that it clearly outlines the financial tradeoffs between owning and renting. Rappaport creates a model that estimates the cash flows from buying a house and selling it ten years later and renting for ten years, assuming that you invest all the money you save by renting. He then looks at historical ten-year periods beginning from the 1970s through the 1990s to see which strategy would have been preferable.

Continue reading “Renting and Buying Compared” →

Why Does The Independent Community Bankers of America (ICBA) Oppose Debit Card Reform?

By Simon Johnson

It’s not hard to understand why large banks oppose any attempt to reform the financial arrangements currently surrounding credit cards and debit cards – in the duopoly run through Visa and MasterCard, big banks earn fees that far exceed their costs. This excess profit gap for debit cards would be substantially reduced by a Federal Reserve proposed regulation now on the table, which would implement the Durbin Amendment from the Dodd-Frank 2010 financial reform act. Senator Jon Tester (D., Montana) has proposed legislation that would delay and effectively derail implementation of the Durbin Amendment; the big banks are very much in his camp.

It’s much harder to understand why Independent Community Bankers of America (ICBA), the lobby group for small banks, is also working so hard for the Tester bill – because community banks are explicitly exempted from having to lower their fees and individual executives from at least some small banks publicly support the Durbin Amendment (e.g., see Senator Durbin’s letter to the ICBA last year).

The most plausible explanation is that ICBA is also one of the country’s largest issuers of credit cards and debit cards – so the representative of small banks actually has, in this regard, the incentives of a big bank. This is a major conflict of interest that is undermining the interests of community bankers and distorting the political process. The ICBA needs to declare this conflict in a transparent manner and step back from its involvement in the Durbin-Tester debate. (UPDATE: The ICBA says that it derives no revenue from debit interchange, despite the fact that the leading industry sources list it as #20 for “Signature Debit Card Interchange” and #13 for “PIN Debit Card Interchange”; for a full explanation, see the note from Cam Fine that appears with the NYT.com version of this column.) It also needs to publish the full details of a “survey” that it uses to claim that most community bankers are against the Durbin Amendment.

Continue reading “Why Does The Independent Community Bankers of America (ICBA) Oppose Debit Card Reform?” →

What’s a Big Government?

By James Kwak

One thing that all parties seem to be able to agree on is that big government is bad. It was President Clinton, after all, who said, “The era of big government is over.” And the current Republican budget-slashing wave seems motivated by the idea that our government is too big.

But what is the size of government, anyway?* When a typical anti-government person thinks of government, she probably has in mind the EPA, the Consumer Financial Protection Bureau, the “jack-booted government thugs” at the the Bureau of Alcohol, Tobacco, and Firearms, OSHA, and all those government agencies that prevent businesses and individuals from getting on with their lives. The idea here is that government intervention in the free market makes the economy less efficient and therefore reduces aggregate societal welfare.

Continue reading “What’s a Big Government?” →

Blog Archive Updated

By James Kwak

At the suggestion of an anonymous commenter, I decided to use Vienna, an open-source OS X RSS reader, to download monthly feeds and “print” them to PDFs, so the blog archive is now up to date. It wasn’t quite what I was looking for, since I wanted an online solution, but I don’t mind installing new software on my Mac as much as I minded it on a PC.

The Myth of the Natural Economy

By James Kwak

“The general equilibirum view tends to lend support to those who want to make the economy more efficient in the sense of having fewer ‘distortions’—you know, all of these neutral economic words—from taxes, from labor unions, from minimum wages, and so on. Now, what has happened in the last thirty years—and this is what Hacker and Pearson note in their book [Winner-Take-All Politics]—is we have gotten ourselves into a feedback situation. As people have gotten richer, conservative people have funded organizations which generate economic research promoting their political views.”

That’s from an excellent interview with economic historian Peter Temin in The Straddler. Temin’s main point is that what he calls general equilibrium approaches to macroeconomics have a political agenda, but they hide that agenda behind an ideology of naturalness. The “natural,” perfectly clearing, perfectly efficient economy, of course, has never existed and can never exist, but it is used to justify certain political prescriptions.

Continue reading “The Myth of the Natural Economy” →

Does The US Have A Lot Of Government Debt?

By Simon Johnson

In the nation’s latest fiscal mood swing, the mainstream consensus has swung from “we must extend the Bush tax cuts” (in December 2010) towards “we must immediately cut the budget deficit.” The prevailing assumption, increasingly heard from both left and right, is that we already have far too much government debt – and any further significant increase will likely ruin us all.

This way of framing the debate is misleading – and very much at odds with US fiscal history. It masks the deeper and important issues here, which are much more about distribution, in particular how much are relatively wealthy Americans willing to transfer to relatively poor Americans?

To think about the current size of our debt, start at the beginning of the American Republic. (For a very short history of US government debt, listen to my conversation with NPR’s Guy Raz from this weekend; we cover more than 200 years in about 3 minutes; if you want more detail, look up the annual debt numbers for yourself at Treasury Direct). Continue reading “Does The US Have A Lot Of Government Debt?” →

Nominate Elizabeth Warren – Provide The Pecora Hearings We Need

By Simon Johnson

Ms. Warren is helping get the new Consumer Financial Protection Bureau (CFPB) off the ground and remains the leading contender to become its formal head (subject to Senate confirmation). She summarizes her substantive agenda this way,

We’re trying to make these markets transparent, which makes it easier for community banks to compete both with large financial institutions and with their nonbank competitors.”

She should now be nominated to the CFPB position. There will be strong Republican opposition and some Democrats who are close to the financial sector may be lukewarm. But a public hearing on her case represents our best opportunity to experience a modern version of the Pecora Hearings – the Senate Banking Committee hearings in the 1930s that laid bare the inner (and rotten) workings of the biggest financial firms (see Michael Perino’s book on Pecora for details).

These hearings would represent a major step forward towards forging a new consensus regarding how to really establish markets (as opposed to the crazy government subsidy schemes that predominate). In addition, the administration would win a big victory with Ms. Warren’s confirmation. Continue reading “Nominate Elizabeth Warren – Provide The Pecora Hearings We Need” →

The FDIC’s Resolution Problem

By Simon Johnson. Links to the articles mentioned below are available here: http://economix.blogs.nytimes.com/2011/04/28/the-problem-with-the-f-d-i-c-s-powers/

Under the Dodd-Frank financial reform legislation (Title II of that Act), the Federal Deposit Insurance Corporation (FDIC) is granted expanded powers to intervene and manage the closure of any failing bank or other financial institution. There are two strongly-held views of this legal authority: it substantially solves the problem of how to handle failing megabanks and therefore serves as an effective constraint on their future behavior; or it is largely irrelevant.

Both views are expressed by well-informed people at the top of regulatory structures on both sides of the Atlantic (at least in private conversations). Which is right? In terms of legal process, the resolution authority could make a difference. But as a matter of practical politics and actual business practices, it means very little for our biggest financial institutions. Continue reading “The FDIC’s Resolution Problem” →

Bond Market Blackmail

By James Kwak

Like probably most people, I have not been following the saga of Iceland and its banks’ foreign depositors, so I was grateful for Planet Money’s podcast last week on the topic. The background, as I understand it, is something like this:

Iceland’s banks offered high-rate savings accounts to depositors in other countries, notably the United Kingdom and the Netherlands. These accounts did not have an explicit government guarantee.
In 2008, the global financial system nearly collapsed, Iceland’s banks failed, and depositors got more or less wiped out.
Iceland, unlike Ireland, did not guarantee its banks’ liabilities. It did, however, choose to bail out domestic depositors in those banks — but not foreign depositors.
The U.K. and the Netherlands both chose to bail out their citizens who had deposited money in Iceland’s banks.
The U.K. and the Netherlands then tried to get the Icelandic government to pay them back. They negotiated a settlement, but that was rejected by a popular referendum in Iceland. Then they negotiated another settlement (which would have cost Iceland about $6,000 per person), but that was also rejected.

Now, there is a legal question about whether or not Iceland has an obligation to bail out foreign depositors in its banks. Remember, there was no explicit government guarantee. The question is whether bailing out domestic but not foreign depositors is illegal discrimination under international law.* Apparently that’s a close question, but it’s not relevant for my purposes.

The economic question, as the podcast framed it, is whether paying off the U.K. and Dutch governments will help Iceland attract foreign investment in the future. They had a bond investor from Vanguard — ordinarily just about my favorite financial institution — saying that a vote against the settlement would make investors less likely to lend money to the Icelandic economy in the future.

Now, this may be true (although I doubt it). But think about what this is really saying.

Continue reading “Bond Market Blackmail” →

$3 Billion Banks

By James Kwak

Jon Macey is no friend of regulation. In 1994, he wrote a paper titled “Administrative Agency Obsolescence and Interest Group Formation: A Case Study of the SEC at Sixty” arguing, in no uncertain terms, that the SEC was obsolete: “the market forces and exogenous technological changes catalogued in this Article* have obviated any public interest justification for the SEC that may have existed” (p. 949). This diagnosis was not confined to the SEC, either.

“The behavior of regulators in [the financial services] industry is due to exogenous economic pressures that, left alone, would result both in major changes in the structure of the financial services industry and in the need for regulation. However, these economic pressures threaten the interests of bureaucrats in administrative agencies and other interest groups by causing a diminution in demand for their services and products. In response to these threats, pressure is brought to bear for ‘reforms’ that will eliminate the ‘disruption’ caused by these market forces.

“The net result of this dynamic is as clear as it is depressing. One observes continued government intervention in the financial markets long after the need for such intervention has ceased. Such intervention stifles the incentives of entrepreneurs to devote the resources and human capital necessary to develop new financial products and to de- velop strategies that assist the capital formation process by helping markets operate more efficiently.”

So what does Jon Macey think of big banks?

Continue reading “$3 Billion Banks” →

Allocative Efficiency for Beginners

By James Kwak

I was catching up on some old Planet Money episodes and caught Allen Sanderson of the University of Chicago talking about how to allocate scarce resources. The first day of introductory economics, he says, there are always more students than seats. Say there are forty extra people, and he can only accept ten more into the class. He asks the class: how should the ten slots be allocated? You can easily guess the typical suggestions: by seniority, because seniors won’t be able to take the class later; by merit (e.g., GPA), because better students will contribute more to the class and get more out of it; to the first ten people outside his office at 8 am the next day, since that is a proxy for desire to get in; randomly, since that’s fair; and so on. Someone also invariably suggests auctioning off the slots.

This, Sanderson says, illustrates the core tradeoff of economics: fairness and efficiency. If you auction off the slots, they will go to the people to whom they are worth the most, which is best for the economy as a whole.* If we assume that taking the class will increase your lifetime productivity and therefore your lifetime earnings by some amount, then you should be willing to pay up to the present value of that increase in order to get into the class. An auction therefore ensures that the slots will go to the people whose productivity will go up the most. But of course, this isn’t necessarily fair, especially when you consider that the people who will get the most out of a marginal chunk of education are often the people who have the most already.

Continue reading “Allocative Efficiency for Beginners” →

Blog Archive

By James Kwak

Last month a reader pointed out that many of the links in the blog archive were broken. The problem is that Feedbooks, the service I was using, no longer allows you to transform RSS feeds into PDFs. I fixed the links up through April 2010, but the problem is that I no longer have an elegant way of creating new PDF archives. Basically I need something that will allow me to type in an RSS feed and will generate a PDF from that feed.

For example, this is the feed for May 2010, in forward chronological order. When I type that feed URL into Chrome, I get raw XML. When I type it into Firefox, it gives me truncated versions of each post. When I type it into Safari, it gives me full posts, but in its infinite wisdom, it sorts them in reverse chronological order; the sort by date feature only allows reverse chronological. When I type it into Google Reader, I get full posts in the right order, but I lose the post dates (they are replaced by the current date). Bloglines is like Safari — it insists on reverse chronological. RSS 2 PDF only gives me post titles. FeedShow displays nothing.

If I could get any of these to work in any browser, I could just convert that to a PDF and be done. Any suggestions?

Update: To be clear, saving a web page (or anything) as a PDF is not the problem. It’s trivial on a Mac (and not that hard on a PC, either). The problem is getting the full text of all the posts in the feed, in the proper order, with the proper dates, on one web page.

Is S&P’s Deficit Warning On Target?

By Simon Johnson

On Monday Standard & Poor’s announced that its credit rating for the United States was “affirmed” at AAA (the highest level possible), but that it was revising the outlook for this rating to “negative” – in this context specifically meaning “that we could lower our long-term rating on the U.S. within two years” (p.5 of the report). This news temporarily roiled equity markets around the world, although the bond markets largely shrugged it off.

While S&P’s statement generated considerable media attention, the economics behind their thinking is highly questionable – although, given the random nature of American politics, even this intervention may still end up having a constructive impact on the thinking of both the right and the left.

It is commendable that S&P now wants to talk about the U.S. fiscal deficit – one wonders where they were, for example, during the debate about extending the Bush-era tax cuts at the end of last year. Continue reading “Is S&P’s Deficit Warning On Target?” →

“Fiscal Conservatives” Dodge $10 Trillion Debt

By Simon Johnson. This post comprises the opening paragraphs of my column today on Bloomberg; the rest is available here: http://www.bloomberg.com/news/2011-04-19/fiscal-conservatives-dodge-10-trillion-debt-simon-johnson.html

Washington is filled with self- congratulation this week, with Republicans claiming that they have opened serious discussion of the U.S. budget deficit and President Barack Obama’s proponents arguing that his counterblast last Wednesday will win the day.

The reality is that neither side has come to grips with the most basic of our harsh fiscal realities.

Start with the facts as provided by the nonpartisan Congressional Budget Office. Compare the CBO’s budget forecast for January 2008, before the outbreak of serious financial crisis in the fall of that year, with its latest version from January 2011. The relevant line is “debt held by the public at the end of the year,” meaning net federal government debt held by the private sector, which excludes government agency holdings of government debt.

In early 2008, the CBO projected that debt as a percent of gross domestic product would fall from 36.8 percent to 22.6 percent at the end of 2018. In contrast, the latest CBO forecast has debt soaring to 75.3 percent of GDP in 2018.

What caused this stunning reversal, which in dollar terms works out to a $10 trillion swing for end-year 2018 debt, from $5.1 trillion to $15.8 trillion?

To read the rest of this post, click here.

Could Goldman Sachs Fail?

By Simon Johnson. This link to MIT Sloan’s website provides a partial transcript and video covering the points made below.

If Goldman Sachs were to hit a hypothetical financial rock, would they be allowed to fail – to go bankrupt as did Lehman – or would they and their creditors be bailed out?

I asked this question on Sunday to four leading experts (Erik Berglof, Claudio Borio, Garry Schinasi, and Andrew Sheng) from various parts of the official sector at the Institute for New Economic Thinking (INET) Conference in Bretton Woods – and to a room full of people who are close to policy thinking both in the United States and in Europe. In both the public interactions (for which you can review video here) and private conversations later, my interpretation of what was said and not said was unambiguous: Goldman Sachs would be bailed out (again).

This is very bad news – although admittedly not at all surprising. Continue reading “Could Goldman Sachs Fail?” →