Making homes more expensive?

13 02 2009

Of all the peculiar ideas embedded in the “stimulus package,” the most clearly illogical is the belief that we ought to make homes more expensive than they would be otherwise. Of course, politicians don’t say that. Politicians say they want to “stabilize” the home market; to help people get out of their debts and recover from their lost wealth, to get the economy growing again. Low-interest loans, home buyer tax credits and investments in “infrastructure” are suggested to as means to accomplish this end.

But this logic holds within it three unforgivable economic fallacies:

First, that our wealth is defined by how much money we have. Politicians say that “people’s homes have lost value” because they have declined in price. This is not entirely true. If it was, then we could just print more money and then everyone would have their wealth back. Prices have declined but the value of home ownership for most people is definitely unchanged in the short-run and uncertain in the long-run. Why? Aside from speculators, most people in their lifetime do not exchange their homes for goods other than homes. If you sell your home and buy another, you’re exchanging homes with money as a method of exchange. If homes stay expensive, you’ll get more money for your home but also pay more for your neighbors. Of course, some homeowners are hurt if they planned to “downsize” by exchanging their homes for smaller ones plus other goods (money). They’ll get less money for their homes so have truly lost value. But those aren’t the people politicians are talking about: they’re talking about “American families” and setting up policies that “make it easier to buy a home.”

So this leads us to the second fallacy: failing to look at both sides of a transaction. Politicians condemn the same “sub-prime lenders” who they praised years ago to opening up credit to the “underbanked.” Today, they complain that the banks “aren’t lending enough” but they never say that people “aren’t borrowing enough” which is exactly the same thing. In the case of housing, the other side of a transaction is buyers. In particular, people who don’t own homes or are looking to buy more expensive homes. These people are definitely better off when homes are less expensive, because they don’t have to give up as many other goods in order to afford a home. The ideal situation for society is that homes are as inexpensive as possible so we can get lots of great housing as well as other goods of our choice. To the extent that the stimulus succeeds in making homes more expensive, it hurts home buyers, today and in future generations, and retards our economic development.

Finally, the last fallacy is the most timeless of all is the “broken window” fallacy. Most people in society, not just politicians, have the notion that housing construction is special because it employs lots of labor which fuels the economy. Bastiat’s famous story tells us why this isn’t so. He tells of a baker whose windows are broken by a vandal. The shopkeeper is devastated, but a passerby comforts him that at least the broken windows will create jobs for the window maker, who will ultimately spent that money to buy bread from the bakery. This is the same concept as the vaunted “multiplier.” The problem with this fallacy is that society has wasted resources, it lost a window and the baker lost the ability to buy things other than replacement windows: new ovens from an oven maker, a suit from a tailor, education for his children, etc. In the case of housing, resources are diverted to building more houses when they could have been spent otherwise. Construction is labor-intensive, but that just means that this labor is diverted from producing the other goods or service that people want to buy but can’t afford to because they have to pay more for homes. What’s unseen are all the goods that we actually want but are never created because more of our money is spent on homes.


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Categories : Economics, Public Policy

Will the Feds wreck the Bulge Bracket?

30 01 2009

This week’s buzz is all about “outrage at Wall Street bonuses.” Obama’s derision of them as “shameful” has given official sanction to the passions of the majority: most people polled respond that wealth should be distributed more equally, that the rich don’t pay enough taxes and that Wall Street bonuses are excessive. Of course, few of these individuals would refuse their own pay raise (no matter how badly their companies were performing) nor was there much outrage over similar government checks like the $127 billion stimulus.

These egalitarian intuitions are relatively harmless as long as government stays out of the economy. Some wealth is re-distributed, but at least the pie keeps growing. However, a grave problem emerges when government tries to apply these values to its control of private enterprises including the Wall Street banks which it partially owns and greatly influences today.

The problem is this: Wall Street bonuses are being paid because some parts of every bank remain profitable. For instance, financial institutions bankers and traders who valiantly shorted the same sub-prime securities that the majority now blame for this boondoogle. The bottom line is that if banks don’t pay these bonuses, they will lose this talent and become even less profitable. Consequentially, the Federal government will lose even more money next year. 

Today’s proposal from Senator Claire McCaskill to cap bailed-out-bank salaries at $400,000 (that of the President) is the logical consequence of a line of thinking: because banks took government money, they should be treated as if they are part of the government. However, this thought directly endangers the original “investment” logic of the bailout which stated that the government was putting money into private enterprise in a hands-off fashion in order to get it back later as stock owners. Left completely to their own devices, Wall Street managers would continue to seek profits which could eventually be returned to government owners. But today’s sentiment puts a whiff of expropriation risk in the air which threatens Wall Streets ability to seek profits. If this spreads, it just about ensures that the US government will lose all of its money invested in Wall Street because those firms will cease to exist. Productive employees will simply leave to join banks which are free of government oversight, and investment.

Is that easier said than done? For the most part, Wall Street firms are just people in offices. TheDeal.com tracks movements on the Street and it seems there’s increasingly a general trend of rainmakers, the most productive bankers, moving from bulge bracket to boutique firms. Some of this is flight from institutions which are fundamentally unhealthy, but I suspect that the motives will increasingly be fear of government oversight. A few recent moves from just the last 3 days illustrate the trend:

  • John Barber, Citi private equity head leaving the firm. No destination yet.
  • Gary Walters, Chase digital media head joining a boutique: Revolution Partners
  •  Hal Kennedy, Credit Suisse restructuring director, joining a boutique: Jefferies.  
  •  Peter Kapp, Citi financial institutions director, joining a boutique: Stifel, Nicolaus. 

While it’s impossible to know the motives, none of these individuals are leaving large banks for other large banks. They are all joining boutiques where they at least have the possibility of commanding those “shameful” pay packages.


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Categories : Financial Services, Public Policy

The anti-stimulus…

22 01 2009

The draft text of the House’s “007″ stimulus plan (where everything is doubled with at least seven digits) has been released and WashingtonWatch.com is offering an excellent prize of $100 per submission for well-written critiques of the stimulus. Finally, a private sector stimulus for economists!

Here’s my submission of less than 150 words:

We’re told that the stimulus bill is investing in infrastructure for America’s future. But did you know that Section 2001 of the stimulus will increase food stamp benefits by 13.6% and remove all work requirements for getting food stamps? That would amount to a minimum of $5 billion in additional spending going literally down the hatch. Moreover, waiving Section 6(o)(2) work requirements means that even people who don’t work or work less than 20 hours a week will be eligible. This will sky-rocket the costs of the program as more people collect benefits.

Picking on food stamps sounds harsh but increasing benefits which encourage people to work less and earn less income is about the worst thing to do in a recession. The program already does this: enrollment increased 32% and payouts grew 58% over the last 5 years despite the economic boom!

Just say no to food stamps, “the anti-stimulus.”

Of course, you may think it sounds a bit heartless to be picking on food stamps but focus on whether this change does anything to further the stimulus: will increasing food stamp benefits help our economy? Does it qualify in any way as infrastructure? I think this is exhibit #1 in pork and hidden spending inserted into the stimulus. 

In this case, the benefits of the program are private and temporary: people who collect food stamps get a subsidy so they don’t have to work as much. All of the money from the program goes to consumption, so we’re no better off in the future. At least if we throw $50 billion+ at building a railway from Los Angeles to San Francisco, we might stimulate new technology or economic development (although, you can guess that I’m severely skeptical). 

That’s precisely the opposite of what we want to happen to get us out of the recession: people have to start working, even if it’s for lower wages that they made previously. When people work, we want them to create socially useful goods/services and generate income which expands the pie and they save and invest. That’s the only way to get out of this.


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Categories : Economics, Public Policy

Should the Feds bailout Facebook?

10 01 2009

Whatever you think of Obama’s calls for new infrastructure investment, it’s worth asking what types of infrastructure are the best or “least-worst” possible investments. As many economist like Alex Tabarrok have pointed out, we don’t want to engage in building the Great Pyramids of Nevada or infrastructure as FDR thought of it. 

Is Facebook infrastructure worth investing in?

A basic economic test is to ask whether each additional $1 invested produces social benefits exceeding private benefits. Private benefits are things we would pay for on-our-own, and someone else would receive income for.  Social benefits are things that we wouldn’t pay for on our own (e.g. someone else’s education), but we get benefit from if others pay for them (e.g. less crime, more productive economy). Government can potentially have a role in investing in these goods on behalf of all. 

Social networks have loosely fit this model from the first bulletin boards through Facebook today. They produce a lot of private value for their members but little for owners. At a social level, these networks enrich knowledge, friendships and overall market (friendship and dating are markets too) efficiency. The problem for owners is capturing value: social networks are inexpensive to operate and anyone who tries to charge users in proportion to benefits will be competed away. This tends to lead to low levels of investment and innovation over time: the decline of Friendster may be a good example. 

Because of the social benefits, I think there’s a case for investing in social networking infrastructure. The question is what specific projects would produce the social benefits in excess of private? This is tricky. For instance, a better advertising system would benefit Facebook privately, but it would also enable them to capture more value which would spill-over into greater social benefits. There are both social and private benefits to most investments. We need to find the projects which at some point Facebook will stop investing because they do not produce private benefits, even though they produce social ones.

Worthwhile projects could include: 

  •  Expand Facebook activity amongst US-based population: Facebook is making most of its investments internationally where its core 18-35 year old, well educated audience can be tapped. In the US, its penetration rate is about 20%. However, there would be social benefits to increasing adoption of Facebook amongst older, less-educated and minority demographics in the United States. The US government could fund a program whose payouts are contingent upon Facebook gaining adoption in these groups.
     
  • Enhance Facebook functionality to support greater democratic engagement. The influence of Facebook in the 2008 election was immense.  I can imagine great social benefits, for instance, of receiving activity streams of one’s local member of Congress (so-and-so voted Nay on proposed bill) or being able to signal your political positions to local Congresspeople right on Facebook. These produce social benefits, but aren’t likely at the top of Facebook’s private investment list.
     
  • Fund Facebook’s development of free tools which enable local public schools and services to join and communicate with social networks. In most climates, these tools could be privately supplied. But in today’s economic climate, local schools and services are halting technology investments across the board. A good solution is for the federal government to subsidize both the development and marketing of these tools.

Of course, in these proposals the government is picking Facebook as a platform over MySpace, Live, Bebo. This raises fairness issues, but there’s no reason to believe that the government should have to invest in every social network. It has the responsibility to invest in projects which offer the greatest social returns per $.


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Categories : Public Policy, Social Networks