Crawl Across the Ocean

Wednesday, March 09, 2011

The Difference Between Lending and Democracy

I read an article many years ago that questioned why banks were getting out of the student loan business when almost 3/4 of students paid back their loans. What the reporter failed to understand was that, unlike 'democracy', where if you have 40% of the people onside you're good to go with a 'majority' government, in the lending business you need a far, far higher percentage of loans to repay you in order to stay solvent.

The logic is simple (especially when lending to 'prime' customers (people with a relatively clean credit history, i.e. most people), where margins are fairly tight) - it takes a lot of 'good' loans that repay in full to offset one bad loan that a bank has to write-off.

I was reminded of this simple truth when reading an article in the Vancouver Sun today, which offered as good news that, "Almost three-quarters of respondents in the RBC poll said they are well positioned to withstand a decline in the housing market."

That is not good news! If there was a decline in the housing market, and one quarter of Canadians were not able to 'withstand it,' that would be a massive financial crisis for this country.

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Thursday, March 18, 2010

Odds and Ends

Just a few links that don't really merit a post of their own...


A somewhat dated paper from the OECD on global housing prices. What's most interesting is that it has a longer set of historical data across a wider range of countries than you usually see.

A few things to note:

As at 2003 mortgage debt as a percentage of disposable income was the same for Canada and the U.S. at 77%. I'm guessing it must be a fair bit higher in Canada by now.

post edited to add: Well maybe not, only because the denominator, disposable income, hasn't been doing so well in the U.S. over the last few years.

Looking at table III.1 you can see that over the period 1970-1995, house price appreciation was greater in Canada than in most of the developed world. Over the period 1970-2005, appreciation in Canada was in the middle of the pack, behind places like Ireland, Spain, the U.K., Holland, Australia and New Zealand which had massive run-ups in housing prices (prices generally tripled or quadrupled in these places even after adjusting for inflation), similar to European countries such as France, Norway and Italy (where prices roughly doubled after inflation) and ahead of the U.S., Sweden, Finland and Denmark (where prices were up 50-75% or so), and a group of countries where house prices peaked in the early 90's and never recovered (in real terms), including Japan, Germany, Switzerland and Korea (little if any increase in real housing prices over the period).

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As a complement to the previous article, here's a well-written piece from the IMF on the global housing market that is more up-to-date. The article suggests that one of the best metrics of valuation in the housing market is the price-rent ratio and notes that the 2 countries where the price-rent ratio exceeds long run averages the most are Sweden and Canada. The Price-Income ratio is also well above the long run average in Canada, but on this metric we trail the countries which showed the huge price appreciation in the OECD report above (Ireland, U.K., Australia, New Zealand, Holland, Spain).

I'd speculate that the reason Canada ranks higher on price-rent is that the countries with the huge appreciation suffered from both a housing bubble and a housing shortage that drove up rents as well. Unlike Canada where the boom led to many years where housing starts far exceeded estimates of household formation, there was little increase in housing starts in places like Australia and the U.K.

The report concludes, "That leads to an uncomfortable conclusion: house prices in many countries still have room to fall."

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An article in the telegraph detailing some research supporting Fred Hirsch's contention that as society grows wealthier we are drawn into intensifying zero-sum competition for positional goods which means the greater wealth isn't increasing our happiness.

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Malcolm Gladwell writes about how civil behaviour in politics has the form of a Prisoner's Dilemma and employs some arguments that will sound quite familiar to anyone who has read through my posts on ethics.


"Here’s a suggestion, borrowed from game theory. What is incivility but a species of collective action problem? A collective action problem is generated whenever a situation's rational opportunities at the individual level generate, at the systemic level, outcomes that are bad for everybody. Consider the familiar example of status-seeking via acquisition of a luxury sport utility vehicle. As consumers compete for this particular clump of positional goods — the feelings of safety that come from a ride bigger than the other guy's, plus the bmw or Mercedes logo over the grille — they have to shoulder mounting personal costs. The competition then turns into a 'race to the bottom,' in which every move to advance my position (larger car, fancier logo) creates a new incentive for you to invest more in pursuit of the same combination of size and status. Because these goods function by position, there is no theoretical upper limit to the ratcheted spending of our competition. Ultimately, the mounting opportunity costs mean we all end up poorer, even as the ends of 'safety' are obliterated by the fleet of urban tanks surging through the city streets.

How and when the exercise of rational self-interest generates system-wide defeats has been the subject of much investigation and analysis. Some scholars have suggested, for example, that individual rationality, amped by greed and cleverness, led to the collective self-defeat we know as the economic meltdown of 2008 — though this analysis says little about the uneven distribution of the costs of that meltdown, whereby the greediest somehow ended up losing the least. But relatively little attention has been given to discursive versions of collective action problems, perhaps because we naively assume that transparency will govern political exchanges; we think we know what the other person's interests and actions are. This assumption is false. Discourse, no less than consumption, has positional and hence competitive aspects. Indeed, winning the argument — or, rather, being seen to win it — is the essence of many discursive exchanges, especially political ones. If politics is reduced to elections or debates, it goes from being a shared undertaking of articulating ends and means and becomes a game of status and one-upmanship."



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David Olive writes about the housing bubble in the Star.

Perhaps oblivious to the fact that almost every metric shows Canadian housing prices and debt levels to be near or higher relative to fundamentals such as incomes and rents than U.S. prices were at the peak of the U.S. bubble, Olive opens by saying that, "Finance Minister Jim Flaherty has headed off any last chance of a housing bubble developing in Canada."

Olive legitimately appears to believe that people who warn about a housing bubble are concerned that housing prices are about to *start* increasing at a rapid rate, seemingly unaware that those warning about a bubble are concerned that prices already *have* risen at a rapid rate and the concern is that they might fall.

So Olive sets forth a number of facts meant to reassure the reader: Ottawa is toughening mortgage rules, taxes on housing are going up, interest rates have nowhere to go but up, etc. and then concludes that we don't have to worry about a bubble because "the fundamentals of our economy don't support another leap in prices."

Aside from his complete obliviousness to the arguments *on both sides* of the housing bubble debate, Olive also puts forth an incredibly weak argument that, "One of the classic characteristics of a bubble is that in the midst of one, no one thinks it's a bubble. If they did, they'd quickly clear their winnings off the table. That fears of an emerging Canadian housing bubble have preoccupied economists, lenders, policymakers and buyers since last fall is a sure indication that the market is not caught up in an irrational buying frenzy."

Obviously the people who matter - those who are buying the houses and driving up prices - don't think it's a bubble. Per Olive's argument, the fact that prices continue to go up should mean that it *is* a bubble. Aside from that, he seems completely unaware how similar the situation is here to what happened in the U.S. In the U.S. a few pundits (e.g. Robert Shiller, Paul Krugman, Dean Baker) raised concerns about a housing bubble, but the vast majority bought into a 'this time is different' argument. Here in Canada, the situation is the same, the government, the Bank of Canada, economists etc. are all on board with the argument that there is no Canadian housing bubble, with a few exceptions (again Robert Shiller, David Rosenberg, Garth Turner).

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A blog on the Science of Cooperation, and from that blog, a recent paper on 'Costly Punishment.' Costly punishment is one of the roads people go down when they twist themselves into pretzels trying to argue that an economy could work just fine if every person was purely self-interested. Of course if people are purely self-interested, they will rip each other off, but if there are sufficient punishments for bad behaviour, it will be in everyone's self-interest to act nice. But what about the self-interest of the people doing the punishment. Taking the time and effort to mete out justice has a cost of its own (hence costly punishment) so the problem of motivating self-interested people remains. The paper in questions suggests that if people are given a choice of entering or leaving a particular collective undertaking (rather than participation being compulsory), the population is more likely to end up being comprised of people who will punish those who fail to cooperate in a group effort.

I'll probably spend some more time on this sort of research a little ways down the line in the series on ethics.

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A couple of interesting posts from Rajiv Sethi on the economic theories of Hyman Minsky. Not much comment from me other than to note that I generally agree with Minsky's argument that an economic boom contains the seeds of its own destruction in that, the longer the boom lasts, the more people behave in ways that make sense during a boom but are unsustainable through a full cycle (e.g. subprime mortgage lending).

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Penultimately, from Economist's View, an article detailing research on the human brain's response to inequality (we appear to be 'hardwired' to dislike inequality - shocking, I know...)

One does feel like banging one's head against the wall reading this part of the article,
"[the result of the experiment] O'Doherty notes, is somewhat contrary to the prevailing views about human nature. "As a psychologist and cognitive neuroscientist who works on reward and motivation, I very much view the brain as a device designed to maximize one's own self interest," says O'Doherty. "The fact that these basic brain structures appear to be so readily modulated in response to rewards obtained by others highlights the idea that even the basic reward structures in the human brain are not purely self-oriented."

Camerer, too, found the results thought provoking. "We economists have a widespread view that most people are basically self-interested, and won't try to help other people," he says. "But if that were true, you wouldn't see these sort of reactions to other people getting money."

Still, he says, it's likely that the reactions of the "rich" participants were at least partly motivated by self-interest—or a reduction of their own discomfort. "We think that, for the people who start out rich, seeing another person get money reduces their guilt over having more than the others."


Here's what David Hume wrote on the topic, in 17 frickin 77 - i.e. 233 years ago.

"the voice of nature and experience seems plainly to oppose the selfish theory.

We frequently bestow praise on virtuous actions, performed in very distant ages and remote countries; where the utmost subtilty of imagination would not discover any appearance of self-interest, or find any connexion of our present happiness and security with events so widely separated from us.

A generous, a brave, a noble deed, performed by an adversary, commands our approbation; while in its consequences it may be acknowledged prejudicial to our particular interest.

Where private advantage concurs with general affection for virtue, we readily perceive and avow the mixture of these distinct sentiments, which have a very different feeling and influence on the mind."

…

"It is but a weak subterfuge, when pressed by these facts and arguments, to say, that we transport ourselves, by the force of imagination, into distant ages and countries, and consider the advantage, which we should have reaped from these characters, had we been contemporaries, and had any commerce with the persons. It is not conceivable, how a REAL sentiment or passion can ever arise from a known IMAGINARY interest; especially when our REAL interest is still kept in view, and is often acknowledged to be entirely distinct from the imaginary, and even sometimes opposite to it."


This really should be, in my opinion, just as obvious now as it was over 200 years ago, and it's sad to see the presumably intelligent and well educated researchers in the article still holding to the absurd belief that people are only motivated by self-interest.

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And finally, on the same topic (more nails in the empty coffins of zombie ideas) here's a paper which shows that people can distinguish historical price patterns in financial markets from randomly generated patterns. The abstract notes that this refutes, "the widespread belief that financial markets 'look random.'" but don't expect any of the people (economists) who subscribe to this theory to change their mind any time soon, any more than the findings on brain response to inequality will affect those who cling, against all evidence, to the notion that people are only motivated by self-interest.

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Tuesday, May 26, 2009

Hoocoodanode?

I was flipping through Jane Jacobs' 2004 book 'Dark Age Ahead ' last night and came across the following passage that I thought I'd pass along for all the economists and pundits out there who offer their plaintive cry of 'hoocoodanode?' with respect to the collapse of the U.S. housing bubble,

"As prices of houses and condominium prices rise, owners can continually borrow more against the rising value of these assets. In Canada, ratios of household debt to household income are thus at record levels.

The miracle of money growing on houses operates even more potently in the United States, where mortgage interest is deductible from income tax and where purchases of resale houses reached record high levels in 2002, as their prices rose to record high levels and mortgage interest rates fell to record low levels. Perhaps the conservative think-tank economist quoted above foresaw and welcomed this bubble. It will burst, either if rising prices significantly push up inflation rates, hence also interest rates, or else if house price inflation slows, halts or retreats."

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Thursday, February 19, 2009

The Home Ownership Scam

Worth repeating, Willem Buiter on the social benefits of home ownership:

Home Loans in the U.S. the Biggest Racket Since Al Capone:

...Why do politicians of all political colours and parties get their knickers so twisted about people losing their homes? In the case of the Tories in the UK and the Republicans in the US, the answer is obvious. Both parties believe that home owners are conservative. Not it the sense that people who are inherently conservative are more likely to become homeowners (although they may believe that as well). This is not a selection story but an osmosis story. Home ownership makes people more conservative. So both Tories and Republicans do everything they can to encourage home ownership. But so do (New) Labour in the UK and the Democrats in the US, so it’s no longer a left-right thing.

The one argument for encouraging home ownership that makes sense is that owner-occupiers look better after their property and its immediate surroundings than would a tenant. This is a simple principal-agent story where it is costly for the principal (the owner) to monitor the care and attention the agent (the tenant) bestows on his property. Add some neighbourhood externalities (I don’t want to live next door to a place where they don’t mow the lawn or paint the exterior of the house), and you have an argument for encouraging owner-occupancy, say by subsidising it.

But a subsidy for owner-occupancy is something completely different from subsidising borrowing using residential real estate as collateral. If they exist, the benefits from owner-occupancy are there regardless of whether the owner-occupier has a mortgage or not. It doesn’t matter whether she borrowed to buy the house, paid in cash, stole it, inherited it from her parents, or built it with sweat equity on land won in a raffle. The US does not encourage owner-occupancy directly, say by paying each head of household who is an owner-occupier, a given amount of cash each year. Instead it encourages and subsidises a particular form of borrowing, regardless of what that borrowing is spent on. Funds, after all, are fungible. I can withdraw equity from my house by taking out a first or second mortgage against it, or by increasing the size of an existing mortgage, and spend the proceeds on Cuban cigars.

All this is rather insane. Through the deductibility of mortgage interest from taxable income, the US tax payer gives vast subsidies to borrowing secured against a particular type of collateral - residential real estate. What so special about this borrowing and this collateral? Fortunately, the UK has abolished this boondoggle. In the US, other forms of preferential treatment for home ownership are piled on top of the mortgage interest-deductibility. Over half the stock of home loans, and virtually all new home lending in the US are heavily subsidized by the lending and guarantees of Fannie Mae, Freddie Mac, Ginnie Mae and assorted smaller smaller government agencies. The direct interventions of the Fed and the Treasury in the market for residential mortgage-backed securities, announced as part of the credit-easing policies of the Fed represent further quasi-fiscal subsidies to housing finance.

This is on top of the creation by the Fed of at least a dozen facilities that accept RMBS as collateral for Fed loans in the earlier stages of the financial crisis. All these quasi-fiscal interventions by the GSEs and the Fed are deeply non-transparent as regards the magnitude of the subsidies involved. They also evade the normal scrutiny and accountability to Congress that is associated with explicit subsidies by the Treasury. The only priviliged treatment of residential housing that makes a modicum of sense from the perspective of encouraging owner-occupancy (as opposed to borrowing to fund whatever expenditures using residential housing as collateral), is the ability to postpone capital gains taxation on the sale of one’s principal residence, and to have one capital-gains-tax-free realisation during one’s lifetime (taken generally when people size down on retirement or when the kids have flown from the nest).

The extreme fiscal largesse bestowed on residential housing, directly and indirectly through mortgage interest deductibility, has led to a massive misallocation of investment in the US. There has been overinvestment in the private residential housing stock and underinvestment in just about every other form of fixed capital: infrastructure, public amenities of all kinds (sports facilities, public recreational facilities, parks etc.), commercial structures, plant and equipment. It is time to correct the distorted incentives that are at the root of this misallocation. The easiest way to do this, in the current tax system, is to end the deductibility of mortgage interest in the personal income tax, close down Fannie and Freddie and end the role of the US government in the provision of residential mortgages. A focused social housing program is of course a legitimate activity of the Federal government. It should be on-budget, that is, fiscal rather than quasi-fiscal.

...


But really, you should read the whole thing...

Buiter does a great job exposing the madness behind out-of-hand government promotion of home ownership, but he doesn't really get into the question of why governments act this way.

And it's not just the U.S. - Canada has gone down the same road with CMHC and a host of other incentives.

And over here, Steve Keen catalogues the extensive list of government interventions in Australia and again has little explanation for the magnitude of the government intervention in this particular area.

I do have a theory on why governments find this area particularly irresistible, but I'll have to save it for a few weeks until I've developed the appropriate background material first.

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Thursday, February 05, 2009

All the News That's Fit to Print

Some fodder for the post I'm eventually going to write about whether we're better off with or without the print media - a little seetype from Garth ' No Greater Fool' Turner,
"A year ago, as I related in my recent book, the real estate editor of a major newspaper who gave “Greater Fool” a full-page review (critical, but interesting) told me months later that was the kiss of death. After advertisers complained, he ended up on the overnight layout desk. The new real estate editor writes about funky paint colours and throw cushions.

But the sponsors left anyway. They smelled the smoke."

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Monday, January 05, 2009

Symmetry Watch #2

Mohican links to the end of year press release(pdf) from the Vancouver Real Estate Board. It is headlined, "2008 brought improved housing affordability to Greater Vancouver"

Somehow, even though prices rise most years, I doubt they have ever titled their year end report, "Year X Brought Deteriorating Housing Affordability to Vancouver!"

To be fair, nobody says the real estate board has to be objective about real estate, improved housing affordability is legitimately a good thing, and it's not a bad press release as these things go.

Anyways, sales were down 35.3% (to 24,626) in 2008 vs. 2007 while listings were up 13.9% (to 62,561).

The average one year change in prices for the greater Vancouver benchmark property was -10.9%, which isn't very good when you consider that prices were still rising one year ago, so the drop from the peak would be that much higher.

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Saturday, December 13, 2008

Better Late Than Never, I suppose

The Globe and Mail posts a decent article on "How High Risk Mortgages Crept North"

It's really a pretty simple story. Used to be, government rules said that if you wanted to buy a house and make a down payment less than 25%, you had to get it insured by the government. The government required a minimum down payment of 5% (already lowered in 1990 from the previous requirement of 10%) and a maximum amortization period of 25 years and charged a fee to cover the increased risk from these low down payment loans.

The purpose of down payments and limited amortization schedules is to avoid situations where people owe more on their house than it is worth( in case of price declines) and generally to ensure that people who buy houses can actually afford them.

This system worked reasonably well for a number of decades.

Starting in 2006, faced with sky-high housing prices, home ownership rates well above long term norms and an economy overheating due to excess demand driven by fast-rising and unsustainable debt levels, the Conservative government*, in its wisdom, decided that the time was right to push housing prices and consumer debt levels even higher so that when the inevitable crash came, people and industry could get hit that much harder.

As part of this plan to ensure Canada was able to participate in the sub-prime debacle, three changes were undertaken:

1) The minimum down payment needed to avoid buying insurance was reduced from 25% to 20%

2) The maximum amortization period was increased from 25 years to 40 years.

3) The minimum down payment rule was removed for insured mortgages.

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In the summer of 2008, finally listening to the various ministry of finance and industry voices that had advised against this folly, the government partially backtracked on these rule changes, limiting amortizations to 35 years and reinstating a minimum 5% down payment rule. Of course, these rules are still looser than they were in 2006, and these rule changes take effect after the housing bubble has peaked so they can't do much to limit the size of the bubble, and we've now got two years worth of mortgages on the books under the zero down payment rules, but again, like the Globe writing a good article on the housing industry, it was better late than never.

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* To be fair to the Conservatives, I don't recall that any of the other parties opposed these rule changes much

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Saturday, December 06, 2008

Media Failure #3

OK, last bit of media-bashing for a while, Vancouver Condo Info reminds of this article from the CBC on the Vancouver Housing Market. Of course there are any number of articles like this one, but this one stands out for its timing (it was published right at the top of the market) and the lack of any balance to the bullish predictions.

Says the CBC, "
B.C. house prices forecast to keep rising: Anyone looking for a dip in the British Columbia real estate market before buying a home might reconsider their strategy.

A report by the Credit Union Central of British Columbia predicts housing prices will continue to rise by as much as 10 per cent this year and as much as seven per cent in 2009.

The report predicts that in 2009 multi-family units such as condos and townhomes could exceed single-family homes in B.C.The report predicts that in 2009 multi-family units such as condos and townhomes could exceed single-family homes in B.C.

Lower mortgage rates, a tight labour market, high income growth and rising in-migration all point to continued high sales volumes and price rises, according the CUCBC's chief economist Helmut Pastrick.

The Economic Analysis of British Columbia released Monday says the current housing boom is unlike previous market cycles that ended with a large oversupply of homes, causing a sharp drop in prices.

In the current market, sales have reached a plateau and the supply of houses is only gradually catching up with demand. And with the recent drop in mortgage rates, the CUCBC expects the number of home sales will pick up once again.


It's almost like they are trying to parody a typical bullish media article from the top of a bubble. There's the classic 'this time is different' reasoning ("the current housing boom is unlike previous market cycles"), there's the reliance on 'experts' who work at institutions with a vested interest in rising prices, the discounting of data that doesn't fit the happy storyline, and so on.

And I can laugh, because I didn't buy a house this year, but anyone who did after reading this article would have to be pretty pissed off since the price of an average detached house in Vancouver has dropped over $100,000 since May. I guess the CBC was right, anyone looking for a dip in the B.C. market *should* have reconsidered their strategy - since far worse than a dip was coming.

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