The great waves of industrial innovation

Published in Law & Liberty.

How did the world of lord and serf, horse and carriage, superstition and disease, turn into the world of boss and worker, steam and steel, science and medicine?

Jonathan Steinberg asks us to ponder this in his lecture series “European History and European Lives: 1715 to 1914.” We can add to his question, among countless other things previously unimaginable, “and the world of jets and space probes, computers and Google searches, antibiotics and automatic washing machines, and sustained long-term economic growth per capita?” Relative to all previous human life, this new world, the one we live in, is truly astonishing. As Steinberg asks us to wonder, “How and why did what we call the modern world come about?”

The answer at the most fundamental level is through the creation and harnessing of scientific knowledge. Far and away the most important event in all of history was the invention of science based on mathematics by the geniuses of the seventeenth century. This is symbolized above all by Isaac Newton, whose masterwork, Philosophiae Naturalis Principia Mathematica, we may freely render into English as “Understanding Nature on Mathematical Principles.” The invention of mathematicized science was the sine qua non of the modern world. Other important modernizing developments in government, law and philosophy are handmaidens to it.

As Alexander Pope versified the impact:

Nature and Nature’s laws lay hid in night:

God said, Let Newton be! And all was light.

Of course, the translation to the modern world was not quite that direct. The new and multiplying scientific knowledge had to be transferred into technical inventions, those into economically useful innovations, those expanded into business ventures by entrepreneurial enterprise, and with the development of management processes for large-scale organizations, those spread around the world in great waves of industrial innovation.

We may picture these great waves over the last two and a half centuries like this:

Waves of Innovation

The result of these sweeping creations by the advantaged heirs of the Newtonian age is the amazing improvement in the quality of life of ordinary people like you and me. As measured by real GDP per capita, average Americans are about eight times better off than their ancestors of 100 years ago. (They in turn were far better off than their predecessors of the 18th century, when the modern world began to emerge.)

In 1897, average industrial wages per week have been estimated at $8.88. That was for a work week of about 60 hours (say six ten-hour days—and housewives had to work 70 hours a week to keep home life going). The industrial wages translate to 15 cents an hour. Correcting for inflation takes a factor of about 25, so 15 cents then is equivalent to $3.75 today. Current U.S. average hourly manufacturing wages are $21.49, adding benefits gives total hourly pay of over $30. In other words, real industrial hourly pay has multiplied about eight times. While this was happening, over the course of a century a lifetime’s average working time per day fell in half, while average leisure time tripled, according to estimates by Robert Fogel.

Along the way, of course, there were economic cycles, wars, recessions, depressions, revolutions, turmoil, crises, banking panics, muddling through and making mistakes. But the great waves of industrial innovation continued, and so did the improving standard of living on the trend.

Joseph Schumpeter memorably summarized the point of economic growth as not consisting in “providing more silk stockings for queens, but in bringing them within the reach of factory girls in return for steadily decreasing amounts of effort.” The Federal Reserve Bank of Dallas demonstrated how more goods for less effort indeed happened—showing how prices measured in hours and minutes of work at average pay dropped dramatically during the twentieth century. Their study, “Time Well Spent—The Declining Real Cost of Living in America,” is full of interesting details—here are a few notable examples. The time required to earn the price of milk fell 82%; of a market basket of food, 83%; of home electricity, 99%; of a dishwashing machine, 94%; of a new car, 71%; and of coast-to-coast airfare, 96%. Of course, no amount of work in the early twentieth century could have bought you an iPhone, a penicillin shot, a microwave oven, a ride on a jet across the Atlantic Ocean, or a myriad of other innovations.

These advances in the economic well-being of ordinary people are consistent with a famous prediction made by John Maynard Keynes in 1930.  In the midst of the great global depression, which might have led to despair about the future, Keynes instead prognosticated that the people of 2030, of 100 years from then, would be on average four to eight times better off due to innovation and economic growth. As 2030 approaches, we can see that his forecast will be triumphantly fulfilled near the top of its range.

How much can the standard of living continue to improve? In 1900, according to Stanley Lebergott, the proportion of Americans who had flush toilets was only 15%. Only 24% had running water, 1% had central heating, 3% had electricity, and 1% owned an automobile. The people of that time could not imagine ordinary life as it is now. Correspondingly, it is exceptionally difficult for us to imagine how hard, risky and toilsome the average life was then.

And if we try to imagine the ordinary life of 100 years into the future, can we think that people will once again be eight times better off than we are? Can the great waves of innovation continue? Julian Simon maintained that since human minds and knowledge constitute “the ultimate resource,” they can. “The past two hundred years brought a great deal of new knowledge relative to all the centuries before that time,” he wrote, “the past one hundred years or even fifty years brought forth more than the preceding one hundred years,” and we can confidently expect the future to continue to “bring forth knowledge that will greatly enhance human life.”

June brings to mind weddings, homeownership and their paradoxical relationship

Published by the R Street Institute.

June, we learn from the National Association of Realtors, is “National Homeownership Month.” Since June is also a traditional month for weddings, it is a good time to address an important and logical, but little understood and virtually never-discussed connection: that between homeownership and marriage.

Homeownership is much higher for married than for not-married households. This makes intuitive sense. But the difference in homeownership rates is pretty remarkable: for the United States as a whole, more than 78 percent of married households own their home, nearly double the 43 percent for those not married. Thus, the overall homeownership rate of 63.5 percent is composed of two very different parts by marital status. This difference holds for all major demographic groups. The married versus not-married dynamic, in turn, gives rise to an intriguing homeownership paradox that we explore below.

We examine homeownership in this context over 30 years, from 1987 to 2017. This makes the homeownership effects of the housing bubble-and-bust into a temporary anomaly in the course of the three decades. That U.S. homeownership was artificially pumped up and then fell back to its trend now looks like a blip in the midst of the longer-term pattern. The artificial homeownership inflation was, of course, heavily promoted by the U.S. government, notably by the Clinton administration’s unwise “National Homeownership Strategy.” This strategy may be summarized as: pump up homeownership by making bad mortgage loans. Naturally, they didn’t say it that way—what they said was by making “innovative” mortgage loans. But it turned out the same.

Looking at the longer term, in 1987, the U.S. homeownership rate was 64 percent. Thirty years later, in 2017, it was 63.5 percent, according to the U.S. Census Bureau’s Current Population Survey.

But the homeownership rate for married households went up significantly over the same period: from 76.2 percent to 78.4 percent. And the homeownership rate for not-married households also went up a lot, indeed by a lot more than the married rate did: from 35.3 percent to 43 percent.

The sum of married plus not-married households are all the households there are. Their homeownership rates both went up from 1987 to 2017. So how is it possible that the overall homeownership rate went down?  That is the paradox. It is summarized in Table 1.

The explanation of the paradox is that the mix of married versus not-married households in the U.S. population changed a lot over these years. The proportion of married households, with their much higher homeownership, fell dramatically from 70.2 percent to 57.8 percent of U.S. households. The proportion of not-married households, with their much lower homeownership rate, correspondingly increased. This is shown in Table 2.

Adjusting out the effect of this shift in household mix, U.S. homeownership rates fundamentally rose over these three decades, as many of us would have hoped.

In sum, to understand trends in homeownership, we must include, as is seldom done, its interaction with marriage.

Letter to Editor Barron’s: Listen up, Uncle Sam

Published in Barron’s.

Governments “should take particular care to prevent real estate bubbles,” writes Michael Heise (“Global Debt Is Heading Toward Dangerous Levels, Again,” Other Voices, May 19).

He’s right, of course. But the U.S. government does the opposite. As it has for decades, it promotes real estate debt and inflates real estate prices through government credit, subsidies, guarantees, and regulation—not to mention the massive monetization of mortgages by the Federal Reserve. When will they ever learn? The best bet is never.

Governments could take bitcoin out of circulation

Published in the Financial Times.

Nima Tabatabai asks about bitcoin, “can financial regulators control this emerging digital monetary asset?” ( Letters, May 18). The answer is they can. If a government sets its mind on it, it can tax, punish and regulate any monetary asset out of circulation. In the 1860s, Congress put a 10 percent tax on state bank notes to prevent their competing with the new U.S. national bank notes. State banks survived by expanding deposits, but state bank notes as a currency were gone. In the 1930s, the U.S. government, formerly on the gold standard itself, made it illegal for its citizens to own gold or denominate payments in it. Violating the prohibition was made a crime punishable by a fine of $10,000 or 10 years in prison. In the 1960s, the U.S. government simply refused to honor its explicit promise to redeem paper silver certificates with the silver dollars which were certified as “payable to the bearer on demand.” Thus U.S. dollar bills convertible to silver ceased to exist as a currency.

What might governments do to bitcoin or its holders or users? That depends on how threatened by it they feel.

S. 2155 won’t end finreg debate, but it’s an important first step

Published in Real Clear Markets.

S. 2155 won’t end finreg debate, but it’s an important first step

The U.S. House reportedly will move next week to take up and pass a modest financial regulatory reform bill already approved by the Senate – S. 2155, the Economic Growth, Regulatory Relief and Consumer Protection Act.

This is not the fundamental reform of the bureaucracy-loving Dodd-Frank Act of 2010 one might once have hoped for, nor is it the much broader reforms proposed by the House Financial Services Committee in its Financial CHOICE Act. But everyone agrees the current political reality is that the latter bill cannot be enacted, while the current bill is a step forward that can actually be taken. A modest step forward is better than standing still.

Small banks and credit unions, defined in the bill as those with assets of less than $10 billion, will be the principal beneficiaries of its reforms, by reducing their compliance burdens with onerous regulations that were inspired by the political emotions of 2010 in the wake of the financial crisis. These lenders are less than 0.5 percent the size of JPMorgan Chase. The costs and burdens of complex and opaque regulation are disproportionately heavy for them.

Community banks and credit unions are enthusiastic supporters of the bill and its expected enactment will be an important victory for them. Small banks represent the vast majority of all banks. There are 5,670 federally insured depository institutions in the United States. Of these, 5,547 or 98 percent, have assets of less than $10 billion. On a still smaller scale, 4,920, or 87 percent of all banks, have assets of less than $1 billion, which makes them less than 0.05 percent the size of JPMorgan.

Among other regulatory de-complexification, the bill would provide small banks the option to have a high and simple leverage capital requirement (tangible equity as a percentage of total assets) replace the complicated risk-based capital calculations arising from the international negotiations known as the “Basel” rules (named after the city in Switzerland). It provides for this ratio to be set in a range of 8 percent to 10 percent. The similar idea of the CHOICE Act specified 10 percent. If combined with a simple liquidity requirement, this is an excellent idea.

A key improvement in the bill is that, for small banks, residential mortgage loans they make and keep for their own portfolio would be considered “qualified mortgages” for compliance with the Dodd-Frank Act. This recognition is essential; when a bank keeps the mortgage loan and all its risks, putting up its own capital as “skin in the game,” it is in a different financial world from those who make the loan and forthwith sell it, passing all the risk to somebody else. Much of the regulatory motivation of the Dodd-Frank Act was trying to deal with the moral hazard of the “originate and sell” mortgage model. That the “skin in the game” model is fundamentally different should have been obvious all along, but better late than never. A sad irony is that the “originate and sell model,” with the flaws that later became so evident, was strongly pushed by government policy, subsidies and regulation.

This regulatory reform bill is pretty complex. In draft form, it is 192 pages long, with many provisions devoted to particular constituency concerns, as you might expect from something that needed a bipartisan deal to get through the Senate. You might say it displays Madisonian balancing of competing concerns of interest groups (or as Madison would have put it, “factions”). Everybody cannot like everything in it.

A sampling of its various provisions includes:

• For big banks, increasing the level at which they are automatically considered “systemically important” from $50 billion to $250 billion in assets—subject to regulators’ ability to overrule in particular cases.

• A special deal on the leverage capital requirement for banks whose principal business is custody of assets (there are only a couple of them).

• More favorable treatment of investment grade municipal bonds for purposes of big bank liquidity requirements. In addition to helping big banks, this is naturally very popular with issuers of municipal securities.

• A regulatory simplification for closed-end mutual funds.

• A break on the treatment of certain brokered deposits, useful to some small banks.

• Easier treatment of some riskier commercial real estate loans. This is popular with real estate developers, of course. Since commercial real estate is often at the center of banking busts, this may be the most dubious of all the bill’s provisions.

• A choice for federal savings associations to have regulatory treatment just like national banks. This is a natural step in the gradual disappearance of a separate savings and loan industry. It is now hard to remember that a special savings and loan industry was in former days considered an important national financial priority.

• Not to be forgotten is an additional taking of the Federal Reserve Banks’ retained earnings, to help reduce the budget deficit.

And numerous other special provisions, displaying that the bill is indeed a product of a democratic legislative processes.

Taking the bill all in all, it should be enacted. But it should by no means be the end of regulatory reform. The House has a lot of ideas for additional steps, many with bipartisan support. We’ll see if anything else happens.

How does our ‘Great Recession’ compare to ones from the past?

Published in Real Clear Markets.

A prominent economist opened his book, The Great Recession, with this observation: “In the years ______, the world economy passed through its most dangerous adventure since the 1930s.”  This should sound familiar. “Its world-wide character and the associated bankruptcies and financial disturbances,” he added, “made this episode the long-awaited postwar economic crisis.”  But what years was Otto Eckstein in fact describing, so how do you fill in the blank in the first quotation?  The correct answer is the great recession of 1973-75. (How did you do on the quiz, esteemed Reader?)

“The capitalist process progressively raises the standard of life for the masses,” wrote the ever-provocative Joseph Schumpeter, but “It does so though a series of vicissitudes.”  Further, “Economic progress, in capitalist society, means turmoil.”  If Schumpeter is right that progressively raising the standard of living for ordinary people requires vicissitudes and turmoil, then cycles of booms and busts do not just happen, but are necessary in theory to economic progress.  They certainly do seem unavoidable so far.  Empirically, recessions are reasonably frequent.  In the last 100 years, there were 18 recessions in the United States, thus on average about once every 5 1/2 years. In the last 50 years, there have been seven recessions or on average once about every seven years.

Many recessions are shallower, but there are occasional great recessions.  How does “our” great recession—that of 2007-09– look relative to some of its predecessors?  Specifically, we compare it to the great recessions of 1981-82, 1973-75, and 1937-38.

The 2007-09 great recession led to a U.S. unemployment rate peak of 10.6%.  This was surely bad, but not as bad as the 11.4% which followed the 1981-82 bust.  The unemployment rate in 1973-75 got to 9.1%.  The great recession of 1937-38 was far worse, with unemployment peaking at about 20%.  (These unemployment rates are not seasonally adjusted.)

For 2007-09, 477 financial institutions failed in the five years from the onset of the great recession.  For 1981-82, the comparable number is 625 financial institution failures.  In the five years after 1973, there were 46 failures, but it is possible that the whole banking system was insolvent on a mark-to-market basis.  There were 262 failures in the five years after 1937.

In terms of peak-to-trough drop in real GDP, 2007-09 is the second worst of our examples.  In order of increasing severity the aggregate real GDP changes were:  1981-82, -2.8%; 1973-75, -3.1%; 2007-09, -4.2%; and estimated for 1937-38, -18%.

These great recessions had very different inflation experiences.  In 1973-75, in addition to the high unemployment, the U.S. suffered from painful double-digit inflation rates, with an annualized average of 10.9% on top of the other problems.  In 1981-82, the inflation rate was 5.2% along with recession, compared to 1.8% in 2007-09.  In 1937-38, they had deflation, or an inflation rate of -1.9%.

Then there is the cratering of the stock market in each case.  As measured by the peak to trough percentage drop in the Dow Jones Industrial Average, “our” great recession was the worst, with a 52% drop.  In 1937-38, the drop was 48%.   The DJIA fell 39% in 1973-75, and 20% 1981-82.  All painful, to be sure, especially if you were on margin.

Short-term interest rates fell dramatically in all four great recessions, but from very different levels.  Three-month Treasury bill yields started the 1981-82 great recession at the remarkable level of 15% and fell to 8.1%, the biggest change in number of percentage points.  The biggest drop measured as a percentage of the initial level was our 2007-09, in which three-month bill yields dropped from 3% to 0.18% or by 94%.  In 1973-75, these yields went from 7.8% to 5.5%, which sounds still very high to us now.  The lowest trough in rates was in 1937-38, when three-month bills went down to 0.05% from 0.41%.

In sum, the great recession of 2007-09 has predecessor great recessions.  These were worse in some ways, less bad in other ways, and present different combinations of painful problems.  All were severe downers.  But great recessions and ordinary recessions notwithstanding, on the trend the enterprising economy keeps taking income per capita ever higher, “progressively raising the standard of life for the masses” over time. If there is some way to do that without the cycles, it has yet to be discovered.

Let’s get rid of Puerto Rico’s triple-tax exemption

Published by the R Street Institute.

Let’s ask a simple and necessary question: Why in the world is the interest on Puerto Rican bonds triple-tax exempt all over the United States, when no U.S. state or municipality gets such favored treatment?

The municipal bond market got used to that disparity, but in fact, it makes no sense. It is an obvious market distortion, on top of being unfair to all the other municipal borrowers. It helped lure investors and savers, and mutual funds as intermediaries, into supporting years of overexpansion of Puerto Rican government debt, ultimately with disastrous results. It is yet another example of a failed government notion to push credit in some politically favored direction. Investors profited from their special exemption from state and local income taxes on interest paid by Puerto Rico; now, in exchange, they will have massive losses on their principal. Just how big the losses will be is still uncertain, but they are certainly big.

Where did that triple-tax exemption come from?  In fact, from the Congress in 1917. The triple-tax exemption is celebrating its 100th anniversary this year by the entry of the government of Puerto Rico into effective bankruptcy. Said the 1917 Jones-Shafroth Act:

All bonds issued by the government of Porto Rico or of by its authority, shall be exempt from taxation by the Government of the United States, or by the government of Porto Rico or of any political or municipal subdivision thereof, or by any State, or by any county, municipality, or other municipal subdivision of any State or Territory of the United States, or by the District of Columbia.

That’s clear enough. But why?  Said U.S. Sen. James K. Vardaman, D-Miss., at the time: “Those people are underdeveloped, and it is for the purpose of enabling them to develop their country to make the securities attractive by extending that exemption.” All right, but 100 years of a special favor to encourage development is enough, especially when the result was instead to encourage massive overborrowing and insolvency.

It’s time to end Puerto Rico’s triple-tax exemption for any newly issued bonds (as there will be again someday). As we observe the unhappy 100th birthday of this financial distortion, it’s time to give it a definitive farewell.

Seven decades of the inflation-adjusted Dow Jones Industrial average

Published by the R Street Institute.

Everybody has observed the renewed volatility of stock prices during the last few months. But for all the volatility, so far, the stock market has moved basically sideways since the end of 2017. The Dow Jones industrial average closed at 24,787 yesterday (April 17), only 0.3 percent different from the 24,719 it was at the end of December—with a lot of storm and stress in between.

Of course, it has moved sideways at a high level. How high?  For perspective, the following graph shows the DJIA over seven decades on an inflation-adjusted basis, expressing the history in March 2018 constant dollars.

We see immediately how much real stock prices can move over time, and how long the basic directional moves can last. The chart falls into five sections. We observe the great bull market of 1949-1966, followed by the great bear market of 1966-1982. Then another great boom from 1982 to the 1990s, which morphs into the runaway bubble of the late 1990s. Then a truly volatile decade which ends up in the big bust bottoming in 2009. Since then, the real DJIA is three times as high as at the 2009 low. In a longer view, it is 14 times what it was in 1949, 12 times as high as at the 1982 bottom and more than three times as high as the 1966 peak—all after adjusting out the endemic inflation of the times.

How high are stock prices now?  Pretty high. The boom and its acceleration last year bears a worrisome resemblance to the shape of the 1990s. However, so far the bull market has lasted only about half as long as those of 1949-1966 or 1982-1999.

What’s next?  Alas, to paraphrase Fred Schwed in his classic 1940 book, “Where Are the Customers’ Yachts?,” the one thing we all want most to know is the one thing we never can know. That’s the future, of course, especially the future of financial markets.

EU could follow Lincoln’s model on dual banking

Published in the Financial Times.

Sir,

When looking at the difficulties of European banking union (“Eurozone banking union heads towards ‘critical phase’”, April 11), perhaps a model to explore is that created by the US during the administration of Abraham Lincoln.

The National Currency Act of 1863, now known as the National Banking Act, created banks chartered by the federal government. These new “national banks”, regulated by the national comptroller of the currency, existed and still exist alongside the “state banks” chartered by the individual US states. Thus we got the dual banking system.

Might the EU similarly think of a dual banking structure, with some banks chartered and regulated by the EU, and others remaining chartered by the individual member states?

What you would have made if you bought big lenders in 2006

Published in Real Clear Markets.

Lending money is a risky business. Lending money when the lender is itself highly leveraged is more risky yet. How bad can the result of this simple fact be for investors in common stock? And have such investors yet recovered from the crisis of 2007-2009?

Suppose you had decided at the end of 2006, when it looked like lending businesses were booming, to invest $10,000 equally divided among the common stock of the dozen biggest U.S. lending institutions. Those would have been eight bank holding companies, two thrift holding companies and two government-sponsored enterprises. Specifically, ranked by total assets, that would have been: Citigroup, Bank of America, JPMorgan, Fannie Mae, Freddie Mac, Wachovia, Wells Fargo, Washington Mutual, U.S. Bancorp, Countrywide Financial, SunTrust and National City.

How would you have done? Your portfolio, bought for $10,000, would at the end of March 2018, eleven years later, been worth $5,960. You would be still be down more than 40 percent. Of course, you are now better off than at the bottom of the stock market in 2009, when it was worth $2,569, or down 74 percent. But the more than eight years since have not gotten you back to even, far from it. The unfortunate history of your big lender portfolio is shown in the following table.

S&P Global Intelligence

You are also in poor shape relative to the Standard & Poor’s 500 index. As of March 2018, you are about 68 percent behind the alternative of having put your $10,000 in the S&P. Your current $5,960 compares to the index’s current $18,620. The history of the relationship is shown in the following graph.

S&P Global

Of course, the performance over the whole period of the lenders’ individual stocks varies by a lot. From the virtually 100 percent loss in Washington Mutual, to the 98 percent losses in Fannie and Freddie, to the 88 percent loss in Citigroup and 44 percent loss in Bank of America, we find gains of 47 percent in Wells Fargo and 128 percent in JPMorgan. Overall, there are nine institutions with their value still down after more than 11 years and only three that are up versus 2006.

It is true that financial markets are always energetically looking forward with thousands of eyes, minds and computers. But despite the diligent efforts, they often don’t see forward very well. So indeed it was in 2006, with the stock prices of the biggest lending institutions at the top of the first (and assuredly not the last) great 21st century bubble.

Slick accounting at the Federal Reserve could prove disastrous

Published in The Hill.

“Mr. Chairman, on exhibit two, panel four, ‘deferred asset.’ This is kind of a nice term, ‘deferred asset.’ As far as I know, the committee has never used the deferred asset. It strikes me as a possible political firefight to bring that into play. All of the scenarios here, other than option one, if I’m reading this correctly, would bring the deferred asset into play, with possible repercussions, I think, for the Federal Reserve.”

This was James Bullard, president of the Federal Reserve Bank of St. Louis, speaking at the September 2012 meeting of the Federal Open Market Committee, according to the minutes. Said a staff member in reply, “It has never been the case that we have had, for the Federal Reserve System as a whole, a deferred asset.” But they knew that they might have one going forward. Earlier in the meeting, the staff had reported that all the options considered to reduce the Fed’s bond portfolio would cause the “creation of a deferred asset,” perhaps even a “substantial deferred asset.”

What in the world were they talking about? In this context, what did this, as Bullard ironically said, “nice” term mean? In fact, they were discussing how, if they ever tried to reduce their huge portfolio of long-term Treasuries and mortgage-backed securities, they were liable to take big losses. They were pondering the effect which the losses arising from any attempt to normalize their balance sheet would have on their financial condition.

What the Fed meant by “deferred asset” in clear language is the “net losses we would take.” What would be deferred is the recognition of the losses in retained earnings. The losses under consideration might occur by selling some of the Fed’s vast investment in long-term securities for less than it paid for them. Could this happen? Of course. Buy at the top for $100 and sell later for $95 means a loss of $5 for anybody.

Already in 2012, the Federal Open Market Committee was struggling with the clear possibility that such losses could be very large, indeed much larger than the Fed’s net worth. Thus, such losses had the potential to render the central bank insolvent on a balance sheet basis, as well as making it it so that the Fed would be sending no money to the Treasury to reduce the budget deficit, perhaps for several years.

In one scenario presented to the Federal Open Market Committee at that 2012 meeting, the “deferred asset” would get to about $175 billion. At the time of the meeting, the Fed’s net worth was only $55 billion, so its leaders were contemplating the possibility of losing up to three times its capital. This was happening while running a long-term securities portfolio of $2.6 trillion.

If negative net worth did arrive, the Fed could still print any money needed to pay its bills, but the balance sheet wouldn’t look so good. And might not publishing a balance sheet with negative net worth mean a “possible political firefight” in Bullard’s phrase? What might Congress say or do? The Fed didn’t want to find out. So it invented having a “deferred asset,” if necessary, rather than reporting a negative net worth.

In short, this “deferred asset” would be an imaginary asset. It would be booked in this fashion to avoid recognizing the effect of net losses on capital. In accounting terms, it would be a big debit looking for someplace to go. The proper destination of the debit for everybody in the world, including the Fed, is to retained earnings, where it would reduce capital, or even make it negative. But the Fed does not choose to allow this, and the central bank defines its own accounting rules.

So the Fed would send the debit to an accounting “deferred asset” instead, which hides the loss and overstates capital. Harshly described, for ordinary banks, this would be called accounting fraud. So more than five years ago, the Fed understood very well the big losses that might result from its massive “quantitative easing” investments, and how such losses might dwarf the Fed’s capital. It knew it could prevent showing a negative net worth by a slick accounting move. Hence the extensive discussion of the “deferred asset,” which does indeed sound a lot better in the minutes than “negative capital.”

Since then, the Fed’s portfolio is much bigger, up to $4.2 trillion, so the potential losses are much bigger now, while the Fed’s capital is much smaller, down to $39 billion because the Congress expropriated a lot of its retained earnings. Interest rates have gone up. Selling down the Fed’s portfolio could now cause an even bigger negative net worth, or “deferred asset.” As we know, the Fed has concluded not to make any sales, only move extremely slowly toward balance sheet normalization by holding all its long-term portfolio to maturity.

Should the Federal Reserve, in the circumstances of 2012 or now, reveal the projected losses from any portfolio sales and resulting “deferred asset” to the public? Should it discuss candidly with its boss, the Congress, how big the losses and negative net worth might turn out to be? Or should it just prepare the accounting gimmick for use, if necessary, worry in private, put on a good face in public, and hope for the best? What would you do, thoughtful reader, in their place?

What’s in a name of a Banking Committee?

Published by the R Street Institute.

Adair Turner, whose insights into finance among other contributions got him promoted to Lord Turner, has concluded that lending on housing and other real estate is by far the largest creator of systemic financial risk and banking busts. This conclusion is clearly correct. Among the principal recommendations of his highly interesting 2016 book, Between Debt and the Devil, is that governments must therefore work to constrain banks’ real estate loans and act to limit their recurring tendency to expand into booms and bubbles.

This is precisely the opposite of the historical policy of the American government, which has usually been to enthusiastically promote the inflation of housing credit and denounce the ensuing busts.  Currently, the U.S. government guarantees about 60% of all outstanding mortgage loans and its central bank has created money to the tune of $1.8 trillion to inject into housing finance.

In this context, we reflect on the highly suggestive symbolic shifts in the names of the Congressional committees with jurisdiction over banking.

From 1913, when it was formed, to 1971, the relevant committee of the U.S. Senate was named the Committee on Banking and Currency—a logical and consistent name.  In 1971, the name was changed to the Committee on Banking, Housing, and Urban Affairs—a very different combination of ideas, displaying interest in very different political constituencies. Shortly before, the Congress had restructured Fannie Mae into a government-sponsored housing finance enterprise, and created another one in Freddie Mac, both actions with momentous but unintended future results.

The Committee on Banking, Housing, and Urban Affairs the Senate committee remains.  This displays, as Lord Turner’s view suggests, an overemphasis on housing.  And “Urban Affairs”? The name change is strikingly supportive of Charles Calomiris’ theory that the dominant coalition in U.S. banking politics shifted in the latter 20th century from an alliance of small banks and rural populists, to one of big banks and urban populists.

The relevant committee in the U.S. House of Representatives for 110 years, starting in 1865, had the same historical name: the Committee on Banking and Currency.  In 1975, this was changed to the Committee on Banking, Currency, and Housing.  Promoting housing finance was gaining focus.  Then in 1977, the name became the Committee on Banking, Finance and Urban Affairs.  “Currency” had lost out.  This was during the 1970s, a decade of runaway consumer price inflation, in which an emphasis on controlling the currency might have been useful.  As in the Senate, “Urban Affairs” represented important Democratic Party constituencies and accompanied the government promotion of expanding housing finance.

The House committee’s name changed in the opposite direction in 1995, with a Republican Party majority in the House for the first time in four decades, mostly maintained since then.  It became the Committee on Banking and Financial Services, then in 2001, simply the Committee on Financial Services.  The new name reflected the committee’s greatly expanded jurisdiction, most notably to include the securities industry.  In recent years, this committee has been the Congressional center of trying to reform housing finance along market lines, and in particular, to reform Fannie Mae and Freddie Mac.  These efforts have yet to succeed, unfortunately.

“What’s in a name?”  Nothing, as Shakespeare makes Juliet argue?  Or, over the last several decades, would committees which focused on “banking and currency” have behaved differently from ones diligently expanding their banking interventions to include “housing and urban affairs”?

Elizabeth Warren is really sad because the CFPB is ignoring her

Published in The Daily Caller.

Senator Elizabeth Warren (D-Mass.) has unintentionally provided great entertainment with an op-ed published last week in The Wall Street Journal. Her essay decries how terrible indeed it is that her political child, the Consumer Financial Protection Bureau (CFPB), is free of Congressional control — exactly as it was designed to be by the Dodd-Frank Act. Moreover, and much worse, under a new director, the CFPB now has no interest in paying attention to her!

To Senator Warren, this is outrageous. To any detached observer, it is funny.

The irony of Senator Warren’s plaint and of her frustration with her discovery that the bureaucratic agency of whose independence from Congress she was a prime author, is beyond the control of any senator, is delicious. The CFPB is beyond even that most basic of all checks and balances, the congressional power of the purse. This is exactly as intended by the Democratic congressional majorities which created it and gave it the power to simply dip into public funds without Congressional approval or appropriation. It does this by helping itself to money out of the Federal Reserve’s income, which is economically equivalent to dipping into the Treasury’s general fund.

That this independence now operates to frustrate Senator Warren is wonderful poetic justice. The irony, the poetic justice and the entertainment were not lost on the readers. In a day, they provided over 800 comments to the WSJ’s website, the vast majority of which enjoyed making similar points.

Here are some sample comments and excerpts:

“This article is the poster child of ‘be careful what you wish for.’ All her screaming cannot change the fact—she created an agency that cannot be controlled by elected officials—and now she is on the other side of that coin.”

“A Democrat creates and weaponizes a bureaucracy only to see her opponents take charge of it. Hoist on your own petard, eh?”

“Amusing to hear Warren rant about how the agency she helped create to be unaccountable to Congress, is now unaccountable to her!”

“Oh please, Ms. Warren. You purposely designed the CFPB to be above oversight. Your sour grapes that your creation in now in Republican control is amusing indeed.”

“In short, the CFPB was designed to be an unaccountable agency led by a single dictatorial director. That was fine with Warren when it was run by Richard Cordray, who aligned it with her. Somehow, things have changed now that the CFPB isn’t being run by one of her ideological cronies.”

“Testifying before Congress had absolutely no effect on Richard Cordray. The CFPB was specifically told its charter did not include consumer auto loans. But that did not stop him.”

“Wow, she was largely responsible for creating this monster and now that it doesn’t behave exactly as she would like, she whines.”

“This is rich. Warren intentionally created the unconstitutional agency with no accountability in order to protect it from changes in Congress that could threaten it. Now they’re not doing what she wants. Such a hypocrite.”

“Now the shoe is on the other foot and the GOP has the chair, and the sky is falling.”

“To see her most prized possession emasculated while she whines powerlessly is such sweet poetic justice.”

And so on.

All this suggests three questions that Senator Warren really should answer:

1. Does she now support requiring Congressional appropriations for the CFPB?

2. Does she now support governing the CFPB with a bipartisan board, rather than a single, authoritative director?

3. Does she see herself — as others see her — sufficiently to understand how funny her article is?

Real estate debt, the devil and U.S. national banks

Published by the R Street Institute.

The attached policy study originally appeared in the Spring 2018 issue of Housing Finance International. 

Housing finance, as we all know, is lending on fundamentally illiquid assets, taking risk on their prices, which are subject to boom and bust cycles, and doing so on a highly leveraged basis for both the borrowers and the lenders. Naturally this business of ours gets us periodically into severe problems, as has been experienced in numerous countries over time.

Adair Turner, the former chairman of the British Financial Services Authority, goes further. In his provocative book, Between Debt and the Devil (2016), he puts the principal culpability for financial crises – and thus the identity of the Devil – on real estate lending.

He points out that banks in recent decades have changed from being primarily lenders to commerce and industry, to being primarily real estate lenders. In the U.S., this fundamental shift in bank credit toward concentration in real estate dates from the 1970s.

Lord Turner writes:

“In 2007, banks in most countries had turned primarily into real estate lenders.”

“Before the mid-twentieth century, banks in several advanced countries were restricted or at least discouraged from entering real estate lending markets.”

“Lending against real estate… generates self-reinforcing cycles of credit supply, credit demand, and asset prices.” (The interaction of real estate prices and lending is without question a key risk dynamic.)

“At the very core of financial instability in mod-ern economies thus lies an interface between an infinite capacity [to inflate mortgage credit] and an inelastic constraint [real estate].”

Thus, the conclusion: real estate finance and mortgages “are not just part of the story of financial instability in modern economies, they are its very essence.”

Quite an indictment. If it is not the whole truth, it has at least an important element of truth.

In this context, we should consider the instructive history of the laws governing real estate lending by U.S. national banks. These are the banks chartered by the U.S. Government and regulated by the Comptroller of the Currency in Washington, D.C., as opposed to the banks chartered by individual states of the United States. Both exist, but before the American Civil War of 1861-65, all banks were state banks. There are now 943 national banks in the U.S. with aggregate assets of $11 trillion, and 4,075 state-chartered banks with assets of $5 trillion.

National banks make a good study in real estate lending because we can go right back to their creation by the National Currency Acts of 1863 and 1864, later renamed the National Banking Act.

The authors of the original National Banking Act took an unfavorable view of having real estate loans and real estate risk included in the assets of the new national banks, the liabilities of which were going to form the nation’s new currency. They addressed their concern in a simple way: the new national banks were prohibited from making any real estate loans at all!

This seems amazing now, when national banks have $2.5 trillion of real estate loans, or 43 percent of all their loans. On top of that, they own $1.3 trillion of securities based on real estate (mortgage-backed securities), which represent 58 percent of their bond portfolios. (For state banks, real estate loans are 57 percent of total loans and mortgage backed securities are 55 percent of their total bonds.)

The prohibition of real estate loans for national banks lasted about 50 years, until 1913. Although the sponsors of the National Banking Act had intended for national banks completely to replace the state banks, instead the state banks survived and then multiplied, and the national banks felt the competitive pressure.

The first statutory permission for national banks to expand into real estate came as part of the Federal Reserve Act of 1913. This allowed national banks to make real estate loans on farm land only. (In those days, half the population of the U.S. was rural. Congress would expand agricultural lending further with the creation of the Federal Farm Credit System in 1916.) But loans from national banks were limited by the law to 50 percent of the farm property’s appraised value – very conservative, we would say.

The 1913 Act included another basic financial constraint: that real estate loans had to be explicitly tied to more stable bank funding. So, at that point, total real estate loans were limited to a maximum of 33 percent of a national bank’s savings deposits. The idea was that deposits payable on demand should not be invested in real estate financing. The same idea was shown in traditional mortgage lending theory with what used to be called the “special circuit” for funding housing finance. This meant using more stable savings accounts, often in earlier days viewed as “shares,” a kind of equity, and not as deposits – the point being to match more appropriate funding to longer-term residential mortgages. Today we pursue the same goal by the creation of mortgage-backed securities or covered bonds.

An additional limitation of the law was that real estate loans were limited to 25 percent of a national bank’s capital. In contrast, for national banks as a whole today, they represent 256 percent of the tangible capital. For state banks, this ratio is 359 percent.

The limitation to farm real estate for national banks lasted only to 1916, when the law was changed to allow loans on nonfarm real estate, but with a maximum maturity of one year. In 1927, this was expanded to five years on improved urban real estate, with the loan still limited to 50 percent of appraised value.

Vast defaults and losses on real estate lending marked the Great Depression of the early 1930s. Jesse Jones, the head of the Reconstruction Finance Corporation, memorably described “the remains of the banks which had become entangled in the financing of real estate pro-motions and died of exposure to optimism.”

However, in following decades the long-term trend for more expansive real estate lending laws continued apace. Allowable loan-to-value ratios increased to two-thirds, in some cases to 90 percent, maximum maturities were increased to 30 years, and the limit on total real estate loans to 70 percent and then 100 percent of time and savings deposits. In 1974, unimproved land was added as acceptable collateral for national banks. In 1982, the final step in statutory evolution was taken: all statutory real estate lending ratios and formulas were removed by the Garn-St. Germain Act of that year. The 1980s and early 1990a featured euphoric real estate credit expansions and then multiple real estate busts.

In 1994, pursuing further expansion of real estate credit, the administration of President Clinton adopted a political real estate lending campaign: the “National Homeownership Strategy.” The idea was to promote so-called “creative financing” – in other words, the U.S. government was pushing for low and no-down payment mortgages and other risky and low-quality loans. The authors of the National Banking Act would have been appalled by this project. They would have accurately fore-casted its disastrous outcome, which arrived in due course as a contributor to the Great Housing Bust and panics of 2007-08.

That, of course, was the crisis which gave rise to Lord Turner’s book, its diagnosis so unflattering to real estate lending, and to his key prescription:

“To achieve a less credit-intensive and more stable economy, we must therefore deliberately manage and constrain lending against real estate assets.”

In this context, “we” means the government, which must, on Lord Turner’s view, constrain real estate lending, not promote it.

Representatives of housing finance like us may or may not agree that this is the right answer, but we can observe that it is consistent with the statutory limitations on real estate lending provided in the National Banking Act as originally designed and during its first century.

Federal Reserve will be judged by future on these years of low rates

Published in The Hill.

The government’s official interest rate price-fixing committee, otherwise known as the Federal Reserve, has just raised its target fed funds rate by a quarter-point. This surprised no one, as the Fed intended, since it works hard to manage expectations.

What would the rate be if it were set in private markets instead of by a government committee? No one knows, but presumably it would be higher.

The Fed’s latest move still leaves interest rates at remarkably low levels. In the 1980s and 1990s, most people would have considered it impossible for the fed funds rate to be under 2 percent. Now we have the Fed’s current target range of 1.5 to 1.75 percent—to make it easy, let’s just call it 1.75 percent. Not only is this rate low, but in real inflation-adjusted terms, it is negative. In February, the Consumer Price Index went up 2.2 percent year-over-year, so the new fed funds target in real terms is 1.75 percent minus 2.2 percent  =  negative 0.45 percent.

It looks like it will take one more increase, at least, to get the real fed funds rate up to around zero and numerous increases after that to approach a normal level. Needless to say, normal real interest rates are positive, not negative.

What might a normal level be? We can make a fair guess by looking at long-term averages. Graph 1 shows nominal fed funds rates and inflation rates from mid-1954 to year-end 2017.

Over this long term, the fed funds rate averaged 4.86 percent. The annual rate of inflation averaged 3.56 percent. So the long-term average real fed funds rate was 1.3 percent.

If inflation going forward runs at the Fed’s target inflation rate of 2 percent, it would suggest a normalized fed funds rate of 3.3 percent. To get there would take six more quarter-point increases. On similar logic, the normalized yield on the 10-year Treasury note would be 4.5 percent, instead of the current 2.8 percent, and the rate on a 30-year mortgage loan would be 6.2 percent, up from the current 4.4 percent level. Of course, if inflation turns out to move higher than 2 percent, the normalized fed funds rate, and also the other rates, will be correspondingly higher.

Graph 2 shows the real fed funds rates over the same years.

As is apparent from this graph, we have lived through and remain in an exceptionally long period of negative real fed funds rates. It is by far the longest stretch of such negative real rates in our six decades of data. While normal real fed funds rates are positive, it is not unusual for them to be negative for some periods, such as when the Fed is facing a recession, or a financial crisis, or both, or has a desire to inflate asset prices. Extended negative real interest rates are good at inducing asset-price booms.

Since the 1950s, there were negative real fed funds rates during the following times:

• Six quarters during 1956-1958;

• Two quarters during 1970-1971;

• 15 quarters during 1974-1977;

• Five quarters during 1979-1980;

• Three quarters at about zero in 1992-1993;

• 11 quarters during 2002-2005;

• Three quarters in 2008.

And then the all-time champion run of negative real fed funds rates:

• 30 quarters, equivalent to 7.5 years, during 2009 to now.

It is hardly surprising that this period has been accompanied by booms in equity, bond and house prices. Was the Fed’s strategy during these years wise? The future will judge that, looking back.

For now, we can say, in sum, that the Fed’s target fed funds rate remains remarkably low, is still negative in real terms, and has a long way to go to get back to normal.

Macroeconomics and the unknowable future

Published in the Financial Times.

Martin Wolf is so right that “a macroeconomics that does not include the possibility of crises misses the essential” (“Economics failed us before the global crisis,” March 21). Indeed, institutions, debt and the temptations of leverage are essential to the theory, especially leverage, which is the snake in the financial Garden of Eden. The expectations of the most rational, intelligent and well-informed people are often enough surprised and shocked by events. That the financial and economic future is not only unknown, but unknowable, is what an adequate macroeconomic theory must incorporate.

How much has the dollar shrunk since you were born?

Published by the R Street Institute.

The depreciation of the U.S. dollar’s purchasing power has been endemic from the post-World War II years up to today. It got completely out of control in the 1970s and has continued apace since then, although at a lower rate. Our fiat currency central bank, the Federal Reserve, has formally committed itself to perpetual depreciation of the purchasing power of the currency (otherwise known as 2 percent inflation), every year forever.

It is hard intuitively to realize how big the effects of compound interest are over long periods of time, whether it is making something get bigger or smaller. In this case, it means how much average prices are multiplying and how much the dollar is shrinking.

The following table simply shows the Consumer Price Index over seven decades, starting with 1946. For each year, it calculates how many times average prices have multiplied from then to now, and how many cents were then equivalent to one 2017 dollar. For example, in 1948, I was in kindergarten. Since then, prices have multiplied by a factor of 10 times. Today’s $1 is worth what $0.10 was then. Taking another example, in 1965, I graduated from college and luckily met my future wife. Prices have since multiplied 7.8 times. And so on.

You may find it interesting to pick a year—say the year you were born, graduated from high school, first got a regular paycheck, got married or bought a house—and see how much average prices have multiplied since. Next, see how many cents it took at that point to have the equivalent purchasing power of $1 now. In my experience, most people find these numbers surprising, including the changes from more recent times – say, the year 2000. They become inspired to start remembering individual prices of things at various stages of their own lives.

Multiplying Prices and the Shrinking Dollar over Time, 1946-2017

You can also project the table into the future and see what will happen if the future is like the past.

Since average prices can go up over 10 times in the course of an single lifetime—as the table shows they, in fact, have—it is easy to see one reason it is hard to generate sufficient savings for retirement. You have to finance paying what prices will be in the future when you are retired. In the last 40 years (see 1977 on the table), average prices have quadrupled. Then, $0.25 bought what $1 does now. So if you are 40 years old now, by the time you are 80, prices would quadruple again. Good luck with your 401(k)!

Economic crises are invariably failures of the imagination

Published in Real Clear Markets.

A fundamental issue in all risk management is oversight vs. seeing.  You can be doing plenty of oversight, analysis, regulation and compliance, with much diligence and having checkers check on checkers, but is the whole process able to envision the deep and surprising risks that are the true fault lines under your feet?  Or are you only analyzing, regulating, writing up and color coding dozens of factors which while important, are not the big risk which is going to take you and perhaps the system of which you are a part, down?  For example, in the midst of your risk management oversight efforts, whether as a company or as the government, could you see in 2005 or 2006, or at the latest by 2007, that U.S. average house prices across the whole country, were likely to drop like a stone?  And see what would happen then?

Most people, including the most intelligent, experienced and informed, could not.

Former Treasury Secretary Timothy Geithner, in his memoir of the 2007-2009 financial crisis, Stress Test (2014), draws this essential conclusion: “Our crisis, after all, was largely a failure of imagination. Every crisis is.” If you can’t imagine it, if you consider that the deep risk event is unimaginable or impossible, your oversight will not see the risk. “For all our concern about ‘froth’,” Geithner continues, “we didn’t foresee how a nationwide decline in home prices could induce panic in the financial system.”

This is a profoundly important insight.  Geithner expands on it: “Our failures of foresight were primarily failures of imagination, like the failure to foresee terrorists flying planes into buildings before September 11.  But severe financial crises had happened for centuries in multiple countries, in many shapes and forms, always with pretty bad outcomes.  For all my talk about tail risk, negative extremes, and stress scenarios, our visions of darkness still weren’t dark enough.”

That was not for lack of effort, but for lack of seeing.  “The actual main failing was over-reliance on formal econometric models,” banking scholar Charles Goodhart suggests in his acute essay, “Central bank evolution: lessons learnt from the sub-prime crisis” (2016).  He points out that as the housing bubble was inflating, there was copious housing finance data which could be and was analyzed:

“There were excellent monthly data on virtually all aspects of mortgage finance in the USA starting from the 1950s.  By the 2000s such data provided over 50 years of all aspects of US mortgage finance.  During this period, there had only been a very few months in which the value of houses, and the mortgages related to them, of a regionally diversified portfolio of housing assets over the US as a whole had faced a loss, and then only a very small one.

“While there had been sharp declines in housing valuations in certain specific regions, i.e. the North East in 1991-2, the oil producing states in the mid-1980s, etc., a regionally diversified portfolio virtually never showed a loss, and then only a minor one, over these 50 years.”  The conclusion seemed clear enough at the time: house prices did not, so would not, fall on a national average basis.  A portfolio of mortgages diversified across regions would be protected.  “Virtually everyone was sucked into the general conventional wisdom that housing prices”—on average—“were almost sure to continue trending generally upwards.”

This clear, though in retrospect completely wrong, conclusion could be professionally quantified: “Put those data into a regression analysis, and then what you will get out is an estimate that any loss of value in a regionally diversified portfolio of greater than about three or four percent would be…highly improbable.”  But as the bubble got maximally inflated, its shriveling became highly probable instead of improbable.  As we know, average U.S, house prices went down by 27% and fell not for a few months, but for six years, in spite of all kinds of government interventions.  The housing market went down for longer than a great many people could stay solvent.

“Of course,” Goodhart reminds us, “econometric regressions are based on the implicit assumption that the future will be like the past.” The less of the past we know, the worse an assumption this is. In this case, fifty years and one country, even a very big country, were not enough.

To expand how much of the past we have studied, both in terms of more time and more places, is perhaps one way to improve our ability to see risks, imagine otherwise unimaginable outcomes, and thus improve our risk oversight.  Perhaps.  There are no guarantees of success.

Competing Mortgage Credit Scores: A decision for those who take the risk

Published by the R Street Institute.

The use of credit scores by Fannie Mae and Freddie Mac, as one part of their decisions about which mortgages they will buy and guarantee, is by nature an “inside baseball” mortgage-finance discussion, but it has made its way into the regulatory reform bill passed by the Senate March 14.

How such scores are statistically created, how predictive they are of loan defaults, how to improve their performance, whether to introduce new scoring methods and the relative predictive ability of alternative methods are above all technical matters of mortgage credit-risk management. These questions are properly decided by those who take the mortgage credit risk and make profits or losses accordingly. This applies to Fannie and Freddie (and equally to any holder of mortgage credit risk with real skin in the game). Those who originate and sell mortgages, but bear no credit risk themselves, and those with various political positions to advance, may certainly have interesting and valuable opinions, but are not the relevant decision makers.

Should Fannie and Freddie stick with their historic use of FICO credit scores, or use VantageScores instead, or both or in some combination?  Naturally, their own scores are favored by the companies who produce them and they should make the strongest cases they can. Should Fannie and Freddie more experimentally use other “alternative credit scores” different from either?  This can also be argued, although it remains theoretical.

The Senate bill requires Fannie and Freddie to consider alternative credit-scoring models and to solicit applications from competitive producers of the scores for analysis and consideration. That is something a rational mortgage credit business would want to do from time to time in any case, and in fact, Fannie and Freddie have analyzed alternative credit scores. The bill further requires that the process of the review and analysis of credit score performance must itself be reviewed periodically, which is certainly reasonable.

Thus the bill would require a process. But when it comes to the actual decisions about which credit scores to use and how to use them in managing the credit risks they take, Fannie and Freddie themselves are the proper decision makers. In my view, they would not necessarily have to make the same decision. Moreover, either or both could decide to run pilot program experiments, if they found that useful.

The Federal Housing Finance Agency (FHFA), Fannie and Freddie’s regulator and conservator, has in process a thoughtful and careful project to consider these questions, has solicited and is gathering public comments from interested parties and displays a very good grasp of the issues involved. But I do not think that, at the end of this project, the FHFA should make the decision. Rather, Fannie and Freddie should make their own credit-scoring decisions, subject to regulatory review by the FHFA—and of course in accordance with the regulatory reform bill, if it becomes law, as I hope it will.

House prices: What the Fed hath wrought

Published in The Hill.

After the peak of the housing bubble in 2006, U.S. house prices fell for six years, until 2012. Are these memories getting a little hazy?

The Federal Reserve, through forcing years of negative real short-term interest rates, suppressing long-term rates, and financing Fannie Mae and Freddie Mac to the tune of $1.8 trillion on its own vastly expanded balance sheet, set out to make house prices go back up.  It succeeded.  Indeed it has overachieved.  Average house prices are now significantly higher than they were at the top of the bubble.  This is shown in the following 20-year history of the familiar S&P Case-Shiller national house price index.

Read the full article here.