Mortgage Finance

This article by John Krainer of the San Francisco Fed has lots of information about the evolution of mortgage finance. This is important for thinking about the financial crisis of course. This is especially relevant for thinking about the relative importance of Government Sponsored Enterprises (GSE's) like Fannie Mae and Freddie Mac versus the non-agency securitizers. We can see, for example, that as the housing bubble proceeded the share of mortgages supplied by the GSE's declined:


We can also see that the non-agency lenders were more highly represented in the more risky types of mortgages at the height of the boom. For 2006 we have this picture:


Thus:

Compared with mortgages purchased by the GSEs, non-agency securitizations were much more likely to involve adjustable-rate mortgages, including option ARMs, to be rated as subprime, and to have less-than-full documentation of borrower income and assets. The median FICO credit score for the non-agency securitizations was about 30 points lower than for the mortgages held or guaranteed by Fannie Mae or Freddie Mac and much closer to the credit scores typically associated with loans guaranteed by Ginnie Mae.

These pictures are not consistent with the view that the housing bubble was the fault of the GSE's alone. Deteriorating standards seemed to accelerate as the GSE share fell.

Real Costs

The Brazilian Real has been appreciating significantly since last March. This rally has pushed the price of Big Mac up dramatically, according to this story in Bloomberg:

Buying McDonald’s Corp.’s flagship hamburger costs 8 reais in Sao Paulo, or $4.62, compared with $3.99 in New York and 2.29 pounds in the U.K. capital, or $3.74.

This is the counterpart to the dollar's weakening of course. But Brazil's President has not taken this lying down. As the Economist reports:

Brazil has gone for the direct approach. Foreign capital has flooded in, attracted by the healthy prospects for economic growth and high short-term interest rates. That has pushed up local stock prices, as well as the real, Brazil’s currency. To stem the tide, the government this week reintroduced a tax on foreign purchases of equities and bonds. Though many doubt the long-term efficacy of such measures, it had an immediate effect. The real, which had risen by more than one-third since March, fell by 2% (before regaining some ground). Brazil’s main stockmarket dropped by almost 3%.

This seems like quite a costly way to prevent currency appreciation -- cause your own stock market to fall. Perhaps a useful move to prick a bubble, but Brazil's appreciation versus the dollar does not seem to be driven by much other than fundamentals.

It's the fault of smart guys

Calvin Trillin explains how the financial crisis was caused by the migration of smart guys to Wall Street. Wall Street used to be populated by the lower third of the class. Then smart guys started going too. That is what caused the invention of complex securities:

“Did you ever hear the word ‘derivatives’?” he said. “Do you think our guys could have invented, say, credit default swaps? Give me a break! They couldn’t have done the math.”

“When the smart guys started this business of securitizing things that didn’t even exist in the first place, who was running the firms they worked for? Our guys! The lower third of the class! Guys who didn’t have the foggiest notion of what a credit default swap was. All our guys knew was that they were getting disgustingly rich, and they had gotten to like that. All of that easy money had eaten away at their sense of enoughness.”

Maskin on the Crisis

Nobel Laureate Eric Maskin discusses what he sees as essential reading on the financial crisis. Here is one tidbit:

I don’t accept the criticism that economic theory failed to provide a framework for understanding this crisis. Indeed, the papers we’re discussing today show pretty clearly why the crisis occurred and what we can do about it. The sort of economics that deserves attack is Alan Greenspan’s idealized world, in which financial markets work perfectly well on their own and don’t require government action. There are, of course, still economists – probably fewer than before – who believe in that world. But it is an extreme position and not one likely to be held by those who understand the papers we’re talking about.

Nobel Prize

Okay, so everybody now knows that Elinor Ostrom and Oliver Williamson won the Nobel Prize. A good day for Berkeley Economics! Williamson paid 82-1 in our pool, and nobody bet on Ostrom. here is the Nobel Prize committee announcement. Michael Spence talks about it here. And here and here are discussions at Marginal Revolution.

Nobel Update

Here are the latest odds for our lottery:

Economist	Payoff to a Dollar Bet
Diamond	5.2222222	to	1
Mortensen	7.6153846	to	1
Sims	7.6153846	to	2
Pissarides	10.2	to	1
Hansen	13	to	1
Nordaus	17.666667	to	1
Shiller	17.666667	to	1
White	27	to	1
Fehr	36.333333	to	1
Dreze	55	to	1
Feldstein	55	to	1
Hausman	55	to	1
Hendry	55	to	1
Jorgensen	55	to	1
The Field	55	to	1
Tirole	55	to	1
Williamson	55	to	1
Arthur	111	to	1
Barro	111	to	1
Broom, John	111	to	1
Dasgupa	111	to	1
Fama	111	to	1
Hart	111	to	1
Holmstrom	111	to	1
Kornai	111	to	1
Krueger	111	to	1
Nelson	111	to	1
Romer	111	to	1
Sachs	111	to	1
Sargent	111	to	1
Wilson	111	to	1
Winter	111	to	1

Strong Dollar

Treasury Secretary Geithner said, as recently as October 3, that “it is very important to the United States that we continue to have a strong dollar,” as reported by Bloomberg. Yet, the dollar continues to slide: 12 percentfrom its peak this year in March as measured by the Federal Reserve’s trade- weighted Real Major Currencies Dollar Index.

As of this point, investors no longer believe this rhetoric, which is standard for Treasury Secretaries:

“Since the dollar has been weak and weakening for years, Geithner was using a code phrase, a carry-over from the Bush administration,” said David Malpass, president of research firm Encima Global in New York. “It means that the U.S. approves of a constantly weakening dollar but doesn’t want a disruptive collapse,” said Malpass, the former chief economist at Bear Stearns Cos. and deputy assistant Treasury secretary from 1986 to 1989.

The government has used the phrase for so long that “I don’t think it has much meaning left for the markets,” said Vassili Serebriakov, a currency strategist at Wells Fargo Bank in New York. “Once you have this policy in place I don’t think there’s any possible choice but for the Treasury to stick to what it’s been saying all this time.”

The problem is that the desire for the dollar to be strong is in conflict with the need to adjust to the large current account deficit. US economic recovery requires an increase in exports, and current account adjustment requires that plus reduced imports, and that requires a weak, rather than a strong dollar. Economic policies pursued to combat the recession do not induce expectations of a stronger dollar in the future.

The problem, of course, is the fundamental conflict between internal and external objectives of economic policy. To be the world's reserve currency requires sacrificing internal concerns for external ones, so that confidence in the currency is maintained. This is hard to do when we are in a deep recession.

Nobel Prize

The Nobel Prize in economics will be announced on Monday. Our annual lottery (which tends to be more accurate than all other pools and lotteries in the profession) is underway. Here are the latest odds.

Economist	Payoff to a Dollar Bet
Diamond	5.5	to	1
Mortensen	7.6666667	to	1
Pissarides	7.6666667	to	1
Shiller	12	to	1
Sims	12	to	2
Nordaus	18.5	to	1
Fehr	25	to	1
Hansen	25	to	1
Dreze	38	to	1
Hausman	38	to	1
Hendry	38	to	1
The Field	38	to	1
White	38	to	1
Williamson	38	to	1
Arthur	77	to	1
Barro	77	to	1
Broom, John	77	to	1
Feldstein	77	to	1
Hart	77	to	1
Holmstrom	77	to	1
Jorgensen	77	to	1
Kornai	77	to	1
Krueger	77	to	1
Nelson	77	to	1
Sachs	77	to	1
Sargent	77	to	1
Wilson	77	to	1
Winter	77	to	1

Lehman Again

Richard Robb has an interesting counter to the argument that the impact of Lehman's failure was overblown. His main point is that the looking only at Libor and the overnight swap market was misleading at that time:

The latest contribution by John Cochrane and Luigi Zingales, like others before them, rests partly on misunderstanding of the data. The authors deduce that Lehman wasn’t the main cause of last autumn’s turmoil by inspecting the daily movements in the spread between Overnight Interest Rate Swaps and three-month Libor, which they define as “the rate at which banks can borrow unsecured for three months.”

But a better definition of Libor under the circumstances was “the rate at which banks said they can borrow”. Libor is the result of a survey, not a measure of actual transactions. In the week of September 15 last year, big banks refused to settle foreign exchange with each other. They were not lending interbank for three month terms, so Libor during that week tells us little.

We could say the same thing for OIS. Volume was light to nonexistent in the week of September 15 last year. What we do know is that three-month T-bills traded at 0.04 per cent on September 17, down from 1.47 per cent on Friday September 12. These are real data that ought to impress the professors that the market was breaking down as fast as it knows how.

In addition to this argument there is the additional point that Lehman's collapse led to the run on money markets because the Reserve Primary Fund held lots of Lehman debt. This cause them to break the buck, and this led to a run on other money market funds. Since money market funds are the main purchasers of commercial paper, this spread the crisis to the rest of the economy. This is the amplification mechanism that was crucial in generating such a large impact from the failure of a relatively small bank failure.

Fiscal Multipliers

Here are some links, courtesy of Mark Thoma and Econbrowser, for discussion on the size of fiscal multipliers.

New Summers Profile

The New Yorker has a profile of Larry Summers. The focus in on how the Obama team dealt with the economic crisis, and how Summers has evolved.

Securitization and Beef

One argument against regulation is that private companies have an incentive to conform to the highest standards to maintain their reputation. They won't shift risks even when the opportunity arises because this will hurt them in the future. Yet, this argument does not always work, as this article in the New York Times on E Coli in ground beef explains.

Ground beef is combined together from different suppliers, much like a collateralized debt obligation. This makes it very hard to identify the source of an outbreak.

Ground beef is usually not simply a chunk of meat run through a grinder. Instead, records and interviews show, a single portion of hamburger meat is often an amalgam of various grades of meat from different parts of cows and even from different slaughterhouses. These cuts of meat are particularly vulnerable to E. coli contamination, food experts and officials say. Despite this, there is no federal requirement for grinders to test their ingredients for the pathogen.

Self regulation does not work here very well:

Unwritten agreements between some companies appear to stand in the way of ingredient testing. Many big slaughterhouses will sell only to grinders who agree not to test their shipments for E. coli, according to officials at two large grinding companies. Slaughterhouses fear that one grinder’s discovery of E. coli will set off a recall of ingredients they sold to others.

Given how often I eat hamburgers this is a most important story. It seems incentives for self-regulation here are much worse than in the financial industry. Notice that with securitization the problem is that it is very difficult to disentangle the loans that make up the security. But in hamburgers it is impossible to distinguish which producers supplied the tainted meat. This is due to the lack of testing at the source, a result of an inadequate regulatory structure and the failure of self-regulation in this industry.

Goolsbee: funniest DC celebrity

Austan Goolsbee is the funniest celebrity in Washington according to Politico. See his standup routine here.