The Economist this week (25 October 2008) claimed that the U.S. national debt is at 38% of GDP (page 40, column 2). I'm still scratching my head over that one. Apparently it thinks U.S. GDP is like $30 trillion or the national debt is only about $5 trillion. No wonder it won't review my book. (It also unfairly ripped Abington, Pa. a few weeks ago.)
More importantly, The Economist also reported (p. 92) that "a growing number of economists, and now the Bush administration, believe that the credit crunch also has to be addressed at its source -- in America's housing market, where prices have fallen almost one-fifth from their preak, and foreclosures have soared." Perhaps there is still hope for the Wright Rescue Plan! Unfortunately, the magazine again ignores my work, though it mentioned plans by Feldstein, Zingales, Hubbard, and Mayer. It recommends Zingales' plan, which entails forced loan renegotations, but notes, correctly, that such a policy could "well lead to a higher cost of credit in the future." No kidding! No other scheme that I have yet seen has hit upon the key insight of the Wright Rescue Plan, that if lenders can mortgage foreclosed property mortgage backed securities can be priced and balance sheet uncertainty will end. And that will be the beginning of the end of the crisis.
Friday, October 24, 2008
Wednesday, October 22, 2008
Mortgage difficulties in 1830: Henry Van Der Lyn as Nostradamus
Reading through part of the Diary of Henry Van Der Lyn (New York Historical Society, Vol. 1, pps. 245-46) today, I was struck by the following entry, dated 1830. It isn't written in quatrains but it does reinforce Mark Twain's notion that history, if it doesn't repeat, at least rhymes:
There was a company chartered Last winter by the Legislature in N.Y. called the Trust Co[mpan]y which is now lending money all over the state, where ever they have applicants, at 7 percent on Bond & Mortgage. They have the lands of each applicant appraised & lend him 1/2 of the appraised value for a term of years. Interest payable every six months. This is a dangerous business both for the Company & the Applicants. Many persons will take larger sums of money than they otherwise would, merely because it [is] as easy to get a large as a small sum and will thus encumber their property by a claim they never can meet, when it is called for & will be disabled by the every encumbrance to obtain any new credit. They will thus live with[ou]t hope and their mortgaged farms will soon show all the ruin & waste attendant as an occupant who has no interest in keeping up the constant repairs necessary to maintain a farm in good condition. Others will endeavor to Mortgage their farms for all the money they can get & never intend to repay the money, making use of this scheme of borrowing in order to sell their farms to the company. Thus in the end a Number of farms will fall into the hands of the Co[mpan]y which they will not be able to rent for any cash rent, and which they will not be able to sell for 1/2 of the money they advanced. At this moment a great deal of money is (I may say a very unusual quantity) is loaned by the Banks at Utica & by this Trust Co[mpan]y on apparently very easy terms, but the time for repayment will soon come & a reaction on the very Banks, who are now so profuse is at hand, when many borrowers will be cramped & be ruined & property will have to change hands; and a general depression, confusion & scarcity of money, will inevitably follow. In short, the Co[mpan]y at N.Y. should not lend their money on the security of farms in the Country: & Persons here, should never, without the most despearate necessity encumber their farms by a Mortgage as they thereby at once lose their independence, their spirits & their Ambition.
There was a company chartered Last winter by the Legislature in N.Y. called the Trust Co[mpan]y which is now lending money all over the state, where ever they have applicants, at 7 percent on Bond & Mortgage. They have the lands of each applicant appraised & lend him 1/2 of the appraised value for a term of years. Interest payable every six months. This is a dangerous business both for the Company & the Applicants. Many persons will take larger sums of money than they otherwise would, merely because it [is] as easy to get a large as a small sum and will thus encumber their property by a claim they never can meet, when it is called for & will be disabled by the every encumbrance to obtain any new credit. They will thus live with[ou]t hope and their mortgaged farms will soon show all the ruin & waste attendant as an occupant who has no interest in keeping up the constant repairs necessary to maintain a farm in good condition. Others will endeavor to Mortgage their farms for all the money they can get & never intend to repay the money, making use of this scheme of borrowing in order to sell their farms to the company. Thus in the end a Number of farms will fall into the hands of the Co[mpan]y which they will not be able to rent for any cash rent, and which they will not be able to sell for 1/2 of the money they advanced. At this moment a great deal of money is (I may say a very unusual quantity) is loaned by the Banks at Utica & by this Trust Co[mpan]y on apparently very easy terms, but the time for repayment will soon come & a reaction on the very Banks, who are now so profuse is at hand, when many borrowers will be cramped & be ruined & property will have to change hands; and a general depression, confusion & scarcity of money, will inevitably follow. In short, the Co[mpan]y at N.Y. should not lend their money on the security of farms in the Country: & Persons here, should never, without the most despearate necessity encumber their farms by a Mortgage as they thereby at once lose their independence, their spirits & their Ambition.
Monday, October 13, 2008
Interest in the debt rises (on the debt too)
As the financial crisis drags on, people are beginning to pay attention to the national debt again. It has soared over $10 trillion, sparking a slew of stories about the national debt clock in New York City running out of digits. Soon, scientific notation may be necessary to express what we owe.
The silver lining is that the federal government is borrowing money very cheaply right now because investors see it as the safest thing going. The trouble is that it is all of short duration and will need to be refinanced in a few years, perhaps at much higher rates if we begin to feel the sting of inflation.
One Nation Under Debt has benefited a little from this resurgence of interest but let's face it, the book has not really received its just due yet in terms of reviews. I just found more evidence of the book's main thesis, that the non-predatory nature of the U.S. government after the ratification of the Constitution was the main reason for the country's economic success, which of course was a necessary precondition to debt repayment. The evidence bolsters the book's main counterfactual, the relative poverty of Canada, which labored under arbitrary, authoritarian rule until well into the 19th century. Its economy suffered accordingly as the following passage shows.
The silver lining is that the federal government is borrowing money very cheaply right now because investors see it as the safest thing going. The trouble is that it is all of short duration and will need to be refinanced in a few years, perhaps at much higher rates if we begin to feel the sting of inflation.
One Nation Under Debt has benefited a little from this resurgence of interest but let's face it, the book has not really received its just due yet in terms of reviews. I just found more evidence of the book's main thesis, that the non-predatory nature of the U.S. government after the ratification of the Constitution was the main reason for the country's economic success, which of course was a necessary precondition to debt repayment. The evidence bolsters the book's main counterfactual, the relative poverty of Canada, which labored under arbitrary, authoritarian rule until well into the 19th century. Its economy suffered accordingly as the following passage shows.
At the other side of the [St. Lawrence] river, which is here about two miles in breadth, we saw a rising village, called, I think, Ogdensburgh. I asked my host whether they held any intercourse with the yonder town? 'Yes,' said he, 'we smuggle across all their commodities, notwithstanding the extreme rigor of the revenue laws.' What, continued I, could they possess that you possess not; is not your climate as good, soil as fertile, and your skill in agriculture equal, if not superior to theirs? 'All that is true,' replied the loyal Scotchman, 'but the governments are not alike.' Then he began in the Highlands squawking, drawling tone, a long history of 'the enormous duties on tea, the total absence of internal improvements &c. in the Canadas.' -- Jeremiah O'Callaghan, Usury, Funds, and Banks (Burlington, Vt.: For the Author, 1834), 20.
Thursday, October 9, 2008
Government Ownership of Banks
I see that the federal government is now considering taking equity positions in banks.
This is not as crazy or unprecedented as it may sound.
The federal government owned shares in both the first Bank of the United States (1791-1811) and the second Bank of the United States (1816-1836). There is a nice article about this in the William and Mary Quarterly by Carl Lane.
Early state governments owned considerable amounts of state bank stock, some of which it purchased and some of which it received as a sort of tax or quid pro quo for granting an act of incorporation.
The benefit of stock ownership was that it provided the government with a nice revenue stream.
The cost of stock ownership was the conflict of interest it created. Pennsylvania and New York, for example, were stingy with new bank charters because they did not want to hurt the value of their stock portfolio or decrease their dividends by allowing competitors to enter. That, of course, hurt both depositors and borrowers.
By the 1830s/40s, national and state governments began to divest their bank and other corporate stocks because of such conflicts of interest.
On net, therefore, I think it would be better simply to adopt my plan (see below), or similar ones recently proffered by Glenn Hubbard, Robert Shiller, or Martin Feldstein. (McCain's plan is too vague to evaluate but note its similarities to mine.)
Another thing we might think of doing is walling off safe institutions -- those with minimal exposure to derivatives -- behind very strong government guarantees and letting the rest crash and burn. The billions could then be spent on unemployment and re-education benefits and we could end this nasty moral hazard problem once and for all.
This is not as crazy or unprecedented as it may sound.
The federal government owned shares in both the first Bank of the United States (1791-1811) and the second Bank of the United States (1816-1836). There is a nice article about this in the William and Mary Quarterly by Carl Lane.
Early state governments owned considerable amounts of state bank stock, some of which it purchased and some of which it received as a sort of tax or quid pro quo for granting an act of incorporation.
The benefit of stock ownership was that it provided the government with a nice revenue stream.
The cost of stock ownership was the conflict of interest it created. Pennsylvania and New York, for example, were stingy with new bank charters because they did not want to hurt the value of their stock portfolio or decrease their dividends by allowing competitors to enter. That, of course, hurt both depositors and borrowers.
By the 1830s/40s, national and state governments began to divest their bank and other corporate stocks because of such conflicts of interest.
On net, therefore, I think it would be better simply to adopt my plan (see below), or similar ones recently proffered by Glenn Hubbard, Robert Shiller, or Martin Feldstein. (McCain's plan is too vague to evaluate but note its similarities to mine.)
Another thing we might think of doing is walling off safe institutions -- those with minimal exposure to derivatives -- behind very strong government guarantees and letting the rest crash and burn. The billions could then be spent on unemployment and re-education benefits and we could end this nasty moral hazard problem once and for all.
Wednesday, October 1, 2008
The Wright Rescue Plan
Last Friday (see below), I posted some ideas about how to rescue the economy from recession. I alerted numerous individuals about the plan by email and also sought media attention for it, thus far to no avail (that I know of, anyway). During the course of email and blog comment discussions, it became clear to me that some readers had not grasped the plan's most important features. In this post, I will be more specific.
The heart of the plan is to give homeowners (including financial institutions that come to own homes via foreclosure) the option of refinancing with the Federal government at 7 percent for up to 50 years. The 7 percent will ensure that most Americans will not opt for the Federal refinance (re-fi) because most already have mortgages at a lower APR. The 50 years is to help lower the monthly payments of homeowners who got in over their heads.
The government will pay off the existing principal balance on the mortgage with Treasury bonds. Right now, the government can borrow at low yields. It is the only large economic agent at present that can with great certainty generate a positive spread between its assets (7% mortgages) and its liabilities (2-3% Treasury bonds).
The plan should provide immediate relief to the financial sector because it will effectively remove uncertainty about the value of mortgage-backed securities (and hence credit default swaps, etc.). Either:
a) borrowers will continue to pay their existing mortgages
or
b) borrowers will re-fi with the Federal government, thus removing the risk of their default from the financial system
or
c) borrowers will default, in which case the lenders can re-fi, which will replace the "toxic" asset on their balance sheet with a safe and liquid one (Treasuries).
With the uncertainty gone, the credit markets can again function and mortgage backed securities will rise in value and will begin trading again, ending the cycle of write downs that has caused the recent bankruptcies.
The Wright Rescue Plan is also much more politically astute than the administration plan because it offers aid to homeowners first. While the total amount of aid needed cannot be known with certainty, the plan is clearly not a "bailout" because the government will almost certainly profit from it (at least at today's gross spreads). The sums already appropriated to the Hope for Homeowners program may very well suffice. Finally, and I can not stress this point enough, the plan could be implemented without creating a new federal bureaucracy. The Treasury and IRS already know how much people earn, whether they have existing mortgages, and so forth. They also have the power to garner wages and track people across state lines, so defaults on the re-fi's should be low. If the government comes to own some homes through default, it alone can afford to hold them until the market turns or to re-purpose them. As noted in various posts below, governments have successfully run mortgage programs in the past.
The heart of the plan is to give homeowners (including financial institutions that come to own homes via foreclosure) the option of refinancing with the Federal government at 7 percent for up to 50 years. The 7 percent will ensure that most Americans will not opt for the Federal refinance (re-fi) because most already have mortgages at a lower APR. The 50 years is to help lower the monthly payments of homeowners who got in over their heads.
The government will pay off the existing principal balance on the mortgage with Treasury bonds. Right now, the government can borrow at low yields. It is the only large economic agent at present that can with great certainty generate a positive spread between its assets (7% mortgages) and its liabilities (2-3% Treasury bonds).
The plan should provide immediate relief to the financial sector because it will effectively remove uncertainty about the value of mortgage-backed securities (and hence credit default swaps, etc.). Either:
a) borrowers will continue to pay their existing mortgages
or
b) borrowers will re-fi with the Federal government, thus removing the risk of their default from the financial system
or
c) borrowers will default, in which case the lenders can re-fi, which will replace the "toxic" asset on their balance sheet with a safe and liquid one (Treasuries).
With the uncertainty gone, the credit markets can again function and mortgage backed securities will rise in value and will begin trading again, ending the cycle of write downs that has caused the recent bankruptcies.
The Wright Rescue Plan is also much more politically astute than the administration plan because it offers aid to homeowners first. While the total amount of aid needed cannot be known with certainty, the plan is clearly not a "bailout" because the government will almost certainly profit from it (at least at today's gross spreads). The sums already appropriated to the Hope for Homeowners program may very well suffice. Finally, and I can not stress this point enough, the plan could be implemented without creating a new federal bureaucracy. The Treasury and IRS already know how much people earn, whether they have existing mortgages, and so forth. They also have the power to garner wages and track people across state lines, so defaults on the re-fi's should be low. If the government comes to own some homes through default, it alone can afford to hold them until the market turns or to re-purpose them. As noted in various posts below, governments have successfully run mortgage programs in the past.
The Philadelphia Fed's Money in Motion Exhibit and the Subprime Mortgage Crisis
Thanks to the Jewish holiday, I had the opportunity to take 5 children, including 3 of my own (yes, Alexander Hamilton Was Wright too) to spend the day in Philly. After the obligatory Duck tour, we checked out the Philly Fed's Money in Motion Exhibit. As a guest museum curator myself (for the Museum of American Finance), I appreciated the exhibits in a new way and the kids had a blast. (I suspect they think, wrongly of course, that they can reassemble the shredded money the Philly Fed hands out upon each visitor's exit. Hey, what else are you going to do with the stuff?)
The exhibit "Supervision Mission" was particularly fascinating and provides unintended insights on the subprime mortgage crisis. The exhibit is a computerized game where the visitor starts off as a trainee. After mastering a basic multiple choice test, the trainee becomes a loan officer who has to make decisions about whether or not to lend to various fictional applicants. It was great fun for the kids and even for me, until I started to get the "wrong" answers, invariably because I turned down loans that my electronic boss thought were "good business for the bank." One applicant wanted a $1 million loan on terms that would have had her repaying some $50,000 per month on expected income of like $20,000 per month. She had other collateral of $2 million but the collateral was not income earning. I turned the sucker down only to be chastised for it!
I managed to get promoted (I think everyone does, eventually) to the final level, investment manager. Here, again, my decisions (60% domestic loans, 15% foreign, 15% Treasuries, 10% cash) were chastised as too conservative. Apparently, they wanted primary reserves of less than 5 and secondary of less than 10.
If this is the sort of supervision the Fed gives its banks I have only two words to say:
No wonder!
The exhibit "Supervision Mission" was particularly fascinating and provides unintended insights on the subprime mortgage crisis. The exhibit is a computerized game where the visitor starts off as a trainee. After mastering a basic multiple choice test, the trainee becomes a loan officer who has to make decisions about whether or not to lend to various fictional applicants. It was great fun for the kids and even for me, until I started to get the "wrong" answers, invariably because I turned down loans that my electronic boss thought were "good business for the bank." One applicant wanted a $1 million loan on terms that would have had her repaying some $50,000 per month on expected income of like $20,000 per month. She had other collateral of $2 million but the collateral was not income earning. I turned the sucker down only to be chastised for it!
I managed to get promoted (I think everyone does, eventually) to the final level, investment manager. Here, again, my decisions (60% domestic loans, 15% foreign, 15% Treasuries, 10% cash) were chastised as too conservative. Apparently, they wanted primary reserves of less than 5 and secondary of less than 10.
If this is the sort of supervision the Fed gives its banks I have only two words to say:
No wonder!
Cause of, and Cure for, Hard Times (New York: 1818)
I'm writing a variety of things right now, including a book called Fubarnomics and a book chapter on corporate capitalism. To help with both, I pulled an old pamphlet out of my collection -- Cause of, and Cure for, Hard Times (New York: 1818) -- and was struck by the similarities with our financial struggles today. I received a photocopy of the pamphlet the hard way, via ILL, about a dozen years ago but if readers are interested it is on Google books and also available for purchase in a 2008 edition on Amazon.
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