Tuesday, September 05, 2006

How Do You Solve A Freely Chosen Problem?

Though we’ve already got soccer moms, NASCAR Dads and security moms, the Washington Post (as well as MSNBC’s registration-free version here) has a new set of voting-bloc parents to introduce to the country: “mortgage moms” who are worried sick about the economy and want the government to do something about it.

‘Mortgage moms’ may star in midterm vote
With wages stagnant and debt growing, Democrats see an opportunity

It’s not the stagnating wages that cause most of the problems in the story, but people’s staggering debts and the softening of the housing market:

BURLINGTON, Ky. - Life is cramped at the Condit household. Dale and Sharon Condit and their two young sons need more room but can't seem to sell their current home — on the market now for three months.

In a year when politics is being roiled by angry debates over the Iraq war and immigration, it might seem odd to imagine the midterm elections being waged over square footage and closet space. But these are parts of a lifestyle that Sharon Condit, a deputy clerk of court, describes as dogged by a sense of limits: "We have dreams of this future, but we can't get it right now."

Okay, so they want to sell their house and buy a bigger one, but can’t find a buyer. Being stuck in a cramped house sounds more like an inconvenience than a crisis, though it must be frustrating to feel you’re standing still rather than making advances. But it’s even worse to feel you’re going backward:
At first glance, the economy's role in this year's midterm elections is a puzzle. Economic growth and unemployment are at levels that in past years would have been a clear political asset for the party in power.

But one layer down in the statistics, the answer is more clear. Flat wages and rising debt nationally have converged to leave millions of middle-class households feeling acutely vulnerable to bumps in their financial planning. The most visible of these are rising energy prices and a softening housing market.

A less obvious but powerful variable is the interest paid by people carrying credit card debt or mortgages whose monthly payments vary with interest rates. People buffeted by these trends have given rise to a new and volatile voting block.

It’s hard to feel sympathy for people who got themselves in debt for things they didn’t need and couldn’t afford. And getting an adjustable-rate mortgage when interest rates are at their lowest point in history is pure dumbassery. If there were only one or two people in this predicament we could shrug them off as fools about to learn some hard lessons about the dangers of debt. But it’s not just a couple of people — it’s enough to become a national problem rather than a collection of personal ones.

So here’s a question for free-market libertarians: is there a solution, when so many individuals make uncoerced bad choices that the sum total of those choices begins to cause national repercussions? I’m not arguing for a government fix, but what’s the free-market one?


Anonymous Wild Pegasus said...

People aren't coerced into making bad choices, but we should be mindful of the bad choices they are subsidized into taking. American money is not a free-market development. It is produced and heavily influenced by government, operating through the Federal Reserve. The Federal Reserve is a government-created but privately-owned cartel of banks. This cartel centrally plans the money supply.

As with all central planning, the results are generally bad. The boom and bust cycles are heavily dependent on the Federal Reserve's control over the money supply. The "boom" occurs when money is too cheap, and people borrow to buy what they really shouldn't have. The "bust" is when the accumulated errors simply cannot be sustained any longer (for one reason or another), and those errors are shaken out of the economy.

I don't have the time to explain this well, but if you're interested, the Mises Institute contains the works of Ludwig von Mises, who explained the crappy effects of the central planning of money. Gene Callahan's Economics for Real People is probably the best book to introduce you to the Austrian School of Economics (if you're really interested).

As for short-term politics, no one is going to vote for "There was no good reason for you to borrow money to buy that. Suck it up." But that's the libertarian response, in the short term. The long term is the separation of money and state.

- Josh

3:16 AM  
Anonymous Sandy said...

What Josh said.

Plus, I'm going to be an ass and tell a few people "I told you so," because a) I did, and b) I'm not running for anything.

Politically unhelpful, but personally satisfying.

4:48 AM  
Anonymous Alex said...

I don't think there is a solution, free market or regulatory or whatever else. If enough people make bad decisions, bad stuff will happen.

The only solution, sadly, is to tighten the belt and do your best to ride it out.

That, and buy when the market hits rock bottom. Oh, and lord it over your friends who fell for the bubble hype.

5:16 AM  
Anonymous Brad Warbiany said...

First solution is to look at government actions which have made it worse. The mortgage-interest deduction, particularly the way that people have been able to borrow money against their house for other spending and write off the interest, is a big portion of it. And previously said, the US money supply & inflation give people a much bigger incentive to leverage into a house to lock down their mortgage payment rather than let rents rise with inflation.

Although, you can go one step farther. If we didn't have a public education system that doesn't teach a bit of economics or logic, we might have a system where people can better weigh good and bad choices and won't pick 3-year ARM's when rates are expected to skyrocket in 2-4 years...

7:23 AM  
Blogger rhhardin said...

Every generation has their Dutch Tulip Bulb bubble. Then they know better, and their children find it out in some other craze.

It's the belief that the world is wanting to hand you free money. Not so.

7:42 AM  
Blogger Jennifer said...

I'd say printing money is a legitimate function of government, or would be if we had gold, silver or something else of concrete value to back it up. It's the mass production of money backed up by nothing but faith that concerns me.

But guys, I know what the government could have done or not done to avoid us getting into this mess in the first place. My concern is: now that we're in this mess, what do we do? I personally stand to gain here: no debt, money in the bank, and I'm waiting to pounce and buy a house once the prices go down. (Yes, I know interest rates will go up, but I don't care. I'd rather be in debt for $100K at 13% interest than in debt for $300K at 3%. You can always refinance to get a lower rate later, but you can't refinance a $300K debt down to $100K.)

On the other hand, having enough money to make a nice down payment on a reasonably priced house won't help me if the economy as a whole goes belly-up. That's what concerns me. Almost all of our growth since the last recession was either in the housing market or in consumer spending, and what financed that spending was cheap money, and people treating their houses like ATMS: I'll borrow against the equity at a nice low (adjustable) rate, and that's how I'll pay for my luxury vacation!

Again, I find it hard to feel sorry for these people. But I'm willing to feel sorry for myself if, after years of doing the right thing, staying out of debt and living beneath my means so I could add to my savings, I end up getting screwed anyway. Just wait: sooner or later the government will decide to do something about this. And I have complete faith that whatever they do will make a bad situation worse.

I don't know what it is yet, though. Allow inflation to wipe out the real value of those debts? Pass legislation magically making the bulk of interest debt disappear? Raise taxes for a fund to bail these people out?

8:46 AM  
Blogger Jennifer said...

Another thought occurs to me: it would be very wrong for a person in September 1929 to have said "Since I own no stock, it won't affect me if the stock market collapses next month." I feel the upcoming pop of the housing/credit bubble is a similar thing.

9:24 AM  
Anonymous Jeff P. said...

Slightly off topic. The people who mortgaged their futures on the concept of a perpetual goods-based economy when every single indicator for a decade-and-a-half told them that the information age was going bring about societal change beyond the proliferation of email are second only to the now-ruined dot-com refugees for sheer short-sightedness. Closing your eyes to economic volitility, especially after the 80s and 90s, is no excuse to whine.

And this comes from someone who has made several bad choices, and, despite holding a middle management job, currently has a net worth several dozen points below the poverty line.

9:32 AM  
Anonymous A Moose said...

Best option, drag your feet for six months. Reason: The fed didn't raise rates last month, which typically is an indication that money will free up. The stagnation in the market is primarily due to people with Jennifer's attitude, "I'll get something when the market comes down", combined with people who are selling thinking "I'll sell when the market picks back up". It's interesting, to me, as I'm in the process of liquidating five properties (Jennifer-If you're interested, contact me at the Yahoo address, 'cept they're down in the MD/DC corridor ;>).

By the way, I'm selling based on personal reasons, to reduce my personal monthly expenditures on mortgages and the like (I'm very reasonable, perhaps cheap, by a lot of people's standards in mortgage to income ratio already, btw). This in turn gives me the flexibility to say "A la verga" to the current high dollar job, and go take one which gives me more time to deal with what I want to. My point is, it has nothing to do with the market, overall I think you'll see a return to sane appreciation rates, and this latest stuff is a temporary phenomena.

Basically, the people who are in a fix right now are generally not in a bad fix, just somewhat uncomfortable by their measuring stick. Long term, we need to start teaching a lot more practical money knowledge in schools, as the people who got themselves into the fix to begin with and want the govt to fix it aren't the ones we want teaching kids in the future.

10:05 AM  
Blogger Jennifer said...

The stagnation in the market is primarily due to people with Jennifer's attitude, "I'll get something when the market comes down"

Considering how many areas (including the DC suburbs) have seen housing bubbles these past few years, you could also phrase that as "I'm not going to buy a house when the only way I can 'afford' it is to go into debt I can't possibly ever pay back."

My area isn't even one of the super-duper-bubbly ones, but get this: in one nearby (non-rich) town, prices are so inflated, and property taxes so correspondingly high as a result, that I wouldn't live in some of those homes even if they were rent and mortgage-free; the taxes alone are almost as much as what we pay now for our very nice, spacious, pretty 3-bedroom apartment the same size as that house. And when insurance and maintenance costs are factored in--no way.

There are companies that offer clever mortgage plans to allow me and my SO to 'buy' almost any local house we want, but we're not damnfool enough to fall for it. The only advantage of buying rather than renting is if you can show numbers which say "even if we don't get a raise or a more lucrative job, and the value of our home stays pretty much the same, we will be better off financially if we buy rather than rent now."

11:40 AM  
Blogger Jennifer said...

EDIT: "If the value of our home stays the same in inflation-adjusted dollars."

11:48 AM  
Blogger Timothy said...

Do nothing. Economies go in cycles (the Austrians were the first to propose this, although I tend to buy the RBC argument more), and any sort of tinkering just makes problems worse.

I don't think this is entirely a problem for fiat currencies. The Great Depression, exacerbated by the central banks to a certain degree, happened long before Nixon took us off of the gold standard. There are arguments against commodity-backed currencies as well (mainly having to do with interest-rate interactions through the exchange rate, IIRC), and reversion to that is fairly unlikely at this point. Further, if there is a peg to a commodity at some fixed price somebody has to set the peg.

In the end, the entire global economy is based on belief and expectations anyway (this is the primary insight of Friedman and Lucas), so bad cycling can be avoided so long as expectations are always pretty much the same. This is what lead Friedman to propose that the fed directly target the money supply for some amount of fixed growth annually, he's since backed away from that idea to a certain degree. Plus it's virtually impossible to do in the real world because the information is hard to get.

Inflation targeting is probably the best workable option, it's certainly better than trying to target the interest rate through open market operations.

Anyway...to get closer to on-target here. In the short term the best solution is just to wait, in the longer term the libertarian free-market solution is elimination of political distortion to the housing market: get rid of the interest deduction, take apart Fannie Mae and Freddie Mac (they're government sponsored monopolies, and let banks be much more discriminatory* in their lending practices. Those things would push a lot of the chaff out of the housing market and help mitigate the problems that we're currently seeing.

*Regarding relevant factors to the credit risk, if that isn't clear.

12:48 PM  
Anonymous Eric the .5b said...

What exactly is the precise problem? That lots of people can't sell their houses for a profit?

I'm unclear.

2:09 PM  
Blogger Jennifer said...

The precise problem, Eric, is that many people got themselves into huge amounts of variable-rate debt with payments they could just barely afford to make when interest rates were low, and now interest rates are rising. So a lot of people are going to find trhemselves owing far more than they can afford. Granted, it's usually their own fault for taking on debt they couldn't afford to pay, but all the same it's likely to drive into poverty enough people to be a bona-fide society-wide problem.

I'm not calling for a government solution even if I thought one might work. But I'm not sure what if any free-market solution exists. (By 'solution,' I mean 'a way to get out of this without a lot of people being seriously hurt, to the point where the whole economy suffers.')

2:31 PM  
Anonymous Eric the .5b said...

"all the same it's likely to drive into poverty enough people to be a bona-fide society-wide problem"

How many people is that in tens of thousands or millions, roughly?

2:45 PM  
Blogger Leonard said...

Jennifer, you write: "having enough money to make a nice down payment on a reasonably priced house won't help me if the economy as a whole goes belly-up".

This bears unpacking, but it's basically false.

In most reasonable/probable scenarios, where "belly up" doesn't mean "depression that's worse than the 1930's depression", then your Federal fiat money will remain good. It will therefore help you through that recession.

Only in a hyperinflation scenario, will your money be reduced to worthlessness by the Fed. In that situation, I guess you'd still call the dollar "money", sort of the way Zimbabwean currency is "money". But in that scenario you'd have been better turning your sortof money into something that is better money. Gold, that is.

As for the larger question of how to deal with mass financial delusion: the libertarian "solution", as everyone here is pointing out, is not a one-size-fits-all thing. It's not a "plan", which you can appreciate in the abstract just by reading it. It's not centralized. It's not understanding in toto by any one person.

Rather, it is the normal diffuse working of the markets, albeit more intense than average. A diverse set of thousands or millions of bad financial arrangements must be renegotiated, restructured, or repudiated. A bankrupcy here, a sale there, a refinance here, a write-off there.

2:47 PM  
Blogger Leonard said...

But of course, there is no way out without suffering. People have made promises to other people, and they will eventually break those promises. But those other people have made their own plans, counting on the fulfilment of the promises. How can this possibly be "solved"?

2:57 PM  
Blogger Jennifer said...

How many people is that in tens of thousands or millions, roughly?

I don't know. How many consumers have to go broke in a consumer-driven economy before the economy itself starts to notice? I don't know that either, but I think there's a good chance we'll reach that number.

there is no way out without suffering. People have made promises to other people, and they will eventually break those promises. But those other people have made their own plans, counting on the fulfilment of the promises. How can this possibly be "solved"?

Yeah, I suspect that's true. What worries me is, I don't think this will be limited to people who took out stupid loans and the lenders who made them; I think the effects will go further.

3:34 PM  
Blogger rhhardin said...

What makes it money, if you're curious, is that you'd accept it back as money.

Money, by the way, is not wealth. When they add up the wealth of a country, they don't count money.

Money is a ticket in line to say what the economy does next, presumably something for you. The Fed adjusts the number of tickets outstanding by absorbing them or distributing them, so that not too many people are competing for the same item, and not too few either. This has nothing to do with regulating wealth.

What they're regulating is the value of the currency.

Gold, by contrast, has fluctuated in real value by a factor of 10 since the 1970s, a perfect example of a really rotten store of value.

3:40 PM  
Anonymous Eric the .5b said...

I don't know. How many consumers have to go broke in a consumer-driven economy before the economy itself starts to notice? I don't know that either, but I think there's a good chance we'll reach that number.

Why so? And I'm sorry to keep replying with questions, but I feel like I'm missing something between "lots of variable-rate debt" and "national or international problem of some severity".

3:41 PM  
Blogger Jennifer said...

Why so? And I'm sorry to keep replying with questions, but I feel like I'm missing something between "lots of variable-rate debt" and "national or international problem of some severity".

Because you'll find huge numebrs if people who'd fueled economic growth by buying things they couldn't afford, and when they can't do that it'll affect others: their favorite restaurants and stores lose business, which means they in turn have less money to spend, and so forth.

Here's a quote from an article in the current issue of "Business Week:"

"the best available estimates show that option ARMs have soared in popularity. They accounted for as little as 0.5% of all mortgages written in 2003, but that shot up to at least 12.3% through the first five months of this year, according to FirstAmerican LoanPerformance, an industry tracker. And while they made up at least 40% of mortgages in Salinas, Calif., and 26% in Naples, Fla., they're not just found in overheated coastal markets: Through Mar. 31 of this year, at least 51% of mortgages in West Virginia and 26% in Wyoming were option ARMs. Stock and bond analysts estimate that as many as 1.3 million borrowers took out as much as $389 billion in option ARMs in 2004 and 2005. And it's not letting up. Despite the housing slump, option ARMs totaling $77.2 billion were written in the second quarter of this year, according to investment bank Keefe, Bruyette & Woods Inc."

That is a HELL of a lot of debt for the economy to absorb if people can't pay it back. Anyway, it's a very good article, and well worth reading.

4:08 PM  
Anonymous Sandy said...

It's actually perfectly acceptable for somebody who said "you know, this whole radio thing is a bubble. I'm going to sit this one out" to suggest we let the irrational exuberance work itself out. The '29 crash hurt, but arguably the cure was worse than the disease.

10:09 PM  
Anonymous Wild Pegasus said...

Two additional notes:

1. Governments aren't needed to print money. Private banks have done this for most of currency's history. Paper money began when the deposit slips for vaults were used in lieu of actually withdrawing the metal. Those slips were privately issued and became very popular, very fast. Even today, Scotland's banknotes are issued by private Scottish banks, not the Bank of Scotland.

2. Actual physical cash is a small part of the money supply. The central planning of money controls not only the physical cash, but all the money that is nothing but ledger marks.

- Josh

9:05 AM  
Blogger Jadagul said...

Lots of material here. Timothy, I know we had at least some of this conversation already, but as far as I can tell the Great Depression was caused by the federal reserve fooling around with the money supply. It was basically a combination of a price ceiling on gold and a commitment to sell as much as anyone wanted at that price ceiling—arbitragers could destroy the government completely. If we'd kept our supply of dollars to the amount of gold we had to back it (and priced gold at the right level) rather than trying to maintain a disparity by brute force and huge liquidity contractions, I think things would have turned out much better. And the last word I heard from Friedman is that in his ideal world he'd freeze the supply of high-powered money completely.

And Jennifer, remember that the people who sold out of the stock market in mid-1929 actually did very well over the thirties.

10:49 AM  
Blogger Karen said...

I actually used to work at a state agency with some regulatory authority over consumer lending practices, specifically automobile loans. (Note how I stare at the ground and kick one foot with the other one in a gesture of shame. Well, the choice really is government lawyers who read this blog and government lawyers who don't. Government lawyers are pretty much a given in life, rather in the death and taxes category. At least I'm better informed than the average.) Anyway, there are a number of things specifically in relation to consumer credit that would help in the longer term.

The federal tax code allows lenders to take very large deductions on the "losses" they have from non-performing consumer loans. These deductions effectively insulate credit card companies from any risk whatsoever, so they issue cards to anything that breathes. (Periodically stories appear on CNN and elsewhere of people who noticed that their cats were receiving VISA offers. My eight year old son got one.) Eliminating some of these protections, and restoring some of the risk to consumer lending will make the banks improve their lending practices. Given my background, I have to argue also for aggressive enforcement of the credit fraud laws. Since I dealt with mostly used car dealers, I perhaps have a skewed perspective on this point, but making lenders and originators pay a few stiff fines for fraudulent applications would be a powerful corrective.

As for the specific problem of ARM's, I have no good solutions. My mother was a loan officer who told me to stay far, far away from anything like that. If I couldn't have made a fixed rate payment, I would never have bought a house. Only education will stop that particular bit of foolishness. That and having a few banks take baths on home loans. I strongly believe that broad-based home ownership is just flat better for the world than having most people be renters.

Finally, Jennifer, go ahead and buy that house, although waiting six months at this point isn't a really bad idea. My husband and I bought a house in 1992 for $70,000. We had a downpayment of $10,000, and his mother co-signed the note, so we borrowed an extra $10K to replace some of the 1970's vintage carpet and wallpaper. (Brown carpet. In the bathrooms. Giant gagging yuck.) Anyway, we got very lucky and the house sold in 1999 for $137,000, giving us a massive downpayment for our new house. The point of this is to demonstrate that houses really are good investments, and if you stretch a bit with the first one, you'll have some serious equity for the next one.

5:31 PM  
Blogger Jennifer said...

Karen, I agree that if you can't afford a fixed-rate mortgage with at least 20 percent down you shouldn't get a mortgage at all, which is why I'm not getting a house yet. Housing prices have risen much faster than inflation in my area these past years, and there's nothing remotely like a house for $70,OOO here, unless you want to live in a small, cramped crack den. Not even when you adjust those 1992 dollars for inflation--somewhere between 100 and 120 thousand, I'd guess? Nope, now you can afford a crack den with an extra room. Hell, at those prices I wouldn't just have a house already, I'd be several years ahead on my mortgage payments.

In some of the worst bubbly markets your 70K starter home costs nearly half a million now. My area's not nearly that insane, but prices are still a lot higher than the local economy can logically support. So either there's a housing bubble in many (though not all) regions of the US, or from now on only rich people will be able to afford homes. I lean toward the bubble theory.

And while a popping bubble is great from the perspective of those with savings, who wish to buy, it's bad from the perspective of those in debt for bubble-inflated homes. Especially if the interest rates make the payments jump each month. Enough people going broke is likely to hurt the economy beyond just them.

8:41 PM  

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