Category: Equitablog

The continuing investigation into the U.S. housing bubble

Posted on by Nick Bunker

As a general rule, the larger and more important an event, the longer it takes to sort out its causes. It’s been close to nine years since the bursting of the U.S. housing bubble and researchers are still sorting out the exact dynamics that lead to such a drastic increase in private debt. Obviously, a large amount of household debt was at the heart of the Great Recession of 2007-2009, either directly by affecting household consumption or more indirectly as debt instruments at the heart of the global financial system. But who borrowed this money? And what drove the increase in lending?

Economists Atif Mian of Princeton University and Amir Sufi of the University of Chicago are doing some of the best research on the causes of the housing bubble and the consequences on the broader economy once it popped. In a new working paper published by the National Bureau of Economic Research, Mian and Sufi build on their previous research, focusing on local area dynamics, to look specifically at individual borrowers using data from credit bureaus.

Their results support their earlier findings: debt grew quickest among borrowers with low credit scores. The ratio of debt to income grew rapidly for lower-score borrowers. The ratio grew by 80 percentage points from 2000 to 2006 for the bottom 60 percent of the credit-score distribution and doubled for those in the bottom 20 percent. And low-credit borrowers increased their debt the most in areas that had the strongest housing price growth.

Mian and Sufi interpret these results as supporting their hypothesis that rising house prices lead low-credit borrowers to borrow against the bubble. This behavior, according to the two economists, was the reason for a large part of the increase in household debt. Furthermore, borrowers from the bottom 40 percent of the credit score distribution were primarily responsible for the defaults from 2007 to 2010.

But what does about other research on the housing bubble say? Manuel Adelino of Duke University, Felipe Severino of Dartmouth College, and Antoinette Schoar of the Massachusetts Institute of Technology challenged Mian and Sufi’s earlier interpretation of the debt loads by ZIP code-level data. Adelino, Schoar, and Severino use individual level data on mortgage borrowing and incomes from mortgage applications and find that middle- and high-income borrowers were the main source of borrowing during the bubble and delinquencies during its bursting. In an earlier paper, Mian and Sufi pointed out these data are flawed due to fraud because of overstated incomes.

In this new paper, Mian and Sufi also show other reasons for the discrepancy. First, the mortgage data used by Adelino, Schoar, and Severino misses many borrowers with low credit scores, which makes borrowing appear more skewed upward in the credit distribution. Secondly, the three economists sort borrowers in their analysis by their 2006 credit scores, which makes many borrowers appear higher in the credit distribution as borrowing during the bubble pushed up credit scores. Mian and Sufi sort by 1997 credit scores to avoid the effects of the bubble.

But what’s the broader importance of the results Mian and Sufi present? As the authors note, several economists are working on modeling the dynamics of the housing bubble. There’s a disagreement about whether the increase in debt was the result of a loosening of a borrowing constraints, in which lenders let borrowers take out loans with less collateral, or of a lending constraint, in which lenders give out more loans. One way to test these competing hypotheses is to see if the debt-to-income ratio moves more than the ratio of debt to the value of housing.

Mian and Sufi find that debt-to-income ratios rose steeply for most households and mostly at the bottom of the credit-score distribution while debt-to-home value ratios actually declined for all groups above the bottom 20 percent of the distribution. This is a pretty good sign that lending constraints were loosened, perhaps by “advances” in lending technology such as securitization, which enabled mortgage lenders to sell their mortgages to institutional investors and then originate more mortgages to sell into the securitization machine.

So while the full history of the debt dynamics of the housing bubble isn’t finished, we are getting closer. The image is still fuzzy, but it’s increasingly coming into focus.

Must-Read: John Quiggin: The Most Misleading Definition in Economics (Draft Excerpt from Economics in Two Lessons)

Posted on by Brad DeLong

Must-Read: John Quiggin: The Most Misleading Definition in Economics (Draft Excerpt from Economics in Two Lessons): “‘Pareto optimal’ is arguably, the most misleading term in economics…

…Pareto sought to undermine the utilitarian version of liberalism that dominated 19th century economics, according to which the optimal (most desirable) economic outcome was the one that contributed most to human happiness, often summed up as ‘the greatest good of the greatest number’…. The egalitarian implications of utilitarianism reflect the fact that the needs of poor people are more urgent than those of the better off. So, aggregate utility all be increased by policies that benefit the poorest members of the community, even if these benefits come at the expense of those who are better off. It follows that a substantial degree of income redistribution will be socially desirable…. Pareto’s big achievement, further developed by a large number 20th century economists, was to show that much of economic analysis could be undertaken without reliance on the concept of utility. Hence, interpersonal comparisons of utility, which invariably lead to the conclusion that redistributing wealth more equally is beneficial, could be dismissed as ‘unscientific’.

Pareto didn’t stop with an attack on the economic implications of utilitarianism. Utilitarians such as John Stuart Mill saw that their philosophical framework implied support for political democracy, including the enfranchisement of women…. Pareto reversed this reasoning, arguing that a highly unequal distribution of income was both inevitable and desirable… any attempt at redistribution must be essentially futile…. Pareto… bec[a]me one of the first advocates of a political position combining an extreme free-market position on economic issues with hostility to political liberalism and democracy….

Describing a situation as ‘optimal’ implies that it is the unique best outcome…. This is not the case…. A highly egalitarian allocation can be Pareto optimal. So can any allocation where one person has all the wealth and everyone else is reduced to a bare subsistence. Recognising the inappropriateness of describing radically unfair allocations as ‘optimal’, some economists have used the description ‘Pareto efficient’ instead, but this is not much better. It corresponds neither to the ordinary meaning of ‘efficient’ nor to the meaning with which the term is commonly used in economics…. Opportunity cost gives us a better way to think about the possibility of making some people better off while no one is worse off. If such possibilities exist, then there are potential benefits that have no opportunity costs…. A ‘Pareto optimal’ situation may be described, more simply as one where all opportunity costs are positive.

Must-Read: Claudia Goldin: The Quiet Revolution

Posted on by Brad DeLong

Must-Read: Claudia Goldin: The Quiet Revolution: “The National Longitudinal Survey… began in 1968 with women who were between 14 and 24 years old…

…One of the questions the survey asked was, ‘What do you think you’re going be doing when you’re 35 years old?’ In 1968, young women essentially answered this question as if they were their mothers…. The fraction that said they would be out of the home was much smaller than the fraction that actually did end up working outside the home. But as these women matured and as successive cohorts were interviewed, their perceptions of their futures, their own aspirations, began to change… to match their actual participation rates…. That meant these young women could engage in different forms of investment in themselves; they attended college to prepare for a career, not to meet a suitable spouse. College women began to major in subjects that were more investment oriented, like business and biology, rather than consumption oriented…. One of the most important changes was the appearance of reliable, female-controlled birth control…. Before reliable birth control, a woman faced a nontrivial probability of having her career derailed by an unplanned pregnancy–or she had to pay the penalty of abstinence…. The pill made it possible for women who were ‘on the pill’ to delay marriage, and that, in turn, created a ‘thicker’ marriage market for all women to marry later and further lowered the cost to women of investing in a career….

Women and men have converged in occupations, in labor force participation, in education, where they’ve actually exceeded men — in a host of different aspects of life. One can think about each of these parts of the convergence as being figurative chapters in a metaphorical book. And this metaphorical book, called ‘The Grand Convergence,’ has to have a last chapter. But what will be in the last chapter?… Gender equality in pay per unit of time worked, must have greater temporal flexibility without large penalties to those who work fewer hours or particular schedules…. The question is, why are there some occupations with large gender gaps and others with very narrow gaps? There are some occupations where people face a nonlinear function of wages with respect to hours worked; that is, people earn a disproportionate premium for working long and continuous hours…. Pharmacy is the opposite…. There’s no part-time penalty…. Saying workers are good substitutes for each other sounds like you’re commoditizing them. But it can be true even for very high-income professions…. Pharmacy, which is my favorite example, is very highly paid. For women, pharmacy is the third highest in terms of annual income for full-time employed workers. For men, it’s the eighth highest…

Must-Read: Julie Nelson: Poisoning the Well, or How Economic Theory Damages Moral Imagination

Posted on by Brad DeLong

Must-Read: Julie Nelson: Poisoning the Well, or How Economic Theory Damages Moral Imagination: “Contemporary mainstream economics has widely ‘poisoned the well’…

…from which people get their ideas about the relationship between economics and ethics. The image of economic life as inherently characterized by self-interest, utility- and profit-maximization, and mechanical controllability has caused many businesspeople, judges, sociologists, philosophers, policymakers, critics of economics, and the public at large to come to tolerate greed and opportunism, or even to expect or encourage them. This essay raises and discusses a number of counterarguments that might be made to the charge that current dominant professional practice is having negative ethical effects, as well as discussing some examples of the harms inflicted in the areas of law, care work, the environment, and ethics itself.

Must-Read: Scott Lemieux: David Brooks is not on a Path of Upward Intellectual Mobility

Posted on by Brad DeLong

Must-Read: Scott Lemieux: David Brooks is not on a Path of Upward Intellectual Mobility: “”David ‘vast, lavishly taxpayer-subsidized spaces for entertaining’ Brooks’s scorching Burke-abject-morons hot take on the killing of Freddie Gray…

…cites Robert “alas, not Paul” Samuelson favorably…. [One should] drop the mic. But it’s probably worth explaining in some detail why Brooks and Samuelson’s vaguely fact-resembling assertion that $14,000 per year is spent on poor people in the U.S. is abject nonsense…. Annie Lowrey does the job very effectively…. Samuelson is citing Ron Haskins… who calculated that in 2011, spending dedicated to the poor averaged out to $13,000 per person below the federal poverty line… Medicaid, food stamps, the earned-income tax credit, the child tax credit, the Supplemental Security Income program, welfare, housing assistance, Medicare Part D, grants for school districts serving low-income children, and Pell Grants.
But… Medicaid helps the disabled… and a huge chunk of its spending goes to doctors, hospitals, and administrators…. School grants go to schools, not families. The earned-income tax credit goes to hundreds of thousands of families that are not below the poverty line. You don’t need to be below the poverty line to get food stamps, either….

Robert A. Moffitt of Baltimore’s own Johns Hopkins University has found that aid to profoundly poor single-parent families dropped 35 percent between 1983 and 2004, while it rose 74 percent for those earning a bit more more. “You would think that the government would offer the most support to those who have the lowest incomes and provide less help to those with higher incomes,” he said, releasing his findings. “But that is not the case.”…

Bonuses, wages, and U.S. compensation growth

Posted on by Casey Schoeneberger

Receiving a bonus check is definitely a pleasant experience even if it’s not always a surprise. Getting an extra bump up in pay in December can be a great way to end the year, assuming the worker isn’t depending upon the bonus to get through the end of the year. Bonuses, as you’d expect from the name, were originally intended to reward workers above and beyond their usual wages and salaries. But some new data indicates that bonuses are fast becoming supplements for wage and salary increases instead of complements to them.

In yesterday’s New York Times, Patricia Cohen highlighted the increasing use of bonuses and non-monetary perks to substitute for wage gains. Cohen digs into data provided by the human resources company Aon Hewitt to look at these trends. According to the data, bonuses and other “variable compensation” were only 3.9 percent of payrolls for the companies surveyed in 1988 when the firm started tracking these data. By 2014, this share increased to 12.7 percent. It’s important to note that Aon Hewitt’s data only covers payroll for salaried employees. And it doesn’t mean that just under 13 percent of every individual worker’s paycheck is bonuses. Rather, that out of all payroll for salaried employees, 13 percent is spent on bonuses.

Yet this movement toward bonuses and other non-salary compensation is part of a larger trend in compensation away from cash wages and salary towards other forms of compensation. Employer-provided health insurance and contributions toward retirement plans are now a bigger share of compensation than bonuses, a trend evident over the past several decades. Together, contributions to health insurance and retirement and savings plans were 13.7 of employee compensation in December 2014.

This large share doesn’t mean that employers pick up more of these benefits than in the past, but rather that the portion they do pick up is a larger share of compensation. In fact, employees are paying more for employer-sponsored health insurance and the share of employers sponsoring retirement plans is on the decline. Most economists would point out that in the long run workers pay for the entirety of these benefits, so these shifts are about making the payment more upfront.

But the increase in bonuses as part of overall worker compensation also highlights important short-term consequences. As Cohen notes in her column, bonuses have become more prevalent since the beginning of the Great Recession in late 2007. This shift is particularly evident in the data beginning last year. As Ryan Sweet points out at Moody’s Analytics, a large portion of the increase in compensation growth measured over the course of 2014 was due to increased incentive pay.

If more recent compensation growth in the United States is primarily driven by incentive pay, then how sustainable is that growth? An actual raise in base pay locks in increased earnings and sets a foundation for the next increase. In other words, the raise is a more transparent way for a worker to understand their actual level of compensation and potentially argue for even more when the time comes. Bonuses and other incentive pay are by their very nature temporary. A rough period comes along for a company and suddenly the worker’s compensation could decline.

Perhaps this trend toward bonuses is temporary. If the labor market continues to heal, a tighter jobs market could shift more bargaining power toward workers and return compensation growth toward regular wage and salary raises. But if this shift is actually structural and a new long-term facet of the U.S. labor market, then some serious thinking needs to be done about its effects on economic inequality and sustainable economic growth.

Things to Read on the Evening of May 26, 2015

Posted on by Brad DeLong

Must- and Should-Reads:

Over at Equitable Growth—The Equitablog

Might Like to Be Aware of:

Must-Read: James Kwak: Greg Mankiw Forgot What He Teaches

Posted on by Brad DeLong

Must-Read: James Kwak: Greg Mankiw Forgot What He Teaches: “Mankiw’s [Trans-Pacific Parnership] column is a perfect example of how ideology works…

…It provides a simple way to interpret the world — people who don’t agree with you are idiots or xenophobes — while sweeping aside inconvenient evidence to the contrary. And first-year economics is as powerful an ideology as we have in this country today…”