John B. Taylor and Russ Roberts “Chart Cast”: Potential GDP and the Current Not-So-Great Recovery

Upon Further Review: a residential housing market with shadow market of foreclosures -or- a total eclipse of foreclosures?

John B. Taylor in his book Getting Off Track : How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis makes the grand observation that the financial crisis was a government lead failure. That government policy, or more succinctly politico policy, set the stage for shenanigans that occurred in the private sector leading to the financial crisis. (1)

Morgenson and Rosner in their book Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon write a detailed account, stretching back decades, and names-names regarding politico policy and the actors that set the stage for shenanigans. (2)

In an essay entitled Upside Down Economics Thomas Sowell writes a concise time line regarding politico policy setting the stage for shenanigans. (3)

M. Jay Wells essay Why the Mortgage Crisis Happened also provides a very good chronological history of politico policy from 1933 to 2008 which set the stage for shenanigans. (4)

Regardless of history and empirical study, certain individuals want to notionally blame the private sector or the market or banks for the financial melt down when in fact the case is politico failure of the first degree. The “market failure” mantra regarding the financial crisis is, of course, carried forward and lauded by politicos themselves to deflect the true case of politico failure.

One then arrives at today’s aftermath, a murky quagmire of residential home values falling and few new homes being built, a deflationary spiral of value if you will. The declining values fueled, in part, by abundant foreclosures with a pipeline full of foreclosures yet to come to market. One might find that the shadow inventory of foreclosures yet to come to market, depicted as a “pipeline”, may well be much bigger than advertised. How so?

Roger Arnold, chief economist for ALM Advisors, writes in an essay entitled U.S. Housing Market Cannot Recover:

“The most important issues to consider are:

　


How many foreclosures have there been?
How many more will there be?
What do the banks plan to do with them?
　
Properties received by banks through the process of foreclosure are carried and accounted for as Other Real Estate Owned (OREO). The three primary categories of OREO are 1-4 Unit Residential, Commercial, and Construction and Development.

In this column, I will only address 1-4 Unit Residential properties, which represent 25% of all OREO at U.S. banks. I will discuss the others in future column or in the comments section below if readers are interested.

There are about 7,000 banks in the U.S. and OREO affects all of them. The principal value of mortgages tied to the OREO at the four largest institutions, JPMorgan Chase(JPM_), Bank of America(BAC_), Citigroup(C_), and Wells Fargo(WFC_) is much lower as a percentage of outstanding loans than at the smaller institutions below them. This is because the smaller banks have foreclosed on non-performing mortgages while the larger institutions have not.

The result of this is that the outstanding value of non-performing mortgages held by the four largest money centers are much higher than at the smaller banks. The money centers have simply not been foreclosing.

The value of the loans attached to OREO, the properties already foreclosed on by the four largest money centers, is only 3% of the value of the non-performing loans they hold; the properties that have yet to be foreclosed on but most probably will be.

The 97% of mortgage loans that have not been foreclosed on but probably will be makes up the largest percentage of what is known as shadow inventory. This number is so horrifically high that even the pundits aware of the issue won't discuss it publicly -- probably because their own livelihoods could be at stake for doing so.” (5)

Arnold goes on to make this statement:

“Just think of the damage that has been done to the housing sector, as well as the national and global economies and financial markets, with only 3% of the probable foreclosures required as a result of the U.S. housing crash having been completed to date.” (6)

Hence the pipeline of foreclosures on their way to market is nothing in comparison to the reservoir of foreclosures feeding the pipeline. Hence it’s not so much a shadow inventory of foreclosures as it is a total eclipse of an inventory.

Notes:

(1) John B. Taylor, Getting Off Track : How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis.

http://www.hooverpress.org/productdetails.cfm?PC=1342

(2) Morgenson and Rosner, Reckless Endangerment: How Outsized Ambition, Greed, and Corruption Led to Economic Armageddon.

http://www.amazon.com/Reckless-Endangerment-Outsized-Corruption-Armageddon/dp/0805091203

(3) Upside Down Economics, Thomas Sowell.

 http://townhall.com/columnists/thomassowell/2009/02/18/upside_down_economics/page/full/

(4) M. Jay Wells essay Why the Mortgage Crisis Happened.

http://www.americanthinker.com/2008/10/what_really_happened_in_the_mo.html

　
(5) U.S. Housing Market Cannot Recover, Roger Arnold


http://www.thestreet.com/story/11533664/2/us-housing-cannot-recover.html

　

　

Obama Mortgage Refinance Plan [White House market intervention-distortion #1,621]

‘President Barack Obama announced a package of proposals designed to jolt the housing market, his latest effort to reignite the economy after four years of foreclosures and falling home prices.

“This housing crisis struck right at the heart of what it means to be middle class in America: our homes,” Obama said in a speech in the Washington suburb of Falls Church, Virginia. “We need to do everything in our power to repair the damage and make responsible families whole.”

The president said his plan would make it easier for homeowners to refinance their mortgages into current low interest rates, which are now below 4 percent. Borrowers, even those who owe more than their homes are worth, would be able to refinance into loans guaranteed by the Federal Housing Administration.

To pay for the program, Obama will ask Congress for a tax on financial companies with more than $50 billion in assets. Congress has refused to act on similar requests twice in the last two years.

“No more red tape, no more runaround from the banks,” Obama said. “A small fee on the largest financial institutions will make sure that it doesn’t add to the deficit.” ’ (1)


Upon further review, the implicit underlying argument of the semi-bailout described above is that the market failed. However, if markets fail, then governments fail too.

Taking the if markets fail, then governments fail too argument to the externality phase, then both markets and government generate externalities. However, the negative externalities [neighborhood effects] associated with markets are often vilified (without regard to positive externalities) ending in a tax and/or regulation. How about government externalities?

Government, more succinctly politicos through the mechanism of government, and public policy, more succinctly politico policy, are always politically framed as only exhibiting positive externalities. Yet once notional politico policy becomes effective, several years hence, cascading unintended consequences occur which are in effect the externalities of politico policy aka government failure e.g. Medicaid, Medicare, social security, the multitude of other Great Society programs, public education K-12 etc., etc.

One needs to examine government failure and associated externalities and the response. Rather than scrapping policy that fails, more policy is instituted to supposedly correct the root policy failure which merely continues to fail.

“Government is the only enterprise on earth that when it fails, it merely does the same thing over again, just bigger.” -Don Luskin, TrendMacro

“I think the government solution to a problem is usually as bad as the problem and very often makes the problem worse.” - Milton Friedman


John B. Taylor, Stanford University economist, wrote a book entitled Getting Off Track, how government actions and interventions caused, prolonged, and worsened the financial crisis. Within this very short book [82 pages] Taylor makes a very convincing argument that government actions, became government failure and set the stage for financial shenanigans [externalities]. No government intervention, then no government failure, and hence no stage set for shenanigans. (2)

The negative externalities being mortgage loan brokers and other mortgage loan access points that engaged in shenanigans as the stage had been set by government through constant and prolonged interventions into the mortgage loan market. Consequentially, mortgages ended up resulting in ownership of homes, at the margin, by buyers who did not qualify. However, the negative externalities could have never occurred had not the environment been created for such negative externalities by government [politicos through the mechanism of government].

In a nutshell, beginning with the market intervention of the community reinvestment act, the promotion of ownership above historical standards by manipulation of GSE’s [Fannie, Freddie, etc.], government directed lowered loan standards, coupled with the Federal Reserve (government) creating a cheap money bubble 2002-2004 created the stage for shenanigans. That the cascading market interventions cause cascading market distortions.

Coming half full circle, we have politicos through the mechanism of government creating market intervention-distortion, creating government failure, causing negative externalities. No doubt mortgage lenders where involved as they took advantage of the environment created for shenanigans. However, rather than reversing course and ending market intervention-distortion policy, the politico, on queue, advocates more market intervention-distortion - or - “Government is the only enterprise on earth that when it fails, it merely does the same thing over again, just bigger.” -Don Luskin, TrendMacro

Now coming three fourth circle, one must examine the proposition that Markets never clear perfectly. Why? Serially uncorrelated errors. Hence no perfection can occur. The market clearing proposition is that quantity demanded will be in equilibrium with quantity supplied with price as the equaling agent. (3)

Closing the loop, paradoxically, intervention-distortion merely creates an environment that magnifies serially uncorrelated errors. That "imperfection" is the argument for intervention-distortion.... when in fact perfection becomes additional imperfection. (4)

In summary, a market never perfectly clears, but it clears in the most part as price changes to bring quantity demanded into equilibrium with quantity supplied. Hence constant distortions impede equilibrium therefore the market distorts and quantity demanded or quantity supplied, given no perfection, can not come into a dynamic equilibrium. In the case of the current housing market, constant and continuous market intervention distortion will leave the market out of equilibrium and delay market clearing, albeit imperfect.

Notes:

(1) Obama Plans Assistance for Rentals, Mortgage Refinancing, Bloomberg/Newsweek, 02/01/2012

http://www.businessweek.com/news/2012-02-01/obama-plans-assistance-for-rentals-mortgage-refinancing.html

(2) Getting Off Track, how government actions and interventions caused, prolonged, and worsened the financial crisis, John B. Taylor, 2009.

(3) After Keynesian Macroeconomics, Robert E. Lucas and Thomas J. Sargent.

http://www.bos.frb.org/economic/conf/conf19/conf19d.pdf

(4) Ibid

What Fannie and Freddie Knew, The SEC shows how the toxic twins turbocharged the housing bubble. - WSJ

Democrats have spent years arguing that private lenders created the housing boom and bust, and that Fannie Mae and Freddie Mac merely came along for the ride. This was always a politically convenient fiction, and now thanks to the unlikely source of the Securities and Exchange Commission we have a trail of evidence showing how the failed mortgage giants turbocharged the crisis. - The Wall Street Journal, 12/23/2011

Link to entire essay appears below:


http://online.wsj.com/article/SB10001424052970204791104577110643650732030.html


Note: for additional perspective, one might consider reading Stanford University economist John B. Taylor’s book Getting Off Track, how government actions and interventions caused, prolonged, and worsened the financial crisis.

http://www.amazon.com/Getting-Off-Track-Interventions-PUBLICATION/dp/0817949712/ref=sr_1_5?s=books&ie=UTF8&qid=1325044510&sr=1-5

Politicos Through the Mechanism of Government: Busting Bubbles and Benumbing Freezes

John B. Taylor in his book Getting Off Track makes the most excellent point that politicos through the mechanism of government created financial policy in regards to home ownership and the finance thereof [1978 - 2007] along with another branch of government [the Fed] creating a cheap money bubble [2002-2004] that set the table for the ensuing financial shenanigans. If one sets the table for shenanigans one should not be surprised that shenanigans actually do occur. -Or- if one sets the table for financial shenanigans then do not be surprised when financial shenanigans actually occur. (1)

Keeping the above observation in mind, what happens when politicos through the mechanism of government create a regulation machine that increases regulation at an increasing rate [1930 - present]. That the regulation increasing at an increasing rate, and in its regulatory summation, becomes a veritable mountain of regulation. That the mountain of regulation becomes a mountain chain of regulation [2008 - present]. Has another table been set for shenanigans?

If the financial crisis was a bubble created by politicos through the mechanism of government, which was merely a central planning scheme, then is regulation merely another central planning scheme, created by politicos through the mechanism of government, to create a “freeze”?

Moreover, if the fermentation of the effervescent bubble creating the financial crisis was approximately time period 1978 -2007, what about the benumb chill of the freeze of regulation with time period 1930 to present? If the financial crisis fermented for 30 years, does the benumbing effect of regulation over 80 years create a regulatory crisis of even greater magnitude than the financial crisis?

Finally, the 30 years of fermentation of the financial crisis was brought to the busting bubble stage by the cheap money effect of the Fed. Does the benumbing effect of mountains of regulation become a total freeze stage (the antithesis of the busting bubble) through a sudden and encompassing hyper-regulatory effect e.g. regulatory policies of 2008 to present embodied by Dodd-Frank, Consumer Protection Agency, EPA, Department of Energy, etc., etc..

In both instances, politicos through the mechanism of government have exercised central planning schemes known as financial policy and regulatory policy. One must consider such central planning schemes by politicos with the following insight:

This way lies charlatanism and worse. To act on the belief that we possess the knowledge and the power which enable us to shape the processes of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harm.

But in the social field the erroneous belief that the exercise of some power would have beneficial consequences is likely to lead to a new power to coerce other men being conferred on some authority. Even if such power is not in itself bad, its exercise is likely to impede the functioning of those spontaneous ordering forces by which, without understanding them, man is in fact so largely assisted in the pursuit of his aims. - F.A. Hayek, from the essay The Knowledge of Pretense (2)


Notes:

(1) John B. Taylor, Getting Off Track, pages 3 and 4.

(2) F.A. Hayek, 12/11/1974, Nobel Prize Lecture, http://www.nobelprize.org/nobel_prizes/economics/laureates/1974/hayek-lecture.html

U.S. Government to Sue 17 Financial Firms Over Home Loans

"The top federal housing regulator filed lawsuits on Friday against 17 of the world's biggest financial institutions, saying they sold $196 billion of risky home loans over four years to Fannie Mae and Freddie Mac without adequately disclosing the risks.

The suits, filed by the Federal Housing Finance Agency, represent the most sweeping action to date from a federal regulator stemming from the mortgage meltdown, which brought the financial system to its knees in the fall of 2008 and helped push the economy into a deep recession." (1)

"Among those targeted by the lawsuits were Bank of America Corp., Citigroup Inc., JP Morgan Chase & Co., and Goldman Sachs Group Inc. Large European banks including The Royal Bank of Scotland, Barclays Bank and Credit Suisse were also sued.

The lawsuits were filed by the Federal Housing Finance Agency. It oversees Fannie and Freddie, the two agencies that buy mortgages loans and mortgage securities issued by the lenders.

The total price tag for the mortgage-backed securities sold to Fannie and Freddie by the firms named in the lawsuits: $196 billion." (2)

Milton Friedman stated many times that legal recourse is one of those checks and balances within free enterprise/free markets to weed out the unscrupulous.

In this particular case exactly where is the root problem? Does legal action need taken to root out the source of the problem or the problem's results?

In John B. Taylor's book Getting Off Track he makes a very convincing argument that the government itself set the stage for financial shenanigans. (3) The community reinvestment act, the Clinton Administration's aim to raise the percentage of home ownership, the lowering of standards for a loan application approval (which was government directed), etc., along with the cheap money bubble created in 2003-2004 by the Fed [government] set the stage for the financial shenanigans that followed. Stated alternatively, no government intervention in the housing market and no government induced cheap money bubble then no stage is set for financial shenanigans. If one sets the stage for financial shenanigans then one should be surprised to find financial shenanigans?!?

Secondly, the residential housing sector is in a depression. Partly due to the above phenomena and also due to the government directing way too many resources into a single sector (residential housing) via the aid of the tax code. Hence suing lenders is going to help the housing market -or- is suing lenders merely blaming some entities for the housing market depression?

Most importantly, how does this action solve the current economic malaise?

Notes:

(1) U.S. Sues Big Banks Over Home Mortgages, Wall Street Journal, 09/02/2011
http://online.wsj.com/article/SB10001424053111903895904576546904174271250.html

(2) Feds sue big banks over sales of risky investments, Yahoo Finance, 09/02/2011
http://finance.yahoo.com/news/Feds-sue-biggest-US-banks-apf-3066897747.html

(3) Getting Off Track: How Government Actions and Interventions Caused, Prolonged, and Worsened the Financial Crisis. John B. Taylor, Hoover Institution Press, February, 2009.

Public School Shenanigans vs. the Voucher-Student-Consumer

A very interesting observation set forth by John B. Taylor in his book Getting Off Track, how government actions and interventions caused, prolonged, and worsened the financial crisis is the cheap money bubble created by the Federal Reserve set the stage for the financial shenanigans that followed leading up to the financial crisis. No cheap money bubble, no environment for shenanigans. That is a most excellent point. If you create an economic environment for shenanigans, don’t be surprised by the ensuing shenanigans. (1)


Taylor’s observation is applicable to public education in the United States. How so? Milton Friedman pointed out the environment for public education shenanigans long ago in his 1955 essay The Role of Government in Education. That is, Friedman introduced the voucher concept, in that, the money should follow the student rather than being bestowed upon the educational institution. By bestowing the money upon the educational institution you create an environment for shenanigans. (2)

Friedman further advocated that this new consumer, the voucher-student-consumer, should be free to choose what educational outlet he/she will spend the money upon. That is, Friedman advocated freedom of choice in schools so the new voucher consumer student had a competitive educational market place competing for his/her business. The student then having the ability to make exchange at the point of mutual self interest.

A basic problem in K-12 education and also in higher education is the failure of funds to reach the classroom (student). Money is funneled away to top heavy in numbers and well paid administration with Cadillac health care plans and defined benefit retirement plans. Many instructors, professors and classroom teachers also have first class benefit plans and the same defined benefit retirement plans. Moreover, professors have tenure (life time appointments) and teacher unions and organizations make it near impossible to remove non-performing public school teachers.

Further, top heavy administration, top shelf benefit plans, lavish retirement plans, and employee entrenchment are not going away any time soon. Nay, nay! The situation is perpetuated by public education employees along with their associated organizations and unions voting for, campaigning for, and providing funding for politicos that will continue the status quo. -Or- voting for and supporting politicos that will perpetuate the environment for shenanigans.

Going back to Milton Friedman, we need to revisit Friedman’s fourth category of spending: Other people (politicos), spending other peoples’ money (taxpayer), on other people (recipient class). The recipient class in this case being public education employees. Hence the environment for shenanigans is closely related to the “other peoples’ money” phenomena. (3)

However, the public education environment for shenanigans is to a major degree mitigated by a simple proposition set forth in 1955 by Friedman: the money should follow the student rather than being bestowed upon the educational institution. The voucher-student-consumer , now given the power to be a rational consumer [holds the purse strings with the freedom to choose], is going to demand that the money arrives at the classroom level for his or her education. A supply will quickly follow.

The voucher-student-consumer will quickly put an end to the shenanigans.

Notes:

(1) John B. Taylor, Getting Off Track, how government actions and interventions caused, prolonged, and worsened the financial crisis.

(2) Milton Friedman, The Role of Government in Education. http://www.freerepublic.com/focus/f-news/1173402/posts

(3) Milton Friedman, Four Catagories of Spending. http://bartsblogg.blogspot.com/2008/10/milton-friedman-4-ways-money-is-spent.html

State tax revenues, consequential spending, and public sector union “rent seeking”

State Tax Revenue, State Spending, and the Real Estate Bubble


State government tax revenue and associated state government spending was in fact related to the real estate bubble. Related in that much tax revenue was generated by the real estate bubble.

State government tax revenue and state government spending from 1995 until the demise of Lehman was related to the following two propositions:

(1) that politicos through the mechanism of government fueled the real estate bubble by creating public policy (community reinvestment act, Fannie and Freddie, etc.) that caused an inordinate amount of capital to be directed into residential and commercial real estate as well as causing marginal buyers to enter the market as these marginal buyers now qualified for loans of which they would not have qualified without government intervention into the market,

(2) that John B. Taylor’s book Getting Off Track is likely the most empirical explanation of the creation of a cheap money bubble by the Federal Reserve. That the cheap money bubble, in and of itself, set the stage (created the environment) for the ensuing financial shenanigans in the residential and commercial real estate markets, (1)

As the real estate bubble was in its many stages of bubbling-up, state tax revenue began increasing at an increasing rate. The tax revenues thrown off by the real estate bubble helped fill state tax coffers.

From the mid 1990’s until the recession of 2001 state governments increased spending in an unsustainable fashion. During the 2001 recession states suddenly found themselves with spending outpacing revenue and the alarm bells went off. Enter the Federal Reserve created cheap money bubble. (2)

As the Federal Reserve induced cheap money bubble played out the real estate bubble continued. As the bubble continued through its stages headed for its eventual collapse, the transactions associated with the bubble continued to throw off tax revenue to state governments.

Hence we have a real estate bubble beginning in the mid 1990’s and ending basically with the collapse of Lehman. We also have state tax revenues increasing in the mid 1990’s, dropping off momentarily during the 2001 recession, then marching on until the demise of Lehman.

Rent Seeking

During this period of increasing state government revenue “rent seeking” increased. What is “rent seeking”?

‘ "Rent seeking" is one of the most important insights in the last fifty years of economics and, unfortunately, one of the most inappropriately labeled. Gordon Tullock originated the idea in 1967, and Anne Krueger introduced the label in 1974. The idea is simple but powerful. People are said to seek rents when they try to obtain benefits for themselves through the political arena. They typically do so by getting a subsidy for a good they produce or for being in a particular class of people, by getting a tariff on a good they produce, or by getting a special regulation that hampers their competitors. Elderly people, for example, often seek higher Social Security payments; steel producers often seek restrictions on imports of steel; and licensed electricians and doctors often lobby to keep regulations in place that restrict competition from unlicensed electricians or doctors.’ (3)

During this period of basically uninterrupted state government revenue growth, one stealth rent seeker was public sector unions. Hence increasing tax revenue of state government became a natural rent seeking target for public sector unions. With increasing state government revenues, union representatives of public sector unions lobbied, through rent seeking, for their supposed right to the increased tax revenue stream. The rent seeking activities of public sector unions is “stealth” in that:

(1) wage increases make too much headline hence the unions want additional employee benefits and retirement benefits as these benefits generally don’t make headlines like a “wage” figure makes headline,

(2) work place rules, sick pay, vacation time, etc. are buried in state employee manuals were the public have minor access,

(3) “total compensation” is then much enhanced yet the “wage” figure still seems somewhat reasonable.

What goes up must continue to go up and rent seeking rigidity

Rent seeking activities are not something granted by "government". Governments do not "think" nor grant benefits. Its important to remember that politicos through the mechanism of government think and grant benefits.

Governments never learn. Only people learn. - Milton Friedman

Politicos that grant rent seeking activities generally due so through a phenomena known as political constituency building. That is, by granting rent seeking activities the selected beneficiaries then become supporters of the particular politico or group of politicos. Hence any reversing of the rent seek activity is opposed by the beneficiaries and hence opposed by the sponsoring/associated politico or group of politicos.

Taking back a rent seeking benefit, reversing such benefits, voids the concept of what goes up must continue to go up. You see, rent seeking activities are in no way related to Sir Isaac Newton proposition that what goes up must come down.

Hence the past rent seeking activities, in this particular case rent seeking activities of public sector unions, becomes rigid in that neither the beneficiary (union) nor sponsor (politicos) want to return any rent seeking gains.

Tax revenue and rent seeking

Politicos like to discuss "government tax revenue". That is, politicos love to label items in political terms. One must not lose sight of the fact that "government tax revenue" is really your tax dollar. Politicos love to lament special interest groups. Yet the same politicos grant rent seeking requests on a regular basis to build constituency.

Hence politicos use your tax dollar to build constituency. Nice huh?

Notes

(1) Getting Off Track, , How Government Actions and Interventions Caused, Prolonged, and Worsened the Finacial Crisis, John B. Taylor, Hoover Institution Press, 2009.

(2) Red Ink Rising, The Economist, print edition, 08/09/2001.

(3) http://www.econlib.org/library/Enc/RentSeeking.html