Topic: Regulatory Studies

The Foreclosure Five Dominate Case-Shiller Price Indexes

A CNNMoney.com report, “Home prices in record drop,” posted a scary map labeled “Falling Homes Sales.” But it actually shows falling home prices. Within the S&P Case-Shiller sample of 20 metropolitan areas, the steepest drop in prices (not sales) were in Phoenix, Las Vegas, San Francisco, Los Angeles, San Diego, Tampa and Detroit.

All 7 of those metropolitan areas (7 out of 20 in that index) lie within 5 states with by far the worst mortgage problems, as shown in my February 21 article, “The Foreclosure Five.” Yet I also showed that states with the steepest price declines also have had huge increases in home sales, which makes the label on the CNNMoney map doubly misleading.

My article used third quarter house prices because fourth quarter figures were not yet available. That turns out to make even less difference than I expected.

The fourth quarter Federal Housing Finance Agency (FHFA) figures show home prices down 21.8% for the year in Nevada, 20.5% in California, 15.2% in Arizona, 19.5% in Florida, and 11.8% in Michigan. Prices were down 3.7% in the median state, North Carolina, but up 21.6% over five years. That means prices fell by less than 3.7% last year in 24 states— including a half dozen states with home prices up a bit, and New York with only a 3.3% decline.

CNNMoney says, “The decline does not seem to be slowing - just the opposite. The average home price dropped 2.5% between November and December in the 20 top metro areas.” The FHFA data for all 50 states, by contrast, show a small 0.1% increase in home prices between November and December.

The article goes on say, “The S&P Case-Shiller National Home Price Index reported that prices sank a record 18.2% during the last three months of 2008, compared with the same period in 2007. Case-Shiller’s index of 20 major metropolitan areas fell 18.5%, also a record.” The FHFA, by contrast, shows that prices fell just 8.2% during the last three months of 2008, or 3.7% if using a median average. Ten percentage points is quite a wide gap.

What accounts for such huge differences between Case-Shiller and federal price indexes? CNNMoney imagines it’s because “Homes purchased without financing or ones too expensive to qualify for a Fannie-Freddie loan are not counted in the FFHA (sic) statistics.” That’s more than unlikely. The inclusion of cash sales and jumbo loans (larger than $729,750 in pricey area) can’t possibly explain why price declines in the Case-Shiller index look so much more dramatic those in the OFHEO/FHFA index.

The real reason is simple: Case-Shiller indexes are hugely dominated by the Foreclosure Five. In the Case-Shiller index of only 20 “top” metro areas, the Foreclosure Five account for 41.2% of that value-weighted index with California alone accounting for 27.4%.

The “national” Case-Shiller index totally excludes 13 states, such as Indiana and South Carolina, and samples only a fraction of many others. The Foreclosure Five account for 28.3% of that “national” index, with California amounting to 17.1%.

As is true of nearly all reprorting about foreclosures, underwater mortgages and falling house prices, what the Case-Shiller price index really shows is that many people are confusing what has been happening in the Foreclosure Five with what has been happening in the nation as a whole.

Toxic TARP: Mr. Geithner’s Takeover Targets

A front-page story in the February 23 Wall Street Journal describes a plan to let the government convert its preferred shares in Citigroup to common stock, taking 25-40% ownership.

It could be worse.  A brilliant February 19 Journal report by Peter Eavis warned that “Government capital injections sit like ill-disguised Trojan horses in the nation’s largest banks,” showing that under Treasury Secretary Geithner’s socialist scheming the government could seize 74% of Citigroup and 66% of Bank of America. Meanwhile, most other reporters kept claiming bank stocks collapsed simply because Geithner had left out a few details.  On the contrary, he said too much, not too little.

The newer Journal report says, “When federal officials began pumping capital into U.S. banks last October, few experts would have predicted that the government would soon be wrestling with the possibility of taking voting control of large financial institutions… . Citigroup’s low share price already reflects, at least in part, a fear among shareholders that their stakes might be further diluted. A government move to take a big stake could backfire, potentially spurring investors to flee other banks, even healthier ones [emphais added].”

Why is any of this a surprise?  Even before the scary “capital purchase program” was unveiled, I wrote in the October 20, 2008 issue of National Review that, “Conservative legislators who expressed fear about letting the Treasury buy mortgage-backed bonds were strangely enthusiastic about inviting the Treasury to acquire equity in companies.  Critics of derivatives became enthusiasts for warrants … which would give the Treasury secretary virtually unlimited power to confiscate the wealth of stockholders of any company foolhardy enough to play this game.” 

More recently, in a February 11 New York Post piece (subtly titled “A Plan to Kill Banks”) I explained that, “Once a bank or insurance company gets in bed with the government, the property rights of that company’s stockholders become uniquely insecure. When the government jumps into the cockpit, smart stockholders bail out.  And depressed stock prices deflate the banks’ capital cushion.”

If “few experts” predicted these consequences of Treasury purchases of bank preferred shares and warrants, then why are they called experts?

Europeans Want Regulatory Harmonization at G20 Summit

Reuters has a very disturbing article about the wish list that Europeans have put together for the April G20 Summit in London. Rather than focus on the source of the financial crisis by calling for sound money and elimination of housing subsidies, the Europeans want to dramatically increase the size and power of international bureaucracies such as the International Monetary Fund. But if the IMF completely failed to predict the financial crisis, why would anyone think the bureaucrats should get more power and more tax dollars? Not surprisingly, the Europeans also want regulatory harmonization, with every jurisdiction required to impose onerous levels of red tape. Apparently, the private sector needs to be punished to atone for the mistakes of governments. Not surprisingly, the Europeans also want to regulate private-sector pay. But the most dangerous plank in their platform is the call for sanctions against jurisdictions that reject the regulatory cartel and instead maintain market-based financial systems. This panoply of bad ideas is a direct threat to American interests, so it will be interesting to see whether the U.S. delegation acquiesces to these bad ideas:

European leaders met in Berlin on Sunday to prepare a common stance on overhauling global financial rules ahead of a broader summit of G20 nations in London on April 2. Below are highlights from a “chair’s summary” of conclusions from the meeting that was seen by Reuters: …We propose that the International Monetary Fund (IMF) and the Financial Stability Forum (FSF) be charged with monitoring and promoting the implementation of the international recommendations on putting the Action Plan into practice. We have today underscored once again our conviction that all financial markets, products and participants must be subject to appropriate oversight or regulation, without exception and regardless of their country of domicile. This is especially true for those private pools of capital, including hedge funds… We also agreed that credit rating agencies should be subject to mandatory registration and oversight. …A list of uncooperative jurisdictions and a toolbox of sanctions must be devised as soon as possible. …We will strongly advocate (at the London summit)…the development of an effective early warning system by the IMF and FSF, working in close cooperation. We will strongly advocate (at the London summit)…the adoption of principles on compensation practices to prevent bonus payments that contribute to excessive risk-taking. …We have agreed today to support doubling the funds available to the IMF.

When Will Ford Defend its Interests?

Earlier this week, the Congress and President Obama authorized a $787 billion borrow-and-spend plan to create “or preserve” 3.5 million American jobs. So, could there be a better time than now for GM and Chrysler to announce they will need billions more taxpayer dollars to avoid having to let go hundreds of thousand of workers? How likely is Washington to cut off the auto producers at this particular juncture?

It shouldn’t come as a surprise that GM and Chrysler are asking for a lot more money because, well, the warnings were issued. In fact, Bush’s decision to defy Congress and provide “loans” to GM ($9.4 billion) and Chrysler ($4 billion) back in December wasn’t even intended as a cure all. It was designed to buy time for the producers to come up with detailed viability plans for their next bite at the apple. And as expected, central to both viability plans, which were unveiled yesterday, is more taxpayer money.  At the moment, a combined $22 billion is being requested, which would bring the total doled out to just under $40 billion.

Just as stunning as the implied blackmail (give us money or we’ll give you idled workers) being perpetrated by GM and Chrysler is the continued silence of Ford. There is probably no company in America that stands to lose more from taxpayer subsidization of GM and Chrysler. (The foreign nameplate producers in the United States are also penalized by subsidies to GM and Chrysler, but in the current environment it is probably wiser for them to bite their tongues. And Ford is more of a direct competitor with the other Detroit producers than are the foreign nameplates, anyway.)

If GM and Chrysler were no longer producing, Ford would be able to pick up market share and productive assets from the others, and ultimately improve its own long term prospects. By keeping GM and Chrysler afloat with subsidies, the government is implicitly taxing Ford. Ford is facing unfair, government-subsidized competition, of the sort alleged against foreign producers all the time. But in this case, the subsidies are real, direct, quantifiable, and large. Ford is relatively healthy now, but continued subsidization of the others could well drive Ford to the trough, too.

When companies are losing billions per month with sales revenues continuing to shrink, it doesn’t require a finance degree to discern an imminent cash flow crisis. Even if the demand environment were picking up, these companies would still be losing money because their cost structures are impossibly inefficient. GM and Chrysler have nibbled around the edges to cut costs. Brands are being sold off or scrapped. Factories are being closed. Dealership arrangements are being terminated. But none of those changes addresses the big issues, particularly for GM: an unmanageable capital structure (its debt burden is too heavy), unmanageable legacy costs (paying for lavish promises made in the past), and uncompetitive operating costs (including still much higher than industry-average compensation).

Reorganization or liquidation under one of the bankruptcy chapters will condense the timetable for resolving this problem, will save taxpayer money, and very importantly, will speed the return to stability in the automobile market worldwide. It’s time for Ford to speak out on behalf of this solution too.

Executive Pay Restrictions

Government-imposed pay restrictions are generally a bad idea; we have literally centuries of evidence showing that price controls always undermine economic performance.

But in the case of executives who came begging to the feds after mismanaging their companies: Sorry, guys, you asked for it.

President Obama’s proposal gets me nervous since it may lead to further meddling by government, but there is a silver lining.  Bailouts are a major threat to the economy’s long-run dynamism, so I want to discourage companies from sticking their snouts in the public trough. Restricting pay for incompetent corporate executives is not a proper role of government (by definition, successful corporate executives do not try to loot taxpayers).  But propping up poorly-run companies is so misguided that second-best (or even 50th-best) options may be palatable.  Corporate chieftains who run their companies into the ground should not be allowed to simultaneously shift the burden of their mistakes to taxpayers and expect multi-million dollar pay packages.

The Freedom to Do Business

Cato author Tim Sandefur has a video on YouTube about a truly awful business regulation in Oregon, one that prevents anyone from starting a moving company without in effect the permission of the existing moving companies. As you can probably imagine, they aren’t eager to give it.

Sandefur and his employer, the Pacific Legal Foundation, are fighting the cartel:

Good for them.

Of Cab Fares and Health Care: Markets with Uncertainty Require Competition between Payment Systems

Last week, I was late for a briefing on Capitol Hill. Some would say that was because traffic snafus caused by the March for Life blocked the usual route from the Cato Institute to Capitol Hill, requiring our cabbie to circle back to Cato and take another route. I say the real reason was the D.C. Taxicab Commission.

The D.C. Taxicab Commission requires all cabbies to use the same fare system. Until recently, the commission required cabbies to use a zone system. Under the zone system, the fare from Cato to Capitol Hill was the same flat rate, no matter what route the cabbie chose or how long the ride. If a cabbie encountered a traffic obstruction that slowed him down, then he bore the cost of that lost time. He received no additional money for waiting in traffic or taking a longer route, and the lost time meant that he would collect fewer fares. Therefore, a cabbie that charges according to zones, or any fixed price per trip, has an incentive to learn about and avoid significant traffic obstructions.

Recently, however, the D.C. Taxicab Commission required all cabs to switch from zones to meters that charge by the minute and by the mile. Under the meter system, the passenger bears the cost of delay, because meters charge additional money for every extra minute and every extra mile. Therefore, cabbies have little incentive to learn about and avoid significant traffic obstructions.

In sum, if our cabbie were paid a fixed price for taking us from Cato to Capitol Hill, he probably would have paid more attention to traffic conditions – on the radio, his mobile phone, etc.. He would have known that the usual route was blocked, because he would have borne the cost of delay. But because the D.C. Taxicab Commission requires him to use a meter, he cared a lot less about delay.

The problem is not the meter system. The old zone system probably had its own perverse outcomes, perhaps dead zones where you couldn’t catch a taxi or cabbies who drove too fast. The problem is that the DC Taxicab Commission dictates a single payment system for all taxis. Absent that mandate, cabbies would use different payment systems and competition would force each to offer better service. “Zone” taxis would slow down and pick up fares in more areas, while “meter” taxis would try to avoid unnecessary delays.

Incidentally, that’s the same reason America spends too much on health care and so few Americans have electronic medical records.

The federal government is the largest purchaser of medical services and it effectively dictates a single payment system for most providers. Medicare pays providers on a fee-for-service basis, which is akin to paying cabbies on the basis of meters. (The federal tax code further encourages fee-for-service payment by insulating consumers from the cost of their health insurance.) As a result, doctors and hospitals have little reason to invest in things (e.g., comparative-effectiveness research, electronic medical records) that help avoid unnecessary services, because Medicare pays for unnecessary services. In contrast, prepaid group plans like Kaiser Permanente receive a fixed amount per patient, which is akin to paying cabbies on the basis of zones. Kaiser conducts comparative-effectiveness research and provides electronic medical records to its enrollees because Kaiser bears the cost of unnecessary or duplicative services.

Markets use competition between different payment systems to improve quality and reduce costs, particularly in markets with uncertainty. That form of competition is usually lost when government runs the show.