Just What We “Need”

by Mario Rizzo

Investors’ eagerness to invest in mortgage debt helped drive mortgage rates to all-time lows this week, Freddie Mac said.

The average rate on 30-year fixed-rate mortgages was 4.78%, the agency said Wednesday, matching a record low set in April. That was down from 4.83% from the previous week and 5.97% a year ago

I am amazed that aggregate-demand economists can look at the housing market and simply wonder how to bring it back to normalcy. Today the Wall Street Journal reports that investors are flocking to invest in mortgage-backed securities now that the Fed has been buying them. Freddie and Fannie are too big to fail, and so forth. The risk premium relative to Treasuries has fallen to the narrowest point this year.

From the investor’s perspective these are relatively safe problem-free investments. On the other hand, from the social perspective these investments delay the necessary adjustment of resources out of housing — remember: the over-expanded bubble sector?

Our aggregate-demanders (aka “Keynesians”) do not need to worry because during recessions the allocation of resources is not important. All that matters is propping up spending and restoring “confidence” in something called “the economy.”

UPDATE: A New York Times editorial argues that the housing stimulus is not working. What is their standard of “working”? It is hard to tell precisely. The complaints are that new housing construction has fallen, prices of houses are expected to fall still further and that more homeowners have negative equity. So presumably a policy that “worked” would have increased housing construction, propped up prices, and prevented the spread of negative equity. No readjustment in their play book! What is more disturbing, but predictable, is that the drumbeat for reconsidering the Fed’s plan to begin exiting the housing market has begun:

And the Federal Reserve, whose interventions have sustained the housing market over the past year, must show flexibility. The Fed has made it clear that it would prefer to begin withdrawing support for the market in the months ahead. But without other strong and successful fiscal measures in place, that could do more harm than good.

Stay tuned.

Pain in the Fannie

by Chidem Kurdas

As Fannie Mae goes for its next withdrawal from the $200 billion kitty the US Treasury graciously made available to this government-created and -sustained mortgage financer, it may be useful to look beyond the current housing slump and consider what it augers for the future.

Having made yet another loss, the government-sponsored enterprise needs more money. A report Fannie filed with the Securities and Exchange Commission attributes the $19 billion third-quarter loss to the housing slump and mortgage defaults.  “We do not expect to operate profitably in the foreseeable future,” says  the company.

I always thought it was a great triumph of government public relations to come up with the sweet-sounding Fannie Mae moniker for an entity officially called the Federal National Mortgage Association.  Now I understand what the nickname really means—a pain in the taxpayers’ backside for the foreseeable future.

The business has been adversely affected by helping delinquent or imminently-in-default borrowers to modify their mortgages so as to reduce their monthly payments. As the economy recovers, defaults will decline, and presumably this aid will no longer be needed. But it is not clear when – or even if – the subsidy program will end.

In fact, it may be extended.  Fannie “may recommend supplementing the program with other initiatives that would allow us, pursuant to our mission, to assist more homeowners.”

Behold: The Recovery Is At Hand

by Mario Rizzo  

The Gross Domestic Product (GDP) is growing again at an annual 3.5% rate for the third quarter of 2009. Some people say this means that the recession is over. Apart from the much-touted stubborn unemployment problem, does this make sense? 

Reflating the Bubble, Part II

by Mario Rizzo

In a recent post I criticized the extension of the Fed’s policy of buying mortgage-backed securities. Then I was told by a quite-knowledgeable economist that I may have misread the report in the Wall Street Journal. The first sentence states:

The Federal Reserve, in a move aimed at keeping interest rates low for home buyers through early next year, decided to extend and gradually phase out its purchase of mortgage-backed securities. (Emphasis added)

So while it is true that the Fed is extending the program, it also plans to phase it out. I replied (in private email) that I preferred to pay attention to what the Fed is actually doing rather than to what it is promising to do.

Reflating the Bubble?

by Mario Rizzo  

The Fed has decided to extend, at least through early next year, its program of purchasing mortgage-backed securities. The Wall Street Journal reports:  

“The Fed’s action signals its belief that the economy, while in recovery, remains fragile and that housing, which has seen some improvement in recent months, has only started to pull out of its slump.”  

What is the objective of their action? When will they know they have succeeded?

Auction Markets and Optimally Sticky Prices

by Joseph T. Salerno

Keynesian macroeconomists, old and new, have long criticized their classical and contemporary opponents for ignoring reality and treating the market economy as a giant auction in which prices are “perfectly flexible,” responding instantly to changes in supply and demand.  This charge is wrong on two counts.  First, all markets for outputs and inputs function precisely like auctions; and, second, auctions are not characterized by perfectly flexible prices but by an optimal degree of stickiness in prices that is determined by the market itself.

In this post I will deal with second point, because it has been generally neglected in responding to the Keynesians.  To illustrate this point I will use the example of a one day on-site auction of 49 unsold condominiums at a 73-unit complex that recently took place in Auburn, Alabama and which I also happened to attend.

Prices and Information

by Jerry O’Driscoll  

In the recent discussion of Say’s Law, the issue of “sticky” prices came up. The term is the source of much confusion. The opposite of “sticky” prices is not “flexible” prices, but infinitely flexible prices. No matter how flexible a price, short of infinite flexibility, there will be quantity responses. Quantity responses are an inherent part of market economies, do not signal market imperfections, and do not typically trigger income-constrained processes.  

Price setting incurs information costs. How does a producer or  retailer know when to change his prices? Where does that information  come from?  

“Prices Must Be Free To Tell The Truth”

by Mario Rizzo

I am not sure who first said this but I believe it was the economist Benjamin Anderson (although Arthur Marget has been credited). In any event, Henry Hazlitt promoted the statement.

I think the very interesting opinion piece by our regular guest-blogger, Jerry O’Driscoll, in today’s Wall Street Journal is in the tradition exemplified by this post’s title. But there is something more. The article shows that falling prices (both absolutely and relatively) in particular markets are not a bad thing for the recovery process. Naive Keynesians get upset anytime an important price goes down. Oy gevalt! What will happen to aggregate demand? There will be a cumulative decline, and so forth.

Recovery doesn’t mean maintaining or going back to unsustainably high prices. (I offered my two cents in the Freeman.) It must involve readjustment of relative prices as a result of the credit-boom and bubble generated distortion of relative prices. Jerry’s article reminds of us all of some basic truths.

Thank You, Alfred Marshall

by Mario Rizzo  

This is not the whole story. But it is reassuring to see that the Great Recession has not repealed the elementary Law of Supply and Demand.  From the Christian Science Monitor:

“Sales of new homes in the United States rose to their highest level in seven months, providing one of the strongest signs that the decline in the residential construction industry may be over.

But to achieve that stabilization, home builders are continuing to lower prices to lure new buyers – a phenomenon taking place in real estate markets around the world.

In June, the sales of new US homes jumped a higher-than-anticipated 11 percent from the level in May, the Commerce Department reported  Monday. The new report suggests that the home-building industry is nearly halfway back to its June 2008 level of sales, after hitting a record low in January (seasonally adjusted).

The problem is that the sales prices continue to fall. In June, the median price of a new home fell back to $206,200, down from $219,000 in May and not much better than the multiyear low of $205,100 in March. Prices for new homes haven’t been this low since December 2003.”

 

Recovery and the Irreversibility of Time

by Mario Rizzo  

An increasing number of articles in the popular press are claiming that signs of economic recovery are becoming more numerous. That may be. However, I am not an economic prognosticator and so I don’t know what to make of that.  

There is a more basic question. What do people mean by “recovery”? It seems that, if articles in the Wall Street Journal are any guide, recovery is often taken to mean a return to normalcy in some key markets – in particular, the housing market.