Category Business

We’re Having the Wrong Conversation About Uncertainty

Danny Vinik 1 Comment

Imagine the following situation: You’re the CEO of a small business with one store and just five other employees. You survived the Great Recession and business has been slowly improving. As the economy improves, you’re thinking about expanding by opening another store with five more workers. Then you hear the President’s State of the Union Address calling for a higher minimum wage. This scares you. A higher minimum wage would raise your costs and prevent you from opening that new store (this is how a minimum wage hurts job growth). Now, it’s the beginning of August and no minimum wage bill has passed. The President isn’t pushing it particularly hard and Congress is focused on other bills. Do you open the second store?

It’s a tough call. It would just about wreck your business if you expand and then Congress passes a higher minimum wage. On the other hand, you’re leaving profits on the table for every day you don’t expand and the minimum wage stays the same. That right there is policy uncertainty and it is what Republicans have been yelling has been holding back the economy for years.

Today, Jim Tankersley at the Washington Post and Kevin Drum at Mother Jones push back and basically declare uncertainty a farce. Here’s Drum:

Republicans wanted to blame the sluggish recovery on mountains of red tape from the business-hating Obama administration, and the press played along. This means that “uncertainty” got a lot of media attention, which in turn means that if you have an “uncertainty index” based partly on media mentions, it would have shown persistent elevation during 2010-12, the heyday of the uncertainty campaign. Sure enough, that’s exactly what it showed:

….

As we knew all along—and as the media should have known all along—”uncertainty” was just an invented partisan talking point. It no longer serves any purpose, so now it’s gone. But the sluggish recovery is still with us.

Roosevelt Fellow Mike Konczal proved last year how ridiculous uncertainty indexes are. It’s more media manipulation than anything else. But this doesn’t mean that uncertainty isn’t real. The simplified example above demonstrates how it works on a theoretical level. But saying that uncertainty is holding back the recovery doesn’t imply that one party or the other has the correct policy prescription. In the above example, you can remove the uncertainty in two different ways: passing a higher minimum wage or the President declaring he is no longer interested in pushing for it. In either choice, the uncertainty disappears.

This isn’t how Republicans described uncertainty as holding back the recovery. For them, uncertainty was excessive regulations and new rules from the Obama Administration. But this is just one factor in the uncertainty debate. There is economic uncertainty. Who knows what the next jobs report will look like? There’s also fiscal uncertainty. The looming potential government shutdown may be holding firms back as well. Same with corporate tax reform which is slowly moving forward. Businesses must take all of this into account. The more threats to shut down the government, breach the debt ceiling, rewrite existing regulations and pass major policies, the more businesses are going to be hesitant to make major decisions. That’s how uncertainty affects the economy, but it’s largely not the Obama Administration’s fault. That’s where Drum is right: it became a partisan talking point in the last election.

So instead of having a smart discussion on how we can actually reduce uncertainty, Republicans fostered a partisan belief that the uncertainty that was really holding back the recovery was the Obama Administration’s regulations and nothing else. Not the economy. Not Congress. It was all on the Obama Administration.

So is it any surprise that as uncertainty has decreased (according to uncertainty indexes meh), liberals are using it to show that uncertainty wasn’t holding back the economy? Tankersley demonstrated this aptly:

The index seeks to measure the effect of policy uncertainty, including pending regulations and expiring tax provisions, on the economy. As you may have heard once or twice over the last few years, many conservatives blame uncertainty for holding back hiring and growth in this recovery. Those lawmakers love to cite this index as proof of elevated uncertainty.

According to the index, the decline of uncertainty this year is clear*.

And the hiring boom that was supposed to follow? Well…

Maybe hiring would be significantly less if uncertainty was at 2009 levels. Maybe reduced uncertainty has offset some of the effects of the payroll tax increase earlier this year and has been an important factor in our recent meager job growth. It’s tough to tell for sure. But no matter what, the facts are that uncertainty indexes show reduced uncertainty and job growth is weak. So liberals have jumped on this to show that reduced uncertainty and job growth don’t go together. This continues to obscure the debate as uncertainty is a drag on growth. But it’s not just regulatory uncertainty. It’s much more. Republicans need to admit that. Democrats need to admit uncertainty exists. And uncertainty indexes need to go away. Then maybe we can have a conversation about how to actually reduce it. Right now, it’s a partisan mud-flinging contest with hand-picked stats and a bogus index used to support them. isn’t that just great?

It’s More Than A Gender Bias Working Against Yellen

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Ezra Klein wrote an insightful blog post yesterday outlining the hidden sexism that has permeated the coverage of who will be the next Fed Chair and how it has harmed Yellen’s candidacy. Here’s Ezra:

People get understandably defensive when you use the word “sexist.” But here’s the simple fact: There’s no male candidate Andrew Ross Sorkin could’ve named who would’ve elicited fears from Fisher that the pick was being “driven by gender.” Not Don Kohn. Not Alan Blinder. Not Roger Ferguson. It would’ve been either a laugh line or a controversy if Sorkin had asked about Tim Geithner’s chances and Fisher had brought up his gender.

When a woman is up for the job — no matter how qualified — the lurking worry is that the pick will be “driven by gender.” When a man is up for it, gender never enters into the conversation. That’s how privilege works in practice: Gender is invisible when it comes to male appointees but a constant presence when it comes to female appointees.

That gets the situation backwards.

There’s never been a female Federal Reserve chief. There’s never been a female Treasury Secretary. There’s never even been a female president of the powerful New York Federal Reserve. This isn’t an accident, and it’s not because women can’t manage those positions. It’s because gender really has played a driving role in appointment processes for a long time. It’s just done so on behalf of men.

I don’t disagree with any of this, but I want to extend it a bit. The title of Ezra’s post is “Funny how gender never am up during Bernanke’s nomination. Or Greenspan’s. Or Volcker’s.” You know what also didn’t come up in those nominations? Race. Sexual Orientation. Religion. You know why none of those things are coming up this time? Because both Yellen and Summers are white, straight and Jewish. That’s nothing new at the Fed. But a woman as Fed Chair? That’s new.

This creates two different levels of bias against Yellen. The first is the explicit and implicit sexism in whether Yellen has the necessary “gravitas” to be Fed Chairman. Of course she does! No man with Yellen’s resume would face similar questions.

There’s also a second form of bias that I’m going to term “newness bias.” This is the bias that exists because everyone is ultra concerned that the Fed choice will be “driven by gender.” After all, for a position as important as Federal Reserve Chairman, it’s vital that the President select whoever is most qualified. He shouldn’t choose an inferior candidate just to break a gender barrier. But no male nomination can ever be “driven by gender,” because every Fed chair before has been male. It’s the same reason neither Yellen or Summer’s selection could be “driven by race.” When there’s never been a female in a certain position, the immediate reaction to breaking that barrier is that the President is doing so just to nominate a woman, not because it’s the right choice.

That’s what Yellen is working against. Ezra spells this out perfectly:

And then, when a female candidate does threaten to break into that top echelon, the whispers begin that the pick is really driven by gender, that more qualified men are being passed over, that it’s all just about political correctness. But the truth is typically closer to the opposite. A woman (or an African American, etc) can only get to the point where she can hold a top position after clearing a much higher bar than the male candidates.

The President may feel that if he is going to name Yellen as the next Fed Chairman, she must be by far the best candidate for the job. Because if not, he’ll face criticism for choosing her over Summers just to install the first woman at the helm of the Fed. It’s an absurd bar that only candidates facing the “newness bias” confront. If Richard Ferguson receives further consideration for the job, expect the fact that he’d be the first African-American Fed Chairman to come up more frequently. And expect analysts to start asking whether his selection would be “driven by race.” He wouldn’t face the blatant sexism about “gravitas” that Yellen faces, but he’d still confront the “newness bias.”

So remember this whenever you hear people questioning whether Yellen’s choice is “driven by gender.” The fact her selection would break a gender barrier doesn’t mean she needs to be more qualified than other candidates to justify her selection. She’s the best candidate for the job and that’s what matters. President Obama would do well to tune out any worries about her “gravitas” or that her nomination would be “driven by gender.” Those are just not-so-subtle ways for her opponents to use her gender to tear her down. It isn’t fair and it isn’t right. I hope the President doesn’t fall into that mindset as well.

Eminent Domain Could Be a Powerful Tool in Housing

Danny Vinik 4 Comments

My post this morning focused on the major flaw in Richmond, California’s plan to use eminent domain for underwater mortgages, but it is always not a bad idea. Eminent domain could have a beneficial use in the housing market.

First, let’s look at a simple housing market. If an underwater borrower falls behind on his payments, the lender (the bank) may decide to either foreclose on the property or to restructure the loan. Foreclosures are costly and time-consuming for banks so sometimes, banks will choose to write down the principal of the loan so that the homeowner becomes back above water and can refinance. The homeowner then makes payments to the bank on his refinanced loan. The bank doesn’t earn as much as it did had the borrower stayed current on the original loan, but it still earns more than if it had gone through with the foreclosure.

But this system becomes a lot more complicated when loans are securitized and sold off to many different investors. This creates a collective action problem. If the government – or any company – wanted to write down the principal of mortgages to bring them back above water, it would have to acquire almost every tranche of the mortgages. If just a few investors refuse to sell, the firm would not own enough of the loans and would be unable to write down the principal. Thus, no company wants to devote its resources to contacting and coordinating with many investors without any guarantee of a payoff at the end. This is a classic collective action problem.

There are also three other small yet important problems that eminent domain solves:

  1. Servicer incentives. Banks normally outsource many aspects of their lending program to servicers as banking activities become more complicated. For instance, servicers collect payments, pay taxes, modify loans and supervise the foreclosure process. Unfortunately, servicers aren’t looking out for homeowner interests – they care about their own bottom line.  This is a problem, because servicers earn the most in fees when borrowers are delinquent or during the foreclosure process. This gives servicers an incentive to not help borrowers become current. It’s also costly for servicers to modify a loan so even if a bank and the borrower both are in favor of principal reduction, the servicer may stand in the way.
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  2. Pooling and Servicing Agreements. A further problem is that servicers are limited in how much they can modify loans by pooling and servicing agreements (PSA). Most loans have been securitized and sold off to many investors, but this creates a problem: investors don’t want the servicer to make huge changes to the loan without their approval, but also want to give servicers some flexibility to make minor adjustments. The rules for what servicers can and cannot do are outlined in the PSA that accompanies the mortgage. Most PSAs only allow the servicer to modify up to five percent of the loan without supermajority approval from investors. If servicers want to significantly reduce the principal on the loan, they must spend resources coordinating with numerous investors, without any guarantee that investors will ultimately approve the principal reduction. The high coordination costs offer little reason for servicers to modify the loans
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  3. Tranche Warfare. A little known problem with principal reduction is that once the loan is securitized, different investors have different appetite for principal reduction. For instance, investors who own the senior tranches of a loan are most likely to be paid off  and may not want the servicer to modify the loan. The owners of the junior tranches, on the other hand, are less likely to receive payment and have greater incentives to reduce the principal. If the servicer does make significant modifications, it is giving the owners of the junior tranches preferential treatment at the expense of investors in the senior tranches. The servicer is technically supposed to represent the interests of the mortgage owner, but when there are multiple owners and their interests diverge, the servicer is left with few acceptable options. At the extreme, investors in the senior tranche could sue the servicer if it modifies the loan. Thus, many servicers have been hesitant to modify loans for fear of legal action against them, even if the majority of owners of the mortgage would prefer to modify it.

Eminent domain solves all three of these problems. Since the municipality owns all parts of the mortgage, the potential for tranche warfare no longer exists (solving problem No. 3). In addition, the city does not need a servicer and does not have to use a PSA so the limitations of the agreement no longer exist as well (solving problems No.1 and No. 2). Most importantly, the collective action problem associated with high cooperation costs is eliminated as well.

A House in Richmond, CA (Photo: Ed Andersen)

A House in Richmond, CA (Photo: Ed Andersen)

Since the city or company is a single entity, it does not have to worry about wasting resources coordinating between many investors. Instead, eminent domain requires all investors to sell at fair market value, eliminating the risk that a few investors defect and refuse to reduce the principal. Eminent domain solves the collective action problem.

That’s where the value of eminent domain is in the housing market. However, it requires that the government to at least offer a fair market value – something Richmond is not doing. Why is Richmond not doing it? Because the only way Mortgage Resolution Partners (MRP), the firm supplying the capital for the proposal, will profit is by paying below market value. Without those profits, MRP would not be interested in the deal. By itself, Richmond doesn’t have the funds to purchase the loans at fair value. It needs MRP’s financial backing and in return, it’s ripping off the original investors so MRP can profit. That’s why this deal is unconstitutional and will surely fall apart in the courts. But don’t overlook the fact that done correctly, eminent domain can be a powerful tool to overcome the collective action problem in modifying loans. It just wasn’t done correctly here.