Thursday, 23 October 2008

The US needs a new financial Yalta - will it get one?

The announcement that the US is to host a conference of 20 leading economic powers on 15 November, after the presidential election, shows once more the close interrelation between economic developments in the United States and the international situation.
The huge bank bailout packages that have been announced, amounting to over $2.5 trillion, or approaching 10 per cent of the GDP of the US and Europe, have temporarily succeeded in preventing the complete break down of the interbank lending market - that is, they have headed off the equivalent of a simultaneous heart attack and stroke. But they have done so only by diverting huge quantities of resources into the core of the financial system, and therefore by threatening to cut off the flow to other sections. By these means the patient has survived the first attack but will gangrene set in in areas where the blood supply is no longer operating properly? Will weaker companies, weaker countries, new areas of potential financial problems, go down - struck with shortage of the financial blood supply, that is inability to obtain funds, or able to obtain them only at interest rates, or with political conditions, that are unacceptable?
The hope is that gradually the whole economic circulatory system will gradually start operating again. But whether it will is not yet clear.
One absolutely certain problem that is coming, however, is the US government budget deficit. This was already going to be over half a trillion dollars next year even before the bail out packages. The figures now being discussed, after the bailouts and with a recession starting. are a trillion or more. How will this be funded? And at what interest rate? Will the US have to rely on its own domestic savers purchasing the necessary Treasury bonds - which implies one, higher, interest rate? Or will foreigners join in? That is crucial for the perspective for the US economy next year and the depth of the coming recession.
If, as seems likely, Barack Obama wins the presidential election this question of whether he can negotiate a new financial Yalta will have to be number one item on his economic agenda.


Alun Griffiths said...

An Interesting paper in this months NBER digest in the United States exploring the social effects of the downturn in the Housing market there, but could easily be applied to many of the other countries affected

View a printable PDF copy of the NBER Digest online at

October 2008
(1) Housing Busts May Lower Household Mobility
(2) Total Compensation Reflects Growth in Productivity
(3) The Federal Student Aid Process is Not Efficient
(4) Hours Spent in Homemaking Have Changed Little This Century
(5) How Costly is Diversity?
(6) Reforming Social Security With Progressive Personal Accounts
Housing Busts May Lower Household Mobility
Fernando Ferreira, Joseph Gyourko, and Joseph Tracy

" In a weak housing market...households get 'locked in' to their homes and are prevented from 'moving up' to larger homes and better neighborhood."

sing two decades of American Housing Survey data from 1985-2005, researchers Fernando Ferreira, Joseph Gyourko, and Joseph Tracy estimate that negative home equity reduces homeowners' mobility. Indeed, mobility is almost 50 percent lower for owners with negative equity in their homes than for those with positive equity. In a weak housing market, it seems, households get "locked in" to their homes and are prevented from "moving up" to larger homes and better neighborhoods.

In Housing Busts and Household Mobility (NBER Working Paper No. 14310), the researchers conclude that this does not imply that current worries about defaults and owners having to move from their homes are entirely misplaced. However, history suggests that the lock-in effects of negative housing equity and high mortgage interest rates were dominant.

The biennial American Housing Survey covers metropolitan areas across the United States. The data allow the researchers to track residence histories and mobility patterns under a variety of housing market conditions. The authors maintain it is important to recognize that lower mobility can be observed only over time, so it will take some years to know how the impact of negative equity will play out in this cycle. They also emphasize that housing market conditions are not the same over time. For example, the subprime market was much smaller over most of their sample period, so the underlying riskiness of borrowers probably was lower in the past than today. In addition, their sample is restricted to owner-occupied homes and excludes investors and second homes, both of which may respond differently to negative equity situations.

Ferreira, Gyourko, and Tracy note that pronounced shifts have occurred over time in house values, leverage, and mobility rates. For example, 1985-97 saw a substantial boom and bust in California housing markets. The data show a peak in mean nominal house prices of $253,617 in 1989, with an average loan-to-value (LTV) ratio of 67 percent, and a two-year mobility rate of just over 15 percent. Prices in California began to fall around 1991, but did not bottom out until 1997 when they reached $201,693, with an average LTV of 78 percent, and a two-year mobility rate of only 11.7 percent. From peak to trough, nominal prices fell by just over 20 percent, with the mean loan-to-value ratio increasing by 16 percent. It was not until 1998-9 that mobility returned to the pre-1989 peak levels, reaching 15.8 percent. Other housing markets that experienced sharp swings in prices and loan-to-value ratios over time also show similar mobility patterns.

The researchers focus on the role of negative equity because households' equity positions vary significantly over the cycle and help to characterize housing busts. To measure negative equity, they construct the homeowner's current LTV ratio using the value of the mortgage balance and the owner's self-reported current value of the house. They also factor in demographic information that influences mobility, including changes in family size, age, race, education, the sex of the household head, marital status, the change in marital status of the household head, and gains and losses in family income.

Ferreira, Gyourko, and Tracy report that being married is not a statistically significant predictor of mobility, but divorce is. Household mobility also increases with the education of the household head. Whites are more likely to move than non-whites, and male-headed households are less likely to move than female-headed households. Each additional year of age reduces household mobility until the household head reaches the early fifties; after this point, aging raises the likelihood of a move. Finally, larger households tend to move less frequently. This is consistent with the hypothesis that children increase the transactions costs involved in moving.

The researchers conclude that reduced mobility has its own set of consequences that have not been clearly identified or discussed in the debate about the current housing crisis. Lower household mobility may result in poorer labor market matches, diminished support for local public services and facilities, and lesser maintenance and reinvestment in the home.

-- Matt Nesvisky

Alun Griffiths said...

I should have added but am going to fast, (Va piano, Va Sano...)

In other words in a "downturn" the wealth redistribution effects go into reverse, except that they never fully compensate for the movement in the other direction in the "upturn" especially as there is quite a large amount of wealth "leakage" (stealing from the system) in the upturn So the poorer are still relatively worse off, and tend to suffer disprportionate effects from other "sectors" of the economic system. A classic Double Whammy.

Plus ca change, plus c'est la meme chose