In my opening essay, “Don’t Panic Yet: A Strategy for Dealing with
the Risk of the Emergence of a Housing Bubble Resulting from the Interdependence of Space and Capital Markets, Fall 2007: Don't Panic Yet, I expressed some concerns about the subprime crisis and suggested the development of a strategy to deal with it. It was part of the decision of the Homer Hoyt Institute’s launching the research roundtable, Research Roundtable of October 2007, on the subject and the ensuing Subprime Crisis Research Program. Preliminary Report on Subprime Crisis Research Program. This blog entry is at least triple my maximum size, but I believe justified as an exception.
Here are some excerpts:
“However, as a relatively new student of the science of networks it seems to me that as with electric power, web communication, and fashion, that some activity goes a long way before it reaches a cascade point, but when it crosses that threshold the system crashes. The behavior of the group, in this case the participants in a local housing market, is an important element in strategy involving the avoidance of a market crisis generated by what is called cascading. The problem is that we don’t have a very good understanding of aggregate market behavior reaching a cascading point, even though we can do pretty well with individual behavior and market behavior continuing on a trend. The great difficulty is in the turning point – and that is what counts…
“…While there does not seem to be much concern that the housing crisis would drive a thriving economy into recession, …we should be mindful that the subprime crisis had an effect on other segments of the capital market; but, we don’t really know what the unfolding impact will be and while it is not prudent to spread an alarm, it is prudent to reduce the risk…
“…The strategy is to mitigate the possibility of a downward spiral in housing prices and the side effect of bringing on a recession. This paper is not focusing on the policies for dealing with the financial crisis as a whole, including preventive measures. That is for parallel work. Rather, the focus is on the avoidance of the financial crisis generating excessive impact on the housing market and the housing market generating an excessive impact on the rest of the economy including the capital market.
“Housing markets are generally local. The strategy is to focus on those housing markets that have the greatest risk of an addition to supply of available housing because of foreclosures or threats of foreclosures. The idea is to keep people in their houses whenever possible.
“The easiest cases are where the homeowner is still employed but living expenses have eroded the discretionary income, and they are faced with an increase in mortgage payments because of a variable rate mortgage, especially teaser rate mortgages. Using such cases as an example, a research program can be designed that would identify the geographical location of defaulted mortgages and mortgages that are high risk.
“Such a study would have an output of market areas that may get substantial increases in supply. Along with such a study would be one that revealed the current oversupply of housing and the trend in local pricing. The result would be the election of a series of markets which are at risk of a bubble. That could be checked against those markets that already experienced high foreclosure rates. The pattern that is likely to emerge is a concentration in a number of states. Some states have already started legislation or other action to help homeowners caught in the problem…
“…A related analysis is to develop model that would indicate when workouts made sense for both the security holder and the homeowner. Lenders may have such models, but buyers are at the risk of asymmetric information. Leveling the playing field may help in getting negotiations that avoid foreclosure.
“Adding foreclosed property to the available supply in an overbuilt market may not help anyone and could do a lot of damage to other homeowners by further depressing prices. The lenders using models may be using micro models that look at the single case without looking at the probability of other lenders taking similar action with the combined result that the oversupply thereby created yields less in proceeds to lenders with numerous mortgages in the area than would be yielded had the market not been further depressed. This is especially true if there is a cascading in the local market.
“The whole idea is to reduce the risk of a cascading price level that would reverberate throughout the local economy and perhaps the national economy in addition to helping homeowners that are in over their heads because they were led astray by aggressive marketing techniques and didn’t realize the risks. The strategy just outlined indicated some ideas for research that are focused on a single housing market. The strategy is to avoid a cancerous decline of prices in the high risk markets, not only because of the impact within the high risk market, but having the price decline metastasize to other local markets.
“While it is true that housing markets are local, there are two ways in which seemingly unconnected housing markets relate to each other. One is that local housing markets are generally tied to their local economies, and not only downturns in local economies affect the local market, but downturns in the local housing market affects the local economies. Further to this line of reasoning, various local economies are linked by their respective economic bases such that depending upon the linkage, what happens in on local economy will generate impacts on its linked other local economies, those from which it buys and those to whom it sells. In a sense, the national economy is a series of linked local economies, some with closer ties than others, but linked. To an increasing extent this is becoming true of selected international economies which may be view as linkages of metropolitan areas.
“A second way in which seemingly unconnected markets relate to each other is through the psychological impact of events. A series of downturns in various local markets will cause some alarm in other markets and may curtail home buying decisions because of the appearance of rising risk. Behavioral science studies show that many people even when told that some event resulting from behavior isn’t necessary typical of most other cases because the behavior is not representative, nevertheless proceed to act on the unrepresentative behavior.
“The series of research projects that may emerge in order to flesh out a strategy for avoiding rampant housing bubbles may be classified in a number of ways. One way is to starts with a national perspective that explores the relationships between a financial crisis and the spread to economic downturn in general as well as to a housing downturn in particular. Such a study would apply the relatively new science of network science and be particularly concerned with emergence.
“The second group of research projects would concern itself with what policies would reduce the likelihood of further downturns in a specific local market. Part of this is relief of hardship for those households directly affected.
“Additionally, part of this may consider reducing the negative impact of the capital market on the local housing market, or put differently looking for measures that would get favorable influences from the capital market. But the focus is on seeing what policies would contribute to averting excessive declines in the local market. Obviously this is through a reduction in would be foreclosures. But, that raises the questions for the next set of research issues. The third set of research issues is highly dependent upon underlying values, or what may be thought of as philosophical views, and matters of law. On the matters of law it is not only existing law, but public policy and changes in law.
“These questions require research in such issues as to how much of the problem is a result of predatory lending and how much is simply poor decision making on the part of borrowers. That, and the criteria used for relief to borrowers will influence the nature of programs to be developed as a matter of strategy. What will the courts enforce when misrepresentations were present in loans with teaser rates? Is the combination of onerous prepayment penalties enforceable if misrepresentations were made? Will it take class action suits to deal with predatory lending results or will state legislators provide relief in staving off foreclosure under certain circumstances?
“This essay is not advocating any particular set of public policies. Rather it is advocating research that would assist public policy decision makers and other participants in the process, borrowers and those on the lending side including mortgage servicers as well as the holders of the mortgages and the derivatives where they exist.
“As this is being drafted, the next series of steps is uncertain, except that the research roundtable that is scheduled within the week of this draft brings together potential researchers and potential funders of research in addition to the Homer Hoyt Institute representatives. The discussion that ensues will likely have on the table a variety of ideas, and the interested parties may explore what questions are critical to get answered in tuning up a strategy…
“Presumably, at some point a white paper, or series of papers, would emerge, authored by and representing a variety of interested parties. Such a paper or compilation would be suitable for wide distribution as an educational service to help people make better decisions.
“Conclusion [-] Some strategies are expected to emerge from the research that is spawned by the forthcoming roundtable. While some strategies will be addressed to institutional change that would avoid recurrence of similar debacles in the capital markets, this essay is focused on avoiding a cascading of foreclosures in some local housing markets. The concern is not only for those directly affected in such markets, but for those to which migration of default would similarly affect other markets, and for the fallout to the economy in general…”
Consilience: A Biological Example -John Khosh
The human body is a good example for demonstrating consilience which implies that what is true for part of nature is true for all of nature. A single set of laws of nature is applicable to all things in the universe, animate and inanimate. The laws of thermodynamic, electromagnetic, gravity etc. are subsets of the single set of laws.
A dynamic and holistic approach is applicable to all biosystems including cells, students and colleges. The phenomena in biosystems are not isolated events, nor stationary. For example, consider health. Our biological system attempts to be self corrective. It is dynamic. As a whole, our health is a matter of degree; and, the degree keeps changing as the biological systems get results from a dynamic process. The tendency is to move toward balance.
Each bodily system is made of organs, which are made up of tissues, which are made up of cells, which are made up of molecules etc. The complexity process in our hierarchical organizations creates some differences in properties in higher layers of organization that may not exist in the lower layer of the system, but the underlying principles are the same for a heart that pumps blood and a water pump in an automobile.
The linked essay Consilience: A Biological Example provides examples from the human body as system, with its various subsystems. The concern is with the wide range of the body’s scale of subsystems that are treated as systems. The synchronization of their dynamic activity is responsible for survival of a biosystem. This biosystem includes the fourteen human's biological systems Synchronization is only possible because of information present in the DNA.
Posted by Maury Seldin on behalf of John Khosh.
Thursday, October 29, 2009
Justice
My blog entry this week is on justice. The discussion of justice may be started with this quote from an insert to the ASI newsletter, “Developing policy for dealing with the subprime crisis may be viewed as a matter of justice. There are different views of justice with differences in underlying values. And, the concept of justice is complex. Yet, considering the issues as a matter of justice provides an opportunity for a comprehensive analysis that considers the conflicts of incommensurability. Fall 2008: Developing Policy for Dealing with the Subprime Crisis: A Matter of Justice
In looking at these issues it will be useful to consider the concept of consilience. Edward O. Wilson, in his book, Consilience: The Unity of Knowledge argues for the fundamental unity of all knowledge. The idea is that, "everything in our world is organized in terms of a small number of fundamental natural laws that comprise the principles underlying every branch of learning." A link that explains the idea in the form of a book review is to my notes for an ASPEC session of Books and Ideas. Notes for Consilience
In looking at these issues it will be useful to consider the concept of consilience. Edward O. Wilson, in his book, Consilience: The Unity of Knowledge argues for the fundamental unity of all knowledge. The idea is that, "everything in our world is organized in terms of a small number of fundamental natural laws that comprise the principles underlying every branch of learning." A link that explains the idea in the form of a book review is to my notes for an ASPEC session of Books and Ideas. Notes for Consilience
Foreclosure & Contagion
The second in the series of my blog entries on foreclosure is on contagion. For contagion the start is a quotation of excerpts from a report on contagion research The Contagion Effect of Foreclosures: The Neighborhood Impact of Subprime Lending, Predatory Lending and Foreclosure ". The quote is “Some neighborhoods see a concentration of foreclosures, the number of distressed properties in close proximity to a given property also has an impact on home value."
The gist of it is that as housing prices decline from homeowners’ defaults, there is a spillover effect of foreclosures on neighborhoods. “Depending upon variances in time and space, foreclosures can depress home prices by as much as 10 percent. When taking into consideration the number of distressed properties in close proximity to a given residence, the residence will decrease in value by an average amount of 1% per distressed nearby property.” Based on average home prices, nearby foreclosures reduce the value of each neighboring home by $5,000 on average. “In addition, inner cities and areas where new construction is prevalent appear to be the hardest hit by foreclosure and the related contagion effects. While there is considerable evidence of this contagion effect, there is little evidence of foreclosure cascading -- where the number of foreclosures in a given neighborhood reaches a ˜tipping point and the foreclosure rate begins to increase rapidly. Anecdotal evidence suggests that when foreclosures in a given neighborhood reach this "tipping point" the entire neighborhood can experience hardship due to a lack of residents to generate fees and taxes needed to support basic services.” The article provides links to the research cited. The Black Swan effect has not been revealed in the academic studies, but the localities studies are limited.
The Neighborhood Impact of Subprime Lending, Predatory Lending and Foreclosure- Stephanie Rauterkus
A growing body of evidence suggests that subprime lending, predatory lending and foreclosure affect neighborhood home values. In “The Neighborhood Impact of Subprime Lending, Predatory Lending and Foreclosure” my colleagues and I discuss what we know so far and areas requiring further research. With respect to subprime and predatory lending, researchers have discovered linkages between these practices and an increase in default probability. These defaults tend to have a spillover effect on entire neighborhoods. While several specific practices have been identified as counterproductive with respect to increasing homeownership, few (if any) regulatory measures have been shown to effectively combat these problems. Much of the issue in this arena tends to revolve around clear definitions of subprime and predatory lending and the related issue of determining how to identify the practice when it occurs.
Various studies have quantified the impact of foreclosures in the range of two to ten percent of home value. Evidence of significant clustering also exists in certain areas. Several states -- Arizona, California, Florida and Nevada in particular -- have experienced unusually high foreclosure rates. Within cities, clustering has also been found in new construction areas on the outskirts of major metropolitan areas. This clustering too has been shown to bring down home values. While estimates differ regarding how close a distressed property must be to a given home to affect its value, the impact has been estimated to be a 1% decline in value per nearby distressed home! When these impact figures are applied to the national housing stock, this means that distressed properties reduce the value of nearby properties by $5,000 on average. Anecdotal evidence shows that concentrated foreclosures can have a devastating effect on neighborhoods. Researchers have investigated this phenomenon to determine if a ‘tipping point’ exists where the foreclosure rate increases at an increasing rate. To-date, no such cascading effect has been found.
Much additional work is needed in this area. More research is needed to explain the means by which foreclosure spreads within and across neighborhoods. Specifically, we need answers to several questions. Why are there large regional differences in mortgage performance? Does state and local regulatory behavior affect loan behavior? How are age-income-ethnic characteristics related to ownership, loan issuance and performance? What role did incentives, moral hazard and adverse selection play in lending behavior? Related to this question, policy-makers have also asked to what extent foreclosures are the result of a “push me” phenomenon where borrowers are pushed up into more expensive homes or a “pull me” phenomenon where brokers are pulled to write more (and larger) loans. How extensive are risk externalities generated by the housing market? That is, what is the impact of risky behavior in housing markets on the broader financial markets? How do we stabilize the housing markets and what roles should state, local and federal entities play in this effort?
Posted by Maury Seldin on behalf of Stephanie Rauterkus, Ph.D.
Complex Systems - Jack Lillibridge
This is a follow-up to our discussion in the Seminar on Strategic Decision Making and my presentation of comments on some books relevant to how concepts from psychological economics may contribute to understanding the current economic situation and what might be done about it. My presentation focused on three books; Predictability Irrational: The Hidden Forces that Shape Our Decisions by Dan Ariely; The Mind of the Market: How Biology and Psychology Shape Our Economic Lives by Michael Shermer; and Nudge: Improving Decisions About Health, Wealth and Happiness by Richard Thaler & Cass Sunstein. However, in the follow-up presentation I tied the discussion to complex systems which you mentioned in your main essay, Subprime Crisis Strategic Decision-Making: A Discussion of What Went Wrong and Strategies to Deal with It and which Paul Carr discussed in his presentation which included Complexity, Risk, and Financial Markets by Edgar Peters.
The theory of complex adaptive systems identifies component processes that undergird these two aspects of nature, such as positive and negative feedback. A notable instance of a complex adaptive system is a living organism, which includes elements of interaction with the environment and of memory.
This view of nature is characterized by two interrelated aspects. One is characterized by equilibrium, balance, continuity, renewal, etc., resulting in maintaining the existing order. I call this first aspect stability. Nature is also characterized by creativity, learning, exploration, risking, etc., resulting in a new, more complex, order. I call this second aspect growth. These aspects are both complementary and mutually interacting, relating to a dynamic ongoing overall process.
There is a dynamic process described as part of the theory that perhaps will contribute to an understanding of the current economic crisis, especially how it could occur as it did. This dynamic process is the time course from a persisting, stable order, through a transition or threshold, to a new, persisting stable order that is more complex. There are at least three things to understand: what could cause a transition, how could the transition occur, and what might the new order look like. For instance, what triggered the transition and what will influence the kind of new order that results?
Posted by Maury Seldin on behalf of Jack Lillibridge. Dr. Lillibridge has a Ph.D. in Psychology.
The gist of it is that as housing prices decline from homeowners’ defaults, there is a spillover effect of foreclosures on neighborhoods. “Depending upon variances in time and space, foreclosures can depress home prices by as much as 10 percent. When taking into consideration the number of distressed properties in close proximity to a given residence, the residence will decrease in value by an average amount of 1% per distressed nearby property.” Based on average home prices, nearby foreclosures reduce the value of each neighboring home by $5,000 on average. “In addition, inner cities and areas where new construction is prevalent appear to be the hardest hit by foreclosure and the related contagion effects. While there is considerable evidence of this contagion effect, there is little evidence of foreclosure cascading -- where the number of foreclosures in a given neighborhood reaches a ˜tipping point and the foreclosure rate begins to increase rapidly. Anecdotal evidence suggests that when foreclosures in a given neighborhood reach this "tipping point" the entire neighborhood can experience hardship due to a lack of residents to generate fees and taxes needed to support basic services.” The article provides links to the research cited. The Black Swan effect has not been revealed in the academic studies, but the localities studies are limited.
The Neighborhood Impact of Subprime Lending, Predatory Lending and Foreclosure- Stephanie Rauterkus
A growing body of evidence suggests that subprime lending, predatory lending and foreclosure affect neighborhood home values. In “The Neighborhood Impact of Subprime Lending, Predatory Lending and Foreclosure” my colleagues and I discuss what we know so far and areas requiring further research. With respect to subprime and predatory lending, researchers have discovered linkages between these practices and an increase in default probability. These defaults tend to have a spillover effect on entire neighborhoods. While several specific practices have been identified as counterproductive with respect to increasing homeownership, few (if any) regulatory measures have been shown to effectively combat these problems. Much of the issue in this arena tends to revolve around clear definitions of subprime and predatory lending and the related issue of determining how to identify the practice when it occurs.
Various studies have quantified the impact of foreclosures in the range of two to ten percent of home value. Evidence of significant clustering also exists in certain areas. Several states -- Arizona, California, Florida and Nevada in particular -- have experienced unusually high foreclosure rates. Within cities, clustering has also been found in new construction areas on the outskirts of major metropolitan areas. This clustering too has been shown to bring down home values. While estimates differ regarding how close a distressed property must be to a given home to affect its value, the impact has been estimated to be a 1% decline in value per nearby distressed home! When these impact figures are applied to the national housing stock, this means that distressed properties reduce the value of nearby properties by $5,000 on average. Anecdotal evidence shows that concentrated foreclosures can have a devastating effect on neighborhoods. Researchers have investigated this phenomenon to determine if a ‘tipping point’ exists where the foreclosure rate increases at an increasing rate. To-date, no such cascading effect has been found.
Much additional work is needed in this area. More research is needed to explain the means by which foreclosure spreads within and across neighborhoods. Specifically, we need answers to several questions. Why are there large regional differences in mortgage performance? Does state and local regulatory behavior affect loan behavior? How are age-income-ethnic characteristics related to ownership, loan issuance and performance? What role did incentives, moral hazard and adverse selection play in lending behavior? Related to this question, policy-makers have also asked to what extent foreclosures are the result of a “push me” phenomenon where borrowers are pushed up into more expensive homes or a “pull me” phenomenon where brokers are pulled to write more (and larger) loans. How extensive are risk externalities generated by the housing market? That is, what is the impact of risky behavior in housing markets on the broader financial markets? How do we stabilize the housing markets and what roles should state, local and federal entities play in this effort?
Posted by Maury Seldin on behalf of Stephanie Rauterkus, Ph.D.
Complex Systems - Jack Lillibridge
This is a follow-up to our discussion in the Seminar on Strategic Decision Making and my presentation of comments on some books relevant to how concepts from psychological economics may contribute to understanding the current economic situation and what might be done about it. My presentation focused on three books; Predictability Irrational: The Hidden Forces that Shape Our Decisions by Dan Ariely; The Mind of the Market: How Biology and Psychology Shape Our Economic Lives by Michael Shermer; and Nudge: Improving Decisions About Health, Wealth and Happiness by Richard Thaler & Cass Sunstein. However, in the follow-up presentation I tied the discussion to complex systems which you mentioned in your main essay, Subprime Crisis Strategic Decision-Making: A Discussion of What Went Wrong and Strategies to Deal with It and which Paul Carr discussed in his presentation which included Complexity, Risk, and Financial Markets by Edgar Peters.
The theory of complex adaptive systems identifies component processes that undergird these two aspects of nature, such as positive and negative feedback. A notable instance of a complex adaptive system is a living organism, which includes elements of interaction with the environment and of memory.
This view of nature is characterized by two interrelated aspects. One is characterized by equilibrium, balance, continuity, renewal, etc., resulting in maintaining the existing order. I call this first aspect stability. Nature is also characterized by creativity, learning, exploration, risking, etc., resulting in a new, more complex, order. I call this second aspect growth. These aspects are both complementary and mutually interacting, relating to a dynamic ongoing overall process.
There is a dynamic process described as part of the theory that perhaps will contribute to an understanding of the current economic crisis, especially how it could occur as it did. This dynamic process is the time course from a persisting, stable order, through a transition or threshold, to a new, persisting stable order that is more complex. There are at least three things to understand: what could cause a transition, how could the transition occur, and what might the new order look like. For instance, what triggered the transition and what will influence the kind of new order that results?
Posted by Maury Seldin on behalf of Jack Lillibridge. Dr. Lillibridge has a Ph.D. in Psychology.
Foreclosure Prevention
My blog entry this week is on “Foreclosure Prevention.” The issues may be grouped around justice, contagion, and strategy. Discussions will be sorted as clusters develop. The series of three blog entries, in successive weeks, starts with strategy, continues with contagion and concludes with justice.
Starting with strategy, consider my essay, “Foreclosure? The Right Way to Play the Suit May be the Wrong Way to Play the Hand: A Strategic Approach to Averting a Crash in the Housing Market and its Fallout.” [Foreclosure Essay with a Strategic Approach.] The idea here comes in two major parts. The first is to avoid a crash in the local market of a subject property. The second is to avoid a cascading of local market housing crashes. At first glance, many people will consider both cases as being remote possibilities, especially the latter. As policy makers could wait until the possibilities seem less remote. The problem is that the longer the wait and the less remote the more difficult it becomes to avert. One could make mathematical calculations that would weigh the chances against the costs, but as with catastrophic events, even low probabilities are of little comfort if the catastrophe strikes. [Think Black Swan.]
Thus, prudent decision makers, when insurance policies are not available or realistic, may take preventive action even with probabilities not favoring the odds of caution. The ego-for-broker's strategy takes the chance. The Minimax strategy constrains the level of risk and maximizes within those constraints. In order to develop such a strategy it is essential to work with local data that identifies the high risk areas. The discussion which follows is a first step in developing such a strategy, cascading, is more difficult to tackle because of the problem of identifying tipping points before they happen. Forecasters do well in extrapolating from the past, but the turning points may arise in different patterns because of differences in people's responses, among other things. It may be a case of emergencie's. The link to the essay and a follow-up item is as follows: Foreclosure Essay with a Strategic Approach
As an interim reading the blog originally planned was longer than the 300 to 500 size I was advised to use, so I have sliced it up for a series of entries. The link to a long version designed for slicing is as follows: Foreclosure Prevention.
Foreclosure Prevention - Comment by Bob Edelstein
Here is an excerpt from study “The Housing Problem and the Economic Crisis: A Review and Evaluation of Policy Prescriptions. It consists of the Concluding Remarks and Remaining Issues.” This is the excerpt: A confluence of macroeconomic, social and financial forces caused the housing and subprime bubbles in the US. Macroeconomic conditions provided several crucial elements. US consumer debt fueled the trade deficit, which was financed substantially with savings by US trading partners. These global imbalances and capital inflows combined with official Fed interest rate policy (in response to the dot com bust and the recession of 2002) generated cheap and plentiful debt. There was copious, cheap mortgage money for homebuyers at one end, and a willing pool of global investors in securitized mortgages, at the other, all lubricated by lax oversight and weak regulation.
New borrowers emerged to meet the expanding supply of mortgage money. Homeownership rates rose among younger and lower income households. The financial sector frenetically expanded products to serve the demand from homeowners and satisfy yield starved investors. Through nothing short of financial alchemy, security issuers created derivatives with higher ratings than what the underlying securities could support. The fee structure rewarded lenders, mortgage brokers, rating agencies, and securitizers for originations rather than financial product viability, thereby creating incentives for increased transactions. Regulatory laxness passively permitted diluted underwriting standards and predatory lending practices, supporting the growth of subprime and Alt-A mortgages, which were then securitized and sold to investors around the world.
Subsequently, with lower growth in demand for homes, prices began to flatten or dip, and the boom in home construction collapsed. Simultaneously, the many subprime mortgages with interest reset provisions started to come due. Combined with lower sales activity and prices, a self-sustaining loop was created, causing marginal borrowers to default, further worsening housing market conditions. As home prices sank and mortgage default rates rose, the value of mortgage securities began to decline and the derivatives market started unraveling. The failure of major U.S. financial institutions, heavily invested in dodgy assets, and the repeated need for tens and then hundreds of billions of dollars in government provided funds to keep them afloat, led to a much broader financial crisis across all asset markets not only within the US but globally.
It is clear that the larger financial and economic crisis cannot be resolved without stabilizing and addressing key issues surrounding the housing market, in general and foreclosures in particular. A solution to the mortgage/home price/foreclosure problems will likely engender stabilizing forces for other critical sectors of the economy. In this paper, we evaluate all the major, existing housing and mortgage related policy proposals, while applying our benchmark criteria of i) future mitigation of moral hazard, ii) bang for the buck, iii) fairness and distributive aspects, and iv) judicious mix of short-term and long term solutions. Going forward, several factors will be important for fostering stability in the housing and residential finance markets:
1. A sustainable, viable plan is likely to require elements of a standardized approach (e.g. for interest rate reduction), as well as triage for case-by-case loan modifications.
2. Losses and gains may have to be shared among three parties: lenders, borrowers and Government.
3. Legal reform may be necessary in order to delink servicers from security investors and clear the way for refinancing.
4. Targeting home-buying assistance to geographic areas with high foreclosure rates would bring the support directly to neighborhoods most in need of housing market stabilization.
5. There is little data on “jingle mail” share of foreclosures and on investor-landlords. A method for addressing these homes, perhaps tied to rental assistance, could keep the homes occupied and off the market.
6. An overhaul, restructuring and redistribution of federal and state regulatory responsibilities might combine the best institutional features of both.
The full report is on the Hoyt website
Posted by Maury Seldin on behalf of Bob Edelstein,Co-Chair of the Fisher Center for Real Estate and Urban Economics at the Haas School of Business, University of California Berkeley.
Liberty without Law: Financial Chaos - Paul Carr
The discontinuities in the complexity versus uncertainty figure can be attributed to non linear phase transitions and the Matthew Effect, "to him who has more shall be given." This is similar to Shermer's "Cumulative advantage and best seller effects."
Should laissez-faire economics be regulated? Too much liberty can degenerate into unaccountable chaos. Thaler & Sunstein (2008) argue that totally free markets can lead to disasters precisely because autonomous individuals are not good decision-makers. Too little liberty may cause stagnation. What is an optimum balance between autonomy and heteronomy (law) ?
Peters (2001) and Shermer ((2009) build on Adam Smith's invisible hand and chaos/complexity theory to show how free markets are by their nature continually evolving, emerging systems that require uncertainty to operate successfully. Let us apply this to the gross domestic product (GDP). Counties with too much regulation, control, and law (such as the USSR and China before 1989) had a low GDP. At this time, Europe and the US had a high GDP, indicating an optimum mix of law and liberty to innovate. In countries without enough law, i.e. anarchy, like Zimbabawe, the GDP was again low. Trust and the Matthew Effect (Shermer) contribute to maximizing the GDP.
Freedom decreases as the price of oil increases. (Friedman's (2008) Law of Petropolitics).
Alan Greenspan, when asked about the present financial crisis, said he had “overestimated the correcting power of free markets.” The delicate balance between law and liberty had been tilted too much toward the latter.
“Confirm thy soul with self control, thy liberty with law.” (Bates 1895 “America The Beautiful”).
Friedman, Thomas. 2008 Hot, Flat, and Crowded,
Peters, Edgar, E. 2001, Complexity, Risk, and Financial Markets, Wiley
Shermer, Michael, 2009. The Mind of the Market: How Biology and Psychology Shape Our Economic Lives, Holt Paperbacks.
Thaler, Richard, Sunstein, Cass. 2008. Nudge:Improving Decisions about Health, Wealth, Happiness
Posted by Maury Seldin on behalf of Paul H. Carr, AF Research Laboratory Emeritus
Starting with strategy, consider my essay, “Foreclosure? The Right Way to Play the Suit May be the Wrong Way to Play the Hand: A Strategic Approach to Averting a Crash in the Housing Market and its Fallout.” [Foreclosure Essay with a Strategic Approach.] The idea here comes in two major parts. The first is to avoid a crash in the local market of a subject property. The second is to avoid a cascading of local market housing crashes. At first glance, many people will consider both cases as being remote possibilities, especially the latter. As policy makers could wait until the possibilities seem less remote. The problem is that the longer the wait and the less remote the more difficult it becomes to avert. One could make mathematical calculations that would weigh the chances against the costs, but as with catastrophic events, even low probabilities are of little comfort if the catastrophe strikes. [Think Black Swan.]
Thus, prudent decision makers, when insurance policies are not available or realistic, may take preventive action even with probabilities not favoring the odds of caution. The ego-for-broker's strategy takes the chance. The Minimax strategy constrains the level of risk and maximizes within those constraints. In order to develop such a strategy it is essential to work with local data that identifies the high risk areas. The discussion which follows is a first step in developing such a strategy, cascading, is more difficult to tackle because of the problem of identifying tipping points before they happen. Forecasters do well in extrapolating from the past, but the turning points may arise in different patterns because of differences in people's responses, among other things. It may be a case of emergencie's. The link to the essay and a follow-up item is as follows: Foreclosure Essay with a Strategic Approach
As an interim reading the blog originally planned was longer than the 300 to 500 size I was advised to use, so I have sliced it up for a series of entries. The link to a long version designed for slicing is as follows: Foreclosure Prevention.
Foreclosure Prevention - Comment by Bob Edelstein
Here is an excerpt from study “The Housing Problem and the Economic Crisis: A Review and Evaluation of Policy Prescriptions. It consists of the Concluding Remarks and Remaining Issues.” This is the excerpt: A confluence of macroeconomic, social and financial forces caused the housing and subprime bubbles in the US. Macroeconomic conditions provided several crucial elements. US consumer debt fueled the trade deficit, which was financed substantially with savings by US trading partners. These global imbalances and capital inflows combined with official Fed interest rate policy (in response to the dot com bust and the recession of 2002) generated cheap and plentiful debt. There was copious, cheap mortgage money for homebuyers at one end, and a willing pool of global investors in securitized mortgages, at the other, all lubricated by lax oversight and weak regulation.
New borrowers emerged to meet the expanding supply of mortgage money. Homeownership rates rose among younger and lower income households. The financial sector frenetically expanded products to serve the demand from homeowners and satisfy yield starved investors. Through nothing short of financial alchemy, security issuers created derivatives with higher ratings than what the underlying securities could support. The fee structure rewarded lenders, mortgage brokers, rating agencies, and securitizers for originations rather than financial product viability, thereby creating incentives for increased transactions. Regulatory laxness passively permitted diluted underwriting standards and predatory lending practices, supporting the growth of subprime and Alt-A mortgages, which were then securitized and sold to investors around the world.
Subsequently, with lower growth in demand for homes, prices began to flatten or dip, and the boom in home construction collapsed. Simultaneously, the many subprime mortgages with interest reset provisions started to come due. Combined with lower sales activity and prices, a self-sustaining loop was created, causing marginal borrowers to default, further worsening housing market conditions. As home prices sank and mortgage default rates rose, the value of mortgage securities began to decline and the derivatives market started unraveling. The failure of major U.S. financial institutions, heavily invested in dodgy assets, and the repeated need for tens and then hundreds of billions of dollars in government provided funds to keep them afloat, led to a much broader financial crisis across all asset markets not only within the US but globally.
It is clear that the larger financial and economic crisis cannot be resolved without stabilizing and addressing key issues surrounding the housing market, in general and foreclosures in particular. A solution to the mortgage/home price/foreclosure problems will likely engender stabilizing forces for other critical sectors of the economy. In this paper, we evaluate all the major, existing housing and mortgage related policy proposals, while applying our benchmark criteria of i) future mitigation of moral hazard, ii) bang for the buck, iii) fairness and distributive aspects, and iv) judicious mix of short-term and long term solutions. Going forward, several factors will be important for fostering stability in the housing and residential finance markets:
1. A sustainable, viable plan is likely to require elements of a standardized approach (e.g. for interest rate reduction), as well as triage for case-by-case loan modifications.
2. Losses and gains may have to be shared among three parties: lenders, borrowers and Government.
3. Legal reform may be necessary in order to delink servicers from security investors and clear the way for refinancing.
4. Targeting home-buying assistance to geographic areas with high foreclosure rates would bring the support directly to neighborhoods most in need of housing market stabilization.
5. There is little data on “jingle mail” share of foreclosures and on investor-landlords. A method for addressing these homes, perhaps tied to rental assistance, could keep the homes occupied and off the market.
6. An overhaul, restructuring and redistribution of federal and state regulatory responsibilities might combine the best institutional features of both.
The full report is on the Hoyt website
Posted by Maury Seldin on behalf of Bob Edelstein,Co-Chair of the Fisher Center for Real Estate and Urban Economics at the Haas School of Business, University of California Berkeley.
Liberty without Law: Financial Chaos - Paul Carr
The discontinuities in the complexity versus uncertainty figure can be attributed to non linear phase transitions and the Matthew Effect, "to him who has more shall be given." This is similar to Shermer's "Cumulative advantage and best seller effects."
Should laissez-faire economics be regulated? Too much liberty can degenerate into unaccountable chaos. Thaler & Sunstein (2008) argue that totally free markets can lead to disasters precisely because autonomous individuals are not good decision-makers. Too little liberty may cause stagnation. What is an optimum balance between autonomy and heteronomy (law) ?
Peters (2001) and Shermer ((2009) build on Adam Smith's invisible hand and chaos/complexity theory to show how free markets are by their nature continually evolving, emerging systems that require uncertainty to operate successfully. Let us apply this to the gross domestic product (GDP). Counties with too much regulation, control, and law (such as the USSR and China before 1989) had a low GDP. At this time, Europe and the US had a high GDP, indicating an optimum mix of law and liberty to innovate. In countries without enough law, i.e. anarchy, like Zimbabawe, the GDP was again low. Trust and the Matthew Effect (Shermer) contribute to maximizing the GDP.
Freedom decreases as the price of oil increases. (Friedman's (2008) Law of Petropolitics).
Alan Greenspan, when asked about the present financial crisis, said he had “overestimated the correcting power of free markets.” The delicate balance between law and liberty had been tilted too much toward the latter.
“Confirm thy soul with self control, thy liberty with law.” (Bates 1895 “America The Beautiful”).
Friedman, Thomas. 2008 Hot, Flat, and Crowded,
Peters, Edgar, E. 2001, Complexity, Risk, and Financial Markets, Wiley
Shermer, Michael, 2009. The Mind of the Market: How Biology and Psychology Shape Our Economic Lives, Holt Paperbacks.
Thaler, Richard, Sunstein, Cass. 2008. Nudge:Improving Decisions about Health, Wealth, Happiness
Posted by Maury Seldin on behalf of Paul H. Carr, AF Research Laboratory Emeritus
Wednesday, October 21, 2009
Three Concepts for Fostering Discipline Development
This essay focuses on three concepts, each of which is complex. The first is what we think we know and how we know it. The second is adjusting for the differences between what we see and reality based on understanding the difference between discursive and presentational forms. The third is an application of the first two concepts to a social science phenomenon rather than physical objects through the application of emerging disciplines.
Although this essay is developed in the context of the philosophy interest group at ASPEC, and as a segue to the forthcoming seminar on strategic decision making at ASPEC (which I lead), it is also developed as a blog entry to Maury's General Blog and to later be used as a blog entry to Maury's Seminar Blog.
By Maury Seldin
Although this essay is developed in the context of the philosophy interest group at ASPEC, and as a segue to the forthcoming seminar on strategic decision making at ASPEC (which I lead), it is also developed as a blog entry to Maury's General Blog and to later be used as a blog entry to Maury's Seminar Blog.
By Maury Seldin
Sunday, August 2, 2009
Subprime Crisis What Went Wrong - Maury Seldin
The approach advocated is a strategic approach; one that recognizes that there is uncertainty and that there is a chance that the decisions that we will make will be in error. The strategic approach recognizes that human beings see the world from many different perspectives and as a result, do not always make decisions in a way the others see as logical. There is always uncertainty as to how others will react to stimuli and the actions that they will take in response to those stimuli. Behavioral economics is an emerging field that recognizes that “logic” varies widely from person to person. Indeed, some “illogical” actions may be a reaction to one’s own decisions. By so-doing, one may constrain the loss from being wrong. To paraphrase Josh Billings, it is not so much what we don’t know that gets us in trouble, as it is what we think we know that turns out to be wrong.
With that in mind, I will share what I think I know that will help in enhancing understanding of the subprime debacle and hope that others will carry it forward or substitute better analyses. Please read the main essay, Subprime Crisis Strategic Decision Making: A Discussion of What Went Wrong and Strategies to Deal With It and send in your comments.
An explanation of the origins of the subprime debacle could start in many places. My choice is to develop a readily understandable line of reasoning that focuses on two ideas. One is wealth creation and destruction. The other is on participants’ perspectives and decisions. By blending those two themes we can look at the debacle as starting with an unsustainable rise in house prices facilitated by less than prudent mortgage finance.
The next stage in the development of the line of reasoning is to consider the wealth destruction facilitated by the mortgage finance innovations, and their abuse, in the capital market. The destruction of wealth resulting from that fiasco reverberated to the rest of the capital market.
The next stage of the line of reasoning is the freezing up of capital markets and government intervention. The rescue plan, nee bail-out, was the first of a series of dramatic changes in the philosophical approach to the issues.
Please read the main essay, Subprime Crisis Strategic Decision Making: A Discussion of What Went Wrong and Strategies to Deal With It and send in your comments.
The Housing Problem and the Economic Crisis - Robert H. Edelstein
"It is clear that the larger financial and economic crisis cannot be resolved without stabilizing and addressing key issues surrounding the housing market, in general and foreclosures in particular. A solution to the mortgage/home price/foreclosure problems will likely engender stabilizing forces for other critical sectors of the economy. In this paper, we evaluate all the major, existing housing and mortgage related policy proposals, while applying our benchmark criteria of i) future mitigation of moral hazard, ii) bang for the buck, iii) fairness and distributive aspects, and iv) judicious mix of short-term and long term solutions. Going forward, several factors will be important for fostering stability in the housing and residential finance markets:
1. A sustainable, viable plan is likely to require elements of a standardized approach (e.g. for interest rate reduction), as well as triage for case-by-case loan modifications.
2. Losses and gains may have to be shared among three parties: lenders, borrowers and Government.
3. Legal reform may be necessary in order to delink servicers from security investors and clear the way for refinancing.
4. Targeting home-buying assistance to geographic areas with high foreclosure rates would bring the support directly to neighborhoods most in need of housing market stabilization.
5. There is little data on "jingle mail" share of foreclosures and on investor-landlords. A method for addressing these homes, perhaps tied to rental assistance, could keep the homes occupied and off the market.
6. An overhaul, restructuring and redistribution of federal and state regulatory responsibilities might combine the best institutional features of both."
Psychological Perspective of Standard Economics - by Jack Lillibridge
My focus is on the following quote from the essay, Subprime Crisis Strategic Decision Making: A Discussion of What Went Wrong and Strategies to Deal With It "There is always uncertainty as to how others will react to stimuli and the actions that they will take in response to those stimuli. Behavioral economics is an emerging field that recognizes that "logic" varies widely from person to person."
This blog comment, linked to my summary of my presentation at the Seminar on Strategic decision Making, is an abridged version of my presentation of comments on some books relevant to how concepts from psychological economics may contribute to understanding the current economic situation and what might be done about it. My presentation focused on three books; Predictability Irrational: The Hidden Forces that Shape Our Decisions by Dan Ariely; The Mind of the Market: How Biology and Psychology Shape Our Economic Lives by Michael Shermer; and Nudge: Improving Decisions About Health, Wealth and Happiness by Richard Thaler & Cass Sunstein.
Psychological Perspective of Standard Economics - By Jack Lillibridge
In my blog comments on Psychological Perspective of Standard Economics built on my presentation for the Seminar on Strategic Decisions I explored how the theory of complex adaptive systems might suggest ideas to help us understand the current economic crisis, how it happened, possible key causal variables, and likely outcomes.
A central idea from the theory is that complex systems, such as the economic system, have a dual nature: a stability aspect and a growth aspect. The stability aspect is characterized by balance, continuity, equilibrium, renewal, etc., and the growth aspect is characterized by creativity, learning, exploration, risking, etc. A human being has a similar dual nature: a stability aspect to insure survival and a growth aspect to deal with unexpected challenges and anticipated needs.
The three books: Predictably Irrational by Dan Ariely, Nudge by Richard Thaler and Cass Sunstein, and The Mind of the Market by Michael Shermer, present and illustrate psychological factors that may influence economic decisions in ways not accounted for in the standard economic model.
Nudge also describes many examples of a general strategy that may improve such economic decisions. The strategy structures the array of decision options of an economic actor in such a way as to make choosing the most beneficial option more likely without restricting free choice.
A brief recap of some of the psychological factors:
o Anchoring is where first impressions and initial decisions shape many others that follow. Once an initial value or percept is set, we are biased toward that original choice.
o Status quo bias is exhibited as a kind of inertia when making decisions. We opt for what we are used to.
o Loss aversion is where people fear losses more than they desire gains.
o When something is free we forget the downside. We perceive what is being offered as being much more valuable than it really is.
o An automatic pilot mode is where people are not actively paying attention to the task at hand.
o A variation of this is where people rely on beliefs, heuristics, models, theories,
etc. without paying attention to whether they are still appropriate in the current situation.
There are many other psychological factors that might be relevant, such as expectations, short-sightedness, self-justification, curiosity, etc., not explicitly dealt with in the books reviewed. Please see essay for further detail.
Posted by Maury Seldin on behalf of Jack Lillibridge. The comment was prepared prior to blog opening and the link is to an essay prepared by Dr. Lillibridge for Maury’s seminar at ASPEC.’ Dr. Lillibridge has his Ph.D. in Psychology.
With that in mind, I will share what I think I know that will help in enhancing understanding of the subprime debacle and hope that others will carry it forward or substitute better analyses. Please read the main essay, Subprime Crisis Strategic Decision Making: A Discussion of What Went Wrong and Strategies to Deal With It and send in your comments.
An explanation of the origins of the subprime debacle could start in many places. My choice is to develop a readily understandable line of reasoning that focuses on two ideas. One is wealth creation and destruction. The other is on participants’ perspectives and decisions. By blending those two themes we can look at the debacle as starting with an unsustainable rise in house prices facilitated by less than prudent mortgage finance.
The next stage in the development of the line of reasoning is to consider the wealth destruction facilitated by the mortgage finance innovations, and their abuse, in the capital market. The destruction of wealth resulting from that fiasco reverberated to the rest of the capital market.
The next stage of the line of reasoning is the freezing up of capital markets and government intervention. The rescue plan, nee bail-out, was the first of a series of dramatic changes in the philosophical approach to the issues.
Please read the main essay, Subprime Crisis Strategic Decision Making: A Discussion of What Went Wrong and Strategies to Deal With It and send in your comments.
The Housing Problem and the Economic Crisis - Robert H. Edelstein
"It is clear that the larger financial and economic crisis cannot be resolved without stabilizing and addressing key issues surrounding the housing market, in general and foreclosures in particular. A solution to the mortgage/home price/foreclosure problems will likely engender stabilizing forces for other critical sectors of the economy. In this paper, we evaluate all the major, existing housing and mortgage related policy proposals, while applying our benchmark criteria of i) future mitigation of moral hazard, ii) bang for the buck, iii) fairness and distributive aspects, and iv) judicious mix of short-term and long term solutions. Going forward, several factors will be important for fostering stability in the housing and residential finance markets:
1. A sustainable, viable plan is likely to require elements of a standardized approach (e.g. for interest rate reduction), as well as triage for case-by-case loan modifications.
2. Losses and gains may have to be shared among three parties: lenders, borrowers and Government.
3. Legal reform may be necessary in order to delink servicers from security investors and clear the way for refinancing.
4. Targeting home-buying assistance to geographic areas with high foreclosure rates would bring the support directly to neighborhoods most in need of housing market stabilization.
5. There is little data on "jingle mail" share of foreclosures and on investor-landlords. A method for addressing these homes, perhaps tied to rental assistance, could keep the homes occupied and off the market.
6. An overhaul, restructuring and redistribution of federal and state regulatory responsibilities might combine the best institutional features of both."
Psychological Perspective of Standard Economics - by Jack Lillibridge
My focus is on the following quote from the essay, Subprime Crisis Strategic Decision Making: A Discussion of What Went Wrong and Strategies to Deal With It "There is always uncertainty as to how others will react to stimuli and the actions that they will take in response to those stimuli. Behavioral economics is an emerging field that recognizes that "logic" varies widely from person to person."
This blog comment, linked to my summary of my presentation at the Seminar on Strategic decision Making, is an abridged version of my presentation of comments on some books relevant to how concepts from psychological economics may contribute to understanding the current economic situation and what might be done about it. My presentation focused on three books; Predictability Irrational: The Hidden Forces that Shape Our Decisions by Dan Ariely; The Mind of the Market: How Biology and Psychology Shape Our Economic Lives by Michael Shermer; and Nudge: Improving Decisions About Health, Wealth and Happiness by Richard Thaler & Cass Sunstein.
Psychological Perspective of Standard Economics - By Jack Lillibridge
In my blog comments on Psychological Perspective of Standard Economics built on my presentation for the Seminar on Strategic Decisions I explored how the theory of complex adaptive systems might suggest ideas to help us understand the current economic crisis, how it happened, possible key causal variables, and likely outcomes.
A central idea from the theory is that complex systems, such as the economic system, have a dual nature: a stability aspect and a growth aspect. The stability aspect is characterized by balance, continuity, equilibrium, renewal, etc., and the growth aspect is characterized by creativity, learning, exploration, risking, etc. A human being has a similar dual nature: a stability aspect to insure survival and a growth aspect to deal with unexpected challenges and anticipated needs.
The three books: Predictably Irrational by Dan Ariely, Nudge by Richard Thaler and Cass Sunstein, and The Mind of the Market by Michael Shermer, present and illustrate psychological factors that may influence economic decisions in ways not accounted for in the standard economic model.
Nudge also describes many examples of a general strategy that may improve such economic decisions. The strategy structures the array of decision options of an economic actor in such a way as to make choosing the most beneficial option more likely without restricting free choice.
A brief recap of some of the psychological factors:
o Anchoring is where first impressions and initial decisions shape many others that follow. Once an initial value or percept is set, we are biased toward that original choice.
o Status quo bias is exhibited as a kind of inertia when making decisions. We opt for what we are used to.
o Loss aversion is where people fear losses more than they desire gains.
o When something is free we forget the downside. We perceive what is being offered as being much more valuable than it really is.
o An automatic pilot mode is where people are not actively paying attention to the task at hand.
o A variation of this is where people rely on beliefs, heuristics, models, theories,
etc. without paying attention to whether they are still appropriate in the current situation.
There are many other psychological factors that might be relevant, such as expectations, short-sightedness, self-justification, curiosity, etc., not explicitly dealt with in the books reviewed. Please see essay for further detail.
Posted by Maury Seldin on behalf of Jack Lillibridge. The comment was prepared prior to blog opening and the link is to an essay prepared by Dr. Lillibridge for Maury’s seminar at ASPEC.’ Dr. Lillibridge has his Ph.D. in Psychology.
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