Bond Vigilantes, Still Invisible

 The inefficiency of refinancing – This paper explores the practice of mortgage refinancing in a dynamic competitive lending model with risky borrowers and costly default. We show that prepayment penalties improve welfare by ensuring longer-term lending contracts, which prevents the mortgage pools from becoming disproportionately composed of the riskiest borrowers over time. Mortgages with prepayment penalties allow lenders to lower mortgage rates and extend credit to the least creditworthy, with the largest benefits going to the riskiest borrowers, who have the most incentive to refinance in response to positive credit shocks. Empirical evidence from more than 21,000 non-agency securitized fixed rate mortgages is consistent with the key predictions of our model. Our results suggest that regulations banning refinancing penalties might have the unintended consequence of restricting access to credit and raising rates for the least creditworthy borrowers.
Refinance Activity and Mortgage Rates – Earlier the MBA reported on the decrease in refinance activity: The Refinance Index decreased 1.4 percent from the previous week. This is the fourth weekly decrease for the Refinance Index which reached its lowest level since June 2010. This graph shows the MBA’s refinance index (monthly average) and the the 30 year fixed rate mortgage interest rate from the Freddie Mac Primary Mortgage Market Survey®.  December mortgage rates are estimated at 4.75% (the rates quoted by several sources yesterday). Although mortgage rates haven’t risen very far – and are still below 5% – it takes lower and lower rates to get people to refi (at least lower than recent purchase rates).

Opening Bankruptcy Court to the States – Imagine a time a year or two into the future. A large American state has reached the limit of its ability to raise taxes and cut spending. It then is unable to roll over its debt. It defaults. Imagine also that a hedge fund has bought a good deal of that debt in the distressed debt markets. It puts all that debt in a newly formed limited liability company, or L.L.C., and when the state in question defaults on the debt, the L.L.C. files a Chapter 11 petition. And then the debtor (the L.L.C.) seeks to enforce that debt, as it is the only asset in the debtor’s bankruptcy estate. “Impossible!” you say, since states enjoy sovereign immunity. Well, outside of bankruptcy they do. But in 2006, the Supreme Court held that the Bankruptcy Clause to the Constitution represents an exception to the normal rule of sovereign immunity. So maybe this little scheme might work, at least if the L.L.C. were given a few other assets to make the scheme a little less obvious. This possibility raises the question of whether we should amend the Federal Bankruptcy Code to allow states to file for relief under Chapter 9, like municipalities, counties and other subsidiary governmental entities can already do. Even if states never filed under Chapter 9, such an amendment might be a good idea for a few reasons.

About 6 Million Didn’t Work at All Last Year – Nearly 6 million Americans looked for work but weren’t able to find employment at all last year, a new report shows. The Labor Department’s report on work experience in 2009, released today, highlights the long-term unemployment problem that’s likely to linger for years. Some 5.8 million job-seekers were without work for the entire year in 2009, an increase of 2.7 million from a year earlier. The majority of those unemployed for the entire year, nearly 57%, were men. Long-term unemployment, which describes people who have been out of work for 27 weeks or more, has been more pervasive in the latest downturn than any other period on record. Of all those unemployed, 41.9% had been out of work for more than six months as of November. Economists widely acknowledge the vexing nature of the problem. It has the potential to be long-lasting, it’s expensive and it’s not clear what policies would be most helpful in solving it.

Worrying about oil prices – The price of oil moved above $90 a barrel yesterday. Is it time to become concerned about the possible macroeconomic effects? In the early part of this decade, consumers seemed to be largely ignoring oil prices, in part because energy expenditures had become a smaller part of their budget than they had been in the late 1970s. But as the price of oil rose over the decade, energy expenditures returned to a position of importance in consumer budgets. I’m persuaded that the oil price shock of 2007-2008 made a measurable contribution to the initial downturn of the Great Recession. Based on the BEA breakdown of consumer expenditures, as of October consumer spending on energy goods and services constituted 5.5% of total spending, a bit below the 6% levels at which we saw significant consumer responses two years ago.
Education Spending and Those International Test Scores –  As my colleague Sam Dillon reported on Tuesday, China gave the rest of the world a run for its money in the Program for International Student Assessment, a test administered to 15-year-olds around the world. But how might money actually have affected these test scores?

The Organization for Economic Cooperation and Development, which administers the test, has put together some handy graphs showing how well a country’s students scored on the reading portion of the test in comparison to other variables, like how rich or educated that country is. Below, for example, is a graph showing a country’s gross domestic product per person versus the country’s reading test scores. The relationship between the two is very weak.

Is the Tax Deal Targeted, Timely, and Temporary? – Is this the best deal we could get in terms of its economic impact? Not by a long shot. Stimulus packages are supposed to be targeted, timely, and temporary, and this bill fails on all three fronts. It certainly could have been targeted better. Take the payroll tax cut. It will apply equally at all income levels and thus, in absolute terms, the highest income taxpayers will receive the highest benefit. Tilting the benefits toward those who are more likely to spend the tax cut rather than save it would enhance its impact. The same is true with items like tax cuts for the wealthy and the estate tax. Is it timely? No, it’s much later than would be optimal. There are lags between the time a bill passes — which this one has yet to do — and the time it actually hits the economy. We don’t need a stimulus several months from now, we needed it months and months ago. Will it be temporary? It’s supposed to be, at least according to what the bill says, but that’s not the intent of the GOP regarding their favorite tax cuts. And as I noted here, it will be hard to raise the payroll tax a year from now if the economy is still lagging, as it’s likely to be, and that sets it up to be extended permanently.


More on the Tax Deal – I got some valid criticisms for my last post on the tax cut deal. In particular, that post may make it seem as if my criticism of President Obama has to do with his negotiating ability. But if Obama really wanted the outcome he ended up with, then he is a master negotiator; where I really differ from him, then, would be in what policy should be.  I want to repeal all the Bush tax cuts, and eliminate the mortgage interest deduction, and eliminate the income cap on payroll taxes, and eliminate preferential rates for dividends and capital gains, and tax carbon emissions, and cut the defense budget (and secure lasting peace in the Middle East). I want to use some of those increased revenues to reduce the long-term deficit, some to provide block aid to state and local governments, some to extend unemployment benefits permanently, and the rest to fund a refundable tax credit for poor people that will basically ensure a minimum standard of living for everyone. But that’s not going to happen. You have to choose among the options you have.
Death Penalty: Can Ending Capital Punishment Help States?… California has a $25 billion deficit and almost 700 inmates on death row. According to a 2008 report issued by the California Commission for the Fair Administration of Justice, maintaining the criminal justice system costs $137 million per year, but the cost would drop to $11.5 million if it weren’t for the death penalty. A 2010 study from the Northern California chapter of the American Civil Liberties Union found that California would be forced to spend $1 billion on the death penalty in the next five years if the state does not replace capital punishment with permanent imprisonment.  California is not the only state where cost has become an argument for abolishing the death penalty.  Last week a commission report recommended to the New Hampshire legislature that the state not expand its death penalty, citing its higher costs as one of the reasons, and the same week a bill to abolish the death penalty in Illinois passed in the state’s House Judiciary Committee.


Bond Vigilantes, Still Invisible – US long-term interest rates have risen somewhat in the wake of the debt deal — and sure enough, we’re hearing warnings about “bond vigilantes” again. OK, guys, first of all: interest rates have soared back to their levels of …. June.  Beyond that, it has been very clear, if you watch the ups and downs of long-term rates, that they reflect just one thing: perceived prospects for recovery, and hence when you might expect the Fed to move off the zero-rate policy. Rates began rising a few weeks ago as data began to suggest a somewhat stronger recovery than previously anticipated (stronger, not strong — we’re still looking at years of very high unemployment). They rose again in the past couple of days on the belief that the stimulus part of the tax deal would actually lift the economy to some extent.
Which States Manage Household Finances Best? – Now you can go to a new website, and see just how good or bad citizens in your state are at managing household finances. Here’s a small spoiler: if you aren’t a citizen of New York, New Jersey or New Hampshire, you are less likely to be among the most financially adept individuals. Those three states were among the top five in at least three of five measures of financial capability, according to a survey of more than 28,000 people. The interactive, clickable map of the U.S. is based on the State-by-State Financial Capability Survey released Wednesday that was developed in consultation with the Treasury Department and the President’s Advisory Council on Financial Literacy. Find the full data here.


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