More on the Fed and the Housing Bubble

I ran into this article today. It's a bit more technical then what I've previously linked to in the past, but if your willing to read through it, its worth it. I had previously posted about how loose monetary policy had been a large contributor to our housing mess. This argues along the same notion. From the article, here are a couple of relevant charts.

Fed Funds Rate














Growth of Subprime Loans















Notice the correlation with subprime growing starting in 2001 and accelerating through 2005, the periods when the Fed held very low interest rates stoking a bubble in housing investment. Whats just as important is realizing that this mess want just subprime, but an explosion of housing lending in general, which is discussed more in t e article. The growth began to slow as the Fed raised rates and then started to fall as the housing bubble popped.

-EJB

Unions Help Workers, Right?

So given the pretty dynamic discussion about “Card Check” that was fostered by my last post, I thought I’d throw out this bomb shell to see what happens. If this above mentioned policy gets enacted it will likely have the effect of increasing union membership; that’s the reason why unions are in such favor of the policy in the first place.

Without getting into the arguments for the right to unions and so on, I want to just look at the macroeconomic effects of unionization. Though all unions are not monolithic, the primary goal is to negotiate a wage for members that is higher then what would have been received in their absence. For any given employer then, a union has a monopoly on a firm’s labor supply. As we all know, monopolies have the ability to charge higher prices than in a competitive market. As a result, union members on average therefore receive higher wages and benefits then non-unionized labor. However, this gain is achieved at the expense of workers who are not unionized and the unemployed, as well as the general economy. The Law of Demand states that the higher wages required for the same labor reduces the total quantity of labor demanded by employers, lowering the wages and the job opportunities for everyone outside the union (as well as union members themselves through lower long term growth in wages).

So to test this theory out I looked at the relationship between union membership and general employment growth. I took a bunch of state data from the Bureau of Labor Statistics on unionized labor rates and employment growth over the past ten years. As seen by the chart below there is a negative correlation between the percent of unionized labor and the growth in overall employment over the time period. I used a ten year period in order to capture an entire business cycle and minimize the effects of one-time events such as Katrina and September 11th.

The result was that over this period, for every 10 percent of workers that were unionized, the state’s job growth rate was 2.6 percent lower. The median “Right to Work” state had job growth of 13.7 percent compared to 10.2 percent for states without these laws. This translates to a growth rate that is 34 percent faster.

*Note that the blue dots are states that are “Right to Work” meaning that it is illegal to mandate that workers join a union if a given employer is unionized. These states on average have much lower rates of unionization, and that is why unions generally oppose such laws. On the other hand, these laws are likely only able to be passed in states with low union membership.

Obviously there are many more factors that affect job growth then just unions (this is why there is a good amount of variance between the data points), including education levels, tax rates, access to infrastructure and so on. Furthermore, the two may just be correlated to some other third condition. However, on average there is relationship between the two. That put together with the logical analysis suggests that larger union states have a more difficult problem with attracting employers who wish to create jobs. A more accurate statistical analysis would require, for those math prone, a multi variable regression analysis. Lacking the software, the time and the desire to exert that effort, I have not done so, but you can look at other studies. As executive summary of one can be found here or the entire paper here. It is only one paper (and written by self desrcibed "free market economists"), but it looked at a host of variables that have an effect on growth and emperically found that after the relative state income tax rate, the second most significant variable was a state’s “Right to Work” laws, which not only has an effect in of itself, but as seen in the chart, is correlated with lower rates of unionization

Some of the outliers in that chart can also be partially explained by the type of unionization that is prevalent. There are two components of the negative effect unions have on overall employment. The first is the income effect, where the quantity demanded of labor gets reduces as the price rises simply because it would require a larger amount of the employer’s money. This effect is relatively even across states. The difference is the second component, the substitution effect, which causes the consumer to reduce the quantity demanded because they shift to alternatives at lower prices. This effect by state varies greatly by the characterizes of the unions of those states. The blue dot at the top of the graph for instance is Nevada, where the bulk of the union presence is related to casinos in Las Vegas. Because gambling is illegal in most areas int he country, there really aren’t many alternatives for operators of casinos so they have to hire this union labor. Likewise, states where the unions are dominated by municipal workers, by that very nature these employees cannot be hired elsewhere. The contrast is manufacturing unions which dominate Ohio, Michigan and other rust belt states. Their labor can very easily be moved to other states, which is why for example, Honda, Toyota and Nissan are building plants in “Right to Work” states such as Texas, Kansas and Tennessee. Even further, labor can be shipped to foreign countries, which is why for instance, GM has built most of its new plants not in Michigan but in Canada and Mexico. This is why unions generally support import tariffs in order to protect their above market wages from competition. (note also that the powers of unions to achieve higher then market wages varies by state due to the legal structure of each state).

In the end even though it would be very reductionist to argue that unions are the only negative drag on the economy, on average they are indeed a negative factor on overall employment. Both logical principles and empirical data suggest that this effect occurs. If this legislation does pass we can expect slower employment growth, slower wage growth, and higher unemployment then we would have going into the future.

-EJB


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So let me start off by saying I am not in favor of the "Card Check" program. I am also generally a supporter of Right to Work laws, because workers should not be forced to unionize. If belonging to a union is highly beneficial to the average worker, then it would follow that workers would voluntarily choose to join - no mandate should be, or would be, necessary. But I must make a few points regarding EJB's post.

First, for those of you who don't know me, I worked as a welder for four summers during my college days. I welded depth gauges for oil fields and submarines. Pretty sweet, I know. Paying dues to the local union was a condition for attaining summer employment with this company. Thus, I was (and continue to be) a nominal member of the union. I had my ups and downs with them. Essentially, I paid union dues but did not receive the full extent of protections and benefits that they offer full-time workers. This and their re-routing of my dues to certain political candidates bothered me. However, I also made well over the market rate for similar summer employment; a fact which can be directly chalked up to the power of the union I joined.

EJB entitles his post "Unions Help Workers, Right?" Then he goes on to show that the increase in unionization tends to cause (or at least, loosely correlates with) a decrease in employment growth. I guess I can't really argue with another chart (how the hell do you have the time to create these charts?), but I can tell you that EJB's initial premise (which is reflected in his title) is flawed. Unions don't help workers, they help their workers. Unions exist to aid their members and that's it. If we substitute my new premise (let's call it..."correct premise A") for EJB's premise (let's call this one..."painfully flawed premise B"), then his chart and data don't carry much force because unions don't - and, according to Correct Premise A, shouldn't - care about unemployed people looking for work; they are not union members.



















Now, it is also obviously true that unions DO help their members. EJB rightly points out that union members, on average, make more than their non-unionized counterparts. I have countered your chart with TWO of my own! (stolen from the afl/cio website, via Dept. of Labor Statistics). Besides just a higher average income, union membership helps narrow the income gap between genders and races. Plus, unions help secure greater benefits for their members.

So, I recognize that EJB would not contest the fact that unions help their members. His point, really, was to show that this aid comes at the expense of certain sectors of society - namely, the unemployed and the non-unionized workforce. But I suppose my response to that would be, so what? Unions were not formed (and are not formed) to benefit society as a whole. They are explicitly and unabashedly fighters for their own members' causes. And while I do not support legislation that would force workers to join unions, I would suggest to anyone that works in a factory to join their local union and reap the benefits and protections they have established.

~JSK

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A couple of things. You state that my premise changed via my title and the post. When I titled this post suggesting unions do not help workers, I was referring to workers at large, so I don't think I was being misleading. This is because as a matter of public policy it is often argued that more unions are better for workers in general and that workers have been hurt by declining unionization rates over the years.

I completely agree that obviously in the static moment, unions do benefit their members relative to non-members. However, even union members are hurt in the long run. This is because over time, less and less union labor will be demanded via the substitution effect previously explained. This is why the car companies are not building new factories in Detroit.

As the chart to the left shows, the Detroit US manufactures annual car production declined over this period. But this was not the case in the larger US industry. The Asian companies who produce cars in the US (in largely right to work, low unionization states) greatly expanded their production. Now obviously there are other factors with the companies going on here, but this shows that even the unionized workers are hurt in the long run because the demand for their labor decreases, resulting in slower wage growth and more unionized workers now finding themselves unemployed. On the macro picture, this is why unionization has been on a steady decline for decades and unions are finding it increasingly important to use the power of government to enact laws that essentially force increases in their membership.

-EJB

A Frank Response from a Local Economics Professor

Don Boudreaux, the chair of the economics department at George Mason University, in my local Northern Virgina, responded to a request from a campaign volunteer for Sen. Obama. The volunteer requested that the Senator be able to come to the school to talk about his economic plan in order to inform students. This is what the professor wrote in reply and then posted it on his blog:


Dear Mr. _______:

Thanks for your note asking if GMU Econ is interested in inviting Barack Obama to campus in order for him to outline his "economic plan."

I can't go along with your suggestion. First, and most practically, such an invitation would really have to come from either the Office of the Provost or the Office of the President -- not from the Chairman of the Department of Economics.

Second, and most importantly, I have negative willingness to be part of an effort to give any politician a platform to speak about economics. Very few of them have any knowledge of the subject, and even fewer of them are courageous enough to speak about it honestly.

Listening to politicians, regardless of party, discuss economics makes me sick both to my head and to my stomach. And the only people who are not similarly affected, I fear, are persons whose knowledge of economics is sufficiently scant -- or whose ethics are sufficiently perverted -- to protect their senses from being insulted by what issues forth from the mouths of politicians speaking on economic topics.

So as an economist, I am no more interested in having Sen. Obama (or Sen. McCain) come to GMU's campus to lecture us on "how to manage the economy" than I would be, say, to have O.J. Simpson come to GMU's campus to lecture us on how to manage one's marriage.

Sincerely,
Don Boudreaux
Professor and Chairman
Department of Economics
George Mason University

I can't say I disagree with the sentiment. Listening to debates and stump speeches on the broad topic makes me want to throw something at the TV. Though formal education isn't synonymous to knowledge, isn't it comforting that out of those men and women who are trying to deal with our housing crisis, 80 percent of them have no background in economics, finance, or business? The scary thing is that we use the political process, populated by those with little knowledge on the subject, electing those with little knowledge on the subject, to determine such policies. This is analogous to using the voting booth to determine what the proper procedure for surgeons is when performing a quadruple bypass surgery.

-EJB

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Well, that is a pretty strongly worded letter - about as strongly worded as your own feelings on the subject. If one were to read only this post, it would appear that economists everywhere were fed up with (and vaguely angry about) politicians purporting to know economics, but failing. However, as with every story, there is a flip side.

I'd like to start with the possible notion that - EJB, close your eyes - economics may not be a science. Barbara Bergmann, an economics professor from the University of Maryland and American University has penned this article (link is to the abstract but below that is another link to the article itself) in which she claims that new methods of empirical study are necessary in the economics field because economists are simply "making it up." The late nobel-prize winning physicist (and all-around genius) Richard Feynman might agree with Professor Bergmann. Further reading here and here.

My point would be, I suppose, that if economics is merely a "social science," then it wouldn't be fair to lambaste the candidates for failing to keep up with the cutting-edge notions of economics (just as it would be unfair to blame them for not surrounding themselves with sociologists, psychologists, criminologists and other pseudo-sciences.)

My second point, however, is that, whether it seems like it or not, these candidates have actually done a good job in surrounding themselves with top-quality economic advisers (most of whom are economics professors). For instance, Obama's economic brain-trust includes: Austan Goolsbee (Professor of Economics at UChicago), Jeffrey Liebman (Professor of Economics and Public Policy at Harvard) and David Cutler (Professor of Economics at Harvard). These are all leading figures in the field and their teaching credentials are rock-solid.

McCain, meanwhile, has surrounded himself with former Reagan advisers like Jack Kemp (former US Representative and strong supporter of supply-side economics) and Phil Gramm (former US Senator and PhD in economics from Georgia).

I suggest that what makes Professor Boudreaux and EJB so irrationally infuriated by the economic policies of Mr. Obama and Mr. McCain might be that they simply subscribe to a different school of economic thought. I dare not delve into the pseudo-science of sociology, but it is simply my educated guess. I must profess that I know next to nothing about economics and its various internal philosophies. I am slightly educated in the law and economics movement, whose main advocate is Seventh Circuit Judge Richard Posner. Thus I may be playing out of my league and I whole-heartedly expect EJB to put me in my place in his follow-up post.

~JSK


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First off, your line "economics may not be a science" and then your talk about the problems with empirical methods - It is true that economics is not a hard science in the sense chemistry and physics are. So in some respect on this point, I agree. But there are many generally agree upon principles that cross schools of thought that somehow don't make it into politicians proposals.

The problem is that you are responding to an argument not made here. The point of the posted email has more to do with the line "Very few of them have any knowledge of the subject, and even fewer of them are courageous enough to speak about it honestly."

JSK gives his analysis of this line saying, "I suggest that what makes Professor Boudreaux and EJB so irrationally infuriated by the economic policies of Mr. Obama and Mr. McCain might be that they simply subscribe to a different school of economic thought." He chalks this up to disgust driven by disagreement over legitimate academic debate.

It is true that both I and Boudreaux draw many of our positions from different schools of thought then many of the economists you just listed. I am somewhat familiar with Goolsbee (for those of you interested, he was also on APDA). If this were just a debate over schools of thought, I would not be frustrated. In reality, that is not what this is about, as your comment alleges, "then it wouldn't be fair to lambaste the candidates for failing to keep up with the cutting-edge notions of economics." Most politicians stated economic views don't even line up with the grander theory behind their advisers, never mind "cutting edge." They don't even correctly argue for the ideas that have been around for decades that show up in the intro level text book of any econ 101 class.

I will give a couple recent examples. First are the stimulus checks. When being passed in Congress, last spring, many of the Democrats argued that we had to "pay" for the stimulus checks by raising taxes. Likewise, Obama's plan to give another $1,000 "stimulus check" to each household will be payed for by more taxes. Neither of these ideas are grounded in any school of macroeconomic thought, even the ones his advisers represent. Textbook Keynesian theory, traditionally the school that the American left has associated with, including many of Obama's advisers, states that the whole point of government stimulus is to take deficits. In doing so, the government finances further consumption, and therefore increases aggregate demand. If taxes are raised to pay for them, that defeats the whole purpose, as every dollar of new "stimulus" is countered by a dollar taken away through taxation; the effect is null. Rather, these kinds of ideas do not have their motives based in macroeconomic policy as advertised; it will not increase employment or increase output growth. It has more to do with a long held desire to socially engineer through wealth redistribution. By claiming it to be macroeconomic policy, it becomes a convenient political opportunity. I can assure you, that none of Obama's economic advisers can honestly tell you that handing out checks paid for by an equivalent increase in taxes will have any macroeconomic benefit. In fact, despite many politicians blaming our current economic woes on government deficits, according to Keynesian thought, in the short run this deficit spending should have actually increased growth over the past 8 years.

Second is the "gas tax holiday" promoted by both Sen. McCain and Sen. Clinton. The idea is absurd, because in the short run the supply of gasoline is relatively fixed (you just cant build a new refinery overnight), therefore, any increase in demand from the lower price by removing the tax will simply result in a price increase back to the level it was with the tax imposed (or at least in the short run) and now the tax savings will just go to the producer, not the consumer. This is why Clinton, when asked could not name one economist who thought this was a good idea (even her own advisers). I'll even entertain you with a Harvard economist, Gregory Mankiw, who stated, "What you learn in Economics 101 is that if producers can’t produce much more, when you cut the tax on that good the tax is kept . . . by the suppliers and is not passed on to consumers."

Like Boudreaux's line said, few understand economics, and the ones who do don't speak truthfully out of a desire for political gain. The result is that we have politicians claiming to "fix" the economy and "create" jobs. This only reinforces the popular notion of the messiah-like powers that politicians supposedly have over the economy. Much of this is because politicians give up all integrity in order to gain power and therefore know they really make no sense. However, some of this is that they truly don't understand a lot of this as evidenced by the recent comments of Sen. Tester, asking Bernanke to tell him what was going on giving his usual line, I'm just a dirt farmer, or a House Financial Service Committee member saying, "You mean the dollar isn't backed by gold anymore?" As spoken about in my recent post, I truly believe some politicians really think our whole mess is just "greed."

It is true that I don't expect our leaders to be experts in every field. However, at the same time they should not be claiming to have the mighty power of controlling, micromanaging and "fixing" the economy just as it would be absurd for a political candidate to claim they know the secrets of cold fusion, how to magically cure all psychological ills in the nation, or debate over the technicalities of complex surgical operations.


-EJB

The Federal Reserve's Role in the Housing Crisis

As is usually the case in discussing economic policy, public debate rarely focuses around facts or theory and usually devolves into overly simplistic notions based in jealousy and frustration. The current housing crisis is no different. Both major presidential candidates, in an attempt to appeal to populous sentiment have chalked up our entire problem to be nothing more then the "greed" of Wall Street and therefore come to the conclusion that the "free market failed." The remedy is then by default more "regulation" which is never defined or explained by those advocating for it.

The reality is that there were a number of factors that have contributed to the housing bubble, the mortgage market collapse and the associated economic downturn. I therefore plan on starting a series of posts that will try to address some of these issues. This first one looks at the role the Federal Reserve had in creating, or at least contributing to, the housing bubble's rise and eventual popping. I bring your attention to the chart below:

The blue line is the ratio of the average price of a home based on an index to total GDP. It was scaled so that 1992 =1. The green line is the Federal Funds rate, the interest rate that the Federal Reserve manipulates when it is reported that interest rates have been "cut" or "raised." This is the rate at which banks lend to each other. The red line is a weighted average of mortgage interest rates.

Normally, house prices only grow as fast on average as GDP does, which correlates with the average incomes of buyers. This makes sense; as incomes rise, there is more demand for housing, and prices rise.

However, you can see how this proportional relationship of the two in the 1990's, shown by a relatively level line, began to change around midway through 2000. This is by no coincidence around the same time that the Fed cut the Fed Funds rate to a very low rate and kept it there for a very long time, particularly relative to the previous recession in 1991-1992. This had the effect of lowering mortgage rates to historically very low levels as seen in the red line. Around 2000, when mortgage rates started falling, home prices started rising as the cost of a mortgage payments went down and therefore the quantity of housing demanded went up. Likewise, the bubble was "popped" around 2006, right when the FED had now raised its rates and mortgage rates started to rise.

Essentially, it was not the "free market" or "greed" that caused this bubble, or at least not in of itself. The Fed, a non-free market institution had a very important role in creating or at least exacerbating the bubble and therefore ultimately our housing and economic woes. This chart (current through June) shows that in order to come back into equilibrium, prices have to fall a good amount further.

For a more detailed explanation, one good example can be read here.


-EJB


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Well, I must confess that, originally, I was one of those calling for the end of the "free market." My belief was that investor greed and market inefficiencies were entirely to blame for the collapse. Clearly, as you have eloquently stated, they were not. You even have a chart which lends itself nicely to your point...and I cannot argue against a chart. Believe me, I have tried...typically the argument ends with me yelling at it and the chart just sitting there...mocking me in its silence.

However, a few quick points. The chart and the statistics that it represents could never be understood by a vast majority of voters. If Obama or McCain were to drag an easel onto the stage and unveil this chart, I can guarantee that their poll numbers would drop.

I also think it would be a mistake to condemn the government entirely. The State's goals were amicable. I think we can all agree that increasing the amount of homeownership, especially among lower income families is a good thing. However, clearly the Fed messed up in choosing what means to follow in order to reach that end.

Furthermore, it would be misguided to ignore the important part that greed did play in the crisis - and I do not mean to suggest that EJ ignores this factor, he simply hasn't gotten to that part of his analysis yet. But to preempt him a little, at the height of the sub-prime mortgage crisis, there was absolutely no way that investors could claim that they did not see a crisis on the horizon. Everyone, including the CEO and CFO of Fannie Mae, recognized that the securitizing of these high-risk loans, coupled with the creation of negative externalities on the part of such organizations as Fannie, was a recipe for future disaster.

The candidates would do well to elaborate on their definition of "regulation," because, clearly, regulation is not the antidote. The important distinction between "oversight" and "regulation" is getting lost in the fracas. Congress, the SEC and the Treasury did not fail in its ability to "regulate" but actually failed to adequately oversee the market. Increasing the SEC's ability to oversee trading of this kind would be a perfectly reasonable response to the crisis...but it would not involve strengthening mandatory disclosure provisions or any other sort of harsh government regulation.


~JSK

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I agree with you that this is too complex for candidates to bring up, but more analysis could be done, or in particular why isn't the media in its endless opinion shows talking about this kind of stuff? I know I for one had a special place in my heart for those charts Ross Perrot used to always bring up to the stage with him. :)

One thing with the Fed and affordable housing though - there were and still are many government polices that were created to increase home ownership and your right that I will get to those in the future, but the Fed had little to do with that by design. The Fed kept rates so low not to increase home ownership, but because they were worried about deflation at the time and wanted to aggressively inflate the money supply. They overdid it though. And it isn't necessarily Greenspan's fault either, but is is because the Fed suffers from the shortcomings of any central economic planning attempt that has been tried. Mainly, it is impossible for anyone to have enough accurate information at their disposal to be able to manage or manipulate an extrmely complex organism as a national economy correctly. There are always unintended consequences of intervention.

-EJB