Tag Archives: mortgage

Why the lack of labor mobility in the U.S. is a problem and how we can fix it

Many researchers have found evidence that mobility in the U.S. is declining. More specifically, it doesn’t appear that people move from places with weaker economies to places with stronger economies as consistently as they did in the past. Two sets of figures from a paper by Peter Ganong and Daniel Shoag succinctly show this decline over time.

The first, shown below, has log income per capita by state on the x-axis for two different years, 1940 (left) and 1990 (right). On the vertical axis of each graph is the annual population growth rate by state for two periods, 1940 – 1960 (left) and 1990 – 2010 (right).

directed migration ganong, shoag

In the 1940 – 1960 period, the graph depicts a strong positive relationship: States with higher per capita incomes in 1940 experienced more population growth over the next 20 years than states with lower per capita incomes. This relationship disappears and actually reverses in the 1990 – 2010 period: States with higher per capita incomes actually grew slower on average. So in general people became less likely to move to states with higher incomes between the middle and end of the 20th century. Other researchers have also found that people are not moving to areas with better economies.

This had an effect on income convergence, as shown in the next set of figures. In the 1940 – 1960 period (left), states with higher per capita incomes experienced less income growth than states with lower per capita incomes, as shown by the negative relationship. This negative relationship existed in the 1990 – 2010 period as well, but it was much weaker.

income convergence ganong, shoag

We would expect income convergence when workers leave low income states for high income states, since that increases the labor supply in high-income states and pushes down wages. Meanwhile, the labor supply decreases in low-income states which increases wages. Overall, this leads to per capita incomes converging across states.

Why labor mobility matters

As law professor David Schleicher points out in a recent paper, the current lack of labor mobility can reduce the ability of the federal government to manage the U.S. economy. In the U.S. we have a common currency—every state uses the U.S. dollar. This means that if a state is hit by an economic shock, e.g. low energy prices harm Texas, Alaska and North Dakota but help other states, that state’s currency cannot adjust to cushion the blow.

For example, if the UK goes into a recession, the Bank of England can print more money so that the pound will depreciate relative to other currencies, making goods produced in the UK relatively cheap. This will decrease the UK’s imports and increase economic activity and exports, which will help it emerge from the recession. If the U.S. as a whole suffered a negative economic shock, a similar process would take place.

However, within a country this adjustment mechanism is unavailable: Texas can’t devalue its dollar relative to Ohio’s dollar. There is no within-country monetary policy that can help particular states or regions. Instead, the movement of capital and labor from weak areas to strong areas is the primary mechanism available for restoring full employment within the U.S. If capital and labor mobility are low it will take longer for the U.S. to recover from area-specific negative economic shocks.

State or area-specific economic shocks are more likely in large countries like the U.S. that have very diverse local economies. This makes labor and capital mobility more important in the U.S. than in smaller, less economically diverse countries such as Denmark or Switzerland, since those countries are less susceptible to area-specific economic shocks.

Why labor mobility is low

There is some consensus about policies that can increase labor mobility. Many people, including former President Barack Obama, my colleagues at the Mercatus Center and others, have pointed out that state occupational licensing makes it harder for workers in licensed professions to move across state borders. There is similar agreement that land-use regulations increase housing prices which makes it harder for people to move to areas with the strongest economies.

Reducing occupational licensing and land-use regulations would increase labor mobility, but actually doing these things is not easy. Occupational licensing and land-use regulations are controlled at the state and local level, so currently there is little that the federal government can do.

Moreover, as Mr. Schleicher points out in his paper, state and local governments created these regulations for a reason and it’s not clear that they have any incentive to change them. Like all politicians, state and local ones care about being re-elected and that means, at least to some extent, listening to their constituents. These residents usually value stability, so politicians who advocate too strongly for growth may find themselves out of office. Mr. Schleicher also notes that incumbent politicians often prefer a stable, immobile electorate because it means that the voters who elected them in the first place will be there next election cycle.

Occupational licensing and land-use regulations make it harder for people to enter thriving local economies, but other policies make it harder to leave areas with poor economies. Nearly 13% of Americans work for state and local governments and 92% of them have a defined-benefit pension plan. Defined-benefit plans have long vesting periods and benefits can be significantly smaller if employees split their career between multiple employers rather than remain at one employer. Thus over 10% of the workforce has a strong retirement-based incentive to stay where they are.

Eligibility standards for public benefits and their amounts also vary by state, and this discourages people who receive benefits such as Temporary Assistance for Needy Families (TANF) from moving to states that may have a stronger economy but less benefits. Even when eligibility standards and benefits are similar, the paperwork and time burden of enrolling in a new state can discourage mobility.

The federal government subsidizes home ownership as well, and homeownership is correlated with less labor mobility over time. Place-based subsidies to declining cities also artificially support areas that should have less people. As long as state and federal governments subsidize government services in cities like Atlantic City and Detroit people will be less inclined to leave them. People-based subsidies that incentivize people to move to thriving areas are an alternative that is likely better for the taxpayer, the recipient and the country in the long run.

How to increase labor mobility

Since state and local governments are unlikely to directly address the impediments to labor mobility that they have created, Mr. Schleicher argues for more federal involvement. Some of his suggestions don’t interfere with local control, such as a federal clearinghouse for coordinated occupational-licensing rules across states. This is not a bad idea but I am not sure how effective it would be.

Other suggestions are more intrusive and range from complete federal preemption of state and local rules to federal grants that encourage more housing construction or suspension of the mortgage-interest deduction in places that restrict housing construction.

Local control is important due to the presence of local knowledge and the beneficial effects that arise from interjurisdictional competition, so I don’t support complete federal preemption of local rules. Economist William Fischel also thinks the mortgage interest deduction is largely responsible for excessive local land-use regulation, so eliminating it altogether or suspending it in places that don’t allow enough new housing seems like a good idea.

I also support more people-based subsidies that incentivize moving to areas with better economies and less place-based subsidies. These subsidies could target people living in specific places and the amounts could be based on the economic characteristics of the destination, with larger amounts given to people who are willing to move to areas with the most employment opportunities and/or highest wages.

Making it easier for people to retain any state-based government benefits across state lines would also help improve labor mobility. I support reforms that reduce the paperwork and time requirements for transferring benefits or for simply understanding what steps need to be taken to do so.

Several policy changes will need to occur before we can expect to see significant changes in labor mobility. There is broad agreement around some of them, such as occupational licensing and land-use regulation reform, but bringing them to fruition will take time. As for the less popular ideas, it will be interesting to see which, if any, are tried.

Paving over pension liabilities, again

Public sector pensions are subject to a variety of accounting and actuarial manipulations. A lot of the reason for the lack of funding discipline, I’ve argued, is in part due to the mal-incentives in the public sector to fully fund employee pensions. Discount rate assumptions, asset smoothing, and altering amortization schedules are three of the most common kinds of maneuvers used to make pension payments easier on the sponsor. Short-sighted politicians don’t always want to pay the full bill when they can use revenues for other things. The problem with these tactics is they can also lead to underfunding, basically kicking the can down the road.

Private sector plans are not immune to government-sanctioned accounting subterfuges. Last week’s Wall Street Journal reported on just one such technique.

President Obama recently signed a $10.8 billion transportation bill that also included a provision to allow companies to continue “pension smoothing” for 10 more months. The result is to lower the companies’ contribution to employee pension plans. It’s also a federal revenue device. Since pension payments are tax-deductible these companies will have slightly higher tax bills this year. Those taxes go to help fund federal transportation per the recently signed legislation.

A little bit less is put into private-sector pension plans and a little bit more is put into the government’s coffers.

The WSJ notes that the top 100 private pension plans could see their $44 billion required pension contribution reduced by 30 percent, adding an estimated $2.3 billion deficit to private pension plans. It’s poor discipline considering the variable condition of a lot of private plans which are backed by the Pension Benefit Guaranty Corporation (PBGC).

My colleague Jason Fichtner and I drew attention to these subtle accounting dodges triggered by last year’s transportation bill. In “Paving over Pension Liabilities,” we call out discount rate manipulation used by corporations and encouraged by Congress that basically has the same effect: redirecting a portion of the companies’ reduced pension payments to the federal government in order to finance transportation spending. The small reduction in corporate plans’ discount rate translates into an extra $8.8 billion for the federal government over 10 years.

The AFL-CIO isn’t worried about these gimmicks. They argue that pension smoothing makes life easier for the sponsor, and thus makes offering a defined benefit plan, “less daunting.” But such, “politically-opportunistic accounting,” (a term defined by economist Odd Stalebrink) is basically a means of covering up reality, like only paying a portion of your credit card bill or mortgage. Do it long enough and you’ll eventually forget how much those shopping sprees and your house actually cost.

It’s Time to Change the Incentives of Regulators

One of the primary reasons that regulation slows down economic growth is that regulation inhibits innovation.  Another example of that is playing out in real-time.  Julian Hattem at The Hill recently blogged about online educators trying to stop the US Department of Education from preventing the expansion of educational opportunities with regulations.  From Hattem’s post:

Funders and educators trying to spur innovations in online education are complaining that federal regulators are making their jobs more difficult.

John Ebersole, president of the online Excelsior College, said on Monday that Congress and President Obama both were making a point of exploring how the Internet can expand educational opportunities, but that regulators at the Department of Education were making it harder.

“I’m afraid that those folks over at the Departnent of Education see their role as being that of police officers,” he said. “They’re all about creating more and more regulations. No matter how few institutions are involved in particular inappropriate behavior, and there have been some, the solution is to impose regulations on everybody.”

Ebersole has it right – the incentive for people at the Department of Education, and at regulatory agencies in general, is to create more regulations.  Economists sometimes model the government as if it were a machine that benevolently chooses to intervene in markets only when it makes sense. But those models ignore that there are real people inside the machine of government, and people respond to incentives.  Regulations are the product that regulatory agencies create, and employees of those agencies are rewarded with things like plaques (I’ve got three sitting on a shelf in my office, from my days as a regulatory economist at the Department of Transportation), bonuses, and promotions for being on teams that successfully create more regulations.  This is unfortunate, because it inevitably creates pressure to regulate regardless of consequences on things like innovation and economic growth.

A system that rewards people for producing large quantities of some product, regardless of that product’s real value or potential long-term consequences, is a recipe for disaster.  In fact, it sounds reminiscent of the situation of home loan originators in the years leading up to the financial crisis of 2008.  Mortgage origination is the act of making a loan to someone for the purposes of buying a home.  Fannie Mae and Freddie Mac, as well as large commercial and investment banks, would buy mortgages (and the interest that they promised) from home loan originators, the most notorious of which was probably Countrywide Financial (now part of Bank of America).  The originators knew they had a ready buyer for mortgages, including subprime mortgages – that is, mortgages that were relatively riskier and potentially worthless if interest rates rose.  The knowledge that they could quickly turn a profit by originating more loans and selling them to Fannie, Freddie, and some Wall Street firms led many mortgage originators to turn a blind eye to the possibility that many of the loans they made would not be paid back.  That is, the incentives of individuals working in mortgage origination companies led them to produce large quantities of their product, regardless of the product’s real value or potential long-term consequences.  Sound familiar?

America’s best pension system? The case of Milwaukee

NPR reports that while many municipal and state governments’s pension systems are suffering from deep underfunding, there are some outliers. One such city is Milwaukee, Wisconsin. With a funding ratio of 90 percent, Milwaukee’s public employees’ plan would seem to have beaten the odds with a very simple (and laudable) strategy: fully fund the pension plan every year.

It is common sense. Make the full annual contribution and the plan can ensure that the benefits promised are available when retirement day arrives.

Except, thanks to government accounting guidance, it’s a little more complicated than that.

The problem is that the annual contribution the city is (prudently) making each year is calculated incorrectly. This flawed approach is why Detroit could claim a few short years ago that its plans were 100 percent funded. It is why New Jersey thought its plans were overfunded in the late 1990s.

Public plans calculate their liabilities – and thus the annual amount needed to contribute to the fund – based on how much they expect the assets to return. Milwaukee’s discount rate is 8.25%, recently lowered from 8.5%.

Unfortunately, if these liabilities are considered safe and guaranteed by the government, then they should valued as such. A better rate to use is the yield US Treasury bonds. In economist-speak: the value of liabilities and assets are independent. By way of analogy: Your monthly mortgage payment doesn’t change based on how much you think you may earn in your 401(K).

On a default-free, market valuation basis, Milwaukee’s pension plans is 40% funded and has a funding gap of $6.5 billion.

The good news – Milwaukee’s elected officials have funding discipline. They aren’t skipping, skimming, or torturing their contributions based on  the desire to avoid paying their bills. And this can be said of many other cities and states. Funding a pension shouldn’t be magic or entail lots of uncertainty for the sponsor or employee.

But that leads to the bad news. Even when governments are responsible managers, they’re being sunk by bad accounting. Public sector accounting assumptions (GASB 25) lead governments to miscalculate the bill for public sector pension contributions. Even when governments pay 100 percent of the recommended amount – as it is presently calculated – this amount is too little to fully fund pension promises.

Last week I posted the Tax Foundation’s map of what pension funding levels look like under market valuation. Almost all state plans are under the 50 percent funded level. That is, they are in far worse funding shape than their current accounts recognize.

Until plans de-link the value of the liability from the expected performance of plan assets, even the best -managed plans are going to be in danger of not having put aside enough to pay these promises. Even the best intentions cannot undo the effects of bad accounting assumptions.

 

 

Richmond, Calif., Eminent Domain, and the Problems of Political Privilege

Sign Of The Times - ForeclosureRichmond, California is now moving forward with a proposal to use eminent domain to acquire more than 600 “underwater mortgages” (mortgages with unpaid balances greater their properties’ market value).

Eminent domain has long been used by governments for various public uses, such as highways, roads, and public utilities.  More recently this has been extended to include shopping mallsbusiness parks, and professional sports stadiums. However, while contemplated by other cities, eminent domain has never been used for the purpose of seizing mortgages. Richmond would be the first city to actually carry out such a plan.

On its face, the plan is straightforward. The city has offered to buy these underwater mortgages at discounted rates from the banks and investors currently holding these mortgages. If the offers are rejected, the city will use eminent domain to force the sale of these mortgages to the city. The city will then write down the debt, refinancing the loans for amounts much more in line with current home values.

While the stated objective of this plan is to provide mortgage relief to homeowners hurt by the most recent housing crises, the plan is rife with opportunities for political privilege and favoritism.  Ilya Somin, a law professor at the George Mason University School of Law, has laid out several problems involved with this scheme:

  • Far from benefiting low-income people as intended, the plan will actually harm them. Much of the money to condemn the mortgages and pay litigation expenses will come from taxpayers, including the poor. Most of the poor are renters, not homeowners, so they cannot benefit from this program. But renters do indirectly pay property taxes through the property taxes paid by their landlords, a cost which is built into their rent.
  • The program would also enrich those who took dangerous risks at the expense of the prudent. It isn’t good policy to force more prudent taxpayers to subsidize the behavior of people who took the risk of purchasing high-priced real estate in the midst of a bubble. Doing so will predictably encourage dubious risk-taking in the future.
  • Prudent Richmonders will also lose out from this policy in another way. If lenders believe that the city is likely to condemn mortgages whenever real estate prices fall significantly, they will either be unwilling to lend to future home purchasers in Richmond, or only do so at higher interest rates. That will hurt the local economy and make it more difficult for Richmonders to buy homes.
  • We should also remember that eminent domain that transfers property to private parties is often used to benefit the politically powerful at the expense of the poor and the weak. In Kelo v. City New London (2005), a closely divided Supreme Court ruled that government could take private property and transfer it to influential business interests in order to promote “economic development.” As a result, multiple New London residents lost their homes for a “development” project that still hasn’t built anything on their former property eight years later. Property owners lost their rights and the public has yet to see much benefit. The Richmond policy would create another precedent to help legitimate future Kelos.

You can read Somin’s article here.

It should be noted that there is a legal challenge underway as banks and investors argue that the city’s plan is unconstitutional. However, regardless of the plan’s legality, it is clear that it will do little to support economic development, aid the housing market, or support future investment in the local economy. It seems more about using these mortgages to privilege the few at the expense of the many.

A government that hands out privileges can expect corruption

According to the Washington Post, the mafia is heavily involved in Italy’s renewable energy market. This is not particularly surprising given that firms in that market compete on a manifestly uneven playing field.

The Godfather Movie in TextIn a market characterized by a genuinely level playing field—one in which no firm or industry benefits from government-granted privilege—the only way to profit is to offer something of value to customers. If you fail to create value for voluntarily paying customers, they won’t volunteer their money. It’s that simple.

But things are different when the playing field can be tilted through government-granted privileges. This is because when the playing field can be tilted, firms have an incentive to find some way to persuade the government to tilt it their way. And the most persuasive techniques aren’t always above board.

The problem is that objective standards for playing favorites are hard to come by. This can corrupt even well-intentioned programs that privilege particular behavior in the name of serving the general good.

Imagine you are a politician and you want to reward firms that specialize in renewable energy. How do you determine who makes the cut? What if you want to reward companies that securitize mortgages for low-income households. How do you decide whom to reward? Or say you want to bailout “systemically important” banks. Where do you draw the line between systemically important and systemically unimportant?

Without objective guideposts, subjective factors loom large: whom do you interact with the most? Whom have you known the longest? Which firms share your ideological perspective? Which are headquartered in your hometown?

Even the most well-intentioned of politicians are susceptible to these considerations because all humans are susceptible to these considerations. That’s why a slew of research has found government-granted privileges are often associated with corruption. For example, in an examination of 450 firms in 35 countries, economists Mara Faccio, Ronald Masulis, and John McConnell found that politically connected firms are more likely to be bailed out than non-connected firms. It’s possible that more deserving firms just happen to be politically connected, but this strains credulity. A more plausible explanation is that in the absence of an objective standard for dispensing privileges, politicians reward those they know.

And when that is the case, firms make it their business to get to know politicians. Just ask Angelo Mozilo, the politically ensconced former head of Countrywide Financial. Countrywide supplied the loans that were repackaged by the federally backed Fannie Mae. And since Countrywide’s business model depended on the favor of politicians, Mozilo made sure he was in good standing with his benefactors. Under a program known internally as the “Friends of Angelo” program, Countrywide offered favorable mortgage financing to the likes of Senate Banking Committee Chairman Christopher Dodd and Senate Budget Committee Chairman Kent Conrad.

The conventional route to profit is to please one’s customers. But when firms are able to profit by pleasing politicians, they will do whatever it takes to please politicians. Which brings us back to Italy and renewables. The current investigation (known as operation Eolo after the Greek god of wind) first bore fruit in 2010 when eight people were arrested for bribing officials with cash and luxury cars. Armed with more evidence, officials have now arrested another dozen crime bosses.

It is good, of course, to have police who investigate these matters. But a far simpler, equitable, and efficient solution is to create a truly level playing field for business. When politicians cannot tilt the playing field in favor of particular firms or industries, businesses have nothing to gain from bribery and connections.

Put away the honey jar and you won’t have an ant problem.