Arnold Kling  

Subprime Daily Briefing, Dec. 18

Localized GDP... Why Do Serial Killers Vastly O...

Early warnings...or hindsight bias?

The New York Times writes,

Edward M. Gramlich, a Federal Reserve governor who died in September, warned nearly seven years ago that a fast-growing new breed of lenders was luring many people into risky mortgages they could not afford.

I have a problem with this. Nearly seven years ago was 2001. My guess is that over 95 percent of the mortgages made from 2001 through 2005 are not going to default. So blowing the whistle in 2001 is too early. All it does is cost you your credibility. It's sort of like Steve Roach forecasting a dire recession. One of these days, we will have a dire recession, and people will say that Roach predicted it. But the fact is that he always predicts dire recessions, they don't happen, and people stop listening.

Having said that, one could argue that if housing prices had started to level off in 2003, the loans made in 2001 and 2002 would have gone bad. But in 2003 the ratio of house prices to income was still basically ok, so it is not clear that we could have had much of a crash.

Richard Florida points out that even now, the high ratio of house prices to incomes in some cities could reflect high ratios of financial wealth to income in those cities. I can see that for Miami--there are plenty of wealthy seniors there with low incomes, so that the ratio of median house price to median income is distorted. I don't see it for New York, because I don't think of the entire New York City region as consisting of coupon-clippers, but it wouldn't surprise me if it turns out that the skewed income distribution in the area makes the ratio of median house price to median income less meaningful.

My main point is that I certainly don't see financial wealth as the explanation for the California cities. Which reinforces my original point, which is that California is another country. My prediction is for a major crash in California, with only a few minor dips elsewhere. Incidentally, the housing market in St. Louis seems fairly robust.

Speaking of California, a reader pointed me to this story in the Wall Street Journal.

Public records show they paid $557,000 for a four-bedroom house and took out a $500,000 mortgage. Her husband is an area manager for an auto-parts retailer and she is a purchasing manager for a firm that sells dietary supplements.

As property values skyrocketed, they refinanced three times, most recently in late 2006, for $835,000, Mr. Oropeza says.

The rest of the country may not have much sympathy for these California high-flyers. The WSJ's economics blog reports,

According to the Wall Street Journal Online/Harris Interactive poll, conducted Dec. 10-12, just a quarter of respondents agree that the government should provide financial help for mortgage holders, while 20% disagree and another 22% strongly disagree.

...Nearly half (48%) of homeowners say the value of their home at least moderately increased in 2007 and 41% are optimistic that its value will increase over the coming year, despite the recent slowdown in the U.S. housing market. Only 15% of homeowners responding to the poll believe their home’s value will decrease in the coming year, including 1% who think it will decrease significantly.

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The author at Roth & Company, P.C. in a related article titled CONGRESS TAXES PEOPLE WHO PAY THEIR LOANS TO GIVE A BREAK TO DEADBEATS writes:
    The House of Representatives sided decisively with deadbeats against people who pay their loans yesterday. By voice vote, they passed... [Tracked on December 19, 2007 9:16 AM]
COMMENTS (7 to date)
stan writes:

That last bit of info reminds me of Nassim Taleb's advice in "Fooled by Randomness" that maybe we should not pay so close attention to the news, if only for our own wellbeing.

Brad writes:

I think I heard Limbaugh talking about this guy as I thumbed through the radio presets an hour ago. Hindsight bias was my gut reaction, and I moved on to sports talk.

Jim writes:

Are you saying that if Gramlich saw a flaw or flaws in the subprime marketplace in 2000 or 2001 it was too early to speak up about it (blow the whistle) or that it was quite reasonable for others to weigh the evidence and "not see" a need to act?

Or that the way the NYTimes wrote about it might lead readers to think this should have been nipped in 2000/2001?

Arnold Kling writes:

I'm saying that the market survived the flaws quite well from 2001-2004. That is partly a result of home prices soaring. But to some extent it may reflect that Gramlich was too conservative in his view of what makes a sound mortgage. In any case, at the time, it was very hard to determine whether the lenders were to aggressive or Gramlich was too conservative. With hindsight, we can say that the lenders were too aggressive in 2006. With hindsight, I doubt that we would say they were too aggressive in 2001-2003.

Joe Kristan writes:

If there is so little support for helping mortgage deadbeats, why is help for mortgage deadbeats sailing through Congress? I suppose Gordon Tullock would have a reasonable public-choice explanation.

Richard Pointer writes:

Re: Saint Louis

Thank goodness!

STL 4eva!

Heather writes:

I don't think that housing prices in California will correct by much. Knowing people who live out there and having been there myself, it is clear that there is a distinct lack of usable land relative to the number of people in the area. Because of the limited amount of resource, the values on homes keep going up. Unless there is a massive layoff by many sectors of the economy in those areas, prices won't change much.

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