Thomas Sewell's blog

People wonder, with interest rates at 2.5%, why aren't people buying mortgages? 2.5% is a great rate! People bought lots of houses at much higher rates during the bubble, right?

The people who wonder that are confusing nominal interest rates with the real cost of a home mortgage. Back in reality, buying a house with a mortgage (or cash, for that matter) is much more expensive than it looks.

Let's do some bubble math with round numbers to make it easy. Say you are buying a house for $100K with a mortgage you are going to pay 5%/year (APR) to the bank on.

So in the first year, you pay $5K for your mortgage, right?

Wait, there's more... in the bubble, what someone was willing to pay you for the house you bought with that mortgage may have gone up another 10%, that "inflation" of the price effectively paying you $10K for having made the purchase.

So now after a year, you've been paid $5K and the bank got $5K on the deal. Everybody wins and you were stupid if you didn't take out a mortgage and buy some real estate. Sound familiar?

They literally were paying you to buy something with a mortgage. Your effective cost wasn't 5%, it was negative 5%. You were getting paid to buy something you couldn't afford to pay cash for with a mortgage. If you had cash, you got paid 10%, but that's not our story today.

Obviously, I'm ignoring the long term to focus on one year at a time, but the story is true if the same conditions of inflating prices continues. Most people only live somewhere for 5-10 years, so it doesn't have to continue as long as you think.

So back to the present. What's the current cost of buying real estate with a mortgage? The nominal rate is down to 2.5%, but what's the real cost?

Same $100K house/mortgage example. 2.5% (APR), you pay the bank $2.5K in interest. Now, however, your house will depreciate and be worth less than you paid for it in a year. To say how much less depends on the real market where you're at and such, but as an example, let's say 7.5% less.

So someone will only pay $92.5K for your mortgaged real estate and after a year you are out $2.5K and $7.5K for a total of $10K. So now your real first year cost for buying that house with a mortgage is $10K, or more like 10%.

So with the change from rising house prices to dropping house prices, instead of getting paid to buy a house with a mortgage, it's now cheaper to rent than pay 10% a year for the privilege of buying a house. The 2.5% you pay the bank is dwarfed by the 7.5% your house is deflating.

How do we get out of this mess and turn the arrow back to rising housing prices? Finish foreclosing on everything that needs to be and sell it all at the current market value as fast as possible. That clears the market and while it's a quick drop, afterwards the cheap foreclosure houses are off the market and it starts making sense for people to buy again, since the arrow is going up again. Every government program to delay foreclosures and keep people owning underwater houses they can't afford just drags the process out longer and longer and means we have a slow decline in prices instead of a quick one. And with a slow decline in prices instead of a post-crash slow increase, nothing turns around because no one can afford the real interest rate of losing money on their home and mortgage.

2.5% is only cheap for a mortgage if prices are steady or slowly increasing. Most people haven't thought it through to the logic behind what's happening, but market prices still tell them what they need to know. Not a good time to buy just yet.

Hat tip to Scott Sumner for continuously pointing out that nominal interest rates don't matter, it's real interest rates that matter instead.

I've seen a lot of confusion online about what the difference is between taxing people and then giving a rebate if you own insurance, and mandating people purchase insurance and penalizing them if they don't.

The mandate requires you to purchase a specific subset of health insurance policies if you don’t otherwise have one that qualifies.

The penalty is collected by the IRS from certain people who aren’t following the mandate.

Congress could remove the penalty portion of the law completely and the mandate portion would still exist and still be unconstitutional.

Many are confusing an enforcement mechanism for the law (the penalty) with what the law requires people to do.

If Congress changed it to a tax break if you own qualifying insurance, you can not own insurance and still be obeying the law, you just don’t get the tax break.

Would people ignore the law a lot more if there was no penalty? Sure, that’s why they put the penalty in there, but that doesn’t change what the law requires, just how well it will be enforced.

Want an infinite margin investment loan? It's still possible, 102% the value of the home guaranteed for the lender by the government!

In response to America's Housing shortage., I'm posting the following:

Supply and demand in a relatively free market is a result of the price level.

To say supply of something is too high, you have to also say at what price. Saying we have a glut right now is saying that supply is too high _at current price levels_, or the converse, that demand is less than supply _at current price levels_.

Normally, you'd fix that by prices adjusting lower until supply and demand matched.

So the actual important question is not "Why do we have a glut", but, "Why are housing prices higher than they should be to balance to market?"

I would point to housing market distortions like banking regulations, mortgage bailouts, tax credits for purchasing homes, mortgage interest rate deductions, mortgage "readjustment" regulations, environmental and "affordable housing" policies (in some local areas).

I would also point to the additional penalties (financial and credit/reputational) currently associated with selling a house for less than the mortgage on it. Of course, that's a result of mortgages loans with too much margin for any "investment", which is a result of so many other factors that most are familiar with.

You may have some other ideas.

If you went to a stock broker and said, "I want to buy $250K worth of stock and I'll put $1K down in order to do so to cover the paperwork costs", they'd laugh you out of the place. Somehow our current government policy is that they will not only encourage 33 times(VA loans) to infinite times (USDA 102% loans) purchases on margin, they'll actually provide a loan guarantee for some of them!

If this sounds financially crazy, that's because it is. It's your tax dollars at work!

I was reading a debate on education and signaling and commented:

At least one reason why more businesses don't do apprenticeship style programs is that it's illegal, as are unpaid internships.

Another legal issue is that you can't effectively contract for someone's labor AFTER you've taught them. You can train an employee and they can then leave for your competitor. Without the costs spent on training the employees, your competitor can pay them more than you can, everything else being equal.

The closest you'll see to apprenticeship is in (foreign) soccer and baseball clubs, where teams get a legal ownership interest in the players they develop. Since that tied-up-contract process is legal in those sports, most players are apprenticed to a team. In sports where because of the rules and/or legalities teams can't bind players like that, colleges play a much larger part as "farm" teams.

There's definitely a paper there for someone who wants to do some sports economics...

Is the FDA obsolete?

How can Underwriter Laboratories work so much faster to "approve" electrical devices as safe? It's because they are relied on by insurance companies that are insuring the liability of the products. Their incentive is to find any safety issues before a consumer sues over it.

Millions of people every year in the U.S. suffer from not having drugs sooner. Who is taking their suffering into account when following the current FDA process for drug approvals?

Worried about drug testing results in an FDA-less country?

Require companies to post an insurance bond to pay possible claims if the drug turns out to be bad. Insist on a transparent process via a third-party provider that is sufficiently underwritten, just like current insurance underwriting works.

At that point, people and Doctors can compare how much that third-party provider charged the drug company to insure the drug and do a quick proxy risk calculation accordingly.

If a company can make a convincing case that their drug is safe enough to avoid claims to their insurer, then it'll be a quick approval process and be on the market quickly.

If it's a dubious and/or highly risky drug, their insurer is going to be incentivized to either require a lot of extra honest studies to prove it's safe or pay a lot more money to offset the risk of claims.

If you insist on government involvement in the drug market, at least align the incentives for the participants with something more useful than the FDA's current "Don't ever approve a drug that has any chance of harm, no matter how much good it would do!"

"Every drug for cancer and other serious life-threatening illnesses that the Abigail Alliance has pushed for earlier access to in our eight-year history is now approved by the FDA! There is not one drug that we pushed for earlier access to that did not make it through the clinical trial process. Many lives could have been saved or extended, if there had been earlier access to these drugs!"
-Frank Burroughs, Founder of the Abigail Alliance

While discussing Communism on EconLog, a comment from Patrick:

If you live in California and your credit card info is stolen by hackers, you will be notified by your CC company. If you live in Texas, you won't. Because they don't have to.

My response was:

Don't forget to tell the story of what is unseen in your example.

What percent of people are financially negatively affected by not being notified in Texas vs. what they would have saved if the State forced notifications? Now compare that to how much every single credit card user in CA is affected by higher fees and costs for owning a credit card as a result of the regulations.

Also, is there a legal rule that prevents a credit card company customer in Texas from including in their agreement with the company that they are to be notified of eventsbased on specified criteria? If not, why do you think people aren't demanding such changes to their CC contract and why aren't there CC companies putting them in and making it a selling point to choose their card?

I strongly suspect that the answer to your complaint isn't that the market has failed, it's that the government regulation in CA forces people to do something other than they'd choose to do on their own and that it doesn't take into acocunt WHY they wouldn't choose that option.

Without even understanding why the market equilibrium in CC contracts exists, it's completely irresponsible to arbitrarily decide to change it based on some feel-good theory about how credit card companies "should" behave based on only the very limited information available to a bureacrat or legislator.

Whenever you hear about some new regulation or consumer protection agency, understand that what the regulation does is limit what people are allowed to do. You should always ask yourself what they didn't think about when they wrote it. What will some of the unintended consequences be?

From their position of limited knowledge, most of the time the people creating these massive regulations don't even understand how it's going to affect them directly, let alone everyone else in the country.

If someone is your servant, they do what you want them to do. If you pay them, it's because you agree on what their work is going to be worth to you. That's called a trade.

If someone is your master, they tell you what to do. If you pay them, it's because they require you to pay them. Sometimes that's called tribute.

Now compare the elites in Washington to those two definitions. Don't especially the progressive Democrats, pushing a health care bill that is overwhelmingly opposed by the people, fit the definition of Master better than that of Servant?

Has Democracy in America led to the servant becoming the master? Or has it always been somewhat that way and the idea of "Public Servants" has always been a sham?

They argue that "it's for our own good" and that the elites know better than the people do what's good for them. That may describe a more "benevolent' slave master in the pre-civil war south, but it's hardly how anyone would describe a good servant.

"The master and servant relationship only arises when the tasks are performed by the servant under the direction and control of the master and are subject to the master's knowledge and consent." - Answers.com

Even that argument falls down pretty flat in the face of billions for bailouts and pork benefitting their friends and fellow elites. It's not their money that's getting spent. Who's in charge here, anyway? Who's supposed to benefit again?

There is a discussion in a NY Times blog with proposals for controlling health care costs.

Most of the ideas make things worse, not better.

Quick summaries:

Jacob S. Hacker, political science academic: Use government price controls.

This quickly turns into shortages. Some political scientists still ignore basic economics.

Len M. Nichols, think tank health guy: Give more power to the Medicare commission to run everything.

Really? Because the Medicare folks already do such a bang-up job of making sure Medicare isn't going to lose trillions over time?

Gail Wilensky, medicare bureacrat who moved to an NGO: Tax more expensive health insurance more and give the secretary of Health and Human Services lots more power over everything.

Yep, Congress is too busy to make the important, hard decisions that the policy elite want to happen, so it's best to outsource it all to the "experts" in the executive. Better deniability for lousy decisions all around.

Joseph Antos, think tank academic: Fix the employer tax break, competition in state markets, give pricing information to patients, make Medicare compete with Medicare Advantage.

And here's our first set of proposals that would actually lower costs while improving things. The solutions are of the "tweak the existing system" mentality, but at least they are steps in the right direction.

Daniel Callahan, think tank guy: Medicare rationing and price controls on health insurance.

At least he comes right out in favor of legally limiting how much health care people get! I'm not sure that's going to be too popular. It's definitely not necessary for bureacrats to tell people how much they need. And of course, price controls always result in shortages anyway.

Leslie Greenwald, think tank academic: Setup rationing by the elite based on "evidence".

Some how I don't think she gets who should be making the decisions about how much health care people should consume...

Arnold Kling, economist: Use vouchers to move from third-party payers to patients as consumers.

Our second idea that would actually accomplish something positive. Not sure it's totally workable, but it's for sure a big improvement on the current system!

My answer to the same question is totally unrealistic in the current political environment, but just for the record:

• Increase supply of medical care by removing legal obstacles. That means removing licensing restrictions (especially for Health care professionals trained in other countries) and removing AMA (Doctor's union) restrictions on the number of new health care workers trained every year. It also means severely limiting the FDA's ability to stop drugs from being produced. At most, they should evaluate and report on, rather then control the legality of drugs. That way Doctors and their patients could choose what risks to take based on their best information available.
• Add more competition to the system by overriding state insurance regulators with a federal mandate that allows interstate commerce in insurance policies. Either end tax breaks for employer-provided plans or make sure that they are matched exactly by breaks for non-employer-provided plans. Prevent any regulators anywhere from regulating what is offered at what price in health insurance plans. Innovation in insurance service doesn't start in state health insurance regulation committees!
• Allow prices to reflect demand as much as possible by providing methods for price transparency in service as well as allowing insurance as insurance instead of pay-for-service plans. Most of that would be taken care of by removing regulatory obstacles as above.

Health care is a solvable problem, but it's unlikely to be solved when most of the proposals to do so just provide more of the same ideas that created the problems in the first place.

When people in this country consume more books than people in another country, we don't lament that U.S. "book costs" are much higher than average and that "something must be done!" Some of this issue results from government distortions of the market for health care at State and Federal levels, but a lot of this issue is also a misunderstang of what's going on.

Prices communicate information to producers and consumers.

When the price of a product goes higher, that tells producers to produce more. It also tells consumers to spend their money on something different, buying less of that product.

When it goes lower, that tells producers to produce less and comsumers to consume more in relation to other things they could spend their money on.

As supply and demand for a product changes, that affects the price. Even though all the possible consumers and all the possible producers don't directly communicate otherwise, the effect of their mass actions on prices is that about the right amount of a product is produced for how much people want or need of it compared to other things they could have spent their money on.

The above is named Supply and Demand and it's about the least controversial idea in economics.

Yet somehow governments persist in ignoring it in the same way the Soviets used to.

The seasonal flu vaccine and the swine flu vaccine are both having shortages when people want them, while both will have plenty available when it's too late to matter much.

Why?
Well, how do producers decide when they need to have what flu shots available for distribution?

The short answer is, they don't. Government bureacrats in a command-and-control style of economics (like the old Soviet Union used) decide the price and also tell producers how much of what to produce when.

Using that same method, the same problems routinely happen in the flu shot market. Shortages, followed by over supply and waste, followed by more shortages, followed by more waste, year after year it goes on as most years the bureacrats don't have the information provided by the simple, lowly, price mechanism of supply and demand.

The "experts" don't have more knowledge than the millions of people combined that would set the price in a flu shot market. Without a market, they don't know where to send flu shots for them to be used the best. They don't know how many are going to be demanded and when they're going to be needed.

Pricing Externalities
If the objective is to increase the number of people that get a flu shot above the number that would naturally get one, because there are benefits that are external to the market transaction. i.e. you think other people benefit from every person more that gets a flu shot, then that's an externality and you can make a case that there should be a price subsidy. Most externalities are negative, meaning an aconomist would fix that by adding to the price in order to pay for it, but in this case the health authorities seem to think there is a positive externality.

The way to solve that externality isn't to take flu shots out of a market and turn the decisions over to a bureacracy. If you make the price producers are paid go up, but the price consumers pay go down, you'd get more production and more people and clinics would buy flu shots.

So if the objective is to be most effective, while also encouraging more people to get a flu shot, then the simple method is for the bureacrats to stay out of it all except to offer a set rebate or subsidy for each flu shot sold and used. Whatever the amount of that is will determine how many more people will get a flu shot.

Here's an extreme example to illustrate this. If the government gave $50,000 per flu shot used to producers and another $50,000 to the person that got that flu shot, I'd guess that there would still be a handful of people in the country that didn't get a flu shot, but not very many. Reduce the amounts and less people decide to sacrifice the time and other resources to get involved, but the same basic principle holds. The principle of Supply and Demand.

The actual newsweek headling was referenced by Marginalrevolution as " Soros puts up $50 million to change economics."

Newsweek calls it "Converting the Preachers".
Try rephrasing that as:

"Cheney puts up $50 million to change climate science." describing an attempt to create a new think tank funded by the oil industry to generate new "science". That should get a similar effect on the opposite political persuasion, except of course that, and the headline of this article, isn't actually happening.

My headline is a little misleading, because it's meant to make a point.

For Soros this is just part of purchasing influence to promote his political policies and power. He's does that a lot, in ways too numerous to enumerate here. He's upset that somehow large swaths of economists have managed to stay out of the Cathedral and have not yet turned 91% Democrat. Why, it seems that economists are closer to only 50% Democrats and most of those still prefer market solutions to government solutions!