Half Changed World

It’s clear that when I don’t have the energy to post, I should put up something about housing costs, and then my commenters will take it from there. 

I’ve been listening to the This American Life’s piece about the housing bubble and crash, and it’s fascinating.  As suggested by the title of the episode, The Giant Pool of Money, it focuses on the supply side of the mortgage business, how it was in everyone’s business to keep generating loans and not to ask questions about whether they were really good risks.  It’s nearly an hour, and if you didn’t grab the podcast already, you need to stream it, but it’s worth listening to anyway.

This week’s book is Predictably Irrational, by Dan Ariely.  It’s a quick read, but has far reaching ramifications.  It’s about how people aren’t as rational as economists think we are.  That’s not particularly surprising, but Ariely goes on to argue that people are irrational in systematic– predictable — ways, and to explain the elegant experiments that psychologists and behavioral economists have developed to tease these out.  So, let’s look at some of the examples:

• People are hugely biased for the idea of getting something for "free."  They’ll take the crappy thing for free over the good thing for a modest cost.

• People don’t know what things are really worth, and so anchor to arbitrary comparisons.  People often won’t buy the most expensive thing on the menu, but they’ll buy the next most expensive thing.  I was particularly impressed by the studies that showed that if the researchers asked people if a percentage was higher or lower than the last two digits of their social security number, and then had them guess at a concrete number, there was a strong correlation between the guess and those last two digits.  Based on this, I’d guess that including a high "buy
  it now" price pulls up the value of bids on ebay, even when no one uses
  the buy it now option.  (Although I don’t know if it would pull them up to offset the increased fee.)

• When you ask people to choose among three things, two of which are similar (but one is clearly better than the other) and one is very different, they’re more likely to choose the better of the two similar choices.  It’s hard to tell if an apple is better than an orange, but a fresh apple is clearly better than a rotten apple — and the presence of the rotten apple stand out against the orange.

All this isn’t just entertaining, but has pretty significant policy implications.  Orthodox economists — for all their pessimistic reputation — actually tend towards a Panglossian view of the world — that we’re in the very best of all possible worlds, or at least that the world couldn’t be made better for anyone without making it worse for someone else.  This is because economists take pretty seriously the idea of revealed preference: the idea that you can tell what agents in a free market prefer by what they chose, given the options that are available to them.

Ariely more or less blows up this idea, by showing studies where given choices A, B and C, no one chose option B, but taking away option B dramatically changes the distribution of choices between A and C.  The bad news is that this means that lots of people are making suboptimal choices all the time; the good news is that it means there’s room for improvements without making anyone worse off.  The problem is that there’s a lot of resistance — for good reasons — to having public institutions adopt the strategies of direct marketers…

Somewhat related books that I’ve read recently:

• Discover Your Inner Economist, by Tyler Cowan (of Marginal Revolution).  While Cowan is much more of a traditional economist than Ariely, I’m not sure you’d be able to tell that by this book.  Cowan’s big take-away here is that economics is about scarcity, and so the key is always to figure out what’s the resource that’s scarce (and it’s often attention or time, rather than money).
• Your Money and Your Brain, by Jason Zveig.  Specifically focusing in on why we behave irrationally when it comes to investing.  I thought the first chapter or two was fascinating, but then it got repetitive, and I didn’t finish the book before it was due back to the library.  Maybe a good one to give to your brother who thinks that he’s figured out a way to beat the markets.

When I posted about whether young people are "falling behind" their parents, almost all of the commenters agreed that a big part of the reason that even relatively affluent young adults *feel* poor is that homeownership seems so out of reach (even with the declining market).  This made a lot of intuitive sense to me.

But my dad then sent me a ton of Census data on homeownership rates by age, going back to 1982.* (Yes, I come by my geekery honestly.)  And his point is that households under age 35 were just about as likely to own homes in 2008 (41.7 percent) as in 1982 (41.2 percent).   Homeownership rates for this group hit a low of 37.3 percent in 1993-1994, and then rose to 43.1 percent in 2004, before falling off slightly.

So how is it possible that homeownership can feel so out of reach to almost everyone I know, even as the homeownership rate didn’t decline at all?  Well, part of the answer is that I live in an expensive housing market, so the "everyone" I know is a biased sample.  (The readers of this blog are more diverse, but I think are still disproportionately living in large urban areas, compared to the country as a whole.)   Also, a whole lot of condos were built in the 1990s, so if by "homeownership" you mean "owning a single family detached home," the homeownership rate probably did decline somewhat.

But it’s also true that a lot of people — at all age groups — bought homes only by extending themselves to their limits.  There was this credit bubble that you might have heard about… (Supposedly in 2005, half of all loans made in DC were interest-only.)  And there was this dreadful fear that if you didn’t jump in right away, even if you couldn’t really afford it, you’d be priced out forever.  So, the people who didn’t buy houses felt like they were falling behind because they couldn’t afford a home, and the people who did felt like they were falling behind because they couldn’t afford anything else.

*The Census table is only online as a text file — if you want my Dad’s Excel spreadsheet, I’m happy to send it on.

In his quasi-blog* at The Atlantic, James Fallows asked whether anyone can name a more stupid policy that passed with bipartisan support during the last 50 years than the McCain-Clinton proposal for a gas-tax holiday.  His pick from the many submissions he received is the mandates and subsidies for corn-based ethanol.  The full list of popular submissions is worth reading — Fallows notes that while some of them had worse effects than ethanol subsidies, in order to make the short list, a policy had to be obviously bad even without the benefits of hindsight.

The policy that I was surprised not to see on the list is the mortgage interest deduction, the one policy that everyone from the Center on Budget and Policy Priorities to the American Enterprise Institute agrees is terrible policy.  It’s expensive, regressive, and most people agree that it makes homeownership MORE expensive for the people likely to be on the margin between owning and renting.  I don’t know if it misses the 50 year cut off, or if Fallows’ readers are likely to be in the group that benefits from it, and so are blind to its faults.

What else would you put on the list?

*It’s a quasi-blog because it doesn’t allow comments.  This is clearly Fallows’ choice rather than The Atlantic’s because Yglesias has a real blog on their site.

I took the BoltBus up to NYC and back this weekend, so thought I’d post a review.  This is unsolicited, and they didn’t comp me anything.

Although you can’t tell it from their website, BoltBus is actually run by Greyhound/Trailways.  It’s their attempt to compete with the "Chinatown buses" which have been kicking their behinds over the past few years on the DC-NY and NY-Boston routes.  Like the Chinatown buses, it’s very cheap — I paid $35 round trip, but they’re selling at least one seat on every trip for just $1 — and doesn’t require you to go to the bus terminal.  (The Port Authority isn’t too bad in NYC, but the bus terminal in DC is several blocks from the metro, and not in the best of neighborhoods).

Unlikely the Chintown buses, on BoltBus, the seats are spread out enough to provide decent legroom, there are powerpoints for each pair of seats, and there’s free wi-fi.  There are screens on the buses, but they didn’t show movies on the trips I took, and it was blessedly quiet.  The buses are new and shiny — in fact, the worst problem on my trip was one of the buses was so new that it stunk from the plastics outgassing.

I hate driving long distances, so even when gas was cheap, I’d almost never drive up to NYC by myself.  As a solo traveler, the question for me is whether the cost savings of a bus is worth the inconvenience compared to taking Amtrack.  Two years ago, the last time I took the bus to NYC, I took the bus one way, the train the other.  With these new buses, the "price" I pay in discomfort for taking the cheaper option has gotten a lot smaller.  (Note that I did go up Thursday and return Saturday — I suspect the more crowded Friday and Sunday buses may be less comfortable.)

The bus is almost comfortable enough that I’d consider taking the boys on it, rather than driving as a family.  With the outlets, I could probably hypnotize them with the portable DVD player enough to keep them from being disruptive.  And between the cost of gas, tolls, and parking in NYC, busfare for three or four is somewhat cheaper than driving, even if we don’t get the super-cheap fares.  But the boys are used to traveling by car, and being able to bring their own sleeping bags and suitcases, and I wouldn’t want to deal with hauling all that on and off the bus.

After reading yesterday’s post, my dad emailed me to say that he thought the question of whether young adults are better off than their parents depends mostly on what level of education each generation has attained.  Specifically, he argued that a young adult with a college degree is likely to be better off than her parents if she’s a first generation college student, but not if her parents also went to college.

Let’s look at the possibilities. 

• If your parents went to college, and you went to college, they are probably earning more than you are.  (Obviously, there are exceptions when the parent suffers from a disability, or chose to be a starving artist, or got laid off, or when the kid joined Google or Microsoft at just the right time, but on average, 55 year old college grads earn a lot more than 25 year old college grads.  To be precise, in 2006, the average 25-34 year old with a bachelor’s degree in 2006 earned $40,276 and the average 55-64 year old with bachelor’s degree earned $50,397. 
• I wasn’t convinced that young college graduates were necessarily earning more than their non-graduate parents but I looked up the numbers, and my father is right.  The average 55-64 year old with a high school degree and no college education earned  $29,283 in 2006.  While there are some plumbers and union mechanics who earn good money with just a high school degree, there’s not enough of them to affect the median.
• Young high school graduates are also earning less than their HS-grad parents — the average 25-35 year old with a high school degree and no college earned just $25,0354.
• And, to fill out the options, the HS grad child of college-graduate parents is clearly downwardly mobile.

[Sources PINC-03-part 37 and PINC-03-part 91.  All figures cited are medians.]

My dad’s point was that because the fraction of the population going to college has increased so much, a significant portion of college graduates are from families where their parents didn’t go to college. And they’re doing better than their parents.  At least in terms of income — they also have more college debt. And, as lots of people commented yesterday, their parents probably own a home that has appreciated significantly since they bought it, while in a lot of the country, homeownership is still out of reach for most young people, even those with good incomes.

Also, check out Figure 4 in this report.

I left off yesterday with Robert Frank’s hypothetical question of which would you prefer, World A, where you live in a 4,000 square foot house and everyone
else lives in a 6,000 square foot house OR World B, where you live in a
3,000 square foot house and everyone else lives in a 2,000 square foot
house.

He argues that most people would prefer B.  I’m not sure whether that’s true, and to the extent it is true, how much it’s driven by the correlation between housing prices and school quality.  I think I’d choose B, but my reasoning is that in world B, there would probably be nicer parks and other public spaces. 

The NY Times this week had an interesting article on people who were rejoicing in Bear Stearns’ downfall, and more generally in the possibility of a setback to the Wall Street types who have driven up the cost of living in New York.

I thought about calling this post, "the book that killed my blog."  I read Robert Frank’s Falling Behind a couple of weeks ago, and have been wanting to post about it ever since, but I’m not sure I can do it justice, especially when I’m tired and distracted.  Although it’s a short book (just over 100 pages, paperback), there’s a lot of ideas packed into it.  So let’s see if I can unpack them.

The main idea in the book is that people’s well being is determined by their relative income as well as their absolute income, and by how far behind they are as well as their ordinal ranking.  I think this is a relatively non-controversial statement if you’re talking about people at the very bottom of the income distribution — most people recognize that the poor in the U.S. are still very well off compared to much of the world’s population, but suffer from their low relative income and status.  But it’s a pretty controversial statement to say that the very high wealth of Bill Gates or Wall Street financiers makes everyone else worse off.

So, probably the first third of the book goes to justify that statement.  This leads Frank into some interesting detours — he first has to justify that "happiness" is something meaningful, and that "having more money" is not synonymous with "being better off."  He then spends a good chunk of space arguing that the reason that other people’s wealth makes us worse off is not envy, or conscious attempts to "keep up with the Jones’" but rather the result of  context affecting our perception of what’s adequate and what’s reasonable.

One example he gives is that the existence of $2,000 grills with all sorts of bells and whistles makes it seem more reasonable for him to spend $300 on a new one, even though his old one that cost $40 had done a perfectly adequate job.  I can verify that I could see this happening as we made our choices about our kitchen. 

In the second half of the book, Franks argues that positional concerns cause people to spend more and more of their money on things where ranking rather than absolute levels of consumption matter.  But this makes everyone worse off, because if everyone doubles their spending, the ranking is left unchanged, only people have less money to spend on other things (or less free time).  I thought this made a lot of sense, although I’m still not entirely convinced by his arguments about what is and what is not a positional good.

Frank poses a pair of thought experiments about this, and I’d be interested in reading some responses.  He asks, which would you prefer:

1) World A, where you live in a 4,000 square foot house and everyone else lives in a 6,000 square foot house OR World B, where you live in a 3,000 square foot house and everyone else lives in a 2,000 square foot house.

2)  World C, where you have 4 weeks of vacation and everyone else has 6 weeks, OR World D where you have 3 weeks of vacation and everyone else has 2 weeks.

I think I’ll stop here, and come back to the discussion after I’ve gotten some responses in the comments.

Last night on the way home, I heard David Frum on Marketplace.  Frum is a former speechwriter for President Bush, and a fellow at the American Enterprise Institute, so I pretty much assume that I’m going to disagree with everything that comes out of his mouth.

But this is part of what he said:

"OK, the price [of energy] is high again. This is the perfect moment to pass a
standby energy tax, a tax that would kick in when the price of oil
falls below say $60 a barrel. Consumers could feel secure that if they
make the investment in a hybrid car, or a smaller house with a shorter
commute, they won’t feel like fools in four or five years…"

This makes a great deal of sense to me.  I think we’ve talked about it here before, but it’s pretty hard for most people to significantly reduce their driving in the short run in response to increased gasoline prices.  As a recent CBO study shows, the highest response is in those areas where there is existing mass transit as an alternative.  And if the price gets high enough, people start limiting leisure travel.  And indeed, there’s some evidence that gas consumption is finally starting to drop a bit.  But most people can’t just decide not to drive to work or the grocery store.  However, if people know that gas prices are going to stay high for long periods, they’re more likely to make the sort of big changes that Frum mentions.

So, what am I missing?  Is there a hidden problem with it that I’m not seeing?  Or if it’s really something that a libertarian true believer like Frum and a green progressive like myself can agree upon, why aren’t any politicians talking about it?

I’m starting to do my taxes, so I’ve been looking at my Prosper statement.  I must stay, the headache of figuring out the taxes is a major disincentive to lending through Prosper.  The couple of bad loans I’ve had are a particular bother.  Prosper’s tax page is pretty much useless: this blog post  and this wiki are a lot more helpful.

Since the last time I wrote about Prosper in October, my performance has dropped quite a bit.  As predicted, the two loans that were 3 months late were sold as delinquent; I now have another 3 that are between 1 and 3 months late.  What’s striking is that only one of them was what I’d consider a "high risk" loan based on credit — the other two had A or AA ratings.  And when I picked my loans, I made a deliberate choice to avoid anyone who wanted money for a real estate deal… So, another sign that people are hurting…