Tuesday, October 30, 2007

Housing and consumption

Willem Buiter looks at the effect of housing on consumption. Amidst it all

Likewise, some current home owners may be planning to ‘trade down’ later in life, for instance when the family home gets replaced by a smaller property when the children leave home, following retirement or following the death of one’s spouse. For them the fundamental value of their endowment exceeds the present discounted value of their current and future planned consumption of housing services. Against that, there are also persons planning to trade up in the housing market.

This is probably a most important point. Given the number of people that seem to regard their property as their pension. There is an implicit belief that there will eventually be a mass trading down. Presumably, this will concertina the gap between family and smaller homes.

The other important point is

The argument for an effect of housing wealth on consumption over and above the pure wealth effect, is that housing wealth is collateralisable. Households-consumers can borrow against the equity in their homes and use this to finance consumption. If they are otherwise liquidity-constrained or credit-constrained, a boost to housing wealth would boost consumption by more than the pure wealth effect.

Buiter plays down this effect. However, outside credit cards, which are notoriously expensive, this is the cheapest and easiest way for the average person to access credit and liquidity. A rise in house prices provides a significant increase in the abililty to borrow, particuarly if, as is usually the case, it corresponds to an increase willingness on the side of financial instutions to offer credit.

Wednesday, October 17, 2007

Mechanism design

Here is Alex Tabarrok on mechanism design.

Evan Davis on the same issue.

Al Roth on Mechanism Design.

Here is another overview which looks at the issue of market failure more generally.

Imperfect Knowledge

John Kay, marvulous as usual, on information and knowledge.

A new book* by Roman Frydman and Michael Goldberg coins the phrase “imperfect knowledge economics” to describe this world of fundamental uncertainty. They use the systematic failure of attempts to analyse exchange rate swings to illustrate the hopelessness of a search for economic explanations that transcend time and place. Frequent discontinuities and transitions in the ways market participants view events mean that economic models, like historical narratives, are context specific. The search for “sharp prediction” – the mantra of the modern scientific economist who seeks to replicate the successes of physics for social science – is doomed to failure.

This seems to be at the heart of exchanges rates. They move to a different tune at different times. The model changes over time. Maybe that is why technical analysis is so prevalent: there is a search for pattern. It suggests that any modelling must try to find the trigger that switches from one model to another.

Interest rates and risk-taking

Vasso P. Ioannidou and others look at the relationship between the level of short term interest rates and the amount of risk that a bank is prepared to take using a natural experiment in Bolivia (where the economy is dollarised and therfore monetary policy is set outside). They find that banks take more risk when interest rates are low: lending standards decline and ex-post default rates rise. However, banks do not charge more for the increased risk.

Sunday, October 14, 2007

Sharia law and interest

Willem Buiter looks at the creation of financial products that are consistent with Sharia law amidst a more wide-ranging defence of debt.

The explosion of wealth, much of it held in financial form, among oil- and gas-exporting nations, many of which adhere, at least notionally, to fundamentalist-literalist forms of Islam, has led to an explosion of financial engineering aimed at circumventing the Quranic ban on riba. Considerable ingenuity and vast amounts of resources are devoted to the construction of financial products that are economically equivalent to interest-bearing loans or interest-bearing bonds, but theologically equivalent to permissible Islamic risk-sharing instruments. The process of certifying financial products as Sharia-compliant is time-consuming and costly; those with the religious authority to provide the desired certification (typically Islamic scholar-jurists) often don’t understand finance. Financial experts tend not to be well-versed in Sharia law and its application to financial structures. Those with the power of certification can extract significant rents from the issuers and buyers of Sharia-compliant problems.

Sunday, October 07, 2007

Banking problems

Willem Buiter gives a great overview of recent problems in the banking industry.

Daniel Gross on the distribution of CDOs.

Tuesday, October 02, 2007