The Oser View

The Picher & the Elevator Operator

Last fall a left-handed pitcher named Cliff Lee signed a $120 million, five-year contract to play for the Philadelphia Phillies. Mr Lee actually turned down more money and more years from other teams in what was this off-season's most frantic bidding war. While professional baseball players are thriving as never before, professional elevator operators are all but extinct. At one time it was inconceivable that visitors to a top-flight hotel, office building, or department store would have to push elevator buttons themselves. A uniformed elevator operator was part of the service that distinguished the first-rate from the third-rate. But that was then

The difference between pitching at the major league level and running an elevator are many and obvious. But, the two occupations have an important underlying commonality. Virtually everything about them is known to both potential employer and potential employee up front. What the duties are, the work-hours and working conditions, what constitutes success, what constitutes failure—all are clear, easy to understand and easy to measure. The common element of the two jobs is how little information about them is hidden.

Most other aspects of human life are bedeviled by hidden information. It's the cause of pointless wars and unhappy marriages. It's the reason stock and bond prices fluctuate. In any market, hidden information makes decision-making more risky. The classic hidden-information markets are horse-trading and used car sales, where sellers have much more information than buyers. This imbalance of knowledge makes it harder to come to a satisfactory agreement even when the seller is being entirely truthful about his horse or car. (How can the buyer really be sure?) But hidden information is a problem even when buyers, sellers, and the transaction process itself are doing their best to be transparent.

Today the problem is particularly severe in American employment market. It's a big reason why unemployment has remained stubbornly high and the average length of time people are out of work continues to increase. Unlike the occupations of pitcher or elevator operator, the qualifications for and expectations of many, if not most, jobs in our post-industrial society resist definition. Jobs with the same title vary significantly from company to company. Job descriptions go on for pages, and even then may not truly get at what the employer wants. Success is qualitative and lacking in standards to measure against. On the other side, resumes and similar documents are exercises in branding and marketing. The would-be employee is promoting him-or herself as a product. While (usually) not lying, she is certainly embellishing her successes and burying any failures. The hiring decision has become fraught with hidden information for both employer and employee.

Dozens, hundreds, or even thousands of people can lose their jobs immediately when a business sends jobs overseas, merges, or fails. But hiring workers is an individual decision, in a process that can often stretch out for months. From an employer's point of view, in-depth diligence and multiple interviews are rational, since the problem of hidden information does not end once a hiring decision is made. Businesses have learned to get more output from fewer workers, but that makes each hiring decision more critical. The cost of hiring the wrong person is very high; at the most senior levels, it can be catastrophic.

But, what's rational at the micro level is far from rational at the macro level, given the high cost to society of massive and prolonged unemployment. The official Bureau of Labor Statistics unemployment rate for February was 8.9% of the civilian labor force, but this significantly understates the problem. The true unemployment rate of 15.9% includes part-time workers who want but cannot find full-time jobs and those who have simply given up hope. When the US economy was functioning well, each of these unfortunate clubs was about 40% smaller. Let's leave percentages and look at the number of unemployed and under-employed people:

Category	Numbers of People per Category	Jobs Needed to Reach Normal
Unemployed	13,863,0001,000	5,545.000
Part-time seeking full-time	8,340,000	3,336,000
Persons not currently in the labor force who want a job	3,369,000	1,348,000
Total	25,572,000	10,229,000

 

 

 

 

 

Ten million is a lot of jobs, just to rebound to more normal levels of unemployment. Nor does it tell the whole story because the supply of workers continues to grow. The Congressional Budget Office estimates that, during the next 10 years, the labor force will increase by 15 million people, net after accounting for retirees and other job leavers. The second table shows how many jobs would have to be created each month over two, three and five years to return to normal employment and accommodate new entrants to the labor market:

Years	Jobs Needed to Absorb Those Currently Unemployed	Jobs Needed to Absorb Net New Entrants	Total News Jobs Needed per Month to Achieve Normal Employment
Years	426,200	125,000	551,200
3 Years	284,100	125,000	409,100
5 Years	170,500	125,000	295,500
10 Years	85,200	125,000	210,200

 

Between February 2010 and February 2011, the total number of net new jobs created in our economy was 1,269,000, an average of less than 100,000 per month. This is insufficient to absorb new entrants to the job market, even without taking more experienced job seekers, but, hidden information hurts new entrants, of whom little is known, even more than people with work histories. The numbers prove it. Between 2000 and 2010, labor force participation for males aged 20-24 dropped from 82.6% to 74.5%. For women, the percentage declined from 73.1% to 68.3%. .

The hand of hidden information in hiring can also be felt in the average length of unemployment. Currently it's an all-time record of 37.1 weeks, more than double what it was as recently as 2007. Filling 10,229,000 jobs at 37 weeks each represents 7,300,000 man-years of unproductive time.

Unfortunately, we have not yet devised a better way to fill jobs than an arduous one-by one process in which hidden information must be fought at every turn. It's an irony of modern life that, as the economy has evolved from agriculture to industry to information, the most crucial information—matching the right worker with the right job—is the most elusive.

Houses of Cards

The Obama Administration recently issued what it disingenuously calls a "plan to reform America's housing finance market." In fact, only four of the document's 31 pages constitute anything even resembling a plan, and the three options in those pages are so sketchy, so devoid of any financial analysis, and so lacking in any concrete steps forward that no reasonable person should take them seriously. All three options are variations on a theme: Except for a drastically scaled back role for the Federal Housing Administration (FHA) and perhaps a few other minor federal guarantee programs, the mortgage market, "would be driven by private investment decisions with private capital taking the primary credit risk." But, the plain and simple fact—a fact that the administration's own report, despite itself, makes obvious—is that the housing market in the United States has been, is, and must be dependent on the federal government for its very existence.

The report explains why, for the first time, the federal government intervened in the mortgage business during the Great Depression. In the 1930s, the private sector proved incapable of sustaining widespread home ownership through debt during a severe economic downturn. The Roosevelt Administration and Congress realized that only government could restart the mortgage business. The creation of the FHA, Fannie Mae, and the Federal Home Loan Banks (FHLBs), later joined by Freddie Mac, was necessary to reverse "severe mortgage market disruptions, widespread foreclosures, and sinking homeownership rates," essentially the same situation that exists today. Beyond restoring mortgage volume, the benefits of government involvement were the standardization of terms, conditions, and documentation; and the provision of liquidity to the savings & loan industry by allowing S&Ls to borrow from the FHLBs using mortgages as collateral. But the most sweeping innovation by far was mortgage securitization, which was invented in the 1970s.

Before the advent of securitization, banks and S&Ls held the lion's share of mortgages since they had no efficient way to disperse the mortgages they originated. Securitization opened up mortgages to a broad range of institutional and individual investors, not just in the US but globally. The reason investments in securitized pools of US mortgages became so widespread is that governmental agencies guaranteed the timely payment of principal and interest if the mortgage-holders themselves failed to pay. Mortgages, in their securitized form, were an investment all but free of credit risk. Investors could be certain of getting their principal returned and their interest paid except in the most catastrophic circumstances.

Because of the lack of credit risk, the market for securitized government-agency guaranteed mortgages has remained strong and vibrant through the present moment. This unabated demand has had several important consequences. One was that support for nearly universal homeownership became official US policy, championed by both Democratic and Republican administrations. Today nearly two-thirds of US households are owners, not renters. Another consequence has been huge growth in mortgage debt outstanding. The total now exceeds all US bank deposits by several trillion dollars. Even if banks wanted to fund nothing but single-family home mortgages, to the exclusion of all other types of loans and investments, they could not. Securitization evolved from an adjunct to the mortgage business to its irreplaceable core.

A third consequence was the substitution of market risk in place of credit risk in a way unique to America. For some of you, this may be a new and somewhat difficult concept, but it's critical to an understanding of why the mortgage market depends on government backing. On page 25, the administration's report summarizes research done on government mortgage support in other developed nations. The research provides little practical help: "The US system, however, is one of the only countries in the world where the mortgages are pre-payable, 30-year fixed rate mortgages." Mortgages have all sorts of terms and conditions. Why are these three--the ability of mortgage-holders to prepay at any time, the thirty-year repayment schedule, and the fixed rate of interest—singled out? The answer is that these are the qualities that create substantial market risk for investors in US mortgages.

To understand market risk, let's assume you are a mortgage investor who has bought a pool of mortgages paying 5%. If interest rates rise, the value of your investment will decline, and its long maturity will exacerbate the loss of value. Moreover, if you have to borrow money to support your investment, as a bank does by taking deposits, the rate of interest of your borrowing may come to exceed the 5% paid by the pool of mortgages. On the other hand, if interest rates fall, you as the investor do not get a commensurate benefit. Because the mortgage holders can prepay their mortgages without penalty, many of them will refinance at lower rates, thereby taking your investment away from you.

Nevertheless, the financial markets accommodated themselves to market risk because credit risk was contained. In fact, after government-guaranteed mortgage securitization became firmly established, the private sector began to securitize certain types of non-guaranteed mortgages safe in the knowledge that the health of the mortgage market was sustained by government involvement. Investment banks exploited a niche based on the ceiling Congress set annually on the size of mortgages Fannie Mae and Freddie Mac could insure. Households that could afford these large non-guaranteed mortgages, called jumbos, typically had higher incomes, better credit, and could make large down-payments. But, despite this inherent mitigation of credit risk, investors demanded higher interest rates on pools of jumbo mortgages because they lacked the biggest risk-mitigant of all: government guarantees. This should not be surprising. Credit risk invariably trumps all other risks.

The parameters changed only during a few years in the middle of the last decade when the housing mania was at its peak. Private securitizations began to include smaller mortgages with exotic structures, i.e. predatory loans. As the administration's report notes, Fannie and Freddie's market share of purchases of new mortgage originations declined from the normal 70% to 40%. Forced by the competition, the agencies lowered their standards, although in general they remained higher than the prevailing norm.

What happened when the bubble burst is instructive. Private mortgage securitization collapsed in the fall of 2007 and has never recovered. To quote from the administration's report again, "In the wake of the financial crisis, private capital has not sufficiently returned to the mortgage market, leaving Fannie Mae, Freddie Mac, FHA, and the Government National Mortgage Association (Ginnie Mae) to insure or guarantee more than nine out of ten new mortgages." (Emphasis added)

Here is the crux of the matter. No law requires any non-governmental entity to make or invest in mortgages. Thirty-year, pre-payable, fixed rate mortgages are fraught with market risk. They become a desirable investment only when credit risk is reduced to negligible levels by government guarantees or when the borrowers and properties are of the very highest quality. Without government backing, the combination of market and credit risk drives most private lenders out of the mortgage business. There are simply much less risky ways to make money. This is a fact that has been clearly demonstrated not just in the 1930s and late 2000s, but through all the years in between. The notion that the private sector can substitute for the government in maintaining the multi-trillion dollar US mortgage market is preposterous. It has never happened and there is no reason to suppose it will happen in the future.

The solution is to reconstitute Fannie Mae and Freddie Mac. They were placed into "conservatorship," whatever that means, in 2008 and the government has poured $150 billion into them since. Obviously they are still essential to the mortgage market. Unfortunately, the only definitive conclusion of the administration's report is that the two agencies are unfixable. "Fannie Mae and Freddie Mac's structural design flaws, combined with failures in management, were the primary causes of their collapse." Thoroughly demonized, they are somehow to be "wound down" in a smooth transition to a privately functioning mortgage market. I can't even imagine what morale must be like, though I am certain that every Fannie and Freddie employee is looking for a new employer. Instead of trying to fix Fannie and Freddie, the whole apparatus of government is focused on eliminating them without any credible substitute in place.

The biggest losers will be the American people. The report talks frequently about protecting taxpayers, but taxpayers and homeowners are exactly the same people. Pretending to protect "taxpayers" by making it much harder and more expensive for "homeowners" to get mortgages is a game no one can win. And the Obama Administration knows it. As I mentioned earlier, the government's intervention in the mortgage market led to a policy goal of encouraging near-universal home ownership. But consider these two sentences on pages 2 and 18, both of which follow platitudes of government support for quality affordable housing.

"This does not mean our goal is for all Americans to be homeowners."

"This does not mean all Americans should become homeowners."

They may as well have said, "Wake up! The American Dream is over."

Ineluctable Modality of the Visible

A Review of Disintegration by Eugene Robinson

James Joyce begins the third section of his novel Ulysses with the phrase "Ineluctable modality of the visible." As in much of his famously difficult prose, Joyce compresses an enormous idea in the fewest possible words. Ineluctable modality of the visible means that human beings inevitably and continually create and then adhere to patterns based on what we see around us. When we look at a house we don't see a collection of geometric shapes but a purpose, an aesthetic, and many subtle clues about its inhabitants. We see each individual house based on the patterns we have built of over years around the concept of "house." We do the same with people, reaching all sorts of conclusions based on no more than a quick first glance. We do this, or more to the point, we are able to do this, for an extremely good evolutionary reason. For most of our 200,000 or so years as a species, humans lived in very small isolated groups. Strangers were rare and dangerous. The ability to recognize them instantly was a major advantage to survival.

Since evolution works far more slowly than culture, what were once evolutionary benefits often adapt poorly to changed circumstances. The notion of "race" is a good example. Biologically, there are no human races; there is just one human race. Skin color, shapes of facial features, and hair texture are trivial differences of no more importance to human commonality than the ability to curl one's tongue (something as a child I always envied in my more fortunate classmates.) But, these minor differences are ineluctably visible. By the 19^th Century, Western science had systematized the observable differences between peoples into hard and fast racial models.

This now-discredited branch of scientific theory is referred to as Scientific Racism, but the term is not quite accurate. Racism is purely negative, comparing groups invidiously against one another. Scientific Racialism is a more precise term for a theory that sought to identify distinctions that could be either positive or negative. Racialism, in this sense, still exists today, and as Eugene Robinson tells us in his excellent new book, Disintegration: the Splintering of Black America, it leaves us with a badly distorted view of what it means to be African-American today.

Robinson argues that it is no longer useful to consider African-Americans as a single unified group. His idea has far-reaching ramifications. If true, and Robinson, a columnist for the Washington Post, makes a strong case, it means that generalizations about blacks in America have no more cohesive meaning than generalizations about left-handers in America. It means one can no longer speak of a "black community" in the singular, and that the position of "black leader" is an anachronism.

Robinson divides African-Americans into four socio-economic groups. It's important to grasp that these are groups, each with enough members to be a substantial and established part of American society. The first group is the Transcendents, the high government officials, business leaders, entertainers, and sports figures who have achieved power and wealth, not in Black America, but simply in America. Another group, which somewhat confusingly consists of two entirely separate demographics, is the Emergents. The first subgroup is of people who have recently migrated from Africa and the Caribbean. Like many immigrant groups before them, they are the self-selected, ambitious and adventurous. They are willing to work hard at jobs well below their real skill levels to get a foothold and assure their children of better lives. In large numbers, their children are responding with excellent performance in school. The other sub-group is the new biracials. Of course, the majority of African-Americans have mixed ancestry. But that happened not usually by choice, and besides, for most of American history, if you looked black you were black and that was the end of the story. Today's biracials have much more of choice in how they define themselves. Interestingly, President Obama is a Transcendent and both kinds of Emergent.

By far the largest group is the Mainstream of middle- and upper-middle class earners. Robinson stresses the very significant economic gains this group has made. Between 1967 and 2005, the percentage of black households earning more than $35,000 (in constant dollars) has risen from 25.8% to 45.3%, while the percentage earning more than $75,000 has grown from 3.4% to 15.7%. So, Robinson asks, "Why hasn't this Mainstream success penetrated the national consciousness?" The answer: "Mostly because we tend to see what we expect to see. Our eyes confirm what we 'know' and everybody 'knows' that black America is mired in intractable problems that defy solution." In other words, the ineluctable modality of the visible.

The growth of the black middle class is unequivocally good, but what about all the horrendous statistics on black unemployment, incarceration, drop-out rates, and teen pregnancy? Are they not accurate? Well, they are certainly inaccurate when applied to the Mainstream of African-Americans whose current situation and future prospects are much better. Unfortunately they are also inaccurate when applied to the roughly 25% of blacks whom Robinson calls the Abandoned. For them, the statistical percentages are much worse. Robinson describes this group as having "less hope of escaping poverty and dysfunction than at any time since Reconstruction's crushing end (in 1877)."

The Abandoned live in neighborhoods that were once economically, though not racially, diverse. In recent times, such neighborhoods were hit by the double misfortune of middle-class out-migration and the loss of working-class jobs that permitted a single (male) breadwinner to support an intact family. Their loss undermined the family structure, turning single-parenthood from the exception to the norm. Lack of economic class diversity was exacerbated as the neighborhoods became magnets for other poor blacks, either dispersed from large public housing projects or unable to afford rents in their gentrifying neighborhoods. Capping it all is racial segregation. As Robinson writes, "All else being equal, we should expect to find poor black, white, and Hispanic people living together. But this simply does not happen." Much research has shown that once the black population of a neighborhood—regardless of its location or income level—reaches about 20-25%, that neighborhood quickly becomes all or nearly all black. There are exceptions, of course, but in once-poor areas the exceptions only occur through the massive input of both private and public resources that produce gentrification.

In the latter part of the 20^th Century "the crisis of the cities" was a topic of political concern and even some action. Today, the Abandoned are truly that. They live in their own isolated worlds, commit violent crimes mostly against each other, and raise children whose early development is so meager that they enter kindergarten already far behind their middle-class peers.

Robinson offers no solutions to these problems, and it's hard to fault him since they are so challenging. But at least he faces them squarely. In this he differs from a study recently issued by the Children's Defense Fund called "The State of Black Children and Families." We can sense trouble in the title itself, which implies a homogenous Black America. The study makes some very interesting points, particularly the hopefulness of a high percentage of young African Americans, which probably reflects the fact that most of them are children of the Mainstream middle class. Coincidentally, the study ends with a section called "The Splintering of Black America." Unlike Robinson, the study deplores the breakdown of a united black community. Its authors issue a clarion call: "We must commit to working together across class lines to heal and repair our communities and our families that live and raise children in them…. Essential to making progress… is the emergences of a new coordinated Black movement that promotes justice for all Black Americans…"

But this is looking backward. Black Americans are splintering just like Irish-Americans, Italian-Americans and every other ethnic group did before them. The problems afflicting the Abandoned are not the responsibility of one particular group of Americans just because they have skin color and ancestry in common. All Americans are responsible for addressing these problems, and only when we all begin to realize it will solutions become possible.

George Jetson's Job

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“George Jetson lives in the future and he works in a factory where all he has to do is push a button. He pushes it and robots do all the work. His job is literally a joke, and the joke is, you can design all those robots to do the work, but you can't design a robot to push a damn button? “

--Leonard Richardson, 2009

The joke is not quite as funny as it was in the 1960s.  Robots are doing the work and George is out of a job.  The predicament of the quintessentially middle-class George is a near perfect symbol of the US socio-economy, a word I’ve coined to denote the deepening bifurcation of modern America.  The economy is recovering, but a large segment of the population, many of whom always considered themselves as solidly middle-class, is not.  The reason is that robots—or computers or low-wage workers in other countries or simply greater individual productivity—are now pushing the buttons.  
On November 24 we got a concentrated picture of what the new socio-economy looks like.  Because of the Thanksgiving holiday, more data releases were crammed into one morning than I can ever remember.  These data were:

Data	Source & Period
Mortgage applications, new & refinance	Mortgage Bankers Association -weekly
Durable Goods Orders	Census Bureau – October
Personal Income & Spending, Personal     Consumption Expenditures Index	Bureau of Economic Analysis – October
Initial & Continuing Jobless Claims	Bureau of Labor Statistics – weekly
Consumer Confidence	University of Michigan – November
House Price Index	Federal Housing Finance Agency – September
New Home Sales	Census Bureau - October

Altogether the data was decidedly mixed, but the markets chose to focus on the good news, especially the continuing growth in consumer spending.  The chart shows spending by consumers for services by month on a seasonally adjusted annual basis.  Spending on services represents about two-thirds of all consumer spending, with spending on non-durable goods accounting for another 22.5 %.  This propels the economy, because it means that almost 90% of what we buy today, we’ll have to buy again

tomorrow, or at least in the next year or so.  As you see, spending on services has been rising steadily since hitting a trough in the summer of 2009.   More than anything else, this is why economists have declared the recession over and why the stock market has rebounded from its March 2009 low.

The other bit of good news was that the fewest number of first-time unemployment insurance claims were filed in the week ended November 20 since the summer of 2008.  Weekly initial claims peeked at 651,000 in March 2009 and have since been trending down.  Still last week’s total of 407,000 remains well above the pre-recession average of about 325,000.  And, continuing unemployment claims, a much more significant gauge, remain unacceptably high and well over the long-term average.  Nearly 4.2 million Americans continue to collect unemployment insurance with 863,000 getting extended benefits. This compares to well under three million from 2004 through 2007.

The market chose to ignore the bad news.  Durable goods orders fell and remain far below pre-recession levels, in terms of total dollars, again on a seasonally adjusted annual rate.  Still, this data series is subject to both large monthly swings and large monthly revisions.   As a result, the markets discounted October’s drop in orders as either a normal pause in a general upward trend or simply a reporting error that would be rectified in a later revision.  

The housing reports were worse than expected, and the expectations were not rosy.  While applications for mortgages rose, home values continued to drop.  The Federal Housing Finance Agency reported that the average value of purchased homes was 1.6% lower in the third quarter than in the second and 3.2% lower than in the third quarter of 2009.   (The data comes entirely from mortgages purchased by Fannie Mae and Freddie Mac.)  At $191,000, the average home purchase price is back where it was six years ago, and 14% below its 2007 peak.

More distressing still is the continuing abysmal slump in new home sales. Calculated on the usual seasonally adjusted annualized rate, just 283,000 new homes were sold in October.  A mere 202,000 new homes were on the market, the fewest since 1968.  Existing home sales also remain at extremely depressed levels.

The picture that emerges is of a strengthening economy within a stagnant society; that is, a bifurcated socio-economy.   In every recent recession, businesses have learned how to produce more with less expense as measured by productivity per hours worked.  Businesses do not forget the lessons when they recover from the shock of the recession.  Consumers, however, forget the shock more quickly.  Those who have jobs begin spending freely again, spurred on by relentless advertising, door-busters, and other come-ons.  But following each recession, a larger pool of unemployed and under-employed is being left behind.  This time, the bifurcation is being widened. Household wealth is being squeezed by falling home values and the unavailability of traditional credit.  Consumers can still use the credit cards but bank lending remains tight, not because banks and credit unions don’t want to lend, but because their regulators won’t let them.  The big shots in Washington piously mouth their hopes for easier credit, but examiners on the ground squelch all attempts to take anything resembling risk.  The outcome is a statistical economic recovery but societal malaise.  The rich will bet richer, the poor will get poorer, while the middle class struggles in a slow-motion downward grind, their lifestyles becoming ever more difficult to maintain.   

We look back on the utopian future imagined for George Jetson in the 1960s with an odd nostalgia.  Maybe the joke was on us after all.      

Yes, Maybe He Could Have

 

 

 

 

But, no, actually, he didn't. The unemployment rate was 6.2% when voters went to the polls in 2008. Now, it's 9.6%. That's why independent voters decided that anyone was better than those in power, flocking to the Republicans and "shellacking" the Democrats. The really interesting parts are around the edges. What tipped the margin of victory or defeat in the close races? Part of this question involves the votes of African-Americans, who have comprised an essential part of the Democratic Party's base since the 1930s.

Every political party in the world, large or small, has a base or bases. You are a member of a political party's base if you would never vote for any other party's candidates. Notice that this is different than saying you would always vote for your party's candidates. Members of a party's base do have a choice: They can vote for their party's candidates or they can stay home. This means that a political party is in trouble if it neglects its base.

The Census Bureau recently published a report, "Voting and Registration in the Election of 2008," that documents how energized the Democrats' African-American base was two years ago. Sixty-five percent of voting-age Blacks voted, about even with Non-Hispanic Whites (66%) and well ahead of Hispanics and Asians, both at 49%. This was a huge increase from previous presidential elections as the chart above shows. In 2008, 12.3% of all voters were African-American, about the same as their percentage of the population as a whole. CBS News estimates that this year only 10% of voters were African-American, implying a loss of three million votes, nearly all of which would have gone to the Democrats.

African-Americans as a group have been hit much harder by the recession than others. Their unemployment rate jumped from 11.4% to 15.7% in the two years it took for the White unemployment rate to go from 5.5% to 8.8%. In housing, the situation is just as bad, and, to make matters worse, a recent study published in the American Sociological Review indicates that the damage was deliberate.

Written by two Princeton University researchers, "Racial Segregation and the Foreclosure Crisis" argues that African-American neighborhoods were specifically targeted for subprime loans that were then packaged, sold, and securitized. Such targeting was possible, indeed easy, because housing in the United States remains intensely segregated. "In areas with large African-American communities—places such as New York, Chicago, Detroit, Atlanta, Houston, and Washington—declines (in housing segregation) have been minimal or non-existent."

This is not exactly news. It's a fact of American life that we take for granted without following its trail of consequences. Princeton's Jacob S. Rugh and Douglas S. Massey did follow the trail. They argue that minority neighborhoods were ideally suited for subprime lending as it evolved in the 1990s because they were served by few mainstream lenders. "Subprime mortgages accounted for 43% of the increase of in black home ownership during the 1990s and 33% of the growth within minority neighborhoods." The initial impact of subprime lending in minority neighborhoods was deceptively beneficial. Easy terms and low or non-existent down payments created loan volume that in turn drove appraised home values higher. Higher values in their turn allowed subprime borrowers to avoid financial problems by refinancing into lower "teaser-rate" ARMs or bolster their reserves with a home equity line.

But with the crash in home values nationwide, several factors came together to put African-American neighborhoods in a vice. All the subprime lenders were gone and the securitization of subprime loans abruptly ceased. Since these lenders had dominated the housing markets in segregated neighborhoods, home values collapsed with their demise. The few mainstream lenders who have previously served the neighborhoods either deserted them, or if they were deeply embedded, collapsed in the general debacle. For all intents and purposes, housing markets in segregated urban neighborhoods evaporated.

Everyone in the neighborhoods suffered. Those residents who remained solvent saw much of their accumulated wealth disappear. Those who did not faced foreclosure rates that rose from 3.3% of subprime loans to 15.6% in 2009. Rugh and Massey conclude, "Ongoing racial segregation, discriminatory lending, and an overheated housing market combined to leave minority groups uniquely vulnerable to the housing bust."

A second conclusion brings the losses suffered by segregated neighborhoods back to the political process. "The utter collapse of subprime lending exposed the extremes of a pricing regime that assessed risks individually but not collectively, not accounting for the aggregate risk of ever-increasing subprime lending and securitization." An aggregate risk of this magnitude is not a local problem; it's a national problem. But the political regime inaugurated in January 2009 decided not to talk about race let alone address it. A Democrat president and congress neglected one of its primary bases, permitting the illusion to flourish that America is a post-racial society.

What could the federal government have done? Well, for one thing they could have designed mortgage rescue programs specifically for racially segregated neighborhoods. Such programs would have included principal forgiveness, payment moratoriums, and restructuring of "teaser" or "exploding" ARMs. Second, the government could have made a market, setting a base price for homes whose owners simply could not pay their mortgages under any circumstances. Third, the government could have subsidized cheap mortgages for new buyers in segregated neighborhoods. Fourth, the government could have instructed its captive mortgage accumulators, Fannie Mae and Freddie Mac, to offer especially advantageous terms for buying mortgages from lenders who would agree to make traditional 30-year mortgages in segregated neighborhoods. Fifth, the government could have targeted jobs programs aimed at repairing and rehabbing homes and commercial buildings. And that's just a start.

Why should the government have spent federal tax dollars on such racially targeted programs? The answer is simple. Not having done so is going to cost a lot more dollars. It's true that foreclosure rates are high in segregated neighborhoods, but not nearly as high as might be expected given the even higher delinquency rates. Lenders don't want to own properties that they can't sell and that entail significant costs to maintain. It makes more financial sense to let them sit abandoned or sell them to vultures at pennies on the dollar. Of course, this is a purely short-term benefit. The long-term disadvantages are obvious. In many cities, stable neighborhoods of working people in the middle- to lower-income brackets are now in serious danger of deteriorating into slums or worse, the urban deserts of east Detroit.

Only a dreamer would expect a new urban agenda to emerge from the Democrats' 2010 election debacle. The only lesson the Democrats appear to have taken to heart is to become more like the Republicans. In 2010, a significant portion of a core Democratic base stayed away from the polls. Unless Democrats take notice and bring race back into the national dialogue, they are likely to lose even more next time around. As long as Blacks and Whites can't live in the same neighborhoods, Americans still have a lot to talk about.

The Ghost of Superiority

In his memoirs, Mikhail Gorbachev recounts the following conversation:

I met with Mr Nixon, and he said to me then: I have grounds to say, on the basis of my vast political and life experience, that the search for the ghost of superiority has taken us too far. Now we do not know how to break away from the mounded stockpiles of nuclear weapons. All this is complicating and poisoning the situation in the world.

The Ghost of Superiority is the wraith that keeps 5,000 nuclear weapons in the US arsenal and 4,000 more that could easily be rebuilt from available materials at an annual maintenance cost of $50 billion. Yet, no nuclear weapon has been used in 65 years, nor has their possession been of any benefit in war, as the US discovered in Vietnam and the USSR in Afghanistan. Today, any nation that used even a single one would, in the unlikely event it survived retaliation, be branded the greatest enemy of humanity in history.

The Ghost keeps a firm grip on conventional military spending too. The US accounts for 46.5% of total annual global military expenditure. We have more active servicemen and women, at 1.58 million, than any nation except China, with its much larger population. (The percentage of active service personal to 1000 population is 5.1 here, compared to 1.7 in China.) We possess the most large fighting ships—aircraft carriers, cruisers, and destroyers. We are number one in fighter aircraft such as bombers, fighters, and attack aircraft. Overall, we spend more than $700 billion a year to maintain our military superiority.

And we don't have any enemies. A nation-state can only have other nation-states as enemies. Of our old enemies, the Soviet Union is 20 years gone, and if China is still Red, it's only as a fashion statement. North Korea? Here is Kim Il Sung's response to a question by New York Congressman Stephen Solarz in 1991:

What's the use of a few nuclear weapons? In 10,000 years' time we couldn't have as many nuclear weapons as you. Assume that we are producing nuclear weapons and have one or two nuclear weapons? What's the point? They'd be useless. If we fire them, they will kill the Korean people.

North Korea would like nothing more than to be our friend so they could benefit from the aid the country so desperately needs. They just want us to leave their political system alone. The same was true of Iraq before we invaded and Iran today. The plain fact is that no country wants foreign soldiers on its soil except in the direst emergency, and even then they don't want them for long.

Sure, there are individuals and small groups that hate the United States, (or more accurately, their own perverted and distorted view of us). But the blunt weapon of military force is a poor and extraordinarily expensive way to protect ourselves. Nobel Prize-winning economist Joseph Stiglitz estimated that our wars in Afghanistan and Iraq will end up costing $3 trillion including long-term medical treatment for US military casualties. Hans Blix, a veteran Swedish diplomat, recounted the following story to American author Richard Rhodes:

After the (2003 Iraq) war, Kofi Annan (then UN Secretary General) and I sat down and estimated the cost of disarming Iraq by inspection versus disarming by war. We estimated that inspection would have cost $80 million—and would have worked as well.

Here's the punchline. This election season the Republicans are clamoring to cut the federal budget deficit by eliminating discretionary social programs and economic stimulus. The Democrats, who favor these programs, are running scared. Their best chance of success lies not in their accomplishments, but in the extreme positions and antics of some of their opponents. Yet the way to reduce the deficit while maintaining and even enhancing such much- needed programs as infrastructure improvements, broadband expansion, and job creation is staring us right in the face: cut military spending. Even if we just brought costs back to the levels of the Clinton years—which, by the way, was the last time the federal budget was balanced—the annual saving would be more than $300 billion. The Bush Administration failed to win any of its wars, but it succeeded brilliantly in creating an atmosphere of terror and fear. As a result, we are so haunted by the Ghost of Superiority that our politicians can't even discuss the defense budget, let alone bring it within reasonable bounds.

Please click on the following to link for a video interview conducted by Wayne VIsser of CSR International.

http://www.youtube.com/user/csrinternational#p/u/4/c5Mg5C6AtVs

Why ShoreBank Succeeded…and Why It Failed

Presented at Roosevelt University

September 7, 2010

ShoreBank lived for 37 years. Its founders acquired the $40 million South Shore National Bank in August 1973. The FDIC seized the $2.1 billion ShoreBank in August 2010. In between, ShoreBank evolved from a small bank serving one community of about three square miles and 80,000 people on the South Side of Chicago into an international icon that inspired, nurtured, and spread the principles of development lending throughout the world. The founders of ShoreBank were the first consultants to future Nobel Peace Prize winner Mohammed Yunis. Their counsel helped turn his insight that poor people deserved and would repay credit into reality. ShoreBank Corporation, the parent holding company then called the Illinois Neighborhood Development Corporation, was the first to seize on the idea that fostering community economic development needed more than just a bank. A bank, after all, is a reactive institution; it can only lend money to others who then initiate action, whether buying a home, improving a business, or rehabbing an apartment building. So, in the 1970s, the holding company created a non-profit to focus on job training and placement; a loan fund to assist minority entrepreneurs reach scale; and a real estate development company to catalyze neighborhood revitalization in South Shore.

Eventually, ShoreBank spread its banking activities through much of the South and West Sides of Chicago, the East Sides of Cleveland and Detroit, and the Pacific Northwest. It spread its non-banking activities throughout the United States and the developing world. ShoreBank Corporation founded and managed the National Community Investment Fund, which is now the largest single investor in community development financial institutions in America. The non-profit Center for Financial Services Innovation has become the nation's leading authority on financial services for underbanked consumers. Through its subsidiary, ShoreCap Management, ShoreBank raised a $28 million fund to invest in banks serving small and growing businesses in the developing world. That fund, created in 2003, has achieved a rate of return greater than 25%. A second fund, which has raised $50 million so far, is in the process of making its first investments. The achievements of the international consulting firm, ShoreBank International Ltd., are truly breathtaking. SBI's practice spans the entire developing world. Its clients and partners are the major international development agencies including the European Bank for Reconstruction and Development, the Gates Foundation, and the International Finance Corporation. In 2009, ShoreBank International facilitated more than 10,000 development loans with an average loan size of $5,000. It trained 485 loan officers, more than a quarter of them women. It raised $62.6 million of debt capital for BRAC, one of the largest microfinance organizations in the world, to fund its initiatives to combat poverty in Tanzania, Uganda and Southern Sudan. 

I have reviewed the activities of some successful ShoreBank ventures, but there were failures along the way too, and even the successes had their share of growing pains. The whole ShoreBank concept was an experiment, and experiments are never a series of unqualified successes. Through all the growth and the trial and error, the heart of ShoreBank remained where it started, at the corner of East 71^st Street and Jeffery Boulevard in Chicago's South Shore. The bank was by far the largest of the many for-profit and non-profit ShoreBank companies. It was the engine, providing the bulk of the profits that drove the whole machine. A banking engine is fueled by its liabilities; that is, its deposits, which are the funds lent to it by its customers and which the bank in turn lends to its borrowers. In low- and moderate-income neighborhoods, the demand for credit inevitably and continually exceeds the supply of deposits. If ShoreBank had simply relied on local deposits for funding, it might have been a moderately successful small community bank, but it would never have achieved even its relatively modest initial goal of revitalizing a single urban neighborhood. The decision, taken in 1975, to reach beyond the community for funding had monumental consequences that went very far beyond the immediate objective.

I am now going to indulge in a little digression to explain a concept that's essential to understanding the ShoreBank story. Many early small-group agricultural societies had a shaman whose job was to make rain at the critical seasons. There was nothing hypocritical about the job; the whole group including the rainmaker truly believed that the rainmaker could make rain. The rainmaker prayed, fasted, and engaged in the arcana of his trade without which he had no power. Usually, of course, the rains came in their proper season, and the rainmaker was duly honored. But rains don't always come. Then the rainmaker had to pay, if he was lucky, merely with disgrace; if not, with his life.

Translated to the modern corporate realm, rainmakers are people who develop successful lines of business where others saw no opportunity. ShoreBank succeeded because it had rainmakers. The founders were the original rainmakers, but as the scope of their activities widened, other rainmakers in key areas stepped up. ShoreBank was a collegial enterprise, built on initiative and integrity. In strict hierarchical organizations, rainmaking is squelched; at ShoreBank it was encouraged and essential. There were rainmakers at many of the non-bank companies, but I am going to focus on the bank.

The first of the bank rainmakers was actually a series of three extraordinary women who succeeded one another in the creation and leadership of raising deposits outside the community. It may not be obvious now quite how radical an idea this was in the mid-1970s. Mechanisms for transferring money were primitive by today's standards, and your bank was a nearby place you physically went to to transact business. The first of these women started with the idea that Catholic women's religious orders—that is, nuns—would be willing to support ShoreBank's development mission as long as they could get a competitive rate for their deposits. The value proposition was simple. The rainmaker and her staff got the rates each day that all the large banks in Chicago were paying for CD's over $100,000. (Back then, those were the only unregulated deposit interest rates.) Then they called the nuns and told them ShoreBank would match the highest rate at each maturity. From that little acorn, the business expanded into an oak whose branches spread across the country, in the process sparking the socially responsible investment movement. Mission-based deposits grew to be the main source of funding for the bank's loans, but the value proposition remained the same: Fostering community development was the sizzle, but a competitive rate of interest was the steak. ShoreBank now had the fuel to expand its operations.

The second rainmaker involved a bit of a secret. No bank loans out all its funds. A greater or lesser portion is always invested in bonds, which provide additional income combined with safety and liquidity. In 1997, ShoreBank decided to leverage its capital; that is, to tap the growing array of wholesale money sources for the purpose of funding a larger bond portfolio. Under its rainmaking manager, the investment portfolio eventually grew to more than three-quarters of a billion dollars, about a third of the bank's assets, and produced a substantial share of its profits. It was a secret, though, for two reasons. First, unlike lending, deposit-taking, or operations, not many people in the bank were involved with the investments, so not many people knew much about them. But more importantly, not many people could know about them. The fact that such a significant portion of the bank's profits were generated by the investment portfolio conflicted with the central ShoreBank theme that it was profitable because of its mission. Belief in this theme was essential, not only in raising deposits but in motivating ShoreBankers. It was a central tenet of the ShoreBank story, but the truth was more complicated.

ShoreBank had three main lending lines of business: single-family, business, and multi-family. The first two were, at best, never more than marginally profitable. They had high overhead costs relative to the amount of loans outstanding. Delinquency, while not usually higher than industry standards, always took its toll. Multi-family, though, was extremely profitable for two decades and was the creation of the greatest rainmaker of all. But in 2009, the multi-family loan portfolio crashed stunningly and so did its rainmaker.

Much of Chicago's South Side was built up during and just after World War I. Many of its buildings are three-storey brick walk-ups in configurations of three, six, twelve or more apartments. The inhabitants were whites of various ethnicities until the 1950s. At that point, African-Americans, many of whom had come to Chicago to work in heavy, war-related industries, finally began to push beyond the boundaries of the small mid-south Black Belt. The populations of South Side neighborhoods changed dramatically, from nearly all white in the 1960 census to nearly all black in the 1970 census. But the ownership of the apartment buildings was slower to change. Some were owned by outright slumlords, others by absentees. Whether deliberately or through force of circumstances few owners would or could screen tenants properly or keep up with needed repairs, let alone modernizations.

Beginning in the late'70s, a rainmaker in ShoreBank's loan area began experimenting with innovative lending practices and structures to return ownership of South Side apartment buildings to local owners. He lent to people with hands-on skills who got quality rehab done cheaply, people who lived in or near the buildings they owned, people who knew how to bring in good tenants and keep out bad ones. He lent based on the value of the buildings after they were completed, not as they were. Most of all, he lent on character, dispensing with red tape and formality. The results were spectacular. By the mid-2000s there were virtually no vacant apartment buildings in the areas surrounding ShoreBank's main offices. More than forty thousand apartments had been renovated and over a hundred local families and groups were working full-time in the real estate business. Delinquency was extremely low and actual losses almost nil. If a borrower got into trouble, it was usually for personal reasons, such as a divorce or an illness. The rainmaker could always find another good borrower to step in and take over before any real damage was done.

But the glowing success hid flaws that eventually brought ShoreBank to grief. On the South Side, every fourth north-south street—71^st, 75^th, 79^th and so on—was built for shopping. Through the 1960s, local commerce throve, but by the time ShoreBank arrived in 1973, it was foundering. The bank's initial efforts were directed toward reversing the decline. ShoreBank lent to small shopkeepers and initiated projects to renovate larger stretches of the commercial strips. Virtually all the loans defaulted, and even the one truly successful project failed to lure retailers to adjacent properties. The old shopping blocks have long been studded with vacant, derelict buildings. The few stores still open offer nothing but the most basic products and services. As a result, the only significant local commerce was in multi-family real estate. And, as it turned out, the only significant market for multi-family real estate transactions was ShoreBank. In the past, there were always other lenders, but none did more than a few deals or were active for more than a brief time. When the recession hit, these lenders were gone, and they haven't come back.

As their tenants lost their jobs, the apartment building owners ShoreBank lent to could not both maintain their buildings and service their loans. Because ShoreBank was the only lender left, there was no market to sell or refinance the buildings. It was then that all the shortcuts in analysis and the idiosyncrasies inherent in character-based lending came home to roost. They hadn't caused the delinquencies, but they made remediation much more difficult. The Bank had lent to some borrowers long after they were overextended. In other cases, collateral was insufficient, even when the loans were originated. By mid-2009, the multi-family portfolio was a shambles, and the rainmaker had been forced to leave ShoreBank.

In a larger sense, though, the reason for ShoreBank's demise is very simple. The economic crisis was not a recession in ShoreBank's neighborhoods. It was and remains a full blown depression, with unemployment rates of 30-40% and no end in sight. In fact, with the expected cutbacks in local and state government jobs, it's likely to get worse. The manufacturing jobs that brought African-Americans from the rural South to Northern cities are gone. Affluent and middle-class African-Americans can find more house for the money on the South Side, but they don't shop where they live and they send their kids to magnet schools or private schools. The original African-American residents of neighborhoods like South Shore are aging. Many of the newer residents are those dispersed from the demolished high-rise housing projects. And, with the exception of a tiny number of so-called "urban pioneers," non-African-Americans still do not move into black neighborhoods in Chicago.

Once many years ago, in a famous moment in ShoreBank's history, our lawyer said, "If ShoreBank woke up one morning and found it wasn't close to the edge, it would do everything it could to get back there as soon as possible." ShoreBank was an enterprise that always worked at the edge. It took big risks, and deep down it always knew that some risks were bigger than it could manage. The worst economy since the Great Depression was one of those risks. But while ShoreBank failed in the end, it succeeded for nearly 40 years. It has changed the world. It was a spark, an innovator, and a model for the enormous pool of talent and energy working on economic development issues around the world today. Its legacy lives on in organizations it founded and that continue to operate such as ShoreBank International. Its legacy lives on through its many alumni whose passion for economic development was kindled at ShoreBank. Its legacy lives on in the lives of millions who have benefited from its services. ShoreBank may be gone, but its ideals remain. That's what sustainability is all about.

 

 

 

 

 

 

 

 

The End of a Dream

It was a lovely dream while it lasted, the dream that the recession had ended. But today's report on existing home sales has surely shaken the confidence of even the greatest optimists. Home purchases fell to 3.83 million units, a year-over-year decline of more than 25%.

This data may be difficult to put in perspective, since it's both annualized and seasonally adjusted. Home buying patterns vary drastically over the year, falling in winter and rising in summer. Warm weather is more comfortable for house-hunting, and families with children want to settle in before school starts in the fall. The table shows data for single-family home sales (excluding condos and co-ops) in the month of July for every year back to 2000.

Year	Homes Sold	30-year Mortgage Rate
2010	338,000	4.54%
2009	460,000	5.25%
2008	440,000	6.52%
2007	490,000	6.69%
2006	521,000	6.72%
2005	594,000	5.77%
2004	592,000	6.08%
2003	553,000	6.14%
2002	478,000	6.34%
2001	471,000	7.03%
2000	437,000	8.13%

Normally home sales rise as mortgage rates fall. This year breaks the pattern. We experienced the least number of sales for any July since 1995 accompanied by the lowest 30-year mortgage rates ever. At the very time mortgages are effectively on sale, no one is buying. There is nearly a year's supply of single-family homes on the market. It's the biggest backlog since 1982, when we had a recession and mortgage rates of 16.75%.

The plain fact is that the housing market is dependent on employment. Only when job creation begins in earnest will we see a real improvement in home sales. And only then will the recession be over.

Quantitative Easing

The Federal Open Market Committee announced a change in tactics today.  The Fed plans to inject additional liquidity in the economy by buying long-term US Treasury securities using the payments of principal and interest it receives from its $2 trillion investment portfolio.  All this liquidity makes borrowing cheaper because there is so much cash available to lend.  Economists call this policy of very easy money “quantitative” because the Fed has already lowered the overnight interbank borrowing rate to 0%, which is as low as it goes. 

The Fed’s reason for today’s change in monetary policy is that the economic recovery is faltering.  “The pace of recovery in output and employment has slowed in recent months,” and “the pace of economic recovery is likely to be more modest in the near term than had been anticipated.”  The Committee does not believe inflation is a threat and will keep the liquidity faucet wide open “for an extended period.”   It must have been difficult to backtrack on its earlier optimism, but the Bernanke Fed is showing the courage to keep fighting the recession that so many have prematurely pronounced dead.