20
Sep
09

Iconoclasm from another blog

Well, since I linked to a bunch of Offsetting Behaviour articles the other day, I might as well link to a bunch of Marginal Revolution articles this afternoon.

(Hat tip: Marginal Revolution)

Let’s start with the premise:

Soon forthcoming in the top-ranked Quarterly Journal of Economics is a very well- received paper by four economists with convincing evidence of what many believe was the primary cause of the subprime boom and bust: That securitization took away the incentive for lenders to properly vet borrowers.

But there’s some new evidence questioning the paper’s findings.

That first assertion, if I’m getting this right, states that since a bunch of players on the secondary mortgage market were buying up loans (and securitized, tranched, risk-reduced, folded-spindled-and-mutilated loans at that), so loan agencies (“originators”, in the terms of the TNR article) would game the secondary market — they were more interested in selling off their debt than in making sure that it was good.

The claim here is that originators would classify borrowers by the credit-score heuristics used by the secondary market.  If Alice came into the First National Bank of Matt with a FICO score of 621, her mortgage would light up the “above 620, probably good” heuristic and the FNBM, knowing that Fannie Mae or someone would blithely buy it up, would simply rubber-stamp the application.  If Bob brought his 619 FICO into the FNBM, however, we’d want to do a much more assiduous job of vetting Bob and his capacity to repay the damn loan: Fannie Mae wouldn’t just jump on Bob’s mortgage the way they would Alice’s.

The upshot is that securitization, and its loose standards for mortgage quality, gave originators a great big hairy incentive to accept an assload of mortgages they really shouldn’t have, thus leading to boom and bust.  If only mortgages hadn’t been securitized, the theory goes, banks would have applied their usual level of critical analysis to all of their loans and poor people wouldn’t have been able to buy houses the evil greedy fat-cat investment bankers wouldn’t have crashed the economy.

Turns out this isn’t so obvious.

In a new paper, two Harvard PhD candidates — Ryan Bubb and Alex Kaufman — take an academic swipe at the big boys and point out the following: Although there is a big jump in mortgages at the 620 credit score, there isn’t a commensurate jump in mortgages that get securitized at that score.

[…]

This suggests that securitizers weren’t relying on the rule of thumb en masse; rather, it was the originators who were relying on it.

This suggests, in other words, that the originator banks weren’t modeling the securitizers’  behaviour when they rubber-stamped Alice’s application and gave Bob the third degree: they were genuinely persuaded themselves that a 621 FICO was just that much better than a 619.  The securitizers, on the other hand, saw a 621 and a 619 about the same way.  (So what happened to the non-securitized mortgages that passed the originators’ heuristics with a 621?)

That isn’t to say a decline in lending standards didn’t happen, just that securitization might not be to blame for it. (There is other research making this point.)

The last time I dug into this stuff, it seemed like the social-engineering regulatory structure surrounding the rating agencies from which these securities were built was a major cause of the decline in lending standards.  I’m not talking about borrowers getting 630 FICOs when they deserve 490s, here, but blocks of mortgages getting AAA ratings when they deserve Bs.  If that’s the case, then surely securitization’s involved somewhere in the decline of lending standards, no?

(This is probably about where my glib dilettantism drops off the cliff of usefulness and a real economist should take over.)

——

Next we have a short book review:

Why does this count as iconoclasm?

Market data do not, upon examination, show a close connection between risk and return, at least not once you start moving out on the risk spectrum beyond T-Bills and the like.  It’s not just the famous Fama and French papers, it is worse than you think.

That may be old news to trained economists, but it’s ground-up sacred-cowburger to me.  (And sacred cows make the best hamburger.)

——

Finally, Greg Mankiw barbecues the notion that preventative care is necessarily cheaper:

(Hat tip: Guess who.)

Mankiw proposes a seemingly absurd thought experiment:

Imagine that someone invented a pill even better than the one I take. Let’s call it the Dorian Gray pill, after the Oscar Wilde character. Every day that you take the Dorian Gray, you will not die, get sick, or even age. Absolutely guaranteed. The catch? A year’s supply costs $150,000.

Anyone who is able to afford this new treatment can live forever. Certainly, Bill Gates can afford it. Most likely, thousands of upper-income Americans would gladly shell out $150,000 a year for immortality.

Most Americans, however, would not be so lucky. Because the price of these new pills well exceeds average income, it would be impossible to provide them for everyone, even if all the economy’s resources were devoted to producing Dorian Gray tablets.

So here is the hard question: How should we, as a society, decide who gets the benefits of this medical breakthrough? Are we going to be health care egalitarians and try to prohibit Bill Gates from using his wealth to outlive Joe Sixpack? Or are we going to learn to live (and die) with vast differences in health outcomes?

(We should recall that thought experiments are meant to explore absurd limit cases.)  The obvious answer — obvious if you’ve been paying attention at all to what I’ve written in the past — is that we “as a society” have no business telling anyone how they should spend their money on themselves.  But it’s easy to take hard-line extremes of position in thought experiments that are themselves rather extreme.

There is, of course, a catch.  Dr. Mankiw didn’t wait until after his thought experiment to bring it up — he introduced it, gently, from the beginning.  I’m more of a dick, so I saved it for later as a “gotcha” moment:

EVERY morning, I take a small white pill that makes me think deep philosophical thoughts about the American health care system, the value of life, and the relationship between man and state. […]

The pill is a statin — a type of pharmaceutical developed over the last few decades to lower a person’s cholesterol. My father died of cardiovascular disease, and unfortunately I inherited his genetic predisposition. Yet I am hoping that modern medicine will help me avoid his fate. So like millions of middle-age men, I take my little pill every morning.

Here is the question I ask as the pill passes through my lips: Is it worth it?

Now you might be tempted to say, “Of course it is.” Most people would prefer to avoid an early death. If the wonders of modern science might put off the inevitable for a while longer, why not give it a shot?

And that is, indeed, how I thought about the decision when my doctor recommended the treatment. One thing I did not consider was the price. Like most consumers of health care, I was insulated from economic concerns. I knew that the insurance company — and, indirectly, all its policyholders — would pick up most of the tab. This arrangement, encouraged by the tax system, ensures that I get the benefit of the pills while paying little of the extra costs they generate.

[…]

Not long ago, I read that a physician estimated that statins cost $150,000 for each year of life saved. That approximate figure reflects not only the dollars patients and insurance companies spend on the treatment but also — and just as important — an estimate of how effective it is in prolonging life.

(Emphasis added.)

That thought experiment isn’t so absurd any more, is it?


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