Mortgage refinancing is not that hard

We continuously take economic decisions. Most of the time, they are trivial. Sometimes they are important, and any sensible person thinks hard before settling on an option. Purchasing a home is complex, for example. Can one afford it? Is it the right price? How will it evolve? How is the financing? Comparatively, refinancing a mortgage is relatively easy: what is the interest saving? What are the fix costs? How long does one expect to hold this mortgage?

Yet, it appears a substantial fraction of those refinancing their home mortgage make lightheaded mistakes, according to Sumit Agarwal, Richard J. Rosen and Vincent Yao. Using a dataset that covers homeowners who only refinance to reduce mortgage payments, they find that 52% pick the wrong interest rate (off by at least 50 basis points) and 17% wait at least six months too long, likely because they do not monitor rates. That could be excused by inattention, but when you consider the amounts involved, they would need to have some very lucrative alternative uses of their time. That is quite disappointing for those who model optimizing agents.

Biased taxable income elasticities

Anytime you apply a distortionary tax, it bring well-being losses from the distortion (although the revenue can be used for well-being enhancing public goods). In addition, there are social losses that arise from the fact that people try to evade the tax by shift to other goods, go informal, or in the case of income shift compensation to non-taxable benefits or other amenities like more flexible work hours. Traditionally, the literature has evaluated the deadweight loss from taxation by looking at the income elasticity of the tax. That may be too simple a statistic in this case.

Brendan Epstein and Ryan Nunn show that ignoring the endogeneity of the non-taxed benefits and amenities leads to serious biases in the income elasticity and thus deadweight loss, to the point that it provide not good guidance on how to set tax rates. They basically do this by providing examples: build simple models, calibrate them, generate data from them and show that the usual empirical method provide crassly wrong estimates. An econometrician could in principle do better by taking all this in account, unfortunately data will be very hard to come by for this.

Why collective wage agreements are bad

Collective bargaining has a few advantages over the alternative, each firm bargaining individually with each trade union. It allows to internalize externalities in the bargaining process. It reduces negotiation costs per firm and union, although it may take longer than for the alternative. However, it prevents individualizing contracts to local circumstances, something that becomes more important as the workforce is getting more human capital and more specialized. Finally, there is that thing with market power.

Xiaomin Cai, Peter Gautier and Makoto Watanabe try to disentangle some of these costs and benefits within a on-the-job search model where both sides are heterogeneous. There is a wage than a planner would use in this context, and it is uniform. However, absent the collective bargaining, you would want wage heterogeneity, because this allows for firms to signal to workers that they have higher labor productivity. Thus, it is better if firms cannot commit to the uniform wage of collective bargaining than if they can commit. A rather unique situation where commitment is bad. And in an empirically plausible case, it is even better not to be restrained by collective bargaining altogether.

Bargaining power and international pricing

In international trade, how is the currency of invoicing determined? This is a big deal as it determines how is carrying the exchange rate risk. Even though this can be hedged, this still has a cost. And in this context, why is there quite frequently billing in a third currency? With such a "vehicle currency," bot exporter and importer face exchange rate risk. That does not seem right.

Linda Goldberg and Cédric Tille draw a theory of bargaining over price and exchange rate exposure between exporters and importers. An important element in this theory is the market structure. To gain a larger effective bargaining weight, you need to be larger and more risk tolerant, so surprise here. Then you also bear more exchange risk. Also, the size heterogeneity of firm on a market matters as well: the smaller firms then inherit the bargaining characteristics of the dominating ones. It would be interesting to see a test of this theory.

Savings and religion II

Various religions have different prescription on how rich people should be. Early Christians advocated low wealth and much redistribution, modern American Protestants seem to lean more towards wealth accumulation and little redistribution, to cite some extremes. What impact does religion have on savings behavior? Of course, nowadays it matters how religious people are. Conditional on a high level of religiosity, the religious affiliation should then matter. Earlier work using the PSID yields results that are puzzling to me: atheists save less.

Can new work by the same author, now going by the name of Anja Köbrich León, with the same dataset be illuminating? Well, not quite. In fact, the results do not seem to be robust across econometric methods, indicating some serious endogeneity issues, as has been hinted in the comments of the first post. So there, I had good reason to be puzzled.

PS: the earlier work is not cited in the extensive literature review. Is Anja hiding something here?

Politics does not make one happy

Humans are social animals and they benefit from interactions with others, most of the time. Personally I enjoy spending time with family, colleagues and neighbors, although I get really frustrated with anything related to politics, as may have transpired on this blog. Does this very anecdotal evidence generalize?

Stephan Humpert takes a German survey and checks how membership to various social groups effects life satisfaction. It is not a surprise there are stark gender difference, although not necessarily the way I would have thought. For example, men are particularly enthused by hobby clubs. Women particularly enjoy parents associations and citizens initiatives, and also sports societies, 26% being members in those. So much for the image of women being uninterested in sports. However, they dislike being in trade unions. Well, trade unions may follow peer pressure at work and may be understandable. Politics are rather neutral in terms of satisfaction. I guess Germans do not get as frustrated as I do, at least those involved in politics.

On the benefits of an international education

Universities encourage study abroad programs because it is a good experience for students to learn about others cultures (and in the case of expensive colleges, a cheap way to make money while students continue to pay tuition). With the Erasmus program in Europe where local tax payers typically foot most of the bill for higher education, the question arises whether it is worth paying for the education of foreigners. Of course, there is a chance that they would stay and thus only one year of all their education has been paid. And this does not necessarily have to be a zero-sum game, as the international education should be enhancing. Oh, and the Erasmus program also seeks to establish more pan-European ties, so there is a political motive at least.

Jan Bergerhoff, Lex Borghans, Philipp Seegers and Tom van Veen try to look into the impact of international higher education using the Lucas growth model. Students study abroad if they find it in their interest, which in this model means that they can benefit from higher human capital in the other country, implying a faster human human capital accumulation the more foreign students there are. The probability the students are staying is then exogenously calibrated. The authors find that the impact on growth rate should be positive, while still modest at current internationalization rates. on a personal level, i can only recommend study abroad, it has certainly helped me, even though my host country probably did not get much out of it.

Why so much policy focus on home ownership?

Some have blamed the Community Reinvestment Act (CRA) for the too risky lending to US homeowners during the house price run-up. Actual evidence for this is hard to come by, though. In this previous post, I discuss that there was indeed more risk taken, but it is not clear whether that additional risk was priced in or not. And were we to blame CRA, it would show in banks giving loans to neighborhoods that should not have received them for economic reasons, only to satisfy CRA.

Patrick Bayer, Fernando Ferreira and Stephen Ross look at the history of mortgages that they can link to credit scores and demographic characteristics. They find that for the same credit score, blacks and Hispanics were much more likely to run into mortgage trouble. While the authors do not mention this, the CRA was clearly targeting neighborhoods with such populations, and banks had to lend more there to comply. This would indicate that there is at least some truth to the CRA blaming. The authors frame this result rather by writing that this is evidence that favoring homeownership is not a good way to reduce wealth disparities. I would agree, but also because owning a home is very poor diversification, especially when this is all the wealth you can have. And there is no evidence that homeownership is good anyway, to the contrary.

Open science in commercial firms

Universities engage in research and put result in the public domain because it fosters the public good. In recent years, though, they have put more focus on patenting research results in order to obtain more revenue in the face of dwindling income from public sources. For-profit firms, though, seem to follow the opposite evolution. They hire more and more researchers to let them publish their results in scientific journals instead of patenting them. This even happens to economists who get hired, for example, by Google, Microsoft, Yahoo, AT&T, and commercial banks to conduct research. For the economists, I kind of understand it as a way to secure top talent when needing advice in complex markets. For hard sciences and engineering, my prior is that these firms have realized that patenting has become very inefficient as seeking exclusivity is now more of a lawyer's than a scientist's job.

Markus Simeth and Julio Raffo have another interpretation of what is happening in for-profit firms, and it looks like what is happening for economists. Using a dataset of R&D performing firms in France that they match with academic publications, they find that the old way of just collaborating with academics is not sufficient to acquire knowledge from the technology frontier, you need to hire them full-time. Adopting the academic discourse and disclosure allow to also benefit from it. And like firms participating in the open source movement, I suppose participating in the open dissemination of science also buys you some academic credibility that can attract top talent.

Unemployment benefits extensions and unemployment spells

During the last recession in the US, the maximum duration of unemployment insurance benefits has been extended several times. The justification has been that as the unemployment rate is higher, it is more difficult for the unemployed to find jobs, and they should not be blamed for not finding one in due time. Of course, this raises the specter of moral hazard, as they may not be enticed to search for a job as avidly as before. The question is then, how much has the unemployment rate increased due to this extension and the associated moral hazard? I reported previously on a nice paper that used extensive theory and calibration to come to the conclusion that about a quarter of the increase in the unemployment rate can be attributed to this. By now, though, we have good data that should allow an empirical analysis.

Henry Farber and Robert Valletta provide the first serious estimations I have seen. They exploit cross-state variations in the extensions to identify their impact on job market transitions. They find little effect from the extensions on re-employment probabilities. Rather, they have prevented people from exiting the labor force, which is surprising given the severe decline in the labor force even after the recession was declared over. This means that the impact on unemployment duration is rather modest on average, but larger for the long-term unemployed. In the end, only a tenth of the increase in the unemployment rate can be traced to the benefit extension.

Foreclosure procedures last too long

The handling of foreclosures in the recent housing crisis in the US has been a serious disaster. The drop in household income made that many households could not service their mortgage obligations and had to default. In addition, the drop in house values meant that many mortgages were worth more that the house that serves as collateral. This encouraged owners to walk away from payments. The mass of defaults lead mortgage servicers to resort to automatic treatment of foreclosures, leading to many errors, in particular foreclosing houses that not at issue. The reaction of many US states was to require longer foreclosure delays, first to make sure procedures are properly followed, second to allow owners to renegotiate, recoup and still make payments. The latter did not work out, as reported here previously. Were these state interventions worth it, in the end?

Larry Cordell, Liang Geng, Laurie Goodman and Lidan Yang use extensive databases of foreclosure procedures to quantify the lengthening of foreclosure delays and what this has cost. An important consideration is how foreclosures happen across states. In some, courts need to get involved (judicial states), in others the procedures only follow the stipulations of the mortgage contract (statutory states). In the former, the length of the procedure went from 26 to 44 months, in the latter from 16 to 22 months. During all this time, both parties are left in limbo, owners have incentives not to pay at all and neglect house maintenance, and lenders get no return on investment and may try to find whatever means to get any money out of the house, including reselling the mortgage. Also, there are externalities on neighborhoods as they get blighted. This is costly. The cost went up from 8% to 12% oh house value in statutory states, while it is from 17% to 30% in judicial states. These costs are estimated by adding unpaid property taxes, excess depreciation and unpaid insurance. This is thus the cost to the mortgage servicer, and does not even include capital costs. For a cost to society, one would also have to add the impact on other property values and deduct the fact that owners are living for free in these homes. There is no doubt the costs are considerable.

Why are children not the focus of our preferences?

In biology, all is about the survival and dominance of the species. It would then be logical that we only care about our offspring and its potential to have further offspring. But somehow, evolution made also care about ourselves, in fact we care a lot about ourselves. And lately we care also a fair amount about other species, but I guess modern culture is beyond the survival motive of evolution.

Luis Rayo and Arthur Robson find good reasons why we care about ourselves and how well we consume and enjoy leisure beyond fitness: ignorance. Specifically, think of the relationship between nature and an individual as that of a principal and an agent. The principal can choose the preferences of the individual, but cannot change them in light of transient circumstances. The agent is oblivious to what happens. The preferences need then to include goods that are not the primary focus of nature, for example means to ultimate goals. This is like placing money in the utility function. We do not care about money per se, but what we can buy with it, and the fact that having more leads us to save more. In the case of evolution, liking to sit in the sun makes us create a sufficient amount of vitamin D and makes us fitter for survival and procreation. But now that we know the effect of the sun and how vitamin D is important, we tend to sit too much in the sun for nature's liking. We are too informed for our preferences and should only care about our children.

New responsibilities

Starting this Summer, I will be taking on new responsibilities. I expect this new challenge to take some time away from my usual activities. As I am not paid or otherwise recognized for the work I do on this blog, the logical conclusion is that my posts will not be as regular as they have been. I hope that the quality of the posts will not suffer. While I may have become more efficient over the years at reading papers and writing about them, looking back I notice that I have become less detailed in my writing. Maybe if I do not feel the internal pressure to post almost every day, this will change. In any case, I expect the frequency of postings to change.

And if you are still reading this through Google Reader, think about moving to a different reader or bookmark this site soon, GR will close on July 1st.

Incomplete contracts can be optimal

When you write a contract, you want to lay out what happens in all circumstances. The intuition that this is best comes from the idea that complete markets are ex-ante optimal for everyone. If some circumstances have been left out, then the contract has to be renegotiated, which may lead to issues for example if there is a hold-up problem or worse if lawyer and courts need to get involved. The uncertainty may also lead to insufficient effort by contracting parties. The accepted wisdom is thus that incomplete contracts are bad.

Well, not always. Maija Halonen-Akatwijuka and Oliver Hart argue that one may not want too complete contracts. While there is no denying that it may be costly to draw a complete contract, their argument is that any contingency that is specified may acts as a reference point that may make negotiating for unspecified contingencies more difficult. If I understand this right, complete contracts may still be optimal, but if you have to have an incomplete one, you better not make it too complete. This non-monotonicity stems from the fact that contracted contingencies act as reference points. If there are too many contingencies and a state of the world is realized that is not accounted for, the parties will disagree which contingency should be taken as reference (each party will take the one that suits its interests best). Renegotiation becomes then costly. Have fewer contracted contingencies, and this is less likely to happen.

Women's emancipation: more education and more divorces

Divorce rates are at an all-time high, and many blame a lack of morals. That is not a good explanation. There is always an economic argument in the background of societal change, and it is no different here. There is more divorce because the incentives are right for that. And if the incidence of divorce has changed, it must be because it now makes more sense for people to divorce, not because sentiments have changed.

Fatih Guvenen and Michelle Rendall argue that the cost of divorce used to be very high for the women. They have a natural bond to their children and want the best for them. But the lack of education and thus earning potential made it difficult for women to raise them on their own. With the increase of education among women, who have now overtaken men in this regard, plus the narrowing of the gender wage gap, the outlook is now much better for a single woman, mother or not. Thus she is more likely to seek divorce under the same circumstances as before. It also implies that women are less likely to seek marriage as they can better fend for themselves. Recall that the female labor supply has dramatically increased over the last half-century. The institution of unilateral divorce laws in the 1970s in the US also contributed to this evolution. Using a carefully calibrated model, the authors can actually quantify this with counterfactual experiments. 25% of the increase in education and half the increase of the female labor supply can be traced back to this divorce law reform. And this increase in education has a very substantial impact on well-being, corresponding to $11,000 a year. The model is rich enough to also quantify how good this education improvement is for attracting a better spouse, which is worth about $4,000 a year.