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Abstract:
Home equity is the single largest component of household wealth for the majority of American households. Yet, there is virtually no way for the average family to insure itself against drops in home value and the ensuing destructive financial loss. Much of U.S. housing policy has focused on helping them against the risk that home ownership entails.

In this paper, we document the development and implementation of a home equity insurance program launched in 2002 in Syracuse, New York. The range of issues arising from the practical implementation of a home equity insurance program, as well as the institutional challenges offer useful data for further extensions of the program.

Highlights of the outcome, to date, of the pilot program include the finding that implementation of the program was feasible on the local level, that customers understand and wanted to take part, and that clean data on housing transactions is a vital component of the future success and expansion of the project.

Abstract:
The homeownership rate rose from 65% in 1995 to 69% in 2005, yet this rise appears difficult to sustain. We argue that the development of new shared equity mortgages (SEMs) that blur the lines between debt and equity would propel further advances in homeownership. The rationale for these mortgages is that the broad financial markets values shares in individual housing returns higher than do hard-pressed prospective homeowners. We describe a new class of SEM and provide survey evidence that the majority of households would prefer these SEMs over interest only and other currently popular mortgages. Financial simulations confirm the value of the securitized SEMs to investors. We present "back of the envelope" computations suggesting an increase in the overall U.S. homeownership of rate of between 1% and 1.5% would be the likely result of development of SEM markets.

Housing Affordability, Mortgages

Abstract:
Reinforcement learning theory has produced important insights into economic behavior. Intriguingly, neuroscientists recently discovered a plausible mechanism through which reinforcement may be encoded in the brain. Yet their resulting "dopaminergic reward prediction error" hypothesis has not yet been incorporated into economics. We develop an axiomatic model that characterizes the empirical implications of this theory for an idealized data set comprising both neuroscientific measurements and choices. Our axiomatization removes the language barrier between economics and neuroscience. This will allow "neuroeconomic" experimental protocols to be developed appropriate to the questions motivating economic, as opposed to purely neuroscientific, interest in learning.

neuroeconomics, decision theory, learning

Abstract:
Strong bequest motives can explain low retirement spending, but so equally can strong precautionary motives. Given this identification problem, the recent tradition has been largely to ignore bequest motives. We develop a rich model of spending in retirement that allows for both motives, and introduce a Medicaid aversion parameter that plays a key role in determining precautionary savings. We implement a strategic survey to resolve the identification problem between bequest and precautionary motives. We find that strong bequest motives are too prevalent to be ignored. Moreover, Medicaid aversion is widespread, and helps explain the low spending of many middle class retirees.

Abstract:
The ``annuity puzzle", conveying the apparently low interest of retirees in longevity insurance, is central to household finance. One possible explanation for low annuitization is ``public care aversion" (PCA), retiree aversion to simultaneously running out of wealth and being in need of long term care. Another possible explanation is an intentional bequest motive. In order to disentangle the relative importance of PCA and the bequest motive, we estimate a structural model of the retirement phase using a novel survey instrument that includes hypothetical questions. We identify PCA as very significant and bequest motives that spread deep into the middle class. Our results highlight potential interest in annuities that make special allowance for long term care expenses.

public care aversion, annuity puzzle,bequest, long-term care, survey methodology, household finance

Abstract:
The current mortgage crisis has increased interest in innovative shared appreciation mortgages (SAMs). The lender accepts a lower fixed interest rate under a SAM in return for a share of the appreciation - or value - of the home over time. SAMs have attracted much recent interest due to their improved (i) spreading of the loss risk across the financial system (thereby reducing the chance of a borrower default when home prices fall), and (ii) correlation of payment timing with the typical lifetime earnings cycle (i.e., lower mortgage payments earlier in one's career).

Unfortunately, the current tax rules make it essentially impossible to develop SAM markets in the U.S. The tax rules for debt instruments with contingent interest generally require both the borrower and lender to report contingent interest each year as if the instrument bore a market rate of (higher) fixed interest. These rules are tax neutral for most instruments, since both the borrower and lender account for the additional contingent interest at the same time. These contingent debt tax rules are not neutral, however, in the case of SAMs since a special earlier-enacted, and unrelated, provision defers the homeowner's interest deductions until payment. The interaction of the two sets of unrelated rules provides an asymmetric result of annual lender inclusions with deferred homeowner deductions. This adverse timing asymmetry can impose a significant net tax cost that makes SAMs extremely unattractive. Curiously, SAMs issued in connection with a workout - rather than upon original home purchase - are not subject to this timing asymmetry since the workout lender does not have to accrue the contingent interest each year. The uniquely punitive treatment for original-issuance SAMs therefore seems quite accidental, especially given the lack of any coherent justification for such singling out. And beyond the negative timing asymmetry and inexplicable line drawing, additional tax concerns arise due to uncertainty in reaching definitive tax results (e.g., threshold uncertainty over whether a SAM should even be treated as debt for tax purposes).

In light of the foregoing, we consider three different reform proposals that could remove the tax impediments to the SAM markets: deferral of the lender's contingent interest inclusions; acceleration of the homeowner's contingent interest deductions (to match the lender's annual inclusions); or treatment of the SAM as equity, rather than debt. While all three of these alternatives would eliminate the current poor treatment of original-issuance SAMs, we strongly believe that the best of the alternatives is the first. As discussed in greater detail in the Article, this approach is relatively easy to implement through very limited regulatory changes, can be structured to have little or no consequences

shared appreciation mortgage, sam, contingent interest, mortgage crisis, debt

Abstract:
Economists do not have reliable measures of current house values, let alone housing returns. This ignorance underlies the illiquidity of mortgage-backed securities, which in turn feeds back to deepen the sub-prime crisis. Using a massive new data tape of housing transactions in L.A., we demonstrate systematic patterns in the error associated with using the ubiquitous repeat sales methodology to understand house values. In all periods, the resulting indices under-predict sales prices of less expensive homes, and over-predict prices of more expensive homes. The recent period has produced errors that are not only unprecedentedly large in absolute value, but highly systematic: after a few years in which the indices under-predicted prices, they now significantly over-predict them. We introduce new machine learning techniques from computer science to correct for prediction errors that have geographic origins. The results are striking. Accounting for geography significantly reduces the extent of the prediction error, removes many of the systematic patterns, and results in far less deterioration in model performance in the recent period.

House price index, sub prime crisis

Abstract:
How significant are individual differences in self-control? Do these differences impact wealth accumulation? From where do they derive? Our survey-based measure of self-control provides insights into all three questions: 1.There are individual differences in self-control not only of a quantitative but also of a qualitative nature. In our sample, standard self-control problems of over-consumption are no more prevalent than are problems of under-consumption. 2.Standard self-control problems do impede wealth accumulation, particularly in liquid form. Problems of under-consumption have the opposite effects. 3.Self-control is linked to conscientiousness' much studied by psychologists. There is a related link with financial planning.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.

Abstract:
What discount rate should be applied to social investments? It is standard to use the market interest rate, thereby respecting private preferences. We show that application of this "revealed preference" criterion rests on faith, not on logic. It is justified only if preferences over all choices, including past choices, are time invariant. The conditions for this to be true are stringent. Under more reasonable conditions, policy makers should be more patient than private citizens, whose choices define the most short-sighted Pareto optimum.

Abstract:
In welfare theory it is standard to pick the consumption stream that maximizes the welfare of the representative agent. We argue against this position, and show that a benevolent social planner will generally place a greater weight on future consumption than does the representative agent. Our analysis has immediate implications for public policy: agents discount the future too much and the government should promote future oriented policies.

Abstract:
We present evidence that many households have only a vague notion of what they are spending on various consumption items. We then develop a life-cycle model that captures this 'absent-mindedness'. The model generates precautionary spending, whereby absent-minded agents tend to consume more than attentive ones. The model also predicts fluctuations over time in the level of attention, and thereby sheds new light on the sharp reduction in consumption both at retirement, and in cyclical downturns. Finally, we find patterns of attention in the data that are consistent with those predicted by the model.

Abstract:
Prior research has established that consumption falls significantly at retirement. What is not known is the extent to which this fall is anticipated during the working years. Do working households expect such a large fall in consumption upon retirement, or are they taken by surprise? Using data from a new survey, we show that many working households do expect a considerable fall in consumption when they retire. In fact, those who are already retired report significantly smaller falls in consumption than are expected by those who are still working. We show that participation in the stock market plays a dominant role in explaining the gap between expectations and outcomes, indicating that much of the gap is a result of unexpected stock market appreciation. The survey produces new insights into the high level of uncertainty in the period leading up to retirement, and the surprises that may lie in store when households actually retire.

Abstract:
Why do similar households end up with very different levels of wealth? We show that differences in the attitudes and skills with which they approach financial planning are a significant factor. We use new and unique survey data to assess these differences and to measure each household's 'propensity to plan.' We show that those with a higher such propensity spend more time developing financial plans, and that this shift in planning effort is associated with increased wealth. The propensity to plan is uncorrelated with survey measures of the discount factor and the bequest motive, raising a question as to why it is associated with wealth accumulation. Part of the answer lies in the very strong relationship we uncover between the propensity to plan and how carefully households monitor their spending. It appears that this detailed monitoring activity helps households to save more and to accumulate more wealth.

Abstract:
A model of endogenous price adjustment under money growth is presented. Firms follow (s, S) pricing policies and price revisions are imperfectly synchronized. In the aggregate, price stickiness disappears and money is neutral. The connection between firm price adjustment and relative price variability in the presence of monetary growth is also investigated. The results contrast with those obtained in models with exogenous fixed timing of price adjustment.

Abstract:
We show that a straight forward approximation of the distribution of durable goods holdings gives rise to a tractable equilibrium (S,s) model of durable demand. We analyze both competitive and monopoly supply. We show that equilibrium interactions lead to elongated impulse responses in demand, to procyclical markups in response to demand shocks, and to countercyclical markups in response to cost shocks.

Abstract:
In the current structure of the U.S. residential mortgage market, a fall in property values may make it very difficult for homeowners to refinance their mortgages to take advantage of falling interest rates. In this paper, we explain the institutional background for this effect and quantify its importance. We confirm that this form of collateral constraint has greatly reduced recent refinancing in states with depressed property markets. We also point to the many ways in which the reduction in refinancing may have inflicted additional damage in these already recession-hit states. Finally, we show that relatively minor institutional changes could have neutralized the damaging effects of the collateral constraints, and we discuss why the institutions have their current structure.

Abstract:
We construct a model of trade with matching frictions. The model provides a simple characterization for the joint proces of prices, sales and inventory. We compare the implications of the model to certain properties of housing markets. The model can generate the large price changes and the positive correlation between prices and sales that we see in the data. Unlike the data, prices are negatively autocorrelated and high inventory predicts price appreciation. We investigate several amendments to the model.

Abstract:
How much information should a policy maker pass on to an ill-informed citizen? In this paper, we address this classic question of Crawford and Sobel (1982) in a setting in which beliefs impact utility, as in Kreps and Porteus (1978). We show that this question cannot be answered using a utility function with standard revealed preference foundations. To solve the model, we go beyond the classical model in two respects, relying on the psychological expected utility model of Caplin and Leahy (2001) to capture preferences, and the psychological game model of Geanakoplos et al. (1989) to capture strategic interactions.

Abstract:
In this paper we argue that many topics in macroeconomics can be viewed as part of the broader theory of the economics of adjustment. We argue that existing approaches to the economics of adjustment take a very narrow view of the role of information. We outline an approach to this topic that stresses the role of learning and information externalities, and discussed through examples how these concerns alter the qualitative nature of the adjustment process. In particular, there appears to be a general bias towards the underprovision of information in a variety of settings which leads to inefficient adjustment.

Abstract:
Economic theorists have given little attention to health-related externalities, such as those involved in the spread of AIDS. One reason for this is the critical role played by psychological factors, such as fear of testing, in the continued spread of the disease. We develop a model of AIDS transmission that acknowledges this form of fear. In this context we design a mechanism that not only encourages testing but also slows the spread of the disease through voluntary transmission. Our larger agenda is to demonstrate the power of psychological incentives in the public health arena.

Abstract:
Mass layoffs give rise to groups of unemployed workers who possess similar characteristics and, therefore, may learn from one another's experience searching for a new job. Two factors lead them to exert too little effort in equilibrium. The first is an information externality: searchers fail to take into account the value of their experience to others. The second is an incentive to free ride: each worker would like others to experiment and reveal information concerning the location of productive jobs. Together these forces imply that in equilibrium the natural rate of unemployment is too high.

Search, Natural rate of unemployment, Information externality

Abstract:
In the current structure of the U.S. residential mortgage market, a decrease in property values may make it very difficult for homeowners to refinance their mortgages to take advantage of declining interest rates. In this paper, we show that this form of collateral constraint has greatly reduced refinancing in states with depressed property markets. We outline the interaction between regional recessions and refinancing constraints.