December 28, 2011

Home sweet home

"Work hard and you will get the reward". That is a tenet any good parent would like to teach their children. The idea rests on the basic principle (assumed to be true) that whatever reward you get will not be snatched from you by someone else. The principle in question: Property Rights.

Property rights are a keystone of human civilization. When we discovered farming, the primitive farmer had to make sure whatever he was growing was not going to be stolen by any passing nomad tribe that "didn't get the memo" that a farmer was growing something for his own consumption or benefit and that it could not just be taken. Imagine how difficult it was to go from communal to private property. Enforcement of property rights became one of the primal functions of proto-States and other central authority entities created in the beginnings of civilization. The difficulty of enforcement of property rights even shapes human culture. The "culture of honor" displayed in the rugged terrains of the U.S. Appalachians -which was the cause for multiple family feuds and killings between 1860 and 1930- was a consequence of a lack of proper property rights enforcement.

Property rights are also a key determinant of economic activity. The better developed property rights are, the most advanced a country is (the highest-ranked countries by property rights protection: Norway, Netherlands, Denmark, Sweden, New Zealand, U.K. Germany, Australia. The U.S. ranks 14th along with Canada & Ireland). Entrepreneurs' investment decisions will be greatly dependent on whether or not they will be able to enjoy the fruit of their effort, and this also applies to savings and possessions. Why owning anything if it can be snatched away from you in the blink of an eye?  Property rights are, thus, the very foundation of Capitalism and of economic development in a country.

Out of all the possessions anyone can have, your home is the most important one. It is the ultimate fruit of your labor, the place where you raise your family and the one asset that can even provide –some would argue- emotional stability. The house stock of the U.S. is $16 trillion -- more than 1x one year's GDP of the country -- representing the biggest asset of households. The system that supports and regulates real estate ownership has traditionally been based on physical records kept in Title Rooms and County Courthouses administering them. Land and Property records have been paramount in the determination of who owns what property in this country.

But then MERS happened.

Created by the biggest mortgage banks, it is the black box where property titles that collateralize mortgages are transferred every time a mortgage is sold to another bank, or packaged as a pass-through security, or wrapped in a MBS, or re-packaged CMO. It was a financial innovation -or workaround, really- to enable easy exchange and transferability of a title that otherwise would have required a person going to the Title Room, peruse over hundreds of records, finding the title in question and go through the Courthouse paperwork to change the beneficiary in the Lien. One huge problem created by MERS: mortgages change hands so many times they simply lose track of who is the legal beneficiary in the Deed of Trust.

People are realizing that legally challenging their lender to produce the title is a winning strategy: banks that can't prove they have the title have to give up the claim and let the homeowner get the house back."Quiet-title actions" are proliferating and organizations are starting to foment these types of legal challenges. The implications for the legal system and the banks' profits could be huge. No wonder bank stocks are in the tank (BofA Price-to-book is 0.26x) while they keep getting hit by more and more lawsuits.

We are talking about property valued in the Trillions (in 2007 MERS registered two thirds of all mortgages in the US) that cannot be traced back to the real beneficiary. We are talking about homeowners diligently paying their mortgage for decades only to find out after all those years that they cannot get their title back because the nominal "owner" of the mortgage cannot produce the title. We are talking about the biggest, most important asset in the U.S. economy being thrown into legal limbo. This is a major blow to the backbone of property rights, and serious threat to the very foundation of Capitalism itself.

December 04, 2011

Pick up that penny

If you found a penny on the ground, would you pick it up? Most people would not. In fact many believe they should be discontinued. They argue that pennies are not commonly accepted, that they are worth more for their metal content than for their monetary (fiat) value, that they are impractical to carry around, and that they are an inefficient store of value (breaking 2 out of 3 qualities money must have: medium of exchange, store of value and unit of account). In sum, the penny is a vestigial remnant of an era long gone that has no purpose anymore - much like the appendix or the wisdom teeth in the human body.

Does this mean that pennies are really worthless?

Fiat money is a very funny thing. It is worth something because we are told so by decree and because we expect (or believe) that someone else will also expect (or believe) it will be worth something when they take it from us in exchange for a good or a service. Enter the key word: "expectations". We hear often about "expectations" from Central Bankers when they manipulate the value of their currency. Inflation (the change in the level of prices) will happen to a great extent if people expect it will. It is the task of central bankers to gauge those expectations and adapt policy making decisions to the population psychological mindset.

But what determines inflation expectations? Some argue expectations are determined by inflation of past periods. Some other even argue that people form inflation expectations considering every piece of information in the economy to reach their expected inflation level (the "rational expectations" assumption).

What if people's expectations were heavily determined by the level of prices instead? What if, in forming future price expectations, it made a difference to have bread prices in the billions as opposed to a couple of dollars? People have a tendency to like stronger currencies. Germans in the 1920's were excited when they could buy a tin bread bin for 1 Rentenmark after paying trillions of Marks for it. The moment the Germans believed they had a strong currency (the new Rentenmark), hyperinflation disappeared. Their inflation expectations were reset because of the existence of fractional money (i.e. pennies).



If the price level was not important in setting inflation expectations, countries with hyperinflation problems would never "reform" their currencies (like China's 1948 3-million-to-1 re-denomination or Brazil's multiple attempts in the early 90's) in order to allow its citizens to pay unitary and fractional prices for basic necessities. Clearly, they sought to establish (with different degrees of success) a perception of currency strength in order to change inflation expectations. In the Brazilian case (see graph below: tip of the hat to Keith Houston/B. Malamud), each time a new currency entered the economy, inflation plunged.



Fractional money is worth something more than the metal it is made with. It is a psychological anchor that helps keep mass perception that cents are still needed and that a currency is strong. Without them (and considering the current insane level of money printing in these times of crisis) inflation could spiral out of control. So, the next time you find a penny in the ground, think about its more subtle value and give the little Lincoln some respect.