Where are the $100 bills?

The basic story of depression economics is that mass unemployment, especially when combined with disinflation, is a symptom of disequilibrium.

In technical terms, it is said that an excess demand for money or safe assets is necessarily counterbalanced via Walras Law by excess supply of labor and production capacity, which we see in the forms of excess unemployment and recession.

In lay terms, this kind of disequilibrium means there is a lot of money lying on the ground--profit opportunities that are simply not being exploited.  So, all we need to do to revive the economy is pick up those $100 bills.

Sounds easy.  So where are they?

They probably lie in investment opportunities that are not being exploited for a complex set of reasons, perhaps fear being chief among them.  With interest rates as low as they are, firms make nothing by sitting on cash, so $100 bills are lying where any profitable investment may be, no matter how small returns may be.

I see big profit opportunities in real estate, particularly in some parts of the country.  When I travel I like to look up real estate prices on zillow.com and compare them to rental rates on craigslist to get a feel for the local price to rent ratio.  While I haven't found a scientific way of doing this carefully, it is clear that these ratios are very attractive for buying in some cities.

The places that look best are low-to-moderate-income areas where home prices boomed and busted the most, like inland areas of California, Las Vegas, and some parts of Florida. In these places one can easily buy a home and rent it out for about 1/10 the purchase price.  If, going forward, both rent and prices increase with inflation, that's a 10% real return, which is phenomenal at any time, let alone when the next best opportunity is a precarious stock market or zero interest in the bank. Places that don't look so good for investment include San Francisco, New York (especially Manhattan), and wealthier areas of DC.

I think this pattern fits what Paul Krugman has been saying about debt:  as credit has tightened, savers need to spend more to make up for spending cutbacks by debtors; otherwise GDP declines.  The savers generally tend to be wealthy, which can make it difficult for them to invest in lower income areas that are less familiar to them, but posses the investment opportunities.  And with investment opportunities scattered among zillions of modestly priced homes that need rehabilitation, upkeep and management, it can be a tough business to get into.  In contrast, locals in moderate-income areas could save a lot of money by buying rather than renting, but they can't because no one will lend to them.

It may sound crazy, but now is the time for subprime lending.

The obvious way for savers to invest in homes at an arms length is by lending to deeply indebted locals. To do this, one needs to step away from old credit models governed by FICO scores to find households that simply got burned in the crash but are likely worthy borrowers going forward.  For example, if some institution were to agree to lend to families walking away from current, deeply underwater mortgage so they could buy another, much less expensive home at today's prices, both the new lender and the current underwater homeowner would gain immensely.  I suspect that's a lot of people and a lot of free $100 bills.

Why isn't this happening already?  I suspect it's because most of the current lending institutions fear walkaways more than they are tempted by lending opportunities, and they fear that trying to exploit the opportunities would cause more walkaways.  So, for this to happen, it would take new lending institutions that are not currently holding a lot of underwater mortgages.  It would also require careful analysis to develop reasonable new lending criteria.

If this did happen, I think we'd start seeing a lot more mortgage write downs, short sales, and fewer foreclosures.  And with these things, higher home values in the most depressed areas, more consumer spending, more jobs, and broader economic recovery.

There must be other kinds of $100 bills lying around.  I see lots of public goods, like education, where the potential returns are phenomenal.  But here I'm wondering about $100 bills in private markets that simply aren't being picked up because the institutions that would normally help savers to exploit those opportunities are broken or don't exist.


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