Wednesday, April 23, 2014

Why did the government allow the Mortgage Forgiveness Debt Relief Act to expire?

By Paul Ritz

Underwater mortgages
Mortgage debt forgiveness helps "underwater" home owners
The Mortgage Forgiveness Debt Relief Act expired on December 31st 2013. Since then there has been a constant demand for its re-enactment, but until now the government has maintained its silence over this issue.

Even though the current state of American economy is far better than what it was 4 years ago but a lot of people are still facing financial hardships.

Numerous surveys and opinion polls have confirmed that the general American population was in favor of re-enactment of the Mortgage Forgiveness Debt Relief Act. The law was enacted for the first time in 2007. 

The intention with which the Obama administration passed this law was undoubtedly in favor of the middle class population. It introduced the much needed provisions and provided some temporary relief to those who were finding it difficult to repay their residential debt. As the situation demanded, the law was reenacted in the subsequent years too. It was widely speculated that the law will be renewed again, but the government allowed it to expire on December 31st 2013. Since then many organization have petitioned Whitehouse to reenact the law. Let’s try to understand why the government allowed it to expire.

The government’s intentions


During the last few months, it became clear that the chairmen of the Senate Finance Committee and House Ways and Means Committee are inclined towards cementing some comprehensive tax reforms before the end of this year. In their official statements they have stated that they intend to check the long list of expiring acts, remove the ones that are no longer needed and make the ones permanent that are worthy and needed in the favor of the American people. The problem is that it will take some time for the tax reforms to be legislated. If the government reenacts the Mortgage Forgiveness Debt Relief Act temporarily then it sends out a message that the Whitehouse is going cold feet on the issue of permanent tax reforms.

Loss to the exchequer


The Mortgage Forgiveness Debt Relief Act allows the people to save on forgiven debt. In the absence of the provisions of this act, the forgiven debt is seen as taxable income. It directly implicates that the reenactment of this law means less revenue for the federal government. At times when the government was about to go default on its debt, lesser revenue is not something to be very cheerful of. This situation has sparked a debate in the Whitehouse circuit. Some senators prefer to raise taxes in order to increase the federal revenue while some prefer to cut on government spending in order to recover the loss. It is estimated that during 2007 to 2013, the Mortgage Forgiveness Debt Relief Act costed the government about 24 billion U.S. Dollars.

The change in leadership


The former chairman of the Senate Finance Committee, Senator Max Baucus from Montana, was in favor of reenacting the Mortgage Forgiveness Debt Relief Act. But before the Congress came into session he was appointed as the U.S. Ambassador to China. The new chairman of the Senate Finance Committee is not that excited about this cause and hence it is taking sometime for the lobbyists to persuade him for renewing this act. It must also be understood that it takes some time for the new leadership to adjust itself to the dynamic political scenarios.

About the authorPaul Ritz is an associate at National Debt Relief. Consumers can take advantage of a free debt counsolidation session to discover their options for debt relief with no obligation.

Image license: ajmexico, CC BY 2.0

Financial news 04/23/2014

NYT: U.S. middle-class wage growth outpaced by foreign countries
AP: College grad. unemployment rate is 10.9% per the U.S. Dept. of Labor
ZH: More low down-payment subprime loans indicates ↓ mortgage standards
CNBC: Private student loans may  immediate payment clause per CFPB
CNN: New Netflix customers to be charged more than existing customers
NAR: Used home sales ↓.2% in March, yr-over-yr median home price ↑7.9%
Bloomberg: Barclay's bank to withdraw from commodities trading business
Business Insider: Amazon sales ↓ 10% in states requiring sales tax charge
BBC: McDonald's U.S. sales down 1.7% in Q1, net income down $1.2 bln
Reuters: Intnl. business investment in China to ↓ due to market & economy

Tuesday, April 22, 2014

Behavioral finance: The inefficiency of human financial decision making

People are slow to react and over optimistic when it comes to financial decision making according to behavioral finance. They also like to pay more in trading commissions and capital gains taxes in addition to insufficiently diversifying their assets. Whether or not that is actually true depends on who is being included in academic research and how accurately the numbers represent the population of investors. Nevertheless, that fact these kinds of financial behaviors exist at all does indicate that perfect market efficiency is a myth so long as humans are directly involved.

Behaviour finance from saurabh chauhan

Behavioral finance studies how people's decision making is influenced by psychology. Since everyone is different, no single financial heuristic applies to everyone, but as the presentation shows, stock market data makes identifiable patterns of financial decision making evident for companies of varying sizes. For example, if earnings results are higher than those forecasted, historical data shows the market overreacts by generating abnormal returns.

Some of the aforementioned data is restated and corroborated by another slide show presented by Alok Kumar at the Yale School of Management. Moreover, according to Kumar, "Prospect theory", as defined by Daniel Kahneman and Amos Tversky, states that a $1,000 loss is perceived more heavily than a $1,000 gain. This means investors are more likely to behave differently to capital gains and losses if they take the presumed perception spread in to account when making financial decisions.

Another factor that influences individual monetary decision making is financial data. For example, also according to the Kumar presentation, there are three kinds of market efficiency including weak, semi-strong and strong. The strongest market efficiency is said to be based on access to public and private financial information. Since not everyone has the same market or corporate data, market efficiency is partially influenced by how much data investors have access to. 

In addition to the impact of financial data on investment decisions is use of analytical tools and evaluative capacity. Since not every investor will have the same analytical approach to financial information, not all assessments will be accurate. In effect, this has the potential to slow down or limit market efficiency to the most informed and aware of participants.

Further elaboration about how behavioral finance affects stock market efficiency is discussed in an additional presentation published by the University of Berkeley Haas School of Business. This slide show is the most thorough of the three as it mentions and provides supporting information for numerous aspects of behavioral finance. For instance, the beginning of the slide show cites Nobel Laureate Robert Shiller in reference to the topic at hand. Specifically, Shiller is quoted as stating “The aggregate stock market in the United States in the last century has been driven primarily by psychology and fads, that it has shown massive excessive volatility.”

The Berkeley slides also discuss the predictability of irrational financial decisions and different kinds of systemic irrationality such as simplification of information and even "magical thinking". Further supporting studies are also cited including one that finds investors fixate on corporate earnings and make decisions based on that instead of also including important cash flow factors such as unpaid accounts receivable. The concept of behavioral finance is also explained in terms of how active managers or asset managers can use the theory to their advantage i.e. by knowing market psychology, making buy or sell decisions that capitalize on the behavioral trends is possible.

Every individual financial decision maker is likely to make use of  his or her own heuristics or models with which monetary actions are taken. Organizations such as investment banks, mutual funds and other money managers are also likely to make use of models such as credit data, economic indicators and corporate reports when implementing transactions. These latter models, such as the Capital Asset Pricing Model and Black-Scholes Model, are logically and deductively arrived at, but are also themselves subject to trader biases. Perhaps only mathematical algorithms used in high frequency trading are the only truly efficient traders.