When top-down works
A while back, I posted on When top-down doesn’t work as it applies to affordable housing policy. The Blogger Communications Commission has requested equal time for the opposing view – an exposition of when top-down does work.
I’m a spokesman and don’t you dare oppose my views
One theme unifies the examples below – and that is the tension between complexity and scale.
Complexity (and its human cousin individuality) loves choice and customization. Complexity required self-organized, bottom-up networks.
Scale loves mass and consistency of action. Scale is usually imposed by fiat, top-down, and implemented through hierarchies.
Since real estate is immovable, it is intrinsically local — it cannot be divorced from its setting – whereas capital is infinitely portable, and in its electronic expression is instantaneously portable. Plus, being digital (numbers), capital loves to scale. As scale increases, so does the value of uniformity.
1. When the matter requires a national standard. Even though there are three levels of government, some matters require national cohesion. Anything to do with Federal taxes, such as the deductibility of mortgage interest, has to be imposed nationally, else it triggers an absurd competition among states.
(For an example of what happens when states are allowed to change the rules to their advantage, Google ‘Alabama juries’ or ‘Alabama tort laws’.)
We’re not from
2. When aggregation adds value. Securitization drove consistency and standardization – drove it too far, because too much information was lost, but that will eventually be remedied (albeit at enormous cost).
3. When standardization improves connectivity. Networks consist normally of nodes, links, and information packets – or, to use the railroad metaphor, of stations, tracks, and cars. It makes a great deal of sense for all the tracks to be the same gauge, and all the cars to match it. Usually the emergence of a standard occurs only as the network scales up – in the US, standardization was not achieved until the early 1880’s, and even today, Australia has three different railway gauges, and ‘there is little prospect of standardization.’
Rail gages around the world:
The larger the area of standardization, the more network value
Property changes hands periodically. So do mortgages. It therefore makes sense to settle on standard closing documents, title insurance formats, mortgage notes, real estate purchase and sale (P&S) forms
We don’t read the fine print because our lawyer does that, and she’s used to it
3. When you want the resulting product to be simple. In this, the real estate analog is the level-payment, self-amortizing mortgage (LPSAM). That’s real-estate-speak for, “you pay the same amount every month for some number of months, and eventually your mortgage is fully paid off.” In the LPSAM, all the sophistication is in the design – the customer interface is simple. Simplicity increases customer understanding, which adds to customer confidence, which expands volume.
I won’t go so far as to suggest that our subprime mess was caused by the introduction of unfamiliar and variable-payment financial forms … but I will suggest that innovation unfamiliarity contributed in two ways:
Home buyers familiar with level-payment self-amortizing were unprepared for the risks of variable-pay.
Securities buyers familiar with basic instruments were unprepared for the risks of derivatives.
What? There was volaltility?
4. To provide clear boundaries. As I’ve written elsewhere, fuzzy boundaries are bad boundaries, because they are cumbersome to enforce and prone to enforcement arguments. Title and recordation in a land or title registry provide clarity and boundaries: something is or is not recorded before something else. (Yes, there can be ambiguity in what property is being secured.) Another good example is HMDA, the Home Mortgage Disclosure Act, which mandates what mortgage originators have to tell customers.
There are some things I have to tell you
5. When you have to pick a convention. As scale increases, the relative cost of being a maverick also rises. When it comes to driving, you either drive on the left or the right, and ideally you’d like any highway you can reach via land to use the same convention. (It gets tricky in Africa, where left and right alternate, but only at vast distances separated by roads where it doesn’t really matter.)
That creates problems of retro-standardization as scale increases. At some point, the costs of being different are unsustainable (hello, Mac OS) and the network effect wins. The best such example is Sweden’s conversion, in 1967, to right-hand drive, the result of a decade and a half of effort:
In 1955 a national referendum was held and there was strong campaigning from both sides. Right side campaigners used rational arguments based on facts, like safer overtaking. The “lefties” played on people’s long-time habits and emotions; “Do you want to see your mother killed?”
Of course such arguments paid off. The result was a landslide victory to stay on the left side – 83% against 15% of the voters. Nevertheless, strong lobbying for switching side continued and this eventually led to the parliament deciding in 1963 that
At 4:50 am on September 3, 1967, all traffic stopped for 10 minutes … and then resumed on the other side of the street.
6. To facilitate interconnectivity. Fannie Mae’s Delegated Underwriting and Servicing (DUS) program is the best example I know of this principle. By offering to buy all mortgages that conform to certain standards, and by having the capital with which to buy anything anyone wants to sell (one of Fannie Mae’s awfully big advantages), Fannie Mae’s money magnet shapes market standardization.
See where the two GSEs are?
7. To assure ‘fair-sharing’ of burdens. Without standardization, you have free-rider risks (people get benefits that others pay for) and lack of coordination (which I wrote about in the context of Shay’s Rebellion). Desegregation was a Federally enforced mandate.
1963: It took Federal might to integrate Ole Miss
8. Portable compatibility. I travel a lot, always with the trusty laptop on which I am typing this.
Without its juice, my laptop soon becomes no more than a backboard. So I need plugs. Here are my possibilities in Brazil:
So I have to travel with a handy universal, which has slightly fewer sliders than a Swiss Army knife, and even then outliers like
Standards enhance portability. In housing, the Real Estate Settlement Procedures Act (RESPA) is a good example: it applies nationwide.
9. To foster tradability. Convert everything into standardized units (called price) and swap the symbols. That, basically, is what money is.
Money wasn’t always standard. When the
It says it’s worth the same!
10. When you’re insignificant without bulk. Aggregation to bulk oneself into a force is common in political contexts – that’s why parties evolved, and why they gravitate toward the blobby center (or, as the politicians like to call it, the big tent).
Conclusion. I mentioned above the theme of complexity versus scale.
Because the objects – real estate assets – are unique and will always be unique, to scale them upward tends to involve putting them in uniform financial boxes, called recognizable debt or equity forms, and then stacking those up.
Standardization wrapped around individuality
The financial equivalent is the safety deposit box.
There can be a lot of intriguing things in those little boxes
Each time we move up a level, we lose detail. Logically this defines the boundaries of a particular program’s reach: if in scaling up you lose essential detail, you need a handoff or aggregation mechanism. So the LIHTC, which is the same financial product – soft equity via tax credits – aggregates at the investor level, but as the risks are unique to each property, it requires a local presence – the sponsor or general partner – to take the risks.
Networks are bottom-up. Hierarchies are top-down. Networks are responsive, hierarchies are consistent. Networks are adaptive, hierarchies hold their shape.
Is the difference between top-down and bottom-up related to the portability of the value creation? That is, when the value doesn’t move, you have to go bottom-up, but when the value is plastic and movable, you go top down?
I’ve got to think about that for a while.
I’ll think about it
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