Professor Rick Larrick has become quite well known as an advocate for the gallons per mile standard of fuel efficiency.   He’s also been following the Cash for Clunkers program very closely, cautioning that the program’s success as an environmental initiative is contingent on its overall reduction of C02 emissions.

Now Larrick has crunched the numbers on the program’s sucess to date, and concludes in a new post on his MPGIllusion blog that the program has been effective in helping the auto industry and in reducing C02 emissions.

Professor Rick Larrick is following the cash for clunkers debate on his MPGIllusion.com blog.  Check out his recent posts to understand why replacing cars and making small MPG improvements aren’t always the greenest things to do.

Fuqua Professor Sim Sitkin recently authored an op-ed column that has generated questions and responses from readers whose interest was piqued by his views on home ownership.  In the op-ed, which was published in several U.S. newspapers, Sitkin offered three suggestions for increasing home ownership in the U.S. (the text of the op-ed is included at the end of this post).

In this post, Sitkin responds to several of the questions he has received.

Responses to Questions Raised:

This isn’t a new idea, is it?
No.  It is my understanding that versions of these ideas have been proposed a number of times in the past. It is also my understanding that versions have also been used in Japan (with some fatal flaws in my view) and in Switzerland, as well as Hong Kong.  I desire no claims to originality — but I must say that I was unaware of much of this, as were the economists and finance experts I spoke with.  To me the point is not whose idea it was originally, nor even if it is correct.  Rather, my objective was simply to raise the issue as a challenge to try to stimulate some more creative thinking about how best to pursue home ownership opportunities while retaining appropriate financial safeguards.  As a note of caution – the details matter.  Sometimes similar ideas have been proposed ways that I believe make the basic idea fatally flawed.  If as longer term loan is simply a way to allow unqualified buyers to purchase homes they cannot afford (e.g., very small payments in the beginning and then balloon payments or a significant jumps as can happen with ARMs), this is obviously a bad idea.  So it must be combined with strict qualification standards, as should be applied to all loans.

Why not allow people to sell their homes sooner than 10 or 20 years?
This misreads the proposal – I am sorry if I was not clear on this point.  The proposal was that lenders could not flip the loan.  There was no constraint proposed on the homeowner at all, who should be able to freely sell their property or just pay off a loan.

Why is this a sensible thing to do when the accrual of equity is so slow compared with other ways of investing money?
For the same reason most people do not take advantage of 15 or 20 year loans, and some go to 40 year loans where they are available. People take out mortgages at a rate they can afford to pay back and for which lenders view them as a reasonable risk (at least this worked until the past few years).   The people this would target are those who could pay reliably and steadily (so qualify using strict standards) but not at a high monthly rate. They are probably seeing this as an alternative to paying rent (from which they capture no value), not seeing this as an option as contrasted with socking away money in the stock market.  So I think that it is often a false and hypothetical trade-off you are raising, but a natural one to think about.  With the proposal, individuals who take on very long term loans certainly do end up paying lots of interest but do very slowly accumulate an asset over a period of time — the other actual alternative is that they pay rent but end up with no asset.  This is why people buy houses to begin with.  The typical loan term was arbitrarily set at 30 years some 70 years ago — so why is 50 or 100 any less arbitrary?

Doesn’t a really long-term loan only make sense for smaller investments rather than big home loans for which so much interest is accrued?
Maybe.  But if this only makes sense for smaller investments, then it might be used only for very inexpensive properties — and 30 year loans may stay the norm for middle class home while 15-20 year loans might be more applicable to homes for the very wealthy.

Why is it helpful to constrain a lender by not allowing them to sell the loan for along period of time?
The objective was that if a lender had to service the loan for a long period of time, it would remove the incentive to make bad loans for a quick buck and then pass on the bad loan to another ill-informed party. This is partly designed to address the problem that created the financial mess we are in at the moment. It would also give homeowners more control as consumers.  A borrower might select a lender not only because of their rates or other terms, but also because of their convenience or high quality customer service . . . only to learn that one week after the mortgage the carefully chosen lender sold it to another bank whose customer service is unsatisfactory.

Are you requiring children to take on their parents’ debt through assumable mortgages?
No not at all. An assumable mortgage does not require that it be assumed, but it makes that an option. It used to be that one could get a mortgage that could be assumable by anyone who purchased your home. Of course, that would only be attractive if interest rates had risen. So if you got a mortgage at 6% and rates had fallen to 4%, you would never assume the mortgage, you would get a new at the lower rate. No prospective buyer was required to assume your mortgage, it was an option they could take or leave. Similarly, children would never be required to acquire the home nor to assume the mortgage — but if the conditions were right, it could be a very attractive as an option.

Sitkin’s Original Op-Ed: Read the rest of this entry »

Dan Ariely’s research on “the IKEA effect” is featured in Harvard Business Review’s Breakthrough Business Ideas for 2009. Dan and his collaborators argue that customers tend to overvalue products like IKEA furniture because they have invested personal time and energy in their creation and assembly.  Managers are also not immune to the IKEA effect, Dan argues, because their judgment of projects’ value is likely to be clouded by previous investments of time and energy in those projects, making it more difficult for managers to pull the plug when things don’t work out.

This summer, Fuqua Management Professors Rick Larrick and Jack Soll published a paper in Science in which they demonstrated that consumers are more successful at comparing fuel efficiency across different cars when it is expressed in gallons per mile (GPM), instead of miles per gallon (MPG).

This weekend their work was recognized in the New York Times Magazine’s “Year in Ideas” issue, and we also launched a new GPM calculator that people can use to find their current GPM, compare cars, or see the GPM for all 2009 cars.

More information about this research, including an interactive fuel-efficiency quiz and a video of Larrick and Soll discussing their work (and commuting in Soll’s hybrid Camry), is available at mpgillusion.com.

This is the final installment in a four-part series of postings by Strategy Professors Will Mitchell and Richard Burton. Mitchell and Burton outline four principles for leading your business as an opportunity driven strategist in tough times, rather than falling into purely defensive positions that are destined to be overwhelmed by economic pressures.

PRINCIPLE 4. MOTIVATE YOUR PEOPLE

We have already told you that part of principle 2 is to “invest in your people”. So, why are we coming back to people? Well, we were reminded about the importance of motivation by a recent talk to the graduating Global Executive MBA class at Duke University by Ferdinando Beccalli-Falco, the CEO of GE International. Mr. Becalli-Falco’s core point was that you will not survive tough times without the commitment of your people.

In our experience, when times are good, the second thing that comes out of our mouths, after “we are customer focused,” is usually “our people are our most valuable resource.” But most of us do not really practice the people mantra. We take advantage of the rising tide to succeed as businesses despite under-performing in how we motivate and build on our employees’ insights. We do not have that luxury when times are tough.

Read the rest of this entry »