Wednesday, September 14, 2005

Compensation, Competition, and Convention

by Tom Bozzo

In a demonstration that there is a business lobby that the Bush administration is willing to take on, the Justice Department has sued the National Association of Realtors over rules that are alleged to inhibit competition from discount real estate brokers (hat tip, Economist's View). At issue are rules that allow brokers to limit access to their listings to other (i.e., discount) brokers' websites. Based on the Antitrust Division's press release, the working group that came up with the rules apparently had noted the potential for abuse, so the AD may have them dead-to-rights.

In the Economist's View post, Mark Thoma wonders about the significance. It's a good question. The action may be notable for disappointing the Heritage Foundation denizens, who consider antitrust legislation to be as evil as any other form of business regulation. In what may be the classic economics oxymoron, this Heritage "executive memorandum" from the George H.W. Bush era claims that "antitrust... laws make American firms less competitive," while this recent one hails Google Desktop as evidence that the services of "trustbusters in Washington and Brussels... are no longer needed." Poor Microsoft.

Beyond that, it's not clear that limitations on the distribution of real estate listings is what's keeping real estate commissions up despite lots of people entering the field to try to cash in on the bubble while the cashing's good. There's a bit of real estate conventional wisdom which, I think, serves to keep commission rates up more than restrictions on Web distribution of listing data: the notion, which those of you who've listed a house for sale may have heard (I have, and I've sold exactly one house), that while you're technically free to offer any commission rate that floats your boat, offering less than the standard rate might dissuade some agents from directing their buyers your way. (*) Hello, social construction of value!

While real estate agents may have it good with commission rates that have no clear causal nexus to the marginal revenue product of their labor, it's actually the conventions of hedge fund managers' compensation that make me wonder most about the market equilibration process. As I understand it, hedge fund investors usually pay both a management fee (% of assets) that would be considered extortionate by the standards of low-cost mutual funds, plus an incentive fee that's traditionally 20% of fund profits. (There are relatively easy ways for hedge fund managers to get around the problem of having to claw back losses before they can earn additional incentive fees, as these articles from Forbes and BusinessWeek note.)

Such terms may make it obvious why downtown Greenwich, CT is being overrun by hedge funds' offices, but it's less obvious why rich investors are willing to pay the fees. A recurring theme here is, regular visitors may have noted, that the rich are undertaxed, and they may be giving the lie to the "Millionaire Next Door" notion that the rich are just more frugal than everyone else. To cut to the (other) chase, many — if not most — of these hedge funds can't be worth their fees, and you'd expect that all the entry might compete the fees down (possibly to the detriment of the SW Connecticut real estate market). So why are the fees seemingly robust to massive entry into the hedge fund racket? I'm just asking.

(*) If you must know, the offer on the current MU Central was contingent on the sale of our old house, so I was not going to try to f*** with the system over a couple thousand bucks' commission coming out of a big pile of bubblicious home equity.
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