Thursday, July 20, 2017

June 2017 CPI

The story continues.  Shelter inflation (YOY) remains at 3.3% and core minus shelter inflation remains at 0.6%.  Core minus shelter inflation has been in a fairly steady decline since the first rate increase in December 2015.  It seems increasingly plausible that the target Fed rate is above the natural rate so that inflation will continue to decline unless the target rate is decreased.  That isn't going to happen.  The available choices appear to be either raising the Fed Funds rate or keeping it at about 1%.  If it needs to be decreased, the Fed will be behind the curve.  I continue to tentatively expect a slow-motion contraction, although without much movement in prices of the major asset classes.  Bond yields don't have much room to fall, housing is being held in depression mode by credit policies, and I don't see any reason at this point for equities to collapse, although that would depend on global economies, future NGDP shifts, etc.

Hsieh and Moretti have made several attempts at estimating the loss of economic activity due to Closed Access housing policies, ranging from around 10% to much higher estimates.

It seems to me that simply comparing consumer inflation with and without shelter inflation gives a good first estimate of the lower range of this cost.  There was a jump in the late 1970s of about 10% in consumer costs due to rent inflation and since the mid 1990s, there has been another rise of 10% to 15%, with a brief pause from 2008 to 2012 because of the foreclosure crisis.  Considering that this doesn't reflect any particular rise in building costs, this seems like a decent estimate of the payment of economic rents to Closed Access real estate owners.

That is just the measure of the extra costs to workers and firms that reside in those cities.  There are additional costs to the US economy due to the exclusion of workers from those cities - workers that didn't have the opportunity to earn additional income which would then be funneled to urban real estate owners because the high cost led them to remain in other cities.  Maybe the higher estimates from Hsieh and Moretti of something like 50% since the mid 1960s aren't out of line.

Wednesday, July 19, 2017

Housing: Part 243 - A Brilliant Argument for More Regulation

I finally got around to watching "Inside Job", the documentary that putatively is about the danger of financial deregulation.  The show was surprisingly effective.

Now, as you might expect, the surface content itself was not particularly moving.  The documentary format made it difficult to go into the details of various regulatory regimes, so this complex topic was diluted down to a simple binary ideal of "regulation" versus "deregulation" that is essentially devoid of meaning.  There was no mention of the importance of housing supply constraints, which is to be expected in such a production.  The focus on CDOs as the core trigger of the housing bubble is obviously problematic since almost all mortgage-based CDO activity happened after home prices had peaked.  And apart from the introductory focus on Iceland, no attempt is made to explain how these deregulatory trends could have happened simultaneously in Canada, the UK, Australia, etc. and would apparently continue to be important factors in those countries.  No mention is made of CDO markets in those countries, though one must assume that its explanatory power in the US is such that it would surely be paralleled in those markets.

But, that is what was brilliant about the documentary.  In spite of all of those weaknesses, the material was compelling and convincing.  The material about sex and drugs on Wall Street effectively packaged the villains of the production for an audience who would already be prone to accept them as villains.  This allowed the effective use of the visual medium to imply causation by mentioning activities of the villains over time alongside selected economic data.

As the viewer proceeds through the production, the subtle brilliance of the director's framing becomes more clear.  Documentary filmmaking is a nearly completely unregulated industry.  We don't even have a regulatory body charged with the review of the content in these sorts of productions.  Yet, clearly, this is a dangerous and powerful medium, capable of molding the consensus of an electorate that understandably will not be able to check the veracity of the information that has been presented.  Documentaries of this type clearly do need to be regulated.  In fact, considering the potential power of the imagery, and the difficulty of dealing with subtle or deep facets of the subject matter, it is probably advisable to simply ban the medium altogether.  Do I even need to mention the famous problem of the abuse of sex and drugs in the film industry?

The weaknesses of the film, then, becomes an ironic defense of regulation that is an even more powerful argument than the actual content of the film.  Brilliant.

I had to check imdb to see if Charlie Kaufman was involved.  It should not go unnoticed that Kaufman has little or no credited professional activity in 2010 when the film was released.  I suspect that he was intimately involved with the project in an uncredited capacity.

A classic signature of Kaufman's handiwork is that the near universal praise for the film among critics and viewers actually ends up serving the ironic point of the film.  This may be his best work, taking the meta-irony even deeper than "Synecdoche, New York" or "Adaptation".  It's enough to make you wonder if Kaufman found a secret portal into credited director, Charles Ferguson's, psyche on the 7½ floor of the Mertin-Flemmer Building.

Monday, July 17, 2017

Economics Detective Podcast

Garrett Peterson over at the Economics Detective kindly asked me to be a guest on his podcast.  We had a great conversation.  I think Garrett managed to help me hit most of the main points of my housing research.

Podcast at the link.

Housing: Part 242 - Incomes and inequality over time

I saw this recently on Twitter, and it always strikes me as odd when this data about tax rates is used to comment on income inequality.  If this is true, then it is a confirmation of the Laffer Curve.  In fact, for tax rates to have had such strong effects on relative incomes, elasticity of supply of high skilled labor and high return capital must be very high.  We see the same thing at the bottom end of the income spectrum.  Strengthening the safety net in the 1960s and after effectively increased marginal tax rates on poor households, when both taxes and subsidies are accounted for.  And, after these shifts in marginal tax rates, we saw this amazing reversal from the entire history of human economic activity.  Leisure time has flip-flopped.  Now, workers with high incomes work more and workers with lower incomes work less.

So, it seems to me that those who might argue for more progressive income taxes based on these trends must make that argument from a labor supply elasticity presumption.  They must presume that the Laffer Curve is relevant here.  And, the argument, it seems to me, would be that the extra production is somehow being captured by the highly skilled and connected workers, and isn't flowing out to the rest of the labor force or to consumers.  The argument would have to start with the idea that, with higher taxes, those high earners would work or invest less.

Now, to me, that seems like a bit of an uncomfortable position.  And, I think the housing story helps to allay that discomfort.  There seem to be two baskets of countries - those that still have strong manufacturing sectors, trade surpluses, and less income growth over the past two or three decades, and those that have shrinking manufacturing sectors, trade deficits, and more income growth over the past two or three decades.  The former countries tended to not have housing bubbles and the latter group did.

According to Mike Konczal's scatterplot above, it appears that we can add one more characteristic to these two baskets of countries.  The former group has not lowered tax rates on high earners and the latter group has.

The larger story here is that the post-industrial economy requires urbanization.  And, the urban housing problem is obstructing that transition.  Countries with a growth orientation are the countries butting up against that obstruction.

This does leave one mystery though, because housing supply is clearly central to this story.  Japan and Germany clearly have fewer obstacles to housing expansion.  So, which way does the causality run?  Do countries moving more aggressively into post-industrial production also happen to develop obstacles to urban homebuilding?  Or do countries that are still more focused on the manufacturing economy also happen to have fewer limits to urban housing supply?  I don't see any satisfying reasons why this correlation should be true with either direction of causality.  Yet, the pattern is there.  The pattern is even there within the US.  Cities at the center of post-industrial economic growth have high incomes and extensive limits on new housing while the other cities do not tend to have those limits to housing expansion.

Strange.  But, the correlation is striking.  Every time I look at these sorts of measures, like in the Fred graph above, they seem to line up quite nicely into these two groups.

Maybe this is an example of trade management.  An argument is sometimes made that the Asian economic success stories developed with the help of some managed protectionism.  In an age built on human capital, maybe housing constrictions serve as that protectionism, limiting competition among the firms that utilize that labor.  Maybe post-industrial firms are attracted to these protected markets.  Maybe this problem of income inequality and housing affordability is a confirmation of the idea of managed protectionism for nascent industries.

Friday, July 14, 2017

Housing: Part 241 - Home Prices compared to wages

Bill McBride at Calculated Risk has a recent post that gives a glimpse into how important understanding the housing supply problem is.  This isn't meant to pick on McBride.  His post will seem quite obvious and reasonable to practically any reader.

In the post, he tracks a ratio of home prices to wages.  This ratio had a range of about 20% from peak to trough before the bubble.  At the turn of the century, it was down at the bottom of that long term range.  Then, it rapidly increased by about 50%.  Then it collapsed, and has slowly risen back toward the top of the long term range.

McBride comments, "Going forward, I think it would be a positive if wages outpaced, or at least kept pace with house prices increases for a few years."

That certainly would be a positive, but it would only be a positive if that happened because we solved the supply problem.  If we don't solve the supply problem, then in most reasonable scenarios of economic growth, this ratio will inevitably grow.  That is because economic growth will be centered in our innovation centers, which now have limited access so that workers must bid up the housing stock to access those labor markets.  Economic opportunity is arbitrarily limited, so payment for access to that will naturally scale up as the American economy expands.

This is like saying, "Going forward, I think it would be a positive if wages outpaced, or at least kept pace with taxi medallion prices for a few years."  That is actually happening now because of disruptors like Lyft and Uber.  And that is why it is a good thing that wages are outpacing taxi medallion prices.

But, if there wasn't disruption, then the value of taxi medallions would simply scale with the amount of activity happening in places like New York City.  It would simply be an asset that is correlated with economic activity at more than a 1:1 ratio.

Since we have incorrectly blamed housing on credit and money instead of on supply, there is this bi-partisan reaction now to basically any organic economic development.  Imagine if Manhattan had a policy of maintaining a fixed supply of taxi medallions and tracking their value.  Then, every time their values began to rise, Manhattan would implement "macroprudential" policies known to slow economic growth and employment.

We're afraid of our own shadows, and we will continue to be until we get this right.

The strange thing is that nobody seems curious about why this is happening.  It's bubbles, bubbles everywhere, and the idea that lenders or speculators in our midst are enticed into madness is apparently so satisfying that observers rarely seem motivated to ask "why?".

Tuesday, July 11, 2017

The Phillips Curve is real.

There are many subtle ways in which we have an intuition to think in terms of competing factions instead of cooperating factions.  Generally, where labor and capital are not artificially constrained, our interests are much more aligned than otherwise.

I think this is partly why the Phillips Curve idea is so persistent.  There is this idea that when the economy is growing and unemployment is low, this will lead to inflation, because workers will be able to demand higher wages from employers.

Of course, the problem is that this hasn't shown up in the data for decades.  Some argue that the Phillips Curve is now flat because the Federal Reserve targets a level inflation rate.  That's certainly true.  I would argue that the Phillips Curve is a measure of monetary policy.  If the monetary regime is pro-cyclical, the Phillips Curve will tilt down.

That is in nominal terms.

In real terms, there does seem to be a persistent Phillips Curve that slopes down.  Wages were unusually high in 2008-2009, but generally, before and after the recession, real wage growth and unemployment have moved within a long term relationship.  Real wage growth is a little low, but it has generally moved up the trendline since the bottom of the recession as unemployment has declined.

I noticed that John Hussman beat me to this.  His post from April 2011 has some interesting details about it.  His take on it is that the nominal Phillips Curve is wrong, and on top of that, even if it was operational, the Fed has the causality backwards.  Inflation won't lead to less unemployment.  If anything, less unemployment would lead to inflation.  But, even that is wrong.

The funny thing is that his point in 2011 was that inflation wasn't going to be helpful.  He thought the Fed was too loose and asset prices were too high.  And he didn't want them to keep policy loose in a quest to lower unemployment.  I would say that this point of view has not aged well.  There was a brief dip in the stock market in 2011, but in the six years since that post, total returns on stocks have averaged more than 10% annually and inflation has remained subdued.

I think he has some great points about the Phillips Curve, but I would argue that this is why the Fed shouldn't worry about tightening today.  Low unemployment won't lead to inflation.  I think we can both be right, here, though.  In either case, tightening or loosening, a Phillips Curve justification seems wrong.

I do have a quibble with Hussman - maybe a speculative quibble, but a quibble nonetheless.  He basically makes a supply and demand argument: "very simply, when a useful resource becomes scarce, its price tends to increase relative to the prices of other goods and services."  So, this still has a lot in common with the basic intuition of the Phillips Curve.  These higher wages are coming from a position of negotiating strength.  A nominal Phillips Curve would suggest that those higher wages are being paid for by consumers through higher prices.  A real Phillips Curve suggests that those higher wages are being paid for by employers.  Viewed as a proportion of income, it certainly appears that there is a trade-off between labor compensation and profits.

But, this inverse relationship doesn't show up in absolute measures of income growth.  However, there is a strange relationship of the second derivative.  If the growth rate in corporate profits increases, about two quarters later, labor income will also tend to increase.  On the other hand, if the growth rate in labor compensation increases, profits tend to decrease over the next few quarters.

Yet again, though, this could be a result of monetary policy.  If the Fed manages the business cycle based on a nominal Phillips Curve model, then monetary policy would be creating this correlation between rising wages followed by declining profits.  And declining profits would still lead to declining wages.

This would be ironic, but it makes sense.  Wages tend to be sticky and employment rates are a lagging economic indicator.  Equity owners hold the residual interest.  When economic shifts happen, they feel it first.  So, if the Fed thinks low unemployment is inflationary, and implements contractionary policy with an idea that this will lower inflation, they may be doing the opposite of what they think they are doing.  Instead of moderating wage inflation, they are moderating profits.

And, why would they expect contractionary policy to lower wage inflation?  What mechanism would be at work that would cause shifting monetary postures to play out initially and primarily in wage levels?  The mechanism would have to be falling profits, wouldn't it?  Isn't that the reason firms would be less willing to increase wages?

In this next chart, I compare the unemployment rate (inverted) with a scaled and detrended measure of the real total return on the S&P 500.  There is a clear cyclical relationship here.  In addition, there even appears to be a relationship over time in levels.  This only involves a couple of trend shifts since 1950, so it could be spurious.  But, when secular unemployment rates have been low, corporate valuations have been high and vice versa.

This suggests that there is a sort of Phillips Curve, but higher wages aren't being paid for with higher prices.  And higher wages aren't being paid for with lower profits.  Higher wages are being paid for with higher growth.  And there is enough growth to go around, so that profit expectations are rising as real wages rise.

This makes sense, too.  Quits rise when unemployment is low.  Employment flows into the labor force rise when unemployment is low.  This is not about us vs. them negotiating power.  This is about growth vs. stagnation.  When unemployment is low, workers might have negotiating power, but more importantly, they have the power of exit.  They can more safely test out alternative sources of income.  This is the real power.  Negotiating power is a fixed pie mechanism.  This power to leave is the power to sort better - the power to search more confidently - the power to become more productive.

We are the 100%.  "You go, we go."  When the Fed begins with the opposite presumption, their contractionary impulses hurt us all.  They should let it rip.  I'm not saying that they should aim for high inflation.  I'm just saying, they should stop worrying about things that are just not useful.  There are many reasons why a "hotter" economy might not be inflationary.  I wish we could give that a chance.

Friday, July 7, 2017

Housing: Part 240 - It's great to see some movement in the right direction.

One of my worries is that when my story gets a wider audience, there will be too much defensiveness about the conventional narrative, and my story will just have too many new re-interpretations of the data for many people to accept.

So, it delights me that over the past several months, there seems to have been a lot of positive movement in the direction of YIMBYism, even in California at the state level.  One of the oddities of discourse on this topic is how rent clearly is an important factor in rising Closed Access prices, yet in debates about whether the bubble was caused by credit supply or credit demand, there is rarely any mention of rent at all.  This leaves academics to simply argue about whether it was irrational bankers or irrational borrowers that caused the bubble.

But, among all the factions in post-recession Closed Access cities, there is no debate or question.  Rising rents are the problem.  And, increasingly, the role of supply constrictions is becoming too obvious to deny.  Once that pillar is knocked down, the façade of a credit-fueled bubble destined to collapse crumbles.

Similarly, important people like Narayana Kocherlakota are coming around to key factors in the crisis.  He recently tweeted:
And, the replies, to my mind were weak.  This issue has been astoundingly ignored.  The reason is that we generally came to agreement that the causes of the bubble were almost all forms of American exceptionalism before we fully addressed the empirics.  This tweet is basically the foundational question of an important early chapter in the book.  I'm am very happy that Kocherlakota is already there.  The rest of the story should be more palatable to him now that he's already a few steps in the right direction.

Wednesday, July 5, 2017

Leverage is not a sign of risk seeking.

Building on this post about JW Mason's paper from the other day, I want to discuss debt and business cycles a little more.


It's strange to me how much space debt takes up in our discourse about business cycles.  These don't look like cyclical measures to me.

I think we get closer to something cyclical if we look at equity values.
Something is wrong with the legend.  This is corporate nonfinancial equities / GDP ... Source

Even this is a little hit and miss, but at least we do tend to see some cyclical behavior here.  And this makes more sense.  When you seek risk in your savings, do you invest in fixed income or do you invest in equities?  And, part of what is happening here is that, on an Enterprise Value basis, firms tend to deleverage during expansions, mostly because the value of equities is rising.  Now, if you were a firm, and equity prices were high, and you wanted to raise capital, would you issue more high priced stock or would you issue more debt?  Why would you leverage up in this context?  You might respond that if interest rates are low, then bonds are basically fetching high prices too.  But, at the end of economic expansions, interest rates tend to be high.  They are low now, but that is because savers are risk averse now.  (There is also an upward drift in equity/GDP because equities increasingly reflect the value of foreign operations.)

How weird is it that in 2006, after a few years of middling stock market returns, when there was a massive influx of savings into AAA securities, we associated that with risk seeking behavior?  Why do we do that?

There is a recent example that might illuminate this issue.  Recently, many people noted that Tesla had a larger market capitalization than Ford. I was pretty amazed by that, so I looked up their financials.

Ford has a market cap of $46 billion plus $143 billion in debt. Tesla has a market cap of $58 billion and $7 billion in debt.  In other words, Ford is 3 times the size of Tesla ($189 billion vs. $65 billion), but claims on their assets are mostly in the form of debt instead of equity.

Now, do you suppose risk-seeking investors choose to invest in Ford over Tesla because they like how the high level of leverage gives them higher returns even though that leverage is dangerous?

Do you think a risk-seeking, over-optimistic market would have more Fords or more Teslas?  And, thus, do you think a risk-seeking, over-optimistic market would have more debt or less debt?  Would it have more equity or less equity?

Investors in Ford are mostly seeking a safe, certain cash flow.  They see some big giant buildings with expensive equipment and they figure that, even if Ford doesn't make a profit for its shareholders, its likely to earn back most of that investment, in any case.

If investors in Tesla are the risk-takers, then why don't they demand that Tesla sell a bunch of bonds to leverage their investment?  Because that's not what motivates leverage!  What motivates leverage is savers looking for certainty.  And, given the choice between loaning cash to Ford or Tesla, they have a clear preference for Ford.

Think of the madness we engage in when we see a potential approaching economic contraction, and we see rising debt levels, and we react by deciding that sentiment needs to be tamped down.  And, lo and behold, if we do it boldly enough, like we did in 2007 and 2008, lending actually does decline when we tear up the financial system.  And we pat ourselves on the back.  "See.  All that risk-seeking debt led to an inevitable collapse, and now those borrowers are finally deleveraging in the way smart people like us knew they needed to."  And, library shelves fill up with articles about the mystery of why interest rates remain so low after the crisis.

Then, debt wants to grow again, because we are afraid to let the economy grow, so nobody wants to own the residual stake (equity).  And, when debt does grow, we fret that it looks like those risk-taking investors still haven't learned their lesson, and we need to have another contraction to get all that excess borrowing out of the system.

Debt in the housing bubble

Now, think about how this played out in the housing bubble.  I have written before about the CDOs, CDOs-squared, synthetic CDOs, etc.  These are all seen as part of excess borrowing and leverage.  But, the problem was that they couldn't find any borrowers to take the mortgages.  That is the only reason those products developed.  If they could have found mortgage borrowers, they would have just packaged them into new basic RMBSs.  The mortgages would have been sliced and diced into new AAA-securities.  But, since they didn't have any new mortgages, they had to slice and dice the B-rated tranches from the existing mortgage pools to create new AAA-securities.

There are two contradictory claims about the period.  One is that spreads were low because the investors were too sanguine about the potential for falling home prices.  The other is that the portfolio managers who were investing in the AAA-rated securities from those CDOs and the exotic CDO products thought they were getting a free lunch, because they had higher yields, but they had a AAA rating.  So, they bought them, not understanding that they were riskier.

Well, what is it?  Were spreads too low or were spreads higher on those securities than they were on normal AAA-securities?  It can't be both.  This is typical of stories about the time.  It's like the facts don't matter.  If portfolio managers really were systematically fooled, then they would have bid those spreads down.  But, they didn't.  How do I know that?  Well, I really only know that because the people that tell this story always claim it, even though it undermines the story.

But, this isn't even really my main point.  My main point is that actually spreads weren't low.  They were high.  There was all this money chasing AAA-rated securities.  But, they couldn't find mortgage borrowers to take the money.  Normally, if this was the case, how would that problem get solved?  The problem would get solved by lowering the spreads until more borrowers were willing to take the mortgages!

Notice how outrageous it is that, among all the stories of stupid investors who didn't know their risks and unqualified borrowers who were duped into borrowing at predatory rates, it seems that nobody has noticed that the overriding problem of the time was that the market for mortgages wasn't settling at a market clearing yield.  Somehow, the spreads demanded by the investors couldn't go low enough to entice new mortgage borrowers, so that they needed to create the securities with other bonds.

This is because the market was already in disequilibrium.  The reason exotic CDOs were spreading was because lenders were too nervous about home equity to lower their spreads and borrowers were too nervous about it to take on new mortgages.  This was because, already, expectations of future home values were negative enough that expectations of negative equity drove a wedge between lender and borrower too large for a price to settle where all the supply of credit could be utilized.

In the midst of this dislocation, prices held fairly steady through 2006 and the first half of 2007.  How?  In 2005, about 2% of homeowning households were selling and leaving Closed Access cities, on net.  Prices were rising even with that selling pressure.  When mortgage markets started breaking down in 2006, which is when exotic CDOs really took off, that migration stopped.  Buying pressure dropped significantly, but at the same time, so did selling pressure.  Households stopped selling and moving away.  And, of course, housing starts were dropping sharply, which also took pressure off of collapsing demand.

PS. John Cochrane finds a particularly explicit example of this type of thinking regarding debt.

Monday, July 3, 2017

Housing: Part 239 - Homes in Contagion Cities during the housing bubble were Inferior Goods

The motion chart from the previous post really helps to visualize the difference between the Closed Access cities and the Contagion cities.  The bubble in Phoenix happened entirely after the Fed began to hike the Fed Funds rate.

The out-migration from the Closed Access cities had been growing since the late 1990s, and peaked in 2004 and 2005.  This surely was facilitated by nonconventional mortgages which helped households living in the Closed Access cities with high incomes to purchase homes and spread their elbows a bit.  But, you would think this would show up in gross migration flows.  You would think that during this time, more potential in-migrants would be able to buy Closed Access homes, so that there would be an increase in both in- and out-migration among the Closed Access cities.  But, according to IRS data, this wasn't the case.  Closed Access in-migration was low and flat throughout the housing boom.  This is one of several oddities that I think creates some doubt about the centrality of the private securitization boom as a cause of bubble prices and migration patterns.  ACS data, which only goes back to 2005, suggests maybe Closed Access in-migration in the top income quintile increased by about 10,000 households during the peak boom years, with little change among other income quintiles.  This compares to net out-migration at the peak of more than 200,000 households, annually, from the Closed Access cities.

One of the interesting things that I think the motion graph helps to show is that as soon as the Fed began to hike interest rates, price appreciation in LA - especially in the top tier markets - moderated.  And, it was after this moderation that Phoenix prices shot up.  But, we can also see that prices in Phoenix are much lower than in LA.  Here is a line graph of home prices over time, by price quintile.  In 1999, the top quintile of prices in Phoenix were similar to the 4th quintile of prices in LA.  By 2004, top quintile prices in Phoenix were lower than 2nd quintile prices in LA.

We can see the downshift in price appreciation in LA here in 2004, when rates began to rise.  And, at the same time, prices in Phoenix shot up.  But top quintile prices in Phoenix peaked at the end of 2005, still below the median quintile in LA.

Of the more than 200,000 households, net, that migrated out of Closed Access cities in 2005, about 85,000 were homeowners from the top two income quintiles.

Technically, we can call what happened in Phoenix a bubble.  It had the classic ingredients of a bubble - temporarily inelastic supply and demand.  But, this had nothing to do with "easy money" and I'm not sure that it really had much to do with easy credit.  The bubble in Phoenix, ironically, was the very early first signal of the bust.  Homes in Phoenix were inferior goods.  As counterintuitive as this is, this should be uncontroversial when one thinks about it for a moment.  That massive inflow of homebuyers in Phoenix in 2005 were buying downmarket.  They were buying way downmarket.  For the migrant households as a whole, it would have been mathematically impossible to do anything else.

Homeownership and rate of first time buyers were declining at the time.  But, how does this square with prices that continued to rise and mortgages outstanding that continued to rise?

Mortgages continued to rise because those Closed Access sellers were very lightly encumbered.  If your home increases in value from $450,000 to $1,000,000 in just a few years, it would be very difficult to be leveraged even if you tried really hard to be.  So the sellers were mostly claiming equity in those sales.  But, the new buyers would have naturally been more leveraged.  When those 85,000 homeowners left town, they had to be replaced by about 85,000 new homeowners.  Homeownership rates were starting to drop, but they weren't dropping by that  much.  About 2% of homeowners were leaving the Closed Access cities annually.  Homeownership rates shift by fractions of a percent.  Those new homeowners are naturally more leveraged.  That is why mortgage levels continued to grow.

Prices continued to rise in Phoenix because there was a migration surge of buyers massively reducing their housing expenditures.  Prices continued to rise in LA because prices in LA were a rational reflection of future rent values.  Today, it is easier to say that, because as we see in the graph, the most expensive homes in one of the most expensive cities in the country, have risen to new highs, even as mortgage markets have remained suppressed.  Those homes in top tier LA markets in 2006 turned out to be decent investments over the following decade.

This is because it is only in extreme and temporary circumstances that a shift in the number of buyers and sellers will move market prices.  Intrinsic value rules.  In Phoenix, briefly, the number of buyers might have pushed prices out of sustainable levels.  That was not the case in Los Angeles.  Consider that, if mortgage expansion could create a sustained increase in prices at the scale we have seen in the Closed Access cities, that the expansion had to have been so far outside normal ranges that it still pushed prices out of rational valuations, even though before that could happen, it first had to make up for those 85,000 fleeing homeowners.  That seems highly unlikely to me.  That's the jab to the credit fueled explanation for Closed Access home prices.  And the uppercut is the strong price trends in those cities in the decade since the mortgage market collapsed.

Friday, June 30, 2017

Housing: Part 238 - Home Price Changes over time

I've been meaning to try this for some time, and finally got around to it.  This is a motion scatterplot of over 10,000 zip codes from 2000 to 2017, showing how home prices changed through the various stages of the boom and bust.  The measure on the x-axis is median zip code home price.  The measure on the y-axis is the 6 month change in zip code median home price (not annualized, continuously compounded).  I have highlighted LA, New York City, and Phoenix.  (Data from Zillow.)

Closed Access Price Appreciation:

Until late 2003, prices within each MSA tended to rise as a group, and prices in the more expensive MSAs were rising more.  This is the fundamental Closed Access problem.  Expensive cities were becoming more expensive.

Subprime Boom:

Around the end of 2003, we start to see the transition away from the GSEs to the private mortgage securitizations (subprime and Alt. A).  This shift was stronger on the west coast, and we can see here how there is a separation between LA and New York.  Note that initially, LA prices increased as a group.  There still was little difference in top and bottom tier housing markets.  Also, there was little impact in Phoenix at this time.  And, we can see that the effect of the shift to private securitizations was to increase prices in the high cost cities.  The trendline for the aggregate national plot becomes very steep during this phase.  This is because the looser terms of the private securitizations were facilitating home purchases in Closed Access cities by households with high incomes.

Rate Hikes & Subprime Boom:

Fed rate hikes began soon after the private securitization boom began, in June 2004.  As the Fed Funds rate increased, the main effect was a decline in top tier price appreciation in LA.  So, during this period, from mid 2004 to late 2005, there was a big difference between low tier price appreciation and high tier price appreciation in some cities, but in LA, this is because all home prices were rising sharply in 2004, and then high tier price appreciation retreated after the Fed began to raise rates.  It was after the retreat of high tier price appreciation in LA that prices in Phoenix finally shot up.

Now, maybe this is a just-so story.  But, I think this is a case where thinking of Fed policy in terms of interest rates is problematic.  I think we are seeing three separate effects here.  First, as rates continued to rise, migration out of Closed Access cities was very high - for both renters and owners.  NGDP growth was starting to moderate.  Homeownership had peaked and was starting to decline.  And, sentiment was starting to turn south in the housing market, partly because of these factors.  This was leading to tactical selling and outmigration of homeowners.  At the peak, which was during this time, about 2% of Closed Access homeowners were moving out of the Closed Access cities annually, net of in-migration.  That is a significant amount of selling pressure, and I think this is a major factor in the downshift of price appreciation during this time.  And, a lot of that pressure was from households with significant equity positions who had owned their homes for a long time.  It appears that there were a lot of families whose home values were far out of scale with their general income and wealth, and they captured the capital gains as the boom peaked.  These appear to have generally been households that aren't particularly leveraged.  So these sales weren't particularly interest rate sensitive.  They were more sensitive to sentiment and expectations.

Second, in the low tier markets in LA, the private securitization market was still the dominant factor.  It was still funding starter homes in Closed Access cities, although by 2005, the flow of first time homebuyers was starting to decline.  But, it appears that aspirational buyers were still entering the housing market at this time in LA.  Again, this was probably not activity that was particularly rate sensitive.  These loans tend to have higher rates than conventional loans.  And, the Fed Funds rate doesn't necessarily have that strong of an influence on long term mortgage rates.  It definitely didn't during this period.  This lending channel remained strong because it wasn't that sensitive to the Fed Funds rate.

Third, the combination of tactical sellers and priced-out renters both led to a massive outflow of population into cities like Phoenix, and that is the main factor behind Phoenix's late price surge.  Certainly this price surge was also facilitated by the loose terms of the private securitization boom, both for first time buyers and for investors.  But, I think migration explains the timing of these events - why the Phoenix surge was so late in the boom and why it occurred after LA price appreciation had already started to wane.  This is also not related directly to interest rates, which is made clear by the fact that the entire boom in Phoenix happened after the Fed began to raise rates.

So, I don't think interest rates, per se, have much to do with these trends.  Money supply and expectations seem more important.

Inverted Yield Curve & Subprime Boom:

When the yield curve inverted in late 2005, which is an important signal of financial dislocation and coming economic contraction, we see an immediate and sharp reaction in all markets.  Really, this should have been the extent of the contraction.  By the time the CDO panic, there had been a significant amount of monetary tightening.  The yield curve had been inverted for nearly two years with predictable results - declining NGDP growth, declining housing starts and investments, moderating or falling prices, the initial drop in employment growth.

By the end of this period, home prices were beginning to decline, but this decline was led by the top end, both locally and nationally.  Within MSAs, it was high tier markets that tended to fall into declining territory first.  And, nationally, we can see the trendline start to fall below 0%, and it has a negative slope when it does.

CDO Panic

By the time of the CDO panic around August 2007, the private securitization market was dead, and the other mortgage conduits didn't expand to take up the slack.  Since private securitizations had been facilitating entry into Closed Access housing markets, at a national level, the drop in demand was most felt in the expensive cities, so at a national scale, it was expensive markets that dropped the most.  The national trendline really goes negative.  But, within those cities, it was the low tier entry markets that had large numbers of recent new buyers with large mortgages who were vulnerable to default and who were now locked out of mortgage access.  Even though they were in entry markets, this was largely young families with high incomes.  We can infer this because the initial drop in homeownership during this time was among young families with high incomes.

GSE Conservatorship & Financial Crisis

Here we can see how these low tier markets continued to drop for months or years after the GSEs were taken over, while top tier markets stabilized.  We can see this in both axes.  First, we see the long tails down to the left that represent low tier markets that, even in 2009 were declining by 10% or 20% or more, every six months.  And, this is such an extreme drop, we can see those dots moving left over this time, as the median prices in those zip codes were decimated.

Buyers in these markets were locked out of mortgage markets by the tight lending standards of the GSEs.  This period and after was when the vast majority of defaults happened.  Really, by the CDO panic of late 2007, nominal home prices at the national level were in unusual negative territory.  The declines between then and September 2008 were gut wrenching and far outside of any modern experience.  And, after that happened housing markets at the low end continued to experience losses for years, that, by themselves, would have registered as generation defining events.  Any relative valuation gains during the boom had been reversed by now.  In most cities, like Phoenix, there had never been any unusual gains in the low tier compared to the high tier, but the low tier losses after 2008 are massive.  (edit: You can really see this by just watching the Phoenix zip codes over the entire period.  High tier markets tend to lead low tier markets, slightly, in both boom and bust, but there is never much difference between high and low tier markets during the boom.  There is an idea that the bust was just the rewinding of the boom.  But, in Phoenix, a true unwinding would have effected all zip codes equally.  This wasn't an unwinding.  This was a massive dislocation targeted at low tier markets.)


That wasn't enough for us, though, and in July 2010, we passed Dodd-Frank.  And, with its passage in this time lapse graph, we can see the market that was just finally starting to stabilize take another pause.  The declines by this time were not as sharp as they had been in late 2008 and 2009, but we can see low tier home prices stall with continued price declines for another couple of years after that.  There were significant valuation discounts in those markets by then.  There was absolutely no reason to restrict lending and demand in those markets.  The rate of first time home buyers had been very low for years by then.  If anything, there had been a deficit of lending at the margin.  And this is not a subtle point.  The lack of reasonable lending in low tier and entry markets had been extreme.  Finally, in 2012, prices ceased their decline. (edit: You can see this by focusing on the national trendline.  It was just starting to move back up to zero when Dodd-Frank was passed, and just as Dodd-Frank passed, the left end of the trendline moved back down, and didn't recover back to zero until 2012.)

Wednesday, June 28, 2017

Housing: Part 237 - Graphs from the ACS

I don't think I have shared these before.

This first one gives an indication of the "house as entry fee" phenomenon in the Closed Access cities.  This is a graph of the average home value, by owner income.  Most first and second quintile owners are older owners who bought their homes many years ago, so values are generally flat across the low quintiles.  Values tend to rise starting with the third quintile, increasing with each quintile....except for the Closed Access cities.

In the Closed Access cities, homes are toll gates to labor markets, and it appears that now, that toll is about $400,000.  So, owners across the bottom 80% of the income distribution all own homes with average values of about $400,000.  It is only households in the top quintile who are willing, in the aggregate, to spend more than the toll value for more shelter.


The next graphs get at the issue of age.  The bust was largely a bust among young people.  This is a point of disagreement I have with Mian and Sufi.  They paint this as a story of rich vs. poor.  Rich households are savers and poor households are borrowers.  This is kind of true.  But, as JW Mason pointed out in the paper I linked to yesterday, this net debt distribution hides a lot of stuff going on at the gross level.  Actually, most debt is held by households with high incomes, and households with middle-to-high incomes tend to be the most leveraged.

More importantly, in terms of wealth, age is at least as important as income.  Older households tend to have high net worth and younger households tend to have low net worth.  We especially see this in the housing market, where young owners tend to be very highly leveraged and older owners tend to be unencumbered or lightly leveraged.  This is the overwhelming pattern in housing markets, and it did not shift during the housing boom.  There was an increase of young owners - mostly young households with high incomes - so, broadly speaking, older owners were either selling and claiming their capital gains or were sitting on homes with rising equity values and falling leverage, and there was somewhat of an influx of younger owners, who naturally initiate ownership with higher leverage.   2017
Closed Access=Red, Open Access=Green, Contagion=Orange   2017
Closed Access=Red, Open Access=Green, Contagion=Orange
In 2006 and 2007, the nation's newspapers were filled with stories of crazed speculators leveraging up homes to flip them, or families in financial distress using home equity to get by, or families recklessly using home equity to over-consume.  Those anecdotes just don't add up to much.  The American housing market is a Cape-size shipping vessel of enduring lifecycle trends, and all these anecdotes of excess and speculation were just so many barnacles that can't amount to much.  Tens of millions of older Americans own lightly encumbered homes and it would be mathematically implausible for tactical borrowers and speculators to amount to anything close to that in terms of market influence.  This is confirmed by the Survey of Consumer Finance, where leverage levels by age were generally stable until equity levels collapsed.

Anyway, back to Mian and Sufi, what this means is that the bust was not about rich vs. poor, but it was about old vs. young, and we can see in these graphs how home ownership among 55-65 year olds was largely unaffected by the housing bust.  That is because those owners have very high levels of equity.  Ownership of households over 65 years has actually risen.

Owners below 45 years of age, however, have been devastated.  Notice, also, that the decline in ownership is fairly proportional across incomes.  Some of this is from foreclosures and some of it is from a post-recession mortgage market that is stifling new ownership.  As a broad first estimate, we might consider the decline in ownership in the Open Access cities to be composed somewhat of foreclosures, but to mostly reflect limited mortgage access.  The deeper declines in the Closed Access and Contagion cities are likely mostly a reflection of higher foreclosures.

Monday, June 26, 2017

Housing: Part 236 - JW Mason throws a truth bomb.

J.W. Mason at John Jay College, City University of New York, who blogs at the Slack Wire posted an outstanding paper in progress (paper is 2nd link in the linked blogpost) about debt, consumption, and business cycles - specifically the Great Recession.  He really gets at many of the problems with conventional ways of talking about these things that I have been grappling with, and he addresses them at depth and with new data.

He complains about the standard treatment of aggregate debt as if it is consumer debt.  On the idea that income inequality led to debt-fueled unsustainable consumption:
(H)ousehold debt varies positively with household income; low-income households report very little debt. Mortgages, student loans, and to some extent auto loans, are specifically middle-income phenomena. Peak debt-income ratios are found near the high end of the income distribution, between the 75th and 90th percentile by income. Absolute debt levels rise monotonically with income. The most natural result of a more unequal distribution of income, therefore, would be a fall in household debt. Poor households do not own the assets for which most debt is incurred, and rich households can buy them outright...More generally, the fact that debt is primarily incurred to finance asset ownership, not current consumption, must be the starting point for any discussion of household debt.
He also notes that all of the increase in household consumption in the decades before the Great Recession was from third party and imputed expenditures (public health care, employer health care, imputed owner-occupier rents, etc.)  There was no aggregate rise in relative consumption expenditures.  He notes:
(T)o the extent consumption trends have diverged from income trends, it has been in the direction of higher consumption as a share of income among high-income households, and lower consumption relative to income among lower-income households. If a mechanism is needed to explain rising consumption demand in the face of more unequal income in the period before 2007, it should focus on luxury consumption among the rich - perhaps driven by a wealth effect from capital gains - rather than on debt-financed consumption among the bottom 95 percent.
Driven by capital gains.  Most studies find that consumption inequality has increased by more than income inequality.  (And, we know why: Closed Access homeowners are spending their economic rents.)

Mason comments, "As people get poorer, they don't borrow more, they buy less. This decline in living standards among lower-income households is reflected in many indicators of health and wellbeing, such as falling life expectancies. (Case and Deaton, 2015) It is strange that so many of these writers implicitly deny that income inequality has led to falling living standards for poor and working class households, but instead has been cushioned by borrowing."  I also think it's strange that a nation supposedly increasingly floundering in consumer debt would subsequently engage in a bidding war on the most durable middle class asset class.

As with so many of these papers, I must swoop in and replace his conclusion with my own, using my alternative version of the housing boom.  My conclusion would begin with one additional point, which is that rising home values were the result of rising rents in constrained cities, and that capital gains on those homes were capitalized economic rents.  There is nothing unsustainable about those gains as long as we continue to limit entry into our productive core urban centers.  The reason for the trends Mason finds can be very broadly explained with three groups of households.  Legacy Closed Access real estate owners that can realize capital gains and use them for consumption, young highly skilled professionals who had taken out large mortgages to gain access to those Closed Access labor markets and incomes, and households throughout the country with lower incomes who are locked out of those labor markets and who did not take on more debt because they weren't bidding on Closed Access real estate.  Those households have stagnant incomes and consumption growth.

I especially appreciate seeing Mason's treatment of debt, cyclically.  The vast amount of debt is a claim on an asset, not consumption debt.  Equity and debt are two forms of ownership.  Equating the shift of ownership from equity ownership toward debt ownership with some sort of recklessness or unsecured debt-fueled consumption leads, in my view, to an incoherent view of debt and business cycles, and I think Mason gets at the root of that problem here.

There is no zero lower bound on the effects of coercion.

Here is an article at about how occupational licensing keeps former criminals from getting work after they are released.

Consider these two proposals:

1) To protect consumers, felons should be prevented from getting occupational licenses.

2) To protect workers, employers should be prevented from asking about criminal records.

Isn't it funny how these are both popular positions, yet they are contradictory?  There are many places where both of these policies are in place.  The reason they are both in place is because politics, at its base, is about status, not about outcomes.  Consumers beat producers.  Employees beat producers.  What about employees and consumers?  That is just a relationship that we don't regulate.  Indirectly, licensing is a constraint on consumers.  You can't hire who you want to hire for a job.  But, the decision point is made at the point of the person becoming a professional, not at the point of sale, so in practice, we generally don't experience this constraint directly, as consumers.

If we thought about that relationship, it would force us to come to terms with some of our unconscious motivations.  Should it be illegal for a couple planning a wedding to discriminate against a gay baker?  Should it be illegal for a plumber to refuse to work for a jewish employer?  Should it be illegal for a family to disown their daughter for marrying a Muslim man?  Should it be illegal for that daughter to consider race, creed, ethnicity, or religion when she chooses a husband?

On this, I feel a bit like Richard Dawkins when he said, "“We are all atheists about most of the gods that humanity has ever believed in. Some of us just go one god further.”

We are all extremists about the liberty to be outrageously discriminatory and prejudiced in our private actions.  Some of us just go one private act further.  If you wonder how anyone can be so heartless to let employers and producers discriminate against employees and customers, you really don't need to look beyond your own conscience and the countless private acts of discrimination that you have never even remotely thought to regulate.

Think of the difference in how we react, even to the words.  If we say that the financial crisis was due to deregulation, and that we need to enact new regulations to keep banks on the right path, this seems so obviously true that it is almost an aphorism.  Of course regulating something is a net benefit.  The first dictionary definition is "control or maintain the rate or speed of (a machine or process) so that it operates properly."  But, think of how differently we react to, "Our deregulated marriage system has such a high failure rate.  We need to regulate marriages."  "So many kids are not served well by our deregulated classrooms.  We need a comprehensive set of teacher regulations to force teachers to work for the benefit of all of their students."  "Studies overwhelmingly show that time spent reading and speaking with children has huge benefits.  Our deregulated family system has failed us.  We need comprehensive regulations about the time and activities that parents engage in with their children."

Our different reactions to these regulations has nothing to do with our needs or with their potential for good.  It has to do with which identity groups in our society retain a sense of liberty and respect in what remains of our liberal heritage.  When we identify with our targets, it makes us uncomfortable to explicitly lower their status.  Commercial regulations tend to have the same second-order problems and costs as these other regulations.  In all of these cases, as "regulation" gets more comprehensive, opaque, and detailed, the costs outweigh the benefits, even though in every case there are certainly good reasons to wish for "regulation" in the dictionary definition sense.  In most of our private lives we intuitively understand that these are the (high) costs we bear for living in a civil society - for being human, really.  It is only in those realms where we identify a sure "other" that we become confident that control and coercion will create benefits.  And, then our policies are more a reflection of who is "other" than they are of any concerted effort toward progress, as with the two contradictory policies that frame this post.

These regulations have more to do with pushing against the status of employers and producers than with the damage of discrimination.  These are "you can'ts".  You can't use your own judgment to hire the person you want.  You can't enter the profession you choose.  You cans, where the policy might raise the status of its target, are hard.  They usually require functional cooperation from the target of the policy, which leads to frequent failures and problems.  You can'ts are easy.  It is easy to lower someone's status, and it doesn't require their cooperation.

And, in this case, we can see the damage of the consequences of policies that are imposed based on our subconscious biases.  And, these regulations are pretty useless anyway.  Most white collar fraud has to be handled in the civil courts, because our criminal system is just too busy with important stuff like keeping you from smoking a mild hallucinogen to bother with things like fraud.  And, if you run the gauntlet to get a civil judgment, that probably won't apply to occupational licensing, because it isn't a criminal judgment.  So, someone running a fraudulent operation will frequently not have any problem getting a license to do business in your state.  But, if they got a DWI, then they are probably out of luck.

This system does little to actually protect you, but it does a great job of keeping people from turning their lives around and aspiring to a middle class ethic once they have a criminal record.  It doesn't matter how dense a web of regulations and rules we concoct.  None of them will grow a conscience for the state.  These examples from coyoteblog are a window into this problem.  The state defaults to rules, not to an emergent common sense, so it tends toward being arbitrary and capricious.  I think this is obvious to anyone who has ever worked in corporate compliance departments.  At some point, you come to terms with the fact that certain forms need to be filed, certain t's need to be crossed and i's need to be dotted, and that it is pointless to busy yourself with anything beyond that.  (To some degree, this is a product of bureaucracy in general, not just the state.  But, this is where the difference between the right of voice and the right to exit is important.)

The basic motive of liberalism should be overturning the ancient human legacy of "you can'ts" or "you musts", many of them patently and intentionally unfair, with "you cans".  This is not a common political intuition.  This is why it is so depressing when politics becomes a center of attention.  Politics is usually about lowering the status of others.  Compare the archetypical political advertisement with commercial advertisements.  The comparison isn't even close.  In the sectors that are strangling us, housing, education, and health care, there are innumerable "you cans" that should have fairly universal support.  You can build a condo building or a house.  You can build or expand a hospital.  You can be a doctor.  You can choose a school for your children.  There are a lot of obstacles to all of these "you cans" that reasonable observers should be able to agree on.  We need to rediscover a "you can" intuition.

Tuesday, June 20, 2017

Financial economics is hard.

I saw this on twitter today.

The natural equilibration of a free economy is so difficult for people to understand that even most traders and practitioners seem to fail to wrap their heads around it.

In this comic, we have the banks and the GSEs.  The effect of "bailouts" or safety nets for these firms is generally understood, as far as it goes.  The effect is explicit in most complaints about those safety nets, but then gets forgotten when applied to social criticism.

I'm not particularly a fan of the private/public GSE model or of the capital requirements and public deposit insurance that form the foundation of public support of banks.  This post is not a defense of those regimes.  But, if we are going to critique them, let's critique them for the right reasons.

What is the primary effect of the public safety net under banks?  The primary effect is to protect lenders to banks.  Who are lenders to banks?  Depositors are.  Public support means that depositors are less sensitive to bank financial instability, because they are protected.  Equity holders aren't protected.  They are generally wiped out when public support is used to save these institutions.  And, what is the effect on those depositors?  The effect is that, because their deposits have a public safety net, they have lower systematic risk, and thus, they earn lower yields.

Look in any description of the low risk investments available to savers, and it will describe bank deposits as one form of very low risk saving, then it will describe any number of similar savings options that have higher yields because they don't have insurance.

It's almost like these markets are highly efficient and things like rational expectations overwhelmingly guide markets in ways that we universally take for granted.  (But, if you want to be a sophisticated fish, you publish articles casting doubt on the naïve theories about "water".)

Similarly, the complaints about the GSEs always center around the "implicit guarantee" that GSE debt always carried.  And, how did we know that there was an implicit guarantee to complain about?  Because yields on GSE debt were low!  Again, the mathematical relationship between risk and return is explicit in the complaint!  The complaint itself is based on a rational expectations, efficiency assumption!

Then, we move to social commentary and we act like none of that happened.  Bailouts help the capitalists and cost the taxpayer, don't ya know.

But, every action has an opposite and equal reaction!  If you made the complaint, you had to know this!  Those safety nets meant that bondholders and depositors earned lower yields.  In other words, those safety nets meant that capital incomes were lower - capitalists earned less.  Do I need to go all caps on this?  Because I will, if I have to!

We can argue about exactly what forms of stabilization are appropriate.  And, believe you me, you don't need to twist my arm to convince me that the stabilizing policies of summer 2008 were not exactly optimal.  But, this idea that financial safety nets mean capital gets its cake and eats it too is just wrong.  The only way to have it both ways is to regulate away potential competition.  Markets with reasonably free entry can't help but pay it back.

And, in the meantime, there seems to be near unanimity about maintaining instability and keeping out competition in the housing market.  "Oh, no!  It's time to tighten again!  There are homeowners who still think real estate is a safe investment.  When will they learn?"  And, gee, guess what investment has yields well above the alternatives and far above the pre-crisis norms?  Rent income is through the roof.  No comics about that though, because for those yields to go down, prices and supply would have to go up, and a sophisticated fish knows there can never be not enough, only too much.

Monday, June 19, 2017

There is never not enough. Only too much.

Calculated Risk has a new post: Lawler: Single-Family Housing Production ‘Shortfall” All In Modestly Sized, Modestly Price Segment

with the following graph.

If we put a time capsule in the ground for archaeologists to dig up in 200 years, and I was asked to put one item in the capsule that best described our time, it would be those scare quotes.

Sunday, June 18, 2017

The flattening yield curve

This is a great article from Josh Brown.  It's an article I'd like to think I would normally write.  He basically says to calm down about the flattening yield curve.  Economies can have years of healthy growth with flat yield curves, even if inverted yield curves are a sign of a coming correction.  This is an excellent point, and normally I'm more than happy to fight the perma-bears and the bubble-mongers.  But, at the risk of being shown a fool, "This time it's different."  (Maybe it's safe to use that phrase in defense of being a bear.)

First, the most significant reason long term rates are low is because we have constructed barriers to long term residential investment.  This is why GDP growth has been anemic, why the labor recovery was somewhat weak, and why there have been headwinds for consumption and balance sheet recovery.  Especially in working class neighborhoods, home prices are still 20% or 30% too low because we have destroyed owner-occupier demand in those neighborhoods, which creates real losses and introduces agency costs to tenancy while also harming working class balance sheets.


So, the reason for the flat curve is a lack of investment, and its already putting both real and nominal economic growth on crutches.

Second, real bank lending is already stagnant.  It has been for about 3 quarters.  This is usually a lagging effect and it points to my third point.

Third, the yield level may have a significant effect on the slope of the yield curve.  The zero lower bound creates non-normal distributions for expected future interest rates, which prevents the long end of the curve from flattening as much as it normally would.  In other words, there is option value in long term interest rates.  I know I am certainly much more willing to take speculative short positions on bonds when rates are very low.  There is a lot of skew here.

Notice how inverted the yield curve became in the late 1970s, when rates were high.  1990 and 2000 were pretty shallow recessions and in both the inversion was also pretty shallow.  But, the 2008 recession was more akin to the 1980-82 recessions, yet the yield curve inversion was much more shallow.  In the late 1970s, rates were around 10% to 15%.  In 2007, they were about 5%.  Today they are 1%.  I think it is pretty clear that a contraction will happen without a true inversion here.  The question is how much slope will we have when the natural short term rate starts to fall without a response from the Fed.  We could be there already.  If we get a couple of bullish head fakes, which is certainly possible in the inflation indicators over the next couple of months, the Fed might even push another rate hike.

I think the Fed's general stance, the broad demands for destabilizing monetary austerity, and these yield curve distortions make a contraction within the year probable.

Wednesday, June 14, 2017

May 2017 CPI and our benevolent monetary overlords

Well, here we go.

CPI less food, energy, and shelter, is down to 0.6%, TTM.  It looks like shelter inflation might have peaked too.

The three month drop in the non-shelter core measure is the worst drop since the BLS began tracking it in the 1960s.  Down about 0.5% since February.

And the Fed raised rates.

This is different than the last recession, though.  Things aren't lined up the same.  We're still raising rates, so rate-sensitive things may still be similar to a 2005 or early 2006 time frame.  That has me a little confused.  I'd like to take some positions that would benefit from falling rates, and the yield curve is already moving down.  But, if the Fed will push short term rates up one or more times, it muddies the water a bit, because the entire curve tends to react to those moves, if only temporarily.

Employment still seems relatively strong.  Flows are holding up pretty well.  That also looks like 2005 or 2006.

Inflation looks like the middle of 2007.

General credit is still growing, it seems.  But, bank credit is flat as a pancake, which is usually a coincident indicator.  Even without these inflation indicators, I would be a little nervous to see rates being pushed up with bank lending so weak.

I think the Fed is committed to recessionary policy at this point.  If (when) they push rates up to much, I don't think they will be quick in reversing their decision, either.  It's a matter of when the various moving parts affect different markets, though.  When do interest rates decline?  When does the labor market turn sour?

I don't think we will see much downward movement in home prices, housing starts, or equity prices unless things get really bad.  And, I still am having a hard time coming up with a detailed forecast for some of the other markets.

If signals turn south over the next couple of months, maybe the Fed will hold off.  But, the Fed sees this softness as temporary, and if some inflation measures have been temporarily down and bounce back, the Fed might see that as cover to raise again, maybe even in September.  I would expect that to lead to a fairly immediate flattening of the yield curve, after which it would be a matter of time before the Fed relents and lowers rates.  It used to be common for rates to peak and fairly quickly be lowered again.  But, lately, the Fed seems to like to sit at the peak rate level for a while before they are willing to lower rates in reaction to economic softness.

I think that's because Closed Access creates a sense among the public that nominal stability only benefits existing asset owners, so there is a strange demand for instability.  I don't see that changing in this cycle.

Friday, June 9, 2017

Housing: Part 235 - Tight Money caused the Great Recession which caused the Housing Bust

This will probably be a long post.  And I may be totally out to left field here.  This is sort of a stream of consciousness post.  I apologize in advance if it is hard to follow.  I've been editing to try to be readable for the book.  I feel like just puking out some ideas on the blog for a change.

First, let me preface this by saying, I am not talking about whether the Fed was hitting their targets or meeting their mandates, as measured, our whether NGDP growth was above or below some threshold.  I am trying to get at something more subtle that maybe is only clear in hindsight.  This isn't a post about second guessing what was done as much as it is a post about what some of the subtle effects of Closed Access could be, and how they might undermine our basic methods for recognizing economic cycles.

Some observers believe that the Great Recession was more a product of tight monetary policy decisions from late 2007 and 2008 than it was a product of the housing bust.  I agree.  But, I tend to push that tight money problem back to early 2007 or even 2006, and I would suggest that the mortgage bust, as we have come to know it, was really a product of the Great Recession.

First, clearly there was a panic that began around August 2007 which destroyed the cash-like character of trillions of dollars worth of securities.  Regardless of one's opinion about Fed policy up to that point, this was a massive dislocation in the market for near-cash securities (Gary Gorton has written about this) which the Fed never countered, at least until the QEs kicked into gear in 2009 and after.  This was followed by policies in late 2008 which were explicitly contractionary, both during and after the crisis events at Lehman Brothers, the GSEs, and other institutions.

Now, considering this, what do we consider to be the defining characteristic of the housing bust?  Defaults?  Defaults overwhelmingly happened after 2007 - even after 2008.  If we define the housing bust by defaults, then clearly tight monetary policy caused the housing bust.  There really is no question about this.  Many anecdotes about defaults filled the papers of 2006 and 2007, but in terms of scale, defaults were overwhelmingly caused by the economic dislocations in late 2008 and 2009.  (Like so many issues regarding the housing boom and bust, the scale is alarming.  This is mountains and mole hills.  Defaults in 2006 and 2007, which were blamed on bad underwriting and supposedly triggered the collapse are a mole hill next to the mountain of defaults that happened when unemployment shot up and NGDP growth collapsed.)  Defaults accelerated after the August 2007 event and accelerated again after the September 2008 event.  More than 90% of the excess foreclosures happened after August 2007, more than 80% after September 2008.

(Even if you believe that prices had to collapse and that monetary and credit policies before September 2008 were appropriate, then, still, an economy full of homeowners with negative equity creates an even more important need for stability of employment and purchasing power.  So, really, even when it comes to the 2007 collapse in private securitizations, monetary and credit policy is endogenous, because those AAA securities broke below face value because of expectations of future defaults.  And those future defaults were bad enough to justify that collapse in valuations only because we explicitly chose public policies that allowed them to happen.  There is little controversy about whether we could have stabilized the economy and the mortgage market more.  The controversy is whether we should have.  The idea that the private securitization collapse caused the Great Recession is circular.  If it did, it is because we chose to allow it.)

How about prices.  Is the housing bust defined by collapsing home prices?  At the national level, the collapse clearly kicks into gear after August 2007.  Prices had been flat from the end of 2005 to August 2007, moving within a 2% range for that entire period.  The national price collapse happened after the August 2007 panic.  The private securitization market had completely collapsed, banks were defensive, and pressure was being applied to the GSEs to pull back.  The only mortgage conduit capable of filling the gap was the FHA/VA conduit.  Funding for homebuyers collapsed, and prices collapsed with it.

GDP growth began its steady decline around then (NGDP growth began to decline in mid-2006, but the decline accelerated in 2007.), the recession officially began in December 2007, unemployment started to shift up, etc.  Except for some commodity inflation, signs are pretty clear that monetary policy was too tight at this point.  So, if we either identify the housing bust by defaults or by prices, in either case, the housing bust happened after monetary policy became contractionary.  As with defaults, the price collapse accelerated after August 2007 and again after September 2008.

How about housing starts?  Housing starts and residential investment began to collapse at the beginning of 2006.  This is a little more subtle.  Before I get into this, though, I would point out that I think defaults and declining prices would be the most common characteristics associated with the housing bust, and that generally those things happened later, relative to the general economic decline, than is generally appreciated.  This is mostly because the small rise in delinquencies and defaults in 2007 was reported on with much more intensity than the many, many defaults that happened later.  The housing bust, as a proposed cause of the recession, is rarely described in terms of housing starts.  So, nothing that is commonly associated with the housing bust was really happening before August 2007.

As I have argued before, I think this early phase of the bust, where contraction was mainly manifest in declining investment, is actually the first sign of economic contraction, it was a development that was generally encouraged because of the mistaken idea that there were too many houses.  Fed members generally saw this as a positive development.  Mortgage growth continued through 2007.  I think this is generally because the rate of new first time homebuyers is more stable than other segments of the market, and these tend to be more leveraged buyers, so there is a natural stickiness to mortgage growth.  But, mortgage growth rates kinked down at the beginning of 2006, just like investment, housing starts, and home equity levels did.  It just took a little longer to adjust down.

This is the period where equity as a percentage of real estate values really started to collapse.  Prices were still relatively stable, but mortgages outstanding continued to rise, thus the rise in aggregate leverage.  Homeownership was falling by then.  I have argued that much of this shift was due to an exodus of capital out of home equity, much of it in the form of owners selling and not repurchasing new homes.  By 2006, first time homebuyers were in decline and exiting owners were increasing at the same time.  In addition to that shift, there was a shift of households out of the Closed Access cities.

Data from American Community Survey
During the boom, these were households selling out of the high priced cities and repurchasing in lower priced cities.  During the boom, some of those homes were purchased by households who were moving into the Closed Access cities, but most of them were purchased from existing Closed Access households who had been renters.  In both cases, this was a shift in ownership from lightly encumbered households (because they generally had significant capital gains) to more leveraged households.

This is where the interpretation is a bit subtle.  Generally, the housing bubble idea is based on the idea that the unsustainable supply of credit led to capital gains which would inevitably be lost, and that households were spending those capital gains on consumption.  But, what if prices reflected reasonable valuations of future rents, and credit supply was simply facilitating the purchase of what were really economic rents from exclusionary local political policies regarding housing?  Then, that consumption wasn't unsustainable.  It certainly wasn't unsustainable for those Closed Access outmigrants who realized their capital gains.  And, the new homeowners that purchased those homes weren't using those mortgages to fund non-housing consumption.  They were using the mortgages to fund the purchase of those expensive homes, and they were, in fact, probably crimping their other non-housing consumption as a result.

We can really think of other homeowners the same way.  Even if a household retained their home and got access to their gains by taking out home equity loans instead of selling their property, they were still accessing economic rents, just like the households that sold or moved.  The value of the homes were just as permanent.  They just chose to continue to hold those homes as unrealized gains instead of selling them and realizing those gains. and Sufi estimate that during the boom these home equity extractions amounted to at least 2.8% of GDP.  We can see this simply by comparing residential investment with mortgage growth.  Generally mortgage growth runs slightly below residential investment, but during the boom, mortgages outstanding were growing by about 2% more annually than residential investment was (as a % of GDP).

The Fed, trying to maintain low inflation, was countering this by reducing currency growth.  I'm not saying they were targeting currency growth.  I'm just saying, if mortgage growth was leading to increased bank deposits that were related to rising consumption, a central bank targeting inflation will naturally limit currency growth.  We can see that PCE core inflation was generally at target during this time, even though currency growth was very low.

Note, by the end of 2006, much of the excess mortgage growth was gone.  Since then, households have had to fund residential investment from other sources.  But, currency growth continued to fall until the summer of 2008.

Now, a reasonable response to this is that, while the Fed might have been a little tardy in reacting to the collapse in mortgage growth in 2007 and 2008, it was perfectly reasonable for them to counter the inflationary pressures of mortgage growth before then.  In terms of viewing monetary policy through the Fed's stated targets and mandate, this is certainly true.  Even in terms of NGDP growth, in late 2006 and early 2007, nominal GDP growth was sort of on the cusp of growth rates that would normally be considered recessionary, and it was subsiding, but it wasn't at a rate that is undeniably recessionary.

Unemployment was also stable, although I would argue that employment growth was actually beginning to weaken substantially, and that the first phase of contraction led to a reversal of the Closed Access out-migration surge, which was a buffer against rising unemployment.  This caused the early signs of cyclical dislocation to be hidden, so that by the time unemployment became a signal of contraction, there had been many months of internal stresses within the economy.  Even having said this, though, the rise in unemployment in the US predates the rise in other countries.  Something unusual was happening here by early 2007.

Setting Fed mandates and targets aside, though, what does this mean simply with regard to stability itself.  What if much of that new housing wealth was the capture of economic rents?  These were largely future potential economic rents, which will eventually be earned through excessively high rental rates on those properties.  Those future rents are capitalized in today's home prices.  This added consumption wasn't being financed by using unsustainable capital gains to borrow from financiers.  It was financed by those future economic rents.

This was basically consumption smoothing by rentiers.  The rentiers were consuming today out of their capitalized future economic rents.  And, on net, we would expect non-rentiers to lower consumption as they suffer from the losing side of the surge in rentier incomes.  Rentiers explain the increase in borrowing.  Non-rentiers explain the increase in low risk investments, such as AAA securities.

Current consumption was being claimed by non-producers.  That isn't controversial.  My tweak to the story is just that this consumption wasn't unsustainable.  So, this means that there would be inflationary pressures.  This means that the rentiers were claiming current consumption from the non-rentiers - they were outbidding them.

What if those gains were sustainable?  Then we have an economy composed of rentiers and non-rentiers.  According to Zillow, from 1998 to 2006, total value of Closed Access residential real estate increased from $2.9 trillion to $7.4 trillion - most of that after 2002.  Even in real terms, this was an increase of about $4 trillion.  Mian & Sufi estimate extracted home equity, nationally, from 2002 to 2006 at $1.45 trillion.  If that is a transfer from non-rentiers to rentiers, that is a major economic dislocation.

Mian & Sufi's 2.8% represents all borrowing through this channel, so consumption would only be a portion of that.  On the other hand, this measure does not include capital gains captured by households either selling homes into the boom or selling high priced Closed Access homes to move to lower priced cities.  Adding all of these sources of current consumption together, it seems that this transfer of rents accounted for much of the growth in personal consumption during the boom.

Real GDP growth per capita was significantly higher in the Closed Access cities during the boom than it was elsewhere, by the way.

Taking all of this together - the low level of currency growth, the significant rise of credit fueled spending, and the moderate levels of total spending and of inflation - suggests that there was a shift in consumption toward households who were harvesting capital gains from housing.  All else equal, without that shift, inflation would have been negligible and nominal GDP growth would have been very low.

Again, I don't think I really need to assert anything here.  This is not controversial.  The idea that debt was fueling consumption is universally accepted.  But, the difference between irrational, unsustainable capital gains and harvesting of permanent economic rents is pivotal here.  What would happen if the source of consumption was from the harvesting of permanent economic rents?  Imports would rise.  Savings would increase.*  Debt would rise.  Everything that happened would happen.  And, if the central bank didn't counter all of this, then inflation would rise, too.  But, the central bank did counter it.

We are an open economy, so when the central bank countered the inflationary effects of this consumption smoothing, at first, it didn't create a problem.  We purchased imports - which, again, were seen as unsustainable overconsumption from debt, but really were consumption smoothing from the owners of our increasingly exclusive asset base.  Inflation is basically a product of monetary policy, and as long as it isn't disruptively high or low, it shouldn't matter that much.  Eventually it mattered because policy became disruptively tight - first leading to extremely sour expectations in real estate markets, then a breakdown in mortgage markets, then finally a sharp downturn in consumer inflation and NGDP growth.

But thinking about inflation in this way, the question arises: how exactly was monetary policy to blame for the housing bubble?  And, how was tightening it supposed to be the cure?  Even in the conventional telling, that this was all reckless and unsustainable debt fueled spending, how was lowering the inflation rate supposed to help?  I mean, if housing debt was allowing households to claim an extra 2% of current consumption, why would that be any different if inflation was 5% or 0%?  Those households were using access to nominal spending power, but they were claiming real output.  Why would a change in inflation change that?

The only way monetary policy could change that is by lowering expectations so much that it induced a crisis of confidence in the housing market by causing home price expectations to collapse - to fall into negative territory.  And, this is clearly what had happened, in a pretty extreme way, by no later than mid 2007.  The Fed's response to these collapsing expectations was to say "the housing correction is ongoing", and to continue to use that term - "correction" - through the end of the year, even after the collapse of private securitizations.

To this day, this is explicitly and widely supported.  The problem, the story goes, with the economy in 2006 was that all those starry-eyed speculators thought that home prices never go down, and that if there was any mistake about how we handled it, it was that we didn't set up markets for those prices to fall earlier.  I am making a damning accusation about the policies that were widely demanded and enacted in this country at that time.  This is awkward, because it should require some contentious claim about what was being demanded.  It's awkward, because the claim itself is not contentious at all.  The explicit demands to create negative expectations in the housing market were broad and loud then, and they are still broad and loud.

Data from Zillow
The reason my criticism is so damning is because the premise was wrong.  The reason my criticism is so damning is a boring little scatterplot which shows that the capital gains funding that consumption were from permanent economic rents.  While the country was fretting about how home prices were becoming unmoored from rational value, rent was becoming a more and more important factor.  It still is.

Notice in the graph how most metro areas basically fall on a line that intersects the origin.  In other words, prices and rents were fairly proportional.  (In 2007, the Contagion cities were causing a bit of a bulge at the top end of the mass of less constrained MSAs, pulling it slightly above the proportional line.)  But, in the Closed Access cities, and generally only the Closed Access cities, the relationship is not proportional because the price also reflects future rent expectations - a cash flow growth premium.  By 2015, even with a basic, linear, unweighted regression between median rent and home prices among MSAs, r^2 is above .85.

Notice one thing that nobody ever expected.  Nobody expected the rents in those high priced metropolitan areas to decline.  We aren't about to see a correction there, even though that is where the correction is needed.  This would require a resurgence in housing - at least in terms of building and lending.

This realization should create a wholesale shift in how we view monetary policy at the time.  Monetary policy was countering this housing-fueled consumption.  But, this wasn't coming from a widespread dissemination of debt to marginal households.  This was coming from a minority of households who had become quite wealthy by obstructing access to opportunity through repressive housing policies.

This seems like the classic problem of a non-optimal monetary regime.  There were two distinct types of Americans - those who were consuming gains from economic rents and those who were not.  The first set didn't need monetary accommodation.  The second set did.

But, in the end, this problem is dwarfed, I think, by two more important factors.
  1. The consumption fueled by housing gains had nothing to do with monetary policy, except that before 2007 we were within a range that allowed the economy to function.  And a functioning economy that contained these pockets of Closed Access was bound to have high home prices.  When we left that range in 2007 and 2008, that source of consumption was undercut.  But, of course, this catastrophe was applauded, not derided.  "If only we had done it sooner."
  2. The effect of the expectations channel overwhelmed any negative effects of the more conventional damage tight monetary policy might have caused for the have-nots.  As I review the data, even the decline in migration out of the Closed Access cities that began to happen in 2006 was mostly due to the decline in migration among homeowners.  The disruptions were targeted to recent homebuyers in Closed Access and Contagion markets.  When those disruptions took hold, the Fed didn't discontinue its tight policy, and since policymakers thought working class borrowers were the source of that extra consumption (They weren't.), they severely clamped down on lending to those markets in 2008 and after.  And, it was late - in 2009 and 2010 - that those households were hit.  But, even there, the hit was largely through housing, as working class neighborhoods really took a beating as a result of those late policy choices.
But, even though this was related to expectations specific to housing, it is still intertwined with monetary policy and the problem of rentier and non-rentier needs.  Some neighborhoods in places like Dallas started to see slow price declines in 2006 and 2007, accelerating in 2008.  Dallas was non-rentier territory.  An extra 5% of inflation over that period might have done wonders for sentiment in places like Dallas where home prices were never particularly high.

It only got worse after early 2008.  Regarding working class homeowners, one might properly conclude that the housing collapse did cause the recession.  But, in that case, it was tight credit policies from the GSEs and Dodd-Frank, in 2008, 2009, and 2010, that caused dislocations in those communities.  Low tier home prices didn't collapse across the country in 2009 and 2010 because of bad underwriting or excess prices in 2005.  So, for those communities and neighborhoods, it was the credit-policy induced housing bust of 2009 and 2010 that exacerbated recessionary conditions in 2009 and after.

Because the exodus of homeowners that had been growing throughout the boom and accelerated in 2006 and 2007, home equity levels collapsed much more strongly than valuations, both the growth of mortgage financing and the harvesting of equity continued to boost consumption after expectations in the housing market had soured.  In addition, sanguine attitudes about the collapse in housing starts meant that there was no natural buffer for declining investment by the time of the first panic in August 2007 and by the time the recession officially began.  Housing starts were already at levels normally associated with the depths of a recession.  Prices began to collapse, in part, because the shift in quantity supplied that could come from changing rates of new building had already been mostly exhausted.  This was met with indifference because of the mistaken notion that we had too many homes.  Ben Bernanke still thought there were too many homes in 2011, and he was far from alone.

For many of these reasons, the collapse was felt first in changing expectations about home prices.  Obviously, negative expectations about values create a natural dislocation in ability to use an asset as collateral.

Here is where you might scold me and explain that it isn't the Fed's job to keep home prices from declining.  I certainly agree, with regard to idiosyncratic price movements.  But, these were nationwide.  As a start, we should have a strong presumption that broad changes in sentiment and price have a systematic or monetary source.  And, obviously my contention that prices are mostly capitalized economic rents from future political exclusion is important here.  But, even setting all that aside, let me suggest that all of our measures of monetary policy effectiveness - inflation, output, NGDP growth, etc. - are not the end goal of monetary policy.  They are proxies.  They are proxies in the service of stability in the business cycle.  In the end, regardless of what we think those proxies were signaling to us, they are only proxies.  If every tactical target the Fed has is on the nose, and an imminent collapse in housing sentiment is going to lead to a generation defining recession, then proxies be damned.  We shouldn't let tactics take the place of the mission.

I don't blame the Fed for looking at those proxies.  It's not their "fault" in that sense.  But, just because the proxies failed doesn't mean that the any of these series of developments were not, in some sense, monetary issues.

But, even saying that, the horrible truth is that we imposed three (really four) stages of collapse on ourselves.  (1) the housing exodus in 2006 and 2007 that coincided with collapsing investment and the retrenchment of migration that had been flowing away from the high cost cities, (2) the August 2007 securitization panic, (3) the wider panic of late 2008, and (4) the federal denial of credit and the late crash of working class housing markets from 2008 to 2011 (and really to this day).  The initial collapse in sentiment might not have even been catastrophic if we had stopped after #2.  Maybe a generous lending policy from the GSEs in 2008 would have been enough to stabilize the economy even with a very tight monetary policy.  Surely the lack of mortgage access had something to do with the sharp drop in low tier prices, and the sharp drop in low tier prices was the root of rising defaults, collapsing securities valuations, etc.

The counterfactual that would be interesting to know would be whether systematic support of generous conventional lending in 2007 and 2008 and after would have been enough to counter any cyclical effects of the repricing in the Closed Access and Contagion cities that might have come from the collapse in private securitizations.  That repricing had happened by the tragic late 2008 episode.  I don't think that most of that repricing was necessary, but in any case the credit repression that happened after that and is still happening - after monetary policy finally became more accommodative (over much public consternation) - was egregious and unnecessary by any measure.

* Much of the savings was from foreign sources.  And much of it was unmeasured because capital gains on those homes are not counted as savings, even though they really are savings if they are permanent, and they certainly are savings for the many households that sold and realized those gains.

Saving rates look low throughout the Closed Access era because the capital gains are received as savings by the rentiers, but they are not recorded as savings.  Whether these are properly considered savings or not depends on if the gains are sustainable.  They are if they are capitalized rents.  They aren't if this was just an irrational credit-induced bubble.  This is the trouble with this topic.  Our interpretation of events affects the causal inputs.