Wednesday, September 2, 2020

August 2020 Yield Curve

Inflation breakevens continue to rise, slowly.  After really flattening out last month, the yield curve perked up in August, somewhat, especially helped by recent Fed discussion about allowing for more catch-up inflation and a more of a symmetrical 2% inflation target.

The move up is a good sign, but higher would be better.  (Sorry, the graphs a bit of a mess.  Sept. 2 is the light blue line in the group of curves toward the bottom.)

The date of the first expected rate hike is displaying a good trend.  Last month, the expectation had moved all the way toward 2022.  Now, it's moved back to June 2021.  It looks like it might have some staying power.  Of course, the Fed communicates loose policy intentions by saying they are committed to keeping rates low for longer.  It is staggering to think such a useless communication policy is the norm, but it is what it is.  The better (more accommodating) they are the faster they will get to the first hike.

Wednesday, August 26, 2020

Housing Policy, Monetary Policy, and the Great Recession

Here's a link to a research paper the Mercatus Center has published by me and Scott Sumner.

Housing Policy, Monetary Policy, and the Great Recession

It's a combination of Scott's work on Federal Reserve policy and my work on the housing bust.  Here is our takeaway:


Policymakers should not slow the economy in an attempt to prevent bubbles, which are not easy to identify in real time. Such efforts to reduce demand in 2007–08 were not only unnecessary but were also responsible for the reces­sion and financial crisis. 

Instead, US policymakers should adopt regulatory, credit, and monetary policies that can help stabilize the econ­omy, allowing the creation of an environment for healthy growth in living standards. Such an approach involves three components:

  1. Reform zoning regulations in urban areas. This would allow for more construction of new housing, espe­cially in closed-access cities such as Boston, Los Angeles, New York City, and San Francisco, where con­strained growth is currently resulting in high housing prices. The United States could sustainably employ many more workers in home construction if restrictions on building were removed. 
  2. Avoid a situation where lending regulations are most lax during booms and tightest during recessions. It was this sort of regulatory pattern that almost certainly exacerbated the severity of the Great Recession. 
  3. Monetary policy should seek stable growth in nominal gross domestic product (NGDP). Rather than target­ing inflation and unemployment, policymakers should aim for a relatively stable rate of growth in NGDP, the dollar value of all goods and services produced within a nation’s borders. Attempts to use monetary policy to pop bubbles in individual asset markets such as real estate often end up destabilizing the overall economy. A stable NGDP growth rate, however, will provide an environment that is conducive to a stable labor market and a stable financial system.


If you're interested, at the link there is a link with a pdf download.  We address a wide range of evidence, some of which I am certain you have not seen before.

Sunday, August 2, 2020

Trends in Housing Supply

Here's a little sneak peak into some work I've been finishing up.   This graph shows the number of permits issued for single family homes and multi-unit projects (duplexes on up to high rise condos).  The measure is the number of units as a percentage of existing homes.  In other words, what is the gross percentage growth in the housing stock, due to single unit and multi unit building.  The black lines are the averages among all large metros.  The red lines are the averages among the "Closed Access" cities - New York City, Los Angeles, Boston, San Francisco, San Diego, and San Jose.

I find several interesting items to note here:

1) Of course, the Closed Access cities build single family homes at much lower rates than anywhere else.  Also, there was absolutely no supply response in the Closed Access cities in the single family market due to the subprime lending boom.  The rate of single family building was lower in 2005 than it had been in any year since 1996.  I have heard anecdotal defenses of the housing bust, claiming that even cities like LA had excess supply where single family homes were being built in the suburbs, where there wasn't really demand for them.  That idea is belied by the data.

2) However, as prices increased, there was a tremendous supply response in the Closed Access cities in multi-unit projects.  In spite of the horror stories of the local hoops one must jump through to build apartments, the Closed Access cities really are building many more apartments than they had before 2003.

3) Since 2004, in fact, the rate of multi-unit building in the Closed Access cities has matched the national average.  In the end, the regulatory obstacles create higher prices.  Potential residents push prices up until it is worth the trouble to build units.  The regulatory obstacles now are raising prices rather than pushing down new supply, relative to other cities.  This suggests that demand is inelastic.  Agglomeration effects, etc. are strong.  This is, in fact, bad news.  This suggests that the regulatory limits to multi-unit housing are more widespread than just the Closed Access cities.  As bad as the regulatory environment is in the Closed Access cities, other cities are not building multi-unit housing at a rate significantly higher than they are.

4) The deep cuts to mortgage lending since 2007 have cut into single family building in the Closed Access cities just as much as they have in other cities.  Building in the Closed Access cities has nearly recovered to pre-crisis levels, but that's all multi-unit.  In the 1970s and 1980s, it was common for multi-unit building to be double or triple what it is today.  To get anywhere close to that today would require a wholesale regulatory overhaul across the country.

Fortunately, the political center seems to be moving in that direction.  We have a long way to go.

I am finishing up a paper with much more detail on housing supply before the crisis, and another with much more detail on the influences on home prices.

Saturday, August 1, 2020

July 2020 Yield Curve Update

The Fed is failing us.  It started out great.  The initial reaction to the pandemic was timely and forceful.  The yield curve on March 18 was signaling confidence.  But, since then, we have been slowly sinking into stagnation.  The long end of the Eurodollar curve is barely over 1% now.  It is true that forward inflation expectations have continued to slowly rise, though they are still well under 2%.

Here are two graphs of yields.  The first shows the Eurodollar curve at several points in time.  It is now at a new low.  The second shows the expected date of the bottom in short term yields.  The yield curve bottom is now settling in on March 2022.  The date is moving away from us over time, not toward us.  This was the pattern during QE1-3, when QEs were on, the date of the first rate increase would stabilize, but the Fed always cut the QEs off before we actually arrived at the date, and when they would stop the QEs, the date would move off into the future again.

When the yield curve inverted in 2019, the Fed reacted moderately well to it, and at least the expected date of the next rate hike was relatively stable, ranging around June 2021 for all of 2019.  Then, their aggressive moves in March actually briefly moved the date closer.  I thought that the pandemic might have actually kicked them into gear a bit to focus more on nominal economic recovery.  Briefly, in March, the expected first rate hike had moved as far as September - next month.  But that didn't last.

This is not a comment on all the emergency lending programs.  They simply should be buying a lot more Treasuries until nominal income or inflation expectations recover more.

Tuesday, July 28, 2020

A miracle homeownership boom!

According to the Census Bureau, homeownership shot up by 2.6% just this quarter!  Normally, that amount of change would take a decade or more.

Vacancies also declined sharply.

According to the estimate of total housing inventory, there were 4.8 million more homeowners in the second quarter than there were in the first quarter.  To put that in perspective, the National Association of Realtors estimates that there were a bit over a million homes sold in the second quarter.

The Census report on homeownership and vacancy includes a warning about changes in their methods of data collection due to the coronavirus.  It seems likely that a lot of renters did not respond to phone interview requests, and somewhere along the lines, the statistical methods for estimating total population went haywire, and we basically don't know anything about how homeownership and vacancies changed during the quarter.

There is a lot about the country we really don't know.  It is hard to know exactly how many people are in a real financial bind and what they are doing about it.  We are flying blind, which is why we need to err on the side of generosity in public safety net provisions right now, and do everything we can to reduce the contagion risks ASAP.

Tuesday, July 7, 2020

June 2020 Yield Curve Update

The yield curve remains at about the same place it was a month ago.

Since the mid-March peak of optimism after the initial reactions to COVID-19, yields have declined, which would suggest that the Fed could do more in terms of basic nominal stimulus.  But, the decline in long-term yields has been real.  Inflation expectations have inched upward, though tepidly.

I don't have an opinion about the various lending programs in place, but it seems like there is plenty of room for the Fed to simply buy Treasuries until inflation expectations move above 2%.  A steeper yield curve would be a good sign.

In the meantime, the low point of the inversion looks like it's moving ahead in time, which is not a good sign.  Along with a steeper yield curve, it would be nice to see market expectations of sooner increases in short term rates.  The Fed can't cure COVID-19, but it can minimize the costs and dislocations caused by nominal decreases in incomes.  There is no reason for the Fed to let the market expect the yield curve to be inverted until 2022, but we might be headed there.

That being said, the Fed has been more active than what I would have expected.  I appreciate the new direction.  They aren't creating nominal economic crises like they did back in 2008.  But, there are parallels, still.  In 2008, during the month after Lehman Brothers failed, when markets were being tossed to and fro, and intensive debates raged about bailouts, TARP, and all the rest, the Fed sat on a 2% Fed Funds target rate - a target rate that was so disastrously high they never really managed to hit it.  In the midst of all the debates about unconventional policy efforts, it seems that it didn't occur to anyone to do conventional monetary policy and lower the rate.

We have sort of a similar issue now, with all the special lending programs, all the kvetching online about who got it and who didn't, etc., and in the meantime, the Fed could be purchasing many more Treasuries than they currently are.

Monday, June 8, 2020

May 2020 Yield Curve Update

 The yield curve (using Eurodollar futures) has undergone a series of shifts with the coronavirus pandemic.  In the first graph, we can see that starting from the end of January, the whole curve shifted down by early March.  It shifted down more by March 10, as the extent of the pandemic became worse.  Then, it steepened over the next week as, across the US, cities, states, and citizens took action.

Then it shifted down again in late March as the pandemic worsened in the early weeks of the lockdown.  Then it steepened again over the course of April and May.

The result of these shifts is that short term rates are much lower than they were at the beginning of March but long term rates are about the same as they were.

I would say that we have encountered a pretty hairy real economic shock, but the Fed has done a decent job of countering that shock so that the nominal shock is lower than it could be.  (Five year inflation is still under 1%, so there is room for more, but obviously the Fed has been very active.)

The second chart here is an estimate of the first month when short term rates are expected to rise.  Before the pandemic, rates were not expected to bottom until September 2021, and that date was potentially moving out in time, just like it did after the GFC when the Fed would prematurely stop doing quantitative easing.

That was the main danger of the pre-COVID economy, that the Fed was pulling back on nominal growth just a little too much.  That, by itself, is unlikely to cause a crisis or an intense contraction, but it does put the economy in more danger of running into problems, especially, as the past 3 months have made clear, we never know what's around the corner.

The shock we did get was strong enough to kick the Fed into recovery mode, so I think the stock market has basically reacted to an exchange of risks.  We got a real shock, but now we are less likely to have whatever low-level monetary stagnation we were going to get otherwise.  If the expected future date of the first rate increase continues to push back to us in time (it's now at June 2021), then that might be evidence that the Fed has mitigated some of the real shock by moving into recovery mode.  Basically, this would create a deeper but shorter recession.

The next graph is my modified inversion measure.  Any spot below the trendlines is effectively yield curve inversion.  We are still technically inverted, but now the Fed has so many programs in place to provide liquidity there might be hope for recovery even if long-term yields remain low.  Understanding that is above my pay grade.  In either case, if 10 year yields can rise above, say, 1.5%, that would definitely be bullish.  Even moreso if the Fed misinterprets buoyant yields as some sort of headwind that calls for more stimulus.

In the meantime, it's a trader's market.  There are a lot of stocks still well below their previous highs and many stocks at all-time highs.  Their relative outcomes will depend on real developments.  A lot of people are talking about where the "stock market" is, but now really is a time where prices on individual stocks can present opportunities for acting on particular knowledge or simply for having the guts to take on potentially embarrassing positions that, nonetheless, have potential.

Friday, May 8, 2020

April 2020 Yield Curve Update

The Eurodollar charts are updated through today.  The Treasuries chart is monthly.

The Treasuries chart suggests that the yield curve is functionally inverted.  (The 10 year yield needs to get above the trendline.) Forward 5 year inflation expectations are below 1%.  There is a lot of focus on the targeted lending facilities, etc., but, as in 2008, the Fed could really just do more standard stimulus.  Just buy a bunch of Treasuries.  If the cash just ends up in excess reserves with no increase in forward nominal spending and inflation expectations, then buy more.

The Eurodollar curves provide a little more optimism.  It is good that in recent days, the long end of the curve has held up and lower rates are mostly from declining rates at the short end.  The Fed could do more, but it could have done less, too.

The last chart, which is the market estimate of the first rise in Eurodollar rates, suggests also that the Fed has stimulated somewhat, but could do more.  Before the coronavirus outbreak, I was worried that the Fed was just keeping monetary policy below neutral, so that the expected first date of an eventual rate increase was slowly moving back in time, similar to what had happened after 2008 each time they suspended Quantitative Easing operations.  I was looking for the expected first date of a rate increase to move back to December 2021, which would have been bearish.

I thought that the pandemic might trigger a response from the Fed that was less complacent, and actually shorten the length of a coming contraction, even if the contraction was deeper.  At first, this seemed to be the case, with the expected first date of a rate hike moving briefly all the way up to September 2020.  Since then, it has moved back to September 2021.

At this point, a lot depends on near term real shocks related to the pandemic.  But, higher inflation expectations would help, on the margin, I think.

Disclosure: I do not have a position in UBT any more.

Wednesday, April 29, 2020

Housing: Part 364 - Rising homeownership rates

This graph from Len Kiefer at Freddie Mac shows the latest movements in homeownership rates.  The Census Bureau reported updated homeownership rates, and the trend continues to be relatively positive.

Now, you can see from the graph that homeownership rates are still very low, when accounting for age.  The best looking group in terms of recent trends is the under 35 group, which has managed to just touch the bottom end of historical norms.  That age group was largely not in the housing market when the crisis struck, so they benefit from having less damaged balance sheets.

In the other age groups, the scars from the crisis are still quite large.  Yet, even though there is a long way to go, it is nice to see movement in the right direction.
However, there is limit to this movement, and I think really what we are seeing here is the continued settlement of American households into the "new normal".  According to the New York Fed, the median FICO score of mortgage borrowers before the crisis tended to float around 715.  During the crisis it moved to as high as 780, and has generally stayed high - 770 as of the end of 2019.
It is difficult to imagine homeownership rates increasing much further without further loosening in lending standards.

In fact, an important source of rising homeownership now is probably the work American households are doing to improve their credit.  The  Fair Isaac Corporation estimates that the average FICO score for the entire market (not just mortgage originations), has moved up from the low in 2009 of under 690 to 706.

That sounds great.  Macroprudential regulations are pressing Americans to be more prudent.  But, there is really only so much Americans can do.  As much as anything, credit scores are a measure of how old you are.  Are you young, with student loans or a bare bones credit card?  Or are you a retired couple with the remains of a mortgage you took out in 1995, living off of a pension and an IRA?

The thing is, you know what was an important factor for that retired couple with the 830 FICO score, paying off the last few years of their mortgage?  In 1995.....they were able to get a mortgage.
The average rising FICO score and the tentatively rising homeownership rate reflect the attempts by some Americans to meet the new more strict norms for owning a home.  All else equal, maybe that is a good thing.  It seems like it must be.  But, we should keep in mind that the way we are creating this trend - really the only way to - is through policies of exclusion.  Rules and regulations that put an extra gatekeeper on the path of the household credit lifecycle.

For some number of households on the margin, the new standards are within reach, and they have made the effort to adjust.  According to Ethan Dornhelm at Fair Isaac, this group has driven the increase in FICO scores.  Many households have been intermittently locked out of credit markets.  But, analysis of households that have had continuous use of credit since 2009 shows that those households have increased their average FICO scores by 29 points.

Account-level delinquencies down double-digit percentages, substantially lower credit card utilization, lengthier credit histories, and less credit seeking activity — it is no surprise that this population has experienced a major improvement in their FICO® Score.

Those households have delayed homeownership a bit, but their balance sheets are healthier.  And, the reason that they are engaging in this adjustment is that exclusion makes returns better.  Locking a lot of households out of entry level homebuyer markets means that entry level homes are a much better deal for those who can get them.

That is one price of "macroprudence".  It creates a rift between the haves and the have nots.  Marginally better-off Americans get an even better deal as homeowners, but they have to work at it a bit harder to be "qualified".  Other Americans will be unlikely to clear that bar, and they end up paying higher rents because when homeownership becomes a better deal for families, it also becomes a better deal for landlords.  Exclusion raises their rental income.

If this is the new normal, then in the long-term, homeownership will rise a bit from here, but not back to earlier norms.  Maybe really just a few percentage points lower than they used to be.  Americans that are homeowners will live in somewhat nicer or larger homes.  Or maybe they will bid up the prices of homes in favored locations.  Americans that aren't homeowners will live in somewhat less nice units, rents will go up over time, and will take a slightly larger portion of their incomes.  This won't be noticeable.  It's not like you could visit a $600,000 home today and then go to an apartment renting for $800 a month, and then revisit similar places again in 10 years and be hit with the realization, "Huh, it really seems like the relative amenities of that apartment have declined by 20% or so compared to the amenities and the rental value of that nice home."  It will just happen, and the newspapers will just keep printing columns about how awful it is when "Wall Street is your landlord."  We will notice, vaguely, that things just seem harder for the tenant in that apartment.
There is no magical resting place where we know we have made the correct set of compromises between prudence and access.  But, one thing to keep in mind when reading those articles about greedy Wall Street landlords is that access to homeownership isn't important because of the financial speculation ownership entails.  That's as least as much a cost as an opportunity.  What is important about it is that homeowners are never in those angry articles about greedy landlords.  What is important about it is that our homes have a sacred quality about them, and when a home has a landlord and a tenant, that sanctity is split.  It has an inherent conflict that cannot be cured.
Set aside those bromides about the American Dream.  Not everyone should be or wants to be a homeowner.  In many dense urban settings, in high-rise apartment buildings, the inherent conflicts of ownership might even outweigh the inherent conflicts of tenancy.  We shouldn't thrust this choice on Americans.
In an age where some cities have political regimes that create extremely high home prices, it is easy to start to think that the important reason that the retired couple has an 830 FICO score is that they were speculators.  But, really, there are couples like that in St. Louis just as there are in San Francisco.  The couple in St. Louis may not have gotten the gains of speculation that the couple in San Francisco did, but they are likely to share a high FICO score.  The reason is that for the past 30 years, they have had the world’s best landlord, who never engaged in a sacred conflict with them, and who, furthermore, didn’t raise their rent in order to compensate for the landlord’s portion of that conflict.
As we continue along in the “new normal”, when you see articles about greedy Wall Street landlords, it is worth keeping in mind that the conflict they are engaged in isn't a product of "Wall Street".  It is an ageless conflict.  And, for households who must engage in it because, on some margin, we have decided, through public gatekeepers of credit access, that they must, their conflict was a public imposition.  We have taken something sacred from them.  Maybe, all told, for the best. But, even so, we should acknowledge our role in their travails.  We must attempt to account for these costs in the quest for public prudence.
If the major cities made it easier to build more dense housing in and near city centers over the next twenty years, then the homeownership rate might become even lower than it is now.  That would be fantastic, because it would reflect Americans engaging in voluntary tradeoffs – moving to the city because of the opportunities and lifestyle it provides, even if it comes with sacred compromises about control over personal space.  Today, public housing policy is making those voluntary trade-offs more difficult while simultaneously imposing other involuntary trade-offs.

Sunday, April 19, 2020

A Missed Prediction and A Couple of Articles

First, just to make it official, my bold coronavirus prediction in the previous post went up in flames.  I had hoped that widespread lockdowns would lead to a sharper decline in new cases, but the decline has been less pronounced.

Earlier in the month, I mapped out two trajectories.  Nothing particularly scientific about them, but at the time, either trend fit the earlier data.  It appears in the last two weeks that new case growth is following the less optimistic trend.

Second, I have seen a couple of recent articles that I figured I would comment on here.  First, here is an interesting article from Salim Furth at Market Urbanism where he comes to a counterintuitive conclusion - that coronavirus infections within the NYC metro area are negatively correlated with subway usage and density.  An interesting and thought-provoking finding that I'm not entirely sure I know what to do with.

Second, here is an article at Bloomberg: "Another U.S.-Wide Housing Slump Is Coming: The coronavirus pandemic will cause many cash-strapped Americans to sell their homes, flooding the market with excess supply." It makes many predictions about a coming housing bust due to the coronavirus.  It's hard to know exactly what will happen, so I will let you decide how much you should fear their predictions.

Obviously, in general, I will take a more optimistic view than the author.  One reason comes from this snippet at the end of the article:
It’s also impossible to quantify how Americans will perceive homeownership given the hardship so many will endure. If frugality is embraced as it was after the Great Depression, homes will once again be viewed as a utility. The McMansion mentality is at risk of extinction.
The reason why the collapse in the subprime mortgage market hit the housing market so hard was because the lead up was predicated on the fact that there had never been a nationwide decline in home prices. But now for the second time in a little more than a decade, Americans are poised to witness the impossible.    
The idea that the housing bust was fueled by the idea "that there had never been a nationwide decline in home prices" is ludicrous no matter how many times it is repeated.  It's the sort of unfalsifiable assertion that has filled in the many gaps in the bubble narrative that couldn't be filled in with data.  Even Case and Shiller didn't predict a nationwide decline in home prices. And the reason they didn't is because there was no reason for one. The reason there was a nationwide decline in home prices is because we made it effectively illegal to sell mortgages to millions of households who would have been homeowners for decades before.  We wiped out demand for housing in their neighborhoods, and prices cratered.  The bad news is that was tragic.  The good news is that you can only perform amputation once.  So, there is a lot of analysis that treats a housing collapse as a natural part of an economic downturn, based on data from the financial crisis, and it just doesn't reflect a natural response of a housing market.  Practically everyone will make that mistake, which is why I think there are potential bargains among the homebuilders.  Asset markets are usually efficient, but occasionally the humans that make them are universally wrong enough to make them inefficient.

Another myth about housing is the "McMansion mentality" as contrasted with the frugal post-depression generation.  This myth can be falsified, however.  Here is a graph that is an estimate of net residential investment.  It is residential investment (excluding brokers commissions) minus the BEA's estimate of the aging of the existing stock of housing.

The period that has been deemed the "housing bubble" period was the culmination of one or two decades of the slowest pace of residential investment since the Great Depression.  Those frugal post-Depression families were building homes like crazy - at a rate not seen since.

One reason they were building like crazy is because they built so little during the Depression.  The last decade - the decade this author associates with "the McMansion mentality" matches the Great Depression in the lack of residential investment.  Homes aren't viewed as a utility.  They are a banned substance.  Would that we were about to engage in a corrective decade like those frugal post-Depression families did.  But we won't. We can't. We're tied up in knots with ungenerous and untrue myths about our fellow countrymen.  So, we will struggle to do much better than a Depression. But it will be a Depression in real growth and consumer surplus, not a Depression in rents, prices, or landlord profits.  Coronavirus might create a brief contraction in prices, but unless we escape the real Depression, it won't be permanent.