Monday, April 6, 2020

March 2020 Yield Curve Update

Well, so much has happened, I hardly need to update the yield curve.  Coronavirus has given us one big push into the recessionary outcome that we have been tentatively dancing around for some time.

The first graph here is the comparison of the 10 year yield and Fed Funds Rate.  The imminent recession has pushed the neutral rates of both down considerably.  But, the Fed has been very responsive.

There are so many moving parts moving in such extreme directions, I really don't have anything to say at this point.  Normally, I would suggest that we should be hoping for 10 year yields eventually to run up above 1.5% or 2% as a first step to recovery, but it is all so complicated now, and the Fed makes it even more complicated than it needs to be, so for now I'm just going to watch.


 Here is the yield curve at several points since the early days of the coronavirus development. Short term rates have steadily moved down but long term rates have bounced around a lot.  Again, I'm not sure I have much to say. A lot of the movement on the long end may have been related more to market disequilibrium than to any systematic trends or expectations.  Again, I am in waiting mode.

Inflation expectations have declined to less than 1%.  As long as that is the case, there is probably a pretty tight limit to how high long term rates will go.

The one thing that might be even slightly informative this month is the expected low point of the Federal Funds Rate.  It had been at September 21 for a while, suggesting that Fed policy was expected to allow some sort of economic contraction that would settle in for more than a year.

But, the coronavirus has made everything suddenly more acute and one interesting result of that is that the expected low point of the Fed Funds Rate is now March 2021. It had gone as early as September 2020, but that might have been related to short term market disequilibria.

If this holds up, it suggests that the Fed has been spurred into a more vigorous reaction, and even though the recession will be much deeper than whatever was going to happen, we might recover more quickly because the Fed has jumped from a "minding the store" approach to a "whatever it takes" approach.

We have suddenly switched from a set of fiscal and monetary approaches that were, mistakenly, aimed at making American household assets illiquid, to a new approach where the Treasury and Fed are creating liquidity wherever they can.  Because the bias for the past decade has been so far in the other direction, there is a lot to be gained by this.

But, of course, the virus creates many uncertainties.

Saturday, April 4, 2020

Investors, Gentrifiers, and Flippers, Oh My!

Last summer there was surge in the "Beware real estate investors!" genre.

Here is NPR, the Wall Street Journal, and the New York Times.  These are all quite similar in content and tone.  I will generally review the NYT piece here.

It starts with "This house in Atlanta was sold three times in one year, a sign of exploding investor interest in starter homes that is reshaping the nation’s housing market and driving up prices."  The house was in a neighborhood that had "fallen on hard times" and went from $85,000 to over $300,000 over the course of those transactions, which, according to the article, included extensive renovations and treatment for a termite infestation.

Here is some of the rhetoric in the article regarding this house:
A confluence of factors — rising construction costs, restrictive zoning rules and shifting consumer preferences, among others — has already led to a scarcity of affordably priced housing in many big cities. Investors, fueled by Wall Street capital, are snapping up much of what remains.
“If it weren’t bad enough out there for first-time home buyers, the additional competition from investors is increasingly pushing starter homes out of the reach of many households,” said Ralph McLaughlin, deputy chief economist at CoreLogic, a provider of real estate data.  
Mr. Makarovich, 34, arrived in 2016, part of a wave of young professionals moving into one of the last affordable parts of Atlanta.  
Ms. Ellis looks at the changes in her neighborhood — and her role in those changes — with some ambivalence. She once derided the out-of-towners moving into the area as carpetbaggers. Now, she is playing at least some role in that transformation. “I was like, what are we doing?” she said. “Are we doing the same thing, ultimately, bringing in people who are going to change the place?”  
Later, investors are described as “locusts (that) came down and bought everything up.”

idiosyncraticwhisk.com 2019
Source: Zillow Data
Here, I will just start with a graph comparing rent affordability and mortgage affordability for both the US and for Atlanta.  This is the portion of the median household income required to either buy a home with a conventional mortgage or to rent the same home.

idiosyncraticwhisk.com 2019
Source: Zillow Data
Beginning in 2007, there was a sharp divergence between rent and mortgage affordability.  The reason investors flooded the market, and are still active is because owning real estate suddenly became very profitable and that divergence has barely closed at all.  Even the recent small amount of reconvergence was mostly from rising mortgage rates, which have reversed since I produced these charts.  Starter homes are usually purchased with a significant amount of leverage.  Entry level buyers are absolutely not being priced out of the market.

If rising costs and zoning rules were the problem here, then both rent and mortgage affordability would be high, which is exactly what you see in a place like Los Angeles, where zoning restrictions and high costs are the actual reason for a lack of affordability.

Clearly, the problem in Atlanta isn't that investors are "snapping up" all the homes.  The problem is that homeowners aren't snapping them up.  As for young homeowners moving into the "last affordable parts of Atlanta", what can one say?  There are vast swathes of Atlanta where homes are available for less than $150,000.  In fact, there are several homes for less than $150,000 within a block of the house profiled in the story.  The reason the buyers didn't buy those houses was because they wanted a nicer house and they had the money to pay for it.  This is not a story about affordable housing.  The house that sold for over $300,000 sold to a relatively affluent couple expressing a preference.

Are all those sub-$150,000 neighborhoods suffering from too much residential investment and too many interlopers?  None of these reporters seem capable of imagining anything else. The article goes on to lament the struggles of another potential homebuyer who is shopping in the $300,000+ range in Atlanta.  Her real estate agent, who also represents investor buyers and who invests in properties himself, says, “If it is anybody’s fault, it’s probably mine, because I brought people in.”

A question one might ask here is, how can the same market provide good investment opportunities for the real estate broker while simultaneously being bereft of affordable units for the tenants?  These homes are affordable for the investor, but not potential home buyers?

One might also wonder why all that capital isn't funding new housing units.  The truth is, that capital is funding new units, but only for the "haves".  Sales of new homes with prices above $200,000 is back near the boom peak, but new homes under $200,000 are practically nowhere to be seen.  We suffer from a lack of affordable housing while mortgage affordability is fabulous, and yet home buyers just aren't interested in building new homes that sell for less than $200,000?

The truth is that there is great demand for affordable homes, but the families who would live in those homes have a very difficult time getting mortgages today.  Here is a graph comparing two measures.  The black line is the average FICO score of new mortgage borrowers.  After the crisis, loans to average American families dried up and the average FICO score of today's borrowers is much higher than it was before.  The orange line is a comparison of home prices in the most expensive 20% of Atlanta's zip codes compared to home prices in the least expensive 20% of zip codes.  When high end prices rise compared to low end prices, this line rises.  After lending standards were tightened, low end homes in Atlanta dropped by more than 30% compared to high end homes, even though there hadn't been much difference during the boom.

The real estate broker and investor is buying the homes whose tenants are blocked from getting mortgages.  Those homes are affordable, but unavailable to their tenants.  The brokers' clients are the types of buyers who can qualify for mortgages.  They aren't interested in living in $150,000 homes.  They are buying the homes above $200,000 that have risen in value and that have ample new supply coming on line.

There is no natural shortage of homes with affordable prices.  There is a shortage of Americans with permission to buy them.

It is the lack of lending that is creating this gentrification process.  Since lower tier homes have been underpriced, investors have incentives to buy those homes and fix them up so they are nice enough to attract high end buyers in the market that isn’t underpriced.  The way to stop this is to allow more working-class households in those neighborhoods to buy homes.  That will be associated with rising prices, until they are high enough that those investors aren’t attracted to the neighborhood anymore.  But, even with higher prices, those mortgages will be more affordable than rents are today.  Instead of bemoaning greedy landlords that jack up rents and evict working class tenants, why don’t we let those tenants solve their own problem?  Many of those tenants are capable of being their own landlords, and regulators today are preventing that from happening.

As the chart shows, low tier prices have been catching back up with high tier prices lately.  This makes it very tempting to point to low tier price increases since 2012 and react in fear that another credit-fueled bubble is on the way.  But, clearly, those rising prices are catch up growth.  It needs to happen.  It is a sign of a return to sustainability, not a return to unsustainable excess.  There should be more of it, and the demand should be coming from the tenants themselves rather than investors.

There is a shortage of homes with affordable rents because their tenants are denied other options and because the prices on those homes are too low to justify building more and increasing supply.  The investors are buying them because they are great deals, but they are only great deals if you can get funding.


Source
Rents have been on the rise, and the only way they will moderate is by increasing supply - bringing in capital.  Yet, these articles routinely paint capital as the enemy.  But the lack of capital is what is driving up rents.  Residential investment in new single family homes is well below any levels in the decades before the financial crisis.  The affordability problem certainly isn't due to too much investment.


Every home has to be owned by someone. If, as a matter of public policy, it can't be the tenant, then it's going to be an investor.  Presumably, New York could only have become such a great city because it was a place that welcomed change, that welcomed newcomers, and that welcomed the capital needed to house them.  How else could it become a metropolitan center with 20 million people?  Those days are in the past.  An early step in that trend was the implementation of zoning laws that led to the condemnation of tenements that housed the newcomers.  Today, these articles suggest that one is expected to apologize for fixing dilapidated units or for becoming a new resident in a long-growing city.  This is not a frame of mind that will help maintain affordability in Atlanta or regain it in New York.  A primary challenge for the twenty-first century economy is that many of our legacy economic centers now fail to perform the most basic function of an urban center – to attract and house people.  We can’t let New York spread that pathology to cities like Atlanta.

Saturday, March 21, 2020

An article at Politico about letting banks help pump some cash into the pandemic scarred economy

Here is the Mercatus Center version:

https://www.mercatus.org/publications/covid-19/get-cash-more-families-need-it-now-give-banks-more-discretion-make-home-equity

Here is the Politico.com version:
https://www.politico.com/news/agenda/2020/03/21/how-mortgages-can-ease-the-downturn-140317

An excerpt:
Certainly, the 2008 financial crisis has created some reasonable fear about mortgage lending. But the dangers that were present in 2008 are not present today. There aren’t millions of recently purchased homes in cities where prices have suddenly doubled in a short period of time. Most borrowers will be long-time homeowners who braved the worst housing market in nearly a century and managed to hold on. In other words, unlike the housing bubble, these borrowers won’t be na├»ve new buyers speculating on a frenzied market; they will be established homeowners seeking financial safety during a pandemic. If ever there was a time to suspend the post-crisis regulatory framework, that time is now.

Thursday, March 19, 2020

The current issue of the National Review focuses on housing.

I have the cover article in the current issue of the National Review.  The issue includes a few good articles on the housing affordability topic.


Here's the conclusion:
The best solution to the entire problem is greater access: freer and more-open markets, in both mortgage-funding and urban land use. 
The financial return on owning a house should come mainly from its rental value, not from excessive capital gains. That should be enough to make owning a home worthwhile. If it isn’t enough, more people will choose to rent, rents will rise, and so will the rental value of homes and the financial return on homeownership.
Today, families are not necessarily choosing to be renters. Many are renters even though it would be worthwhile to them to own their home if they could. Rents are rising just about everywhere today because we have eliminated choices. 
Solve the problem of access, and affordability will follow. Choices are the key to the goal of affordability and fairness. We need to make more of those choices legal again. 

Friday, March 13, 2020

Long Term Yields as a call option

A long time ago, I played around with the idea that when yields are near zero, forward yields act more like call options on future interest rates than unbiased market expectations of future rates.

The second half of this post.

And here I discuss the idea.


What this means is that there is an unreliable relationship between long term yields and uncertainty.  That is because there could be uncertainty about the business cycle, or rising concern about a contraction, which would normally cause rates to decline.  But, there could also be uncertainty about the various potential states of the future.  For instance, let's say that the marginal expectation for 5 year forward rates is 0.5%, with a standard deviation of 0.5%.  What if there is a change in uncertainty that, somehow, leaves the marginal expected rate the same, 0.5%, but increases the standard deviation of that expected rate.  Since all of the expected future rates that were already below zero would still all just be truncated at zero, this would actually raise the market rate, because in those future scenarios where rates are higher, they wouldn't be truncated at zero.

In the chart here, think of each forward rate as the expected value of a range of potential rates, shown here as normally distributed expectations.  But, those distributions are truncated at zero.  The expected value of all potential scenarios would be higher than the median value because every value below zero would only count as zero.

Basically, this is just like a call option.  Call options can rise in value because, either (1) the expected future price of the underlying security increases or (2) the variance of expectations about the future price increases, making expected positive outcomes more valuable.

Yields have had some strange behavior this week, and I wonder if this could be part of it.  In options speak, maybe long term expected rates have been falling but with higher implied volatility this week.

I have been wondering when the right time is to sell long bond positions.  Earlier this week might have been the best time.  But, I suspect, because of this effect, when there is a positive shock from a Fed announcement or something that signals optimism to the market, the initial effect may be that interest rates decline quite a bit because there will be more certainty about the future economy.  I doubt that there will be a strong force pushing actual rate expectations much higher in the near term.  The net effect may be that the first move in long term rates will be to settle at a lower level that is actually more in line with what expectations are now, but which market prices are now biased away from due to uncertainty.

Treasury markets seem a bit unable to perform price discovery this week, and I assert that that is evidence in favor of my hypothesis.  If the Fed can get Treasury markets to calm down, long rates might decline.

One side effect of this would be that, if the Fed announces some big stimulus that calms markets, that should trigger declining long-term rates, and that will make it look like the Fed creates stimulus by lowering rates all along the yield curve.  I think that is not a useful way to think about Fed policy.  Stimulative Fed policy should cause the long end of the yield curve to rise.  In this case, it could very well cause median expectations of future rates to rise from 0% to 0.4%, but simultaneously reduce uncertainty so that the market rate falls from 1% to 0.6%, or something.  That would give a false statistical signal about how Fed policy affects the yield curve.


Disclosure: long UBT

Monday, March 2, 2020

February 2020 Yield Curve Update

Well, this month appears to have presented the triggering event that will tip the Fed's hawkish bias over the tipping point.  It seems likely now that the Fed will chase the natural rate down to zero from here and there will be some sort of traditional contraction or recession related to the cycle.  In other words, in the second chart, we should have hoped for the dots to move up, but instead, they will likely move sharply to the left.  That chart uses monthly averages, so the 10-year yield is already well below the February point (in red).  The Fed is expected to announce an emergency rate cut.  Obviously, they should.  But, unless sub-1% short rates somehow leads to the 10 year moving up to 2% or 3%, there will likely be some period of economic contraction before rates increase again.

That means there probably still are some gains to be wrung out of a long bond position.  Regarding the other asset classes, however, housing looks increasingly bullish, and is relatively defensive in the current context, so I don't think there is much to fear in real estate.  And, equities certainly could decline, maybe even enough to become a legitimate bear market, but it is possible that they won't decline precipitously.  I think the jury is still out on that, though whatever the indexes do, this will likely be a trader's market for a while.  At some point, beaten down stocks will present long opportunities.

That relates to one bright spot in this month's update.  The yield curve has been inverted at the short end since early 2019.  The date of the expected rate low point had been September 2021 for a while.  As the last chart shows, we seem to have been moving toward that date, suggesting that there has been enough momentum in the economy to get back to a normal yield curve eventually.  But, the curve has been flattening lately, and it looked like it might tip back to December 2021 or even March 2022, which would suggest that we aren't really moving closer to a normal yield curve and that, as with the periods between QEs, more Fed loosening would be necessary to kick rates up over time.

But, with the corona virus dust up, even though yields have dropped down significantly, much of that has been at the short end.  In other words, markets expect the Fed to react.  So, even though most indicators in the past week have been negative, the yield curve has actually tilted up a little bit, and now the rate low point has moved to June 2021.  In other words, the negative thesis has probably been confirmed (We will proceed through a standard yield curve related contraction.) but as we proceed through the contraction, the market expects the Fed to be nimble enough to prevent it from being too deep or long-lasting.  I hope that's the case.






Disclosure: I have long positions in HOV, VNQ, and UBT.

Wednesday, February 26, 2020

Housing: Part 362 - All residential investment flows to consumer surplus

There is a hypothesis that I would like to dig deeper into in the long term.  Looking at the long-term data on residential investment and personal consumption expenditures on rent, I would argue that all residential investment flows to consumer surplus.  This makes real estate somewhat special as an asset class.

For example, if investment into communications technology increases, we would expect that to be related to a shift in more spending on communications tech.  More investment in railroads vs. airports would be related to more subsequent spending on rail travel vs. air travel, etc.  You build stuff and then people use it.

But, the odd thing with real estate is that our consumption of it is highly sensitive to our incomes.  We will tend to spend x% of our incomes, on average, on rent expenditures (both imputed and cash) regardless of whether, in our time and place, that spending gets us 3,000 square feet or 1,000 square feet.  In fact, spending on housing is a bit inelastic, so that, if anything, in times and places where x% gets us 1,000 square feet, we spend more for it than we do in times and places where x% gets us 3,000 square feet.

In terms of national accounting, residential investment and rental expenditures appear not to have much correlation at all.  For instance, we are spending more of our domestic incomes on rent than ever today, but we are at the end of a decade with basically no net residential investment after accounting for depreciation of the existing stock of homes.  We spend more because we invested less.

This has important implications for how we think of real estate vs. other assets.  All residential investment leads to consumer surplus.  That doesn't mean that new units are given away for free.  It means that when profitable new units are built, they reduce the rental value of the existing stock by at least as much as the added value of the new unit.

Take a look at San Francisco over the past 20 years or so.  Basically, compared to other areas, its real estate values have doubled.  This clearly is the result of restrained supply.  At some level of new supply, prices there could have been maintained at their 1997 levels, relative to other places.

Compare San Francisco to Austin. The population in Austin from 1997 to 2019 roughly doubled from about 1 million to 2 million.  San Francisco went from about six and a half million to just under eight million.  The relative median home price in Austin stayed about the same while San Francisco doubled.

How much building would it take in San Francisco to get rid of the excessive rents that are due to supply constraints?  What if we doubled the size of San Francisco?  What if it was now home to almost 16 million people?  That would have been a massively different 20 years.  That's building and growth at roughly 6 times the growth rate San Francisco allowed.  Would that be enough to eliminate the supply constraint and take two or three percentage points a year off of rent inflation?  Would it even take that much building?  Maybe only adding enough units to grow by 4 million would be enough to bring prices back down to the initial norm.

The simple math here is that if doubling the size of San Francisco would mean that prices drop back to normal, that means that trillions of dollars in residential investment would have no effect on the total value of all residential real estate in San Francisco.  They would have twice as many homes but they would all be worth half as much. So, the total value would be the same.  All those trillions of dollars would be claimed as consumer surplus in the form of lower rents.


In markets with elastic supply, there is a fairly steep decline in marginal utility.  The 3,500 square foot house just doesn't add that much value compared to the 3,000 square foot house. In those markets, that is probably the most important factor that creates an equilibrium between the cost of building and the willingness of buyers to build more.

This is a reason why real estate makes a useful tax base, and why property taxes have the potential to be an effective public revenue producer while homeowner income tax benefits are not very useful.  Those tax benefits basically induce homeowners to live in 3,500 square foot houses that they don't really value much more than they value 3,000 square foot houses, and property taxes leave total rent expenditures about the same, but those expenditures only buy 3,000 square feet instead of 3,500 square feet - again, a difference that doesn't amount to much for consumers with steeply diminishing marginal utility.

On the other hand, if the location of a unit in San Francisco makes it worth $5,000 per month, then tax effects that provide a 20% subsidy to that spending will just mean it is worth $6,000 per month.  Subsidies to housing in Austin would have to work through added residential investment while subsidies to housing in San Francisco simply flow to the bottom line of the real estate cartel members.

I am just spitballing here, thinking about this idea.  Input is welcome.

Monday, February 24, 2020

Housing Part 363 - Did increasing debt cause rising home prices?

I've been playing around with some data on home prices, debt, and construction employment, by state.  First, here is a graph covering 4 distinctive periods of time, comparing changes in home prices to changes in construction employment. (The construction employment measure I am using is the proportion of state employment that is in construction. So if at the start of the period, 5% of the state employee base is in construction, and at the end of the period it is 6%, that registers here as a 20% increase in construction employment.)

Note that there is a surprisingly stable relationship here, throughout the different phases of the boom and bust.  This includes states like California and states like Texas. (Here, I am using the 11 states for which the New York Fed publishes quarterly per capita debt statistics.) There is truly a supply response to rising prices that appears to be generally universal across geography and across time.  The problem, of course, is that in the Closed Access areas, the base level of construction employment is very low and prices are very high, so these relative changes unfortunately are heavy on price changes and light on construction changes.

Source
This is all well enough as it is.  What I would like to reconsider today is the role of debt in this relationship.  Generally, this relationship is taken to be obvious.  Here is a graph comparing home prices and mortgage levels.  Before the crisis the relationship seems unassailable.  Before moving on, I suppose I should point to the obvious divergence after 2011.  Should that give us pause regarding this relationship?

If I was to, say, suggest that, rather than having had a housing bubble, we had a moral panic about lending, which created a one-time 30% or so drop in home values because the new lending standard added a sort of liquidity premium to home equity investments, so there was a one-time price shock then prices continued upward reflecting fundamental value.  Wouldn't a graph of that event look exactly like this?  I have added Canadian data here for a counterexample.

One problem here is that there is no controversy about the potential for a lack of liquidity to push prices lower.  Home prices would go even lower if we made mortgage lending completely illegal. But that doesn't generalize to prices above a reasonable, liquid equilibrium.  The fact that more generous lending today would cause prices to rise (reducing the liquidity premium on the yield earned by real estate owners) doesn't mean that more generous lending would lead to an irrational increase in prices.

Given current interest rates, US home prices are clearly very cheap compared to rents in most places.  Here is a graph of construction employment, mortgage affordability, and rent affordability in Atlanta.  In 2008, a bunch of construction workers were laid off, and homes went on a 30%-off sale.  At the same time, the FICO score of the average borrower shot through the roof.  Lending tightened dramatically.  These market shifts are so extreme, the only reason that the shift toward affordable ownership vs. renting isn't the most talked about issue of our day is because when the body of canonized wisdom is incorrect, it literally blinds us to reality.  You can't see things that you can't look at.  An example I use is that we don't question gravity after watching a magician levitate.  Gravity is canonical. That's fine. Gravity appears to be a true concept. Making it canonical saves us loads of time and effort. But, if we believed that some people had special powers to call on angels to lift us into the air - if that was canonical - we would leave the magic show with a deeply confused and dangerous confidence about how the world works.  Why bother looking to see if there were ropes or hidden platforms? Obviously the guy called on some angels.  You could be like, "But, mom, I saw a cord attached to a harness.  That's how he did it." And your mom would get angry. "What an insulting thing to say about a man who has power over angels."

But, let's leave that all aside.  Let's look at the bubble period.  This graph compares rising debt levels and rising prices between states.  Similar to the first graph above, but the y-axis now is the change in debt rather than the change in construction employment.

Before the crisis, there was only one 2-year period (from the end of 2003 to the end of 2005) where there was any relationship at the state level between debt and home prices.  From 1999 to 2003, debt rose at about the same rate in all eleven states.

One intuition we might have about that correlation is to say, well, sure, we should expect that.  There was a mortgage bubble, and in places with inelastic supply, prices went up, and in places with elastic supply, they built too many homes.  But, remember the first graph.  The change in construction was positively correlated with rising prices, not negatively.  Debt in states like Ohio and Michigan was not related to a significant rise in construction or prices.  The only state that is an outlier from 1999-2003 was Texas, which saw debt rise at a lower rate than most other states, even though Texas had a healthy building market.

One problem is that the canonized narrative is a hodge-podge of different stories.  They all make sense as individual parts of a broader narrative that properly puts supply constraints and rising rents at the center of the story. But, they really don't fit together well within the canonized narrative.  The idea that households were both desperately cashing out housing ATMs and also engaging in a bidding war on entry level housing is a tough pair of assertions to pair up.  I think there is some truth to both stories, but the true version makes more sense if we remove the presumption that the "big story" here is debt leading to an unsustainable price bubble.  The price bubble was largely an equity bubble.  Where mortgage debt increased, it was generally where there was a combination of available home equity and declining rates of local economic growth that caused demand for liquid assets.  So, until the end of 2003, prices were unrelated to levels of debt.

From the late 1990s until 2008, mortgage debt increased from about 43% of GDP to 73%.  From the end of 2003 to the end of 2005, that figure increased by about 8%.  So, 8% out of 30% of the rise was associated with rising home prices, at the state level.  Even there, that doesn't mean that the entire increase in home prices during that time was caused by expanding mortgage issuance, but at least it's plausible that some of it could be.  Now, it could be that the 6% increase in mortgages/GDP after 2005 was recklessly underwritten and ultimately destabilizing, but it had nothing to do with rising home prices.  And, much of the 16% increase that happened before 2004 happened in places with neither unusually rising prices nor rising rates of construction.

It is likely that much of the correlation even in 2004 and 2005 between debt and price growth is a lagged reaction to the price growth of the previous few years.  Buyers requiring more debt to buy more expensive homes and homeowners having more access to home equity.  That makes debt a lagging factor.

That clearly is the case during the period from the end of 2005 to the end of 2008, which was characterized by declining prices while debt was still increasing.  During that period, the relationship between changes in prices and changes in debt became negative.  That is because both declining prices and increasing debts were largely the product of prices having been driven higher before.  Prices had more room to drop and homeowners had more equity to draw on during the early recession period.  At least, until prices collapsed so much and lenders pulled back, so that they didn't have access to equity any longer.

Then, after 2008, there really was a highly positive correlation between rising prices and rising debts, or, more to the point, declining prices and declining debts.

The subsequent events and the policy postures that they called for take on a much different hue if causation largely goes from rising prices to rising debts than if causation largely goes from rising debts to rising prices.  Unfortunately, we went all in on the latter when the case for it was not necessarily strong.

Thursday, February 20, 2020

Housing: Part 362 - The Odd Case of the Elites vs. the Masses

It is strange that a rant from Rick Santelli delivered from the floor of the Chicago Mercantile Exchange, where he was being cheered on by a bunch of securities traders, is referenced as the founding moment of the Tea Party.  Wall Street style trading floors aren't usually associated with populist anti-Elite moments.



But, the strangeness doesn't end there.  He's complaining about a new Obama proposal to modify mortgages for struggling homeowners.  Now, I'm not necessarily a huge fan of the modification idea.  What really would have been better would have been to stop the horrendous combination of tight monetary policy and newly very tight lending which would have helped to stabilize housing markets.  It's a very distant second-best plan to keep pounding down on housing markets and then to construct some sort of program contrived to help and/or hurt various actors affected by the process.  It's like tying concrete blocks to a guy's ankles, pushing him off a boat, and then throwing him a lifesaver.

But, it's just so odd that there was so much anger toward speculators and banks that it was considered populist to wish that people would lose their homes.  The elites didn't dare to suggest that home prices should stabilize or that part of the solution should be stabilizing the lending market so that people who could have been borrowers for much of the past few decades could still get loans.  But, they did dare to suggest finding ways to keep families in their homes, which caused Santelli's ire.

Here's the kicker.  Most of the damage done to working class home equity was done after the Santelli rant.  Since punishing homeowners and tying the hands of lenders was the rallying cry of the day, low tier home prices crashed in the years after the Santelli rant.  From February 2009, when he made his appearance, to early 2012, home prices in low tier Atlanta neighborhoods, for example, lost about 30% of their values - about twice the decline they had experienced before February 2009.  None of that drop, especially after February 2009, was inevitable, natural, helpful, or an unwinding of anything unsustainable that had happened before.

What percentage of the homeowners in those neighborhoods had bought their homes in 2006 and 2007 with inappropriate mortgages?  A couple percent?

Santelli and his trader friends were very concerned about moral hazard.  "Don't throw the lifesaver to the guy with the blocks around his ankles! If you do, he'll never bother to learn how to swim!"

What's the opposite of moral hazard? Sadism?

Jim Cramer also had a famous rant on CNBC. It was more timely, prescient, and would have been helpful to those Atlanta homeowners.  About the same time that Santelli was ranting, Cramer was being hounded by Jon Stewart and others for being one of the elites that caused this mess.

If only we were better at choosing our populist champions.  Instead, American populists are complaining about what big paddles the elites have, after spending a decade bending over and yelling, "Thank you sir, may I have another."  It seems to me that a reason that a crisis happens every now and then is because every now and then a crisis becomes inexplicably popular.

Thursday, February 13, 2020

January 2020 CPI Update

Nothing to really say here.  Shelter inflation continues at 3+%, non-shelter core inflation keeps muddling along at about 1.5%.  There is nothing particularly unsustainable about this, regarding the business cycle.  It's just a continuation of the sign that the Fed is erring toward hawkish.  There is room to loosen and avoid contraction. But the odds are probably on the side of eventually having some real shock that pushes us into recessionary conditions, or at least falling yields.