Monday, April 22, 2019

IW on the web

Tech entrepreneur David Siegel has an interesting and thorough post up at that is a sort of reference point to cutting edge or wise thinking on a vast array of topics.  One reason I am posting a link here is because David kindly includes the work of Scott Sumner and myself on the financial crisis and the housing bubble, prominently, as work that should be read and understood.

Regarding our work, he begins with:

Understanding the Great Financial Crisis

A good way to see the storytelling effect is to look at the “common wisdom” of the Great Financial Crisis of 2008/9, an event that impacted every person on earth and destroyed a billion jobs. Almost everyone got the story wrong. Michael Lewis’s book and movie, The Big Short, was popular but completely missed the true cause and effect. So did Niall Ferguson and many experts.
In reality, two people — Kevin Erdmann, an investor and Scott Sumner, an economist — have shown that the “common wisdom” does not fit the facts. Using the scientific method and hard evidence, they show that the GFC was a result of bad reactions to scarce resources

I appreciate David's support and his willingness to consider this new point of view.  But, in addition to that, his post can be fruitfully used as a starting point into inquiry in a number of topics.

He lists my book "Shut Out" as an "advanced" reading.  For those visiting IW from David's post, if you don't want to dive into a long tome of "advanced" reading on the topic, here are a couple of shorter pieces that may get the ball rolling.  I'm not sure they are any more accessible, but they are much shorter, and introduce the basics.  (My writing tends to be analytical rather than narrative, but I don't think you will find any of my work to be nearly as difficult as, say, the typical academic article in an economics journal.)

Housing Was Undersupplied during the Great Housing Bubble

The Danger in Using Monetary Policy to Address Housing Affordability

Thursday, April 11, 2019

March 2019 CPI Inflation

Here are the updated inflation numbers.  Non-shelter core is down to 1.1%, shelter is still at 3.2%, and core CPI inflation is at 2.0%.  As IW readers know, the reason this is important is that (1) shelter inflation is largely an imputed figure of rental values of owned homes that involve no cash transactions and, (2) in the era of Closed Access, in some important markets, these transfers have little effect on production.

This is the setup that I worry will cause the Fed to be behind the curve.  They believe that merely stopping the rate hikes will be enough.  Of course, in this context, the inverted yield curve is also a bad sign in this context.

It's not so much that 1% inflation would be an automatic disaster.  I'm not even sure it's a great recession indicator.  It's more a problem of being shielded from timely cyclical developments because of misreading the measures that should lead to shifts in policy trends.

It seems that, along with the Great Moderation, has come a peculiar Fed behavioral tick, where the Fed Funds rate is held for some time at a plateau, which is followed by a contraction.

Monday, April 8, 2019

Real Phillps Curve Update

Here are a couple of charts comparing real wage growth and unemployment.  My contention is that the Phillips Curve is real, not inflationary.  It only appears to be inflationary when monetary policy is procyclical.  When unemployment is low, real wage growth is higher, largely because of better matching, fewer frictions in labor markets, and higher labor productivity.

If we treat the Phillips Curve as nominal, then the inclination is to reduce growth to prevent inflation, and unemployment will be invariably driven higher in a misguided attempt at moderation.

If we treat the Phillips Curve as real, then the inclination is to celebrate low unemployment unconditionally, and allow the benefits of highly functional markets to continue to accrue.

There is a relatively stationary long term relationship between real wage growth (I prefer using CPI less food, energy, and shelter as the deflator) and the unemployment rate.

We shouldn't be afraid of real wage growth.  And, in either case, wage growth is humming along pretty close to the long-term trend.  Celebtrate that unconditionally.

Wednesday, April 3, 2019

Housing: Part 348 - How Affordable Is Housing?

The other day, I looked at Price/Rent ratios over time in various cities.  In Dallas and Atlanta, by this measure, prices have been relatively similar in 1998, 2006, and 2019, but they were extremely low in 2013.  Other cities I looked at were more mixed.  Prices looked high in 2006, and generally looked higher in 2019 than they had in 1998 or 2013.

Here, I will look at the same cities, in the same way, but here, I am looking at mortgage payments/rent payments, which is another way to think about affordability.

A couple of caveats:
1) Here I am using the 30 year conventional mortgage rate, but I am applying it to a 100% loan-to-value.  I know that's not realistic as a mortgage product, but it's a way to get at the relative value here.  I don't want to give the buyer a 20% advantage just by assuming a down payment, but my point here isn't particularly to look at mortgages with higher spreads.  In any case, it is the relative values over time that are informative, so this shouldn't matter that much.

2) All data is from Zillow.  (Zillow rocks.)  But, they only have rents back to 2010, so 1998 and 2006 are estimated rents based on metro area level affordability measures and prices.  It probably doesn't matter that much for 2006, but 1998 might be taken with a few grains of salt.

Looked at in terms of mortgage payment/rent payment for a house at a given price level, housing affordability for buyers is well below levels of 1998 and 2006.  For instance, in Atlanta, in 1998 or 2006, the mortgage payment on a $160,000 house would have been similar to the rent payment.  In 2013 and 2019, the mortgage payment on a $160,000 house would be about 60% of the rental payment.

By this measure, even in 1998, mortgage affordability would have been pretty good.  Price/rent was near long term lows and mortgage rates had been high since the 1970s.  By this measure, home prices are well below historical norms, and for buyers of those homes, there is little interest rate risk, because the homes are already priced at a discount when taking interest rates into account.

People who are complaining that loosening lending standards will push prices up to levels that hurt affordability have a (somewhat) plausible point.  But, this measure is why I think that they are applying that point at a standard that reflects their own preference for tight lending more than it reflects a half century of American homebuying norms.

Also, of course, it is noteworthy that from 1998 to 2006, mortgage affordability improved in Dallas and Atlanta.  That's what an elastic housing supply does for you.  On the other hand, in this measure, it was only the high end of Dallas and Atlanta that became more affordable.  One could argue that this is a sign of loose lending.  On a Price/Rent ratio level, prices in Dallas and Atlanta rose fairly proportionately.  But, if we think of Rent/Price as a sort of yield on housing, the yield is higher on low end homes, which means that their prices should be less sensitive to changing risk-free rates.  (Going from 9% to 8% has less of an effect on price than going from 4% to 3%.)  So, prices should rise less because of falling risk-free yields in low tier homes than in high tier homes.  If these estimates are accurate, though, it appears that low tier prices in those cities were more sensitive to changing interest rates, so that falling rates increased prices as much as they decreased the mortgage payment. (Although, keep in mind, the 1998 data I am estimating here wouldn't be dependable at that level of granularity.)

Here is San Francisco, too.

One interesting pattern here is that mortgage/rent ratios are pretty similar in every city.  For instance, a $160,000 home in every city would have a mortgage/rent ratio of somewhere around 50-60%..That's the case from Dallas to San Francisco.  Of course, there aren't many $160,000 homes in San Francisco.  But, the pattern is curious.

Tuesday, April 2, 2019

March 2019 Yield Curve Update

Since the zero lower bound distorts the yield curve at very low rates, an inverted yield curve at low rates is worse than an inverted yield curve at higher rates.  This is a reason why the curve didn't invert in the 1950s.

The necessary adjustments here could be made either by just looking at the short end of the curve, recognizing that the long end of the curve will have a bias for a positive slope. Or, it could be estimated with a regression of the depth of the inversion in the various economic downturns that have happened since WW II.

Here are visualizations using each estimate.

In the Eurodollar market, the inversion of the short end is very deep.  Today rates bounced up a bit.  They will do that.  In the post-WW II era, though, even though rates seem to bounce around within the inversion, yield curve normalization has only happened when the short end rate has been lowered.  At this point, I have a fairly strong expectation that short term rates will be well below 2% before 2021.

The estimate using the 10 year minus Fed Funds spread also has us well into inversion.  As this graph shows, in 2006 and 2007, the 10 year rate moved up and down without normalizing for some time, then, when the Fed finally lowered rates, the entire curve came down.

The inversion from early 2006 to summer of 2007 was especially extended.  I think the Fed was already sucking cash out of the economy far to aggressively for that whole period.  The housing boom is what delayed contraction, because many households could access their home equity for liquidity.  Lending was still growing at something close to double digits even into mid 2007.

Today, this source of liquidity is not significant.  Mortgages are growing at low single digits, if that.  Home equity is still declining.  General bank lending is at around 5% annual growth.  So, I expect falling rates to come sooner this time.  But, admittedly, I was surprised by a rising yield curve after the Fed raised rates in 2015, so my credibility on this point is worth the monthly subscription price to this blog.

Whatever else happens, this is definitely an inversion event at this point.

Friday, March 29, 2019

You can't solve a housing bubble with tight money, but you can cause a crisis

Here is a brief I wrote that Mercatus recently posted.  I don't think I've posted it here yet:

The gist:
But note that while the consumption of these newly wealthy real estate owners was inflationary, there is little that monetary policy could have done to change that. In other words, they were using newfound wealth to claim an additional 1.3 percent of GDP for their own consumption, according to Mian and Sufi. That claim on current consumption would remain whether the Fed produced 10 percent inflation or 2 percent deflation. In fact, as the United States discovered in the end, the only way for monetary policy to affect that claim on current consumption would be to allow disruptions in capital markets to become so severe that these rentiers would not be able to access their wealth. The future rental value of their homes has not changed. That future rental value is a product of high demand for living in cities with restricted supply of housing. Monetary policy can’t fix that. It didn’t fix it. Rents in the Closed Access cities are at least as high as anyone might have expected them to be in 2005. The only thing the housing bust accomplished was to prevent the value of those future rents from being fully capitalized into home prices after 2007.

If, before the housing bust became catastrophic, monetary policy within a functional range could not change the ability of these rentiers to claim more current production, then what economic adjustments must happen to satisfy their new consumption demands? If these rentiers were claiming 1.3 percent of additional GDP, where was it going to come from? If they were increasing their current consumption but not their current production, the gap must be met somewhere. Either other Americans would have to reduce their consumption by 1.3 percent of GDP, or an additional 1.3 percent of GDP would need to be imported, or some combination thereof. That had to happen regardless of the stance of the Fed.

Housing: Part 347 - Price/Rent Ratios over time

Here are some graphs of price/rent ratios, by zip code, for several metro areas.  (All x-axes have the same 2013 rental value, while the y-axes represent the estimated price/rent ratio for each year.)

The data is from the inestimable  Price/rent ratios before 2010 are based on my estimates, using price and affordability data. (Except the first graph, where the x-axis is price, and it changes over time.)

This relates to one of the points I made in Shut Out, that the positive relationship between Price/Rent and a range of other measures (price, rent, income) means that you have to be careful attributing rising prices in low-tier zip codes to easy credit.  In the few metro areas where low tier prices did rise dramatically, I contend that this was really the result of high tier prices levelling off because there is a maximum price/rent level within each city.

Comparing LA and Seattle is useful here.  Low tier prices didn't rise at a different rate than high tier prices during the boom in Seattle.  But they did in LA.  Here, comparing LA to Seattle, we can see that the crescent shape of the Price/rent pattern was the same in both cities throughout boom and bust.  The difference is that homes across LA had gotten so expensive by 2006 - more than $400,000, even in the lowest quintile of zip codes - that by 2006, the P/R on low end homes was close to high tier P/Rs.  In 1998, Quintile 1 P/Rs in LA were about 7x (!), less than half Quintile 5.  In 2013 they were a little more than half, at 12.7x.  In 2006, they were within 17% of the peak P/R at 25x.

In Seattle, the peak P/R was 28x, not much lower than LA.  But, rents, and thus prices, are much lower in Seattle, so Quintile 1 P/Rs only went from about 70% to 75% of Quintile 5 P/Rs.  The ratio started much higher than LAs but didn't move much.  That is because prices in Seattle never went high enough for more than a small portion of the market to hit peak P/R levels.

Following are scatterplots of P/R against annual rent value.  In the updated 2019 numbers, P/R ratios across Seattle have moved higher than they are in LA for any given rental value.  But, since rents are lower in Seattle than they are in LA, the metropolitan median P/R ratio is still a little lower in Seattle.

Phoenix and Miami both seem to have seen some recovery at the low end.  They seem to contradict my claim that low end markets are underpriced.

Dallas and Atlanta are interesting.  Atlanta has partially recovered and Dallas has fully recovered to peak P/R levels, generally across the metro.  This also contradicts my claim that low end markets are underpriced.  I might have been able to say that in 2013 about both the cities and the low end within the cities.  But, not now.

This is a great example of how the premises determine the conclusion in a way that I am not sure can be resolved.  First, note that by this measure, in both Atlanta and Dallas, there was absolutely no sign of excess prices in 2006 and the collapse to 2013 was outrageous.  That would be the case even if you believe that home prices should not be sensitive to real long term interest rates.  Long term inflation protected treasury rates dropped from 4% in the late 1990s to about 2% in 2006 and are now near 1%.  Yet, in Dallas, at all three points, price/rent ratios were similar.

Now, if home prices aren't sensitive to rates, you might conclude that prices look reasonable in Dallas today.  But, you would also have to conclude that prices were reasonable in 2006 and that they were outrageously low in 2013.

On the other hand, you could argue that home prices should be somewhat sensitive to interest rates, and so prices in Dallas have been undervalued both during the bubble and after the bubble.  Or, taking all cities into account, it seems reasonable to conclude that home prices are sensitive to real long term interest rates, and where supply is elastic, supply increases rather than price.  Where supply is inelastic, price increases rather than supply.

If that is true, though, then cities with moderate or low price/rent ratios today should be building like crazy and rents should be declining.  Instead, building is tepid and rents are climbing.  I blame that on tight lending.  But, what if it's really because home prices really aren't sensitive to long term rates?  If that was true, then when rates are low, high land costs would cause building to be tepid and rents would rise.  Price/income would rise too.  That matches today's environment, but it doesn't match the boom period where low rates were associated with building and with moderating rents in the cities with elastic supply.

It seems to me that we have some sort of control over how sensitive home prices are to interest rates.  If they are not sensitive, it seems like an unstable equilibrium.  It is where we are now, with rising rents, rising price/income, but very low mortgage expenses for a leveraged buyer, compared to 1998 when mortgages cost 7%.

In the unstable environment, potential buyers are locked out because mortgage payments may take a large portion of their incomes.  But, in the meantime, so does rent.  And in that equilibrium, it will only get worse.  In the stable equilibrium, the important comparison would be real mortgage expenses vs. renting expenses, which would lead to a negative feedback loop where buyers could bring on new supply, and low rates would naturally help moderate housing costs.

Monday, March 25, 2019

More talkin'

I had a nice conversation with Josiah Neeley of the R Street Institute and Doug McCullough of the Lone Star Policy Institute on their podcast "Urbane Cowboys".

Elsewhere, Emily Hamilton, a research fellow at the Mercatus Center was on the Marketplace Morning Report, on NPR, discussing housing.  (Her segment starts at about 5:20.)  She was there, in part, to discuss a new brief co-authored by her, Salim Furth, and myself.

Also, some readers might be interested in this.  I don't work for this firm, Hoya Capital, but I found out that they just started a new housing ETF that is partially based on some of the same ideas you see here at IW.  The ETF is meant to give investors broad exposure to the housing market in general - including builders, REITS, lenders, etc. - so that investors can gain from a supply recovery in housing, however that recovery ends up being shaped.  That's my brief attempt at describing it, but certainly, if you are interested, you should peruse the details at the site.

Friday, March 22, 2019

Market Concentration

John Cochrane discusses an interesting paper that claims that, while national concentration has increased, local concentration has decreased.  In other words, each location has more competition within various industries, but the competition is more among national chains than among local firms.  So, there top firms claim a larger portion of the national market, but at the local level, consumers have more choices.
What's going on? The natural implication is that the town once had 3 local restaurants, two local banks, and 3 stores. Now it has a McDonalds, a Burger King, a Denny's and an Applebees; a branch of Chase, B of A, and Wells Fargo, and a Walmart, Target, Best Buy, and Costco. National brands replace local stores, increasing the number of local stores.

Thursday, March 21, 2019

Writing and talking

Garrett Peterson kindly asked me back on the Economics Detective podcast.  It's always a pleasure to chat with Garrett.  The podcast is here:

And, here is an op-ed in the Los Angeles Daily News:

Claiming that building more L.A. housing would only benefit newcomers misses the point. The newcomers are coming already, and they aren’t waiting for L.A. to build them homes. Rest assured, until the rate of new building is increased, the homes that those newcomers will take will still be provided, quietly and sadly, one unit at a time.