Tuesday, September 15, 2015

Housing Tax Policy, A Series: Part 61 - Strong prejudices and imposed malaise

A few days ago, I happened to be listening to NPR's "Morning Edition".  The show's introduction was:
Here are two major effects from California's long-running drought.  If you work on a California farm, you are making less money.  If you own a California farm, you may be making more.  We'll report both sides of the equation this morning......
What followed were two stories.  One from a farm with limited access to water, and one from a farm with access to water.

In the first story, they describe the consequences that having a limited harvest has on the workers.  Many acres weren't planted, and those that were have smaller fruits because of the lack of water.  The reason workers are making less money is that there is less fruit.  Though this work is usually paid piecemeal, some farms are paying higher piecemeal rates to help counteract the effect of the poor harvest for the workers who remain.  Nevertheless, these workers live lives on the margin, and they have few resources at their disposal to survive during these challenging times.

In the second story, which directly followed the first story, they describe operations at the farm with water access.  We learn that prices rising due to falling production are helping, though there are signs that they will not remain high.  Further:
While prolonged drought has strained California agriculture, most of the state's farms, it seems, aren't just surviving it: They are prospering. 
The environment, though, that's another story. We'll get to that.... 
farmers in 2014 replaced about 75 percent of their surface water deficit by draining their groundwater reserves.
James McFarlane, who grows almonds and citrus near Fresno, is one of those farmers. He says that drought has been "beyond terrible" for some farmers. But for him personally? "It's been a good year. We've been able to make some money, and you have to just count your blessings and call that a good year," he says.... 
Howitt says that there are two contrasting realities in California agriculture these days. "Some people just don't have the underground water. You meet these people and they really are in poor shape," he says. But where there is water, "you have investors pouring money into planting these almond trees at a rate that they've never seen before." 
But this is also where the environmental damage comes in.

The interesting thing about deeply ingrained prejudice is that it comes from perceptual blinders we don't realize we are wearing.  The prejudice that has the strongest hold on us is the one we wear on our sleeve.  So, the story presents the facts that belie NPR's framing without hesitation.  These stories and the way they were framed are a textbook example of how our biases can control our perceptions so strongly that our perceptions become our biases.  Uncritical listeners will come away from the presentation of these stories with some caustic new perceptions.  Workers are damned if they do and damned if they don't while big-agribusiness gets by just fine, even if they have to destroy the environment to do it.  But, the preconceptions are doing all the work here.

In any volatile economic situation, owners accept the most exposure to that volatility, by design.  Of course, low income workers may be less able to weather volatile conditions, but, for instance, at the water-deprived farms, where workers have less work, the farms will be losing money.  Even in the face of the economic disruption, NPR tells us that some of those farms are raising their piecemeal rates to help workers get by.  In other narrative contexts, where farmers are seen as salt-of-the-earth families, the volatile nature of farming is easy for us to notice.  That story is an archetypal narrative in American culture.  The farms in these stories are only different from those farms in that they may be better capitalized to survive a temporary problem, but they are just as exposed to the vagaries of nature and markets.

So, what we have here is a volatile situation, where at some farms the workers and the farmers are not doing well and at some farms the workers and farmers are doing quite well.  And, in dollar terms, the farmers have both the worst and the best of it, because they accept more of both the downside and upside risk.  NPR sends reporters in to the poor farms and notes the woes of the workers and sends reporters in to the prospering farms to note the success of the farmers. "If you work on a California farm, you are making less money.  If you own a California farm, you may be making more."

The condition I describe is not complicated, nor hidden from plain view.  And, I would believe that the reporters and producers involved in this story had every intention of conveying an honest account of these settings.  I suspect that the self-editing of perception is so strong on this topic that they simply did not notice half of the reality that was staring them in the face.  It's like they were wearing eyeglasses with polarized lenses that filtered out prospering workers and failing owners.

This selective perception creates a motivating set of apparent facts.  For instance, the possible mismanagement of groundwater looks like it is simply in service of speculative gains by corporate farmers.  How differently would we think about the environmental issue if the stories were framed around failing farmers that didn't have water and prospering workers who were working at farms that did?

We have an understandable bias to believe that the cost of labor is always too low and the returns to capital are always too high.  Ironically, it is specifically returns to risk-taking that we tend to deem too high.


These biases play out starkly in the way we conceive of national economic management.  We have few misgivings about creating an upward biased safety net under aggregate wages.  This is effectively the justification for a slightly positive inflation target.  And, it is a good justification. Money illusion is real.  There is no point in fighting it when we have fairly straightforward ways of mitigating it.  So, there is general agreement that polices which keep nominal wage growth safely above zero are probably helpful.  They probably help to minimize unnecessary frictions that would keep labor markets from functioning healthily.

But, these same issues are factors in capital markets, too - especially among low risk asset classes or assets where we have policies that encourage high leverage.  These factors may even be more important when applied to capital, in terms of creating a stable economic atmosphere.  The aggregate nominal value of collateral has its own zero bound problem.  When there is a systemic collapse of nominal collateral values, all sorts of financial transactions and relationships break down.  As with wages, there is an easy solution - manage nominal values with a bias toward slight inflation.

Let's just sit and notice our feelings about that for a second.  Think about your feelings regarding inflation meant to keep many workers employed, who for one reason or another, find themselves with sticky nominal wages that are above the current market clearing wage level.  Now, think about your feelings regarding inflation meant to keep many investors solvent, who for one reason or another, find themselves with collateral valued at less than the debt it is securing.

I submit that, especially if we are talking about a condition where these nominal declines in value are widespread, there is very little difference between those two scenarios.  The main difference comes from our biases about them and our deep, subconscious moral reactions to wage labor vs. capital income.

Imagine if the biases were reversed.  Would we argue that countercyclical monetary policy was dangerous because workers who were routinely rescued from unemployment would become soft and entitled?  Would we argue that workers who are spared the fear of mass unemployment will become irresponsible in their wage negotiations?  Would we complain that 3% inflation was just a bailout of workers?

At the base of the causes of our recent malaise, I lay this bias.  In hindsight and in foresight, monetary and regulatory policy built around the goal of stability would have allowed us to avoid an enormous amount of damage.  Yet, even having seen the damage, can we even suggest in louder than an uncertain whisper that, maybe, just maybe, it would make sense to err on the side of liquidity when aggregate, national home price levels were down 5%, 10%, even 15%?

It is striking to me how much this anti-capital attitude resonates - how much of our peripheral vision is blackened by our moral pique.  Thinking again of farmers, would we feel any moral ambiguity over some historical episode where farmers were losing their land as values declined by 5% or 15% or 25%?  Would there be any doubt about their role as victims in that narrative?

Yet, were homeowners in the recent disturbance qualitatively different than the archetypal farmer in that story?  But, we became so convinced by the path of nominal values (a path that, frankly, was not particularly out of line in our post-WW II experience, even in terms of unsophisticated nominal measures of valuation) that this belonged in the category of "speculation" that we demanded comeuppance and lesson-learning over stability.  The crisis was simply a playing-out of our moral demands over time.  We imposed damage on nominal capital until the damage was so great that it led to damage on nominal wages, and only then could we give ourselves permission to manage for stability.

Our moral demands meant that homeowners, who were mostly middle class families, took a massive hit to our net worths.  We try to substitute "predatory lenders" into the narrative, in order to keep the moral cast of characters coherent, and many find it easy to make this substitution.  But, if we think about this for a minute, it's not a very satisfying substitution.  In effect, it says, it's the lenders' fault that we had to impose this nominal instability on innocent households because if we had managed nominal stability, the lenders would have kept preying on us.

Maybe I am wrong about all the pesky details surrounding the housing boom.  But, I think pointing out that home prices were justified by the present value of future rents, that incomes of new homebuyers weren't unusually low, that the levels of down payments and monthly payments weren't unusual, that defaults seem to have come from price declines instead of from poor credit characteristics of home buyers, and that all of these points continue to be confirmed by rising rents and home prices that are rising with no help from mortgage markets, is sort of like pointing out that a military conquest was ill-advised after thousands of soldiers have died in its cause.  Social reexamination is a long and unlikely process.  This perspective I am laying out may be wrong or right, but in either case it will appear to be antagonistic.

In the meantime, we will continue to notice always that labor is too cheap and capital is too rich.  Those California farms contain either undercompensated labor or overcompensated owners.  This is the complete set of available observations.  Opinions on the Fed appear to come in four categories these days.  Either the Fed is too tight because Wall Street wants to keep wages low, or it is too loose and the de facto cost of living is eating away at wages.  Either the Fed is too loose because Wall Street loves rising asset prices or it is too tight because bankers hate to see the present value of those interest payments eaten away by inflation.  What we all know to be the case is that the Fed is under the thumb of moneyed interests.  We can disagree about the facts that confirm it.

Likewise, either home prices and stock indexes are too high or rents and profits are too high.  Too high.  Always too high.  There will always be a bubble in capital asset markets, the question is only whether the bubble is in their numerators or their denominators.

The alternative might have been to hold the Federal Funds rate at 4% or so back in 2005 and to provide regulatory support for mortgage originations.  Maybe we would have seen inflation reach 3% or 4% while home prices fell slowly in real terms over several years as supply continued to expand.  I fear that a plurality of Americans, even knowing the pain we have endured and even accepting my counterfactual, would choose the path we took - would say that accommodating the continued expansion of homebuilding would have been unacceptable relative to the path we took.

The one complaint about crisis policy that is a guaranteed applause line is to complain that after September 2008, we bailed out Wall Street while Main Street suffered.  Why shouldn't they applaud?  After all, I think I heard on NPR that, even while unemployment remains elevated, many corporations have been reporting record profits.  Ain't that always the way it is, fella?  Ain't that always the way it is?


  1. Great post. Although, usually, it is farmers presented as noble creatures, and of course we have an entire USDA throwing money at farmers...and an entire rural economy federally subsidized...federal water projects, power projects, roads, subsidized airports, subsidized telephone service etc.

    I concur with you that popular conceptions of the Fed are cartoon-like. And yet...is not regulatory capture to be suspected with every federal agency?

    Why did the Fed establish an inflation numerical target, but not a numerical employment target?

    Really, IOER just happens to put money in banker pockets for doing nothing?

    And Fed staffers are paid as if in sinecures--they are insulated from the real economy. In fact, since Fed staffers get step raises, they would be better off in a deflationary economy. So, if we assume that people operate rationally, then it is in the interest of Fed staffers to recommend deflationary policies.

    BTW, I praise your wages post over at Historinhas....

    1. Thanks for the shout out!

      I would expect capture, too, and you're right that we should expect it to be run for the sake of the staff, though that is a small issue in the broad scheme of things, I suppose. But, regarding the banks, if they are captured by them, then they are doing a very poor job of it.

      I would be careful about IOER. I don't think the banks get any significant benefit from it. There are too many moving prices and rates and too much competition for deposits for anyone to grab much in the way of rents, I think.

  2. Kevin-

    A couple quibbles.

    The way banks got their excess reserves was not so much by competing for deposits.

    When the Fed buys bonds from the 22 primary dealers (Goldmans, Nomuras etc), it then deposits freshly minted (digitized) cash into the commercial bank accounts of the 22 primary dealers, and takes possession of the bonds. So the commercial banks get $4 trillion in deposits rather quickly.

    As a digression, some people thus erroneously conclude the Fed has only "swapped reserves for bonds," Not true.

    Little noticed, the Fed also created something called the Primary Dealers Credit Facility, and loaned money to the primary dealers, when they were buying big during QE.

    So, the ultimate bond-sellers got $4 trillion in cash, AND $4 trillion in cash was deposited into commercial banks. One of the strange things is that the Fed has never surveyed bond sellers to find out what they did with their $4 trillion. The Fed talks about portfolio re-balancing, and suspects the bond sellers re-invest, though I suspect they might be consuming a lot also.

    Quibble No 2: Yes, Fed staffer pay by itself it hardly important in a nation the size of the US. But---if a culture is created inside the Fed, where everyone is insulated from the real economy, in fact personally benefits from recessionary deflations, what sort of culture would you expect to evolve?

    As you know, having bias, and then applying high IQs to verify the moral and intellectual righteousness of those biases is common. The Fed has been hiring lots of PhDs for years, is the largest bulk consumer. The "Fedborg" is a bit cartoony, but maybe not that far off...

    And really, they hold a confab in Jackson Hole and have six panel discussions, and all six are on inflation? Not one on aggregate demand? Or Market Monetarism? Really? Fischer give a keynote lecture and mentions inflation 70+ times and aggregate demand once?

    Maybe cartoons understate the extremities found in the Fed.....

    1. Do you have a link for the reserve issue? I'm having a hard time understanding what you are saying.

      Point 2 is well taken, but that is a completely different sort of regulatory capture from the kind usually claimed and from the kind I mention in the post.