Monday, February 29, 2016

Economic Forbearance in America

Here is a post from Brookings on occupational licensing (HT: Arnold Kling) with a striking graph from the White House report on Occupational Licensing (pdf):

As strident as I have become on the housing issue, I could believe that occupational licensing causes more economic stress than housing constraints.  The second graph shows the growth in licensing requirements over time.

I think this issue actually intersects quite a bit with the housing issue.  If you are cutting hair in San Jose, and the rent just got raised to 60% of your income, you've got to make a change.  But, the problem is, your credentials only have value locally.  The barber's license gave you some competitive advantage in California, but it's probably useless if you move to Iowa.

So, now, not only have you been pushed out of your home and your community, but the state has incentivized you into an occupation such that this dislocation will be especially painful.

Also, remember that fluctuations in homeownership have been highest among the younger age groups.  They are also entering an economy that is more defined by credentialism, and their migration patterns, shown above, are affected most strongly.  We really have been taking it to young adults.

I wonder if this is a partial explanation of the migration patterns we saw in the 2000s.  State licenses will apply in Riverside.  So, it might be worth spending 40% of your income on rent in Riverside, even if it means a 20% cut in income.  And, there is some regional reciprocity in licenses, so maybe this means the move to Las Vegas or Phoenix is also valuable, even if the housing contagion is spreading to those cities.  Those states would be much more valuable locations than a state where your license is worthless.

This affects countless sectors - health care, construction, education, personal services.  And, the problem is more acute with two wage-earners.

There is a lot of discussion about the problem in Europe of having a monetary union where there are cultural limits to labor migration and significant differences in local governance and standards of living.  I'm afraid we are moving in that direction without taking notice.  These issues are largely local in nature.  Pragmatically, this adds up to meaningful limits on interstate trade, but it has happened in a piecemeal sort of way.  Death by a thousand cuts.

Thursday, February 25, 2016

Corporations should pay their fair share.

Corporations should pay their fair share.  This is a refrain often heard on the campaign trail.  Believe it or not, the US has the highest corporate tax rate (35% + state taxes, estimated to total about 39%) in the world. Here is a list of corporate tax rates, by country.  In addition to the high rate, the US is one of a few (and shrinking) number of countries who tax foreign income.  Most countries only tax corporate revenue that is earned within their borders.  Even this wouldn't be that big of a deal if the US didn't have extraordinarily high tax rates.  If the US taxed worldwide revenue at a reasonable rate, similar to other countries, then corporations wouldn't have to pay that much after deducting the taxes they have already paid to the foreign countries where the income was earned.

Before we get into the numbers, I just want to consider how weird the public debate on this is.  For instance, the Obama administration has been pushing for capital controls to prevent corporations from moving out of the country to lower tax jurisdictions (which, as noted above, is roughly the entire rest of the world).  Burger King was targeted because they merged with Tim Horton's and moved their headquarters to Canada.  Moving to Canada is now considered a tax dodge.  Literally any business any US corporation conducts abroad can be derided as a tax dodge, because there is nowhere else a corporation could conduct business under a more onerous tax regime.

The usual response to this is that the real rate is much lower because of all the corporate loopholes.  Think about this.  If real corporate tax rates were actually lower, then why would they be moving to Canada?  Either de facto tax rates are low, or there is an epidemic of corporations moving to other countries to avoid high taxes.  Both can't be true.

Here is the White House (pdf: corporate tax expenditures start on page 228) estimate of tax deductions.  In 2015, corporations will pay about $340 billion in taxes.  Corporate tax deductions ("tax expenditures") total about $130 billion.  Of this, about $65 billion (from the White House file) is "Deferral of Income from Controlled Foreign Corporations".  This is the net additional tax firms would pay to repatriate their earnings from foreign subsidiaries.  Note, this is only considered a tax deduction because (1) the US has the highest corporate tax rate and (2) we impose that tax on foreign earnings in a way that most of the developed world does not.  In other words, if we simply mimicked, say, Denmark (23.5% tax on domestic income), US corporations would pay lower taxes and this $65 million would not be considered a tax deduction, because Denmark would have never considered it to be taxable income in the first place.

The next four largest corporate tax deductions are: $11.4 billion on "Deduction for US Production Activities", $9 billion on municipal bond interest, $7.6 billion for low income housing credits, $6.6 billion for expensing R&D activities.  These four, together, account for about half of the remaining deductions, and I think only the $11.4 billion would contain some of what people might generally be imagining when they think about corporate tax loopholes.

As a comparison, the four big individual housing tax deductions (imputed rent, mortgage interest, capital gains, and property tax deductions) total about $218 billion.  The deduction for employer provided health insurance is about $206 billion.

There is support among economists on both the right and left to eliminate (not reduce - eliminate) the corporate income tax and to eliminate these individual deductions.  These changes would, on net, make the tax code more progressive without reducing total revenues significantly.  Some of the housing deductions are much like the supposed deduction on foreign corporate earnings.  They are only considered deductions because we presume to tax them to begin with.

The taxation of rental income from tenants, which is not imposed on homeowners, is a very large and regressive tax expenditure.  This regressive taxation would automatically go away if we stopped taxing capital income.  Some, or all, of any revenue shortfall, in aggregate terms (local, state, and federal) could be made up for with higher property taxes.  Lower income households tend to spend more on housing, so property taxes are still somewhat regressive, but they are less regressive than our current set of capital taxes, which include large tax benefits, like nontaxed imputed rent and deducted mortgage interest, that are aimed solely at high income, high wealth households.  Somewhat higher property taxes would also probably help to alleviate some of the volatility we have seen in housing markets.

Anyone having political debates where they presume that higher corporate taxes are a step toward fairness is simply not engaging with reality.  Our current tax regime compares unfavorably in this regard to every other country on the planet, and doing the exact opposite of that would actually better achieve the end result of creating a more fair tax regime.

Corporate taxes don't fall on the corporation.  After tax capital income has been a very stable proportion of total domestic income for many decades, with various levels of corporate income tax.  The distribution of incomes emerges from an infinitely complex set of inputs which are not significantly changed by a marginal change in corporate tax rates.  Corporate taxes are not particularly progressive or regressive because they don't particularly fall on shareholders.  In these two graphs we can see that total capital income (after tax corporate profit + interest income + proprietor income) is fairly stable over time, after tax profit is more stable than pre-tax profit, and most of the change in capital incomes come from changing shares of interest and proprietor income, not changing tax rates.  Capital income is such a stable portion of domestic income that its level is an insignificant factor in changing wage levels.  And, corporate tax rates have little discernable effect on the aggregate level of after tax capital income.  In short, corporate taxation would not be an important topic on a pragmatic platform for economic prosperity and fairness, and to the extent that it might be a topic, the elimination of corporate taxation would be the policy goal.

The effect of taxes on after tax profits can be seen clearly with municipal bonds, which are one of the larger corporate tax deductions.  The White House estimates this deduction at $9 billion, or a little less than 1% of domestic corporate profits.  So, the accounting for this appears to pull the effective tax rate down by a little less than 1%.  But, this tax deduction isn't a corporate tax deduction.  It is a municipal tax deduction.  Since municipal bonds are tax deductible, they pay lower interest rates, saving money for local governments and agencies.  So, if a municipal bond pays 3%, an equivalent corporate bond will typically pay something like 4%.  This is a well known issue.  So, this tax deduction reduced corporate taxes by $9 billion, but it also reduced corporate profits before tax by something close to $9 billion.  The existence of the municipal bond tax deduction has little effect on after tax corporate income.  Most taxes that are universally applied will have a similar effect.  Municipal bonds just happen to be publicly traded in liquid markets, so that we can see the effect easily.

Here is one more graph, measuring Compensation over time.  The upper and lower bands represent the maximum and minimum share of domestic income that has gone to compensation over this period.  Overwhelmingly, it is the growth rate of total domestic income that raises future Compensation levels, not the relative share, which is fairly stable over time.  And, of course, according to my recent research, both the decline in total growth of domestic income and the decline in relative compensation income to the bottom portion of its long-term range, are largely attributable to our destructive limitations on urban housing expansion.  This is why we don't see an unusual rise in capital incomes in the graphs above.  I didn't include income to homeowners in that graph, and that is the income category that has risen during our recent malaise.

We are the 100%.  Overwhelmingly, our well-being is a product of past growth rates.  Income shares between corporations and laborers are too stable to make much difference in aggregate income levels, and even if they weren't corporate taxes don't have much of an effect on after tax corporate income anyway.  The best tax regime, considering these issues, is the regime that encourages production and growth.  I will leave it as an exercise for the reader to decide if haranguing corporations as they move away to anywhere else in the world to avoid a tax that has little effect on income distribution is a sign of success.

Wednesday, February 24, 2016

Housing: Part 121 - Michigan's Odd Place in the Housing Bust

Michigan keeps strangely popping up in readings about the housing bust.  It's strange, because I don't think Michigan is the place we usually think of when we think about the housing bubble.  Mian and Sufi seem to use it as an example of how low income households were herded into unsustainable mortgages.  Low income neighborhoods in Detroit certainly paint a certain picture in our heads.

They find correlations at the local level between low incomes and home price volatility.  I would expect gentrifying or improving neighborhoods to experience housing gains at the local level in any market, bubble or no.  And, I would expect neighborhoods with a large number of recent purchases to be more vulnerable to a severe price contraction.  I'm not sure how to separate these issues from signals of predatory credit.  Maybe they address this in ways I haven't seen yet.  I haven't looked at all of their research.

Share of mortgages with principal balance exceeding estimated home value: 2009:Q4
Share of mortgages with principal balance exceeding estimated home value: 2009:Q4
Source: San Francisco Fed
But, at the metropolitan area level, Detroit seems like a strange choice as the lead character in the housing bust drama.  Home prices in Detroit were flat during the boom - even declining in real terms.  This is because depopulation was bringing down rent inflation and expected rent inflation.  Housing was becoming more affordable in Detroit.  It is true that this is not a particularly fitting context for some types of subprime loans, according to Gary Gorton, which tend to depend on stable or rising home prices.  So, there may have been some borrowing on inadvisable terms.  But, it seems likely that the housing boom in Detroit was less about high expectations about capital gains than it was about staking an ownership claim in a neighborhood that wasn't dying.

Negative equity was high in Michigan at the bottom of the bust, which does sort of place it in a category with the places that saw sharp price spikes and contractions.  But, on an aggregate scale, Detroit does not show any signs of the boom.

Mortgage affordability was flat, much as in the Open Access cities of the sunbelt, until it fell to extremely low (affordable) levels after the bust.  It seems especially wrong-headed for us to be afraid of mortgage credit when the median household in Detroit could buy the median home with a conventional mortgage and payments would only require 10% of their income.

I think the problem in Michigan wasn't a problem of too much credit.  It was a problem of too little income.  Mian and Sufi describe the early rise in unemployment in northern Indiana because of the failing RV industry.  In this graph, we can see how unemployment in Detroit was elevated during the boom.

In the next graph, we can see that in late 2005, coincident with the inversion of the yield curve, expenditures on new motor vehicles dropped sharply.  The 2006-2007 period was a sort of minor recession with full-employment for the rest of the country, because deprivation was focused on housing.  Homebuilders are spread throughout the country.  And, households either escaped the cost of rising rents by being owners, or experienced the pre-recession recession through higher costs, not through lower wages or the unemployment that tends to accompany negative wage pressures.  But, this was not the case in Detroit, because the pressures on fixed investment and expenditures on durables were focused on Detroit, where there is a concentration of producers.

By the way, to the extent that employment in Detroit is a signal of our hobbled credit markets, the recent tick up is not such a great sign.

The bust in Detroit, therefore, had a different quality than the bust in the rest of the country.  In Detroit, the collapse in incomes clearly came before the collapse in housing market.  If only the rest of the country looked like Detroit, we might have been willing to accept stimulus in 2006 when we could have avoided a crisis.

Here are two maps of foreclosures in 2007 and 2009.  In 2007, the area around Detroit is the core of the foreclosure problem.  Outside of the Detroit area, foreclosures were not elevated at that time.  We can see here that cities like Dallas and Charlotte - pure Open Access cities where building was strong - had slightly elevated foreclosure rates relative to the rest of the country.  But, nothing outside of the Detroit areas, as of June 2007, would create concern.  Remember, the subprime origination market had already collapsed by this time.

In June 2009, Detroit still looks bad.  Places like Dallas and Charlotte still looked about the same as they had in 2007.  But, now, the core of what really became known as the housing bust is clear in Florida, Arizona, Nevada, and California.

In Detroit and its surroundings, there was never a housing bubble.  Price fluctuations were based on localized factors.  And, in that area, the bust happened in the normal way.  Employment and incomes collapsed first and economically stressed households couldn't make their mortgage payments.

The rest of the country was either Open Access, where home prices and foreclosure rates weren't fluctuating wildly, or was Closed Access (or a contagion area), where foreclosures followed after home prices collapsed.

In this last graph, we can see the relative decline of incomes in Detroit.  In 1979, Detroit still had higher household incomes than San Francisco.  From the peak in 1999 to the peak in 2008, the median income in San Francisco increased by more than 23% while it increased in Detroit by less than 7%.  This, despite the fact that San Francisco was the epicenter of the tech sector, the cause of the drop in incomes after 1999.  Median household income in Detroit - nominal income - has only just now surpassed the 2008 level.

In a few decades, when other cities are able to compete and the source of its economic rents weakens, San Francisco may be the blue line on that last graph - a city with homes in search of jobs instead of a city with jobs in search of homes.

PS: pithom makes a good point in the comments that oil prices were rising at the time that auto sales were falling, so that I shouldn't get too excited about credit as a causal factor.  That's true.  Although, Mian and Sufi using the Detroit housing market as a prominent example of the housing bubble in House of Debt remains an oddity in either case.

Tuesday, February 23, 2016

Housing: Part 120 - We are the austerity counterfactual

The other Anglosphere countries generally had a housing boom, like us, but without the bust.  We are the outlier because of the bust, not because of the boom.

Here are graphs from the Economist.  The first is for Home Prices in real terms.  The second is for Home Prices / Rents.  In both cases, the figures are just indexed, and if you look closely, you can see that they understate the price movement of the other countries, relative to the US, in the Price/Rent graph, because they are at lower levels in the earlier years.  This is especially interesting in the case of Canada and Australia.  These are countries known for having nothing but space.  Yet, they have managed to create a supply problem in their housing markets.  The value of dense cities and the seemingly universal refusal to build in them in the Anglosphere countries has led to land, land everywhere, and not a spot to live on.

Before the crisis, we were the winner of the bunch, because we still have Texas, Arizona, etc.  We have some economic opportunity in places willing to build houses.  But, America, of all places, needlessly lost faith in our financial sector, and imposed austerity on ourselves.  Isn't it weird that, in America of all places, even the pundits and economists who rail against austerity seem to only want public debt.  There is near unanimous agreement in this country that we just can't handle debt privately.  No.  With regard to the private sector, we're all in the austerity camp.

Here is a graph comparing household debt, as a percentage of GDP, for Canada, Australia, and the US.  I have used Federal Reserve measures for the US to get a longer time series, but the measure is the same as the one for the other two countries.

The US breaks from the trend of the others after the bust.  This suggests that US household debt levels are about 30% below where they would have been if we had followed the other countries.  I actually think that debt has accumulated everywhere since the bust because the bust has exacerbated the savings glut problem which has pushed interest rates down.  So, maybe if the bust hadn't happened, the other countries would have seen debt levels slightly lower than they are.

But, in any case, US mortgage leverage is about back to the comfortable range it was in before the bust.  We probably need about 30% growth in home values and in mortgage levels to get back to equilibrium values in housing.  It could be that more than 10% is from a real decline in available housing stock because of our decade long homebuilding depression.  But, as we see with the metropolitan area data, since housing demand becomes inelastic in the face of supply constraints, if anything, the housing shortage has inflated the equilibrium value of the existing housing stock.  I think it is possible that we need to see prices move up by that much in order to trigger enough new homebuilding to reverse course and create a housing stock that is affordable again.

That probably also means well over 1.5 million units per year for a while.  I doubt we will allow either those prices or those quantities to develop.  But, I think, ironically, that is the only way, in the long run, along with urban development reform, to reduce the absolute level of household debt.  The irony is that if San Francisco and Manhattan were filled with high rise condo buildings and Phoenix and Dallas had thousands of new 3,000 square foot homes for median income households, debt levels would be much lower.  The only sustainable macroprudential policy is abundance.  There is no political faction currently in favor of true macroprudence.  But, boy are we all excited about "getting tough" on people.  Wall Street would just love to make us more like Canada.  They see billions in profits from moving that green line up.  Just let 'em try.  We're gonna "get tough" on 'em if they do.  We're no chumps.

Monday, February 22, 2016

January 2016 CPI

Well, I'd say this is a good development.  It looks less likely now that we will be tricked by high shelter inflation into a deflationary shock for the rest of the economy.  Non-shelter core inflation seems to be trending up now.

Here are my graphs for core inflation, with and without shelter, updated.  I don't think we are totally out of the woods.  In some ways, I think we are basically in a similar position as late 2007, but without the housing boom.  Then the Fed appeared to be loosening, and inflation recovered while the economy appeared to be stabilizing.  But, by the end of 2008, we discovered that things weren't nearly as stable as we had thought.

I think something like that is still a possibility.  It is still the case, as it has been for the better part of 20 years, that inflation is being pushed up by supply constraints in the housing market.  This will still cause the Fed to tighten monetary policy to a level below their stated targets.  Since 1997, non-shelter inflation has really fluctuated around a stable trend of about 1.5%, generally moving between 1% and 2%.  But, the Fed stance has shifted to a more hawkish posture, which seems to treat 2% as an inflation ceiling.  If shelter inflation remains above 3%, Core minus Shelter inflation may range even lower as we move forward.

I think the market tends to share this concern.  Friday, the Eurodollar yield curve flattened somewhat on the news.  The short end of the curve moved up about 3 basis points, but the long end of the curve moved down up to 5 basis points.  My model had shown an expected second rate hike as late as the end of 2017, last week.  This has moved back to about April 2017 now.  But, the slope of the curve after the hike continues to flatten.  It is so low that now, after the expected rate hike of April 2017, rates are expected to rise by only 1/4% per year!  This is essentially a flat yield curve.  I hope there is enough strength in the economy for recovery to continue.  Recent dovish comments from some Fed members are heartening.

Here are some long term graphs of shelter inflation, by region.  The two Americas come across pretty clearly here.  The first graph is the ratio of Shelter price levels to the price level of Core CPI less Shelter.  Rent prices in the Midwest and the South have risen fairly closely to Core CPI prices.

The Northeast has had unusual rent inflation since the late 1980s.  Rent inflation was pretty normal in the West, along with the South and the Midwest, until the mid-1990s.  This is when the urban housing shortage kicked into gear.  Since the mid-1990s, rents in the West have grown at a faster rate and have been more volatile than the other regions.

The last graph shows Trailing 12 month Shelter inflation for each region.  Here we can see that rent inflation shot up in all regions after housing starts collapsed in 2006, though the Midwest didn't rise quite as sharply.  Regional rent inflation tends to move somewhat independently.  But, at the beginning of 2006, there was a singular outside force that caused rent inflation to shoot up across regions at a similar scale.  A sharp negative shock in credit markets caused a sharp negative shock in housing supply.  Then, by mid-2007, the credit crisis had begun to drive home prices down, leading to defaults and foreclosures.  By then, households were sharply reducing their housing demand because they were literally losing their houses, and moving into whatever unit they could manage.  This sharp decline in rent inflation, and the initial recovery from it, were also both quite uniform.

Now, we are going back to a context where regional differences are more important, and rents in the West are shooting up more than in the other regions, although our continued War on Credit means that there is a lack of supply in all regions, so rent inflation is high in all regions.

Friday, February 19, 2016

Should I be bullish on manufactured homes?

I'm mostly on the sidelines regarding the housing/treasury position until the smoke clears a little more on mortgage expansion.  In the meantime, I noticed that manufactured homes just had their best quarter is quite some time, with unit sales up about 20% over last year.  Could this be the outlet valve for some of the pent up demand for housing?

SAAR, monthly
Manufactured home sales are well below previous norms.  It seems to me that sales could easily double from here, or more.  And, if financing might be able to expand since much of it is outside the traditional bank-held or conventionally securitized mortgage market, maybe manufactured homes get a boost for households without other options.

I might have to look into this.

Comments welcome.

Thursday, February 18, 2016

Housing: Part 119 - Review of Household Debt and Credit Report

Yesterday, I referenced the potential influence of the bankruptcy reforms in 2005 on the apex of the housing boom, including possible evidence for the more intense late-boom price swings in Arizona, Florida, and Nevada.  Today, I will look at a few more graphs.  I have looked at these before, but I think there is some new significance related to recent additions to my overall narrative.

First is the graph of mortgage originations, by FICO score.  As my version of events is shaping up, I think we can see a couple of distinct events.  Now, I think we can probably pin down the sharp decline at the end of 2003 on the accounting scandals at the GSE's and the subsequent pressure on them to play it safe.  Note that the decline in originations at that point is weighted, oddly, toward the higher FICO scores.  These are the borrowers who would have been using GSE loans.

In the following graph, we can see that FICO scores were actually rising until 2003.  They fell until early 2007.  But, we can see here that, (1) typical FICO scores of borrowers were still within recent norms, and (2) the decline did not come from a surge of low FICO score borrowers, but from the decline in high FICO score borrowers, probably due to the decline in GSE activity.

Also, it is likely that as short term rates rose from 2004 to early 2006, high FICO score borrowers were engaging in fewer opportunistic refinancings.

In the last graph, we see delinquency levels, by state.  I have scribbled in the point in time where funding for subprime loans had completely dried up and AAA subprime securities were trading at a discount.  By this time, there had been distress in the subprime funding industry for a year or more.

I am currently reviewing Gary Gorton's work on the crisis.  He points out that subprime borrowers and lenders depended on the ability to refinance.  A lot of observers have discussed the problem of teaser rates and rate resets.  But after the run on shadow banks, there were basically no subprime loans available.  Many of those defaults after mid-2007 were related to negative equity.  But, even if those households had been willing or able to refinance, there simply was nobody to borrow from.  Should teaser rate resets have become a problem?  Maybe.  But, really, there is no way of knowing, because the liquidity crisis removed the option of refinancing, even for households who might have reasonably expected to be able to refinance.

Wednesday, February 17, 2016

Housing: Part 118 - Bankruptcy Reform in 2005, Another in the Chain of Credit Shocks

I was looking at the latest graphs from the Quarterly Household Debt and Credit Report.  Looking at this one:

I realized that I had not looked into the effects of the 2005 Bankruptcy Reform Act (BAPCPA) on housing markets.  Note that it came into effect right at the top of the housing boom.

And, it turns out, there are at least a couple of papers on this topic.  One from Donald P. Morgan, Benjamin Iverson, and Matthew Botsch at the New York Fed, and one from Ulf von Lilienfeld-Toal and Dilip Mookherjee.

The effects of BAPCPA included making it more difficult for some households to use the homestead exemption in bankruptcy.  So, before BAPCPA, households would consolidate their wealth in their home equity and seek relief on their unsecured debts.  The passage of BAPCPA lowered some of the implicit value of homeownership, especially among highly leveraged or economically stressed households.

Both papers find significant correlations between home price movements before and after 2005 and the scale of the homestead exemption.  Here is one chart on the difference between states, from the L-T & M paper.  Home prices rose faster in 2004 and 2005 in states more affected by the law and then declined more sharply after the law was in force and mortgage defaults became more common in bankruptcies.

Among the states with high homeowner protections: Nevada, Arizona, and Florida (although some states that did not experience extreme price movements, like Texas and Oklahoma, also have strong protections).

It seems that this might have increased demand for homeownership in 2005, during the rush of bankruptcies and then decreased the demand for homeownership after 2005.  Also, it has made it more likely for households to default on their mortgages, as opposed to their unsecured debts.  Additionally, L-T & M find contagion effects in geographic areas with large numbers of bankruptcies.

Tuesday, February 16, 2016

Housing: Part 117 - The canary had it coming

Scott Sumner references this nice summary, on Facebook, of the market monetarist argument, by Eliezer Yudkowski.  (Well, a long summary.)

One of the comments was: "I think I finally understand why so many people keep saying inflation is a good thing.  I still disagree, because it seems to be mostly for the benefit of foolish people who haven't saved enough for deflation to be helpful to them."  This seems to be a common theme among monetary hawks and populists.  Monetary stability is a bailout for irresponsible speculators.

A century ago, populists held the opposite view.  William Jennings Bryan made a political career out of demanding inflation for the common man.

Think of all those irresponsible, greedy 19th century banks.  Some farmer waltzes in to their loan office in the spring and says, "Hey, if you loan me some cash now for seed, I will pay you back, with a hefty profit, in the fall, when I harvest."  And, banker after banker, with dollar signs in their eyes, agreed.  Never mind that for this unlikely speculation to be sustainable, they needed to depend on the farmer to get out of bed each morning to plant, weed, fertilize, and harvest.  They needed to assume he would be healthy and functional throughout the summer.  Oh, and there needed to be some rain the spring, but not too much.  Don't forget that hoards of insects infesting whole regions was not uncommon at the time.  The farmer would need to time just right when he planted and harvested to account for fickle and unpredictable weather.  Compared to our defunct subprime mortgage originators, Bryan's agricultural bankers were daredevils.

The whole system was built on a fa├žade of greed and over-optimism.  And Bryan wanted to just come along and bail out the farmers who were foolish enough to put themselves in a position where deflation would hurt them.

Here's the problem.  The most leveraged, risky economic participants will always be the first harmed in the face of an economic shock.  Our obsession on this fact has led us, maddeningly, to a place where economic stability, itself, is now considered to be a moral hazard issue.  This is why I think our current economic policy is a policy of self flagellation.  There is a plurality of support in this country for imposed self-harm, explicitly because it harms those people who are most vulnerable to potential harms!

It's even worse than that.  The problem at the core of finance is the intractable comingling of desert and luck.  In a world of abundance - of extended education, saving, and retirement - we are all like Bryan's farmers.  And we're not comfortable with it.  Many households, faced with the dilemma that the privilege of living in California means spending 35% or more of their incomes on rent, decided that ownership, even leveraged ownership, was a useful hedge of that high and uncertain cost.  They experienced the modern equivalent of a farmer's ill-timed flood.  And, come to find out, our public policy was to seed the clouds.  And, when some of us yell, "Stop it!  This is harming people."  The response is, "How else will they learn?  They keep borrowing money to plant their seeds, assuming they will have a hearty harvest in the fall.  They need to understand that crops can fail.  How will they understand that if their crops don't fail?"

And, just like Bryan's farmers, it seems as though whenever thing go sour, whenever the risks we exposed ourselves to turned against us, there's a God damned banker doing the devil's work.  The banker made the loan that ended up failing, and the banker demanded the keys to the house when the farm was auctioned off.

Bryan hated the banks, too.  But, he wished to push the harm to them through the soft default of inflation.  Today, we won't settle for that.  We want hard defaults.  Lessons need to be learned.  Even our progressive president has peopled the FOMC with monetary hawks.  And, shelves full of books about the inevitable housing bust complain that we should have bailed out the borrowers instead of the banks.  OK.  How about some monetary support so the bust wasn't so inevitable?  I'm not even talking about hyperinflation.  What if we had just mimicked the policy regimes of the 1980s and 1990s, when home prices fell in real terms, but were relatively stable in nominal terms?  Meet Bryan halfway.  But, nothing but a bust will do.  We imposed this on ourselves, and it's not even controversial.  The median household can barely get a mortgage today.  Where is the outrage from the median household?  Nothing is so damningly pro-cyclical as public sentiment and public policy.

Our proverbial fields lay fallow because many housing "farmers" can't even fund their "seed", yet the political winds demand monetary contraction, for fear of a too-abundant harvest.  If eating requires credit, we resolve to starve, valiantly.

Monday, February 15, 2016

Eurodollar Futures

I thought it was time to put my rate hike estimating tool to bed, but it looks like I'm back in business.

Here is what the curvature of the Eurodollars futures market is saying about future rate movements.

The next expected rate hike has dropped back to late 2017, but it is moving around a lot.  There is a lot of uncertainty.  The previous rate hike certainly did help meet the Fed's goal of keeping risk premiums high.  Macroprudence!

Coming movements in the yield curve should be telling.  Right now, I would say that the yield curve is close to being inverted, if we adjust for distortions from the zero lower bound.  But, it's not too late.  A reversal in the rate hike would be the least I would hope to expect in a sane world.  But, maybe we can move forward in any case, depending on how things develop.

In this second graph, we can see that the length of time between now and the expected next rate hike has spiked, but it isn't as long as the length of time that was expected before and during QE3.  If the yield curve flattens more, I don't expect things to turn out well.  But, maybe there is a chance that positive real economic growth can manage to salvage normalcy.  Of course, as always, mortgage expansion would solve all of this much more effectively than marginal rate changes.

(The gaps in the graphs reflect the period where the model was dormant because the curvature of the yield curve at the short end had disappeared.)

Friday, February 12, 2016

Odds & Ends

1: Amid all the bad news, the Atlanta Fed GDP forecast has become surprisingly bullish:

2: The Michigan Inflation Survey is falling to new lows.  In the year 2045, this graph will be referenced in a cutting edge article by the yet-to-be-named new Fed chair, explaining that, in hindsight, the Fed had erred by being to hawkish during and after the Great Recession.  I hope this is not an early signal of falling rents, which would be very bearish considering the severe lack of housing supply.

3: Mortgage debt remains flat.  I have bitten on a couple of false starts regarding housing recovery.  But, at this point, I am resigned.  I'm mostly on the sidelines until this madness sorts itself out.  In a sane world, the homebuilders would be leading a sit-in at the steps of the U.S. Congress and at least one candidate would make housing expansion - including mortgage expansion - a centerpiece of their platform.

4: Here is an interesting graph that ties in to my recent post on the age-related effects of the boom and bust.  Here, we can see how the 65+ group, which is very heavy in equity and is less vulnerable to labor markets, has sailed through the period as if nothing happened.  Meanwhile, the under-45 groups experienced newfound access to mortgage credit markets until the crisis, and have been especially stressed since then because they tend to have higher leverage.

Thursday, February 11, 2016

Housing Part 116 - The 2006-2007 Mystery and Synthetic CDOs

As the bubble story goes, synthetic CDOs were an insidious new creation that helped create the subprime bubble and allowed mortgage originators to keep originating mortgages with marginal borrowers.  You might have already guessed that I will disagree.  But, this one is so complicated it almost broke my brain, so I have put it below the fold.

Wednesday, February 10, 2016

Housing Part 115 - Value of New vs. Existing Homes

One of the oddities of the housing boom was the fact that median prices for new home did not rise as quickly as the median price of existing homes.  This may not seem so odd if one is able to explain it by claiming that many new mortgages were going to low income households, so that marginal new homes tended to be at lower price points.  But, this explanation doesn't work for me, since I have found that the average incomes of new home owners did not actually decline during the period.  My explanation has been that this was a product of location.  There are clear migration patterns away from high cost cities.  Housing starts in Open Access cities were much higher than housing starts in Closed Access cities, so it doesn't seem crazy to expect that the declining relative price of new homes would correlate with rising building rates in Open Access cities.  It seems obvious enough to me that I have been, more or less, stating it as fact.  But in this case, the data is not quite as clear as I would have thought.

The first graph compares the US Median home price, according to Zillow, to the median new home price according to the Census Bureau.  It is a little difficult to see the relative changes on this graph, so on the next graph, I have reproduced this as a ratio.  And, I have graphed it alongside the ratio of permits for new housing units in the Closed Access cities / Open Access cities.

The ratio of permits was much higher in the late 1980s, mostly attributable to California.  But, it dropped sharply in the early 1990s, and remained low after that.

In this second graph, we can see that there was an earlier period with relatively low new home prices, in the late 1970s.  Home Price/Rent was high then, as it was in the 2000s.  And, in the 1970s, high inflation made mortgage payments high, too.  Nevertheless, homeownership was rising at that time - again, much like the 2000s.  It appears to me that the reasons for the lower new home prices then were somewhat similar to the reasons for it in the 2000s.  Households were trying to hedge against rising rents, and since home prices were generally efficient, marginal new homeowners were downsizing in order to accommodate the cash flows of ownership.  I think this explains why, counterintuitively, in both periods, even with rising relative home prices and rising ownership, growth of real housing expenditures shifted down (shown in the next graph).  Relatively lower value new homes is a sign of the answer to this conundrum.

But, what I thought we would find is that as new home prices declined, relative to existing homes, we would see a parallel decline in permits issued in the Closed Access cities.  It seems obvious that this should have happened, simply as a product of population growth.  In 1988, the three main Closed Access cities had 254% of the population of the four main Open Access cities.  By 2007, that was down to 174%.  Just by virtue of being larger, we should have expected the Open Access cities to be issuing more permits over time.

But, instead, the ratio remained pretty level from 1992 to 2006.  Now, I think partly what is happening is that the way we normally look at housing starts, in raw units, without adjusting for population, the level of recent periods gets overstated a little bit.  I have rendered permits as a proportion of population in these next graphs, which I do in order to compare rates of new building among cities.  When we do that, the rate of housing starts (or permits, which follow each other closely) are much more level in the 2000s than they appear to be in unadjusted long term graphs.

Even though the rates of new permit issuance in the Closed Access cities is so low that it is hard to tell, there was an upward trend of permit issuance in those cities during the boom.

I still think location played a large role in the relative decline of new homes, but some of it was playing out within metro areas, with existing core city properties rising sharply in price and some level of building in the suburbs serving as an outlet for households priced out of the core areas.

This trend reversed after the crisis.  There has been a small rise in the relative level of new building in the Closed Access cities, mostly because the mortgage crisis has hampered building in the Open Access cities.  But, the change isn't large enough to explain the extreme jump in relative new home prices.  I don't think location has much to do with the recent trend.  It has more to do with the fact that middle income families don't have reliable access to mortgage financing, so new building is skewed to the small portion of households at the top of the income distribution who can qualify for mortgages.

Here is one last graph, which I think helps us to think about the similarities and differences between the 1970s and the 2000s.  In the 1970s (and early 1980s), high inflation meant that mortgage payments were very high across the country.  This graph shows the median home in Houston, San Francisco, the US, and the median new home, all relative to median incomes in the respective areas.  The lower prices of new homes in the 1970s were helping to make mortgages affordable for marginal new households, across the country.

Mortgage rates had declined by the 1990s, and during that period, mortgage affordability for new homes moved higher above the median existing home, as affordability was less of a constraint.

By the 2000s, affordability was tied to location.  Homes in Houston were as affordable as ever, but San Francisco had nearly as much of an affordability issue as it had in the early 1980s.  Here, we can see the mortgage affordability of new homes moving back down closer to the affordability of existing homes.  And, if affordability was largely influenced by location at that time, we would expect this accommodation to happen through location.

Here is a graph of lot and home square footage.  In the late 1970s and in the 2000s, real long term interest rates were one cause of rising Price/Rent levels.  Since real long term interest rates don't particularly effect the cost of building, we would expect low real long term interest rates to lead to a substitution of more structures and less lots.  Since high inflation rates in the 1970s and early 1980s made affordability difficult regardless of location while low real long term interest rates were pushing up prices, we see a reaction to these factors in a very sharp decline in lot sizes, and a small decline in structure sizes.  There was a general downsizing and a substitution of structure for lot.

In the late 1990s and early 2000s, affordability problems were a product of location.  Households had to solve the affordability problem by building away from the cities.  So, during that period, falling long term real interest rates were creating a substitution of structure for lot, but also the "downsizing" by moving to less valuable locations meant that households were substituting both larger structure and lot sizes for less valuable locations.  So, the decline in lot size is less severe than in the early 1980s and home sizes were actually increasing during the 2000s, even though the BEA shows a decline in the growth trend of real housing expenditures, and new home prices were declining relative to existing homes.  The drop in real housing expenditures was a drop in the utilization of location value.  Households were building larger homes that were, nonetheless, less valuable.

From 2006 to 2009, home size remained level during the deep part of the bust, and now median new home size is rising along with the relative price of new homes because they now tend to be purchased by households with higher incomes.

Tuesday, February 9, 2016

Another Brief Note on the Yield Curve

Saw this on twitter today:
Here is the CME Group interactive Fed Watch tool.  These models show that yesterday, the odds of a rate hike at all in 2016 were about 35%.  That has fallen to about 25% today.  My model, which is based on the curvature of the yield curve showed a mean expected rate hike date in August, yesterday.  But today, that has moved all the way back to May 2017, with a slope after that which is still about 8 or 9 basis points per quarter.

I use Excel Solver to do the estimate, and, interestingly, Solver seems to have more than one optimal answer on the yield curve data from yesterday and today.  One answer is the August and May inflection points.  The other answer is basically that the next rate hike is highly uncertain, and far in the future.  Since expectations of remaining at zero do not affect the inflection point, because there is no inflection point in that case, I think my model is giving a different answer than the models that are based on rate levels.  I think the correct way to read all of this is that about 1/3 of the market thinks rates will rise, with a mean date of next May, and it will rise by about 25 basis points per quarter.  The other 2/3 of the market thinks rates will not rise at all.

The biggest red flag here is that, as far as I can tell, there is apparently zero expectation of a possible retrenchment.  The clear response right now would be to take a do-over and move rates back to near zero.  And there is no expectation of that happening at all, that I can tell.

The populists and Austrians think this is just proof that we have a bubble economy that can't grow without monetary stimulus.  They seem to like it when this happens, as if the S&P 500 at 2100 was fake and it is only real at 1850, or maybe 1600, or maybe less.  We've got a case of national Munchausen Syndrome.

Don't even worry about suggesting some optimal monetary policy.  Just give me a policy that isn't vulnerable to explicit communal self-immolation.

Monday, February 8, 2016

The Yield Curve Curves Again

Last summer, the then-future rate hike was moving ahead in time, always 6 months in the future.  Until we revive the mortgage credit market and the single family homebuilder market, that may be the best we can hope for.  Where is capital supposed to go if we effectively obstruct trillions of dollars of potential investment?

As we moved through 2015, the Fed decided to impose a rate hike, and so, finally, the expected date of the rate hike became anchored in time, and we finally caught up to it in December.  Since then, the yield curve has flattened sharply.  In fact, we may be near the equivalent of an inverted yield curve now, with forward rates boosted by distortions of the zero lower bound.

In the most recent rate hike periods, rates have risen by about 50 to 70 basis points per quarter. During QE3, the slope implied future rising rates of only about 15 to 35 basis points per quarter.  I suspect this partly reflected expectations of slower rises and partly reflected expectations that we would not leave the zero lower bound.

Now that the Fed hiked rates, the slope has declined all the way to about 8 or 9 basis points per quarter.  There is also a lot of uncertainty about the date of future rate hikes.  This is so low that I think it reflects a very strong expectation that rate hikes will never come.  Long term rates in Japan were in the 2% range until recently during a long period of low short term rates.  This is basically a flat yield curve.

The fact that there isn't a unanimous call for the immediate reversal of the rate hike is pretty much the picture of our dysfunctional era.  We know what we want, "and deserve to get it good and hard."

In the meantime, the short end of the yield curve now curves up yet again.  And, we are back to a context where the next future rate hike is expected to be about 6 months in the future.  Probably the best we can hope for is that we are back in the context of the ever-moving rate hike, always 6 months in the future.  If we ever start building homes again, maybe it can rise naturally.  Until then, if the Fed decides to continue to pretend it controls short term rates in some sort of Phillips Curve fantasy, then they will push us over the edge again.  This time, though, it won't be preceded by a housing collapse or a tepid, but manageable NGDP growth path, because there is little housing market to ruin and NGDP growth is already tepid.  We basically are already back to 2007, where wage growth is strong, but is all being eaten up by rising rents.  I don't see any reason to think we can't walk right back into a 2008 situation, given public and FOMC viewpoints.

Thursday, February 4, 2016

Housing Part 114 - More on Homeownership Rates

In the recent post on homeownership rates by age, Ironman helpfully pointed me to some archived Census information before 1994.  I haven't been able to find age-specific homeownership rates in the old pdf files, but I did realize that there is digital data going back to 1982.

This confirms that there was a similar rise in homeownership among the younger age groups in the late 1970s and early 1980s.  I did find one other source with some decadal age data, and it suggests that homeownership rates in 1970 were slightly lower than 1980 for both young and old households.

It looks like homeownership has been pushed up slightly because of a permanent increase in ownership rates for households over 65 years old from 1982 to around 2000, where it leveled off at a rate similar to 55 to 64 year olds.

From 1982 to 2005, homeownership rates for 45 to 64 year olds were fairly stable at high levels.  Note that there was very little change in ownership among these groups during the boom, but ownership has fallen by about 5% for both of those groups since then.  This is a story of a bust, not a bubble, folks.

In 1982, homeownership for 35-44 year olds was higher than it was at its peak in 2005.  The rate for households younger than 35 was also near the 2004 peak in 1982, and the decadal source suggests that it also peaked at a level at least as high as 2004.  Of course, 1982 was a time of crazy speculation, when households took on unsustainable mortgages because they were convinced that home prices would never stop rising because of loose monetary policy.

But seriously, as I have mentioned before, this seems like strong evidence that credit fueled demand and easy credit terms aren't as strong a factor as people seem to think.  Before 1982, real long term interest rates were very low and nominal rates were very high.  That made mortgage term onerous.  But, the low real rates meant that homes had high intrinsic values because future rents were worth more in present value.  Also, the high inflation meant that imputed rental income and accumulating capital gains on homes provided a significant tax advantage.  Whichever of these factors dominated, they clearly overpowered the negative influence of those payments on 12% mortgage rates.

If intrinsic value is what dominates, then these changing homeownership rates simply reflect marginal reactions to real long term interest rates.  If the tax benefits of inflationary gains are what dominate, then that same effect would not have been as important in the 2000s, because inflation was lower.  So, the rising homeownership rates in the 2000s could reflect some ease of ownership resulting from low interest rates and aggressive lending.  And, there might have been a secondary effect of the tax benefits on the high home price appreciation that was happening at the time, even though that wasn't a reflection of broader inflation.

The 1970s and the 1995-2005 periods also were periods with rent inflation, so rising homeownership rates in both periods could have been a sort of hedging reaction, where younger households felt more incentive to avoid the uncertainty of future rising rents.  (By the way, put another knot in the rope for the theory that urban housing supply constrictions are actually a cause of the declining real interest rates, because they remove some uses of capital while producing capital gains for existing capital.  It so happens that we have two periods where rent inflation was high, real long term interest rates were low, and home prices were high.  I don't have detailed data on metropolitan specific housing measures for the 1970s, but there seems to be evidence that urban housing constraints were ratcheted up during that period.)

In any case, what is clear is that for households over 45 years old, homeownership was never elevated, and has dropped precipitously since the bust.  And for households under 45 years old, there do seem to be systematic fluctuations in homeownership over time, and homeownership rates in 2005 were within the range of ownership levels we had seen before.  In fact, they were at a level we had seen when mortgage rates were over 10%, so there simply is no reason to think that marginal homeowners in the 2000s needed to be any different or less suited than households who might have owned homes at other times in the HUD era.

PS: I also found this graph on page 131 of this report, which gives us some age-specific information going back to 1960.  This also shows 1980 homeownership rates for working-age households at the same level as in 2000.  And households skewed younger in 1980 than in 2000, so within each age group, ownership would have been higher in 1980 to make up for the demographic shift.

Tuesday, February 2, 2016

Housing Part 113 - Fixed Investment vs. Location

Since supply is such a large factor in the shape of our housing markets, we have this strange circumstance where we are building houses in precisely the places where they are the least valuable.  Isn't that a strange economic turn of events?  And, since that is the case, it is kind of odd to me that supply isn't the central topic in all of the public discussions about housing and home prices.

A hunch I have had about this curiosity is that, since the building mostly happens in places with moderate prices, this is inflating private fixed investment.  The space over San Francisco and Manhattan is filled with hundreds of thousands - millions - of extremely valuable little cubes hanging in the air.  For a half million dollars' worth of steel, gypsum board, and concrete, a little million dollar condo is just waiting their for us to claim.  There is a tremendous amount of location value sitting there like gold buried in the ground.  And, frustratingly, it is only there because the density enabled by centuries of wise and prescient planning made it so.

Since we won't unlock that value, we instead build houses in Dallas and Atlanta, where a half million dollars' worth of lumber and gypsum board creates a home worth a little more than half a million dollars.  This isn't to cast aspersions at those Open Access cities.  There isn't location value there because they are doing things right, because they haven't created economic rents through limited access to capital investment.  Right now, most of that location value in Manhattan and San Francisco is due to those rents.  So, the true measure of value we would get from building in those cities would eventually come from pulling their market values back down to their intrinsic, "Open Access" values.  That is probably still somewhat higher than Dallas and Atlanta, but not nearly as high as their current market values.  The main benefits from building in the Closed Access cities would be through the decline in all of the costs related to those cities and the goods and services they produce.

But, back to my hunch.  I think part of the reason that the boom looked especially bubbly was because we measure all that lumber and gypsum board in private fixed investment, but we don't measure intrinsic location value in private fixed investment.  So, the suboptimal pattern of not building in valuable locations, ironically, makes it look like we are investing more.

Well, I finally got around to checking the data on this.  The first graph here is single unit building permits in the Dallas, Atlanta, and Phoenix metro areas, versus San Francisco and New York City.  We can see how building in the Open Access cities out-paced building in the Closed Access cities, in the late 1990s and early 2000s, until the bust temporarily pulled them down.

A more complete analysis regarding the dense city cores would obviously consider multi-unit values, too, but I'm not sure if there is a measure of the market value of new multi-unit structures that I can use for the comparison.  To give an idea of the scale, single unit structures usually account for 2% to 3% of GDP (although it has averaged around 1% since the crisis).  Multi unit private fixed investment in structures used to climb above 1% of GDP during expansions, but hasn't reached 0.4% since the 1980s.  Building in our prosperous cities of an additional 0.5% of GDP would release a large amount of location value.  It would be like investing in a 401k when your employer has a matching program.

The second graph compares private fixed investment in single unit structures to the estimated total value of new single unit homes sold.  In other words, for each $1 of new houses we built, how much lumber and gypsum board did we need to use.  And, we can see that it fits the pattern of my hunch.  Homes in the 1990s and early 2000s required more inputs.  They were composed of less location value and more materials value.  When building in the Open Cities collapsed in the crisis, relative to the Closed Cities, the few homes we were building had more location value, so the proportion temporarily fell.  Even though homebuilding is still highly constrained, it has recovered somewhat in the moderately priced cities, so the proportion has risen again.

Also, here, we can see something that I hadn't fully appreciated before.  Total building in the Closed Access cities has been strong (relative to the depression levels of the rest of the country).  But, that has been almost entirely because of multi-unit building.  This isn't because those cities have suddenly seen the light.  It's just because the constraints created by our hindered mortgage market aren't a constraint for large corporate developers, so their building rates are still determined by the same bureaucratic obstacles they always are.  Urban multi-unit building is still much lower than it needs to be, but it isn't particularly constrained by our self-imposed credit bust.  Despite the high location value, single unit homebuilding in the Closed Access cities remains very low.  I had thought they would be higher.

The last graph here compares the normal measure of private fixed investment in single unit structures, as a proportion of GDP, to a measure of the market value of those structures, including both location value and input values.  They have been set to 100 in 1990 for the sake of comparison.  We can see here the extent to which private fixed investment has been inflated because we have been substituting materials and work for intrinsic location value.  Starting at 100 in 1990, the red line is the relative level of the cost of those inputs. The blue line is the relative level in the market value of the new homes (which includes materials and location value).

Maybe it's a small thing.  There was certainly a healthy amount of building going on in the 2000s, in either case.  But, another brick in the wall, as they say.

PS: I'm not sure I'm happy with the indexed graph above.  Here is the same graph, shown as a % of GDP.  Here, the difference between the blue line and the red line is a broad estimate of location value.

The complication here is that location value is mostly economic rents.  So, the end result of either having the problem (little building in valuable locations) or solving the problem (extensive building in valuable locations) would be to have lower location value.