Wednesday, September 28, 2016

Housing: Part 180 - The association of housing dislocations with deregulation is pernicious.

From the current draft of the manuscript:
To the extent that fiscal or demand side policies have an effect, the removal of owner-occupier tax benefits and implementation of higher property tax rates can remove some volatility in home prices - and the Open Access cities tend to utilize some of those policies. But, these policies work by changing the underlying intrinsic value of properties. They allow the price mechanism to work. They don’t bring prices down by blocking access to ownership. They bring prices down by creating access! The association of housing dislocations with deregulation is pernicious. Closed Access cities in the boom had deregulated demand and regulated supply. Open Access cities in the boom had both deregulated supply and demand. Now, because of limitations on mortgage lending, Closed Access cities have both regulated supply and demand, and Open Access cities have deregulated supply and regulated demand. Which of those four contexts is the just, fair, and functional context? Is there any question?

The United States has imposed the worst set of policies at every step of the shifting housing market. First, we imposed severe supply constraints in our most economically dynamic cities and combined that with an innovative financial sector that created financial access to those highly sought after markets – sometimes with securities that contained risky terms like low down payments. Then we imposed financial suppression, but not by eliminating favorable tax treatments or other reductions to the financial advantage of owning property. The set of responses we imposed have resulted in a dysfunctional mortgage market where value is not the constraining factor in housing demand – access is. Qualifying for a mortgage has become more constraining than being able to afford a mortgage. We have imposed both supply and demand shocks in dysfunctional ways. Instead of creating a housing market where buyers can make decisions on the margin, we have created a binary market. Can I get a rent controlled apartment or not? Can I satisfy all of the local interest groups to build a new condo building or not? Can I qualify for a mortgage or not? Do I initiate a short sale and put the negative equity on the bank or not? Do we make a go of it one more year in the Closed Access city or migrate?

Binary decisions lead to stress, anger, and social dissonance. Policy should always aim for allowing decisions to be made on the margin. This is the foundation of a liberal, civilized society. Even worse than the high costs created by limited supply is the lack of marginal choices.

Monday, September 26, 2016

The Closed Access problem in pictures.

I don't know the data source on these, but @PatrickRuffini posted these maps on twitter showing the geographic concentration of college degrees among millennials.  It's a great visualization of the new value of the central cities, and the brain drain to the Closed Access metro areas.

There is some concentration of educated millennials in Chicago, but it looks less blue (educated) than the Closed Access cities.  Chicago doesn't really qualify as a Closed Access city - they build a decent number of homes and rents and prices aren't crazy.  Chicago is sort of an interesting city.  It has its problems.  But, it has the advantage of density still as a draw.  How much of the decline in crime in the Closed Access cities is related to their exclusive housing policies and the massive outmigration of their poor and less educated residents.  Is Chicago suffering more from our current sources of social strife because they didn't passively kick out the riff-raff like the other major cities?

Washington, DC has the most extreme concentration of educated millennials.  Washington isn't a Closed Access city.  Rents are high, but they aren't high as a proportion of incomes.  In Washington, the high incomes come from political rents and those incomes are used to bid up rents, as opposed to the Closed Access cities, where incomes are from competitive industries, but workers have to spend those incomes on uncomfortably high rents in order to have access to those industries.

In California, the large scale segregation is clear here.  The educated millennials have filled in the coastal metropolises, except for a few of the worst parts of LA.  And, those without degrees have been pushed out to the Inland Empire.

In the south, there is a concentration in the Research Triangle in North Carolina, but there aren't any Closed Access MSAs in the south.  Florida generally has a low concentration of education, which follows along with the migration patterns I have found.  It appears to serve the same function for the Northeast as Arizona, Nevada, and the Inland Empire do for the West - the main destination for out-migrants who are priced out of the entire Closed Access regions.

One takeaway that I think these visualizations help to notice is that these cities don't have high incomes and high levels of education because of their local education policies.  It's not like there aren't universities in the rest of the country and these cities are sending all of their public school children to local colleges.

Americans are being educated across the country, and then, they are moving to the Closed Access cities after they are educated.  To a certain extent, that has always been the case.  What has changed is that this has become even more pronounced.  And, these cities used to be centers of working class opportunity, too.  But, they aren't any more.  They are now sources of working class stress, and they keep dumping hundreds of thousands of stressed working class households on the rest of the country instead of being a source of working class opportunity.

I touch on this in the book.  Autor, Dorn, Hanson, et. al. have been publishing research about labor rigidities that have left many communities stagnant.  They blame the loss of manufacturing to Chinese competition.  But, why did previous generations of displaced laborers not suffer the same rigidities?  Why is China different?

I think the reason is that (1) much of the trade deficit is a product of the closed access housing problem because American firms earning economic rents from the limited access orders in those cities are earning excess profits on foreign revenues.  Those profits fund the trade deficit.  And (2) the natural economic healing that should happen in the face of economic dislocations is blocked by Closed Access housing.  When the transition out of agriculture happened, working class laborers moved to the cities to work in factories.  Today, the same transition would happen, but they would be moving to the cities to work in non-tradable sectors - service sectors (including residential construction!).  But, today, they are outbid for the limited housing, so we are imposing labor market rigidities on our most vulnerable communities.

Thursday, September 22, 2016

Monetary Policy is like backing up a trailer.

I like to think of monetary policy like backing up a trailer.  In this graph of interest rates and GDP growth, think of the Federal Reserve as backing up a trailer through time.  When the trailer goes to the right, inflation and interest rates go up.  When the trailer goes to the left, inflation and interest rates go down.

The truck is short term rates.  The Fed has direct control of the steering wheel.  The trailor is long term interest rates.  The Fed only has indirect control of the direction the trailor is going.
In the 1970s, the Fed was slightly biased towards accommodation, so as the trailer started to veer right (long term rates rising), they would turn the steering wheel to the right.  But, they wouldn't steer it far enough to get the trailer to start turning left again.  So, as happens when you back up a trailer, interest rates would just keep moving in the same direction.
Eventually, they would turn past the tipping point, and the trailer would veer back to the left (long term rates falling).  Then, just as with a trailer, they would have to quickly turn back to the left (lower short term rates) in order to keep the momentum from swinging to far in the other direction.
In 1981, Volker took a very hard turn to the right.  He really cranked that wheel.  Then he took a hard turn to the left, then straightened it out.  It was a little wobbly, as backing up always is, but for the next 30 years, the Fed was backing up on a vector slightly to the left.
In the 1980s and 1990s, if the trailer started veering left, the Fed would turn left enough to get straightened out again, but that was about it.  They would turn the wheel back to the right and then straighten it before it got moving too far to the right.
In 2002, they straightened out the wheel, before the trailer started turning right.  Then, while the trailer was still basically going straight, they started turning the steering wheel to the right.  NGDP was moving along at 6% or so with no sign of acceleration and long term interest rates were moving along at 4% with no sign of acceleration.
Misunderstandings about the causes of the housing bubble made everybody freak out.  We made ad hoc theories about how low short term rates cause asset bubbles, even though the NASDAQ bubble had just happened 5 years earlier while both short and long term real rates were relatively high.  Even though housing Price/Rent ratios had been pretty high in the 1970s and 80s with double digit mortgage rates.  Even though inflation (especially outside of shelter inflation) was low.  We reasoned from a price change about housing and ignored every other indicator there was, and started cranking that steering wheel to the right.
The inevitable happened in 2007.  And, when the trailer took a hard turn to the left, the Fed reacted by turning the steering wheel sharply to the left.  But, when a trailer gets that far from straight, you have to turn that wheel like crazy to correct it.  It sure felt like the Fed was turning the wheel like crazy, but they never really even turned enough to the left to get the trailer straightened out.  When we hit the zero lower bound, we were jackknifed.
QE helped to get things straightened out a little.  But, with a few wiggles along the way, the trailer has basically spent the last decade still veering to the left.  Now, we are in an even worse position than we were in 2004.  The trailer hasn't even straightened out yet.  It's still veering left, and yet the Fed has started turning the wheel to the right already!  GDP growth and long term rates are giving a clear signal.  We are so wound up, we will be jackknifed again before the Fed has time to even crank the wheel back to the left.  When that happens, I just hope they see what's happening quickly enough, and have the resolve to counter with the QE to end all QEs until this thing gets straightened out.
But, considering that some Fed officials still talk as it they had the steering wheel pinned to the left in 2008, when they objectively had straightened it out at 2% as the trailer was careening for the ditch, I'm not sure we can count on that.
In the meantime, much of the public, including the financial community, is standing along the road, "helping", saying, "Yeah.  Crank 'er right.  You got it.  Give 'er a good hard turn."  All I have to say is, when Wall Street layoffs start coming down, I hope the former fixed income traders that have been "helping" don't go into trucking.

Tuesday, September 20, 2016

Housing: Part 179 - Prosecuting the Banksters

Elizabeth Warren wants to know why the FBI "failed to hold the individuals and companies most responsible for the financial crisis and the Great Recession accountable."

She has posted letters to the FBI and to the DOJ Inspector General, citing potential illegal activities at 14 corporations from the FCIC report, which the DOJ has declined to prosecute.

In the 9 of the 11 referrals that refer to corporate activities, where dates are referenced they range from August 2006 to the end of 2007.  This is common in the complaints about wrong-doing.  The reason is, securities from 2005 and before performed pretty well.  There are few who would have standing to complain.

My question is, how can you place responsibility for the crisis on banks that were either trying to place mortgages in a declining market or trying to sell securities whose values were collapsing?  Clearly the collapse happened before these activities were happening.  The causation here is backwards.

I'm sure a common reaction to this is that malfeasance was happening before 2006, but that, in the words of Warren Buffett, you don't know who is swimming without trunks until the tide goes out.  That's all well and good as a presumption, but this is simply question begging.

I say that it was the collapse of credit that caused the crisis, not a boom in credit.  That may seem wrong, but referring to a bunch of desperation moves during the collapse does nothing to address this question.  The rise in prices is frequently taken as proof itself that credit expansion created an unsustainable market.  But, at this point, there is plenty of academic work showing that credit was a passive factor.  This requires more than a presumption.  It requires evidence.

The other 2 of Warren's 11 points refer to activities at the GSEs.  Citing the FCIC: "Fannie Mae may have overstated assets, earnings and capital through various accounting improprieties. . . [and] a failure to disclose accurate information about the state of risk management at Fannie Mae."
Fannie and Freddie were actually very conservative during the boom.  LTVs and FICO scores were becoming less aggressive and the GSEs lost a significant amount of market share, which they only began to regain as private lenders were reeling during the early part of the housing contraction.

But the greatest irony here is that the first round of pressure coming from housing boom angst was directed at the GSEs in 2004.  They were accused of managing earnings at the time.  Among their sins was overstating their loss reserves and underreporting their earnings so that they would have more room to take losses without it affecting future stated profits.  The CEOs were driven out during that round of pressure.  It took until 2007 and early 2008 for the CEOs to settle their cases.  Both of them agreed to make donations to funds meant to help suffering home owners.

Now, their successors are being blamed for understating loss reserves literally at the same time that they were paying fines for overstating previous loss reserves.  It's kind of like the joke, if your price is too high it's gouging, if it's too low, it's predatory pricing, and if it's the same, it's collusion.  I think we can safely say that there was no functional way to be the CEO of a GSE from 1998 to 2008 without being accused of criminality.

I think there is something here regarding the problem we continue to have with mortgage markets that continue to be inaccessible to middle class homebuyers.  There aren't any hard and fast rules directing banks to lock them out of credit.  But, there are a lot of vague liabilities attached to it.  There is so much profit to be made making mortgages to owner-occupiers in the bottom half of the housing market.  It is perplexing to me that we haven't seen more activity in the market, even if it would have to be outside the securitization market and outside commercial banking.  Yet, it doesn't seem to be developing.

But, the limits keeping marginally credit-worthy households from getting mortgages may not be quantifiable.  If you were an analyst at a bank, and you presented a report to the head of the mortgage division about how much money there is to be made in middle income mortgages, he's going to take it to the CEO, who will have it on his desk, next to a letter from a US Senator asking pointedly why he isn't in jail.  That's a market that's not about to clear.

I think this is another aspect of the issue that fits in the North, Wallis, and Weingast limited access order framework.  There is a lot of risk being imposed here through the discretion of powerful people.  And, it's got the economy tied up in knots, hurting the most vulnerable households the most, as limited access orders and discretion of power brokers usually does.

I suggest writing in "dart throwing monkey" in November.  It's not optimal, but it would be a huge step in the right direction.  It works for portfolio management.  Why wouldn't the same be true of governance, especially when discretion, grudge-bearing, and liquidationism are the order of the day.

Monday, September 19, 2016

Socialized Gains and Privatized Losses

I think there is general consensus that the GSEs could be transitioned into a sort of public utility that issues guarantees on conventional mortgages.  The private/public setup was a mistake.  Back when it was set up, it made some sense, in that there was a need for a national entity with a capital base to provide a liquid market for mortgage securities.  Financial markets have matured a lot since then, and there really isn't much need for a capital bearing source of liquidity.  In an emergency, the Federal Reserve has now normalized the purchase of MBS as a monetary activity, so to the extent that emergency liquidity is useful, the Fed appears to be able to support the MBS market.

I think the Federal Reserve is actually the correct place for the GSE utility.  The guarantee function is really a purely monetary function.  The guarantee fees are a sort of seigniorage.  The utility could be run at a slight profit, much as current Fed operations are.  Occasionally, there might be a contraction so severe that the cost of those guarantees is more than the income.  In those cases, the Fed can open up its magic vault and pull out some cash.  It seems like this requires capital.  But, really, that idea is just a vestigial requirement related to private ownership.  Private firms don't have magic vaults.  If you think the GSEs need capital to fund their guarantee business, then just imagine that the Fed keeps a trillion dollar bill in that magic vault for "capital".

Having the guarantee business at the Fed also matches accountability and responsibility, since, really, if losses are so bad that the GSEs are taking them, something has gone wrong in the management of the national nominal economy.

One of the problems with the private/public setup was that, when public support for markets was most needed, the public was angry at financiers and profiteers.  The last thing they were going to stand for was some sort of public support that was going to boost the profits of shareholders.

This is a real public policy problem, because equity holders basically own systemic risk.  That is conceptually where all the excess returns of equity ownership come from.  Any public policy that serves to reduce systemic risk is going to, first and foremost, benefit equity holders.  In 2007 or 2008, if the Treasury had announced that they would stand by and promise to serve as a creditor to the GSEs, if necessary, and that they would encourage the GSEs to lend liberally in the meantime, while the Federal Reserve goosed the money supply to aim for 2% to 4% inflation until markets stabilized, they would have been pilloried for supporting the bankers that did this to us.

The only policy that would have provided stability was off limits because the public saw it as an example of privatized profits and socialized losses.  Yet, if the federal government had implemented those policies, there would not have been socialized losses.  It's plausible that not a single penny would have been required to support the GSEs if nominal support had been introduced in early 2008 or earlier.  The losses only came because there were a lack of policies for nominal stability.

Isn't it funny how much concern there is about privatized profits and socialized losses, yet nobody ever worries about socialized profits and privatized losses?

Think of President Obama's "You didn't build that." speech, or similar rhetorical justifications for marginal tax rates of 50% or more.  They are built on the reasonable idea that property rights, a function legal system, and infrastructure are dependent on a well-funded public sector.  These are socialized profits.

Privatized profits should be paired with privatized losses.

But, when losses are widespread.  When they engulf entire markets and industries, this is by definition a systemic, public issue.  In this case, losses should be socialized.  When this happens, shouldn't those who supported socialized profits be coming out of the woodwork to support social support for all those taxpayers who had been socializing their profits during the expansion?

Red: Effective Corporate Tax Rate
Green: Corporate profits as share of GDI
It's even worse than that.  Our tax policies on capital income are pro-cyclical.  When corporate incomes fall - an early indicator of economic contraction - our effective corporate tax rate goes up.  That is because our tax code specifically socializes profits and privatizes losses.  Most corporate losses have to be carried forward as write-offs against future profits.  In fact, the trigger that put the GSEs under their capital requirements when they were taken into conservatorship was the write off of tax assets.  Regulators said that future foreclosures would be so numerous that the GSEs were likely never to be profitable again in the near future, and so they would never be able write off future income taxes against their losses.  (And, yes, less than two weeks later, the Federal Reserve held the target rate at 2% the day after Lehman failed because they were worried about inflation at the same time the Treasury was expecting millions of future foreclosures.)

So, while everyone is worried about privatized profits and socialized losses, we have actually socialized profits and privatized losses, and I would argue that this was a primary cause of the crisis - much more important than underwriting in 2005.  We implemented trickle down economics.  We insisted on enforcing systemic losses, because those bankers did this to us and they had to pay.  And, wouldn't you know it, in 2009, there was an employment crisis.  If one didn't know better, you might almost believe there was some causality there.

It's almost like business cycle policy isn't about stability.  Imagine if home prices hadn't dropped by a quarter.  Especially imagine if home prices in low priced neighborhoods, hadn't dropped.  That was the most difficult part of the crisis.  It was really late 2008 and 2009 before we were able to knock low priced housing prices fully into submission.  A lot of privatized losses had to be created to do that - mostly by then in the form of lost home equity of working class homeowners.  We may be entering a secular age, but even a secular nation requires mortification of the flesh.

Friday, September 16, 2016

August 2016 CPI Inflation

A bump up in inflation this month.  Shelter inflation continues to rise.  Core inflation without shelter rose to 1.6% this month.  This probably gives more cover to the Fed to raise rates.  Looks like markets reacted negatively to the report.

I guess people actually believe that 2 1/2% inflation created an economic upheaval in the 2000s, so since inflation is above target in a category that literally involves no cash and no actual transactions, we need to reduce the amount of cash in the economy to counteract it.

Here are the month-over-month and year-over-year inflation charts.

I wonder what the effects of a tightening will be.  Normally, there would be a fairly direct link to currency in the economy, but since the source of control now is interest on reserves, instead of entering the economy through bond holders, currency would have to enter (or leave) through banks' credit decisions.

I don't know.  Does it make much difference?  How would we know what the effect of a policy shift would be?  The levels of currency, excess reserves, and credit, are due to a complex mix of factors.  Do any readers have links to, say, Fed research on what exactly they would look for to know what sort of effect rising interest on reserves was having?

Wednesday, September 14, 2016

Preparing for contraction

Here's another graph, building on the post from yesterday.  This has federal receipts as a percentage of GDP, unemployment rate, and equities.  (The equities measure is based on real total returns, detrended with a 3% annual growth rate.)

There is a pretty strong correlation between equities, unemployment, and federal receipts, with equities leading by about 2 quarters.  In real, total return terms, equities peaked in late 2014.  Federal receipts peaked in 2015.  The unemployment rate has been flat for nearly a year.

Meanwhile, the yield curve is flattening.  In 1995 and 1998, the yield curve flattened, and the Federal Reserve lowered interest rates, easing their relative posture, which, in both cases caused long term interest rates to reverse and rise again.  This is a sign of success.  In the late 1990s, the stock market boomed.  This is also, at its base, a sign of success.  Isn't it?  Is there anyone who wouldn't trade today's economy for the 1990s?  I think, in today's self-flagellating mood, this would be considered failure.  Even a couple years of 10% or 15% gains would be met with gnashing of teeth.

Fortunately, we don't have to worry about that.  We aren't going to get a couple years of 10% to 15% gains.  We're slaying that dragon.

In 1995, you can see unemployment bottoming out, then with the timely accommodation, re-establishing its downward trajectory.  There would be plenty of room for that to happen today if we freed the mortgage market.  That would cause long term rates to rise even with today's monetary policy.

In 1998, the economy responded well, too.  And, when the stock market was sky high, labor compensation as a share of GDI was higher than it ever has been since.  And inflation was mild.

Since then, it seems as though the Fed treats falling long term interest rates as stimulus - as a reason to continue tightening.  I have avoided taking a pure defensive position because there is the risk that the Fed would reverse course and trigger a rebound in markets.  But, I have decided that bureaucratic inertia more or less ensures that eventually, another hike will be implemented, and we are already probably too high.

The problem is, I'm not sure where to take a position.  In 1991, a long bond position and some sorts of short positions on real estate would have paid off.  In 2001, a short stock position or long bond position would have paid off.  In 2007, all three positions would have paid off.

The problem is, I don't see much room to fall (or rise in bonds) in any asset class.  For stocks, this looks like 1991, for housing 2001, for bonds, there's just nowhere to go.

Other than leveraged down-market residential real estate, I think the other area where there is potential for a gain is in a position that gains from a low and flat yield curve.  It will take a little bit of creativity.

Tuesday, September 13, 2016

It's 2006 again, or maybe 1999

Corporate profits are trending down.  The yield curve is flattening.  And, it's just a matter of time before the Fed raises rates again.  This is an unusual recovery because interest rates never recovered and firms and households never re-leveraged.  That probably makes it more like the 1990s.

In the early 1990s, there was a deep and persistent housing correction and a persistent stagnation in mortgage credit.  Then, there was a long and steady recovery.  The housing collapse in 2007 was deeper, with some complications, but I think we will see a long term recovery again.  As in the 2001 recession, housing will probably hiccup slightly and then continue to recover.  There really isn't much of a source for contraction in housing, as credit deprived as the market has been.

Credit has actually been growing in mortgages - finally.  The weekly figures on closed end real estate loans have been inching up on a 10% annualized growth rate.  When we contract, this might flatten for a little while.  Then it will continue to accelerate.  There is so much pent up demand that growth will eventually have to explode.

I think we are getting to a point where the lowest priced homes are finally regaining enough equity for the market to be liquid again, in spite of mortgage markets that have been fettered.  As this process continues to unfold, there will be a positive feedback effect as growing equity begets liquidity, begets sales, begets rising prices, etc.  At the bottom end of the market, there is probably a 30% gain to be had.  If you have the disposition for low priced real estate ownership, this is probably a good time to get in.  (Disclaimer: Don't take advice from cocker spaniels with blogger accounts.)  There may be a lull in the market as the Fed creates a brief, unnecessary contraction.  But, this is probably among the best sub-asset class to be in - direct ownership of low priced residential single family homes.  (Remember: Disclaimer.)

Outside the Closed Access cities, there was never much difference in home price trends among the quintiles of zip codes, by price....until after the bust when the federal government enforced Draconian and wrong-headed barriers to mortgage credit through bank regulation and control of the GSEs.  The lowest quintiles fell by, typically, about 30% more than the top quintiles, and never recovered.  Working class savings went down a black hole.  But, finally, it looks like the low priced zip codes might be recovering.  With hope, this will come with recovering homeownership and the demand that would come along with that, growing construction employment, and a boost to incomes.

On the downside, it looks like top quintile homes are decelerating.  This looks like 2006.  The Fed is squeezing the money supply again.  This is the same dynamic that there was in 2006, except in 2006, we were starting from a much higher level with more credit available.  Now, it's just the first few green shoots of credit in the low priced markets that are finally creating much awaited recovery, and the less credit constrained zip codes are moderating because nominal economic activity, in general, is moderating.

I think this will look more like 2001 than 2007 because housing market prices don't reflect a healthy credit market now, anyway.  So, prices at the low end may hang on and continue to rise, unless regulators clamp down on new mortgage activity.

I suspect that the target rate is already above the natural interest rate, so that the natural interest rate isn't going to rise, and may fall.  That is why the yield curve has flattened, NGDP growth is weak, and high end home prices are levelling off.  It doesn't matter too much.  I expect it is a matter of time until the Fed raises rates again - maybe December.  The error will eventually become clear at that rise or the next one, and some sort of QE program or something will be initiated again.  I suppose there is the danger that the inflation-phobes convince the Fed not to do what's necessary to reverse contraction.  And, if the anti-debt crusaders clamp down on credit markets, too, the combination of those pressures could be disastrous.  But, lacking that, I think the natural growth in mortgage credit, which should have some momentum, will help to keep positive pressure on currency growth and economic growth in general.  We can hope.

Given distortions of the zero lower bound, we may be close to what would be an inverted yield curve in a normal environment.  Another hike would seem likely to do it.  Two hikes seem nearly certain.  Seems like we're amid an example of IMH.  I'm looking for defensive or counter-cyclical positions.  I hope for the country's sake this is 1995 and not 1999 or 2006, but I don't see any indication that the doves can hold on indefinitely.

Monday, September 12, 2016

Housing: Part 178 - The Front Loading of American Housing Expenses

In the book, I may play around with an idea regarding mortgage amortization that would lead to mortgage payments that are somewhat variable in nominal terms but less variable in real terms over the life of the mortgage.  Partly what led me to think about this is considering the number of ways we impose financial insecurity on American households.

Owning a home has many natural and arbitrary advantages.  The main natural advantage is control.  This is paired with the disadvantage of non-diversified large asset that correlates to other personal financial risks.  But, it appears to me that the control premium is worth more than the non-diversification cost for most households.

The main arbitrary advantages are the tax advantages of tax-free imputed rent, the mortgage tax deduction, and deferred or exempted capital gains.

All of these arbitrary advantages front-load the costs of ownership, because they raise the value and price of a home, but that value is due to cash flows that come slowly or in the future.

This is exacerbated by the treatment of mortgages as nominal securities.  So, as the home gains in value each year, the real value of the mortgage payments declines over time.  This is true whether it is a floating rate or a fixed rate loan.  The real value of the mortgage payment in year one will be higher than the real value of the mortgage payment on the same mortgage in year 15.

Some of the cash-out refinancing that is common in mortgage markets is necessary to simply slow down the decay of the real value of the mortgage payment.

So, the advantages of home ownership, made more acute by tax policy, induce households into becoming homeowners earlier.  This means they will rationally try to become homeowners when they are younger, their incomes are slightly lower, and they have saved up for a smaller down payment.  Frictions in the housing market induce them to buy a larger home that will reflect their future consumption preferences - again when they will expect to have higher incomes, etc.  All of this leads to a natural and predictable tendency to purchase a house that is somewhat financially destabilizing at the point in time when the household is purchasing it.

On top of this, there is the nominal mortgage, so that the mortgage payment for that home is higher in the early years than it will be in the later years.  So, households are induced, rationally, to utilize forms of debt or other methods for funding the mortgage in the early years.

Most people, who are under the odd illusion that access to credit causes households to irrationally bid up home prices to values unmoored from their present cash values, might see this as an advantage.  Front loading costs would prevent the lemmings they think populate the American home buying market from buying even larger homes, because it forces them to be credit constrained.

Considering that many neighborhoods aren't particularly credit constrained, and yet prices in those neighborhoods don't rise uncontrollably until the marginal household there becomes credit constrained, this notion that we have to constrain credit seems to me to be bizarre.  This bizarre belief is the core ideal of our current credit policy.  Don't let the rubes get their hands on any borrowed funds.  They can't handle it.  For once there are plenty of one-handed economic policymakers in Washington, because their second hands are all employed patting each other on the back for shutting down that dangerous mortgage market that somehow funded homes for 40 years before inevitably collapsing.  In the midst of a "bubble", only a masochist would suggest that prudent lending would be more lenient lending.  Then, when unnecessarily tight lending led to a bust, it became even more reputationally risky to suggest more lenient lending.

There is probably an axiom here.  Most unspeakable policy proposals are self-evidently bad.  But, especially in a crisis, the policy that is most needed is inevitably also an unspeakable policy.  That is why it is a crisis.  The problem is picking the right unspeakable policy - pulling the yoke from the scramble (tm).

This is one of many areas in housing policy that are theory by attribution error.  We presume that households are prone to excess, so we impose financial instability on them as the cure.  And, when this produces a bunch of young, highly leveraged, over-committed new homeowners - it proves that we were right about them all along.

I wish we could take this another direction.  Obviously, get rid of all the tax benefits.  But, also, if mortgages amortized in a way that was more like a real (inflation adjusted) security, then the cash outflows of homeowners would be less front-loaded.  I reject theory by attribution error, and I believe that these adjustments would lead households to be much less financially strained when they first buy their homes.

We take for granted that households deleverage after a financial crisis.  That's what they would do if they, in the aggregate, were generally risk-averse.  Reasonable households match empirical evidence, unlike the lemming households of our fever dreams.  It seems like the "bubble" was empirical evidence of lemming households, but much of my current project has been a process of discovering that this belief comes largely from errant premises determining a false conclusion.

California - the epicenter of the housing bubble - makes these front-loaded factors even worse.  Rent control even causes these to apply to renters.  If your rent inflation will be limited, you will pay more for the initial rent, because that buys you access to future economic rents - the political ability to pay future below-market housing rents.

Proposition 13 - the infamous property tax policy that is in place there, also makes housing costs more front-loaded, because embedded in the purchase of a home is the right to below-market property taxes in the future.  And, as rent inflation increases the price of homes, there is a positive feedback effect that makes the future property tax benefits even larger.

In housing, it appears that homo economicus is alive and well.  Everyone seems to agree that tax benefits lead to higher housing consumption.  Clearly California's back-loaded tax benefits lead to higher prices.  Oddly, it is widely acceptable to imply this ultra-rational condition when complaining about how tax benefits cause homo economicus to overinvest in over-priced housing.  Or, to blame deleveraging for a timid recovery.  But, to imply the same condition to defend market efficiency is free market fundamentalism.  Who wants to be one of those na├»ve people?

So, we keep front-loading costs, creating large incongruities in life-cycle cash flows, and blaming bankers, speculators, and middle class households for the truly inevitable instability that our policies create.

Friday, September 9, 2016

Orwell's Seemingly Radical Intellectual Honesty

I came across this Orwell quote today (HT: EPPC):

I hope the account I have given is not too misleading. I believe on such an issue as this no one is or can be completely truthful. It is difficult to be certain about anything except what you have seen with your own eyes, and consciously or unconsciously everyone writes as a partisan. In case I have not said this somewhere earlier in the book I will say it now: beware of my partisanship, my mistakes of fact and the distortion inevitably caused by my having seen only one corner of events. And beware of exactly the same thing when you read any other book on this period of the Spanish war.

This seems radical, and it should be everyone's mission to reach this sort of level of constructive self-doubt.

As radical as it seems, though, it doesn't go nearly far enough.  "It is difficult to be certain about anything except what you have seen with your own eyes" is clearly wishful thinking.  In economics and finance the most powerful lies are the ones confirmed by our own eyes.

Friday, September 2, 2016

Labor Force Participation

A while back, I did several posts on labor force participation.  My general conclusion was that LFP wasn't as bad as it was generally made out to be for several reasons:

1) The hump and decline in LFP was largely due to a combination of (1) a one-time jump in female participation from the 70s to the 90s and (2) a long term secular decline across ages and gender.

2) When looking at male participation rates over the long term, there is a pretty stable slightly downward trend, except for the 16-19 and 55+ age groups, which have idiosyncratic movements based on cultural changes, etc.

3) LFP was above trend in 2007, so that forecasts tended to (1) start too high and (2) be flat or positive, which, in hindsight, was wildly optimistic, and contrary to half a century of experience.

So, LFP was a little bit below trend after the recession - not outside of historical norms, once the trend is accounted for.  Some of the downward trend of the 45-54 group is probably related to the way our disability programs induce people in that age group to leave the labor force, but that trend has been sloping downward for decades.  The 25-34 age group may have dropped by 1% or so in a way that will persist below the trend.

Within the working age groups, it looks like LFP has, more or less, recovered to expansion levels.  The 25-34 group might have some slack left.

This leaves a bit of a mystery for me, because I have been moving to an argument that we were deceptively in a sort of full employment recessionary condition by late 2006.  But, LFP moving above trend into late 2007 contradicts that idea.  This was a strange period, though.  Some of the growth in incomes was through rent inflation - most of which is imputed rent of owner-occupiers.  But, property values were flat or declining.  So, owners weren't getting any wealth effect from their properties, and in fact some were facing losses.  Owners had higher costs and incomes in a way that they would only know because the BEA told them they did.  Renters were transferring more of their incomes to landlords.  These amount to fractions of a percent of NGDP growth in a given year, but we are also talking about fractions of a percent of labor force participation.

It seems like there is something mysterious going on in the business cycle, when contraction is focused on housing, there is an increase in nominal production and income in a category that is mostly imputed - that requires no cash.  Wages rise.  Renters pay more of those wages to their landlords.  Owners pay themselves higher rents, though they don't know it.  So, a growing part of incomes is simply transfers on sunk costs to owners.  Does this create a boost in employment in the early part of the contraction?

In the current context, is employment even more of a lagging factor than it normally is?

Thursday, September 1, 2016

Housing: Part 177 - Future Research on Housing Tax Benefits

Way back over 18 months ago, I started following my nose down a path about the housing market.  Back then, I hadn't thought seriously about the supply problem that has become the central element in my story.  At first, I was just wondering how much of an effect tax benefits had on relative home values.  My inclination was that housing tax benefits, in addition to being regressive, were destabilizing.  This is because, when credit contraction cuts off demand in the owner-occupier market, there is a gap between the equilibrium price of that market, which enjoys tax benefits, and the landlord market, which enjoys fewer tax benefits.

Housing is such a large expense, that income effects dominate.  On a national level, total housing & utilities spending has been about 18% of total personal consumption expenditures for decades.  There should be a balance between the cost of building a new home and the after tax value of future imputed rents.  If tax benefits push the value of future rents up, households will increase their housing consumption until the cost of building a new home moves up to 18%.  Obviously, I'm taking a lot of shortcuts here, but that's a very simplified version of what I think happens over the long term.

So, with tax benefits, demand increases, in terms of imputed rents.  And prices rise until they reach the present value of the after tax future rents.  Again, simplified, but I think this is the best way to think about it.

So, I think partly what we are seeing at the low end of the market is a drop in demand for housing because demand has shifted from owning to renting.  Much of the tax advantages are not captured by households with lower incomes, so at that end of the market, the difference between the owner-occupier price and the landlord price is lower than it would be at the high end of the market.  But, I think one way to think about the shape of the housing market is that most of the market used to be dominated by owner-occupiers, so that the prices of single family residences basically reflected the tax benefits.

In 2008, when the owner-occupier market was dead, there was probably some distance prices had to fall in order to induce non-owner occupier support.

But, I am thinking about the zip code level data for the 8 years since then.  The support for mortgage credit at the bottom half of the market has basically dried up, while the top end of the market has recovered.  This is about as pure of a natural experiment as one could hope to get regarding the effect of tax benefits on home prices.  What we have are two markets - the low end where an owner-occupier market has become, on the margin, a landlord market.  And the top end, which remains an owner-occupier market.

The Open Access cities and other cities that weren't effected by the housing supply problem and the sharp Closed Access city out-migration provide a pretty clear picture of how that transformation has affected prices.  My first stabs at this effect, back in parts 1 and 2, were about 23%, which I backed off on to about 15%.

The difference between the highest quintile of zip codes and the lowest quintile in the Open Access cities (here, Atlanta, Dallas, and Houston) has settled in at about 25%, compared to where they were in 2008.  I think landlords are making high returns right now, so maybe this is elevated.  On the other hand, it does seem like the bottom quintile zip codes have been moving along with top quintile incomes for several years, in all city types, suggesting that those markets are moving along some equilibrium level.

This seems like a topic that would be fruitful for further research.