Wednesday, November 30, 2016

Two Doubts About the Liquidity Effect

There is this story of how the Federal Reserve goosed the economy and the housing market with excessive monetary expansion, and then when the inevitable bust came, they fought the bust again by turning on the money spigots and lowering interest rates to save us from further decline.

The way that raising and lowering interest rates works is through the liquidity effect.  The Fed buys treasuries with new money.  That money gets deposited at the banks.  And, since the banks have more reserves as a result, there is less demand for cash in the overnight bank borrowing market, and short term rates decline.

The broader effect of a cash injection should be to raise rates, because the new money should raise inflation.  So, the liquidity effect is a temporary effect.  Over longer periods of time, interest rates should rise and fall with inflation rates.

From May 2007 until March 2009, however, the Federal Reserve didn't buy any Treasuries.  In fact, they sold hundreds of billions of dollars worth of them.  Whether one describes Fed policy at the time as "tight" or "loose", how could the liquidity effect have brought down interest rates?  They weren't buying anything.  They weren't injecting money into any markets.

It is true that they were making emergency loans to banks, but they were purposely selling a dollar of Treasuries for each dollar of lending in order to prevent interest rates from declining.  In April 2007, the Fed held $902 billion in assets supplying reserve funds.  From April 2007 to August 2008, the total balance sheet of the Fed, including emergency loans and treasuries, grew by only about $2 billion per month.

In a falling rate environment, demand for cash should have been increasing, so, I think, if anything, it seems like the Fed would have needed to increase their holdings by more than usual in order to maintain a neutral stance.  But, in any case, how can anyone describe this period as a period where the Fed was dropping rates through the liquidity effect?

Furthermore, if the liquidity effect had anything to do with rates at the time, why were 3 month treasury rates well below the Fed Funds rate?  The Fed was injecting cash into the banking system through loans and it was selling hundreds of billions of dollars worth of short term treasuries.  If they were lowering rates through the liquidity effect, wouldn't treasury rates have been higher while the Fed Funds rate declined?

In the same graph, moved forward a few years, it looks like there is a similar problem with the QEs.  One of the Fed's stated goals with the QEs was to push down long term rates.  Yet, with each round, what we see is rates falling in the period before the round of QE and then rising during the implementation.

One might argue that rates were anticipatory.  But, the liquidity effect can't be anticipatory.  The liquidity effect happens because of frictions in the market that allow real-time changes in supply to temporarily overwhelm other factors that determine price, including expectations.  If markets can anticipate the liquidity effect, then they should anticipate all temporary movements.

It seems to me that the normal explanations for Fed policy during this period don't hold up.  Am I missing something?

Tuesday, November 29, 2016

Question for readers interested in workshops/presentations/consultation

I plan on having a complete and organized version of my housing work published in book form next year.  In the meantime, I have a question for readers:

How much interest is there in private consultations, presentations, workshops, speeches, etc. about the issue?  My new way of looking at the relationships between the housing market and broader markets has implications for policymakers and various types of investors and traders.

I would like to know if there is enough interest from any of you to justify putting together a package or presentation of some sort, now.  For readers who work in the financial sector, as the economic recovery ages, the ideas I have been developing here could create new ways to construct tactical contrarian positions or to reconsider the shape of the business cycle.  For readers in the public sector, there are implications for housing, credit, and monetary policy.

If you belong to an organization that might be interested, please e-mail me at .  I would like to get an idea of what content you would want me to focus on, the depth or amount of time you would want to devote to it, and what budget you might have available for it.

I can present the fund managers or policy makers in your firm or institution with a set of ideas that I think they will find unique and thought-provoking.  I'd love to get some feedback about possible ways to help some of you gain some value from this work.

Monday, November 28, 2016

Housing: Part 188 - Demand elasticity?

I have mentioned before that narratives of the housing bubble tend to presume a schizophrenic model of rational expectations.  Home buyers were bidding prices up because of irrational exuberance and also because various public subsidies and programs lower the price of homeownership.  In the case of the former, these buyers were paying for homes with little regard for intrinsic value or relative cash flows, or they were buying them with exaggerated expectations of those cash flows.  In the case of the latter, buyers were paying more for homes because the present value of far future imputed rental income and capital gains were being precisely increased by tax deductions and interest rate subsidies.

There is a related schizophrenia in the way home demand has been described during the period.  Mortgage brokers were aggressive because they were being paid from the high fees and high interest rate income generated by subprime borrowers.  The private securitization business is usually described as an engorgement of the shadow banking sector on these fees.  On the other hand, home buyers were attracted to the market because government support of the GSEs lowered mortgage rates and the Fed (supposedly) was pushing rates down by goosing the money supply.

Now, again, I suppose it is possible for both of these effects to be in play.  Rates could be low at the same time that mortgage brokers are aggressively trolling for fee income, and both of these factors could lead to more demand for homes.  But, demand elasticity is sort of doing the tango here.  With regard to basic rates, demand is elastic, so that lower rates lead to more buying.  But, when it comes to the privately securitized mortgages, demand has to be inelastic or else there would be strong headwinds against those brokers expanding the market.

In a way, I acknowledge that both of these things were happening in the two Americas.  Lower conventional rates did cause home prices in most of the country to rise moderately -  maybe about 20% from trough to peak as real interest rates declined.  In the Closed Access cities, demand for home buying was less elastic because lack of access had been holding lower priced homes down.  There had been no regulatory or market barriers keeping families from spending 40% or 50% of their incomes on rent, but there had been barriers to spending 40% or 50% of their incomes on mortgage payments.  As those barriers were removed, pent up demand for home ownership was released.

This led to prices rising in the Closed Access cities in a systematic way.  It led to a burst of tactical selling from existing Closed Access home owners and a surge of out-migration as those families moved on with their capital gains in hand.

There are ways that segments of the market reacted differently, and those different reactions are sometimes related to changes in the marketplace for mortgages.  What I find frustrating about the conventional credit supply explanations for the "bubble" is that these subtleties are rarely addressed.  There is a market called "America", where non-conventional mortgages, housing starts, debt levels, and prices were all rising at the same time while conventional interest rates were low.  And, as that story gets told, demand elasticity moves to and fro as needed, usually with little apparent notice.  In that story, households with a lack of self control are blamed, oddly, for a surge in transactions that may represent the single most back-weighted arrangement of cash flows a household could engage in.  In that story, we have to pretend that $2 trillion in mortgage debt was pushed through these securitization fee machines to those households who lacked self-control and then disappeared - somehow not showing up at all in the balance sheets of households with below average incomes.

Saturday, November 26, 2016

In Defense of Black Friday

I think the way we react, socially, to Black Friday is a great example of anti-market bias and how it feeds the Trump phenomenon (or the "What's the Matter with Kansas" phenomenon, or whatever we might call it).  Privately, clearly this is a popular event, yet publicly, we mostly signal disdain for it.  As with many things, our private actions are probably a better indicator of our true values.

What is Black Friday, really?  It is the culmination of a holiday about thanksgiving and generosity.  After a day spent with family and loved ones, many of us rush out to buy gifts for them.  Is there another shopping day, other than the last day or two before Christmas where more of the purchases are gifts - tokens of love and gratitude?  The newspapers find the 40 people who got into a scuffle and put them on the front page, and they become the poster children of the event, even while 100 million others spent a pleasant and fun day looking for special gifts for one another.  Our biases are so strong here that we allow those poster children to be stand ins for ourselves, even when most of us have personal experiences on Black Friday that are wholly at odds with that picture.

And, who benefits the most from Black Friday?  It's not "1%ers" standing in line before Best Buy opens their doors at 5am.  Markets - faceless, uncaring markets - create this emergence of abundance that on this day more than any other is discounted and broadly distributed.  If you are willing to get up early and stand in line for a little while, you can get a $100 laptop computer for your daughter.  That laptop would be a miracle of innovation if it cost $10,000.  It's certainly a miracle at $300.  But, for this day, this abundance is even more accessible.  Black Friday's success and its value in this regard is irrefutable.  The shoppers are voting with their feet.  They go because this is event is good for them.

But, commerce can only be vulgar in our public postures, so we concentrate on the retailers that provide this abundance.  They are preying on the workers who have to run the store.  They are tempting their customers into a frenzy of consumerism.  Never mind that our own experiences overwhelmingly undermine this narrative.  Black Friday is mostly an event, shared with friends and family, that is about giving.

And the event is part of the value.  We might knit a sweater instead of buying one to make a gift more personal.  But, the amazing abundance we share has made this more difficult.  We aren't miracle workers.  We can't build our own laptop.  But, what we can do is have an adventure.  We can get up at 4am and go stand in the cold together.  We can speedwalk to the electronics department, with the brief thrill and drama of wondering if any laptops will be left when we get there.  That story will be part of the gift.  "We surprised you, didn't we?  You thought we were going to buy that refrigerator, and we told you they were sold out when we got there, but really we went to get your laptop.  It was so cold that morning.  In line, we saw Jenny's parents - you know Jenny, from your old soccer team.  They were there to get her an X-Box.  Even though we were there an hour early, there were quite a few people in line ahead of us.  But, there were still two left when we got in.  We almost didn't get one."

You didn't just work for an afternoon at your boring job to get that laptop for your daughter.  You went on an adventure.  And, since you went on that adventure, you were able to get her a better laptop than she thought you could afford - and a story about how you spent a morning on an adventure for her.

But, on Black Friday, when you got home from shopping, you logged onto Facebook, and what did you see?  Probably a few posts of Facebook friends posturing.  "I'm boycotting Black Friday.  No shopping today.  Who's with me?" with lots of comments and likes in support.  A sort of private/public shaming of your adventure.  And, a subtext that for some people that you know, saving a few hundred dollars on a laptop is less valuable to them than moral preening.  Talk about coming from a position of privilege.  Anti-consumerism is useful because the pretext is a statement against commercial power while the subtext is that you're well off enough not to concern yourself with vulgar commerce and the scarcity of material things.  It's a twofer.

Reactions this shaming won't generate:
1) Gee.  You are right.  I am ashamed.
2) Hmm.  I'm interested in your moral and political opinions.
3) I wonder if there are programs at your church which would help me to be more morally upright.

In this story, there is a darkness.  But, it isn't from the retailers or the shoppers.  It's from the shamers, who proudly infuse this story with their own negative prejudices.  A prerequisite of a community that builds a sense of unity and goodwill is for a plurality of citizens to refrain from this sort of darkness.  But, sub-communities thrive on signals that demean others.  The difference between signals that are necessary expressions of moral mutual re-enforcement and signals that are ungenerous degradations of outsiders is subtle.  It seems like these days we have a bit too much of the latter.

In a way, this is an expression of the never-ending battle between fundamentalism and liberalism.  Fundamentalism has all the tactical advantages.  At its core, fundamentalism always builds on an imperfect aphorism.  Here, it might be, "Overconsumption and materialism are indecent."  Other popular aphorisms might be, "You have no right to question the word of God." or "We must be intolerant of intolerance."  All of these aphorisms are true, and because they are unassailably true, they are effective defenses when we depend on them to generate ungenerous degradations of other people in order to mark our status among those we affiliate with.  I'm afraid this means that those taken in by a fundamentalist mindset are destined to become more shrill and insistent when they are faced with natural appeals for moderation.  Maybe that tendency is how liberalism maintains itself.  The tendency of the shamers to signal to their community at the expense of outsiders naturally leads to their irrelevance.

I'm hoping for a return of liberalism.  In the meantime, enjoy your shopping.  I'm sure your daughter will appreciate the laptop, and she'll love the story about your adventure.  Don't be ashamed for our sake.

Monday, November 21, 2016

Recession watch: Attribution error and inadvertent self-flagellation as policy and social norm

Here is a scary looking graph.  (HT: NickatFP)

Leverage is out of control, apparently.  We need some macro-prudential oversight, it seems.  This is a pretty common worry, and the comments at the link, as of now, are pretty common too.

"well rates are so low why would you not?"

"This is not going to end well."

Even the apologists seem to accept the premise.

"doesn't seem too worrisome, optimal capital structure altered by rate enviro. Not overly leveraged, could raise equity if need b"

Even though we've been hearing for years now that corporations are using low interest rates to leverage up, nobody seems to notice that leverage, according to this measure, has been very low for years while rates have been low.  Attribution error and confirmation bias are strong enough not to notice that this graph tells an improbable tale of corporations suddenly increasing their debt levels by 50% over just a few months after being very tepidly leveraged for a decade.

It is true that huge spikes in leverage appear to presage contractions.  On that I can agree that this chart is useful.  If we take a deep breath, though, what we see is a relatively flat level of leverage through the 1980s.  Then, at the onset of the 1990 recession, leverage shot up.  It moved back down to that typical level of about 1.2x EBITDA until it shot up again during the internet boom, with a second spike in the 2001 recession.

After that, leverage fell to practically half the 1980s levels, after which it moved back to about 0.9x.  Then it spiked again during the 2008 recession.  Then it dropped again, first to about 0.8x, then recovering to about 1.0x, before the recent spike to 1.6x.

What's going on here?  What's going on is that debt levels are a pretty boring, stable factor, but profits are volatile and dependent on nominal national income levels.

What we are seeing here aren't surges of debt.  We are seeing collapses in profit.

The first graph here compares corporate debt ("credit market instruments") to corporate equity values.  The second graph compares corporate debt to corporate profit.

In every case where leverage surged, it was falling profit that was causing it.  What causes profit to fall sharply?  This is almost entirely a monetary phenomenon.  Other factors, like debt levels and income shares, tend to evolve at a glacial pace.

So, every time nominal incomes start to disappoint, the first incomes to be affected are profits.  And, when this causes leverage to rise, the broad response is, "Oh, look.  Corporations are taking on too much risk.  This is going to be bad.  We better pull back the reins before they go any farther."

Is it possible to find a middle ground, where we counter softness in corporate profit without leading to high inflation, like in the 1970s?  I don't know.  What I do know is that what we are doing is a misidentification and a mistake.  The question here shouldn't be, "How hard do we pull back?"  The question should be, "How much can we accommodate before we risk inflation?"

The questions that guide policy now aren't even pointing in the right direction.  This was catastrophic in 2006-2008.

This is one of the advantages of NGDP level targeting.  It naturally pulls us in the right direction.  Not because it is some brilliant and difficult targeting scheme, but because it keeps us from doing so much damage.  It's like investing with passive rebalancing.  Literally doing nothing is better than what you would have done if you were trying to pay attention.  There isn't anything incredible about passive investing.  It effectively trades you a bottle of water for the Molotov cocktail you were reaching for.  If that is a benefit to us regarding our own hard-earned money, imagine how much we need it regarding our public positions about what other people are doing with their money.

Sunday, November 20, 2016

We don't need a wall. The solution to too many immigrants will include more immigrants.

It is ironic that in 2016, it is the anti-immigration candidate who won the surprising election.  Immigration has been dead for a decade.  The unavoidable irony here is that animus toward immigrants will always tend to happen when there aren't many immigrants.  That's because economic stress is the root cause of that animus, and immigrants aren't particularly attracted to places with economic stress.

If you work in a working class industry and live in a town where 2% of the population are immigrants, and the local economy is stagnant, you are apt to see the immigrants as disruptive competition.  If that same town was thriving with an 8% immigrant population, you would be less likely to be concerned.  This is one of many reasons why growth is fundamentally important.

We solved the migration problem in 2008 by killing the economy.  It was a bipartisan effort, and it was very successful.  On one side of the aisle or the other, we made sure that mortgage originators failed, that MBS defaulted, that middle and lower-middle class households didn't have access to mortgages any more.

In any case, we succeeded in killing the economy.  And, we can see the effects from IRS data.  This is data that measures migration and adjusted gross income, from tax returns.  Here, we can see that immigration collapsed after 2008.  (Closed Access cities are California and Northeastern urban centers.  Contagion cities are the "bubble" cities.  Open Access here refers to the rest of the country.)  The concern about immigration that Donald Trump has tapped into is related to this collapse.  The same stresses that have caused migrants to stay away cause the few that remain to especially meet anger.

Here is an estimate of the average incomes of immigrants.  We can see here that the collapse was mainly focused on low income immigration.  High income immigrants still come, especially to the enclaves in California and the northeast.

Dark lines are in-migration.  Light lines are out-migration.
The same has happened within the country too.  In-migration rates tend to be fairly stable, but migration in general has fallen across the country - especially in the Contagion cities.

Until 2006, the rest of the country was building houses for the Closed Access households who had to leave for want of housing.  We closed that avenue down, and it has continued to remain closed down for a decade.

And, here's what has happened to incomes in the meantime.  Between that first graph of immigration levels and this last graph of relative earnings, is there any question about what the true source of stress is regarding feelings about immigration?  The Closed Access areas went for Clinton and most of the other areas went for Trump.

The way to reduce anxiety about immigration is to help all of the parts of the US develop economies that will attract more of them.

I harp a lot on the problems of limited housing in the Closed Access cities.  But, the story these graphs tell says that the damage we have done to ourselves since 2005 is worse than the damage the local Closed Access policies were inflicting on us.  The Closed Access cities imposed deprivation on us, and we responded to that deprivation by adding more.

By analogy, it is like a drought caused rice prices to soar, and we responded by salting the fields in order to prevent greedy new homesteaders from getting in on the rice craze.

None of this requires detailed debates about economic policies or programs.  We get most of the way there simply by not salting the fields.  We need to go back to 2005.  In 2005, we were in the midst of a long-term drought in housing.  If that drought bothered you, then we solve the drought by fixing policy in the Closed Access cities.  In the meantime, let's stop salting the fields in Topeka and Columbus and Charlotte.  The big giant red flag in those cities has been the collapse in mortgages and homebuilding and the collapse in home prices at the bottom half of the market, where they had never really been excessive, in those cities.  Let's stop salting the fields.  If, after we do that you're still bothered by the effects of the drought, then, sure, let's fix that problem.  In the meantime, let's stop salting the fields.

Thursday, November 17, 2016

October 2016 Inflation

I am a bit frozen in place as to whether we are looking at a bullish continuation or a bearish turn.  Rising treasury yields are a good sign, both because they suggest an improving economic outlook and because they imply a passive loosening of monetary policy in a way that the Fed seems not to usually counter in real time.

On the other hand, the inflation doomsday scenario is building, as the Fed talks up rate hikes while non-shelter inflation falls to well below target.  I'm a bit surprised that long bonds have been as strong as they have been.

My suspicion is that we will tend to see a lot of sideways movement across asset classes and that sometime during 2017, yields will turn back down if the Fed continues to read shelter inflation as a monetary phenomenon.

The divergence between shelter and non-shelter inflation continues this month.  In five of the last six months, Shelter inflation has been over 0.3% and non-shelter core inflation has been under 0.1%.  The CPI now lists unadjusted year over year core inflation at 2.1%, consisting of 3.5% shelter inflation and 1.2% non-shelter core inflation.

A reminder that loyal readers probably don't need at this point - most shelter inflation is imputed and has nothing to do with cash transactions.  We are tightening monetary policy to counteract a price level that probably has little to do with monetary policy and much to do with supply.  Supply of this particular asset tends to react positively to monetary and credit expansion.  At this point, I don't think housing starts are particularly sensitive to interest rates.  But, inflation would be helpful in continuing to raise nominal home values and incomes, to help heal the damage we have wrought on the bottom half of the housing market and rebuild equity.  (Note, this isn't because rising prices are always good.  This is because prices where they currently stand are unusually low because we inflicted a credit crisis on the low end of the housing market that pushed implied yields on investment up for the few investors who could tap into the market.  Advantages of home ownership include both the natural advantages of control and arbitrary tax advantages.  The tax advantages largely accrue to the high end of the market, and control advantages accrue more strikingly to the low end of the market.  We have perversely created a post-"bubble" housing market that has maintained the high end tax advantage while undermining ownership at the low end, and this is reflected in relative prices.)

If homebuilding drops a bit, it will be blamed on rising interest rates cutting into demand.  I declare this, pre-emptively, to be a spurious correlation.  That actually gives me some hope, because if the regulatory obstructions to mortgage lending can be loosened a bit, then in this battle between the neutral rate and the inadvertently hawkish Fed, the neutral rate might have a chance to get out ahead of the curve, and then I think we would see rising interest rates, an accelerating homebuilding market, and a rejuvenated recovery.

As a speculator, I think it would be easier to position for a predictable Fed over-reach, but as a citizen, I'm pulling for the more complicated potential for a recovery, despite ourselves.

Tuesday, November 15, 2016

Housing: Part 187 - The solution to our problems is urban

I've seen several articles suggesting that, instead of expecting workers to move to urban areas for employment, we should be providing more support in areas with stagnant labor markets - jobs programs, social services, etc.  It isn't just people that are struggling.  It is places.  And, depopulating those places doesn't solve that problem.

It's a compelling point of view, and would that it were so.  But, I'm afraid it is unrealistic.

Imagine the previous period of urbanization, when technological advances in agriculture reduced agricultural employment, freeing up those workers for other productive activities and creating the dislocations that always come with growth.  The technological era of mass production meant that the new jobs were in the cities because production was centralized.

It didn't have to be that way.  It was determined by our technological context.  If communications had been the next wave of human innovation, maybe those former workers would have stayed in their little towns and would have worked on semaphores scattered across the countryside.  But, in the world where we lived, centralized mass production arose as the path to progress.

What if we had taken this position during that phase of urbanization?  What if we had agreed that tenements filling Manhattan island had more downside than upside, that the stresses of urban life were worth avoiding, that the way to approach falling agricultural employment across the country was to support those towns and work on policies that would bring jobs to those areas?

Can we all agree that this would have been a disaster?  That the results of this policy would be very similar to the stagnation and frustration that we see across the country today?  The available policy choices for a nation are those choices that fit the technological context that we have.  Ignoring that is costly.  Norway could decide tomorrow that the negative externalities of fossil fuels are too great, and that they can't justify taking income from that sector anymore.  Maybe you agree with that assessment.  But, we can all agree that if they made that choice, Norway would pay a high price for it.  It would be a mighty sacrifice.

Today, the globe is undergoing a new wave of urbanization.  I attribute this to the combination of two factors.  First, the frontier economic growth of developed economies is coming through highly networked and highly skilled information workers.  These workers clearly gain great value from being located in tight geographic clusters.  Whether this is expected or surprising is beside the point.  Their choice of location and the evolving prices associated with those locations are stark empirical confirmation of this development.  The fact that practically all the major new tech. firms are headquartered within a few miles of one another is not an accident.  There is no fear that Goldman Sachs will be moving their headquarters to Cincinnati in order to save on costs.

Second, the transition out of manufacturing, due mostly to automation, but clearly associated with the rise of developing economies, is leading to a transition into new sectors.  These generally are the non-tradable sectors - local services, construction, health care, etc.  These sectors have to be centralized, not because production is centralized, but because they have to be near their customer base - by definition, really.  And, the customer base happens to be this subset of information workers who do happen to be highly centralized.

Again, you can debate the cause as I have outlined it here.  But, the rise of a handful of cities where those centralized sectors are located and the extreme costs workers are willing to accept to be within commuting distance of them, tell an extreme story that must be true, regardless of the details that fill it in.

This wave of urbanization is pressing up against a political framework that has evolved which is not capable of accommodating high density development.  We have put roadblocks in front of the path to progress.  This has not been the product of a conscious public conversation.  Citizens in Pittsburgh and Cleveland didn't vote on referenda where they agreed that the downsides of urbanization are too great, and it would be preferable to take a second-best path toward a different technological solution.  The current equivalent of funding a semaphore network.

In effect, what has happened, just because of an accident of politics, is that the citizens of New York City, and Boston, and San Francisco, and Los Angeles (and London and Toronto and Sydney...) have decided that they like their cities just the way they are, thank you very much.  Modern democratic polities have increasingly evolved to accommodate these demands.  They vote for the pros that come from stability.  And, they happen to capture economic rents that come from stagnation where you get to be grandfathered in to the prime location.  (Of course, the millions of workers from the most economically vulnerable households who have been forced to move out of those cities over the last couple of decades don't get to share those gains.)  Americans in Pittsburgh and Cleveland suffer the externalities.  They are denied the natural salve that would moderate their economic dislocations - the ability for some portion of the community to migrate to places with more opportunities.  This is a human right and a process that is ancient.  It predates humanity itself.  It was, in fact, a factor in the creation of humanity.  More than ever, the free migrations of birds and caribou and butterflies are sacred to us, but not those of our fellow humans.  Sure, we argue about the right to cross that line that runs along the banks of the Rio Grande.  We need to address the line that surrounds San Francisco and New York City.  The first step is seeing the line.

And, consider the families who have been most exposed to the dislocations of today's technological shift.  They are stuck between that line along the Rio Grande and the line around the northeastern and Pacific cities.  Is it any wonder that they are mad about trade and immigration?  If we actually had a universally consistent policy in favor of the right to migrate, they wouldn't be so mad.  They have selectively been forced to take on the negative externalities of these accidental restrictions on freedom.  And the collective response of many of the citizens of those enclaves of economic privilege is to march and protest, to label those people who are locked out of their cities as sorts of heretics because of the forms of their frustration.

We could choose, like the hypothetical Norwegians, to sacrifice for some higher cause.  What exactly is the cause?  That a few lucky real estate owners get million dollar windfalls while the screws turn ever tighter on renters?  That the highest income workers get an income boost because there is a moat around their cities that prevents potential upstarts from competing?  That the little shady suburb full of $2 million dollar cottages doesn't have to have that 20 unit condo building next to the train station that would just totally ruin the local vibe?  That the 200 unit skyscraper downtown would charge market rates that offend our sensibilities?  (By the way, what a strange phrase - "market rate" - to describe the price of a new building that amounts to about 1/3 actual construction costs and 2/3 fees, kickbacks, taxes, etc.  Interesting how that phrase creates a sort of rhetorical lie that buildings sell for three times their cost because of the market.)

What exactly are we sacrificing for?  There isn't another choice here.  We either sacrifice or we urbanize.  If we deny ourselves the benefits of the natural technological pathway that lies before us, we give those gains up.  There isn't some nearly equivalent alternative.

And, let's not act as boiled frogs here.  There are a few cities where incomes are much higher than in the rest of the country.  This doesn't happen naturally.  There are significant patterns of migration away from those places.  Human beings don't behave this way without coercion - even if that coercion is unappreciated and hidden in a complex set of political restrictions.

Sunday, November 13, 2016

What would a trade war look like today?

One of the many risks of a Trump presidency is a disruption in trade.  But, in thinking through the issue, I can't quite imagine what would happen in today's context.

The large trade deficit today is peculiar.  Part of the reason it is so large is that many of our most productive corporations operate in frontier information and financial sectors that don't involve the movement of goods across a border.  So, if Google makes a profit in Australia, it is more likely to register as the revenue and profit of a foreign subsidiary than as an export.  Part of the trade deficit is simply the result of this semantic distinction.

But, the trade deficit is the mirror image of the capital surplus.  We send a lot of dollars overseas to buy goods, and instead of using those dollars to buy goods from the US, foreigners save a lot of those dollars and invest them in the US.  Funny thing is, though, after decades of this - after trillions of dollars of excess investment - the income US investors make on foreign investments outpaces the income that foreigners make on their US investments by a wider margin than ever before.  Foreigners are running to stay still, at best.

I think the reason for this is that the US has many global corporations who are earning above market returns.  (I have come to attribute that to the role of urban housing in the information economy, but that's a complicated story.)  Whatever the cause, the implications of this are interesting.  US firms are reinvesting our foreign profits in high return operations.  If we reinvest $100 billion that will earn 10% returns, then if foreigners can only earn 5% returns, they have to invest $200 billion in the US just to maintain a stable net international capital income.

This is why we have a sustainably large trade deficit.  Foreigners have to keep selling us stuff in order to maintain a capital income.  If they stopped selling us stuff to invest it, our net foreign income would balloon, and our firms would end up owning an accelerating portion of their capital.  Currency values, interest rates, trade levels, etc. adjust to an equilibrium that draws foreign capital to the US.

So, given this context, what would happen if the US imposed a policy with the aim of reducing the trade deficit?  The causal factor for the deficit - the need for foreigners to save - would not go away.  It wouldn't be that difficult for foreign markets to enact tariffs, etc. to instigate a trade war.  But, they would need to stop our corporations from getting revenues through their foreign subsidiaries.  That is a little more difficult and intrusive.  It would involve some sort of capital repression, nationalization, etc.  Would they be willing to go that far?

If they didn't go that far, and there was still pressure to gather dollars in order to invest in US assets, then what would give?  Would the trade deficit remain, and US tariffs would end up being a revenue source for the US government, with little effect on trade?  Would production move back to the US?  If it did, and the trade deficit declined, then would our foreign assets and income balloon?  Would the dollar rise in value?

I'm having trouble imagining all the moving parts.  Anybody have any ideas?

Saturday, November 12, 2016

The Real Anti-Immigration Party

Just a friendly reminder that those voters marching against the anti-immigration President-elect live in states that have forced, on net, more than 3 million of their own residents out over the past decade - generally the poorest and least educated.

These are, across the board, our richest, most aspirational, cities, and they have already built magic walls around themselves that only allow in the educated and most well-off residents from the rest of the country.  Everyone else is locked out of their economic fortresses while soaking up those 3 million housing refugees.

Oh, look, now the folks in the Capitol are upset about the lousy attitudes of the proles out in the districts.  How precious.

Wednesday, November 9, 2016

JOLTS, Sept. 2016

It's been a while since I posted JOLTS data.  Generally, the data continues to follow the pattern of an aging recovery.  I continue to believe that we are at a place where monetary policy can be important.  If the Fed pulls back too much, we will contract.  If they accommodate rising wages, then recovery can continue for a long time.

I think the association of rising wages with inflation is a virus.  Wages are rising because a healthy economy reduces the frictions that allow firms and workers to adjust and shift.  If corporate profits are leveling off while wages rise, then monetary policy needs to accommodate enough nominal activity to prevent corporate profits from falling enough to disrupt these healthy economic trends.  If that becomes inflationary, then we can moderate, but to pre-emptively pull back is going to trigger contraction by cutting into corporate profits.

The election has presented a bit of a surprise, though.  I have been focusing on monetary policy because I assumed no relief was going to come to the mortgage market from GSE expansion or regulatory easing on the banks.  After everyone took a deep breath last night, Trump didn't act like a monster when he gave his speech, and markets rebounded this morning.  Banks are up in the 5% range as I type this.

Could it be that Trump will govern as a sane person, and that also some of the Dodd-Frank regulations that have cut low income households out of homeownership will be retracted?  I don't have the feeling that Trump explicitly understands the connection between the banks and the condition of his rural voter base.  But, he does seem to have a bias toward lighter banking regulations.  Does this mean that we will meander our way into finally healing the housing market?

The yield curve has also steepened significantly today.  Up by 25 basis points or so at the long end of the Eurodollar curve.  This is exactly what I would expect to happen if mortgages were going to expand and the housing market was going to heal.

Wouldn't that be funny if Trump ended up being our rescuer?

Tuesday, November 8, 2016

Housing: Part 186 - Where do credit constraints kick in?

Building on the last couple of posts, I want to think a little more about the idea of credit constraints and how they can affect prices.

In sort of the same vein as Scott Sumner's frequent complaint that it seems like in 2007 everyone suddenly forgot all the macroeconomics that they had learned over the previous 50 years, it seems to me that some basic finance has been forgotten, too.

Given a certain market rate of return on highly liquid at-risk assets, investors seem to be able to earn excess returns over time for holding assets with similar risks, but with less access to ownership or less liquid markets.  Price is the inverse of yield.  So, small cap stocks, assets which cannot be easily purchased on liquid markets, small private businesses, etc., tend to sell for lower prices (higher implicit expected returns).  This is why back-testing might suggest higher risk-adjusted returns in some alternative asset class, and then when the financial sector responds by creating a bunch of ETFs and other mechanisms that provide access to that asset class, the returns disappoint.  Once the asset class becomes liquid, it loses its excess returns.  This is a common problem in finance.  Return anomalies frequently disappear after they are exploited.

So, traditional models of finance would predict that, once all factors are accounted for, owner-occupied housing should have a higher rate of return than investments with similar risks, because there are obstacles to ownership.  As those obstacles are removed, required returns will decline to normal levels, providing a temporary price boost, and leading to future returns more in line with similar assets.

Most neighborhoods were never credit constrained, so taking the general context of housing markets as a given, those neighborhoods would reflect equilibrium prices without an additional liquidity discount.  In neighborhoods that are credit constrained, we might expect lower prices.  And as those constraints are lifted, as they might have been in the 2000s when new mortgage products were widely marketed, we might expect those prices to rise to levels similar to the neighborhoods that were never constrained.

There is no reason to believe that the new price levels will be above a reasonable level.  That is the case, even if the removal of credit constraints causes low priced homes (presumably more credit constrained) to rise more than high priced homes.  Our presumption should be that access to credit makes the market more efficient, not less.

Zip code level rents in 1998 and 2006 are inferred
from MSA median rent changes for years before 2010
Here are graphs of Dallas and Los Angeles, comparing home prices and price/rent ratios, by zip code, over time.  It seems logically unassailable that credit access would have something to do with rising prices in the expensive cities.  Yet, if that was the case, I think we should see the slope of these relationships flattening.

Instead, Dallas shows little change at all.  Los Angeles, which has a pattern similar to the other Closed Access cities, has rising Price/Rent at the top end of the market.  This naturally pulls prices higher, pulling all P/R levels up along with it.  The slope of the relationship doesn't change much.  It's just that all zip codes kind of climb the P/R ladder as prices rise in general.  In both Dallas and Los Angeles, P/R stops rising around $400,000 or so, suggesting that this is related to the ability to capture tax benefits.

When I create the same graph with incomes on the x-axis, however, we do see a pattern that suggests credit expansion.  In low income neighborhoods, the P/R ratio did rise slightly more than in the high income neighborhoods, in Dallas.  In Los Angeles, it rose substantially more.  By 2006, the slope of relative P/R by zip code income had flattened substantially.

In San Francisco, where all zip codes had reached that $400,000+ range where Price/Rent seems to flatten out, the P/R trendline completely flattened out by 2006, even going slightly negative.

In Boston, where top end valuations didn't move that much during the boom, the rising P/R levels at lower incomes show up clearly, too.

I think what we are seeing here is the difference between the extensive margin (new buyers) and the intensive margin (spending among existing buyers).  I have shown that there was much less correlation between rising homeownership, non-conforming mortgage growth, and price increases than it seemed.  Most of the rise in ownership came before the unusual rise in prices, and the rise in non-conforming mortgages was actually associated with a sharp decline in homeownership.  Homeownership peaked in early 2004, just when the big jump in non-conforming loans was getting started.  By 2006, and especially by 2007 when prices began to really tumble, homeownership was on its downward path.

Yet, clearly, when looking at zip codes by income, there was a strong rise in prices, negatively correlated with incomes.  All of this together suggests  the bulk of the expansion was at the intensive margin - higher prices and more debt even though ownership didn't seem to be expanding in these areas.

But, even here, the data balks.  There isn't evidence in the broader survey data, such as the Survey of Consumer Finances, of an unusual rise in debt levels of households in the mid and lower income quintiles.  And, the most extreme peculiarity about the cities where low income zip codes had the largest price increases is that, during that time, low income households were moving away from those cities by the hundreds of thousands.  Such a strange juxtaposition.  A massive outflow of households from the places where home prices were rising the most.  Where was the demand coming from?

It seems clear that, to some extent, changes in population composition were important.  But, in the end, I think it may be a distraction to think of this through a supply and demand framework.  What caused what?  Who was buying, and how much money did they have?

As I mentioned in the previous couple of posts, intrinsic value rules.  And, this is where these Price/Rent to Price Level graphs come in.  What caused the rise in prices?  Supply constraints?  Migration patterns?  Expansion of credit access?  These all probably played a part.  But, when we note this relationship between P/R and Price, we don't actually need a special explanation for why low priced homes increased by more than high priced homes.  Anything that leads to rising prices will trigger this positive feedback effect.  Whatever the root causes of rising prices, those causes simply became strong enough in the Closed Access cities to make this effect noticeable.

Because what started me down this path was noticing the lack of evidence for mortgage growth and homeownership among low income households during the boom, I have tended to be more amenable to the passive credit school (the school of thought that believes credit expansion was more of an effect than a cause of the housing "bubble").  But, I think that is really the wrong question to ask.  And, since it is the wrong question to ask, it leads both passive and active credit proponents to the wrong conclusions.  They mostly disregard rent as an input to price, which seems defensible because prices were so volatile while rents tend to change slowly.  So, prices, almost by definition, reflect irrational expectations.  (If you disregard the sole source of income for a financial asset, by what basis could you even construct a rational model?)  Then, they end up just arguing about whether it was mostly low income buyers, flush with new credit, who were irrational, or whether everyone was irrational.

Intrinsic value rules.  What actually happened was that the market was ruthlessly rational in spite of us.  Intrinsic value pushed these prices up that P/R ladder as the various influences on rising prices in the Closed Access cities became increasingly extreme.  The only way we could have prevented this from happening would have been to implement extreme economic dislocation and financial repression.  Oh, look!  That's what we did!

If we pull the fetters off the mortgage market without fixing the Closed Access supply problem (or, alternatively, getting rid of the corporate income tax* or the owner-occupier tax benefits) low priced homes would naturally start climbing that ladder again as those markets heal.  This would finally begin to heal the balance sheets of working class homeowners who have survived all that we have imposed on them.  And, I don't see how that will happen without leading to a new chorus for macro-prudential regulations or monetary suffocation to shut it down.

* The largest owner-occupier tax benefit is the non-taxability of imputed rent.  It seems to me that the most feasible way to eliminate this relative benefit would be to eliminate the corporate income tax.

Wednesday, November 2, 2016

Housing: Part 185 - the phases of the bust

 I want to look at the graph from yesterday's post some more, because I think that graph highlights the turning points of the housing bust well.

We can roughly divide the period into 6 sections:

1) Normal market, with Closed Access supply problem.

2) GSEs and FHA in decline while private securitizations rise.  Since the GSEs and FHA tend to serve first time buyers, this exchange of market share coincided with a decline in homeownership.  But, private securitizations, probably helped by both a loosening of regulations regarding marginal lending and by the decline in the public conduits, grew to take their place.  The less stringent limits on terms for the private securitizations allowed home prices in credit constrained markets of the Closed Access cities and Contagion cities to rise, though these loans were generally to households with high incomes.  The change during this time was in the terms, not in buyer incomes.  So, even though homeownership was beginning to decline, price increases during this time were at their strongest.  First time buyers were as strong as ever here, so we can presume that tactical selling out of ownership was strong.  During this time, there was strong out-migration from the Closed Access cities - weighted toward low income households, but not necessarily weighted toward renters.  During this period, there was probably some profit taking among existing homeowners in the Closed Access cities, who, because the private securitization boom was pushing their home prices up, were incentivized to take capital gains, even where they had been enjoying artificially low property taxes.

Researchers like Mian & Sufi write about a transfer from high wealth to low wealth households, but in a lot of ways, wealth is a proxy for age.  If we think in terms of income, migration data from this period suggests that there might have been some profit-taking among low income households.  I suspect there was a bimodal distribution of migrants - poor renters forced out and low income owners taking profits - both induced by an expansion of housing consumption among young, educated, high income workers in the Closed Access cities, which was made possible by the lenient terms of the private securitization market.

3) In the spring of 2006, the Federal Reserve intentionally pushed the Federal Funds Rate high enough to slow real housing growth.  And they succeeded royally.  Mortgages held on banks' balance sheets had been strong, helping to counteract the relative decline in GSE and FHA lending, but banks predictably reduce lending in the face of an inverted yield curve.  We can see the effects of this policy choice.  So, at the margin of the market - new home sales - we see a sharp drop.  New home buyers were still relatively strong, however.  The continued entry of first time buyers begins to cause leverage to rise during this time, as the wave of tactical selling builds from existing homeowners exiting the market.

4) By 2007, the number of first time buyers begins to drop, but the exit from ownership continues.  This causes new home sales to fall even farther, and home ownership rates really begin to fall.  But, intrinsic value rules.  Rent inflation was rising sharply, and home prices remained near their peaks, because intrinsic value dominates supply and demand in asset markets that are not in disequilibrium.

5) In late 2007, disequilibrium hits.  Both buying and selling dry up.  Notice that the homeownership rate levelled off somewhat in 2008 despite the drop in first time buyers.  Tactical selling was strongest when prices were high.  That stopped after prices began to drop.

6) In late 2008, the GSEs were taken into conservatorship and the banks were in disarray.  The GSEs severely tightened credit standards, to widespread approval.  The Fed finally fully committed to stability.  So, prices and sales finally bottomed out and stabilized.  But, because the stabilization was targeted at the high end and left the low end out, the apparent stabilization of the housing market was a bit of a mirage.  This period was the worst period for the bottom half of the housing market.  And the continuing drop in homeownership was concentrated at middle incomes and the bottom.

Keep in mind that homeownership to begin with was already 80% to 90% for the top 40% of households, by income, so the rise in ownership among those groups, as a proportion of existing non-owners, was much stronger than in lower income groups.  And, today, compared to 1995, ownership rates are lower for the low income groups and higher for the high income groups.  We gave low income households a bust when they never had a bubble.

These last charts are annual changes in median home prices, by zip code (from Zillow Data).  Zip codes are arranged by price on the x-axis, on a natural log scale.

Across many cities, the same pattern developed in 2008 and 2009.  The aggregate market appeared to have stabilized, but we removed liquidity from the bottom half of the market.  The number of defaults that happened during this period is many, many times the number of defaults that had happened before the subprime market collapsed in 2007.