Monday, November 19, 2018

Housing: Part 331 - More on Mortgages and Homeownership

Here are a couple more graphs on mortgages and homeownership.  The first one is from the Survey of Consumer Finances, which is conducted every three years.

From 2004-2007, homeownership declined somewhat, but mortgaged homeownership increased.

The second graph has the number of mortgage accounts from the New York Fed and the number of owner-occupied homes from the Census.  Owner-occupiers topped out around the end of 2005 when housing starts peaked.  But, oddly the number of mortgage accounts shot up in 2006 and 2007.

It appears that there were three factors at work in 2006 and 2007:

1) An increase in the number of unmortgaged owners selling their homes and transitioning to renting while a declining but somewhat stable flow of first time buyers that were naturally leveraged continued.

2) Unmortgaged owners - mostly older households - taking on new mortgages.  (Most homeowners under 55 already have a mortgage.)

3) Increasing investor activity.

It is interesting that the sharp increase in mortgages in 2006-2007 is not associated with rising ownership or rising prices, and it is associated with sharply falling housing starts.  For all of those reasons, I think it has been incorrect for so many people to treat the late rise in mortgages, which performed terribly, as if they were responsible for the housing bubble.  They had nothing to do with it, and if anything, they were propping up a housing market that would have otherwise been in unnecessarily deep decline.

In my feistier moments, I wonder if this was actually a sign of a need for liquidity.  Interest rates were at their cyclical peak.  These weren't mortgages taken out at low rates.  Currency growth was very low at the time.  This was expensive debt taken out when cash was relatively scarce.

Would it be too crazy of me to say that there was already a liquidity crunch, and that the only reason nominal GDP growth was still limping along at rates that were only marginally recessionary was because households sitting on recent real estate gains tapped those properties for cash?  Were those households, on net, speculating, or were they getting cash wherever they could get it, and currency from the Federal Reserve wasn't where they could get it?

Maybe I'm wading into waters that are over my head here.  Please tell me if I am.  But, it seems to me that causation could go either way here.  Mortgage debt could rise in a search or liquidity, or the Federal Reserve could contract the growth in the money supply as a way to counter excess liquidity coming from a speculative bubble.  Wouldn't one clue about the direction of that causality be the direction of housing starts.  If the causal trigger was a flood of debt into hot housing markets, then housing starts would be rising.  If the causal trigger was a lack of liquidity, housing starts would be collapsing.  It seems like the evidence is pretty clearly stacked against the idea that the Fed needed to be counteracting the rising mortgage levels.  Housing starts and currency growth were both contracting.

In the narrative that treats everything as excess, each step along the way is just one more facet of the bubble.  So, the mortgages originated in 2006 and 2007 were just the last gasp of that process - a continuation of the excesses that preceded them.  It seems perfectly reasonable to say, "They did this to us.  They caused this to happen.  They created the bubble, and the bust was inevitable."

But, what if the "bubble" was primarily the result of a supply shortage?  There were still trillions of dollars of home equity to be harvested, even if those trillions weren't unsustainable paper profits created by a credit bubble.  So, that wealth was available to tap for liquidity as nominal economic activity contracted.

Instead of saying, "They did this to us." we should say, "They delayed the tragedy we imposed on ourselves, but we would not relent, so the tragedy happened eventually anyway."  Those borrowers in 2006-2007 might have saved us.

Rentiers - Closed Access real estate owners who were capturing monopoly profits - were claiming an outsized portion of new production.  In order to use their property values to claim that production they either had to sell them (to a new owner that was likely more leveraged) or they had to take out debt that was collateralized by them.  This accounted for more than 100% of new personal consumption expenditures during the boom.  Eventually, the collapse of sentiment and, eventually, property values, in real estate, caused that debt-funded consumption to collapse, and there was little monetary accommodation until the end of 2008.  Nominal consumption collapsed until that happened.

The borrowers and investors were maintaining the growth of the nominal economy until they couldn't anymore.  This is a good example of how fundamental our priors and presumptions are about what happened.  Priors that say debt is unsustainable, lender and speculator driven, and reckless, would lead to a conclusion that collapse would bring discipline.  That bad things are good.  But, changing those priors, recognizing that debt-funded consumption was the product of a deep inequity in our economy, that it was sustainable and natural as long as that inequity remains, leads to a conclusion that what Americans needed was relief.  Discipline was abuse.

The homeowners with growing equity are the monopolists that need to be tamed.  But, in 2006-2007, the borrowers were the only thing keeping us afloat.


  1. Of course liquidity was were late-cycle and, by late-2007, inflation was well above target. Central banks add loads of stimulus early in a cycle and then gradually withdraw it as you near zero-slack. The "flaw" is that financial assets do not account for this shrinking liquidity backdrop. Houses, stocks, and other assets should actually trade at very high multiples early cycle and lower multiples later cycle...but they don't. Asset valuations tend to be pro-cyclical instead of counter-cyclical so you end up with both pricey assets AND shrinking liquidity late-cycle. This is why the path of things like stocks is boom-bust instead of a fairly steady line (which would be much more rational).

    1. Some of that might be plausible, but equity prices were moderate, and PE expansion that came late was from declining profit, not rising prices. In fact, PE ratios had been high in the early cycle and declined back to the teens before profits were hit, just as you say they should.

      Home price/rent also had peaked by the end of 2005 and was declining slowly during the period I describe above and, as I have documented, those prices were not due to a cyclical event, except to the extent that cyclical factors affected the migration flows created by the urban shortage.
      Core Inflation was slightly above the 2% target, and also commodity inflation had a spike. These are certainly important reasons why monetary policy was tightened enough to help trigger a financial crisis, but it was boosted by inflation of imputed rents of homeowners. Non-shelter core inflation was well below 2% in 2007. This is a reason why we need to think about the housing problem more carefully when we think about monetary policy going forward.

  2. > Would it be too crazy of me to say that there was already a liquidity crunch, and that the only reason nominal GDP growth was still limping along at rates that were only marginally recessionary was because households sitting on recent real estate gains tapped those properties for cash?

    I don't follow this thinking because the way you wrote above, the cash the buyer used was conjured from thin air, but of course the act of borrowing cash from someone else does not expand the money supply --- it simply moves cash from lender to borrower. Increasing mortgages does not expand the money supply if rich people are taking money they otherwise would have spent on yachts and investing in MBS instead.

    The "borrow to expand the money supply" story would need something else to support it, like higher assets-to-reserves ratios at banks. Banks, not borrowers or lenders, can expand the money supply if they make more loans on the same capital. Fortunately, I think this is easy data to get --- isn't this just the M1 money supply? i.e., if you see increasing mortgage volumes and increasing M1, then I think you can say that the borrowers and the banks were expanding the money supply together.

    Apologies in advance if this is either wrong or totally obvious.

    1. I'm willing to be corrected on this, but here is how I would put it. Let's say you have an unmortgaged home and no income. You have wealth, but in order to consume from that wealth, you must convert it into something liquid. In theory, one could use equity shares in a house as units of exchange, but in our economy, that is not a universally accepted means of exchange. In order to make that wealth liquid, it usually must be converted into a debt security. One way to do that is to sell the home. But, here, to keep it simple, think of tapping home equity. It's the same basic process. So, the owner goes to the bank and the bank establishes matching liability and asset accounts. For the bank, there is an asset of $x in the form of a home equity line of credit and a liability of $x in the form of a checking account or savings account. Now, the homeowner can use that home equity to consume. This, effectively, creates a form of money. The central bank is the last mover, though, and if they are targeting a rate of inflation, the creation of the new deposit at the bank would be inflationary, and the central bank would reduce the growth of currency by buying fewer treasuries in order to maintain a stable inflation level.

      Since so much money, in the form of bank deposits, was being created out of housing wealth, the Federal Reserve was being very stingy with currency creation. Most of the time, people talk about the "housing ATM" in "ceteris paribus" terms, as if the Fed is part of "ceteris paribus", but I would argue that the Fed is never "ceteris paribus". This is like Scott Sumner's idea of "monetary offset", but instead of offsetting fiscal policy, an inflation targeting Fed will offset debt-funded deposit growth.

      By 2006-2007, it seems clear that there was rising demand for holding more near-cash securities, not for the purpose of consumption, but for the purpose of avoiding risk. To meet that demand, either debt or cash must be created. It's hard to know how strong the correlation would have been, but I would argue that in 2003, if the Fed had increased the money supply, it would have generally just been inflationary. But, by 2006 and 2007, more cash would have increased the supply of money and decreased the demand for money, and both would have had the effect of reducing debt creation. Maybe not enough to completely counteract the inflationary effects of creating currency, but I don't think that's totally out of the question. For starters, non-rent core inflation was barely over 1%, and rent inflation had shot up as housing starts collapsed. Renewed residential investment would have reduced rent inflation, so even with higher inflation in other categories, total inflation might have remained tame. And, some of the demand for near-cash was certainly due to concerns about the economy and the housing market. So, I think, ironically, more cash creation would have had muted inflationary effects and reduced debt growth, in part because households would have regained confidence about housing and shifted back into home equity and out of liquid assets.

      But, again, if anyone reading this wants to correct the nuts and bolts of any of this, I'm open to it.

    2. You confuse me again by talking about currency creation and money creation interchangeably.

      Yes the Fed prints currency (federal reserve notes) but we did not run out did we? When the Fed prints currency, it is simply swapping one form of base money (bank reserves) for another (federal reserve notes) so there is no net money creation. Currency creation is not money creation at all.

      If banks are creating new deposits on the same reserves (say, by loaning against homes) that *is* money creation -- not base money, but M1 money, which (unlike shares in a house) is as good as base money from a medium-of-exchange viewpoint.

      > if they are targeting a rate of inflation, the creation of the new deposit at the bank would be inflationary, and the central bank would reduce the growth of currency by buying fewer treasuries in order to maintain a stable inflation level.

      Again, you are confusing currency with base money. The Fed does not use currency (paper money) to buy bonds. It creates new base money (money in the Fed's own account at the Fed) and uses that to buy bonds. The seller's bank receives those funds, which just means that the new money (again, not currency, just bits in the Fed's computer) moves from the Fed's own account to the seller's bank's reserve account.

      So let's see. Confusion over currency vs base money aside, I think we agree that:

      1. only the Fed can expand (or contract) base money (well, the Fed and counterfeiters...), which is M0

      2. the money supply that matters the most for economic activity is M1

      3. the private sector *can* expand M1 (to a point), and does in fact expand it when (for example) a homeowner takes out a mortgage, and the bank provides an increased demand deposit account balance (assuming the bank's capital i.e. reserve balance stays fixed).

      4. An inflation-targeting central bank will react to the M1 expansion by either reducing the supply of M0 (selling off its bond holdings) or increase the demand for M0 (say, by paying higher IOR).

      So I guess the nuts-and-bolts I would correct would be to sharpen your use of the word "currency". My understanding is that the word has two meanings: (1) a system, the "US dollar" abstractly (and the banking regime that supports it) is collectively "a currency" ("currency" as a countable noun); and (2) bank notes (dollar bills and coins) are "currency" ("currency" as an uncountable noun). Demand deposit account balances and Fed reserve balances are not "currency" in either sense, but they are both "money". Demand deposit account balances are part of the M1 money supply. The M0 money supply is precisely Fed reserve account balances plus outstanding currency (in the dollar bill / coin sense). When the Fed "expands the money supply" (in the monetary policy sense), this does not involve currency creation at all; it involves increasing the Fed's own reserve account balance and then using that balance to buy assets (typically Treasurys). The Fed also has a currency management role, but when the Fed prints more dollar bills, it swaps them for reserve balances, and there is no net change to M0. Thus printing currency is completely independent from monetary policy.

      Hope that helped... I agree with your larger point that the expansion of total mortgages represented an expansion of the M1 money supply that was much needed to keep the economy running, and essentially reduced the extent to which the Fed needed to expand M0 to hit its inflation target compared to a situation where people were not expanding mortgage balances.


    3. Thanks for the input. I do need to think about this, in terms of presentation.

      While you are technically correct about open market operations, the reason I use the terminology I do is because pre-IOR, OMO did generally lead to currency creation.

  3. It is a dazzling thing to realize that with one keystroke, the Fed can conjure $1T or any other amount of base money into existence, and then just start buying stuff with it.

  4. Properly understood, it is not dazzling at all.

    Economically, anyone can create money. The only barriers are from the legal system.

    The limit to making money in a competitive system is people's willingness to hold your money (instead of getting rid of it as fast as possible).

    In a recession, people typically want to hold more money. So it is only fair that the money creators oblige.

    Such money creation on demand happens even under eg a good standard.

    (George Selgin has a lot more and much cleaner writing on the mechanics involved.)