Tuesday, November 5, 2019

A look at trends in homeownership.

Here's a new post I have up at the Bridge, at Mercatus.

Here's a chart from it:

The brief summary is that there hasn't been any recovery in homeownership rates at all from the bottom of the housing bust for middle aged households.  The small amount of recovery we have seen recently is all among young households - generally households that were young enough to miss the crisis.

And, of course, I revisit the basic point that it is a myth that there was excessive or unsustainable homeownership during the housing boom.

Here is a Jed Kolko piece at Trulia that adds some interesting details to the story.

Friday, November 1, 2019

October 2019 Yield Curve Update

The yield curve still seems to be following the bearish timeline.  My axioms here are:

1) The true measure of inversion isn't a slope of zero.  At the zero lower bound, it is a slope of a little more than 1% (10 year minus Fed Funds), which declines as the base yield rises.  (At about 5%, meaningful inversion happens at a slop of zero, and higher than that, the slope will tend to become more negative the higher yields are.)

2) The neutral rate is a moving target.  If the Fed drops its target rate too slowly, long term rates will tend to stabilize but not rise, and this usually ends in some sort of contraction.  If the Fed gets ahead of the dropping short term rate, then long term yields will pop up like they did a couple times in the 1990s, and contraction will be avoided.  So, if the scatterplot keeps moving to the left as it did this month, that's bearish.  If it moves up, that's bullish.

The second graph is the Eurodollar yield curve, which continues to move up and down a bit but with a negative short term slope and a pretty flat long term slope.  I expect the short end of this curve to eventually drop below where it was in late August.  It will be good news if it doesn't.

Monday, October 21, 2019

September 2019 CPI Inflation and Yield Curve Updates

Sorry, I have been a little slow posting this month's update. This month was a return to the longer-term form. Shelter inflation moved up to 3.5% and non-shelter core CPI inflation moved down to 1.5%. Not much to add. I continue to think that the slower the Fed is to lower short term rates, the lower they will eventually go. I still think the yield curve is effectively inverted because the zero lower bound should bias long term yields higher. Normally, one might suspect that real estate and residential investment are important factors in the inverted yield curve. I would speculate that inverted yield curves lead recessions because they are signs of disequilibrium. Long term yields can't go as low as they need to. And one reason is that in order for yields in real estate to decline, prices need to rise, but rising prices require expanding money and credit. A similar point could be made with bonds. Cash is required to bid bond prices higher. But, the oddity with this cycle is that real estate borrowing has been repressed during the expansion. A loosening of regulatory pressure would probably release credit into low tier housing markets, raising prices, and triggering residential investment. Leading cyclical indicators in real estate will probably be most useful in high tier markets this cycle because those markets have not faced such unusual regulatory obstacles to funding. And, as AEI housing measures show, for instance, high tier prices have leveled off and inventories of homes for sale have grown.

I'm not sure what to expect other than continuing low long term yields, though.   Equity risk premiums are already at high levels.  Stocks could dip from declining growth expectations, but I'm not sure that we should expect much of a dip in equity prices.

Because homebuilders are both a defensive and a speculative position from here, they might offer some opportunities.  Hovnanian (HOV) was so low this summer that it received a warning from the NYSE that it might be delisted.  It has recovered sharply from those lows and makes an interesting position to follow as a reflection of the potential for pent up demand to emerge for new homes.  Increases in revenues should have a magnified effect on their market capitalization.  There was a recent paper that made a good statistical case that market concentration in homebuilding was holding back housing starts and pushing prices higher.  The executives at Hovnanian must have had a laugh about that, as, a decade after the crash they are still working to get revenues high enough to bring their financial and operational leverage back to more sustainable levels.

Otherwise, among equities, I think we're more in a period of keeping dry powder ready than we are in a period of excessive downside risk.  In spite of low yields, a bond position probably still isn't the worst position to have in the world, tactically, although they don't offer much benefit as a long term portfolio allocation.

Wednesday, October 16, 2019

Housing: Part 357 - The subtext behind the crisis is spoken aloud.

I have developed a framework for understanding the housing bubble and the financial crisis which attributes the pre-crisis market upheavals to fundamental structural issues (an urban housing shortage that triggered a migration event out of the coastal urban centers), and the financial crisis to a series of politically popular policy errors based on passionately held beliefs about the causes of the bubble.

Because the errors were so passionately and universally held, they are frequently stated explicitly. I am working on a follow up book to Shut Out where I frequently make seemingly crazy claims like that the country was clamoring for a financial crisis or that there was a consensus in favor of imposing pain. It’s not really a claim I intended to make or wanted to make. And I don’t feel like I’m particularly skilled at communicating this history. Yet, when I attempt to construct a narrative history of the crisis, I keep running into powerful people saying these horrible things explicitly and uncontroversially.  People had taken too many risks and public policy reactions to a recession couldn’t be so successful that they allowed those people to avoid losses.

Even today, the most common complaint against the Fed and Treasury is that they didn’t inflict more pain.  When I point that out, the reply is that the pain was earned. And that is why the corrective against the terrible policy choices that were well in place by 2008 goes back to identifying the correct factors behind the housing bubble. The explicit justification for choices throughout the development was that risk takers needed to learn a painful lesson. It’s a pretty low bar to establish that financial collapse wasn’t a productive or reasonable tool for economic management.

Consider the common observation that a disruption like the Great Recession or Great Depression affects financial behavior for a generation. Young people have systematically been turned off risk taking behavior. That observation is correct, and under the presumption that crisis was inevitable or necessary, it seems like it is just a sort of natural fact. But changing those presumptions highlights the horrible realization that the generational scar was a disastrous and popular public policy decision. We have engineered a lot of damage.

One of those generational shifts has been the turn away from homeownership and from home building. Here is an example from the Pew Center of seeing these huge cultural shifts as inevitable or exogenous rather than as a result of our self imposed financial damage.  Seeing the housing bust as inevitable, the Pew Center asks, Why are housing trends that date to the Civil War suddenly reversing?  But realizing that it was a self-imposed policy choice, the question should become, "My God, what have we done?"  Maybe I’ll revisit that link in another post.

A similar reaction to the Pew article is the idea that the deep depths of the housing collapse in 2011 or 2012 were just the last inevitable gasps of the corrective housing bust.  Many reviews of the crisis rest on this presumption.  Today Bill McBride at Calculated Risk had an update about housing sales. Unlike many of the explicit positions about Fed and Treasury policy in 2007 and 2008, the idea that collapsing housing markets in 2010 or 2011 were ok isn’t held passionately and it isn’t based on malice. Here is a quote from the post:

When the YoY change in New Home Sales falls about 20%, usually a recession will follow. The one exception for this data series was the mid '60s when the Vietnam buildup kept the economy out of recession.   Note that the sharp decline in 2010 was related to the housing tax credit policy in 2009 - and was just a continuation of the housing bust.

So, there is a chart of home sales that shows that 20% contractions are almost always associated with a recession, and that chart shows a second wave of 20% contraction in starts after the worst contraction since the Great Depression and it’s “just a continuation of the housing bust”.

Frequently, I am directed to read Calculated Risk as a source of documentation about the excesses of the pre-crisis mortgage market, and rightly so. The site is full of detailed descriptions of many problematic characteristics of the market at that time. Post after post of detailed analysis.

Then, in 2010, a secondary contraction happened that was of notable size. I have documented how that late contraction was not an unwinding of anything that had happened before.  The losses were concentrated in credit constrained markets that had not had housing booms and who were locked out of newly stingy mortgage markets.

As I have documented, the collapse of prices in many of those markets was worse after mid 2010 than it had been in 2008. McBride is correct that the tax credit ended about then. Surely that was one factor that led to a brief stabilization then secondary collapse.  But even with the tax credit, mortgage markets were clearly tighter than they had been in decades.  Homeownership rates were well below long term ranges for all age groups younger than 65 and were still falling precipitously. The housing contraction in 2010 had nothing to do with the housing boom of 2005 and everything to do with public policy choices from 2008 onward.

An event that registers as one of the seven worst housing contractions since the early sixties has triggered practically no analysis.  It barely registers any attention at all. It reminds me of the Salt River Canyon in Arizona, which would be a wonder of the local geography of it was located in Indiana, but in Arizona, at most, merits a slight squiggle on the map where the highway winds through it.

Hundreds of billions, if not trillions, of dollars in home equity was sucked out of homes in working class neighborhoods because it just seemed so convincingly prudent to trigger such losses.  As far as I can tell, there was never an explicit justification for it, because nobody bothered to notice it.  Occasionally, the scale of it rears it’s ugly head, as it does in the chart at calculated risk, and it demands to be explicitly justified.  Is it justified with hundreds of posts about the state of lending in 2010? No. That phase of the crisis is still neglected, but it is neglected explicitly.  A contraction in new home sales of 20% is usually a big deal, but this time, by presumption, let’s say it wasn’t.

When Americans were passionately looking for financial losers to be the scapegoats for our housing sins in 2008, it is hard to miss them saying it out loud.  But the neglect of the post 2008 collapse was a quiet neglect and the explicit statements of neglect only bubble to the surface accidentally.

Thursday, October 10, 2019

CFPB: Get rid of the "Ability to Repay" Rule

During the financial crisis, many new rules and mandates were put in place to make it more difficult for lenders to issue mortgages.  This was based on the false notion that the housing bubble happened - that houses doubled in price or more in several regions - because marginal households were pressed into expensive mortgages they couldn't afford.

Those rules have made it very difficult for many qualified borrowers to buy affordable homes.  The effect has been to make homes less affordable, not more, while also damaging working class balance sheets.

Here are a couple of excerpts:

But after the passage of Dodd-Frank, low-tier prices in many metropolitan areas dropped by 10 percent or more, compared to high-tier prices. The metropolitan areas that had the least negative price shock after Dodd-Frank were the very expensive cities. The negative shock that followed Dodd-Frank hit the hardest in the cities where there hadn’t been a positive shock during the bubble. The cities that fed the premise that led to the passage of Dodd-Frank were the cities where prices were least affected by it (see figure A6).

Housing markets in the expensive cities have not changed much from the precrisis boom. Homes are still expensive because rents are high, and rents are high because of limited building. In all other cities, there has been a systematic change in housing markets since the crisis. Rent affordability has become worse but mortgage affordability has become better.
The demand shock created by limits to new lending has compressed price-to-rent ratios, pushing prices below replacement cost. So rents are rising, mortgage affordability in most cities is better than at any precrisis point of comparison, and supplies are stagnant because prices are too low to induce new building, especially in the most affordable markets where credit constraints are the most binding and affordability is most important. According to data from Zillow.com, the rent on the median American home claims about 28 percent of the median household’s income. In the period since the crisis, rent has generally claimed a larger portion of household income than it had at any time for decades before the crisis. But a conventional mortgage on that same home would only claim about 16 percent of the median household’s income. In contrast to rent affordability, mortgage affordability since the crisis has been better than at any time for decades before the crisis. And these shifts are most extreme in the most affordable cities. The less expensive housing is, the better a mortgage payment stacks up against the rent payment on a typical house. This is not the time to add regulatory obstacles to potential new homeowners.

Here is figure A6 and notes:


Note: This heatmap uses the median home value at the ZIP-code level, estimated by Zillow. First, metropolitan areas were sorted into five quintiles according to metropolitan area home prices at the peak of the housing boom in 2006. Quintile 1 contains the least expensive metropolitan areas and quintile 5 contains the most expensive metropolitan areas. Next, within each metropolitan area, ZIP codes were sorted by median home price into five quintiles. And price appreciation of the lower quintiles from December 2000 to the later dates shown was compared to the price appreciation of the higher quintiles. For instance, from December 2000 to August 2007, in the least expensive metro areas (quintile 1), the least expensive ZIP codes saw an average price appreciation of 37 percent while the most expensive ZIP codes saw an average price appreciation of about 33 percent. Low-priced homes appreciated, on average, by 3.3 percent more than high-priced homes, as shown in the figure. From December 2000 to December 2013, the least expensive ZIP codes in the least expensive metro areas saw an average price appreciation of about 28 percent, compared to 36 percent for the highest-priced homes in those metro areas. So low-priced homes appreciated, on average, 6.1 percent less than high-priced homes, as shown in the figure. The figure highlights two key issues: First, the unusual and extreme rise in low-tier homes within metropolitan areas was largely confined to the most expensive cities, which allow very little building. By the time Dodd-Frank passed in July 2010, that phenomenon had reversed, and so from December 2000 to June 2010, among all types of cities, there was remarkably little variation in home price appreciation between high-tier and low-tier markets. After Dodd-Frank, low-tier prices in the expensive cities, which had previously seen extreme price appreciation during the boom, were not greatly affected. But low-tier prices in the more affordable cities, which never had extreme price appreciation, were pushed down more than 10 percent. Source: Zillow, “Economic Data,” accessed August 29, 2019, https://www.zillow.com/research/data/. The particular data series used was the median home price by ZIP code for all homes (ZIP_ZHVI_AllHomes).

Tuesday, October 1, 2019

California wants more monopsony in the labor market.

The case of AB5 in California is an interesting clarifying case regarding the motivations and goals of labor regulation.  AB5 redefines the distinction between contractors and employees and is mostly an attempt to force Uber and Lyft to treat their drivers as employees rather than contractors.  This will entitle them to benefits, workplace protections, and the minimum wage.  My experience with these firms is that the contractor status is a key component of the benefits of their model, and that in most markets, changing to an employee-based model will make it difficult for them to continue.

Normally, one argument in favor of higher minimum wages is that firms have monopsony power over unskilled laborers, so they hire fewer workers and pay them less than if the market were more purely competitive.  Thus, raising the minimum wage does not lead to much unemployment.  Firms can afford to pay more.  The minimum wage just transfers some of the monopsonist gains back to the workers.

But, the interesting thing about this particular market is that you would be hard-pressed to find a market that was a closer approximation of pure competition.  On the customer side, Uber & Lyft are basically commodities.  Riders can check on both services, and will generally go with the one that has the shortest wait at the lowest price.  Many drivers drive for both, so there is little the firms can do to differentiate their service.

On the driver side, the firms must pay enough to entice drivers to be available.  In fact, Uber and Lyft pay more than the market clearing price for drivers that have riders in their cars because in order to win more passengers, they need to pay enough to induce drivers to be available, which in this industry, inevitably means idle time.

In fact, Uber & Lyft have very little control over what their drivers earn.  Since this is a competitive industry with free entry and exit, and since the firms must accept as many drivers as they can, within reason, so that they can offer customers a shorter wait time than the other firm does, drivers determine their earnings by entering or exiting the market.  If Uber & Lyft pay more than is necessary, more drivers will enter the market, and they will spend more idle time without riders in their cars.  This will happen even within the existing pool of drivers. If Uber decides to raise the payment they make to drivers in a market, that will induce more drivers to Uber and away from Lyft.  If you ask drivers what happens in markets where one of the firms changes their pay rates, you will find that the total weekly earnings don't change much.  If Uber raised their pay rates, then a driver who drives for both will find that they get more rides from Lyft because drivers will have substituted between the two firms until the net total pay (idle time plus paid time) roughly evens out.

This is a classic case of queuing.  And you can see the queue adjusting in real time to changes on the ground.  In fact, that is the beauty of the contractor model.  There are hundreds or thousands of drivers in a city, and drivers are constantly adjusting between Lyft and Uber, between times of day or location.  Each driver is in a constant chess match to find the most lucrative way of driving that matches their needs and constraints, and the key variable at the center of those tactics is minimizing idle time.  Each driver is increasing or decreasing their willingness to queue depending on the opportunities available to them as drivers or outside the rideshare industry.

Compare this to the minimum wage debate.  Effectively what minimum wage opponents argue is that those markets are generally competitive, so that a high minimum wage will increase unemployment.  Unemployment is a queue.  The minimum wage is set above the market clearing rate, so workers queue to supply the limited demand for employment.

In the minimum wage debate, monopsony is treated as a preexisting condition which the minimum wage is meant to cure.  Here, there clearly is no monopsony.  In fact, these firms are so lacking in market power that even the proponents of AB5 sometimes express doubt that their business model is sustainable. In reality, AB5 is meant to create monopsony.  But, queuing is already a natural part of this model.  So, what AB5 would do is make Uber & Lyft gatekeepers reducing the quantity of labor supplied in the market.  Since drivers would be employees, and the firms would be responsible for their total earnings from both idle and active time, the firms would have an incentive to minimize idle time.  They would have an incentive to limit the number of drivers.

This would not necessarily change the total amount of queuing time.  It would simply segregate it so that the riders who are now chosen by the gatekeepers to be employed would have less idle time, and the riders who are not chosen would be in the queue known as unemployment.

I think this would be tragic.  The beauty of the contractor model is that workers who have been turned away by the gatekeepers in other industries that have employee models can enter this business without dealing with gatekeepers.

One aspect of this industry that would be interesting to study is that there is a great amount of variation in driver earnings.  Even this MIT study which found low earnings levels on average (which I think have been revised up) shows a tremendous range in driver earnings.

What's interesting is that this is a completely open marketplace.  There is little that drivers can do to keep other drivers from horning in on their driving strategy.  There are few barriers to entry.  (Even the car isn't much of a barrier.  There are companies that partner with Uber and Lyft that will rent you a car for less than $5/day.)

What you find if you ask drivers about their work is that there is a tremendous amount of variety among drivers regarding what they need from their work and what strategies they use to get what they need.  In the minimum wage debate, opponents often point out that employers will make non-wage adjustments to counter regulated wage gains - less flexibility, fewer benefits, etc.  What we can see here is that the drivers themselves, in the unregulated rideshare market are actively engaged in some massive rebalancing between pecuniary and non-pecuniary benefits.  The variance in earnings might be partly explained by skill, or location.  I'm sure in Phoenix it's easier for a driver that lives in old-town Scottsdale to roll out of bed and turn the apps on and get rides immediately than it is for one on the far west side who might need to drive downtown to get to a busy area.  But, surely those factors can't explain that much variation.  Drivers are making choices about when they want to work, what types of riders they want to pick up, etc.  The 2am bar scene is a sure-fire earnings winner, but many drivers happily sit it out.

So, from a public policy point of view, those who would regulate this market aren't trying to fix a market failure.  There is no market failure.  AB5 creates monopsony power by imposing a wage floor and a regulatory framework in this market, with the hope that the economic rents will be claimed by the drivers.

This is telling.  I think it's a bit of a misunderstanding to think that Progressive, egalitarian political policies are intended to make up for economic rents claimed in imperfect markets.  Egalitarian policies require economic rents.  You can't divvy up the spoils in your preferred way if you don't have spoils.

In this particular case, engineering corporate power and then trying to transfer the gains to the workers will be a huge loss.  First, I just don't think the business model can work that way.  There are countless ways that drivers now manage their queuing in a way that is productive which simply couldn't be managed centrally, including being simultaneously available for both Uber & Lyft. But, furthermore, this is basically a classic labor market.  This is not much different than, say commission sales work.  In the same way, sales jobs frequently have highly variable earnings distribution that comes from hard-to-quantify skills.  Many workers try out sales, fail miserably, and then quit.  So, there are some real winners, but also high turnover, and many workers that just don't do sales well and don't make much money doing it.  This market isn't much different than that.  If there are some drivers who are only making $5/hour, then they shouldn't drive.  Or, maybe they are retired and they just like to have an excuse to get out of the house and meet people.  Creating a market that drives this vast sea of diversity out and turns it into a cookie cutter job where you go where you're told, everyone makes a similar, lowish wage, with much less flexibility for the drivers will mean that a lot of drivers will lose things they value.  And, many of the drivers that are making $20/hour or more will either make a lot less or will be driven out of the market altogether because being contractors is a key element to their driving strategy.

And, this will likely fail at its own goals.  The loss of productivity and the loss of a potential chance to earn income without gatekeepers making the hire/no hire decision will leave a lot of drivers out.  In the current competitive rideshare market, it is other opportunities that determine what drivers earn.  If similar work can get you $12/hour in other jobs, and a driver in that city can earn $13, then that worker, on the margin, will drive, adding to the queue time for all drivers as more drivers must divvy up the same number of rides, until similar drivers are only making $12 after factoring in idle time.  Regulatory impositions like this do nothing to improve those other opportunities.

The rhetoric on this issue tends to be anti-corporate, as if this regulation will force the firms to treat their workers better.  But, the firms are powerless to significantly increase the pay to their drivers.  The regulation requires a playing field that engineers more corporate power.  The idea is to use that corporate power to lessen wage inequality.  It will only lessen wage inequality within the rideshare industry, and it will do so at the expense of some of the better paid drivers and at the expense of potential drivers who will now not get hired.  And it will lower the value added from the rideshare industry.

AB5 is crony capitalism.  It has to be.  It can't do what it purports to do without creating a framework that gives the firms power to limit access to the market.  As I mentioned in the previous post, this might be a generalized point.  Maybe more powerful firms are correlated with less variance in wages.  The egalitarian project requires powerful firms so they can be directed by the state to distribute the gains from that power.  But, trying to engineer that outcome with policies like AB5 is fraught with potential downsides.  I haven't seen evidence that AB5 proponents have attempted to fully understand those downsides.  It would probably be impossible to fully understand the potential downsides.  In the end, driver incomes are determined by the available alternatives.  This applies generally to all workers, really.  It is unlikely that the fates of workers in general will improve by imposing regulations meant to take available alternatives away.

The fact that the rideshare industry is such a decent approximation of textbook competitive markets makes it a great example for understanding which complaints about our present economy are complaints about information being conveyed by functional markets about the state of the world and which complaints are about market failures.  To my eye, there is a lot of confusion on this distinction.

Monday, September 30, 2019

Maybe corporations don't have enough power.

I think I have expressed skepticism previously that corporate or monopsonist power can explain the apparent growth in income inequality.  First, a careful look at changing income proportions shows that a decent portion of the drag on real incomes is due to housing expenses. Relatively little is due to rising corporate or interest income. Most of the relative difference between high and low incomes is more variance between different laborers or between wage earners and professionals who are frequently proprietors.  In fact, if corporate income or power was rising, monopsony power in labor markets should lead to less variance in wages.  High wages come from skill development and specialization. Frequently these are tied to specific institutional contexts. Specialization would make high earners more vulnerable to being captured by a few or one corporate buyer of their labor.

In a context of monopsony power, wages at the top of the spectrum would be held lower. Corporations wouldn't then voluntarily distribute them to workers with lower wages. But if firms lacked monopoly power, they wouldn't be able to retain the gains from that. The gains would be captured as consumer surplus by the firms' customers. In order to be competitive in the market for their goods and services, firms would have to assert their monopsonist power just to remain competitive by transferring those gains to the consumer.

Here, I am reminded of the conventional wisdom that asserts that mid 20th century corporations were more loyal to their workers and that a corporate job was more of a lifetime gig because corporations took care of their workers.  That doesn't really match very well with income data which doesn't show much variation in corporate operating income as a portion of total domestic income over long periods of time. But it does match with a context where more skilled workers were captured by powerful firms and less skilled workers benefit indirectly as consumers.  Maybe labor incomes had less variance because firms back then were more powerful.

Sometimes an IPO comes up for a company that markets itself as a tech startup, and people joke that it's just a dog food distributor with an app attached to it, or something.  But, maybe we have that backwards.  Maybe every company today is a tech start up.  Maybe, what pushed your wages up in the past was, say, being a machinist in a specific sector, where a few firms were interested in your skills.  But, today, a key path to higher wages is a job with a title like "systems administrator" or "data manager", and your skills are applicable in some way to 80% of the economy.

I suspect that generally there is too much focus on corporate power. Rather than debate whether they have too much or too little, I think attention is better focused on other structural issues. Rising costs of housing, education, health care, and public infrastructure, together with barriers to migration, are more important factors holding down real incomes below their potential. A problem with the corporate power issue may be that the argument about its effect have the sign of the factor wrong.  In the financial crisis, I think the focus on enforcing losses rather than maintaining broader stability presents a similar example where determined policy programs that have the sign wrong (more housing was needed in 2005, not less, for instance) are much, much worse than benevolent indifference.

There is an intersection between these issues. Because of the housing shortage, there is a lack of market access and mobility. Y combinator must be located in Silicon Valley. Being in Silicon Valley is essentially a 40% tax on business development.  The lack of access to that location simultaneously makes certain actors wealthier while reducing overall creative destruction.

The way to progress is to have more y combinators. Adding to the already high costs and barriers with new taxes and mandates hardly seems like a helpful response.

What if the problem is that corporate power is too low? Then lowering their power will worsen inequality even more. Things like codetermination might create even more obstacles to mobility and migration. Maybe the internal politics would serve to further increase the bargaining power of specialized high wage workers.

But, most importantly, over long stretches of time, labor and capital income grow at nearly a 1:1 correlation.  In so many ways our relationships are symbiotic more than they are in conflict. Maybe the focus on relative power is itself a problem. When the economy is growing, the rate of quits increases, and as the Atlanta Fed shows, wages for job switchers increase faster in a growing economy than the wages of other workers. It isn't the relative status of workers compared to employers that is the engine of that shift, it is the relative status of new, more productive firms over old, less productive firms. Surely the way to shared prosperity lies there.  An economy where a restaurant owner is bringing in customers like crazy, but she can't serve them because the potential waiters have found more productive things to do.  That seems like a problem to the restaurant owner.  The response shouldn't be to force them to pay waiters more.  The response should be indifference, which means the restaurant still feels pinched while some other firm somewhere produces high wage opportunities for workers because a growing economy is imbuing those firms with power.

Friday, September 13, 2019

Yield Curve mid-September 2019 update

There has been quite a lot of movement in yields since last month, so I thought it would be useful to look at an update.

During the last half of June and July, the long end of the curve came down while the short end moved up a little bit.  I wish we had an NGDP futures market to check these intuitions against, but I think the best interpretation is that in June the Fed had reversed track a bit and signaled more dovish policy going forward, but then some compromises in that posture began to arise, so while they certainly are more dovish than they were several months ago, some of the optimism that was pressing long end rates higher in June has receded.

The slope of the curve from two years onward has remained relatively stable since then and the movements have mostly been movements in the estimated low point of yields in 2021.

At first glance, rising rates since the end of August are bullish.  But, that is entirely due to rising short term rates.  The long end has actually flattened slightly compared to the beginning of August (the blue line compared to the pink line).  There are obviously a mixture of factors here, and continued strength in the labor market is probably one reason for optimism.  But, it seems to me that the net movement of the past two weeks is probably bearish.  Less faith that a dovish commitment by the Fed will prevent a bit of a downturn.  That would lead me to suspect that the coming decline in the target short term rate will be somewhat tepid and will be associated with a sympathetic decline in the long end of the curve at first, back toward or below the levels of late August.

Thursday, September 12, 2019

August 2019 CPI Inflation

Here are the monthly inflation updates.  It will be interesting to see if the Fed treats 2% as a symmetrical target or a ceiling.  There might be an argument for treating it as a ceiling at this point in the business cycle, because employment is so strong.  But employment is a lagging indicator.  At this point, I think the Fed has reduced the potential of worst case scenarios, but I don't think they will loosen up monetary policy aggressively enough to avoid a bit of a contraction.  And the depth of the contraction mostly depends on future decisions.

In addition to the problem that these measures are backward looking, of course, there is the issue, which is always the focus of these posts, that the shelter component is not particularly related to monetary policy, since it mostly measures the estimated rental value of owned homes, and even in the case of rented homes, frequently is measuring the growth in economic rents from the ownership of a politically protected asset, which is really more of a political transfer of wealth than an effect of monetary policy.

All of these questions about monetary policy discretion would be unnecessary under an NGDP futures targeting regime.  Hopefully, we can continue moving in that direction.

The last couple of months have seen an upward movement in non-shelter core inflation.  This puts core CPI at 2.36% and non-shelter core CPI at 1.68%.

Monday, September 9, 2019

Part 16: The conclusion to my series on housing affordability

A conceptual starting point for housing affordability and public policy

Here is an excerpt, but the post is short, so please click the link if you're interested.

Understanding this value and the systematic returns that homes provide leads to a somewhat paradoxical conclusion that (1) homeownership is usually a good investment, and (2) the smaller the investment, the better. In other words, an owner-occupied home with a low rental value can be a great investment, but the downside is that it requires living in a home with a low rental value.

The various posts in this series have considered housing affordability with a focus on rent. This focus has led me to the following policy suggestions: we should (1) maintain relatively high property taxes, (2) reduce or eliminate income tax benefits of homeownership, including the non-taxability of the rental value of owned units, (3) eliminate urban supply constraints, (4) reduce regulatory barriers to mortgage lending, especially in low tier markets, and (5) encourage innovation in real estate markets that reduces transaction costs.

I hope you have found some interesting ideas in the series.  I found it useful and enjoyable to systematically lay out a conceptual review of these ideas.

Here is a link to the whole series.

Wednesday, September 4, 2019

August 2019 Yield Curve Update

I had a brief flirtation with optimism, but the last couple of months have seen a bearish turn. 

This first graph is a graph comparing the Fed Funds Rate and the 10 year Treasury yield.  The orange line is the effective inversion line.  The zero lower bound means that long term yields have a kind of option value, biasing the yield curve upward.  This is my attempt at adjusting for that effect.  The yield curve is highly inverted.

In the meantime, the Fed seems to be tepid about their recent dovish turn.  It would take quite an aggressive posture for them to get ahead of this.  For this to become less bearish, the 10 year yield would need to rise substantially.  It's unlikely to do that without an aggressively dovish move, which the Fed would signal with a sharp decline in the Fed Funds Rate.

I expect the long term rate to bounce around a bit, but it seems unlikely that it will push back away from inversion.

The second graph shows the yield curve at various dates over the past few months.  It has flattened even as short term rates have declined.

Tuesday, September 3, 2019

Part 15 of my Housing Affordability at Mercatus

As the series nears a conclusion, I question the notion that homeowners are more leveraged than renters, or that, all things considered, the housing boom was associated with a rise in household liabilities.
The idea that paying $700 in rent is preferable to a $300 mortgage payment comes from the idea that a potential home buyer would be adding a new liability to their household balance sheet. It would involve leverage, and leverage is dangerous.
But this idea is, itself, a product of mental framing. There are assets and liabilities that we explicitly include on balance sheets, like the value of a home and a mortgage, or the market value of a corporation’s future profits. And there are assets and liabilities that we don’t explicitly include, like future rental expenses or the market value of a laborer’s future wages.
The explicit financial engineering that spread before the financial crisis has taken on a lot of criticism over the past decade.  That financial engineering, ironically, created risks and costs that were more transparent and visible than the implicit financial engineering that has been an unwitting side effect of deleveraging Americans’ explicit balance sheets.
A significant part of corporate financial analysts’ academic training is to properly account for the liability of the rents corporations have committed to paying.  Wouldn’t it be prudent for mortgage regulators to account for this liability also when evaluating the benefits and costs of the lending standards applied to households?

Tuesday, August 27, 2019

Coming to terms with discretion

The development of such a strong canon regarding what caused the housing bubble and what we should expect the economy to do during the recession has led to a subtle issue regarding causes and consequences.

The strength of the canon - that excessive lending and speculating had to be beaten down - and the passion for approaching it, meant that the entire episode has an air of inevitability, even where it was completely discretionary.

I mean, really, take any version of what happened in 2008.  It will have the pretense of inevitability.  Ask, "What caused the financial crisis?" and the answer will contain an implicit transitory property so that the answer will actually be the answer to "What caused the housing bubble?"  The FCIC report is basically entirely built on this premise.

Basically, a=c (things that might have caused a housing bubble = a crisis happened) was so universally accepted, that nobody has paid much attention to the second part of a=b and b=c (things that might have caused a bubble = did cause a bubble) and (the development of a bubble = a crisis).  Of course, much of my work debunks a=b.  This naturally means b=c is essentially a meaningless relationship.  A bubble that never really was could hardly be said to have caused anything.

Now, as far as a=b goes, there are library shelves full of claims about that connection.  Even though one might disagree with them, at least they exist.  But b=c was essentially presumed.  Yet, it wasn't inevitable at all.  In fact, once one is led to doubt whether a=b, one realizes that regardless of whether credit, speculation, etc. caused a bubble, the question of whether a collapse is inevitable isn't settled at all.  The collapse was completely under our discretion, and it was simply the universal agreement about that discretion that made it seem inevitable.  Like an abusive parent hitting a child and exclaiming, "Well, he broke the rules.  What would you have me do?"  The answer to that question was obviously to accept the abuse 100 or 200 years ago, simply because its acceptance was canonized.  It isn't acceptable today.

Simply questioning the premise reveals the dissonance.  The reason the crisis happened wasn't because there was nothing we could do about it.  The reason it happened was that, going as far back as 2006, or arguably even earlier, turning points just kept piling up where policymakers chose contraction, panic, decline, and collapse because to do otherwise would be coddling risk takers, bailing out wrong-doers, letting those who did this to us off the hook.  I don't even think I need to establish the point.  The public record is so saturated with that idea that it is undeniable.  It covers practically every page of every review of the period, every criticism of the Fed and the Treasury.  It's the story we have told ourselves about what happened.

Anyway, I am treading again over this territory, because I came across this graph today (here).

And, it really drives home the damage that those discretionary decisions did.  The places that are hurt much, much worse by cyclical dislocations are the places that are struggling already.  Successful places bounce back.  If not for the recession, "distressed Americana" in this graph would at least still be treading water.  Instead, there is a gash in its flesh in 2009 that isn't going to heal.  And, rest assured, the parts of the country that suffered that gash were not in the throes of a speculative frenzy.  They certainly didn't need to be taken down a notch so that those reckless people that did this to us had to be punished.

If you are concerned about the bifurcation of economic growth in this country, then there is a big giant elephant in the room regarding that issue.  We walked that elephant into the room, and it took a big, elephant-sized crap on the places that really needed stability.

Even if you think there was an unsustainable bubble and excesses had to be painfully purged from the system, consequences be damned:  THIS is the consequence.  Oh, by the way, it didn't need to be done.  a<>b .  But, even if we save that debate for another day, the imposed "discipline" that so universally was hoisted on the economy to knock it down to size had downsides that should be faced honestly.  a<>b, but even if a=b, there are a lot of questions we should have asked about, really, how committed we should have been to b=c.

Monday, August 26, 2019

Housing Affordability, Part 14

Here is my latest post at Mercatus: "Because of Housing, All Taxes on Capital Tend to Be Regressive".  Here is the conclusion.  Go to the link for the details.

 (T)he income tax code, as it exists, has regressive effects regarding housing affordability.Given those effects, it is inaccurate to treat capital taxation in general as a progressive tax. Corporate taxation, in general, creates a regressive rent subsidy. A different tax regime that focused on property taxation rather than generalized capital taxation could plausibly produce public revenue in a way that would be more progressive than a tax code that taxes capital income more generally. This should cast doubt on common presumptions about how and why to change the tax code.

Friday, August 16, 2019

July 2019 CPI Inflation

Core inflation has recovered a bit in the last two months, but we remain in the context of relatively low non-shelter inflation and high shelter inflation, averaging out to roughly on-target total core inflation.

I will probably continue to do these updates for a while, but I suspect the context is set, and specific shifts in inflation won't affect things much in the near term.  Inflation isn't likely to shift sharply in either direction, and in the time frame that is important for the Fed right now, noise dominates information.  So, effectively, Fed discretion will rule, although it will frequently be cast in language of inflation or interest rate control.

The context in place seems to be that the Fed will loosen.  Not so much to avoid a bit of a contraction, but not so little as to be greatly disruptive.  Excess shelter inflation is part of that context, but other factors will come into play, too.

Here, I think the 2008 event is informative.  The Fed is somewhat forgiven for allowing NGDP and inflation expectations to drop so sharply because at that time inflation was slightly above target.  This makes inflation seem like an important short term element in Fed decision making.  But, I disagree with that analysis.  Inflation wasn't anywhere near a level that would have led any sane regulator to sit aside as one panic after another struck the economy.  And, even as the Fed did that, the overwhelming criticism of them was that they were even daring to try to stabilize financial markets.  Even today, many commentators explicitly complain that selected economic agents weren't made to suffer enough.  The financial crisis in late 2008 happened because it was popular.  Slightly above target inflation is simply one of several justifications that were used to allow it to happen.  For any reasonable observer with a straightforward goal of maintaining economic stability, none of those justifications were plausible excuses for allowing such economic dislocations to occur.

The reality in late 2008 was that any reasonable monetary or fiscal policy would have caused a rebound in housing prices, as a side effect.  That would have been taken as indefensible.

We don't have the same dramatic setup today, so the stakes aren't as high.  But, similarly, inflation and interest rates will be used to communicate short term monetary shifts even though those shifts will have little to do with either.

Wednesday, August 14, 2019

Part 12 of my Housing Affordability series at Mercatus

Are Property Taxes Regressive?

The conclusion:
A region that allows ample new supply and imposes higher property taxes is friendlier to households with lower incomes than a region with obstructed housing supply and low property taxes.

Thursday, August 8, 2019

July 2019 Yield Curve Update

The yield curve has taken a sudden turn for the worse.

The Fed's tradition of using interest rates to convey their monetary stance is such a constant source of confusion.  The conversation about yields so often seems to hinge on the idea that the central bank is in full control of interest rates and uses them to make it more or less profitable to borrow and invest.  It baffles me how ubiquitous this sort of idea is in both professional finance and economics.

Recent movements in yields are a great case in point.  It is common to hear this shift described in terms of expectations about Fed rate cuts.  But the whole yield curve shifted down.  This is not a sign that the Fed will be loosening monetary policy more aggressively.  This is a sign that they won't be loosening aggressively enough.  The neutral rate just changed, leaving the Fed behind as a victim of institutional inertia.  That is in contrast to recent times when yields did react to clear signals from the Fed that it was going to be more aggressive.  In those cases, short term rates fell and long term rates increased.

I only update my graph of the adjusted yield curve inversion monthly, so the red dot for July is at about the same spot as it was at the end of June.  Of course, the 10-year rate has dropped 25bp since then.  So, unless some sort of economic or political development greatly improves economic prospects in spite of a tight monetary posture, raising 10 year yields back up, then we are already at a point where, even with short-term rates at zero, the yield curve will be effectively inverted.  This will likely lead to complaints about how the Fed is using QE4 to keep long term interest rates low to boost investment and asset prices, including from many otherwise sensible people who are generously paid to manage other people's assets.

Monday, August 5, 2019

Part 11 of my housing affordability series at Mercatus

Low Property Taxes and Obstructed Housing Supply Are a Bad Mix
"It would seem that raising property taxes would make housing more expensive.  They are, effectively, a tax on materials to build homes.  But the binding constraint to affordable and reasonable housing in twenty-first century America isn’t material.  It isn’t a lack of affordable physical space.  It is the political obstruction to placing those materials in dense urban centers."

With a universal expected market return, lower property taxes and just a small expectation of persistently rising rents can lead to much higher housing prices.  That's the first order effect.  But, as a second order effect, the value of homes as assets that are speculative claims on local political cartels, might mean that lower property taxes will be associated with higher rents.  It seems that higher property taxes might lead to lower quantity demanded, but also lower supply, with a net effect of less housing at higher cost, with cartel real estate owners pocketing the profits.  The political implications of that might change when the oligopolists would otherwise have been middle class pensioner grandparents, but the economic implications don't.

Tuesday, July 30, 2019

Part 10 of my Housing Affordability series at Mercatus

Property Taxes Can Be a Tax on Monopoly Power.

"If politically maintained monopoly power is going to remain, claiming monopolist profits through taxes is an improvement. The fact that the tax doesn’t affect rents is a sign of efficiency. If rents must be elevated, better that they go to local public services than to the real estate cartel."

The series will continue each Monday with discussion of the effect of various regulations and taxes on housing costs.

Sunday, July 28, 2019

Housing: Part 356 - Black Homeownership

Here is a new Bloomberg article on black homeownership.  The title is:
"Black Homeownership Falls to Record Low as Affordability Worsens"

The headline, and the article, are wrong.  Affordability isn't bad and that isn't why black homeownership is falling.

Here is a graph in the article, which also has an incorrect headline.  It says, "Over 25 years, the gap between blacks and whites has widened."  What the graph really shows is that from 25 years ago to 15 years ago the gap was narrowing, and then for the past 15 years it has been widening.

Here is a graph that combines old decennial Census data with the more recent quarterly data to provide a little more historical comparison.

From the Great Depression to the late 1960s, white homeownership rose as a result of Federal programs that explicitly excluded black families.  Then homeownership for black families increased, but then fell back again in the 1980s, for reasons I am not familiar with.  Then, in the late 1990s, it recovered back to the levels of the late 1970s, relative to aggregate US homeownership rates.

Then, homeownership peaked in 2004 for black families as well as for the US in general.  And the drop in ownership since then has been stronger among black families than among others.

To describe these trends with "Over 25 years, the gap between blacks and whites has widened." obscures what is important.  Black homeownership was recovering and expanding when mortgages were more available.  Note, however, that the recovery in ownership peaked near the beginning of the private securitization boom that lasted from roughly 2004 to 2007.  Since then the relative homeownership rate collapsed.

The disparate impact of the recession, the crisis, and the subsequent sharp tightening of lending standards on black households has been strong.  But, who would dare to claim that the pre-crisis housing market was good and that post-crisis lending market has been detrimental?

Here are the Zillow measure of mortgage and rent affordability - the portion of the median household's income required to pay the rent or the mortgage on the median housing unit.  It would be more accurate to say that it has been especially unaffordable not to be a homeowner in recent years.

Wednesday, July 24, 2019

Housing: Part 355 - Homes and population growth

I noticed that housing units per adult has actually started to level off.  This is interesting because total permits and total starts are still below past averages.

So, maybe the new neutral run-rate for new units is less than 1.5 million annually.  Maybe the need for new units is less acute than I have been saying.

But, there is a problem of causation here.  More people means we need more homes, but also, a lack of adequate housing can lead to less people - both by limiting migration and by limiting family formation.

And, it is true that population growth has slowed.  Before the financial crisis, it tended to run at 1-1.2%.  Since the crisis, it's more like 0.7%.  So, in a way we solved the housing shortage, in part, by reducing population growth.  If this is the new normal, then maybe 1.2 million units a year isn't an unsustainably low peak.  But, if population growth, either through immigration or through family formation, returns to anywhere close to historical norms, then housing starts probably need to catch up a bit and then settle at something closer to 1.6 million units annually.  (Ignore the big drop in housing/adult in 2000.  I haven't taken the effort to try to account for the discontinuity in the data there.  I suspect that mostly that discontinuity comes from an overestimate of the housing stock in the late 1990s, but it isn't central to the main trends I am discussing here.)

Certainly an argument can be made that population growth through family formation has been naturally slowing, so that we shouldn't expect population growth to continue at historical norms.  On the other hand, there are many good reasons to counter that decline with more generous immigration policies.  And, while there is a long term down trend in natural population growth, there was a sharp downshift that appears to have been related to the economic turmoil of the crisis and to the lack of housing growth since then.  Even without immigration, it seems likely that natural population growth has declined more than it otherwise would have after the crisis.

Also, there is always the important signal here of rent inflation, which has persistently run high for the past 25 years and returned to high rates during the post-crisis recovery.  That is not a signal we would see in a country where housing was being depressed by natural declines in population growth.

Tuesday, July 23, 2019

The latest posts in my Mercatus Housing Affordability Series

The last two posts in my series were:

"Tight Lending Regulations are a Wealth Subsidy".  An excerpt:

Thinking in terms of rental value, public policies and market innovations that lower mortgage interest rates can be broadly beneficial to consumers, even if those benefits don’t accrue to the actual borrowers who use those low rates.  That is because higher mortgage interest rates have a similar effect on price as exclusionary lending standards.  Downward pressure on price creates a rental subsidy for home buyers who don’t require a mortgage.

"Property Taxes Are Rent to a Public Landlord" An excerpt:
If there is concern that the net effects of government policies, in total, favor housing and lead to market volatility, a return to higher levels of property taxation can be a useful tool for countering it.

Writing the series helped clarify my thinking on several issues.  I hope you find some nuggets of interest in it too.

Thursday, July 11, 2019

June 2019 CPI Inflation

Here is my monthly inflation update.  We continue along in the same pattern.  This month there was a bit of a bump in non-shelter inflation, but the trailing 12 month rate remains about 1.1% and shelter inflation remains about 3.4%.

Going forward, I think inflation may become a less important indicator.  The Fed has shifted to a more dovish posture and they are not insisting on holding the target rate at a plateau.  It would be a shock if they don't lower rates this month.  So, I am happy to say that my worst fears appear not to have come to pass.  Monetary policy is on the margin of neutral.  Unless the Fed reverses course, I suspect there will either be a slight contraction or a continuation of the expansion.  For now, I will call that a tentative prediction, but it seems to be where we have moved.

We are probably near the point in time where a tactical long position in fixed income should shift into more of a long position in equities and real estate, either now or over a few months as this plays out.

In terms of broader influences, I'm more worried about nominal growth rates in Australia and Canada than things like the tariff issue, but I'm no expert on those issues.  That's just my hunch.

Monday, July 8, 2019

Squeezing "Unqualified" Borrowers

The latest post in my Mercatus bridge series.

More on how recognizing the key importance of rent as the measure of affordability - for both owners and renters - helps clarify the issue.  Tight lending is making housing less affordable for renters.

Considering this set of circumstances, the idea that housing affordability is getting worse because prices are high and that the solution is even higher interest rates or tighter credit access is a disastrous misreading. It will lead to a vicious cycle of segregation between households that can qualify under today’s standards (and who then can buy ample units at favorable terms) and households that cannot qualify (and who must keep economizing while a large portion of their wages is transferred as rent to the ownership class).

There are two options. Re-opening credit markets to entry-level buyers will return the market to a more equitable equilibrium. Maintaining the market as it is will continue down the path of settling at a new equilibrium where certain households live in smaller, less adequate units, either because of size, amenities, or location.
Please read the whole thing.

Here is the link to the full series.

Sunday, July 7, 2019

Housing: Part 354 - Nashville follow up

I wanted to revisit one graph, because I think it tells the story so well about what's happening in many US cities while lending standards are tight.

In the process, I realized that I should have adjusted for inflation, and in the process of doing that, I realized I had a minor excel worksheet error.  Here is the chart with the error fixed and the dollars constant.

In the last post, the linear trendlines were pretty nearly lined up.  But, the things that would affect the price/rent relationship should generally scale with inflation, so this is probably a more accurate portrayal of the Nashville market.  There has been some recovery of price/rent ratios in the low-to-mid part of the market.

At the top end of the market, P/R ratios are up about 5 points since the bottom, which was around 2011.  The bottom should be up at least that much too.

Low tier prices have risen as much or more than high tier prices.  But, as I pointed out in the previous post, this is because of low tier rent inflation, and the positive feedback of units with higher rents moving up to higher price/rent ratios.

That is still evident in this corrected graph.  At the high end, adjusted for inflation, price changes since 2011 are generally due to a recovery in price/rent levels.  That is the part of the market where building is taking place.

At the low end, little building is taking place, and rising prices are largely from rising rents.  Here, we can see that, even adjusted for inflation, the bulk of zip codes have moved from rents typically around $1,100 per month to rents more like $1,300.  P/R ratios in that part of the market have risen by around 2x and the rise in rents led to an additional P/R expansion of another 2x or so.  So, the low-to-mid part of the Nashville market moved from $1,100 rents at a P/R of 10x to $1,300 rents at a P/R of 14x.  The combination of those things was enough to cause those areas to appreciate in price faster than high end Nashville where rents have remained about the same in real dollars and P/R has increased by about 5x.

Some of the increase in rents is due to gentrification and in-fill capital improvements, but the tendency to blame those capital improvements for the increasing problem of unaffordable rent completely misses the point.  Rents won't come down until those segments of the market get as much capital as the top end is getting.  And, the top end is getting a lot.

Friday, July 5, 2019

June 2019 Yield Curve Update

Rates have continued to dip.  Forward markets have already moved much of the way back toward zero.  This has been somewhat surprising to me.  I expected the Fed to maintain the Fed Funds rate at a plateau level, as they did in the last two cyclical reversals.  But they are almost certain to start to lower the target rate this month, and that is great news.

There is still some potential for trading gains in forward rate markets, I think, because short rates are highly likely to return to near zero.  I hope the newly dovish turn by the Fed is enough to give that move some oomph.  I think an important signal will be the long end of the curve.  If it remains low as the Fed lowers the target rate, this is a sign that the Fed is following the neutral rate down, and isn't really inducing nominal growth.  It will be a bullish sign if the long end of the curve moves up.

In fact, using the adjustment I make to the yield curve, at today's levels, the 10 year treasury yield would still be effectively near inverted rates even if the Fed lowers the target rate to zero.  My worry is that mistaken associations between low rates and loose money will prevent the Fed from being aggressive enough.  But, recent Fed communications have been more promising.

The first graph here shows the 10 year rate vs. the Fed Funds rate, and shows my modeled inversion indicator.  By this measure, the curve has been inverted for many months and moved much farther into inversion territory this month.  In some ways, that is a good sign, because it reflects expectations of near-term Fed rate cuts.  But, ideally, it would be better if long term rates held firm.  The fact that long term rates are declining along with short term expectations is a sign that frictions in credit markets were keeping long term rates high.  To me, this is the best way to think about yield curve inversion.  Some set of frictions in the market prevent long term yields from declining to unbiased forecasts of future short term rates when the yield curve is inverted.  I suspect that this causes problems with credit allocation that may be a causal element in the contractions that tend to follow inversions.  If long term rates decline when short term rates are lowered, that suggests that lowering rates has removed those frictions and allowed long term rates to move to a less biased level.  So, the good news is that Fed dovishness is helping to offer relief to markets, but the bad news is that this means an inversion is in effect and that usually leads to a contraction.

The market is currently priced to expect the dots on my scatterplot to move sharply to the left as short term rates are lowered.  But, the key to avoiding a recession is for the upcoming dots to also move up.  If they don't, then I suspect that we will be playing catch-up and economic growth expectations will remain subdued, which will continue to lead capital to safer assets instead of into riskier investments that can trigger productivity and employment strength.  It is hard to tell in real time, but it is beginning to look like real GDP growth peaked a year ago and that the 4 quarter real GDP growth rate will move back down below 3%.  One might expect real growth to level off as unemployment bottoms, but employment growth has been pretty stable since 2012 at 1.5% to 2%, and continues to move in that range as workers re-enter the labor force, so changes in employment growth don't point to a GDP slowdown yet.

The best thing that could happen is the Fed lowers the target rate aggressively, long term rates rise with new real growth and inflation expectations, and then FOMC members and pundits who incorrectly view lower rates as a stimulus to risky investments will interpret higher rates as less stimulative, and they won't pressure the Fed to stop lowering the target rate.

Wednesday, July 3, 2019

Housing: Part 353 - The Seemingly Strange Case of Nashville

There are two core constructed details that have formed a basis for much of my analysis about the 21st century housing market and the financial crisis.

  • Price/rent ratios tend to rise as rents rise, but at some point in each metropolitan market they reach a ceiling.  This means that (1) excessive price appreciation in low tier homes during the housing boom in cities like LA and NYC was mostly a product of rising rents. and (2) The core error of the FCIC and most analysis of the crisis was missing this fact and blaming rising prices on aggressive credit markets instead.
  • In most cities, rents were moderate enough that there was not an unusual rise in low tier home prices from this effect, but after the boom, when credit was greatly tightened, low tier prices were decimated, frequently falling more than 20% compared to high tier prices.
This first graph basically tells that story (PS: Many thanks to Zillow.com for making so much price and rent data public):
idiosyncraticwhisk.com 2019
Data from Zillow

LA is highly unusual, both for having such high price appreciation and for having such a divergence between the high and low end during the boom.  These are related.  They both come from the extreme shortage of supply relative to demand for housing in LA.

Seattle is more expensive than Atlanta because incomes are higher there and supply of housing is more constrained, though much better than LA.  So, you see a bit of difference between Seattle and Atlanta during the boom, but little difference between the top and low tier of each city.

Then, during the bust, bottom tier home prices in both Seattle and Atlanta collapse, to the point where low tier prices in Seattle had total appreciation that was no more than high tier appreciation in Atlanta.

idiosyncraticwhisk.com 2019
Data from Zillow
I recently had occasion to look up data in Tennessee.  I have gotten so used to seeing this pattern that running the numbers has become rote.  Almost every city looks something like Seattle and Atlanta.  So, I was quite surprised when Nashville looked like this:

Nashville looks like Atlanta before the crisis and Seattle after the crisis, and it doesn't have the lagging low tier price appreciation of either of those cities.  In fact, it is high tier prices that have been lower in recent years.

What gives?

It turns out that in recent years, Nashville has been on fire, economically.  Population growth, in-migration, rising incomes.  Things are going really well there.  Things are going so well that housing supply pressures are making it look more like a Closed Access city.  Well, it's more the case that there are two Nashvilles.  The top half of the housing market operates like an open access city before the crisis.  The bottom half of the housing market operates like a closed access city because new tighter lending standards are preventing owner-occupiers from buying homes in those sub-markets.  This has compressed price/rent ratios so that yields are high enough to induce buying by landlords.  This can happen through lower prices or by rising rents.  In practice, it can be a little bit of both.  In Nashville, it appears that economic success has led especially to rising rents, because pressure for residency in Nashville is pushing up demand for Nashville housing.  At the top end, this leads to more supply.  But, that demand pressure also appears to be seeping into the low tier, where it can only push up rents, because buying pressure is limited mostly to landlords and they are still mostly just buying up the existing stock, apparently at price points that still can't induce much new supply.

Here is a Fred chart of housing permits in Nashville.  The red line is single family homes and the blue line is multi-unit homes.  Both are very healthy.  Pre-crisis Nashville had strong rates of new home building.  It may be unique among cities where building was well above the national average before the crisis and has recovered to those pre-crisis levels.  You just don't see this in other cities.

I presume that eventually, rents will rise high enough to trigger even more building at the low end, putting a stop to excessive rent inflation.  But, it hasn't happened yet.  Though, multi-unit starts are very strong.  To the extent that investors will build new stock, it will tend to be multi-unit.

idiosyncraticwhisk.com 2019
Data from Zillow
Here is a graph of median rent and mortgage affordability in Nashville and in the US over time.  (Again, all hail Zillow.)  The national story here is that rent affordability has been high (though it has moderated recently) but that mortgage affordability has never been better.  There has never been more reason to loosen lending standards.  This is basically why the low tier of most cities is lagging in price and supply with rising rents, because we have financial gatekeepers preventing potential low-tier buyers from closing this financial arbitrage gap.  Price is not the moderating factor keeping mortgage expenses so low.

But, note what the Nashville story is here.  It has traditionally been an exceptionally affordable city, in terms of rent.  But during the housing boom and after, that gap has closed, and Nashville isn't particularly affordable any more.

idiosyncraticwhisk.com 2019
Data from Zillow
Because of these high-tier vs. low-tier supply issues, this affordability problem is especially pronounced in low-tier Nashville neighborhoods.  Zillow only has rent data from 2010, but here is a graph comparing aggregate median rent levels in each zip code in Nashville from 2011 to 2019.  The x-axis measures the starting median rent and the y-axis measures how much rent has increased in that zip code since then.

More affordable areas have experienced rising rents much higher than more expensive areas.  So, the median rent affordability measure above really splits a divide between top-tier areas where rent affordability has remained low and low-tier areas where it has moved up more.  In Nashville, this has been strong enough factor to swamp the compression of price/rent ratios.

idiosyncraticwhisk.com 2019
Data from Zillow
And, this brings us back to the bullet points at the beginning.  The counterintuitive issue at the core of the question of rising home prices is that rising rents cause price/rent ratios to rise.  Here is a comparison of rents and price/rent ratios in zip codes in Nashville in 2011 (blue) and in 2019 (red).  As we can see, the typical pattern holds.  Price/rent ratios rise as rents rise, up to a point, where they level out.  At the top end of the market in Nashville, price/rent ratios have increased since the market bottomed, and top end price/rent ratios now average around 17x or so, up from around 14x in 2011.

One would think that price/rent ratios at the bottom end would have to have expanded at least that much, because prices have appreciated at least as much at the bottom.  I have added linear trendlines here, reflecting the portions of Nashville that are not at the peak price/rent level.  As you can see, that relationship hasn't changed much since 2011.  A typical unit renting for $1,200 has a price/rent ratio that is right at the same level it would have been in 2011.  But, rising rents have pushed all housing units up this price/rent ratio incline.  This is basically the same effect that was happening in places like LA before the financial crisis.

The long and short of it is that there are zip codes in Nashville where rents might have been $1,000 per month and looser lending may have pushed price/rent ratios up from 10x to 12x.  The trend line in this graph would have moved up.  Instead, because of tight lending, rents in those zip codes are more like $1,200 with price/rent ratios around 12x.  The trendline hasn't moved at all, yet this doesn't make housing more affordable.  This is one of many reasons why the focus on affordability should be on rent, not price.  Rent is the coherent source of information for that question.

I have concluded that the relative rise in low-tier prices in cities like LA during the bubble was unrelated to loose lending markets.  That is a tough argument to make, because it coincided with loose lending markets, and it just seems to make sense that loose lending would create new buyer demand that might push prices up.  But, here, in Nashville, we can see the same effect, and here, the effect coincides with tight lending.  In both cases, however, rising rents and rising price/rents coincide with limited supply.

Tight lending standards have created the same context in the rest of the country that supply constraints in Closed Access cities had created before the crisis.  Any positive economic developments will create a side effect of pushing up the cost of living for families with the lowest incomes.  Eventually, I presume, Nashville will hit a rent level that pushes prices high enough to induce enough investor building to level off rent inflation.  There will be a new normal, where the level of rents will be higher for low-tier tenants relative to where they used to be, but once we hit that level, the rate of change in rents should level out.

There is no rule here that points us to the correct place.  Maybe access to mortgages should be tightly regulated and housing should be more expensive than it used to be for low-tier tenants.  An advantage of that market norm would be lower rates of mortgage defaults, etc.  It would be a safer equilibrium with less volatility and less punctuated distress.  But, the cost of that safety comes at the expense of low-tier tenants.  They replace less punctuated distress with more chronic distress.  And, if prices are going to be depressed by limiting access to capital, then that means, mathematically, that we are enforcing a system of inflated returns to those who happen to have capital.  Again, maybe that's ok.  We just need to be honest about the implications of these lending norms.

If this is the new normal, then most cities have a few decades to look forward to that look like Nashville today.  Economic success will mostly simply mean rising cost of living for households with lower incomes.  This will be blamed on all sorts of supposed problems with laissez-faire markets, but most of it lays at the feet of a national consensus that has supported an extreme regime shift meant to make real estate markets less volatile.  Supporting an economic structure that benefits all Americans will require coming to terms with the pros and cons of that consensus.

Follow up.