Monday, March 25, 2019

More talkin'

I had a nice conversation with Josiah Neeley of the R Street Institute and Doug McCullough of the Lone Star Policy Institute on their podcast "Urbane Cowboys".

Elsewhere, Emily Hamilton, a research fellow at the Mercatus Center was on the Marketplace Morning Report, on NPR, discussing housing.  (Her segment starts at about 5:20.)  She was there, in part, to discuss a new brief co-authored by her, Salim Furth, and myself.

Also, some readers might be interested in this.  I don't work for this firm, Hoya Capital, but I found out that they just started a new housing ETF that is partially based on some of the same ideas you see here at IW.  The ETF is meant to give investors broad exposure to the housing market in general - including builders, REITS, lenders, etc. - so that investors can gain from a supply recovery in housing, however that recovery ends up being shaped.  That's my brief attempt at describing it, but certainly, if you are interested, you should peruse the details at the site.

Friday, March 22, 2019

Market Concentration

John Cochrane discusses an interesting paper that claims that, while national concentration has increased, local concentration has decreased.  In other words, each location has more competition within various industries, but the competition is more among national chains than among local firms.  So, there top firms claim a larger portion of the national market, but at the local level, consumers have more choices.
What's going on? The natural implication is that the town once had 3 local restaurants, two local banks, and 3 stores. Now it has a McDonalds, a Burger King, a Denny's and an Applebees; a branch of Chase, B of A, and Wells Fargo, and a Walmart, Target, Best Buy, and Costco. National brands replace local stores, increasing the number of local stores.

Thursday, March 21, 2019

Writing and talking

Garrett Peterson kindly asked me back on the Economics Detective podcast.  It's always a pleasure to chat with Garrett.  The podcast is here:

And, here is an op-ed in the Los Angeles Daily News:

Claiming that building more L.A. housing would only benefit newcomers misses the point. The newcomers are coming already, and they aren’t waiting for L.A. to build them homes. Rest assured, until the rate of new building is increased, the homes that those newcomers will take will still be provided, quietly and sadly, one unit at a time.

Tuesday, March 19, 2019

Housing: Part 346 - Making the Crisis Inevitable

My new policy brief is up at Mercatus.  The important part:
This means that a collapse in prices was not inevitable. But more importantly, this means that calls for tighter monetary policy during the boom were calamitous. Loose monetary policy has been widely blamed for high home prices and for the debt-fueled consumption that they funded. Critics, and even Federal Reserve policymakers, generally agree that monetary policy should have been tightened sooner. But this is the wrong conclusion. In fact, monetary policy was powerless to counteract the debt-fueled consumption of the boom period, and the bust was only inevitable because the Fed tried to solve a problem that it could not functionally solve with tighter monetary policy.

As in 2005, the primary stresses that characterize the American economy do not have a monetary source or solution, but mistaken monetary attempts at solutions are capable of adding to those stresses. Certainly, there is no reason to tighten policy today as a reaction to high home prices. 

Monday, March 18, 2019

Housing: Part 345 - Come on in. The water's fine.

Via Tyler Cowen:

Between 2003 and 2006, the Fed raised rates by 4.25%. This tightening induced a large contraction in deposits, leading banks to substantially reduce their portfolio mortgage lending. Yet, this contraction did not translate into a substantial reduction in total mortgage lending. Rather, an unprecedented expansion in private-label securitization (PLS), led by nonbank mortgage originators, substituted for most of the reduction in bank portfolio lending and thus largely undid the impact of Fed tightening on the mortgage lending boom.

Edit: it isn't so clear in my excerpt, but what is interesting in this paper is how they isolated the sensitivity of bank deposit rates to the fed target rate to show that banks systematically substituted securitized lending for portfolio lending. In other words, tightening monetary policy was a key factor leading to the growth of private securitizations. The Fed was tightening, in part, to slow down mortgage lending, but what they ended up doing was slowing down everything else.  I have a brief coming out soon explaining how it was unlikely to be any other way.

Tuesday, March 12, 2019

February 2019 CPI

Inflation took a step down this month.  There is little need to repeat my monthly mantra.  This takes us a step further to a situation where consumption may be waning, but the Fed thinks inflation is near their target because of high imputed rent inflation.  And, they think the risk is toward more inflation because of the low unemployment rate and Phillips Curve thinking.

Trailing 12 month core inflation is at 2.1%.  But, core-non-shelter inflation is down to 1.2%.  (Sorry, not shown.  I'll update when I can.)  TIPS forward inflation is also below 2%, although it has recovered from its recent lows, but that is also a bad sign, since that suggests expected non-shelter inflation is below 1% for the next 5 years, unless there is a building boom around the corner.

Monday, March 4, 2019

Housing: Part 344 - Square Footage over time

Here is an interesting piece on housing supply in England. (HT: TC)

There are two graphs in the piece, shown here.  And, the author, Ian Mulheirn, argues that data on home size shows that there isn't a supply shortage.

I have posted on a previous post of Mulheirn's where he makes a similar argument.  His previous post was somewhat persuasive to me, although astute readers pushed back in the comments on my post.  On this new post, I think Mulheirn might be betraying a bias toward his conclusion a little more clearly (at least for me to see).

The charts show that in England as a whole, floor space per person has increased by about 4% since 1996, although that all came in the late 1990s, from one data point.  For London, floor space has been level since 1996, and has declined since 2000.  He interprets this as evidence that there is not a supply constraint nationwide, and only a small constraint in London.

There is a similar story in Manhattan.  Population in Manhattan is about 25% lower than it was in 1910.  But, over that century, a lot of square footage has been added in Manhattan.  So, two things are going on at the same time.  We are getting richer, so we don't sleep 6 to a room in tenements anymore.  And, building hasn't been able to keep up with that change in standards.

So, benchmarking to an unchanging floor space size is not a neutral way to benchmark.  This is obvious looking at the very long term in Manhattan.  The irony is, units could have been added vertically to provide that extra space in Manhattan to maintain a stable population.  All that building wouldn't have added any new strains to the things like the city's transportation infrastructure.  One would hope that, over a century, the transportation infrastructure would have become more efficient so that the population could have even grown.

But, even over the shorter timeframe to the mid 1990s, one can imagine changes in norms, such as siblings being less likely to share bedrooms or households having fewer members, on average.  Since 1996, per capita real GDP in the UK is up 36%.  Now, I don't expect floor space to increase 1:1 with real incomes.  But, even there, some of the reasons we wouldn't expect floor space to increase would be because of local supply constraints that make it difficult and also because richer households might spend less of their incomes on shelter.  So, there is some combination of factors at work.  Either floor space should have increased by 36%, or there are supply constraints, or rents should have declined as a portion of household income.

Outside of London, according to Mulheirn's previous post, rents have declined as a portion of incomes, and here he shows that floor space is up slightly.  That does suggest that supply is not particularly constrained in those areas.  This could be because of looser building policies or because of less demand for living in those places.

In London, it appears that the 36% growth in real incomes has led to about 36% growth in rental costs for slightly smaller units.  That suggests that rent inflation is significantly higher than general inflation in London, which is similar to what is going on in American Closed Access cities.  That seems like the sign of a constrained asset class that collects economic rents for exclusive ownership rights.  I'm not sure that supports Mulheirn's position that there isn't a supply problem as much as he thinks it does.

Friday, March 1, 2019

February 2019 Yield Curve Update

Well, could the Fed end up with a soft landing here?  Interest rates have recovered somewhat.  We are basically at the same place we were a month ago, but it seems that sentiment has turned toward asking the Fed for more wage growth rather than worrying so much about inflation and asset prices.  And, the market seems to believe that the Fed is done hiking.  Forward inflation expectations are moving back up too.

In terms of my measure of inversion, it hasn't budged, and when inversion has happened in the past, it has always been uninverted by lowering short term rates, not by sitting tight while long term rates rise.  That doesn't mean it would be impossible.  My hunch is that we are still more likely to see an eventual contraction, where the Fed will hold to the current rate target for too long as conditions deteriorate.

It still seems like the best position is to be somewhat defensive - that the next big asset class move will be higher bond prices.

But, there does seem to be a change in the air.  Can positive sentiment be strong enough to push savers into risk-taking and push long term yields up while the Fed stays put?

Wednesday, February 27, 2019

Quick note on Interest on reserves and inflation expectations

I've been working on the follow up book to Shut Out.  Some version of this graph will probably be in it.  It shows that the deep drops in equity values didn't come from the disastrous September 2008 Fed meeting after the Lehman Brothers failure.  They came during the period when the Fed began paying interest on reserves.

The story in a nutshell is that the Fed had the target interest rate pegged at 2%, which was far too high at the time.  In order to maintain the peg, they would have had to sell every Treasury on their balance sheet.  So, in order to suck cash out of the economy and maintain their interest rate target, first they asked the Treasury to issue T-bills and deposit the proceeds at the Fed, to fund emergency loans they were making to panic-stricken financial firms so they wouldn't be inflationary.  Basically, the Treasury was selling T-bills so the Fed wouldn't have to.  Then, when the Treasury had deposited hundreds of billions of dollars at the Fed and was balking at borrowing more, the Fed began paying interest on reserves, so they could effectively borrow directly from the banks.

Now, the point of this was because they were afraid of creating inflation when they made emergency loans.

In this graph, I also have the implied expected 5 year inflation rate, from TIPS markets.  For much of the time they were sucking credit from the banking system, 5 year expected inflation was negative 1%-2%.

Saturday, February 16, 2019

Housing: Part 343 - New Homes and Vacancies During the Boom and Bust

There may be a similar post to this one back in the previous 342 housing posts, but something I happened upon today reminded me of it.  Price trends among sold homes, vacant homes for sale, and existing homes give a clue about what happened during the turn in housing.

I haven't shown it here, but the median existing home price didn't rise as much in 2004-2005 as the mean home price.  That is because expensive cities were getting more expensive, so the distribution of prices was becoming more skewed.  The rise of prices in the most expensive places caused the average to rise more than the median.

But, here we can see that the median new home was slightly declining in value relative to the median existing home, especially in 2005-2007.  That is because Americans were not adding more expensive homes to the housing stock.  They were adding less expensive homes to the housing stock, compared to past trends.  That is because the housing boom was facilitating a decline in housing expenditures the only way it could, by creating compositional shifts of population to less expensive places.  Having a building boom in less expensive cities is, in fact, the only way to reduce aggregate housing expenditures in a Closed Access context.  We can't have a building boom in the expensive cities, and rents aren't going to moderate if we slow down building.  A building boom is the only way to do it.  And, it was working.

Since the crisis, the median prices of new homes has moved much higher because we have used mortgage suppression to slow building down and to reduce ownership in low-tier markets.  Because building is the way to reduce housing expenditures, rental expense has remained level for homeowners while rent for non-owners has continued to take a larger portion of their incomes, since the crisis.

Also, note the measure of the median asking price compared to the median existing home price.  It started to rise in 2005.  This was during the mass exodus from the Closed Access cities.  At the same time, vacancies rose among non-rental homes, and inventory of homes for sale was also increasing, suggesting that sales were becoming more difficult to come by.  But, note that during that time, the average price of homes for sale was rising.  This suggests that the inventory was at the high end.  It also happens to be the case that during that time, rates of sales and prices were slowing more rapidly in high end markets within each metro area.

This continued to be the case through 2007 and 2008 when defaults started to rise.  That is because it wasn't low end borrowers defaulting that caused vacancies to rise.  It was a change in sentiment at the top end.  The top end fell first.

The median asking price of units for sale has remained elevated because of the mortgage suppression.  Today there aren't as many sales at the low end, and many low-end households are sort of grandfathered into their units, and can't readily sell and buy into another unit, either because credit is tight or because they lost equity in the crisis.

Friday, February 15, 2019

January 2019 CPI Inflation

Non-shelter inflation came in relatively close to the Fed target this month, preventing non-shelter Core CPI inflation from declining too far as the hot January 2018 figure dropped off the back end.  Core non-shelter inflation fell from 1.5% to 1.4%.  Shelter inflation is holding up at about 3.2%.

So, we continue along at low rates of non-shelter inflation that aren't disruptive, in and of themselves, but if they decline, will probably find accommodation to be tardy because of the supply-heightened shelter inflation.  The same story that has been the case for several years, really.

The inverted Eurodollar futures yield curve between now and 2021 and the leveling off of mortgage lending and home sales suggest we are moving in that direction, but of course some indicators continue to be strong.

Thursday, February 7, 2019

Upside Down CAPM: Part 9 - The mystery of long term returns

Timothy Taylor has a post up about long term returns.

There is this:
In real terms, the "safe" rate doesn't look all that safe.
Indeed, if you look at the "risky" assets like housing and corporate stock, but focus on moving averages over any given ten-year period rather than annual returns, the returns on the "risky" assets actually look rather stable.

May I suggest the upside down CAPM model?  "Risky" assets earn a relatively stable *expected* return, which is whipsawed by real shocks to cash flows.  Over longer time frames, the shocks tend to wash out, and the expected return approximates the realized return.  (Mainly here I'm talking about equities.) "Riskless" assets have an expected return that is more volatile, and reflects a discount from the stable expected return on at-risk capital, which shifts with sentiment and on-the-ground reality.  They have more stable short term cash flows, but long term returns that can fluctuate.

There is basically a risk arbitrage between volatile cash flows and the expected return on stable cash flows.

He discusses the r>g issue.  Upside down CAPM says that (at-risk) r is relatively stable.  When g is higher, then r and g tend to converge, and risk-free r rises with g and converges with at-risk r.  If we're worried about r>g, upside down CAPM says to increase g.  Mostly, that can be achieved with something like NGDP level targeting that minimizes nominal income volatility, reducing the discount that must be taken to avoid it.  I predict that under NGDP level targeting, debt levels would decline, real long term interest rates would rise, and average income growth would rise.

Wednesday, February 6, 2019

Upside Down CAPM: Part 8 - Deficit Spending isn't stimulative or inflationary

Modern Monetary Theory (MMT) - not to be confused with market monetarism (MM) - has been a popular topic lately.  I have some thoughts on the matter, which I will lay out here.  I ask for generosity from the reader, and for corrections in the comments if I declare something here that is demonstrably wrong.  I don't have a deep understanding of MMT, and this isn't meant to be a critique of it, but the main issues that seem to form the core of MMT thought are related to some ideas that have been floating around in my head that probably aren't good for much more than embarrassing me, but I want to air them out.

As I have mentioned in some previous "Upside Down CAPM" posts, I think it is best to think of safe debt as a service provided from the borrower to the lender.  The service of delayed consumption - low risk saving.  This is the primary motivation for the aggregate use of debt in developed economies.

Considering this, I think it is best to think of public debt as a service the federal government is particularly capable of providing.  Since it can provide the safest form of deferred consumption, it gets to "sell" it at the highest price (bonds with the lowest yields).  This is wholly separate from the question of budgets and spending.  So, it is best to think of government deficits as two separate acts.  First, the act of taxing and spending.  Second, a debt transaction.

So, in this framework, all spending is funded by taxes.  Whether it is stimulative, inflationary, etc., stems from the spending itself, funded through taxes.  When that happens, capital (in both real and nominal terms) is transferred from private to public hands, affecting aggregate decisions about investment, spending, etc.

Now, if the government decides to engage in deficit financing, there is a second act.  This is purely nominal.  When it sells Treasuries, it simply creates offsetting accounts - an asset account in the private domain and a liability account in the public domain.  The creation of these accounts is purely nominal.  No real capital shifts as a result of this accounting.

In the aggregate, this is no different than imposing a tax.  Within the private sector, it is a decision to delay the distribution of that tax.  But, in the aggregate, the real capital was removed from the private sector when the spending was triggered.  If the government taxes a different individual in the future to pay back the bondholder or just defaults on the bond, the first order effect is the same.  The accounts are simply erased, and just as when the Treasury bond was issued, there is no aggregate effect on the use of real capital.

Ricardian equivalence is usually referenced here as a source of stimulus or lack thereof.  The idea is that the creation of those accounts affects the private sector's notion of its own wealth.  If it fully internalizes the cost of future taxes, then the issuance of the bonds isn't stimulative.  If it doesn't, then the bonds are stimulative, because they trigger new spending from this perceived wealth.

But, I think Ricardian equivalence is not particularly relevant.  The private sector, in the aggregate, can't spend those Treasuries.  It might be able to use them as collateral for private borrowing, which then can stimulate spending.  But, then the spending is coming from the growth of the money supply, which is under the control of the central bank.  The central bank will be managing its own targets regardless of deficit management, so any inflationary or stimulative effects from that will be offset in the natural course of monetary policy management.  Whether any spending is facilitated by the existence of treasury bonds, other assets, or simply growth in base money, is not particularly important to the question of whether public spending or borrowing is either stimulative or inflationary.

There is the issue of foreign savers.  In that case, the distinction is that they are outside the domestic tax base, so the consequences of future taxation are more complicated than simply a redistribution within a stable aggregate.  In that case, the first order effect of a default would benefit the domestic balance sheet.  But, still, it seems to me that the margin on which the effect of the debt rests is whether the interest rate is lower than the domestic income growth rate, so that the eventual tax will be paid with fewer dollars, relative to national production.

As long as long term income growth is higher than the rate of interest paid on the bonds, this process is beneficial because of the public ability to profit by selling deferred consumption.  The benefit doesn't come from the deficit itself, but from the government's ability to provide this service better than the next best provider.

In terms of thinking of public spending on the margin, that spending is useful or not useful, regardless of whether it is funded by taxes or bonds.  Practically speaking, some public spending might provide a very high return, and much public spending doesn't provide a return at all.  That's not the point of some spending.  Most of the growth in income isn't the result of public spending at all.  The ability of the government to gain from providing the service of deferred consumption is unrelated to the benefits or lack thereof of public spending.  And, even the ability of this service to lower deadweight loss by shifting taxes to wealthier future taxpayers is only partially related to the spending it funds.  The income growth that reduces that deadweight loss can come from effective public spending.  It could also come from regulatory decisions that aren't related to spending, or it could come from private sector innovations that have little to do with public spending.  If an unknown Mongolian tinkerer invents a perpetual motion machine next year, the entire globe will eventually become much richer as a result, and we will have benefitted for having facilitated deferred consumption purely because of the positive shock created by the Mongolian tinkerer.

The upshot of this is that deficit spending should have little to do with cyclical considerations, except to the extent that an economy with either cyclical fluctuations or secular malaise will be correlated with a high demand for safe assets.  But, it is much better for everyone if there is more demand for making risky investments, in which case, it would be more likely that income growth would be high and Treasury rates would be high, and the budget deficit would naturally be falling because of rising incomes, as it was in the late 1990s.

Whether it is a Keynesian or an MMT framework, the idea that funding spending with bonds versus taxes can be stimulative or inflationary seems questionable to me.  And, the idea that spending, in general, is stimulative or inflationary seems questionable.  The devil is in the details.  Spending should be done because that specific spending is useful, regardless of cyclical matters, and cyclical stimulus should come from monetary policy.  It is probably useful for some developed nations like the US to maintain a significant amount of public debt, but not as a cyclical governor, rather as a public service to risk-averse savers.  But, at the same time, fiscal policy should aim to reduce the risk-aversion that leads to the demand for that service.

Certainly, if something like this is beneficial, it should be done during economic downturns, but there is no reason this should be treated as a cyclical governor.  There is no reason to leave these hundred dollar bills on the floor during economic expansions.  It is just a double-entry accounting entry.  It isn't expansionary in and of itself except to the extent that it lowers deadweight loss, and that is something we should always aim for.  So, hypothetically, the proper level of public debt is the level that maximizes the value of this service, which has mostly to do with the ability to pay the interest from future income.  This is little different than the process a private firm would use to arrive at a target capital base, where generally the level of debt is the level that markets will fund without creating default risk that increases the credit spread that the firm faces.  Obviously, the failure of a nation is much more significant than the failure of a firm, so the limit should be set where default risk is highly unlikely.  Yet, that might be a relatively high level.

Sunday, February 3, 2019

January 2019 Yield Curve Update

I have discussed how there is a sort of mental accounting problem with the yield curve model.  The zero-slope is treated as a constant, when, in fact, meaningful inversion happens at low yields when the 10 year yield is as much as 1% higher than the fed funds rate, and at higher yields, the inversion has to become fairly steep to become meaningful.

During the past two months, the curve has become meaningfully inverted.  Here, in the Eurodollar futures market, the upward bias of the longer term yields is clear.  What is important is that forward rates in the 2-3 year time frame are inverted.  I suspect those 2021 Eurodollar contracts will close at rates much closer to zero.

Here is the plot of the Fed Funds Rate against the 10 year Treasury, shown with the adjusted inversion levels.  From this point, a normalized yield curve is highly unlikely to develop without lowering the Fed Funds Rate.  Expect the 10 year yield to be below 2% by the time that process is finished.

Friday, February 1, 2019

Housing: Part 342(A) - Building Homes Helps

Quick follow up to the earlier post.

I should have added in the numbers for the US, for more perspective.  Here, I have also added Atlanta, which I would point to as an example of a city that was growing and has generous local building policies, but doesn't have as strong of an income trend as Austin.

I apologize, though.  This first graph is getting a little messy with all this new data.  The messier lines are for housing permits per thousand workers, on the left scale. Per capita income is the right scale.

Austin = Blue
Seattle = Red
San Francisco = Green
US = Black
Atlanta = Purple

Points I would make.
  • Ample building is one reason why Austin and Atlanta have per capita income levels near the national average.  Mobility is a key equalizing factor.
  • Notice that home prices in Austin have trended higher since the crisis compared to the national average.  Atlanta has trended lower.  So there are three basic trends here:
  • San Francisco (and Seattle to a lesser extent) had high incomes and high home prices during the boom, and have continued on those trends since the crisis.  Building levels have recovered to their boom levels in both cities (low in SF and moderate in Seattle).
  • Austin had average local incomes and home prices during the boom and both incomes and prices have risen since the crisis.  Building has recovered to its strong boom level.
  • Atlanta had average incomes and prices during the boom and lower income and home prices since the crisis.  Building was strong during the boom and has been weak since the crisis.
The takeaway from these trends is that the housing boom was facilitating aspirational mobility.  But, since there is a supply limit in most of our most prosperous cities, in those cities, aspirational mobility can only lead to a bidding war on prosperity and a segregation by class and income.  Homes could only be built where it is legal to build them.  Incomes were high where housing obstruction causes that segregation to happen but building was high where it isn't so obstructed.  Seattle is in the middle between Austin and San Francisco, and where it ends up will be determined by supply.

There has been much misplaced kvetching about overinvestment in housing during the boom.  Notice how, of these cities, Austin is the only one that shows a real reaction in building permits.  That's because it has great economic promise and it doesn't restrict housing growth.  Imagine if Seattle and San Francisco had supply reactions like Austin did!  Imagine if housing permits could have doubled in those cities between 2002 and 2005.  The deep and undeniable irony is that if those cities, and others like them, had local housing supply that was responsive to demand like Austin's is, there never would have been a national moral panic about overinvestment in housing.

By the way, also note that, even with all of that building in Austin, even as late as 2006 and 2007, there was no price collapse there!  I can't tell you how much the literature on this topic is tainted with the presumption that the price collapse in non-bubble cities is the result of overbuilding.

Now, look at Atlanta.  There was little change in the rate of building in Atlanta during the boom.  Atlanta had a sort of steady-state rate of growth - a strong rate of in-migration - that continued during the boom.  And, then the bottom dropped out, and it didn't recover.  Building is still very slow in Atlanta, local incomes have dipped, and home prices dropped below the national trend.

That is because the moral panic that began in 2008 led to a public imposition on entry-level and low income home buyers.  The sort of buyers that used to be able to move to Atlanta aspirationally.  The borrower-based lending constraints that have been in place since 2008 that have kept first time homebuyer rates low and have reduced homeownership among young households and households with low incomes killed the Atlanta housing market in a way that high-flying Austin had the escape velocity to outrun.  Within each metro area, a comparison of building rates and prices between high tier housing markets and low tier markets is similar to the comparison between Austin and Atlanta.

As a result of all of this, building pre-2008 was strongest where incomes were moderate and building post-2008 is strongest where incomes are high.  Pre-2008 was defined by constrained supply and post-2008 is defined by constrained demand.  The ideal would be a housing market similar to Austin and Atlanta in 2005, that is relatively unconstrained by either supply or demand, and Americans are in fairly universal agreement that 2005 Austin and Atlanta is to be avoided at all costs.  And all costs is exactly what we're getting.

Housing: Part 342 - Building homes helps

I pulled up these charts today while responding to an e-mail, and they seem worth sharing.

This is Austin, Seattle, and San Francisco.  They each are cities with high demand for population growth and strong income growth.  They really make a nice example of how housing supply works.  When there is high demand for living in a city, it can block growth, like San Francisco, which may actually increase local incomes because of the obstructions to competition in the local labor force, but those higher incomes are generally claimed by higher housing costs.  And, the pressure is especially strong on households with lower incomes, who end up moving away at a high rate.

It can grow tepidly, as Seattle has done, which is enough to minimize the migration, so it stops the worst of the outcomes of blocked housing supply.  But, costs still move up a bit.

Or, it can grow boldly like Austin.  Austin brings in migration and offers strong income growth and the willingness to share it.  Not only are all sorts of Americans moving to Austin, but they get to keep more of their incomes when they get there because housing is more affordable.

There are rumblings of Closed Access policies in Austin, but so far their housing policy has been commendable.  If those who oppose change ever do get the winning hand in Austin, two things are certain:

1) Austin will become more expensive and will offer economic opportunity that is only accessible to richer households.

2) Those who support Closed Access policies will declare that supply and demand is an oversimplified model and building more homes in Austin couldn't possibly cure the cost problem. (It looks like they have already started.)

Follow up post.

Monday, January 28, 2019

Washington Examiner reviews "Shut Out"

Joseph Lawler at the Washington Examiner did an excellent job writing a detailed review of "Shut Out".

He even contacted Mian and Sufi both for comment. (Their work is subjected to extensive reinterpretation in the book.) They understandably didn't have time to provide thorough feedback.

I will be very pleased if every journalist has anywhere close to the understanding and accuracy that Joseph has.

Saturday, January 26, 2019

Talking Housing on C-Span

Washington Journal kindly invited me to chat on Washington Journal the other day.

Of course C-Span is top notch, and the host, John McArdle, had great questions.  I was pleasantly surprised that the callers also had questions that generally got at the heart of the problem in one way or another.

Wednesday, January 16, 2019

Equity Values and Business Cycles

This chart is basically a "Financial Accounts of the US" version of the P/E ratio.  Also, here I show corporate debt as a ratio with corporate profit.

These are as of the 3rd quarter of 2018.  After the recent pullback in equities, while earnings are strong, the P/E ratio (blue) is back to the teens.  And, corporate leverage is in a conservative range too.

Going forward it seems that there are two likely paths:

1) Stable NGDP growth leads to slightly lower profit growth, but higher wage growth and higher real total growth.

2) Unstable NGDP growth leads to lower profits and wages.

If (2) happens, equity losses will be widely blamed on valuations and debt even though they will more likely be caused by unstable NGDP growth.  In hindsight, it will always look like high valuations caused equity contractions and high debt levels, because equity prices will be lower and vulnerable firms will suddenly be too leveraged.  But cyclical contractions rarely have anything to do with valuations or corporate debt.

Friday, January 11, 2019

December 2018 CPI Inflation

Mostly moving sideways.  I thought there was a chance that inflation would really step down this month, which would be bearish.  Of course, if the Fed is trying to be a counterweight, then there is the bad-news-is-good-news phenomenon, but here I think bad news would call for a pull back in the target interest rate, and the best we can hope for is for the Fed to hold the target rate steady for a while.  (This is sort of a strange phenomenon.  Before the past couple of decades, it was unusual for the Fed Funds Rate to have a plateau like it did in 2000 and 2006-2007.  But, that seems to have become normal now.)  So, bad news is still bad news, and it seems as though it is just a matter of waiting for the Fed to get to far behind a falling natural rate.

Maybe there is some chance that the natural rate can chug its way back above the target rate again and the slow recovery can continue.  The yield curve inverted pretty deeply earlier this month.  It has levelled out quite a bit since then, but it is still inverted.  So, I think this is like 2006 or 2000, where the inversion will bounce around a little bit but not go away until rates start to decline.  In 2006 and 2007, homeowners with housing bubble capital gains could tap home equity lines or sell their homes to create some monetary breathing space.  That isn't the case today, so my hunch is that the time between the initial inversion and the eventual fall will be shorter - more like 2000.  But, I haven't been particularly accurate in my predictions of timing so far.

Last January had a noisy spike in non-shelter core inflation, so even though non-shelter core is at 1.5% this month, it is more likely that after this month it will notch down to about 1.2%.  The last quarter has been running at closer to 2%, but without that January spike, the YOY rate has been around 1.2% so if inflation is to build from here, that is where it would be building from.

Tuesday, January 8, 2019

Housing: Part 341 - Arbitrary categories should not determine sentiment and policy

Housing can be consumed in three basic ways:

1) Tenancy

The capital is provided by an investor.  The investor takes the risk of changing value and the responsibility for maintenance.  The tenant pays for the service of shelter in the form of a cash payment.

2) Mortgaged Ownership

The capital is provided by an investor.  The tenant takes the risk of changing value and the responsibility for maintenance.  The tenant makes a fixed payment to the investor for the use of her capital.  The tenant does not make a cash payment for the service of shelter, because the tenant is also the owner.

3) Free and clear Ownership

The capital is provided by the tenant.  The tenant takes the risk of changing value and the responsibility for maintenance.  The tenant used her own capital, so she makes neither a fixed payment to an investor nor a cash payment for rent.

The production and consumption of shelter is basically the same in all three scenarios.  There is simply a shift between who plays the various roles.  In the first scenario, we say that the investor is providing landlord services to the tenant.  In the second scenario, we say that the investor is providing financial services to the tenant.  In the third scenario, we say (or at least the BEA says) that the investor is earning "rental income of persons".

But really, we're just shuffling around a group of agents who, together, are providing capital for shelter, maintaining the shelter, and consuming the shelter over time.  The way they are shuffled has little bearing on the aggregate amount of capital and the aggregate value of the shelter.  Yet the way we think about each different scenario and the way it affects public policy is tremendous.

In this graph, the top line is the total value of shelter consumed, as a percentage of GDP.  It is pretty stable over long periods of time.  During the 1960s and 1970s, it was 8-9% of GDP.  During the 1990s and 2000s, it was about 10%.  Since the crisis, it has run at more like 11%.  (Clearly, this isn't because we have created more shelter since the crisis.  This is because demand for shelter can be inelastic.  Rent inflation has been high because we are not producing enough new housing, so we are spending more for less.)  All that being said, this is consumption that is stable over quite long periods of time.

In the graph, the next line down is gross value added - the cost of housing before maintenance and upkeep.

The next line down is operating surplus - the net income to the agents providing the capital in each scenario after subtracting maintenance and upkeep, consumption of capital (basically natural depreciation), taxes, and subsidies.

Finally, the red line is the portion of the housing capital income that goes to the investor in scenario 2.  This is actually a bit misleading, because the operating surplus is real income.  It increases over time with inflation.  Interest income includes a premium for expected inflation that is paid in cash over time and appears as financial income when it really is not.

That last red line, then, is a fairly arbitrary measure, both because it doesn't even measure real income and because it is only one type of income from one of the three scenarios of ownership.  But, it is the scenario that is labelled "financial", and it gathers more attention than any of those other, stable, less arbitrary measures.

During the housing bubble, the expansion of the housing stock was allowing households to moderate their housing consumption by moving to cities where the capital providers don't capture economic rents from political oligopolistic power over real estate.  So, the operating surplus to housing (which is the non-arbitrary measure of housing income) was declining.  But, the arbitrary measure got all the attention.

Maintaining lower interest rates that weren't contractionary would have kept the red line low, and possibly would have kept net operating surplus moving lower.  Since then, there has continued to be a lot of focus on the arbitrary red line, and a lot of happiness about how much lower it has moved.  At the same time, the non-arbitrary measure of income to housing has moved up (because of a lack of supply, which is ironically related to that declining arbitrary red line) to a level not seen since the early days of the Great Depression.

By railing against "financialization" and "Wall Street" profits, we have managed to shovel more income into the hands of oligopolists than any housing bubble ever could have.

Sunday, January 6, 2019

Housing: Part 339 - Self-Imposed Stagnation

Here is a graph comparing long term real GDP growth per capita and per worker.  Also, I show the 10 year trailing average annual real total return on the S&P500.

Real GDP per capita had been rising by about 2% for many years.  Real GDP per worker generally rises at about the same rate, but in the 1970s, it dipped down to less than 1%.  This is because the baby boomers were entering the workforce, so the labor force was increasing faster than population was, and we weren't getting as much productivity growth per worker as we had previously.  Some of this might just be a product of worker composition and young workers being less productive.  But, I think this shows why the 70s were a decade of economic insecurity even though it doesn't necessarily show up in real GDP growth or even real GDP growth per capita.

One plausible reason that equity risk premiums have been high recently and real bond yields low is that an aging population means that there are many households in the saving phase of their lives.  But, that doesn't explain the 1970s when real bond yields were also low.  In the 1970s, there was a surge of young adults.

Notice in this graph that total returns in equities seems to track pretty well with GDP growth per worker.  Since investor expectations can't be measured it has become widely accepted that even long term stock market movements are the product of fickle sentiment and that stock market returns are more volatile than changing economic growth rates because of that fickle sentiment.  Relationships like this suggest that sentiment isn't as fickle as it has been claimed to be.

There also seems to be a widely held belief that the US stock market is overvalued because of loose monetary policy.  To the extent that that sentiment affects public policy, and I think clearly it has, it is probably one reason why real growth has been so slow.  I'd like to stake out the principle that in order to propose the goal that the central bank should aim to lower real returns for existing shareholders, your model of how the world works should be at a level of confidence that is practically certain in a way that few economic models have ever been.

In my Upside Down CAPM model of thinking about capital markets, expected real total returns are fairly stable, at about 7% annually.  This is a combination of expected growth and current income.  When growth expectations decline, savers become risk averse.  So, two things happen to equity returns.  First, the equity risk premium (the difference between Treasury yields and equity returns) widens because safe-seeking investors are willing to accept lower returns while total expected returns on at-risk capital like equity remains relatively level.  Second, the growth portion of expected returns declines, which means that the income portion increases.

Recently and in the 70s and 80s, payout rates were high (dividends + buybacks) and in the 90s they were lower.  Generally, payouts are referred to as a bottom up phenomenon, as if firms can't find good investments, so they send the cash back to investors.  I think this is more appropriately viewed as a product of low growth, so that there may be some correlation between high payouts and low growth, but that it is more directly a product of low growth because equity investors require more cash flow in their total returns to make up for the lack of capital gains growth they expect.

The changes in real returns over time are related to the changes in GDP per worker, due to both the real shock of lower productivity and lower expectations that will naturally come along with that.  Those past equity investors, on the margin, expected returns of around 7% plus inflation, and where their realized returns differed from that, it was due to changing profits and changing expectations from those unforeseen changes in real production.

This is all a long-winded way of getting to the point I want to make, which is about the current decline in growth.  Here is a similar graph, but here I am comparing GDP growth per worker and per capita to the percentage of GDP going to residential investment, because that is the main reason for the recent decline.

Before the financial crisis, there was little relationship between Residential investment and GDP growth.  Some of the short-term growth in the 2000s before the crisis might have been related to it.  But, as I tend to point out, that was at least as much a product of building in the 1990s being below long term norms than it was a product of excessive building in the 2000s.  The low ten year moving average in 1999 was unprecedented in post-WW II data.  The high ten year average in 2007 was not.  So, maybe a lot of the rise in per capita GDP growth from just under 2% to somewhat above 2% was from homebuilding.  But it was homebuilding production that was reasonable and sustainable.

But, what I want to talk about is the post-crisis decline.  That decline can clearly largely be attributed to collapsing residential homebuilding.  GDP growth per capita declined from about 2% to about 1%, and residential investment declined by 2% of GDP.

I like Arnold Kling's conception of patterns of sustainable specialization and trade.  It is better to think of an economy as a coordination problem with frictions rather than as a set of accounting identities.  And, I think it would be uncontroversial in any audience to suggest that this is a large part of what happened after the crisis.  There were millions of construction affiliated workers after the crisis that faced frictions in finding work in a different sector.  Possibly, the recent uptick in per-worker GDP growth, the recent low levels of unemployment, and anecdotal claims that construction workers are hard to come by, are signs that those adjustments have finally been made.

My disagreement with the consensus on this is that none of that had to happen.  For the past decade, those workers should have been engaged in building homes, and GDP growth per capita should have been 2% instead of 1%.  Not only would that have meant that none of those painful adjustments needed to happen.  But, it also would have meant that we would have about $2 trillion worth of housing providing the service of shelter for American households.  And, the result would have been that American households would be shoveling a few hundred billion dollars less each year of unearned rental income to real estate owners.  (Of course, this is complicated by the fact that many of those real estate owners are homeowners, who can only capture that "income" by staying in a home that has inflated rental value, but a suppressed market price, so they can't actually realize the gains from their economic rents except by living in a home that has rental value higher than it should have to begin with.  But, this is getting too far down the rabbit hole.)

But, here we are, a decade later, and maybe most of those former construction workers have either moved to other sectors or just dropped permanently out of the labor force.  So, then, what do we do about the housing shortage?

Well, I have written some about the inequities in the way we have contracted the housing market, and I expect to write some more.  But, really, in the end, there is nothing unsustainable about this context.  We could have achieved similar ends by raising property taxes, or any number of things.  All consumption has some foundation of technological, tax, and regulatory factors that has an effect on supply and demand.  Just because our current context seems inequitable to me, that doesn't mean it can't exist as it is.  Non-owners will consume less housing, owners will consume more, and real estate investors will earn higher returns than I think they would in my preferred regime.  But, it's a sustainable regime.

So, the "economy" doesn't need housing to recover.  It could be that we now are at a new pattern of sustainable specialization and trade, and the new pattern just includes less consumption of shelter by the have-nots.  The workers that have been on the sidelines for a decade instead of building homes have slowly found other productive things to do.  So, fixing the housing shortage is more about equity than it is about growth.  It is possible that we have finally entered a new phase of growth, that ten years from now, GDP per worker will have risen by 20% and equity investors will have earned 12% annually plus inflation, that working class families will be moving to Sacramento by the thousands so that young entrepreneurs can rent their old studio apartments in San Francisco for $7,000 a month, and that marginal workers will still be paying $1,000 rent to live in homes in Cleveland that they could buy for $60,000 because we have decided as a public policy objective that it is too dangerous for them to have a mortgage.

Every line in those graphs could move back toward the top while the residential investment line stays at the bottom.  We would just live in an economy where some households don't consume housing like we did in the past, and real estate capital earns slightly higher returns.

PS: Since equities aren't as tied to domestic production as they used to be, it could be that the rate of real total return on equities will be less volatile going forward as a function of changing domestic productivity.  So, it could be that equity returns for the S&P 500 over the past ten years are higher than they would have been 40 years ago, given the same slow rate of GDP growth per worker, and that it won't rise as high as it used to with rising US productivity.

Saturday, January 5, 2019

Another view of the Eurodollar market

Here's another way to look at the yield curve.  Here are Eurodollar futures contracts, which I have tracked over time with fixed maturities.  This gives an indication of the recent relative moves in the yield curve.

I suspect that in the 2020ish contracts, there will be a good position to take for a move down to nearly zero.  But, my hunch is that this recent move will be reversed somewhat, and either the Fed will do one more hike, or they will keep the short term rate where it is, and eventually they will start moving the Fed Funds rate down, too late, and that will be where the big move happens.

(Caveats about taking investment advice from strangers with blogs, etc. etc.  Rule of thumb: Don't make any investment decisions you would blame me for if they went bad.)

Friday, January 4, 2019

International Comparisons of Equity Markets and Economic Growth

I don't really have anything interesting to say about these things, but I was comparing equity markets from some of the "housing bubble" countries, and I realized that while the US market has basically doubled from its pre-crisis high, Canada, Australia, and the UK all remain below it (in dollar terms, using US-based national ETFs).   2019
Maybe it's not that interesting.  Maybe, the US, Canada, and Australia are all basically moving in the same direction, and Canada and Australia had equity booms in 2007 because they are highly weighted in commodities.  And, maybe the UK has suffered from the double whammy of being the financial center for a stagnant continent.

But, at first glance, this throws me a bit for a loop.  My story is that first our economy was being held back by urban housing constraints, and now it is being held back by credit market constraints.  Both constraints, as far as I can tell, have been more severe than the constraints in the other countries.  Certainly the constrained mortgage market has been.  Yet, during the decade where our banks have been unable to fund housing and rising rents are reducing real economic growth, we are the outlier with fantastic equity growth.

Now, I can tell a just-so story here - that the housing problem costs households but it actually protects urban firms from competition to the extent that their host cities maintain a geographic monopoly on their core networks of skilled labor.  And much of those firms' profits are from overseas revenues.  The rising stock market is somewhat divorced from the broader economy, and housing is part of it.  But, I'm not sure I have a way to confirm that that isn't an ad hoc story.

Here are graphs of GDP growth and unemployment rates.  Here, clearly Australia is the winner and the UK is the loser.  It's a pretty stark contrast between Australia's straight-as-a-post GDP growth and the collapse of its equity market during the crisis.  But, again, this is probably mostly due to the economics of commodities.

On the unemployment rate, the US was the clear loser during the crisis, which I would attribute to the collapse of the construction sector after the mortgage industry was fettered and to less stabilizing monetary policy.  Although, real GDP didn't drop particularly sharply compared to the others.

But, unemployment has improved with the rising stock market, even though GDP (relative to the others) has not.  The same can be said for the UK.  Unemployment has been surprisingly positive there even though both GDP growth and the stock market have been poor.

Broadly speaking, I have spent most of the past few years double checking the conventional narratives about what has been happening economically, and I have become accustomed to finding data that decisively bends convention over and paddles it across the rear.  This is an unusual case where the data doesn't easily form a story that jumps out with a clear explanation.

Maybe part of what is going on here is that stock markets map to where the securities are traded, and that isn't very correlated any more to where the value is added.  Maybe stock markets just aren't good proxies any more for domestic production.  Not because of old shibboleths like "the stock market isn't the economy", but because the stock market is basically representative of parts of the economies of various locations around the world.  They are more representative of sectors than of geographical areas.

Wednesday, January 2, 2019

Upside Down CAPM: Part 7 - Debt is Ownership

I was reading this piece on debt jubilee (HT: JW) and it occurred to me that this is an issue that gains clarity from the Upside Down CAPM idea. (In short, capital is inherently at risk.  It has a natural long term real rate of return of about 7%, which is basically the return on equity ownership.  Fixed income is a trade between capital owners in which the lenders are the true consumers.  They want to transform risky capital into riskless deferred consumption.  They pay a premium <earning less than 7%> in order to avoid risk.)

I have written skeptically about jubilee before.  The idea is popular because the first order effect is forgiveness of debts.  It is imagined to be a transfer from the powerful to the powerless.  But, that just isn't a very useful way to think of debts, in the aggregate.  We tend to think of debts through the prism of consumer debt, but consumer debt is more of a transactional device.  Most household debt is mortgage debt, which is a clear case of Upside Down CAPM.  The ownership of the house is split between an equity holder who takes responsibility for upkeep and maintenance and takes on the risks of market volatility, and the debt holder who exchanges those risks for a fixed return.  The only reason mortgage financing works is that home equity is, itself, very nearly a fixed income type of ownership, in which most of the return comes from rental value.  (That is one of the core problems with Closed Access housing supply.  It makes home equity less like fixed income and causes a breakdown that makes housing financing less functional.)

Thinking about jubilee from an Upside Down CAPM perspective helps to clarify this.  Modern economies have already incorporated jubilee financing deep into our economic systems.  Capital markets are already dominated by a financial security that automatically forgives the debtor all of their principal when they are unable to pay it.  That security is called shareholder equity.

Sometimes, borrowers (for lack of a better word) opt out of jubilee by selling fixed income securities instead of equity.

Incidentally, I wonder how much overlap there would be on a Venn diagram of people who think debt jubilee would be a great idea and people who think limited liability corporations have been a good idea.

The problem comes from contexts where selling equity is difficult or impossible.  The problem with selling equity as an individual is that this is essentially indentured servitude.  Where that can be managed safely (see, currently, Lambda School, which seems to be a great example of this) it can work, but it is difficult.  So, where jubilee is discussed today, it typically has a focus on things like student debt.

But, student debt is an anomaly.  It probably shouldn't exist in the way that it does, and it only does because it is subsidized by Federal guarantees.  Debt is a service provided by the borrower to the lender - providing risk free deferred consumption.  Students aren't remotely in a position to provide that service.  So, the government steps in to provide that service in their name.  But, since policymakers have not come to terms with the incoherency of this program, the program has been designed to leave many indebted former students in dire straits with unpayable debts that they should never have been in a position to take on.

I hope that developments like Lambda School can help lead us to a new financial technology that better matches funding with students, and creates an equity-like funding mechanism (a jubilee-eligible mechanism, as it were) for school funding.  That probably means being more honest about the demand for education, and the difference between the development of marketable human capital, which is a powerful source of economic equity and betterment, and education that is less vocational and is better viewed as consumption than investment.