Thursday, May 16, 2019

An interesting juxtaposition of issues.

There is this:
AOC & Bernie Sanders talking about limiting interest rates on unsecured debt to 15%.

Then there is this:
A story about a new type of loan to help people meet rent.

Then there is this:
A story about households who can't get mortgages for small amounts.

There has been some pushback on the AOC/Sanders proposal.  But, it seems clear to me that those homeowners in the third story could get an unsecured loan of some sort with very high rates more easily than they could get any sort of mortgage.  That is odd.

Saturday, May 11, 2019

April 2019 Yield Curve Update

Sorry, I'm a little slow to this update.

The yield curve inversion remains in place.  The curve as of Thursday looked very similar to the levels at the end of March and April.  This seems to be a trading opportunity.  I consider a yield curve to be a signal rather than a cause.  During inversions, there is a bias in forward rates.  Something keeps forward rates from moving as far below short term rates as they should, which means that there appears to be potentially persistent profit available by shorting forward rates when the yield curve is inverted.

It seems like the trading position to take is to position for reversion while the Fed keeps the short term rate stable.  Forward rates will move up and down within a range.  Then, when the Fed moves the short term rate, forward rates will move out of the trading range.  If it lowers the rate proactively, forward rates will move up.  If it lowers the rate reactively, forward rates will move down.

It seems to me that the probable outcome here is that, on the first chart, 2019 will look like 2006 and 2007.  A brief vertical period eventually with a breakout to the left and down.

Keep in mind that I am actually a cocker spaniel and my master doesn't even know that I maintain this blogspot account, so I can't legally be responsible for your trading gains and losses, and you really shouldn't even be reading this nonsense.


You taking actionable advice from this blog

Friday, May 10, 2019

April 2019 CPI Inflation

We appear to be seeing a rebound in shelter inflation and a decline in non-shelter inflation.  The inverted yield curve, stabilizing home prices, declining residential investment, and a peak in existing and new home sales all suggest parallels to 2006.  This is now three consecutive months with core non-shelter deflation.  (Caveat: there were some parallels to 2006 two years ago, too, so follow my logic with a grain of salt.)

As in 2006, these conditions are generally related to marginally contractionary monetary policy.  In 2006 and 2007, consumption was able to continue growing in spite of monetary contraction because the housing bubble had provided trillions of dollars in home equity to draw upon for liquidity.  The housing ATM postponed our self-imposed recession.  There isn't much of a housing ATM available today.  On the other hand, what made the recession Great was the late and extreme tightening of credit access that created a post-2008 default crisis and wealth shock targeted among low tier home owners.  You can't kill a dead horse, so on that front, there is safety relative to 2006.  There's a good slogan for proponents of macroprudential credit controls.  "You can't kill a dead horse!"  Though, as rising rent inflation makes clear, you can continue to kick it.

As has been the case for most of the last 20 years, rent inflation for tenants has been running higher than rent inflation for owners. Additionally, credit markets have been suppressed for the last decade, pushing prices down.  This created a wealth shock for owners during the transition to the new normal where housing markets are characterized by federal exclusionary rules.  But, as we move away from that one-time effect, the low price of homes for families that are "qualified" under the new regime becomes something of a rent subsidy for "qualified" owners.  The rental value of their homes is rising, but since credit suppression provides them with excess returns on their investment, those rising rents aren't reflected in rising mortgage payments, so that their spending isn't as constrained in other types of consumption.  In spite of this, inflation in non-shelter core components is still barely running above 1%.

It continues to appear to me to be the case that we have finally entered the period of time where the Fed will keep the target rate steady, creating a plateau period where the yield curve is inverted.  The curve will fluctuate somewhat during this time, but it will remain inverted.  It is unlikely to un-invert unless the Fed proactively lowers the target rate.  Eventually, the target rate will be biased enough toward contraction that the Fed will have to start chasing the neutral rate down, and everyone will declare those rate cuts to be stimulative, even though they will really reflect a Fed policy that is just walking backwards more slowly.

In the recent press conference, Fed chair Powell said, "Overall inflation for the 12 months ended in March was 1.5 percent. Core inflation unexpectedly fell as well, however, and as of March stood at 1.6 percent for the previous 12 months. We suspect that some transitory factors may be at work. Thus, our baseline view remains that, with a strong job market and continued growth, inflation will return to 2 percent over time and then be roughly symmetric around our longer-term objective."

Employment is a lagging indicator.  Neither rent nor shelter were mentioned in the press conference.

Thursday, May 2, 2019

Housing: Part 349 - Homeownership rates

The Census Bureau recently published the 2019 first quarter numbers on the housing stock.  Homeownership rates had bottomed out in 2016 at 62.9%.  That was one quarter which was probably an anomaly.  Generally, the bottom appears to have been about 63.5%.

It had generally risen since then, up to 64.8% last quarter.  However, this quarter, it moved back down to 64.2%.

I have been watching this number because there have been mixed signals on the housing market.  As the analysts at AEI point out, by some measures, mortgage standards have been easing.  However, according to the New York Fed, there hasn't been any loosening to pre-crisis standards in terms of originations by FICO score.

At the same time, the low rate of building has been levelling out along with prices and resales in some markets.  It seems unlikely to me that homeownership can continue to recover without easing in terms of borrower quality.  My interpretation of this mix of data is that the various factors that are causing a shortage of housing supply are pushing up housing costs, which leads to the use of riskier mortgage terms, and that part of the problem is that the constraints on lending to financially marginal households who would have been buyers in previous generations is one factor that is causing the shortage.  Looser lending would help pull up prices in low tier markets, back to price points that make new building profitable.  That's what needs to happen to lower housing costs in general.

However, my hypothesis would need to be reconsidered if homeownership continued to rise while borrower-based lending standards remained tight.

This quarter is an interesting number, because it presents the possibility that my point of view is correct.  On a noisy measure like homeownership, it is hard to tell what is noise and what is signal until some time has passed.  It could be that the 62.9% number and the 64.8% number were just noise, and that homeownership bottomed out at about 63.5% and only very slightly rose to about 64.2% where it will remain.  If it is still in this range in a year, that is plausibly the case.  If this quarter turns out to be the outlier, and homeownership is up to 65% next year, then perhaps a recovery is possible in homeownership without expanding lending to more marginal borrowers.

Time will tell.

On High Tier vs. Low Tier Prices

I want to discuss tier price levels for a moment.  There has been some recent recovery in low tier prices vs. high tier prices, which appears to lend credence to the idea that lending is loosening substantially, in spite of the FICO score data.  There are a couple of caveats to note here.

First, there is a bias in the way some analysts use Case-Shiller indexes.  As with so many factors on this topic, it is purely a function of priors.  It isn't a bias at all if the conclusion that credit markets were the main cause of rising low-tier prices before the crisis is already taken to be true when the data is analyzed.  However, it does appear to be a bias if you question that conclusion.

Case-Shiller has 20 city-specific indexes, which includes all 5 Closed Access cities.  Be careful looking at analysis of low- versus high- tier prices that uses those indexes. If the data is heavily populated with Closed Access data, it will not be indicative of national markets.  Low-tier vs. high-tier prices act differently in those cities than in other cities.  I go into that a little bit here.  Or, better yet, buy Shut Out to read about it(using code 4S18MERC30 for a discount).

Furthermore, even in national stats there is a bias here.  The problem is the extreme nature of the walloping we handed to low tier housing markets.

Imagine a city where high tier markets bottomed out at a 20% decline and low tier markets bottomed out at a 50% decline.  As a proportion of the peak price, that's a 30% additional decline in the low tier.  In spite of conventional wisdom to the contrary, in most cities, that wasn't undoing anything.  Low tier prices hadn't risen significantly higher than high tier prices had.

The bottom came around 2012.  Now, if someone uses 2012 as a baseline, they may find that high tier prices have recovered by 25% since then, while low tier prices had recovered by a whopping 40%.  If one treats the 2012 market as the benchmark, it would seem that low tier prices are 15% overvalued.  But, if we treat the pre-crisis level as the benchmark, then there has been no catch up.
  High Tier 80% x 1.25% = 100%
  Low Tier  50% x 1.4% = 70%

In other words, low tier prices are still 30% undervalued compared to high tier prices, and there has been no catchup at all.  Because conventional wisdom has been so blind to the fundamental causes of the crisis, this sort of bias is very common among academic papers, policy papers, and general journalism.  It's fascinating how an innocent shift in priors can create these self-fulfilling biases in the analysis.  There are clues about these biases though, once your frame of reference moves to a place where useful questions aren't obscured by priors.  On this issue, for instance, it would seem to be a mystery why low tier building rates are still dead if prices are 15% inflated.  But, it isn't really a mystery at all if those prices remain relatively low.

Keep in mind, this is a hypothetical example, although it is a realistic number for many cities.  There has been some low-tier recovery. Maybe the post 2012 appreciation rates have been more like 50% compared to 20%.  But, in this example, for instance, to completely re-attain previous norms, low tier prices would have to double from their lows while high tier prices only rise 25%.  Even though this is arithmetically the case, it would be quite a difficult point of view to sell to someone who is convinced that excess lending or speculative buying is the ever-present monster under the bed that needs to be thwarted.  As Russ Roberts of EconTalk fame frequently laments, data isn't as powerful as we would like it to be in these debates, because the issues are just too complex and too bound up by differing premises.  Isn't it striking?  There is a stew of ever evolving priors informed by data, informed by priors, etc. etc. which leads us to a point where it isn't possible to come to agreement about whether low tier prices are overvalued at  a 100% appreciation level vs. 20%.  How do we ever come to know anything?

Monday, April 22, 2019

IW on the web

Tech entrepreneur David Siegel has an interesting and thorough post up at that is a sort of reference point to cutting edge or wise thinking on a vast array of topics.  One reason I am posting a link here is because David kindly includes the work of Scott Sumner and myself on the financial crisis and the housing bubble, prominently, as work that should be read and understood.

Regarding our work, he begins with:

Understanding the Great Financial Crisis

A good way to see the storytelling effect is to look at the “common wisdom” of the Great Financial Crisis of 2008/9, an event that impacted every person on earth and destroyed a billion jobs. Almost everyone got the story wrong. Michael Lewis’s book and movie, The Big Short, was popular but completely missed the true cause and effect. So did Niall Ferguson and many experts.
In reality, two people — Kevin Erdmann, an investor and Scott Sumner, an economist — have shown that the “common wisdom” does not fit the facts. Using the scientific method and hard evidence, they show that the GFC was a result of bad reactions to scarce resources

I appreciate David's support and his willingness to consider this new point of view.  But, in addition to that, his post can be fruitfully used as a starting point into inquiry in a number of topics.

He lists my book "Shut Out" as an "advanced" reading.  For those visiting IW from David's post, if you don't want to dive into a long tome of "advanced" reading on the topic, here are a couple of shorter pieces that may get the ball rolling.  I'm not sure they are any more accessible, but they are much shorter, and introduce the basics.  (My writing tends to be analytical rather than narrative, but I don't think you will find any of my work to be nearly as difficult as, say, the typical academic article in an economics journal.)

Housing Was Undersupplied during the Great Housing Bubble

The Danger in Using Monetary Policy to Address Housing Affordability

Thursday, April 11, 2019

March 2019 CPI Inflation

Here are the updated inflation numbers.  Non-shelter core is down to 1.1%, shelter is still at 3.2%, and core CPI inflation is at 2.0%.  As IW readers know, the reason this is important is that (1) shelter inflation is largely an imputed figure of rental values of owned homes that involve no cash transactions and, (2) in the era of Closed Access, in some important markets, these transfers have little effect on production.

This is the setup that I worry will cause the Fed to be behind the curve.  They believe that merely stopping the rate hikes will be enough.  Of course, in this context, the inverted yield curve is also a bad sign in this context.

It's not so much that 1% inflation would be an automatic disaster.  I'm not even sure it's a great recession indicator.  It's more a problem of being shielded from timely cyclical developments because of misreading the measures that should lead to shifts in policy trends.

It seems that, along with the Great Moderation, has come a peculiar Fed behavioral tick, where the Fed Funds rate is held for some time at a plateau, which is followed by a contraction.

Monday, April 8, 2019

Real Phillps Curve Update

Here are a couple of charts comparing real wage growth and unemployment.  My contention is that the Phillips Curve is real, not inflationary.  It only appears to be inflationary when monetary policy is procyclical.  When unemployment is low, real wage growth is higher, largely because of better matching, fewer frictions in labor markets, and higher labor productivity.

If we treat the Phillips Curve as nominal, then the inclination is to reduce growth to prevent inflation, and unemployment will be invariably driven higher in a misguided attempt at moderation.

If we treat the Phillips Curve as real, then the inclination is to celebrate low unemployment unconditionally, and allow the benefits of highly functional markets to continue to accrue.

There is a relatively stationary long term relationship between real wage growth (I prefer using CPI less food, energy, and shelter as the deflator) and the unemployment rate.

We shouldn't be afraid of real wage growth.  And, in either case, wage growth is humming along pretty close to the long-term trend.  Celebtrate that unconditionally.

Wednesday, April 3, 2019

Housing: Part 348 - How Affordable Is Housing?

The other day, I looked at Price/Rent ratios over time in various cities.  In Dallas and Atlanta, by this measure, prices have been relatively similar in 1998, 2006, and 2019, but they were extremely low in 2013.  Other cities I looked at were more mixed.  Prices looked high in 2006, and generally looked higher in 2019 than they had in 1998 or 2013.

Here, I will look at the same cities, in the same way, but here, I am looking at mortgage payments/rent payments, which is another way to think about affordability.

A couple of caveats:
1) Here I am using the 30 year conventional mortgage rate, but I am applying it to a 100% loan-to-value.  I know that's not realistic as a mortgage product, but it's a way to get at the relative value here.  I don't want to give the buyer a 20% advantage just by assuming a down payment, but my point here isn't particularly to look at mortgages with higher spreads.  In any case, it is the relative values over time that are informative, so this shouldn't matter that much.

2) All data is from Zillow.  (Zillow rocks.)  But, they only have rents back to 2010, so 1998 and 2006 are estimated rents based on metro area level affordability measures and prices.  It probably doesn't matter that much for 2006, but 1998 might be taken with a few grains of salt.

Looked at in terms of mortgage payment/rent payment for a house at a given price level, housing affordability for buyers is well below levels of 1998 and 2006.  For instance, in Atlanta, in 1998 or 2006, the mortgage payment on a $160,000 house would have been similar to the rent payment.  In 2013 and 2019, the mortgage payment on a $160,000 house would be about 60% of the rental payment.

By this measure, even in 1998, mortgage affordability would have been pretty good.  Price/rent was near long term lows and mortgage rates had been high since the 1970s.  By this measure, home prices are well below historical norms, and for buyers of those homes, there is little interest rate risk, because the homes are already priced at a discount when taking interest rates into account.

People who are complaining that loosening lending standards will push prices up to levels that hurt affordability have a (somewhat) plausible point.  But, this measure is why I think that they are applying that point at a standard that reflects their own preference for tight lending more than it reflects a half century of American homebuying norms.

Also, of course, it is noteworthy that from 1998 to 2006, mortgage affordability improved in Dallas and Atlanta.  That's what an elastic housing supply does for you.  On the other hand, in this measure, it was only the high end of Dallas and Atlanta that became more affordable.  One could argue that this is a sign of loose lending.  On a Price/Rent ratio level, prices in Dallas and Atlanta rose fairly proportionately.  But, if we think of Rent/Price as a sort of yield on housing, the yield is higher on low end homes, which means that their prices should be less sensitive to changing risk-free rates.  (Going from 9% to 8% has less of an effect on price than going from 4% to 3%.)  So, prices should rise less because of falling risk-free yields in low tier homes than in high tier homes.  If these estimates are accurate, though, it appears that low tier prices in those cities were more sensitive to changing interest rates, so that falling rates increased prices as much as they decreased the mortgage payment. (Although, keep in mind, the 1998 data I am estimating here wouldn't be dependable at that level of granularity.)

Here is San Francisco, too.

One interesting pattern here is that mortgage/rent ratios are pretty similar in every city.  For instance, a $160,000 home in every city would have a mortgage/rent ratio of somewhere around 50-60%..That's the case from Dallas to San Francisco.  Of course, there aren't many $160,000 homes in San Francisco.  But, the pattern is curious.

Tuesday, April 2, 2019

March 2019 Yield Curve Update

Since the zero lower bound distorts the yield curve at very low rates, an inverted yield curve at low rates is worse than an inverted yield curve at higher rates.  This is a reason why the curve didn't invert in the 1950s.

The necessary adjustments here could be made either by just looking at the short end of the curve, recognizing that the long end of the curve will have a bias for a positive slope. Or, it could be estimated with a regression of the depth of the inversion in the various economic downturns that have happened since WW II.

Here are visualizations using each estimate.

In the Eurodollar market, the inversion of the short end is very deep.  Today rates bounced up a bit.  They will do that.  In the post-WW II era, though, even though rates seem to bounce around within the inversion, yield curve normalization has only happened when the short end rate has been lowered.  At this point, I have a fairly strong expectation that short term rates will be well below 2% before 2021.

The estimate using the 10 year minus Fed Funds spread also has us well into inversion.  As this graph shows, in 2006 and 2007, the 10 year rate moved up and down without normalizing for some time, then, when the Fed finally lowered rates, the entire curve came down.

The inversion from early 2006 to summer of 2007 was especially extended.  I think the Fed was already sucking cash out of the economy far to aggressively for that whole period.  The housing boom is what delayed contraction, because many households could access their home equity for liquidity.  Lending was still growing at something close to double digits even into mid 2007.

Today, this source of liquidity is not significant.  Mortgages are growing at low single digits, if that.  Home equity is still declining.  General bank lending is at around 5% annual growth.  So, I expect falling rates to come sooner this time.  But, admittedly, I was surprised by a rising yield curve after the Fed raised rates in 2015, so my credibility on this point is worth the monthly subscription price to this blog.

Whatever else happens, this is definitely an inversion event at this point.

Friday, March 29, 2019

You can't solve a housing bubble with tight money, but you can cause a crisis

Here is a brief I wrote that Mercatus recently posted.  I don't think I've posted it here yet:

The gist:
But note that while the consumption of these newly wealthy real estate owners was inflationary, there is little that monetary policy could have done to change that. In other words, they were using newfound wealth to claim an additional 1.3 percent of GDP for their own consumption, according to Mian and Sufi. That claim on current consumption would remain whether the Fed produced 10 percent inflation or 2 percent deflation. In fact, as the United States discovered in the end, the only way for monetary policy to affect that claim on current consumption would be to allow disruptions in capital markets to become so severe that these rentiers would not be able to access their wealth. The future rental value of their homes has not changed. That future rental value is a product of high demand for living in cities with restricted supply of housing. Monetary policy can’t fix that. It didn’t fix it. Rents in the Closed Access cities are at least as high as anyone might have expected them to be in 2005. The only thing the housing bust accomplished was to prevent the value of those future rents from being fully capitalized into home prices after 2007.

If, before the housing bust became catastrophic, monetary policy within a functional range could not change the ability of these rentiers to claim more current production, then what economic adjustments must happen to satisfy their new consumption demands? If these rentiers were claiming 1.3 percent of additional GDP, where was it going to come from? If they were increasing their current consumption but not their current production, the gap must be met somewhere. Either other Americans would have to reduce their consumption by 1.3 percent of GDP, or an additional 1.3 percent of GDP would need to be imported, or some combination thereof. That had to happen regardless of the stance of the Fed.

Housing: Part 347 - Price/Rent Ratios over time

Here are some graphs of price/rent ratios, by zip code, for several metro areas.  (All x-axes have the same 2013 rental value, while the y-axes represent the estimated price/rent ratio for each year.)

The data is from the inestimable  Price/rent ratios before 2010 are based on my estimates, using price and affordability data. (Except the first graph, where the x-axis is price, and it changes over time.)

This relates to one of the points I made in Shut Out, that the positive relationship between Price/Rent and a range of other measures (price, rent, income) means that you have to be careful attributing rising prices in low-tier zip codes to easy credit.  In the few metro areas where low tier prices did rise dramatically, I contend that this was really the result of high tier prices levelling off because there is a maximum price/rent level within each city.

Comparing LA and Seattle is useful here.  Low tier prices didn't rise at a different rate than high tier prices during the boom in Seattle.  But they did in LA.  Here, comparing LA to Seattle, we can see that the crescent shape of the Price/rent pattern was the same in both cities throughout boom and bust.  The difference is that homes across LA had gotten so expensive by 2006 - more than $400,000, even in the lowest quintile of zip codes - that by 2006, the P/R on low end homes was close to high tier P/Rs.  In 1998, Quintile 1 P/Rs in LA were about 7x (!), less than half Quintile 5.  In 2013 they were a little more than half, at 12.7x.  In 2006, they were within 17% of the peak P/R at 25x.

In Seattle, the peak P/R was 28x, not much lower than LA.  But, rents, and thus prices, are much lower in Seattle, so Quintile 1 P/Rs only went from about 70% to 75% of Quintile 5 P/Rs.  The ratio started much higher than LAs but didn't move much.  That is because prices in Seattle never went high enough for more than a small portion of the market to hit peak P/R levels.

Following are scatterplots of P/R against annual rent value.  In the updated 2019 numbers, P/R ratios across Seattle have moved higher than they are in LA for any given rental value.  But, since rents are lower in Seattle than they are in LA, the metropolitan median P/R ratio is still a little lower in Seattle.

Phoenix and Miami both seem to have seen some recovery at the low end.  They seem to contradict my claim that low end markets are underpriced.

Dallas and Atlanta are interesting.  Atlanta has partially recovered and Dallas has fully recovered to peak P/R levels, generally across the metro.  This also contradicts my claim that low end markets are underpriced.  I might have been able to say that in 2013 about both the cities and the low end within the cities.  But, not now.

This is a great example of how the premises determine the conclusion in a way that I am not sure can be resolved.  First, note that by this measure, in both Atlanta and Dallas, there was absolutely no sign of excess prices in 2006 and the collapse to 2013 was outrageous.  That would be the case even if you believe that home prices should not be sensitive to real long term interest rates.  Long term inflation protected treasury rates dropped from 4% in the late 1990s to about 2% in 2006 and are now near 1%.  Yet, in Dallas, at all three points, price/rent ratios were similar.

Now, if home prices aren't sensitive to rates, you might conclude that prices look reasonable in Dallas today.  But, you would also have to conclude that prices were reasonable in 2006 and that they were outrageously low in 2013.

On the other hand, you could argue that home prices should be somewhat sensitive to interest rates, and so prices in Dallas have been undervalued both during the bubble and after the bubble.  Or, taking all cities into account, it seems reasonable to conclude that home prices are sensitive to real long term interest rates, and where supply is elastic, supply increases rather than price.  Where supply is inelastic, price increases rather than supply.

If that is true, though, then cities with moderate or low price/rent ratios today should be building like crazy and rents should be declining.  Instead, building is tepid and rents are climbing.  I blame that on tight lending.  But, what if it's really because home prices really aren't sensitive to long term rates?  If that was true, then when rates are low, high land costs would cause building to be tepid and rents would rise.  Price/income would rise too.  That matches today's environment, but it doesn't match the boom period where low rates were associated with building and with moderating rents in the cities with elastic supply.

It seems to me that we have some sort of control over how sensitive home prices are to interest rates.  If they are not sensitive, it seems like an unstable equilibrium.  It is where we are now, with rising rents, rising price/income, but very low mortgage expenses for a leveraged buyer, compared to 1998 when mortgages cost 7%.

In the unstable environment, potential buyers are locked out because mortgage payments may take a large portion of their incomes.  But, in the meantime, so does rent.  And in that equilibrium, it will only get worse.  In the stable equilibrium, the important comparison would be real mortgage expenses vs. renting expenses, which would lead to a negative feedback loop where buyers could bring on new supply, and low rates would naturally help moderate housing costs.

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.