Thursday, May 30, 2019

Housing: Part 350 - Perceptions of reckless lending

I like to get feedback on my work from real estate investors, developers, etc.  Most of the time, they simply see me as na├»ve or silly.  Some doofus with a theory sitting next to you on an airplane isn't going to cause you to stop believing your own eyes.  And, real estate is still mostly local.  Knowing the up and coming parts of town, the best corner for a new building, etc. are still more important than having a fine-tuned perspective on macro trends.  Whatever is driving the macro-level, there will still be apartment buildings sitting half empty in one part of town while they can't get built quickly enough in another.

It is a difficult conundrum, because macro-level work needs to be able to withstand a critique from on-the-ground market experience.  Yet, success on the ground doesn't necessarily require having a coherent interpretation of the market.  The guy with the bustling bagel shop on the corner might be able to do just fine even if he sees the world through a collection of layman's fallacies.  If he makes a decent bagel and manages his staff well, it probably won't affect his livelihood if he thinks the Federal Reserve is controlled by the Rothschilds and that the economy is just being pumped up in a series of fake inflationary bubbles.

So, I try to hear what strangers have to say, even though I realize it is a bit dangerous that I am capable of being stubbornly immune to their criticisms.

Recently, I had a conversation with a woman who is a small-scale landlord.  The kind of street-wise investor that you typically see in that market, who knows how to put their money to work.  It is interesting to talk to people like this because they operate from a different framework than I do.  I have shown how there is a systematic relationship between price and rent within each metro area, and I have hypotheses about why that is - costs of management, access to capital, income tax benefits, etc.

It is rare for people who actually invest in local real estate to have thought about these things, even though you would think it would be important.  Usually they just have some personal rules of thumb: only buy properties with a gross return above x%, don't rent to x, y, and z types of people, don't buy properties in x, y, and z parts of town, etc.  These rules of thumb effectively come to the same result as a quantitative analysis of returns would do.

Typically, these investors simply dismiss out of hand the possibility of investing in high tier single family homes, because they are too expensive.  That will happen in either case, whether looking at the market systematically and quantitatively from a macro level, or using their rules of thumb.  If you recognize that something is too expensive to pay off as an investment property, you don't necessarily need to spend a lot of effort to explain why it is.  But, since they use their rules of thumb, they never confront the oddity that their single largest investment is exactly the investment they dismiss out of hand - the very home they sleep in every night.  To them, that is simply a different category of activity.  That is consumption, not investment.

It is perfectly reasonable that they own their home.  Part of what they are consuming is the act of ownership - control.  But, not fully confronting these conceptual issues leaves many functionally successful investors in a position of misunderstanding macro-level issues and policy issues.  For a start, I think it is common to underestimate how pro-ownership public policy goals unlock value for other households that current homeowners frequently take for granted without having really thought about it.  In other words, it is perfectly rational that they paid more for their house than they would ever have dreamed of paying for an investment property, yet creating markets or public programs that would allow other households to do exactly the same thing seems reckless and dangerous - using public subsidies to feed speculation and over-consumption.

Aaaaanyway, I digress.  The woman I struck up a conversation with had some pointed reasons for dismissing my broad theory of the housing bubble.  One reason, which she explained to me, was that her son bought a house in Wyoming during the bubble while he was finishing college.  As she explained it, she and his father had agreed to co-sign on the mortgage so he could qualify.  But, when it came time to close on the sale, they were out of the country on a trip.  They were preparing to come up with a way to sign the proper documents when her son informed her that the banker said it was unnecessary.  They would approve the loan without requiring a cosigner.  She was aghast.  Her son had very little income at the time.  It was outrageous that the bank would approve the mortgage.  Furthermore, this was during the bubble.  Home prices were elevated, precisely because this sort of recklessness was moving the market.

This is the sort of feedback that I consider interesting.  I have to acknowledge these sorts of excesses properly in order to arrive at a truthful explanation of what happened.  At first blush, this seemed like feedback that I should chew on as a source of caveats.  But, the more I chew on it, the more peculiar it seems.

First, here is a chart of median real home prices in Wyoming, with real home prices in California included for a reference point.  Also, I have included an estimate of conventional mortgage payments on the median Wyoming home.  (Data from Zillow and Fred)

There are some interesting things going on here.  First, I think this is a good example of how the bubble idea has infected our perceptions of the time.  I am sure that her memory of prices in Wyoming isn't technically wrong.  The unit her son was buying was probably 10% or 20% higher than it would have been a few years earlier.  A frugal investor would notice such a thing, and would think twice about buying in such a market.

Yet, prices in Wyoming just wouldn't have led to any sort of notions about a special market that was bloated by recklessness.  Those notions have been planted in our perceptions because of places like California.  As the chart shows, the scale of the market just isn't in the same ballpark.

And, here is a chart of foreclosure sales in California and Wyoming. (Data from Zillow)  This perfectly reasonable woman has a picture in her head of something that happened that just didn't happen.  It was even convincing to me until I sat on it for a while.  If, indeed, there was a rash of reckless lending in Wyoming before 2007, then we should conclude that reckless lending had nothing to do with either a housing bubble or a foreclosure crisis, or at least was far from sufficient as an explanation.

She was explaining to me why lending was responsible for a boom and bust by using a market that didn't have a boom and bust.

Yet, this isn't even the half of it.

What she is perturbed about is the fact that the bank was engaging in such reckless underwriting.  Yet, her son didn't have trouble making the payments.  He ended up doing fine.  I mentioned to her that this was interesting, because even though there was an expansion of lending, in hindsight, it was focused on more qualified borrowers - those with college educations, professional career tracks, higher incomes, etc.  And, Stefania Albanesi, Giacomo De Giorgi, and Jaromir Nosal found that, even where loans went to borrowers that appeared to be less qualified, they were borrowers who had bright prospects.  Their incomes, FICO scores, etc, improved after getting their loans.  And, her son seemed to fit that profile.

No, she replied.  Underwriting isn't based on wishful thinking.  It's based on whether the borrower can make the payment today.  It was reckless.  Not only is this good advice, but she has built a sizable and durable nest egg by being careful about the prices she pays for investment properties and the tenants she fills them with.  To suggest otherwise would be foolish and, really, offensive to everything she identifies with.

But, notice, she isn't upset that he got the mortgage.  She expected him to get the mortgage.  She was willing to vouch for him in order that he could get the mortgage.  She was in the best position to decide if he was worthy of the loan, and she was willing to take financial responsibility for the loan in order to help make it happen.  She is just upset that the bank's underwriting came to the same conclusion she did using methods that were not conventional.  And, after all, the bank was right to make that decision.

Yet, understandably, considering the way that perceptions have developed concerning the bubble, there is no way I could ever convince her that conventional wisdom about the bubble is wrong.  She has personal experience that clearly seems to confirm the conventional wisdom.  Reckless lending led to bubble prices that were bound to collapse.  And the evidence for this is that a bank agreed to make a loan that she, herself, having more information than the bank had, would have made.

I wish I could have been a fly on the wall when she described the ravings of this fool to her husband that night.

Wednesday, May 29, 2019

Uber and wages in a free economy.

Here was a recent article about Uber and Lyft drivers in Washington, DC, colluding to game surge pricing at the airport.
Every night, several times a night, Uber and Lyft drivers at Reagan National Airport simultaneously turn off their ride share apps for a minute or two to trick the app into thinking there are no drivers available---creating a price surge. When the fare goes high enough, the drivers turn their apps back on and lock into the higher fare.
It's happening in the Uber and Lyft parking lot outside Reagan National airport. The lot fills with 120 to 150 drivers sometimes for hours, waiting for the busy evening rush. And nearly all the drivers have one complaint:
“Uber doesn’t pay us enough, what the company is doing is defrauding all these people by taking 35-40 percent,” one driver told ABC 7.
There is a lot going on here.  Really, these drivers aren't colluding against Uber and Lyft.  They are colluding against the customers, who must pay surge pricing.  Uber and Lyft must compete against each other for riders, which drives their fares down to the competitive level.  The drivers are actually colluding so that they and the firms can claim monopoly profits from airport customers.

Their complaints are against the firms, but really, the culprit is competition, which prevents both them and the firms from boosting their incomes at the expense of riders.

In fact, their complaint against the firms is even more misguided than that.  The firms are charging riders a competitive rate and they are overpaying the drivers.  This is a classic economic problem.  There is a queue at the airport.  Those drivers are choosing to go sit in line at the airport instead of driving around the rest of the city picking up riders on the go.  And the reason is that, at standard rates, airport rides are more lucrative for them.  The reason for a queue, conceptually and in this particular case, is that the price is too high.

If the price was too low, you would have a queue of customers, like during the oil shocks of the 1970s when price controls were put in place.  Here, the price Lyft and Uber pay to the drivers at the airport is too high, so the producers (the drivers) are queuing.

Paying drivers more would only make this problem worse.  If they are waiting for an hour to get a fare now, then if the typical fare doubled, drivers would wait for two hours.  Uber and Lyft aren't determining the hourly wage for these drivers.  They are determining it by deciding to wait in line.

The only other way for Uber and Lyft to solve this problem would be to ration the supply of drivers in some other way.  In a way, this is one reason drivers might want to be classified as employees instead of contractors.  If Uber and Lyft treated drivers like employees, they would manage how many drivers there were and where they drove.  They could eliminate the queuing, which would raise wages and reduce the waste of queuing, but it could only happen by being a gatekeeper.  The only way to get rid of the queue would be to tell some of the potential, qualified drivers that they aren't invited any more.  They aren't "hired".

This is similar to the issue of minimum wages.  The way this raises the wages of some is by eliminating the wages of others.

That isn't all bad.  Here, it would lead to less waste by eliminating over-long queues.  But, small scale gains due to monopoly power or economic rents don't add up to social gains.  Everyone can't earn more than the competitive income by using market power to impose exclusion.

The queue is wasteful, but I'm not sure there is a solution.  The economics of driving basically will always come down to queuing.  Whatever rate Lyft and Uber pay, whether drivers are sitting at the airport, or driving around town, the economic breakeven for the drivers will be a function of queuing in some way.  It will determine when and where they drive.  In any given part of town, how long do they need to wait to get a rider, how long do they need to drive to pick up the rider, and how long will the average ride be?  That equation comes down to how much time is a rider in the car versus how much time is the car empty.  There are several supply and demand variables that lead to an equilibrium level for any particular location, but in the end, that equilibrium will be driven by the willingness of drivers to queue in order to get a fare and it seems that some queue, such that it is, will remain wherever Uber and Lyft set their fares and their driver reimbursement levels.  Limiting the number of drivers at the airport queue, where the extra 50 or 100 cars in line has little effect on the quality of service, may seem like a no-brainer.  But, trying to reduce queuing out in the marginal markets around a city will change the supply and demand dynamic in a way that will lead to deadweight loss on the margin.  Reducing the number of drivers will necessarily increase wait times for riders, changing demand for drivers.

I am sure there are teams of economists working on this problem at Uber and Lyft.  I suspect they don't so much mind being tricked into surge pricing at the airport.  They certainly aren't going to raise driver payments in an attempt to address the issue.

Tuesday, May 28, 2019

Brigham Burton and Carly Burton have been arrested.

I used to have a little signage subcontracting business which I sold in 2010.  I sold it to a fellow named Brigham Burton (formerly Kent Burton.  He also has used many LLCs, such as Burton Partners, Rockline Equity, Greenwood Equity, Funding Now, Drive Executives, Eleava Services, and others).

I had to sue him in civil court in order to get fully paid for the business.  The judgments I was granted against him included fraud and conversion.  He appealed the rulings, and the appeals court upheld them, including the punitive damages that were assessed.  The appeals court confirmed that "based on the record in this case, the jury could have found by clear and convincing evidence that Burton’s conduct was aggravated and outrageous, evincing an evil mind. Therefore, we decline to set aside the punitive damages awards."

The criminal justice system has taken notice of the Burtons now.  They were just arrested.  I'm not entirely sure of the details, but I think some of these charges relate to what they did to me.  Really, all I know is that the state has me registered as a victim who is notified when something happens in the case, like the Burtons being arrested.

Here are their mugshots.


Wednesday, May 22, 2019

FEECon 2019

I will be at FEEcon 2019 in Atlanta on June 14 for a panel on housing markets.

Looks like lots of fun and interesting things are happening there.

Here's a link:

And here is more about FEE:

If you will be there, be sure and say hello.  And, if you will be in the Atlanta area, check it out.

Tuesday, May 21, 2019

Progress means giving up what is sacred today for sacred unknowns of the future

Arnold Kling has a link to a study on education with this abstract:
Can schools that boost student outcomes reproduce their success at new campuses? We study a policy reform that allowed effective charter schools in Boston, Massachusetts to replicate their school models at new locations. Estimates based on randomized admission lotteries show that replication charter schools generate large achievement gains on par with those produced by their parent campuses. The average effectiveness of Boston’s charter middle school sector increased after the reform despite a doubling of charter market share. An exploration of mechanisms shows that Boston charter schools reduce the returns to teacher experience and compress the distribution of teacher effectiveness, suggesting the highly standardized practices in place at charter schools may facilitate replicability.

 A key point here: "An exploration of mechanisms shows that Boston charter schools reduce the returns to teacher experience and compress the distribution of teacher effectiveness..."

That sounds terrible, doesn't it?  I think this is key to fundamentally different approaches to progress. It seems like supporting the current providers is key to improving current institutions.  But transforming institutions sometimes means making current providers less important.

There was a time where having a creative, problem-solving blacksmith was key to having effective transportation.  Replacing that blacksmith with impersonal, monotonous factory work seems wrong.  It involves losing something sacred.  Yet, making blacksmiths unimportant was key to the transportation revolution.  You would not set foot on an airplane to take a vacation or a business trip halfway around the world if the airplane depended on a team of blacksmiths using experience and tactile expertise to create the engine parts.  The sacred act of visiting the Egyptian pyramids in person, or coordinating with an Asian businessperson could only be possible by eliminating the sacred role of learned and expert craftsmen.

The extreme version of this transformation is in telecommunications. Barely a human hand touched the phones we carry in our pockets with millions of circuits and parts.  Yet, those phones are only possible because new forms of creative work have been created.

To an extent, the need to unleash the creativity of teachers in the classroom is required because that creativity has to overcome the shortcomings of the institution it is embedded in.  It seems like it would be losing something sacred to create a more effective institution that would make that creativity unimportant.  Yet, what if a better institution leads to better education, even without creative teachers constantly bustling and working to overcome an ineffective institution?

A Silicon Valley designer can use creative work to improve the effectiveness of a million circuits in a phone that will be used by a million people.  That is a lot of leverage that the blacksmith couldn't have.  An institution that requires an immense amount of effort to effectively educate kids a roomful at a time is using an awful lot of sacred effort.  Wouldn't it be great to educate those kids with teachers that didn't need to be so creative?  And, wouldn't it be great to move to a world where the effort going into that creativity was leveraged beyond a room full of 20 kids?

So often, the difficulty in supporting progress comes in losing the known sacred in exchange for the unknown sacred.  In the end, progress depends on faith in emergent change.

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?