Tuesday, June 18, 2019

May 2019 CPI Inflation

Sorry I'm a few days late on this.

Core CPI continues to ride along the 2% target range, bifurcated between shelter and non-shelter prices.  CPI shelter inflation is at about 3.3% over the past 12 months.  The non-shelter core components are now down to 1.0% over the past 12 months.

Inflation isn't that great of a short-term signal.  After all, non-shelter inflation was at or above 2% in 2008 and 2009 while nominal GDP growth was collapsing.  But, the period leading up to that, in 2006 and 2007, had a similar character - high shelter inflation and low non-shelter core inflation.  Yet, when that signal appeared in 2017, it reversed in spite of Fed postures that continued to signal tightening.

All that being said, it certainly seems as though maintaining an inverted yield curve with non-shelter inflation at 1% is clearly too hawkish.  It appears as though the Fed is looking to reverse course, which is very good news.  A couple rate reductions is prudent at this point.  Unfortunately, that is likely to meet the howls of those who claim a low target interest rate inflates prices in capital markets.  But, it seems the FOMC has become more immune to that, which is great.

I have been suggesting that long bond positions would be profitable, and expecting that an inertial Fed would create marginal buying opportunities in other assets as that opportunity played out.  The long bond position is mostly finished because of the zero bound. Mid-to-long term rates aren't able to go much lower.  If the Fed gets ahead of things here, maybe they will curb any pullbacks in equity markets or housing markets.  I'm happy to see that tactical opportunity disappear if it means the Fed doesn't encourage unnecessary contractions.  In fact, maybe that would make those opportunities even more fruitful, without waiting on a pullback, if the economic expansion is allowed to continue, chipping away at risk aversion.

But, the story remains.  Inflation is very low.  To the extent that real wage growth continues to disappoint, this is largely a structural supply issue that creates a transfer from tenants to real estate owners, which is measured as inflation.

Monday, June 17, 2019

Mercatus Series on Housing Affordability

I have a blog series on housing affordability that is slowly rolling out (1 per week) at The Bridge.

I find discussions about housing affordability to be frequently frustrating.  One reason is that homeownership is generally treated as if it is a wholly different type of consumption than tenancy is.  This is odd, because in national accounts, the BEA treats tenancy the same for both owners and renters.  I find it useful to disaggregate our economic activities regarding shelter so that every home has an owner, a financier, and a tenant, regardless of whether those agents are all different or are all the same individual.

There is certainly a risk that comes from becoming an owner-occupier and taking ownership of a single large asset that can frequently be much larger in size than your total net worth.  On the other hand, there is also value that comes from getting rid of the principal-agent problems that come from having various stakeholders who all have competing interests on a single asset.  For owner-occupiers, those conflicts are erased, which seems to lead analysts to act as if these three different relationships to a property disappear when those agency conflicts disappear.

In this series I maintain these three roles as factors for all homes - financier, owner, and tenant - and consider various aspects of housing markets and housing policy.  This process has led me to new points of view regarding these issues, and I hope you find something to think about in each post, also.  In hindsight, I find that the posts have a veneer of dryness, but they are short, and I am hopeful that each one has at least one new idea that will shift you in your seat a bit and help you to take a few moments to deepen your own sense of how these factors play out in the marketplace and in the various public policies that affect that marketplace.

The tl:dr on the first four parts:

  1. Thinking Clearly About Housing Affordability:  "Here is the core analytical error: housing affordability should be measured in terms of rent, but our understanding and policies have erroneously focused on price—to disastrous ends.  From monetary policy to credit policy to regulations on local development, responses to the housing bubble have consistently and explicitly aimed for less residential investment, fewer buyers, and fewer homes.  Limiting the supply of homes has had a predictable effect of increasing rents.  In other words, the problem of affordability, in terms of price, was “solved” after 2007.  Affordability in terms of rent was not.  Understanding the difference between these two measures will be an important factor in correcting the policy errors that led to the crisis and creating better, more equitable, more stable economic outcomes in the future.
    I argue in my book, Shut Out, that the housing collapse and the financial crisis were not inevitable.  They weren’t even useful.  In fact, their very purpose was mistaken.  The fundamental measure for housing affordability is rent, not price.  And, trying to bring down prices instead of bringing down rents inevitably will fail on its own terms.  In the long run, prices will be determined by rents anyway."

  2. What Are Landlords Good For?:  "More efficient markets lead to higher real estate transaction productivity. The resulting higher prices convey that information: owning a home is more valuable now, because it can be done with less hassle. Landlords would be less necessary because transaction costs would be a smaller problem, making homeownership more valuable.  Only focusing on price might tempt one to suggest that transaction cost-reducing innovation should be avoided because it would only increase prices."

  3. Homeowners Make the Best Landlords:  "When considering the benefits of home ownership on the margin, the focus should be on capturing the excess yield that seems to be widely available to owners.  It is this yield that is most important to marginal potential owners, not capital gains... It may be more accurate to think of that excess yield as a form of patronage.  A lucrative wage available to those with access to ownership.  The wage is earned by performing the duties and taking the risks of a landlord. Upon becoming the owner, the wage remains, but the duties of the job can be shirked.  There is no problem tenant to evict.  No vacancies to fill.  No complaints to manage.  It’s a cushy job you can get because your Uncle Sam pulled some strings down at the bank."

  4. Real Estate Investment Doesn’t Increase Spending:  "The housing bust is creating more excess capital income than a housing bubble ever could have."

Sunday, June 9, 2019

May 2019 Yield Curve Update

Good news on the monetary policy front.  The Fed has been signaling a willingness to ease, and currently, futures markets are predicting a 25 basis point rate deduction in July (with some probability even of a 50 bp deduction!).  Initially, this brought the yield curve down out to several years, but in the days since then, the short end of the curve has remained lower while the curve from 2020 onward has recovered back to late May levels.  That's a great sign.  Maybe the Fed will ease enough to avoid a contraction.

The primary thing to look for in the yield curve, I think, is reaction of the long end.  I think we are clearly in inversion territory now, which means that there has been some distortion in long term yields.  As short term yields decline, that distortion will be eased, and long term yields will initially decline along with short term yields.  Eventually, the positive signal will be a divergence between short and long term rates, with a flattening of the short to mid term curve and a slight upward slope.  It seems as though the Fed is willing to be aggressive enough to make that happen.  This is a positive surprise to me.

Expectations have changed so sharply that already, if you look at the December 2020 contract on the Eurodollar curve, half of the gap between the November peak rate of about 3.2% and 0% has already been filled.  In terms of taking a long position on forward rates, the horse is already mostly out of the barn.  If the Fed is aggressive, forward rates may not have that much farther to fall.

In the second chart here, I would expect the typical pattern to happen, where, as the Fed Funds Rate declines, the 10 year rate will decline along with it along the inversion trend line.  At some point, the 10 year will stabilize.  A rule of thumb I would expect to look for is if the Fed has gotten too far behind the 8-ball, then the economy will deteriorate and the Fed Funds rate will continue to decline.  Or, if they get ahead of the ball, then the 10 year will recover.  So, I suppose I would expect the inversion to eventually reverse.  The scatterplot will cross back over the trendline.  It would be a bad sign if the scatterplot crosses the trendline horizontally and it would be a good sign if it crosses it vertically.

It moved vertically in 1996 and 1999.  But, in those cases, the curve wasn't inverted, or the inversion hadn't been in place quite as long.  In cases where it has been inverted for at least this long, recession followed.  In 2001, the inversion was reversed by lowering the Fed Funds rate, so it crossed horizontally.  It seems as though we could go either way.  I have been prepared for the mania about asset prices to drive the Fed to a too hawkish position, but the fact that the market thinks there is a chance for a 50 basis point move in July suggests that the Fed is no longer as hawkish as I thought.

Friday, June 7, 2019

Housing: Part 352 - Building market rate homes helps make housing more affordable

Nolan Gray has a great write-up at CityLab about a new working paper that attempts to empirically measure the process by which substitutions across housing markets work.  This is one process by which new high-end units can help create broad affordability.

Gray's piece is about a new working paper by Evan Mast.

The take-away:
Building 100 new luxury units leads 65 and 34 people to move out of below-median and bottom-quintile income neighborhoods, respectively, reducing demand and loosening the housing market in such areas. These results suggest that increasing housing supply improves housing affordability in the short run.
Keep in mind that the status quo in the Closed Access cities is that tens of thousands of households of lesser means move away each year because of affordability issues.  This work only measures moves up-market, not the cessation of outmigration.

In the extreme, where high-end housing demand is inelastic and low-end housing demand is very elastic, one might expect new supply to lead mostly to an expansion of high-end quantity demanded with little or no expansion of low-end quantity.  That is effectively what is happening on the margin today.  As high-end demand continues to grow, demand at the low end is reduced by substituting out of the metro area.  The migration data tells us this is the state of demand.

So, functional substitution between housing sub-markets could still lead to better affordability even if there was not an expansion of quantity demanded among low-tier tenants.  It would still be an improvement if lower rents simply allowed them to remain in the units they have.  It would be an improvement simply to stop that distressed outflow.

Mast's findings are a bonus.  Not only can the new supply stop the outflow.  It can even lead to low-tier increases in quantity demanded.

Wednesday, June 5, 2019

The popularity of the nationalistic rhetoric of Trump, Warren, and Sanders is a failure of economics

Elizabeth Warren posted "A Plan for Economic Patriotism" this week.  It begins like this:
I come from a patriotic family. All three of my brothers joined the military. And I’m deeply grateful for the opportunities America has given me. But the giant “American” corporations who control our economy don’t seem to feel the same way. They certainly don’t act like it.
Sure, these companies wave the flag — but they have no loyalty or allegiance to America. Levi’s is an iconic American brand, but the company operates only 2% of its factories here. Dixon Ticonderoga — maker of the famous №2 pencil — has “moved almost all of its pencil production to Mexico and China.” And General Electric recently shut down an industrial engine factory in Wisconsin and shipped the jobs to Canada. The list goes on and on.
These “American” companies show only one real loyalty: to the short-term interests of their shareholders, a third of whom are foreign investors.
As with her other proposals, there is a mixture of good and bad, and a lot of details.  Maybe the rhetoric isn't that important, in the end, to the actual policies.  But, the rhetoric here is chilling.  The history of public movements calling out groups for their supposed divided loyalties is a long and disgraceful one.  Considering the starkness of the rhetoric, and the parallels between Trump, Warren, and Sanders regarding their use of the form, it is interesting to consider how, for all of us, our reactions to each of them differ so much.  The bridge between Warren and Trump voters seems to be increasingly noted.  It seems plausible that this new press release is part of a plan by Warren to build on that.

But, I want to step back from that for now, and just consider the practical issues raised in Warren's statement.  Economics, at the least, should serve as an inoculation against this sort of rhetoric, and in this, it seems it has failed.

Consider the global economy as it might be, full of functional, productive societies with wealthy residents.  In that world, the places we currently consider developed might produce 20% of global goods and services.  Instead, today we produce something more like 70%.  At some previous point, it was more like 80%, and developing economies have been catching up.

That process of catching up is fabulous.  It is all to the good.  The only sustainable way of becoming a developed prosperous place that we know if is to move toward a system of a universally applied rule of law, human rights protections, personal freedom, and self-determination.  With that foundation, people engage in the process of specialization and trade that is the source of economic abundance.

This is the key - specialization and trade.  So, imagining this fabulous development - the whole world becoming civilized, humane, and wealthy until our part of it only produces 20% of that abundance - exactly how does one expect that shift to happen?  As the developing world moves from 20% to 30% of global production, they will necessarily specialize in some additional portion of world production.  It might be apparel or pencils.  It might be something else.  But it will be something. And much of it will be items that used to be produced in the developed economies.

The idea that the Dixon Ticonderoga company has much of a say in this is obtuse.  And, furthermore, the idea that their acquiescence to this global transformation is the result of "the short-term interests of their shareholders" is ludicrous.  There is nothing short term about this.

The reason that this rhetoric doesn't destroy Warren's public credibility is because of the failure of economics education.  The reason this can be construed as a short-sighted decision is that it is almost universally seen as a way to take advantage of the low wages of developing economy workers.  As if this is just a heartless example of exploitation rather than a reaction to epochal shifts in global productivity.

I propose a simple statement as a starting point for remedying this problem: "Production doesn't move to where wages are low.  It moves to where wages are rising."

That is the story of economic development.  This doesn't mean there aren't growing pains that sometimes hit some workers the hardest.  But, it does mean that in the end, all of those gains, on net, go to workers.  Returns to global at-risk capital are about 8% plus inflation.  They were 8% a century ago, they average about 8% today, and they will likely be 8% or less a century from now, if the world continues to grow with a capitalist framework.  But, workers today earn ten times or more what they did a century ago, and in another century - especially in places that are catching up - they will earn at least ten times what they earn today.

It really is ironic that Warren uses the Dixon Ticonderoga company as an example here.  Leonard Read, the founder of the Foundation for Economic Education was perhaps most famous for writing the essay, "I, pencil".  An excerpt:
I, Pencil, am a complex combination of miracles: a tree, zinc, copper, graphite, and so on. But to these miracles which manifest themselves in Nature an even more extraordinary miracle has been added: the configuration of creative human energies—millions of tiny know-hows configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human masterminding! Since only God can make a tree, I insist that only God could make me. Man can no more direct these millions of know-hows to bring me into being than he can put molecules together to create a tree.
An interesting aspect of that essay is that it contains several practical references to geographical locations of production, many of which I am sure have become dated as global production and specialization have evolved.  The essay is at once a timeless conceptual reminder of the profoundness of the invisible hand and a record of the fleeting nature of its operation.

I found this with a quick google search, which is a nice educational aid used in some New York state elementary school classrooms.  The education is being done.  But, the continued popularity of its absence is a call for ever more.  Godspeed, New York elementary teachers.

(PS; Karl Smith weighs in here with some interesting supporting details about the history of Dixon Ticonderoga.  He also discusses currency manipulation, but I think that is an overstated factor in the American trade deficit.)

Housing: Part 351 - The downfall of "Pick-A-Pay" loans

Here is a great article on the history of Golden West Financial Corporation and the development and downfall of option ARMs. (Pick-A-Pay or option ARM refers to mortgages where the borrower can choose their monthly payment for some period of time - sometimes at a rate that doesn't even cover the interest, so that the principal amount grows rather than declines.) An excerpt:

Five months after the Times’s “pariah” story ran, the paper’s Floyd Norris wrote a column about Golden West’s loans. The business columnist had entirely missed the original piece on the Sandlers, he says, and knew little about their bank’s history. Like other option ARMs, Norris wrote, Pick-a-Pay loans were racking up big losses. But when reading Wells Fargo’s first-quarter earnings report, he noticed that less than one-third of 1 percent of Golden West’s loans were expected to recast before the end of 2012, meaning that borrowers wouldn’t see large payment increases for many years. “That struck me as an amazing number,” he says. “How the hell could that be?”

It was the ten-year option at work. Over the next few days, Norris researched the terms of Pick-a-Pay loans, and concluded that the loans’ ten-year option and high loan-to-value cap were remarkably generous, and an attempt to do right by borrowers. Yet in a catastrophic market decline, those terms stripped the bank of leverage. Homeowners could pay less than interest-only in the hope that the market would recover, restoring their equity. If prices stayed depressed, however, they didn’t have much to lose, as their payments “could well be less than the cost of a comparable rental,” Norris wrote.

“I understand it makes some people feel better to know that they have identified someone who acted outrageously,” Norris says. “But sometimes it’s more interesting when nobody acted particularly outrageously and things blew up anyway.”