Monday, October 21, 2019

September 2019 CPI Inflation and Yield Curve Updates

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

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

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

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

Wednesday, October 16, 2019

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

Thursday, October 10, 2019

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

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

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

Here are a couple of excerpts from my comment to the CFPB:

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

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

Here is figure A6 and notes:


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

Tuesday, October 1, 2019

California wants more monopsony in the labor market.

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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

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