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.


  1. I'm a pathologist, and generally the hospital blood bank falls within the laboratory, and, by extension, the purview of the pathologist. In the 90s and 2000s it was becoming understood that blood products had historically been over-utilized, that subtle downsides of transfusions were under-recognized. Now, hospitals have blood bank committees that set policies about when transfusions should and should not happen (and how much), leading to less utilization; other clinicians in general have come to accept this, but there was a time, when I was in training, when this was not the case as the paradigm was changing.

    At that time, every unit of blood product was "approved" by the pathologist, but there was sometimes disagreement about propriety. I was taught, wisely, to "never argue over the patient's bed (or on the OR table). The time to fight this out was in the blood bank committee *beforehand* as policy was formed, not over a specific patient while they were gravely ill (unless gross harm would be committed). The harms of transfusions were on the margins, and in aggregate, and it's best to defer to the clinician who is there with the patient (for now, anyway). The harms were likely small enough that it didn't over-ride the risk you would be producing by stealing the clinicians attention.

    I find this analogous to TGR when you write: "It’s a pretty low bar to establish that financial collapse wasn’t a productive or reasonable tool for economic management." If there were excesses that lead to the crisis, they should have been dealt with beforehand, not while standing on the ledge. The resulting collapse did not solve the problem, and likely have resulted in situations that are bound to repeat, eventually.

    Relatedly, is there any evidence that the crisis causes or accelerated flight from small stressed rural/industrial areas, and caused subsequent (further) economic decline? It's common nowadays to see such decline used as an excuse to stifle growth; would be ironic if all this "necessary" pain laid the seeds for policies that will keep us from being able to crawl out of the hole.

    1. > Relatedly, is there any evidence that the crisis causes or accelerated flight from small stressed rural/industrial areas, and caused subsequent (further) economic decline?

      Don't economists usually see migration from distressed areas to more productive areas as a good thing? Lots of our hosts writing is about how restrictive housing policies in the most productive cities turns them into closed access cities, and keeps that migration from happening.

      Instead we get a reshuffling of a few programmers into San Francisco and about as many other people leaving for the less productive contagion cities.

      The restrictions on credit stifled that shuffling and other movements, but that's not a good thing.

      Kevin can probably say something with more substance.

      Your anecdote about the proper policies for use of blood products is interesting. It reminds me a bit of how we handled technical incidents at Google.

      'Stopping the bleeding', eg getting servers back online and serving content to users is the most important short term objective in almost any incident. Use as much metaphorical ducktape and spit as required. But afterwards we are having a proper review to look at the root causes to see how we can avoid the problem in the first place in future, or detect it automatically earlier at least. Those reviews are even called 'post mortems'.

    2. Good comments. Interesting comments on transfusions, Trent. I think that's a great analogy. And, it points to the corrosiveness of political institutions, since policymakers and policy advocates didn't necessarily disagree about avenues for stabilization. In 2008, they were arguing over the patient's bed about how much to make him suffer before they decided to give him the antidote. In 2010, there just wasn't anyone in the room. There was an antidote but his suffering just didn't seem like it should be addressed. Sorry to torture your analogy.

      On migration, it's a bit complicated. The thing is, if we are at a cultural/technological level that calls for urbanization, mathematically, some places are going to depopulate and decline. Every era has places that don't match up with the values of the time. So, the question is, are people staying in places because those places have improved or because they are trapped in bad places.

      I have a paper in the works that will serve as a background to my recent comment for the CFPB on the "ability to repay" rule. There is a problem with trying to attribute rent inflation to local housing supply, and that is that some cities, like Detroit or St. Louis, are struggling a bit. So, if you just do a regression between rent and housing permits among the largest MSAs, the relationship is messy. St. Louis doesn't build much and they have low rents while LA doesn't build much and has high rents. The way I was able to differentiate between those types of cities was to compare population growth in, say, 2000-2003, to population growth in, say, 2004-2006. 2004-2006 is characterized by a national increase in housing and economic growth. So, in 2000-2003, the Closed Access cities were not growing by much, but since they are characterized by a shortage of supply, in 2004-2006, growth there declined even more, because higher incomes and the ability to use those incomes to increase shelter consumption necessarily meant those cities couldn't hold as many households. On the other hand, the other low growth cities tended to increase their population growth in 2004-2006. The growing economy and the ability of Americans to secure better housing meant more people could move to those cities. It suggests that those cities still hold potential opportunity when the economy is strong. Now, I didn't look at non-metropolitan areas, but it seems likely that their depopulation increased during the boom and probably has stabilized since then. But, I don't think that's because they have gained new economic opportunities.

      In general, the best case context is probably one where the Closed Access cities grow a lot and secondary cities grow moderately, and many rural areas depopulate. Of course, where opportunities can be developed in those areas, they should be. But, it's probably most realistic to think that those opportunities are more likely to develop in urban areas.

  2. It is past obvious that there should be an explosion of housing production all along the West Coast and in a few other markets in the United States. If you want to raise living standards, which is what I thought macroeconomics was about, this is the plan. It would also reduce inflation, as measured.

    So, let's talk about wages and how they might be rising---an inflationary risk!---and, of course, "free trade".

    And also Hong Kong! What a wonderful place, a citadel of free enterprise! (the fact that Hong Kong has the world's most expensive housing, that eviscerates family formation, and results in an average woman having 1.2 babies, is not often mentioned).

    I think I must be the one wearing a tinfoil hat. After all, the macroeconomics profession is talking about wages and trade, not housing. But then I read Idiosyncratic Whisk. So maybe Kevin Erdmann is wearing a tinfoil hat too.

  3. > The subtext behind the crisis is spoken allowed.

    Am I missing a clever pun, or should that be 'aloud' or 'out loud' or so?

  4. You know, I mostly agree with Kevin Erdmann.

    Still, there are wrinkles.

    For example, this from the IMF, Oct 16

    "The pace of global economic activity remains weak, and financial markets expect rates to stay lower for longer than anticipated in early 2019. Financial conditions have eased even more, helping contain downside risks and support the global economy in the near term. But loose financial conditions come at a cost: they encourage investors to take more chances in a quest for higher returns, so risks to financial stability and growth remain high in the medium term."


    Okay, so investors like real estate, and "commercial" banks actually lend heavily on property.

    Adair Turner writes and talks about this.

    So, in developed nations, we are trapped. The way to boost the economy is to get commercial banks to lend more (the endogenous creation of money). More debt, and higher property prices.

    Of course, in a recession, the borrowers cannot make good. That means banks fail. When banks fail, you get less lending and property values retreat...egads!

    In decades past, lower rates worked. Then lowering rates and QE worked (we think).


    I think the gig is up. Why not stimulate spending through helicopter drops? Too simple? Bypasses the financial crowd who wants their fees?

    Is lending more and more on property (commercial and residential) really a good idea?

    1. I think the most robust economy will tend to have more equity capital. The best way to create that context is through something like NGDP targeting. Debt is a defensive financial tool. If an economy is relying excessively on it, I think the way to solve that is to get rid of the factors that make savers feel defensive, not to inject bureaucrats into the lending decision.

    2. Well, sure, target NGDPLT and pray for no recessions.

      But public policy must be made in the real world, and in the real world the bureaucrats and other political groups have already assured nearly universal property zoning.

      So, we can print up new money and have it flow through commercial banks (the endogenous money supply) to the buyers of property and thus sellers of property, or we can print up new money by giving ordinary people tax cuts (the Treasury prints up money to offset lost tax revenues, aka a money financed tax cut).

      Presently, the policymakers and macroeconomics profession are skittish about money-financed tax cuts, although a lot of major players are now recommending as much, such as BlackRock, Pimco, or Ray Dalio. Even Stanley Fischer.

      Heavens to Betsy, I am not advocating a real estate bust as salubrious, in the manner of the 2008 tight-money myrmidons.

      What I am proposing is that the present banking and central banking system, due to structural impediments and institutional imperfections (including pervasive property zoning) results in money flows to leveraged real estate as a major avenue to stimulate economic growth.

      That is rather a fragile arrangement.

    3. I think the connection between monetary stimulus and real estate leverage has been overstated. In fact, the unusual rise in household debt was more associated with negative regional NGDP shocks in 2006 than it was with rising NGDP growth and rising home prices before that.

    4. Of course, if you don't like debt and leverage, a straightforward policy lever would be to equalize the tax treatment for debt and equity.

      Straightforward, not necessarily simple.

  5. Well, changing topics....

    from Pimco--

    they say the Fed should buy more MBS, and by selling MBS the Fed us making buying a house more costly.

    1. Interesting. As you know, I think viewing interest rates as the mechanism for monetary policy is problematic.

  6. That phase of the crisis is still neglected, but it is neglected

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