Housing supply isn't constrained in Phoenix

Scott Sumner has a post over at econlog today about the mystery of low housing starts.

But what if supply is also constrained in Phoenix and Las Vegas?  I don’t have any good explanation for what that might be so, but the data strongly suggests that there is some sort of supply problem.  The high prices are back, but construction remains severely depressed......I have no idea why supply in these markets is so constrained.  I’ve read articles that make vague references to the cost of land and labor, but no real explanation of why things are so different from 2003.

As Scott frequently points out, bubbles are not nearly as numerous as they are made out to be.  It is important to remember that what happened in cities like Phoenix in 2005 was an extreme anomaly.  A combination of population flows and capital flows that briefly pushed both the demand for real shelter and the funding available for it high enough that the local short run supply curve became disruptively inelastic.

In most cities at most times, where demand hasn't pressed quantity demanded so far up the supply curve that it becomes inelastic, changing demand only has minor effects on price.  When markets are relatively normal and supply isn't extremely inelastic, changing demand mostly affects quantity.  Even in 2006 and 2007, housing starts underwent extreme fluctuations before prices followed them down.  So, the signal in Phoenix is a reasonable reflection of changing demand.  (There was another anomaly in housing, after the crisis, where severe limits to lending pushed prices down in many cities.  That, again, though, was an extreme anomaly.  As Scott shows in his post, slowly this anomaly has reversed, also.  So, Phoenix was subjected to two anomalous housing events.  An extreme upswing in prices - what you might call a bubble - followed by an extreme downswing in prices that was also far from a level that long term fundamentals would justify.)

Source

You can see this in population and migration data.  One effect of extremely tight lending that has prevented aspirational middle class homeownership since the crisis is that population and migration trends that had been steady since WW II into places like Phoenix have been sharply curtailed.  Migration briefly declined to nothing in Phoenix for a few years after the crisis, and has since recovered to a level where the difference between Phoenix population growth and US population growth is only about half what it was pre-crisis.

Phoenix builders could build thousands more homes each year without much rise in cost.  Actually, prices in the low tier existing housing stock in Phoenix probably need to rise a little bit more to make building profitable.  This is a sign that lending regulations are the key variable moderating demand.  Building rates are highly correlated with income and with home prices, both within and between metro areas.  Low tier demand is in retreat because it has been pressed into a landlord's market.  This shows up both as a decline in inter-metro migration and in a retreat of real housing consumption combined with high rent inflation in low tier and rental markets.  The FHFA and CFPB's have-nots are either stuck in place or in retreat.  This also shows up in American Housing Survey data that suggest household size has continued to slowly decline among homeowners but has reversed and started to climb for renters, since the crisis.

What about the issue of costs?  I suspect there is something to that.  Low interest rates do make land more expensive. (Back yards are much more rare in the new neighborhoods in Phoenix than they used to be.)  Regulations, etc. have all probably risen somewhat since the crisis.  So, low tier prices might need to rise even more than they would have needed to without those issues.  But these are marginal changes that can't be responsible for such universal and extreme shifts in building rates around the country.

Source

On the topic of labor costs, however, I think there is something interesting here.  Here is a graph of construction employment in Phoenix as a percentage of total employment.  This did briefly rise during the boom, and then collapsed to very low levels after the crisis.  This is especially striking if you believe, as I do, that Phoenix never had an oversupply of homes, only a sharp negative demand shock, which is clear in the population chart above.  (I think the 2010 dip is probably due to a data revision, which is likely due to population growth that was lower in 2008 and 2009 than shown.)

Economists such as Peter Boettke and Arnold Kling talk about the economy as a coordination problem.  I think this is a valuable and useful way to think about the economy.  The problem here is that this extreme disemployment in construction has been universally accepted as something that was necessary.  Economists have treated the collapse in construction employment as the necessary correction that had to take place, and blamed the slow recovery on the scale of that correction.  But, what if that wasn't a correction at all?  What if that was the disequilibrium.  Consider the scale of the damage we have imposed on our own economy through monetary and credit strangulation that we were able to permanently disassociate 3-4% of the Phoenix labor force from a reasonable and useful local industry.  This damage has been so diligently imposed that the dislocation remains in place a decade later and these workers have disappeared.  Builders complain of a labor shortage.  What happened to them?  Did they give up? Did they move away?  Did they have to go through a difficult (and unnecessary) transition to other work?

Hysteresis has been an idea sometimes used to explain the slow recovery.  Here's your hysteresis.  Even today, I commonly see people react to slow housing starts by asking, "Aren't we still working off the oversupply of the bubble?"  That is absurd.  It was absurd when Bernanke asserted it in 2011.  It was absurd in 2005, frankly, though one can certainly understand how conventional wisdom got it wrong at the time.  The fact that this idea is still floating around the zeitgeist in 2019 is a signal of how misguided conventional wisdom has been about housing.  The persistent unemployment of those workers was a policy goal shared by both populists and technocrats.

A nice review of "Shut Out" at CATO

David Henderson, one of the frequent posters over at econlog, who I have always enjoyed following, has a very nice review of "Shut Out" at Cato.  It begins:

In his recent book Shut Out, Kevin Erdmann, a finance expert and visiting fellow at the Mercatus Center at George Mason University, has two main messages. The first, which is not controversial among economists, is that restrictions on residential construction in coastal California and the urban Northeast have constrained supply so much that housing in those areas is virtually unaffordable for people in the lower- and middle-income classes. His other message is more controversial: the financial crisis last decade was not due to a housing bubble but, rather, to bad policy decisions based on the idea that there had been a bubble. Whereas I was already convinced of his first point, I, like the majority of economists, was skeptical of his second. But because of all the data and reasoning he brings to the issue, I now find myself at least 90% convinced.

Please click on the link (pdf) for the rest.

I need to get that darn second book finished to address the other 10%.

The Divergence in Incomes and in Resource Usage

Recently, I was listening to Russ Roberts at EconTalk interview Andrew McAfee.  The topic was the surprising change in trends in resource use.  It appears that as economies grow, at first resource use increases, but eventually economic growth comes from more efficient use of resources instead of through the brute force of added resources.  Surprisingly, the use of many resources has been declining for some time in the developed world.  Not just in per capita terms, but in total.  Now, getting richer seems to mean using less.

They mentioned that the divergence seemed to happen around 1970.  Here is a graph of real GDP growth, iron and steel, and cement use, all indexed to 1970, using data from McAfee's website.

Although I don't think they mentioned the parallel in the program, I immediately thought of this graph that is frequently cited in the income inequality debate.  The source of this graph has made it quite clear what they think caused the divergence.

It seems likely to me that these issues are linked.  As economic growth became decoupled from the Malthusian quest for more resources, it became associated with rising services and status competition.  There could be a number of things going on here.  First, if it is easier to meet basic physical needs, there may be less motivation to increase income above a certain threshold.  Also, the real economic value of services and status items may be more difficult to track because it isn't based on the blunt measure of a physical quantity of inputs.  Variable inflation rates may be more difficult to track.  Think of the difference in rent between San Francisco and Little Rock, or groceries at Whole Foods vs. Wal-Mart.  Or, the price of a last-minute business class airplane ticket vs. an economy ticket.  Or, the vast number of services created by the internet that are commonly provided for free.  Think of the cost of Bloomberg financial services vs. the huge amount of data sites like Zillow make available for free.  The value of things versus the price of things has become highly variable.

In any event, these developments seem certainly to be related, and the transition away from a resource based economy seems like a much more relevant trigger than President Reagan.  I suspect there is a combination of mismeasured well-being and variance in well-being that is largely played out in status seeking services.  Thus, measured inequality seems high even though most households can purchase basic goods at real costs that are far below what they were in 1970.

I wonder if those who give Reagan such an important role in relative measured income growth after 1980 would feel such a strong intuition about the first graph, and hail Reagan as the president who curtailed resource usage.

An interview with ALEC

I really appreciated being allowed to share my work with ALEC at their recent conference in Phoenix.  I saw a lot of great nuts and bolts activity going on there in the service of creating an equitable and economically vibrant nation.

Here is a short interview from the conference.

November 2019 CPI inflation

Inflation remains in a holding pattern - about 2.3% core inflation, which consists of 3.3% shelter inflation and 1.6% non-shelter core inflation.

The yield curve is, similarly, in a holding pattern.  How this plays out will depend on unanticipated real shocks over time and the future bias of the Federal Reserve.  My inclination is to continue to believe the short term outcome will mostly accrue to declining Treasury yields and the depth of that decline will greatly depend on the willingness of the Federal Reserve to support short term NGDP growth.  The slow moving train wreck (or not) continues.  As long as non-shelter core inflation remains below target and the yield curve remains effectively inverted, my expectations will be somewhat bearish.

Momentum in equities when reputational risks are high

This blog originally was supposed to mostly be about investing tactics, but I got sidetracked when I discovered the housing issue that has ended up taking over.

Here is a post on the topic I used to dwell on - tactical investing for high returns by being insensitive to reputational risk. A recent example of this issue is Hovnanian Enterprises, a major homebuilder that is still so down on its luck as a result of the housing bust that as recently as July, it was being threatened with delisting from the NYSE.

All along, they have mostly just needed the market in new housing to recover.  They need revenue to fully regrow back into the financial and organizational framework that had developed under the Hovnanian name in 2005.  They have so much organizational and financial leverage that small increases in revenue will translate into large increases in market capitalization.  This will further be enhanced by knock-on effects of recapturing the value of tax assets and written down developments, and paying or refinancing debt at more favorable terms.

After the July delisting notice, Hovnanian released results of two quarters which have provided strong evidence that revenues will be growing and these positive developments will be coming.  Normally, efficient markets would internalize these developments immediately, and a firm's share price would immediately jump to a level reflecting the new expectations.  Financial research has shown a momentum effect.  In other words, a trend in share prices doesn't happen 100% at once.  It mostly happens at once, but there does appear to be some predictable serial correlation.  A recent trend shift or a recent positive or negative shock to a share price will tend to continue in the short term, to a certain extent.

But, in unusual positions where reputational risk has become acute, this momentum effect can become very large.  I am sure there were some institutional holders who were forced by their own rules to unload shares when Hovnanian received the delisting notice.  At some point, the reputational danger of having owned a stock or of recommending a stock, can overwhelm the objective value of it.  In these cases, the market for that equity becomes very tepid.  It's sort of like very thirsty wildebeests coming upon an oasis.  They very understandably approach it carefully at first, not sure if it is safe.  But, almost inevitably, the whole herd will be lined up at the shore, sucking up water vigorously.  To someone who happens to have been at that oasis when the herd showed up and recognizes already that there are no crocodiles, this process can seem excruciatingly slow.

Here is the Hovnanian stock chart from the past 6 months.  The positive shocks are noticeable after each quarterly announcement, but even those shocks took place over several days.  Following the initial quarterly shock, there was further upward drift for some time.  The more recent positive shock also took several days to play out.  It will be interesting to see if a positive drift follows this shock also.  If revenues do climb from here, the share value is likely many times the current market value.  Getting from here to there will reflect a combination of objective results, expectations, and changing reputational risks.  It is the implicit position on reputational risks that can provide very high returns over time, but it comes with the occasional risk of losses, and those losses will necessarily be devastating and embarrassing.

Source

Great Review of Shut Out in the Economic Record

Declan Trott, an economist with Australia's Department of the Treasury, has written a very nice review of Shut Out for Economic Record, a journal of the Economic Society of Australia.  It offers a concise and well-written overview of the book's thesis.

Unfortunately, there is a pretty hefty paywall.

A couple of brief excerpts:

But what if this fall in prices were not the inevitable bursting of a bubble, but an unnecessary and self-inflicted panic? This is Kevin Erdmann's contention. . . This is a provocative thesis, not to be accepted lightly.  Yet Erdmann has assembled a formidable battery of data and argument to support it.

. . .

It is the detailed documentation of the (housing bust), and the treatment of the entire episode as a panic rather than a bubble, that is Shut Out's key contribution relative to the academic literature. 

. . .
And, I was flattered by his closing comment.

As a member of the PhD tribe, I occasionally found myself wishing for more equations and regression coefficients, and simpler charts.  But still, somebody should give him an honorary degree. 

That sounds just like my editors and internal reviewers.  Why does everyone hate complicated charts so much? Anyway, this review was a pleasant Thanksgiving surprise.

A postscript on the review of the crisis

Upon re-reading my summary of the housing bubble and financial crisis, I suspect some skeptical readers might find my summary lacking because it may seem as if I am writing off what was clearly a boom in residential investment and home building.  It may be worth a clarification.

There certainly was an increase in building from the mid-1990s to the mid-2000s.  But, in terms of either the number of homes per capita or the rate at which they were being built, nothing was outside of historical norms.  Residential investment seemed high, but part of what is accounted for as residential investment is brokers commissions, which don't really add to the housing stock.  Brokers commissions were high, however, because the shortage of urban housing made existing homes too expensive.  Subtracting commissions out of residential investment reveals a long term decline that was briefly interrupted with rates of residential investment similar to the 1970s.

There wasn't really a national building boom.  There was a moderate rise in building.  The reason it seemed so disruptive is that the Closed Access cities can't allow a sustainable amount of building.

That means that any time Americans try to increase our real consumption of housing at the same pace that our incomes are rising, a disruptive migration event must occur, because if the consumption of housing expands and some cities cannot expand their local stock of housing to accommodate it, those cities must depopulate.  That's what happened before the financial crisis.

Policymakers since then, whether they understand it or not, have been trying to avoid this disruption by either keeping incomes low (through tight monetary policy) or by reducing demand for housing (through tight lending standards).  That has reduced the migration out of the Closed Access cities, but it has come at the expense of living standards for Americans everywhere.

A review of the crisis narrative

Over at econlog, a commenter has asked me for a comprehensive review of the standard narrative and my objections to it.  His summary of the standard narrative is clear and concise, but thorough, and I thought it might make a nice template for posting a summary of my new narrative.

His description of the standard narrative is indented, and my responses are not.

A variety of factors (securitization introducing a principal-agent problem, organizational changes in banks/GSEs, regulatory encouragement, etc.) led to much looser standards for lending. This included:
No-documentation loans.
A growth in subprime lending.
Shrinking requirements on down payments.

These factors were all definitely at work.

This led both to an increase in for-occupancy home purchases by people who used to be renters, and in speculative home purchases (which were now easier to finance, and looked profitable as home prices were rising).

The private securitization boom, which is associated with all of these developments, lasted from roughly the end of 2003 to mid 2007.  Homeownership rates had been increasing since the mid-1990s, but they peaked near the beginning of that period, and then declined.  The relatively high level of homeownership was generally due to age demographics.  Homeownership rates for all working-age groups were about the same they had been in the early 1980s, at the high end of their recent ranges, but not unprecedented, and by the end of the subprime boom they were back in the middle of the long term ranges.  American Housing Survey data suggests that this was because, both, the rate of first time homebuyer activity declined, and an increasing number of existing owners sold out.

Of course, someone has to own every home, so this means that investor ownership increased.  In some volatile markets, some of that activity was speculative and ill-considered.  It probably hastened the early defaults in those markets because investors are more likely to default when equity becomes slightly negative than owner-occupiers are.  But, the investor activity was more of an effect of volatile markets than a cause of them.  Prices were nearly topped out by the end of 2005, and most speculative activity happened in 2006 and 2007.

In short, it is implausible to blame speculating investors for the rise in prices from 1997 to 2005 and it is implausible to blame rising homeownership from 1997 to 2004 on the loosening standards of the subprime boom.

So, what did cause rising prices?  In at least 2/3 of the country, prices weren't outside of historical norms relative to rental values.  They were slightly high, which can be explained with low long term real interest rates, but not unusually high.  In 5 primary cities [NYC, LA, Boston, San Francisco (+ San Jose), and San Diego] prices were high because rents were very high and were rising.  Fundamentals fully account for high prices in those cities, and this is more obvious with every passing year.  Their rents are high because they allow an astoundingly low quantity of building.  I call them the Closed Access cities.  Loose lending may have added demand to the buyer market in those cities beyond what was previously possible, but it was generally allowing borrowers with high incomes to buy in cities where rental expenses are also outside historical norms.  Households with lower incomes were flooding out of those cities at the time by the hundreds of thousands each year. 

A smaller set of regions had something more akin to a true bubble - prices that were likely to retract at some point in the natural course of things: Arizona, inland California, Florida, and Nevada.  I call them the Contagion cities.  They were the primary landing ground for the Closed Access outmigrants, and the primary cause of their brief positive spike in home prices was that they were generally overcome by in-migration.  The demand was for actual shelter.  Families were moving to these places, in droves, specifically to drastically lower their housing expenses.  Recently, I have been working on preliminary evidence that during the periods where prices were rising in the Contagion cities, there was no unusual rise in borrowing.  That happened after prices and rates of new building in these regions had peaked.  Borrowing at the state level tends to lag both the building booms and the price spikes.

It would be very difficult for these cities to overbuild because they natural have heavy in-migration, and at the time it was higher than normal.  In fact, at the metropolitan area level, in the 2003-2006 period, rates of building were especially correlated with population growth.  Population growth in Contagion cities suddenly collapsed when the migration event out of the Closed Access cities collapsed.  This was happening by the end of 2006.  By then, the Fed should have been trying to stabilize housing markets, not slow them down. Yet, even in late 2008, the main criticism they faced was that they weren't destabilizing housing and financial markets enough.

The shortage of homes in these cities is the fundamental cause of the housing bubble and ill-informed policy reactions to it caused the financial crisis.

This rise in home prices was not sustainable (80% increase in 6 years, much faster than inflation), and eventually slowed/ended, this happened concurrently with raises in the interest rate (and thus in the rates of adjustable mortgages)
This would not have created a crisis by itself (housing markets have had downturns in the past) except for the fact that many homeowners either:
Couldn’t afford their mortgages and could no longer refinance them using new equity from price appreciation.
Had “negative home equity” and lived in no-recourse states, making it cheaper to default than to keep paying their mortgages.

The Fed had inverted the yield curve by the beginning of 2006.  To the extent that monetary policy is communicated through interest rates, the peak of the housing boom coincides with them.  Adjustable rates have little to do with the default crisis.  Defaults were highly sensitive to cohort (how soon after you borrowed did prices begin to collapse).  2007 was the worst, followed by 2006.  The yield curve was inverted and the short term Fed Funds rate was at or near the 5.25% high point throughout the period when those mortgages were taken out.  Rising rates on adjustable mortgages have nothing to do with the default crisis.

Falling prices (negative equity) were by far the largest factor leading to defaults.  Lending standards were tightened sharply during 2007, so it is true that it was harder for borrowers to refinance.  The drop in homeownership in 2007-2008 was mostly among homeowners with high incomes in the "bubble" areas where prices were collapsing the most sharply.  Declining middle income and lower-middle income homeownership rates were a very lagging event, really not happening until after 2008, after lending standards had been sharply and permanently tightened, which caused a largely unacknowledged second housing collapse that was focused mainly on low tier neighborhoods, and which affected nearly every city in the country.  The bottom of prices around 2012 was not a return to normalcy, it was a self-inflicted collapse in credit constrained markets that were now locked out of mortgage access.

This led to a snowballing increase in delinquency rates which started prior to the crisis and lasted through the recession. It was also unique in that it happened in a correlated fashion across the country, unlike prior downturns which tended to be local.
This then impacted the financial sectors as many instruments built on securitized mortgages were discovered to be worthless, and entire companies went bankrupt.

The fact that it was correlated across the country is a solid signal of how wrong the standard narrative of its causes is.  Cities have huge differences in prices, rents, rates of building, vacancy, etc.  It is implausible that overbuilding or unsustainable prices could have done this. It was the result of national policy choices aimed at doing it, first by tight monetary policy that began to limit liquidity and change sentiment (leading to collapsing new building rates beginning in 2006) and continued to push markets into further disequilibrium as it remained too tight until the end of 2008.  By the end of 2008, lending standards had been tightened (average FICO scores of approved borrowers moved from around 710 to 750 over the course of 2008, a huge shift, which largely remains today). So, from the end of 2008 onward, high tier home prices stabilized but low tier prices had their worst declines after that.

A postscript.

Comments on the Quarterly Report on Household Debt and Credit (2019 Q3)

Here are a few updates on the data.

 First, mortgage originations by FICO score.  This continues to remain near levels it has been since 2009.  In fact, the average FICO score of borrowers started moving up in the second quarter of 2007, just before home prices started to collapse.  They basically hit the new plateau in the second quarter of 2009.  As I have shown, much of the devastating loss of equity in entry level homes happened after 2008.

This is the actual cause of the housing bust (and the financial crisis). The general collapse in home prices came after credit tightening, and the continued additional collapse focused on low tier housing came well after credit tightened, after it settled permanently at the new normal.  To this day, the consensus response to that claim is that it had to happen in order to bring credit standards back to normal.  But, borrower standards were normal.  The typical FICO score of borrowers in 2006 was the same as it had been in 1999.  The squeeze continues.

Total mortgages outstanding seems to be settled at about 3-5% annual growth.  And total number of mortgage accounts outstanding fell from about 98 million in 2008 to 81 million in 2013, where it remains.  That would be a bit laggardly in a fully recovered market, but it is very laggardly in a market with a severe shortage of housing and a rent expense problem.

Second chart shows the balance of debt of different types.  Good job America!  We have managed to push all that borrowing out of HELOCs and into credit cards, because the lesson we all learned from the financial crisis was that unsecured debt is preferable to secured debt. I read the terms on my credit cards and I can't help but shout "Stability! Prudence!"  We're so much wiser now.  Kudos everyone.

Remember, if you sell your house short because you're 30% underwater, that's really bad.  But, if you have to sell your house because you hit a rough patch and nobody will lend on more than 80% LTV and/or perfectly documentable income, that's just being reasonable.  If that happens to you, try being a little gracious about it.  It was for your own good, silly.

Third, debt outstanding by age (adjusted to per capita). Some analysis of the crisis sets it up as rich (savers) vs. poor (borrowers).  But, really, the only reason it looks like that is because the crisis was more a matter of old (savers) vs. young (borrowers).  Borrowing was moving up as much for the old as it was for the young, but older borrowers tend to be less leveraged. The older groups have increased their borrowing since the crisis.  That is because they didn't tend to own homes with high leverage during the boom, so they escaped the housing collapse with less damage.  And, that has allowed them to continue borrowing after the boom, because borrowing scales with wealth and income, to a certain extent.  The younger borrowers took a hit in the foreclosure crisis and are now catching up.

Unless there is a return to looser lending, though, it seems like there is a limit to how much catch up can happen.

Housing: Part 358 - Sometimes the answer is simple

Elizabeth Warren:

"From our trade agreements to our tax code, we have encouraged companies to invest abroad, ship jobs overseas, and keep wages low."

Bernie Sanders:

"Since Trump was elected, multinational corporations have shipped 185,000 American jobs overseas. That is unacceptable."  

City of San Jose:

San Jose has taken the rare step of publicly opposing the project, saying it would add far too many jobs, exacerbating the region’s housing shortage.  

New York City:

It’s only natural that Amazon saw its promise to create 25,000 jobs as a blessing, for creating jobs is most of what we have ever asked of American companies. But given the realities of our economy — an economy that Amazon is relentlessly and ruthlessly transforming according to its narrow self-interest — it’s also only natural that many New Yorkers wanted nothing to do with it.  

These days, things don't make sense.  Things are said in one context that sharply contradict things said in other contexts.  There is confusion and stress.

It is natural to view this confusion and to conclude that things are complicated.  But, sometimes, things are simple.  Sometimes, things seem complicated because we are blinded to the simple nature of the problem.

To Ptolemy, the solar system was very complicated.

If you walked into an elevator with a simpleton and told them, "You know, the reason the sun moves across the sky is because we are spinning on a sphere.", the simpleton would have said, "Huh. Cool.  I did not know that." and happily exited at his floor.

If you walked into an elevator with Ptolemy, you would have a lot of work to do and many things to explain.  When the door opened, he would have exited unconvinced.  Ptolemy simply knew too much.

Here is a good rule of thumb: When things are complicated, inputs are messy, running at cross purposes, and many factors cancel out other factors.  Complicated contexts don't tend to move to extremes.  What tends to move to extremes is a context dominated by a single factor.  (This also works in equity investments.  Finding small cap stocks with large upside potential usually involves finding firms that have some very large single variable at work.  That is why you can outmaneuver professional analysts.  Professional analysts are paid to know everything.  Their job is to understand complexity.  To paint a picture of all the pieces.  Since overwhelming single factors are rarely certain, and speculators must expect to lose frequently, it is reputationally difficult for analysts to predict extreme valuation moves based on single factors.  If the stock they follow is likely to soon quadruple in value, their intuition will be to say, "It's complicated.")

So, the fact that markets and the economy seem to have some really extreme problems and incoherencies is a signal that the problem is not complicated.  The problem is overwhelmingly due to one factor.

In a sentence, that factor is:  The economy and the housing market of 2005 were what a highly successful economy looks like if our leading economic centers refuse to build more houses, and that economy is almost universally feared and actively avoided.

Mid month Yield Curve Update

Enough has happened in credit markets that I figured it was time to update charts.  The long end of the curve has moved up a bit, which has led to some expressions of relief.  I'm not sure we're totally out of the weeds.

The entire curve has moved up from its lows by about 1/2%.  That's mildly bullish.  It suggests that the market doesn't think the Fed has to react quite as strongly to maintain stability.  But, what would really be bullish is if short term rates were at more like 1% and the long end of the curve would be at 3%+ (circa 2003).  That was a yield curve of a marginally neutral central bank creating stability.  But, because of the housing bubble, very few people believe that about 2003, so it still seems to me that the pressure will be to take a hawkish posture, and eventually, the yield curve will move back down.

The second graph here compares the Fed Funds rate and the 10 year yield from 2004 to the present.  The diagonal lines are my estimation of a functionally inverted yield curve.  While the recent uptick is reassuring, for it to really signal that we are out of the woods, the 10 year yield needs to move up to 3% or more without being followed up by the Fed Funds rate.  Until then, I consider these recent movements to be noise while we are still basically inverted (circa 2006-2007).

One thing to check is housing markets.  The more recovery we see there, the more likely we are to be safe.  That is growth in price, sales, and borrowing.  Rising prices and rising borrowing would signal that the channel for capital to react to low yields by flowing into real estate is operating (though it is hobbled at best in today's regulatory environment).  Rising new sales would signal that financial capital is capable of funding real investment.  In other words, strong home prices would show that prices can react to fundamentals, strong housing starts would show that real investment can react to changing prices, and rising borrowing is the connective tissue for these market responses.  I suspect that an inverted yield curve reflects a breakdown in those mechanisms, which is why it is a good predictor of recessions.

This is not to say that home prices have to move in an ever-rising cycle in order to maintain economic growth.  The problem with housing is constrained supply, through local regulations and now through disastrously tight federal mortgage regulation.  These factors drive up rents, and I suspect also put downward pressure on interest rates, since residential investment should, but can't, be a moderating influence on long term real yields, keeping them from being persistently too high or low.  Building lots of homes would bring down home prices. 

The third graph shows the Fed Funds rate and 10 year yield from 1994 to 2002.  In 1996, the curve flirted with inversion, and the Fed responded by lowering the Fed Funds rate, which was followed by recovery in long term rates.  This happened again in 1999, and at first, the Fed stayed put as long term rates rose, but then it followed them up too aggressively.  By 2000, the recessionary signal was starting to develop.  First, a rising Fed Funds rate pushed the curve to inversion, which became stronger as long term rates declined.  Then, the tepid response meant that the Fed Funds rate declined over the next couple of years, remaining contractionary enough to keep long term rates from rising.  The same thing happened in 2007-2008.

It seems as though, in the 1970s, the Fed generally erred on the dovish side, inflation was getting too high, and the long end of the curve would rise while the Fed deeply inverted the curve.  Since 1980, the Fed has generally erred on the hawkish side, inflation has remained moderate, and recessions have been avoided when the long end was allowed to rise, but have followed when the long end has remained level during inversions.

Of course, this whole tightrope could be avoided if the Fed abandoned interest rates as a communication device and policy tool and instead targeted forward domestic income growth.

Going forward, if the 10 year doesn't rise much from here, then I would expect a typical descent into a contraction, with the Fed following the yield curve back down to zero.  If it does rise from here, up to something above 3%, then either 1996 or 1999 will be a good guide, and either we will avoid contraction altogether or yields will follow the clockwise path similar to the 1999 to 2002 path, and a contraction will eventually happen, but we will get another year or two of expansion first.

I continue to fear that a misunderstanding of the causes of the financial crisis will create pressure both on and off the FOMC to be too hawkish, but I must admit that the Fed was more willing to reverse their recent rate hikes than I had expected them to be, to our benefit. There is some hope that the Fed might continue to be responsive.

A look at trends in homeownership.

Here's a new post I have up at the Bridge, at Mercatus.

Here's a chart from it:

The brief summary is that there hasn't been any recovery in homeownership rates at all from the bottom of the housing bust for middle aged households.  The small amount of recovery we have seen recently is all among young households - generally households that were young enough to miss the crisis.

And, of course, I revisit the basic point that it is a myth that there was excessive or unsustainable homeownership during the housing boom.

Here is a Jed Kolko piece at Trulia that adds some interesting details to the story.

October 2019 Yield Curve Update

The yield curve still seems to be following the bearish timeline.  My axioms here are:

1) The true measure of inversion isn't a slope of zero.  At the zero lower bound, it is a slope of a little more than 1% (10 year minus Fed Funds), which declines as the base yield rises.  (At about 5%, meaningful inversion happens at a slop of zero, and higher than that, the slope will tend to become more negative the higher yields are.)

2) The neutral rate is a moving target.  If the Fed drops its target rate too slowly, long term rates will tend to stabilize but not rise, and this usually ends in some sort of contraction.  If the Fed gets ahead of the dropping short term rate, then long term yields will pop up like they did a couple times in the 1990s, and contraction will be avoided.  So, if the scatterplot keeps moving to the left as it did this month, that's bearish.  If it moves up, that's bullish.

The second graph is the Eurodollar yield curve, which continues to move up and down a bit but with a negative short term slope and a pretty flat long term slope.  I expect the short end of this curve to eventually drop below where it was in late August.  It will be good news if it doesn't.

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.

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.

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 Zillow.com, 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:

FIGURE A6. THE DIFFERENCE BETWEEN 1ST-QUINTILE PRICE APPRECIATION AND 5TH-QUINTILE PRICE APPRECIATION, DECEMBER 2000 TO THE DATES SHOWN IN EACH COLUMN

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, https://www.zillow.com/research/data/. The particular data series used was the median home price by ZIP code for all homes (ZIP_ZHVI_AllHomes).

 

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.

Maybe corporations don't have enough power.

I think I have expressed skepticism previously that corporate or monopsonist power can explain the apparent growth in income inequality.  First, a careful look at changing income proportions shows that a decent portion of the drag on real incomes is due to housing expenses. Relatively little is due to rising corporate or interest income. Most of the relative difference between high and low incomes is more variance between different laborers or between wage earners and professionals who are frequently proprietors.  In fact, if corporate income or power was rising, monopsony power in labor markets should lead to less variance in wages.  High wages come from skill development and specialization. Frequently these are tied to specific institutional contexts. Specialization would make high earners more vulnerable to being captured by a few or one corporate buyer of their labor.

In a context of monopsony power, wages at the top of the spectrum would be held lower. Corporations wouldn't then voluntarily distribute them to workers with lower wages. But if firms lacked monopoly power, they wouldn't be able to retain the gains from that. The gains would be captured as consumer surplus by the firms' customers. In order to be competitive in the market for their goods and services, firms would have to assert their monopsonist power just to remain competitive by transferring those gains to the consumer.

Here, I am reminded of the conventional wisdom that asserts that mid 20th century corporations were more loyal to their workers and that a corporate job was more of a lifetime gig because corporations took care of their workers.  That doesn't really match very well with income data which doesn't show much variation in corporate operating income as a portion of total domestic income over long periods of time. But it does match with a context where more skilled workers were captured by powerful firms and less skilled workers benefit indirectly as consumers.  Maybe labor incomes had less variance because firms back then were more powerful.

Sometimes an IPO comes up for a company that markets itself as a tech startup, and people joke that it's just a dog food distributor with an app attached to it, or something.  But, maybe we have that backwards.  Maybe every company today is a tech start up.  Maybe, what pushed your wages up in the past was, say, being a machinist in a specific sector, where a few firms were interested in your skills.  But, today, a key path to higher wages is a job with a title like "systems administrator" or "data manager", and your skills are applicable in some way to 80% of the economy.

I suspect that generally there is too much focus on corporate power. Rather than debate whether they have too much or too little, I think attention is better focused on other structural issues. Rising costs of housing, education, health care, and public infrastructure, together with barriers to migration, are more important factors holding down real incomes below their potential. A problem with the corporate power issue may be that the argument about its effect have the sign of the factor wrong.  In the financial crisis, I think the focus on enforcing losses rather than maintaining broader stability presents a similar example where determined policy programs that have the sign wrong (more housing was needed in 2005, not less, for instance) are much, much worse than benevolent indifference.

There is an intersection between these issues. Because of the housing shortage, there is a lack of market access and mobility. Y combinator must be located in Silicon Valley. Being in Silicon Valley is essentially a 40% tax on business development.  The lack of access to that location simultaneously makes certain actors wealthier while reducing overall creative destruction.

The way to progress is to have more y combinators. Adding to the already high costs and barriers with new taxes and mandates hardly seems like a helpful response.

What if the problem is that corporate power is too low? Then lowering their power will worsen inequality even more. Things like codetermination might create even more obstacles to mobility and migration. Maybe the internal politics would serve to further increase the bargaining power of specialized high wage workers.

But, most importantly, over long stretches of time, labor and capital income grow at nearly a 1:1 correlation.  In so many ways our relationships are symbiotic more than they are in conflict. Maybe the focus on relative power is itself a problem. When the economy is growing, the rate of quits increases, and as the Atlanta Fed shows, wages for job switchers increase faster in a growing economy than the wages of other workers. It isn't the relative status of workers compared to employers that is the engine of that shift, it is the relative status of new, more productive firms over old, less productive firms. Surely the way to shared prosperity lies there.  An economy where a restaurant owner is bringing in customers like crazy, but she can't serve them because the potential waiters have found more productive things to do.  That seems like a problem to the restaurant owner.  The response shouldn't be to force them to pay waiters more.  The response should be indifference, which means the restaurant still feels pinched while some other firm somewhere produces high wage opportunities for workers because a growing economy is imbuing those firms with power.

Yield Curve mid-September 2019 update

There has been quite a lot of movement in yields since last month, so I thought it would be useful to look at an update.

During the last half of June and July, the long end of the curve came down while the short end moved up a little bit.  I wish we had an NGDP futures market to check these intuitions against, but I think the best interpretation is that in June the Fed had reversed track a bit and signaled more dovish policy going forward, but then some compromises in that posture began to arise, so while they certainly are more dovish than they were several months ago, some of the optimism that was pressing long end rates higher in June has receded.

The slope of the curve from two years onward has remained relatively stable since then and the movements have mostly been movements in the estimated low point of yields in 2021.

At first glance, rising rates since the end of August are bullish.  But, that is entirely due to rising short term rates.  The long end has actually flattened slightly compared to the beginning of August (the blue line compared to the pink line).  There are obviously a mixture of factors here, and continued strength in the labor market is probably one reason for optimism.  But, it seems to me that the net movement of the past two weeks is probably bearish.  Less faith that a dovish commitment by the Fed will prevent a bit of a downturn.  That would lead me to suspect that the coming decline in the target short term rate will be somewhat tepid and will be associated with a sympathetic decline in the long end of the curve at first, back toward or below the levels of late August.

August 2019 CPI Inflation

Here are the monthly inflation updates.  It will be interesting to see if the Fed treats 2% as a symmetrical target or a ceiling.  There might be an argument for treating it as a ceiling at this point in the business cycle, because employment is so strong.  But employment is a lagging indicator.  At this point, I think the Fed has reduced the potential of worst case scenarios, but I don't think they will loosen up monetary policy aggressively enough to avoid a bit of a contraction.  And the depth of the contraction mostly depends on future decisions.

In addition to the problem that these measures are backward looking, of course, there is the issue, which is always the focus of these posts, that the shelter component is not particularly related to monetary policy, since it mostly measures the estimated rental value of owned homes, and even in the case of rented homes, frequently is measuring the growth in economic rents from the ownership of a politically protected asset, which is really more of a political transfer of wealth than an effect of monetary policy.

All of these questions about monetary policy discretion would be unnecessary under an NGDP futures targeting regime.  Hopefully, we can continue moving in that direction.

The last couple of months have seen an upward movement in non-shelter core inflation.  This puts core CPI at 2.36% and non-shelter core CPI at 1.68%.