Some data on households & housing

Commenter "Glenn" had some input on this post.  He motivated me to check up on some Census data.  I thought what I found was interesting enough to include on a bonus weekend post.

Here is a graph of vacancies:

I think this shows a bit more of a weak supply / strong demand signal than Glenn does.

But, then I looked up household size, which I hadn't looked at for a while.

I would have expected a sizeable hump from this recession, due to the tremendous drop in new home production.  There was a hump in 2009 and a small bump up in 2013.  But, I can't say that there is an obvious deviation from trend.  In fact, I think this is a data point against my (on hold) bullish call on homebuilders.  The decline in household size has added significant housing demand in the past few decades.  Between the probable minimum level that is likely close to the current level, which should prevent further falls in average household size, and a population pyramid that probably points to more growing households over the next couple of decades than shrinking households, this should flatten out, which might be another reason to expect somewhat lower home demand than we have seen in the recent past.  Baby boomers are mostly already in "empty nest" phase, and their children are still early in family-building phase.

At this link, there is a graph of household formation that is updated monthly.  It shows household formation regaining momentum after a weak 2013.

This is a fun graph, as there is fodder here for any framing.  The rise in homeownership could be attributed to baby boomer lifecycles, but the trend suspiciously turns sharply in 1994, when interstate banking expansion was tied to CRA incentives.  But, homeownership leveled off before the steepest part of the home price/rent ratio run up.  P/R bottomed out back at 1990's levels, which seems about right to housing bubble folks.  But it is still below the ratio of the late 1970's, when real rates were previously low, but nominal rates were in the double digits, which confirms the bias of a housing bull like me.

Evidence is Optional for Finance Cynics, a continuing series: Cash Flows to Owners

While I'm complaining about the fact that everyone seems to be wrong about everything, let's talk about cash flows to owners - dividends and share buybacks.

Everyone from Matthew Yglesias at Vox to the Economist are worried about massive buybacks and how this means that corporations are just pocketing your cash instead of investing in America.

Yglesias:  "It means that the basic link between healthy corporate profits and a healthy middle class is broken."

The Economist: "Share buy-backs - Corporate cocaine"

I don't want to even get into the conspiratorial tone with which buybacks are usually treated.  It's simply a return of capital to owners, no different than dividends.  The main adjustment it does demand from us is that historically dividends were the primary method for returning capital to owners, so that indexes, like the S&P500 or the Dow Jones Industrials, which tracked share prices over time also served as decent proxies for the growth of capital.  But, buybacks cause return of capital to be treated, mathematically, like capital gains.  Buybacks have gained favor in recent decades.  So, in order to compare capital growth to other measures of wealth or income, equity indexes need to be reduced by the amount of buybacks.  At this point, return of capital is causing index returns to be overstated by more than 2% per year as a measure of retained capital, which really adds up over time.

I repeat, this is simply a mathematical adjustment that needs to be made for analysis.  Total returns are unchanged, except for this arbitrary change in accounting for them.

But, forgetting all the misconceptions surrounding buybacks, the more basic point is:  There is NOTHING unusual about the current levels of payouts to equity holders.

Here is an excellent article by the inestimable Aswath Damodaran going over the basics of share buybacks.  Here is one of his graphs, showing the total level of corporate payouts to owners over the past 30 years.  The level of payouts is slightly below the levels of the 1980s.

I think arguments can be made for either looking at net payouts or gross payouts.  But, with net payouts between 3%-4% and gross between 4%-5%, both are moderate.

What if we look at a longer time frame?  Here is 150 years of dividend history, from Robert Shiller's data.  Keep in mind that this is only dividends.  Buybacks have only become popular since the 1980's, so we would compare these payouts to the gross payouts from Damodaran's graph, which were around 6% in the 1980's, dipped to 2% to 3% in the 1990's, and are back up to around 4%-5%.  Historically, payout ratios have rarely fallen much below 4%.  If anything, there is a long term downward trend in payouts to owners, following a range that current levels fall squarely within.

How can there be so many topics where so many people are so confident about things that just obviously aren't so?  Would it be a shocking coincidence if the bad guys in these stories were predictable?

How much human misery has been caused by people who got in the habit of believing things, not based on whether they were true or false, but based on whether they had a predetermined bad guy?  It's kind of the story of human history, isn't it?  I'm excited about biotech, AI, robotics, nanotech, and everything else, but, man, the real breakthrough would be if someone invented a way to point this bias out to each of us in a way that would make us say, "Oh, geez.  You're totally right.  That is what I'm doing.  I will now update my beliefs with this in mind.  Thank you."  Human progress would explode.  The main reason the singularity will happen is because, frankly, the bar is set very low - and I don't exclude myself.  We all purposefully develop strong convictions through gross avoidance of evidence.  It may be the core identifying feature of humanity.

Framing is Everything: Housing and Monetary Policy

There is some disagreement about the interplay between monetary policy and interest rates.  I will avoid that discussion here.  But, whatever the direction of interest rates (or returns on any security), there are contradictory effects on existing owners and new owners.

If interest rates on a security go up, then for new owners, future returns will be higher.  But, in order to receive higher returns on an existing pool of assets, given a stable cash flow, the nominal value of those assets must fall.  A perpetual bond is the purest mathematical example of this.  If market rates are 5%, and I pay $100 for a perpetuity that pays $5 annually, then if market rates rise to 10%, my perpetuity that pays $5 annually will only fetch $50.  Note that if market rates fall to zero, the perpetuity's value goes to infinity.

So, we have borrowers and creditors; we have current owners and future owners.  As a first order effect, interest rates don't create anything in a closed economy.  A lower rate will mean less income for creditors and more income for borrowers - capital gains for current owners and lower returns for future owners.

It is sadly common for people to frame finance in terms of good guys and bad guys.  This set of contrary players means that commenters can pick and choose from the outcomes above as they people their narrative.  It is surprisingly common to see essays that bemoan low interest rates, because they simultaneously benefit "Wall Street" (by raising asset prices) while hurting "savers" (by lowering returns).  Sometimes, amazingly, "Wall Street" will be cast as the borrower while pensioners are the creditors.  There are so many things wrong here, including the fact that industrial borrowing doesn't rise when interest rates are low.  But, without even getting into the subtleties, savers are Wall Street.  Wall Street is savers.  The idea that "Wall Street" is a net borrower or that it pockets the capital gains from lower rates without suffering the lower returns is wholly incoherent.

The asset class least exposed to risk free interest rates is probably equities.  In low inflation environments, higher risk free interest rates are usually associated with lower risk premiums, and corporate leverage doesn't increase when rates are low, and is fairly stable anyway, so that equity values are only marginally associated with interest rate changes.  Increases in equity prices mainly reflect increased aggregate demand as the Fed reaches policy more optimal for everyone in the face of a negative demand shock.  (Another widely believed pair of opposites is that corporations are binging on easy money to spike their profits and also corporations are sitting on piles of cash instead of investing in the American economy....both at the same time.)

Note that the longer the duration of cash flows on a security - the closer it is to a perpetuity - the more elastic is the price as a function of the required return (the market rate).  A T-bill paying off $100 in one year will only change slightly in price as rates change.  30 year bonds are the longest bond durations we usually see in the US.  Stocks are a type of perpetuity, but since their required returns tend to be higher than bonds because of income uncertainty (decreasing the present value of their future cash flows), and the equity risk premium tends to move contrary to risk free bond rates, their interest rate exposure is usually not so great.  The asset that is closest to a perpetuity is real estate.  And, since real estate rents will rise with inflation, the interest rate that determines broad asset values in real estate is the very long term real rate, which tends to be lower than the nominal rate.

Here, I have used the FHFA All-Transactions Home Price index and the CPI Rent of Primary Residence index as proxies for home prices and rent to estimate an implied real return on ownership of homes, based on a 100 year home life.  Then, I compare this to the 30 year mortgage rate (minus core CPI), using the 30 year mortgage as a proxy for the required rate of return.  The difference between the implied return and the real 30 year mortgage rate is an estimate of alpha (excess return) to home ownership.  In many financial markets, we would expect this to be arbitraged away.  Frictions to arbitrage include the advantages of owner-occupation, tax preferences for owner-occupants, lack of access to credit for potential owner-occupants, etc.

The absolute level of return is arbitrary.  I am assuming that the costs of ownership are stable over time as a proportion to rent.  If this assumption is relatively benign, then the relative level of excess return should be comparable over time, given an assumed proportional cost.

The first pair of charts assumes low costs of ownership, and thus high alpha to home ownership.  We see that in the low interest rate environment of the 2000's, access to home ownership spread, which led to a decline in alpha.  Price to Rent ratios collapsed in the crisis, as well as long term interest rates, so that alpha to home ownership is again very high.  The alpha isn't the result of difficult monthly payments, as it had been 30 or 40 years ago.  It's due to the dead real estate credit market.

This is why cash and investment buyers have been such a large part of the market.  The level of alpha has been high enough that home ownership provides excess risk-adjusted returns even without the tax benefits of owner-occupation.

Let's say that this version of the model understates costs of ownership.  Interestingly, since this leads to lower implied returns, the cash flows discounted from the future rent payments are relatively larger, the duration of the home itself is longer, the home is more like a perpetuity, and thus the intrinsic value of homes is improved even more by today's low real long term interest rates.  So, an assumption that implies a housing bubble (negative alpha on homes) also implies that current alpha on homes is very high.  In other words, regardless of how much excess returns home ownership provided in the past, it is currently providing very high excess returns.

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Here's my point, regarding framing (no pun intended).  A common view about the Fed is that they are helping "Wall Street" with loose monetary policy and that one way this happens is through nominal inflation of durable assets.  But, this view is confused by a lack of appreciation for the mathematical relationship between asset prices and implied returns on those assets, which I described above.

For a case in point, look at what we have in housing.  Home prices are low because Fed policy has been too tight.  I think everyone would agree that looser monetary policy would raise nominal home prices.  But, who benefits from rising home prices?  By and large, middle class families.  And, who benefits from low home prices?  Well-funded "Wall Street" investors, who earn excess returns on the homes because of the limited number of buyers.  (You might, rightly, suggest that I have just reversed the double standard that I described above.  But, here, I am referring specifically to excess returns over the fully arbitraged market rate.  We would see a sort of revealed preference, here, if home prices do increase by 10% or 20%, at which time we will almost certainly see many more owner-occupier, mortgage-based buyers, and many fewer "Wall Street" buyers).  And who loses because of low home prices?  How about a million construction workers?  How about young families facing rising rent because of crimped housing supply?

Now, let's just imagine that everyone could fold up their tail feathers for a moment, and stop squawking about winners and losers and good guys and bad guys.  We've got people who would like to buy houses, but they can't.  People who would like to live in houses, but there aren't enough.  People who'd like to build houses, but nobody is hiring them.  All these things happen when the prices are right.  The prices aren't right.  This graph is why.

But, none of these people are going to get the things they want, except those darned Wall Street investors who are raking it in with their real estate investments while we patiently wait for homeowner mortgage buyers to come back from the dead.  I really doubt that large scale non-bank real estate investment funds have single-handedly captured the Fed so that they could grab a few extra points on their rental holdings until things get back to normal.  The Fed is just reflecting the national demand for policy failure.  As a matter of fact, housing speculators are the only participants in this story whose activities are actually helping push things back to normal.

I'd say a good measure of the intellectual sanity of this country would be the number of stories we might see in op/ed periodicals, from left-wing to right-wing, lauding housing speculators for helping workers, renters, and homeowners recover from this mess.  Instead, it seems that everyone agrees that homes are too expensive and speculators are to blame.  But the information in defiance of this belief is clear.  Debt service as a proportion of income is at record lows while mortgage debt as a proportion of home values is still too high.  By these measures, home prices have never been more out of whack - to the low side.  I'm beginning to think that there is no error the consensus wouldn't be willing to embrace.  The data is there.  It's not hard to look it up.  The imbalance here - in the opposite direction of conventional wisdom - is unprecedented.

As a speculator, I appreciate the fact that there is no shortage of those willing to take the wrong side of so many trades, but I'd prefer that we stop cutting off our nose to spite our face.  We are the 100%, after all.

PS. Sober Look with additional comments.

Young adult male employment and the housing bust

In yesterday's post, I reviewed labor force by age and gender and found that about 1/3 of the movement below trend in LFP seems to come from males under the age of 35.  There are about 35 million working-age males between 20 and 35, and LFP rates for this group (though this data is a bit noisy) are roughly 2 1/2 to 3% below trend.  About 1 million young adult males have disappeared from the labor force.

Here is a graph of construction employment and unemployment.  With September's reading, the construction unemployment rate is 7.0% - basically back to 2004 levels, when the construction unemployment rate was 6.8% and U-3 unemployment rate was at 5.4%.  Note, though, what has happened to construction employment over that time.

In September 2004, there were about 7 million construction employees.  In September 2014, there were about 6 million.  A loss of.....about 1 million workers from the construction labor force.  What proportion of these workers would be males under 35 years old?  It must be pretty high.

This is a topic where I think supply vs. demand issues are not easily disentangled.  The Fed allowed a tremendous demand shock, which we have mostly grown out of.  But, the one area where credit markets aren't nearly back to a healthy equilibrium is in housing, where homes are still much more leveraged with debt than they have ever been before (I have postponed my bullishness on housing since that post, waiting to see if we can overcome the credit problem.).  This leverage is entirely the product of the decline in home values that came out of the demand shock.  But, the disequilibrium is creating a supply shock now, because overleverage in the housing market has stalled housing credit markets, which is hampering existing home sales and new home construction.  Rent inflation is high right now.  (It's the only source of inflation in core CPI right now.)  So, this is a supply problem, but the solution is more aggregate demand to push up home prices by another 10% or so.

So, this is an aggregate demand problem, but it doesn't have anything to do with sticky wages.  These young males aren't out of the labor force because their reservation wages are too high.  They are out of the labor force because there aren't any houses to build.  But, the solution is still inflation.  Ironically, household formation has been low.  These young males would be building houses for themselves!  If the Fed had provided just a little bit more liquidity before ending the QE programs, these young males would have jobs and they would have houses - with lower rents than the houses that are available now - because the demand problem is a supply problem.

The Fed just released a new labor indicator that suggests a very strong labor market - similar in measure to 1987, 1997, or 2005, when the economy was basically settling into full utilization (here is a cautionary comment).  I agree with the finding in this measure.  We have a strange situation, where the economy is very strong, except for housing, which is dead as a doornail.  It was recovering, but has stalled out over the past two years.

I was readying myself for a speculative position, based on the idea that homes are much cheaper than people seem to be accounting for.  But, the prices may not be able to overcome a market without functioning credit markets or Fed-provided cash.  (Yesterday, calculated risk noted that, at least in Phoenix, non-cash buyers were up 10% YOY, so maybe there is hope if the second derivative of mortgage levels can be sustained.) So, while I have been right in my bullish calls on unemployment this year, I am afraid that the futures market has been right all along about the weak yield curve in 2015-2016.  Growth in investment might have to come entirely from industry for the next couple of years.  The downside risk is that there isn't enough escape velocity, and the Fed will not take part in another round of liquidity.  The neutral scenario is probably that we muddle along, with middling inflation and low interest rates.  Even though the balance between savings and investment will continue to improve, all that savings will have to be filtered through industry.

In the meantime, these marginally attached young males will remain non-employed and ill-housed.  And baby boomers who would prefer the long-term return profile of real estate will have to save through less favored means.

The end-game seems to be vulnerable to a tipping point - either another deflationary crisis, or an economy hot enough that it builds to where home leverage reaches normal levels and then explodes in a flurry of credit creation.

PS:  Good news from the Fed today.  If this more accommodative posture continues, the effect on interest rates, at least in the medium and long term parts of the yield curve, should be positive.

Labor Force Participation by Age and Gender

Here is the infamous Labor Force Participation chart.  Next, is the chart, broken out by age and gender.  The shape disappears when we disaggregate, except that the one-time increase in the 1970s & 1980s in the female working age categories parallels the one time increase in aggregate LFP.

I estimate that after accounting for age and gender, labor force participation is between 1% and 1 1/2% below cyclically adjusted trend.  There are a few categories that don't have long-term linear behavior.  There are cultural changes in the 55+ category, which had, many years ago, been very high among men, then bottomed in the 1990s but are now increasing again as productive lifespans increase.  These have leveled out after rising, and it is hard to know whether any of this leveling is cyclical.  Most of the issue of Social Security disability benefits plays out in this age group, so my simple analysis here doesn't help to quantify that issue very much.  The 16-19 year old category has declined tremendously, also, for cultural reasons, and it displays significant cyclical movement.  It has been stabilized since 2010, and was likely affected by the minimum wage increases of 2007-2009.

The remaining categories have linear patterns that allow us to estimate their cyclical deviations.

 These are pretty noisy series, so these will be broad estimates.  Here are the high participation male groups.

The 45-54 male category has shown some significant cyclical behavior.  It has recovered and is within about 1/2% of the trendline.  The 35-44 male group had less cyclical behavior and is also near trend.

The 25-34 male group had sharp cyclical behavior and is still about 2-1/2% below trend.

The 45-54 group is probably echoing some of the long term trend among the older group, where more people are able to at least partly disengage from the labor force as we become wealthier in general.  Age 50 is a trigger year for disability benefits, so the long term decline among 45-54 year olds is probably a signal of that issue.  I think this signals that recent increases in disability claims are more a sign of boomers hitting 50+ than they are of age adjusted changes in claims.  So, I think this problem will stop drawing down the LFP trend as the boomers age.

Here is the Male 20-24 category.  Like the male 25-34 category, this group has seen a sharp cyclical decline.  It is still about 3% below trend.

The female groups are a little harder to estimate because the trends are shorter and there seems to be more noise.  I don't see any obvious cyclical drops in the younger groups (including 20-24 year olds, not shown in this graph).  It depends on where you set the trends, but as a whole, there is probably less than a 1% deviation from trend.

Aggregate LFP tends to move about 0.5% above and below trend through business cycles.  In this cycle, it may be about 1 1/4% below trend, even after adjusting for age & gender.  I think we can broadly divide this decline into three roughly equal parts:

1) Cultural changes among 16-19 year olds and 55+ year olds, which may have been affected or amplified by cyclical issues.  These changes are mostly the product of wealth and longevity, and are probably not a concern.

2) Sharp declines among men under 35 years old.  I don't think the data show a surge of college admissions among men, relative to women, so I don't think that is the explanation.  The good scenario is a leveling of gender expectations - more house-dads, etc.  The bad scenario is that there is a budding underclass of unemployable unskilled males.  It is important to keep in mind the scale here.  We are talking about maybe 2% of the males in this age group.  But, I would say that this is the category that does represent a potential structural issue that might need to be addressed or that might represent involuntary or dysfunctional changes in labor force behavior.  There has been a distinct change in young adult male working behavior coincident with this cycle.  Could this be related to the collapse in construction labor?  Cyclically, we tend to think of the lower LFP in these ages as related to returning to school during downturns.  But, over the longer term, education correlates with higher labor force participation.  Could there be a new wave of long term convergence between male & female LFP, beginning in the younger groups, that is related to the very high relative levels of higher education among young women?

3) Fairly normal cyclical behavior among the prime working age males and females.

But, there is one additional issue:

4) The labor force might be overstated by up to 0.4%-0.5% if the VLT unemployed would normally have been categorized as exiting the labor force.

September Employment Review

Well, I juuuust barely got my gap down - 5.94%, as reported - almost dashed by rounding.

Here are the durations.  Mostly what we saw this month, I think, was a correction in the noise among short term unemployment to finally reflect what we're seeing in the unemployment claims data.  Long term unemployment stalled.  So, it seems that we have seen most of the decline in unemployment that will have come from faster exit rates associated with the end of EUI.  Further declines will come from the 0.8-0.9% of the labor force that has been unemployed for more than 2 years and the slow continued improvements typical of maturing recoveries.  The very long term unemployed had been linearly declining for two or three years at a rate of about 0.05% per month, but this decline has stagnated for 3 or 4 months.  Here is a graph of my estimate.  This could be typical noise.  If it is noise, we might hit 5.5% by December.  If there is some sort of deceleration here, then we might hit 5.7% in December (though, of course, the reading of any given month can range over several tenths).

Here is a comparison of the September reading and my running December forecast levels:

The pessimistic scenario assumes that all the durations under 27 weeks will stabilize and that among the 27+ week durations, there will just be 0.1% of a decline among each of the more recently unemployed as the post EUI cohorts continue to fill this category and as the VLT unemployed level just reverts back to the 0.8% level that it has been hovering at since June.

The optimistic scenario reflects a slight decline in regular 15+ week durations and a reversion to trend among the VLT unemployed.

Here is my graph of unemployment claims and total unemployment.  It tells the same story.  This month, unemployment declined in line with the decline in unemployment claims, but there was no reversion back toward the long term norms, since the very long term unemployed have held steady.

The main question, going forward, is whether the VLT unemployed continue to exit steadily, pulling the unemployment rate slowly down similar to the previous 25 years' experience, or does unemployment stagnate as it did in the 1980s at a slightly higher level.  I'm not sure that anyone has any idea, since this cohort of unemployed workers doesn't have a precedent in post-WW II US.





Flow1

Looking at flows, I'd say the trends still look good.  The new decline in the unemployment rate comes mainly from an increase in net UtoE (green line in Flow1), which I would characterize as mean reversion after a couple of months where this flow was weak.  Weakness in labor force came from flow from employment.  Flows from unemployment out of the labor force were right on trend.

Flow2

The unemployment rate comes from the difference between the net UtoE flow and the net NtoU flow.  While my analysis above seems to suggest an unemployment rate that will begin to stall, when we look at flows in this way, with such strong trends in these net flows, it seems more likely that unemployment will continue to fall.

Looking at smoothed net flows over a longer time frame (Flow2 - note the color legend is different than in Flow1) net flows also continue to look strong.  Flows between unemployment and employment (red) still look good.

Changes in labor force participation are reflected in the difference between net NtoE (the green line in Flow2) and net UtoN (the blue line in Flow2).  The incredibly strong labor market in 2005-2007 is clear here.  While net UtoN is still a little high and probably will be for some time while VLT unemployment remains elevated, net NtoE has been very strong this year, hitting levels similar to the 2005-2007 period.  This is another signal of our bifurcated labor market.  While there are a large number of marginally attached workers and very long term unemployed, the rest of the labor market has signs of a mature and bullish business cycle.  Or, maybe as with so many issues, the demographics make this more benign than we imagine.  Possibly, with more older working-age people, there is simply more opportunistic, temporary employment and more marginal employment behavior.  There are clearly cyclical movements, but maybe the demographics inflate both the secular and cyclical trends.



Flow3

Looking at the individual flows (Flow3), all trends are good.  The flows between E and U finally reflected a fall in EtoU, which has been signaled by unemployment claims for several months.  This decline should be sustained, and not just a single monthly deviation.  The U and N flows continue to decline to recovery levels.  And, the net flow from EtoN appears to mostly have come from and increase in the EtoN flow.  In other words, the decline in labor force participation this month was not a product of marginalized workers leaving the labor force.  It was from employed workers leaving the work force.  Workers coming straight from Not in the Labor Force to Employment remains fairly strong.

Finally, regarding wages, I disagree with the negative reactions that I'm seeing.  Clearly, inflation needs to be accounted for.  And, I think it is more accurate to think of wage levels and employment levels as both being affected by the broader economic context.  Real wage growth is right where we would expect it to be in this context.  Even if the unemployment rate is overstated, which I think it is, and the current labor market is similar to what would normally be about 5% unemployment, 1% YOY real wage growth would be fairly typical.  If inflation is going to keep reverting to around 1.5%, there is little reason to expect nominal wage growth of 3-4% in any labor market.  It could happen, but I don't see why the current wage trajectory would be disappointing.  I suspect the complaints about wage growth reflect social desirability bias, as much finance reporting does.

Great News from Scott Sumner

It looks like he might get an NGDP futures market going.  This is great news.  I agree with him that the Fed should already be managing something like this, even if they aren't targeting NGDP, simply as a forecasting tool.  Not only is the Fed not doing this, but it is illegal for Americans to take part.  (Yes, that is insane.  Paul Rhode - via Robin Hanson - explains, in a way, why the Fed isn't doing it and why you can't do it, here.)

We should all wish him the best.  It sounds like it is going well so far.

Here is more from Sumner on the sorry state of US financial repression.

The Aggregate Demand Problem: Housing Edition

As QE3 comes to a close, home price increases dwindle while real estate lending remains dead and all-cash buyers head for the exits.  Homes remain overleveraged, keeping the market of current homeowners tethered down.

What might we expect to see?  How about this (HT: CR), from the New York Times: "Indians Join the Wave of Investors in Condos and Homes in the U.S."  According to the article, foreign buyers make up 7% of the market for US homes, and the number is up 35% in the past year.

This gives me some hope for the housing market.  The quantity of foreign buyers may not be large enough to make up the difference, though.  Homes probably need to appreciate at least another 10% to reach normal leverage levels.

I will take this as evidence in favor of my view of housing, in any case.

It may be true that wages have largely readjusted with the passage of time, despite substantial inflation.  However, with the zero lower bound, short term commercial investments still have to be funded with above-market interest rates, and homeowners are still living in homes with less equity than they expected to have, funded with mortgages that are being paid back in dollars worth more than they were expected to be worth.

Possibly, the natural short term interest rate is near zero, so that the commercial investment problem has also moderated with the passage of time.  But, the problems with home and mortgage values have not been fully solved.

What if our declining Federal deficit is pushing developing world savers from the Treasuries market into the housing market?  "Austerity" to the rescue!  If only we could have "austerity" and an aggressive central bank.

Cyclical Misdirection in Income Distribution

A common complaint in the public discussion of income trends is the tendency to treat income bins as stationary.  If the top 10% of incomes increases by 50% over a decade, but the lowest 10% remains level, then someone might say, "All the gains went to the top 10%." or "The rich got richer while the poor got poorer."  But, the complaint is that these aren't the same people.  There is significant movement between bins, because of lifecycle effects, economic mobility, etc.  At long enough horizons, most of the original occupants of a given bin will have moved to other bins.

But, in some ways, especially with the popular treatment lately of describing the top 5% or 1% or 0.1%, there can be very strong errors from this linguistic statistical short cut due to cyclical changes, even in relatively short time frames.

I am going to describe this in a very broad brush.  Short of doing very involved panel studies, I'm not sure if empirical data is possible.  Please let me know in the comments if anyone knows of research along these lines.

Imagine two kinds of income earners in an economy - wage earners and capital owners.  In a deep recession like the one we have just experienced, they will have very different experiences.

The distribution of wage incomes will shift slightly to the left, mostly as the result of a small percentage of wage earners losing their entire income through unemployment.

The distribution of capital income might be fairly tight entering the recession, since in the mature portion of the previous recovery, bonds would be paying well, and equities would be growing at rates similar to broad economic growth.  During the recession, especially when equities lose half their value as they did in this recession, capital income will be negative for many owners, with more variance.  And, as the economy snaps back, capital income might be higher than normal, but again with more variance, as equities produce above average returns, and extra gains depend on how much exposure each owner has to equity.

In an economy peopled by, say, 90% wage earners, the distribution would be overwhelmingly peopled by wage earners, but the cyclical shifts would be almost entirely the product of capital income earners shifting in the distribution.

When we are talking about the extreme ends of the distribution (the top or bottom few percent), the error will always make the changes in distribution look less equitable than they really are, because the population shifts from the extremes can only go in one direction.  Households that move out of the top bin can only move into lower bins.

So, unless we are using panel data or somehow adjusting for these changes, in the pre-recession period the top 1% will be a rough mixture of capital and wage income.  Then, during the recession, the top 1% will consist almost entirely of wage income.  And, after the recession, because of the added variance in capital outcomes and because of the catch-up growth that tends to come after severe downturns, most of the top 1% will consist of capital income.

At the bottom of the distribution, the large number of capital earners with negative returns would increase the population of very low income units so that the lowest bins would decline and the median would decline.  Also, if the data source has a $0 lower bound and is based on tax reporting with carry-forwards, then the variance of post-recession capital income could be especially high, with many units claiming very low incomes until they use up their tax assets, then suddenly jumping back into the highest income bins if returns continue to recover.

So, we would want to say that the highest incomes suffered the least decline in the recession and then snapped back the most, while the lowest incomes and the median incomes suffered.  But, ironically, the suffering we would be measuring would be mostly the suffering of the capital owners.  Of course, capital suffers the brunt of the loss in recessions.  That's why it earns a premium.  That's why we don't recommend working class families and pension funds to take highly leveraged positions on the stock market.  As with so many things, most people understand this intuitively in their personal dealings.  But, when we approach the bigger picture, we can lose our moorings.

Framing is everything: Unemployment Insurance Edition

Josh Bivens at EPI has posted an epilogue on EUI titled Historically Small Share of Jobless People Are Receiving Unemployment Insurance.  (Hat Tip: Economist's View, where the post is titled "The Shrinking Social Safety Net...") He starts:

Unemployment insurance (UI) is a crucial component of the American social safety net, but since 2010, the share of unemployed workers receiving UI benefits has eroded to one of its lowest points in decades.

He concludes:

Between stubbornly long average durations of unemployment spells and cutbacks in UI at both state and federal levels, the recipiency rate dropped sharply in 2012 and 2013. Then the Emergency Unemployment Compensation (EUC) program that was signed into law in the middle of 2008 expired at the end of 2013, and Congress failed to extend it.

Here is the graph:
 

 

Lengthened unemployment durations are known, fairly uncontroversially I thought, to be a product of unemployment insurance.  From Laurence Ball's 2009 paper:

One story is that a decrease in aggregate demand initially causes a rise in short-term unemployment, but this turns into long-term unemployment if the slump continues. The initial short-term unemployment causes inflation to fall, but then inflation stabilizes. At that point the NAIRU is higher because of the large pool of long-term unemployed. This story is lent plausibility by evidence (in both my 1997 and 1999 papers) that a long duration of unemployment benefits magnifies hysteresis.

That kind of sounds like now.  Here is the 1997 paper from Ball, where he finds that many labor market distortions may be overstated, but that extensive unemployment insurance together with tight monetary policy, seems to lead to long term unemployment.

Here is a discussion by Paul Krugman, in 1994, that describes the sharp tradeoff between unemployment and wages, especially when wages are increasingly divergent, with policies like employer health and other mandates, minimum wage hikes, and generous unemployment insurance, leading to higher unemployment.

So, it seems odd to me that much of the public support for extended unemployment insurance simply ignores this problem.  And the implication of articles like the EPI article and Thoma's reference too it is that extended unemployment insurance (EUI) has been stingy.  While there have been states, especially in Europe, that have had UI policies more generous than recent US policy, the plain fact of the matter is that recent US policy has been much more generous than any previous US policy, and that the shape of the current labor market is reflective of this generosity.  As a prerequisite to a serious discussion, surely we must agree on this, and then address the balance between generosity and recovery.

The Evidence from 2008

Here is a graph of the unemployment rate, superimposed onto a graph of the ratio of continued claims to initial claims.  This ratio is a rough measure of the difficulty involuntarily unemployed workers have returning to employment.

Note that in the previous two downturns, EUI was not implemented until continued claims had risen for more than a year, and then plateaued.  In the recent downturn, EUI was implemented by President Bush in July 2008, very early in the cycle, before unemployment durations were particularly long.  Also, we must remember, that the Federal Reserve was explicitly pushing a disinflationary policy at the time.  In fact, none other than Janet Yellen, at the fateful September 2008 FOMC meeting (which happened after the Lehman Brothers failure and before the 4th quarter CPI collapsed to a SAAR of -8.85%), agreed with the consensus view that the Fed Funds Rate should be kept at 2%, and that with an inflation target of 2%, over/under risks were roughly balanced.

Furthermore, we have seen a remarkable decline in inflation compensation for the next five years in the TIPS market. I would not rely heavily on this decline to support my view, but I do have to say that the decline is a lot more reassuring than the alternative. I was also encouraged by the 30 basis point drop in long-term inflation expectations in the most recent Michigan survey. I anticipate that the recent jump in the unemployment rate will place some additional downward pressure on growth in labor compensation, which has been quite low, and in core inflation.

Although the jump in the unemployment rate probably partly reflects the extension of

unemployment insurance coverage, a back-of-the-envelope calculation suggests that the upper bound on this effect is just a few tenths of a percent. (pg. 34)

So, in September 2008, the FOMC was reassured by falling inflation expectations, after EUI had already begun, and EUI itself became an input into tighter monetary policy.

The labor market subsequently froze up.  We can see in the graph above how continued claims spiked to extremely high levels, but then roughly followed the path of previous recessions.  Long term unemployment is a poor signal for EUI because of the circular causation.  By 2012, as signaled by the behavior of regular UI, labor markets were back to where EUI had been discontinued in previous recessions.

So, EUI was more generous than ever before, it was implemented sooner and kept longer than in any previous cycle, and it was implemented while the Fed was pursuing tight policy (not only in 2008, but arguably when it discontinued QE1 and QE2).

Measures of Unemployment Insurance

Here are some graphs to supplement the EPI graph.

The first graph shows UI as a proportion of Labor Force, instead of as a proportion of unemployment.  The second graph is a reproduction of the EPI graph, but with UI subdivided between regular UI and EUI.  The third graph further subdivides the EPI graph, so that it shows regular UI as a proportion of UI eligible unemployment (less than 26 weeks) and EUI as a proportion of EUI eligible unemployment (more than 26 weeks).

In late 2013, the proportion of all unemployed workers who were on EUI had fallen to about 12%.  EPI implies that this was due to stingy policy.  But, we can see that coverage was declining in spite of the fact that EUI was still nearly twice as generous as in previous cycles (a max. of 47 additional weeks compared to 26 weeks).  Coverage was basically back to historical recovery levels in late 2013, even as generous benefits continued.

Why was coverage so low?  Because by 2013, the labor market was divided between a regularly functioning market, where few newly unemployed workers were experiencing durations above 26 weeks, and a small group of very long term unemployed workers who had outlived the unprecedented level of EUI benefits.  Exits from long term unemployment have accelerated since the end of EUI, so that, if we still had 73 weeks of total coverage, EUI would be covering less than 1 million workers.

There is probably no amount of time extensions that would be able to pull EUI coverage back to the coverage levels we have seen at the height of these three cycles.  There just aren't that many workers left who would be eligible for EUI, even if it were available for 4 years.  The total number of long term unemployed, whether eligible for UI or not, is now about 30% of total unemployment and is below 2% of the labor force.

Short term UI behavior is well into recovery mode.  Newly unemployed workers are dealing with an employment market that would never have been remotely considered fitting for an EUI policy.

So how does EPI find such a low recipiency rate?  Because the denominator they are using (total unemployment) includes about 1.2 million very long term unemployed workers, many of whom timed out of EUI some time ago, and who have unemployment durations of well over 2 years.  Any honest review of this policy would need to start with the question, "How much of this long term unemployment problem is a product of aggressive EUI?"

Considering monetary policy and the behavior of the labor market seen in my first graph, one has to wonder.  How much of that spike in UI coverage in late 2008/early 2009, followed by the stubborn persistence of very long term unemployment in 2010 and after, was a product of the combined monetary/EUI policy?  I don't have the precise answer to that question.  But, surely that is the question to ask.  "Did the negative side effects of tight money and generous EUI outweigh the positive benefits of the generosity?"

Unfortunately, it sounds to me like broad segments of the American electorate are under the impression that EUI is simply stimulus, because it transfers cash from savers to spenders (I'm not even going to get into that here).  It looks to me like, when the next critical moment comes, the consensus view will be to have even tighter monetary policy and more generous EUI. 

Conservatives seem to generally support tight monetary policy, along with many libertarians.  Progressives are torn.  Some think we should have looser monetary policy.  Others think we should have tighter monetary policy.  They also can't decide if conservatives are stupid or evil, though they are sure it is one of the two.  (Progressives that argue for tight money get a double whammy.  Conservatives are evil, so they secretly want to help the rich at the expense of the poor, but they are also stupid, which leads them to support tight money.)  Of course, since looser money (2%-4% inflation or 5%+ NGDP growth) would actually benefit pretty much everyone, most of all unemployed workers, these positions achieve an Abbott & Costello level of confusion.

Meanwhile, while progressives use EUI as a shaming cudgel, as in this EPI post, EUI was passed in 2008 with near unanimous Congressional support and a Republican president.

These days, we all know how desperately wrong everyone else is, but self-destructive governance seems to have safe bi-partisan support.