Coming to terms with discretion

The development of such a strong canon regarding what caused the housing bubble and what we should expect the economy to do during the recession has led to a subtle issue regarding causes and consequences.

The strength of the canon - that excessive lending and speculating had to be beaten down - and the passion for approaching it, meant that the entire episode has an air of inevitability, even where it was completely discretionary.

I mean, really, take any version of what happened in 2008.  It will have the pretense of inevitability.  Ask, "What caused the financial crisis?" and the answer will contain an implicit transitory property so that the answer will actually be the answer to "What caused the housing bubble?"  The FCIC report is basically entirely built on this premise.

Basically, a=c (things that might have caused a housing bubble = a crisis happened) was so universally accepted, that nobody has paid much attention to the second part of a=b and b=c (things that might have caused a bubble = did cause a bubble) and (the development of a bubble = a crisis).  Of course, much of my work debunks a=b.  This naturally means b=c is essentially a meaningless relationship.  A bubble that never really was could hardly be said to have caused anything.

Now, as far as a=b goes, there are library shelves full of claims about that connection.  Even though one might disagree with them, at least they exist.  But b=c was essentially presumed.  Yet, it wasn't inevitable at all.  In fact, once one is led to doubt whether a=b, one realizes that regardless of whether credit, speculation, etc. caused a bubble, the question of whether a collapse is inevitable isn't settled at all.  The collapse was completely under our discretion, and it was simply the universal agreement about that discretion that made it seem inevitable.  Like an abusive parent hitting a child and exclaiming, "Well, he broke the rules.  What would you have me do?"  The answer to that question was obviously to accept the abuse 100 or 200 years ago, simply because its acceptance was canonized.  It isn't acceptable today.

Simply questioning the premise reveals the dissonance.  The reason the crisis happened wasn't because there was nothing we could do about it.  The reason it happened was that, going as far back as 2006, or arguably even earlier, turning points just kept piling up where policymakers chose contraction, panic, decline, and collapse because to do otherwise would be coddling risk takers, bailing out wrong-doers, letting those who did this to us off the hook.  I don't even think I need to establish the point.  The public record is so saturated with that idea that it is undeniable.  It covers practically every page of every review of the period, every criticism of the Fed and the Treasury.  It's the story we have told ourselves about what happened.

Anyway, I am treading again over this territory, because I came across this graph today (here).

And, it really drives home the damage that those discretionary decisions did.  The places that are hurt much, much worse by cyclical dislocations are the places that are struggling already.  Successful places bounce back.  If not for the recession, "distressed Americana" in this graph would at least still be treading water.  Instead, there is a gash in its flesh in 2009 that isn't going to heal.  And, rest assured, the parts of the country that suffered that gash were not in the throes of a speculative frenzy.  They certainly didn't need to be taken down a notch so that those reckless people that did this to us had to be punished.

If you are concerned about the bifurcation of economic growth in this country, then there is a big giant elephant in the room regarding that issue.  We walked that elephant into the room, and it took a big, elephant-sized crap on the places that really needed stability.

Even if you think there was an unsustainable bubble and excesses had to be painfully purged from the system, consequences be damned:  THIS is the consequence.  Oh, by the way, it didn't need to be done.  a<>b .  But, even if we save that debate for another day, the imposed "discipline" that so universally was hoisted on the economy to knock it down to size had downsides that should be faced honestly.  a<>b, but even if a=b, there are a lot of questions we should have asked about, really, how committed we should have been to b=c.

Housing Affordability, Part 14

Here is my latest post at Mercatus: "Because of Housing, All Taxes on Capital Tend to Be Regressive".  Here is the conclusion.  Go to the link for the details.

 (T)he income tax code, as it exists, has regressive effects regarding housing affordability.Given those effects, it is inaccurate to treat capital taxation in general as a progressive tax. Corporate taxation, in general, creates a regressive rent subsidy. A different tax regime that focused on property taxation rather than generalized capital taxation could plausibly produce public revenue in a way that would be more progressive than a tax code that taxes capital income more generally. This should cast doubt on common presumptions about how and why to change the tax code.

July 2019 CPI Inflation

Core inflation has recovered a bit in the last two months, but we remain in the context of relatively low non-shelter inflation and high shelter inflation, averaging out to roughly on-target total core inflation.

I will probably continue to do these updates for a while, but I suspect the context is set, and specific shifts in inflation won't affect things much in the near term.  Inflation isn't likely to shift sharply in either direction, and in the time frame that is important for the Fed right now, noise dominates information.  So, effectively, Fed discretion will rule, although it will frequently be cast in language of inflation or interest rate control.

The context in place seems to be that the Fed will loosen.  Not so much to avoid a bit of a contraction, but not so little as to be greatly disruptive.  Excess shelter inflation is part of that context, but other factors will come into play, too.

Here, I think the 2008 event is informative.  The Fed is somewhat forgiven for allowing NGDP and inflation expectations to drop so sharply because at that time inflation was slightly above target.  This makes inflation seem like an important short term element in Fed decision making.  But, I disagree with that analysis.  Inflation wasn't anywhere near a level that would have led any sane regulator to sit aside as one panic after another struck the economy.  And, even as the Fed did that, the overwhelming criticism of them was that they were even daring to try to stabilize financial markets.  Even today, many commentators explicitly complain that selected economic agents weren't made to suffer enough.  The financial crisis in late 2008 happened because it was popular.  Slightly above target inflation is simply one of several justifications that were used to allow it to happen.  For any reasonable observer with a straightforward goal of maintaining economic stability, none of those justifications were plausible excuses for allowing such economic dislocations to occur.

The reality in late 2008 was that any reasonable monetary or fiscal policy would have caused a rebound in housing prices, as a side effect.  That would have been taken as indefensible.

We don't have the same dramatic setup today, so the stakes aren't as high.  But, similarly, inflation and interest rates will be used to communicate short term monetary shifts even though those shifts will have little to do with either.

Part 12 of my Housing Affordability series at Mercatus

Are Property Taxes Regressive?

The conclusion:

A region that allows ample new supply and imposes higher property taxes is friendlier to households with lower incomes than a region with obstructed housing supply and low property taxes.

July 2019 Yield Curve Update

The yield curve has taken a sudden turn for the worse.

The Fed's tradition of using interest rates to convey their monetary stance is such a constant source of confusion.  The conversation about yields so often seems to hinge on the idea that the central bank is in full control of interest rates and uses them to make it more or less profitable to borrow and invest.  It baffles me how ubiquitous this sort of idea is in both professional finance and economics.

Recent movements in yields are a great case in point.  It is common to hear this shift described in terms of expectations about Fed rate cuts.  But the whole yield curve shifted down.  This is not a sign that the Fed will be loosening monetary policy more aggressively.  This is a sign that they won't be loosening aggressively enough.  The neutral rate just changed, leaving the Fed behind as a victim of institutional inertia.  That is in contrast to recent times when yields did react to clear signals from the Fed that it was going to be more aggressive.  In those cases, short term rates fell and long term rates increased.

I only update my graph of the adjusted yield curve inversion monthly, so the red dot for July is at about the same spot as it was at the end of June.  Of course, the 10-year rate has dropped 25bp since then.  So, unless some sort of economic or political development greatly improves economic prospects in spite of a tight monetary posture, raising 10 year yields back up, then we are already at a point where, even with short-term rates at zero, the yield curve will be effectively inverted.  This will likely lead to complaints about how the Fed is using QE4 to keep long term interest rates low to boost investment and asset prices, including from many otherwise sensible people who are generously paid to manage other people's assets.

Part 11 of my housing affordability series at Mercatus

Low Property Taxes and Obstructed Housing Supply Are a Bad Mix

"It would seem that raising property taxes would make housing more expensive.  They are, effectively, a tax on materials to build homes.  But the binding constraint to affordable and reasonable housing in twenty-first century America isn’t material.  It isn’t a lack of affordable physical space.  It is the political obstruction to placing those materials in dense urban centers."

With a universal expected market return, lower property taxes and just a small expectation of persistently rising rents can lead to much higher housing prices.  That's the first order effect.  But, as a second order effect, the value of homes as assets that are speculative claims on local political cartels, might mean that lower property taxes will be associated with higher rents.  It seems that higher property taxes might lead to lower quantity demanded, but also lower supply, with a net effect of less housing at higher cost, with cartel real estate owners pocketing the profits.  The political implications of that might change when the oligopolists would otherwise have been middle class pensioner grandparents, but the economic implications don't.

Part 10 of my Housing Affordability series at Mercatus

Property Taxes Can Be a Tax on Monopoly Power.

"If politically maintained monopoly power is going to remain, claiming monopolist profits through taxes is an improvement. The fact that the tax doesn’t affect rents is a sign of efficiency. If rents must be elevated, better that they go to local public services than to the real estate cartel."

The series will continue each Monday with discussion of the effect of various regulations and taxes on housing costs.

Housing: Part 356 - Black Homeownership

Here is a new Bloomberg article on black homeownership.  The title is:
"Black Homeownership Falls to Record Low as Affordability Worsens"

The headline, and the article, are wrong.  Affordability isn't bad and that isn't why black homeownership is falling.

Here is a graph in the article, which also has an incorrect headline.  It says, "Over 25 years, the gap between blacks and whites has widened."  What the graph really shows is that from 25 years ago to 15 years ago the gap was narrowing, and then for the past 15 years it has been widening.

Here is a graph that combines old decennial Census data with the more recent quarterly data to provide a little more historical comparison.

From the Great Depression to the late 1960s, white homeownership rose as a result of Federal programs that explicitly excluded black families.  Then homeownership for black families increased, but then fell back again in the 1980s, for reasons I am not familiar with.  Then, in the late 1990s, it recovered back to the levels of the late 1970s, relative to aggregate US homeownership rates.

Then, homeownership peaked in 2004 for black families as well as for the US in general.  And the drop in ownership since then has been stronger among black families than among others.

To describe these trends with "Over 25 years, the gap between blacks and whites has widened." obscures what is important.  Black homeownership was recovering and expanding when mortgages were more available.  Note, however, that the recovery in ownership peaked near the beginning of the private securitization boom that lasted from roughly 2004 to 2007.  Since then the relative homeownership rate collapsed.

The disparate impact of the recession, the crisis, and the subsequent sharp tightening of lending standards on black households has been strong.  But, who would dare to claim that the pre-crisis housing market was good and that post-crisis lending market has been detrimental?

Here are the Zillow measure of mortgage and rent affordability - the portion of the median household's income required to pay the rent or the mortgage on the median housing unit.  It would be more accurate to say that it has been especially unaffordable not to be a homeowner in recent years.

Housing: Part 355 - Homes and population growth

I noticed that housing units per adult has actually started to level off.  This is interesting because total permits and total starts are still below past averages.



Source

So, maybe the new neutral run-rate for new units is less than 1.5 million annually.  Maybe the need for new units is less acute than I have been saying.

But, there is a problem of causation here.  More people means we need more homes, but also, a lack of adequate housing can lead to less people - both by limiting migration and by limiting family formation.

And, it is true that population growth has slowed.  Before the financial crisis, it tended to run at 1-1.2%.  Since the crisis, it's more like 0.7%.  So, in a way we solved the housing shortage, in part, by reducing population growth.  If this is the new normal, then maybe 1.2 million units a year isn't an unsustainably low peak.  But, if population growth, either through immigration or through family formation, returns to anywhere close to historical norms, then housing starts probably need to catch up a bit and then settle at something closer to 1.6 million units annually.  (Ignore the big drop in housing/adult in 2000.  I haven't taken the effort to try to account for the discontinuity in the data there.  I suspect that mostly that discontinuity comes from an overestimate of the housing stock in the late 1990s, but it isn't central to the main trends I am discussing here.)

Certainly an argument can be made that population growth through family formation has been naturally slowing, so that we shouldn't expect population growth to continue at historical norms.  On the other hand, there are many good reasons to counter that decline with more generous immigration policies.  And, while there is a long term down trend in natural population growth, there was a sharp downshift that appears to have been related to the economic turmoil of the crisis and to the lack of housing growth since then.  Even without immigration, it seems likely that natural population growth has declined more than it otherwise would have after the crisis.

Also, there is always the important signal here of rent inflation, which has persistently run high for the past 25 years and returned to high rates during the post-crisis recovery.  That is not a signal we would see in a country where housing was being depressed by natural declines in population growth.


The latest posts in my Mercatus Housing Affordability Series

The last two posts in my series were:

"Tight Lending Regulations are a Wealth Subsidy".  An excerpt:

Thinking in terms of rental value, public policies and market innovations that lower mortgage interest rates can be broadly beneficial to consumers, even if those benefits don’t accrue to the actual borrowers who use those low rates.  That is because higher mortgage interest rates have a similar effect on price as exclusionary lending standards.  Downward pressure on price creates a rental subsidy for home buyers who don’t require a mortgage.

"Property Taxes Are Rent to a Public Landlord" An excerpt:

If there is concern that the net effects of government policies, in total, favor housing and lead to market volatility, a return to higher levels of property taxation can be a useful tool for countering it.

Writing the series helped clarify my thinking on several issues.  I hope you find some nuggets of interest in it too.