Wednesday, December 28, 2016

Housing: Part 198 - Bank Credit through the recession

I think this graph is useful in thinking about the recession and housing.

Excess reserves really can be thought of as treasury bills.  If the Fed unwound the entire mass of excess reserves simply by exchanging it for treasury bills so that instead of reserves, the banks held treasury bills, would anything change?  It seems to me that this would be functionally equivalent to what we have today.

So, really, interest on reserves, the QEs, etc. can all be thought of as ways to maintain deposit levels at the banks while the banks accumulate treasuries and agency securities.

This might be all well and good in a crisis (notwithstanding the question of whether the crisis could have been averted in the first place).  But, the natural market demand for mortgage debt will be high as long as our geographical centers of economic opportunity are governed by limited housing.  Since we blamed credit itself for the problem of high home prices, we developed a national policy framework of smashing down the level of mortgages outstanding.  But, we never actually tackled the real source of the problem, which is the Closed Access cities.

So, since 2008, regulatory pressures and federal control of the GSEs have been the main tools for suppressing mortgage growth.  So, we have basically diverted 10% of bank assets out of residential investment and into treasuries.  (Did I hear somewhere there was a problem with a savings glut and low interest rates?)

So, since 2007 (2006, really) we have had recession level GDP growth and recession level residential investment.

One other item that I think is of interest here is that real estate lending began to drop at the banks by early 2007.  When the private securitization market collapsed in summer 2007, real estate lending also stopped growing at banks.

I used to think that the collapse of private securitizations was due to a liquidity crunch and was the cause of subsequent dislocation.  To some extent, it was.  But, I think the chain of events was a little more complicated, and the collapse of private securitizations was actually more of an effect than a cause.  In fact, the drop in mortgage lending was a lagging factor.  Total mortgages outstanding didn't peak until 2Q 2008.  By then, home prices had collapsed by more than 10% and homeowners had lost trillions in home equity.

The drop in mortgages didn't happen because there was a lack of money.  It happened because there was a lack of faith in home equity.  The first collapse was in home equity.  More than $1 trillion of that collapse happened before 1Q 2007 when home prices were still basically at their peak.  This was a shift of existing homeowners out of the market.

It's ironic that every guy at the end of the bar knows that what happened is that all those silly, greedy speculators thought that home prices could never fall, and that they kept pushing prices up when the drop was inevitable.  On the contrary, for more than a year before prices collapsed, home owners were fleeing the market in anticipation of a price collapse.  When the collapse in mortgages finally happened, it wasn't because mortgage originators ran out of suckers.  It was because rating agencies, lenders, and qualified home buyers all became convinced that housing was doomed to collapse.  The Fed's response was, "Yeah.  Probably right.  We'll be letting that happen."  And the collapse was the last thing to happen.

So, originations from both the banks and from private securitizations were drying up by early 2007, because nobody was willing to be a lender or a borrower with those expectations.  When private MBS securities collapsed later in the year, it was because of expected future defaults that were presumed to be inevitable because of those expectations.  The Fed confirmed that they would enforce, or at least allow, those expectations to come to fruition.  Because we all just knew that supporting anything short of a complete collapse would be irresponsible.  We have come to conceive of systematic instability as a public good.

Notice that graph of GDP and residential investment.  They collapsed together by mid 2006, even though mortgage growth was still healthy.  The first collapse was a real collapse - an unnecessary real collapse.  And the real collapse is what eventually led to the nominal collapse.

I happen to think that the market monetarists are on to something, and that nominal instability can create instability in real production.  But, in this particular case, the real economy was the first mover.  This was still a monetary phenomenon in many respects.  Bernanke himself takes "credit" for that drop in residential investment because the Fed had raised rates into mid 2006, which we might call the interest rate channel of monetary policy.  Then, the Fed clearly signaled in 2007 and 2008 that they were willing to watch the bottom drop out of housing.  That is what we might call the expectations channel.  And even after the disaster of September 2008 when the Fed finally committed to stability - still over the objections of many flavors of liquidationists - most of the collapse in the low end of the housing market was imposed through punitive and erroneous regulatory policies.

But, all that being said, much of the damage might have been avoided with a simple NGDP growth peg.  If the Fed had had an NGDP growth target, they would have had to support the nominal economy despite themselves.  It's possible, I think, that the effect this would have had on expectations might have been enough to prevent the collapse in home price expectations that had caused the initial collapse in home equity to begin with.

Now, the lack of housing is the main source of inflation, so we could functionally cut inflation by encouraging investment or we could dysfunctionally cut inflation by taking away money.  In a regime of excess reserves, I think this means cutting deposit growth.  That seems to be happening since the first rate hike.  Housing starts seem to be leveling off while shelter inflation increases while non-shelter inflation is falling back toward 1%.  Will it continue now that we have had another rate hike, or will the surprising financial optimism that has accompanied the Trump election overcome it?

Monday, December 26, 2016

Inflation expectations

CPI rent inflation has spent 2016 slowly climbing from 3% toward 4%.  In the meantime, Zillow's rent measure has cooled off.

Is this a signal that CPI rent inflation might cool off as well?  CPI core inflation outside of rent is already on its way down to 1%.  If rent inflation joins it, then core inflation would start moving down away from the Fed's target levels.

This certainly isn't due to overbuilding.  Housing starts have leveled off in the past year at levels typical of recessions.  This seems like a potential sign of declining demand.

On the other hand, inflation expectations have been rising since August.  Will inflation expectations turn back down as a result of the recent rate hike?  That's my expectation.  The question is how much will economic activity turn down?  How much will this effect homebuilding?  How quickly would the Fed reverse course if, say, 10 year treasuries fall back toward 2%?

I am fairly sanguine about the potential for a deep contraction now, but on the other hand, the answer to that last question plainly seems to be, "not very", in which case I do worry that the downsides here are bad.

I think the long term play these days is to be long on homebuilding with a long bond position as a hedge.  But, I wish there was better visibility about the short term.  A post-inauguration announcement about weakening some of the more damaging aspects of Dodd-Frank would be great.  In some ways, the direction it looks like things are going is somewhat positive - better than I had expected.  But, it's not so great that tactical positions are so dependent on political developments, even if that is necessary to a certain extent.

Thursday, December 22, 2016

Housing: Part 197 - It's barriers to trade that are hurting rural workers, not free trade

Tim Duy has recent comments on a popular recent topic - the supposed problem of free trade.
Was this “fair” trade? I think not. Let me suggest this narrative: Sometime during the Clinton Administration, it was decided that an economically strong China was good for both the globe and the U.S. Fair enough. To enable that outcome, U.S. policy deliberately sacrificed manufacturing workers on the theory that a.) the marginal global benefit from the job gain to a Chinese worker exceeded the marginal global cost from a lost US manufacturing job, b.) the U.S. was shifting toward a service sector economy anyway and needed to reposition its workforce accordingly and c.) the transition costs of shifting workers across sectors in the U.S. were minimal.
He concludes that a & b were right, but that c was wrong, and this has had disastrous results.   A couple of other comments from the post:
My take is that “fair trade” as practiced since the late 1990s created another disenfranchised class of citizens. 
The damage done is largely irreversible. In medium-size regions, lower relative housing costs may help attract overflow from the east and west coast urban areas.
Housing costs are an effect, not a cause.  Lower housing costs do not attract overflow.  Lower housing costs are the result of a lack of demand.  But, the thing is housing costs aren't low anywhere.  Rents are high across the board today because we killed the mortgage market and the homebuilding market a decade ago.  They only look low because the coastal urban areas are high.  The reason those areas are high cost is because "fair trade" doesn't include free movement of capital and labor within our own country.

We don't need new federal subsidy programs or job training programs.  We need to let people take the jobs that are already there.  Practically every article on this problem - including Duy's post here - notes the issue of housing affordability.  There would be no great obstacle to the shifting of workers across sectors.  The obstacle is that when they try to make that shift, the gates are closed.  It is expressed through cost, because we still let supply and demand determine the price of housing in the Closed Access cities.  But, at its base, this is a problem of inelastic supply.  The house that worker needs won't get built.  It won't be built because the voters in New York City, Boston, and California make sure it won't get built.

The price, in that context, simply reflects the value that worker is being kept from.  The more opportunities there are in those cities, the higher the price of the housing stock has to be bid to in order to keep those workers out.  The scale of the excess price of a house in coastal California and the northeast is sort of a measure of how much opportunity those workers are getting screwed out of.

Manufacturing employment hasn't been declining any faster than it had for decades before.  Why are things so tense now?  The consensus now seems to be that the housing "bubble" covered up this problem until 2007, and now it has been laid bare.

Actually, the housing "bubble" was just a reflection of the blocked opportunity.  Homes were built outside the Closed Access cities as a second-best alternative.  There was nothing unsustainable about that.  In fact, opening up the Closed Access cities would have provided even more opportunities for growth.  When we killed the housing market, we created a dislocation that continues today.  The stress isn't from a decline in manufacturing.  That's not new.  It's that we have stopped allowing what little bit of that natural transition we were allowing before 2007.  Now, we've got our thumbs down on the whole country, not just the Closed Access cities.

We don't need to fear free trade.  We actually need to try it for a change - in our own country.  California.  New York.  Tear down this wall.

Tuesday, December 20, 2016

Housing: Part 196 - Observations on the GSEs as a housing subsidy

The GSEs (Fannie & Freddie) are frequently blamed for feeding the housing bubble.  This is strange, since their behavior was countercyclical.  When home prices were rising the fastest and were at their highest, GSE growth was slowing.  From 2003 to 2006, total mortgages outstanding that were issued through the GSE conduit only grew at an annual rate of about 5%.  And total GSE book of business plus private MBS held by the GSEs only grew at 6% annually over that time.  From the end of 2003 to the end of 2006, they lost a fifth of their market share.  That's not even in terms of originations - that's based on mortgages outstanding.

Another cited source of excess from the GSEs is the lower interest rate that is facilitated by the low cost of debt that comes from the government's guarantee - explicit or implicit.  Before the crisis, this amounted to about 0.25% if we compare it to the typical spread between conforming loan rates and jumbo rates.

Let's compare this to income tax benefits to homeowners, which, according to the White House, amounted to about $218 billion in 2015, including tax savings from imputed rent, mortgage interest, capital gains, and property tax deductions.

About $5 trillion in GSE facilitated mortgages were outstanding in 2015.  A rate reduction of 0.25% on $5 trillion is equal to $12.5 billion - roughly 6% of the value of income tax benefits.

In 2015, net income to homeowners after expenses and depreciation but before interest expense was $748 billion.  Comparing these numbers, as a first estimate, income tax benefits were equal to 29% of the net income value of owned homes.  The GSE subsidy amounts to less than 2% of the net income value of owned homes.

When I began this series, which I thought would last maybe a dozen posts or so, that tax effect was the question I was trying to answer.  I ended up chasing this topic down several other rabbit holes, although ironically, I think I have been led back to a confirmation of the distortions created by those income tax benefits.  That confirmation itself backs up the other findings I ended up with.

The owner-occupier from much of the bottom tier of the housing market was effectively locked out of the homebuyer market from 2007 on.  We can basically use the 1st quintile of zip codes, by home price, as a proxy for housing markets that lost their owner-occupier demand, and the 5th quintile as a proxy for housing markets that didn't lose their owner-occupier demand.

Across the board, prices diverged at that point.  The market bottomed in 2012, and since then prices have rebounded in the new normal.  It seems that, relative to 1999, prices in the 1st quintile are tracking about 10% to 20% below 5th quintile prices.

This is probably a very low estimate of the effect of income tax policy on home prices, because 1st quintile homes never internalize much of the potential tax benefits.  Looking across zip codes at Price/Rent ratios, even in 1999, P/R in 1st quintile zip codes was much lower than in 5th quintile zip codes.

Between the collapse of private securitizations and tightening standards at the GSEs, the market for mortgages in the bottom tiers of the housing market dried up in 2007.  The gap of more than 10% between the value of a home for a landlord and the value for an owner-occupier meant that we created a context where the bottom had to drop out of home prices at the low end before a new equilibrium could be found.  We killed the mortgage market and that created the drop in home prices at the low end - not the other way around.

One other point here, looking back at the jumbo spread graph:  The shock in 2007 was not limited to private subprime securitizations.  There was a shock in jumbo spreads at the same time.  This is because it was a liquidity shock.  Not a liquidity shock from a lack of cash, per se.  But, a liquidity shock from a lack of mortgage borrowers.  And the reason is that the country lost faith in the housing market.  Buyers and lenders were convinced that home prices were about to plunge in an unprecedented way, and the Fed confirmed that they intended to let this happen.

This caused credit risk to shoot up across buyers, because the credit risk wasn't coming from buyer characteristics.  It was coming from housing expectations.  Thus jumbo loan markets were just as stressed as subprime.

And, the one set of institutions that were immune to this shock were the federal agencies - the GSEs and FHA - since their investors didn't take on credit risk.  Since the GSEs were semi-private, they were derided as being greedy and reckless.  Since FHA was public, they were able to go about the business of supporting the mortgage market, and continued to expand.

Monday, December 19, 2016

Housing: Part 195 - More on homeownership, income, and wealth

Here are a few more charts on homeownership from the Survey of Consumer Finance.

First, the mortgage debt and home values as a proportion of total assets.  For the lower income quintiles, debt is less important and home values are more important.  As incomes rise, homes comprise a smaller portion of total assets and households hold more mortgage debt.

This is just another way of repeating that the rise in mortgage debt was not a low income phenomenon.  On the other hand, changing home values have more of an effect on low income balance sheets, on average, than they do on high income balance sheets.

But, there is a caveat.  The second graph compares the relative changes in the value of homes, arranged by household income.  This shows how the housing price boom was concentrated at higher incomes.  When you look at home prices within each MSA, there are many MSAs with relatively little difference between low income and high income zip codes.  But, in the Closed Access cities, home prices in low income zip codes increased significantly more than in high income zip codes.

Yet, here we see the opposite pattern.  This country has segregated by income, so measures of the top income quintile are largely measures of Closed Access cities.  The 2nd income quintile is mainly a measure of non-urban incomes and home values.  The bottom quintile includes a lot of retirees and idiosyncratic households.  As I look at this a second time, I'm surprised by the sharp relationship.  Home values in the 2nd income quintile rose by less than 50%.  Homes for top decile families rose by nearly 150%.

The last chart shows homeownership rates by net worth.  I have pointed out that higher homeownership during the boom was among households with high incomes and young households.  Here we can see that among high net worth households, homeownership has always been nearly universal.  Credit access during the boom was mostly a way to increase ownership of households with high incomes but not as high net worth.

We can also see here how our fears of credit and our over-reaction, have led to mortgage markets that are very unfriendly to households without the means to make a large down payment.  The boom helped high income, middling net worth households.  The bust has hurt low income, middling net worth households.  And many households have been pushed to the bottom net worth quartile because they owned homes.

Friday, December 16, 2016

October Inflation and the rate hike

Inflation continues its recent path.  Core CPI is at 2.1%.  Shelter inflation is up to 3.6%.  Core CPI inflation excluding shelter is down to 1.1% and the trend is down.  Core CPI inflation excluding shelter over the past 9 months has only risen by 0.4%.

The Fed, as expected, raised rates this week.  Tim Duy notes that the rate hike came with a bit of a hawkish shift.

At this point, I am cautiously maintaining my expectation that the most likely outcome here is a decline in long term interest rates and some economic contraction, but my certainty is not high, and this could play out over months.  If long term rates continue to rise sharply over the next month, then I will be less confident of that outcome.

Here is a graph of the Eurodollar yield curve.  Rates had actually started to rise somewhat before the election.  Then, there was a jump right after the election.  Since then, the curve has risen somewhat.  With the rate hike, the short end of the curve moved up, but the long end didn't move much.

With interest on reserves as the new monetary tool, and with the Fed balance sheet more or less stationary, a reaction from the banks of sending more reserves to the Fed would have to come at the expense of currency, if I am thinking about this correctly, so shrinking currency would be a bearish signal, I think.

This new monetary regime seems strange to me.  Normally, with the Fed Funds rate target, the Fed would basically be in control of the quantity of currency and reserves, and they could make daily adjustments to purchases around the target.  But, it seems like now they have created a situation where the quantity of reserves and currency will be a market function.  If they aren't planning on buying and selling treasury bills like they used to, it seems like quantities could shift quite a bit while we wait on the next FOMC meeting.  But, I'm not an expert on the nuts and bolts, here, so please tell me if I am incorrect.  Maybe it would take more than a few basis points for things to get out of whack, but do we know how elastic the supply of excess reserves is?

Thursday, December 15, 2016

Housing: Part 194 - The normalization of dysfunction

This Slate article is a good example of how the base cause of our economic and social malaise gets sort of baked into our policy choices.

The headline: "Rents Are Falling in New York City. Is This a Crash?"

Rents in New York City are leveling off at about 3 times the unencumbered cost of building a new unit.  New units are being built at a rate that would almost accommodate internally generated population growth.
Total permits topped 50,000—more than any year since the early 1960s.
Population growth of NYC in the decade of the 1960s - a whopping 1.5%.

This is the problem.  We need an economic coup.  There is a gate locked between Americans and opportunity at the outskirts of a half dozen metropolitan areas.  That gate needs to be crashed.  There is no winning move here that doesn't involve a "crash".  We either manage for stability, or we manage for opportunity and freedom of movement.  They are mutually exclusive.

But, as with so many issues, change is what scares us.  Progress is change.  This is the core problem with many attitudes about international trade - a lack of discernment between unuseful change and change from progress.  If you're against change, you may be against progress.  In fact, you're probably against progress.

So, Trump gets a popularity boost from negotiating with Carrier to keep a plant in the US.  This generated a good dose of bipartisan complaints about how this isn't actually helpful in the broad scheme of things.  Sometimes our broad prosperity demands that local producers lose - even when those local producers are workers.  Boy, there's an unpopular truth, huh!

Shouldn't it be so much easier to say that sometimes our broad prosperity demands that local real estate moguls lose?  I wonder if there will be a vocal bipartisan response to these concerns about crashing real estate?  More likely there will be a consensus in agreement that "Whoa Nelly, we need to slow this puppy down.  Next thing you know, 2 bedroom apartments in Manhattan will be going for $2,000 a month.  There be dragons!"

The asymmetry here is sort of funny.  Economists seem to be in pretty wide agreement that we shouldn't generally stand in the way of geographical shifts in manufacturing employment, but there is a healthy debate about how we can support vulnerable workers who endure dislocation because of it.

On the other hand, who is out there demanding that New York City should expand housing until rents decline by at least 50%? (This would actually be the best thing we could do to support those ailing workers, by the way!)  I don't see a lot of cheerleading for that dislocation.  And, maybe the best way to encourage that would be to throw massive subsidies and transfers at existing Closed Access real estate owners in exchange for opening up those cities to new residents.  How's that for a non-starter - let's let Donald Trump build thousands of units in New York City and send him millions of dollars in aid to make up for the losses on his existing buildings.  But, Donald doesn't have to worry.  Everyone wants stability.  We'll demand that NYC slows down their permit approvals enough to keep the rents flowing.  We wouldn't want a crash.

Wednesday, December 14, 2016

Interest Rate Signals

I see a lot of talk about the inflationary effects of some policies Trump may propose, and of course interest rates have risen surprisingly since the election.  But I noticed an interesting pattern.


The rise in inflation expectations began in September, and has been pretty stable.  The rise in real rates shot up after the election, and now has started to retrace a little bit.

Also, the rise in inflation expectations seems to correspond to a rise in food and energy inflation, but at the same time, core inflation outside of shelter has been falling.  It's heading back to 1%.  So, does the rise in CPI signal a coming rise in core CPI?  The TIPS market seems to think so.

I'm still unsure.  Will the rate hike be more contractionary than it is expected to be, leading to an eventual reversal in inflation expectations?  Or, is this a de facto monetary loosening through a sort of fiscal expectations channel, and now rate hikes will be less contractionary than they would have been.

I will be very curious to watch rate movements after the hike.  In the meantime, my indecisiveness may be costing me some trading gains.  Not sure what to think here.  I think because of the zero lower bound, we are later in the rate hike cycle than it looks, and in a position where raising rates into falling core inflation is ill-advised.  But, the Trump effect is muddying the waters.

In the meantime, low tier housing appears to be accelerating while high tier housing continues to moderately rise.  There are reports of high tier contraction in the Closed Access cities, and I don't really see any sign of expanding mortgage financing in the broader numbers, so while the high tier price trends seem ok, I don't see where the fuel for low tier pricing is coming from, especially since we seem to have come to a transition point between investor buying and owner-occupier buying.

A lot of mixed signals.  Still seems dicey to me, but I'm afraid I'm just watching opportunities pass me by.

PS:  Here are some comments from Scott Sumner and Matthew Yglesias.  I might be a little more pessimistic than them, because I think the Fed overestimates fiscal stimulative effects, so monetary offset is more than 1:1.  On the other hand, to the extent that the mixture of monetary and fiscal influences leads to more inflation but lower real growth, that might help to continue the grindingly slow recovery in housing and end up boosting real growth.

Tuesday, December 13, 2016

Causality reversal is bad.

One problem with an empirical approach to complex systems is that frequently relationships can be found, but the causality is hard to determine.  If a relationship is very strong, reversing the causality can ironically lead to strong confidence about very wrong conclusions.  This is basically what I have found in housing.  There are very strong relationships between the prices of homes and the size of the mortgage market.  This relationship exists regardless of the cause of home prices, but there seems to be a strong bias to see the causality going from credit to prices.  When constrained supply is what causes prices to rise, we blame creditors.  Then, on top of supply deprivation, we impose demand deprivation.  This is what we did in housing.  Most people are supremely confident that we did the right thing, because the relationships are clear.  But since they have the causality wrong, they have no idea that public policies behind both supply and demand deprivation have been devastating to the American working class.  Hundreds of books and articles have been written about how strong those relationships are, with the causality wrong.  When I think about the mass of misidentification that is out there, taken by the public as evidence, I wonder if a response can possibly break through the fog.

J.W. Mason has a post up that seems to engage in a lot of causality reversal regarding the minimum wage. (HT: Matthew C. Klein)  Some of his causal inferences are probably conventional, so my reactions may be somewhat idiosyncratic, and maybe they are more of a comment on conventional economics than on Mason, but here they are nonetheless.
Let’s start at the beginning. Suppose there is some policy change, or some random event, that boosts desired spending in the economy. It could be more government spending, it could be lower interest rates, it could be a rise in exports.
Causality: Spending creates production?  This is, at best, a muddle.  But, the rest of the story depends on it.
Lower unemployment increases the bargaining power of workers, forcing employers to bid up nominal wages. These higher wages are passed on to prices, leading to higher inflation.
Causality: Labor utilization is inflationary?  Pro-cyclical monetary policy would lead to the same result, right?  So, now, Mason's story depends on two serial assumptions about causality - spending creates production and labor utilization creates inflation.  The simple Phillips Curve has broken down in recent decades.  But, real wage growth still correlates strongly with labor utilization - as does the Quits rate.  Might labor's "bargaining power" lead to better job matching and fewer frictions in the labor market?

See how causality does all the work here?  One interpretation says fewer frictions in the labor market has broad real benefits.  The other will say we should add frictions to the labor market.  Same evidence.  Different causality.  Diametric conclusions.

Mason does follow this with an extensive list of potential ways that an economy running near potential could generate higher real growth, many of which boil down to less friction and more efficient matching and utilization.

But, he follows with:
If we follow this a step further, we could even say that in the long run, the big problem isn’t that excessively high wages do lead to the substitution of capital for labor but that excessively low wages don’t. People like Arthur Lewis argue that it’s the low wages of poor countries that have led to low productivity there, and not vice versa; there’s a well-known argument that the reason the industrial revolution happened first in Britain and in China or India (or in Italy or France) is not that that the necessary technical innovations were present only in Britain. They were present many places; it was the uniquely high cost of British labor that made them profitable to adopt for production.
Causality: High wages lead to substitution of capital for labor?  It seems like surely the causation runs the other way - capital leads to higher wages.  It is only when higher wages are imposed legally that the causation would run the way Mason suggests, in a particular case.  Mason links to arguments for his causation, but surely all can agree that these are, at best, interesting contrarian arguments.  We should add another unlikely causation assumption to his series logical steps here.

This seems like a bit of selective observation, too.  I mean, I'm happy to argue that the idea that capital moves to places where wages are low is wrong.  But if high wages were the causal factor, I wouldn't need to argue about it.  Aren't most people complaining about capital moving to places with low wages?  It would be strange for that to be the common perception if high wages were what attracted capital.  Is capital attracted to where it can exploit weak labor or to where strong labor requires substitution?  It can't be both at the same time.

Isn't it more likely that universal legal protections for existing and new capital are the causal factor that leads to capital inflows and rising wages?

If a plethora of high wage options for labor is the cause of capital intensification, then I guess we don't have to worry about laborers dislocated because of capital induced declines in manufacturing or agricultural employment.  Capital was attracted to agriculture because ag labor had so many opportunities for high wages?  And, all that labor moved to the cities because of those high wages, and it was only after they moved there that capital was induced into the cities for the new manufacturing production?  So, there was some other cause of high wages in both the newly industrialized cities and in the depopulating rural areas, and capital infusion was a lagging result of the higher wages that had come from this outside cause?  And, now production is moving from the rust belt to the developing world because rust belt wages are too low and high wages in China are attracting capital as a substitute?  Are there people making these arguments?  Is there a literature on this that lurks in the shadows outside of the public conversation?  Are there Marxists out there who complain that CEOs are moving capital into developing economies because wages there are high?

Going back to the beginning of Mason's post, he seems to think that when McDonalds' CEO claims that the minimum wage leads them to replace workers with capital, leading to unemployment, that this is a problem for minimum wage critics, because higher productivity should lead to general expansion, mitigating the cost of unemployment.  Here, Mason has a great post showing how pro-MW arguments about efficiency wages and anti-MW arguments about rising productivity are both basically the same argument, selectively observed to ignore the mitigating side.

But, I think his general assumptions about causality lead him to a sort of false equivalence about this.  There is a difference between capital utilized in the face of a price floor and capital utilized because of other causes.  There is no reason to believe that the positive effects of a minimum wage will be strong enough to create employment for the workers who are unemployed in that efficicency wage story.  On the other hand, on the issue of capital-induced productivity, that capital had to be taken from somewhere.  Capital doesn't just pop up out of nowhere.  There are tradeoffs.  Capital wasn't deployed somewhere else so that it could be deployed to replace sub-MW workers.  There is no reason to believe that the net change to productivity will be positive.  And, especially given the central place of propensity to consume in the pro-MW arguments, where the income is supposedly transferred from employers who would be more likely to invest to workers who would be more likely to spend, there is no reason to expect this capital to just pop up out of nowhere.  Spending causes production, Mason told us.  How exactly did that capital show up if this whole ball started rolling because we induced more people to buy hamburgers instead of saving their incomes to build kiosks?

Monday, December 12, 2016

Housing: Part 193 - The 5 million missing homeowners.

RealtorMag notes that about 6 million mortgages have been denied since 2009 because of overly tight standards (HT: John Wake).  That comports pretty well with my estimate of 4 to 6 million missing homes, either measured by the rate of housing starts compared to historical averages or by housing units per adult.

And, the fact that this shortage has been created by removing credit access for middle and lower middle class households means this shortage is all felt at the bottom half of the income distribution.  The rise in homeownership was not really related to credit access to households with marginal incomes.  That never really happened.  But the drop in homeownership is related to a lack of credit access.

New ownership was concentrated among high earners, but lost ownership is concentrated among low earners, such that the net result is homeownership is more limited to higher income households than it has been for decades.  Both the boom and the bust contributed to this.

How did we get this so wrong?  Here is an American Spectator article from 2009 that is trying to work out whether the Community Reinvestment Act or the GSEs or some other government intrusion is to blame for the "bubble". (Again HT: John Wake)  They pin much of the blame on the expansion of mortgages with loose terms in private securitizations and at the GSEs, and in an extensive description of changing market share among those groups, they couldn't find the space to mention that FHA market share had declined from 16% to 4% of the market by the top of the boom.  The primary source of low down payment mortgages.  I don't think this is purposeful.  FHA went down the memory hole because it didn't fit anyone's narrative of excess.  And the narrative had to be excess, right?  I mean, look at those prices, the rising ownership rates, etc.  So, we collectively forgot that 12% of the market that used to be dominated by 3% down payment mortgages had disappeared, and, lo and behold, like the pet rocks of the 1970s, suddenly we found a bunch of institutions who were offering low down payment mortgages, and they were gaining a lot of market share!  Scary!

The American Spectator closes:
PREVENTING A RECURRENCE of the financial crisis we face today does not require new regulation of the financial system. What is required instead is an appreciation of the fact–as much as lawmakers would like to avoid it–that U.S. housing policies are the root cause of the current financial crisis. Other players–greedy investment bankers; incompetent rating agencies; irresponsible housing speculators; shortsighted homeowners; and predatory mortgage brokers, lenders, and borrowers–all played a part, but they were only following the economic incentives that government policy laid out for them.If we are really serious about preventing a recurrence of this crisis, rather than increasing the power of the government over the economy, our first order of business should be to correct the destructive housing policies of the U.S. government.
The details are more subtle than this, though, aren't they?  It was the retraction of federal involvement that clearly led to this.  Limits in the FHA framework had prevented those loans from funding Closed Access housing at prices that reflected the true value of future rents.  They also tended to have more stable terms than the terms that developed in private securitizations.  The retraction in the FHA conduit was destabilizing.

I am still working on the data, but it looks to me like the main thing the new terms in the private securitizations did was allow high income households to bid up the prices of low tier homes in the Closed Access cities, and it accelerated the migration of low income households out of those cities, many of whom cashed out of their homes.  The private securitization boom, ironically, may have been a massive redistribution from high income to low income households as high income households were able to get mortgages that allowed them to get into the Closed Access enclaves.

Given that we are stuck with Closed Access cities, I think this was all for the best, such that it was.  If we are going to saddle ourselves with cities set up to only be able to house high skilled and rich people, we might as well get on with the business of moving them all in and moving everyone else out.  And, if a bunch of working class homeowners got six figure capital gains from it, it seems like that's quite a ways down the list of things to complain about.  The problem was that we all had a freak out about it and we've been shooting ourselves in the foot ever since.

And, further, thinking about narratives and interpretations, I have come to view paragraphs like the quoted one above with some exasperation.  That's quite a list of dupes and villains they have there.  Go to a place like Wikipedia or any other public description of the period, and the list will be even longer.  Certainly an overly-accommodative Fed would usually be on there.  This should be a sign of how wrong that story is.  There are so many holes in the story that literally a dozen or more different groups had to become irrational, in turn, with a variety of different motivations, to plug all those holes in the story.

Most discussions about the period are arguments over these dei ex machina.  Everyone takes one or two out, switches out a villain for a dupe, etc., and then argues about the slight differences in how they plug the holes in the story built on false premises that they all agree on.  My favorite hole plug is the villain/dupe.  The investment banker villains who became so greedy that they duped themselves.  On the other hand, I suppose that's what I am claiming we have done to ourselves - duped ourselves into self-destruction - not so much from greed but from an addiction to confirmation bias and attribution error.  So, I guess, who am I to judge?

But, none of these narrative machinations are required if we simply step back and ask, "Wait a minute, in cities like Atlanta and Houston and Dallas, where homes were perfectly affordable in 2007 and where there really never was that much of a spike in defaults, what exactly happened that required the top quintile homes to fall 10% and the bottom quintile to fall more than 20%?"  It never had to happen.  There are no holes to fill.

Thursday, December 8, 2016

Housing: Part 192 - Regulatory limits to mortgage access

Here is a good article from the Wall Street Journal on the regulatory limits to mortgage access. (HT: Nick Timiraos).  The article begins:
Sean Dobson wanted to start a mortgage bank four years ago to serve borrowers with middling credit or irregular income. He eventually decided that growing regulatory hurdles and other costs would erase his returns.
Instead, he purchased thousands of homes in states from Texas to Indiana and now rents them to people who might have been his borrowers.
Pretty much the story of the decade.  The comments on that article reflect the general attitude of the electorate on this matter, which is why we will continue to impose these problems on ourselves.

On a related note, here is an interesting post from Richard Green at USC regarding the CFPBs DTI limits (HT: Mark Thoma).
The Consumer Financial Protection Board has deemed mortgages with DTIs above 43 percent to not be "qualified." This means lenders making these loans do not have a safe-harbor for proving that the loans meet an ability to repay standard. Fannie and Freddie are for now exempt from this rule, but they have generally not been willing to originate loans with DTIs in excess of 45 percent. This basically means that no matter the loan-applicant's score arising from a regression model predicting default, if her DTI is above 45 percent, she will not get a loan.

This is not only analytically incoherent, it means that high quality borrowers are failing to get loans, and that the mix of loans being originated is worse in quality than it otherwise would be. That's because a well-specified regression will do a better job sorting borrowers more likely to default than a heuristic such as a DTI limit.

Wednesday, December 7, 2016

Housing: Part 191 - Affordability is not the problem

Thinking about housing in terms of affordability causes a lot of confusion, I think.  There is confusion about the difference between the affordability of using a home (rent) and the affordability of owning a home.  There is confusion about the difference between real housing consumption (size, location, etc.) and nominal housing consumption (the rent check).  And, I think there are two big reasons why affordability is not a coherent way to think about housing expenses, anyway.

1) Housing is largely a sunk cost.  The homes we have were built in the past and they are what they are.  Since the 1960s, Americans have spent about 18% of our personal consumption expenditures on housing with surprising regularity.  Lacking a major shift in a number of political and cultural factors, we will continue to spend about 18% of our budgets on housing.  It doesn't matter if those houses are 500 sq. ft., 2,000 sq. ft., with or without air conditioning, with thatched roofs or tile.  We will spend 18% of our budgets on it.  It is that affordable.  The affordability, in the aggregate, is the one thing that doesn't change.  Everything else changes to keep affordability where it is.

And, we certainly won't suddenly discover that we can't afford the homes we have built and have to leave some of them empty until we can afford to fill them.  They are here, they are ours to use, and we will pay about 18% of our personal household spending for them.

2) Affordability is not what is keeping people from moving to cities with employment opportunities.  It looks like affordability is the problem.  If you lost your manufacturing job in Buffalo, and you're thinking of moving to New York City because there are more jobs there, you might decide not to move because it is too expensive.  It is the affordability that is keeping you out.  But, even here, the affordability problem is just the messenger.  It is the rationing mechanism for a housing stock that is relatively fixed for political reasons.

In a market with free flowing capital, labor, and money, price has more meaning.  But, in the Closed Access cities, there are limits to the flow of capital and labor.  If you decide to move to New York City, the shift in demand isn't going to move across an upward sloping supply curve.  Supply has a pretty hard cap on it.

So, it doesn't matter if Brooklyn apartments rent for $500, or $1,000, or $2,000, or $4,000.  There isn't one for you.  Fixing this by fixing affordability isn't going to move the supply curve.  It's simply substituting non-monetary rationing mechanisms for the monetary one.

The housing bubble was a huge neon sign blinking to the country that this is the core problem of our time - that there is a structural problem here that is eating us alive.  And, the consensus error of seeing the bubble as a demand or credit phenomenon has delayed the progress on this problem for a decade while we impose self-inflicted wounds on ourselves.

Monday, December 5, 2016

Colorado - keepin' the riff raff out and bein' heroes.

There is a pretty good correlation between party affiliation and dysfunctional housing policies.  For each Clinton or Obama voter that a state gains, they will lose a resident to out-migration over the next decade.  I say this half-jokingly, but clearly these migration patterns are connected to certain policy frameworks that arise out of the "blue" metro areas.  The causes of this problem are complicated, and it could be that cities with housing problems become more blue, or that blue cities create innovative labor markets that extract value from density - value that they are then unable to tap because of those housing policies.  But, maybe Dallas would have trouble achieving the level of density that is demanded in San Francisco and New York City, too.  Maybe the difference between Dallas and San Francisco isn't that San Francisco won't allow enough density.  Maybe it's that San Francisco is the city that made density so valuable that any 21st century Western city would run into supply problems because of the demand for housing that value would create.

But, here comes Colorado, to put the causality back to policy.  Here is a new proposed Constitutional amendment that literally is the problem.  On the one hand, at this point, it would be unfair to claim this proposal represents broad support from Coloradoans.  On the other hand, it is such a nicely packaged example of the problem at the heart of the progressive policy framework, that it is worth looking at.
From the article:
It’s quite the long shot, but one of the first constitutional amendments that will try to get on the 2018 ballot aims to limit residential growth in Colorado’s highest-populated counties.Filed by a Golden man and a woman from Wheat Ridge, the so-called “Proposition 4” will aim to limit new residential building permits in Adams, Arapahoe, Boulder, Broomfield, Denver, Douglas, El Paso, Jefferson, Larimer and Weld counties to 1 percent of the current number of existing units in both 2019 and 2020.
The proposition would also require 30 percent of new developments be affordable housing or affordable senior housing.

This is just classic.  The limit on the number of new units is literally THE cause of unaffordable housing.  No city that limits housing in the face of demand has broadly affordable housing and no city that allows housing supply to grow to meet demand has unaffordable housing.  The correlation is practically 1:1, and the different outcomes in these cities are famously becoming more and more extreme.  This is not anywhere close to a subtle point.  This amendment is, at its base, the formulation of the one and only cause of unaffordable housing at an aggregate level.

But, then we have that precious second part.  Now that Colorado would make it illegal for affordable housing to be built, in practice, they would demand it by mandate.  Because that's just how much they care.

In Dallas, affordable housing just kind of shows up everywhere.  Across the distribution of incomes in cities like Dallas, household spending on rent settles at a comfortable portion of household budgets.  Most households adjust their real housing consumption to get to that comfort zone - by changing location, size, etc.

But, if Colorado can manage to pass this amendment, it will become like San Francisco and New York City.  There, households manage their housing costs by applying to the local "affordable housing" commissioners.  In those cities, affordable housing doesn't just show up.  The reason you have affordable housing is because people who vote the right way - the right-thinking, moral people who are on the right team, and who care more about you - are fighting for you.  They are out there doing the hard work for justice because that's how working class people win.  The way households get affordable housing in urban California and New York City is because those cities are filled with heroes, God bless 'em.  What would you do without them?

Of course, for many households, what you do with them is you move away from them to Dallas, where affordable homes just sort of appear.  I know.  It's weird.  But, they just sort of are there, even though Dallas is sorely lacking in heroes.  Go figure.

Friday, December 2, 2016

Housing: Part 190 - Rent and Mortgage Affordability

Zillow maintains measures for both rent and mortgage affordability, which basically measure the amount of the median household's income required to afford to rent or to buy the median home with a conventional mortgage.  I think this chart of housing affordability in the largest 100 cities does a good job of telling parts of the story.  (About 1/3 of the country isn't represented in this graph.  That rural portion of the country tends to have lower rent and mortgage costs, similar to the left end of the series shown below.)

From 1981 to 2001, the main change was that lower inflation premiums in interest rates made mortgages more affordable.  So, from 1981 (purple) to 2001 (blue), the relationship maintained its basic shape, but mortgage affordability moved down quite a bit.  (The trendlines are 2nd order polynomials.)  Even in 2001, rent affordability was relatively normal and mortgage affordability responded to rent affordability at less than a 1 to 1 basis.

Then, the relationship changed.  The change in the relationship coincided with rising rents.  (The entire set of red dots shifts to the right, and the high rent cities especially shift.)  Notice that mortgage affordability where rents were low did not shift.  The shift in mortgage affordability was strongly related to rent.  The higher rent expenses were in a metro area, the more mortgage affordability shifted up from 2001 to 2006.

This is why when researchers looked at national data, it looked like prices were rising sharply with little relationship to rents.  This relationship is non-linear.  So, when prices were aggregated among these cities, the high prices in the very expensive cities in 2006 moved the aggregate price estimate up more strongly than they moved the aggregate rent estimate.  A time series of the national data looks like prices unmoored from rents.  But, clearly the change in the 2000s was that home prices became much more responsive to rent levels, at the MSA level.

An expansion of credit availability may have helped push home prices up where credit allowed home values to reflect rents in ways that they couldn't before.  In a city where rent affordability is up to 35%, there is no federal agency that regulates rental contracts, refusing to approve rental agreements that take more than 30% of the tenant's income.  But, there are federal agencies that enforce the amount of income mortgage contracts might claim.  This constraint declined during the private securitization boom, which probably did allow home prices in high rent areas to be bid up.  But, note, this is a significant change to the story.  This would imply that home buyer markets were becoming more efficient during the boom, not less.

I'm not sure how much that explains.  Expected future rent inflation can explain the non-linear relationship between price and rent.  Credit might have helped facilitate those price levels, but, as I have shown in previous posts, given rising rents and prices, home prices across each MSA were rising in a surprisingly systematic way.  On a Price/Rent basis, home prices in zip codes we might expect to have been more credit constrained did not move above the level we should have expected, given the rising rents they were experiencing.  Rent levels had an effect on prices, expected future rent levels had an effect, and credit availability probably accommodated some of that, but I'm not sure how much.

If one believes that credit was the causal factor in home prices and pushed them away from efficient prices, one might be able to come up with an argument that explains why credit only flowed to certain cities, and only pushed prices up where rents were high.

This is where the experience of housing markets since the boom shines a light on things.  We severely cut back on the mortgage market.  We killed the private securitization market, and the GSEs severely curtailed the number of loans they make to the bottom half of the market.  (FHA did make up for some of that, but they also tightened standards.)  Yet, killing the mortgage market did not shift the relationship between price and rent back to the previous regime.  Since the end of the boom:

  1. Rents have risen even more.
  2. Prices have declined everywhere, so that mortgage affordability at the cheap end of the spectrum is extremely low.
  3. High rent cities still have high prices, and there is a non-linear relationship between price and rent.
We still have cities with very high rent.  We still have cities with high rent inflation expectations.  (And we have high rents that justify the rent inflation expectations implied by the boom prices.)  We don't have a generous credit market.  Yet, the new relationship remains.  Screwing up the credit markets didn't do anything to flip the regime back.  It just hamstrung the housing market across the board, whether mortgage affordability was 20% in your MSA or 60%.  Because mortgage availability wasn't the cause of the regime flip to begin with.  The collision of highly valuable core city labor markets with incapable homebuilding markets in those cities was.

PS.  Note the odd movement in rents and mortgage expenses from 2006 to 2015.  Those dots all moved sharply down and to the right.  Since the housing market has become defined by these overwhelming limits to supply and credit, we have an ironic condition where the only way to create more affordable housing is for home prices to rise.

Thursday, December 1, 2016

Housing: Part 189 - Below Market Rate housing

One of the ongoing battles between YIMBYs and NIMBYs is the extent to which below market rate (BMR) housing should be part of the solution to a more functional housing supply.

In a recent post, I argued that the seen part of a healing housing supply at market rates would be rising housing expenditures at the high end of Closed Access cities, because those are the households who have been reducing their real housing expenditures and who naturally would be willing to expand their real housing consumption.  For households with lower incomes, their reaction to a healing housing market will be to maintain their real housing consumption but to take advantage of moderating rents to reduce their nominal housing expenditures.  Millions of them have been moving out of the Closed Access cities in order to reduce their nominal housing expenditures, and it would be a huge win to stop that migration flow.  The benefits of a healing housing market on the low end of the market would mostly come in the form of things that would stop happening.

That's a tough rhetorical argument to win, though.  "Look!  Our new housing expansion programs are working because rich people are moving into new fancy apartments and low income families are staying in the same apartments they had!"  It's a losing argument, even though that outcome is a vast improvement over the current state of affairs, where a high income family moves into the low income family's house and the low income family moves to Las Vegas because they can't afford to stay.

It seems as though the better solution would be to build BMR units so the low income family can move into those units instead of moving to Las Vegas.  But, the main difference between this solution and the market rate solution is simply to move the pieces of the puzzle between the seen and the unseen.  Now, unseen in the city somewhere, on the margin, there is a low income family priced out of the housing market as market rates are bid up, and the seen part of the policy is that, on the margin, a low income family moves into a BMR unit.  The family in the BMR unit might have especially affordable rent, but families in the rest of the city will likely have marginally higher rents because supply in market rate units will be more constrained.  This is simply a ratcheting up of the incongruities that define Closed Access polities.

The main goal is the expansion in total units.  The composition of the city's population isn't going to change because we insist on building units that are "affordable" instead of "luxury".  The reason high income households are bidding up the housing stock isn't because Closed Access cities are full of magnificent units.  It's because those units are located in Closed Access cities.  The only way to eliminate the demand for "luxury" units is to eliminate the Closed Access policies that make them exclusive.

But the main point I want to make here is that the existence of BMR units and the expectation that they will continue to be part of a city's housing stock is, a priori, a description of a housing problem that hasn't been solved.  There are many cities in this country with function housing markets, where families spend a normal, comfortable portion of their incomes on rent.  For most families, there are a range of options for real housing consumption, and they tend to settle on a level of housing that fits in a comfortable range of spending for a given income level.  What characteristics do cities have where this is the case?  Universally, they have policies that allow adequate building of market rate housing, and they don't have BMR units as part of the city housing policy (except for units that qualify for typical federal rent subsidies and other programs directed at poverty relief).

To propose BMR units as part of a housing plan is to perpetuate a housing policy that has the character of Closed Access.  The point of a functional housing plan would be to reduce the market rate.  This is the only way, at a fundamental level, to achieve a functional housing plan.  Imagine that we try to fix a city's housing problem by perpetually building BMR units.  Is there any conceivable future scenario that isn't characterized by stress and incivility?  In those scenarios, market rates would still be high.  The justification for BMR units is that market rate units would accommodate unmet demand for units from high income households, and that BMR units would target lower income households.  As I argue above, this is incorrect.  But, even if we agree that it's correct, then the very presumption of the policy is that there will continue to be a perpetually unmet demand for housing from high income households.  The future of a city with a BMR policy will be just as stressed as the present.  What would have changed?

The way to make housing affordable is to stop piling a bunch of idiosyncratic costs (taxes, fees, logistics, delays, inflated construction costs, etc.) on new units.  The city has complete control over allowing "BMR" units simply by refraining from these impositions.  If new housing could be built at cost, it would be affordable.  At this point, though there are a variety of paths that take them to their shared conclusion, it seems that, at bottom, the one thing that many constituencies of Closed Access cities don't want is affordable housing, writ large.  They all (homeowners, renters, advocacy groups, etc.) want unaffordable housing, and they want to engage in interest group battles that carve out exceptions that make their housing affordable (property tax limits, rent control, BMR units, etc.).

The reason that the city can't remove all those extra impositions from new units seems to, in part, be due to the fact that all those special interest carve outs prevent them from funding the city budget without them.

I wonder how much of the motivation for BMR policies comes from a sense of the sanctity of homes and the vulgarity of market prices.  This same sense seems to populate opinions about things like education and health care, too.  While these attitudes come from an understandable motivation, I am afraid that a lack of appreciation for the power of market prices to undergird an affordable and civil economy is leading to policies that are causing these sectors to eat us alive.  Because housing is local, it may be the best example we have of the damage that can be done in the name of sanctity.  There is an undeniable correlation between places where this sense of sanctity has a strong hold on local policy choices and where vulnerable families are stressed out by high costs and a lack of choices.  But, this sense of markets imposing vulgarity on transactions that have an element of sanctity causes many people to be more comfortable with demand that is routed through a local commissar who doles it out in a fashion that explicitly is sanctified by an organized program of desert and fairness than by an uncaring landlord, in spite of the stresses that this program clearly causes at the macro level.