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.

Wednesday, November 30, 2016

Two Doubts About the Liquidity Effect

There is this story of how the Federal Reserve goosed the economy and the housing market with excessive monetary expansion, and then when the inevitable bust came, they fought the bust again by turning on the money spigots and lowering interest rates to save us from further decline.

The way that raising and lowering interest rates works is through the liquidity effect.  The Fed buys treasuries with new money.  That money gets deposited at the banks.  And, since the banks have more reserves as a result, there is less demand for cash in the overnight bank borrowing market, and short term rates decline.

The broader effect of a cash injection should be to raise rates, because the new money should raise inflation.  So, the liquidity effect is a temporary effect.  Over longer periods of time, interest rates should rise and fall with inflation rates.


Source
From May 2007 until March 2009, however, the Federal Reserve didn't buy any Treasuries.  In fact, they sold hundreds of billions of dollars worth of them.  Whether one describes Fed policy at the time as "tight" or "loose", how could the liquidity effect have brought down interest rates?  They weren't buying anything.  They weren't injecting money into any markets.

It is true that they were making emergency loans to banks, but they were purposely selling a dollar of Treasuries for each dollar of lending in order to prevent interest rates from declining.  In April 2007, the Fed held $902 billion in assets supplying reserve funds.  From April 2007 to August 2008, the total balance sheet of the Fed, including emergency loans and treasuries, grew by only about $2 billion per month.

In a falling rate environment, demand for cash should have been increasing, so, I think, if anything, it seems like the Fed would have needed to increase their holdings by more than usual in order to maintain a neutral stance.  But, in any case, how can anyone describe this period as a period where the Fed was dropping rates through the liquidity effect?

Furthermore, if the liquidity effect had anything to do with rates at the time, why were 3 month treasury rates well below the Fed Funds rate?  The Fed was injecting cash into the banking system through loans and it was selling hundreds of billions of dollars worth of short term treasuries.  If they were lowering rates through the liquidity effect, wouldn't treasury rates have been higher while the Fed Funds rate declined?

In the same graph, moved forward a few years, it looks like there is a similar problem with the QEs.  One of the Fed's stated goals with the QEs was to push down long term rates.  Yet, with each round, what we see is rates falling in the period before the round of QE and then rising during the implementation.

One might argue that rates were anticipatory.  But, the liquidity effect can't be anticipatory.  The liquidity effect happens because of frictions in the market that allow real-time changes in supply to temporarily overwhelm other factors that determine price, including expectations.  If markets can anticipate the liquidity effect, then they should anticipate all temporary movements.

It seems to me that the normal explanations for Fed policy during this period don't hold up.  Am I missing something?





Tuesday, November 29, 2016

Question for readers interested in workshops/presentations/consultation

I plan on having a complete and organized version of my housing work published in book form next year.  In the meantime, I have a question for readers:

How much interest is there in private consultations, presentations, workshops, speeches, etc. about the issue?  My new way of looking at the relationships between the housing market and broader markets has implications for policymakers and various types of investors and traders.

I would like to know if there is enough interest from any of you to justify putting together a package or presentation of some sort, now.  For readers who work in the financial sector, as the economic recovery ages, the ideas I have been developing here could create new ways to construct tactical contrarian positions or to reconsider the shape of the business cycle.  For readers in the public sector, there are implications for housing, credit, and monetary policy.

If you belong to an organization that might be interested, please e-mail me at idiosyncraticwhisk@gmail.com .  I would like to get an idea of what content you would want me to focus on, the depth or amount of time you would want to devote to it, and what budget you might have available for it.

I can present the fund managers or policy makers in your firm or institution with a set of ideas that I think they will find unique and thought-provoking.  I'd love to get some feedback about possible ways to help some of you gain some value from this work.

Monday, November 28, 2016

Housing: Part 188 - Demand elasticity?

I have mentioned before that narratives of the housing bubble tend to presume a schizophrenic model of rational expectations.  Home buyers were bidding prices up because of irrational exuberance and also because various public subsidies and programs lower the price of homeownership.  In the case of the former, these buyers were paying for homes with little regard for intrinsic value or relative cash flows, or they were buying them with exaggerated expectations of those cash flows.  In the case of the latter, buyers were paying more for homes because the present value of far future imputed rental income and capital gains were being precisely increased by tax deductions and interest rate subsidies.

There is a related schizophrenia in the way home demand has been described during the period.  Mortgage brokers were aggressive because they were being paid from the high fees and high interest rate income generated by subprime borrowers.  The private securitization business is usually described as an engorgement of the shadow banking sector on these fees.  On the other hand, home buyers were attracted to the market because government support of the GSEs lowered mortgage rates and the Fed (supposedly) was pushing rates down by goosing the money supply.

Now, again, I suppose it is possible for both of these effects to be in play.  Rates could be low at the same time that mortgage brokers are aggressively trolling for fee income, and both of these factors could lead to more demand for homes.  But, demand elasticity is sort of doing the tango here.  With regard to basic rates, demand is elastic, so that lower rates lead to more buying.  But, when it comes to the privately securitized mortgages, demand has to be inelastic or else there would be strong headwinds against those brokers expanding the market.

In a way, I acknowledge that both of these things were happening in the two Americas.  Lower conventional rates did cause home prices in most of the country to rise moderately -  maybe about 20% from trough to peak as real interest rates declined.  In the Closed Access cities, demand for home buying was less elastic because lack of access had been holding lower priced homes down.  There had been no regulatory or market barriers keeping families from spending 40% or 50% of their incomes on rent, but there had been barriers to spending 40% or 50% of their incomes on mortgage payments.  As those barriers were removed, pent up demand for home ownership was released.

This led to prices rising in the Closed Access cities in a systematic way.  It led to a burst of tactical selling from existing Closed Access home owners and a surge of out-migration as those families moved on with their capital gains in hand.

There are ways that segments of the market reacted differently, and those different reactions are sometimes related to changes in the marketplace for mortgages.  What I find frustrating about the conventional credit supply explanations for the "bubble" is that these subtleties are rarely addressed.  There is a market called "America", where non-conventional mortgages, housing starts, debt levels, and prices were all rising at the same time while conventional interest rates were low.  And, as that story gets told, demand elasticity moves to and fro as needed, usually with little apparent notice.  In that story, households with a lack of self control are blamed, oddly, for a surge in transactions that may represent the single most back-weighted arrangement of cash flows a household could engage in.  In that story, we have to pretend that $2 trillion in mortgage debt was pushed through these securitization fee machines to those households who lacked self-control and then disappeared - somehow not showing up at all in the balance sheets of households with below average incomes.

Saturday, November 26, 2016

In Defense of Black Friday

I think the way we react, socially, to Black Friday is a great example of anti-market bias and how it feeds the Trump phenomenon (or the "What's the Matter with Kansas" phenomenon, or whatever we might call it).  Privately, clearly this is a popular event, yet publicly, we mostly signal disdain for it.  As with many things, our private actions are probably a better indicator of our true values.

What is Black Friday, really?  It is the culmination of a holiday about thanksgiving and generosity.  After a day spent with family and loved ones, many of us rush out to buy gifts for them.  Is there another shopping day, other than the last day or two before Christmas where more of the purchases are gifts - tokens of love and gratitude?  The newspapers find the 40 people who got into a scuffle and put them on the front page, and they become the poster children of the event, even while 100 million others spent a pleasant and fun day looking for special gifts for one another.  Our biases are so strong here that we allow those poster children to be stand ins for ourselves, even when most of us have personal experiences on Black Friday that are wholly at odds with that picture.

And, who benefits the most from Black Friday?  It's not "1%ers" standing in line before Best Buy opens their doors at 5am.  Markets - faceless, uncaring markets - create this emergence of abundance that on this day more than any other is discounted and broadly distributed.  If you are willing to get up early and stand in line for a little while, you can get a $100 laptop computer for your daughter.  That laptop would be a miracle of innovation if it cost $10,000.  It's certainly a miracle at $300.  But, for this day, this abundance is even more accessible.  Black Friday's success and its value in this regard is irrefutable.  The shoppers are voting with their feet.  They go because this is event is good for them.

But, commerce can only be vulgar in our public postures, so we concentrate on the retailers that provide this abundance.  They are preying on the workers who have to run the store.  They are tempting their customers into a frenzy of consumerism.  Never mind that our own experiences overwhelmingly undermine this narrative.  Black Friday is mostly an event, shared with friends and family, that is about giving.

And the event is part of the value.  We might knit a sweater instead of buying one to make a gift more personal.  But, the amazing abundance we share has made this more difficult.  We aren't miracle workers.  We can't build our own laptop.  But, what we can do is have an adventure.  We can get up at 4am and go stand in the cold together.  We can speedwalk to the electronics department, with the brief thrill and drama of wondering if any laptops will be left when we get there.  That story will be part of the gift.  "We surprised you, didn't we?  You thought we were going to buy that refrigerator, and we told you they were sold out when we got there, but really we went to get your laptop.  It was so cold that morning.  In line, we saw Jenny's parents - you know Jenny, from your old soccer team.  They were there to get her an X-Box.  Even though we were there an hour early, there were quite a few people in line ahead of us.  But, there were still two left when we got in.  We almost didn't get one."

You didn't just work for an afternoon at your boring job to get that laptop for your daughter.  You went on an adventure.  And, since you went on that adventure, you were able to get her a better laptop than she thought you could afford - and a story about how you spent a morning on an adventure for her.

But, on Black Friday, when you got home from shopping, you logged onto Facebook, and what did you see?  Probably a few posts of Facebook friends posturing.  "I'm boycotting Black Friday.  No shopping today.  Who's with me?" with lots of comments and likes in support.  A sort of private/public shaming of your adventure.  And, a subtext that for some people that you know, saving a few hundred dollars on a laptop is less valuable to them than moral preening.  Talk about coming from a position of privilege.  Anti-consumerism is useful because the pretext is a statement against commercial power while the subtext is that you're well off enough not to concern yourself with vulgar commerce and the scarcity of material things.  It's a twofer.

Reactions this shaming won't generate:
1) Gee.  You are right.  I am ashamed.
2) Hmm.  I'm interested in your moral and political opinions.
3) I wonder if there are programs at your church which would help me to be more morally upright.

In this story, there is a darkness.  But, it isn't from the retailers or the shoppers.  It's from the shamers, who proudly infuse this story with their own negative prejudices.  A prerequisite of a community that builds a sense of unity and goodwill is for a plurality of citizens to refrain from this sort of darkness.  But, sub-communities thrive on signals that demean others.  The difference between signals that are necessary expressions of moral mutual re-enforcement and signals that are ungenerous degradations of outsiders is subtle.  It seems like these days we have a bit too much of the latter.

In a way, this is an expression of the never-ending battle between fundamentalism and liberalism.  Fundamentalism has all the tactical advantages.  At its core, fundamentalism always builds on an imperfect aphorism.  Here, it might be, "Overconsumption and materialism are indecent."  Other popular aphorisms might be, "You have no right to question the word of God." or "We must be intolerant of intolerance."  All of these aphorisms are true, and because they are unassailably true, they are effective defenses when we depend on them to generate ungenerous degradations of other people in order to mark our status among those we affiliate with.  I'm afraid this means that those taken in by a fundamentalist mindset are destined to become more shrill and insistent when they are faced with natural appeals for moderation.  Maybe that tendency is how liberalism maintains itself.  The tendency of the shamers to signal to their community at the expense of outsiders naturally leads to their irrelevance.

I'm hoping for a return of liberalism.  In the meantime, enjoy your shopping.  I'm sure your daughter will appreciate the laptop, and she'll love the story about your adventure.  Don't be ashamed for our sake.

Monday, November 21, 2016

Recession watch: Attribution error and inadvertent self-flagellation as policy and social norm

Here is a scary looking graph.  (HT: NickatFP)

Leverage is out of control, apparently.  We need some macro-prudential oversight, it seems.  This is a pretty common worry, and the comments at the link, as of now, are pretty common too.

"well rates are so low why would you not?"

"This is not going to end well."

Even the apologists seem to accept the premise.

"doesn't seem too worrisome, optimal capital structure altered by rate enviro. Not overly leveraged, could raise equity if need b"

Even though we've been hearing for years now that corporations are using low interest rates to leverage up, nobody seems to notice that leverage, according to this measure, has been very low for years while rates have been low.  Attribution error and confirmation bias are strong enough not to notice that this graph tells an improbable tale of corporations suddenly increasing their debt levels by 50% over just a few months after being very tepidly leveraged for a decade.

It is true that huge spikes in leverage appear to presage contractions.  On that I can agree that this chart is useful.  If we take a deep breath, though, what we see is a relatively flat level of leverage through the 1980s.  Then, at the onset of the 1990 recession, leverage shot up.  It moved back down to that typical level of about 1.2x EBITDA until it shot up again during the internet boom, with a second spike in the 2001 recession.

After that, leverage fell to practically half the 1980s levels, after which it moved back to about 0.9x.  Then it spiked again during the 2008 recession.  Then it dropped again, first to about 0.8x, then recovering to about 1.0x, before the recent spike to 1.6x.

Source
What's going on here?  What's going on is that debt levels are a pretty boring, stable factor, but profits are volatile and dependent on nominal national income levels.

What we are seeing here aren't surges of debt.  We are seeing collapses in profit.

The first graph here compares corporate debt ("credit market instruments") to corporate equity values.  The second graph compares corporate debt to corporate profit.


Source
In every case where leverage surged, it was falling profit that was causing it.  What causes profit to fall sharply?  This is almost entirely a monetary phenomenon.  Other factors, like debt levels and income shares, tend to evolve at a glacial pace.

So, every time nominal incomes start to disappoint, the first incomes to be affected are profits.  And, when this causes leverage to rise, the broad response is, "Oh, look.  Corporations are taking on too much risk.  This is going to be bad.  We better pull back the reins before they go any farther."

Is it possible to find a middle ground, where we counter softness in corporate profit without leading to high inflation, like in the 1970s?  I don't know.  What I do know is that what we are doing is a misidentification and a mistake.  The question here shouldn't be, "How hard do we pull back?"  The question should be, "How much can we accommodate before we risk inflation?"

The questions that guide policy now aren't even pointing in the right direction.  This was catastrophic in 2006-2008.

This is one of the advantages of NGDP level targeting.  It naturally pulls us in the right direction.  Not because it is some brilliant and difficult targeting scheme, but because it keeps us from doing so much damage.  It's like investing with passive rebalancing.  Literally doing nothing is better than what you would have done if you were trying to pay attention.  There isn't anything incredible about passive investing.  It effectively trades you a bottle of water for the Molotov cocktail you were reaching for.  If that is a benefit to us regarding our own hard-earned money, imagine how much we need it regarding our public positions about what other people are doing with their money.