Friday, October 21, 2016

Signs of Recession

Bill McBride notices a cool down in the apartment market.  All four measures of market tightness from NMHC fell sharply in the 3rd quarter.  He seems to see this in real terms, as a trend shift in supply and demand, where supply has finally caught up to demand.  Multi-unit building has been relatively strong compared to the previous highly constrained couple of decades.  But, of course, housing starts in general are very low.  There is no way that the supply of homes has caught up to demand.

Here is the chart from Calculated Risk.

Rent inflation remains high, and appears to still be climbing, although the CPI rent measure can lag somewhat.  Mortgages outstanding are just barely growing and homeownership is still dropping, so there is no sign that the single family market is capturing any extra housing demand.

Maybe rent inflation will begin to wane.  But, if it does, I think this will be a sign of generally nominal contraction.

Notice that this level of looseness in the apartment market has previously been associated with the beginning of recessions.  I don't think this has as much to do with real housing supply as it has to do with money.  We are at the beginning of a nominal downshift, and this is one sign of it.  There is no lack of demand for housing.  There is a nascent decline in nominal activity.

Here, it may be worth revisiting BEA statistics on housing expenditures.  Nominal housing expenditures have run pretty close to 18% of PCE for 35 years.  It spiked in 2008-2010, because housing expenditures are sticky and nominal incomes dropped faster than households could adjust.  Consider this long-term flat trend.  Also, note that there was absolutely no rise in this measure from 2002-2006, during the supposed housing bubble, when Americans were recklessly overbuilding homes, as the story goes.

The chart title is wrong.  This is a measure of housing PCE as
a proportion of total PCE, not the other way around.
Basically, what the data tells us is that, in an economy burdened with Closed Access housing markets, where housing is perpetually undersupplied, residential investment is a freebie.  It simply transforms inflationary housing expenditures into real housing expenditures.  Oversimplifying a bit, it means that households live in 2,400 square foot homes instead of 2,000 square foot homes, but their expenditures remain the same.  There is nothing unsustainable about that.

The next graph compares the BEA measure for real housing and utilities expenditures to the measure for real total PCE.  Even in 2002-2006, some of that flat nominal spending on housing was inflationary as real housing continued to decline.  The housing bubble was a moral panic about something that really wasn't even happening.  That is not uncommon for moral panics.

Notice that the jumps in real housing expenditures all happen during recessions, and are a result of falling total PCE, not rising real housing expenditures.  The softening of the apartment market appears to insiders like it is a product of their supply and demand factors, and at very local levels, those factors certainly dominate.  But, in the aggregate, softening demand for housing is probably a sign of softening nominal demand in general.  Growth in real PCE has never really even moved back up out of recessionary levels.  Past contractions have tended to drop at least 3%.  Will real PCE growth drop to sub-1% in the next 18 months?

Thursday, October 20, 2016

TBTF isn't the problem. TSTS is.

TSTS = Too Small to Save

The problem with Too Big to Fail, as generally described, is that we have let certain financial firms become so powerful that we were forced to save them in the crisis.  But, the crisis was a liquidity crisis.  The collapse of the housing market and the related collapse of the subprime mortgage market were products of contractionary monetary and credit policies.  This shouldn't be a controversial statement.  Policy makers at the Fed and the Treasury, plus just about everyone who either supports or questions Fed policies during the boom and bust, have explicitly stated that home prices had to collapse, that the Fed could not provide support for nominal economic activity in 2006 and 2007 because that would be bailing out irresponsible investors and lenders.  It is a matter of public consensus that policies in 2006 and 2007 could have lent support to housing markets and we chose not to, in order to impose discipline on the market.

I suspect that few readers will regard that last sentence as false.  Most will regard it as an obvious statement of wisdom.  At this point, just typing it sort of makes my blood boil.  Maybe a few of you join me on that.

Below the fold is an extended excerpt from Ben Bernanke's "The Courage to Act", about events in early 2008 (pg. 202-205):

Tuesday, October 11, 2016

Book step 1.

The first draft of the manuscript is done.  Blogging will be light this week, but I suspect as I decompress and look around, the next couple of weeks will be a flood of things I wish I'd included.  A couple have already occurred to me.  Like, concepts or visuals that seem like they should have come to me before, now that I've thought of them.  I'll post them when I can.

Thursday, October 6, 2016

Housing: Part 181 - Predatory Lending in the bubble

Here are a couple of old graphs from the Survey of Consumer Finances that I don't think I posted before.

First is homeownership by education.

Second is homeownership by occupation.

Remember all those stories in the papers back during the bubble about all those doctors and lawyers and accountants being duped into buying homes?  Remember all those poor souls who were tricked into mortgages that anybody could tell you were too complicated for someone with a Bachelor's Degree to understand?

Basically all the new homeownership went to professionals and owners with a college degree.

Homeownership has declined in the bust in every category.  But, really, it's such a small price to pay in order to teach those predatory lenders that you don't go around cashing checks on the backs of college graduates and doctors who can't properly manage their own affairs.

Those high school drop outs and service employees will be fine.  They'll bounce back.  They are powerful enough in this rigged system to come out on top in the end.  They kept themselves out of that nasty housing bubble, didn't they?  Let's just hope those college graduates don't start getting crazy again.  We'll have to do some macroprudence to keep them where they belong.

Here's another good one.
Income quintiles

Tuesday, October 4, 2016

Our peculiar housing problem.

I saw this op-ed by a Manhattan city council member. (HT:MY)  The op-ed mentions the recent report from the President Obama's Council of Economic Advisers about the urban housing problem.  The recent reports from the President's staff on housing and occupational licensing really have been unusually lucid and clear-headed.

The Manhattan City Council member, Helen Rosenthal seems to agree that the report is well done.  But, she adds this caveat:
But the White House’s toolkit falls woefully short in that it completely ignores a rapidly growing threat to affordable housing in New York City and across America: short-term rental of residences on platforms like Airbnb.
In his op-ed, Jason Furman succinctly points out that “basic economic theory predicts that when the supply of a good is constrained, its price rises and the quantity available falls.” Airbnb is the prime offender of this basic economic tenet in that it facilitates the widespread removal of housing from the New York City market, constraining supply and driving rent through the roof.
But, we also have the problem that developers only want to build new "market rate" units for the "luxury" market, so when supply increases, it simply draws in more luxury tenants, increasing local rents.

It appears that, from London to Los Angeles, the West's major cities have encountered a strange happenstance.  A v-shaped demand curve that just happens to be centered at the current level of supply.

What defines a "luxury" good?  My stab at a definition would be, "A luxury good is a good that confers high status because of limited supply."  We should probably put a moratorium on the production of new luxury goods until we can figure this mystery out.

Wednesday, September 28, 2016

Housing: Part 180 - The association of housing dislocations with deregulation is pernicious.

From the current draft of the manuscript:
To the extent that fiscal or demand side policies have an effect, the removal of owner-occupier tax benefits and implementation of higher property tax rates can remove some volatility in home prices - and the Open Access cities tend to utilize some of those policies. But, these policies work by changing the underlying intrinsic value of properties. They allow the price mechanism to work. They don’t bring prices down by blocking access to ownership. They bring prices down by creating access! The association of housing dislocations with deregulation is pernicious. Closed Access cities in the boom had deregulated demand and regulated supply. Open Access cities in the boom had both deregulated supply and demand. Now, because of limitations on mortgage lending, Closed Access cities have both regulated supply and demand, and Open Access cities have deregulated supply and regulated demand. Which of those four contexts is the just, fair, and functional context? Is there any question?

The United States has imposed the worst set of policies at every step of the shifting housing market. First, we imposed severe supply constraints in our most economically dynamic cities and combined that with an innovative financial sector that created financial access to those highly sought after markets – sometimes with securities that contained risky terms like low down payments. Then we imposed financial suppression, but not by eliminating favorable tax treatments or other reductions to the financial advantage of owning property. The set of responses we imposed have resulted in a dysfunctional mortgage market where value is not the constraining factor in housing demand – access is. Qualifying for a mortgage has become more constraining than being able to afford a mortgage. We have imposed both supply and demand shocks in dysfunctional ways. Instead of creating a housing market where buyers can make decisions on the margin, we have created a binary market. Can I get a rent controlled apartment or not? Can I satisfy all of the local interest groups to build a new condo building or not? Can I qualify for a mortgage or not? Do I initiate a short sale and put the negative equity on the bank or not? Do we make a go of it one more year in the Closed Access city or migrate?

Binary decisions lead to stress, anger, and social dissonance. Policy should always aim for allowing decisions to be made on the margin. This is the foundation of a liberal, civilized society. Even worse than the high costs created by limited supply is the lack of marginal choices.

Monday, September 26, 2016

The Closed Access problem in pictures.

I don't know the data source on these, but @PatrickRuffini posted these maps on twitter showing the geographic concentration of college degrees among millennials.  It's a great visualization of the new value of the central cities, and the brain drain to the Closed Access metro areas.

There is some concentration of educated millennials in Chicago, but it looks less blue (educated) than the Closed Access cities.  Chicago doesn't really qualify as a Closed Access city - they build a decent number of homes and rents and prices aren't crazy.  Chicago is sort of an interesting city.  It has its problems.  But, it has the advantage of density still as a draw.  How much of the decline in crime in the Closed Access cities is related to their exclusive housing policies and the massive outmigration of their poor and less educated residents.  Is Chicago suffering more from our current sources of social strife because they didn't passively kick out the riff-raff like the other major cities?

Washington, DC has the most extreme concentration of educated millennials.  Washington isn't a Closed Access city.  Rents are high, but they aren't high as a proportion of incomes.  In Washington, the high incomes come from political rents and those incomes are used to bid up rents, as opposed to the Closed Access cities, where incomes are from competitive industries, but workers have to spend those incomes on uncomfortably high rents in order to have access to those industries.

In California, the large scale segregation is clear here.  The educated millennials have filled in the coastal metropolises, except for a few of the worst parts of LA.  And, those without degrees have been pushed out to the Inland Empire.

In the south, there is a concentration in the Research Triangle in North Carolina, but there aren't any Closed Access MSAs in the south.  Florida generally has a low concentration of education, which follows along with the migration patterns I have found.  It appears to serve the same function for the Northeast as Arizona, Nevada, and the Inland Empire do for the West - the main destination for out-migrants who are priced out of the entire Closed Access regions.

One takeaway that I think these visualizations help to notice is that these cities don't have high incomes and high levels of education because of their local education policies.  It's not like there aren't universities in the rest of the country and these cities are sending all of their public school children to local colleges.

Americans are being educated across the country, and then, they are moving to the Closed Access cities after they are educated.  To a certain extent, that has always been the case.  What has changed is that this has become even more pronounced.  And, these cities used to be centers of working class opportunity, too.  But, they aren't any more.  They are now sources of working class stress, and they keep dumping hundreds of thousands of stressed working class households on the rest of the country instead of being a source of working class opportunity.

I touch on this in the book.  Autor, Dorn, Hanson, et. al. have been publishing research about labor rigidities that have left many communities stagnant.  They blame the loss of manufacturing to Chinese competition.  But, why did previous generations of displaced laborers not suffer the same rigidities?  Why is China different?

I think the reason is that (1) much of the trade deficit is a product of the closed access housing problem because American firms earning economic rents from the limited access orders in those cities are earning excess profits on foreign revenues.  Those profits fund the trade deficit.  And (2) the natural economic healing that should happen in the face of economic dislocations is blocked by Closed Access housing.  When the transition out of agriculture happened, working class laborers moved to the cities to work in factories.  Today, the same transition would happen, but they would be moving to the cities to work in non-tradable sectors - service sectors (including residential construction!).  But, today, they are outbid for the limited housing, so we are imposing labor market rigidities on our most vulnerable communities.

Thursday, September 22, 2016

Monetary Policy is like backing up a trailer.

I like to think of monetary policy like backing up a trailer.  In this graph of interest rates and GDP growth, think of the Federal Reserve as backing up a trailer through time.  When the trailer goes to the right, inflation and interest rates go up.  When the trailer goes to the left, inflation and interest rates go down.

The truck is short term rates.  The Fed has direct control of the steering wheel.  The trailor is long term interest rates.  The Fed only has indirect control of the direction the trailor is going.
In the 1970s, the Fed was slightly biased towards accommodation, so as the trailer started to veer right (long term rates rising), they would turn the steering wheel to the right.  But, they wouldn't steer it far enough to get the trailer to start turning left again.  So, as happens when you back up a trailer, interest rates would just keep moving in the same direction.
Eventually, they would turn past the tipping point, and the trailer would veer back to the left (long term rates falling).  Then, just as with a trailer, they would have to quickly turn back to the left (lower short term rates) in order to keep the momentum from swinging to far in the other direction.
In 1981, Volker took a very hard turn to the right.  He really cranked that wheel.  Then he took a hard turn to the left, then straightened it out.  It was a little wobbly, as backing up always is, but for the next 30 years, the Fed was backing up on a vector slightly to the left.
In the 1980s and 1990s, if the trailer started veering left, the Fed would turn left enough to get straightened out again, but that was about it.  They would turn the wheel back to the right and then straighten it before it got moving too far to the right.
In 2002, they straightened out the wheel, before the trailer started turning right.  Then, while the trailer was still basically going straight, they started turning the steering wheel to the right.  NGDP was moving along at 6% or so with no sign of acceleration and long term interest rates were moving along at 4% with no sign of acceleration.
Misunderstandings about the causes of the housing bubble made everybody freak out.  We made ad hoc theories about how low short term rates cause asset bubbles, even though the NASDAQ bubble had just happened 5 years earlier while both short and long term real rates were relatively high.  Even though housing Price/Rent ratios had been pretty high in the 1970s and 80s with double digit mortgage rates.  Even though inflation (especially outside of shelter inflation) was low.  We reasoned from a price change about housing and ignored every other indicator there was, and started cranking that steering wheel to the right.
The inevitable happened in 2007.  And, when the trailer took a hard turn to the left, the Fed reacted by turning the steering wheel sharply to the left.  But, when a trailer gets that far from straight, you have to turn that wheel like crazy to correct it.  It sure felt like the Fed was turning the wheel like crazy, but they never really even turned enough to the left to get the trailer straightened out.  When we hit the zero lower bound, we were jackknifed.
QE helped to get things straightened out a little.  But, with a few wiggles along the way, the trailer has basically spent the last decade still veering to the left.  Now, we are in an even worse position than we were in 2004.  The trailer hasn't even straightened out yet.  It's still veering left, and yet the Fed has started turning the wheel to the right already!  GDP growth and long term rates are giving a clear signal.  We are so wound up, we will be jackknifed again before the Fed has time to even crank the wheel back to the left.  When that happens, I just hope they see what's happening quickly enough, and have the resolve to counter with the QE to end all QEs until this thing gets straightened out.
But, considering that some Fed officials still talk as it they had the steering wheel pinned to the left in 2008, when they objectively had straightened it out at 2% as the trailer was careening for the ditch, I'm not sure we can count on that.
In the meantime, much of the public, including the financial community, is standing along the road, "helping", saying, "Yeah.  Crank 'er right.  You got it.  Give 'er a good hard turn."  All I have to say is, when Wall Street layoffs start coming down, I hope the former fixed income traders that have been "helping" don't go into trucking.

Tuesday, September 20, 2016

Housing: Part 179 - Prosecuting the Banksters

Elizabeth Warren wants to know why the FBI "failed to hold the individuals and companies most responsible for the financial crisis and the Great Recession accountable."

She has posted letters to the FBI and to the DOJ Inspector General, citing potential illegal activities at 14 corporations from the FCIC report, which the DOJ has declined to prosecute.

In the 9 of the 11 referrals that refer to corporate activities, where dates are referenced they range from August 2006 to the end of 2007.  This is common in the complaints about wrong-doing.  The reason is, securities from 2005 and before performed pretty well.  There are few who would have standing to complain.

My question is, how can you place responsibility for the crisis on banks that were either trying to place mortgages in a declining market or trying to sell securities whose values were collapsing?  Clearly the collapse happened before these activities were happening.  The causation here is backwards.

I'm sure a common reaction to this is that malfeasance was happening before 2006, but that, in the words of Warren Buffett, you don't know who is swimming without trunks until the tide goes out.  That's all well and good as a presumption, but this is simply question begging.

I say that it was the collapse of credit that caused the crisis, not a boom in credit.  That may seem wrong, but referring to a bunch of desperation moves during the collapse does nothing to address this question.  The rise in prices is frequently taken as proof itself that credit expansion created an unsustainable market.  But, at this point, there is plenty of academic work showing that credit was a passive factor.  This requires more than a presumption.  It requires evidence.

The other 2 of Warren's 11 points refer to activities at the GSEs.  Citing the FCIC: "Fannie Mae may have overstated assets, earnings and capital through various accounting improprieties. . . [and] a failure to disclose accurate information about the state of risk management at Fannie Mae."
Fannie and Freddie were actually very conservative during the boom.  LTVs and FICO scores were becoming less aggressive and the GSEs lost a significant amount of market share, which they only began to regain as private lenders were reeling during the early part of the housing contraction.

But the greatest irony here is that the first round of pressure coming from housing boom angst was directed at the GSEs in 2004.  They were accused of managing earnings at the time.  Among their sins was overstating their loss reserves and underreporting their earnings so that they would have more room to take losses without it affecting future stated profits.  The CEOs were driven out during that round of pressure.  It took until 2007 and early 2008 for the CEOs to settle their cases.  Both of them agreed to make donations to funds meant to help suffering home owners.

Now, their successors are being blamed for understating loss reserves literally at the same time that they were paying fines for overstating previous loss reserves.  It's kind of like the joke, if your price is too high it's gouging, if it's too low, it's predatory pricing, and if it's the same, it's collusion.  I think we can safely say that there was no functional way to be the CEO of a GSE from 1998 to 2008 without being accused of criminality.

I think there is something here regarding the problem we continue to have with mortgage markets that continue to be inaccessible to middle class homebuyers.  There aren't any hard and fast rules directing banks to lock them out of credit.  But, there are a lot of vague liabilities attached to it.  There is so much profit to be made making mortgages to owner-occupiers in the bottom half of the housing market.  It is perplexing to me that we haven't seen more activity in the market, even if it would have to be outside the securitization market and outside commercial banking.  Yet, it doesn't seem to be developing.

But, the limits keeping marginally credit-worthy households from getting mortgages may not be quantifiable.  If you were an analyst at a bank, and you presented a report to the head of the mortgage division about how much money there is to be made in middle income mortgages, he's going to take it to the CEO, who will have it on his desk, next to a letter from a US Senator asking pointedly why he isn't in jail.  That's a market that's not about to clear.

I think this is another aspect of the issue that fits in the North, Wallis, and Weingast limited access order framework.  There is a lot of risk being imposed here through the discretion of powerful people.  And, it's got the economy tied up in knots, hurting the most vulnerable households the most, as limited access orders and discretion of power brokers usually does.

I suggest writing in "dart throwing monkey" in November.  It's not optimal, but it would be a huge step in the right direction.  It works for portfolio management.  Why wouldn't the same be true of governance, especially when discretion, grudge-bearing, and liquidationism are the order of the day.

Monday, September 19, 2016

Socialized Gains and Privatized Losses

I think there is general consensus that the GSEs could be transitioned into a sort of public utility that issues guarantees on conventional mortgages.  The private/public setup was a mistake.  Back when it was set up, it made some sense, in that there was a need for a national entity with a capital base to provide a liquid market for mortgage securities.  Financial markets have matured a lot since then, and there really isn't much need for a capital bearing source of liquidity.  In an emergency, the Federal Reserve has now normalized the purchase of MBS as a monetary activity, so to the extent that emergency liquidity is useful, the Fed appears to be able to support the MBS market.

I think the Federal Reserve is actually the correct place for the GSE utility.  The guarantee function is really a purely monetary function.  The guarantee fees are a sort of seigniorage.  The utility could be run at a slight profit, much as current Fed operations are.  Occasionally, there might be a contraction so severe that the cost of those guarantees is more than the income.  In those cases, the Fed can open up its magic vault and pull out some cash.  It seems like this requires capital.  But, really, that idea is just a vestigial requirement related to private ownership.  Private firms don't have magic vaults.  If you think the GSEs need capital to fund their guarantee business, then just imagine that the Fed keeps a trillion dollar bill in that magic vault for "capital".

Having the guarantee business at the Fed also matches accountability and responsibility, since, really, if losses are so bad that the GSEs are taking them, something has gone wrong in the management of the national nominal economy.

One of the problems with the private/public setup was that, when public support for markets was most needed, the public was angry at financiers and profiteers.  The last thing they were going to stand for was some sort of public support that was going to boost the profits of shareholders.

This is a real public policy problem, because equity holders basically own systemic risk.  That is conceptually where all the excess returns of equity ownership come from.  Any public policy that serves to reduce systemic risk is going to, first and foremost, benefit equity holders.  In 2007 or 2008, if the Treasury had announced that they would stand by and promise to serve as a creditor to the GSEs, if necessary, and that they would encourage the GSEs to lend liberally in the meantime, while the Federal Reserve goosed the money supply to aim for 2% to 4% inflation until markets stabilized, they would have been pilloried for supporting the bankers that did this to us.

The only policy that would have provided stability was off limits because the public saw it as an example of privatized profits and socialized losses.  Yet, if the federal government had implemented those policies, there would not have been socialized losses.  It's plausible that not a single penny would have been required to support the GSEs if nominal support had been introduced in early 2008 or earlier.  The losses only came because there were a lack of policies for nominal stability.

Isn't it funny how much concern there is about privatized profits and socialized losses, yet nobody ever worries about socialized profits and privatized losses?

Think of President Obama's "You didn't build that." speech, or similar rhetorical justifications for marginal tax rates of 50% or more.  They are built on the reasonable idea that property rights, a function legal system, and infrastructure are dependent on a well-funded public sector.  These are socialized profits.

Privatized profits should be paired with privatized losses.

But, when losses are widespread.  When they engulf entire markets and industries, this is by definition a systemic, public issue.  In this case, losses should be socialized.  When this happens, shouldn't those who supported socialized profits be coming out of the woodwork to support social support for all those taxpayers who had been socializing their profits during the expansion?

Red: Effective Corporate Tax Rate
Green: Corporate profits as share of GDI
It's even worse than that.  Our tax policies on capital income are pro-cyclical.  When corporate incomes fall - an early indicator of economic contraction - our effective corporate tax rate goes up.  That is because our tax code specifically socializes profits and privatizes losses.  Most corporate losses have to be carried forward as write-offs against future profits.  In fact, the trigger that put the GSEs under their capital requirements when they were taken into conservatorship was the write off of tax assets.  Regulators said that future foreclosures would be so numerous that the GSEs were likely never to be profitable again in the near future, and so they would never be able write off future income taxes against their losses.  (And, yes, less than two weeks later, the Federal Reserve held the target rate at 2% the day after Lehman failed because they were worried about inflation at the same time the Treasury was expecting millions of future foreclosures.)

So, while everyone is worried about privatized profits and socialized losses, we have actually socialized profits and privatized losses, and I would argue that this was a primary cause of the crisis - much more important than underwriting in 2005.  We implemented trickle down economics.  We insisted on enforcing systemic losses, because those bankers did this to us and they had to pay.  And, wouldn't you know it, in 2009, there was an employment crisis.  If one didn't know better, you might almost believe there was some causality there.

It's almost like business cycle policy isn't about stability.  Imagine if home prices hadn't dropped by a quarter.  Especially imagine if home prices in low priced neighborhoods, hadn't dropped.  That was the most difficult part of the crisis.  It was really late 2008 and 2009 before we were able to knock low priced housing prices fully into submission.  A lot of privatized losses had to be created to do that - mostly by then in the form of lost home equity of working class homeowners.  We may be entering a secular age, but even a secular nation requires mortification of the flesh.