Thursday, July 20, 2017

June 2017 CPI

The story continues.  Shelter inflation (YOY) remains at 3.3% and core minus shelter inflation remains at 0.6%.  Core minus shelter inflation has been in a fairly steady decline since the first rate increase in December 2015.  It seems increasingly plausible that the target Fed rate is above the natural rate so that inflation will continue to decline unless the target rate is decreased.  That isn't going to happen.  The available choices appear to be either raising the Fed Funds rate or keeping it at about 1%.  If it needs to be decreased, the Fed will be behind the curve.  I continue to tentatively expect a slow-motion contraction, although without much movement in prices of the major asset classes.  Bond yields don't have much room to fall, housing is being held in depression mode by credit policies, and I don't see any reason at this point for equities to collapse, although that would depend on global economies, future NGDP shifts, etc.

Hsieh and Moretti have made several attempts at estimating the loss of economic activity due to Closed Access housing policies, ranging from around 10% to much higher estimates.

It seems to me that simply comparing consumer inflation with and without shelter inflation gives a good first estimate of the lower range of this cost.  There was a jump in the late 1970s of about 10% in consumer costs due to rent inflation and since the mid 1990s, there has been another rise of 10% to 15%, with a brief pause from 2008 to 2012 because of the foreclosure crisis.  Considering that this doesn't reflect any particular rise in building costs, this seems like a decent estimate of the payment of economic rents to Closed Access real estate owners.

That is just the measure of the extra costs to workers and firms that reside in those cities.  There are additional costs to the US economy due to the exclusion of workers from those cities - workers that didn't have the opportunity to earn additional income which would then be funneled to urban real estate owners because the high cost led them to remain in other cities.  Maybe the higher estimates from Hsieh and Moretti of something like 50% since the mid 1960s aren't out of line.

Wednesday, July 19, 2017

Housing: Part 243 - A Brilliant Argument for More Regulation

I finally got around to watching "Inside Job", the documentary that putatively is about the danger of financial deregulation.  The show was surprisingly effective.

Now, as you might expect, the surface content itself was not particularly moving.  The documentary format made it difficult to go into the details of various regulatory regimes, so this complex topic was diluted down to a simple binary ideal of "regulation" versus "deregulation" that is essentially devoid of meaning.  There was no mention of the importance of housing supply constraints, which is to be expected in such a production.  The focus on CDOs as the core trigger of the housing bubble is obviously problematic since almost all mortgage-based CDO activity happened after home prices had peaked.  And apart from the introductory focus on Iceland, no attempt is made to explain how these deregulatory trends could have happened simultaneously in Canada, the UK, Australia, etc. and would apparently continue to be important factors in those countries.  No mention is made of CDO markets in those countries, though one must assume that its explanatory power in the US is such that it would surely be paralleled in those markets.

But, that is what was brilliant about the documentary.  In spite of all of those weaknesses, the material was compelling and convincing.  The material about sex and drugs on Wall Street effectively packaged the villains of the production for an audience who would already be prone to accept them as villains.  This allowed the effective use of the visual medium to imply causation by mentioning activities of the villains over time alongside selected economic data.

As the viewer proceeds through the production, the subtle brilliance of the director's framing becomes more clear.  Documentary filmmaking is a nearly completely unregulated industry.  We don't even have a regulatory body charged with the review of the content in these sorts of productions.  Yet, clearly, this is a dangerous and powerful medium, capable of molding the consensus of an electorate that understandably will not be able to check the veracity of the information that has been presented.  Documentaries of this type clearly do need to be regulated.  In fact, considering the potential power of the imagery, and the difficulty of dealing with subtle or deep facets of the subject matter, it is probably advisable to simply ban the medium altogether.  Do I even need to mention the famous problem of the abuse of sex and drugs in the film industry?

The weaknesses of the film, then, becomes an ironic defense of regulation that is an even more powerful argument than the actual content of the film.  Brilliant.

I had to check imdb to see if Charlie Kaufman was involved.  It should not go unnoticed that Kaufman has little or no credited professional activity in 2010 when the film was released.  I suspect that he was intimately involved with the project in an uncredited capacity.

A classic signature of Kaufman's handiwork is that the near universal praise for the film among critics and viewers actually ends up serving the ironic point of the film.  This may be his best work, taking the meta-irony even deeper than "Synecdoche, New York" or "Adaptation".  It's enough to make you wonder if Kaufman found a secret portal into credited director, Charles Ferguson's, psyche on the 7½ floor of the Mertin-Flemmer Building.

Monday, July 17, 2017

Economics Detective Podcast

Garrett Peterson over at the Economics Detective kindly asked me to be a guest on his podcast.  We had a great conversation.  I think Garrett managed to help me hit most of the main points of my housing research.

Podcast at the link.

Housing: Part 242 - Incomes and inequality over time

I saw this recently on Twitter, and it always strikes me as odd when this data about tax rates is used to comment on income inequality.  If this is true, then it is a confirmation of the Laffer Curve.  In fact, for tax rates to have had such strong effects on relative incomes, elasticity of supply of high skilled labor and high return capital must be very high.  We see the same thing at the bottom end of the income spectrum.  Strengthening the safety net in the 1960s and after effectively increased marginal tax rates on poor households, when both taxes and subsidies are accounted for.  And, after these shifts in marginal tax rates, we saw this amazing reversal from the entire history of human economic activity.  Leisure time has flip-flopped.  Now, workers with high incomes work more and workers with lower incomes work less.

So, it seems to me that those who might argue for more progressive income taxes based on these trends must make that argument from a labor supply elasticity presumption.  They must presume that the Laffer Curve is relevant here.  And, the argument, it seems to me, would be that the extra production is somehow being captured by the highly skilled and connected workers, and isn't flowing out to the rest of the labor force or to consumers.  The argument would have to start with the idea that, with higher taxes, those high earners would work or invest less.

Now, to me, that seems like a bit of an uncomfortable position.  And, I think the housing story helps to allay that discomfort.  There seem to be two baskets of countries - those that still have strong manufacturing sectors, trade surpluses, and less income growth over the past two or three decades, and those that have shrinking manufacturing sectors, trade deficits, and more income growth over the past two or three decades.  The former countries tended to not have housing bubbles and the latter group did.

According to Mike Konczal's scatterplot above, it appears that we can add one more characteristic to these two baskets of countries.  The former group has not lowered tax rates on high earners and the latter group has.

The larger story here is that the post-industrial economy requires urbanization.  And, the urban housing problem is obstructing that transition.  Countries with a growth orientation are the countries butting up against that obstruction.

This does leave one mystery though, because housing supply is clearly central to this story.  Japan and Germany clearly have fewer obstacles to housing expansion.  So, which way does the causality run?  Do countries moving more aggressively into post-industrial production also happen to develop obstacles to urban homebuilding?  Or do countries that are still more focused on the manufacturing economy also happen to have fewer limits to urban housing supply?  I don't see any satisfying reasons why this correlation should be true with either direction of causality.  Yet, the pattern is there.  The pattern is even there within the US.  Cities at the center of post-industrial economic growth have high incomes and extensive limits on new housing while the other cities do not tend to have those limits to housing expansion.

Strange.  But, the correlation is striking.  Every time I look at these sorts of measures, like in the Fred graph above, they seem to line up quite nicely into these two groups.

Maybe this is an example of trade management.  An argument is sometimes made that the Asian economic success stories developed with the help of some managed protectionism.  In an age built on human capital, maybe housing constrictions serve as that protectionism, limiting competition among the firms that utilize that labor.  Maybe post-industrial firms are attracted to these protected markets.  Maybe this problem of income inequality and housing affordability is a confirmation of the idea of managed protectionism for nascent industries.

Friday, July 14, 2017

Housing: Part 241 - Home Prices compared to wages

Bill McBride at Calculated Risk has a recent post that gives a glimpse into how important understanding the housing supply problem is.  This isn't meant to pick on McBride.  His post will seem quite obvious and reasonable to practically any reader.

In the post, he tracks a ratio of home prices to wages.  This ratio had a range of about 20% from peak to trough before the bubble.  At the turn of the century, it was down at the bottom of that long term range.  Then, it rapidly increased by about 50%.  Then it collapsed, and has slowly risen back toward the top of the long term range.

McBride comments, "Going forward, I think it would be a positive if wages outpaced, or at least kept pace with house prices increases for a few years."

That certainly would be a positive, but it would only be a positive if that happened because we solved the supply problem.  If we don't solve the supply problem, then in most reasonable scenarios of economic growth, this ratio will inevitably grow.  That is because economic growth will be centered in our innovation centers, which now have limited access so that workers must bid up the housing stock to access those labor markets.  Economic opportunity is arbitrarily limited, so payment for access to that will naturally scale up as the American economy expands.

This is like saying, "Going forward, I think it would be a positive if wages outpaced, or at least kept pace with taxi medallion prices for a few years."  That is actually happening now because of disruptors like Lyft and Uber.  And that is why it is a good thing that wages are outpacing taxi medallion prices.

But, if there wasn't disruption, then the value of taxi medallions would simply scale with the amount of activity happening in places like New York City.  It would simply be an asset that is correlated with economic activity at more than a 1:1 ratio.

Since we have incorrectly blamed housing on credit and money instead of on supply, there is this bi-partisan reaction now to basically any organic economic development.  Imagine if Manhattan had a policy of maintaining a fixed supply of taxi medallions and tracking their value.  Then, every time their values began to rise, Manhattan would implement "macroprudential" policies known to slow economic growth and employment.

We're afraid of our own shadows, and we will continue to be until we get this right.

The strange thing is that nobody seems curious about why this is happening.  It's bubbles, bubbles everywhere, and the idea that lenders or speculators in our midst are enticed into madness is apparently so satisfying that observers rarely seem motivated to ask "why?".

Tuesday, July 11, 2017

The Phillips Curve is real.

There are many subtle ways in which we have an intuition to think in terms of competing factions instead of cooperating factions.  Generally, where labor and capital are not artificially constrained, our interests are much more aligned than otherwise.

I think this is partly why the Phillips Curve idea is so persistent.  There is this idea that when the economy is growing and unemployment is low, this will lead to inflation, because workers will be able to demand higher wages from employers.

Of course, the problem is that this hasn't shown up in the data for decades.  Some argue that the Phillips Curve is now flat because the Federal Reserve targets a level inflation rate.  That's certainly true.  I would argue that the Phillips Curve is a measure of monetary policy.  If the monetary regime is pro-cyclical, the Phillips Curve will tilt down.

That is in nominal terms.

In real terms, there does seem to be a persistent Phillips Curve that slopes down.  Wages were unusually high in 2008-2009, but generally, before and after the recession, real wage growth and unemployment have moved within a long term relationship.  Real wage growth is a little low, but it has generally moved up the trendline since the bottom of the recession as unemployment has declined.

I noticed that John Hussman beat me to this.  His post from April 2011 has some interesting details about it.  His take on it is that the nominal Phillips Curve is wrong, and on top of that, even if it was operational, the Fed has the causality backwards.  Inflation won't lead to less unemployment.  If anything, less unemployment would lead to inflation.  But, even that is wrong.

The funny thing is that his point in 2011 was that inflation wasn't going to be helpful.  He thought the Fed was too loose and asset prices were too high.  And he didn't want them to keep policy loose in a quest to lower unemployment.  I would say that this point of view has not aged well.  There was a brief dip in the stock market in 2011, but in the six years since that post, total returns on stocks have averaged more than 10% annually and inflation has remained subdued.

I think he has some great points about the Phillips Curve, but I would argue that this is why the Fed shouldn't worry about tightening today.  Low unemployment won't lead to inflation.  I think we can both be right, here, though.  In either case, tightening or loosening, a Phillips Curve justification seems wrong.

I do have a quibble with Hussman - maybe a speculative quibble, but a quibble nonetheless.  He basically makes a supply and demand argument: "very simply, when a useful resource becomes scarce, its price tends to increase relative to the prices of other goods and services."  So, this still has a lot in common with the basic intuition of the Phillips Curve.  These higher wages are coming from a position of negotiating strength.  A nominal Phillips Curve would suggest that those higher wages are being paid for by consumers through higher prices.  A real Phillips Curve suggests that those higher wages are being paid for by employers.  Viewed as a proportion of income, it certainly appears that there is a trade-off between labor compensation and profits.

But, this inverse relationship doesn't show up in absolute measures of income growth.  However, there is a strange relationship of the second derivative.  If the growth rate in corporate profits increases, about two quarters later, labor income will also tend to increase.  On the other hand, if the growth rate in labor compensation increases, profits tend to decrease over the next few quarters.

Yet again, though, this could be a result of monetary policy.  If the Fed manages the business cycle based on a nominal Phillips Curve model, then monetary policy would be creating this correlation between rising wages followed by declining profits.  And declining profits would still lead to declining wages.

This would be ironic, but it makes sense.  Wages tend to be sticky and employment rates are a lagging economic indicator.  Equity owners hold the residual interest.  When economic shifts happen, they feel it first.  So, if the Fed thinks low unemployment is inflationary, and implements contractionary policy with an idea that this will lower inflation, they may be doing the opposite of what they think they are doing.  Instead of moderating wage inflation, they are moderating profits.

And, why would they expect contractionary policy to lower wage inflation?  What mechanism would be at work that would cause shifting monetary postures to play out initially and primarily in wage levels?  The mechanism would have to be falling profits, wouldn't it?  Isn't that the reason firms would be less willing to increase wages?

In this next chart, I compare the unemployment rate (inverted) with a scaled and detrended measure of the real total return on the S&P 500.  There is a clear cyclical relationship here.  In addition, there even appears to be a relationship over time in levels.  This only involves a couple of trend shifts since 1950, so it could be spurious.  But, when secular unemployment rates have been low, corporate valuations have been high and vice versa.

This suggests that there is a sort of Phillips Curve, but higher wages aren't being paid for with higher prices.  And higher wages aren't being paid for with lower profits.  Higher wages are being paid for with higher growth.  And there is enough growth to go around, so that profit expectations are rising as real wages rise.

This makes sense, too.  Quits rise when unemployment is low.  Employment flows into the labor force rise when unemployment is low.  This is not about us vs. them negotiating power.  This is about growth vs. stagnation.  When unemployment is low, workers might have negotiating power, but more importantly, they have the power of exit.  They can more safely test out alternative sources of income.  This is the real power.  Negotiating power is a fixed pie mechanism.  This power to leave is the power to sort better - the power to search more confidently - the power to become more productive.

We are the 100%.  "You go, we go."  When the Fed begins with the opposite presumption, their contractionary impulses hurt us all.  They should let it rip.  I'm not saying that they should aim for high inflation.  I'm just saying, they should stop worrying about things that are just not useful.  There are many reasons why a "hotter" economy might not be inflationary.  I wish we could give that a chance.

Friday, July 7, 2017

Housing: Part 240 - It's great to see some movement in the right direction.

One of my worries is that when my story gets a wider audience, there will be too much defensiveness about the conventional narrative, and my story will just have too many new re-interpretations of the data for many people to accept.

So, it delights me that over the past several months, there seems to have been a lot of positive movement in the direction of YIMBYism, even in California at the state level.  One of the oddities of discourse on this topic is how rent clearly is an important factor in rising Closed Access prices, yet in debates about whether the bubble was caused by credit supply or credit demand, there is rarely any mention of rent at all.  This leaves academics to simply argue about whether it was irrational bankers or irrational borrowers that caused the bubble.

But, among all the factions in post-recession Closed Access cities, there is no debate or question.  Rising rents are the problem.  And, increasingly, the role of supply constrictions is becoming too obvious to deny.  Once that pillar is knocked down, the fa├žade of a credit-fueled bubble destined to collapse crumbles.

Similarly, important people like Narayana Kocherlakota are coming around to key factors in the crisis.  He recently tweeted:
And, the replies, to my mind were weak.  This issue has been astoundingly ignored.  The reason is that we generally came to agreement that the causes of the bubble were almost all forms of American exceptionalism before we fully addressed the empirics.  This tweet is basically the foundational question of an important early chapter in the book.  I'm am very happy that Kocherlakota is already there.  The rest of the story should be more palatable to him now that he's already a few steps in the right direction.

Wednesday, July 5, 2017

Leverage is not a sign of risk seeking.

Building on this post about JW Mason's paper from the other day, I want to discuss debt and business cycles a little more.


It's strange to me how much space debt takes up in our discourse about business cycles.  These don't look like cyclical measures to me.

I think we get closer to something cyclical if we look at equity values.
Something is wrong with the legend.  This is corporate nonfinancial equities / GDP ... Source

Even this is a little hit and miss, but at least we do tend to see some cyclical behavior here.  And this makes more sense.  When you seek risk in your savings, do you invest in fixed income or do you invest in equities?  And, part of what is happening here is that, on an Enterprise Value basis, firms tend to deleverage during expansions, mostly because the value of equities is rising.  Now, if you were a firm, and equity prices were high, and you wanted to raise capital, would you issue more high priced stock or would you issue more debt?  Why would you leverage up in this context?  You might respond that if interest rates are low, then bonds are basically fetching high prices too.  But, at the end of economic expansions, interest rates tend to be high.  They are low now, but that is because savers are risk averse now.  (There is also an upward drift in equity/GDP because equities increasingly reflect the value of foreign operations.)

How weird is it that in 2006, after a few years of middling stock market returns, when there was a massive influx of savings into AAA securities, we associated that with risk seeking behavior?  Why do we do that?

There is a recent example that might illuminate this issue.  Recently, many people noted that Tesla had a larger market capitalization than Ford. I was pretty amazed by that, so I looked up their financials.

Ford has a market cap of $46 billion plus $143 billion in debt. Tesla has a market cap of $58 billion and $7 billion in debt.  In other words, Ford is 3 times the size of Tesla ($189 billion vs. $65 billion), but claims on their assets are mostly in the form of debt instead of equity.

Now, do you suppose risk-seeking investors choose to invest in Ford over Tesla because they like how the high level of leverage gives them higher returns even though that leverage is dangerous?

Do you think a risk-seeking, over-optimistic market would have more Fords or more Teslas?  And, thus, do you think a risk-seeking, over-optimistic market would have more debt or less debt?  Would it have more equity or less equity?

Investors in Ford are mostly seeking a safe, certain cash flow.  They see some big giant buildings with expensive equipment and they figure that, even if Ford doesn't make a profit for its shareholders, its likely to earn back most of that investment, in any case.

If investors in Tesla are the risk-takers, then why don't they demand that Tesla sell a bunch of bonds to leverage their investment?  Because that's not what motivates leverage!  What motivates leverage is savers looking for certainty.  And, given the choice between loaning cash to Ford or Tesla, they have a clear preference for Ford.

Think of the madness we engage in when we see a potential approaching economic contraction, and we see rising debt levels, and we react by deciding that sentiment needs to be tamped down.  And, lo and behold, if we do it boldly enough, like we did in 2007 and 2008, lending actually does decline when we tear up the financial system.  And we pat ourselves on the back.  "See.  All that risk-seeking debt led to an inevitable collapse, and now those borrowers are finally deleveraging in the way smart people like us knew they needed to."  And, library shelves fill up with articles about the mystery of why interest rates remain so low after the crisis.

Then, debt wants to grow again, because we are afraid to let the economy grow, so nobody wants to own the residual stake (equity).  And, when debt does grow, we fret that it looks like those risk-taking investors still haven't learned their lesson, and we need to have another contraction to get all that excess borrowing out of the system.

Debt in the housing bubble

Now, think about how this played out in the housing bubble.  I have written before about the CDOs, CDOs-squared, synthetic CDOs, etc.  These are all seen as part of excess borrowing and leverage.  But, the problem was that they couldn't find any borrowers to take the mortgages.  That is the only reason those products developed.  If they could have found mortgage borrowers, they would have just packaged them into new basic RMBSs.  The mortgages would have been sliced and diced into new AAA-securities.  But, since they didn't have any new mortgages, they had to slice and dice the B-rated tranches from the existing mortgage pools to create new AAA-securities.

There are two contradictory claims about the period.  One is that spreads were low because the investors were too sanguine about the potential for falling home prices.  The other is that the portfolio managers who were investing in the AAA-rated securities from those CDOs and the exotic CDO products thought they were getting a free lunch, because they had higher yields, but they had a AAA rating.  So, they bought them, not understanding that they were riskier.

Well, what is it?  Were spreads too low or were spreads higher on those securities than they were on normal AAA-securities?  It can't be both.  This is typical of stories about the time.  It's like the facts don't matter.  If portfolio managers really were systematically fooled, then they would have bid those spreads down.  But, they didn't.  How do I know that?  Well, I really only know that because the people that tell this story always claim it, even though it undermines the story.

But, this isn't even really my main point.  My main point is that actually spreads weren't low.  They were high.  There was all this money chasing AAA-rated securities.  But, they couldn't find mortgage borrowers to take the money.  Normally, if this was the case, how would that problem get solved?  The problem would get solved by lowering the spreads until more borrowers were willing to take the mortgages!

Notice how outrageous it is that, among all the stories of stupid investors who didn't know their risks and unqualified borrowers who were duped into borrowing at predatory rates, it seems that nobody has noticed that the overriding problem of the time was that the market for mortgages wasn't settling at a market clearing yield.  Somehow, the spreads demanded by the investors couldn't go low enough to entice new mortgage borrowers, so that they needed to create the securities with other bonds.

This is because the market was already in disequilibrium.  The reason exotic CDOs were spreading was because lenders were too nervous about home equity to lower their spreads and borrowers were too nervous about it to take on new mortgages.  This was because, already, expectations of future home values were negative enough that expectations of negative equity drove a wedge between lender and borrower too large for a price to settle where all the supply of credit could be utilized.

In the midst of this dislocation, prices held fairly steady through 2006 and the first half of 2007.  How?  In 2005, about 2% of homeowning households were selling and leaving Closed Access cities, on net.  Prices were rising even with that selling pressure.  When mortgage markets started breaking down in 2006, which is when exotic CDOs really took off, that migration stopped.  Buying pressure dropped significantly, but at the same time, so did selling pressure.  Households stopped selling and moving away.  And, of course, housing starts were dropping sharply, which also took pressure off of collapsing demand.

PS. John Cochrane finds a particularly explicit example of this type of thinking regarding debt.

Monday, July 3, 2017

Housing: Part 239 - Homes in Contagion Cities during the housing bubble were Inferior Goods

The motion chart from the previous post really helps to visualize the difference between the Closed Access cities and the Contagion cities.  The bubble in Phoenix happened entirely after the Fed began to hike the Fed Funds rate.

The out-migration from the Closed Access cities had been growing since the late 1990s, and peaked in 2004 and 2005.  This surely was facilitated by nonconventional mortgages which helped households living in the Closed Access cities with high incomes to purchase homes and spread their elbows a bit.  But, you would think this would show up in gross migration flows.  You would think that during this time, more potential in-migrants would be able to buy Closed Access homes, so that there would be an increase in both in- and out-migration among the Closed Access cities.  But, according to IRS data, this wasn't the case.  Closed Access in-migration was low and flat throughout the housing boom.  This is one of several oddities that I think creates some doubt about the centrality of the private securitization boom as a cause of bubble prices and migration patterns.  ACS data, which only goes back to 2005, suggests maybe Closed Access in-migration in the top income quintile increased by about 10,000 households during the peak boom years, with little change among other income quintiles.  This compares to net out-migration at the peak of more than 200,000 households, annually, from the Closed Access cities.

One of the interesting things that I think the motion graph helps to show is that as soon as the Fed began to hike interest rates, price appreciation in LA - especially in the top tier markets - moderated.  And, it was after this moderation that Phoenix prices shot up.  But, we can also see that prices in Phoenix are much lower than in LA.  Here is a line graph of home prices over time, by price quintile.  In 1999, the top quintile of prices in Phoenix were similar to the 4th quintile of prices in LA.  By 2004, top quintile prices in Phoenix were lower than 2nd quintile prices in LA.

We can see the downshift in price appreciation in LA here in 2004, when rates began to rise.  And, at the same time, prices in Phoenix shot up.  But top quintile prices in Phoenix peaked at the end of 2005, still below the median quintile in LA.

Of the more than 200,000 households, net, that migrated out of Closed Access cities in 2005, about 85,000 were homeowners from the top two income quintiles.

Technically, we can call what happened in Phoenix a bubble.  It had the classic ingredients of a bubble - temporarily inelastic supply and demand.  But, this had nothing to do with "easy money" and I'm not sure that it really had much to do with easy credit.  The bubble in Phoenix, ironically, was the very early first signal of the bust.  Homes in Phoenix were inferior goods.  As counterintuitive as this is, this should be uncontroversial when one thinks about it for a moment.  That massive inflow of homebuyers in Phoenix in 2005 were buying downmarket.  They were buying way downmarket.  For the migrant households as a whole, it would have been mathematically impossible to do anything else.

Homeownership and rate of first time buyers were declining at the time.  But, how does this square with prices that continued to rise and mortgages outstanding that continued to rise?

Mortgages continued to rise because those Closed Access sellers were very lightly encumbered.  If your home increases in value from $450,000 to $1,000,000 in just a few years, it would be very difficult to be leveraged even if you tried really hard to be.  So the sellers were mostly claiming equity in those sales.  But, the new buyers would have naturally been more leveraged.  When those 85,000 homeowners left town, they had to be replaced by about 85,000 new homeowners.  Homeownership rates were starting to drop, but they weren't dropping by that  much.  About 2% of homeowners were leaving the Closed Access cities annually.  Homeownership rates shift by fractions of a percent.  Those new homeowners are naturally more leveraged.  That is why mortgage levels continued to grow.

Prices continued to rise in Phoenix because there was a migration surge of buyers massively reducing their housing expenditures.  Prices continued to rise in LA because prices in LA were a rational reflection of future rent values.  Today, it is easier to say that, because as we see in the graph, the most expensive homes in one of the most expensive cities in the country, have risen to new highs, even as mortgage markets have remained suppressed.  Those homes in top tier LA markets in 2006 turned out to be decent investments over the following decade.

This is because it is only in extreme and temporary circumstances that a shift in the number of buyers and sellers will move market prices.  Intrinsic value rules.  In Phoenix, briefly, the number of buyers might have pushed prices out of sustainable levels.  That was not the case in Los Angeles.  Consider that, if mortgage expansion could create a sustained increase in prices at the scale we have seen in the Closed Access cities, that the expansion had to have been so far outside normal ranges that it still pushed prices out of rational valuations, even though before that could happen, it first had to make up for those 85,000 fleeing homeowners.  That seems highly unlikely to me.  That's the jab to the credit fueled explanation for Closed Access home prices.  And the uppercut is the strong price trends in those cities in the decade since the mortgage market collapsed.

Friday, June 30, 2017

Housing: Part 238 - Home Price Changes over time

I've been meaning to try this for some time, and finally got around to it.  This is a motion scatterplot of over 10,000 zip codes from 2000 to 2017, showing how home prices changed through the various stages of the boom and bust.  The measure on the x-axis is median zip code home price.  The measure on the y-axis is the 6 month change in zip code median home price (not annualized, continuously compounded).  I have highlighted LA, New York City, and Phoenix.  (Data from Zillow.)

Closed Access Price Appreciation:

Until late 2003, prices within each MSA tended to rise as a group, and prices in the more expensive MSAs were rising more.  This is the fundamental Closed Access problem.  Expensive cities were becoming more expensive.

Subprime Boom:

Around the end of 2003, we start to see the transition away from the GSEs to the private mortgage securitizations (subprime and Alt. A).  This shift was stronger on the west coast, and we can see here how there is a separation between LA and New York.  Note that initially, LA prices increased as a group.  There still was little difference in top and bottom tier housing markets.  Also, there was little impact in Phoenix at this time.  And, we can see that the effect of the shift to private securitizations was to increase prices in the high cost cities.  The trendline for the aggregate national plot becomes very steep during this phase.  This is because the looser terms of the private securitizations were facilitating home purchases in Closed Access cities by households with high incomes.

Rate Hikes & Subprime Boom:

Fed rate hikes began soon after the private securitization boom began, in June 2004.  As the Fed Funds rate increased, the main effect was a decline in top tier price appreciation in LA.  So, during this period, from mid 2004 to late 2005, there was a big difference between low tier price appreciation and high tier price appreciation in some cities, but in LA, this is because all home prices were rising sharply in 2004, and then high tier price appreciation retreated after the Fed began to raise rates.  It was after the retreat of high tier price appreciation in LA that prices in Phoenix finally shot up.

Now, maybe this is a just-so story.  But, I think this is a case where thinking of Fed policy in terms of interest rates is problematic.  I think we are seeing three separate effects here.  First, as rates continued to rise, migration out of Closed Access cities was very high - for both renters and owners.  NGDP growth was starting to moderate.  Homeownership had peaked and was starting to decline.  And, sentiment was starting to turn south in the housing market, partly because of these factors.  This was leading to tactical selling and outmigration of homeowners.  At the peak, which was during this time, about 2% of Closed Access homeowners were moving out of the Closed Access cities annually, net of in-migration.  That is a significant amount of selling pressure, and I think this is a major factor in the downshift of price appreciation during this time.  And, a lot of that pressure was from households with significant equity positions who had owned their homes for a long time.  It appears that there were a lot of families whose home values were far out of scale with their general income and wealth, and they captured the capital gains as the boom peaked.  These appear to have generally been households that aren't particularly leveraged.  So these sales weren't particularly interest rate sensitive.  They were more sensitive to sentiment and expectations.

Second, in the low tier markets in LA, the private securitization market was still the dominant factor.  It was still funding starter homes in Closed Access cities, although by 2005, the flow of first time homebuyers was starting to decline.  But, it appears that aspirational buyers were still entering the housing market at this time in LA.  Again, this was probably not activity that was particularly rate sensitive.  These loans tend to have higher rates than conventional loans.  And, the Fed Funds rate doesn't necessarily have that strong of an influence on long term mortgage rates.  It definitely didn't during this period.  This lending channel remained strong because it wasn't that sensitive to the Fed Funds rate.

Third, the combination of tactical sellers and priced-out renters both led to a massive outflow of population into cities like Phoenix, and that is the main factor behind Phoenix's late price surge.  Certainly this price surge was also facilitated by the loose terms of the private securitization boom, both for first time buyers and for investors.  But, I think migration explains the timing of these events - why the Phoenix surge was so late in the boom and why it occurred after LA price appreciation had already started to wane.  This is also not related directly to interest rates, which is made clear by the fact that the entire boom in Phoenix happened after the Fed began to raise rates.

So, I don't think interest rates, per se, have much to do with these trends.  Money supply and expectations seem more important.

Inverted Yield Curve & Subprime Boom:

When the yield curve inverted in late 2005, which is an important signal of financial dislocation and coming economic contraction, we see an immediate and sharp reaction in all markets.  Really, this should have been the extent of the contraction.  By the time the CDO panic, there had been a significant amount of monetary tightening.  The yield curve had been inverted for nearly two years with predictable results - declining NGDP growth, declining housing starts and investments, moderating or falling prices, the initial drop in employment growth.

By the end of this period, home prices were beginning to decline, but this decline was led by the top end, both locally and nationally.  Within MSAs, it was high tier markets that tended to fall into declining territory first.  And, nationally, we can see the trendline start to fall below 0%, and it has a negative slope when it does.

CDO Panic

By the time of the CDO panic around August 2007, the private securitization market was dead, and the other mortgage conduits didn't expand to take up the slack.  Since private securitizations had been facilitating entry into Closed Access housing markets, at a national level, the drop in demand was most felt in the expensive cities, so at a national scale, it was expensive markets that dropped the most.  The national trendline really goes negative.  But, within those cities, it was the low tier entry markets that had large numbers of recent new buyers with large mortgages who were vulnerable to default and who were now locked out of mortgage access.  Even though they were in entry markets, this was largely young families with high incomes.  We can infer this because the initial drop in homeownership during this time was among young families with high incomes.

GSE Conservatorship & Financial Crisis

Here we can see how these low tier markets continued to drop for months or years after the GSEs were taken over, while top tier markets stabilized.  We can see this in both axes.  First, we see the long tails down to the left that represent low tier markets that, even in 2009 were declining by 10% or 20% or more, every six months.  And, this is such an extreme drop, we can see those dots moving left over this time, as the median prices in those zip codes were decimated.

Buyers in these markets were locked out of mortgage markets by the tight lending standards of the GSEs.  This period and after was when the vast majority of defaults happened.  Really, by the CDO panic of late 2007, nominal home prices at the national level were in unusual negative territory.  The declines between then and September 2008 were gut wrenching and far outside of any modern experience.  And, after that happened housing markets at the low end continued to experience losses for years, that, by themselves, would have registered as generation defining events.  Any relative valuation gains during the boom had been reversed by now.  In most cities, like Phoenix, there had never been any unusual gains in the low tier compared to the high tier, but the low tier losses after 2008 are massive.  (edit: You can really see this by just watching the Phoenix zip codes over the entire period.  High tier markets tend to lead low tier markets, slightly, in both boom and bust, but there is never much difference between high and low tier markets during the boom.  There is an idea that the bust was just the rewinding of the boom.  But, in Phoenix, a true unwinding would have effected all zip codes equally.  This wasn't an unwinding.  This was a massive dislocation targeted at low tier markets.)


That wasn't enough for us, though, and in July 2010, we passed Dodd-Frank.  And, with its passage in this time lapse graph, we can see the market that was just finally starting to stabilize take another pause.  The declines by this time were not as sharp as they had been in late 2008 and 2009, but we can see low tier home prices stall with continued price declines for another couple of years after that.  There were significant valuation discounts in those markets by then.  There was absolutely no reason to restrict lending and demand in those markets.  The rate of first time home buyers had been very low for years by then.  If anything, there had been a deficit of lending at the margin.  And this is not a subtle point.  The lack of reasonable lending in low tier and entry markets had been extreme.  Finally, in 2012, prices ceased their decline. (edit: You can see this by focusing on the national trendline.  It was just starting to move back up to zero when Dodd-Frank was passed, and just as Dodd-Frank passed, the left end of the trendline moved back down, and didn't recover back to zero until 2012.)