Monday, August 22, 2016

Housing: Part 175 - About Mian & Sufi's "extensive margin"

Mian & Sufi's very timely work was an early nudge on the path of consensus views about the housing bust.  Their first popular work on the subject was published by early 2008 - before 90% of the foreclosures had even happened.  I will spend some time in the book explaining how both their findings and the recent findings of Foote, Loewenstein, Willen, etc. all can be true because of the particular shape of the American housing market - the two Americas, closed and open.

Mian & Sufi talk about the extensive margin (marginal new homeowners) and the intensive margin (existing homeowners who borrowed more because of available credit).

As I have worked through the data and the narrative I am building, I have realized what a central role the decline of the GSEs and federal housing agencies have played (Freddie, Fannie, Ginnie, FHA, etc.) in the whole affair.  The harassment and takeover of the GSEs by the Bush administration may be the most important story of the last 20 years.  It seemed to be motivated by a dislike of "crony capitalism", of which the GSEs seemed to be a prime example.  There is some legitimacy to that point of view.  In fact, I will argue that there isn't much reason to have the GSEs issue debt to own loans and MBSs outright, though there may be a place for them to continue to issue guarantees.  This is more or less what the Obama administration has called for.

Though, the way these concerns were handled might have been the main cause of all of the negotiated "bailouts" and emergency economic policies that followed.  And, given Bush's rhetorical concentration on the "ownership" society, this decline is ironic.  It appears that the GSEs had been an important source of relatively safe homeownership, and this support for ownership has been significantly undermined.

The Bush administration has been gone for 7 years, and since then the Obama administration and Congress have only worsened the condition of the GSEs.  The fixation on predatory lending which I believe has been due to a misidentification of the causes of the housing boom and bust has led to an imposition of standards on the banks and GSEs that has basically shut down homeownership for households that are most dependent on credit.

The association of credit with predation has been quite damaging for American households on the margin, for whom credit, even with its risks and difficulties, is a necessary ingredient for progress and financial management.  The moral panic has created much more pain than moral hazard ever did.  As Henry Paulson says in his book (pg. 74) about the summer of 2007, "The administration’s goal was to minimize as much as possible the pain of foreclosure for Americans, without rewarding speculators or those who walked away from their obligations when their mortgages were underwater."  This was clearly the policy at the Fed, too.  So, policymakers spent months trying to work out ways to selectively freeze interest rates for homeowners who qualified as sympathetic while we kept interest rates high for "speculators".  The problem is that, the core of the "bubble" was that the very act of living in San Francisco or New York City or other Closed Access cities that define themselves by housing deprivation is necessarily an act of speculation.  Those sympathetic homeowners the Treasury was trying to select for assistance were the speculators that created the bubble.  In fact, the most speculative households of all were Closed Access renters, who exposed themselves to extreme fluctuations in cost.

Before the speculators that chose ownership had their crisis, those lousy speculators who chose renting had been having a crisis for years.  Millions of them saw their speculative housing positions fail.  (They were the worst kind of speculators.  They were shorts.  Very large short positions on housing.)  When their speculation went against them, they had to cover their short positions, which meant moving to a city with less expensive rent.

So, while the Treasury and the Fed were trying to push the "speculators" into failure while saving good, wholesome Americans, it turns out they were pushing good, wholesome Americans into failure.  As far as I can tell, this is one of the few things policymakers accomplished over the past decade which enjoys nearly universal public support - busting that darn bubble.  Done and done.  Who says Americans can't come together to get things done anymore?

Anyway, back to Mian & Sufi and the extensive margin.  The "subprime bubble", where private securitizations briefly claimed much higher market share than they had before or since, lasted from 2004 to mid-2007.  Would you believe that the "subprime bubble" was associated with the sharpest 3 year decline in homeownership, up to that time, since records have kept (1965)?

The period that everyone associates with this massive predatory push for homeownership at the margin was actually associated with a massive outflow of households from owning to renting.

That is because a big part of the cause of the rise of private securitizations was the harassment of the GSEs.  Private securitizations were filling the gap.  The terms of the privately securitized mortgages, being removed from the bureaucratic norms of conventional loans, were more amenable to ownership by Closed Access households who generally had high incomes but were living in or moving to high cost Closed Access cities.  But, the retreat of conventional mortgage issuance, which appears to have been associated with healthy homeownership, was the more important factor.

Here is a graph comparing the annual growth of owner and renter households.  On the extensive margin, the "bubble" was associated with a sharp change in trend away from ownership.  Since the GSEs have been taken into conservatorship, the number of homeowners, in absolute terms, not even adjusted for population growth, has declined.

In Paulson's "On the Brink", page 437:
Our decision to put Fannie and Freddie into conservatorship forestalled their collapse and prevented a wider financial system meltdown.  Crucially, public backing for the GSEs from Treasury and the Federal Reserve ensured that affordable mortgage financing was available during the worst moments of the financial crisis and beyond.  This would prove to be the government's most effective form of economic stimulus, helping to put a bottom on the sharp home-price declines that had so damaged the GSEs and were driving the country into a deep recession.  Without such public support, I am convinced, the housing market would have ground to a halt for lack of financing, home prices would have continued their downward spiral, foreclosures would have skyrocketed, and financial institution balance sheets would have suffered much greater losses.  All of this would have led to an even more prolonged downturn - and the additional loss of millions of jobs.
Now, there is always the problem of the counterfactual.  And, in Paulson's defense regarding the accuracy of this paragraph, it is true that our policymakers were capable of enacting much worse counterfactuals than this.  And, they would have been popular for having implemented them.  In some ways, the Treasury and the Federal Reserve were a buffer between what the American people demanded and what needed to be done.  So, when the Federal Reserve eventually did try to stabilize the economy, they took a lot of criticism from both ends of the political spectrum.

But, Paulson is simply in denial (along with many others) here regarding the American's who could have most used support.  The GSEs, under conservatorship, did nothing to support housing where it was most in need of support.  How much of today's ill-tempered populism is due to this denial?  And, it comes down to the misidentification of the housing boom with marginal homeownership, which seems to have left nearly everyone to support the decline of credit to

Friday, August 19, 2016

Housing: Part 174 - San Francisco as the next Detroit

One implication of the Closed Access problem is that the productivity of innovative cities is taken as economic rents, which are shared by firms, workers, and real estate owners.  This is similar to other places in previous eras.

Detroit was the San Francisco of its day.  Because of survivorship bias, path dependence of supply chains and organizational advantages, etc., the large automakers of the mature industry enjoyed excess profits.  These profits were geographically constrained, and so local interest groups - unions, city governments, etc. - could extract some of them for themselves.  The problem is that these extracted rents are sticky.  The interest groups that capture them tend to contrive moral stories about why and how they were able to capture them.  So, when something comes along like Toyota and Honda, the industry that was once bathing in excess now suddenly is hampered with excess costs which are difficult to remove.  When the tipping point arrives, the bottom falls out fast.  In the case of automakers, we now have the perverse outcome that there is a thriving automobile manufacturing industry in the country except for the one place that was in a position to maintain it.  Suffocated by its own success.  The rent seeking around automakers, coincidentally, seems to have been a somewhat equalizing force, mostly being claimed for working class union members and city services (though corruption was part of the story, too, as it inevitably is when rent seeking is endemic).  The rent seeking around tech, finance, trade, etc., in the Closed Access cities seems to be a force for exclusion and inequality through housing - a sort of meritocratic kleptocracy.

The broad story of frontier economic leadership in the 21st century may come down to a race between Western cities that have a legacy of risk taking and creativity, but are unable to allow the density that would realize the full value of that culture, and Eastern cities that are capable of building densely but that still seem to be developing the culture of risk taking and creativity that draw so many of the world's brightest to Western universities and innovation centers.  Maybe I don't know what I'm talking about regarding the Eastern cities.  Please add color in the comments, if you have thoughts on the matter.

Anyway, I thought this story about Ford was interesting, given this backdrop.

The company is doubling the size of its staff in Palo Alto, California, to more than 300 employees, expanding its offices and labs in that city, and signing new partnerships with companies that are developing technology for self-driving cars. The moves are the latest by Fields to reposition Ford into a full-fledged mobility company.
...
Since he became CEO in 2014, Fields has moved quickly to expand Ford's operations in Silicon Valley. Within months of taking the helm, he opened the company's research and development center in Palo Alto, saying the automaker wanted to be "part of the conversation" in an area rich with tech talent and engineers working on autonomous-drive vehicles.

Geography is as important as ever, ironically, even in endeavors that require few geological inputs.  So, even Detroit is moving to Silicon Valley.

Thursday, August 18, 2016

Housing: Part 173 - Attrition at Fannie Mae

I posted this graph the other day of the weighted average FICO score on Fannie Mae's books over time.  Their average FICO score has generally been rising since the 1990s.  It has especially risen since conservatorship.  The federal government has taken near complete control of the mortgage market and basically locked out the bottom half of the market from mortgage credit.  This is the single most important economic development of the past 8 years - possibly more important than the NGDP collapse of late 2008.  It has resulted in a loss of wealth targeted at middle class and lower middle class households across the country.  Most losses in home equity at the bottom end of the housing market came after this development.  Conservatorship and QE mark a turning point where the federal government shifted to a policy of economic stability instead of a policy of instability.  While the public discussion centers around bailouts, this is probably the more important story.  Beginning in 2008, the federal government engaged in a massive (and necessary) liquidity injection, but it was targeted at the least credit constrained households.  Through regulatory threats aimed at the banks and government ownership of the GSEs, this liquidity injection was specifically withheld from credit constrained households.

After September 2008, while unemployment raced to 10%, those households were kept out of the recovery.  So while home prices at the top half of the income distribution began to stabilize, home prices at the bottom half continued to collapse as they had been since late 2007.

Here are price changes over time in LA.  LA is probably the most extreme example, but the pattern is pretty common across cities.  High priced homes were the first to decline in value and the first to recover.   Most of the lost value in the top quintile of zip codes within MSAs happened before September 2008.  Most of the lost value in the bottom quintile of zip codes within MSAs happened after September 2008.

The next graph compares the top quintiles in each of the top 20 MSAs, by price, to the bottom quintiles.  (In the Contagion cities, most of the extra rise in the bottom quintile is from Riverside and, to a lesser extent, Miami.  Price changes were relatively similar across Phoenix and Tampa during the boom.)  You can see in this graph that prices in the less credit constrained zip codes of the Closed Access and Contagion cities topped out first by early 2006.  Low priced zip codes held on fairly well until mid 2007 when the private securitization market collapsed.  The private securitization market was highly focused on the Closed Access cities.  Its collapse meant demand for low priced homes in Closed Access cities collapsed, which also meant that the pressure pushing low income households out of the Closed Access cities and into the Contagion cities also collapsed.

So, those cities saw sharp price decreases in 2007 and early 2008, focused on low priced homes.  The other cities had less difference between different quintiles and also had less of a price collapse in general during that time.  The non-metropolitan parts of the country generally looked like the Open Access cities.  The GSEs were capital constrained because of their mounting losses.  That constraint was relieved in September 2008 when the federal government took over.  But, the new very tight lending standards that had been put in place because of capital constraints remained in place.

By early 2009, the Federal Reserve was purchasing mortgage backed securities to introduce liquidity into those markets, and we can see the effect Fed efforts had.  For zip codes that the federal government was supporting, prices generally stabilized.  But, prices at the low end continued to collapse for three more years in all types of cities.  Notice that there wasn't much price decline at all in the Open Access cities until after conservatorship and QE, and it was focused on low priced zip codes, which fell on average by 15% after the end of 2008, compared to the top quintile, which fell by 6% on average in those cities (Dallas, Houston, Atlanta).

In the Contagion cities, prices in the lowest quintiles fell by 38% after 2008 while the top quintiles fell by 15%.  This, despite the fact that by the end of 2008, any excess valuation gains that had gone to low priced zip codes in some cities had been reversed.

Consider the scale of that economic dislocation - homes in the lowest priced zip codes of the Contagion cities took a 38% hit to market values that was unnecessary and unrelated to any sort of bubble pricing.  By then, their price levels weren't relatively any higher than the "Other" category of large MSAs, which includes everything from Seattle to Detroit.  We whacked nearly 40% off the values of the homes owned by the most credit constrained households as a policy choice.

Those houses have valuations that have now moved back above the valuations of the "Other" MSAs, without a functionally expanding mortgage market, if there is any doubt about that.

And, if there is any doubt about the source of pressure on home values in this country, notice how the highest priced zip codes in the country, by a long-shot - the high priced zip codes of the Closed Access cities - are now more than 20% above their peak "bubble" prices.

Sorry, I get going...

The topic of this post was supposed to be the more minor issue of GSE underwriting.  Notice in the first graph that while the average FICO score on new business was higher in 2003-2007 than it had been in 2000-2001, the rise of the average FICO on the book of business was even stronger than we might expect.  In 2004-2007, the average FICO on new business was slightly lower than the average FICO on the book of mortgages.  This should cause the average FICO on the book of business to decline.  But, it continued to rise or remain stable. That means there was attrition of low FICO mortgages out of the GSEs during the housing boom.

This is what Foote, Gerardi, Goette, and Willen and Foote, Loewenstein, and Willen have found.  Data which only tracks originations misses some of the churn within the existing pools of mortgages.  So, to get an idea of how the GSEs were shifting, we need to not only consider their originations, but also the changing shape of their existing book of business.

Using Fannie Mae's reported book of business and new business, by FICO score, I have estimated the proportion of mortgages that were lost from their existing book of business each year.  Some of this attrition would simply represent mortgages that were refinanced as Fannie Mae mortgages. But, we know that, since the average FICO score on the book of business was rising faster than we would expect from the FICO scores on new business, some of the low FICO attrition was moving out of Fannie's books.

So, at the back end, there was a shift of mortgages out of Fannie Mae that were either being refinanced in private securitizations or were households who were selling their homes.  That is what Foote et. al. find in the first link above, that subprime mortgages were not particularly associated with new ownership.  Many of those mortgages were refinanced conventional mortgages.

Attrition was highest among the lower FICO scores during the private securitization boom.*  This has reversed since the bust because it is easier for high FICO score households to refinance.  In recent years there has been some loosening of underwriting, so low FICO score originations are slowly rising again.  This could be partially due to the slow recovery of equity that is finally available to those households simply through inflation.  There could be a significant amount of latent demand in those neighborhoods as equity recovers and those homeowners are able to use leverage to adjust their housing consumption upwards after a decade of deprivation.



* Attrition was very high in 2003 because low interest rates at the time created a rush of refinancing.  The <620 category is very noisy, because it represents a very small portion of Fannie mortgages, and the measure uses Fannie's reported proportions, which are rounded to the nearest percentile.

Wednesday, August 17, 2016

July 2016 Inflation

Inflation continues to moderate.  Shelter inflation continues above 3% and core CPI excluding shelter continues to move around 1.5%, leaving total core inflation at just above 2%.

Over the past 5 months, however, while shelter inflation has remained above 3%, core CPI excluding shelter has increased by only about 0.3%.  That's about 0.73% annualized.

I am sort of in wait-and-see mode.  It seems like it is just a matter of time before the Federal Reserve sees some mixture of measures that entices them into rate increases that create a downturn.  I suspect it will be a relatively weak downturn without much of a leading decline in homebuilding, since that industry is already so weakened.

I don't see a lot of speculative opportunities in that context.  I think there is an unusual correlation between homebuilders and interest rates, where rising rates will correlate with housing growth.  This is because rates aren't the constraining factor in housing expansion.  So, there might be some hedged positions that have positive risk/reward balance, combining high income positions that will decline in a rising rate environment with positions in high beta homebuilders.  Something like a long exposure to NLY together with long exposure to some homebuilders.

As always, for those who have the ability, highly leveraged direct ownership of low-priced rental housing seems like the most lucrative risk-adjusted way to earn profits in this environment.  Whether through income or through capital gains, it seems like those properties have significant upside with little downside.

Tuesday, August 16, 2016

Housing: Part 172 - A Bubble both rational and unmoored

Some more quotes from Hank Paulson's "On the Brink":
 Government policies, from the implicit support of the GSEs to tax preferences, had pumped up the housing bubble and exposed the financial system - and taxpayers - to far too much risk. (p. xix)
Fannie and Freddie were the most egregious example of flawed policies that inflated the housing bubble and set off the financial crisis.  It is absolutely crucial that we now end the time out and tackle GSE reform.  We need to dramatically rein in their missions and shrink their size by sharply reducing their ability to hold mortgages on their balance sheets, and by limiting the mortgages they can insure.  This can be done by limiting guarantees to first-time borrowers or restricting the size of qualifying mortgages or the income of borrowers, or some combination of all three.  Government guarantees should always be explicit, and the government should charge any user of its guarantee a fee large enough to create room for a robust private mortgage market.  Without the discipline provided by a private mortgage market, we will be at risk of another binge with government-provided incentives leading to yet another housing bubble.
To be sure, housing subsidies are not restricted to the GSEs.  Other government incentives, from the mortgage interest deduction on person income taxes to programs run by the Federal Housing Administration and various state agencies, have contributed to a systemic bias toward overinvestment in housing. (p. xxxiii)
I don't really have a strong opinion of the GSEs.  In the book, I will recommend reining in their missions and treating them as a utility within the Federal Reserve.  I will argue that the mortgage guarantee function is a purely monetary function.  I agree that government guarantees should be explicit and that this was a problem.

But, I honestly can't figure out what Paulson is getting on about here.  Estimates of the effect of the GSEs usually point to something like a quarter percent reduction in mortgage rates.  The most egregious example of policies that inflated the housing bubble?  The GSEs barely expanded during the height of the home price boom.  But, even if they had, the GSE subsidy amounted to a single digit percentage boost to market home prices.  And, that subsidy had been in place for decades, so the attempt to blame it on the rapid price increases of the 2000s is weak.

But, I have a broader problem with the implications of these paragraphs, and this is something that is not unique to Paulson.  Here, he is talking about how tax and subsidy policies boost the values of American residential real estate and encourage leverage.  This is true.

Yet, he refers to this episode as a bubble.  A bubble suggests something temporary and bound to correct.  And, Paulson seems to have seen the decline in home values as a correction, as does almost everyone.

But, taxes and subsidies wouldn't lead to an unsustainable boost in prices.  They would lead to a permanent boost in prices.

Think about this a little bit with me.  Almost everyone agrees that either speculative fervor or reckless availability of credit led home prices to be bid up to levels that were unmoored from economic reality.  Households were bidding up real estate with small down payments and risky terms, with little regard for the downside.

But, that's a regime shift from what Paulson is talking about above.  Tax and subsidy policies depend on rational valuations.  If the GSEs caused real estate to be over-consumed because households would spend more where there were marginal declines in interest rates that were combined with long term tax benefits on the back end, then those are hyper-rational households.  Talk about homo-economicus.  Isn't it funny how nobody minds using homo-economicus when it is used as a presumption of bubble behavior?

Households that bid up the price of the housing stock by 20% because of tax policies and subsidies are an entirely different animal than households rabidly bidding prices up to the stratosphere if you let them get their hands on a little credit.  These are polar opposites.  A story that presumes to be characterized by both at the same time simply doesn't make sense.

Homo-economicus seems to explain most of what happened, as far as I can tell.  But, if that's the case, then the bust was due to policy changes.  There weren't policy changes in taxes or supply obstacles.  There were policy changes in credit and money.  It would be nice if there were policy changes in taxes and supply obstacles instead.  That would create a "bust", but it would be a bust related to healing rather than needless suffering.

If that isn't the case - if this was a bubble based on irrational exuberance - then taxes and interest rates have little to do with it.

Of course, there is the Austrian business cycle version of events that claims while ABC proponents can see the dangers of low interest rates, the rest of the world can't.  Other than being tricked by the central bank, the rest of the world does act as homo-economicus and bids prices up to the levels that seem reasonable when the central bank pushes interest rates down.  So, in that story, buyers were rational, but naïve.  Of course, nearly all of the synthetic CDOs, CDO squareds, even most of the regular CDOs, and even a large portion of the privately securitized mortgages themselves were issued after late 2005, when the Fed had pushed short term rates up sharply.  By January 2006, the Fed Funds Rate was up to 4.3% with a flat yield curve, and the Fed didn't stop until it hit 5.25% with an inverted yield curve.

Any argument based on the idea that all those exotic mortgage securities were induced by low interest rates and loose money would literally be the most wrong argument made in the history of arguments.  It literally couldn't be more wrong.  Did I mention that I mean that literally?  It would be like arguing that the Dust Bowl era Okies were seeking refuge from a multi-year flood that hit Oklahoma in the 1930s.  Literally, it is that wrong.

I wonder how many ABC proponents were complaining in 2006 that a central bank with interest rates pegged too high might cause rational but naïve savers to catastrophically under-invest.  The reason those synthetic CDOs filled a market niche is because so few Americans were willing or able to take the equity position in real estate - even in the 2/3 of the country where mortgages were still quite affordable by any historical standard.  So the "Big Shorts" manufactured a synthetic equity position where, in exchange for making part of the payments that homebuyers would have made, they would capture a huge pay day if the underinvestment continued until it became catastrophic.

PS. I agree with the prescription that we should eliminate the income tax benefits of home ownership and that relatively higher property taxes would be good for places like California.  But, as it stands, we do tend to have a significant tax focused on real estate - the property tax.  I'm not so sure that, all told - property taxes, income tax benefits, and subsidies - it adds up to much of a net subsidy for housing.  The idea that real estate is heavily subsidized seems popular, but is it really true?

Monday, August 15, 2016

Housing: Part 171 - Paulson and the GSEs

Some quotes from Hank Paulson's "On the Brink":
The GSEs presented another case of unintended consequences.  From my first days at Treasury, I had sought to reduce the role and strengthen the regulation of Fannie Mae and Freddie Mac, which owned or guaranteed about half of America's residential mortgages.  Government policies, from the implicit support of the GSEs to tax preferences, had pumped up the housing bubble and exposed the financial system - and taxpayers - to far too much risk. (p. xix)
Please consider time carefully here.  Hank Paulson became Secretary of the Treasury in July 2006.  In the previous two years, when the total value of US residential real estate owned by households had increased by 16% per year, the total amount of mortgages guaranteed or owned by the GSEs had grown by 6% and 5%.  Growth in guaranteed mortgages in GSE MBSs was even lower.  Paulson's first days at the treasury came at the tail end of a sharp and sudden drop of 20% in market share at the GSEs.
Their (Fannie & Freddie) charters exempted them from state or local taxes and gave them emergency lines of credit with Treasury.  These ties led investors all over the world to believe that securities issued by Fannie and Freddie were backed by the full faith and credit of the U.S.  That was not true, and the Clinton and Bush administrations had both said as much, but many investors chose to believe otherwise. (p. 56)
This is said un-ironically, in a chapter that outlines the process by which the US government, at Paulson's request, essentially made the guarantee explicit.  But, the whole idea that there was not a guarantee is incoherent.  The GSEs were required to meet a federal minimum capital requirement.  As is typical in that context, that led the GSEs to keep very low capital levels.  If you are going to regulate firms with capital requirements, you can hardly require them to keep more capital than an unregulated firm facing at-risk creditors would keep.  And, when you have the requirement, the regulated firms have little choice but to generally maximize their leverage under that requirement.  Has it ever worked any other way?

The idea that the guarantee wasn't really true is incoherent because if there was no guarantee, then what were the capital controls for?  What would have happened if the government had determined the GSEs to be out of compliance?  What would have happened if they decided that the firms had to be taken over because of non-compliance, and had said they would not guarantee the bonds?  The investors would have been furious.  If there are haircuts to be taken, bondholders are perfectly capable of demanding a change of control themselves.  If there was no guarantee, then what business was it of the federal government what level of capital the GSEs kept?  The only reason they operated the way they did was because the guarantee and the capital requirements were a clear part of the same package of federal interventions.

The market had presumed that a guarantee was in place because there is no functional way in which federal enforcement could have operated without it.

While the GSEs did fund a small increase in certain adjustable rate and non-amortizing loans, I don't see much evidence of weakened underwriting.  Here is a graph of FICO scores at origination of new business and total book.  Underwriting tightened up during the crisis and continued to be tightened up after conservatorship.  The GSEs have been making very high profits for the government by charging hefty guarantee fees and only lending to the most credit-worthy households.

Certainly, the privatized gains/socialized losses problem with the GSE setup was not optimal.  But, normally, the reason this is cited as a problem is the moral hazard it creates.  I don't see much evidence of a moral hazard problem at the GSEs.  Fannie was doing better than Freddie, to be sure.  But, the GSEs seem to have been among the least aggressive institutions during the housing boom.  Keep in mind that homeownership had risen from the mid-1990s to 2004, and then leveled and dropped off after the GSEs market share declined.  Most net homeownership happened when the GSEs were strong, when home prices were well below their peaks of early 2006.  The GSEs probably had something to do with that.

I don't think the setup where the GSEs own mortgages is optimal, but I think the idea that they have been associated with risk and bubble pricing is pretty weak.  It isn't moral hazard that was the problem, it's that, given the moral hazard issue, when it came time to stabilize the market, the most stabilizing policies were politically unavailable, because they would have led to shareholders potentially profiting from a government guarantee.  That is what bothers the electorate.  Few people seem to have a problem with federal economic policies that allowed a quarter of real estate wealth to evaporate and GDP growth to collapse, then stagnate for a decade.  But, if an implicit guarantee made explicit would lead to a private profit.  Or, if a loosened general monetary policy might cause stock prices to rise or corporate profits to strengthen, there is backlash.  At the heart of the crisis, there are several tipping points where we chose instability over stability in order to either prevent some people from profiting or to ensure that they would be ruined.  These choices were in response to a consensus, not some partisan demand.

Friday, August 12, 2016

Housing: Part 170 - Is Housing Difficult to Short?

This is frequently cited as a reason why the housing market is supposedly inefficient and prone to bubbles - that it is difficult to short housing.  One of the things I find odd about the academic economic treatment of housing is how often rent is ignored.  In the debate between the credit supply school and the passive credit school about what caused the "bubble" (Was credit expansion a cause or an effect of the "bubble"?), whole articles can neglect to even mention rent.  Frequently, home buyers in hot markets will be associated with speculative fervor or with "self control problems".  Generally, these characterizations are part of ad hoc constructions of interpretations of the data, basically suggesting that no other justification for their behavior can be found.  This is common across schools of thought and political points of view.  And, frequently, these explanations will be used in the interpretation of the data in papers that literally do not mention rent as a motivation for ownership.

Wouldn't you know it?  In a national conversation about housing that ignores the entire fundamental basis for home values - the value of rent cash flows - a consensus has developed that home buyers are irrational.  How in the world could you conclude that they are rational if you ignore the sole source of reason in their decisions?

The issue of the inability to short housing is a part of this bias.  The idea that this is the case - that we can't short housing - presumes that our positions on housing are entirely positions taken for capital gains.  But, let's think about this.  Every single one of us comes out of the womb with a lifelong short position on a non-marketable perpetuity on housing.  By far - it isn't even close - the single largest financial "holding" of the average American is a short position on housing they will use.  And that position can certainly be adjusted.

In fact, you could consider the housing bubble to be a short squeeze.  It was a strange short squeeze.  We are used to thinking of short squeezes as the result of short positions covering capital losses.  But, our short position on housing is like a short position on a floating rate perpetual bond.  The face value remains at par, but the coupon payments change.  So, hundreds of thousands of housing shorts were squeezed out of the Closed Access cities during the "bubble", "covering" their short positions by reducing their short exposure to housing, moving to cities with lower rents and less rent inflation.  Some of them even managed to hedge their short positions by taking a long position.  Those households were famously, and summarily, screwed over, even if we have not (and may never) come to terms with what we did to them through public policy.

The way to prevent the short squeeze would have been to introduce liquidity into the housing system - to issue stock, as it were.  We did precisely the opposite.  So, the sharp rise in rent inflation in 2006 and 2007 along with the unprecedented decline in housing starts during the same period, can be seen as a massive short squeeze perpetrated on American renters.  When home prices finally collapsed in late 2007 because of the liquidity crisis in mortgage securities, those households who had tried to hedge their natural short positions with matching long positions (ownership) now faced the worst of both worlds - they were squeezed on their floating rate short positions at the same time that they were squeezed by a massive liquidity discount on their long capital positions.

More houses and more mortgages would have fixed both squeezes.  A decade later, the squeezes are largely still in place - a decade later.  And many observers, infuriatingly, are calling for macroprudential governance in order to refrain from too much housing and mortgage growth while our leaders publish books about that time in 2007 & 2008 when they courageously saved the world.

In fact, the shorts of "The Big Short" fame, who had short positions on housing, were not that different from the typical American.  Their short position on mortgages was a sort of floating rate short, where they had to continue to make coupon payments to the long positions in the synthetic CDOs as long as the housing market remained functional.  The reason they fared well while the typical homeowner fared poorly is that they paired that short position with a position that was long on a liquidity crisis.  Those traders pocketed most of their gains by autumn 2007, before more than 90% of defaults happened and before most of the decline in home prices.

The difference between those shorts and the Americans who had hedged their short positions by becoming owners was that homeowners were vulnerable to a liquidity crisis while the "Big Shorts" depended on one.  Ironically, it was the inability of American households to take long positions on housing that led the market to become catastrophically inefficient.

Thursday, August 11, 2016

Housing: Part 169 - The subtle misdirection of false positives

I think we had a moral panic about mortgages a decade ago and we imposed a recession on ourselves as a result. This creates a sort of positive feedback loop, similar to, say forming an opinion about a mistreated ethnic group because they frequently lash out against their mistreatment - "See.  They are a bunch of animals.  That's why you can't treat them any better."  We closed down the mortgage market, imposing desperation on low priced housing market, and now we say, "See. We were right.  This is why you can't let people have mortgages.  Too dangerous."

There are so many facts that appear to support the bubble story, which viewed more carefully, really don't.

Here is a recent post at calculatedrisk remembering the rise of housing inventory in 2005 that caused him to begin to call the end of the housing boom:  Bill McBride, understandably, sees this as a vindication of his predictions about unsustainable housing markets at the time.  I don't blame him.  How could he come to any other conclusion?

The links in the post refer to rising inventory, and it looks like the examples are from Orange County, CA.  That is interesting.  We are supposed to believe that an expansion of mortgage credit to marginal homebuyers eventually ran out of steam, where the last suckers in the Ponzi scheme that was pushing home prices up finally were so incapable of paying their mortgages that defaults started piling up, leading to falling demand and falling prices where homes had been overbuilt.

Yet, Orange County is hardly the first place that would come to mind if we think of (1) a surplus of homes or (2) credit constrained households.  The reason Orange County was an early source of excess inventory is because the Fed was sucking cash out of the economy to counteract the housing boom, and since the boom was based on fundamental supply issues, that attempt at a solution was perverse.  So, while housing markets in low income parts of L.A. were still quite strong, and while low income households were still streaming out of L.A. to places like Phoenix for lack of housing in those neighborhoods, places like Orange County were starting to feel the pinch of a liquidity constrained economy.

Here is a graph of the change in housing turnover in LA.  In 2005 and 2006, turnover was falling in the high priced zip codes.  The slowdown started at the top.  There is a similar pattern in prices.

In 2005, when inventory started to build, and even in 2006, there was a significant amount of out-migration from the zip codes with lower incomes because of a lack of housing.  Eventually, the liquidity crisis hit the mortgage markets that were facilitating that migration, and those neighborhoods succumbed, too.  So, missing this subtle aspect of the period - that the problems started at the top - leads to a sense of support for a story that may be mostly backwards.

I don't have detailed enough data on housing inventory to confirm the turnover and price data with inventory data, but the Census Bureau has some inventory data, broken down by region.  They have a measure of the median asking price of vacant homes.  In the next graph, I have plotted the ratio of the median price of vacant homes to the median price of new homes sold.  While this isn't nearly as geographically detailed as the Zillow data above, it does tell the same story.  As the boom aged and became a bust, the inventory of vacant homes appears to have been weighted toward higher priced homes, even into 2008.  This was not the case in the Midwest.  It was mainly in the West, the Northeast, and in the South.

Friday, August 5, 2016

The path to shared prosperity is lavender, Pt. III

Some more scattered thoughts I neglected to include in the earlier parts:

One theme of the original op-ed was the implication that regulatory and tax burdens on private economic activity are inconsequential.  Normally, for those who disagree with that implication, the focus is on how regulations make it harder for firms to be productive.

Our broken housing market bares the counterintuitive core of this disagreement, though.  On the surface, it looks like those who emphasize the importance of a light-handed regulatory regime are defending corporations.  Progressives frequently refer to these arguments as fronts for the rich and powerful, as if the rich and powerful are the source of the argument, and the idea that economic gains "trickle down" to the less powerful is just a sort of cover for the real motivations.

But, dismissing the effects of sloppy or overbearing regulatory regimes on private economic outcomes covers up the way those regulations help entrenched interests just as much as it covers us the way regulations hurt new competition.

A heuristic that ignores these effects tends to miss ways in which productivity and abundance are squelched.  And, that is a problem.  But, the far more damaging problem is that the heuristic misses the ways in which powerful entrenched interests benefit from overbearing regulations.  Since it goes unnoticed, it spreads unabated.  This seems to be ironic, but it shouldn't.  Old money and entrenched corporations are to progressive egalitarianism as the Bootlegger is to the Baptist.  The irony is crucial to the form.  The most entrenched political economic rents are inevitably enabled by those who suppose that tax and regulatory policies aren't an important driver of private economic activity.

The dismissal of effects on private activity is what makes taxation and fair tax rates such a central theme.  They act as a direct public transfer, so they operate in the realm of the seen.  The central position of tax policy in the progressive story of the late 20th century is a product of that selective observation.

One irony is that as marginal tax rates declined on high income labor and rose on low income labor (mostly in the form of means tested subsidies), the historical norms of work and leisure flipped, with high income workers now working longer hours, in general, than low income workers.  That certainly seems like a betrayal of the idea that second and third order effects of tax policies are unimportant.  But, more to the point, the idea that changing tax rates, themselves, could explain more than a small portion of the measured changes at the highest income levels, requires an unspoken belief in those second and third order effects, mathematically if not rhetorically.

So, we are stuck in this endless loop, where overwhelming and obvious regulatory barriers prevent equity and broad affluence, and redistribution through taxation is the solution proposed to fix it.  Those refugees from New York, Massachusetts, and California aren't moving to Arizona, Texas, Florida, and Georgia for the taxes.  They are clearly moving because of the uncountable ways in which freely flowing capital and labor can do things like provide affordable housing.  You know what has never sustainably created a city full of affordable housing?  A public "affordable housing" policy framework.  The only cities with aggressive "affordable housing" programs are cities filled with voters who presume that equitable capital allocation is public capital allocation and that private capital allocation is just so much "trickle down" economics.

The housing crisis has a megaphone, pointed at our ears, and it is yelling, "The crucial source of equitable abundance is the lightly regulated flow of capital."  Freedom of entry is so key.  One may argue against the dislocations it creates - whether those dislocations are laid off factory workers or neighborhoods losing their character - but one cannot honestly argue against freedom of entry while presuming to support shared prosperity.

One might hope that the relationship between careful regulation and freedom of entry could be parsed intelligently, so that important regulatory details could be maintained without being captured by entrenched interests.  The endless flow of economic refugees out of our blue cities to places Hacker Pierson characterize as "cut and extract" suggests that the enlightened blue states haven't figured that out.  Let's hope they can.  Until they do, thank goodness for the second best alternative "cut and extract" states.  Fortunately, the only thing standing in the way of the solution is the simple act of recognizing the best parts of the non-blue policy framework and implementing those - namely, the centrality of private capital in the pursuit of equitable growth.

This sort of discipline is common among those who compete in the world of private capital.  Industrial espionage is usually meant to find the best of what competitors are doing.  Political espionage is usually meant to find the worst of what competitors are doing.  In this regard, the political homogeneity of the American academy does not engender hope.

Thursday, August 4, 2016

The path to shared prosperity is lavender, pt. II

I want to expand a little more on yesterday's post, because I think the obstructionism in the housing market and the clear economic stress and inequality that come from that present such a great case study in how the red vs. blue framing fails to lead us to productive policy shifts.

Yesterday, I referenced a New York Times op-ed by Jacob S. Hacker and Paul Pierson, where the authors describe red state versus blue state policies as "cut and extract" versus "investments in education, infrastructure, urban quality of life and human services".

I mentioned in the earlier post how I think part of the problem with the "blue" case is that it treats private capital as a fixed factor.  In the op-ed, the "red" policies - "low taxes, lax regulations or greater exploitation of natural resources" - are dismissed as poor drivers of growth.

I suggested a motte and bailey fallacy in yesterday's post regarding the causes of high urban housing costs, and I think this is another sort of motte and bailey fallacy.  This is similar to a common way of approaching minimum wage hikes.  Clearly at some level minimum wages are destructive, and at some level they are insignificant.  How often are studies of 30 cent localized hikes used as evidence in support of a nationwide hike to $15?  Or, for that matter, how many economists supported the hike from $5.15 to $7.25 from 2007 to 2009, based on the idea that small hikes in a strong economy would be unlikely to create disemployment only to sit silently in 2009 as the last hike was implemented amid unemployment that had jumped by 4% in the prior year?

Marginal changes in taxation or regulation are dismissed as insignificant, and this sort of leads to a heuristic where those policies are placed in the "all else equal" bucket.  So, every suggested investment in education, infrastructure, urban quality of life, and human services, comes packaged with its own set of marginal expected benefits, and the mandates or taxes that are required to create them are marginal enough to ignore, in isolation.

This amounts to a contortion of scale when scale is small enough to be a rounding error among uncontrollable factors.  How much of public debate really revolves around this problem of implied disagreements about marginal effects?  That's all well and good.  And, nobody has a monopoly on accurate measurement of marginal effects.  So, those disagreements aren't about to go away.

But, a problem arises when marginal effects cease to be marginal.  And, this is what we see in the housing problem.  Hacker and Pierson notice that there is a housing problem.  But, their heuristic - that the benefits of public dispensation can be counted as benefits while the relationship between public policy and private capital dispensation is muddled enough that it can be ignored - has been carried to a scale far beyond reason.

The housing context in Closed Access cities is so obstructed that the effect of taxes and regulations has ceased to be marginal.  It is existential.  There is broad repression of private capital.  That repression defines those cities.  Yet, they hold their heuristic so strongly - that the only capital worth measuring regarding public policies is public capital - that they can regard the cause of the stresses in those cities as insignificant.

Yet, it is clear beyond doubt that blocks full of high rise housing in places like Manhattan and San Francisco would be transformative - in a way that would represent a massive transfer of wealth and income from rich to poor.  That looks like a "greater exploitation of natural resources" to me.  It's hard to think of a more extreme example of exploitation of natural resources than capturing trillions of dollars of value out of little cubes of space 300 feet above the streets of Manhattan.  There is one, and only one, way to get there - lax regulation on residential housing where those valuable little cubes reside.

If you think it can't be done, keep in mind that these cities have no problem finding ways to create commercial density.

But, the heuristic is too strong.  Private capital is a ceteris paribus variable.  "We should remember that the key drivers of growth are science, education and innovation, not low taxes, lax regulations or greater exploitation of natural resources," the authors report, axiomatically.  "Water?" asks the fish.  "What's water?"

Private capital is desperately needed in the blue cities.  Privately allocated capital intended to earn a profit for wealthy investors.  Trickle down, some might call it.  What a strange thing to call it.  Did the millions of blue city refugees who fled to places like Phoenix, Dallas, and Atlanta have to wait for apartments to trickle down from the rich homeowners in those cities?  Of course not.  Those cities are full of spacious, inexpensive living spaces - spaces available for little more than the cost to build them.

In Dallas wealthy homeowners reach a limit of diminishing utility on luxury housing.  There is little to limit the clamoring for luxury housing in New York City and San Francisco, because the arbitrary (regulatory) limits to private capital inflows have turned those units into status goods.  It is precisely the places that limit the application of private capital where residents end up fighting over a limited supply like jackels, with the powerful sucking up all they can, leaving the weakest without.

It seems as if expanding housing in the Closed Access cities will simply attract more rich homebuyers.  (The Financial Times had a great recent piece about Tokyo, where housing is affordable and relatively plentiful because of deregulated zoning.)  In the act of fixing the problem, the residual stresses of the limited regime will look like a "trickle down" effect, where new housing creates its own political problems and dislocations and the spoils seem to go to the powerful.

Ironically, the arbitrary constraints in the Closed Access cities that attract the rich, powerful, and skilled, create a sense of high status in those cities.  Then, we mistake the outcomes of inequitable policies as signs of greatness.  We end up believing that the source of value in those cities is some inherent quality that they possess.  We create these economic centers where power and wealth become ensconced through arbitrary deprivation, then we idolize the status of that power.  Yet, the power and the status come from the economic rents which flow into the cities where competing labor and capital are locked out.

At the other end, the destitution those cities create for their low status residents lead them to move to more open states.  And those states are ridiculed for taking in more than their share of federal transfers.

In a paradigm that takes no measure of private capital flows, those public transfers count, but the endless line of migrants are missed.  The excess profits earned by blue city landlords, highly skilled workers, and firms, in their cities walled off to competitors, are missed.  All that matters are transfers and status.  With those blue colored glasses on, it looks like the Closed cities have the status and the Open cities get the transfers.  Who wouldn't want to be blue?

Imagine what bright path this country could travel if the equalizing effect of flowing private capital could be recognized.  It has become obvious.  Can it become obvious enough to overcome our need to divide?  The thing is, if the blinders about that can be removed, we can still make the science, education, and innovation stuff happen, and it might actually be wonderful.  These regimes aren't mutually exclusive.  Is putting a hard cap on the size of our innovative cities helping to create innovation?