Housing Policy, Monetary Policy, and the Great Recession

Here's a link to a research paper the Mercatus Center has published by me and Scott Sumner.

Housing Policy, Monetary Policy, and the Great Recession

It's a combination of Scott's work on Federal Reserve policy and my work on the housing bust.  Here is our takeaway:

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Policymakers should not slow the economy in an attempt to prevent bubbles, which are not easy to identify in real time. Such efforts to reduce demand in 2007–08 were not only unnecessary but were also responsible for the reces­sion and financial crisis. 

Instead, US policymakers should adopt regulatory, credit, and monetary policies that can help stabilize the econ­omy, allowing the creation of an environment for healthy growth in living standards. Such an approach involves three components:

1. Reform zoning regulations in urban areas. This would allow for more construction of new housing, espe­cially in closed-access cities such as Boston, Los Angeles, New York City, and San Francisco, where con­strained growth is currently resulting in high housing prices. The United States could sustainably employ many more workers in home construction if restrictions on building were removed. 
2. Avoid a situation where lending regulations are most lax during booms and tightest during recessions. It was this sort of regulatory pattern that almost certainly exacerbated the severity of the Great Recession. 
3. Monetary policy should seek stable growth in nominal gross domestic product (NGDP). Rather than target­ing inflation and unemployment, policymakers should aim for a relatively stable rate of growth in NGDP, the dollar value of all goods and services produced within a nation’s borders. Attempts to use monetary policy to pop bubbles in individual asset markets such as real estate often end up destabilizing the overall economy. A stable NGDP growth rate, however, will provide an environment that is conducive to a stable labor market and a stable financial system.

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If you're interested, at the link there is a link with a pdf download.  We address a wide range of evidence, some of which I am certain you have not seen before.

A miracle homeownership boom!

According to the Census Bureau, homeownership shot up by 2.6% just this quarter!  Normally, that amount of change would take a decade or more.

Vacancies also declined sharply.

According to the estimate of total housing inventory, there were 4.8 million more homeowners in the second quarter than there were in the first quarter.  To put that in perspective, the National Association of Realtors estimates that there were a bit over a million homes sold in the second quarter.

The Census report on homeownership and vacancy includes a warning about changes in their methods of data collection due to the coronavirus.  It seems likely that a lot of renters did not respond to phone interview requests, and somewhere along the lines, the statistical methods for estimating total population went haywire, and we basically don't know anything about how homeownership and vacancies changed during the quarter.

There is a lot about the country we really don't know.  It is hard to know exactly how many people are in a real financial bind and what they are doing about it.  We are flying blind, which is why we need to err on the side of generosity in public safety net provisions right now, and do everything we can to reduce the contagion risks ASAP.

The popularity of the nationalistic rhetoric of Trump, Warren, and Sanders is a failure of economics

Elizabeth Warren posted "A Plan for Economic Patriotism" this week.  It begins like this:

I come from a patriotic family. All three of my brothers joined the military. And I’m deeply grateful for the opportunities America has given me. But the giant “American” corporations who control our economy don’t seem to feel the same way. They certainly don’t act like it.

Sure, these companies wave the flag — but they have no loyalty or allegiance to America. Levi’s is an iconic American brand, but the company operates only 2% of its factories here. Dixon Ticonderoga — maker of the famous №2 pencil — has “moved almost all of its pencil production to Mexico and China.” And General Electric recently shut down an industrial engine factory in Wisconsin and shipped the jobs to Canada. The list goes on and on.

These “American” companies show only one real loyalty: to the short-term interests of their shareholders, a third of whom are foreign investors.

As with her other proposals, there is a mixture of good and bad, and a lot of details.  Maybe the rhetoric isn't that important, in the end, to the actual policies.  But, the rhetoric here is chilling.  The history of public movements calling out groups for their supposed divided loyalties is a long and disgraceful one.  Considering the starkness of the rhetoric, and the parallels between Trump, Warren, and Sanders regarding their use of the form, it is interesting to consider how, for all of us, our reactions to each of them differ so much.  The bridge between Warren and Trump voters seems to be increasingly noted.  It seems plausible that this new press release is part of a plan by Warren to build on that.

But, I want to step back from that for now, and just consider the practical issues raised in Warren's statement.  Economics, at the least, should serve as an inoculation against this sort of rhetoric, and in this, it seems it has failed.

Consider the global economy as it might be, full of functional, productive societies with wealthy residents.  In that world, the places we currently consider developed might produce 20% of global goods and services.  Instead, today we produce something more like 70%.  At some previous point, it was more like 80%, and developing economies have been catching up.

That process of catching up is fabulous.  It is all to the good.  The only sustainable way of becoming a developed prosperous place that we know if is to move toward a system of a universally applied rule of law, human rights protections, personal freedom, and self-determination.  With that foundation, people engage in the process of specialization and trade that is the source of economic abundance.

This is the key - specialization and trade.  So, imagining this fabulous development - the whole world becoming civilized, humane, and wealthy until our part of it only produces 20% of that abundance - exactly how does one expect that shift to happen?  As the developing world moves from 20% to 30% of global production, they will necessarily specialize in some additional portion of world production.  It might be apparel or pencils.  It might be something else.  But it will be something. And much of it will be items that used to be produced in the developed economies.

The idea that the Dixon Ticonderoga company has much of a say in this is obtuse.  And, furthermore, the idea that their acquiescence to this global transformation is the result of "the short-term interests of their shareholders" is ludicrous.  There is nothing short term about this.

The reason that this rhetoric doesn't destroy Warren's public credibility is because of the failure of economics education.  The reason this can be construed as a short-sighted decision is that it is almost universally seen as a way to take advantage of the low wages of developing economy workers.  As if this is just a heartless example of exploitation rather than a reaction to epochal shifts in global productivity.

I propose a simple statement as a starting point for remedying this problem: "Production doesn't move to where wages are low.  It moves to where wages are rising."

That is the story of economic development.  This doesn't mean there aren't growing pains that sometimes hit some workers the hardest.  But, it does mean that in the end, all of those gains, on net, go to workers.  Returns to global at-risk capital are about 8% plus inflation.  They were 8% a century ago, they average about 8% today, and they will likely be 8% or less a century from now, if the world continues to grow with a capitalist framework.  But, workers today earn ten times or more what they did a century ago, and in another century - especially in places that are catching up - they will earn at least ten times what they earn today.

It really is ironic that Warren uses the Dixon Ticonderoga company as an example here.  Leonard Read, the founder of the Foundation for Economic Education was perhaps most famous for writing the essay, "I, pencil".  An excerpt:

I, Pencil, am a complex combination of miracles: a tree, zinc, copper, graphite, and so on. But to these miracles which manifest themselves in Nature an even more extraordinary miracle has been added: the configuration of creative human energies—millions of tiny know-hows configurating naturally and spontaneously in response to human necessity and desire and in the absence of any human masterminding! Since only God can make a tree, I insist that only God could make me. Man can no more direct these millions of know-hows to bring me into being than he can put molecules together to create a tree.

An interesting aspect of that essay is that it contains several practical references to geographical locations of production, many of which I am sure have become dated as global production and specialization have evolved.  The essay is at once a timeless conceptual reminder of the profoundness of the invisible hand and a record of the fleeting nature of its operation.

I found this with a quick google search, which is a nice educational aid used in some New York state elementary school classrooms.  The education is being done.  But, the continued popularity of its absence is a call for ever more.  Godspeed, New York elementary teachers.

(PS; Karl Smith weighs in here with some interesting supporting details about the history of Dixon Ticonderoga.  He also discusses currency manipulation, but I think that is an overstated factor in the American trade deficit.)

Progress means giving up what is sacred today for sacred unknowns of the future

Arnold Kling has a link to a study on education with this abstract:

Can schools that boost student outcomes reproduce their success at new campuses? We study a policy reform that allowed effective charter schools in Boston, Massachusetts to replicate their school models at new locations. Estimates based on randomized admission lotteries show that replication charter schools generate large achievement gains on par with those produced by their parent campuses. The average effectiveness of Boston’s charter middle school sector increased after the reform despite a doubling of charter market share. An exploration of mechanisms shows that Boston charter schools reduce the returns to teacher experience and compress the distribution of teacher effectiveness, suggesting the highly standardized practices in place at charter schools may facilitate replicability.

 A key point here: "An exploration of mechanisms shows that Boston charter schools reduce the returns to teacher experience and compress the distribution of teacher effectiveness..."

That sounds terrible, doesn't it?  I think this is key to fundamentally different approaches to progress. It seems like supporting the current providers is key to improving current institutions.  But transforming institutions sometimes means making current providers less important.

There was a time where having a creative, problem-solving blacksmith was key to having effective transportation.  Replacing that blacksmith with impersonal, monotonous factory work seems wrong.  It involves losing something sacred.  Yet, making blacksmiths unimportant was key to the transportation revolution.  You would not set foot on an airplane to take a vacation or a business trip halfway around the world if the airplane depended on a team of blacksmiths using experience and tactile expertise to create the engine parts.  The sacred act of visiting the Egyptian pyramids in person, or coordinating with an Asian businessperson could only be possible by eliminating the sacred role of learned and expert craftsmen.

The extreme version of this transformation is in telecommunications. Barely a human hand touched the phones we carry in our pockets with millions of circuits and parts.  Yet, those phones are only possible because new forms of creative work have been created.

To an extent, the need to unleash the creativity of teachers in the classroom is required because that creativity has to overcome the shortcomings of the institution it is embedded in.  It seems like it would be losing something sacred to create a more effective institution that would make that creativity unimportant.  Yet, what if a better institution leads to better education, even without creative teachers constantly bustling and working to overcome an ineffective institution?

A Silicon Valley designer can use creative work to improve the effectiveness of a million circuits in a phone that will be used by a million people.  That is a lot of leverage that the blacksmith couldn't have.  An institution that requires an immense amount of effort to effectively educate kids a roomful at a time is using an awful lot of sacred effort.  Wouldn't it be great to educate those kids with teachers that didn't need to be so creative?  And, wouldn't it be great to move to a world where the effort going into that creativity was leveraged beyond a room full of 20 kids?

So often, the difficulty in supporting progress comes in losing the known sacred in exchange for the unknown sacred.  In the end, progress depends on faith in emergent change.

Market Concentration

John Cochrane discusses an interesting paper that claims that, while national concentration has increased, local concentration has decreased.  In other words, each location has more competition within various industries, but the competition is more among national chains than among local firms.  So, there top firms claim a larger portion of the national market, but at the local level, consumers have more choices.

What's going on? The natural implication is that the town once had 3 local restaurants, two local banks, and 3 stores. Now it has a McDonalds, a Burger King, a Denny's and an Applebees; a branch of Chase, B of A, and Wells Fargo, and a Walmart, Target, Best Buy, and Costco. National brands replace local stores, increasing the number of local stores.

Housing: Part 328 - Bank Capital and the Crisis

John Cochrane has an interesting post up today about the role of bank capital in the financial crisis.  He is referencing some recent work from Laurence Kotlikoff.

Larry puts it all together nicely by starting with the 2011 Financial Crisis Inquiry Commission report:

"There was an explosion in risky subprime lending and securitization, an unsustainable rise in housing prices, widespread reports of egregious and predatory lending practices, dramatic increases in household mortgage debt, and exponential growth in financial firms’ trading activities, unregulated derivatives, and short-term “repo” lending markets, among many other red flags. Yet there was pervasive permissiveness; little meaningful action was taken to quell the threats in a timely manner. "

Larry then takes apart each of these non-culprits, as below.


In my view, the understanding that the crisis was a run, that without a run there would have been no crisis, somewhat like the 2000 tech stock bust, and that lots and lots more capital is the only real answer, has emerged slowly over the last 10 years. Larry's essay is good for putting all the others to rest.

The point of this is to suggest stronger capital requirements for banks, and I basically agree with all of that.  In an age where there are money market funds, securitized mortgage securities, fintech, etc., is there a reason to subsidize and support a banking system built around a mismatch between assets and liabilities?  I don't think so.  There are a number of potential ways to change that system, and people with much more expertise than me will debate what the best way is.

The two-cents I will add here is simply that, in order to get to the conclusion that a systemically unstable banking system was the cause of the crisis, Kotlikoff and Cochrane dismiss many of the same supposed causes that I have also dismissed.  They have already basically come to the same conclusions I have about the causes of the crisis, but their focus is on bank capital rather than on what caused the stresses on bank capital.

Eighty percent of my job is done here, I think.  I would only ask them to take one step back and to consider that if so many of the supposed causes of the financial crisis are not particularly compelling, then maybe the stresses on the banking system were not inevitable.

Sure, given the stresses that the banks ended up taking on, a better banking system would have responded better.  But, those stresses should have never happened.  Both can be true.  It can be true that those stresses revealed weaknesses in the banking system, and it can be true that reasonable attempts at broad stabilization in 2007 and early 2008 would have prevented those stresses from ever developing.

I fear that for those who are advocating for a more stable banking regime, the idea that a fragile regime was a root cause of the crisis is a powerful point to promote, and that it would feel like making a rhetorical compromise to agree that the crisis could and should have been averted, even with the banking regime we had.  Yet, they already have come to conclude that the evidence underlying the presumption of inevitability is weak.  It will be interesting to see how they respond to a new narrative.

Housing : Part 310 - The premise determines the conclusion, a continuing series

Here is an interesting symposium at the NBER on the financial crisis (HT: MR).  Previously, I have written about how the crisis and its presumed causes were predetermined.  When the question is asked, "What caused the financial crisis?"  The answer always comes in the form of "This is what caused the housing bubble."  The inevitability of the crisis is canonized.  It doesn't even need to be asserted.  This can be seen throughout the slides that are provided at the NBER link.

A set of slides from Nicola Gennaioli and Andrei Shleifer discusses the difficulty of seeing bubbles and preventing them from blowing up.  It includes this graph, which all reasonable people are supposed to agree is part of the "the banks did this to us" story, where banks got all leveraged up with irrational exuberance and short-term greediness.

Can I suggest that this seems a bit underwhelming?  I mean, there are legitimate debates to be had about the most systemically safe ways to fund investment banks, but I think if you showed this graph to anyone that didn't have priors that there was a massive financial crisis caused by risk-taking, nobody would look at this and say, "This is clearly the picture of a financial system ready to blow up in 2007."

Morgan Stanley is the only bank shown here that had leverage in 2007 that was significantly higher than previous levels.  Maybe you could argue that leverage had been too high for the entire decade shown on the graph.  But, then this is just axiomatic.  It's a plausible condition that is lying in wait to explain any crisis.  Really, in that case, you could remove the y-axis, or change the numbers to half or to double the numbers shown here, and the argument wouldn't fundamentally change.  I mean, if Morgan Stanley had been leveraged 20 to 1 or even 10 to 1, and a financial crisis struck, it's not like economists would all look at this graph, with that different scale, and say, "Well, leverage clearly didn't cause this crisis.  Now, if they had been leveraged 30 to 1, then leverage would be important."

No. Leverage is a plausible cause of financial crises, and so any level of leverage, in hindsight, can be called out as the cause of the crisis.  The premise is overwhelmingly the source of the conclusion.  And, certainly leverage is a plausible cause of financial crises.  That's what makes it such a compelling culprit that the premise itself seems sufficient to reach a conclusion.

Here's another slide from that deck.  Here, referring to Lehman and what appear to be optimistic expectations in 2005, they say, "Analysts at Lehman Brothers understood the consequences of home price declines. However, they severely underestimated the probability and magnitude of these declines."

Again, this is hardly new ground.  This is consensus stuff.  But look at those scenarios.  There is nothing wrong with them.  There is a 50% chance of home prices rising by 5% per year, and a 5% chance of a shock to home prices worse than anything we have seen since the Great Depression.

And, who is to say that those probabilities are wrong?  Who is to say that if we could relive the 2000s a hundred more times that 95 of those times would turn out just fine?  Oh, and by the way, this scenario analysis would be pessimistic if it was applied to Canada, Australia, or the UK over the same time period.  We do have several versions of economies entering 2006 with very high home prices, and the evidence suggests that having a generation-defining housing bust is highly unusual.

This is such a deep and ironic example of how the premise that a severe contraction was necessary actually caused the crisis, and then served as its own confirmation when that crisis happened.  This error of looking back at scenario analyses and judging it based on a single outcome only seems reasonable because the premise that the crisis was inevitable is so strongly held.  (And, I don't mean to single out these authors.  This is the consensus treatment.)

This forecast was made in the summer of 2005.  From August 2005 to August 2008, the national Case-Shiller price index dropped by about 7%.  That part of their worst case scenario was actually too pessimistic.  It was their expectation of stability after that which was too optimistic.  From August 2008 to the end of 2011, prices fell another 14%.  And, it was during that later period where nine out of ten of the mortgage defaults happened.

Now, I'm not going to spend paragraphs here walking through the entire timeline again.  Surely we can all agree that by the end of 2008, public policy itself is implicated in the eventual outcomes.  Public policy can even be implicated in the declining prices before August 2008.  But, the irony here is so deep.  What was the overwhelming reason for holding back on stabilizing policies throughout that time?  It was that we had to let prices drop to avoid moral hazard.  To impose discipline.  They had done this to us because of their optimism, greed, and riskiness, and they needed to learn a lesson.

It's fitting that Lehman failed in September 2008, right when the first three years of that pessimistic scenario ended.  Their pessimistic scenario covered the outcomes that had occurred up to then.  In September 2008, the Treasury took over Fannie and Freddie and cut off lending to entry level borrowers, creating a late collapse in low tier home markets that nobody seems to have noticed (because the premise accepted, even demanded, collapse) and the Fed implemented disastrously tight monetary decisions by holding the target rate at 2% and then implementing interest on reserves that sucked hundreds of billions of dollars out of the economy.

I see slides in these programs bemoaning the role of pro-cyclical financial markets in creating a boom and bust, but I don't see much about public demands for pro-cyclical regulatory and monetary regimes.  There is no doubt that the Fed and the Treasury could have avoided the post-2008 price collapse with earlier and more accommodative actions.  The premise was that contraction was necessary.  The premise was the reason we allowed or insisted on instability.  And the premise is why that subsequent instability can be blamed on the market that we imposed the premise on.

Another example of the strength of the premise, from the same set of slides is a reference to the work of Case, Shiller, and Thompson, who surveyed homebuyers for several years, and found that their long-term expectations for home price appreciation are unrealistically high.  This has been blamed for fueling the crisis.  The Shiller real housing chart that was so popular during the boom is referenced, which I have addressed before.  That chart is based on national average numbers, which completely erases the localized nature of the housing supply problem that caused the bubble.  Treating the housing bubble as a national phenomenon helps to feed the false presumption about its cause, because it is a lot easier to blame the bubble on national excesses if it is a national phenomenon.

Along this vein, the panelists reference the survey work of Case, Shiller, and Thompson, and note that during the years from 2003 to 2008, the average long term annual gains homebuyers expected in four different counties were:
11.6% Alameda County (San Francisco)
8.1% Middlesex County (Boston)
9.5% Milwaukee County (Milwaukee)
13.2% Orange County (Los Angeles)

They note "Forecasts were roughly in line with extremely rapid home price growth witnessed prior to the surveys but were way off from future realized growth."  Treating the bubble as if it was a national phenomenon and treating the bust as if it was inevitable means that we can ascribe (false) meaning to this result.  But, here is a graph of the median home price in each metro area (from Zillow).  These cities have very different stories.  Nothing in Milwaukee was outside of historical norms.  As with most of the country, prices were somewhat buoyant in 2004 and 2005, but that is understandable given the low long term real interest rates of the time.

So, how much of the "bubble" is explained by these expectations?  If Milwaukee buyers had high expectations but home prices were about $200,000, then did the expectation of 11.6% price appreciation explain $700,000 homes in San Francisco?  It seems more likely that there is some bias in the response to this question that has little effect on prices.  Let's say there is some effect.  Maybe 15%?  Maybe without these high expectations, San Francisco home prices would have only been $600,000 at the peak instead of $700,000.  What if home prices in San Francisco had stopped at $600,000.  Would we then have looked at the housing data and said, "Oh, expectations can't explain that.  Now, if homes were selling for $700,000, then we might be looking at a bubble, because then San Francisco prices would be 15% too high, and that would be a reason to suspect these biases in expectations."?  No.

Since the premise that demand, unmoored from rational value, exists prior to the analysis, this bias in buyer expectations can explain everything from $200,000 homes in Milwaukee to $700,000 homes in San Francisco, and everything in between.  And, when the "inevitable" bust comes, those high expectations will be sitting there, ready to fill in the narrative.  The reason it seemed like there was a bubble was that home prices in Boston, LA, and San Francisco were double or triple the price of homes in Milwaukee.  But, the false premises about its cause led us to watch the median home price in Milwaukee decline by 15% over the next five years - an incredible loss by any historical standard - and consider that reasonable, even though there was never a reason for homes in Milwaukee to lose a penny of value.

Another presentation by Aikman, Bridges, Kashyap and Siegert asks "Would macroprudential regulation have prevented the last crisis?"  But macroprudential regulation caused the crisis.  In their presentation, the first step to achieving macroprudence is identifying the buildup of risks in the economy.  The first item in their list of examples of challenges to achieving this is the recognition of a housing bubble.  While many of the tasks of achieving macroprudential stability are difficult and were not done well, according to the presenters, this first step was achieved, because the Federal Reserve noted correctly in 2005 that home prices were overvalued by 20%.

But, that was the problem.  Home prices didn't need to fall by 20%. As the housing market started to collapse, the Fed signaled that if home prices did fall by 10% or 20%, it wasn't going to do anything to counteract it.  That was a "correction".  The initial drops in housing starts were enough to buffer the sharp drop in demand that naturally followed.  But, when housing starts fell as far as they could, ratings agencies started to forecast unprecedented declines in prices, and the Fed continued to see instability as a necessary medicine for enforcing discipline and avoiding moral hazard, prices collapsed.  The more they collapsed, the more that the false premise led us to demand discipline and to rail against moral hazard.

Step 4 in their action plan is to "Take action to reduce the build-up in household debt".  The macroprudential action here, surely, should be local, since the rise in these balances was local.  And, the clampdown on lending to borrowers with low incomes and low credit scores, which seems like the obvious macroprudential response, has killed low tier markets, and it has nothing to do with what happened during the boom.  All of the rise in debt payments that were over 40% of income was among households with high incomes, because those are the households bidding up home prices in the Closed Access cities.

I don't see anything in these slides that seems to acknowledge the importance of supply constraints in rising debt levels.  The entire discussion happens within the premise that credit supply is the cause of both the boom and bust.

Another presentation also discusses leverage and over-reliance on short-term borrowing in the financial sector.  Here is a chart from that presentation:

I would point out here that most of the increase in home prices had happened by the time short term repo financing began to rise above the level of long term financing.  By late 2005, the Fed had raised the short term rate to nearly 5%, and the yield curve was inverted.  Banks weren't saving on interest expense when they increased their reliance on short term financing.  This wasn't a matter of "borrowing short and lending long" and pocketing the difference, while creating an externality of systematic risk.

It is certainly useful to consider ways in which a financial system can be more resilient, but these discussions are like a group of doctors standing around a patient who is repeatedly hitting his head with a mallet, and discussing the importance of avoiding headaches by staying hydrated.  Staying hydrated is important!  This is true!  But, it isn't the problem at hand.

Upside Down CAPM: Part 6 - Leverage before a crisis

I recently saw these graphs, from the IMF:



Source

Here is text from their Global Financial Stability Report (Chapter 2),  "The prolonged period of loose financial conditions in recent years has raised concerns that financial intermediaries and investors in search of yield may have extended too much credit to risky borrowers, potentially jeopardizing financial stability down the road. These concerns are related to recent evidence for selected countries that periods of low interest rates and easy financial conditions may lead to a decline in lending standards and increased risk taking."

It seems to me that there is a strong and common presumption that complacency or risk-taking lead to borrowing, and that this presumption really does all the work here.



Source

In the text above, there are several red flags.  Has there been a prolonged period of loose financial conditions?  I don't think so.  There is that phrase, "in search of yield".  People who want yield buy equity.  High yield bonds may be somewhat like equity on the gradient from low yield/low risk securities to high yield/high risk securities.  This horrible phrase is central to my "Upside Down CAPM" framework.  Low yields for fixed income securities aren't a signal of risk-taking, and investors complacent about risk wouldn't push yields down, even in high yield bonds.  If expected returns for equities are around 7% plus inflation, then investors funding bonds that pay 5%, nominally, aren't searching for yield or risk, because there is a better source for both of those things in equity markets.

I'm not sure we can even conclude how attitudes about risk might influence the relative level of high yield corporate debt.  And, household debt, which is mostly associated with mortgages, should grow inversely with risk-taking, as it would signal a bias toward real estate with stable cash flows over corporate investments with highly cyclical cash flows.  It seems plausible that the relative amount of risky debt securities could either rise or fall with attitudes about risk.

This seems like a simple counterfactual to consider.  What if the level of risky debt outstanding wasn't positively correlated with systemically dangerous attitudes about risk.  What would these charts look like?  Wouldn't they look just like this?  When a contraction hit, wouldn't we see disequilibrium in the market for high risk debt and a surge in low yield safe securities?  And, then, as cash flows stabilized and markets healed, wouldn't we see markets for riskier securities recovering?  In other words, the drop in risky lending and the initial recovery reflect the market dislocations that come from uncertain and volatile cash flows, not from attitudes about risk.  This is movement into and out of dislocation, not a shift in a steady equilibrium.

So, the top graph is a spurious correlation.  Of course risky debt outstanding is highest right before economic contractions.  There is no reasonable counterfactual where this wouldn't be the case.  And, the second graph shows that (in the years before a financial crisis), risky debt levels first rise as markets re-attain normalcy, and then the level of risky loans actually levels out in the years before the crisis.

There are any number of models that could explain this pattern.  The conclusion comes from the presumptions, not the evidence.

This is where turning the model upside down seems useful.  In the IMF report, low yields are associated with easy financial conditions.  I think this leads to confusion.  Low yields are associated with demand for certainty in cash flows.  I realize it takes some hubris to stand up against an entire body of research, so that having this discussion is sort of unwise of me.  I'd love to see evidence that there is more to it than this.  But, from where I stand, it looks like low interest rates are a sign of difficult financial conditions, and that fact is so counterintuitive that we have just gone barreling along with economic models that are backwards.

Part of the problem is the unfortunate habit of equating low long term interest rates with loose monetary policy.  Using the financial sector as a measure for financial conditions might, itself, be part of the problem.  When the financial sector increases in size, this is generally treated as risk-seeking behavior.  But, the financial sector is generally in the business of being an intermediary for fixed income securities.  Investors didn't need the financial sector to invest in Pets.com.

Note, that Pets.com wasn't put out of business through bankruptcy, because the ownership was completely in the form of equity.  They simply liquidated and paid any remaining cash to the shareholders.  Notice that the collapse of the internet bubble is not associated with a financial crisis.  That is because there was little debt involved.  The IMF has it correct in this regard.  But the reason it wasn't associated with debt and the reason it didn't lead to a financial crisis is because it was associated with risk-taking!  And risk-takers had equity positions.

So, this is where the standard models go off the rails, because that error flips the story on its head, and it leads the IMF and most other observers to a position where they see signs of risk-aversion and their solutions are to limit lending and cut back on monetary expansion.  Then, the collapse in cash flows that ensues gets blamed on risk takers.  The correlations between debt - even high yield debt - and subsequent financial crises are correct.  The interpretations are suspect.  What leads to a crisis is when a large portion of the set of savers demands certain cash flows and then subsequent cash flows become so volatile that those demands are not met.

Zero is also part of the problem.  Zero looms large in the way we construct these models, and it shouldn't.  Take zero out of the equation.  Now, think of an economy where savers can expect yields of minus 2%.  Or, let's take that to an extreme.  Savers can expect yields of minus 50%.  These economies exist.  Would you associate these economies with "easy financial conditions"?

Housing: Part 300 - The Global Bubble Hypnosis is a Larger Problem than NIMBYs

Here is a recent article at the Financial Times.  The headline:

New York property jitters herald declines elsewhere

 The first line:

Clouds are hovering over New York’s housing market.

This is a great example of the mass hypnosis that has infected the public consensus on housing.

There is a broadening realization that the lack of access to urban labor markets and the lack of access to affordable urban housing are the prime challenge of early 21st century economics.  The problem is, solving that problem requires economic dislocation and upheaval of urban housing markets.  If you see falling real estate prices in urban centers should your reaction be to worry about "clouds hovering" over urban real estate markets?  I say, celebrate.

If our primary economic problem is that a lack of housing in urban centers causes it to be overpriced by a factor of 2 or more, then the DIRECT solution to that problem is that urban real estate needs to lose 50% or more of its value.  This article begins by noting that the median price per square foot in New York City has declined by 18% from last year.  Your reaction to that should be, "That's a great start!"  Full stop.  If that's not your reaction, then what are you doing?  What's your purpose?

Further, the article argues that global capital markets are leading to a new synchronization of urban real estate markets, so that additional supply is such a strong factor in bringing down urban housing costs that new units in New York City can bring down prices in London.  Your reaction to that should be, "Wonderful news!  Supply is a much more powerful factor than we thought."  Full stop.  If that's not your reaction, then what are you doing?  What's your purpose?

Reasons given in the article for this drop in New York prices include: (1) removal of tax benefits, (2) "glut" of luxury supply, (3) globalization, (4) "financialization", (5) "ultra-loose" money.  Your reaction to that should be, "Oh.  OK.  Those must all be good things.  Let's do more of those things."   Full stop.  If that's not your reaction, then what are you doing?  What's your purpose?

But, that's not the direction the article takes.  The article notes that sales volume is also down, and, as is the convention, it treats this downturn as the inevitable end of a boom bust cycle.  So, instead of seeing the drop in sales as a sign that all these good things might come to an end - as something we should counter - the article treats the boom that preceded it as the problem, and the solutions proposed are all policies aimed at stopping the real estate expansion before it develops!

This is an explicit defense of a monetary and credit regime that is specified to ensure rising urban real estate costs.

Now, admittedly the problem of solving urban costs is difficult, because normalized, unconstrained urban housing markets would require building with few unnecessary obstructions and low costs.  And, part of what happens in these regimes is that the bridge between basic costs and market value gets filled with all sorts of "limited access" rent seeking.  Developer fees, concessions to advocacy and neighborhood groups and municipal powers, queuing, etc.  These added costs emerged.  They didn't develop as some sort of plan.  So, if supply actually starts to increase enough to bring rents down to a reasonable level, these extra costs will have to be reduced in order to allow new development to come online profitably. Since the cost of queuing is pure waste, the first step here is "easy".  Just keep pushing through more projects for approval that are bringing in those "clouds".  There are a few trillion reasons why local planning boards aren't going to do that to existing owners and developers.

But, for activists and researchers who want to solve the urban housing problem and for global financial journalists who cover these markets, the reaction to that political problem should not be to kill any booms in their infancy.  The reaction should be, "How do we entice these urban planning departments to keep pushing through new supply when it looks like a downturn is coming?"  Because, to refer to any supply in these cities as anywhere close to a "glut" is a laugh.  A horrible, dark, depressing laugh.  There will be a glut of supply when rent in New York City is similar to rent in Atlanta, or even Chicago.  Until then, any use of the word "glut" to describe New York City housing should be met with laughter.

The reason we are engaged in this odd public rhetorical house of mirrors is because we all have a virus in our brain.  It's a cultural meme.  And it's a received canonical premise that there was a housing bubble, and that bubble was caused by loose money and loose credit.

The housing bubble, such that it was, was caused by an extreme shortage of urban supply.  Because of that shortage of supply, the process of meeting the public need for housing requires a "bubble" and the availability of credit that is flexible enough to allow for ownership where rents regularly take 50% or more of a household's budget.  Since supply in those cities barely responds to price, prices in those cities have to be bid up to high enough levels to induce outmigration so that new housing can be built in the rest of the country where supply can react to high prices and high demand.  At the peak of the US housing "bubble", credit markets were just beginning to push market prices to a level that induced that new supply.

Now, it would be better to build ample units in the urban centers.  But, since that doesn't appear to be close to happening, this was a second-best solution.  And, in terms of rent - which is the appropriate measure for considering housing affordability - 2005, briefly, was the one point since 1995 where supply at the national level was abundant enough to moderate rising rents.

Unfortunately, the Closed Access cities in the US are such a problem that in order to create enough housing at the national level, we had to induce a mass migration event out of those cities, and that mass migration event was the source of the dislocations in places like Phoenix that drove the country to demand a credit and monetary contraction.

This is the first step to fixing the problem.  We need to get that virus out of our heads.  The problem, all along, was supply.  Trying to pop the bubble before it inflates is the opposite of what we need to do.  I think the first rhetorical step to beat this virus is to stop thinking about housing affordability and housing markets in terms of price.  Price is a secondary function.  Affordability is about rent.  And, in the end, price is also about rent.  And, in the past 25 years, there have been two successful means for moderating rents.  (1) build like it's 2005, or (2) pull back on the money supply and credit so severely that a good portion of the country is foreclosed upon.

If we had committed to (1), today rents would be lower, prices would be higher, homeownership would be strong, and American balance sheets would be healthy.  It would be nice if a lot more of those American households could also live in the coastal cities.  I don't know if that can happen, but it sure as heck isn't going to happen if there is a consensus reaction to protect those precious urban real estate values every time the solution actually starts to play out by worrying about a "glut" of supply, and then by accepting pro-cyclical credit and monetary policies in order to "pop" the "bubble".

In that counterfactual, where the urban supply problem isn't solved and the rest of us commit to abundant supply, there would be gnashing of teeth about how the Federal Reserve is feeding bubbles and they are at fault for making home prices too high.  We have indulged that intuition for a decade now.  Now we know how wrong that is.  This was the darkest timeline.  Let's roll the dice again and proceed with the knowledge that doing it wrong has provided us.

New York real estate is getting cheaper and is pulling housing costs down in other cities, says the Financial Times, because (1) removal of tax benefits, (2) "glut" of luxury supply, (3) globalization, (4) "financialization", (5) "ultra-loose" money.  OK.  Those must all be good things.  Let's do more of those things.  What's your purpose?

Housing: Part 297 - A Review of the Soon-To-Be New View on Housing

As I prepare parts of this project for wider dissemination later this year, it is nice to see several schools of thought which inform this new view gaining favor. My project is the puzzle piece that solves some of the remaining mysteries and pulls these schools of thought into a coherent whole.

There are three movements or focal points of research that have become building blocks for this new view:

• Market Monetarism:  This is a school of thought based on the idea that central banks should focus on stabilizing nominal incomes rather than focusing on inflation and unemployment. This seems to be gaining momentum, and it seems like it would lead to better central bank policy outcomes. The important point for my project is that, since market monetarists tend to measure de facto central bank outcomes with nominal income growth, they tend to conclude that the financial crisis was created by tight monetary policy in 2008, the crisis was not inevitable, and there was no direct, inevitable link between the housing bust that had been building in 2006 and 2007 and the recession in 2008 and 2009.

• The Passive Credit School: Researchers like Demyanyk or Adelino, Schoar, & Severino, or Albanesi, De Giorgi, & Nosal, or Foote, Loewenstein, & Willen have been building a set of research that questions some of the presumptions of the popular accounts of the housing bubble. Borrowers during the boom didn't have particularly low incomes, low credit scores, or less education than usual, the crisis wasn't triggered by defaults that followed rate resets (as many had predicted), systemically destabilizing mortgage products were mostly being used by sophisticated borrowers who defaulted because home prices collapsed rather than because of affordability problems. Etc.

• The New Urbanization:  Richard Florida has been describing this phenomenon for years. Hsieh & Moretti have done some interesting work. I would put the work of Autor, Dorn, & Hanson in this category. The YIMBY movement is building steam. Even though many urban housing activists tend to seek regulatory solutions rather than focusing on supply, there is a budding consensus that a lack of affordable urban housing is a really big problem

There are several blind spots and false premises which keep these movements from seeing that an endemic shortage of urban housing is the connective tissue that binds them all together.
The broad consensus that the housing boom was, fundamentally, a credit bubble prevents market monetarists from taking the leap to realizing that even the housing crisis was caused by destabilizing tight monetary and credit policies, which date back to as early as 2006 and continue in many ways to today. It's hard enough to try to claim that the housing bubble and bust didn't cause the recession. It would be crazy to try to argue that a recession caused the housing bust, but that is essentially what happened.

That broad consensus also prevents the passive credit school from pushing to a strong conclusion, because since they still tend to believe what happened can be described as a bubble, that there has to be some ad hoc explanation for why a bubble developed. This increases the confidence that the credit supply school has in the competing theory that unsustainable credit supply was the causal factor in the housing bubble and bust. The passive credit school would be on much firmer ground to conclude that there was no (or only an isolated) housing bubble. But, they cannot reach that conclusion based on currently accepted presumptions.

The new urban movement also is limited by the consensus presumptions about the housing boom. If your motivating principle is that we need more housing, it's a pretty big obstacle to have this idea that only a dozen years ago our big problem was that we had too much housing. So, again, their voices are weakened whenever policies that would solve the problem would seem, as a first order effect, to increase lending, home prices, or building development. All of their work is much more coherent once that false presumption is removed.

New evidence, which help to see that the consensus presumptions are wrong, include:

• The flight from homeownership, and from living in the urban centers with constrained housing markets developed before the most aggressive price inflation happened, before the private securitization markets boomed, well before the CDO market that started the series of financial panics.  First time home buyers were declining as a portion of all households by 2005.  The private securitization boom was not associated with any increase in lending to first time buyers.
• The peak bubble period was associated with a massive migration event from cities with high home prices to cities with lower home prices.
• Taking all types of units into account, there was never an oversupply of housing in any city with a strong housing market. The rise in construction employment was not unsustainable.
• The cities where low tier home prices rose more sharply than prices in high tier markets were an anomaly, and the source of that price differential was not credit supply.
• The anomalous collapse in low tier home prices was universal across cities, and it happened after late 2008. It was not due to a supply overhang or to a lack of qualified borrowers. It was due to the regulatory imposition of extremely tight lending standards through the federally controlled GSEs and standards set by Dodd-Frank.
• The time after the extreme tightening in credit standards is the time when the US market deviates from international comparisons. US-specific monetary and credit policies aren't likely explanations of boom period home prices because boom period prices followed international patterns.
• The primary factor influencing home prices during the boom was location, and when comparing locations, changing rent levels explains nearly all rising prices.

In sum, rising prices during the boom were due to deprivation of supply, not excess credit and money. Once this realization is allowed to inform our presumptions about the market, the importance of the three schools of thought above, and the over-riding problem that connects them - an endemic shortage of housing - becomes clear.

Increased housing supply is what would have fixed the housing bubble. The myth that there was an oversupply overwhelmed our collective sense about what was happening. The Fed was never too accommodative. Home buyers, for the most part, were never too optimistic or speculative. There were never too many homes.

Once those conditions are accepted, the bold conclusions that the three movements above should lead to become obvious, and those seemingly unrelated movements reinforce each other.

An unleveraged banking experiment.

I have written previously about my own confusion regarding the issue of bank capital.  The issue seems largely rhetorical to me.  It comes down to whether you call deposits capital, in which case you're an unleveraged money market fund, or you call deposits liabilities, in which case you're a bank.  The difference seems to be that insuring deposits turns them into liabilities.

There are so many debates in finance that seem to me like they could be solved simply.  Too big to fail could be solved by using private deposit insurance instead of public insurance, which would lead to prices that reflect risk.  Even with public insurance, I'm not sure what's stopping us from simply pro-rating insurance fees to reflect changing capital levels or size.  Money market funds seem to do just fine.  To the extent that there is some risk in NAVs falling below $1, it seems to me that a standard contract for investors could have a clause that if NAV ever falls below $1, then withdrawals must pay an additional 1% fee.  This would be a fairly insignificant amount, it would reduce panic withdrawals, and to the extent that there were still withdrawals, they would naturally push NAV back above $1.  In the rare event that this happens, it seems like this would be a stabilizing policy with little cost to investors.

I am sure that I am naïve on these matters and there are good reasons why some of these ideas aren't used.

But, regarding bank deposits, I would like to imagine a system with 100% capital requirements.  Instead of making deposits, depositors would just buy shares in the bank.  The returns depositors earn would not change much, because today depositors make up a very large portion of the capital available to banks, so the returns that currently go to equity holders would be spread pretty thin when shared among the new depositor/shareholders.

But, depositors want certainty.  In this regime, they could get certainty by selling at-the-money puts on their shares.  Depositors would make deposits or withdrawals by buying or selling shares.  The bank would mediate their asset base by buying and selling shares on the open market.  So, sometimes, withdrawers would be selling shares to depositors and sometimes they would be selling to the bank.

This would be a 100% capitalized banking system.  The put sellers would basically be taking the role that today's equity holders take, but with much less volatility because even failed banks usually only have capital shortfalls of a few percentage points of their assets.  In today's system, equity in a failed bank would fall to $0 if the value of assets fell below the value of liabilities.  This system would be more like a money market fund.  A failing bank whose shares had sold at $100 might now sell for $98.  Depositor/shareholders would exercise their puts, and the put sellers would now be shareholders.  The depositor/shareholders wouldn't lose a penny, and they would be free to reinvest their $100 back into the same bank at $98 per share or into another bank.  The main factor determining that decision would be how high the put premium was.  If a lack of confidence led to a run on shares, the bank could recapitalize by buying shares at the market price if that price fell below NAV.  The only losers would be the put sellers.

There could even be a public agency through the Fed that was a major put seller.  This would create a natural method for recapitalizing banks during nominal financial crises, because depositors would buy shares in other banks, and when the Fed funded exercised puts, it would be a natural monetary injection into the system that was automatic and didn't require discretionary decisions about which institutions to support.  Of course, this whole system would work better with some moderate inflation so that share prices tended to have an upward trajectory and exercised puts weren't triggered frequently.

In a way, this wouldn't be much different than today, where the Fed owns a bunch of treasuries and also holds reserves that they pay interest on, and monetary policy comes from managing both of those quantities.  In this system, they would earn income on treasuries they own and on puts they sell, and they would manage the quantities of treasuries and bank shares that they own from exercised puts.  It would sort of be a nationalization of the commercial banking system, because as a put seller, the Fed would basically be taking the risks that current bank shareholders take.

Today, banks are induced to take risks because the upside flows to shareholders.  In this system, that upside would still exist, but it would have to be earned through put premiums as income.  Riskier banks could offer shareholders higher dividends, but it would come with higher put premiums.  Maybe seeing that bank share prices rarely declined by more than a couple percentage points, few depositor/shareholders would even bother buying puts.

Since upside profits would be retained by the depositor/shareholders, put sellers would have less potential upside than today's bank shareholders do, but that would also translate into less downside risk.  They would mainly be trading a regular income stream for the occasional shock.  The main regulatory issue there would be how much leverage put sellers would be allowed to utilize when they sold puts.

Anyway, this is all academic.  But, I like to think about these sorts of things using a different rhetorical framework to try to think more clearly about these issues in a way that separates rhetorical factors from real factors.  Limiting ourselves to the rhetorical frameworks we generally accept seems like it leads to limited solution sets and to solutions that solve rhetorical problems when really, what we need are solutions to real problems.

I hope you haven't found this brief post to be a waste of time.  I welcome comments that point out how ill informed this post is.

Links

I don't have much to say or add.  This is a great summary of policy recommendations for the California housing market.  Title: "25 Solutions From A Builder’s Perspective To Fix The California Housing Crisis"



Also, here is an excerpt from a recent EconTalk podcast with Brink Lindsey and Steven Teles.  It is on the topic of occupational licensing.  I generally find that it is hard to exaggerate how much the defense of licensing depends on assumptions that vastly overstate the utility of licensing and understate the amount of coordination and safety we take for granted in ways that have nothing to do with licensing. Lindsey makes a great point regarding that.

Brink Lindsey: Sure. Yeah, you're absolutely right that--licensing doesn't do its work by insuring that incredibly complicated tasks are performed by highly trained people. So, you use the example, 'Of course, we don't want somebody walking off the street doing heart surgery.' But the fact is, that there is no licensing of heart surgeons. There's only licensing of general practitioners. If you complete a U.S. residency in anything, and pass a state medical exam, you are a doctor--licensed to practice medicine. So, if you complete a residency in podiatry and pass a state licensing exam, you are legally entitled to do heart transplants or brain surgery or anything you can convince anybody to let you do. But, of course, that's not going to happen, because no practice will hire you; no hospital will give you admitting or surgical privileges. Simple commercial incentives backstopped by concerns about malpractice liability will suffice to ensure that highly complicated tasks are performed by highly trained people. What licensing does is ensure that tasks that don't require all that extensive training are still performed by highly trained people. And they have a captive audience and they can overcharge for it. So, there's just no problem with, you know, wildcat brain surgery. But, there's a lot of problem with people having to pay too much to get a finger splinted, or to check out for an ear infection, or to do lots of other humdrum things that mid-level professionals like nurse practitioners could perform fine but that in most states are not allowed to do so because of the licensing regime.

Housing: Part 274 - Wow! Scott Wiener swings for the fences.

California State Senator, Scott Wiener, has introduced legislation that would be revolutionary.  I agree with "Market Urbanism" that this would immediately transform the California housing industry, to the extent that building is not obstructed in other ways, which it certainly will be if passed.  But, momentum is turning into a hopeful direction.  And, the focus on density around transit means that this bill is an aggressive way to push housing expansion in a way that weakens arguments claiming building will increase traffic, will only be for rich newcomers, and will increase rents on other local units.

In short:

These three bills (1) mandate denser and taller zoning near transit; (2) create a more data-driven and less political Regional Housing Needs Assessment process (RHNA provides local communities with numerical housing goals) and require communities to address past RHNA shortfalls; and (3) make it easier to build farmworker housing while maintaining strong worker protections.

If enough momentum can ever build in housing supply so that rents moderate or fall, and the perverse migration pattern pushing working class households away from economically strong cities can reverse, it will be interesting to see how the debate evolves.

Housing: Part 273 - Rental income in a repressed regime

Reader Ben Cole pointed me to this article on rising housing costs.  In general, I thought it was a decent article.  It avoided some of the worst problems I see in housing reporting.  But, I think it might make for a useful template from which to look at some basic reminders about housing income and costs.

The article includes this graph:


The measure the author uses does appear to include both owner-occupied rent and tenant rent to individual owners.  This does represent almost all rental income, because housing is a very unconcentrated sector, and most properties are held by individuals.

But we have to be careful about these measures, because housing is a real asset, but the BEA measures income in nominal terms.

Ownership is divided between residual owners (equity holders) and fixed income owners (creditors).  I can use BEA data to estimate the incomes of owners and creditors for both owned and rented properties.  Here is the data for "Net Operating Surplus", which is net income before interest payments:

Rent has generally been rising as a portion of domestic income.  Before the 1990s, this was largely due to increasing consumption of real housing.  Since the 1990s, rising, and even level, rental income is due to rent inflation in cities with constraints on housing expansion.

Next, I further disaggregate this between creditors and equity-holders.  The equity lines (the dark lines) should roughly add up to the graph that I copied from the article.  These measures of rental income to owners are much less stationary than the net operating surplus measure I used to show total net rental income above, but we can see that most of that movement is due to shifting shares of income between owners and creditors.  It has little to do with net operating surplus.

A major cause of this shift is the problem that interest payments include an inflation premium while rental income is in real terms. (Owners gain their inflation premium through the nominal rising value of the property over time.)  So, these measures are really pretty useless.

Next, I have estimated the real interest payment, and added the inflation portion of the interest payment back to the owner, since that portion of the payment really is a purchase of equity, if we think about it in real terms.  (A level nominal value of the outstanding mortgage is actually a declining real value because of inflation.)  I have simply subtracted annual CPI inflation from the effective interest rate, so this measure is a bit messy, but it's close enough.

Here, we can see that the author is on to something, even though she has arrived there accidentally.  Owners really are pocketing a rising income.  This rising income comes from two sources: (1) rising net operating surplus from rising rents, and (2) declining real mortgage rates, and the larger factor is declining mortgage rates.

This points to one of the misconceptions about housing that comes from paradigms that pin Wall Street as the boogeyman of the crisis.  Incomes to financial intermediaries and creditors have been cut very low.  The reason is that lending markets are generally competitive.  Returns get bid down to the competitive level, and since the crisis has led many investors to seek safe income, there are many competitors for lending.  Homeowners, on the other hand, are protected by (1) political limits to new housing in Closed Access cities, and (2) political limits to lending that limit access to new ownership in other cities since the crisis.  Both of these limitations to competition increase their profits, but they have different effects on price.  The first limit increases rental income with a stable yield on investment, so property values increase.  The second limit increases rental income by increasing the yield on investment, so it operates by increasing rent and decreasing price.  This means that it is good for homeowners in general, but very bad for existing owners who need to sell and very good for existing potential buyers who can still buy in spite of the government's attempts at thwarting mortgage lending.

Since investors tend to be much less leveraged than owner-occupiers, they have not benefitted as much from low interest rates.

Using Federal Reserve measures of mortgages outstanding and real estate market values, we can estimate yields for homeowners and lenders, based on current home prices.

These yields tend to run together over the long term.  The deviations in the 1970s are due to inflation shocks, which caused mortgages outstanding to be repaid with inflated dollars, decreasing the real yields to lenders.  Then, when inflation was pushed back down in the 1980s, that led to higher yields for lenders, since the dollars they were paid back with were worth more than they had been expected to be.  But, the ability of homeowners to refinance limited the upside to lenders.  The recent deviation isn't from an inflation shock.  It is from the two sources of obstruction - obstructed building and obstructed lending - which push owner yields up and lender yields down.


Here is a section from the article:

In the aftermath of the downturn, home values nose-dived, distressed properties were plentiful, and interest rates were at all-time lows. In conditions like those, owners hold all the cards - even when they’re also the tenants.
That’s well and good for Americans who are already homeowners, but the flip side is that many renters have been stuck. Many have been unable to transition into homeownership, whether because of stricter underwriting and regulations — or because of what Khater calls “economic” reasons like unemployment or stagnant wages. And as home prices started to rebound, ownership became out of reach.
“The decline in homeownership and rapidly rising home prices are a driver of inequality,” Khater said in an interview. “As a lower proportion of Americans own a home and that’s the biggest portion of wealth, that drives a wedge between the haves and have-nots. Homeownership is a great way for the middle class to achieve wealth and those opportunities are declining.”
Khater has advocated developing housing policy to address supply — more options that are more affordable for ordinary Americans — rather than demand, with more attractive financing deals. For owners and renters alike, he said, shelter is the biggest expense. If policymakers addressed out-of-control housing costs, that would be “a great way to enhance living standards,” Khater said.

The "That's well and good for Americans who are already homeowners" line is sort of an echo to my analysis above, but the author seems to ignore the huge capital losses that were taken by homeowners.  This is a strange conclusion to come to when describing the aftermath of a foreclosure crisis.  But, confusion about these matters is not unusual.  It partly comes from confusion about housing as an investment vs. as consumption.  The author is describing a situation where an owner-occupier who owned a $200,000 house that had annual net rental income of $10,000 now owns a home worth, say, $175,000, with net rental income of $12,000, in real terms.  I don't think homeowners are out celebrating their windfall rental income profits as a result of this.

On the other hand, if they are wealthy enough to be considered worthy by the CFPB, and they managed to refinance their mortgage from 6% to 4% in the meantime, then they probably are quite happy about that.  But, that added cash flow didn't come from their market power over their renter (themselves), but from their market power over "Wall Street", who are competing over who can lend to the limited number of borrowers the government has deemed acceptable.

This is yet another way that the "they bailed out Wall Street instead of bailing out families" rhetoric is not useful.  It's not even wrong.  It's like watching a TV channel that has a scrambled signal.  It comes from seeing information in a way that renders it incapable of conveying a coherent story.  In the section from the article above, the quoted economist joins the conventional view that loosened lending standards can't be a part of the solution.  At least the quoted economist recognizes the supply problem.

Housing: Part 254 - Solutions will be approved and mandated.

I fear I am entering curmudgeon territory, but there are just so many examples of wrong-headed thinking.

Here is an article at Slate: "The Housing Industry Still Hasn’t Realized It’s Building Too Many Homes for Rich People"

That headline really tells you everything you need to know about what will follow, doesn't it?  I mean, what sort of world does the author live in where he can imagine that an entire industry would not notice this?

"(T)his week, we got evidence that one of America’s largest industries may be running into trouble because its products appeal only to the upper crust."

"(W)ith each passing month, the homebuilding industry is pitching its products at a smaller, wealthier demographic slice."

Dozens, if not hundreds, of firms are constantly positioning in various niche markets to gain market share, and this just totally missed their attention.  Where the industry had a massive decline in revenues so that they all continue to have difficult decisions about how much operational downsizing they need to do and where some have debt burdens that are still larger than their new smaller revenue base can support - so that practically any reasonable revenue growth would improve net profit margins - and, gosh darn it, they just can't get it through their thick skulls that there is a low tier market to serve out there.  A market they were all happily serving 10 years ago.

Also, remember that in most cities, even though low tier markets never appreciated more than high tier markets during the boom, they have fallen behind high tier markets by 10% or more since 2008.  If low tier markets were less profitable, one might expect builders to at least raise prices back to those previous relative levels.  Strange that they would lower prices on those homes if the lack of profit is what drives this.

"There’s also evidence that existing homes (about 10 times more existing homes are sold each year than new homes) are getting too expensive for buyers."

One idea I hope to popularize is that we should think of affordable housing consumption in terms of rent.  Homes are getting too expensive because their rents are rising because we have broken the supply conduit.

"To their credit, in this expansion, the mortgage industry has not responded to the rising challenge of affordability by massively lowering its standards or by offering no-money down mortgages and other exotic lending instruments...Of course, there are a limited number of people in the U.S. who have $40,000 or $50,000 in cash lying around to make a down payment."

"Clearly, there is something of a housing shortage in the United States."

"The solution to the problem is for developers to increase the supply of affordable homes, and to bring large numbers of homes to the market that are closer in price to existing homes."

Come on, developers!  You're failing us!  The solution to this problem is for you to provide supply for a market that we are determined to block funding for.  This your moral failing.  Just one more piece of evidence of Wall Street screwing over Main Street.  m'I right?

Of course, at the time I clicked on the article, the highlighted reader comment was:

"I would like to know more statistics about BUYERS in the past 5-10yrs. How many were American full-time residents and how many are foreigners, and of what class of dwelling?"

If there is anything worse than corporations, it's foreigners.  They ruin everything.

The comments at articles like this offer an interesting peak at the fever dreams that drive policy today.  There is one thing going on here - we have nearly universal support for obstructing access to mortgages compared to any previous modern standard - and this clearly has killed demand in entry level housing markets.  This is the obvious reason for the shift in housing markets.  There is nothing subtle about what has happened.

It's a little strange, because everyone that supports this shift should at least be able to come to terms with the effect it would have on the market.  Instead of pretending this isn't a factor, they might say, "Well, homebuilders are only providing supply for top tier markets, but that makes sense, since we have shifted credit policy to decrease activity in lower tier markets."  I think the core of the problem is that everyone thinks standards were sharply weakened during the boom and they have just gone back to normal.  They don't realize that there was little shift in standards during the boom and the shift away from the norm has been during the bust.

Of course, recognizing that explains all of these mysteries about how the housing market has evolved since the crisis.  But, people can't see it.  So, this creates a sort of natural Rorschach test where they fill in the blanks with things that are wrong.  There will always be some sort of perceived evidence in their favor.  But, it is evidence that we know is not decisive because we know it is wrong.  So, the reasons given - near-sighted builders, foreign buyers, a "rigged" economy, poor decisions of homebuyers, etc. give us a clue about what wrong reasons people are drawn to.  They inevitably are about divisions, perceived inequity, in-groups and out-groups, corporate flaws, etc.

I think this is a reason why problems like this are so hard to solve, even if our chosen narrative villains didn't have anything to do with our original errors of judgment.  Since our judgments weren't built on actual relevant facts, we end up filling in the holes in our narrative with our chosen villains.  Once we do that, correcting to a more truthful narrative feels like it requires some sort of tribal disloyalty, because we filled the story with our tribe's mythology.

If you can talk yourself into believing that an industry that lost 3/4 of its revenue base has managed to err in leaving whole portions of the market untapped, then really, your narrative is flexible enough to accept any myths you may wish to attach to it.  But, in the end, what choice would you have, if the world is aligned against uttering the truth?

(Another irony here is that the complaint about the pre-crisis market was how profitable it was to sell mortgages and homes to the low tier market.  Everybody making bank on the backs of unsuspecting lower-middle class families.  Now, I guess it's impossible to make profits on the low tier.)

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Here is an article at the Financial Times by columnist Rana Foroohar. It is part of a series of posts where FT columnists point to important charts covering the past decade.  Her chart shows that buybacks and dividends have roughly fallen and risen in proportion to equity values.  And, interest rates have declined over the past decade.

That's the chart.  I'm not sure how she expects dividends and buybacks to move relative to broader market levels, but she seems to think this is important.  And, again, through some questionable assumptions about causation, we end up with a tale of dastardly corporations and a rigged economy.

As she tells it:
1) Loose monetary policy leads to low interest rates.
2) Low interest rates lead to binge borrowing by firms.
3) Firms use that cheap debt to buy back shares.
4) Share buy backs push up share prices.
5) This enriches the wealthy, since they own equities.

Let's accept #5.  Numbers 1 through 4 are based on nothing.  There is no mechanism through which the Fed could somehow be pushing long term interest rates well below the neutral rate for years on end.  Monetary policy hasn't been loose, and if it had been, it wouldn't lead to a decade's worth of low long term interest rates.  What were bond rates in 1979?  This shouldn't be difficult.

Borrowing by firms isn't unusually high, either, in relation to enterprise value or to GDP.  In nominal terms, levels get higher over time, though, so you can certainly make a graph that shows lines with positive slopes if you want to make this claim.  One complaint about firms, to the contrary, has been that they are sitting on too much cash.

Total payback ratios equity yields (dividends plus buybacks) have run around 5% of market value, plus or minus, for more than a century, and they continue to run at about that level.  [edit: It appears to me that total payout ratios (dividends plus buybacks as a percentage of earnings) also tend to have a stationary long term mean level of about 60-70%.]  Nothing unusual has been happening, except that regulatory changes in the 1980s led firms to shift some of this return from dividends to buybacks.  If you want to know the reason for this, and you're having trouble getting to sleep, ask an accountant.  It's not nearly as exciting as stories about "Wall Street" and "Main Street", though.

Using buybacks instead of dividends does raise share prices - or more precisely, dividends make share prices decline while buybacks don't.  Basically, shareholders receive $1 in added share value instead of $1 in cash.  But, there is nothing about buying back 2% or 3% of the equity stock each year that can, say, push prices up to 10% or 20% or 30% above some reasonable value they would have had otherwise.

So, a whole lot of nothing here is added up to create a story of an entire economic system rigged to benefit the elites at the expense of "Main St."  And, this is from the Financial Times.  Good grief.

Foroohar's book, alternately titled: "Makers and Takers: The Rise of Finance and the Fall of American Business" or "Makers and Takers: How Wall Street Destroyed Main Street" has 4.4 out of 5 stars at Amazon.  I'm sure it's a real page turner.  Much more interesting than an accounting textbook about the arithmetic differences between buybacks and dividends.

Foroohar's narrative exists above the plane of empirics.  The system is rigged.  Wall Street got bailed out and Main Street didn't.  How would you even address this claim, empirically?  It can't be.  It is simply a narrative construction and it is naturally satisfying enough that it can be filled with the detritus of our data filled age with little trouble.

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Here is even more good stuff from FT.  This time about housing in Silicon Valley.  More rigged economy.  Here, the sin committed by the dastardly firms is...brace yourself...growing businesses that provide many high paying jobs.  I know.  Corporations are the worst.

The entire article is about how these firms create pressures in the Silicon Valley housing market that make it hard for poor residents to remain.

It took a lawsuit from the city of East Palo Alto to get the social-networking company to consider ways to mitigate the effects of its whirlwind growth. The result was an $18.5m grant to build affordable housing for people on low incomes....

...“The narrative that has been preferred by these corporations is that it’s all because of their largesse. But they were coerced to the table,” says Romero. “When all is said and done, it doesn’t address one 150th of the impact that the size of these developments will have.”

Or, there is this:

The rent inflation is a symptom of the speculators who are pouring into the area to cash in on tech money.

So, I guess the reason Dallas has affordable housing is because they have more effective lawsuits against their local corporations?  I guess, if it weren't for "speculators", those apartments would be renting for $600 a month?  Dallas has fewer speculators?

Elsewhere, we have choice phrases like "Facebook and Google have shown themselves adept at buying up whatever dreams they haven’t been able to crush." and Google's headquarters "is spreading like a rash through Sunnyvale". "Instead of contributing to affordable housing, they 'don’t pay their fair share of taxes, they park the money overseas'."  "These companies have a lot of capital that they could invest in affordable housing if they wanted to."

This article really lays it on thick.  Here we have a case of firms that happen to operate in an industry that is geographically captured in some ways by an area with dysfunctional polities.  To suggest that housing in Silicon Valley is a problem because Google and Facebook aren't as community oriented as, say, Delta Airlines or Home Depot are in Atlanta is bizarre.  The companies have nothing to do with this problem.  The article makes a brief reference to Prop. 13.  But, it just keeps circling back to building resentment against these firms.  In any functional city, does it even occur to people to think that employers are supposed to be actively involved in the local housing market?  Yet, when politics leads to dysfunction, we seem to be naturally drawn to a certain type of narrative.

Imagine trying to get away with describing the expansion of any other group of people as "spreading like a rash".  Economic rhetoric, especially since the housing bust, has been quite stark.  When this sort of thing gets pointed out, it is common for people to react indignantly.  Playing up wealthy corporations as victims is unseemly, isn't it?

When the medieval priest declared that local witchcraft was causing the outbreak of fevers, his solutions tended to be terrible for the local witches.  But, you know who else the solution would be terrible for?  The people with fevers!  While our newspapers are filled with heated debates about the use of privileged language or ethnic and racial tensions, they are also filled with rhetoric that is sharply and obviously uncharitable to a predictable target.  It's so strange that we can compartmentalize like that.  I mean, even the language itself sometimes is quite parallel.  How can we become more sensitive to it in some contexts and remain insensitive to it in other contexts.  It regularly deposits scales over our eyes so that we don't notice the most obvious solutions to our problems.  I mean, for anyone who just sits down and looks out at the world for a second, the idea that Silicon Valley housing is more of a mess than housing in Chicago is because Facebook isn't engaged enough with its community, or the idea that share buybacks have led to a rigged economy of haves and have nots, or the idea that homebuilders desperate for revenue are just leaving whole markets unmet - these ideas are nutty.  I mean just fruit loops.  I might forgive the guy at the end of the bar for thinking such things.  He probably thinks I'm an idiot because I wouldn't know how to clean the valves on a '68 Mustang.  There's a lot to know in the modern world.  But, for cripes' sake, I'd like to think if he turned to the Financial Times, he'd have a chance at getting a little smarter about financial matters.

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One last one.  Here is an article about an affordable housing proposal in LA.  The headline, "L.A. County’s Latest Solution to Homelessness Is a Test of Compassion" is a testament to our time.  We don't need "tests of compassion".  There is a vast realm of economic interaction and cooperation that might include compassion but doesn't require a super-human core of it at the visible center of everything we do.  That is the realm of human action where most problems are solved.  We have become so enamored with the more visible forms of compassion that exist on the edges of that vast realm, that we have ground the gears of progress and shared well-being to a halt.

So, LA has a homelessness problem, and they have this proposal to raise taxes and then pay individuals $75,000 if they will build an "affordable" backyard unit and rent it to a homeless or needy family.

According to the article:

On top of that, the county will also streamline the permitting process, an arguably attractive incentive considering that most of these “accessory dwelling units” in U.S. cities are illegal.

The article does mention that new laws at the state level might ease some of those restrictions.  But, this is madness.  It's illegal to just build these units with your own funds.  If we rid ourselves of those types of restrictions, housing in LA would be affordable.  Instead, LA is making an exception to those restrictions, but only limited to households who take public money to do it.

This makes sense when we understand that this is not really a solution.  It's a test of our compassion.  Private investors and speculators will not be a part of this process.  That isn't the place they fill in our narratives of the time.

There used to be a time when American corporations made things.  Today, they only serve as villains for our fever dreams.  And, apparently, we'll have it no other way.  That's not just a pithy aside.  Think about the problems these articles are addressing.  There are trillions of dollars' worth of benign economic transactions - the transactions that would naturally take place in an unfettered context - that would solve these problems.  They don't happen because they are effectively illegal.