Thursday, October 27, 2016

The Obama administration sees its own nose.

Hey, look what the Obama administration discovered today! (HT: Andy Berner)

The impact of the financial crisis on current borrower access to mortgage credit is evident. (KE: The impact of borrower access to mortgage credit on the financial crisis is evident.  - FIFY) Today, the credit score of the typical new mortgage borrower is nearly 40 points higher than the typical borrower in the early 2000s. The average credit score for those obtaining a loan backed by Fannie Mae and Freddie Mac (collectively, the government sponsored enterprises, or GSEs) in conservatorship is nearly 750. The minimum credit score to qualify for a mortgage at the GSEs is 620, yet only 1 percent of all new mortgages originated across the industry are to borrowers with FICO scores below 665. While creditworthiness is certainly a critically important factor, this credit selectivity is especially sobering given the fact that more than 40 percent of all FICO scores nationally fall below 700. While a variety of factors contribute to these outcomes, it is clear that the GSEs and the secondary market can do more to reach a broader swathe of creditworthy households. Constraints on access to affordable credit have ripple effects across the owner-occupied housing market. When a large number of first time homeowners cannot buy a home, established homeowners may face a harder time relocating or moving up in the market.

If only the Bush administration had figured that out in the last year of their term, or if Obama had noticed in the first year of his.  The GSEs were taken over in 2008.

The curious thing about my project is many facts are slowly being accepted across the spectrum of observers.  But, will readers be willing to accept the conclusions that those facts point to when they populate a coherent narrative?  Will we admit that we fought an unnecessary war?  And, in the end, is that what the delay is about, even if that isn't a conscious choice?

It is the lack of credit what done us in, not an excess of it.  As this graph points out, and the White House memo seems to acknowledge, there was no excess to begin with.  Some try to concoct a story that FICO scores were somehow inflated by the housing boom.  But, an expansion of credit or real housing expenditures doesn't show up if we look at incomes or spending, either.  And, in any case, if the expansion of credit can happen with little discernible movement in FICO scores for nearly a decade, what does that say about the scale of a 50 point increase that happened during the bust.

The government took over most of the mortgage market, and supported the top half of it.  For the bottom half, the worst of the bust came after that - both in terms of defaults and in terms of lost equity.

If they actually follow through on this, prices at the low end of the housing market will rise significantly, which would be great.  Not because it matters whether prices are high or low, but because it matters that prices are free to reflect accessible markets.  The only reason those prices are low now is because we are killing the mortgage market, and locking middle income households out of the market, to keep them that way.  That's the rigged system.

Success might push us even more quickly into a recession, because there seems to be a consensus that we have to prevent markets from clearing.  But, at least there is are green shoots of statements of the obvious here.  Baby steps.

Wednesday, October 26, 2016

Housing: Part 182 - The Only Solution for Closed Access Cities is to Build Luxury Market Rate Units

A common complaint in the Closed Access cities is that they can't allow housing expansion at market rents because all the developers want to build is luxury apartments.  When they try "trickle down" housing policy, it just attracts more high income residents to the luxury apartments and just puts more pressure on working class tenants.

The surprising thing is that, if you think about it for a bit, they are actually making an arguable point.  Or, at least, it would appear to be an arguable point to anyone who was simply trusting their own experiences and observations about what was happening.

But this is one of those Bastiat things, where the good stuff is all happening outside our field of vision.  Here's why.

As a city's housing supply becomes constrained, the first response of households is to reduce their real housing expenditures.  We can see this effect, really, in just about all cities, in the "drive until you qualify" distribution of home values.  As you move into the city core, more amenities and shorter commutes mean that you get less house for the same money.  The same adjustment happens across the board in a city as the entire city develops constrained housing.  The house has to get smaller or the drive longer in order to keep costs manageable.

In cities like Seattle, Washington, DC, Minneapolis, etc. where there are supply constraint issues, but not to the level of the Closed Access cities, households generally can make those adjustments across the income spectrum.  The median household tends to feel comfortable with rent in the 20% to 30% range.  This has moved up to 25% to 35% because we have imposed a housing shortage on the entire country by killing the mortgage market.  But, as the first graph here shows, up until 1995, rents settled around a common range.  After 1995, cities with especially high incomes (which can only be maintained by exclusion) also developed very high rents - even as a proportion of those high incomes.  This is because housing became so constrained that households couldn't downsize any more, and for households that valued remaining in those cities, they had to allow housing expenditures to rise as a portion of their incomes.

Washington retains normal rents, as do Seattle and other cities that are regarded as expensive because they still are functional enough that most households can downsize enough to keep housing in that comfort range, even if the home itself is not as physically comfortable as they would prefer.

Here was my attempt at graphically describing this effect.  As housing becomes constrained, households begin to allow it to take on more of their household budget.  Demand becomes inelastic.  But, at some point, income effects become too strong, and demand becomes elastic again for the current residents.  At some level, there is a maximum amount that households can spend on housing, where demand maxes out.

This is why Closed Access cities have a peculiar migration pattern of low income households moving away in such large numbers.  At some point, there is potential in migration, and these in-migrants have less elastic demand for housing the current residents.  In other words, they have higher incomes, so when rents rise, they can accept the higher rents on the given housing stock, so they can bid up rents, forcing the previous residents out.

Across the distribution of incomes, households move along that demand curve to the right.  The higher their incomes, the less they need to spend on rent as a portion of their incomes.  They achieve this by reducing their real housing expenditures, as households in many cities do.

This is another old graph of mine that describes this phenomenon.  At low incomes, rent pulls in a large portion of Closed Access incomes.  As incomes rise, households in Closed Access cities spend a similar amount as households in other cities do, on rent.

So, at the two extremes, there are households with very elastic housing demand, in terms of the proportion of their incomes - but convex at one end and concave at the other.  If we imagine an expansion of supply in the graph above, rents will decline.  For low income households, they will tend to remain in the same unit, and will allow their rental expenses to decline from 60% to 50% of their incomes.  For high income households, their rent spending is already at a comfortable 20% of their incomes, so falling rents will allow them to increase their real rent expenditures until they can once again spend 20% of their incomes on rent, but for a more comfortable unit.

Thinking about this in the aggregate, notice what this means regarding the effect of new supply on housing consumption.  The pent up demand for housing is focused within the high income households.  They are naturally the households that will expand their real housing consumption.*

So, if a Closed Access city manages to expand the supply of units, the overwhelming natural demand for those units is going to come from high income households.  The measure of how much that new supply helps low income households isn't going to come from seeing low income households move into new units.  It has to come indirectly.  First, by seeing that they have more money to spend on non-housing consumption, because that's what they have been cutting back on.  Second, by seeing that they stop fleeing the city by the thousands for lack of affordable housing.  Closed Access cities are so dysfunctional that expanded real housing consumption among low income households is way down the road in any scenario that addresses the problem.

Since the direct effect of new housing - what the locals see - is high income households buying them up - expanding their real housing consumption, it looks to any reasonable observer like "trickle down" economics.  Then, they react by obstructing new market-rate units.  And, ironically, it is the obstruction that continues to make their city dysfunctional.  It is the obstruction that makes those units "luxury" units.  It is the location.  The reason the location makes those units status goods is because of the constricted supply.  So, again, Bastiat might point out to us that across the city, low income households are forced out of existing units that have now become a little more "luxury" because of the obstructed supply.

The irony is that many of those forced out households move into units in Phoenix or Dallas with higher ceilings, more square-footage, etc. than those "luxury" units in the Closed Access cities, because in cities that don't obstruct building, developers have an abundance of choices for all types of households.

* In fact, the opposite of this is what happened in the housing bubble.  More flexible mortgage terms allowed high income households in the Closed Access cities to expand their real housing consumption.  In the Closed Access cities, where home prices were by far the highest, this was not a phenomenon focused on low income households.  Low income households were being forced out of the Closed Access cities by the hundreds of thousands during the bubble, because high income households were able to use those mortgages to outbid them.

Tuesday, October 25, 2016

September 2016 Inflation

Sorry I'm a little late on this.

Trends continue.  The housing shortage continues to push rents up and the money shortage continues to push other inflation down.

First is the month-over-month graph.

Then is the trailing 12 months graph.

Notice on the monthly graph that the trend outside of shelter is down.  Now, trailing 12 month non-shelter core CPI is at 1.4%.  In the last 7 months, non-shelter prices are up 0.45%.  In the 5 months before that, prices rose by 0.95%.  In other words, annual inflation outside of shelter is unlikely to rise back up above 1.5% for quite a while.  It is probably more likely that it will move below 1%.

Forward inflation expectations implied by TIPS bonds have been moving up from low levels, but those are based on total inflation, which includes shelter.  Core CPI is above 2% now when shelter is included.  Five year forward breakeven inflation is under 1.6%.

Let's hope the hawks can be overcome quickly when this comes to a head.  Our perpetual recession is its own sort of macro-prudence, I guess, so we've got that going for us.

It will be interesting to see what happens.  If rent inflation continues to rise, it might encourage the hawks.  On the other hand, if rent inflation falls under these supply conditions, that is a really bearish signal (like in 2007).  I would take it as a signal of a potentially more severe contraction.

At the risk of sounding vain, I wish I could have gotten the book finished and in front of some faces 6 months ago.  A public conversation about this would be useful.

Monday, October 24, 2016

Signs of Recession, Part 2

I guess signs of recession will be a new series.  Whoop-die freakin' do.

Here are some apparently mixed signals from employment flows.

 Net employment flows between unemployment and employment have taken a sharp turn into recessionary territory.

But, on the other hand, flows from out of the labor force, into employment, are very strong - at least as strong as 2004-2005.

The flows in 2004-2005 were related to the huge migration flows out of the Closed Access cities during the housing boom.  In 2006, flows into employment dropped dramatically - from unemployment, and especially from out of the labor force.  This is because the Federal Reserve inverted the yield curve and purposefully slowed down real residential investment.  The beginning of the collapse of the mortgage markets that resulted, both reduced funding for new homes in Contagion cities and reduced the pressure on the housing stock in the Closed Access cities.  So, the first effect of the recessionary conditions of 2006 wasn't for unemployment to rise, it was for those migration flows out of Closed Access cities to dry up.

The interesting thing about that migration was that it wasn't a traditional migration to employment.  There were plenty of jobs in Closed Access cities.  It was migration due to cost, which is this super-duper way we have decided to run an economy these days, with a virtual wall surrounding our most dynamic labor markets so that we naturally segregate by income and skill, with a rent-soaked high income urban core and a deprived rural inland.

So, the decline in migration in 2006 didn't lead to unemployment.  Those households who were now staying in the Closed Access cities were employed.  They were just economically stressed by costs in spite of being employed.  Rent inflation shot up in 2006 and 2007 while housing starts collapsed and this migration pattern sharply declined.

So, I don't expect to see the same patterns as we move into this recession, because that migration pattern isn't in place today.  Households are already stuck in the high cost Closed Access cities because for a decade we have made sure to prevent housing and mortgage finance from recovering.

So, what do gross flows tell us about flows between employment and not-in-labor-force?  Here, the indicator is recessionary.  I'm not sure what forces are behind the net flow.  Normally the net flow would turn negative at the same time that gross flows began to downtrend.

I don't know if there are any home runs that can be hit in this context.  I'm not sure there are any obvious areas of excess valuation or systemic risk.  This could be sort of a mix of 1991 (relatively mild stock market shock) and 2001 (relatively mild pause in housing expansion) and there certainly isn't much upside in bonds to prepare for.  I'm not sure there is much to do but wait for the Fed to blame something else for the recession after they crimp the money supply too much and give themselves permission to do QE4.  I hope it happens sooner rather than later.

Friday, October 21, 2016

Signs of Recession

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

Here is the chart from Calculated Risk.

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

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

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

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

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

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

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

Thursday, October 20, 2016

TBTF isn't the problem. TSTS is.

TSTS = Too Small to Save

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

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

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

Tuesday, October 11, 2016

Book step 1.

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

Thursday, October 6, 2016

Housing: Part 181 - Predatory Lending in the bubble

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

First is homeownership by education.

Second is homeownership by occupation.

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

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

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

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

Here's another good one.
Income quintiles

Tuesday, October 4, 2016

Our peculiar housing problem.

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

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

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

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

Wednesday, September 28, 2016

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

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

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

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