Wednesday, May 24, 2017

Housing: Part 231 - Bloomberg to Canada: Time to Party Like It's 2008!

The article's title is "Canada Must Deflate Its Housing Bubble", from the editors.  And it is a panoply of the errors that led us to our 2008 debacle.

The problem is home prices.  Period.  There is no other reason to demand tight money in Canada.  Inflation has been moderate for years, unemployment has basically been flat at around 7% since 2012 (still 1% above the pre-2008 bottom), and, since 2012, annual nominal GDP growth has ranged between 0% and 5%.

High home prices are blamed on "foreign money, local speculation and abundant credit".  No mention of supply constraints.  It would take a decline of 40% for Toronto home prices to fall back to historical norms relative to incomes, according to the article.

Just as in the US, in practice what Bloomberg is calling for is to kneecap the economy until they get the housing collapse they think they need.  A 10% or 20% or more collapse in housing prices will be seen as success - a "correction".

"Granted, the bubble bears little resemblance to the U.S. subprime boom that triggered the global financial crisis." says the article.  Except that it does.  The resemblance is just in the place where Bloomberg isn't looking.  There is little resemblance from a demand side (credit) perspective because this is a supply problem, and in every country people collectively view what is going on and blame it on whatever happens to be the credit and monetary regime in place at the time.  Homes always require a healthy credit market, and when home prices are high, unsurprisingly, credit markets are always active.  You would think the lack of a resemblance would be a clue that credit and speculation aren't the fundamental causes of the price boom, but the blinders are just too strong on this issue.

That being said, the structure of the private securitizations market in the US was especially primed for a vicious cycle once expectations turned south.  Canada has a better banking system, so a financial crisis is less likely.  If they go down this path, it will be interesting to see how different it will be from the US contraction.

The Bank of Canada didn't take Bloomberg's advice, and signaled that they will keep the policy rate at 0.5% today.  Good for them.  As chatter about a housing bubble continues, it bears watching.

Tuesday, May 23, 2017

Housing: Part 230 - Supply and Demand during a housing boom.

One aspect of a hot real estate market that is thought to lead to cyclical volatility is the wealth effect of rising prices.  Existing homeowners get an income boost from rising capital gains in their homes.  This shifts the demand curve out because existing home owners can use their newfound equity to buy up into the hot market.  It also shifts the supply curve down because some households who might have had to sell their homes due to temporary financial stress can now tap home equity in order to continue making mortgage payments.

These are legitimate factors that might feed a bubble.  But, I think there is a significant mitigating factor - outmigration.  I think this factor might be overlooked, because we tend to model markets in a ceteris paribus framework, and the way that this factor mitigates the bubble is through a shift in the market itself, as former homeowners sell and move away from the local market.

This first chart is the estimate of population shifts from IRS data.  This is net domestic migration into and out of the Closed Access and Contagion cities since 1995.  This roughly matches the net domestic migration we see in the ACS data that begins in 2005, specifically for homeowners.  There was a buildup of migration, peaking around 2004 or 2005 at 1.5% or more of the local population.

In the Closed Access cities, this means that at the peak of prices and sales, there was selling pressure that amounted to more than 1.5% of existing units each year.  That's a hefty mitigating factor.

Usually, home sales volume runs about 5% of the existing stock.  (I'm not sure why the Zillow measure shown here shows such a decline in 2016.  NAR existing home sales haven't declined like this.)  That bumped up to about 7% during the boom.  Sales turnover was higher in the Contagion cities, but the Closed Access cities tended to run near the national average.

Data from Zillow
This means that about 1/4 of home sales in the Closed Access cities were from homeowners selling out of the market and moving out of town.  That's a lot of selling pressure.  This doesn't include households that might have sold properties and remained in the city as tenants.

There was a sharp jump in privately securitized mortgages in 2004-2006, and there was a jump in home price appreciation in 2004 and 2005, which leveled off in 2006.  We tend to attribute those 2004-2005 gains to the new, more flexible mortgages, and certainly they were a factor.

But, the degree to which that new demand from buyers flowed to price is dependent on how elastic this migration-related supply was.  Maybe prices would have gone up another 30% if this outmigration hadn't kicked in.  Or, maybe one reason prices accelerated in 2004 and 2005 was that the "low hanging fruit" had been picked out of Closed Access markets, and the homeowners who were easily induced to migrate had already sold and left, and supply shifted out less over time as the population of potential movers was tapped.  Or, maybe we overestimate the effect of demand on these markets in general, and home prices at the MSA level are more bound to the present value of future rents than we give them credit for.  The quantitative answers to these questions are beyond my abilities, but they seem to be questions that have not been asked nearly enough because changes in the mortgage market have taken center stage while the sharp shifts in migration during the boom were less directly visible.

In any case, it seems to me that the degree to which Closed Access prices remained close to a reasonable valuation vs. being pushed to unsustainable or irrational levels, depends more on the elasticity of supply coming from those existing owners than it does on the new demand that might have been facilitated by the new borrowers.

The Contagion cities are the mirror image of the Closed Access cities, so their markets were characterized more by new demand.  But, we can see this migration-supply factor coming along even there, beginning in 2005.  The first shift in migration in the Contagion cities in 2005 was an upshift in out-migration, even as migration from the Closed Access cities remained strong.  Then, in 2006, even while the private securitization boom remained strong, net migration really dropped in Contagion cities, and home prices leveled out there.

We can also see a mitigating factor across cities.  Portland, OR took in a lot of California migrants during the boom, like Phoenix, but its total population growth was more subdued and home prices there were less volatile.  This is mostly because home prices there started out higher.  They peaked about the same level in Phoenix and Portland.  This is what we would expect to see if migratory shifts on the margin, regulated by the cost of housing relative to the Closed Access source cities, were an important factor in finding an equilibrium price.

Added:  Another comparison we might make with the 1-1.5% rate of Closed Access out-migration is that first time homeowners tend to represent just over 1% of households per year.  (It has been lower than that during our decade of demand deprivation.)  And, during the housing boom, homeownership was rising by about 0.5% per year.  It has fallen at about that same rate since then.  The rate of out-migration from Closed Access cities during the boom was larger than either of those measures.

Friday, May 19, 2017

Housing: Part 229 - Public policy, behavioral finance, and attribution error

Robert Shiller has a new post up. (HT: EV)  He is discussing the housing bubble, how home prices are moving up again, and what a mystery it is:
The problem for economists is that these changes don’t correspond to movements in the usual suspects: interest rates, building costs, population or rents.
I happen to have a book or two coming out that explains how home prices were entirely explained by interest rates, building costs, population, and rents.  Anyone who reads this blog knows that the evidence in this regard isn't marginal.  In all these factors, the shocks were extreme.  (Regarding building costs, in most areas these were tame, and home prices were tame.  In Closed Access cities they mostly are related to political obstruction.  eg. How much would it cost to build a 40 unit condo in the Mission District in San Francisco?  Show your work.)

I hope this whole episode helps to bring real estate finance into the 21 century.  I have been treating housing, as an asset class, like an index.  There could be a real estate index just as there is an S&P 500 or a Dow Jones index.  Dr. Shiller, in fact, has introduced many indexes that move us in that direction.  Because we have these indexes in equities, it is very common to see that asset class treated as an entity with measurable aggregate behaviors.  The interesting thing is that we seem to need to have the indexes in order to help us think that way.

There are indexes for bond prices, so if I ask you what the going rate for 10 year bonds is, you look in the Wall Street Journal and say, "Looks like it's at 2.4% today."  Tomorrow will be different.

But, in real estate, you ask someone at a real estate fund what the current return is on new developments, they say, "Well, the investment committee has it at 5%."  Then, you see them 6 months later, and they'll say, "It looks like the investment committee will be moving the cap rate down to 4%.  This will lower our income, but it will open up a lot of new investment opportunities for the fund."  OK.

It will be a sign of progress if when I ask you what the current return on real estate is, you look it up in the Wall Street Journal.  Returns on investment aren't a policy decision in a developed market.  They emerge.  But, we are probably a long way from that possibility.  Now, many insiders would probably say this is ivory tower naivety.  But, before there was a Dow Jones Industrial Average, it would have seemed just as na├»ve to think that you could stick a restaurant group, a steel fabricator, and a hundred other firms into a bucket and come out with anything meaningful.  Now, there are massive parts of the investment market that hardly do anything else.

In the meantime, we have a bunch of economists looking at national data that doesn't capture any of the inter-MSA details that are defining our market.  And, the real estate sector itself is heavily focused on extremely local factors that largely determine the idiosyncratic returns of each individual project.  Localized public sentiment drives those markets, and the entry of pesky amateur investors is naturally seen as problematic.  It is very easy for those to groups, each missing the core part of the story - the difference between MSAs - to come to agreement that a bunch of speculators must be screwing up the buyers' market.

I suppose that having more developed measures of value doesn't stop every guy at the end of the bar and every Austrian Business Cycle proponent from calling the equity markets bubbles, too.  So, maybe this isn't the problem.  Although, I think the public sentiment created by attribution error in real estate markets is somewhat contagious, and is partly to blame here too.  Coincidentally (?) a favorite tool of the equity bubble mongers is Dr. Shiller's CAPE measure.

Tuesday, May 16, 2017

Housing: Part 228 - International and Domestic Migration

One reason we might excuse Closed Access cities for the large amount of migration outflows they produce is because they have long been entry points for international immigrants.  This is still true today.  But according to Census Bureau estimates, they are not much different than the other major cities.

Net international migration into Closed Access cities is about the same rate as the Contagion and Open Access cities.  What makes the Closed Access cities Closed Access cities is that they generally can't even manage to house their own offspring.

Sunday, May 14, 2017

Peter Conti-Brown on the Fed

I just got around to listening to this Macro Musings podcast with Peter Conti-Brown about the history of the Federal Reserve.  Fascinating throughout.  It is clear that Conti-Brown has a thorough deep and broad understanding of the history and inner workings of the Fed, and I thought his descriptions of some of its history were entertaining and interesting.

Highly recommended for finance nerds.

Friday, May 12, 2017

April 2017 CPI Inflation


Non-shelter Core CPI, year over year, now down to 0.8%.  Luckily those rent checks that homeowners write to themselves and put in their bank accounts each month are keeping inflation near its target level.*

That's why the Fed needs to raise rates next month, because all that rental income is just causing an avalanche of fixed residential investment.  We need to stamp this thing out before it gets out of hand.

Are we going to get a repeat of 2008, where by the time the Fed meets, 5 year inflation spreads in the TIPS market are back down below 1.5%, and FOMC members will explain to us how we can't really trust market measures?

OK, Wall Street Journal!  Time for one of your well-timed op-eds, explaining how it's the Fed's job to create panics and contractions!  This is your speciality.  It's your time to shine!

* I just had a great idea.  I don't know why I didn't think about this before.  We should have hard price targets for homeowner rents.  The Federal Reserve should send a letter to homeowners each month, directing them to raise or lower their rents.  Then, the Fed can adjust rent inflation so that we precisely hit our inflation target every month!  This will also increase household income!  This seems like the sort of idea that President Trump could get behind.

Wednesday, May 10, 2017

Equity Returns and GDP Growth

Part of the secular stagnation story is about demographics.  Real GDP growth has been lower than at any previous time since at least WW II.  But, if we adjust this for labor force growth, we see that real GDP growth is low, but it is within the range of previous periods.

Even so, notice that real GDP growth per worker is currently very low, even though we are in a recovery phase, and it has been near zero twice since the recession.  In the post-WW II era, this has generally been associated with a recession.  Maybe this is related to the Great Moderation.  When real GDP growth per worker was low in the 1970s, quarterly growth whipsawed through recessions and recoveries.  Now, both the top and bottom have been moderated, so we get a slow, grinding recovery with the same level of real GDP growth per worker.

S&P Data from Robert Shiller
It looks to me like, over the long term, returns on equities are related more to real GDP growth per worker than they are to unadjusted real GDP growth.  They certainly are more related to real GDP growth, over the long term, than to nominal GDP growth, even though the zeitgeist currently seems to accept some sort of Austrian business cycle idea that monetary accommodation leads to real stock market gains.  I think this is an error.  The stock market rises when the Fed accommodates because monetary policy has been too tight throughout the current period, so accommodation leads to real growth, and a rising stock market is a secondary effect of real economic growth.

As we see in the second chart, the returns to equities are much more variable than changes in GDP (a 200% ten year return corresponds to average annual GDP growth of around 2%).  This makes it look like there is a reaction of equities to nominal growth, because if nominal accommodation leads to real growth, equity returns will have gains in excess of the real GDP gains.

But, the point here is that, even adjusting for the demographic problem, there is a stagnation problem.  It's not particularly worse than the problem we had in the 1970s, but it is a problem.  GDP growth, adjusted for labor force size, needs to recover if we are going to see better returns to equities over the next decade.  (Total returns to equities have been much worse than they look in the past couple of decades because returning capital through buybacks instead of through dividends creates a side effect of inflating the stock indexes, but it doesn't really change total returns.  So, whenever someone uses an unadjusted stock index, like the S&P 500, without adding in dividends, it will be skewed.  I am probably making a separate error here, because I am comparing S&P returns to GDP, even though corporate revenues have become increasingly global.  That's something to keep in mind.  Maybe adjusting for foreign profit would add a downward trend to the equity returns, and make them look more like the unadjusted GDP growth.)

I'm still not sure if the secular stagnation problem is a demographic problem.  There seems to be a general sin wave pattern of 35 years or so that goes back at least to the early 20th century.  Maybe, this is a shadow of the demographics issue.  Maybe, when baby boomers were crowding into the labor force in the 1970s, they were bringing down productivity because there was an inflow of young, inexperienced workers.  And, today, they are bringing down productivity because low labor force growth today is the result of retiring baby boomers who are leaving the labor force at their peak levels of productivity, taking a lifetime of experience with them.  Maybe, we have another decade or so of this, and when the baby boomer retreat has peaked, growth per worker will naturally begin to rise again.  Buying in after the next recession might be like buying in after WW II or after the 1982 recession.  It's probably more like the post-WW II period, because inflation and nominal bond yields are low, so that there will probably be a period of significant excess returns to equity, like there were in the 1945-1970 time period.

Monday, May 8, 2017

Housing: Part 227 - The Housing Boom was progressive wealth redistribution

One of the notions about the housing bubble that is horribly backwards is that it was characterized by lenders trolling for low income borrowers to put them in overpriced homes.  The "they did this to us" narrative implies that, somehow, a rapacious financial sector was able to push home prices up in some cities to maybe double or more than their reasonable values by pressing all this new credit onto the marginal market.

I have many posts about this.  About how, in the aggregate, this wasn't happening at all.  Here is some data from the American Housing Survey that addresses the point.

First, here is the average price paid for homes by owners in each income quintile.  (These are based on national income quintiles.)  There is a general pattern across cities here.  (Open Access here refers to the entire country outside the Closed Access and Contagion cities.)  Home prices for top quintile owners tend to be a little more than twice the level of home prices in the second quintile, in all cities.  But, this isn't a measure of home values.  This is a measure of the price paid.

The thing is, Closed Access cities have dysfunctional housing markets, so families that manage to get into a home tend to stay in that home.  In California this is also encouraged by property tax rates that reset when a property is sold.  So, average length of tenure in Closed Access cities is much higher than in other cities.  And, length of tenure is higher for owners with lower incomes than it is for owners with higher incomes.  This is because (again, despite what you read in the papers) it is when households have higher incomes that they tend to make opportunistic home purchases.

This means that when prices are rising, most households with lower incomes are living in homes that are worth a lot more than what they paid for them.  Here is a graph of home values (in other words, today's market price), by income.  Now, the picture changes a bit.  In Contagion and Open cities, the pattern is similar than it is for prices paid, but a little flatter.  But, for Closed Access houses, the pattern is much flatter.  The value of the average home owned by a household in the 2nd quintile is not much different than the value of the average home owned by a household in the 4th quintile.  The main difference is that the household in the 2nd quintile is sitting on a pile of capital gains.

One thing we might expect to see in this context is the use of home equity credit by those households with lower incomes, to spend some of those gains without having to sell their homes.  All else equal, this is bound to happen, because they are the households with more capital gains to draw on.  Researchers who have noticed that outcome sometimes refer to those households as having "limited self control".  I'm sure many of them do.  I certainly do.  You probably do, too.

It should also not come as a surprise that when home prices started dropping like a stone, owners who had taken out equity loans tended to default more often than similar households who had not.  How could there have been any other outcome, really?  But, this mathematical inevitability just added to our resolve that in the midst of a systemic breakdown, lending standards needed to be tightened and liquidity constrained mortgage markets should be left to die.  Otherwise, we would be letting the ones that did this to us off the hook.

Here's one more graph.  This shows the ratio between price and value for 2007 and 2013.  At the height of the boom, owners with low incomes were sitting on a lot of capital gains - much more than owners with high incomes.  This is because high income owners were the buyers.  They were more likely to have bought their homes recently.  (Also, most homes owned by households in the bottom two quintiles are owned free and clear.)

This idea that rising mortgage debt was the product of households with stagnant incomes desperately mortgaging their futures to fund current consumption is just plain wrong.  The idea that the housing bubble happened on the backs of low income borrowers is just plain wrong.  (The bust did happen on the backs of low income borrowers.  But that's on us.  That has been a public policy choice made through the state-controlled GSEs and Dodd-Frank.)

Saturday, May 6, 2017

Housing: Part 226 - Australia looks to break its winning streak

Reader Benjamin Cole alerted me to the recent rate decision at the Reserve Bank of Australia.  It seems that for the last couple of years, the RBA has been moving along at a somewhat tight stance, with low inflation, unemployment that has slowly edged up, and home prices that keep rising.

Here is an article from last month about Australian monetary policy that is basically a litany of the errors I think the US made in 2006 and 2007.  It has all the basics - a bias toward raising rates because of high home prices, expectations of a home price collapse, and a preordained narrative that blames those expected price declines for the expected recession.
“It seems the RBA is stuck between a rock and hard place,” said CoreLogic head of research Tim Lawless. “They aren’t likely to push rates higher just to quell housing market exuberance — doing so could push inflation lower and the Australian dollar higher as well as cancel out some of the much-needed stimulus that many sectors of the economy are benefiting from. “On the other hand, the RBA would be loath to push rates lower out of concern for adding further fuel to an already over heated housing market.”
While 70 per cent of experts polled by disagreed that Sydney and Melbourne are in a “bubble”, economist Saul Eslake has issued a warning. “A house price fall north of 10 per cent is the most likely cause of the next recession,” he told The Australian.

There are some differences between Australia & pre-recession US.  According to the article, mortgage rates are rising while the central bank holds the policy rate steady.  In 2006, mortgage rates in the US were staying low as the Fed raised rates, which I attribute to building recessionary conditions.  Also, housing starts in the main Australian cities do appear to be increasing somewhat.  It could be that they need to increase much more than they are.  The US Closed Access cities would probably need to double building rates to reverse their migration patterns.  If the Australian cities are in similar circumstances, it could be that a 20% or 30% increase in building isn't enough to trigger a regime shift.

According to this article, rent in Sydney is rising, although not as sharply as it had previously.  And prices continue to climb.  That suggests that new supply is allowing costs to moderate somewhat, but not enough to reverse expectations of continued inflation.  Of course, this leads to pushback from opposition parties that say it proves that new supply won't bring down costs.  It would be nice to see a city try to really do a regime shift on supply.  But, that would be difficult, politically.

It seems like Australia is in the sort of position the US was in before the recession, though.  There is an asymmetry to their policy.  They have a bias toward a tight policy because they are afraid of home prices, so, in the uncertain world of monetary policy, it seems like they are destined to follow a somewhat stochastic path until that path happens to become tight enough to be destabilizing.  There is little chance, on the other hand, that they will happen to become too loose.  It seems to me that this makes a recession somewhat inevitable, but not particularly predictable.  In the US, housing starts collapsed before the recession, and this isn't happening in Australia.  Maybe that difference is enough to keep Australia on the right side of the tipping point.  In the US, collapsing housing starts were, maddeningly seen as a positive.  My limited view suggests that doesn't seem to be so much the case in Australia, although worries about mortgage debt can easily turn into "solutions" that lead to less building.

Friday, May 5, 2017

Housing: Part 225 - Here we go again.

Migration is heating up out of California again. (HT: John Wake)

The Contagion cities are far, far, away from the levels of housing starts in 2005 when out-migration was really kicking.  In 2005, some of the out-migration was from Closed Access homeowners tactically selling into the boom.  That had an effect on the shape of the bubble in the Contagion cities.  Now, the out-migration is more focused on renters and households with lower incomes.  It will be interesting to see how this plays out differently.

Rent inflation in Contagion cities is high now, but it is not triggering a particularly strong homebuilding market because middle class buyers can't get mortgages easily, so supply is constrained.  To solve the supply problem, credit needs to be loosened, but that probably means rising prices in Closed Access and Contagion cities.

The recession that appears to be coming will probably slow all this down.