Monday, July 25, 2016

Mortgage literature bleg

Do any readers know of literature proposing the use of mortgages with adjustable interest rates but fixed payment rates?  Sort of like an option ARM, but without the option.  The payment doesn't adjust with the interest rate, the principal does.

Does anyone know if there are detailed proposals of this sort of thing, or if there is anywhere where mortgages like this are used?

Tuesday, July 19, 2016

Housing: Part 167 - Open and Closed Access


Here is a link with estimates of what income is required to affordably buy the median house in various cities. (HT: John Wake)

I think there is a rhetorical subtlety that is sometimes missed in public debates about housing.  There are people who argue that the supply issue is overly simple Econ 101 stuff and that there are many factors that influence housing costs - local incomes, geographic barriers, building costs, etc.

But, scale can be important, and frequently scale can help to simplify problems.  That argument applies in most of the country, shown here within about 20% of the national average.  In those places, causality is absolutely a muddle.  In fact, where causality is a muddle, that might be a sign of a functional system.

But, in the Closed Access cities, the scale of the supply problem has greatly overtaken all those other factors, to the point that an approximation of the problem really can boil down to one issue - supply.  When the scale of that problem recedes, and other factors start to matter, we will know those cities have functional housing markets again.

The same can be said for the slow recovery of the economy from the crisis and the continuing feeling of financial stress.  Normally, there are an uncountable number of factors that make debating about the causes of economic growth, equity in growth, asset prices, and business cycles difficult.

This is true of investment, too.  I don't know how many others look at it this way, but I find that most equities are not worth speculating on.  The potential gains don't outweigh the cost of non-diversification.  Where speculation tends to be profitable is where a firm's success depends largely on a single variable where, for some reason, the connection hasn't been recognized by other investors, or where insight into that variable allows an investor to take a position on the variable by taking a position in a firm.

That used to be what I spent my time on.  But, it appears that I have happened upon an issue where this is the case at the macro level.

The clear factor that deepened the bust and has prevented a healthy recovery is the closing down of the mortgage market for the bottom half of the home owning population.  With a strong positive correlation to income, families are losing their homes and facing rising rents across the country today, not just in Closed Access America, and there is one overwhelmingly important reason - we shut down the bottom half of the mortgage market.


from FHFA 2015 report to Congress
Here are Fannie Mae originations, by FICO score.  This shift is seismic - a multi-sigma shift in underwriting standards compared to at least a half century of practice.

And, the GSEs had not been aggressive during the housing boom about expanding originations.  They had actually been very timid.  The growth in GSE originations sharply turned down from 2004 to 2006.  Origination only turned back up as the private market failed in 2007, and continuing to grow slightly in 2008 and 2009, until it flat-lined, where it remains today.


from Fannie Mae 10-Ks and author's calculations
Look at the comparison of the existing book of mortgages and new originations.  In 2008, the GSEs simply stopped serving the bottom of the market.  Only homes at the top end of their range of valuations were being served.  Not only were the new mortgages highly weighted to top range price levels, but down payments went sharply higher too.  During the boom, down payment levels were rising or staying level over time.  In 2008 and 2009, when we desperately needed to accommodate liquidity in housing, the one source of credit left with the potential for growth - the GSEs - was residing over an extreme rise in down payment levels on approved mortgages.


Keep in mind, the vast majority of the downturn in low priced zip codes happened in 2008 through 2010, after mortgage originations dried up in those areas.  In 2009, many low priced zip codes were still seeing 2% or 3% in monthly declines in prices, month after month.  The boom had long passed.  They needed support.  And we let them fail in what, in the end, was a public policy failure.

Now, we can continue with this new normal, and those with the ability to buy and manage real estate can make quite high returns buying and renting homes at the bottom half of the market, and those homes can remain less expensive, in Price/Rent terms, as higher priced homes are or as lower priced homes used to be.  Maybe there is no public value in encouraging ownership for families with median incomes or below.  Maybe that argument can be made.  But the economic malaise we are experiencing has nothing to do with expansive home ownership.  Ownership had expanded among high income households.  The malaise is related to a regime shift where we have removed the ownership option for households below the median.  So, those households have experienced an extreme shock to net worth and their children will generally lack access to the option of home ownership, if this is the way we decide to keep things.



Monday, July 18, 2016

Dean Baker gets it

Dean Baker at CEPR sees the same problem I do regarding inflation.

It is reasonable to exclude shelter when assessing patterns in inflation since its price follows a qualitatively different dynamic than most goods and services. Rent reflects supply and demand conditions in the housing market. The factor driving rent increases is an inadequate supply of housing.
While higher interest rates will in general be expected to dampen inflation by weakening the labor market and putting downward pressure on wages, this would not be the case with rents. Higher interest rates will slow construction and in this way make the shortage of housing worse. For this reason inflation caused by rising house costs would not be a good rationale for raising interest rates.
Go get 'em Dean!

Goodness, don't read his comments though.  Makes me grateful for my awesome readers/commenters.

Saturday, July 16, 2016

The liberty agenda

Will Wilkinson has a great piece up at Vox that is a nice summary of the need for reforms and the unifying and important message of classic liberalism regarding today's problems.

The nut of the issue:

The problem is that, as the law stands today, economic liberties are not considered "fundamental" enough to merit special legal protection. And that means regulations of the economic sphere are subject to the least demanding level of legal scrutiny — "rational basis." They are considered justified, more or less, simply by virtue of the fact that they have made it through a legislature or city council.
....
And that, in a nutshell, is how the economy got rigged — from bottom to top, from occupational licensing for hair braiders to ironclad intellectual property protections for tech billionaires. American law does not consider economic liberties to be "fundamental" in the way that, say, the right to have an abortion or the right to get a same-sex marriage are fundamental, and so regulations of economic life aren’t required, as matter of law, to have any practical relationship to the goals they are supposed to achieve.

And that means there has been very little to keep interest groups, large and small, from slowly rigging our economy with self-serving regulations under the guise of the public interest. 

You rig an economy or a society by taking away the presumption of rights.  This is obvious to everyone in contexts outside of commerce.  The loss of that presumption in commerce is the key to so many of our social dilemmas.

Friday, July 15, 2016

June 2016 Inflation

We continue down the road I fear this month.  Here are graphs of month over month and year over year inflation.

Rent inflation continues to strengthen at over 3% and core inflation outside of rent continues to revert back toward the 1% range.


And markets react with rising interest rates, due to expectations of Fed tightening.

Here is an excerpt from the Bloomberg article:

Steadying energy costs and the dissipating influence of the strong dollar will stoke price pressures more broadly and enable companies to regain the ability to charge their customers more. Faster inflation underpinned by an improving economy and a healthy job market would also enable the Fed to resume raising interest rates.
“We’re starting to see upward pressure on the inflation numbers,” Jim O’Sullivan, chief U.S. economist at High Frequency Economics Ltd., said before the report. “It reinforces the case for the Fed to resume tightening, though they’re highly risk averse right now.”
We have low inflation because of the current tight monetary posture together with high rent inflation because of the current tight credit policy posture, and this is leading us to tighten both even more.  There is no housing market to kill this time.  If this does lead to a recession, it will probably be much shallower than the last one, maybe without much of a pullback in the stock market.  I don't know.  I'm looking at my calendar.  Looks like it's 1937.

Thursday, July 14, 2016

Housing: Part 166 - A great paper on migration patterns and housing supply

Here (pdf) is a great paper from Peter Ganong and Daniel Shoag with several interesting empirical findings regarding migration patterns.

They find empirical confirmation of many of the patterns I have been covering here.  And they find that the reversal of historical migration patterns toward income opportunities is responsible for creating income inequality.  High income workers still retain the historical migration pattern because their higher incomes provide a higher return on the payment they have to make for housing - the gatekeeper to opportunity in a closed access city.  For low income workers, the return to tapping into productive labor markets isn't high enough to cover the cost of limited access housing, so they are induced to migrate away from income opportunities.

Here is Figure 6 from their paper.  In past periods, all of these regressions would have positive slopes.  In other words, workers migrate to places with higher income potential.  But, in the recent period, the regression with migration and gross incomes for low skilled workers has a negative slope.  Yet the regression for incomes net of housing expenses remains similar to the historical norm.

Housing expense is the dominant issue of our time, and it is the dominant issue directing the migration of low income workers.

What we called a housing bubble was actually a refugee crisis.  Migration patterns explain what happened much better than banking activities.  Blaming the housing bubble on bankers is like blaming illegal immigration on coyotes.  We impose desperation and exclusion on people, then when the context those people face is invariably peppered with incivilities and difficulties, we demonize the very agents who are trying to facilitate access to opportunity despite all of our efforts to deny it.

Thursday, July 7, 2016

Housing prices discounted by local inflation

Recently, I looked at the Shiller Real Home Price Index, discounted by general CPI, discounted by Shelter CPI, and in individual cities, discounted by local CPI owner equivalent rent inflation.

Click on the link, and you will see the two graphs there.  On the national level, using shelter inflation instead of general inflation brings down the relative price of homes considerably.  And, during the recent period, where divergence between cities has been strong, we can see that in many parts of the country, home prices have been reasonable, while cities like San Francisco are extreme outliers.

Here I have added the other cities which have both Case-Shiller price indexes and monthly CPI measures of local owner equivalent rent inflation - a total of 12.  All are indexed to 1995, or to the earliest date available.

Generally, these show the same pattern, with various cities falling somewhere between Dallas and San Francisco.  Case-Shiller tends to measure Closed Access type cities, so they are heavily represented here.  Most of the secondary regional centers and rural areas across the country (outside of California and New England) look like Dallas and Atlanta.

The one thing we might note on these two graphs is that the variance between cities is tighter when we use local rent inflation as the discount factor.  The reaction between price and rent is pretty systematic.  I believe that the exaggerated reaction of price comes from a mixture of (1) rent expectations, which act like a growth rate on home valuations and (2) a natural increase in price/rent levels as prices rise, which is probably mostly due to tax benefits.  I haven't posted all of my work on those issues on the blog, but in both cases, the relationships are strong - especially the latter factor.

At the national level, before the 1950s, the home price index had tended to range between 85 and 115, except for during the interwar period, where it was lower.  Using shelter inflation to adjust the index since then, it had remained in that range until the late 1990s, and was, in fact, at the bottom of the range when the housing boom started.

So, we can see that now there is a split.  The open access and Midwestern cities, adjusted for local rent inflation, have continued to move in that range, moving back to the bottom of the range after the bust.  The Closed Access cities tend to be far above that range.  And, the other cities moved well above that range during the boom and are now in the middle of the long term range, along with the national average.

The influence of the Closed Access cities on the national average is evident here by the fact that Seattle follows closely with the national measure in both graphs.  Seattle is sort of at the mid-point between fully closed access and a functional housing market.  It will be interesting to see if they can manage to maintain a healthy tech industry and an open access housing market.  It could go either way.  But, we can see here what a chimera the national measure is.  Seattle's housing market is nothing like the market that most American's experience between the coasts.

Most Americans live in the housing market of the green and grey lines.  The high rents and higher prices of the Closed Access cities cause them to have an outsized effect on a value-weighted average of the country's home values.  Also, the vast majority of new homes were built in places representative of those green and grey lines.

Wednesday, July 6, 2016

Housing: Part 165 - The homebuilding recovery may lag the price recovery

Here is a hopeful Bloomberg article on renters buying their homes from institutional landlords (HT: John Wake).  It makes sense.  In many cases, where the only thing holding back tenants from owning was credit access, it's a no-brainer.  A tenant described in the article will actually lower her monthly payments by shifting from rent to mortgage payments on the same home.  This appears to be the case on millions of properties around the country.

But, this brings up an issue I have been thinking about lately.  Previously, I had considered a convergence trade that would profit from a recovering housing market - a short position on long term treasuries and a long position on homebuilders.  Yields on home ownership are far higher compared to treasuries than they have been in the past.  Interest rates are not the constraining factor in homeownership right now.  So, as households move back into ownership, rising home prices should trigger homebuilding which should cause interest rates to rise.  Since housing yields and treasury rates have diverged, both rates and prices could rise quite a bit in order to converge.

But, I wonder if the homebuilding part of that sequence would be more of a lagging factor than I had thought it would be, in which case the demand for capital would not rise as sharply and there would be less upward pressure on interest rates.

Because of the tax benefits of ownership and the principal-agent problems associated with rentals, non-owning households tend to have less demand for housing than owner-occupiers.  So, when a lack of credit access shut millions of households out of the owner-occupier market, this triggered a negative feedback loop that decreased demand for housing expenditures.  So, there isn't necessarily a latent demand for housing that requires an immediate supply response.  There is potential latent demand for housing that would slowly re-emerge as households attain ownership again.

It could be that the value of ownership will cause market values to rise as that shift occurs, but that the shift in both price and homeownership rate will need to recover somewhat before there is a significant response in homebuilding.  If that is the case, there could be more of a sequence of events as such: (1) rising ownership, (2) rising prices, (3) rising rents, (4) rising new home sales, (5) rising interest rates.

Given the political times we are living in, this will be interpreted as a bubble (rising ownership, rents, and prices) and there will be pressure for self-flagellation before we even get to rising new home sales, let alone rising interest rates.  And, the result would be continued stagnation with limited access to credit, rising rents, and interest rates hitting zero.

Institutional investors will be blamed for raising rents on tenants and for selling homes to tenants at supposedly inflated prices.  There will be broad demand for the Fed to raise rates in order to stave off asset inflation, even though (1) this will actually keep long term interest rates low and (2) interest rates don't have much influence on current real estate values now anyway.  As in 2007, the only way rising rates can kill the housing market is by rising far enough to undermine the real productive economy.  And, the supposed new housing bubble will again be blamed for pushing us into recession.  It could be that housing will not recover far enough to trigger a collapse large enough to create massive defaults.  I would hope.

I hope that I am wrong on this.  In any event, it seems to me that the best way to capture safe alpha is to own rental properties outright.  I think they can be owned with a decent level of leverage with little risk.  Even if a worst case scenario eventually leads to capital losses, as long as they remain unrealized, a landlord would make quite healthy returns on rents, especially in the entry-level part of the market.

Monday, July 4, 2016

Happy 4th of July

I recently was reading Laura Ingalls Wilder's "Farmer Boy" with my kids, and I found the ending to be an interesting view into the difficulty of defining "freedom" and how changing technology and economics change our fundamental points of view.  Here, the encroachment of an economy based on specialization and trade are clearly seen as threats to rugged individualism.  It's funny how in our transition away from agriculture, that idea has been reversed and now those who emphasize the importance of a functioning flexible and free economy are associated with rugged individualism.

Today, I hear people exhort college students to avoid the private economy and to go into public service in order to better help others.  Yet, Almanzo's mother exhorts him to avoid the private economy and to remain on the farm because, in the private economy, he would be forced to help others and would lose his independence.

If you google this passage, you will generally find people applauding Almanzo's mother and bemoaning the direction we have traveled since then.  To the contrary, I think Almanzo's mother's position highlights the moral progress we have made.  But, then, I also must confess that we are much less free, in a sense, than Almanzo was, and we are better for it, even as the extension of cooperation and dependency to an unfathomable breadth creates stress for our senses of self and of safety.  There is, unfortunately, no settled ground on which our human nature can rest.

I especially like Almanzo's response to the dilemma, which also seems to shine a light on the human condition.  To paraphrase: "So, Almanzo, do you want progress or independence?"  "Really, Dad?  I can choose what I want?"  "Yes, Almanzo.  What do you want?"   "I want a horse!"

From "Farmer Boy":
Father told her that Mr. Paddock wanted to take Almanzo as an apprentice.
Mother's brown eyes snapped, and her cheeks turned as red as her red wool dress. She laid down her knife and fork.
"I never heard of such a thing!" she said. "Well, the sooner Mr. Paddock gets that out of his head, the better! I hope you gave him a piece of your mind! Why on earth, I'd like to know should Almanzo live in town at the beck and call of every Tom, Dick and Harry?"
"Paddock makes good money," said Father. "I guess if truth were told, he banks more money every year than I do. He looks on it as a good opening for the boy."
"Well!" Mother snapped. She was all ruffled, like an angry hen. "A pretty pass the world's coming to, if any man thinks it's a step up in the world to leave a good farm and go to town!" How does Mr. Paddock make his money, if it isn't catering to us?" I guess if he didn't make wagons to suit farmers, he wouldn't last long!"
"That's true enough," said Father. "But--"
"There's no 'but' about it!" Mother said. "Oh, it's bad enough to see Royal come down to being nothing but a storekeeper! Maybe he'll make money, but he'll never be the man you are. Truckling to the people for his living, all his days -- He'll never be able to call his soul his own."
For a minute Almanzo wondered if Mother was going to cry.
"There, there," Father said, sadly. "Don't take it too much to heart. Maybe it's all for the best, somehow."
"I won't have Almanzo going the same way!"
Mother cried. "I won't have it, you hear me?"
"I feel the same way you do," said Father. "But the boy'll have to decide. We can keep him here on the farm by law till he's twenty-one, but it won't do any good if he's wanting to go. No. If Almanzo feels the way Royal does, we better apprentice him to Paddock while he's young enough."...
..."He's too young to know his own mind," Mother objected.
Almanzo took another big mouthful of pie. He could not speak till he was spoken to, but he thought to himself that he was old enough to know he'd rather be like Father then like anybody else. He did not want to be like Mr. Paddock, even. Mr. Paddock had to please a mean man like Mr. Thompson, or lose the sale of a wagon. Father was free and independent; if he went out of his way to please anybody, it was because he wanted to.
Suddenly he realized that Father had spoken to him. He swallowed, and almost choked on pie. "Yes, Father," he said.
Father was looking solemn. "Son", he said, "you heard what Paddock said about you being apprentice to him?"
"Yes, Father."
"What do you say about it?"
Almanzo didn't exactly know what to say. He hadn't supposed he could say anything. He would have to do whatever Father said.
"Well, son you think about it," said Father. "I want you should make up your own mind. With Paddock, you'd have an easy life, in some ways. You wouldn't be out in all kinds of weather. Cold winter nights, you could lie snug, in bed and not worry about young stock freezing. Rain or shine, wind or snow, you'd be under shelter. You'd be shut up, inside walls. Likely you'd always have plenty to eat and wear and money in the bank."
"James!" Mother said.
"That's the truth, and we must be fair about it," Father answered. "But there's the other side, too, Almanzo. You'd have to depend on other folks, son, in town. Everything you got, you'd get from other folks.
"A farmer depends on himself, and the land and the weather. If you're a farmer, you raise what you eat, you raise what you wear, and you keep warm with wood out of your own timber. You work hard, but you work as you please, and no man can tell you to go or come. You'll be free and independent, son, on a farm."
Almanzo squirmed. Father was looking at him too hard, and so was Mother. Almanzo did not want to live inside walls and please people he didn't like, and never have horses and cows and fields. He wanted to be just like Father. But he didn't want to say so.
"You take your time, son. Think it over," Father said. "You make up your mind what you want."
"Father!" Almanzo exclaimed.
"Yes, son?"
"Can I? Can I really tell you what I want?"
"Yes, son," Father encouraged him.
"I want a colt," Almanzo said....
..."If it's a colt you want, I'll give you Starlight."
"Father!" Almanzo gasped. "For my very own?"
"Yes, son. You can break him, and drive him, and when he's a four-year-old you can sell him or keep him, just as you want to. We'll take him out on a rope, first thing tomorrow morning, and you can begin to gentle him."

Wednesday, June 29, 2016

Housing: Part 164 - The Supply Catch-22

There is a widely held sense that housing costs are positively correlated with mortgage credit.  The truth is mostly in opposition to this, I think.  The irony comes from confusion between ownership and consumption, inflation vs. real consumption, and presumptions about the dominance of demand where supply is the important factor.

If supply was universally elastic, real housing consumption would probably correlate with credit expansion, but the supply that would be triggered by rising home prices would bring down rents.  Nominal housing expenditures, in terms of rent, would grow much more moderately than real housing expenditures.  This is basically what happened in parts of the country during the boom where supply was not politically constrained.

Where supply is politically constrained, there is no way for real housing expenditures to grow, so to the extent that new credit allows marginal households to maintain ownership, demand for housing consumption, in terms of rent, shifts to the right and there probably is some positive correlation between credit and rents.

Whether an increase in available credit or limited access housing policies in cities that can maintain sustainably high wage incomes, in either case the effect is to cause more inelastic demand for housing consumption.  Supply appears to be the more important factor here.  Rent inflation was moderating in the boom and rose sharply in 2006 and 2007 as credit and housing supply growth collapsed.

There was a temporary drop in rent inflation from late 2007 to 2010, as foreclosed households were forced to make a shift in housing consumption while under financial stress, and this created a negative shock in nominal housing demand.  But, in the credit constrained environment we have had since then, rent inflation has moved back up.  This is because constrained credit has created a housing supply constraint across the country.  Housing supply is more important in determining rent inflation than demand that might be triggered by expansive credit, so rents are rising now just as they had been rising in the Closed Access cities when credit was more available.

Since credit creates supply where supply is not politically obstructed, mortgage credit will clearly reduce total housing expenditures.  This is the ironic outcome created by inelastic demand with constrained supply.  To reduce inflationary spending on housing, we have to increase mortgage expansion.

In these Fred graphs, we can see the conundrum.  Real housing expenditures per capita have been flat since 2005 when housing starts collapsed.  Because of the Closed Access cities, real housing expenditures have been declining relative to other spending since the 1980s.  In the first graph, we can see that since the mid 1990s, compared to non-shelter inflation, wages have been growing strongly.  But, for the 15% of personal consumption expenditures that go to housing, that has all been going to rent inflation, which has run roughly even with wage growth.

Source

We can see that in the next graph, which looks at levels instead of rates.  The shelter inflation index dipped below wages after the crisis due to the negative shock from foreclosures, but it is now climbing back up, taking more wages each year even as wages rise while real housing consumption remains flat.

Source
 
So, the problem is that housing is getting more expensive for the average household.  If we mistakenly see rising credit access as the primary cause of rising prices and rising demand for housing consumption, then we will mistakenly look to more credit constraints as a means to reduce those expenses.  But this will only make the supply problem worse which will only make expenses rise higher.
 
The problem is that home prices will likely rise if we expand mortgage credit because prices are artificially low right now, due to the severe lack of credit.  This is why housing starts are still so low.  Every excuse under the sun is trotted out for why housing starts are low, but clearly the overwhelming factor is a lack of mortgage availability for the bottom third of the potential homebuyer market.  When home prices rise, this will be taken as a sign that credit does indeed increase housing expenses.  But, a commitment to that credit expansion will lead to more supply and a reduction in rent inflation.  Normally, I would expect prices to be forward looking and for future supply-based mitigations in rent levels to be immediately captured in home prices, pulling prices back down.  But, (1) in the Closed Access cities, there won't be a supply-based mitigation in future rents and (2) at this point, markets will probably require a confirmation of that commitment before prices reflect that effect.  So, prices will probably initially rise across cities.
 
In the meantime, as often as not, articles I see that bemoan the rising cost of housing call for the very policies that are creating the problem.  And attempts at mortgage expansion are met with anger.  "Here they go again.  The banks are going to stick it to us again."