|Source: Calculated Risk|
This last point is one that I would like to think about here, and as I begin writing this, I am not sure if I grasp all of the implications.
Dwarfing the Cantillon Effect
There is some debate over whether there is any significant transfer of value to financial interests who are the first to receive new dollars when the Fed expands the money supply. Despite it's questionable significance and likely small size, this idea holds some status in the populist economics mind, (usually only noticed during an expanding money supply, but forgotten during monetary contractions when the effect would reverse) along with the notion that monetary expansion is a payoff to Wall Street, pushing equities to unsustainably high levels.
I am not going to unpack the whole issue here, but if loose money caused unsustainably high equity gains, wouldn't the stock market of the 1970's have been going gangbusters? The reason equities have been rising during periods of monetary expansion is because monetary expansion has been what the economy needs. The rise has been mostly a product of healed economic wounds and improved expectations. The fact that so many observers see rising stock prices as a reason to complain about the effects of Fed policy is just one more reason that we are lucky it hasn't been worse than it has. There is a mood of self-destruction in the air.
But, here, again, housing is different. Because banks and regulatory constraints are binding, monetary expansion through the credit channel does have direct effects on home prices - but it's complicated. Since 2007 when the mortgage market froze up, home prices have been held below intrinsic value. Because returns move inversely to prices, this has countervailing effects. Rent is more stable than price, so falling prices meant that the returns to home ownership have increased. In addition, the shortage in housing that this has created has pushed rent inflation higher, making returns to home ownership even higher. But, these gains are only captured over time, as rents are collected (or implied). And, since owner-occupiers aren't exactly marking their implied rent to market, this effect among owner-occupiers will tend to have considerable lag as an influence on behavior. For renters, on the other hand, the hit to real income is felt immediately. New homeowners feel the effect immediately, because they are marking to market when they engage in a real estate transaction, but this is countered by the home seller who realizes his relative capital loss. Homeowners who buy new homes might feel some of this positive effect without as many mitigating effects on the selling party, but of course new home building has been very low. And institutional renters do feel the positive effects of higher rents, which is leading to strong growth in construction for rentals.
The decline in price that leads to this higher implied return, on the other hand, is felt immediately by many homeowners. Homeowners with high equity levels may have the same lagged reaction to unrealized capital gains as they do to the high implied return. But, homeowners that are leveraged or that would be tapping into home equity for cash, would feel this effect immediately.
So, frozen mortgage markets and tight monetary policy have lowered home prices. This simultaneously creates higher inequality in reported real household incomes, deflationary pressures through the credit channel, and a supply shock felt only by renters. It's a sort of bizarro Cantillon effect - the economic advantaged gaining income at the expense of the disadvantaged, simply as a result of the change in an asset price because of Fed cash. Except this is due to a dearth of Fed cash and a decline in asset prices.
If mortgage markets can expand, the direct effect on asset prices (specifically homes) would be much stronger than it is in the regular Cantillon effect. But, it would lead to a reversal of the problematic effects of the bizarro Cantillon.
Here is a provocative new paper that points to the credit problem as a cause of the employment crisis.
Revisiting my Housing Narrative
Real estate values would be nearly double where they are if credit markets had been functioning. Some of that value has probably been lost forever because of the depth and length of the downturn. And, that value would have been roughly divided between the value of new building and the nominal increase in the value of existing real estate. One reason home prices were so high in the 2000s was because long term interest rates were low. But, one reason was that we weren't increasing home supply fast enough, so that less of that growth in real estate value was coming from growing supply, and more was coming from price appreciation. As I mentioned, rent inflation was pretty high throughout the period. Also, excess returns to real estate, according to the BEA, were high throughout the period - another sign that there were frictions to supply growth.
Monetary policy was so tight in the 2000s that the increase in equity that came from rising prices did not lead to excessive inflation. The late 1970's is a good example of loose money and high inflation, and during that time real estate market values also increased above trend. But, as we know, inflation ran between 6% and 12% during that period. To call the 2000's loose and inflationary, in the absence of consumption inflation is very debatable. I'm surprised at how confidently this narrative is so widely accepted. I argue that frictions in home supply were creating a supply shock in the 2000s, which was creating supply-based inflation. Tight monetary policy was pulling "Core minus Shelter" inflation below 2% for this entire period. Shelter inflation was above 2% for the entire period.
So, I'm crazy, right? Well, here is a graph of annual growth in closed end real estate loans. The trend through 2006 was for more than 11% growth, annually. What looks more out of line? The 2000's or the 2008-2014 period?
Here's a graph of the market value of household real estate, with a log scale. Until 2006, there was a quite stable 8% annual growth rate. (Again, this is roughly divided between nominal price appreciation and new building.) Again, I ask. What looks more out of line? The 2000's or the 2008-2014 period? The trend line through 2006, when real estate market values were at about $25 trillion, would now be above $45 trillion. So, should the burden of proof be on the narrative that says we should be on the 50 year long trend line? Or, should the burden of proof be on the narrative that says we should have seen a sudden and unprecedented destruction of $20 trillion in household nominal wealth?
Man, it's hard for me to remain civil when I work through all of this stuff and think of SJWs sniveling "The banks did this to us." while they complain about loose money as if it's a "bailout" and constantly remind us how concerned they are about inequality.
A very early sign of recovery in this area appeared today. This needs confirmation, as it can be a noisy indicator. A big jump in mortgage applications. Since interest rates aren't the binding constraint on monetary expansion right now (probably the topic of my next post), mortgage expansion should create a fantastic economic context, regardless of Fed rate decisions this year. Let's hope.