Ok, one more graph on the timing of the crisis. Here we can see the problem of inflation targeting.
There has been some discussion about how commodity prices bumped up in 2007 & 2008, which caused the Fed to be too hawkish. And, I have discussed how current inflation is negligible, but for supply-shock shelter inflation. But, I think we can step back even further, and see this problem even earlier.
I have looked at the period around 3Q 2006, when the yield curve inverted. But, let's look even further back, to 2Q 2006 (0b), or even 4Q 2005 (0a). Even before the yield curve inverts, we can see that liquidity is having an effect on the housing supply. (Remember that currency growth, which has tended to be between 7% and 10% since the 1970's, fell under 5% by 2005.) By 4Q 2005, shelter inflation took a sharp turn upward. This was a monetary-related supply shock. Because everyone was so thrown off by high nominal home prices, this seems implausible. But, if we pull shelter out of the inflation indicators, we see that non-shelter inflation collapsed by 4Q 2006, with Core CPI less Shelter falling all the way to 0.7%. Core CPI with Shelter included was still at 2.1%! Seemingly above target.
Keep in mind that shelter inflation takes a 3 sigma turn upward between time 0a and 0b when we look at the next graph. (It is normally a fairly stable measure, like Core CPI is.) While shelter inflation is soaring, home prices are stagnating and new home supply is collapsing. How can this be interpreted as anything other than a massive supply shock? And this all happened before 3Q 2006! But, because the narrative of predatory, reckless banks is more believable than the mathematical relationship between yields and prices, nobody can believe this was the case.
Note here that currency growth falls in 3Q 2006 also, and will remain around 2% until 2008. So, keeping all of these things in mind, we can think about mortgage growth, shown in this graph. At this point, mortgage growth isn't funding new homes anymore. It's not funding home price appreciation any more. At this point, mortgage debt has become a source of desperation liquidity. Mortgage levels as a percentage of home values turned up sharply by around Q1-Q2 2006. As I showed in Part 12, this liquidity coming through mortgages between 2004 and 2007 all came from households in the top 40% of incomes. Households in the bottom 60% of the income distribution were not increasing their outstanding mortgages during this period.
It looks to me like the Fed created its own supply-side inflation shock, then mistook that for a positive demand shock, and subsequently worsened what was already a negative demand shock. But, can we blame the Fed when the entire country is seemingly wrong about housing?
I am hoping that I can make some inferences about tax benefits of home ownership and the relative supply of housing in later posts.