Friday, March 4, 2016


The complexity of the errors about housing that are embedded in conventional wisdom is so high that I don't see how we can fix them.

From ZeroHedge (HT: PC):
"The biggest source of inflation is shelter aka Real Estate.  Real Estate inflation has been surging for years thanks to the Fed's specific policies aimed at boosted real estate property prices.  It's likely that recent tightening will slow this inflation. The Fed created this part of the problem and is now, belatedly, addressing it."
There are so many errors packed into such a short and seemingly irrefutable statement.

Shelter inflation is not "real estate" inflation.  Shelter inflation is rent inflation.  Rising rents certainly can make homes more valuable and increase the prices of homes.  But, if we are talking about Fed policy and interest rates, then no.  If home prices rise because of interest rate policies, it has no effect on rent inflation.

In fact, if home prices were rising because of low interest rates, then rent inflation would be falling, because it would induce more home buying and more supply.  In fact, the persistence of rent inflation while housing starts struggle along at extremely low levels would be the first obvious fact to look for as a confirmation of failing supply.  This would be a sign of, if anything, Fed policy that is too tight and rates that are too high.

Fed tightening will only cause rent inflation to decline if it tightens so strenuously that it triggers another crisis that causes major permanent re-adjustments in household spending.  Households are already spending more of their incomes on rent than they ever have before, for less real shelter, so it remains to be seen whether households would be willing to adjust any more, in the aggregate.  It could be that more tightening will cause more adjustments in other discretionary spending as households hunker down in the minimum real level of shelter consumption they are willing to accept.

Of course, owner-occupiers won't feel much of this directly.  It will be mostly felt by renters.

And, why are housing starts so low, if home prices are so inflated?  This is a pretty basic question that would need to be answered before the (seeming) entire country decides that homes are overpriced because of Fed policy.  Somebody needs to send a memo to the homebuilders.

But, to even address that error, we have to address the error that near zero interest rates are a policy choice, as if we would be at 4% if the Fed had wanted to peg us there.  Not to mention that the most significant policy decision of the past 20 years has been the series of Fed decisions that pulled the rug out from under the housing market from which it still hasn't recovered.

So, rent inflation has the opposite reaction to Fed policies that ZH thinks, which are actually the opposite policies that ZH thinks they are, which have pushed real estate prices in the opposite direction from what ZH thinks they did.  Tightening will slow inflation in every category except the one ZH thinks it will.  The Fed did create this problem (ZH got that one right) but the problem is the opposite of what ZH thinks it is, and thus the tightening is coming too soon, if anything, not belatedly.

Other than that, Zero Hedge made a trenchant observation.  :-)


  1. Great post.

    The problem is NIMBYism.

    There is an interesting idea that if you constrain the supply of good X but the money supply rises you get inflation. So did the central bank cause inflation or the constraint in the supply?


    I thought of IW when reading the above post. So banks really cut back on lending during the Great Recession,

    I have seen versions of this in Los Angeles. If ever house prices start to go down, banks start raising underwriting standards, and scowling at appraisers who come in with high appraisals. This, of course, drives house prices down more, becoming a self-fulfilling prophesy in some regards.

    I understand this: If the economy looks weak, it makes sense for every individual bank to cut back raise underwriting standards. In unison, the effect is....

    Especially if the transmission belt for new money into the economy is through loans...

    Reminds of the ol' farmer problem. No one is making enough money on corn, so they all plant even more acreage, and improve yields...

    1. The tricky thing with housing, and with the recent crisis, is that supply and demand get all mixed up with leveraged owner-occupiers.
      It seems clear to me that there was one large dislocation that lies at the center of everything. Home values were pushed down to well below their intrinsic values because the mortgage market was undercut and wasn't replaced with a viable alternative. This shows up as both a supply and a demand problem. Supply because the banks had their balance sheets blown up when the collateral underlying much of their loans was damaged. Demand because households lost the nominal equity that they would normally utilize to enter into new transactions.