Thursday, May 25, 2017

Housing: Part 232 - Credit supply, housing supply, and financial crises.

Credit causes financial crises.  How do we know?  Because that is our set of possible outcomes.  Mian, Sufi, and Verner have a new paper out, titled, "Household Debt and Business Cycles Worldwide". (HT: John Wake)
We group theories explaining the rise in household debt into two broad categories: models based on credit demand shocks and models based on credit supply shocks.
They find that when household debt rises, this is associated with a temporary rise in consumption that is followed by a drop in GDP growth.

They dismiss a rational expectations credit demand shock cause because this would mean that higher debt levels are based on optimism about future economic growth, and that doesn't jibe with the predictable decline in GDP growth that happens after household debt grows and the low interest rates that tend to coincide with these periods of rising debt.

What if we expand the set of possible causes to include supply constraints?  Supply constraints lead to rising home prices in cities with productive employment.  The debt is a result of households buying access to constrained future production.  This is why rising household debt is related to low interest rates, rising home prices, and subsequent declining growth rates.

The bidders on restricted housing do have rational expectations for their own rising incomes.  Incomes are rising in those cities.  It is their countrymen who are denied access to those local economies who have stagnant incomes.

Since the credit demand shock story fails this test, MS&V can attribute these results to credit supply shocks, which they attribute to behavioral biases among lenders.

They also note that the relationship is non-linear.  Higher debt/GDP ratios lead to falling GDP growth but lower debt/GDP ratios don't lead to rising GDP growth.  This, again, comports with a housing supply cause.  Elastic housing supply simply allows housing to continue to expand at the cost of construction.  There is a floor on home prices in a functional economy.  Inelastic housing supply where potential incomes are high causes prices and debt to rise and crimps economic opportunity and growth.

It is odd that the supply issue is so invisible in these academic discussions, because, first, it is such an obvious problem right now.  This is not an unknown issue.  And, second, it is generally accepted that for home prices to rise excessively, supply needs to be inelastic.  Even these credit shock models can only cause these results when housing supply is inelastic.  The supply problem is built into the models, at some level.  It's really a sort of rhetorical issue that it isn't allowed to be causal.

Of course, as is the norm on these papers, amid extensive discussions of the role of price expectations in borrower behavior, rent is simply not mentioned as a determining factor in home prices or expected future home prices.  A text search for rent comes up empty.

This leads to a fundamental difference in thinking as the business cycle proceeds.  If we think of the debt as a product of a credit supply shock and overly optimistic lenders and speculators, then their optimism is the source of the problem.  In the Great Recession, this reached outrageous levels by September 2008 when the Fed was still bracing against inflation after home prices had dropped by more than 20% and were still falling by about 1% monthly, nationwide, and the public was beside itself because we were "bailing out" the ones that did this to us.  But, the key period is really back in the 2006-2007 period.

The sharp decline in housing starts and residential investment was welcomed, because obviously the lenders and speculators were overfunding new building.  The initial declines in GDP growth were accepted because, obviously, all that credit had led to overconsumption which needed to calm down.  And, eventually the collapse of the private securitization market - a massive hit to nominal growth - was seen as medicine well-taken, and the GSEs were castigated for attempting to make up for it - just more greedy lenders, and weren't they the problem to begin with?

Long term interest rates which remained very low throughout that series of events, because there was already a flight to safety, and already home equity was not considered safe.  Since we are so strongly led to see credit as causal, this looked like a credit supply phenomenon, and those low rates were interpreted to be stimulative.  It's the central bank and our collective notion of acceptable public policy that has a behavioral bias.  Those low rates were shouting that bad things were on the horizon.  Some will find this unbelievable, but I think that if the Fed had lowered rates in late 2005, and kept the Fed Funds rate at, say, 4%, long term rates would have moved higher, residential investment would have stabilized, buyers would have returned to the housing market, and the CDO boom would never have occurred.  The CDO boom was a product of the flight to safety, both by investors and by home owners fleeing the housing market.  A credit supply shock view meant that we saw a flight from the housing market as a positive - a correction.  But, a negative housing supply shock view would have properly led us to notice that was a sign of severe dislocation.

It seems to me that, in practice, behavioral finance is simply collective attribution error.  We were convinced that there were these massive forces of irrational actors in the marketplace, and given any support, they would re-enter the housing market and push everything out of whack.  MS&V attribute the end of the boom to changing sentiment.  Surely this is true.  The difference in interpretation here is whether we encourage that change in sentiment to disastrous ends or work to counter it and stabilize it.  At that point, monetary and credit policy become endogenous, and our interpretations of these cycles become self-fulfilling prophecies.  They note, by the way, that these crises tend to be worse in economies with constrained monetary policy.  Yet, since the cause of the crises is determined to be excess credit, this interpretation of the cycle leads us to put self-imposed limits on monetary and credit policy.  With that interpretation, it would seem like madness to try to provide stability if that is only going to encourage more borrowing.

MS&V note that GDP forecasts tend to be too optimistic going into the bust, in that they don't reflect what MS&V find to be predictable declines after the boom in household debt.  To the point above, it seems that forecasts which did shade lower would also become endogenous, because this would encourage more growth oriented monetary and credit policies.  I wonder if forecasts in 2006 had been lower, would we have accepted looser monetary policy?  I'm not sure we would have.  The drop in growth comes from this paradigm that views credit as a disease and stability as dangerous.  The drop in growth was a choice, even if it was a choice we didn't admit or understand we were making.

It is telling that the howls of protest in late 2008 weren't complaints that stabilizing monetary policy had been tardy.  The complaints were that policy should have been tighter in 2004 or 2006 or 2008.  And the chorus of ad hoc inflation phobia that claimed inflation was actually high in 2004 and 2005 if you counted home prices as part of the basket of consumer prices suddenly turned to silence when home prices were dropping by double digits.  To do anything about that "deflation" would be a "bail out" don't ya know?  And it would only encourage that dangerous credit supply that leads to crises.  The credit supply thesis has an endogeneity problem.

Maybe you could say the housing supply thesis has an endogeneity problem too, and that Canada, Australia, etc. are just kicking the debt can down the road.  At least their result has option value.

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.

Wednesday, May 3, 2017

Housing: Part 224 - Follow up on House Flipping

Here is a post at the New York Fed about investor buying with some annual data.  Investor buying did begin to grow somewhat in 2003 and 2004, picked up more in 2005, at the height of the boom, and then was at its strongest in 2006 and 2007.

Here is a chart from the post.

This shows a little bit of an uptick in investor buying earlier than an uptick in google searches for "house flipping" showed up in the previous post.  But, even here, investor buying is a lagging factor.  Here are home prices in Contagion cities during the same time frame (annual, end of period levels).

Prices had generally peaked basically at the end of 2005.  But, the peak times for investor buying were 2006-2008.  Keep in mind that homeownership peaked in 2004, by 2005 first time homebuyers were in pretty steep decline, and by 2007, the ownership rate in general was declining sharply.  It makes sense that investor buying would come in as a result of that.  You're going to live somewhere, and someone has to own it.

Now, it is true that a lot of money was flowing out of the Closed Access cities, and the table was set in the Contagion cities for a speculative bubble - large inflow of migrants, some who were renters and some with large windfalls from sales of Closed Access real estate.  There were clearly short term fluctuations in Contagion markets that were volatile.  You could even call them a "bubble".  They have a completely different signature from the Closed Access markets.

And, while I would defend the social value of owner-occupier loans with low down payments as a way to broaden financial access to ownership, there isn't such an argument for low down payment investor buying.  Regardless of how much these loans pushed up prices in 2004 and 2005, they were clearly poised to increase volatility downward as the markets collapsed.  It seems reasonable that we should not have institutions that are set up to encourage this sort of borrowing.  (On the other hand, what happens in 2006 if this investor market isn't there to support housing markets where the owner-occupier market is collapsing.  They probably increased volatility and defaults in 2007 and 2008, but they were probably stabilizing markets in 2006.)

But, all that being said, the investor market looks like a market that was growing to replace a collapsing owner-occupier market.  By 2005, according to American Housing Survey data, there was both an increase in existing owners shifting to renting and a decrease in existing renters shifting to owning.  Of course investors will have to fill the gap there.

Sunday, April 30, 2017

Housing: Part 223 - The Housing Bubble Granger Caused Its Own Villains

Public sentiment is pro-cyclical.  I think this creates a weird bias in our conception of cause and effect.  For instance, when public consensus coalesced around the idea that we had to flagellate ourselves for the sin of overindulgence, we were really focused on what was going on in the housing market.  But, by then, the things that were going on were as much a product of our self-flagellating public policies than they were of any excess.  So, things that were really lagging factors in the housing bubble - private securitizations, CDOs, synthetic CDOs, loans bound to default - are universally accepted as the causes of the bubble.  They pop up everywhere.  I find that in articles with many citations, these assertions are frequently not cited.  They aren't cited because (1) there is no empirical backing for them and (2) they are so universally accepted that no citation is demanded by the reader.

Even as I have become cynical about public perceptions, I find that I am still occasionally surprised.  Today, I was surprised when I saw a Google Trends chart of searches for "House flipping".  I had assumed that this was something that happened as prices were rising.  (Caveat - maybe Google Trends isn't an accurate reflection of what was happening in the markets.)  But, "house flipping" turns out to also be a lagging factor.  Here is a chart of the S&P/Case-Shiller national home price index and Google Trends measure for "house flipping".  There weren't many searches for house flipping when home prices were rising in 2004 and 2005.  Prices topped out in early 2006, and the burst in house flipping searches happened from summer 2005 to early 2008.

Friday, April 28, 2017

Housing: Part 222 - Plausible problems that aren't binding

I have seen many claims since the housing bust of rising costs and rising regulations.  I don't doubt that these are problems.  In fact, really, a core feature of Closed Access housing policy has to be the imposition of artificial costs on new development.  If they didn't impose artificial costs on new development, Closed Access planning departments would be overrun by developers with potential projects.  In fact, this is, in practice, the main function of "affordable housing" demands in Closed Access cities.  Forcing these units on developers imposes a cost on the "market-rate" units they are building, which is an important factor keeping "market rates" above....well...above market rates.

Scott Sumner has recently been discussing the problem of rising labor costs, and the apparent problem builders are having finding qualified workers.  We are, after all, well into an economic expansion, unemployment is low, and immigration from the south has been weak since the recession, so it certainly is plausible that this is a real problem for builders.

On the other hand, total construction employment is still weak and relative construction earnings aren't exactly jumping through the roof.


In any case, I think this issue has the same problem as the other issues.  If rising costs were the problem, what we would see is prices at the low end of the market rising, especially regarding the regulatory costs, because those would fall more sharply on low tier building.  But, since 2008, low tier prices have lagged behind high tier prices.  If cost was the binding constraint, we might see units built in the low tier lagging, but prices would be rising.  Both units and prices are lagging in the low tier, because the problem is demand, not supply.  Specifically, repressive regulatory limits preventing middle class buyers from getting mortgages.

Considering how repressed that market is, it is implausible that capacity utilization and cost are the problem.  It looks like a cost problem, because since there is no funding in that market, builders have to try to build to the lower price point.  In a non-repressed market, prices would be much higher, especially in the lower tier - at least 20%.  But, builders are price takers.  They are competing against existing homes.  So, to them it looks like a cost problem, because they can't pay higher wages and make a profit, either way.  There would not be a labor constraint problem if mortgage credit was flowing and home prices were 20% higher.

Further, I think there is a lack of appreciation for just how bad housing still is.  Much of the building is happening in the Closed Access cities.  Building is so constrained there that there isn't much of a cycle regarding housing permits and housing starts.  So, in those cities - the expensive cities - housing starts are where they were in 2005.  But, in the cities where much of the building would normally take place, housing permits are still 1/3 to 1/2 their normal levels (The Texas cities are doing a little better.)  and construction employment is still near the recession lows as a percentage of total local employment.

My permit chart is only updated through late 2015, but housing starts have basically been flat since then.  Considering all of this, it is astounding how many people I see talking about the next "bubble" or talking about how tight monetary policy is reasonable because of these cost pressures.  And, it looks like the Fed is set to tighten again in June.  Ironically, this obsession with bubbles is the most glaring example of herding behavior we have today.  Of course, when this bubble obsession leads regulators and the Fed toward cyclically damaging policies, this only bolsters the bubble-mongers' self-opinion, because they think the bust proves the bubble.

In hindsight, Fed policy was disastrous in the summer of 2008.  How could they be worried about inflation a week after the Treasury informed the GSEs that they would be so overwhelmed with future foreclosures that they would never realize their tax assets?  I agree with Scott Sumner that they were basically following the zeitgeist.  Clearly, the Fed was actually more loose than consensus would have had them.  How many complaints are there about the various "bailout" programs after the September 2008 meeting?  How many complaints, on the other hand, are there about the fact that the Fed Funds Rate was sitting at 2% while the nominal economy was collapsing?

Many today would have the Fed at 2% already.  Of course there is no way we will ever get to 2% because the yield curve will crash long before that.  The idea that people are talking about bubbles now as if Fed policy is somehow causing speculative money to flow into real estate markets or the stock market just blows my mind.  Real estate lending and commercial and industrial lending haven't grown by a single dollar in six months, rents and prices at the top end of the real estate market are flattening out, non-shelter core inflation is tumbling back to 1%, and the Fed is being pressed to raise rates.

Monday, April 24, 2017

Housing: Part 221 - The Education Premium

One issue that has been floating around for a while is the education premium in housing.  The idea is that getting into good schools requires living in the right neighborhoods.  Prices in those neighborhoods get bid up, and working class households get locked out of better school districts because they can't afford to buy into the right neighborhoods.

I think there are several interesting things to think about here.

1) Even though the idea that the housing market is riding on a wave of animal spirits, barely tethered to any sort of intrinsic value, seems to be taken broadly as obvious, there are many ways in which everyone seems to assume extreme efficiency.  One example of this is when they speak of federal subsidies like those implicit in the GSEs and tax benefits.  If one thinks those subsidies help to bloat home prices, one must accept that those subsidies are sifted through all sorts of deferred benefits - far future capital gains exemptions, the value of slightly lower interest rates many years into the future, etc.  I agree with this!  These markets are remarkably efficient.  If you really think about the implications of how these benefits would trickle down into market prices, it really is incoherent to complain that these subsidies helped to seed a "bubble".  Either buyers are led to prices that reflect a meticulous arrangement of far-off and imputed benefits, or they just fly off to the stratosphere whenever some noob gets his hands on an approved mortgage contract.  These effects live in different universes.

Now, few of us sit down and work out the present value of future non-taxed imputed rent.  But, that's because these markets are so efficient.  Zip code level prices seem to me to suggest an amazing level of broad market efficiency.  Mian & Sufi found that low end home prices appreciated more than high end prices, and they attributed that to expanding credit access at the margin.  That implies some market inefficiency.  But, the difference in price appreciation they found is actually a product of extreme efficiency.  There is far too much substitution between various overlapping sub-markets in any city for prices at one tier to rise by 20% or 30% more than prices in another tier because of credit access.....Actually, I take that back.  Since 2007, we have enforced such repression in credit markets, removing potential owner-occupiers from the bottom tier of the market so completely, that low tier pricing is especially cheap.  Low tier prices would appreciate more if we re-opened the mortgage market today.  But, it didn't in 2003-2006.  Then, to the extent that credit access was helping to pull up prices, it was fairly uniform across markets.  And, I think because of the maxing out of tax benefits, rising prices tend to moderate above about $400,000 or $500,000.

I'm still unsure how much that effect amounted to (the effect of loose mortgage terms on broad Closed Access prices).  Net out-migration of homeowners from Closed Access cities amounted to tens of thousands of households in 2004-2006.  It seems that new buyers with credit triggered a lot of sellers.  Without the Alt-A market, would prices have been similar to what we saw, but with less selling and out-migration from the Closed Access markets?  The Contagion cities are a different matter.  There was some temporary price surge there based on their particular context of in-migrating renters and those Closed Access sellers with windfalls looking for a place to rest.

Anyway, I'm rambling.  Schools and home prices are another example of how this efficiency is implicit in the complaint.  Housing markets are so efficient, that even the bundled service of education gets filtered into the market price, apparently with a surprising amount of specificity regarding both the quality of the school district and the value that quality bundles with the house.

2) The problem itself is actually just a side effect of the Closed Access problem.  In every city, there are many bundles of services and amenities that form the base value of a given neighborhood.  In most cities, families are actively choosing between those bundles of amenities, of which education is only one.  So, the reason this is a problem isn't strictly because the premium itself exists.  It's because Closed Access cities prevent families from making this choice on the margin.

In most cities, families would be choosing size of unit, commute, safety, neighborhood character, nearby services, and a host of other factors to determine their optimal unit.  Families who prioritized better schooling would make adjustments in all of these other areas.  So, typically, if the median household spends 25% of income on housing, a family that values education in a city with an education premium might live in a smaller unit, a little farther from work, etc.  But, the median household would still tend to spend about 25% on housing.  There are many margins for adjustment.

In Closed Access cities, this margin for adjustment is gone.  The only margin left for adjustment is leaving town for an Open Access city.  So, a family that values education is spending 45% of their income on housing.  They are spending 45% because all of the other margins for adjustment have been tapped out.  So, their choice is to either spend 60% of their income on housing and get better schools, spend 45% on housing for poor schools, or leave town.

It looks like that family's problem is the education premium.  But, it isn't.  Their problem is Closed Access.  They could also have some sort of subsidized housing or rent control, so they would be spending 35% of their income on housing, but they would be stuck in a bad school with the same bad choices.  Closed Access removes marginal options.

So, all of the marginal sources of adjustments that aren't taken as a sort of civil right (square footage, location, etc.) get adjusted away to try to pull expenses back toward the comfortable level.  But, clearly for the majority of households in those cities, all of those adjustments can't get expenses to a comfortable level.  So, the one adjustment that we consider a civil right - a chance for decent schooling for our kids - becomes operative, and the only reasonable way to adjust it is by raising or lowering our expenses.  It looks like a civil rights issue, but it is really just a side effect of Closed Access.  The real civil rights issue is the right to invest capital in real assets without undue harassment from local officials, which has been so watered down that entire mega-cities lack adequate housing.

Thursday, April 20, 2017

Housing: Part 220 - If it looks like a demand problem, you have a supply problem.

I frequently use the supply vs. demand framework to describe the difference between an Open Access vs. Closed Access city, or to push back against "bubble" talk.  But, sometimes, I suppose, this can be misleading, because really all price changes are demand phenomena.  2017

Here is basically a universal housing supply and demand curve for owned homes in a metro area.  The difference between metro areas is where their supply curves fall.  Closed Access cities have supply curves that are nearly vertical (inelastic) in any reasonable context.  Open Access cities have supply curves that are reasonably flat (elastic) in any context that has been tested.  And the Contagion cities generally look like Open Access cities, but they took on such huge in-migration from Closed Access cities that they reached their supply curve turning points.  (As I have proceeded through the project, in some ways Miami has become a less than perfect fit as a Contagion city, but Florida in general fits the type, I think.)

The difference between these cities is their supply elasticity.  Full stop.  Closed Access cities have both short and long term inelastic supply, Contagion cities developed inelastic short term supply, but they have elastic long term supply (or at least, the demand curve moved back to the elastic portion of the supply curve when the Closed Access migration surge abated), and the Open Access cities have both short and long term elastic housing supply.

But, the irony is that, on the ground, changes in home prices are all going to be triggered by demand, because that's what is more volatile.  So, rising rents, falling real long term interest rates, new tax benefits, etc. all create these volatile price shifts in Closed Access cities, and observers all say, "See!  It's a demand problem!"

Let's say foreign buyers can avoid some sort of capital gains tax, and they start piling into closed access city real estate (because that's where capital gains expectations will be highest), and prices go up.  Pass a law against foreign investment, and prices go down.  See! It's a demand problem!

Or, a major shift in credit policies causes prices to rise or crash.  See!  It's a demand problem! 2017
But, there are demand shifts in Open Access cities.  If we measure shifts in demand by the number of permits issued, then Open Access cities have much higher shifts in demand than Closed Access cities do.  Heck, during the "bubble", the Contagion cities had more than 1% annual population growth, just from the housing refugees fleeing the Closed Access cities.  Believe me, they know about demand.  The Contagion cities?  Now, there was a demand problem, although even there, the bubble came from the shift in short term supply elasticity when permit issuance couldn't rise to match migrant inflows.

But, you usually don't hear about demand problems in Open Access cities.  For some reason there is never a problem of excess foreign buyers in Dallas.  Are there a lot of foreign buyers in Dallas?  I don't know.  Nobody cares.  You want a house, they'll build you a house.  Maybe there are more foreign buyers in Dallas than there are in Vancouver.  Does anybody even bother to measure it?

How do you know if you live in a city with a housing supply problem?  It will look like a city that has a demand problem.  How do you know if your city doesn't have a housing supply problem?  It won't look like it has a demand problem, even if its demand for new housing is twice the national average.

Friday, April 14, 2017

March 2017 CPI

Um....Hmm... Yeah...

It will be interesting to see what happens to June Fed Funds Futures on Monday...

I'm pretty sure, though, that the drop in shelter inflation is due to over-building in high end urban condo markets.  :-p

Wednesday, April 12, 2017

The problem with school choice?

It has recently occurred to me that many people who object to "school choice" policy programs hold these two opinions in their heads at the same time:

  1. Funding good school districts everywhere is important.  We can see how important it is to people because there is a huge premium in real estate where schools are better.  Families seek out better school districts and they are willing to pay to be in those districts.  This ends up being unfair because marginalized families are priced out of those districts and are not able to attend the schools they would prefer to attend.
  2. School choice doesn't work because it is very difficult for families - especially marginalized families - to "shop" for a school.  They don't have the time or the ability to know, really, which schools are better, so the idea that they have a choice is sort of a misnomer.  They will end up in schools that are underperforming, just because it is so difficult to accurately audit the schools to know which ones are performing well for your children.

Thursday, April 6, 2017

Housing: Part 219 - The Post-Industrial transition and housing bubbles.

I have been moving toward a grand theory of economic epochs.  We are moving toward a post-manufacturing economy.  Just as the move from agriculture to manufacturing led to a wave of urbanization, because production at the time needed to be centralized, today the move from manufacturing to services and non-tradables also requires urbanization, for two reasons.  First, because a core of highly networked and skilled innovation workers need to remain in close contact with one another.  And, second, because they now bring with them a large number of non-tradable sector workers who provide services to them.  This is the new economy.  This is the natural transition of a free society to an information economy.  Those workers we are fretting over, whose jobs are being stolen by Chinese workers or robots, are transitioning to new forms of labor just like every generation before them did.  They are becoming nurses, yoga instructors, baristas, nannies, life coaches, construction workers (if we dared let them), tech support workers, etc., etc. etc.  Those jobs need to be near their customers.  They need urbanization.

I just happened to see a graph comparing manufacturing employment across several countries (Hat Tip: Adam Tooze)  The graph compared US manufacturing income to Japan, Germany, and Korea.  Manufacturing employment has been stronger in all three than in the US.  Guess what else they have in common.  None of them had a housing bubble.  And they tend to run trade surpluses.

So, I went to Fred to see if the pattern holds.  And it does.


The housing bubble, trade deficit countries are down there with the US with half the manufacturing employment that Germany has.  They have moved to a post-industrial economy.  That requires urbanization.  Nobody has figured out, politically, how to allow it to happen.  I predict that the first one that does will experience a flowering of equitable economic growth. 2017
Source: World Bank (via Fred)
PS.  Here's a graph of GINI indexes.  The trade deficit/ housing bubble/ post-industrial economies also have another thing in common.  More income inequality.  A cap on the admittance into the key urban economies has created an economy of exclusion based on a sort of meritocracy.  If you have skills and connections, you can earn an excessively high income, much of which goes to your landlord.

Wednesday, April 5, 2017

Randal O'Toole's American Nightmare

I was recently made aware of Randal O'Toole's book on the housing bubble, "American Nightmare".  I'm embarrassed to say it had escaped my vision before now.

I have developed a sort of "everyone is wrong about everything" attitude about this topic.  But O'Toole basically gets it right.

Most of the book is a brief review of the history of homeownership and urban housing policies, capped off with an explanation of how that history led to the bubble because of disastrous supply constraints that are always at the heart of housing affordability problems.  The credit issues were a result of that problem, not the cause.

He has a 10 point prescription for fixing the problem that is generally pretty good.  It includes more skepticism about FHA, the GSEs, and the rating agencies than I generally hold.  But, his skepticism includes the point that in high cost areas, where low down payments were used to help usher new buyers into homes, we should probably have been requiring higher down payments because constricted housing creates more volatility.  That's a good point, worth considering.  And, he notes that those sorts of measures would be unnecessary, if not for the supply problem itself.

In general, I think ownership should be more about self-selection than about affordability.  Transaction costs are high, so there is a natural self-selection of buyers who expect to own long enough to amortize transaction costs.  Beyond that, it's not like families are choosing between buying a home or living under a bridge.  They will be renting if they aren't buying.  Affordability is only a problem in high inflation contexts because of mortgage conventions and money illusion.  Obstructing ownership for affordability reasons isn't coherent.  Typically, the decision to own reflects some deferred consumption, because of the front-loaded nature of mortgage cash outflows.  The notion that we have to keep households with moderately low incomes from access to mortgage financing, because they will become reckless speculators if we don't, is policy from attribution error.  High down payments are an added obstacle that prevents households from gaining control over their living space.

But, as O'Toole notes, low down payments are really mainly a problem in Closed Access contexts.

I have generally thought well of O'Toole's work on topics like mass transit.  After reading this book, my estimation of the quality of his work on topics that I am not as informed about just went up.  He got the big picture right on this one where others rarely have.

Tuesday, April 4, 2017

Housing: Part 218 - Closed Access real estate is now a cyclical signal

I've been seeing this sort of article recently (HT: JW), about rents or prices dropping at the top end of the housing market.

I think this is one of the potentially useful tactical concepts that can come out of a new understanding of the housing bubble.  This also happened in the bubble.  The first shift in housing markets, in the Closed Access cities in 2006, was a downshift at the top end.  An exodus from home equity had been happening for years before mortgage markets collapsed in late 2007.  For more than a year before mortgage markets collapsed, there had been a fairly conventional decline in home prices that was concentrated at the top tier markets in cities where prices had risen.

That was the correction.  It was minor, local, and focused at the top and in equity (not credit).  Everything that happened after private securitization markets collapsed was a public policy choice that had little to do with the bubble.

The collapse in home equity in 2006 and 2007 was the product of a flight to safety.  Public opinion and public policy has the benefit of being able to impose itself on the country regardless of how obtuse it is, and so, two years after markets had turned to defensiveness, our consensus public policy choice was to teach the supposedly reckless market a lesson and really create a panic.  Nothing is more pro-cyclical than public sentiment strong enough to impose itself.  2017
Each dot = one zip code. (Source: Zillow Data)  x-axis: log home prices, y-axis: annual log price change
selected western US Closed Access and Contagion cities shown

...Anyway, back to 2006.  Across cities, it was the top end that led the initial contraction.  One explanation for this is that Closed Access real estate has become sort of like a growth stock.  The value of Closed Access real estate is its protected claim on future economic productivity.  This is manifest through expected long term rent inflation in those cities.  So, Closed Access real estate prices are more exposed to long term real growth rates.

The bubble-monger mentality that has been created by Closed Access consequences leads to this pro-cyclical public policy.  Just as the stock market is an early indicator of economic and employment trends, now Closed Access housing is also an early indicator.  But, we can't utilize these indicators for stabilizing public policy because this will be seen as protecting Wall Street or protecting real estate speculators.  Especially now in real estate, these early downshifts are treated as the inevitable collapse of an overheated market, and they are generally welcomed.

I don't think the ingredients are there for a disaster like we saw in 2008 and 2009, but we are still destined to walk right into a contraction while patting ourselves on the backs for it.

If these contractions were based on a permanent shift toward more building in the Closed Access cities, first, we would need to see housing starts far above what they are - at least double - and, second, the first reaction to that regime shift would be a collapse in Closed Access home prices, because they would lose their claim on exclusion.  This would be considered disruptive, so there would be a plurality of forces in Closed Access cities that would come together to ensure continued exclusivity - for the sake of local stability.  Limited access governance begets limited access governance.  Even North, Wallis, and Weingast don't have a prescription on how to reverse this.

But, on the national level, didn't a plurality of forces demand instability? Yes.  The problem is that we have a shortage of (local) supply, and (national) credit markets are mostly a passive effect of this.  But, we mistakenly have thought that we have too much credit, creating too much supply.  So, we tend to err on the side of limiting supply, which can avoid short term local disruptions at the local level, with the cost of long term national exclusion, and we err on the side of limiting credit, which creates short term national disruptions.

The disruptions we would see locally from solving the Closed Access problem would be at a completely different scale than what we are seeing.  They would be on the scale, to the downside, of the price appreciation we saw in the 2000s.  These small scale declines, I think, are more of a sign of marginal cyclical shifts in expectations.  National expected income is declining because of cyclical shifts downward, which means there are fewer rents to claim from exclusion.  This hits Closed Access real estate values.

There seems to be a difference between now and 2006.  In 2006, rents were rising as prices began to contract.  That is because the exodus from home equity happened first and housing starts were already sharply falling.  This cycle is different because there hasn't been as much panic about a housing bubble, and housing starts, while weak, aren't collapsing.  So, there appears to be some softness in rents, too (although this isn't showing up in the CPI data yet*).  But, if that softness in rent was considered permanent, rather than cyclical, Closed Access price contractions would be extreme.

* There can be a lag in rent inflation in the CPI.  It will be interesting to see if CPI rent begins to slow down.  Will that remove inflation pressure, causing the Fed to stop monetary tightening?  The road ahead is interesting.  I'm getting tired of being unclear about it.  It seems like this has been the case for some time.

Monday, April 3, 2017

Housing: Part 217 - Some observations on taxes

I have found a pattern in home prices that I attribute to tax benefits, where high tier homes tend to sell at Price/Rent multiples of maybe 30% or more above low tier homes.  I think the price differentials we saw in Closed Access cities that were blamed on loose credit were actually a product of this factor.  In general, I would prefer to see the income tax benefits of homeownership removed, including the tax exemption of imputed rent, the deductibility of mortgage interest, and the exemptions on capital gains taxes.  The easiest way to do this, I think, would be to generally eliminate taxes on capital.  Many economists, as I understand it, would point out that taxes on capital aren't particularly progressive, because they really fall on owners, workers, and consumers proportionately after wages, prices, and profits adjust to the new equilibrium.  But, actually, I think capital taxation is a bit regressive because of these housing issues.  There is a huge gain to homeowners, especially high income homeowners, that would be difficult to get rid of as long as we tax capital income.  And, increasing property taxes a bit would capture back some of that tax revenue in a way that might be a little bit regressive, but is probably less regressive than the income tax benefits we currently have.

But, there is a caveat I hadn't thought of.  Property taxes are based on market values.  Market values currently reflect those income tax benefits.  So, property taxes are now somewhat progressive.  A home worth $1,000 in monthly rent now might sell for $150,00 while a $2,000 rental unit in the same town might sell for $400,000 (instead of $300,000).  That means that, by rental value, property taxes now are somewhat progressive.  Presumably, if the income tax benefits were removed, that high end home would only sell for $300,000, and their property taxes would also be lower.  So, my preferred tax regime would be more regressive than I have been admitting to.


There were some changes to the capital gains exemption in the 1990s.  It used to be that you could get an exemption on capital gains when you sold a home, but you had to purchase a new home or be over 55 in order to claim the exemption.  That requirement was removed in 1997.  This has generally been blamed, along with all the other tax benefits, for feeding the bubble, and I agree that the range of tax benefits does tend to inflate prices.

But, I think we may have overlooked the way that this actually made the bust worse.  As I have argued, there was a surge of permanent selling as early as 2003 or 2004 - homeowners selling and not buying back in.  With this change in the tax rules, households could bank their Closed Access capital gains, tax free.  In fact, if you were bumping up against the maximum ($500,000 for a couple), you might be induced to sell by that rule change, to reset your exemption.

Would the exit rate have been so high during the bust if that rule hadn't been changed?  I have to think that, at least, many of those sellers would have repurchased other homes.

These are tough arguments to make when most people think the problem was that the bust didn't come soon enough.  But, given that the bust was largely avoidable and unnecessary, this seems like an example of a disruptive unintended consequence.


Another piece of fuel to the fire was Bush's Mortgage Forgiveness Debt Relief Act of 2007.  Normally, a household would have to pay taxes on debt forgiven in a foreclosure.  But, seeing the mounting problem in the collapsing housing market, the Bush Administration signed this law in December 2007, providing relief from the tax consequences of foreclosure.

Coincidentally, by February, we were seeing articles like:
Homeowners: Can't pay? Just walk away. and Subprime loans defaulting even before resets. by February, as default rates suddenly spiked, and some homeowners appeared to be defaulting "strategically".

We have seen the bust as an inevitable result of the bubble.  It wasn't.  That has blinded us to the various discretionary policies that, in the end, did make it inevitable.

Thursday, March 30, 2017

Housing: Part 216 - Mortgages and Ownership in the boom and bust

There are so many ways in which we were tricked by our very own eyes and our very strong biases toward coming to pre-ordained conclusions about the housing boom.  Generally, these biases led us to blame lenders and speculators when prices were rising sharply.  One way our predispositions seemed to be confirmed was the appearance of a hot mortgage market in the midst of the boom.

Now, I like to make the point that any context with rising prices, for any reason, is bound to have a hot lending market.  You can always put obstacles in the lending market, which is what we have done since 2007, to keep prices lower, but this is different than pushing prices up through lending.  It is easy to see how a household who is obstructed from credit will not create demand for homeownership (although, they will still create demand for housing).  But, if access to credit creates unsustainable or irrational demand that pushes prices too high, we should expect this to lead to some mitigating factors - the natural drop of demand among buyers who see the market as too expensive, the natural decision of current owners to exit the market, etc.  There might be some positive feedback mechanisms from loose lending that cause demand to shift up, so that there is some level of positive feedback in hot markets, but it seems to me that the data says these mechanisms have been overstated, and they certainly weren't causal.  In other words, the case for tight lending causing prices to retreat below a sort of non-arbitrage price level is easier to make than the case for loose lending causing prices to rise above a reasonable estimate of a non-arbitrage price level.

One reason that credit seemed important was that mortgage debt was rising during the period.  But, according to the Survey of Consumer Finances, the typical mortgaged homeowner had leverage that was declining during the boom, and was only slightly higher than the pre-bubble level even after the bust.  (This is probably due to owners overestimating their home values during the bust, in part.)  It appears that leverage was mostly rising during the boom because there were fewer households who were unencumbered.

This doesn't quite match the conventional wisdom, because we imagine the housing ATM to mostly apply to households who had Loan To Value (LTV) levels of, say, 80%, getting home equity loans and moving their LTV to 90% or 100%.  It doesn't really make sense that the housing ATM would mainly lead to some households taking on mortgages who didn't have any to begin with.

What I have found is that first time homeownership was probably slightly elevated from the mid-nineties on (though the financial character of buyers did not change much throughout the bubble, and if anything was strengthening).  This led to rising homeownership, which peaked in 2004.  From then until 2006 or 2007, the trend reversal in ownership was coming from a rise in permanent sellers - owners exiting ownership.  Then, in 2006 and 2007, the collapse of the mortgage market and public policy pressures against marginal lending caused first time buyers to fall.  Selling pressure remained strong, and homeownership rates really began to collapse as we now had weak entry and strong exit rates into homeownership.

So, in that 2004-2007 period - the subprime boom period - I think the primary influence on leverage was not the housing ATM factor, but this shift in ownership - a slightly strong first time buyer market (though no stronger than it had been for a decade) and a strong sellers market.  The sellers tended to be long term, unencumbered owners.  So, there was a tradeoff of owners without a mortgage selling to first time homebuyers who were leveraged, just as first time buyers have generally always been leveraged in the modern US housing market.  The stability in leverage levels, which then began to shoot up when prices stabilized and began to decline, was from a shift in owner composition.

We can see this in the SCF measures of homeownership, both with and without a mortgage.

Looking across all families, mortgaged ownership increased by about 8% from 1995 to 2007, but total ownership only increased by about 4%.  (Note that the collapse of the credit market lagged the outflow of owners.  From 2004 to 2007, mortgaged ownership increased by just under 1% while unmortgaged ownership fell by more than 1%, leading to a net decline in ownership during the private securitization boom.)

Notice how there is a rise in mortgaged ownership across incomes, but this only led to a rise in total ownership in the top 60%.  That 4% fall in unmortgaged ownership seems to cross income levels.  It is matched by a 4% increase in mortgaged ownership in the bottom quintiles, that leaves ownership flat, and in the middle and higher incomes, mortgaged ownership increased by more like 10%, leading to a net increase in total ownership.

In the lower quintiles, the rise in mortgaged ownership was entirely offset by a fall in unmortgaged ownership.  This suggests the possibility that at least part of the story was a rise in low income lending which is hidden in the aggregate numbers by an outflow of former low income owners.

But, if we look at ownership by age, I don't think this bears out in a significant way.  Rising mortgaged ownership is highly correlated with age.  And, ownership in the lower two income quintiles are also highly weighted to older age groups.  The rising mortgaged ownership in the lower quintiles must be coming mostly from the use of leverage among lightly encumbered older, long term owners.  (By the way, the length of tenure for owners in the bottom quintiles, especially in Closed Access cities is very high - typically over 20 years.)  And young owners are largely in the high income quintiles, so the rise in mortgages to younger age groups must have been mostly to buyers with high incomes.

So, that rise in mortgaged ownership among the low income quintiles is a bit of a mystery.  What was causing so many older owners to retain mortgages?  Was it just a cultural shift with baby boomers?  Products like reverse mortgages?

As you might suspect, I think migration in and out of Closed Access is an important factor here.  ACS data which has details and statistical power regarding these issues only goes back to 2005.  The migration patterns in 2005 were very strong, but while their scale was unusual, the direction of the trends should be similar to what had been happening for a decade.  We might assume that ownership patterns in Closed Access cities in the mid-1990s were much closer to the ownership patterns we see in the rest of the country, and that the sharp differences that have developed since then are largely the product of the cost-based segregation that has developed.  (Although, this isn't borne out by state-level ownership rates, which seem to have been below the national average in California and Massachusetts for some time, so maybe my intuition fails me here.)

Among mortgaged homeowners, in the massive outflows that were happening in 2005 and 2006, what we see is a sharp net outflow of households that were young and households that had low incomes.  For the general population of Closed Access MSAs, the bottom 60% of households were moving away, on net, at a rate of about 2% a year, at the height of the bubble.  But, for homeowners, it was more like 3%.  Keep in mind, middle class and poor households don't tend to own homes in Closed Access cities, so in absolute numbers, this is a small portion of the total population of migrants.  But, it gives us a window into these shifting ownership patterns.

Let's take a look at ownership patterns at the top income quintile and the 2nd quintile.  Here, the orange bars are Contagion cities, the red bars are Closed Access cities, and the green bars are everywhere else.  The dark bars are 2005, the light bars are 2014, the solid bars are mortgaged and the striped bars are unmortgaged owners.

Notice, in the top income quintile, ownership in Closed Access cities is similar to other cities.  At the top end, Closed Access residents have to make some compromises, regarding the size of the unit, etc.  But, in terms of budget and ownership status, their spending and ownership patterns are maintained.  As we move down the age groups, Closed Access ownership declines, because the older owners were more likely to buy their homes before the bubble, and younger households have been priced out for 20 years.  Also, note how sharply mortgaged ownership has collapsed for younger households in the highest income quintile.*

Now, look at the 2nd income quintile.  This is a different story.  Ownership among older households is still fairly similar across cities.  These are generally households that have owned homes for a long time.  But for working age households, now there is a sharp difference between Closed Access and other cities.  Among younger households with moderately low incomes, ownership in Closed Access cities is negligible.  Across working age groups, it runs 20% or more less than in other cities.

There would be a natural reaction from existing owners to rising prices in constrained cities to capture those capital gains, partly through selling and moving, and partly through taking out mortgage debt.  The migration and ownership data suggest that selling is a significant factor.  Where capital gains would be caused by supply issues, of course they would be captured in a number of ways, some of which include using the home for collateral.  As we move down the age and the income distribution, Closed Access ownership, both mortgaged and not mortgaged, falls farther below the levels we see in other places.  This suggests that, on net, supply pressures have a sharp effect on the quantity demanded of homeownership.  To the extent that there is a notion about the bubble that expanding credit creates its own demand, pushing prices into an ever-climbing spiral, that appears to be a broad overstatement.  In terms of quantity, it seems clear that among existing owners, a city with rising prices will have lower demand for housing units than a city with stable prices, even as some of those households capture their capital gains through home equity borrowing.

My shorthand for the housing bubble in the Closed Access cities is that non-conventional loans weren't putting middle income and poor households in homes; they were facilitating the sale of homes from wealthy old homeowners to high income young buyers.  But, looking at SCF national data that goes back to the 1990s or AHS data on cities that goes back to about 2000, there isn't an obvious shift in ownership patterns.**  There certainly isn't any shift that is a counterpoint to the sharp downward shift we have seen in young, high income homeownership in Closed Access cities since the bust.

In the end, I don't think there was a shift.  There was a slight increase in ownership among the young, nationwide, but there was nothing peculiar about what was happening in the Closed Access cities - the "bubble cities".  The non-conventional loans were simply facilitating the same sorts of purchases from the same types of demographic groups that had always bought homes.  To the extent that they were critical in facilitating rising prices, they were allowing normal transactions at price points that had reached levels too high for conventional loans to handle.  They were simply accelerating the normal process of in and out migration from Closed Access cities.  The slight drop in Closed Access population during the boom appears to be about half-explained by the difference in family size between small families that move in and larger families that move out.  Thus, the migration acceleration led to population decline.

* Consider what this tells us regarding causality.  If creative financing caused the bubble, then when those mortgage markets collapsed, we should have seen prices falling and ownership remaining fairly level for high income groups.  Instead, Closed Access ownership among high income young households has collapsed.  The reason it has collapsed is because high prices are caused by supply constraints which push rents up.  Housing expenses in those cities take a large chunk of any household's budget - even a household in the top income quintile.  Supply constraints caused local housing costs to rise above the norms we use for conventional mortgages.  Creative mortgage terms were allowing high income buyers to purchase homes outside the norms of conventional mortgages, which is the only way to purchase a home in Closed Access cities.  Young, high income homeownership has collapsed in Closed Access cities, in spite of some retraction in prices, especially in lower tiers of the market, because creative mortgages weren't creating the price problem; they were just facilitating ownership in cities that had high costs.  Now we have imposed constraints on creative financing, so young households with six-figure incomes are trapped in the renter's market and prices are too low to entice the remaining long-tenured owners to sell.

** Upon review, I think I made an error here.  The income quintiles I use are based on national quintiles.  The bottom two quintiles in the Closed Access cities only amount to about 16% of Closed Access population each and the top quintile amounts to about 30% of Closed Access population.  If both renters are owners are leaving, the relative number of low quintile owners could be declining even if the homeownership rate for those quintiles isn't falling that much.  So, the homeownership rate in the Closed Access cities could have risen during the boom because of changing composition to more high income households, even if the rate within each quintile, as I have defined them, remains fairly level or declines slightly.  So, my shorthand would be true, even with the homeownership rate data that we see.  In fact, this should have been obvious to me as a product of thinking about these things through the lens of national income segregation.