Wednesday, March 8, 2017

Housing: Part 211 - Measures of savings and credit supply

In a recent profile of Amir Sufi (HT: John Wake):
Sufi emphasized that the debt run-up resulted from a positive credit supply shock—not a sudden demand for more credit. Credit supply shocks occur when lenders decide to offer more loans based on “reasons unrelated to actual underlying performance of companies or the income of households.”  Because these spikes occur when interest rates are low, Sufi rules out increased credit demand as a factor. If lenders were reluctant to expand credit supply, interest rates would have risen.
I can see how he arrives at this conclusion.  But, my question is, where did that credit come from?  Lenders can't conjure up capital out of thin air.  For interest rates to have been low, savings needed to be strong.

Measures of savings tend to show low savings rates at the time.  Capital gains aren't included in savings rates, though.  In the graph here, home values are inverted.  Notice that savings moves up when home prices move down and vice versa.  This is normally treated as a source of unsustainable consumption, but in this case, that is not necessarily true. (1) The gains were largely gains in Closed Access real estate, which are permanent gains until a sea change happens in urban governance, and are certainly permanent for households that sell and realize capital gains.  (2) During this time, there appears to have been a significant amount of harvesting of real estate capital gains which were then transferred into savings instead of into consumption.  This combination of factors explains why interest rates were low while savings was low and credit levels were spiking.  Sufi is right that credit demand wasn't particularly high.  This is further confirmed by the declining rate of homeownership at the height of the housing boom.

In a way, I think Sufi's comment here gets halfway to a contrarian point of view regarding credit and business cycles.  There is an element of Scott Sumner's reasoning from a price change here.  Let's call it reasoning from a credit quantity.  As Sufi notes, credit levels could rise because of rising demand or rising supply.  The rise in debt leading to a financial downturn is usually presented as if it is from demand.  But, this seems wrong to me.  Usually, it is associated with a rise in mortgage debt.  In this recent case, mortgage debt was clearly associated with two factors:

1) Closed Access home values, which reflect an arbitrary limit on productivity, and thus would be associated with declining economic expectations.


2) Low real interest rates, which are usually also associated with declining sentiment.

Yet, these trends in debt are usually treated as bouts of risk taking and exuberance that are unsustainable - inevitably leading to a bust.  Shouldn't we treat these periods of rising debt levels as the first signs of a downturn in sentiment, not as naïve exuberance?


  1. Another source of credit would be the huge capital surplus that spiked the same time housing prices peaked.

    1. True. I forgot to mention that. I should probably put a link in to a post I have done about that.

    2. Hm. Maybe I haven't blogged on this. A long time ago I blogged on the capital surplus.

      Since then, I have come to the conclusion that some of our foreign income doesn't come so much from risk-taking as it does from excess profits of Closed Access firms. The reason countries with capital surpluses also have housing booms isn't because global savings funds a boom. If that was the case, there wouldn't be a relationship between home prices and capital flows. Capital would flow to where it is easiest to build a home, and that is where prices would remain level.
      The reason there is a relationship is because the root cause is Closed Access. Closed Access workers and firms have excess income from exclusion, some of that income comes from foreign sales, and those foreign sales create demand for dollars. The capital flowing back to the US, UK, Australia, and Canada, is profit from these foreign revenues, and the trade deficit isn't really a deficit nor is it unsustainable. It's simply the use of foreign income to buy foreign goods.

  2. Great post.

    I do think capital markets are global. So low savings rates in US (as measured) are not important. Global capital is abundant, and the US a good place to invest.

    There are so many danged moving parts in the real estate, banking, monetary policy, global capital flows being a blind dog in a meathouse.

  3. Great post.

    I do think capital markets are global. So low savings rates in US (as measured) are not important. Global capital is abundant, and the US a good place to invest.

    There are so many danged moving parts in the real estate, banking, monetary policy, global capital flows being a blind dog in a meathouse.

    1. Ha! True.
      I'm not sure it will fly, but I claim that global capital isn't abundant. There's a lot of it crossing the us border in a way that we measure, so we thought it was abundant, but mostly it's crossing borders because of the inequities of exclusivity.


    JLL says 24% of US real estate sales to foreigners….

    I suppose "capital is abundant" is a relative term. I do some real estate reporting, and the market has cooled off in premier markets in Q4 2016 to now.

    Still, a complaint is often, "There is too much capital chasing too few deals."

    My exposure to energy markets tells me that any good idea gets VC funding, and lots of second-stage funding, and a lot of so-so ideas get money too.

    I think there is an "artificial" accumulation of capital through forced savings, such as in sovereign wealth funds, public pension plans, insurance laws (to run a business in CA you must have insurance. They invest proceeds), and then the whole China story.

    Unlike say, parts of the 1960s through 1980s, I can think of no industry that is starved for capital, or indeed any industry that is struggling to meet demand.

    If you want to build a building in West L.A., and get it permitted, the least of your worries is finding financing.

    I agree with you on exclusivity.

    I call what Kevin Erdmann is doing a "big blackboard story."

    In the old days, a room might have a jumbo blackboard across the front, and you would start write down all important, and then secondary, elements of the story. Not a bad method, actually, and lost today.

    1. In my experience, real estate investment professionals (at least in commercial real estate) could all have tattoos saying that there is too much capital chasing too few deals. They say that literally all the time.

    2. Ha! That's funny, Bill.

      Then, when a downturn comes, theory by attribution error is right there ready to use, since any reasonable person could have seen that there was froth in the market.

      I don't know, Benjamin. The more I think about it, the more I wonder what it even means to say there is "too much capital". Will there be too much capital in Robin Hanson's em-dominated future?

      I think the problem is that we have limited the ways in which capital can be usefully deployed. Some of that I blame on Closed Access, some may be a natural result of the current technological context. Equity risk premiums are pretty high now, so I don't think we have exhausted at-risk outlets of investments. The fact that mortgages outstanding are lower than they were a decade ago, in nominal terms, while we inhibit its growth through regulation, seems like the opposite of a "too much capital" problem, though it does seem like a "too few deals" problem.

  5. bill-

    Well, tattoos, or the prominent message on their websites.

    I think you are right, on the other hand I contend we transitioned from relative capital-scarcity to relative capital abundance in the 1990s. And never went back.

    You hear the complaints about "hurting savers." You can't make money today as a saver. Nor should you. The market is saying there is a glut of capital.

    As I think we all agree, the Fed could sharply raise short-term rates but it would just lead to a collapse of rates in the medium-term.

    I come back to my position there should be serious boosts in aggregate demand, obtained through monetary stimulus, unzoning property, cutting regs, taxes and the size of the public sector.

    Having enough capital to build businesses or real estate to accommodate the demand is the least of our worries. So, we have "capital abundance."

    If you are old, you remember the cry of "crowding out."

    Haven't heard that one in a while.

  6. bill/Kevin:

    From National Real Estate Investor:

    "Overall, the increase in foreign capital is upping the stakes in an already highly competitive market. There is still a lot of frustrated capital not being placed in deals, according to Fletcher. JLL recently worked on a large transaction in a U.S. gateway market where 20 investors were chasing the same acquisition. “While we continue to see strength in the market, I think we will continue to see capital flow in,” says Fletcher. “We’re certainly not forecasting any let up for the back-end of this year.”


    This quote is actually a year and half old now, but I think it supports my view there is an "abundance of capital" on the market, or perhaps a "capital glut."

    This is probably a good problem to have, and requires a ramping up of demand. The answer to capital gluts is greater demand, larger economies and higher living standards.

    1. Benjamin, I think this is the cosmopolitan version of "The Mexicans are taking our jobs." Instead, since there are plenty of jobs and not enough houses, it's, "The foreigners took our houses."

      Why doesn't Germany have a capital glut problem? Why doesn't Dallas? Why is it only cities that can't manage to build any houses that are always drowning in foreign capital? Strange.