Friday, February 17, 2017

We are the 100% follow up.

Earlier, I was lazy, and I compared compensation and capital income over time with a measure of capital income that included corporate tax.  But, over the long term it is after tax capital income that will equilibrate in domestic incomes.  So, I subtracted corporate tax from the "operating surplus" measure.  This makes the relationship stronger.  Over time, real compensation and real capital income before tax have a .9724 correlation.  Compensation and real capital income after tax have a .9756 correlation.  This is especially interesting, since corporate taxes are pro-cyclical, and so on a cyclical level, corporate income is more noisy after taxes.  (Effective corporate tax rates go up during contractions because losses aren't fully and immediately deductible.)  Even with that extra cyclical noise, removing tax from capital profit strengthens the relationship.

Taxing capital income is not an effective way to break us apart.  We are the 100%.

We are the 100%.

Eons ago, I told commenter TravisV that I intended to look at this paper, and I finally have.  The abstract is:
Three mutually uncorrelated economic disturbances that we measure empirically explain 85% of the quarterly variation in real stock market wealth since 1952. A model is employed to interpret these disturbances in terms of three latent primitive shocks. In the short run, shocks that affect the willingness to bear risk independently of macroeconomic fundamentals explain most of the variation in the market. In the long run, the market is profoundly affected by shocks that reallocate the rewards of a given level of production between workers and shareholders. Productivity shocks play a small role in historical stock market fluctuations at all horizons.
This would appear on the surface to push against the notion that we are the 100%.  Over the long term, fluctuations in stock market value come from reallocation between workers and shareholders.

The actual findings of this paper are interesting and useful, but I think we need to be careful about how they are interpreted.  Much like the Mian & Sufi findings about the housing boom, mostly what is going on here is that they have adjusted away almost the entire story, and they are analyzing the small sliver that is left.  They have detrended the data exponentially.  For instance, take a look at this graph from the voxeu article:

Over the long term, we can see here that fluctuations from the trend largely correlate with changes in the share of income to shareholders.

From the article's conclusion:

Technological progress that raises aggregate consumption and benefits both workers and shareholders plays a small role in historical stock market fluctuations at all horizons...
Indeed, without these shocks, today's stock market would be about 10% lower than it was in 1980. The shocks responsible for big historical movements in stock market wealth are not those that raise or lower aggregate rewards, but are instead ones that redistribute a given level of rewards between workers and shareholders.
This seems like misleading interpretation to me.  We are talking about a 10% fluctuation over a period where the trend growth was something like 700% in real terms.

Here is a scatterplot of real capital income and real compensation since WW II.  If you want to know what capital income will be in a given year, an extremely good proxy would be knowing the level of compensation in that year - and vice versa.  The correlation is .97.

So, whatever we might learn from this paper - and there are things to learn from it - it seems very important to keep in mind that this paper is about a 3% portion of the total story.

It seems to me that the quote above should be prefaced with the sentence: Technological progress that raises aggregate consumption and benefits both workers and shareholders explains general growth in stock market values, which is about 97% of the growth in income and wealth.  Shifting factor shares might explain much of the other 3%.

It's a shame that the human psyche is so drawn to battles over relative status.  The story of human history and human advancement is a story of the battle to overcome this mental defect.  We are the 100%.  How much social attention is paid to the 97% of the story versus the 3%?

The largest risk of economic dislocations, like what we have seen over the past couple of decades, isn't the actual shocks themselves.  It is the human tendency to retreat into battles over relative status.  Notice that their measure of the effect of factor shares on stock wealth has declined since the late 1990s.  How's that workin' for ya?  Is there any disagreement that 1968 and 1998 were better for both shareholders and workers than 1978 or 2008?


Thursday, February 16, 2017

NY Fed Household Debt Report: Signs of Debt Growth?

The New York Fed reports that household debt rose in 2016 4Q.  This is a positive sign.  The scenario for continued recovery would center on housing recovery and mortgage recovery.  Positive signals include a decline in shelter inflation, a rise in non-shelter inflation, a rise in interest rates, a rise in housing starts and prices, and a rise in mortgages outstanding.  If that doesn't come together, I expect the Fed to overtighten and to trigger a contraction.

Last month's CPI data suggests a possible shift in this direction.  Now, the 2016 4Q household debt data also suggests a positive shift.  Mortgage debt increased by about $130 billion and other household debt also increased.

In both cases, I am concerned that these are just the latest head-fake.  Data from commercial banks suggests that the mortgage data is (not sustained).

So, I remain tentatively neutral-to-bearish, in wait-and-see mode.  There isn't any reason that the expansion should reverse simply due to its age, but this seems like a context where, nevertheless, the risks of being exposed to a contraction are higher than usual.

Wednesday, February 15, 2017

January 2017 CPI Inflation

A major reversal this month.  Good news or noise?

Month over month change in non-shelter core CPI was over 0.3%.  Year over year non-shelter core inflation is at about 1.3%.  Rent at Zillow has been signaling moderation recently.  Does that mean CPI shelter inflation will now also continue to moderate?  If non-shelter inflation is from demand-side pressures, I don't see how it could.  I'm still mostly in wait-and-see mode here.

Tuesday, February 14, 2017

Housing: Part 207 - The Glut of Houses

This is covering old territory, but I thought this chart was worth tossing up here.

Source - table 8
This should show the massive misallocation of capital into housing during the 2000s bubble.  The huge run-up in housing units, fueled by loose credit and cheap money.  A run-up so massive it would take years to work off.  Bernanke noted in 2011, "Builders would start construction on only about 600,000 private homes in 2011, compared with more than 2 million in 2005.  To some extent, that drop represented the flip side of the pre-crisis boom.  Too many houses had been built, and now the excess supply was being worked off." (The Courage to Act, p. 503)

Millions of extra homes must have been built in order to create inventory that would take that long to work off.  There are a lot of books on the bubble that I haven't read.  I can only assume that this data appears somewhere.  Maybe they have a different version than I do, or maybe my scale is messed up.

I see two frequent comments about Closed Access real estate.

1) The supply limit is due to geography.  There just isn't a way to build much in those cities.

2) Markets are getting hot.  There is a bit of a bubble.  Skylines are dotted with cranes.  There is too much building.  Rents are starting to soften.  The building market needs to pull back before it creates another boom and bust cycle.

These two observations are mutually exclusive.  Either there is a geographical limit to building, in which case, all potential building can only partially accommodate the demand for housing in those cities, or there is the potential to build too much, leading to a bust.  It's one or another.  Functionally, we appear to govern as if we believe both at the same time.  So, we make excuses for the lack of building that keeps rents high, and then, when enough building occasionally makes it through the political gauntlet to actually cause rents to moderate, we, maddeningly act like that is a problem to solve.

The idea that geography is the limiting factor here is wrong on its face, in either case, which is clear simply by opening one's eyes.  Are developers throwing up their hands in the Closed Access cities because there is just no developable land to purchase, or do they have many potential projects that are stuck in political limbo?  Is anyone going to honestly try to argue that if every building project in the pipeline now was fast-tracked, that developers wouldn't have any potential projects to follow up with?

This is the odd position we are in because of Closed Access policies.  Closed Access is an unstable equilibrium.  The current rent and price levels of Closed Access homes depends on exclusion.  The price of Closed Access homes contains an implicit assumption that millions of low-income households will have to move away for lack of affordable housing.  Dislocation is baked into the Closed Access market.

If there was ever enough building in those cities to heal that future dislocation, home prices in that city would collapse.  A natural supply and demand equilibrium would be destabilizing in the short run.  It would lead to billions of dollars in capital losses.  So, we govern the economy to maintain an unstable equilibrium, where the unmet demand for Closed Access housing is balanced against expectations of future supply deprivation and future dislocation of disadvantaged residents who Closed Access cities just won't make room for.

There is no way to balance that equilibrium.  In places like Texas, the equilibrium is basically the cost of building, and supply and demand shift to maintain that basic balance.  But, since Closed Access has come to define our economy, and since we have managed to address it with delusions of attribution error, we bounce from boom to bust, always nervous about the next big kick in one direction or another, because so much wealth in Closed Access economies is derived from the presumed ownership of exclusionary policies in the far future, which are imputed into the prices of those restricted assets today.

Wednesday, February 8, 2017

Liberalism wins with capitalism, but first, there need to be liberals.

One might have a standard that we should refuse to admit refugees if this will lead to even a single terrorist or criminal incident.

One might also have a standard that we should refuse to mine for coal if this will lead to a single drop of toxic materials in a watershed.

I dream of a country where political factions are divided between those who see these statements both as wrong, in a similar way, opposed by those who see them both as acceptable.

Instead, we have a country where few people seem to see these both as similarly wrong, and there are two larger groups who see one version as correct and the other as wrong.  Their different positions seem to be based on a pre-programmed double-standard.  In both cases, the optimal standard in the world we live in clearly involves compromise.  The optimal amount of refugee acceptance or immigration will, unfortunately, inevitably lead to some instances of crime involving those immigrants.  The optimal amount of electricity will, unfortunately, inevitably lead to some instances of environmental accidents or increases in trace toxins.  We accept these compromises as endogenous when it comes to crimes committed by citizens, or when it comes to toxins we release from our backyard fireplace, or the production of solar panels, or the delivery of some fossil fuels within the status quo.

The differences in these positions seem to come from different forms of sectarianism, who have different suppositions about who are insiders and who are outsiders.  Outsiders don't get compromises.  They get ultimatums.

We will be moving in the right direction if we can somehow break away from sectarianism and move to a political context where the disagreements are between conservativism and liberalism.  The great miracle of markets and capitalism has been capitalism's tendency to deal a winning hand to liberalism, freeing the world's communities from their local status battles, within which the potential of the community is held back in service of the protection of the powerful.  It is difficult for this miracle to play out if there are no liberals to carry the mantle.  Liberals deal in principles, not identities.  Liberals are relativists, not absolutists.

Monday, February 6, 2017

Bank deregulation

John Cochrane has a post today about the potential for Dodd-Frank reform.  The short version is: it would be a good development if we could find a compromise where banks are less regulated in exchange for requiring higher capital requirements.

I agree with this, but really, I think this is simply the what any real deregulation looks like.  I think the GSEs really help to bring clarity to this issue.  They are similar here to commercial banks.  They have very low capital requirements, which worries a lot of observers.  Along with those capital requirements is de facto government backing for their debt and issued securities.

So, banks have FDIC insurance, which provides safety for depositors.  This means that as banks take in deposits (which are liabilities for banks), the interest rates required by those depositors don't react to the risks created by leverage, since FDIC insurance is basically like a credit default swap for the depositors.  Any non-financial corporation would naturally remain less leveraged, outside of crisis situations, because they would have to pay higher interest rates for debt as their leverage increases.  Since FDIC insurance undermines this basic market source of moderation, banks have to be regulated so that they don't become too leveraged.  They are forced to keep a minimum level of capital.

But, the minimum level of capital required has to be less than what the natural market level of capital would have been.  Otherwise, what's the point?  And, banks would simply be out-competed by non-regulated substitutes if they were forced to hold capital levels above the natural market level.

I'm not an expert on the repo market, but it seems to me that we created a similar problem by inventing the accounting fiction that repos are not loans, which also makes the interest rate on repo financing non-responsive to leverage risk.

In any case, there is a natural pairing between capital requirements and regulatory restraints.  As regulation and public insurance of various kinds ratchet up, capital requirements naturally decline.  If banks were completely deregulated, they would naturally hold more capital.

I wonder if commercial banks, as they exist today, are an anachronism anyway.  If they were deregulated, I wonder if they would mostly go away.  Is the central intermediation that they engage in - borrowing short and lending long - even necessary today?  Is the regulatory framework that supports this intermediation actually maintaining a risk in the economy that isn't even necessary today?  Would money market funds, REITs, investment banks, and a host of other financial agents rise up in ways that would match asset-liability maturities within each institution?

This is really clear when thinking about the GSEs.  If they didn't have federal backing, their business model would probably be ineffective.  And, if their capital requirements were set too high, their business model would probably be ineffective.  Both of those factors need to be in place for the GSEs to exist, and those factors come as a pair.  What point is there of having capital requirements if there is no guarantee?  The bondholders would not be accepting a discounted interest rate in that case, and they would be perfectly able to demand their own bankruptcy terms if there was no federal backing.  Imagine how awkward it would be to have the capital requirement without federal backing.  If the bondholders held securities that had become impaired, or where there was a probability of future default, they would naturally be in communication with the boards of the GSEs to manage the firms in everyone's best interest.  Imagine if, without giving them any support, the federal government stepped in and imposed a settlement on them that neither the equity holders or the bondholders had invoked.  What would be the point?  The capital requirement without the guarantee would do nothing but add risk.  That's what is so strange about how so many policymakers still pretend like there was never a government guarantee on GSE debt.  Of course there was.  There had to be.  And, it was invoked in 2008, if there was ever any doubt.

In the book, I walk through the argument that there should not be GSE debt, but that there should be a government guarantee of GSE MBSs.  It would be a public good which really can only be provided publicly.  That's a story for another day.  But, clearly, in the case of the GSEs we can see that, in and of itself, regulatory insurance and capital requirements go together, and they can induce institutional forms that increase systematic risk.  Public insurance increases systematic risk.  Maybe that is counterintuitive.

It seems to me that many people assume that deregulation somehow helps insiders and powerful institutions, and that, if we did deregulate banks, those same people would quite naturally and quickly, shift toward getting mortgages from privately funded REITs, investment banks, and MBS investors and toward putting their short term savings into money markets that invested in commercial paper and short term treasuries, and it would never occur to them that they were intimately involved in the devolution of power from previously regulated institutions.

Cochrane's idea of deregulating and raising capital requirements seems like a step in the direction of simply deregulating, which is all for the best.  But, if there was only some deregulation, then the capital requirements would still have to remain lower than what the completely deregulated market would provide.  In fact, it seems like what we see in the marketplace of substitutions for commercial banks are many forms of saving that don't particularly use leverage at all.  This would be even more the case if we stopped giving debt tax advantages over equity.

Thursday, February 2, 2017

Housing: Part 206 - Update of Homeownership rates

It is starting to look like homeownership rates are stabilizing.  Here are the quarterly homeownership rates, by age, from the Census Bureau. (Under 35 is on the right hand scale.  Others on the left.)

Each age group has an ownership rate about an average of 4% below the 1994 levels - and from about 5% to 10% below the 2004 highs.  1994 was a secular low point in ownership, so homeownership rates are basically 4% below any HUD era levels, once you adjust for age.  That would be all well and good if it was by choice, and not due to a national dislocation.

But, on the bright side, it looks like this might be the bottom.  A baby step toward normalization.

Wednesday, February 1, 2017

Housing: Part 205 - First-time home buyers and Last-time home sellers

'Member that time when predatory lenders were beating the bushes for new home buyers to feed their greedy mortgage origination machines? 'Member? 'Member when they ran out of qualified home buyers so they started convincing a bunch of households who had no business getting mortgages to take on debt and buy a home?  Then they sold those mortgages off to unsuspecting investors, who were left holding the bag when those unqualified new homeowners defaulted.  'Member?

There is a very specific time period where this was happening.  From about 2004 to 2007, the number of privately securitized loans that were part of this scam was much higher than in any other period.

Just think how many new, unsuspecting homeowners must have been drawn into the housing market by this massive amount of activity.  Nearly $2 trillion in predatory loans to unsuspecting, unqualified borrowers.  That would have to translate into more than 10 million borrowers.

In any given normal year, there might be a million and a half first-time home buyers.  Just think how much first time home buyer levels must have jumped, even if a small portion of those $2 trillion in new loans had gone to those unqualified borrowers.

Finally, I have some data from the American Housing Survey to document this terrible predation.  This massive expansion of marginal homeownership to households who had no business being owners.  2017
This first graph is an annual estimate of first time homebuyers.  The second graph is a bi-annual estimate of the number of existing homeowners who sold and didn't repurchase homes - in other words, households that exited the housing market.

If you are trying to figure out how you are reading these graphs wrong, you can stop.  You're reading them correctly.  There wasn't a surge of first time homebuyers.  There was a drop in first time buyers during the private securitization boom, and at the same time, there was a surge of households out of the housing market.  2017
There are two lessons to take away from this, both of which are difficult, especially the second one.

First, to a first approximation, everything we thought we knew about the housing boom is wrong.  Take your brain, shake it up like an etch-a-sketch, and start over.  Until you can do that, you will be pointlessly defending false pretenses.

Second, remember how we had to have the housing bust and the recession, because the previous period of overconsumption and over-borrowing, built on the backs of the lower middle class, required it?  Remember how deregulated markets allowed lenders to put debt on millions of households, and healing meant letting those lenders go bankrupt and those borrowers default?  Remember how we had to sharply curtail lending to households who had been borrowing from banks and GSEs for decades because national financial penance and prudence demanded it?  Remember how the Federal Reserve couldn't provide cash for an ailing economy, because it would just allow these housing speculators to skate by without the discipline of the market?  Learning the first lesson means recognizing this second lesson.  Learning this second lesson probably means feeling guilty or defensive, or incredulous.

Take that etch-a-sketch and shake away those feelings, too.  The health of the American working class requires us to.  To the extent that many households on those margins are still hanging on to their homes, their home values have probably, generally, been dealt a 20% negative shock or more because we have devastated the owner-occupier market for those homes that had been in place and stable for decades.  If a home normally is worth about 3x an owner's annual earnings, then we have wiped away the savings of millions of American households to the tune of 6 months earnings or more.

A lot of damage has been done.  The good news is, some of this can be undone.  The millions of first-time homebuyers missing over the past decade can still buy homes, if we let them borrow like millions of Americans safely had for decades.  By the way, that will require millions of new workers in the construction sector.  Many of those workers might be Mexican immigrants.  The animus those immigrants will experience in an economy where they are building homes for working class families will be much less than the animus they experience now in an economy with few homes for them to build.  It will also help regain working class savings in home equity and it will lower the cost of living for so many families renting in markets that are lacking in supply.

The bad news is that we did this.  The good news is that this means we can change it.  And, we are all in this together.  Across the political spectrum, the errors that have been committed change.  Some blame deregulation and bankers.  Others blame the GSEs and the CRA.  Others blame the Federal Reserve.  But, everyone has been blaming their selected foils for something that did not happen.  We all did this in our own ways.  Now, we can all shake our internal etch-a-sketches, and work together on the one thing that needs to be done, which is to simply give up our false presumptions and stop fighting political battles over phantoms.