Archive for February 2010
Tomorrow we’ll send out the latest issue of The Greenfield Advisor, our periodic e-mail newsletter. Back “in the day….” when we were called Mundy Associates, the firm’s newsletter was entirely printed and called The Mundy Insider. In deference to the trees we’re saving (the subscription list now runs in the thousands), our current newsletter is entirely via e-mail. If you’d like a subscription — and they’re free — just drop us an e-mail to email@example.com. You’ll be added to the list. You can also simply download a .pdf of the file from our website, www.greenfieldadvisors.com.
The current issue focuses mainly on this year’s Economic Forecast dinner, held this month by the Seattle CFA Society. I make it a point to attend every year, and we generally take a few folks with us. The speakers are top-flight, and the information was terrific. For more details and my “take” on what they had to say, please check out the newsletter.
It’s an interesting question for a couple of reasons. First, I’m in the real estate analysis biz, and since housing is a b-i-g chunk of real estate, it’s interesting from a purely academic perspective.
Second, though, there is a fair argument that at the apex of the recent housing bubble, we got the mix wrong. Congress, in their infinite (cough… cough….) wisdom, encouraged home ownership for all. It sounds like a noble idea, but one without too much economic sense. Simply put, even though the United States is LARGELY a nation of homeowners, we are not ALL homeowners. There are a lot of important economic reasons for this, w-a-a-a-a-y behond the scope of this blog. That having been said, over a reasonably long period of time, (say, a few years), the supply side of the equation can more-or-less match demand, and an equilibrium of sorts can emerge.
The problem arises when non-economic forces enter into the equation (such as artificial government stimuli) and home ownership is foisted off on market participants who really should be renters. There are plenty of ways to do this — mostly through artificially high levels of liquidity.
It’s hard to say exactly WHEN the recent housing bubble crested, but a quick glance at the Census Bureau’s American Housing Survey as of the end of 2007 is probably pretty close. (Anything closer than that would be pure conjecture anyway). We had 124.4 million housing units in the U.S., both rental and owner-occupied, of which 110.7 million were occupied. The different — a vacancy rate of about 11% — is pretty normal. This number includes new construction and actual vacancies, and there is a fairl amount of economic literature showing that a very low vacancy rate is not efficient in a healthy market, particularly among rental units.
Here’s where life gets interesting. Of the total number of occupied units, 75.6 million were owner-occupied, or about 68%. Many economists now agree that this proportion was too high — that the ownership rate in America was artificially propped-up by Congressional direction toward “easy” mortgage money. Since it was those “easy” borrowers who got in trouble first, one of the important questions being asked now is, “What is the best level of owner-occupancy for the market?” In a free market economy, “best” is what emerges at equilibrium without any external artificial interference.
We don’t really know where the market will level out, but discussions suggest the owner occupancy level should be closer to 60% than 68%. If this is the case, then in a static no-growth model, we would have about 66.4 million occupied dwellings. That’s a shift of about 9.2 million homes. Naturaly, many of these will be absorbed in the rental side of the equation, and that’s what we’ve seen lately — it’s why the fundamentals on new apartments has looked rugged for a while. That ruggedness won’t last long — much if not most new construction built for owner-occupancy is not suitable for rental, at least in the long-term. Luxury homes, luxury condos, and vacation “second” homes are either the wrong housing product or in the wrong place for such an easy shift to be accomodated. As such, we should see the apartment fundamentals get back to normal before the owner-occupied side of the market does.
Our natural “equilibrium” absorbtion of new housing in America is about 1.9 million units per year (about 1/3 rental and about 2/3 owner-occupied), so a big chunk of any excess will be eaten up by new demand as we come out of the recession. Nonetheless, it will take a while for the excess supply to be absorbed and for things to get back to normal in the new housing sector.
Seriously busy, on serious stuff. I mean it. I’m not complaining, mind you. Nothing wrong with busy, in the right doses. It keeps me off the street and out of trouble. AND…. It pays the bills. None of us are as rich as we thought we were, right? I commented last evening over drinks, “I’m sure every now and then, Bill Gates turns to Melissa to fuss about money, and says, ‘Who do you think I am? Warren Buffett????’ “
But, I digress. My ever vigilent and underpaid team has been encouraging me to climb out of my shell once and a while and deliver some of my economic rants and ramblings to random unsuspecting Rotary and Kiwanis Clubs. For those of you lucky enough to miss these, I’ll spend the next few blog entries sharing a few thoughts with you. As always, my lawyer(s) ask(s) that I tell you that these ramblings do not constitute investment advise or the official or even unofficial opinions of Greenfield Advisors, your experience may vary, subject to credit approval, if you suffer anything lasting more than four hours contact a physician, not valid in Wisconsin, etc., etc., etc.
Today’s rambling is about INFLATION. In nearly every talk I’ve given recently, someone asks why neither I nor any of the economists I’m surveying are forecasting inflation. After all, the gov’t has been “running the printing presses night and day, right?” Well, haven’t they been? And surely such a flood of money coming out of Washington (well, technically a whole bunch of it has come from the NY Fed, but who’s counting, right?
And while I’m on the subject, Paul Kruegman thinks a little inflation may be good for the nation’s soul. I won’t elaborate on his theories, but with all deference to his recent Nobel Prize, while most of us of a certain age WISH we couldn’t remember the 70′s, apparently Paul actually CAN’T. Fortunately for all of us, one of the few things both the Bush administration and the Obama administration could agree on is to NOT spend very much time listening to Paul Kruegman.
(Digression — I met my wife in the 1970′s — proof that the decade wasn’t ALL bad. However, the list of good things to come out of that decade is short.)
Clearly, the actions of the Treasury and the FED in the past year-and-a-half have had the effect of pumping enormous amounts of liquidity into the system. In a ceteris parabus world, this would stimulate demand, which without commensurate increases in production (which is highly fixed in the short-run) would lead inexorably to inflation. Yes, yes, you… the student in the back of the room…. you’re wondering if households and businesses wouldn’t do the rational thing and simply save the extra money? Well, the problem is that actions which may be good for society as a WHOLE may not be good for INDIVIDUALS acting atomistically. This is part of the whole “moral hazard” body of research. Households and businesses ANTICIPATING that liquidity would stimulate inflation would go out and spend today (rather than see the value of their wealth dissipate tomorrow). Thus, inflation becomes a self-fulfilling prophesy. However, even if they DID save, the banks would be flush with cash and be forced to lower borrowing terms until savings simply made no economic sense, and then businesses would borrow if for no other reason because the marginal cost of production would have been lowered… etc…. etc… etc…
So anyway, we’re back to the question, if the gov’t has pumped zillions of dollars into the economy, why hasn’t this translated into inflation yet, and when will it?
The answer is, probably never. Why not, you ask? Because the liquidity that has been pumped into the system in response to the banking crisis (indeed, near-collapse) has served not to increase the money supply, but to replace a massive, sudden shrinkage in “off-book” liquidity that households and businesses were drawing from pre-2008. Think about household budgets which could be “balanced” every month on the back of credit cards and home equity lines. Was this a good thing to do, economically? Heck no, but it was a souce of liquidity in the economy, and had the same effect as M-1 money for all practical purporses. The same was true with small business lines of credit, easy home loans, etc. When the credit dam broke in the summer/fall of 2008, it carried with it trillions of dollars in off-balance-sheet liquidity. Had the “gov’t” not reacted the way it did, we would have…. well…. both Christina Romer, the Chair of the President’s Council of Economic Advisors, and Ben Bernake are students of the history of the Great Depression. They are both well aware that PRECEEDING the stock market crash, for a period of a couple of years, there was a huge shrinkage in the supply of money in the U.S. When the damn broke in 2008, they were well aware of what history tells us could happen.
We can debate for days the roots of this problem — easy money, lack of financial controls, lack of credit market oversight come quickly to mind. Clearly, there will need to be changes. Sadly, most of the solutions are in the hands of politicians…. many of the loudest voices are pointing fingers in the wrong directions. Re-regulation of the system in the coming years must take care not to kill the various geese which lay the golden eggs.