Relevant and even prescient commentary on news, politics and the economy.

Real Estate Insanity…working off the excess inventory?

by Tom aka Rusty Rustbelt Real Estate Insanity So my son and me are thinking about buying a duplex in Ohio and fixing it up this summer. He would live in half and we would rent the other side. Given the number of foreclosures this should be an easy deal, right? Wrong. The realtors tell me no one will finance the properties, not even the banks that own them. Why? It seems many of the banks did not get around to assigning “asset managers” for a year or two, which means the water pipes froze in the winter, burst in the spring and destroyed the interior of the properties. Even when asset managers were promptly assigned, many were incompetent and/or corrupt. So there are many thousands of properties with reasonable looking exteriors but with ruined interiors. Even with sweat equity labor the fix up costs will be very high. This will eventually be fixed with bulldozers.

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ECB Rates Policy is Clogged in Key Periphery Markets

by Rebecca Wilder

ECB Rates Policy is Clogged in Key Periphery Markets

How the Euro area (EA) will grow, according to Mario Draghi:

The outlook for economic activity should be supported by foreign demand, the very low short-term interest rates in the euro area, and all the measures taken to foster the proper functioning of the euro area economy.

In this post, I address Draghi’s point that the ECB 1% refi rate will support economic activity through the lens of the mortgage market. Specifically, I find that the interest rate channel is clogged in the economies that are in most desperate need of lower rates: Spain, Portugal, and Italy.

Regarding ‘very low short-term interest rates’, what Draghi means is that the standard interest rate channel of monetary policy will stimulate domestic demand via increased spending by consumers and firms. If ECB policy is indeed passing through to retail credit (households and firms that borrow from banks to buy goods and services), then we should see evidence of this as falling interest rates to retail credit sectors, like those for consumer goods, home mortgage lending, loans for businesses, or even corporate credit rates to finance business investment.

In mortgage markets, the Euro area average borrowing rates are indeed falling. Banks started lowering mortgage borrowing rates, on average, in September 2011 in anticipation of ECB rate cuts that eventually occurred (again) in November 2011. Specifically, average Euro area mortgage rates are down roughly .25% since the local peak in August 2011.


But a closer look across mortgage markets shows a worrying trend for key periphery economies. The pass-through from ECB rate setting policy to mortgage borrowing costs is clogged in Spain, Portugal, and Italy, where mortgage rates have risen since the ECB cut the refi rate to 1%. Indeed, these are the economies that ‘need’ the stimulus to offset the fiscal consolidation.
Sure, mortgage rates are arguably low – but they’re not lower.

In Spain and Portugal, 91% and 99% of their respective new stock of mortgages sit on variable rate loans, so the pass through to the real economy should be rather quick IF mortgage rates declined (see Table below). True, Spain and Portugal are unlikely to experience any boom in real estate lending over the near term. However, had the ECB policy lowered mortgage rates, then disposable income would rise via lower monthly mortgage payments, thereby stimulating other sectors of the economy, all else equal.

In Italy, just 47% of the mortgage market is variable, so the immediate stimulus would be more muted compared to Spain and Portugal via disposable income. However, Italy didn’t experience a credit boom, so lending to firms and households could and should be warranted. But amid the fiscal consolidation and stressed debt markets, fewer borrowers are credit worthy AND mortgage rates have risen near 1% since EA mortgage rates peak on average in August 2011.

Core mortgage rates are falling, and this could create a positive stimulus for Spain, Portugal, and Italy down the road. But for now, the transmission mechanism, dropping the ECB refi rate to 1%, is not easing housing and mortgage financial conditions in those economies hit hardest by fiscal austerity.

Rebecca Wilder

Reference Table: reference for variable rate share of mortgage market

originally published at The Wilder View…Economonitors

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Housing Bubbles: Less Frothy but Europe is Behind

by Rebecca Wilder

Housing Bubbles: Less Frothy but Europe is Behind

Wolfgang Muenchau’s article in the Financial Times, There is no Spanish siesta for the Eurozone, inspired me to update my post on housing bubbles around the world (really just Europe and the US). He argues that Spain’s bubble was much more extreme, and that the price adjustment is less mature compared to the others. I would add here that it’s European housing markets more broadly that look overvalued compared to that in the US, as measured by the price to rent ratio.

The chart below illustrates the housing bubble, as measured by the house price to rent ratio, in the US, Spain, the UK, and Ireland that is normalized to Q1 1997 and through Q1 2011. The price to rent ratio can be compared to a price to earnings or a price to dividend ratio in finance. It measures the relative value of the asset: the price of the asset (purchase price of a home) divided by its flow of fundamental value (rental income earned or the value of having a roof over your head). As the price-rent ratio falls, the market home values moves closer to fundamental value.


Spanning the years 2005 to Q4 2011 and indexed to 1997 Q1, home values peaked at roughly 1.7 times rent in the US, 1.8 times rent in Spain, and north of 2 time rent in Ireland and the UK. Since the peak, though, US home values have fallen to 1.0 times rent – a considerable reduction in asset prices toward fundamental value. In contrast, home values in Spain, the UK, and Ireland remain quite elevated to rents, 1.3 times, 1.6 times, and 1.4 times, respectively in Q4 2011. If 1.0 is deemed equilibrium, either home values in Spain, the UK, and Ireland must fall further and/or rents rise to normalize home values. That’s a tall order: rising rental values amid defficient and contracting domestic demand in Spain and possibly Ireland.

The UK has more of a fighting chance, given its relatively easy monetary policy, compared to Ireland and Spain, where more accommodative monetary policy is very lagged amid fiscal contraction. Without growth, though, default is probably the only answer left to normalize housing markets in Spain and Ireland.

originally published at The Wilder View…Economonitors

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Rent Control, Redux

by Mike Kimel

Rent Control, Redux

There’s been a small dustup on rent control lately on the blogosphere. Peter Dorman has been pointing out that the theory everyone knows may not fit the facts. I myself covered the topic before here. Its worth a read, I think, but here’s the takeaway

Now, I haven’t been in NYC in decades, but I do know this. After a few decades, there’s time for a market to adjust. If it doesn’t pay to be a landlord, expect fewer people to want to be landlords – the supply of dwellings for rent relative to dwellings for sale will dwindle. If it doesn’t pay to be a renter, expect fewer people to want to be renters – the demand for dwellings for rent relative to dwellings for sale will dwindle. Either way, if rent control “ruined New York City real estate markets” and has been doing so since 1943, one thing we should expect is that the percent of occupied housing units that are owner-occupied (as opposed to renter occupied) in NYC is much higher than in places where the real estate markets were not ruined by rent control.

Following a look at the data:

Put another way, in NYC, where generations of rent control has destroyed the rental market, two thirds of all occupied dwellings are rentals. In the rest of the US, two thirds of all occupied dwellings are not rentals. By the numbers, it seems the rental market is extremely healthy in NYC relative to the rest of the country. And BTW… the bottom three slots of the national ranking of states and the District of Columbia, the three locations with the lowest percentage of owner occupied housing as a percentage of total occupied housing, were taken up by the Washington DC, New York, and California. It just so happens that when I hear people talk about how rent control has destroyed a market, driving out landlords and renters alike, the story is usually about DC, NYC, or San Francisco. Funny, huh?

Two more points… fourth from the bottom of the list, right above California, is Hawaii, while at the other end (i.e., at the top of the list) we find we find Minnesota, West Virginia, Michigan and New Hampshire. Also, if you work your way through the data, you’ll find that big cities like Boston, LA and Houston all tend to have relatively low homeownership rates. I’m guessing anyone whose mouth isn’t automatically programmed to say “rent control” can noodle out for him/herself exactly what is going on here.

The saddest thing about the economics profession today is not the number of economists who believe things that make little sense and who refuse to look at data that is so readily available. The saddest thing, frankly, is that the fairy tales told in the profession make their way out into the real world and affect real decisions.

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Lifted from comments

Lifted from comments on the housing situation by Spencer…Housing vs. Household formation. Of course the point also being…what is going to be the source of growth for US citizens?

kharris comments and adds another contributing factor on the housing market:

…Banks already have pretty nearly all the housing assets they care to have, thank you very much. If banks don’t want more housing assets, then they won’t lend much money against houses. That reluctance to lend is going to keep effective housing demand down, even if demographics are favorable.

And herein lies the problem. Housing demographics are responding to labor market conditions, and financial conditions. Each needs to improve, and the failure of either to improve limits improvement in the other. We traditionally rely on housing to lead recoveries, and there are self-reinforcing limitations on housing right now. Rather than overall growth responding to housing, this time housing needs overall growth. That means we need some other source of growth to lead.

In response to that situation, one party says “cut taxes and regulation and (mumble, mumble, mumble), and then the economy will be great and all our problems will be gone.” The other party says “the best we can do is go small and pretend it’s enough.” There is no alternative source of growth in either of those.

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Random Notes 3 June 2011

  1. Buce has been on fire recently, so I’ll probably have to do a post about why this post is so off-target, though his conclusion is correct (short version: he’s been misled).
  2. If I’m reading this morning’s SIFMA Brief correctly, Moody’s—whose rating skills Robert has discussed at length—(1) may downgrade US debt if we spend too much and (2) will downgrade US banks unless we spend too much on them. Oh, and the banks object to regulation because it would “artificially” reduce asset values (presumably, many of the same ones Moody’s wants protected).
  3. Relatedly, James Salt (probably h/t Felix) notes that “generous” UK banks are playing reporting games. (The US version is to deny the rework and leave the asset marked at unsustainable levels.)
  4. That this is spot-on would make me sadder if I thought we still lived in anything resembling a meritocracy, or even a developing economy.
  5. If we needed further evidence of that, the state with the best secondary eduction system in the country is pushing forward with privatize-the-gains.
  6. I’m more and more convinced that China “is different,” but very much not certain the differences will make an ultimate difference. Daniel Gross is inclined to think not. More on this as I finally finish my review of BoomBustOlogy, which you should expect to see some time before the apocalypse.
  7. I assume everyone has already seen this. Just in case, check out the facts, stylised or not.
  8. Oh, and Felix is wrong here. But that’s a post that will probably never be written by me. Someone else want to send it in?

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Industrial Production and Housing Starts


Industrial production and housing starts were reported today. It has been well covered elsewhere, but I though I would make a couple of comments.

Compared to other cycles this recovery in industrial production continues to be moderate.

It is stronger than in the weak recoveries, but compared to the depth of the downturns the rebound is quite weak. The good point is that in the early stage of a recovery industrial production is driven largely by inventory rebuilding. But we have probably passed that point in the cycle as the economy shifts from the recovery stage to the expansion stage. This means that we are now seeing quite strong industrial production that is driven by changes in final demand rather than by inventory restocking. This implies that good growth in industrial production is likely to continue in contrast to previous expansions when industrial production growth flattened out after inventory restocking ended.

The other point in the report was that capacity utilization was rising. Normally rising capacity utilization is an important driver of business capital spending and is a good omen for continued growth. But that optimistic premise should be tempered by the point that one of the reasons capacity utilization is rising is that industrial capacity is actually contracting.

It is down -1.3% from a year ago, the largest contraction on record.


In contrast to growth in industrial production housing starts actually fell from 659,000 to 593,000. This reflects the major difference between the two economic sectors. Industrial production is being driven by a rebound in final demand while final demand for housing is weak. Moreover, this weakness in housing demand reflects the over a decade of over-production in housing that built excess supply that still has to be worked off.


The fundamental driving force behind housing demand is household formation. In the short run other factors enter the picture. But no matter how many bells and whistles you add to the model, household formation will remain the most important factor. It is not a good determine of month to month fluctuations in the housing market but it is the key factor driving long term demand. Household formation is essentially a function of young people leaving home and setting up independent house keeping. That is one reason it is surprisingly cyclical as in hard times young people either remain or return home. But the long run trend is clear. After the baby boomers leaving home and setting up housekeeping lifted household formation to over 2 million annually in the 1970s and 1980s household formation has fallen to under 1.5 million annually. Moreover, it should remain at that low level unless we have some fantastic rebound in immigration.


This is easy to see if you look at a smoothed series of household formation and housing starts. In the 1970s and 1980s annual housing starts averaged over 2 million. But this was accompanied by household formations of over 2 million annually. So over that period supply and demand were in rough balance and despite the highly cyclical nature of both economic series, significant long term imbalances never developed. But look at what has happened since the late 1990s. Housing starts have significantly outpaced household formation creating a large supply of excess housing that will have to be worked out of the system. But with household formation now expected to remain well below 1.5 million this implies an extended period of housing starts remaining at or near their current low levels rather than the historic pattern of strong rebounds. This cycle the pent-up demand for housing is negative.

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Measuring Bubbles

Brad DeLong and John Cochrane agree on something. I must dissent.

Delong and Cochrane agree that

“The underlying decline in wealth from the housing bust was … around $400 billion. …”

Indeed, relative to the size of the economy the losses during the crash of the dot-com bubble were four times as large.

I object that the two sums being compared are not comparable at all.

OK so this was a comment on DeLong so when you see “you” read “DeLong”

Why do you compare the losses during the crash of the dot-com bubble to the $400 billion rather than to the $25 trillion ?

The losses during the crash of the housing bubble are, you claim, $25 trillion.

Someone who has forgotten 2000 (or 1999 or 2001 or … well I clearly am that someone) would compare the $400 billion to the decline in the value of shares of corporations with names which ended .com. I don’t think that was $ 1.2 trillion.

For some reason, you and Cochrane count the whole loss around that time as the dot.com shock and only losses on subprime mortgages this time. The former value of the former shares of Lehman isn’t in the sum which equals $ 400 billion.

I think that it is possible to distinguish the shock due to burst bubbles from the total consequences in a meaningful way. I’d say the reasonable comparison is the total decline in share values then to the total decline in the value of housing now. The current bubble loss would be about $ 6 trillion for the USA not $ 400 billion.

It doesn’t make sense to compare total losses then to losses born by banks now and conclude that the losses born by banks now are smaller than total losses then, but a lot of damange was done because all of the losses born by banks now were born by banks.

I’d say that in the US alone, and ignoring commercial real estate, about $ 6 trillion in “wealth” was revealed to be a fantasy.

That’s gotta to hurt. It hurt even more because investment banks shared the rubes delusions this time, but the delusion was huge and the so was the delusione (disappointment)

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Policy and housing: someone’s gotta give!

by Rebecca

Housing demand is being propped up by government subsidies and low mortgage rates, and the level of supply is held back by low prices. Right now, the housing market is a complicated hodgepodge of policy, foreclosures, and very weary potential home-buyers.

Home sales are stabilizing; home building is stabilizing; and home prices (might be) stabilizing – the chart to the left illustrates a positive trend in sales away from distressed and first-time home-buyers, the targets of policy, according to the NAR. But what would the housing market look like if the massive policy expired this year? Not good, and it will.

Some points on the housing market:

  1. Subsidies are set to expire. If the Fed continues to buy its average of $105 billion in GSE-backed MBS per month (see the NY Fed’s website for weekly updates), it will max out the announced $1.25 trillion in four months. The $8,000 tax credit for first-time home-buyers expires at the end of this year. The Fed’s Treasury buyback program will run its course by October.
  2. There are several home price indices out there, each painting a slightly different picture of the level and trend in aggregate home values (see AB post).
  3. The foreclosure modifications program is holding off some foreclosures; but the program is no match for market forces.
  4. There is a large shadow inventory out there – potential sellers that are reluctant or unwilling (TIME calls some of these sellers “accidental landlords”) to relinquish home ownership at current prices. However, if home values continue to take baby steps forward, shadow sellers (new supply) will emerge.
  5. There is a bimodal distribution of sales across the high-end and low-end housing markets. Low-end sales are hot, while the upper end is not.

The housing market still has a long, long way to go before unsubsidized demand equals supply at a price that doesn’t exacerbate foreclosures – strategic or otherwise. With virtually all of the subsidies expiring within four months, it’s hard to believe that policymakers won’t give.

So who’s gonna cry uncle? My bet’s on the Fed, as it lacks does not require Congressional approval. Some Fed officials even tout that the MBS program should be scaled back; that’s ridiculous, given points 1. through 5. above. I agree with Daniel Indiviglio at the Atlantic: the Fed is more likely to increase its MBS purchase program, rather than to curtail or even adhere to the current limit.

By the way, the Fed and the Treasury have successfully dropped mortgage spreads to 2006 levels, even lower on the 30-yr; but it took an accumulation of $1 trillion in MBS to date to do that.

Rebecca Wilder

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