Lead Story: Nobel Laureate Robert Shiller wrote a piece for the NY Times this weekend discussing how the current housing market run-up in price is now the third highest in history behind only the post-World War II era and the housing bubble of the aughts. The article makes the typical strong points and solid analysis that one would expect from arguably America’s foremost housing economics expert. Shiller discusses how the increase in house prices after WWII was brought on by a booming economy, limited supply and demand from returning soldiers starting families and the generous incentives offered to them by the government. He also goes into detail about how easy credit, low interest rates and government policy pushing for an “Ownership Society” led to the aughts housing bubble.
One place where the article falls short though, IMO is the analysis of the current run up in values. Shiller discusses low interest rates and a growing economy but points out how those factors do not always lead to higher prices historically. He also points out that housing costs cannot outpace income growth forever, which only a fool would disagree with. However, he really doesn’t touch on the critical factor that has driven price increases beyond wage growth in the current cycle: the lack of adequate housing production to meet demand. Academic research indicates that we have a housing unit deficit of 2.5 million and continue to fall behind. Shiller addresses both interest rates and economic growth as potential causes (emphasis mine):
But the market reaction to interest rates is hardly immediate or predictable. The housing market does not react as directly as you might expect to interest rate movements. Over the nearly seven years of the current boom, from February 2012 to the present, all major domestic interest rates have increased, not decreased. So, while interest rates have been low, they have moved the wrong way, yet the boom has continued.
Another explanation is simple economic growth. But, as a matter of history, prices of existing homes — as opposed to the supply of newly built homes — have generally not responded to economic growth. There was only a 20 percent increase in real prices of existing homes in the 50 years from 1950 to 2000 despite a sixfold increase in real G.D.P.
Note in the second paragraph above that Shiller rightly points out that economic growth typically leads to more starts, not necessarily higher prices. The difference in this cycle is that economic growth did not lead to the typical boom in housing construction, which has been mired at near-recessionary levels, despite a long growth cycle. As such, the capital created through a growing economy was focused on a relatively small number of units to provide shelter rather than spread across a large number of units as has happened during previous economic booms. When demand exceeds supply, prices tend to rise which is exactly what happened here. It’s truly puzzling to me why this was not addressed in the article as it seems to be a critical detail.
Unfortunately, a housing slowdown will make this deficit even worse since production will slow even further if builders can’t turn a profit. Housing is a unique asset as it is a combination of consumption and investment. When it comes to the consumption component, there is not a readily available substitution to either owning or renting. If household formation and population growth outpace production at a time to economic expansion, prices will rise substantially as they have since 2012. Making matters worse, it becomes steadily more difficult to construct more units in such an environment since inputs become more expensive and the ability to pass increased costs on to buyers decreases since wages aren’t keeping pace (unless, of course interest rates are falling – which they are not). As such, production will likely fall when it is needed the most as it becomes less and less profitable to build. If you want confirmation of this take a look at the price chart of a publicly held home builder or read one of their earnings reports.
I conclusion, I do not disagree with Professor Shiller that there will be a day of reckoning at some point if price growth (and for that matter the monthly cost of ownership now that rates are rising) continue to leave wage growth in the dust. However, I also think its important to point out that this situation was caused by a lack of production to meet demand in the market (both for sale and for rent) just as much as the post war run-up was caused by demand from GIs and the housing bubble was caused by government policy, low rates and exotic mortgages. Its difficult to contemplate a market’s ultimate undoing without acknowledging how it got here in the first place which is why one cannot have this discussion without first acknowledging the elephant in the room: supply.
Gusher: The US just became a net oil exporter for the first time in 75 years. See Also: Cheaper oil isn’t the domestic economic boon that it used to be.
Overlooked: While the yield curve gets all of the attention, the difference between the earnings yield on stocks and the yield on cash is an often overlooked but very reliable indicator of a bear market that has been flattening of late.
Re-Arranging The Deck Chairs: If Eddie Lampert really wanted to save Sears and Kmart, perhaps he’d be better off making the stores feel less like prison commissaries rather than endless financial engineering. But See: Eddie Lampert may have shattered Sears (and his reputation) but he has made billions on the deal thanks to the structure of his investment vehicle and a healthy dose of financial engineering.
Other Side of the Story: Despite a lot of critics (like yours truly) who have been ranting about corporate welfare, a recent poll found that New Yorkers approve of Amazon moving to their city by an overwhelming majority.
Not Quite As Intended: Opportunity Zones were created a year ago with the hope that they would breathe new capital into under-invested areas. However, early results show a rush of capital into zones in cities like LA any NY that were already attracting investment and little new capital going into depressed rural areas where it is needed most.
Piling On: Northern California’s recent wildfires have burned homes at a greater pace than developers are building them, deepening a housing shortage that already has left millions struggling to find affordable places to live.
Thinking Big: California State Senator Scott Wiener has introduced a a refined version of an unsuccessful measure he wrote last session to make it easier to add four- to five-story apartment buildings near transit centers without local government OKs.
Not to Scale: Uber is not a scale-able business because larger size does not bring operating prices down. That, combined with the lack of a network effect, indicate that the world’s most valuable private company could be dramatically overvalued.
Addicted: A new survey from Business Insider found that 44% of millennials would rather give up sex than quit Amazon for a year. and more than three in four millennials would choose Amazon over alcohol. In other words, our demographic future is pretty much screwed.
And You Thought Bitcoin Was Bad: California Utility PG&E sold a $200MM catastrophe bond in August to insure against liability from future fires. Now the company is being blamed for the blaze and the bond has lost 95% of its value.
Down the Tubes: Someone made a million dollar derivative bet a year ago that Bitcoin would be worth $50k by December 28, 2019. Barring the greatest rally of all time, it will expire worthless. John Mcafee was unavailable for comment.
Chart of the Day
All about the three point shot (h/t Steve Sims)
Golden Grahams: A Tennessee man faces up to three years in prison for urinating on a Kellogg’s cereal conveyor belt at a Memphis facility.
Tis the Season: A kid in Great Britain caused quite a stir when he brought a blow up sheep sex doll that he got on line to a school nativity play.
Happy Meal: Three Sonic employees were arrested after ecstasy was found in a kids meal.
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