Month: April 2021

Commercial Mortgages

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April 25, 2021

by Steve Stofka

They’re at it again. Thirteen years ago, the financial crisis originated in RMBS, residential mortgage-backed securities. Now banks and investment companies have been packaging CMBS, mortgage-backed loans on office and retail space, not residential, properties. Most of these loans are backed by or facilitated by the Small Business Administration and other government agencies. Who will pick up the tab when some of these loans default because of the pandemic? The same people who picked up the tab for the financial crisis – taxpayers. Even if the direct cost of bailouts is repaid, the loss of economic output and incomes is a crushing blow to many Americans.

Next month, the Federal Reserve will release its semiannual Financial Stability Report a comprehensive examination of the assets and lending of America’s financial institutions. Their last report in November 2020 was based on nine months of data, six months after Covid restrictions began. Concerning the Fed were several trends that were far above their long-term averages.

High yield bonds and investment grade quality bonds were almost double long-term trend averages (Fed, 2020, p. 17). High-yield bonds are issued by companies with low credit quality. Well established companies with good credit issue bonds rated investment grade. These are attractive to pension funds and life insurance companies who need stability to meet their future obligations to policy holders. Many companies took advantage of low interest rates during the Covid crisis. 60% of bank officers reported relaxing their lending standards; that same practice preceded the financial crisis in 2008. Will we eventually learn that commercial property evaluations were overvalued, just as house prices were generously valued before the financial crisis?

Many commercial mortgages are backed by commercial real estate (CRE) and packaged into CMBS, commercial mortgage-backed securities. The Fed noted that “highly rated securities can be produced from a pool of lower-rated underlying assets” (p. 51). This was the same problem with residential mortgages. CMBS are riskier than residential mortgages and delinquencies on these loans have spiked (p. 27). The Fed devoted most of their TALF (below) program in 2020 to CMBS (p. 16). 

Before the election last year, more than 70% of those surveyed by the Fed listed “political uncertainty” as their #1 concern (p. 68). 67% listed corporate defaults, particularly small to medium sized businesses. Respondents were from a wide range of America, from banking to academia. Only 18% of respondents were concerned about CMBS default. Simon Property Group (Ticker: SPG), the largest commercial real estate trust in the U.S. fell by almost 50% last spring. Although it has recovered since then, its stock price is still 20% below pre-pandemic levels.

Who thinks that the market for commercial space, retail and office, will return to pre-pandemic levels? Vacancy rates have improved, but even hot markets like Denver have a 17% direct vacancy rate (Ryan, 2021), near the 18% vacancy rate during the financial crisis, and far above the 14% during a healthy economy. 25% of space in Houston, Dallas and parts of the NY Metro area is vacant.

The stock market is convinced that the economy will come roaring back. In total, investors may be right but I think there will be some painful adjustments in the next year or two. The Covid crisis has diverted the habits of people and companies into new channels, and the market has not priced in that semi-permanent diversion. I would rather not wake up to another morning like that one in September 2008 when we learned that the global financial world was on the brink of disaster. I hope that the Fed report released in a few weeks will show a decrease in some of these troubled areas.

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Photo by John Macdonald on Unsplash

TALF – Term Asset Backed Securities Loan Facility

Federal Reserve System (Fed). (2020 November). Financial Stability Report. Retrieved from https://www.federalreserve.gov/publications/files/financial-stability-report-20201109.pdf. (Page numbers cited in the text are the PDF page numbering, six pages greater than the page numbers in the report).

Ryan, P. (2021, April 20). United States Office Outlook – Q1 2021, JLL Research. Retrieved April 24, 2021, from https://www.us.jll.com/en/trends-and-insights/research/office-market-statistics-trends

Finger Pointing

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April 18, 2021

by Steve Stofka

Some restaurant employers complain that they can’t find workers and blame the stimulus payment and the extension of unemployment benefits. Workers complain that businesses are not willing to pay for the additional health risk of close contact with the public. Child-care remains an ongoing obstacle for many. Pick your target – the bums in Washington and their relief programs, cheap business owners, belligerent customers, or unmotivated employees. Oops, almost forgot one other culprit – the Covid virus. Finger pointing does not build solutions. Finger touching does.

In its March survey, the National Federation of Independent Business reported (2021) that 42% of owners reported that they could not fill a job opening, yet only 28% reported offering higher wages. Some expressed their concern that unemployment benefits were too generous, reducing the demand for jobs.

In a recent study, Gabriel Chodorow-Reich and his colleagues at Harvard (2018) found that an extension of unemployment benefits had only a small macroeconomic effect on unemployment, employment, job vacancies, and wages. However, they noted that some studies focusing on particular industries and workers have found greater effects from more generous unemployment benefits.

In macroeconomic models benefits for employed or unemployed workers does affect the unemployment rate. Benefits for the employed raise the input cost of labor and causes an increase in the price of a product. An increase in price leads to a reduction in demand. Employers respond to that demand reduction by laying off employees or not adding to their workforce. Unemployment benefits reduce incentives for workers to find work. States charge employers a fee for additional benefits, further driving up labor costs. However, in the aggregate, a change in benefits has only a small effect on wages and unemployment.

In a crisis, providing relief to specific populations and business sectors is difficult. When the CARES act was passed at the start of the pandemic, the paycheck protection aspect was designed to help small businesses. Big corporations took advantage of loopholes in the law’s language and exhausted that targeted relief for small businesses. Big business got big by being voracious, leaving little for the competition. A government that enacts broad relief measures are criticized for giving relief to those who don’t need it. We would rather blame each other than blame a virus.

Inflation

Inflation expectations have an effect on wages. If workers expect higher prices in the near future, we want higher wages to cover our living costs. We see the price of gas go up from $2 per gallon to $2.80 per gallon in the past six months and reason that a lot of prices will be going up. We listen to the news in our car and hear inflation is up such and such a percent. We check the price of hamburger or some other grocery item. For the sake of simplicity, some economic models assume that consumers are knowledgeable about setting inflation expectations. We don’t have the time to be experts, so we guess at it and correct our expectations as we get new information.

In a recent paper, Ehsan Ebrahimy (2020) and fellow economists at the International Monetary Fund studied the effects that pandemics and wars had on inflation. Pandemics generated uneven swings in prices during the pandemic, but the recovery period brought an offsetting of those price swings. They found no net inflation effects from pandemics like the Spanish flu.

Expectations contribute to inflation. The price of residential toilet paper during the Covid crisis is a small example of this phenomenon. Different production plants make commercial and residential toilet paper because consumers are willing to pay more for a softer product. In the first months of the pandemic, panic buying and hoarding caused a shortage of toilet paper and a rise in price. Manufacturers like Kimberly-Clark built more production of residential toilet paper and store shelves were restocked in recent months. Responding to the increased inventory, people started using the toilet paper they hoarded. Now there is a surplus of toilet paper and prices have dropped below pre-pandemic levels.

Unlike pandemics, war involves the destruction of  physical capital, factories and offices. In the recovery periods following war, the IMF researchers found a persistent inflation in developed economies because some of the productive capacity had been destroyed. When there was less supply to meet demand, prices went up. Even a country not directly damaged in a war, like the U.S. in the past two world wars, suffered lasting inflationary effects in the post-war recovery periods. During WW2, the U.S. used up a lot of raw materials and production to make weapons. Following the war, inflation shot up over 10% in the U.S., five times the current rate. Following that inflation spike, the economy fell into recession, which caused a price plunge, followed by another spike in inflation to over 7%. The inflationary shock waves following the war took seven years to dissipate.

The researchers concluded that there was little evidence to support a belief in a sustained inflationary trend during the recovery from this pandemic. That does not rule out the possibility of uneven short-lived price rises. As shown above, expectations have an effect on prices.

We are more comfortable when we humanize the causes of inflation, pointing the finger at “those people.” We prefer to live in a world of intent, not random chance. Attacks on Asian-Americans have increased as if someone born and raised in America had something to do with the Covid virus. Employers blame Congress or unmotivated job applicants, who blame heartless employers. As Rodney King said, “Can’t we all just get along?” (Sastry & Bates, 2017). We can use our fingers to connect, not blame.

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Photo by Humberto Arellano on Unsplash

Chodorow-Reich, G., Coglianese, J., & Karabarbounis, L. (2018). The macro effects of unemployment benefit extensions: A measurement error approach*. The Quarterly Journal of Economics, 134(1), 227-279. doi:10.1093/qje/qjy018. Retrieved from https://scholar.harvard.edu/files/chodorow-reich/files/ui_macro.pdf

Ebrahimy, E., Igan, D., & Peria1, S. M. (September 10, 2020). The Impact of COVID-19 on Inflation: Potential Drivers and Dynamics. International Monetary Fund Research. Retrieved from https://www.imf.org/~/media/Files/Publications/covid19-special-notes/en-special-series-on-covid-19-the-impact-of-covid-19-on-inflation-potential-drivers-and-dynamics.ashx

NFIB. (2021, April 13). Small business owners struggle to find qualified workers. Retrieved April 17, 2021, from https://www.nfib.com/content/press-release/economy/small-business-owners-struggle-to-find-qualified-workers/

Sastry, A., & Bates, K. (2017, April 26). When L.A. erupted in anger: A look back at the Rodney King riots. Retrieved April 17, 2021, from https://www.npr.org/2017/04/26/524744989/when-la-erupted-in-anger-a-look-back-at-the-rodney-king-riots

Working Worries

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April 11, 2021

by Steve Stofka

Early Saturday morning came the news that Amazon workers at the Bessemer, Alabama plant had rejected a union by more than 2-1. The strength of the rejection surprised analysts and advocates. Companies who offer competitive wages and generous benefit packages often win against union adoption elections.

Amazon workers at Bessemer start at $15 an hour; adjusted for relative cost of living, it is $17.30, slightly below the national median warehouse wage of $17.77. In addition, Amazon offers comparatively generous medical benefits. In a 2020 study, Antonios Chantziaras at the Durham University Business School and two professors at Greek business colleges found that auditing fees are higher for U.S. companies that have unions, an indication of the complexity of union work rules (2020). It makes economic sense for companies to pay workers enough to dissuade any organizing efforts.

The Amazon workers who would be receptive to union organizing are those in Los Angeles, where the starting pay is the same $15 hour. According to the BEA, the cost of living in L.A. is 40% higher than in Bessemer. The starting pay of $15 is above California’s minimum wage of $14, but indexed to the nation as a whole, that $15 per hour in L.A. is worth only $11 per hour.

Bernie Sanders and others campaigned in Bessemer to show support for union organizers. Instead of trying to organize where workers would be motivated to join a union, workers in Amazon’s 230 warehouses have been waiting to see the results of the Bessemer election. Why does organized labor and the politicians who support them campaign with the most effort in those geographic areas that are the least likely to succeed?

According to many analysts the economy is on a coiled spring, ready for explosive growth. There are many positive signs but the contradictions are puzzling. For two consecutive weeks, initial jobless claims have risen. However, the Bureau of Labor Statistics reports that the 4-week average of unemployment claims has not risen (FRED Series CC4WSA). The past two weeks may be data noise or a seasonal shift in the workforce, but that is not the sign of an economy poised to leap into action. In March, the 4-week average of claims was almost double the number of claims in March 2020, as the nation went into lockdown.

The Covid pandemic has uncovered startling disparities in our economy. According to the Bureau of Labor Statistics, those who kept their jobs this past year have seen a 4% increase in weekly wages (FRED Series CES0500000011). The other half of that story is ugly. Those service businesses who are open may offer jobs at lower wages. With many businesses still closed, job applicants have what economists call low bargaining power and are willing to take less pay.

The Relief Act and the recent stimulus checks have helped many. Let’s hope that these worrying signs are just noise and that the country is back to full recovery.

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Photo by Christopher Burns on Unsplash

BEA. (2019). Cost of living calculator. Retrieved April 11, 2021, from https://research.stlouisfed.org/publications/cost-of-living/calculator

Chantziaras, A., Dedoulis, E., & Leventis, S. (2020). The impact of labor unionization on monitoring costs. European Management Journal, 38(2), 288-307. doi:10.1016/j.emj.2019.09.004. Retrieved from https://www.sciencedirect.com/science/article/pii/S0263237319301100#!

Inflation Not

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April 4, 2021

by Steve Stofka

I will keep this short on Easter weekend. The March Labor report that came out two days ago surprised to the upside, but I am not convinced that this will be a robust recovery this year. The relief act passed a month ago may give the kick needed. Despite the inflation warnings of some, the employment trends don’t signal inflationary pressures this year.

The unemployment rate declined from 6.8% at the end of last year to 6.2% at the end of March. However, the rate is still 1.7% above the 4.5% long-term natural rate of unemployment, an estimate of what the unemployment rate could be if available labor and other resources were employed. A year ago, the unemployment rate stood at 3.8%.

The labor force shrank by .2% this past quarter, about the same as the last quarter of 2017 and the 3rd quarter of 2015. Considering there is a pandemic, that shouldn’t be worrisome, but it is unusual for the labor force to shrink in the first quarter of the year. The last time was in 2011, a time when it seemed there might be another global recession. It’s not a sign of a robust recovery.

Total Employment is still 4.5% below last March, but Construction employment is only 1.2% down from last March. Even though Construction is only 5% of employment, it’s direction signals positive secondary movements in the economy.

There is a formula economists use to estimate the output gap in the economy. When it is positive, that signals some degree of inflationary pressures. When negative, as it has been for most of the past decade, that signals low inflation. We won’t get the first estimate of first quarter GDP for a few more weeks, but the employment data this past quarter estimates a small positive gap and little inflation.

Happy Easter, folks, and stay safe!

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Photo by Sebastian Staines on Unsplash