Category: housing affordability

The Change Changed

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November 13, 2022

by Stephen Stofka

October’s CPI report released this week indicated an annual inflation of 7.7%, down from the previous month. Investors took that as a sign that the economy is responding to higher interest rates. In the hope that the Fed can ease up on future rate increases, the market jumped 5.5% on Thursday. Last week I wrote about the change in the inflation rate. This week I’ll look at periods when the inflation rate of several key items abruptly reverses.

Food and energy purchases are fairly resistant to price changes. Economists at the Bureau of Labor Statistics (BLS) construct a separate “core” CPI index that includes only those spending categories that do respond to changing prices. It is odd that a core price index should exclude two categories, food and energy, that are core items of household budgets.

Ed Bennion and other researchers (2022) at the BLS just published an analysis of inflationary trends over several decades. Below is a chart of the annual change in energy prices. Except for the 1973-74 oil shock, a large change in energy prices led to a recession which caused a big negative change in energy prices.

We spend less of our income on food than we did decades ago so higher food prices have a more gradual effect, squeezing budgets tight. Lower income families really feel the bite because they spend a higher proportion of their income on food. In the graph below a series of high food price inflation often precedes a recession. Unlike energy prices, there is rarely a fall in food prices. Following the 2008 financial crisis, food prices fell ½% in 2009. It is an indication of the economic shock of that time.

Let me put up a chart of the headline CPI (blue line) that includes food and energy and the core inflation index (red line) which does not. Just once in 75 years, during the high inflation of the 1970s, the two indexes closely matched each other. Following the 1982-83 recession, the core CPI has outrun the headline CPI.

A big component of both measures of inflation is housing. The Federal Reserve (2022) publishes a series of home listing prices calculated per square foot using Realtor.com data. You can click on the name of a city and see its graph of square foot prices for the past year. You can select several cities, then click the “Add to Graph” button below the page title and FRED will load the graph for you. Here’s a comparison of Denver and Portland. They have similar costs.

The pandemic touched off a sharp rise in house prices in both cities. Denver residents have attributed the big change to an influx of people from other areas. However, Census Bureau data shows that the Denver metro area lost a few thousand people from July 2020 to July 2021 (Denver Gazette, 2022). In the decade after the financial crisis, there simply wasn’t enough housing built for the adults that were already here.

The surge in home buying has not been in population but in demographics. As people approach the age of 30, they become more interested in and capable of buying a home. The pandemic helped boost home buying because interest rates plunged from 5% in 2018 to 2.6% in 2021.

Record low interest rates enabled Millennials in their 20s and 30s to buy a lot more home with their mortgage payment. That leverage caused housing prices to rise. A 30-year mortgage of $320K has a monthly mortgage payment of $1349 at 3%. At 5%, it is $1718 and at 7% it rises to $2129. Ouch!

Rising rental costs and home prices drive lower income families to less expensive areas in a metro area or entirely out of an area. Declining public school enrollment has forced two Denver area counties to announce the closing of 26 schools and transfer them to other schools (Seaman, 2022). As the number of students decreases, the schools infrastructure costs do not change, increasing the per student costs. Buses have to be maintained, drivers paid, schools staffed with guards, cafeteria staff, janitors and administrative personnel. Once schools are shuttered, the building may be sold and converted to other uses, either residential or commercial. The public schooling system is like a large ship that takes some time to change course.

During our lifetimes we experience many changes. They can happen quickly or emerge over time. The effects may be short lived or last decades. Families are still living with the consequences of the financial crisis fourteen years ago. Carelessly planned urban development isolates the residents of a community. The social and economic effects can last several generations. As we grow older, we learn to appreciate William Faulkner’s line, “The past is never dead. It’s not even past.”

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Photo by Davies Designs Studio on Unsplash

Bennion, E., Bergqvist, T., Camp, K. M., Kowal, J., & Mead, D. (2022, October). Why inflation matters. U.S. Bureau of Labor Statistics. Retrieved November 11, 2022, from https://www.bls.gov/opub/btn/volume-11/exploring-price-increases-in-2021-and-previous-periods-of-inflation.htm

Denver Gazette. (2022, March 25). Denver joins big city trend with pandemic population slip. Denver Gazette. Retrieved November 11, 2022, from https://denvergazette.com/news/local/denver-joins-big-city-trend-with-pandemic-population-slip/article_65c6393d-2a4d-5b91-837c-f8c3efce3778.html

Federal Reserve. (2022). Median listing price per square feet:Metropolitan Areas. FRED. Retrieved November 11, 2022, from https://fred.stlouisfed.org/release/tables?eid=1138280&rid=462

Seaman, J. (2022, November 10). Schools targeted for closure in Denver, Jeffco have disproportionately high numbers of students of color, data shows. The Denver Post. Retrieved November 11, 2022, from https://www.denverpost.com/2022/11/10/dps-jeffco-school-closures-students-of-color/

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Housing Affordability

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August 14, 2022

by Stephen Stofka

The National Association of Realtors (2022) publishes a Housing Affordability Index (HAI) that measures median housing prices, mortgage rates and median family income to determine a ratio of housing costs to family income. June’s index was the lowest affordability since 1989. Since the Fed began raising rates this year, affordability has fallen by a third. In the notes I’ll include some comments on the methodology behind the HAI.

With technological progress, we expand our definition of what is a necessity. We argue whether government has a responsibility to ensure that each family has a certain level of sustenance – adequate housing, food, a source of income and access to educational resources. Those in neighborhoods with single family homes resist efforts to build affordable multi-family housing. A real estate developer earns a higher profit building expensive townhomes than affordable housing units. Should a developer be compensated if required to build affordable housing? City councils would prefer not to bring up the subject of using tax money to compensate a developer for doing less.

We disagree about who should pay, who should get and how much. Several decades ago, the homeless were less visible, a huddle of a human being lying under a tree or on a park bench, occupying about 18 square feet. In destination cities like Denver, Portland, L.A and other western states, encampments of homeless in colorful pop-up tents line downtown sidewalks and along streams and rivers that course through the town. Depending on the size of the tent each person may occupy up to 50 square feet. Like the rest of us, they are taking up more space per person. Are there more homeless or are they simply more visible?

The reasons why people are homeless are numerous and varied but the dynamics of housing supply and demand are key factors. Where demand for rental housing is low, landlords of affordable units may skip a criminal background or credit check. When demand is high, rents are higher and landlords are more discriminating. They may require higher security deposits as a tool to screen out renters. The annual change in rental costs was 6.3%, below the 7.3% increase in housing costs but workers’ wage increases have not kept pace in the past year. (I’ll put the series identifiers and index numbers in the notes at the end). Over a long time period, have earnings kept up with housing costs?

I began with 1973, the year that the U.S. and most of the world adopted floating exchange rates between currencies. This allowed capital more freedom to move around the world. Several economists mark that as a turning point when the returns to labor began to lag behind the returns to capital. Today’s workers make $612 for every $100 that workers made in 1973, a 6:1 ratio. Housing costs have risen even faster. The Bureau of Labor Statistics calculates that a person spends $888 for shelter today for each $100 spent in 1973. In computing the CPI, the Bureau of Labor Statistics (2022) and the Census Bureau include mortgage payments, taxes and insurance – PITI – to determine the cost of shelter itself (32% of income), about 5% for utilities and another 5% for maintenance and repairs. Together they make up more than 40% of a family’s income.

We measure things in order to compare qualities. An example might be measuring the width of a bookcase and the width of a space in the living room where we want to put the bookcase. Comparing total housing costs across five decades is difficult. We prefer to live in bigger spaces and in far greater comfort than we did 50 years ago. Today’s new homes average 2600 SF. The thirty year average is 1800 SF. Moura et al (2015) estimated that each of us has twice the space of a person living in 1900. Total housing costs may have grown almost 50% faster than wages but per capita housing space has grown at least as much. Adjusting for the larger personal space, we could conclude that wages have kept up with total housing costs. But that’s not how many of us perceive affordability. More space and comfort has become our standard.

Changing standards and expectations cause a shift in definitions and benchmarks. The BLS includes the cost of cell phones, computers and internet access under Information and Information Processing. Many families consider these to be utility expenses as necessary as the heating and electric bill. The BLS estimates a family spends 3.5% of their income on these modern day necessities – about $3000 a year. TV cable subscriptions add another 1%. Five decades ago, a family had a $0 monthly cost for these. Together that cost represents $320 per month that impacts housing affordability. The cars we drive today are safer, more mechanically reliable and more fuel efficient but we spend more of our income on transportation costs. In the post-war period, food and clothing were almost half of a typical family’s expenses. Today those items make up just 13% of a family’s spending (BLS, 2014). We live in bigger homes because other items that used to take up a lot of space in our budget have shrunk.

News media often puts current economic measures in historical context – the highest since and the lowest since – but these quantitative measures are not adjusted for improvements in the qualities of goods. On a hot summer’s day five decades ago, there might have been several overheated cars on the drive home from work. Changing a flat tire on the side of the road was common. Automobile deaths were far higher. Older people died from heat exhaustion in uncooled apartments and homes. Our standards and expectations have changed.

Each month economists measure thousands of data points – as numerous as the stars in the night sky. Economists and politicians connect those dots using different paths of reasoning, motivation and perspective. We may cling to a particular doctrine that clouds our interpretation of the data. In the end economic issues are personal. Have our earnings kept up with our housing costs?

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Photo by Tierra Mallorca on Unsplash

BLS. (2014, April). One Hundred Years of price change: The consumer price index and the American Inflation Experience : Monthly labor review. U.S. Bureau of Labor Statistics. Retrieved August 12, 2022, from https://www.bls.gov/opub/mlr/2014/article/one-hundred-years-of-price-change-the-consumer-price-index-and-the-american-inflation-experience.htm

BLS. (2022, February 11). Relative importance of components in the Consumer Price Indexes: U.S. city average, December 2021. U.S. Bureau of Labor Statistics. Retrieved June 17, 2022, from https://www.bls.gov/cpi/tables/relative-importance/2021.htm

Lautz, J. (2022, January 7). Tackling home financing and down payment misconceptions. http://www.nar.realtor. Retrieved August 12, 2022, from https://www.nar.realtor/blogs/economists-outlook/tackling-home-financing-and-down-payment-misconceptions

Moura, M. C., Smith, S. J., & Belzer, D. B. (2015). 120 years of U.S. residential housing stock and floor space. PLOS ONE, 10(8). https://doi.org/10.1371/journal.pone.0134135

National Association of Realtors (2022). Housing affordability index. http://www.nar.realtor. Retrieved August 12, 2022, from https://www.nar.realtor/research-and-statistics/housing-statistics/housing-affordability-index. As constructed, an affordability index of 100 should be affordable. However, the NAR calculates a mortgage payment that is not typical. They base their calculation on a 20% down payment. The average down payment is only 10%. First time buyers typically put down only 7% (Lautz, 2022). This raises the mortgage payment and lowers the affordability. After adjusting for this, an HAI reading of 140 is probably a better benchmark of affordability.

 U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Housing in U.S. City Average [CPIHOSSL], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CPIHOSSL, August 13, 2022. July’s annualized increase was 7.3% and climbing.

U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Rent of Primary Residence in U.S. City Average [CUUR0000SEHA], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CUUR0000SEHA, August 13, 2022. July’s annualized increase was 6.3% and climbing.

U.S. Bureau of Labor Statistics, Consumer Price Index for All Urban Consumers: Shelter in U.S. City Average [CUSR0000SAH1], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CUSR0000SAH1, August 12, 2022. Note: Total cost of shelter was 39.90 in April 1973 and in 2022 it is 354.45, an 8.88 ratio.

U.S. Bureau of Labor Statistics, Average Weekly Earnings of Production and Nonsupervisory Employees, Total Private [CES0500000030], retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CES0500000030, August 12, 2022. In July 1973 the index was 153.14. In July 2022 937.38. A 6.12 ratio.

Thirty Year Horizon

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April 10, 2022

by Stephen Stofka

In the period leading up to the financial crisis a speculative fever engaged many of the actors in the housing market. This included homebuyers, agents, mortgage brokers, investment firms and risk managers convinced that housing prices could only rise. Homebuyers, struck by FOMO fever, jumped into the home lottery, gambling on a quick flip for a profitable gain with little investment. The frenzy of this market is marked by an opposite phenomenon. Small investors with a portfolio of ten or fewer houses are outbidding conventional buyers with all cash offers. Investment capital is at war with consumption capital.

The Atlanta branch of the Federal Reserve (2022) maintains a Home Ownership Affordability Monitor (HOAM) that ranks the affordability of a home at current prices and interest rates in cities and counties through the country. Readers can select the city, county they are interested in and they’ll see the affordability index. Hover over a county on the map and they’ll see the median home price, median household income and the share of income a house payment would be. The mortgage payment is based on the 3.6% interest rate of two months ago. After the recent rise in interest rates, you can add on at least $200 or more to the monthly payment.

A total housing cost of up to 30% of gross income is considered affordable according to the HOAM guidelines. A rule of thumb to calculate an affordable housing budget is to divide annual gross income by 40. For instance, $80,000 / 40 = $2000 per month. An index above 100 is affordable. The metro Denver area is in the 70s. With an index below 50, a typical household in the LA area would spend more than 50% of their gross income on housing. Some of the counties in the Dallas-Ft. Worth, Texas area and most of the counties in the Atlanta, Georgia area are affordable and that helps explain a growing population in some southern states.

Few will be surprised to learn that housing prices in many cities are unaffordable. Since the housing crisis, not enough housing has been built and low interest rates have increased the pool of qualified buyers. The higher demand puts upward pressure on prices. Older homeowners on a reduced income may resist selling because they cannot find a suitable replacement – a paradox of rising home prices.

In the chart below I’ve added on the Fed’s 2% inflation target to real GDP growth as a benchmark for the 30-year mortgage rate. Rates have been low the past decade but GDP growth has been low as well.

The red line is real economic growth after inflation + 2%. In the last quarter of 2021, economic growth was just 5% above the same quarter of 2019. That two year growth rate is moderate but not strong. The one year growth rate of 5.5% is due to what economists call base effects. Because of the pandemic the 2020 base number was weak, making moderate growth look stronger than it is.

The Fed is expecting growth to average 2.75% this year and decline to 2.3% in 2023 (FRED Series GDPC1CTM). Add in the Fed’s 2% inflation target as I done and the 30 year rate should find a balance in the range of 4.5-5.0%. However, that rate will probably overshoot before finding an equilibrium. The war in Ukraine will make it more difficult for that balance to happen. Homebuyers should not expect 30-year rates to fall below 4% in the near term.

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Photo by Laib Khaled on Unsplash

Federal Reserve. (2022). Home Ownership Affordability Monitor. Federal Reserve Bank of Atlanta. Retrieved April 7, 2022, from https://www.atlantafed.org/center-for-housing-and-policy/data-and-tools/home-ownership-affordability-monitor

Home, Sweet Home

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April 3, 2022

by Stephen Stofka

Interest rates belong to the world of money assets where changes can happen as fast as a keystroke. Prices are “sticky,” moving slower in the concrete world of real goods and services. This week the 30-year mortgage rate rose to 4.67% (MORTGAGE30US), but home prices are still high, reflecting the higher demand for homes at low interest rates. Denver was 11th in the country with an annual price increase of more than 20%, according to the Case Shiller index for January (DNXRSA see note). Six months ago, a 30-year rate was 2.87%, near a historic low. The difference in monthly payments on a 30-year $240K mortgage is $245.

When we buy a home, we leverage our down payment into a stable asset and become our own landlord. When the BLS computes the CPI inflation index, they include an item called Owner Equivalent Rent (OER) and it contributes 25% to the CPI index, the largest component of that index. Based on a survey of actual rental housing, OER represents the opportunity cost of renting our home to ourselves rather than to someone else at the going market price. While this might seem contorted, it reminds us that a home represents consumption capital, an investment whose benefits we consume during the time we own the asset. A home is the largest component of most household wealth.

The Federal Reserve charts changes various components of household wealth (Fed, 2022). Our homes represent a stable base of change, as the chart below shows.

The light green shaded area is the change in our home equity. You can visit the site and play with the time controls. Because the change is so stable, people’s expectations became anchored until the housing and financial crisis when the change in housing equity turned negative. People were shocked that such a thing could happen on a broad national scale. It is not unusual for home prices to turn down in a local area, usually in response to a substantial shift in the economic base of an area. Home prices in some Midwest cities experienced substantial losses as manufacturing went to other countries with lower labor costs. In the 1980s, the decline in oil prices made investments in oil shale on Colorado’s western slope unprofitable. Thousands lost their jobs and the prices of working class homes in Denver experienced a 10% decline (DNXRLTSA). Over several decades across the entire country, home prices are sure to rise but the probability of regional economic declines is equally sure.

The blue bars in the graph above represent the volatile changes in stock market equity. Compare that volatility to the stable changes in bond equity (orange). That’s why financial advisors recommend a growing portfolio allocation to bonds as we grow older. The small deviations in bond and real estate prices help anchor the large deviations in stock market wealth.

As mortgage rates rise, people can afford less home and the decrease in demand should relieve the upward momentum of rising home prices. There are those who play momentum in stock prices, buying and selling to take advantage of short term changes in sentiment. The graph above highlights the difference in deviations of stocks and homes. Playing the real estate market like it was the stock market got a lot of people in trouble during the 2000s. A home is an investment in stability, not a raffle ticket to riches.

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Photo by Scott Webb on Unsplash

Home Price, Denver Note: Even affordable homes in Denver have experienced sharp prices increases, rising 19.6% in January (DNXRLTSA).

Fed. (2022, March 10). Board of governors of the Federal Reserve System. The Fed – Chart: Changes in Net Worth: Households and Nonprofit Organizations, 1952 – 2021. Retrieved April 2, 2022, from https://www.federalreserve.gov/releases/z1/dataviz/z1/changes_in_net_worth/chart/

Life Choices

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September 19, 2021

by Steve Stofka

Economics is built on the principle of the rational person capable of making a choice between two options. In casual conversation we use the word “rational” to mean making sense but in economics it means making a choice. The choices presented may have constraints that make the word “choice” seem inappropriate. Does an addict have a choice? Yes. Sometimes we steer our lives with a critical choice of more or no more, having to choose between an unbearable more and a no more that contains an equally unbearable number of unknowns.

We might leave a job with only the hope that we can find another one soon. We may cast a no more vote, rejecting an incumbent for an unknown candidate. People living in the path of a hurricane or forest fire must make the difficult choice of evacuating the area or staying in their home and hoping they will be safe. Making a no more choice with family relationships can twist a person’s mind and soul in knots. A battered women may endure more until they reach the point of no more and leave their situation.  

As the Delta variant of Covid-19 sweeps through the population, many people are making difficult life choices about their jobs. In March 2020, the number of job openings plunged more than a third from 7 million to 4.6 million. In January this year, openings regained their pre-Covid levels and have risen quickly since then. The July report indicated almost 11 million openings, a series record.

After adjusting to online work, some workers have made that a critical preference. They have said no more to long commutes. Some have moved from dense urban areas to less populated states like Montana where rents or house prices will not consume half a paycheck. They have said no more. The sudden job loss last year caused some workers to rethink their priorities and career choice. The lack of affordable childcare has been a deciding factor for some workers.  

In economics, utility theory explores a choice between quantities of two goods. For example, will I have more pizza or more ice cream? These simple unrealistic examples help a student practice the concepts but are not suitable for no more life choices. Because these decisions act like switches, their calculations are hard to model. We may be able to bargain with our company who wants workers back in the office. Many times, we have to make a hard choice, one that can’t be undone.

We may revisit difficult choices, trying to understand and refine our decision making process. Many younger workers will look back and see this as a defining moment in their life. Some will wonder what if, replaying their choice. In a period of five years, our grandparents and great-grandparents endured rationing during WW1, followed by the Spanish flu that killed thousands, then the severe recession of 1921. Life narrowed their choices and they endured. By the time a person reaches their 80s, they have decided on more about 30,000 days. We remember the no more decisions more than we remember the many decisions of more. Each day is a crossroad.

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Photo by Einar Storsul on Unsplash

The Urban Refugee Crisis

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Photo by Julie Ricard on Unsplash

September 13, 2020

by Steve Stofka

In popular urban areas, affordable housing has been a persistent problem. Housing costs can consume 50% or more of a working person’s pay. Urban residents have become refugees in their own city, living in tents on downtown sidewalks.

Homeless tent “cities” in urban areas were already a problem, and the Covid crisis has exacerbated the situation. The tent areas are a breeding ground for 19th century diseases like cholera and typhus (Gorman, 2019).

The free market has not been able to solve this problem. Wanting to maximize his return on a property investment, a developer has more incentive to build luxury units than lower cost condos or apartments. Are they greedy and rapacious? Let’s take the developer out of the equation. Imagine telling a farmer that they must dedicate part of their land to growing more affordable wheat when rye is twice the price. In front of capitol buildings in mid-west states, there would be tractor protests by farmers. So why should it be different with a developer? They have an asset, an input, and want to get the most out of that asset.

Cities have tried several solutions with poor results. Santa Monica, a destination city in California, passed a rule that 30% of new multi-family housing had to be affordable units. Residential building has come to a halt (SCAG, 2019).

The city and state of California have passed funding laws to support affordable housing, but it is expensive (Camner, 2020). In popular coastal states where taxes are already high, a proposal of affordable housing subsidies to developers arouses ugly passions.

Affordable housing is a negative externality, a cost not borne by the developer or the buyer of a upclass condo or townhome. Perhaps there should be a fee on each unit? The cost of the externality is so expensive that the high per unit fee would limit sales of new units and raise little revenue to build affordable housing.

Let’s suppose that a couple buys a new condo from a developer. The couple has paid in the 75th percentile of housing prices in that area, but they enjoy ocean views and the cultural and social amenities of the neighborhood. In front of their new condo complex, several homeless people pitch tents on the public sidewalks. The couple is outraged. For the price they have paid, they reason that they should not have to endure the sights and behaviors of the homeless. The couple complains to the developer and the city. An urban economist would understand that the couple shares some tiny responsibility for the homeless problem but they, and their fellow residents, are bearing the costs out of proportion to their responsibility.

If there were a way to cut up and distribute the homeless problem among all the residents of an area, the problem might not be so noticeable. Fortunately, we live in a society that does not dismember human beings to achieve a perfectly equitable distribution of society’s costs. There will always be what biologists call a “clustered” distribution of homeless people.

Planned refugee camps have better health conditions than tents thrown up on a sidewalk. Should a city like Santa Monica accept the clustering problem and house their homeless in urban refugee camps? The city could provide better sanitary conditions and perhaps build a clinic at the refugee camp that would relieve downtown emergency rooms of attending to the many medical needs of the homeless.

In want of a perfect solution, our society has created an ever worsening problem. If the homeless can abide living clustered together with little privacy and no sanitation on a public sidewalk, then they would certainly abide a tented refugee camp with a bit more order, sanitation and medical facilities nearby.

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Notes:

Camner, L. (2020, February 10). Santa Monica’s affordable housing policies have failed -. Retrieved September 11, 2020, from https://www.smdp.com/housing-policies-have-failed/185877

Gorman, A. (2019, March 11). Medieval Diseases Are Infecting California’s Homeless. Retrieved September 11, 2020, from https://www.theatlantic.com/health/archive/2019/03/typhus-tuberculosis-medieval-diseases-spreading-homeless/584380/

Southern California Association of Governments (SCAG). (2019). Profile of the City of Santa Monica, p. 12. Retrieved from https://www.scag.ca.gov/Documents/SantaMonica.pdf

Thanksgiving Leftovers

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December 1, 2019

by Steve Stofka

My wife and I were visiting dear friends in Cedar Falls, Iowa, a college town surrounded by farms, small industrial businesses and several Amish communities. The people are friendly, the town is bucolic, and the downtown area has been revitalized after a flood several years ago. I was introduced to Hurts Donuts, a franchise of cake style donuts that just opened in Cedar Falls (KWWL, 2019). Yum, yum.

A 1600 SF house built in the 1950s can be had for less than $200K. I priced one house in Cedar Falls that would have sold in Denver for $350-$400K. Asking price was $180K. We helped a friend move into a townhome with 1100 SF living area and a garage. Rent? $850 per month, half of what I could rent a townhome in Denver.

Do the residents make considerably less? Not according to Best Places (n.d.). Their median household income and average income are almost exactly the national average. Cedar Falls sister city is Waterloo, which has the largest population of African-Americans in Iowa. At about 10,000, that’s less than 2% of the state’s population. That’s half of the black population in a neighborhood two miles from where I grew up in New York City. Iowa doesn’t do black. New York City does.

The city made the local news this year when the financial web site 24/7 ranked the city as the worst place in America to be African-American. Ouch. A reporter with the Waterloo-Cedar Falls Courier dug deeper into the Census Bureau numbers used by 24/7 and confirmed that the data was not skewed or taken out of proper context (Steffen, 2019).

Presidential candidates visit the twin city area frequently. Elizabeth Warren was going to be back in Cedar Falls on December 1st, but we couldn’t stay there. Candidates for either party pound the rostrum and offer solutions for big problems. The biggest problems are the small ones next door to us.

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Works Cited:

Best Places. (n.d.). Cedar Falls, Iowa. [Web page]. Retrieved from https://www.bestplaces.net/economy/city/iowa/cedar_falls

KWWL. (2019, November 6). Hurts Donut open today in Cedar Falls. [Web page]. Retrieved from https://kwwl.com/news/top-stories/2019/11/06/hurts-donuts-open-today-in-cedar-falls/

Steffen, A. (2019, February 2). Waterloo Confronts List’s Label as Worst Area to Be Black. Waterloo-Cedar Falls Courier. [Web page]. Retrieved from https://www.usnews.com/news/best-states/iowa/articles/2019-02-09/waterloo-confronts-lists-label-as-worst-area-to-be-black

Wikipedia. (n.d.). Bayside, Queens. [Web Page]. Retrieved from https://en.wikipedia.org/wiki/Bayside,_Queens

The Skittish Market

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August 11, 2019

by Steve Stofka

I had some whole hazelnuts left over and left them out for the squirrels. They smelled them, tried to bite them, gave up and buried them in the ground. No surprise there. Squirrels bury food. But that got me to wondering. Do hazelnuts soften after a few weeks in the ground? If so, then that might be an indication that squirrels have some primitive notion of future time. I buried a few hazelnuts in the garden and dug them up this week. Still as hard as they were when I put them in there.  Maybe two weeks is not long enough.

We bury money, not nuts. We put it in banks and other institutions called “financial intermediaries” and hope that our savings grow into a big money tree over time. Our bank, mutual or pension fund sends us statements every month or quarter and tells us how big our tree has grown. Financial advisors caution us not to go out and look at our money tree every day. Why? Because sometimes the wind comes and breaks a few branches.

This past Monday was a bit windy. In response to escalating trade tensions, the Chinese yuan weakened in the global money market, and the Chinese central bank did not intervene as the exchange rate dipped below a key number of 7 yuan to the dollar. President Trump accused the Chinese of manipulating their currency because they had taken a free market approach much like the U.S. does. That’s the upside down world we live in now. If the Chinese don’t manipulate their currency, they are guilty of manipulating their currency.

The popular Dow Jones index dropped 3%.  How much is that? A little perspective might help. The financial crisis began when investment firm Lehman Brothers went bankrupt on September 15th, 2008. The stock market dropped 4.4%. A dip below a key number in the money exchange rate between China and the US was all it took to drive the market down a remarkable 3%. In short, the market is extremely sensitive right now to information. Don’t look at your money tree. Some of the branches have been broken.

How do the banks and pension funds grow our money trees? They loan the money out to people and businesses who need it. Unlike nuts and seeds, money doesn’t grow when left in the ground. Growth during the past decade of recovery has been slow but unemployment is at 50-year lows so demand for consumer credit is high – credit card rates are the highest in 25 years – over 17% (Note #1).

Here’s a graph showing credit card rates (the blue dots) and the prime rate (red line), the rate that banks charge their best business customers.

Here’s a chart of the spread or difference between the two rates. Notice that the spread decreases a few years before a recession actually occurs or banks get increasingly worried about a recession. Banks were already telegraphing their fears two years in advance of the 2008-09 recession.

As you can see, the current spread is increasing, not decreasing. Banks are not worried about getting paid because the economy is strong, and people are working. Credit card defaults are near all-time lows (Note #2). Interest rates are the price of money – the price of time. Banks are confident that they can raise their prices for people who want to borrow money.

Less than two weeks ago, the Fed cut interest rates for the first time in a decade. Chairman Powell cited concerns about global growth and warned that the market should not expect further cuts unless data justified such action. He called the ¼% rate cut a mid-course correction.

Conflicting signals – the “yes, buts” – drive market volatility higher. The economy is good. Yes, but the global economy is weakening.

Wage growth is slow. Yes, but unemployment and delinquencies are very low. Housing costs are through the roof and people won’t be able to keep up their payments. Yes, but annual increases in housing costs for the whole country are only 2-1/2 to 3%, the same as they were for most of the 90s and early 2000s (Note #3).

The yield curve recently inverted, meaning that short term rates are higher than long term rates. Yes, but workers in the retail industry are particularly vulnerable and their real weekly earnings are still rising (Note #4). The yes, buts.

As children we were told to go to sleep and we may have said, “yes, but I saw a spider on the ceiling, and I don’t want it to eat me while I’m sleeping.” It’s just a trick of the light, now go to sleep. “Yes, but I heard a mouse under the bed. What happens if it gets under the covers?” That’s just the wind outside, now go to sleep.

Not once did we worry before going to sleep, “Yes, but what about my piggy bank?” That’s what some of us do as adults. “Yes, but what if the financial crisis comes again and uproots my money tree and carries it up into the sky?” we ask. Close your eyes, now. Don’t listen to the market noise. It’s only the wind. Don’t look under your financial statement every minute for mice and bugs.

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Notes:

  1. Highest credit card rate in 25 years
  2. Credit card delinquency, FRED series DRCCLACBS
  3. Housing costs, FRED series CPIHOSNS
  4. After adjusting for inflation, median weekly earnings of full-time retail workers have risen 10% since the end of the recession. Annual earnings of $33,000 (in 2018 dollars) are far below the median $45,000 for all workers.

Growth Periods

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July 28, 2019

by Steve Stofka

Did you know that housing costs double every twenty years? The predictability surprised me. Both rents and home prices double. Based on the last forty years of data the average annual increase is about 3-1/2% (Note #1).

House prices can only get ahead of earnings for so long before a correction occurs. Take a look at the chart below. Yes, low interest rates reduce mortgage payments so people can afford more home. That’s what we said in the 2000s. This trend does not look sustainable to me.

I was doing some work on potential GDP and wondered which president since World War 2 has enjoyed the longest and strongest run of real (inflation-adjusted) GDP above potential. Potential GDP is estimated as a nation’s output at full employment.

I won’t start with the #1 award because that would be no fun. Nixon came in fourth place with a run of strong economic growth from 1971 – 1973. The oil embargo that followed the Arab-Israeli War of 1973 sent this country into a hard tailspin that ended that growth spurt.

Ronald Reagan comes in third with a cumulative total of 24.5% growth above potential GDP. The expansion began in the third quarter of 1983 and ran through the second quarter of 1986. These strong growth periods seem to last two to three years.

Second place goes to President Truman with a short (less than two years), sharp 25.2% gain that ended with the beginning of the Korean War.

And the award goes to…the envelope please…Jimmy Carter. Wha!!? Yep, Jimmy Carter. The growth streak began in 1976, the year Carter was elected, and ended in 1979 when Iran overthrew their Shah, oil production sank, and oil prices doubled. At its end, the expansion had totaled 25.5% above potential GDP. In less than two years, the nation soured on Carter and put Reagan in office.

What about other Presidential administrations? We might remember the late 1990s as a heady time of skyrocketing stock prices during the second Clinton administration. The output above potential was only 11.5% but is the longest period of strong growth, lasting almost four years, from the first quarter of 1996 through the last quarter of 1999.

George Bush’s growth streak was only slightly higher at 12.8% but is the second longest growth period, beginning in the third quarter of 2003 and ending in the last quarter of 2006. A year later began the Great Recession that lasted more than 1-1/2 years.

Barack Obama’s presidency began with the nation deep in a financial crisis. By the time he took office fourteen months after the recession began, the economy had shed 5 million jobs, 3.6% of the employed. Employment was more than 6 million jobs below trend. The economy did not start growing above potential until the first quarter of 2010. The growth period ended in the third quarter of 2012, but employment did not regain its 2007 pre-recession level until May of 2014, 6-1/2 years after the recession began. It is the weakest strong growth period of the post-WW2 economy.

President Trump’s streak of strong growth began in the last few months of Obama’s term and is still ongoing with a cumulative gain of 7.5%. Unlike other growth periods, this one is marked by steadily accelerating growth above potential.

I’ve charted the cumulative growth above potential and the period length for each president.

As the economy shifted away from manufacturing in the 1980s, the days of 20-plus percent growth ended. Manufacturing is more cyclic than the whole economy. The manufacturing sector contributes to strong growth in recovery and pronounced weakness at the end of the business cycle each decade. In the 1980s, economists and policy makers in both government and the Federal Reserve welcomed this shift away from manufacturing. They dubbed it the Great Moderation and it ended twenty years later with the Great Recession.

President Trump is on a mission to begin another “Great” period – the resurgence of manufacturing in America. It is a monumental task because manufacturing depends on a supply chain that is presently located in Asia. In 2013, Apple tried to manufacture and assemble its high-end computer, the Mac Pro, in Texas. Production faltered on the availability of a tiny screw (Note #2). Six years later, the Trump administration is levying 25% tariffs on Apple products to encourage them to manufacture computers again in Texas.

The widespread use of tariffs usually leads to fewer imports. As other countries retaliate, exports decrease. Slowing global growth poses additional challenges to repatriating manufacturing to this country. If Trump can realize his passion, we may again return to those days of heady growth and more severe business cycle corrections.

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Notes:

  1. The Case-Shiller home price index (HPI) for home prices. The Consumer Price Index’s rent of a primary residence.
  2. A NY Times account of Apple’s last attempt to manufacture in the U.S.A.

Optical Illusions

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May 12, 2018

by Steve Stofka

I have long enjoyed optical illusions. Is that a picture of a rabbit or a duck? Which way is the cube facing, right or left? (Some examples) Is that two people facing each other, or a vase? (Image page) These can be even more fun when shared with a friend or sibling. Can’t you see the rabbit? No, it’s a duck!!!

Moving images present a selective attention deception. When asked to count the number of basketball passes, we may not see the gorilla that walks across our field of view. (Video)

These examples excite our curiosity and fascination as children and carry important lessons for us as adults. We sometimes misinterpret the data our senses receive. Those with a strong ideological bent may focus narrowly on only that data that supports their view of the world, or that makes them feel comfortable.

Let’s look at an example. Real (inflation-adjusted) median (middle of the pack) household income peaked in 1999 at $58,665. In 2016, income climbed to $59,039. However, personal income did not peak till 2007, at $30,821. Like household income, personal income finally rose above that peak in 2016.

PersVsHouseholdIncome

In the household series, the past twenty years have been especially tough. In the personal series, only the past ten years have been that difficult. What accounts for the difference in the two series? Households have grown faster than the population. Population Income / Households will be lower when households increase.

But what is income? Household income is money income received and does not include employer-provided benefits and retirement contributions (Census Bureau Defs). The BLS does track total compensation costs which do include these benefits, and those costs are 67% higher today than they were in 2001.

Benefits

If an employer gave an employee $500 a month for health care expenses and the employee sent the money to the health insurance company, that would be counted as income in the data. But because the employer sends the money directly to the insurance company, that income is not counted. Because of World War 2 wage and price controls, and to avoid being taxed under the income tax system, most employee benefits never touch the employee’s pocket, and are not counted as income. This becomes important when something not counted, benefits, grows much quicker than the income that is counted, or money received.

Since 1970, real hourly wages have grown only 3%. Bernie Sanders and other Democrats use a similar figure to press for more social welfare programs. Total hourly compensation has grown 60% (Fed Reserve blog) and most of that is not included in household income.

HourlyWagesVsTotalComp

Is it a rabbit or a duck?

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Do Millennials have it worse than Boomers did at this age?

I’ll call them the Mills and the Booms, so I don’t wear out my fingers. The Mills were born about 1982-2001 so they are 17 – 36 years old today.  A decade after the worst recession since the Great Depression, home and apartment prices are rising fast in many urban areas.  Mills are now the largest generation alive and are at an age when a majority of  them are independent and increasing the demand for housing.

Some Mills are trying to provide shelter for their families when the competition for housing puts constant upward pressure on prices. Some Mills are paying off student loans, while paying $800 to $1000, or more in California, to share a 3 bedroom house with  two other people. It is stressful.

The Booms were born approximately 1946 – 1964. The youngest are 54; the oldest are 72. When the Booms were 17-36, the year was 1982, and oh, what a year it was. The Booms had just endured a decade of double-digit inflation rates (it is now less than 2%), four recessions, mortgage rates that were considered a “bargain” at 9% (4% today), and high housing and apartment prices because there was so much demand for living space from this post war baby boom.

Oh, and tax increases. Tax rates were not indexed for inflation till 1985, so higher wages each year to keep up with that double-digit inflation meant that many workers were kicked up into a higher tax bracket each year. One of Ronald Reagan’s campaign promises was to stop the sneaky practice of dipping deeper into worker’s pockets every year. He got elected President, beating President Jimmy Carter who had told workers to turn the heat down and put a sweater on.

How do today’s monthly debt payments compare? Household Debt Service Payments as a percent of disposable personal income are 5.8% today compared to 5.6% in 1982. The 37-year average is 5.7% (Federal Reserve).

What are those average debt service payments buying? Better cars, more education, more square footage of housing space per person, and computers and electronics that didn’t exist in the 1980s. People are paying more for housing but are enjoying 30% more square footage per person (Bloomberg). In 1982, 17% of the population 25 years and older had a college degree. Today, it is double that percentage (Census Bureau table A-1), an achievement that the Mills can be proud of.

The Mills do have it better than the Booms, who had it better than the generations before them. That “good old days” talk that we heard from Bernie Sanders on the campaign trail are based on some foggy memories. The reality was way tougher than Sanders remembers or talks about because his perception is clouded by his ideology. He only sees the data that tells him it’s a rabbit. He doesn’t see the duck.