Category: housing

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.

Price Acceleration

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June 19, 2022

by Stephen Stofka

There are several series of inflation and each offers a different perspective on annual price changes. Each month the Bureau of Labor Statistics publishes a headline number CPI-U, or Urban index, which estimates the annualized price change for urban dwellers of all ages. It also publishes a CPI-W or Worker index, which is focused on the spending priorities of working families. Yet another series is an index that the Federal Reserve uses to establish a longer term trend for price changes. This week the Fed enacted a rate increase of .75%, its strongest response to inflation since 1994, to counter the acceleration in price changes.

Working families and the general urban population differ in their spending priorities in transportation costs, household expenses and health insurance (BLS, 2021). Out of every $100 of income, working families spend about $2.40 less on maintaining a household, but $3.80 more on transportation. Being younger, they spend less on health insurance, about $1.50. The difference between the two series indicates which part of the population is bearing the weight of price changes. When transportation costs rise more than housing costs, the difference between the Workers and Urban index is positive.

In 2015-16, increases in senior housing costs caused the difference to go deeply negative. Starting in mid-2021, rising costs for new and used cars produced a positive difference, the highest since WW2. The Russian attack on Ukraine in February accelerated increases in gas prices and working families have borne more of that burden. Rising food costs have an almost equal impact, although working families tend to spend more eating out.

Just as we feel changes in our car speed, we feel changes in inflation. We expect some variation up and down around an average, but expect a balance of up and down. We are sensitive to acceleration, the change in speed, and become alert to too much up or down. Since mid-2021, the monthly acceleration in price changes have been mostly up.

Because pandemics only come along once a century and strangle the global economy, it was hard to tease out the underlying trend. Look at the negative drop in inflation in April 2022 on the far right side of the graph. The acceleration in price changes seemed to be easing up. In May 2022, the acceleration turned positive again and that prompted the Fed’s strong move this week.

Price changes in energy and food are both seasonal and volatile. To understand the trend, the Fed looks at yet another CPI index that excludes food and energy. Before the pandemic, the variation around the trend was small.

After the pandemic the variation in inflation was as severe as the early 1980s. Supply chains had been shut down, goods were stacking up at US ports, people were getting vaccinated and were spending money. With a shortage of new cars because of a chip shortage, used car prices increased a historic 45% in June 2021. Veterans in the industry shook their heads in disbelief. What should the Fed do? It has a double mandate of full employment and stable prices. Unemployment was still high at 6% in the spring of 2021. They maintained a zero-interest rate policy. As unemployment fell below 5% in September 2021, they probably should have increased interest rates a little.

Russia’s invasion of Ukraine and China’s month-long shutdown of Shanghai factories this spring threw yet another wrench in the forecast. Families abruptly switched their spending from household to more social spending, services and travel. Airline fares increased 38% in May. The change in spending patterns caught the buying managers at Target, Home Depot and Wal-Mart by surprise and these retail outlets now have excess inventory.

The housing market is experiencing declines as people respond to rising interest rates. The real estate giant Redfin just reported that home sales fell 10% y-o-y in May 2022, down 3% in one month from April (Ellis, 2022). Rising rates will curb the volatility in price changes but they usually cause a recession. Investment spending, both commercial and residential, responds first and that causes a decline in economic activity. Over the past few months the Atlanta Fed has revised their 2022 GDP forecast from over 2% annualized growth to 0%. Each revision has been negative.

During the pandemic, households reduced their spending and have stored up a lot of spending power. There is a lot of untapped equity in homes as well. Higher interest rates will slow residential and commercial investment spending. Inflation may stay elevated if consumption spending remains strong and offsets that decline.

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Photo by Piret Ilver on Unsplash

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

Ellis, T. (2022, June 17). Home sales post rare May decline as mortgage rates rise. Redfin Real Estate News. Retrieved June 17, 2022, from https://www.redfin.com/news/housing-market-may-home-sales-decline/

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/

Dueling Dancers

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December 13, 2020

by Steve Stofka

As I read and listen to arguments on both sides of an issue, they fall into two categories: the ontological and the utilitarian. Those terms make our arguments sound erudite and rational. In the wrestling match of ideas and opinions, we need shorter names that will fit on a wrestler’s robe: the Onts and the Utis. This fight has been going on a long time.

If you are an Ont, you argue about the nature of things. Most of the time, you try to gain the upper hand in defining an issue. If someone is new to this country and is hungry or homeless, you might argue that people who have just arrived here are not entitled to government benefits. They may be human beings, but you narrowly describe them as free riders, something which is of great interest to Onts, who see everyone else’s free riding, but not their own.

The Ont does not think city governments should tolerate homeless people on downtown streets. Onts have characterized homeless people as drug addicts and self-indulgent people who should get a job or sit in jail making license plates. Homeless people command a lot of city services, particularly visits to the local emergency room. Taxes support the well-being of free riders, a divisive issue with Onts.

Onts are concerned about moral hazard, the inducement to take on more risk when a person doesn’t have to suffer the consequences. If an Ont gave a homeless person some money, that person would probably spend it on drugs, putting themselves further at risk. The Ont is doing a noble act by not encouraging the ruinous behavior of a homeless person.

If you are a Uti, you think that the practical solution is the right solution in an imperfect world. You care about the homeless person because you care about yourself and can’t stand the thought that you live in a society that would permit such human tragedy. Do you go downtown and hand out some of your savings to those homeless people to show you care? Well, maybe that wouldn’t be practical, you tell yourself.

A Uti recognizes moral hazard but doesn’t crusade against it the way that an Ont does. People put themselves at risk because they don’t bear the consequences of their risky behavior. Yes, we’d like to minimize that, but we don’t want to put others at even more risk because the community ultimately bears the consequences of their risky behavior.

A Uti lives in the real world, an imperfect version of the imagined utopia of the Ont. Yes, things are supposed to work a certain way, but “frictions” – messy entanglements – interfere with the perfect. The Uti wields his scythe, cutting the harvest while the Ont hoists his pickaxe and joins the crusade against the unholy.

A thousand years ago, Pope Urban II called on Christians in Europe to free the Holy Land from the Muslim infidels. The Pope appears on his balcony above the faithful crowds at the Vatican. At his rallies, President Trump emerges from his big plane and speaks to the devoted crowd. Think of President Trump wearing a pope hat embroidered with “MMGA” – Make Me Great Again.

Like the crusades of old, 136 Congressmen joined the army behind Texas’ attempt to get the Supreme Court to nullify the electoral votes of four battleground states. The court told them to turn in their pickaxes and go home. An Ont clings to their conviction that their solution is right even when it is not practical. If challenged, an Ont redefines the issue.

The practical problem that an Ont wants to solve is how to be right on every issue. The Ont is a Uti in disguise. The Uti use an Ont maneuver when they define the practical solution as the right solution in an imperfect world.

When both wrestlers in any argument take their robes off, it is difficult to tell them apart. As the two wrestlers circle each other, bystanders cheer on their favorite fighter but it is the bystanders who get hurt in a tangle between two political heavyweights. Media companies profit hugely; we are both the unpaid performers and the spectators of the political and cultural circus.

Who knew that philosophy could be so much fun?

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Photo by The New York Public Library 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

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.

Grandma’s Kids

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May 27, 2018

by Steve Stofka

The birth rate has touched a 30-year low, repeating a cycle of generational boom and bust since World War 2. The first boom was the Boomer generation born in the years 1946-1964 (approx). They were followed by the baby bust Generation X, born 1964-1982. The Millennials, sometimes called Generation Y and born 1982 – 2001, surpassed even the Boomers in numbers. Based on the latest census data, Generation Z, born 2002- 2020, will be another low birth rate cohort.

These numbers matter. They form the population tide that keeps the entitlement system afloat. Social Security and Medicare are “pay as you go” systems. Older generations who receive the benefits depend on taxes from younger generations for those benefits. As the population surge of Boomers draws benefits, the surge of Millennials is entering their peak earning years.

To maintain a steady population level, each woman needs to average 2.1 births. During the Great Recession, the birth rate for native-born Hispanic and Black women fell below that replacement level. White and Asian women fell below that level during the recession following the dot-com boom in the early 2000s. Foreign born Hispanic and Black women are averaging a bit more than 2-1/2 births. The average of foreign born White and Asian women is just about replacement rate.

Around the world, birth rates are falling. Social welfare programs depend on inter-generational transfers of income. When a smaller and younger generation must pay for a larger and older cohort, there is an inevitable stress.

I will distinguish between social welfare programs and socialist welfare programs with one rule: the former require that a person pay into the program before being entitled to the benefits from the program. In this regard, they are like insurance programs except that private insurance policies are funded by asset reserves held by an insurance company. Government “insurance” programs are “pay as you go” systems. Current taxes pay for current benefits. The Social Security “reserve” is an accounting fiction that the Federal government uses to track how much it has borrowed from itself.

Examples of social welfare programs that require the previous payment of dues are: Social Security, Medicare, Unemployment and Workmen’s Compensation Insurance. Although the latter two are paid directly by employers, they are effectively taken out of an employee’s pay by reducing the wage or salary that the employer pays the employee. Employers who fail to understand this go out of business early in the life of the business. I have known some.

Examples of socialist welfare programs that are based on income, or need: Medicaid, TANF (Welfare), WIC, Food Stamps, Housing and Education Subsidies. There is no requirement that a person pays “dues” into a specific program before receiving benefits.

Health care in America is primarily a social welfare program with socialist elements. The Federal government does subsidize all employer provided health insurance and most private insurance through the tax system or the Affordable Care Act. However, most beneficiaries must pay some kind of insurance to access benefits. Under the 1986 EMTALA act, emergency rooms are notable exceptions to this policy. They are required to treat, or medically stabilize, all patients insured or not.

As Grandma begins to draw benefits from Social Security and Medicare, she relies on the earnings of her kids who form the core work force aged 25 – 54. Grandma has paid a lifetime of dues into the social welfare programs and wants her benefits. Grandma votes.

Her grandkids want government subsidies for educational needs and job training. They depend on socialist welfare programs with no dues. The grandkids don’t vote.

The kids are caught in a generational squeeze.  Their taxes are paying for both their parent’s benefits and their kid’s benefits.

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Housing Trends

In the spring of 2008, there was an eleven month supply of existing homes on the market.
2010 – 8-1/2 months
2012 – 6-1/2 months
2014 – 5-1/2 months
2016 – 4-1/2 months
2018 – 4 months

In some cities, a median priced home stays on the market less than 24 hours.

Here is another generational shift.  Grandma and Grandpa now own 40% percent of home equity, up from 24% in 2006. Their kids, the age cohort 45 – 60, own 45%. Those under 45 have only 14% of home equity, down from 24% in 2006.

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Brave New World

E-Commerce is now 9.5% of all retail sales, almost triple the percentage ten years ago. (Fed Reserve series ECOMPCTSA). In 2000, the percentage was less than 1%.

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.

Home Sweet Asset

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April 3, 2016

Normally we do not include the value of our home in our portfolio.  A few weeks ago I suggested an alternative: including a home value based on it’s imputed cash flows.  Let’s look again at the implied income and expense flows from owning a home as a way of building a budget.  The Bureau of Labor Statistics and the Census Bureau take that flow approach, called Owner Equivalent Rent (OER), when constructing the CPI, and homeowners are well advised to adopt this perspective.  Why?

1) By regarding the house as an asset generating flows, it may provide some emotional detachment from the house, a sometimes difficult chore when a couple has lived in the home a long time, perhaps raised a family, etc.

2) It focuses a homeowner on the monthly income and rent expense connected with their home ownership.  It asks a homeowner to visualize themselves separately as asset owner and home renter. It is easy for homeowners to think of a mortgage free home as an almost free place to live. It’s not.

3) Provides realistic budgeting for older people on fixed incomes.  Some financial planners recommend spending no more than 25% of income on housing in order to leave room for rising medical expenses.  Some use a 33% figure if most of the income is net and not taxed.  For this article, I’ll compromise and use 30% as a recommended housing share of the budget.

A fully paid for home that would rent for $2000 is an investment that generates an implied $1400 in income per month, using a 70% net multiplier as I did in my previous post. Our net expense of $600 a month includes home insurance, property taxes, maintenance and minor repairs, as well as an allowance for periodic repairs like a new roof, and capital improvements.

Using the 30% rule, some people might think that their housing expense was within prudent budget guidelines as long as their income was more than $2000 a month.  $600 / $2000 is 30%.

However, let’s separate the roles involved in home ownership.  The renter pays $2000 a month, implying that this renter needs $6700 a month in income to stay within the recommended 30% share of the budget for housing expense.  The owner receives $1400 in net income a month, leaving a balance of $5300 in income needed to stay within the 30% budget recommendation. $6700 – $1400 = $5300.  Some readers may be scratching their heads.  Using the first method – actual expenses – a homeowner would need only $2000 per month income to stay within recommended guidelines.  Using the second method of separating the owner and renter roles, a homeowner would need $5300 a month income. A huge difference!

Let’s say that a couple is getting $5000 a month from Social Security, pension and other investment income.  Using the second method, this couple is $300 below the prudent budget recommendation of 30% for housing expense.  That couple may make no changes but now they understand that they have chosen to spend a bit more on their housing needs each month.  If – or when – rising medical expenses prompt them to revisit their budget choices, they can do so in the full understanding that their housing expenses have been over the recommended budget share.

This second method may prompt us to look anew at our choices.  Depending on our needs and changing circumstances, do we want to spend $2000 a month for a house to live in?  Perhaps we no longer need as much space.  Perhaps we could get a suitable apartment or townhome for $1400?  Should we move?  Perhaps yes, perhaps no.  Separating the dual roles of owner and renter involved in owning a home, we can make ourselves more aware of the implied cost of our decision to stay in the house.  A house may be a treasure house of memories but it is also an asset.  Assets must generate cash flows which cover living expenses that grow with the passage of time.

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The Thrivers and Strugglers

“Bravo to MacKenzie. When she was born, she chose married, white, well-educated parents who live in an affluent, mostly white neighborhood with great public schools.”

In a recent report published by the Federal Reserve Bank at St. Louis, the authors found that four demographic characteristics were the chief factors for financial wealth and security:  1) age; 2) birth year; 3) education; 4) race/ethnicity.

While it is no surpise that our wealth grows as we age, readers might be puzzled to learn that the year of our birth has an important influence on our accumulation of wealth.  Those who came of age during the depression had a harder time building wealth than those who reached adulthood in the 1980s.

Ingenuity, dedication, persistence and effort are determinants of wealth but we should not forget that the leading causes of wealth accumulation in a large population are mostly accidental.  It is a humbling realization that should make all of us hate statistics!  We want to believe that success is all due to our hard work, genius and determination.

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Employment

March’s job gains of 215K met expectations, while the unemployment rate ticked up a notch, an encouraging sign.  Those on the margins are feeling more confident about finding a job and have started actively searching for work.  The number of discouraged workers has declined 20% in the past 12 months.

Employers continue to add construction jobs, but as a percent of the workforce there is more healing still to be done.

The y-o-y growth in the core workforce, aged 25-54, continues to edge up toward 1.5%, a healthly level it last cleared in  the spring of last year.

The Labor Market Conditions Index (LMCI) maintained by the Federal Reserve is a composite of about 20 employment indicators that the Fed uses to gauge the overall strength and direction of the labor market.  The March reading won’t be available for a couple of weeks, but the February reading was -2.4%.

Inflation is below the Fed’s 2% target, wage gains have been minimal, and although employment gains remain relatively strong, there is little evidence to compel Chairwoman Yellen and the rate setting committee (FOMC) to maintain a hard line on raising interest rates in the coming months.  I’m sure Ms. Yellen would like to get Fed Funds rate to at least a .5% (.62% actual) level so that the Fed has some ability to lower them again if the economy shows signs of weakening.  Earlier this year the goal was to have at least a 1% rate by the end of 2016 but the data has lessened the urgency in reaching that goal.

ISM will release the rest of their Purchasing Manager’s Index next week and I will update the CWPI in my next blog.  I will be looking for an uptick in new orders and employment.  Manufacturing lost almost 30,000 jobs this past month – most of that loss in durable goods.  Let’s see if the services sector can offset that weakness.

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Company Earnings

Quarterly earnings season is soon upon us and Fact Set reports that earnings for the first quarter are estimated to be down almost 10% from this quarter a year ago.  The ten year chart of forward earnings estimates and the price of the SP500 indicates that prices overestimated earnings growth and has traded in a range for the past year.  March’s closing price was still below the close of February 2015.  Falling oil prices have taken a shark bite out of earnings for the big oil giants like Exxon and Chevron and this has dragged down earnings growth for the entire SP500 index.