As usual, the Fed- like the financial industry- does not understand real estate.
Home prices should never, ever, ever, ever be rising when the economy is slowing. Period. And we are slowing.
Home prices should never, ever, ever, ever be increasing while wages, and, thus, inflation is flat. Period. Interest rates should be rising as the economy is growing (which will occur next year), as the unemployment rate is lowering (as it is now), as wages and incomes are rising, and as housing prices increase, as a result of the aforesaid factors. That is the “only” environment in which a housing market is a healthy one. Period.
But, at last week’s press conference, in response to a question from a New York Times reporter, Chairman Powell says that the present level of home prices “are not of a level of concern”; that “it’s healthy; that “housing prices are not a financial stability concern at the moment”; and that “it’s not an issue we’re concerned about”- even though most people can’t find a home they can afford and most people can’t afford to move to a larger home. And profits from flipping houses, are, as in the early 2000s, being used to replace flat wages and lost jobs (and, in this case, safe yield).
The economy is going to improve in the coming months- but this is a separate matter to home affordability, present prices; and availability; especially as wages remain stuck- and will continue to be.
Chairman Powell also said that target inflation will not be reached anytime soon- which is code for: Your income will be flat unless you work at Goldman Sachs and underwrite tech IPOs.
How can we (and the Fed) not connect the instability in the equation of: wage stagnation + resulting persistently low inflation= rising home prices? Who lives in homes? Snails?
This is the same Fed that is explicitly, allegedly, and, in recent months, vociferously, concerned with economic inequality. Yet, it sees no problem with home prices being where they are, with unemployment and wages being where “they” are.
It’s a farce. It’s mere jawboning and lip-service.
Stagnant inflation, and, certainly, disinflation, is an inconsistent with rising home prices- period. The former, sans the latter, is unsustainable, because all inflation, short of temporary or transient supply shocks, results from heightened demand. And demand comes from jobs and rising wages (and available discretionary income), which can cause rising production costs (certain government policies, if permanent, can cause long-term inflation expectations). At the end of the day you either have demand leading to higher prices- or you have demand destruction from higher prices. Which one it is depends on jobs and wages.
But I suppose it would be, almost, blasphemy for the Fed, right now, to call-out the housing market as being inflated, because that market is helping prop-up jobs, is providing household wealth and trickle down spending, and is helping housing-related commodities, like lumber and copper, to remain stabilized.
But really, it’s prove-ably, and proved wrong to say that low interest rates stimulate inflation. Cheap money stimulates disinflation by financing excess capacity, zombie companies, scale, loss leaders, capital misallocation, and even asset crashes (which, can, eventually, leaves asset prices even lower than where they started- see: the housing crash of 2007).
Ben Bernanke tried this in the early 2000s; lowering rates because there was little inflation expectations, and then, after holding rates too low and allowing imbalances to build, tried to raise rates, while dismissing a flat and then inverted yield yield curve as a mark of nothing more than the result of a high savings rate, a low term premium, and anchored inflation expectations- when it was, really, a danger signal, as housing prices had exploded higher while wages were stagnant. Bernanke popped the bubble that he and Alan Greenspan blew by maintaining low interest rates for too long, because inflation was low. The point is that low rates and low wages, with rising housing prices, were being “red-flagged” by investors as an unsustainable combination as soon as the Fed decided to normalize. The longer the imbalances occur and are dismissed, or ignored, or misunderstood, the bigger the crash when the party is over.
If this Fed ever determines it’s time to raise rates after years of home price acceleration- or if the economy begins to improve and yields rise (both of which will happen soon- an improved economy and higher yields), that is when we see who is naked- i.e. once the tide goes out. It has to happen sooner or later.
But this particular rising tide- rising rates- may not be the cause of a housing “event”. And we may never get a housing “crash”; but this does not mean the housing market is stable (more on this below).
The only thing that can cause structural and sustainable inflation is, not monetary stimulus, but wage growth (or a long-term government policy or permanent supply shortages of a commodity necessary to modern life and that is used in many products). And the only way to get wage growth is to stop the offshoring and outsourcing to China. The real blasphemy.
We must fix the wage problem or we’ll never fix the inflation and asset bubble and “two-Americas” problem. Low wages and outsourcing are the sources of all evils– including the evil of those with stagnant wages trying to buy higher priced homes.
In 1979 the U.S. and China reestablished diplomatic relations and signed a bilateral trade agreement granting China Most Favored Nation status. Then, President Clinton signed the U.S.-China Relations Act of 2000 in October, 2000, granting Beijing permanent normal trade relations with the United States. Between 1980 and 2004, U.S.-China trade rises from $5 billion to $231 billion.
Since 1979, average wage growth has decelerated sharply, with the biggest declines in wage growth at the bottom and the middle (any increase in real wages over the entire period took place in the short window between1996 and the early 2000s). Notably, since the late 1970’s the workforce has also largely shifted out of manufacturing and into the service industries, as manufacturing began to be sent offshore. The biggest declines in relative employment occurred in the Great Lakes region (generally, a/k/a “The Rust Belt”- though this term applies to more geographic areas that lost manufacturing jobs) as manufacturing declined for several reasons (including a strong dollar that aided Japanese exports to the U.S.).
Anytime economies change and jobs are lost, creeps-on the arrogant and intellectual “creative destruction” crowd to tell workers to “buck-up”, “re-train”, and “look at it as an opportunity”. Two and three decades ago, factory workers moved to retail and office jobs due to offshoring, and now retail is moving to warehousing and shipping, instead of storefronts, due to e-commerce (and due to a lot of other trade and inflation related phenomena). Is someone who learned and loved working with people, and providing human-to-human service, and customer interaction in a retail store or shopping mall now expected to “re-learn” how to work on a redundant and boring warehouse assembly line? They were told a couple of decades ago to stop working on an assembly line and learn how to work in an office or retail store. Is this “creative destruction”? It sounds, to me, like “uncreative reversion”- for workers, at least. Leave the Ford factory- then return to the Amazon warehouse.
If only we could find a president who would levy tariffs and impose sanctions to stop the offshoring, reinstate the business cycle and the Philips curve, and stop the need for the Fed to lower rates to save the economy with the false premise that it will stimulate inflation while it, merely, pumps up asset prices.
But where could we ever find such a president who is so bold and strong as to make it his prime objective to take a stand against China and corporate America and return jobs and a business cycle and wage growth to this nation?
But really, who even wants our jobs back from China? We liked it better with our jobs being sent to China. Right? Much better, I suppose, to see the rusting out of our “rust belt” so that China can take the jobs and pay for its “road and belt”. Right? Better to destroy our middle class so that China could develop a middle class. Right? Better that China should have people who can afford discretionary spending than we should have it in Ohio, and Michigan, and Illinois, and in upstate New York. It’s much more important that Wuhan thrives. Right?
The unhealthiness of the housing market is different than in the 2003-2007 period. In both cases, cheap money was the culprit. In both cases, the chasm between home prices and affordability were vast. Both periods included people buying houses with the objective of fixing them up and selling them in short time periods. Both periods saw people flipping homes as an income substitute (or income supplement). But there is one big distinction between the two time periods: The hunt for yield phenomenon that has infiltrated the single family home market in recent years.
We may never get a housing “crash” this time. But the opposite of a crash is not strength and stability. Booms and crashes will still occur at the high end of the market as economic forces (and even foreign policy effects on domestic investments) dictate. Before the pandemic, high end markets, such as those in Greenwich, CT and Los Angeles, CA were weakening. The lower rates and yields (and the hunt for people-free spaces in the pandemic) saved those markets. But there may be a different kind of negative impact on the lower ends- and even middle class ends- of the housing market. Instead of crashes and foreclosures as interest rates rise, the result may be a society of unaffordable housing, as homes have become replacements for safe yield-producing asset investments (i.e. Treasuries). Ironically, and worth understanding, low interest rates that have fueled the housing market may help sustain the housing market- but not due to appreciation (that eventually has to end when the music stops and there are no more buyers with jobs and money left) but because the DNA of the homebuyer and bond investor have changed. Large investors, such as investment funds, are buyers and long-term holders of houses for the rental income they provide as part of our society’s (and the world’s) endless and painful hunt for safe yield. So, inflated home prices may actually be sustained- even as wages, inflation, and rates and yields remain low and homes are unaffordable for many (with the latter two remaining low “because of” offshoring that led to stagnant domestic wages). On the other hand, as rates and yields rise, house ownership as a bond alternative becomes less a less attractive investment strategy- though yields would have to rise a lot to reverse this trajectory. Let’s not forget that real estate investments not only offer yield, but also offer capital appreciation and tax benefits.
Because home prices are sustainable, with a low risk of a major crash, it does not mean that the housing market is healthy. In fact, it means the opposite; it means that American workers have to compete with private equity investors for the three bedroom brick house on the corner of Elm and Main- as their wages remain stagnant.
Asset prices will remain high from yield-hunting investors, making those houses unavailable to wage earners.
The Fed says that asset prices (meaning stocks and credit) may not be unreasonable based on where yields are. But that can’t apply to homes. Yields are low because inflation is low. Inflation is low because wages are low. So who can buy homes at these prices? Not American workers. It’ s only American investors who can benefit from the low rates and yields if wages don’t budge. As for inflation, businesses can’t raise prices, sustainably, even with supply shocks, if jobs and wages don’t rise. That’s just a formula for demand destruction (and then the need to scale using cheap capital to get more revenues as a way to achieve more profits to offset low margins- which is the death knell for small business, as scale, and the largest players, takes over industries).
The economy will be better next year- but housing is not a forward indicator, like stocks and bonds. Houses require down-payments and high carrying costs- today. You can’t buy and hold- unless you are a well-funded liquid investor. If prices are too high and inventory too low, today- a better economy will exacerbate the problem- tomorrow (unless yields rise so much that it incents single family home investors to revert back into Treasuries). But those same high yields will hurt aspiring homebuyers,. On the other hand, if those higher yields are due to growth and inflation expectations (rather than due to government debt), it would mean that people are working and wages and inflation are rising. Yields may rise, but not by much- unless it’s debt related, because wage growth, or lack thereof, will keep inflation low- even as the economy improves. This means that we can have growth without wage growth- so, it’s manufactured growth, through stimulating assets- and the yield curve will, eventually, invert. This is a more likely outcome than the curve steepening much, even with growth, because of the situation the pandemic and the Fed have created- it’s all asset growth. It’s simply the early Bernanke years all over again. The hope is that the real economy catches enough fire to offset the risk- and prevent asset bubbles from popping through real growth, organic growth, and wage growth. It’s always a race against time.
Of course, the Fed is in a pickle. And we’re all in that pickle with it. But to assert that as wages remain stagnant and as joblessness rises, it’s okay for home prices to rise- is magical thinking.
It’s not okay.
And if Chairman Powell is not persuaded by me- he can ask Ben Bernanke for “his” experience with the issue.
Wages can not decline or stagnate as home prices rise- period. There is no healthy way around that fundamental truth. If long term, well-financed yield-hunting investors are the homebuyers, prices could be sustainable in such a case- but a society would not be. Home ownership must be tied to middle and working class affordability- and not be beholden to Wall Street as an alterative asset class- especially when that alternative is because wages are too low, forcing interest rates forever downwards.
Houses across America are meant, primarily, to be places to live for the middle class and the working class- and not meant, primarily, to be an asset class.
But as someone who takes no pride in identifying problems- as opposed to solving them, here’s what I’d suggest:
- The Fed: Allow the yield curve to steepen to provide investors with yield while cheap short term money still helps small businesses (ideally, do this in concert with numbers 2 and 3 so that wages and consumers can, simultaneously, grow stronger, providing businesses with organic growth from greater consumer confidence and spending to replace trickle down, manufactured spending from low rates and asset appreciation). There’s no need to push investors further into risk. We will go there on our own based on the 2021 outlook and already accommodating rates. It’s growth expectations- even sans inflation expectations- that could be driving the appetite for risk and higher yields. You can have growth without inflation (such as when we come out of a recession and have job growth, but slack in the labor market keeps wages suppressed), keeping yields in check- but you can’t have a lot of healthy growth for long without wage growth- and inflation, so, with moderated growth, bond buying will persist. So, there will be a free-market-driven cap on long term rates. People, such as retirees, who need yield, are consumers, too. Even without the measures described in 2 and 3 below, higher yields won’t sink stocks for long, as growth returns- and even if stocks are a bit lower, it is not the end of the world, especially as banks become healthier from a steeper curve, are more willing to lend, and excesses come out of markets. A steeper yield curve would encourage healthy lending to growing companies instead of low rates and low yields encouraging unhealthy lending to zombie companies, and risky credit investments.
- The White House: Maintain and increase tariffs on imports from Asia- and China.
- Congress: Create tax incentives for companies to manufacture in the United States to offset the benefit of low wages when manufacturing in China or in the USMCA nations.
- Ignore the globalists and put America first, and return the business cycle, and acceptable profit margins and inflation, to America, so that scale is not required to grow earnings, thus creating the insatiable demand for Chinese consumers, thus, forcing us to deal with CCP policies and practices- and viruses.
If we do all of this- homes will stop being used as trading vehicles for Americans and as safe-haven yield-producing assets by Wall Street, wages will rise, Americans would be able to aspire to, and buy, better and larger homes, and the housing market will be a healthy one with houses used, primarily, as a place for Americans to live- and not, primarily, as things to flip for income and to rent-out for yield.