By Karl Smith
I’m a big fan of Tom Lawler, but I think his rant – posted earlier today by Bill McBride – is misguided. Lawler’s essential complaint is that the Fed is stepping outside of its mission by buying up Mortgage Backed Securities. According to a recent analysis by two of the Fed’s own economists, the Fed’s policy of purchasing billions in Mortgage Backed Securities lowers interest rate on mortgages, but does little to bring down interest rates paid by other borrowers.
This result isn’t immediately obvious – and indeed is somewhat controversial – because economists often assume that financial markets are tightly linked. When the interest rate on Mortgage Backed Securities declines, investors will shift their money towards other types of lending (credit cards, ex) driving down rates in that market.
Not so say the Fed economists. Their analysis suggests that the links are not as tight as previously thought. Investors who normally buy-up mortgages are reluctant to switch to a different type of asset. Hence, the Fed’s purchases of MBS give a lot of benefit to mortgage borrowers, but not many other folks.
What really upsets Lawler, however, is that the Fed economists think this is a good thing. Lawler writes:
While the authors don’t explicitly state their “findings” this way, that effectively is what their “findings” imply.
There are, however, several things missing from the paper. First, of course, is the issue of whether monetary policy should be conducted in a fashion that alters the allocation of credit to one sector of the economy relative to other sectors of the economy.
Its perfectly fine for the Fed to direct credit towards one sector of the economy – in this case housing – when that sector experienced a credit meltdown that paralyzed the rest of the economy. Now perhaps Lawler feels – as a great many people do – that housing hasn’t experienced a credit meltdown, so much as a correction from a fundamentally unsustainable bubble. Under this view, all the Fed is doing now is inflating the same bubble that caused so much damage last time.
I, of course, think the new mini-bubble in housing has deeper roots that have little to do with the Fed’s mortgage purchases. Even if you don’t buy my story, however, there is the a much more fundamental reason to be skeptical about this view of the world. The U.S. has a radically unsustainable shortage of home building. Things have improved recently, but housing starts are well below what’s needed to keep up with population growth.
The chart below shows the number of new houses units dived by the number of new Americans each year (absolute population growth).
Though both birth rates and housing market face swings the ratio of new homes to new people was centered just under .7 for decades. This represents the fact that most housing units have more than one occupant, though some (vacation and second homes) typically have none.
In the late 80s the Savings and Loan crisis unfolded, just as Latino immigration began to ramp up. As a result the ratio of new homes to new people fell to its lowest level on record. Western metropolises, like Los Angles, faced a severe housing shortage. On the eve of the current crisis the ratio had just recently risen back into the normal range. Then in 2006, the subprime lending market began to unravel and the ratio rose sharply. After the collapse of Lehman and the onset of the Global Financial Crisis, the ratio exploded to record levels.
Even today the rate of new housing starts relative to population growth is lower than it was during almost anytime in the three decades from 1960 until 1990. Some of this is may be because its harder to actually build houses these days. Byzantine zoning regulations and home building industry gutted by the crisis mean that contractors who know how to get new projects moving are in short supply. Nonetheless, the fact that the two major collapses in home building occurred in the wake of a financial crisis, strongly suggests that the problem is in the mortgage markets.