Slimmer RMA won’t improve affordability

I’m not convinced that reforms to the RMA will lead to any improvement in housing affordability. Much like work expands to fill the time available, house size and features expand to fill the budget available.

When banks look at houses as the premier security for all lending, even if you have a solid business generating free cash flow, whatever cost reductions in house construction can be achieved are likely to be immediately consumed in the form of bigger kitchens, more media rooms and larger garages.

State houses were 60 square metres back in the day, the average house size is more than 200 square metres now, and there is a strong cultural preference in New Zealand for housing arrangements that don’t work in a city with the geography of Auckland – water everywhere gets in the way!

In The House of Debt, US research shows a marginal propensity to consume gains in housing value between 0.1 and 0.4! The surge in retail spending last year on the back of house price gains in Auckland isn’t surprising. How many people are being prudent are using higher house prices to reduce their debt and build actual wealth? Not many, if any.

92% of household net worth in New Zealand is tied up in home equity. No one can afford the capital losses that housing affordability policies would actually produce. Witness the fury over attempted changes at school zones – that’s nothing compared with how people will mobilise to protect their rents from choosing to purchase a Ponsonby villa in 1970 and never selling.

Many households also don’t have mortgages – if they sell at the peak and downsize then that’s a permanent reset of their lifetime consumption possibilities. Selling in Auckland and retiring elsewhere is one reason why it mightn’t be too big a deal that home ownership is slipping in Auckland. Maybe more young people are realising they might need to buy their retirement home in a cheaper provincial city first?

Central bank credibility

An interesting comment has been made around the financial news sites and blogs since the Swiss National Bank decided to abandon the 1.20 EURCHF peg on Thursday.

It’s that the Swiss National Bank has somehow damaged their credibility by abandoning the peg and thus market participants lost a fortune on Thursday. Some FX dealers that let their clients trade with high leverage needed to raise additional capital to meet regulatory requirements and open on Friday.

If anything, the Swiss National Bank has proved the power of central banks is limited and that they are very credible because if they weren’t credible then no one would have lost money on Thursday. But they had given guidance that they’d keep the peg against the Euro for some time.

There hasn’t been any discussion of the net winners in the money market on Thursday. When the European Central Bank starts up quantitative easing then the Euro will weaken further and some of the mark-to-market losses the SNB has incurred will be recovered.

For other market participants, this is a lesson that trying to intervene in the foreign exchange market to protect your currency from becoming too valuable or too undervalued is a fool’s errand. A central bank with a balance sheet equal to 85% of GDP is basically a sovereign hedge fund up against the global financial markets.

In terms of what impact this will have on Switzerland itself, higher spreads are a likely result. This will suck for CHF denominated loans that need to be rolled over and Swiss firms or foreign firms looking to rollover or reissue CHF denominated bonds.

There is another lesson about risk and leverage. Retail investors have no business trading FX with leverage of 50:1 when the largest FX desks at the biggest banks in London, New York and Tokyo probably wrote off $1 billion on Thursday. I don’t understand what could compel people to think they have an edge here, when clearly almost all market participants were surprised and the spot market for CHF dried up meaning people couldn’t liquidate positions.

Debt and Wealth Inequality

Initial endowments matter. I’m reading House of Debt and enjoy the points made early in the book about how the poorest households lose the most when they take on leverage they can’t afford.

When house prices fall 30% and you have a 20% deposit you are exposed completely to house prices. You are now a mortgagee sale statistic in New Zealand with a disproportionate amount of negative consequences that entails relative to the United States where in most states you can simply hand the keys back to the bank and have the property go into foreclosure.

My main concern with households that use Kiwisaver to top up their house deposit is that they generally stop contributing to Kiwisaver and thus have no diversification outside of New Zealand home equity. In the next recession, this will suck for them because unless they’ve made significant headway in reducing the principal of their mortgage, their household’s balance sheet and income statement will be a sea of red.

Just because almost everyone thinks that something is a good idea, particularly around the holiday season, for young couples to enter into highly leveraged housing services contracts with a high level of spending reset attached (maintenance, lawnmower service, sum insured valuation etcetera) doesn’t mean that it’s a good idea and in fact probably means it is batshit insane!

A lot of young people need to slow down and realise that rushing into major contractual agreements before their household’s balance sheet can take on that risk is extremely risky. If you look at the finance literature, the empirical evidence is quite clear – high capital returns in the recent past are the best predictor of low future capital returns in the near future. Mean reversion isn’t just an academic turn of phrase.

Reinsurance rates dropping?

It would be cool if New Zealand journalists did their job and worked through this sort of information (FT registration needed) to things like “sum insured” that affect New Zealand policy holders. Infographics are in, aren’t they?

In the aftermath of Christchurch, it astounds me at the lack of detailed investigative or advocacy journalism into the structure of the insurance industry. Some journalists have gotten close and written excellent stuff, but still no cigar.

The narrative doesn’t really have time for detailed market microstructure discussions that are essential for building a base of knowledge with which to think about the long term policies that might be required to address any market failures seen or thought to be seen.


Statistically Ignorant People Freak Out About Plane Crashes…Yet Again

Statistic Brain bust out the data that shows a 1 in 29.4 million chance of dying on a single airline flight. There are other numbers I’ve seen, like 1 in 11 million and 1 in 13 million but overall, given the enormous number of aircraft movements every single day around the world, only people ignorant of statistics and probability will be freaking out over airline travel.

This is a direct link to other instances of ignoramus behaviour – like counting all of the “social costs” of something “bad” without calculating the benefits that accrue to the individuals who choose to undertake a “risky” activity.

There’s nothing you can do to manage these sorts of tail risks other than not engage in the activity – which is stupid – so worry about things that you can actually control and get on with your life. The funny thing is that you can quickly Google search likelihood of dying in a plane crash and figure this out for yourself, but that’s not sensationalist news coverage and most people are very reactive to anything that happens that is brought to their attention via television news or social media – they lose any semblance of rational thought they may have possessed.

TARP turns a profit?

Over at Vox, there’s a nice post on how TARP has turned allegedly turned a profit. But when I went over to the US Treasury website Troubled Asset Relief Program page, and read through some of the reports they’ve produced on the matter, I’m not sure that Vox is being clear enough here about what those figures actually mean when you start thinking about how this money was mainly disbursed in 2008 and 2009, but has been repaid over time.

Claiming to have made a trivial profit relative to the enormous amount of capital deployed into an industry that lost a lot of money on bad investments isn’t prudent. $15 billion / $426 billion over 5 years is a lower return for the US Treasury than buying their own product (bills, bonds, notes) and holding them on their own balance sheet as Treasury stock.

For all of the time that this capital was deployed recapitalising failed firms and acting as a vehicle for stimulus, there was some next best alternative foregone. For example, upgrading long deferred infrastructure upgrades and maintenance in the US could have provided substantial fiscal stimulus and achieved many of the things that TARP boosters claim to have aided in ensuring like a really slow, grinding recovery from the GFC.

But that’s not what happened, and the economic literature is quite clear that the long term impact of graduating into a recession permanently lowers lifetime earnings for college graduates. When you add in the growing level of under-employment and frustration around the distribution of opportunities in the economy, the past few years have spawned a non-trivial number of 20-30 year olds who are absolutely furious about how things have turned out for them. That doesn’t bode well for anyone who prefers market based solutions to problem solving via the price system.

Economics models as quantitative parables

A while ago in internet time, John Cochrane wrote an interesting post called “Policy Penance” where he discusses how academia and central banks are interacting in 2014, at least in the US with the Federal Reserve and macroeconomists from different schools of thought.

The central thrust of the post is that central banks can’t just make speeches and guide expectations, on some level they have to follow rules because the moment they “break their own rules” they incur a credibility cost – it’s more expensive in terms of output or inflation trade-offs – to achieve their inflation target, output or unemployment rate goals.

Time consistency of monetary policy is hard in an environment where central banks are close to academia but not as close to finance as you’d expect. This means that a lot of actors in the markets the Federal Reserve plays in are still fumbling in the dark following the balance sheet expansion of QE and the subsequent, long-awaited and still misunderstood “taper” or reduction in Federal Reserve purchases of MBS, Treasuries and other bonds.

When you then look at the regulatory response to the global financial crisis, and how Dodd-Frank has changed the way that the desks with the largest notional exposure to interest rate sensitive derivatives do business, and how all of these factors are interacting in an environment where to many financial market actors it seems like the central bank is making it up as they go along then you aren’t making the system more stable – you’re making asset prices ever more closely entwined with market participants interpretations of central bank action than they ever have been in history.

If you look at long term interest rates – the US 10 Year at 2.11%, 10 year gilts at 1.83% and German 10 year bunds at 0.63% the conclusion is that market participants expect low interest rates and low inflation for quite some time to come. What academics aren’t getting their heads around fast enough is that in order for the goals of the central bank to be met, capital losses will be imposed on the bondholders.

Forcing interest rates higher is a complete reversal of the “protect the bondholders” mantra from the onset of the global financial crisis. When interest rates rise, bond prices fall. Total returns can still be positive if held to maturity but that’s not guaranteed with changes in how capital flows into and out of the bond markets. The massive expansion of central bank balance sheets has been accompanied by massive increase in outstanding bonds. The New Zealand government has been a major issuer through the crisis for example.

I think that looking at broader labour market indicators as a driver of central bank action is a devil’s bargain. A central bank is about price stability and financial stability, not labour market outcomes or terms of trade. It’s concerning how much attention Janet Yellen is giving to the legitimate issues in the US labour market – this is stuff Congress and the Department of Labour should be sorting out!

We know that a floating currency is essential for New Zealand’s easy access to global capital and far from adding more instruments or targets to the Reserve Bank’s mandate, or indeed any central bank’s mandate, ensuring the correct policy settings are there to achieve the outcomes people want is more important than using the central bank as some enabler of other policy goals far outside their core competency.

Diminishing returns from social media interaction

I’m convinced that we are several “killer apps” past this point.








It’s a story of  devolution as opposed to evolution.

We are going backwards as a society as we move closer and closer towards inane instantaneous interactions that can easily be taken out of context and spawn self-reinforcing negative feedback cycles that end in false ignominy for the poor individual who stuffs up online.

Does automation make us dumb?

Over at the Wall Street Journal:

We are learning that lesson again today on a much broader scale. As software has become capable of analysis and decision-making, automation has leapt out of the factory and into the white-collar world. Computers are taking over the kinds of knowledge work long considered the preserve of well-educated, well-trained professionals: Pilots rely on computers to fly planes; doctors consult them in diagnosing ailments; architects use them to design buildings. Automation’s new wave is hitting just about everyone.

I don’t think automation makes us dumb, but it sure does mean that end-to-end understanding of complex processes is less likely for someone starting out in the workforce.

I am not convinced that not repairing anything is good for anyone. We buy new when problem solving down to component level could bring about increased levels of specialised knowledge to make systems more resilient to failure.

The rising entry level requirement for cognitive ability in many roles means that even though more people are attending university than ever before, the gap in on-job performance will become even larger because of the complementarity between highly skilled workers and machines.

But the great conceit here is that everyone thinks that they’re above average – their psyches resent the idea that a machine can do a better job – and have mountains of data to back that judgment up.

The downside of these great leaps in technological innovation is that they are likely to be thwarted by politicians attune to how important feelings and emotions are to most of the human population.

It won’t be the automation that makes us “dumber” – it’ll be the attempts to put the brakes on automation that lead to unintended consequences and a less efficient allocation of resources by firms.