Friday, December 23, 2016

Donald Trump does magic

Trump does magic. Maybe it will be black magic sometime, but he's an amazing phenomenon. He's the fundamental right now. It's all Trump. He's in charge, and it's really making a change.

We believe that psychology drives the macro economy, and there's something changing our psychology. We have a business-oriented president who wants to cut corporate taxes, who wants to cut regulations, and who sympathizes with business. Maybe it's not a good thing — it's a good thing for business, though.

Once people start to believe that it's a new era, it could go on for a while, even if it's unfounded. It's about human psychology, and it's what they call self-fulfilling prophesy.

Tuesday, December 20, 2016

CAPE ratio is now over 27

The cyclically adjusted P/E (CAPE), a valuation measure created by economist Robert Shiller now stands over 27 and has been exceeded only in the 1929 mania, the 2000 tech mania and the 2007 housing and stock bubble.

Monday, December 5, 2016

Donald Trump could be good for American economy

A businessman with a lifetime of experience in management has been elected president of the United States. Donald J. Trump’s administration may be viewed as an experiment — an opportunity to discover whether one particular businessman’s perspective and skills will be assets in governing a nation.

Mr. Trump’s background evidently appealed to voters, but he should be careful not to be overconfident. His election may be a culmination of a trend in society of lionizing business stars and expecting too much of them.

We’ve seen this phenomenon in the outlandish salaries paid to top chief executives and in the public enthusiasm for them. Rakesh Khurana, dean of Harvard College, described the trend eloquently in his book “Searching for a Corporate Savior: The Irrational Quest for Charismatic C.E.O.s” (Princeton, 2002). He discerned a long trend in American business toward choosing chief executives from outside a company and paying them handsomely for some presumed business flair despite their ignorance of the long-term internal issues facing a company.

Professor Khurana warned that expecting these people to perform acts of genius was asking for trouble. The charismatic outsider tends to become authoritarian, alienating others in the company. The executive’s desperate efforts to live up to their promise may sometimes result in wild gambles. There are grounds for concern that President Trump could be this kind of outsider chief executive.

Mr. Trump has a number of business books to his name, all written with co-authors. Often these books are amusing, if simplistic and boastful. “How to Get Rich” has advice like “Business Rule #1: If you don’t tell people about your success, they probably won’t know about it,” “Business Rule #2: Keep it short, fast and direct” and “Business Rule #3: Begin working at a young age. I did.” Maybe these nostrums are important for Mr. Trump but they seem to have little to do with making a country rich.

But there is still possibly another, more interesting strand in his advice: Mr. Trump’s admonition to be ambitious.

“How to Get Rich” also includes a “final rule,” “Think big and live large.” The book says: “In some ways, it’s easier to buy a skyscraper than a small house in a bad section of Brooklyn.” I’ve actually been giving a version of this advice for years to my students: Go for big ideas and avoid the trivia. My version of big and Mr. Trump’s are different, of course: He is known for his large, splashy buildings, while I try to encourage out-of-the-box economic ideas. Big ideas can lead to great things when they are encouraged, perhaps especially by a president.

Ambitious thinking led to big infrastructure projects like the Hoover Dam, the Golden Gate Bridge and La Guardia Airport, the kinds of projects we could use today. It also led to intellectual and humane triumphs, like the Dorothea Lange photo record of poverty in America, financed by the New Deal program the Farm Security Administration. Those stunning images gave dignity to the people of that difficult time.

A business-oriented president could be helpful in this intellectual world, too, by taking actions like doubling the budget for the National Science Foundation, which was created in 1950 when Harry S. Truman was president, and infusing the National Institutes of Health, the National Endowment for the Arts and the National Endowment for the Humanities with more cash. But of course a president must resist the temptation to meddle in their grant-making process. These are democratic institutions and must stay that way.

An inspirational business-oriented president would also promote enlightened business thinking — an approach that would embrace kindness and consideration to all people, workers included, and wouldn’t be focused only on those destined for fortunes. The country could also use an emphasis on the technical side of business, an aspect that may be unexciting and even off-putting to many people but remains very important. I’m thinking of such things as actuarial science, accounting, securitization and structured products.

Business has many dimensions. Consider another book, one by Georgia Levenson Keohane, the executive director of the Pershing Square Foundation. It is “Capital and the Common Good: How Innovative Finance Is Tackling the World’s Most Urgent Problems” (Columbia University Press, 2016).

Ms. Keohane focuses on the welfare of those people who aren’t anywhere close to becoming billionaires. She describes the theory and history of social impact bonds, green bonds, vaccine bonds, micro-finance, public-private partnerships and other routes to financial inclusion. Ms. Keohane has many ideas that could do much good and could conceivably be pursued much further under a business-oriented president.

In the best of outcomes, Mr. Trump will find a way to live up to this opportunity in the coming years, carefully fulfilling a promise to bring in the “best and most serious people” in the business community rather than the most loyal — choosing people who have a history of thinking big while not overreaching and who have technical expertise and compassion as well.

To be truly successful, Mr. Trump shouldn’t shoot for flashes of genius with immediate results. It would be better to work patiently, in the hope of bettering lives over the long run. With the proper approach, modern business could really improve the work of our government institutions.

Monday, November 28, 2016

Human beings love stories

In the epilogue to my book [Finance and the Good Society] I say, finance, financial theory is a thing of beauty. When you read about a general equilibrium in financial markets where prices reflect scarcity, they sum up the demand of everybody and they put a number on it so that the scarce resource can be suitably distributed among its various uses and not squandered. And how it takes into account all of the demands and desires of people – you don’t even know them, you’ve never met them; it is a thing of beauty.

This leads some people however to worship the structure a little bit too much, because the financial theory, which I love and admire, is only a half-truth anyway. So this reminds me of your speaker from a year ago, Eugene Fama, who I think he and I agree on just about all of the facts but we differ on the interpretation. And he wants to give efficient markets a benefit of the doubt. Okay well let him do that but I doubt that markets are efficient so it’s not perfect. And there’s a bigger human element than you might imagine. So I’ve been involved with behavioral finance now for 30 years with a growing group of finance theorists.

I’m married to a psychologist as well. I think the field of neuroscience is just as revolutionary as the field of artificial intelligence because it’s changing our view of ourselves, and so we don’t fit the theoretical model of finance.

Paul Glimcher, who’s a Professor of Neural Science at New York University, wrote a book called Neuro-economics, and he said anything that people are presumed to be doing must have a brain structure that supports it. So he wants to find out. And he says that economic theory supposes that people consistently maximize a utility function – expected utility function. That’s a pretty complicated thing to deal with. Maximize an expected utility function, subject to a budget constraint. So he says, “I want to know where in the brain that happens”. So to make a long story short, he hasn’t found it yet.

I mentioned that in my book I talk about financial professions. And I mentioned some that are not uniformly loved. But again I’m not an apologist for these people. But I also feel that they do have a position in our civil society. So let me talk, first of all, about the least loved financial profession. That’s the financial lobbyist.

In our book Phishing for Fools George [Akerlof] and I talk about lobbyists as actually having an important part of our rule making. Because congressmen are really public people that have very little time to think about policy. And lobbyists come in. They like lobbyists that are not totally dishonest; that’s why a lobbyist has to say no to some requests. He actually has a moral purpose. So maybe I didn’t convince you, but I think that there are good lobbyists. And that they are part of what makes the system work. Because the only problem with our system is if there’s an imbalance – if certain social groups have more lobbyists or more expensive lobbyists than others. But if every group has a lobbyist representing and these lobbyists have some sense of praiseworthiness as I think they do, then I think they’re a positive.

I wanted to talk about some innovations. In order to make civil society work, it’s like an engine. It has to be tuned right and managed right. And so in history there are various people with a civil society mode of thinking who propose innovations.

In Amsterdam in 1602 they set up the first stock market that really had daily trading. And they had shares held in a street name so that you didn’t have to go through all the reporting every day when shares are traded. And then the newspapers of the day, actually they weren’t newspapers yet in 1602, they were coming soon though; by the 1610s Holland had the world’s first real newspaper, so they would tell you the price of the Dutch East India Company in their newspaper. Now that is an innovation, which I think was very public spirited and it involved legal changes that allowed this to happen. But what it meant is that organisations could be valued in a marketplace, the value would be known by everybody and it provided incentives to take part in a risky venture that you couldn’t have taken part of in such a flexible way until then. It’s an interesting story because they had a short sale crisis in, I think it was 1609, and they temporarily outlawed short sales. So the invention had its problems.

Then in 1811 New York securities law was the first to really establish limited liability as a clear principle for all stock contracts, which was an adventuresome innovation. It brought us on the edge though because if you have limited liability that means you can’t put corporate executives in jail for their mistakes. And it looked like a bad idea because they thought it would lead to too many disruptive and dishonest businesses. But somehow it didn’t.

Another example is index debt; inflation index debt was first invented, as far as I can tell, in 1780 in the state of Massachusetts for a revolutionary war. And they invented a consumer price index to underlie the debt.

Other adventures are more recent. Ethical investing – I’m not sure that’s an invention. The benefit corporation is an invention of the last decade; we have non-profits and we have for-profits and it involves something slightly between that.

Another invention that I think is coming out of civil society again, which hasn’t happened yet on any scale, is GDP-linked debt – something I’ve been advocating. But I’m discovering that other people are advocating it too. It’s because it’s a risk-sharing device between countries and between investors and governments. So these are innovations that, they don’t seem to happen by the profit motive alone. They happen when there is someone in civil society advocating them.

I think that this is a particularly risky time in history. Where our risk of inequality is great because people’s sources of incomes are rapidly being challenged. But at the same time I think we’re more understanding of the role of psychology and the functioning of our institutions, and we have to think through how we can be part of civil society; how we can make financial institutions that function better with real people, but don’t get too cynical about their manipulative-ness but are also not unmindful of the deep desire people have to be praiseworthy.

We have a celebrity society, where people are admired who are not really doing much. So we’re living in a social media age where certain things go viral. So, how to engineer around that? I mentioned the benefit corporation, which is a new thing that is in the United States primarily. I don’t know what other country has it yet; it’s only a few years old. But a benefit corporation has in its charter a profit motive, but also some other stated motive like the environment or alleviating poverty or creating opportunity. But the company writes that in itself and then it becomes part of company culture hopefully.

Now, how they weigh the conflicting objectives is not defined in the law, but you just have to pay attention to both of them. But the idea that your company has a moral purpose may change their whole environment. Now, making money might be described as a moral purpose but it’s kind of tainted in some people’s eyes. There should be some other moral purpose. A lot of the states have a requirement that the company issue every year a benefit report – what they’ve done to fulfill their social or environmental goal. The question is, would you rather work for a company like that or one that was strictly for money?

To the extent that their clients allow them to, asset managers and asset owners should incorporate ESG. I would. I think in the long run, the question is, ‘how big a hit does it take on your profits?’ You might not want to invest in certain companies that are morally challenged. And I can live with that. I’d expect maybe a somewhat lower return. On the other hand I’m not even sure it will have a lower return. Because it puts you in a different space and it puts you into a different mode of thought. You attract a different kind of people in your enterprise.

The main thing that I’m working on right now, because I’m President of the American Economic Association for one year – it’s an honorary rotating thing – is my presidential address, which I have to give in January. I have a tentative title for it of narrative economics. And what I’m talking about is how social science economics, and also finance, differs from other social sciences in that we almost never use the word ‘narrative’. The people who use it the most are actually journalists. You know, you read the newspaper and they’ll say, ‘the narrative from Donald Trump is this’, or ‘the narrative about Hilary Clinton is this’. But economists don’t do that.

So what is the idea? The idea is that the human mind is very impressed by stories and they tend to be human-interest stories. And these stories inform people’s feelings and emotions. So if we’re trying to understand business fluctuations, we have to try to understand their animal spirits. And why sometimes they’re excited and willing to work very hard, and other times they’re despairing and thinking, ‘I’m out of here you know. I’m going to just try to hoard my cash and not do anything’. So what determines those things? And it is, I think, a story. What I’m looking at for my presidential address is stories behind big economic events.

Monday, November 21, 2016

Rober Shiller on DoubleLine Shiller CAPE fund

I am happy to see that the concept of combining the CAPE ratio, to identify undervalued sectors in the large-cap stock universe, with the DoubleLine strategy, to improve fixed income returns, has been such a success since it was launched. It makes sense to include this fund as part of a diversified portfolio, since it is likely to be sufficiently different in its generation of alpha as to augment the portfolio's long-term performance.

Thursday, November 3, 2016

We could see more disruptions and protests

Something has to be done about the two trends of rising inequality and weak growth, for if they continue we may see more unhappiness, discontent and political disruption.

Sunday, October 2, 2016

Theres always some worry to worry about housing collapse

There’s always reason to worry [about a coming collapse]. We’re in a holding pattern right now … People are less excited about buying because they themselves don’t believe [home prices] will be going up a lot. Back in 2006, when the homeownership rate was setting records, people had extravagant expectations.

Monday, September 19, 2016

Technology and social revolution worldwide

For the past several centuries, the world has experienced a sequence of intellectual revolutions against oppression of one sort or another. These revolutions operate in the minds of humans and are spread – eventually to most of the world – not by war (which tends to involve multiple causes), but by language and communications technology. Ultimately, the ideas they advance – unlike the causes of war – become noncontroversial.

I think the next such revolution, likely sometime in the twenty-first century, will challenge the economic implications of the nation-state. It will focus on the injustice that follows from the fact that, entirely by chance, some are born in poor countries and others in rich countries. As more people work for multinational firms and meet and get to know more people from other countries, our sense of justice is being affected.

This is hardly unprecedented. In his book 1688: The First Modern Revolution, the historian Steven Pincus argues convincingly that the so-called “Glorious Revolution” is best thought of not in terms of the overthrow of a Catholic king by parliamentarians in England, but as the beginning of a worldwide revolution in justice. Don’t think battlefields. Think, instead, of the coffeehouses with free, shared newspapers that became popular around then – places for complex communications. Even as it happened, the Glorious Revolution clearly marked the beginning of a worldwide appreciation of the legitimacy of groups that do not share the “ideological unity” demanded by a strong king.

Thomas Paine’s pamphlet Common Sense, a huge bestseller in the Thirteen Colonies when it was published in January 1776, marked another such revolution, which was not identical with the Revolutionary War against Britain that began later that year (and had multiple causes). The reach of Common Sense is immeasurable, because it wasn’t just sold but was also read aloud at churches and meetings. The idea that hereditary monarchs were somehow spiritually superior to the rest of us was decisively rejected. Most of the world today, including Britain, agrees.

The same could be said of the gradual abolition of slavery, which was mostly achieved not by war, but by an emerging popular recognition of its cruelty and injustice. The 1848 uprisings around Europe were substantially a protest against voting laws that limited voting to only a minority of men: property holders or aristocrats. Women’s suffrage followed soon after. In the twentieth and twenty-first centuries, we have seen civil rights extended to racial and sexual minorities.

All of the past “justice revolutions” have stemmed from improved communications. Oppression thrives on distance, on not actually meeting or seeing the oppressed.

The next revolution will not abolish the consequences of place of birth, but the privileges of nationhood will be tempered. While the rise in anti-immigrant sentiment around the world today seems to point in the opposite direction, the sense of injustice will be amplified as communications continue to grow. Ultimately, recognition of wrong will wreak big changes.

For now, this recognition still faces strong competition from patriotic impulses, rooted in a social contract among nationals who have paid taxes over the years or performed military service to build or defend what they saw as exclusively theirs. Allowing unlimited immigration would seem to violate this contract.

But the most important steps to address birthplace injustice probably will not target immigration. Instead, they will focus on fostering economic freedom.

In 1948, Paul A. Samuelson’s “factor-price equalization theorem” lucidly showed that under conditions of unlimited free trade without transportation costs (and with other idealized assumptions), market forces would equalize the prices of all factors of production, including the wage rate for any standardized kind of labor, around the world. In a perfect world, people don’t have to move to another country to get a higher wage. Ultimately, they need only be able to participate in producing output that is sold internationally.

As technology reduces the cost of transportation and communications to near the vanishing point, achieving this equalization is increasingly feasible. But getting there requires removing old barriers and preventing the erection of new ones.

Recent free-trade agreements under discussion, the Trans-Pacific Partnership and the Transatlantic Trade and Investment Partnership, have suffered setbacks as interest groups attempt to bend them to their own aims. But, ultimately, we need – and probably will get – even better such agreements.

To achieve factor-price equalization, people need a stable base for a real lifetime career connected to a country in which they do not physically reside. We also need to protect the losers to foreign trade in our existing nation-states. Trade Adjustment Assistance (TAA) traces its roots in the United States back to 1974. Canada experimented in 1995 with an Earnings Supplement Project. The European Globalization Adjustment Fund, started in 2006, has a tiny annual budget of €150 million ($168.6 million). US President Barack Obama has proposed to expand the TAA program. But, so far, this has meant little more than experiments or proposals.

Ultimately, the next revolution will likely stem from daily interactions on computer monitors with foreigners whom we can see are intelligent, decent people – people who happen, through no choice of their own, to be living in poverty. This should lead to better trade agreements, which presuppose the eventual development of orders of magnitude more social insurance to protect people within a country during the transition to a more just global economy. 

Wednesday, August 31, 2016

Economic inequality is not talked about much

Economic inequality is already a concern, but it could become a nightmare in the decades ahead, and I fear that we are not well equipped to deal with it.

Truly extreme gaps in income and wealth could arise from many causes. Consider just a few: Innovations in robotics and artificial intelligence, which are already making many jobs uncompetitive, could lead us into a world in which basic work with decent pay becomes impossible to find. An environmental disaster like global warming, pollution or disease could sharply reduce the ability of people of ordinary means to live in specific regions or entire countries.

Future wars using ever more highly destructive technology, including chemical, biological, radiological or nuclear weapons, could devastate vast populations. And it’s not out of the question that dire political changes, like the rise of racist or otherwise exclusionary social structures, could have terribly damaging consequences for less privileged people.

Of course, I dearly hope none of these things ever happen. But even if they are unlikely, as part of our progress to a better world, we should be thinking now of how we might address them.

The current presidential campaigns in the United States have not really touched on long-range issues like these. The campaigns have instead been focused primarily on short-term concerns, and on issues facing people of middle income instead of those in extreme poverty.

The private sector isn’t helping much, either. It has not gone very far in developing insurance or hedging markets to protect against these risks. That raises an important question: Can we depend on the benevolence of society to compensate and care for those who would lose out if dire events actually happened?

One way to judge the likely outcome is to look at what has happened in the past. In their new book “Taxing the Rich: A History of Fiscal Fairness in the United States and Europe” (Princeton 2016), Kenneth Scheve of Stanford and David Stasavage of New York University looked at 20 countries over two centuries to see how societies have responded to the less fortunate. Their primary finding may seem disheartening: Taxes on the rich generally have not gone up when inequality and economic hardship have increased.

Instead, they found that taxes tend to rise when warfare increases, largely “because war mobilization changed beliefs about tax fairness.” These tax changes were generally aimed at ensuring national survival, not correcting economic inequalities.

Professor Scheve and Professor Stasavage found that democratic countries have not consistently embraced more redistributive tax policies, and most people do not vote strictly in their narrow self-interest. As the right to vote broadened through the centuries, for example, and people without property began to vote, they did not consistently act to tax the rich. These findings run counter to a popular narrative. Recall that in 2012, Mitt Romney said that in a democracy, a candidate who offers tax breaks to the less well-off at the expense of the rich will win mass support “no matter what.” That claim does not appear to be supported by the historical record.

Instead, it appears that, for better or for worse, the majority of people share simple notions of entitlement and fairness. Professor Scheve, Professor Stasavage and their colleagues found that in 2014, when people in the United States were asked what marginal tax rates they would “most like to see” on family incomes of $375,000, the median answer was 30 percent, with the bulk of answers ranging from 20 percent to 40 percent. (The federal marginal tax rate for that income is 33 percent.)

This is consistent with my own survey results, which focused on inheritance taxes. In 1990, Maxim Boycko, then with a Moscow think tank, the Institute of World Economy and International Relations, and I asked both New Yorkers and Muscovites: “In your opinion, what inheritance tax rate for really wealthy people do you think we should have?” The average answers in the two cities were virtually identical: 37 percent in New York, 39 percent in Moscow. Taxing around a third of wealth, more or less, seemed fair to people. And perhaps it is reasonable, in the abstract, yet what will we do in the future if this degree of taxation won’t produce enough revenue to meaningfully help the very poor as well as the sagging middle class?

Along with nine other economists, I contributed to a project that engaged in really long-term forecasting. The results appeared in a book edited by Ignacio Palacios-Huerta of the London School of Economics: “In 100 Years: Leading Economists Predict the Future,” (M.I.T., 2013). None of us expressed optimism that inequality would be corrected in the future, and none of us ventured that any major economic policy was likely to counteract recent trends.

For example, Angus Deaton of Princeton, commenting on what he called the “grotesque expansions in inequality of the past 30 years,” gave a pessimistic prediction: “Those who are doing well will organize to protect what they have, including in ways that benefit them at the expense of the majority. ” And Robert M. Solow of M.I.T. said, “We are not good at large-scale redistribution of income.” Both Professor Deaton and Professor Solow are fellow Nobel laureates.

No one seems to have an effective plan to deal with the possibility of much more severe inequality, should it develop. In the disturbing book “Poverty and Famines: An Essay on Entitlement and Deprivation,” (Oxford, 1983) Amartya Sen, a Harvard professor, documented an extraordinary thing: In each of four devastating famines in different parts of the world, there was enough food to keep everyone alive. The problem in each case was that the food was not shared adequately. Systems of privilege and entitlement permitted hoarding of food by people of status whose lives went on much as usual, except that they had to brush off starving beggars and would occasionally see dead bodies on the street.

Satyajit Ray’s 1973 movie “Distant Thunder” depicted one of those terrible episodes, the Bengal famine of 1942-43. Millions died, almost all from the lower echelons of society. Among the privileged classes, only the most moral seemed to find the situation troubling enough to help in a significant way.

Despite past failures, we should not lose hope in our ability to improve the world. In a recent column, I described ways in which society might change a deep-rooted sense of entitlement by radically broadening wage and job insurance. Such a program would be a start in getting us prepared to deal with some of the immense challenges that may lie ahead.

Monday, August 22, 2016

What is the CAPE Ratio

Robert Shiller’s CAPE ratio is defined as the price of a share divided by the ten-year moving average of its earnings. Using the ten-year moving average helps us gain long-term perspective and account for inflation. The ratio is used to assess valuations in the Markets.

The ratio currently stands at 26, almost at par with levels seen before the US financial crisis of 2008. 

Tuesday, August 16, 2016

CAPE and mean reversion

In early days of Robert Shiller's career, he made a discovery that would eventually win him a Nobel Prize. He found that stock prices bounced around too wildly to be explained by standard theories. This has been labeled the “excess volatility puzzle,” and financial economists have written countless papers trying to explain it. But now, excess volatility provides a clue to a possible problem with some of the forecasts we’re seeing in the presidential race.

Excess volatility means that a forecast is more volatile than the thing it’s predicting.

That’s why Shiller’s excess volatility puzzle showed that the stock market probably isn’t efficient. If stock prices have excess volatility, then unusually high prices today imply that stocks are too expensive and are more likely to fall than rise. In fact, that’s exactly the principle that drives Shiller’s cyclically adjusted price-to-earnings ratio, or CAPE -- a popular measure of how expensive or cheap stocks are. Because stocks are more volatile than prices, CAPE generally tends to revert to the mean. This won’t tell you exactly what stocks will do tomorrow or next week, but they offer the promise of a little bit of predictability in an otherwise ineffable market.

Monday, August 1, 2016

Housing prices could fall now

People should buy houses if they want the house and not for speculating on price increases.

Monday, July 25, 2016

Longer term land prices could go lower

Buy land: They’re not making it anymore. That often-repeated adage sounds like good financial advice.

But over the long run, it hasn’t been. Despite solid price increases over the last few years, land and homes have actually been disappointing investments. It’s worth considering why.

Let’s start by looking at the numbers. The best long-term data on land in the United States is for farmland, which is valuable in its own right and can also be considered a great reservoir that can be converted to housing and other purposes at opportune times.

Over the century from 1915 to 2015, though, the real value of American farmland (deflated by the Consumer Price Index) increased only 3.1 times, according to the U.S. Department of Agriculture. That comes to an average increase of only 1.1 percent a year — and with a growing population, that’s barely enough to keep per capita real land value unchanged.

According to my own data (relying on the S&P/Case-Shiller U.S. National Home Price Index, which I helped create), real home prices rose even more slowly over the same period — a total increase of 1.8 times, which comes to an average of only 0.6 percent a year.

What all that amounts to is that neither farmland nor housing has been a great place to invest money over the long term.

To put this in perspective, note that the real gross domestic product in the United States grew 15.5 times — or, on average, 3.2 percent a year — from 1929, the year official GDP numbers began to be kept, to 2015. That’s a much higher growth rate than for real estate. But why?

For home prices, a good part of the answer comes from supply and demand. As prices rise, companies build more houses, and the supply floods the market, keeping prices down.

The supply response to increasing demand may help explain why real home prices nationwide fell 35 percent from 2006 to 2012 (and even more in some cities). Investment in residential structures in the United States was at near-record levels as a percentage of GDP just before the price declines. Prices have been rebounding since then — and so has construction of new houses.

But it is true they aren’t making land anymore. And, in fact, farmland prices have done better than home prices over the last century, as well as in the worst years for housing, the years bracketing the recent financial crisis. Real farm property values actually rose 21 percent over the full financial crisis, that is, between 2006 and 2012. For farmland, there was only a small, 3 percent drop in real price from 2008 to 2009, which was quickly reversed.

The Green Revolution

Don’t get too excited. They aren’t making land, but because of technological advances collectively called the Green Revolution, there has been something akin to a long-term supply increase. This 20th-century miracle in agricultural science greatly improved crop yields per acre. From the standpoint of farm output, there was no need for new land. This revolution involved the discovery by Fritz Haber of a cheap process to produce ammonia for fertilizer at the beginning of the century and the discovery of new high-yield strains of wheat by Norman E. Borlaug at midcentury. Both men won Nobel Prizes for their work. These innovations permitted multiplication of yields per acre and very likely saved hundreds of millions of lives from starvation worldwide.

The effects of this revolution are complicated. One might think progress that improves yield per acre would put upward pressure on land prices. But that is not necessarily so if it occurs globally and prevents food price increases that would otherwise earn farmers more revenue.

What’s more, the food revolution may be accelerating with changes like lab-produced milk from genetically modified yeast and lab-produced meat from stem cells, eliminating the need for livestock and their pasture. This could have deleterious effects on farmland prices.

The value of land

Of course, underneath every home is a piece of land. Although that is typically only a bit of former farmland, it is often in an urban or suburban area, where a plot of land tends to cost much more than in the country.

Sometimes that little piece of land dominates the value of the home, particularly in dense urban areas. But if we are to understand long-term trends, we need to realize what land represents, even in Manhattan or Silicon Valley or any booming area. People in such places usually aren’t buying land for its own sake but for the myriad services that housing provides. A home is not just a place to sleep and store clothing and keepsakes. It can be a place that is convenient to a stimulating place of work, good schools and entertainment and, indeed, part of an entire human community.

These services have developed enormously over the last 100 years, changing the spatial and geographic dimensions of housing. There are vastly more highways and automobiles, telephones and various electronic connections, enabling people to leave center cities and still obtain the housing services they want. Thus, from a long-term perspective, these developments relieved a great deal of the upward pressure on home prices in cities.

Right now, there are some interesting developments in the supply of housing services that economize even further on urban land. We have recently seen interest in “micro-apartments,” which may be little more than 200 square feet but manage to squeeze in a kitchen, a bathroom and an entertainment center. For many people, this tiny space, with its proximity to like-minded people, interesting neighborhoods and restaurants, is preferable to living in a house in a far-flung suburb. Carrying this idea further, keepsakes can be kept in remote storage, maybe deliverable someday, on demand, with driverless cars. Already, rules are being changed in many cities, including New York, allowing the little apartments to be built and to accommodate many more people per acre of city land. These factors could lead to near-zero future demands on valuable urban land.

When you add all this together, the slow long-term pace of farmland and home price increases is not surprising. Nor would it be shocking if this trend continued for the next century, despite price surges over the last few years.

A more extreme outcome is also quite plausible. In a hundred years, we might even see much of our former farmland converted back to wildlife preserves. In fact, it’s far from inconceivable that the real price of land could be even lower than it is right now.

Wednesday, June 15, 2016

Many assume home prices will keep rising upwards

Rising home prices set off fears that real estate will become even more expensive, making it impossible ever to buy a home in a given city.

It’s easy to understand how such worries spread, but the historical record suggests that these fears are generally exaggerated. Cities with steep price increases today will probably have much smaller upticks in the future. And for the most part, differences in price increases among cities are well explained by short-term variations in employment growth.

Consider some recent trends. In the year ended in March, cities like Denver, Seattle and Portland, Ore., had employment growth of more than 3 percent, according to the Bureau of Labor Statistics, along with double-digit home price increases, according to the S.&P./Case-Shiller indexes. At the same time, employment growth has been relatively tepid in cities like Boston, Cleveland and New York, and so have home price increases.

This is not rocket science. When businesses in a city have an unusually successful year and hire a lot more people, new employees arrive, but initially there aren’t enough homes for them. Home prices rise immediately so that demand effectively equals the existing supply, inevitably causing ripple effects. Someone with a new, high-paying job will outbid someone else, who will have to lower her sights and accept a less attractive house. People much further down the ladder will end up living with their parents or with roommates.

On a national scale, this suggests that weak employment growth of the kind shown in May’s jobs report, with only a 38,000 increase in nonfarm payrolls, could eventually hurt home prices across the country. That’s possible. But even without a national price slowdown or decline, there is reason to believe that double-digit increases won’t continue for long in individual cities. Short-term variations abound, but for the most part, the differences in long-term home price increases in individual cities are about plus or minus one percentage point annually. (Exceptions include San Francisco and Portland, whose home prices have grown almost two percentage points above average annually since 1987.)

Cities with big home price increases recently have issued more building permits per capita. This supply response has the potential to reverse at least some of the prices: When housing supply increases, it tends to bring high real estate prices down, though that takes time.

There is another wrinkle, however. Demand lately has tilted toward homes in central cities, where land is scarce, rather than in more spacious distant suburbs. This creates imbalances. New homes in the suburbs have often remained unsold for long intervals. Construction of apartment buildings has increased in cities since the financial crisis, but new arrivals with good jobs often haven’t wanted to live in apartments. This may explain 2016 data showing that permits for new buildings with five or more units have flagged. Despite these problems, the supply response to higher home prices should moderate or reverse some of the biggest increases.

Yet many people assume that home prices will rise ever upward. These expectations are more modest than in the years leading up to the 2008 financial crisis, but they are substantial. The January 2016 Pulsenomics U.S. Housing Confidence Survey showed that expectations for home price increases over the next 10 years averaged 3.7 percent a year nationally, which implies a 44 percent total increase by 2026. Expectations were a little higher for homeowners than renters and higher yet for recent buyers — which appears to reflect a wishful-thinking bias. They were highest for recent buyers in high-price-increase cities, peaking at almost 6.5 percent a year.

Historically, however, investing in homes just hasn’t rewarded most homeowners that much. As I have calculated, home prices corrected for Consumer Price Index inflation nationally were nearly flat for the century ending in 1990. And when nominal home prices are deflated by per capita disposable personal income, it turns out that real prices of existing homes fell 12 percent while real prices of newly built homes fell 30 percent from 1975 to 2015.

As their disposable income has grown relative to home prices, individuals have bought more housing. That’s partly why average household size declined to 2.5 people in 2015 from 2.9 in 1975. The percent of households consisting of a single person rose to 28 percent in 2015 from 20 percent in 1975. There are other explanations for this, but one is certainly that housing has been getting cheaper, relative to income, so we are consuming much more of it.

New homes are larger: Median floor space has risen to 2,169 square feet in 2010 from 1,525 in 1973, census data shows. This large increase generally holds within major metropolitan areas and outside them. While living space is constrained in the heart of large, high-priced cities like New York, builders elsewhere have usually been able to accommodate people’s demands for cheap large homes roughly where they want them.

Given these facts, why do people still worry that home prices are getting out of reach? The answer can’t be found in the housing data. Instead, these fears may reflect anxieties about other issues — like income inequality, globalization and the threat of job losses because of robots and artificial intelligence. In prosperous cities, rising prices may connote economic exclusion.

After all, American society is increasingly divided according to educational attainment and income. In some circles, rarefied home prices may set off worries about being unable to live in choice locations shared with successful people. Home prices may, unfortunately, be viewed as a measurement of success in life rather than merely of floor space, and fear of being priced out of housing may well be rooted in deeper broodings about maintaining a position in the social hierarchy.