Based on the first chart. Capital income from housing doesn't matter very much compared to non-housing capital income (check out how closely that latter is correlated).
Also capital income from housing actually looks to be declining pretty sharply for almost a decade?
To the extent housing does matter it looks a lot less volatile than non-housing capital income.
TL;DR. More people are renting vs buying nowadays. Real estate has been a relatively good investment since WW2 but stock markets have appreciated more. Water is wet.
Regarding stock market returns, I'm curious if the calculated returns on stocks as a class properly takes into account failed companies. Take the FTSE 100. If a mid-tier one of those companies fails (Lehman's collapse for example) the FTSE 100 doesn't lose 1% of it's value. Instead the 101st most valuable UK company takes it's place. Does anybody know how well measures of stock market returns take into account effects like this? Or are they measured on the total market value of all traded equities?
It depends on what you are looking at, but generally index returns (such as the FTSE 100) are calculated as if you are rebalancing your portfolio periodically to reflect the changing composition of the index over time, which is what a passive index fund manager would do for you if you were to invest in a FTSE 100 index fund, for example.
I am not aware of any non-index based stock market performance measures like what you are suggesting--e.g. if I bought all the stocks in the FTSE 100 index in 1994 and never rebalanced, what would have happened? I suspect that the returns would indeed have been a lot worse but I can't say for sure.
So I think you are right about issues existing; survivorship bias and limitations/concerns when using an index as a proxy. These are usually mentioned in the fine print hidden at the bottom if they are acknowledged at all.
The FTSE 100 does not measure returns on stocks as a class. But it does take into account failed companies.
The FTSE 100 measures returns of 100 market cap weighted companies. How FTSE 100 handles things like dividends, adding or removing companies, historical data...There are hundreds of pages of explanations, rules, formulas, disclaimers and other methodologies at the bottom on the website: http://www.ftse.com/products/indices/uk
If a company represented 1% weight of the index (somewhere around the 30th largest company might be ~1%). If that company suddenly failed and it's stock price dropped to a tiny fraction of a pence (or basically zero), then yes the index will drop 1% in value. Company sized #101 will take it's place the next day.
Maybe more important: the company does not even have to fail for this 1% drop, if the market just thinks the company will fail and no one wants to buy the stock, it will push the price down to zero and the index will drop 1%.
Scary thoughts.
Stocks are worth what someone wants to buy it for and there is no other definition.
The price you see was the last price someone was willing to pay for it.
Stock returns are not about companies successes and bankruptcies, though there is a strong connection obviously. What investors think about a company and its stock price is more important and what stock returns measures are showing.
Flash crashes happen and financial crises happen but in general companies tend to fail slower than Lehman. So investors will sell at different points as a company's stock price falls. Different indexes will track this. As a stock leaves the FTSE 100 it may enter the FTSE 250. There are indexes with thousands of stocks. And there are 100,000+ indexes out there. Pick the one most relevant to you. No index will be perfect. You can always create your own.
The big famous indexes are often products/services run by companies and they compete. LSEG and Standard & Poor's (S&P 500) for example. These companies selling their index licenses and index data and other related stuff are usually public companies so their stock is in its own indexes. It can get circular weird. For the FTSE 100 look at the London Stock Exchange Group (ticker LSE) website under products and services- FTSE Russell: http://www.lseg.com/
Hope this helps a bit. Apologies if not clear. I find this stuff can be confusing sometimes and I work in finance and do this all day. Happy to happy more if I can.
TL:DR Indexes are just proxies but they do capture company failure. How they do it involves looking at the fine print methodology for the index you are using.
Could that decline also be due to new home owners who are purchasing at high prices (due to cheap debt) are finding that they aren't making anywhere near as much from renting those places out because the expense ate up their margins?
Yes, I think that happened and not clear the effect or extent of it.
Capital income from housing is complicated and messy to study partly because of imputed rents.
This leads to weird situations where expensive homes whether you live in it, rent it, rent it at loss (or leave it empty) can be counted as rent.
My guess is a big reason for the decline over the last ~10 years is housing prices took a hit after the financial crises in 2007/2008. It looks like owner-occupied went down more than tenant-occupied based on Figure 2 in the link.
From what I can see, this data-set and analysis seems to indicate that investors have been discouraged from investing in productive assets and investment vehicles by the low interest rates (or IRR). In response, people are spending more money on luxuries (such as their houses).
In the long run, this seems to be partly due to Henry George theorem (https://en.wikipedia.org/wiki/Henry_George_theorem). Otherwise real estate wouldn't be that exceptional than other asset classes, as the article suggests.
Housing is also a market where people can get very involved in the local government to prevent additional supply from being brought on line, despite soaring demand, mostly via zoning. Look at places like Palo Alto and Boulder.
I agree, but purchasers must be willing to pay more (no matter the cause), and this money has to come from somewhere. Expensive housing is a luxury, irrespective of the reason for its cost.
The money comes from the future. It's conjured up by banks based on future earning potential.
I'm conflicted a bit, but I suppose I agree with you that it's a luxury, if we agree that "not having to commute for 2 hours each way" constitutes luxury.
I'd even invert that bit about coming from the future. Due to the aging demographic shift and the otherwise impossibility of saving on a generational and national scale, there's a huge demand to encumber future earning potential for goods and services today. This is fundamentally why interest rates are so low - our aging population demands to be owed goods and services when they've retired, and the only way to provide that is to convince people to provide it in the future (ie, take on debt).
It's not just our aging population. It's also a side effect of running large trade deficits with developing nations. China's entrepreneurs generate huge profits, and they want to invest them somewhere safe. In terms of default risk, investments in the USA are about as safe as your mattress, and pay about the same interest ...
Or, of you prefer ( as I do ) government debt is a hedge against future GDP growth.
The population may be aging but people are working longer. And in an economy with feeble monetary velocity, entitlements to old folks has pretty high relative velocity.
Low interest rates are less about entitlements than they are about attempting to restart consumption. The problem is that low interest rates encourage dinking around with M&A activity rather than investing in productive enterprise that might employ people. This leads to high private sector debt levels, which further suppresses wages. The "winners" are just sitting on mounds of cash and having trouble finding outlets for it.
I have been working remotely for 10 years now. And not setting foot in a office is my first requirement when vetting potential employers. It is doable.
You will be amazed at what dedicated team of people could do in a year using only skype, whatsapp and basic competence.
Is this not the intention of the monetary policy? To stimulate spending now rather than later.
I could see the harmful effects this could cause when used as a long-term solution. Such as the recent extended US policy since the recession. Pushing people to make purchases doesn't help them rise out of the income bracket. Is this a known factor in contributing to the income divide?
I don't follow; the rent/imputed rent/price of a house is based more on the prices of the houses around it than on the improvements made to the house itself. Mark Zuckerberg excepted, most people don't spend on luxuries by buying up the neighborhood. I also don't follow how the relatively cheap price of debt leads to discouraging productive investment (unless you mean that it encourages risky investment).
When it comes to housing, most people are "payment buyers." How much they can spend on a house is dictated by how large a monthly payment they can afford. With a 30-year mortgage, interest rates have a huge impact on the monthly payment, since in the first years you are basically covering the interest plus a tiny slice of principal.
Assuming that your housing budget is a fixed fraction of your income, and assuming your income is basically stable, then as interest rates drop, you can afford to pay more for a house. Assuming that you are competing against other people in the same circumstance in an auction market, lower interest rates will tend to push up prices, while higher interest rates will depress them.
Part of the author's point seems to be that this is even more true in areas that are housing-constrained, like the Bay Area, where people push their purchasing power to the limit to buy a house that still doesn't meet their needs (space, schools, commute). As people devote more and more of their income, as a percentage, to housing, they are effectively doubling down on real estate as an investment.
Interesting exercise: assume all new house buyers are "payment buyers", and calculate the impact on house prices of mortgage rates moving from 3% to 4%.
From my calculations, you get a drop of 10% in house prices.
But... is this a 10% drop across the board? I suspect it will impact the higher-priced market segment especially.
My logic: Higher interest rates -> Fewer people can afford the more expensive houses -> More competition for (interest in) lower-priced homes -> Lower-priced homes might actually see a price increase (bidding wars, etc.) while higher-end segment suffers from lack of interest/smaller pool of buyers.
We bought a smaller and cheaper house than we could afford based on that logic… :-)
The Jumbo loan cap will also wierdly effect this scenario. 417k to 625k depending on median county home price. You can sometimes see prices tightly grouped around the limit, plus or minus down payment percentages. Then you are also talking about weird buyer preferences for buyers with lots of cash, who can pay down the lending amount to the cap, or sellers that will split assets so that each sale is below the cap.
Lots of strange market things happen around those caps.
And at ~5 million home sales/year, and an average home price of $240,000, a 10% drop in prices would be about $110B. That's deflation noticeable at the GDP level. My first mortgage (2001) was 7.25%.
If by 'author', you mean the author of the posted article, I agree completely. The parent poster I was responding to stated 'people are spending more money on luxuries (such as their houses)'... which I think gets the causation backward from what you describe. I'd wager that most payment buyers aren't lacking for other things to spend on.
There seems to be a need to clarify and expand on nickff's comment, so let me give it a shot. ...
Lower interest rates mean that lower-return, less productive investments may attract capital (savings) that, all else equal, would be captured by higher-return uses if interest rates were higher.
For example, suppose I run a factory that has an opportunity to invest $1MM in new machinery to increase productive efficiency, resulting in 2% higher profits. Meanwhile, you run a factory that would benefit similarly from a $1MM investment, but to the result of a 5% increase in profits (from the same level). If prevailing interest rates for investments with a similar risk profile to ours are 4%, then since 4% > 2%, there is no interest rate at which I can issue bonds (or get a bank loan) such that (a) somebody would be willing to buy those bonds in preference to other similarly risky bonds (or give me a loan in preference to other similarly risky borrowers), while at the same time (b) I would be able to make a profit by taking their cash and investing it in new machinery in my factory. The result is that my investment does not get funded–indeed, knowing that investors will demand 4% and that I can offer at most 2%, I will not even ask for their money. On the other hand, in the same macroeconomic environment you can profitably attract capital to your factory, because you can sell bonds to willing buyers at 4% and use the money to fund an investment that will gain you 5%. And so do ask for funds, and you do get funded; and others in a situation similar to yours do too, while I and others like me don't. So broadly, throughout the economy as a whole, each dollar invested results in productive growth of at least 4%, after controlling for risk.
Now imagine that the situation in our factories is the same as before, but that interest rates are only 1%. You can still issue bonds, of course, but now so can I. And if we do both issue bonds, the result is that the average economic return on investment is lower: my 2% productive gain and others like it bring down the average. If capital markets are functioning well, there's nothing wrong with that. Interest rates should be lower in the latter situation because there's more cash that people are trying to put into productive uses; the most productive uses should still most easily attract dollars, so all of the investments returning 4% that were available before should still get funded; only afterwards should the leftover cash flow to less productive investments like the one in my factory.
But in reality there are many reasons to think that broadly lower interest rates might result in capital being allocated to less productive uses at the expense of more productive ones. First, investors cannot always easily distinguish between more and less productive investments. Things usually tend to work out all right in part because borrowers only have an incentive to borrow if they believe they can profitably make use of borrowed dollars; but less productive borrowers can turn a profit at lower interest rates, so if lenders can't distinguish them from their more productive competitors for borrowed dollars, then the macroeconomic return to investment will fall as less productive investments partially crowd out more productive ones. Second, investment competes with consumption, which is unproductive by definition. People will forgo spending cash today only if they're promised so much more tomorrow that it seems worth the wait; when interest rates are low, people will spend more money today on non-productive uses (consumption)
than they would if interest rates were higher.
Well-functioning capital markets should sort it all out. But it's not at all clear that we have well-functioning capital markets. Some of the potential reasons for that are well mooted; another class of reasons has to do with the fact that out capital markets are subject to massive manipulation by central bankers. Interest rates today are not extraordinarily low because lots of people are willing to forgo spending today in exchange for a pittance more tomorrow; interest rates are near zero because central banks have created a whole lot of money out of nothing, and that cash has to go somewhere. Indeed, this is a major reason that mainstream monetary theory says you should lower interest rates during a recession: by doing so, you jump-start the economy by enticing people to spend money now that they otherwise would have waited to spend until tomorrow—but that's essentially because you've made money tomorrow worth less than it would have been otherwise, not because you've made money today worth more.
So at the same time, you're also probably shrinking future economic growth. And there's not much reason to think that all these crisp, newly minted dollars are flowing to the most productive uses. Indeed, much of that money (by design) has gone to shoring up the balance sheets of big banks, mainly by inflating the value of government-issued bonds (thus lowering broad interest rates) and other assets—including houses.
Thanks for the expansion. My oversimplified theory is that central banks created the post-crisis money to replace the mortgage payments on $500,000 loans for $200,000 houses made to people making $20,000/year that were never going to be paid back. It's not really that the wealth of the payment buyer has increased; it's that the balance sheets of the banks have been expanded.
>investors have been discouraged from investing in productive assets and investment vehicles by the low interest rates
Not really. They've been discouraged from investing in productive assets because of anemic demand - caused in turn by high income and wealth inequality.
No point in building another factory if the people who would purchase its output are stuggling to pay down student loans, rent and spending the little disposable income they do have on an iPhone.
If interest rates are low, the marginal investor sees little benefit to deferring the enjoyment of their earnings. A great deal of bonds and bank deposits are used to finance corporate investments in human resources and technology; from giving a line of credit to a family owned restaurant to buying an SMA line for an electronics manufacturer.
That makes no sense at all to me. If a company wants to borrow money to finance corporate expansion low rates is a great time to do it because the money is cheap.
Parent is talking about investors, not about firms. From afar, there seems to be a great deal of overlap. Up close, not so much. An eternal task for executives is convincing owners that the firm shouldn't just sell all its assets and distribute the proceeds.
there was a HN post recently ( that I can't find at the moment ) saying that low interest rates are a motivation for people to do silly things in the financial markets to get better returns.
> But increasingly the battle seems to be one over methodological choices and data interpretation rather than major data errors or fabrications, as the initial FT work suggested.
It's not saying that. The Economist refers to itself earlier¹ saying this:
> All told, Mr Piketty is guilty of sloppiness (certainly in his notation), and perhaps of some errors. But there is little evidence, so far, to support the serious charge of cherry-picking statistics. Nor have his findings that wealth concentration is, once again, rising been fatally undermined.
You claimed that he was being fraudulent, and this is saying the opposite.
My article most certainly does not say that he "deliberately" altered his data, which I presume to mean towards his world view. You can't just lay out one side of the accusations then ignore the response entirely, especially when the economist is not backing up the FT's highly slanted take on it.
Also capital income from housing actually looks to be declining pretty sharply for almost a decade?
To the extent housing does matter it looks a lot less volatile than non-housing capital income.
TL;DR. More people are renting vs buying nowadays. Real estate has been a relatively good investment since WW2 but stock markets have appreciated more. Water is wet.