Posts Tagged ‘unemployment’

Bad Ideas Result in Bad Outcomes

October 7, 2009

As regular readers know, I’ve been away from blogging for a bit while I’ve been in the middle of a job transition. In my month-long hiatus, it seems like little has changed: the health care debate continues, the deflation/inflation and economic outlook remains uncertain, and the stock market continues to “climb a wall of worry.”

As the immediacy of the financial crisis recedes, the question of what has brought us to our present state remains largely unanswered. Or rather, there are dozens of answers, not THE ANSWER.  Among the myriad causes that are put forth: the Fed, Wall Street greed, deregulation, excessive regulation, Chinese savings rates, the Democrats and the Republicans. In past posts, I’ve added my 2 cents by pointing to the culture of “overspeculation.”

Fundamentally, bad outcomes are generally the result of either bad luck, bad ideas, or some combination of the two.  It may well be that the “bad idea” from which our financial upheaval arose is the belief that homeownership is an unequivocably good thing.  I came across a prescient 2004 article in BusinessWeek that outlined some of the reasons why home ownership is not as advantageous to the poor:

  • a house is often a poor family’s sole investment: concentrating their assets in an a vehicle that combines the historically lackluster long term returns of housing with the high risks of leverage
  • the poor have a higher “cost of carry” in home ownership than the wealthy, because they often pay higher interest rates and their lower tax rate reduces the effective subsidy of a mortgage deduction
  • while a mortgage was once considered a means of “forced savings,” the growth of easy-to-obtain home equity lines, interest-only and negative amortization mortgages all have negated the (already dubious) savings argument

British economist Andrew Oswald has noted the correlation between high unemployment and high home ownership.  Although more recent work has created a more nuanced interpretation of that relationship (good overview in a Slate article here), this “Oswald Hypothesis” clearly has at least a grain of truth.  The theory argues that home ownership makes people “sticky” geographically, and therefore less likely to move to find a job or better employment.  This may be particularly true for the poor given that “borderline” housing is typically already less liquid than homes in upscale neighborhoods, further reducing labor mobility.  This lack of salability in poorer neighborhoods is particularly acute in economic downturns, just the time when geogrpahic flexibility for workers is most important.  

Those who defend policies that promote broader home ownership often point to social benefits — homeowners have a sense of “skin in the game” of American society.  These arguments are no doubt true and important.  But the advantages of reinforcing such a sense of inclusion should be weighed against the costs.   Moreover, there other ways to promote engagement with community without the consequences attached to distorting housing market incentives.

This is not necessarily to argue against such incentives for home owners.  Certainly, I and many others personally benefit from many of these.  But every policy that distorts market mechanisms has consequences, many of which are unintended and adverse.  We may not yet be through thoroughly testing the “Oswald Hypothesis.”  If that theory is correct, current real estate conditions, whereby many homeowners have negative equity, will make labor mobility particularly poor this cycle.  This, in turn, would suggest particularly intractible rates of unemployment and consequent sluggish economic growth.  If blind faith in the “goodness” of high home ownership rates is indeed a bad idea at heart, we may not yet have seen all the corresponding bad outcomes.

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Of Unemployment Peaks and Economic Troughs

January 14, 2009

One of the great delights of doing research is when results, rather than confirming what you thought you knew, provide a different answer and allow you to gain new insight.  There’s been much talk of the need for additional stimulus (beyond the tremendous amount already in place which is discussed in “Whole Lotta Stimulatin’ Going On“).  Part of the rationale is the desire to keep consumption going by maintaining employment.  The assumption was challenged in a good column in Forbes the other day.  Looking back historically, the record of the timing of economic bottoms and unemployment peaks is quite surprising.  The chart below illustrates the unemployment rate (vertical axis in percentage terms).   

Unemployment Peaks, Economic Troughs

Unemployment Peaks, Economic Troughs

The notation at each cyclical spike denotes the lag between the official end of the recession (the economic trough) and the peak of unemployment.   The key insight is that unemployment peaks after the economy bottoms.  While it is obvious that productive employment is a good thing for the economy, it suggests that an economic turnaround is not directly tied to lowering the unemployment rate.  This suggests we should move cautiously in considering programs to boost employment  if the primary rationale is supporting consumption.  The above data suggest that turning around unemployment is not the key to turning around the economy — rather, employment statistics follow economic activity and often lag by long periods.

There are lessons here for investors as well.  In most past cycles, the capital markets anticipate economic recoveries.  If employment lags economic recoveries, which in turn lag market recoveries, this suggest that the stock market may rally well before unemployment peaks.  If this holds true this cycle, investors can expect their stocks to gain even as the unemployment situation worsens.  As the headlines will focus on increasingly dire employment data, investors would do well to keep in mind the old Wall Street adage, “markets climb a wall of worry.”