Thursday, December 12, 2013

Statistics Norway Shows Creativity

I know, I've been picking on Statistics Norway (SSB) quite a lot. But isn't it my duty as a taxpayer in Norway? What I'm going to say this time is most probably too arrogant, taken into account that I'm an amateur, whereas SSB is full of professionals. I've never even seen a "macroeconomic model" in real life. But due to some combination of luck and skill, when it comes to house price forecasts during the last 12 months, I've beaten the KVARTS model SSB uses. That's where the arrogance probably comes from. Don't get me wrong: I have not published any accurate house price forecasts but, unlike KVARTS model, I have at least seen the possibility for price decline given the current fundamentals.

I will now simplify things (but so does KVARTS), and you should take this as my guess at what has happened here:

We got a "sneak peek" at KVARTS in June this year, when SSB invited an economist from a private bank to test the model. He wanted to see what, according to KVARTS, happens to house prices (hot topic in banks as well, it seems) if Brent oil price drops to $50 and stays there for the next three years. You might think house prices would drop? So did the economist, but this is not the case. Like him, you've most likely underestimated the robustness of Norwegian economy, as this would only reduce the house price growth to 2,1 % for the three-year period 2014-2016. Ok, this sounds ridiculous, you might think. Surely they have not taken into account the psychological effects? Wrong again. Without the effect of negative sentiment, prices would climb 6,3 %.

There you have it. That's KVARTS (version 06/13). Unable to see a house price decline even in a scenario many would label "doomsday".

Well, it so happens that the housing market cools down fairly dramatically and house prices start to decline during the summer, and this without any drop in oil price nor a visible drop in the absolute level of any other fundamentals. What do you do with a model that doesn't match reality? You scrap it, or you adjust it. Taken into account the "robustness" of KVARTS I described above, it probably doesn't take a small adjustment to get the house prices falling? Remember, the absolute levels of fundamentals have not really changed. But SSB doesn't have the time or the resources to overhaul the whole model. No, this calls for something like the opposite of deus ex machina ("diabolus ex machina"?). Enter the "strongly negative sentiment".

Here you have KVARTS, version 12/13. Finally able to see a house price decline, although only as a consequence of people's irrational fear and pessimism. It's very convenient, because it means that you don't really need to change your model for it to match reality, do you? The model is pretty much correct as it was, but the problem is with the reality; there are some irrational short-term fluctuations caused by strongly negative sentiment. In plain English it means "people have got it all wrong", and in plain Norwegian something like "folk har tatt feil". Because this sentiment doesn't match the real reality (?) suggested by the fundamentals, the effects will be short-lived, and soon enough we're back on the upward trajectory suggested by KVARTS.

SSB, please correct me if I got it all wrong?

What I think has changed in the economy, in reality, is the rate of change in the fundamentals. Like I showed in my previous post, SSB knows this - everyone knows it. It's called "utflating" in Norwegian and it's been going on throughout the year, not just in the autumn when the sentiment became increasingly negative.  It's the flattening out that increases pessimism among (heavily indebted) people. It's fundamentals driving sentiment (although this smells like "the chicken or the egg"). People are not stupid. When the growth slows and turns even a little bit negative, they get more pessimistic - for a reason. People got pessimistic because of a suddenly cooling housing market and real house price decline, and the price decline was due to other fundamental factors which even a real estate broker has admitted. They also got pessimistic when they heard (last winter?) that economic growth is slowing down in Norway.

To me it seems the change in the rate of change in fundamentals is clearly not captured even close to the extent it should be in KVARTS. The "bust" in boom and bust is totally missing here? Again I point out, as my amateur opinion, that a model heavily informed by what happened in 2008-2009 might be too robust, especially if that's the only real "bust" that falls within the data period. As far as I know, KVARTS uses data back to 1995, and so ignores the housing bust of late 80s and the recession that followed it.

Ådne Cappelen and Thorbjørn Eika at SSB, please read some Hyman Minsky, will you? Especially the parts where he talks about how a stable, robust economy invites instability by making people take oversized risks through oversized debt? It seems to me that in your model you have build the most robust economy ever, and if it doesn't call for too much leverage, and thus instability, then I can't see what would? I know, you can't incorporate these things in your model, even though you might think there's something to it. Well... Fuck the model? At least it should come with the same warning stickers cigarette packs have on them. "The Norwegian people, in aggregate, are probably smarter than KVARTS."

Feel free to share this, because I'd really like to hear some opinions from experts on all this. (Twitter: @catonyourface)

(I can't resist the temptation to float a "conspiracy theory" here: Was the time and resources needed to adjust KVARTS the real reason for SSB not giving out a forecast in September? The timing might be a bit too early, though.)

Sunday, December 8, 2013

The Death of Economic Cycles

I guess I could say I was born under a lucky star. In the year of my birth, 1979, Businessweek published as their cover story a now famous article "The Death of Equities". What followed was a revival of equities, culminating in the dotcom bubble of 2000. If you bought in 1979 and sold in early 2000, you made a fortune. The big picture is that the standard of living  in the Nordics has mostly been improving during my lifetime (there was a fairly deep recession and house price declines in the late 80s/early 90s, though). It seems that with higher standard of living comes higher house prices, and household debt. One could ask if we have had it too good.

But let's move to the subject. Mark Thornton, an economist, who wrote about the Norwegian housing bubble already in January this year (on my birthday, of all days!), has written a short update on the situation in Norway. In it he links to my blog reports as evidence that Norwegians have entered the "denial phase". I think he's right in that there seems to be a widespread denial of the possible - even likely - negative consequences of the house price decline that has just started.

 It seems that nearly every driver of economic growth is expected to flatten out. An extreme example of this is this Dagens Næringsliv interview with Rune Bjerke of DNB where the leader of biggest bank confirms that

  • investments in new houses [due to declining house prices, I assume],
  • investments in the oil sector,
  • private consumption, and
  • investments by companies in general, other words all the main drivers of economic growth, will more or less flatten out ("flate ut"). "Flate ut" has become a real catch-phrase in Norway during the autumn! It reminds me of "boligfest", housing party, which was all over media just a year ago, but is now gone. It referred to the rising house prices and the related "wealth effect".

What Norway has gone through during the last 20 years could be described as some kind of "Golden Age". And especially the last 3 to 4 years - after the massive worldwide fiscal & monetary stimulus managed to turn the looming, deep downturn into a prolonged boom in Norway - have been seen even as unhealthy (for example, in the article Bjerke talks about healthier, more sustainable housing market and oil & gas sector, referring to the high growth rates of past).

All this takes me again back to Irving Fisher and the "permanently high plateau" of stock prices in 1929. After admittedly unsustainable, even unhealthy growth in house prices and oil & gas sector, what we should expect according to Bjerke and Statistics Norway (see my previous post) is a couple of years of simultaneous flat development in any imaginable indicator in the Norwegian economy, followed by... new growth. And the reason for nothing really going wrong in the coming years? I know I will be underestimating their intelligence, but it sounds to me like the reason is that things are so well in Norway today. Salaries will keep on rising at 3-4 % p.a. and continued work-based immigration will keep demand for housing high. All this despite lack of growth and investments, declining oil price and increasing unemployment. 

Like I mentioned, Statistics Norway even assumes that the oil price will decline over 20 % during the next two years. According to Bjerke and SSB, as well as many other experts in Norway, things just flatten out at all-time-high levels after a long period of substantial growth. There are exceptions, like Nordea Bank (who expect 15-20 % house price decline), but even in their forecast the word recession is nowhere to be found.

In my amateur opinion, based on the decline in nearly all indicators, the base scenario for Norwegian economy in 2014 should be a recession. Unless, of course, one assumes that the economic cycles are dead.

I must finish with a side note. The Norwegian people, experts and media are looking for reasons behind the house price decline, and as I have already mentioned, pessimism is very high on the list of suspects. It's the negative media and all these "doomsday prophets" (forecasting a 15-20 % house price decline makes you one) that are causing the negative spiral. Am I seen as an enemy of the public? Who knows.

The truth is that you need "pessimists" (people suspecting a bubble), and many of them, to avoid a bubble. And you need them to feel free to air their opinion in the media, early on when the prices have taken off, without being branded as doomsday prophets or pessimists. And some people actually need to heed this advice. This has not been the case in Norway, and as a result the public opinion has been the most complacent I've ever witnessed. This complacency, lack of concern, is one of the reasons for what is most likely a housing bubble. Two years ago the previous prime minister, Jens Stoltenberg, tried to warn against a bubble. He tried to affect the sentiment that was too positive. But it seems no one paid attention. Now the widespread concern for "too pessimistic" media coverage just speaks for the underlying concern for a housing bubble. A change in sentiment doesn't take a healthy market down, but it will always help to bring down a bubble.

Reality Hits Statistics Norway

As I reported earlier, Statistics Norway didn't have the resources needed to perform a house price forecast in September, just when it started to be clear that the prices are heading down. Fortunately they have put their house in order and came out with a forecast last week:

Source: (in Norwegian) (Sep'13 forecast is my assumption of what it could have looked like...)

It seems they have abandoned all hope for a price increase in 2014. But Norwegian "wealth effect recipients" don't need to worry, as SSB has also abandoned their linear extrapolation. It's going to be a nice little dip, a lot less steep than in 2008-2009, and then the sky is the limit again?

I read the report, searching for a good explanation for the shortness of the dip, and this is what I found:

The Norwegian economy is going to perform sub-par ("lavkonjuktur") throughout the forecast period (2014-2016), with GDP growth at 0,7 %, 2,1 %, 1,9 % and 2,5 % in 2013, 2014, 2015 and 2016, respectively. But despite this sub-par performance, income growth will remain high, which will give new support to house prices when the usually short-lived (according to SSB's model) psychological effects wear out.

I have to note that SSB expects (Brent) oil price to decline gradually throughout the period and to end up at around USD 90 per barrel in 2015. I will not go into more details, but the overall picture is that nearly everything seems to just flatten out nicely. More about this in my next post!