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Thursday, February 13, 2014
Wednesday, February 5, 2014
Change In The Way EFF House Price Index Is Calculated
Here's a comparison between the new index (published Jan'14) and the old index (published Dec'13, indexed by me, Jan'03=1,00) from January 2012 to December 2013 (the last month we have old index data for):
Notice how the monthly fluctuations follow a new pattern. The gap between the new index and the old index (new minus old) is not stable as you can see from this graph (data from Jan'10 to Dec'13):
Note especially the sharp change in January 2013. It looks like the high growth between January 2012 and January 2013 is smoothed down in the new index. The adjustment becomes again smaller throughout 2013, coinciding with sharply slowing growth.
I don't know yet what to think of this. What we can be sure of is that the Jan'13 adjustment gives us higher year-on-year growth in Jan'14 compared to what it would have been in the old index, or in the new index had the gap between the new and old been more stable. It also makes it more likely that year-on-year growth in Feb'14-May'14 will be significantly lower than it was in Jan'14 (-1,0 %, which was surprisingly strong...), doesn't it? Help me out here, quants :-)
And if you think I have done a "Reinhart-Rogoff" with my Excel, let me know as soon as possible.
Notice how the monthly fluctuations follow a new pattern. The gap between the new index and the old index (new minus old) is not stable as you can see from this graph (data from Jan'10 to Dec'13):
Note especially the sharp change in January 2013. It looks like the high growth between January 2012 and January 2013 is smoothed down in the new index. The adjustment becomes again smaller throughout 2013, coinciding with sharply slowing growth.
I don't know yet what to think of this. What we can be sure of is that the Jan'13 adjustment gives us higher year-on-year growth in Jan'14 compared to what it would have been in the old index, or in the new index had the gap between the new and old been more stable. It also makes it more likely that year-on-year growth in Feb'14-May'14 will be significantly lower than it was in Jan'14 (-1,0 %, which was surprisingly strong...), doesn't it? Help me out here, quants :-)
And if you think I have done a "Reinhart-Rogoff" with my Excel, let me know as soon as possible.
Sunday, February 2, 2014
High Loan-To-Value Mortgages And The Real Concern For The Norwegian Youth
During the last week or two I have participated in a debate over the Norwegian financial authorities' limit on high loan-to-value mortgages dating back to 2012. The limit is not absolute, but it pushes banks in most cases to require that the buyer of the property finances 15 % of the purchase with equity. In other words, it limits the mortgage to 85 % of property value. This is known as "egenkapitalkrav på 15 %" in Norwegian.
(For further information on reasons behind this kind of limit, I suggest you read this Bloomberg article by Peter Orszag. He looks at the newly imposed limit in New Zealand, but mentions also that Canada, Israel, Singapore and Sweden among others have similar limits.)
The public opinion in Norway until late has been strongly against the raised limit. Catering to this opinion helped the newly elected government to win the elections; the parties campaigned on reducing the limit back to 90 %/10 % were it stood earlier (although it was less strictly enforced back then, and 100 % loan-to-value mortgages weren't unheard of). For sure, this is a controversial tool, but then again, there are no perfect tools. In the end, the limit is criticized exactly because it achieves the goals it was meant to achieve. You need to evaluate the pros and cons of it to form an opinion on it. I'll start by presenting the cons taken up by the dominating side, before I move to the pros, and most importantly, the underlying reasons behind raising the limit.
Norway has a relatively egalitarian society, reflecting the strength of the Nordic social-democratic movement. People are for equal opportunity. Equal opportunity can be defined in many ways, and in Norway it clearly includes the opportunity to buy a home given that you have an income that can serve the loan. What creates inequality (klasseskille) is leaving people with less (inherited) resources on the rental market, where they pay for their housing a lot more than the homeowners do (not least thanks to the heavy tax benefits enjoyed by mortgage-holders). Add the enormous house price appreciation witnessed in Norway, and you get a feeling that the rich get richer and the poor get poorer, and it's hard to deny that it hasn't been the case during the last 20 years.
The main* argument against the 85 % limit is thus that it creates inequality by leaving the ones without large savings and/or financial help from parents on the rental market. And people here genuinely -- and somewhat understandably, when we take into account the recent history -- believe that one is always better off owning. The conclusion from this is that young people should be helped to "enter the market" as early as possible, so that they don't "waste" their money by renting.
The intentions behind the policy of high homeownership, especially among the less well-off, are no doubt good. But good intentions don't always lead to good outcomes. This policy was taken to one kind of extreme in the U.S. in early 2000, where it was one of the reasons behind the subprime crisis that started in 2007. The pursuit of high homeownership has been taken to an extreme in Norway too, although we shouldn't draw too many parallels between these two countries. Whereas in the U.S. it was the means that became extreme (subprime/NINJA loans), in Norway it has been the level of achievement that is in my opinion extreme.
Homeownership in Norway has achieved what one could almost describe as cult-/religion -like status, and the homeownership ratio stands at over 80 %. In the age group 30-34 year-olds, 74 % own their own home, in the group 25-29 year-olds 52 %, and even in the group 20-24 year-olds whole 19 % are homeowners (source: NIBR). These are mind-blowing numbers, many times higher than in most of the other developed countries. And compared to inhabitants of the other rich nations, Norwegians privately own relatively little financial assets like stocks and bonds. Most of their wealth is tied to the property market. For an outsider this might sound like a sign of a bubble, but for Norwegians the central role of the housing market is rather something to be proud of (this might explain why prime minister Solberg used the concentration of wealth on the housing market as an argument against a bubble, like I told earlier).
As I have stated on earlier occasions, I'm concerned for the Norwegian youth. It's clear that there is a risk related to taking a mortgage with a high loan-to-value ratio. The house prices do fall, and sometimes significantly.
According to the latest review of banks' lending practises from fall 2013 (see Finanstilsynet, in Norwegian), the loan-to-value ratio exceeds 85 % in 35 % of mortgages to under 35 year-olds. In 12 % of the youth's mortgages the loan-to-value ratio exceeds 100 %.
These are young people who have the most productive decades of their life right in front of them. According to NIBR, 52 % of 20-34 year-olds are homeowners. Of these, according to Finanstilsynet, 35 % have mortgages where the loan-to-value ratio exceeds 85 %. This is where in my opinion the biggest risk to Norwegian economy lies. Many of these young people have seen no alternative to owning. And the state and the banks have taken care that an internationally disproportionate share of them get to own -- by providing them with easy credit.
I'm not the only one who is worried that the young people who have been helped to the market might end up getting hurt. The 85 % limit is there because Norwegian and international financial authorities, among others, directly or indirectly (through bubble concern) share my concern for the Norwegian youth. This includes Norges Bank, Finanstilsynet, Ministry of Finance, IMF, OECD, and so far three Nobel laureates in economics. (Some evidence here, here** and for example here.) Do these authorities, or I, know for sure that the house prices will fall significantly? No. But we know that the risk of this happening is real. We know that no one should state that they help the young people by providing them with easy credit, so that they can buy property that according to many indicators is already overvalued.
So here are the two sides to this debate (somewhat tongue-in-cheek, if you allow):
Team A: "We're helping the young people by calling for easier access to credit"
Members:
Mostly homebuilders and real-estate agents (!) since the house prices started to fall.
Team B: "We're helping the young people and the Norwegian economy by restricting access to credit"
Members:
Norges Bank
Finanstilsynet
IMF
OECD
Yours truly
It's time for you to choose your side.
---------------------------------------------------------
* Some people more understandably oppose the limit on the grounds of negative consequences of government intervention in the markets. It's another story, but I think you don't want to start here if you want to free the markets from government intervention. A free market is not reality, and banks don't need to behave like they would behave in a free market. Instead, they have very strong (perhaps short-term, but nevertheless) incentives to lend out more freely than is healthy for the economy.
** This is a very important article in that it reveals what the government really thinks about the housing market. I think we can thank the new finance minister Jensen for saying out loud something that she and the prime minister Solberg since have tried to downplay in public; there is a real concern for the housing market. This perhaps also explains why the government didn't even try to keep it's promise to take the limit back to 90 %/10 %.
(For further information on reasons behind this kind of limit, I suggest you read this Bloomberg article by Peter Orszag. He looks at the newly imposed limit in New Zealand, but mentions also that Canada, Israel, Singapore and Sweden among others have similar limits.)
The public opinion in Norway until late has been strongly against the raised limit. Catering to this opinion helped the newly elected government to win the elections; the parties campaigned on reducing the limit back to 90 %/10 % were it stood earlier (although it was less strictly enforced back then, and 100 % loan-to-value mortgages weren't unheard of). For sure, this is a controversial tool, but then again, there are no perfect tools. In the end, the limit is criticized exactly because it achieves the goals it was meant to achieve. You need to evaluate the pros and cons of it to form an opinion on it. I'll start by presenting the cons taken up by the dominating side, before I move to the pros, and most importantly, the underlying reasons behind raising the limit.
Norway has a relatively egalitarian society, reflecting the strength of the Nordic social-democratic movement. People are for equal opportunity. Equal opportunity can be defined in many ways, and in Norway it clearly includes the opportunity to buy a home given that you have an income that can serve the loan. What creates inequality (klasseskille) is leaving people with less (inherited) resources on the rental market, where they pay for their housing a lot more than the homeowners do (not least thanks to the heavy tax benefits enjoyed by mortgage-holders). Add the enormous house price appreciation witnessed in Norway, and you get a feeling that the rich get richer and the poor get poorer, and it's hard to deny that it hasn't been the case during the last 20 years.
The main* argument against the 85 % limit is thus that it creates inequality by leaving the ones without large savings and/or financial help from parents on the rental market. And people here genuinely -- and somewhat understandably, when we take into account the recent history -- believe that one is always better off owning. The conclusion from this is that young people should be helped to "enter the market" as early as possible, so that they don't "waste" their money by renting.
The intentions behind the policy of high homeownership, especially among the less well-off, are no doubt good. But good intentions don't always lead to good outcomes. This policy was taken to one kind of extreme in the U.S. in early 2000, where it was one of the reasons behind the subprime crisis that started in 2007. The pursuit of high homeownership has been taken to an extreme in Norway too, although we shouldn't draw too many parallels between these two countries. Whereas in the U.S. it was the means that became extreme (subprime/NINJA loans), in Norway it has been the level of achievement that is in my opinion extreme.
Homeownership in Norway has achieved what one could almost describe as cult-/religion -like status, and the homeownership ratio stands at over 80 %. In the age group 30-34 year-olds, 74 % own their own home, in the group 25-29 year-olds 52 %, and even in the group 20-24 year-olds whole 19 % are homeowners (source: NIBR). These are mind-blowing numbers, many times higher than in most of the other developed countries. And compared to inhabitants of the other rich nations, Norwegians privately own relatively little financial assets like stocks and bonds. Most of their wealth is tied to the property market. For an outsider this might sound like a sign of a bubble, but for Norwegians the central role of the housing market is rather something to be proud of (this might explain why prime minister Solberg used the concentration of wealth on the housing market as an argument against a bubble, like I told earlier).
The real concern for the Norwegian youth
As I have stated on earlier occasions, I'm concerned for the Norwegian youth. It's clear that there is a risk related to taking a mortgage with a high loan-to-value ratio. The house prices do fall, and sometimes significantly.
According to the latest review of banks' lending practises from fall 2013 (see Finanstilsynet, in Norwegian), the loan-to-value ratio exceeds 85 % in 35 % of mortgages to under 35 year-olds. In 12 % of the youth's mortgages the loan-to-value ratio exceeds 100 %.
These are young people who have the most productive decades of their life right in front of them. According to NIBR, 52 % of 20-34 year-olds are homeowners. Of these, according to Finanstilsynet, 35 % have mortgages where the loan-to-value ratio exceeds 85 %. This is where in my opinion the biggest risk to Norwegian economy lies. Many of these young people have seen no alternative to owning. And the state and the banks have taken care that an internationally disproportionate share of them get to own -- by providing them with easy credit.
I'm not the only one who is worried that the young people who have been helped to the market might end up getting hurt. The 85 % limit is there because Norwegian and international financial authorities, among others, directly or indirectly (through bubble concern) share my concern for the Norwegian youth. This includes Norges Bank, Finanstilsynet, Ministry of Finance, IMF, OECD, and so far three Nobel laureates in economics. (Some evidence here, here** and for example here.) Do these authorities, or I, know for sure that the house prices will fall significantly? No. But we know that the risk of this happening is real. We know that no one should state that they help the young people by providing them with easy credit, so that they can buy property that according to many indicators is already overvalued.
So here are the two sides to this debate (somewhat tongue-in-cheek, if you allow):
Team A: "We're helping the young people by calling for easier access to credit"
Members:
Mostly homebuilders and real-estate agents (!) since the house prices started to fall.
Team B: "We're helping the young people and the Norwegian economy by restricting access to credit"
Members:
Norges Bank
Finanstilsynet
IMF
OECD
Yours truly
It's time for you to choose your side.
---------------------------------------------------------
* Some people more understandably oppose the limit on the grounds of negative consequences of government intervention in the markets. It's another story, but I think you don't want to start here if you want to free the markets from government intervention. A free market is not reality, and banks don't need to behave like they would behave in a free market. Instead, they have very strong (perhaps short-term, but nevertheless) incentives to lend out more freely than is healthy for the economy.
** This is a very important article in that it reveals what the government really thinks about the housing market. I think we can thank the new finance minister Jensen for saying out loud something that she and the prime minister Solberg since have tried to downplay in public; there is a real concern for the housing market. This perhaps also explains why the government didn't even try to keep it's promise to take the limit back to 90 %/10 %.
Thursday, January 9, 2014
Paul Krugman vs. Erna Solberg
Paul Krugman has managed to stir some public debate again. He came to Norway and stated what almost any economist would state at this point -- pretty much what Robert Shiller had said already in 2012 and Vernon Smith in 2013 --, namely that this looks like a housing bubble. That makes it now three Nobelists. Krugman, who is not exactly a person who tries to avoid confrontation at all costs, must have been nevertheless surprised by what followed:
No other than the prime minister, Erna Solberg, replied to Krugman and denied the existence of a bubble. Norway is different and foreign economists don't understand it. The usual stuff.
And this time Krugman wasn't even provocative in his comments! It seems in Norway mere mentioning the word "bubble" is provocative enough? This reminds me of what Jeremy Grantham of GMO, a renowned investor, said in a Wall Street Journal interview:
I'd say Norway compares with Australia in this matter. Overall, there's of course nothing bad in being optimistic. One could argue even the opposite. It's just that it's not really helpful if your goal is to avoid a bubble, is it?
Not surprisingly, it didn't take long until the "propaganda machine" of real estate brokers and homebuilders was lined behind the prime minister. I've got to say it amuses me how these guys, many of whose business has started to cool down and who believe in the "it's the negative sentiment, stupid" story (and continue to be proponents of the "we're not building enough" story), start tearing their hair out when faced with bubble suggestions and come out with their often weak arguments. Another clear sign of a bubble?
Guys, you can't argue against a bubble by just presenting the factors that prove that Norway is different. To argue against a bubble you need to show us how much higher price level those factors can support and that that price level is not yet exceeded. It's the price where the bubble always is. Your arguments could (and probably would) be used as well to justify a price 50 % above the current level.
The foreign economists look at indicators like price-to-rent, price-to-income and debt-to-income exactly because they don't want to get entangled in country-specific factors. You are denying the warning messages derived from these common indicators by relying on nothing else than country-specific factors. That often leads to a conclusion that "this time is different", and that's what these economists have learned to be afraid of.
So if you tell me Norway is rich, I say it's probably reflected in the price level already. Incomes are high? Debt-to-income is already around 210 %, close to world record levels. You say you're not starting to build new houses before 70 % of them are sold in advance? I say that this practice keeps the supply fairly tight, and a tight supply leads to higher prices. You think you can avoid a substantial fall in prices by keeping the supply tight? It's hard when you've contributed to the bubble with the very same practice. In addition, it's very hard to forecast the future need for housing, as work-based immigration to Norway is of cyclical nature. And forget the "people are moving into cities" argument. It's been the same in every country that has experienced a housing crash during the last 10 if not 30 years. This argument might very well have contributed to the bubble, like the bigger-than-national price decline now experienced in Oslo suggests.
In the article Erna Solberg is quoted arguing against a bubble by saying that in Norway there is one asset people put their savings in and take loans against, and it's housing. Isn't this a weakness, not a strength?
Denying a bubble outright is not smart. Being afraid of a bubble is smart. Former contributes to a bubble, the latter helps in avoiding it. So which one do you choose? Denying a bubble is of course a natural reaction from someone who is shit-scared of a bubble and thinks that negative sentiment can lead to a crash.
Let's face it. The government is obviously "very concerned with the housing market", as the outspoken new finance minister, Siv Jensen, told in October (neither denying nor confirming a bubble). This is fully in line with the concern for a bubble the previous prime minister, Jens Stoltenberg, aired already more than two years ago. So either Erna Solberg's comments were based on her private opinions, or then she is trying to calm people down. If the latter is true, we all should be worried. This is what Krugman probably referred to when he said that it's a sign of a bubble that politicians come out and say everything is OK.
I have a message to these people who use their expert -- or authoritative -- position to directly or indirectly push people to buy their first home or invest their savings in a rental apartment: If this turns out to be a bubble and there's a 20-40 % decline in the coming years, you should be ashamed. What you are telling people who are facing a big and very risky financial decision is that there's not really any risk there.
No other than the prime minister, Erna Solberg, replied to Krugman and denied the existence of a bubble. Norway is different and foreign economists don't understand it. The usual stuff.
And this time Krugman wasn't even provocative in his comments! It seems in Norway mere mentioning the word "bubble" is provocative enough? This reminds me of what Jeremy Grantham of GMO, a renowned investor, said in a Wall Street Journal interview:
"America is a very, very optimistic-biased society, as I believe, incidentally, Australia is, for whatever that means. We're the two great optimistic societies. You can have a conversation about a housing bubble in England, and they'll say, 'oh, is that right? Let me see the data.' If you have one in Australia, you have World War III! They hate you. They hate you for years! [laughs] The idea that you could suggest that they were having a housing bubble. [laughs]"
I'd say Norway compares with Australia in this matter. Overall, there's of course nothing bad in being optimistic. One could argue even the opposite. It's just that it's not really helpful if your goal is to avoid a bubble, is it?
Not surprisingly, it didn't take long until the "propaganda machine" of real estate brokers and homebuilders was lined behind the prime minister. I've got to say it amuses me how these guys, many of whose business has started to cool down and who believe in the "it's the negative sentiment, stupid" story (and continue to be proponents of the "we're not building enough" story), start tearing their hair out when faced with bubble suggestions and come out with their often weak arguments. Another clear sign of a bubble?
Guys, you can't argue against a bubble by just presenting the factors that prove that Norway is different. To argue against a bubble you need to show us how much higher price level those factors can support and that that price level is not yet exceeded. It's the price where the bubble always is. Your arguments could (and probably would) be used as well to justify a price 50 % above the current level.
The foreign economists look at indicators like price-to-rent, price-to-income and debt-to-income exactly because they don't want to get entangled in country-specific factors. You are denying the warning messages derived from these common indicators by relying on nothing else than country-specific factors. That often leads to a conclusion that "this time is different", and that's what these economists have learned to be afraid of.
So if you tell me Norway is rich, I say it's probably reflected in the price level already. Incomes are high? Debt-to-income is already around 210 %, close to world record levels. You say you're not starting to build new houses before 70 % of them are sold in advance? I say that this practice keeps the supply fairly tight, and a tight supply leads to higher prices. You think you can avoid a substantial fall in prices by keeping the supply tight? It's hard when you've contributed to the bubble with the very same practice. In addition, it's very hard to forecast the future need for housing, as work-based immigration to Norway is of cyclical nature. And forget the "people are moving into cities" argument. It's been the same in every country that has experienced a housing crash during the last 10 if not 30 years. This argument might very well have contributed to the bubble, like the bigger-than-national price decline now experienced in Oslo suggests.
In the article Erna Solberg is quoted arguing against a bubble by saying that in Norway there is one asset people put their savings in and take loans against, and it's housing. Isn't this a weakness, not a strength?
Denying a bubble outright is not smart. Being afraid of a bubble is smart. Former contributes to a bubble, the latter helps in avoiding it. So which one do you choose? Denying a bubble is of course a natural reaction from someone who is shit-scared of a bubble and thinks that negative sentiment can lead to a crash.
Let's face it. The government is obviously "very concerned with the housing market", as the outspoken new finance minister, Siv Jensen, told in October (neither denying nor confirming a bubble). This is fully in line with the concern for a bubble the previous prime minister, Jens Stoltenberg, aired already more than two years ago. So either Erna Solberg's comments were based on her private opinions, or then she is trying to calm people down. If the latter is true, we all should be worried. This is what Krugman probably referred to when he said that it's a sign of a bubble that politicians come out and say everything is OK.
I have a message to these people who use their expert -- or authoritative -- position to directly or indirectly push people to buy their first home or invest their savings in a rental apartment: If this turns out to be a bubble and there's a 20-40 % decline in the coming years, you should be ashamed. What you are telling people who are facing a big and very risky financial decision is that there's not really any risk there.
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.)
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
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,
...in 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: ssb.no (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!
Source: ssb.no (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!
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