Wednesday, September 12, 2007

The Gold Standard

I would like to draw your attention to this article by Megan McArdle. Megan does a great job of outlining a lot of the reasons that I too oppose the gold standard. I know that among the Austrians, the gold standard is rather popular, and is supported by Paulities (Ron Paul for President supporters). Megan points out some of the absurdities in their position, but I also especially appreciate that she points out that allowing the currency to fluctuate eases the adjustment process. For the record, I am in favor of a monetarist approach to issue of the money supply, because I believe that the discretionary monetary policy of the Fed does us no favors, and imposes a fixed-rate of interest, that is far removed from the market rate. If you are interested, check out the divergence in LIBOR, and short-term treasuries. Or the spread between three-month treasuries and the Fed Funds rate... Take your pick, but also the Fed will have to bow to reality and make their adjustment, 5% Fed Funds. I don't think it will be lower than that because of the need to keep inflation in check.

Back to the Gold Standard, another important point that Megan makes is that because of the suddenness of adjustments required by a gold standard, recessions were deeper and much more severe, which reminded me of a graph I had put together for a paper I wrote about interest rates and how GDP growth had significantly lower standard deviation over time. I would also posit that the relative predictability of GDP has reduced the overall discount rate, which has foster a higher rate of growth. Risk, you have to remember is tied to volatility, and interest rates are tied to risk, lower volatility (ie. greater predictability) and lower rates will come with it.

That's my two cents for what's it worth. More to come on the 'R' word in the next post

Thursday, August 9, 2007

From the Department of Economic Literacy or lack thereof

I was browsing through the news this morning and I came across this lovely item in the Politico by Roger Simon.
THE POINT: Clinton is promising “a national response” to “the crisis of the more than 4 million young people between 16 to 24 who are out of school and out of work.” Barack Obama has announced an “urban poverty” agenda that covers some of the same ground.

The programs are interesting because they show how the conversation in Washington would change with a Democratic president. Some Clinton details from a campaign prĂ©cis: “She will … launch a $100 million Public/Private Internship Initiative to give at-risk middle- and high-school students job skills and work experience during the summer. … In addition, she will offer 1.5 million disconnected youth a second chance with meaningful job training in growing industries in their own communities, including renewable energy, health care, construction and financial services.”

Thats the meat of it... and the illiteracy part comes in here. Senator Clinton and Senator Obama, who has a similar program both voted for the minimum wage increase. There are numerous studies that talk about the effect (negative) on teen employment prospects because of a minimum wage increase. This one here is my favorite. The totally ironic thing as the study points out, the very people that Senator Clinton hopes to help through her new government program, are the very SAME people the minimum wage bill that she so proudly voted for has hurt the most. The most logical thing would be to remove the distortion and get rid of the minimum wage, but thats not how politicians think. One government mistake, needs another government program to fix it... only in Washington.

A better idea, save $99,999,000 and send all of the senate to Professor Mankiw's ever so popular economics class. :)

Tuesday, August 7, 2007

Article of the Day

This article by Arnold Kling on TCS Daily is a must-read today if you are at all interested in the health care debate.

Friday, August 3, 2007

Misunderstanding Economists

The latest article in Foreign Policy, entitled "5 Lies My Economist Told Me," is a classic example of a red herring argument. It posits a list of arguments that "Economists" would make. All I can do is laugh. This post does as good a take down of FP as I could. H/T Tyler Cowen.

Thursday, August 2, 2007

The Minimum Wage

I know I am few days late and the Federal Minimum Wage jumped up, but I recently came across this article on the minimum wage at the Federal Reserve Bank of Cleveland's website. Their conclusion should be familiar to anyone who has taken Econ 1A, when you increase the price of a good (Or in this case labor), you will consequently lower the demand. More in depth studies I have read, posit that the welfare gains to the lottery winners (those who keep their jobs) are more than offset by the welfare losses to those who gain into unemployment. Another argument is that by reducing the number of low wage (and hence low skill) jobs we are also making it more difficult for the unskilled to gain entry into the work force. Also, whenever you raise the price of something above its market clearing price you create incentives to form a black market. The cigarette market is a perfect example. Before the anti-smoking forces managed to jack up prices, there was very little black market activity in cigarettes. In places like New York City, there is a huge black market thanks to the Indians which do not have to pay the city tax. Regulation in interfering with the price mechanism has a multitude of unintended consequences, and the minimum wage bill, while making for good political theater, will ultimately end up hurting the people it is intended to help.

Monday, July 30, 2007


I am doing valuation work, and use NPV(Net Present Value)!! Its the superior measure, especially when considering multiple investment alternatives. IRR (Internal Rate of Return) may be easier to understand, but it is a bad way of looking at multiple investment alternatives. More to come...

Economics of Dating

This post will be filed under Monday-FunDay... though technically any day can be a FunDay, Sunday being my favorite day for FunDay. Today, being Monday will have to make up for the lack of fun yesterday. I was browsing through the Free exchange blog at the Economist website, and I came across an interesting post on how male dating prospects would be enhanced by the addition of the "Crush" application to the Facebook website. Being a single guy, anything that involves the psychology and economics of dating is fascinating to me. The behavioral basis of economic decisions is a very small subset of my professional work, but a larger subset of my personal interest. It is human behavior, and the assumption of rationality that underpins economics, and one of things that I find most fascinating. I am not going to debate rationality today, but suffice it to say, most of the attacks on rational behavior I find very unconvincing because it is often a projection of the author's rationality onto their subject, that causes them to diagnose the subject as irrational. Anyhow, back to dating...

One of the common problems associated with being a male, is that there is a cost associated with getting a date. That cost is often rejection, and opportunity cost associated with rejection, though that may be somewhat offset by the benefit gained from honing a better approach. In my observation, there are three basic choice sets for dating. One, is the sales guy approach, in which dating is a numbers game, ie. ceteris paribus, if I talk to X amount of girls, I will get Y amount of phone numbers, and Z amount of dates. The second approach is a variation of the sales guy approach, we'll call it the Ali approach in honor of my friend. This approach seeks to improve on the odds by deselecting certain girls based on observed characteristics. The trade-off is that more observation time and selecting of females will increase the lower the number of X's needed to get Y amount of numbers and enhance the chance of Z dates. The third approach is to rely on the networked approach. This in my opinion has the highest chance of Z per X but, because of the limited pool of X available, it also produces the least amount of Z dates.

The different basic approach that one uses actually is very interesting, because it implies a certain appetite for risk, and also puts an implicit value on rejection, and can reveal some other insights into how this person would react in other situations.

Implied Rejection Cost
Low Medium High
Sales Guy X
Ali X
Network X

From this we can see their implied cost of rejection.

The Facebook application, because of its networked capability increase the numbers of X far beyond the number you would meet in a typical weekend. It also reduces the psychological cost of rejection because if the girl does not have you as a crush, there isn't any public rejection. My theory is that the whether rejection is public or private it doesn't really matter, because public rejection is rejection none the less. The addition of Facebook and the internet will do little change the approaches and success rates of the three main approaches. The Network guy will continue to use his network to acquire dates, and will have the highest probability of Z from X. The Sales Guy approach will have the lowest probability, but again, no matter the approach, X is the determinant factor. Your psychological profile will determine which approach you use. If the cost of rejection to you is low, your optimum dating approach is the sales guy approach. If you place a high cost on rejection, then use your network to minimize the cost of rejection. That is your optimum approach, and it is likely you place a relatively lower value on Z. Whereas the Sales Guy puts a higher value on Z. The Sales Guy probably will do best professionally in a people-centric environment because the skills he has developed to do well in dating, (deemphasis of rejection, highly conversational) will serve him well professionally. He is most likely to be a salesperson, or a hospitality type. The Ali approach is often related to a strong analytical skill set. The skills developed here are a keen sense of place, and how one fits into it, along with an analysis of a variety of factors that will ensure the greatest likelihood of success. The Ali-type is a great analyst and adviser. The Network guy is likely to be something of an analyst but not much of one, because he lacks the good communication skills that the analyst has. He is likely to work in IT, or something similar, in which high-value social skills are not that important, whereas expertise is. His job does not require innovation in a broad sense, in other words, he is not good at thinking "outside the box" but very good at managing the space within the box.

Happy Monday!

Friday, July 27, 2007

Credit Crunch?

I'm working on a piece for work about whats going on in the credit markets. I thought I'd post a quick summary of my thoughts to date.

First, the business media is FINALLY starting to notice whats been going on for at least the last month. I noticed this a few weeks ago, and started to wonder. Well, actually in my business world this has been an issue since last year. Pricing has been elevated beyond what fundamentals would dictate, as cap rates were below lending rates on some Class A deals in the coastal markets. 2005 through mid-2006 that deal gets done. Late 2006 through 2007, we are seeing deals fall through because of the credit markets. This has filtered through into the Private Equity market as evidenced by Chrysler and a few other deals (Alliance Boots, Allison Transmission) that have been unable to be sold into the market. This was all quite predictable, as risk has been steadily been underpriced because of the absence of defaults. The subprime issue has reminded bond investors that risk is still around. Hence, investors are no longer shelling out for whatever deal comes to market, thereby reducing liquidity and increasing the risk premium. All of that is healthy. Risk matters and has in my opinion been devalued by market participants in the global chase for yield. That it is returning more to normal, means that the Bernanke Fed is finally squeezing out the excess money that the Greenspan Fed injected into the market in the aftermath of the recession and September 11th. Between October 2001 and January 2005, M1 grew an average of nearly 5.5% year-over-year. Some will dispute the use of M1, but I prefer it as a money measure, because it is the only measure most easily controlled by the Fed and gives an indication of their policy stance. Looking over the last 18 months, M1 has only grown at an average rate of .5%. A far cry from the Greenspan Fed era. The excess money is finally being squeezed out. So what does this mean? For commercial real estate, a return of risk, and a cap rate reversion, especially as it becomes laughable to underwrite continuous 6%+ rent growth in secondary markets over 10 years in light of the housing oversupply. (No kidding, I've seen some deals we've underwritten with that as an assumption). For the rest of the economy, lets hope the Fed doesn't overshoot. And we should see a fall in commodity prices. I am afraid though that a recession may be necessary to put the inflation genie back in the bottle.

Monday, July 16, 2007

Barter & Real Estate

There was an article this morning in the, the Phoenix Business Journal, (sub. required) that talked about a housing related "service." The website is called, and it claims to be re-inventing the way we buy and sell real estate. Thats the headline on the website, at least. Actually, it is not a reinvention of any sort.

Being an economist, I found the site interesting for two reasons.

1. The use of Barter
2. Another demonstrated use of the internet

The use of barter is indicative that there is insufficient capital in the system and that the money system has broken down. Similar things occurred in Russia after the ruble crisis of 1998. The currency in use no longer served as a store of value, which led to it no longer being an effective means of exchange. Barter, which is demonstrably less efficient than a monetary transaction only comes into play in modern times when the money system breaks down. My guess is that in places like Zimbabwe, where the money system is broken (because of government action), barter goes on quite frequently. In real estate, the transaction market has become decidedly less liquid, particularly here in Phoenix. In other words, at the current pricing levels, there are not enough buyers in the market. Sticky pricing prevails, and hence the supply of homes, at a given price is above the market clearing rate. The bargaining comes into play because there isn't sufficient capital for these particular buyers and sellers and the transaction market doesn't move fast enough. Its interesting, because its an inefficient way to transact. WHICH, brings me to point #2... the internet.

By now, everyone has read posts about the internet and real estate, and how it changes everything. Sure. Old story, lets move along right? The oft-overlooked thing about the internet is that its greatest power is in lowering the cost of information. The dramatic effect this has had on the consumer market is evident in shopping comparison sites. It has also had an effect on the auto industry, and now it is rolling into real estate. Greater competition, and more information at effectively zero cost has reduced the value of the services that agents provide. This is the biggest effect that this site will have. The swapping is of no consequence, it is the service based pricing, that will effectively undermine the current real estate agent pricing structure. Successful agents in both commercial and single-family will need to identify how they provide value to the seller, beyond throwing things up on the MLS, which is losing its information monopoly to sites like trulia and zillow.

Wednesday, June 13, 2007

Dissecting Mandel

Journalist / blogger Michael Mandel of BusinessWeek, has a provocative article that claims that GDP was overstated by a rough estimate of $66 billion over the three years. In other words, real GDP should be about 0.5% lower today, than it otherwise should be. Lets review his assertions:

1. Productivity as a whole should be lower over the last few years, reported as 1.8%, and should be 1.6%
2. Manufacturing output growth is overstated by 40%

From this he draws these implications:

1. The "speed limit" for the economy is lower, implications for Fed policy
2. US is losing competitiveness
3. Current metrics are outdated

Let us look at his evidence.
"When Houseman first uncovered the problem with the numbers that is created by offshoring, she was primarily focused on manufacturing productivity, where the official stats show a 32% increase since 2000. But while some of the gains may be real, they also include unlikely productivity jumps in heavily outsourced industries"

Why, may I ask are they unlikely? Logically this makes no sense. In fact, it is intuitive that productivity would rise the fastest in the most heavily outsourced industries. Let us consider why. The first factories to be outsourced are the least competitive ones, and hence the ones with the lowest productivity if we assume wage rates are approximately the same. As an example. I have three factories, one with a productivity rate of 50, one at 100, and one at 150. Now, lets say I offshore 1/3 of my factories. I would choose the least productive. Average domestic productivity before the offshoring occurred was 100, now with the two remaining factories it is 125, an increase of 25%, due primarily to offshoring. So, it is actually rather likely productivity would jump in the offshored industries.

"Yet Washington's official statistics show that productivity per hour in the furniture industry went up by 23% and output by 3% between 2000 and 2005. Those numbers baffle longtime industry consultant Arthur Raymond of Raleigh, N.C., who has watched factory after factory close. "And we haven't pumped any money into the remaining plants," says Raymond. "How anybody can say that domestic production has stayed level is beyond me." "

Well, when you think about it, it really isn't baffling, because logic tells us that by removing poorly performing factories out of a fixed pool, by definition must raise productivity. Mr. Raymond really should take some math classes and not act so surprised, yet Mandel uses this as evidence to back up his claim of uncompetitive American workers. "
"In some sectors, productivity growth may be an indicator not of how competitive American workers are in international markets," says Houseman, "but rather of how cost-uncompetitive they are."

Time for school for you too, Mr. Mandel. Mr. Raymond needs a friend.

So we can dismiss Mandel's assertion in #2, there hasn't been a change in American competitiveness to be concerned about. Resources are being allocated as the market determines. Nothing wrong with that. The competitive factories stay, the bad ones go, and America is better off through lower prices.

I think this also begins to chip away at #1. Let us finish the demolition job, for Mandel makes another crack at supporting assertion #1 with "evidence." His "evidence":
Yet no matter how hard you look, you can't find any trace of the cost savings from offshoring in the import price statistics. The furniture industry's experience is particularly telling. Despite the surge of low-priced chairs, tables, and similar products from China, the BLS is reporting that the import price of furniture has actually risen 6.7% since 2003.

The numbers for Chinese imports as a whole are equally out of step with reality. Over the past three years, total imports have climbed by 89%, as U.S.-based companies have rushed to take advantage of the enormous cost advantages. Yet over the same period, the import price index for goods coming out of China has declined a mere 2.3%. "

Well, he has no evidence. He says import prices have risen 6.7% despite the "surge". Yet, he somehow fails to put a number on the surge. And, even further, if we adjust for inflation, which by rough calculations has risen by 8.3% since 2003 (thru 2006). His price "increase" is actually a decrease of 1.6%. Funny how that works out. So in real terms, the unenumerated "surge" has actually worked to decrease prices.

The next paragraph tells us absolutely nothing, except that China has increased its exports to the United States. This is his "evidence", on which he bases his calculation pyramid... So, color me not convinced on #1.

As for the rest of his complaints about the import price index does not take qualitative changes into account, well myself and many other economists have the exact same complaint about the CPI, and in fact health care too. So, my big response will be, yes... and your point?

#3, I agree. I think some metrics we do use are outdated and could be improved. Capital investment is a big one. But, if our objective is to describe the general welfare of people within the political borders of the US, I think we do a good job for a difficult task.

Light Posting

Sorry for the light posting, had a lot of stuff going on at work, and thats the word of it... a lot of interesting things have happened in the last month, so expect a flurry...

Wednesday, May 2, 2007

Great Quote

I usually avoid too much philosophical discussion on this blog, but I couldn't resist with this quote:

"Capitalism makes us rich. ... But that's not why I love it. The marketplace, unfettered by government regulation but fettered by competition, gives each of us a chance to transform the world in the way we wish."

Thats from Russell Robert's book, "The Invisible Heart"

H/T Don Boudreaux

Tuesday, April 17, 2007

Moral Hazard, the Subprime Market and the Nanny State

Foreclosures tick up a bit, and government officials are falling all over themselves to save people from themselves. Ohio is planning on issuing a $100 million bond to bail troubled borrowers out. See this article in USA Today for details. And now, Freddie and Fannie already under significant pressure for their financial shenanigans, are rolling out new products to deal with the fall out.

Fannie and Freddie innovating to help out is not as big an issue for me personally. Though, I suspect the political pressure being brought on them has something to do with it.

Here is where the moral hazard comes in though. If states like Ohio, or probably California soon, or even the Federal Government spend tax dollars to essentially bail out borrowers who made poor decisions, then what is the incentive for those borrowers or any borrowers to do their due diligence and make sure they can afford a home? There is none. This was not a failure of the private market. People made bad decisions, and companies made bad decisions in extending credit. The rush of politicians to shield people and companies from their poor decision is one step further down the road of infantalizing the populace.

This is bad from an economic standpoint because of the moral hazard, and how it distorts future market decisions, and even worse from a policy perspective because it reinforces the idea that the government is the answer to everything.

So, maybe next time, I have difficulty paying the bills, I'll send a request to my buddies in Washington, they can pay it for me. We can call it an earmark, after all, there's no reason I should starve because I spent too much money going to Vegas. (ed: is it possible to spend too little money in Vegas?)

Monday, April 16, 2007

Subprime (Again....)

Felix Salmon over at his new blog points an article at Bloomberg, which I hadn't noticed. Fremont General, a large-sized originator of "subprime" loans, has recently sold several chunks off at a loss. The latest was a $2.9 billion chunk of loans, while we don't know the explicit quality of these loans, we can make a few assumptions here. First, Fremont sold these at a $100 million discount. Do the math and that is an expected loss of about 3.45%. If we make the assumption that this particular chunk of loans is representative of the market, then the so-called meltdown in subprime is not something to feared, it'll hurt, but it is not the end of the world.

Also, I would point out, this how healthy financial markets work. They discount and work through the bad stuff. Just as we did after the S&L crisis. In the apartment market we are already seeing that, with reversions of condo-conversions happening, and some minor REO stuff on failed conversions. There is significant amounts of "vulture" capital waiting to make a play.

Watch the subprime market, but if Fremont General is any indication, it won't be as bad as some are prognosticating.

Friday, April 13, 2007

Chasing Yields

The more and more data that I look into, it becomes apparent that Fed Chairman Ben Bernanke may have been on to something with his notion of a liquidity "glut." I wouldn't use the term glut, because that implies an excess of what the market demands. I don't believe that is the case, as the supply of capital has shifted to the right in a traditional AD / AS framework, we would expect more investment at a lower interest rate. Let me fill you in on some of the research that I've done. First let me preface it with the conventional wisdom in Commercial Real Estate, which is that investors are chasing yields, and so are banks. This is true, low lending rates have driven down cap rates and in some cases, below lending rates, meaning the owners are what I call "momentum" investors. They are gambling that the market will appreciate. This is particularly evident in Southern California. Rule of thumb, anything below about a 6.25% cap based on actuals, is someone who is banking on momentum, or they are engaging in a redevelopment through conversion or rehab.

So back to the story, I am doing some research on India for my global macroeconomics class, and interestingly enough real yields on Indian debt have declined over the last several years. We can mark this off as coincidence, based on better management of inflation by the Central bank. Yet the key story is that inflation accelerated in 2006, from 3% to about 6% (according to the Economist Intelligence Unit), and interest rates did not respond. What was astounding to me, and this really connects into monetarism, is that the supply of M2 jumped from a growth rate in the teen, about 18% in 2005 if memory serves, to over 24% in 2006. Inflation up? Coincidence? I'll let you be judge. So, in India we have declining real rates of interest.

Across the small pond we call the Pacific Ocean, and across a few mountains, we come to lovely state of Texas. So how are India and Texas linked? From 1990 to 2002, gross nominal yields averaged about 17.5%. By 2006, those same yields had fallen to 11.6%. As they say, the plot thickens....

Wednesday, March 21, 2007

More on Subprime

And this is what passes for analysis from Nouriel Roubini:
"This fairy tale spinned by free market supply side voodoo fundamentalism zealots will blame the otherwise appropriate current Congressional action on predatory lending for being one of the main causes of the credit crunch that will lead to a painful recession (as the WSJ editorial page recently claimed) while forgetting that predatory lending practices developed by free unregulated markets created the toxic waste that is subprime and near-prime mortgages.. This voodoo religion cabal will also incorrectly blame regulators"

I am not sure if this whole sentence qualifies as "analysis." I recognize that we as the blogging community are not all that filtered, but as an economist, we do like approach things from an objective manner. Roubini clearly does not, and lets his emotions color his analysis, which is very unfortunate. It may fire up his fans, but hardly leads to intelligent debate.

Dave Altig, over at macroblog covers this ground from a less excited perspective yesterday. The risk is two fold From a housing perspective, how long does the reduction in credit to the riskier borrowers last? And what effect does that have on housing demand? Secondly, does the default risk as Altig points out spread to commercial mortgages?

The answer remains... we shall see.

As a side note, apartments will likely benefit from the lack of liquidity in the subprime market. This will be very regional, but could spell good news for places like North Scottsdale, and other prime Class A buildings / Locations, who lost a lot of renters to conversions and for-sale housing.

More Thoughts on Subprime

Alex Tabarrok at Marginal Revolution hits the nail on the head on what really distresses the whole bubble blogger / subprime bear contingent. It comes through in their language (McMansions, Housing ATM, 'binge' borrowers, reckless, etc etc, ) (ed: we get the point) . It really is about expanded access to credit, that the poor and unwashed, might (gasp) actually be able to buy a house. As the Instapundit would say.... read the whole thing

Monday, March 19, 2007

Inflation- Current CPI Report

Dave Altig, over at the always excellent macroblog, has an interesting post with a round-up of the recent inflation report.

Altig is eminently more qualified than I to discuss the details of inflation reporting. Suffice it to say, the news is not looking good on that front, and it is making it increasingly less likely that the Fed will lower short-term rates. A lot of the recent market talk has focused on the idea that inflation will fall exogenously because of slower growth. Suffice it to say, this is not proving to be the case. My thinking is not fully fleshed out, but taking a look at the CPI, I pulled out some components, as proxies for the tradable goods sector, and for the protected sector. I pulled appliances, machine tools, shelter and education. Appliances and machine tools are very open to foreign competition, and education and shelter are not (for obvious reasons). Education costs are an old story, and as expected have been increasing on average over 6% a year. Shelter, though is weighted as a fairly large portion of the CPI. For a while, it seemed to increase at about the general rate of inflation. Then recently, particularly in the second half of 2006, that rate of increase shot up averaging 4% for the last six months. For the first two months of the year, it is an excess of 4%. As has been noted previously, shelter costs are lagging, so that inflationary pressure will likely subside by the second half of 2007. Still, for me the more disturbing trends was the proxy variables for appliances and machine tools. This tells me that import pricing, which has been a deflationary drag on the overall CPI is no longer helping out, and because of that, inflation risks remain to the upside. Those betting on a fed rate cut anytime soon, do so at there own risks. I have been an optimist up to this point on the fate of the economy, but numbers like these don't help the case. The imbalances being built up by China and to a lesser extent Japan (via the carry trade) are beginning to show up outside of the commodity markets.

Light Posting

I got caught up in a few things at work and also for school. As such, I'll cross post my essay here. This essay was written for my favorite class so far in my MBA. Why??? Well, duh, its econ! And as my professor said, loving economics is a good thing.

Without further ado...

Essay 2

If one considers two countries that have different levels of technological infrastructure (e.g., expenditures on private and/or public research and development, large amounts of spending on advanced university research centers for "high technology", extensive patent laws that are enforced aggressively within the country, etc.), which country might be more at risk relative to long-run economic growth? Explain using the module. Can public policies be developed to try to alter this situation, and if so, what measurements might help us summarize the extent and impact of such public policies on economic growth?

The two countries that are the subject of this essay will be called Techie and Laboria. Techie is characterized by high levels of technological infrastructure, with quality universities, government subsidized R&D, strong protections for intellectual property, an efficient and well protected patent systems, and a strong respect for the rule of law, as it is aggressively enforced. Laboria is quite the opposite, it has weak institutions, bribery is commonly known, intellectual property protection if it exists is weak, and the few universities that do exist are oriented toward educating the elite and are considered prestigious because graduates are strong candidates for entry into the civil service.

Risks to Growth

Techie will likely be the least at risk relative to long-run economic growth. Its institutions and technological infrastructure make it more likely that it will see continued Total Factor Productivity (TFP) growth. High levels of research spending make it more likely that breakthroughs will occur and strong intellectual property laws that are vigorously enforced provide an incentive for private-sector agents to continue to pursue research. A strong university system makes it likely that Techie will be strong in basic research, which seems to provide the foundation for future technological change, which leads to higher TFP through better machines and workers. Due to its excellent university system, strong institutions, and strong legal apparatus, superior products and companies will have access to the marketplace. The best products will have the chance to succeed, and the energy of entrepreneurs and business people, will be focused on satisfying market needs rather than responding to the dictates of government or working to influence those dictates to benefit themselves.

For precisely the opposite reason, Laboria faces a far greater risk of stagnation. Weak institutions, and a cosseted elite rule a country with little respect for the rule of law, but rather on the rule of whom you know. Little or no research means that Laboria does not innovate but rather copies. The lack of an intellectual property framework reduces the incentive to innovate, because it is easier to simply copy others, especially since the marketplace is directed towards ruling coterie’s benefit. The closed nature of Laboria’s economy allows the elites who hold special licenses to import certain goods to gain monopoly profits. Overall, the lack of genuine market system, strong rules for enforcing contracts, and a closed economy, as much as a lack of technological research capability inhibit the growth of Laboria.

Policy Guidelines-Techie

Techie should take further steps to open its economy to foreign trade, as it will benefit from a wider pool of investment capital and foreign technical know-how. It should continue to invest heavily in education and research. Education investment is dependent on its level of development. Techie should invest where it will gain the greatest returns. Techie should continue to insure that playing field is level for all competitors and that price signals are accurately given in the economy. Private property rights, both physical and technical should continue to be enforced. In other words, Techie should strengthen the public policy steps it is already pursuing to maintain increases in TFP.

Policy Guidelines-Laboria

High investment in universities or shipping students off to foreign countries is a standard practice in less well off countries. It is in fact, the wrong step to take. The best thing that Laboria can do, is the hardest, and that is begin to open its economy and loose the “animal spirits” of free enterprise.

Property Rights

The first step in this process is codifying and establishing property rights, and working to ensure the legal system protects them. Hernando De Soto identifies undefined property rights held by the poor as a huge source of untapped assets, which can power economic growth by establishing a basis for credit to be granted. I would also argue that a stable monetary framework is an essential part of stable property rights. Through inflationary monetary policies governments undermine the property (savings) of its citizens.


After property rights on a physical level, trade needs to be opened up to bring in foreign expertise and technology. As the economy opens up, workers will need to be educated and labor laws relaxed.

Human Capital

Education should initially focus on literacy for the general population and primary education.

Transparency and Government

The size and role of government should be reduced to reduce the scope for bribe taking and rent seeking. This is a long process in a country, and one of the best ways to reduce corruption is by promoting transparency in government, and by limiting its role. As the income of the country starts to grow through the basic steps of reducing the diversionary role of government, the middle class will grow and in the process create the basis cultural and societal framework that is conducive to a strong civil society that will promote greater advances in growth.

Innovation and Intellectual Property

At this point as the returns from playing catch up begin to diminish, it will be necessary to build on physical property rights by implementing increasingly stronger intellectual property protection. Coincident with the development of an innovation oriented growth policy; competitive universities and research institutions should be developed. The development into serviceable products of basic research should be left to the private sector as they will be market driven and have a better idea of how basic research should be translated into an actual product. The key point here is that the incentives for innovation should be created through the introduction of a serviceable and enforceable patent system. Though, the optimal balance must be found between intellectual property protection and the diffusion of innovation, so that organizations don’t hide behind intellectual property laws to protect their monopolies and therefore retard innovation that is essential to continued growth.

Markets and Regulatory Policy

I am hesitant here to strengthen the hand of government because it is often used to deaden the “invisible hand” rather than strengthen it. In this case, there is a role for government in ensuring a clean civil service, open entry into markets, and protecting the populace. In doing all this, the government should work to make sure that the tax base is broad and as non-distortionary as possible. It is here in the tax code that in rich countries, especially the United States that there has been numerous avenues opened for rent seeking. The tax code should be as neutral as possible in concerning the actions of economic agents. The specific role of government should focus on consumer welfare and regulatory agencies should be held to a strict standard of cost-benefit analysis when implementing new regulations.


The challenges that Laboria and Techie face are very different, and the consequent policy prescriptions are slightly different. Techie’s policy should focus on continuance of its existing policy and adapt government regulation to technological change. Laboria faces the much greater task of reorienting its entire framework towards a growth-oriented policy. The best thing Laboria can do is to begin to level the playing field and allow the market to work. As this process opens up, Laboria will grow faster than Techie because it will be playing catch up, and we will begin to see economic convergence between the two. As that happens, the policy of Laboria needs to change its emphasis towards Techie’s initial emphasis on promoting innovation. Good policy will promote strong growth in TFP.

Monday, March 12, 2007

Activity Based Costing in a Non-manufacturing Organization

Activity-Based Costing, a fundamental principle of managerial accounting is presented specifically in a manufacturing or production based environment. It is easier to understand and teach it this way because manufacturing environments lend themselves to easy applicability of the principles of ABC. There are distinct steps in a process, and fairly easily separable costs for each process. In a non-manufacturing organizations (NMO), the task becomes much harder. How for example, do you value the steps in making a sale? Obviously, certain activities, particularly marketing campaigns are easier to evaluate as they have distinct sets of activities and easily defined costs.

In my opinion, the best way to evaluate NMO activities is to take a page from project management, and break down an overall project into component activities, and look at the hours used in the process as a per-hour cost. So, in a knowledge-based NMO, costing is focused on worker productivity and pay. The hard part is quantifying the benefits of say me blogging... thats a post for another day, today was cost day!

Friday, March 9, 2007

The K.I.S.S. principle and the stickiness of ideas

K.I.S.S. - Keep It Simple Stupid

Long an acronym in corporate circles, the so-called KISS principle means exactly what it says. It is something uneducated execs say to their techies (or Economists) all the time, keep it simple, meaning relate it to something I can understand. I run into this challenge all the time in my day job. I am busy explaining why this metric I developed is the best thing since sliced bread, and I get a blank stare from my boss (not an economist). I get frustrated and remember back to my grad school days of tutoring and nurturing young minds in the basics of economics, and inevitably drift back to my first econ class in college (micro 1A). In that class, we learned the basics of utility (or as later professor termed, it "happiness") through the idea of binge drinking (something most college students understand rather well).

In pitching an idea, I have learned to stay away from the exciting technical aspects involved with data collection, etc (ed. Yeah... like watching paint dry exciting) and paint with a broad brush the idea and its outcomes. Big surprise... this works much better.

I think in the same vein, whether it be business, economics, real estate, or whatever, the ability to convey precise information in a concise manner is all important. This readily explains the appeal of socialist economics, and protectionism. Environmentalists are also notorious for this tactic. (watch Al Gore's movie, or the "Save the Whales" campaign, acid rain, the anti-ddt campaign). Socialism as an idea is so appealing because it is utopian and easy to understand. Socialism also takes advantage of an innate trait of humanity to be slightly risk-averse. The answer is why worry, it will be taken care of. The stark reality of socialism is a painted writ-large across Eastern Europe, Russia, China, etc. That message, and view countered the simplistic idea of security, equality and prosperity for all.

Environmentalists are often wrong, but they have been so successful in propagating their message because they have been experts at finding the right way to deliver their message. For instance, DDT, the bane of malarial mosquitoes was banned because Rachel Carson, wrote a book called "Silent Spring." It was a title, and a subject everyone could relate to. They took this simple message, and caused a stir, and got ddt banned. The ultimate consequence is being born by millions of dead Africans over the last 30 years, and not to mention that her ideas were wrong on a scientific level. The usefulness of DDT was hard to explain in the face of silent spring. The environmentalists were able to portray a complicated idea in a simple manner and create stickiness.

Stickiness becomes important, because it take a proposition, and is able to communicate that proposition on a simple level that the intended audience is able to relate to. Talking about deadweight losses due to tariffs or trade barriers is hard when it is compared to the image of a 50-year old steel worker, head in his hands, talking about his mill won't be able to operate anymore because his plant was outsourced. The unemployed steel worker was sticky. The idea that free trade isn't always a good thing becomes sticky. I am not sure what the solution is, but economists, especially free-traders need to do a better job of winning the idea war against the easy path of statism. Don Boudreaux over at Cafe Hayek, does a great job again of arguing for the free market and in this respect uses the unfortunate example of Walter Reed Hospital in this post.

When it comes to business, you should be able to state your reason for business as a KISS principle. Why are you in business? Why do we (as a company) need to do your project?

Remember, kisses are sticky (consequence of nature), and your ideas should be too. So next time, when you are pitching a project, talking economics at the proverbial cocktail party, explaining to your client why this building is so great, think of kisses, and then talk.

The Carry Trade as Keyser Soze

"And like that he was gone. Underground. Nobody has ever seen him since. He becomes a myth, a spook story that criminals tell their kids at night. "Rat on your pop, and Keyser Soze will get you." And no-one ever really believes."

"Keaton always said, "I don't believe in God, but I'm afraid of him." Well I believe in God, and the only thing that scares me is Keyser Soze" - Verbal Kint in the Usual Suspects

One of my other favorite lines from the Usual Suspects was when Verbal Kint (Kevin Spacey) says that the "greatest trick the devil ever pulled" was convincing the world he didn't exist. Scientists, when they look at planets, never really see the distant ones, but they know they are there. How? They see distortions in the light coming from stars, a bend if you will, in the spectrum. Based on the distortion of the expected light, they can surmise that the planet is there.

And so you are asking yourself, what does this have to do with economics or real estate, or really anything? Well, like the light bending, showing the existence of a planet, just like the market bent showing the existence of the carry trade or maybe it was all just coincidence.


February 21st- The Bank of Japan raises interest rates 25 basis points to 0.5%
February 27th- Bottom falls out of DJIA 30, Nasdaq, S&P 500
March 2nd- Reuters states "Yen has best week in 14 months"

The carry trade is based on two bets, low Japanese interest rates, and a stable or falling yen. A rising yen, and higher rates destroy the motives behind the carry trade. The actions of the BOJ were obscured for a day or two by a falling yen. As the effect of the increase was beginning to be priced into the traders models, the trend reversed. A hiccup in the Chinese market, created an avalanche around the globe. Traders unwound positions in the US equity markets (sell sell sell) and bought Yen to pay off their loans in Japan. End result, equity markets down, the Yen up. Sure enough, exactly what we would predict happened, the yen strengthened, and equity markets were hit hard.

Fundamentals have now reasserted themselves, but beware the of the devil we can't see. As Verbal Kint, would say, "The greatest trick the devil ever pulled was convincing the world he didn't exist."

Tuesday, March 6, 2007

Best Paragraph of the Day

"If you want to fight carbon emissions, then join the Pigou Club and push for taxes on bad energy. If you want to fight carbon emissions at a personal level, then act as if there were a high tax on your use of energy from carbon-emitting sources, and reduce your use of that energy. If you are not really all that worried about carbon emissions, but you get pleasure from making empty, self-righteous gestures, then do what Al Gore does -- buy carbon offsets."

Arnold Kling today at TechCentralStation

Thursday, March 1, 2007

Thoughts on a Committment to Excellence

Here's a plug for one of the business books I actually do like, Good to Great, by Jim Collins. Its a good book for keeping on the shelf because it outlines some principles for the success of companies. One of his insights that struck me, was the commitment of top management especially, but also among middle managers to ultimate success of the company. He and his team identified a key distinction between the generation of super star CEOs (Al Dunlap, Jack Welch, Larry Ellison, Scott McNealy, etc) who sometimes emphasize their own celebrity above that of the company. Oftentimes, their genius built success, but in the long-run it proved illusory. The book has a much better researched list, but you get the idea, the primary interest of the super star CEOs is their own success, not the continued success of their organization.

I would like to elaborate on that idea of the commitment to success of the organization because it goes beyond celebrity or all-star bosses and in mediocre companies it takes the form of CYA. EVERYONE in a corporate environment is familiar with the CYA boss or co-worker. The primary interest of this person or persons is CYA, and like the celebrity CEOs, they are more interested in their survival and success than that of the company. CYA people in my experience are risk averse, and adopt a, don't-rock-the-boat mentality. In addition, they are good, "yes-men," especially in the presence of a superior. This kind of attitude which puts individual succedss over organizational excellence is detrimental to moving the organization toward the broad path to sustainable success. This brings me to another point in "Good to Great": Find the right people.

Finding the right people is essential, and the biggest reason to weeding out CYA type team members. Also, a big improvement can be changing the incentives that person faces. One the great insights in economics is that people respond to incentives. Intrinsically motivated people are difficult to identify and retain. An alternate path that an organization can take to ensure the right people are retained is to create incentives within the system to allow these people to succeed.

First, empower your employees. The modern manager is no longer a king among men but a facilitator and a coach, more than anything else. Organizational excellence is built on fully utilizing the talents of all team members.

Second, set your incentives right. Intrinsic and extrinsic motivation matter. People work on the basis of the intrinsic motivation (hence empowerment) but also ultimately for a paycheck. All jobs combine a mixture of both. Think of it as a combined pay package. For certain people, usually the right people, results matter. Pay them for those results. This is especially true for process oriented positions, pay for productivity, it'll work out better for both the organization and the employee.

Third, reward innovation and risk-taking. Take risks, as the old adage goes, nothing ventured, nothing gained. Many entrepeneurs as their organization matures become risk averse. Averseness to risk is the first sign of a stale organization. Keep it entrepeneurial, keep it a little risky and success will come. Every great company had that moment after their initial success where a follow-up was needed to an original success, as Lloyd Dobler (echoed by Van Wilder) would characterize it, "its that dare to be great situation." Being good enough is not the answer, dare to be great. Success is a relentless process of innovation and risk-taking, embrace it, don't fear it.

The sum of all these makes a successful organization culture and begins the fertilization process of a ultimate success for the organization.

Tuesday, February 27, 2007

Virtual Companies

Powerful computing tools, an ease in the transfer of information and a burgeoning contract manufacturing infrastructure are bringing us closer to the world of personalized manufacturing, in essence a virtual company. It is within reach today, for one person to harness together different sources to create a virtual company. Imagine a manufacturer without a factory. This is the money quote from Kevin Maney of USA Today, "Before long, "user-generated content" won't refer only to media, but to just about anything: user-generated jeans, user-generated sports cars, user-generated breakfast meats. This is because setting up a company that designs, makes and globally sells physical products could become almost as easy as starting a blog..." Hat Tip: Instapundit

This idea sounds very intriguing. In fact, downright revolutionary.... but typical of Web 2.0 hubris, it is also highly unlikely, and not for the reasons you think. It is quite possible and happening now, in a variety of service industries. A friend of mine, is enhancing his website with, and creating a property database via a service called E-Lance ( Guys from Ohio to India bid on his project, and he selects the best bid. Truly, globalization at its core. Distributed interactions of individuals, making free, unencumbered economic decisions. When we economists talk about free trade, that is what we are talking about. It is simply the unencumbered trade of individuals.

Ok, back to the main point. Distributed manufacturing from virtual companies will not catch fire for the most part, and it mainly has to do with you... the consumer. Successful companies find it essential to control the consumer experience, because that is how you judge them. Everything from the first point of contact through the product experience is essential to defining the brand and your experience. If a product is delivered without the end brand controlling the experience, flaws, and bad experiences will creep in. Quality and experiential uncertainty will lead many companies to keep at least some aspects, if not final assembly of manufactured materials in-house for the foreseeable future. Web 2.0 and Amazon are a bridge too far, except for niche products or products where quality of manufacture is not an important aspect.

Monday, February 26, 2007

Principal-Agent Issues

Just was thinking about it... and its one of my favorite subjects to ponder. Particularly after reading this post James Hamilton over at econbrowser. It seems the good folks over in San Diego are a poster child for a principal-agent issue. The government attempts to cover this gap, by enforcing a fiduciary responsibility. Is there another way besides regulation to solve this issue?

I am not too sure... any thoughts would be welcome in the comments.

The Gas Tax-Pigovian?

In this post from the Only Republican in San Francisco, and as many in the blogging world know, Greg Mankiw has been advocating a pigovian tax on gasoline. My collaborator over at The Economics of Sports, is a strong advocate of this type of tax. There is of course, the reaction.

I think the pigovian tax is state coercion dressed up in a warm fuzzy, environmentally sensitive dress. Mankiw lays out his arguments. To sum Mankiw lays out seven reasons to support a $1.00 increase in the gas tax.

1. The Environment
2. Congestion
3. Regulatory Relief
4. The Budget
5. Tax Incidence
6. Economic Growth
7. National Security

Let us look at these one by one. The first argument is that by raising the tax on gasoline, consumption will be reduced and will spur the development of alternatives (supposedly "greener"). The central premise of this argument is that carbon and the byproducts of petroleum consumption are a significant. I don't think anyone who would argue against the ideas that burning petrol is a relatively dirty business. I believe the case for CO2 as a big global warming driver is much weaker due to the relatively low radiative forcing value for C02 compared to other gases such as H20 and methane.

But as Professor Mankiw should know, the cost must be less than the benefit. And it is actually pretty unlikely that a $1.00 increase in the gas tax will do much to reduce consumption. We have already had an increase of well over a $1.00 in the price consumer's pay at the pump, with very reduction in consumption. Is there a magic tipping point at $3 a gallon? $3.50... who knows, but based on the empirical evidence, we know gasoline is a highly inelastic product, and a $1.00 increase in the tax will likely do very little to change that fact. Secondly, by increasing the price of gasoline via a tax, the government is also reducing the price incentives that would be communicated by the market, reflecting actual issues of scarcity and cost. For instance, so even if gas is an elastic good, the price indicator loses some its value when it is distorted by a tax. It is the same reason, many economists oppose taxes in general, because it distorts the workings of the market. Why gasoline would be any different.... remains a mystery to me.

Congestion: The congestion argument is really the same argument as the consumption argument. People will drive less, therefore congestion will decrease. For the same reason a higher gas tax won't reduce consumption, it is highly unlikely that it will do much for congestion. I believe that this has a lot to do with the relative cost of gasoline related to income and that people's homes and jobs are a fixed variable in the short-run, and therefore congestion will not change. In anti-car cities such as Portland, which purposely build less roads and in fact narrow roads to make congestion worse (basically raising the cost of driving), has done little to help with congestion. Raising the cost yet again, is highly unlikely to change American housing preferences and do little to reduce congestion.

Regulatory Relief: Professor Mankiw is treading on weak ground here. He is arguing that a large increase in the gas tax would eliminate CAFE standards, which distort consumer choice. He is right, CAFE standards do, and should be rightfully eliminated on their own merit. If the good Professor believes government would do something so sensible, he has more faith in it that I do. Regulations and agencies never really die. If a gas tax went through it would no doubt be accompanied by an increase in CAFE standards on the basis of an environmental and anti-consumption argument.

Budget: The classic line, we need to raise taxes to close the future budget deficits. Really? Why stop with the gas tax? Why not raise income taxes? Impose a VAT... etc etc etc... the answer to the budget issue is to cut spending, and grow the economy, not raise taxes.

Tax Incidence: Professor Mankiw rests his argument again, that higher prices in the US will reduce consumption. Maybe... maybe not. For one, consumption needs to fall, and unfortunately for the good Professor, oil operates in a global market. IF US consumption did fall, what makes anyone think that other nations will not take advantage of the lower prices to increase consumption. Still, the end result is that the consumers are paying higher prices... hard to see how a net increase of 80 cents as opposed to a dollar... is a great deal.

Economic Growth: Yes, consumption taxes are preferable to income taxes. Agreed. BUT and here is the big but, this rests on the argument that congress will offset a gas tax increase with a decrease in the income tax... which, based on past history is highly unlikely. Increasing the costs of transportation throughout the system, likely will lead to lower economic growth and a general increase in prices... the net result.. is a negative for the economy.

National Security: This is the one argument that conservatives latch on to. We need to stop sending our oil money to Hugo Chavez and the terror supporting Saudis... right?? Raising the tax will do that? Really? Lets accept that the price of oil begins to fall, due to a decrease in consumption (which we already known is pretty darn unlikely)... which fields go first? Well, as we know from Econ 1A producers like to produce where the marginal revenue is equal to the marginal cost... so the highest marginal cost fields will be shut first. Want to guess where those are located? BIG HINT: It isn't in Saudi Arabia or Iran... so, in other words, the higher cost of gasoline, coupled with lower overall oil prices as suggested by Professor Mankiw, will only make the national security situation worse by increasing our reliance on Saudi and other middle eastern oil producers... oops.

The net of all this: The gas tax is a bad idea. An increase in government power via a regressive tax, will do nothing to enhance our national security, nor will it likely help the environment, or encourage alternative energy sources. The gas tax, dressed in pigou clothing is not the free market panacea that its supporters would have you believe. It is a statist solution, that induces government coercion to change private behavior.

Tuesday, February 20, 2007

The Great Big Shadow

The great real estate boom, created some interesting situations in a variety of markets like Las Vegas, Phoenix, S. Florida, etc.... The massive wave of condo-conversions in these markets, appealed to investors for a variety of reasons, and somewhat like the dot-com boom and subsequent collapse, the chickens are coming home to roost. For the most part, industry commentators have focused on the effect on the banking system. Given, the dispersion of risk associated with MBS (mortgage backed securities), I believe that the risk to the banking system is fairly limited. Share prices of a few institutions such as HSBC, have fallen, and also New Century (NCEN) due to their exposure to the sub-prime mortgage market, but there does not seem to be any real risk of systemic collapse for a variety of reasons. Individual banks or lending institutions may run into some trouble, but for the most part, the big guys have hedged their exposure through MBS debt, and are much larger than in previous banking crises, such as the Latin American crisis of the 1980s and the S&L debacle. The end result, may be some hurt on the share price, and a reduction in capital availability to lower-end (ie. riskier) borrowers.

The real guys to be hurt, will be the speculators, as the slowdown in home sales volume has prevented them from liquidating their investments. The vultures and speculators have turned to a suddenly strong rental market as a solution to this problem. Hence, the title of this post, the Great Big Shadow.

The Great Big Shadow refers to the fact these units (both multi and single-family) are not easily tabulated by researchers. Little signs start to point to their impact. The first check is anecdotal. Look at hot areas for condo-conversions, and note the slow-down in sales volume for all types of residential real estate. It is an implied estimator of demand. Secondly, Craigs List and other internet sources indicate a significant amount of units for rent. Thirdly, driving around my hometown, I have seen a big change in the number of signs, and indications of concessions on many apartment buildings, especially ones that the big boys (public REITS) own.

All in all these are signs that indicate something is wrong. I'm not a huge believe in anecdotes, because they often obscure the forest for the trees. Lets take a look at Phoenix in particular, because I live here, and there's good data for it. Its a large, fairly liquid market, and saw a good amount of speculation, particularly in 2005, and on into 2006. Job growth is strong, and so is net domestic migration. These are all good indicators for a strong apartment market. And, to top it off, home prices skyrocketed, creating quite the spread between rent and mortgage payments.

For instance, according to the Census Bureau, the median home price was $127,900 in the second quarter of 2000. Extrapolating (and with a little estimating) using the OFHEO repeat sales index, we determine that by the end of 2006, the nominal median home price in the Phoenix-Mesa-Scottsdale MSA was $281,100. The mortgage to rent ratio rose from 1.3 to 2.1, meaning that the premium for owning a home was 130% of rent in 4th quarter of 2000, and by the end of 2006, this measured 210% of average market rent.

The sum of all this evidence, there was a huge pool of renters for apartments. The evidence backs it up, measured absorption rose every year coincident with the recovery in the employment market and the domestic migration number. Then in 2006, funny things start to happen, measured absorption, adjusted for conversions fell significantly, dropping from about 9,000 units in 2005 to 2,300 in 2006. All other signs pointed to a significant increase in net apartment demand (also called absorption). It didn't happen. The results....The big guys began to see this, and began to offer concessions to maintain occupancy levels. Other research I've done indicates that yields for apartment units also peaked in the third quarter of 2006, and have been trending upward, as opposed to their previous compression trend. The hard data isn't there yet, indicating rising vacancies, and falling rents... but, given building in excess of demand, an abundance of conversion activity, anecdotal evidence, of a lot of rental inventory, and knowing that certain buildings are being recalled from conversion and put back into rental inventory, it seems the shadow is beginning to loom large. Look for this story to become more apparent in 2007 as the year unfolds.

It is a great reminder that past performance does not equate to future results. Looking back, things look great, but 2007 will illustrate the dangers of looking backwards to forecast the future.

Las Vegas, S. Florida, Orange County and other markets with heavy building or conversions are facing a similar issue. Until, the for-sale market is able to absorb the available inventory, rent growth for apartments will be subdued, and the shadow of uncounted inventory will continue to affect the real estate market.

Saturday, February 17, 2007


You could almost see this one coming.... The Chavez regime's "successes" in fighting poverty, so favored by his apologists in the first world, are being undermined because Chavez is relearning the same lessons of Castro and Mugabe. I feel bad for the Venezuelan people, because they will feel the full brunt and pay the price for the incompetence of the Chavez regime and its "21st Century Socialism." I have to ask Mr. Chavez, if socialism failed in the 20th century, why would it work in the 21st?

Its sad day for this world, but I am sure someone, some way will find a way to blame George Bush.

Thursday, February 15, 2007

Post V-day thoughts

So for a little treat for single people, we can revel in the cost of Valentine's day, see this link from the Economist's Free Exchange blog.

What the Economist's blogger does not explore is why demand is so inelastic on Valentine's day. My quick little theory, guys generally know the implicit cost of no action (equal to the net present value of future benefits), and thereby calculate that the present value of the future benefits (both explicit and implicit) of the relationship or date(s) is greater than the explicit costs of the valentine's day gifts and greater than the loss of benefit that equates to no action.

Tuesday, February 13, 2007

Minimum Wage Follies

See this article from the Arizona Republic . It is fairly anecdotal, so I would take it with a grain of salt, but it does conform to what research and theory tell us. If you raise the wage floor, the least qualified workers will be let go. And sure enough, high school students, who are the lowest skilled minimum wage, legal workers, are the first to go. A good substitute for legal workers are illegal workers. Suffice it to say, the minimum wage debacle that is about to pass Congress will be more deleterious than beneficial for its intended targets, and it is likely that we the citizens of this country will pay the price Congress' economic illiteracy, as high schoolers in Arizona are now. It will get worse.

Monday, February 12, 2007

Demand vs Supply Side

Just a quick thought, as we were analyzing the Tucson apartment market this morning, it brought on a quick thought. Demand vs Supply. Basic economics right? Even, the non-econ will tell you economics is about supply and demand (they're not correct, but I digress) for changing definitions, see this post from Mike Mandel at Economics Unbound.

Well I think in the apartment industry, the big boys (Equity, Archstone, etc) have focused too much on the supply side of the equation. Their mantra has been "supply constrained" markets, aka high barrier-to-entry markets, places where it is hard to add additional supply. The other focus of which only one big boy (Camden) uses, is demand side. In the supply restricted areas (which incidentally aren't all that restricted, see the multifamily permit boom in SF, Oakland, and LA-all popular supply-constrained markets).

The biggest problem for the supply constrained markets, is their inherent volatility. In a study that I did, we identified the most volatile markets from a rental rate perspective and calculated a beta for them. San Francisco, San Jose, Oakland, New York, Boston were the top-5. The interesting finding from all this research is two things. Supply constrained markets are generally more volatile, and definitely more sensitive to economic conditions. This means that appropriate discount rate applied to these markets should be higher because of the greater degree of risk. Current valuation practices do not take this factor into account. In fact, over time, the high growth regions have generally outperformed (using real $2005) the so-called supply constrained areas.

In conclusion, the supply side focus is trendy, but wrong-headed and will leave certain big guys in the apartment industry with a bad hangover in a downturn. Yield management will help mitigate some of this effect, but that won't avoid the storm. It leaves companies like Camden, well placed to outperform its peers.

Friday, February 9, 2007


Outlook 2007

The Economy

Although 2006 started off with strong economically, the year finished on a lower note. In the first half of the year, GDP growth surged forwarded at a 4.1% annualized rate. Third quarter GDP growth slowed down to an annualized rate of 2.0% and it is likely that fourth quarter GDP growth will be similar, though slightly higher at 2.5% due a slowdown in personal consumption expenditures and an increase in the savings rate. We expect this trend to continue into the first half of 2007. Job growth will slow to an average gain of 125,000 jobs a month, from an average of 165,000 jobs gained a month in 2006. If credit conditions continue to normalize and don’t retract, as we expect, growth should recover in the second half due to an increase in net exports, a stabilization in the residential housing sector, and inventory rebuilding, which we predict will rebound after a decline inventories. Other key indicators such as demand for office space are also showing a slowdown after strong gains in the beginning of 2006. Equipment Leasing is still growing strongly year-over-year, but has shown some leveling off, which according to past data is a leading indicator of economic activity. Both of these statistics combined paint a picture of a slowdown in growth, and not an outright recession. Anecdotal evidence has suggested that small businesses especially, are having difficulty attracting and retaining talent. This is backed up by an increase in jobs posted online compared to the labor force. Higher demand for skilled labor will increase compensation in certain areas, and raise the overall skill level in the economy, which initially will lower productivity growth as we are seeing now, but will increase overall productivity growth, and by a matter of course, raise wages. Consequently the increase in income, and low unemployment will support growth in personal consumption expenditures.

Continued below-trend growth will contribute to an easing in pricing pressures. This trend is already evident, as the annual rate of inflation as measured by CPI has tailed off towards the end of 2006, from a high of 4.1% in June 2006, down to 2.0% in November. The less volatile “core” CPI, which excludes energy and food, fell from a high of a 2.9% annual gain in September 2006, to an annual gain of 2.6% in November. The acceleration in the rate of inflation that was propelled by energy prices seems to largely have subsided, lessening the pressure on the Federal Reserve to raise rates. If this deceleration continues, the Federal Reserve will be able to lower short-term rates as most observers expect them to.

Inflationary expectations, while still elevated from over comparable periods in 2005, have started to recede back to more comfortable levels.

Job growth will continue to be concentrated in service sectors jobs, with manufacturing employment falling slightly. Metropolitan areas with strong professional business sectors, and new household formation will continue to benefit, whereas slower growth metropolitan areas with strong base employment such as the San Jose-Santa Clara MSA, will continue to have a stratified labor market with strong gains at the very top end for skilled workers, but slow overall growth in employment and median income.

The Investment Climate

Low interest rates and a continuing improvement in average NOI moderated out the effect of a severe reduction in condo conversions. Low interest rates kept cap rates at a low level and improvements in NOI held pricing steady despite the absence of the aggressive bidding of the condo conversion buyers. Average seller cap rates fell slightly from 6.4% to 6.1% in 2006, despite a rise in equivalent bond rates from a 2005 average of 6.0% to a 2006 average of 6.5%. This indicates bullish investor sentiment for the future of multifamily properties. However, we believe that, pricing will stabilize in 2007. Gross yields and average cap rates will shift slightly higher, representing a broad stabilization of pricing in the market, as NOI expectations will shift slightly. We believe that operationally, the broad market hit a cyclical peak in expected rent per unit in the third quarter of 2006. Some markets, especially in the Midwest will experience favorable investment conditions, but slow in-migration will temper any gain in pricing power by owners. Given the expected trends, we expect the average yield per unit to increase slightly reflecting a leveling off of and possible decline in some markets in price per unit.

New apartment building starts will increase over their levels last year. Some previously planned for-sale projects will shift over into rentals due to strong rental traction and a slowing for-sale market. Also, rising construction costs, which had put a heavy damper on new apartment construction in many markets and had skewed new construction toward Class A product, have eased and will allow builders to pursue a wider variety of new construction projects. In addition, many properties that were set to be converted to condos, in fast rising markets like Phoenix, Las Vegas and Florida will revert back to rental properties. All of these factors will increase the available supply of apartment units.

In the longer term, a deepening of the available finance pool via CMBS debt, market indices and other financial tools, will lower the cost of capital, and allow investors greater flexibility in taking on risk. Financial innovation has deepened capital markets in other industries and will lead to lower lending rates, and hence better pricing.

Cap rates have fallen significantly since 2000, and part of this is a reflection of capital deepening, and partly due to an overall lower cost of capital throughout the economy. Fed Chairman Ben Bernanke has described this as a global savings glut, by which he means that global capital availability has increased faster than the available projects to invest in. Lower default rates, and sustained disinflation throughout the world, have also helped lower the cost of capital. We are projecting a slight rise in cap rates in 2007.

Apartment Operations

The slowdown in job growth will manifest itself in slowing household formation, and therefore a lower rate of absorption for apartments. We are forecasting that demand will fall about 30% in the major metropolitan areas that we track, from approximately 93,000 units in 2006, to around 63,000 units in 2007, the vacancy rate will increase 10 basis points to 5.5%. Construction in the major metropolitan areas will total 70,000 units in 2007, slightly exceeding the rate of demand. Overall, the level of concessions should rise slightly because of a slackening in demand. Uncertainty in the for-sale market is currently benefiting apartment operators. In the last half of 2007, we expect that the for-sale market will firm up, contributing to a slackening in demand for apartment units as mortgage rates remain at historically low levels. A general fall in for-sale housing prices via HOA concessions, payment of closing costs, and other non-price concessions, and even in some markets outright year-over-year price declines, will help raise the level of affordability. Some of the gains in affordability will be offset by stricter lending standards, particularly in the subprime market. Overall, though capital is abundant in the mortgage markets, which means that lending rates will remain low and demand should firm up.

First Post

Hey this is my first post to this blog. I'll plan on updating it most every day with my general ruminations on economics, business and how it all affects the real estate world.