Friday, October 9, 2015

The Republican Wrecker Caucus Strikes Again

The so called Republican "Freedom Caucus" in the House of Representatives is at it again .After failing miserably in their attempt to shut down the government in 2013 (see prior posts: and they have succeeded in forcing the retirement of House Speaker John Boehner and prevented House Majority Leader Kevin McCarthy from succeeding him.  The wrecker caucus as I call them has no interest in governing, in fact by their actions they don't really understand how the Constitution works. Simply put without 60 votes in the Senate and a 2/3 majority in both Houses the Senate Democrats and President Obama hold most of the high cards.

As I previously wrote they are very much like the nihilistic student protesters of the late 1960s. They care more about making a point than actually governing. It feels good for them, but it is the country that will suffer. Just like some of their 1960s counterparts they are oh so dour and oh so mean spirited. Where is the optimism of a Ronald Reagan? The wreckers don't understand that the way to success is with a smile on your face and a song in your heart.  

Moreover after watching the wreckers in action why would American voters want to give control of the government to the Republican Party. If it weren't so tragic, one can argue that the wreckers are part of some diabolically Clintonian scheme to elect Hillary president.

Don't you think its time for the grownups, if there are any left, in the Republican Party to take charge?

Wednesday, October 7, 2015

Giving Opportunism a Bad Name: Hillary and TPP

Hillary Clinton came out against the Trans Pacific Partnership (TPP)  trade agreement today. After publicly supporting it over 30 times as President Obama's secretary of state, she has succumbed to the hot breath of protectionism now emanating from the left wing of the Democratic Party and it new exemplar, Bernie Sanders. Simply put, she is giving opportunism a bad name.

Now with much of the Republican Party under the spell of the protectionist Donald Trump, the chances of Congress approving the TPP next year are slim and none. The situation is further complicated by John Bohner's departure from the House leaving the Republican rookies in charge. It was a tough sell to give Obama "fast-track" authority earlier this year; it will be a far tougher sell next year.

Meantime in a world that is growing more chaotic by the day, this is not good news for the United States and it is certainly not good news for the global stock markets.

Saturday, October 3, 2015

My Amazon Review of Michael Storper's "The Rise and Fall of Urban Economies: Lessons from San Francisco and Los Angeles"

Winners and Losers in the New Urban Economy

Michael Storper et. al. have written an important book on the impact of the “new economy” on the growth and decline of major urban centers. It is destined to become a classic in regional economics and urban planning. The lead author is a professor of urban planning at UCLA. The authors use the Los Angeles and San Francisco metropolitan areas from 1970 to the present as a contrasting case study of how these two regional economies adapted to the transition from an industrial economy to an information economy.  To Storper and his coauthors San Francisco succeeds because it has a far more adaptable and open source business ecology than the more enclosed corporate world of Los Angeles. Further San Francisco’s advantage is augmented by a more far seeing and cohesive business/government community that adopts public policies to enhance the information economy. To the authors it is these two critical factors more than the role of immigration and the 1990s collapse of aerospace in Los Angeles that account for the stunning differences in economic performance.

To be sure these are valid points, but to my mind the authors over-state their case. Simply put the Los Angeles of 1970 suffered from the “tyranny of an installed base” and lacked the high gross margin businesses that could withstand the increasing tax and regulatory pressures coming from local government and the state of California.

Now let’s look at the data. In 1969 the Los Angeles CMSA had approximately four million workers with 1.1 million of them engaged in manufacturing. At the same time the San Francisco CMSA had approximately 2.1 million workers with fewer than 400,000 engaged in manufacturing. Los Angeles was a manufacturing region, in fact the largest in the U.S.. If that is all you knew and you posited that the revolution in global trade would bring U.S. manufacturing to its knees in the coming decades, then you would predicted that San Francisco would easily outperform Los Angeles. By 2013 employment in Los Angeles increased to 7.6 million, but manufacturing jobs plummeted to 700,000. By contrast San Francisco employment increased to four million jobs while manufacturing barely declined to 360,000 jobs.

What Los Angeles had was low margined traditional industrial, aerospace and apparel jobs, while San Francisco had much higher margined technology and specialized production jobs. To further prove my point the worst performing Bay area county was the one with the most traditional manufacturing jobs, Alameda County. Although people talk about the economic juggernaut of Silicon Valley few talk about the success of Alameda County’s major city, Oakland. Although it is an exaggeration, economically speaking the Los Angeles of 1970 looked a lot more like Oakland than San Jose.

One of the advantages Silicon Valley had was a legacy of the politics of the 1960s. Recall that at that time the primary buyer of advanced electronics was the Department of Defense and Silicon Valley vigorously competed with Highway 128 in Boston and Texas for the business. With the Kennedy-Johnson years defense money flowed to Boston and Texas and not to Silicon Valley which did not have the near monopoly position that Los Angeles had in defense oriented production. So what did Silicon Valley producers do to respond? They went after the commercial market and became far more adaptable than their competitors. Thus, when the aerospace recession of 1969-76 hit, Silicon Valley was prepared.

The authors duly note that Los Angeles was a major technology center in 1970, but most of that technology was based on aerospace. Unlike northern California where most technology enterprises were small and entry was easy, the ecology of the aerospace industry is based on large units with difficult entry. While job mobility in aerospace is high, for example I spent two years in the aerospace industry and worked at two large firms, capital mobility is not. You didn’t see venture capital funding aerospace start-ups.

Another way in which the tyranny of an installed base affected Los Angeles was the presence of a huge Hispanic population in the area. This meant that when the manufacturing base collapsed, the political structure had to respond to the loss of employment opportunities for that population. The response was to beef up the ports of Los Angeles and Long Beach which made them the entrepot for the flood of goods coming in from Asia. To the authors this activity increased middle and lower income employment, but were nowhere near the high jobs being created in San Francisco. What choice did the political establishment have?

This review doesn’t do justice to the very serious economics work that the authors present. I just wanted to point out to future readers to not completely buy in to the authors’ thesis. Initial conditions are very important and cannot be discounted. However, the authors offer much food for thought and demonstrate that public policy in this area is very difficult to make.


Tuesday, September 29, 2015

Housing is Back, UCLA Anderson Forecast, September 2015

After a long, hard slog, housing starts (both single and
multi-family) are poised to approach the long-term
average (1959-2014) of just under 1.5 million units in
2016. (See Figure 1) Specifically we are forecasting housing
starts of 1.14 million units this year and 1.42 million units
and 1.44 million units in 2016 and 2017, respectively. This
level of activity is well above 1.00 million units recorded in
2014 and the 2009 low of 0.55 million units. Remember that
the level of activity we forecast is far from the mid-2000s
boom level of above two million units a year. We would also
note that with the shift to multi-family starts, the per-unit
GDP “bang for the buck” has declined, but that factor has
been partially offset by increased emphasis on higher-end
housing in the new construction market.

Our forecast is underpinned by continued growth in
real GDP that will likely run at a 3% rate in 2016, continued
jobs gains in excess of 200,000 a month for most of the forecast
period, relatively low mortgage rates--at least through
2016 and household formations in excess of one million a
year in 2016 and 2017. (See Figures 2, 3, 4 and 5) To dig into
the weeds, our estimates for household formation is derived
from the Current Population Survey which when compared
to the Housing Vacancy Survey seem conservative. Further,
the improving labor market will act as an ongoing stimulus
to household formations.

Although low mortgage rates have been with us for
years, what is important is that credit standards have eased
with respect to FICO scores and down payment requirements
have been reduced. To be sure we are not going back to the
“wild west” lending standards of 2005, but compared to
2010, and yes early 2014, mortgage credit conditions have
decidedly eased. Moreover, we do not believe that higher
mortgage rates will meaningfully cut into housing activity
until 2017 as a rise in rates will initially hasten buyers into
the market out of fear that rates will go much higher. Time
will tell whether or not this assumption is too heroic

Figure 4 30-Year Conventional Mortgage Rate,
2005Q1 – 2017Q4

Figure 5 Household Formations, 2010-2017F

Figure 2 Real GDP Growth, 2005Q1 – 2017Q4F
Sources: U.S. Department of Commerce and UCLA Anderson Forecast

Figure 6 S&P/Case-Shiller Home Price Index, 20 City Composite, 2000 - June 2015, 2000=100

Figure 7 Existing Home Sales, 2000 - 2017F

The rebound in housing construction is being confirmed
by rising home prices with the widely reported Case-
Shiller Index up 5% year-over-year and up 30% since the
low in 2012. (See Figure 6) Similarly, existing home sales
are forecast to be 5.3 million units this year up from the 4.1
million unit low in 2008. (See Figure 7) We forecast that
existing home sales will reach 5.5 million units in 2016 and
modestly decline to 5.3 million units in 2017.

Interestingly, the housing recovery is occurring
under the backdrop of an unprecedented decline in
home ownership. Specifically, the home ownership rate
has declined from 69% in 2005 to the current 63.5%,
which is roughly where it was in 1989. (See Figure 8)
The decline in the home ownership rate is attributable to the
after effects of the housing crash of 2006-2010 which scared
off would be homeowners, tighter mortgage requirements,

Figure 9 Student Loan Debt, 2006Q1-2015Q2F, $Billions

Figure 8 Homeownership Rate, 1965 - 2015Q2, NSA

sluggish income growth, a shift in consumer preferences to
urban versus suburban lifestyles, and the rapid growth in
student loans which now exceed $1.2 trillion (See Figure
9) In fact, the biggest drop in homeownership has taken
place in 25-34 year old cohort where the rate dropped 5 full
percentage points from 1993 -2014.1 We believe that this
declining trend has about run its course and will soon begin
reversing. In support of this notion we note that the recent
decline in life events associated with home ownership such
as marriage and childbirth have ebbed and are now in the
process of reversal.

The Boom in Multi-Family and Rentals

The flip-side of the decline in the homeownership
rate is a rise in renting which has triggered a boom in multifamily
housing starts (See Figure 10). Multi-family housing
starts which bottomed in 2009 at 112,000 units will exceed
400,000 units this year and average 460,000 units over the
next two years. The boom is underpinned by rents increasing
at a 3.5% a year rate in the official data, but according to the
publicly traded apartment real estate investment trusts, rents
are increasing on the order of 4.5-5.0%. (See Figure 11) As
we have noted before, the official data tends to lag the actual
market place because of the prevalence of rent controlled
jurisdictions in the official sample. Simply put, rents in con-

Figure 11 Consumer Price Index, Rent of Primary Residence, January 2000 - July 2015, Percent Change Year-Over-Year

Figure 10 Multi-Family Housing Starts, 2000Q1 – 2017Q4F

trolled jurisdictions aren’t typically marked to market until
a vacancy occurs. The primary reason that rental increases
have been sustainable is a very low 4% national (based on
79 cities) apartment vacancy rate, roughly half of what it
was a few years ago. (See Figure 12)

Moreover, this cycle has given rise to nationally oriented
single-family rental businesses funded by institutional
investors and public offerings of shares. This business is the
creature of the huge amount of bank foreclosed property that
came on the market in the aftermath of the financial crisis
enabling the bulk buying of single-family homes. Thus far,
single-family rentals have captured an unprecedented half
of the total rental market over the past few years and the
public companies have been reporting rental growth on the
order of 4% a year. 

In fact we are now witnessing the purchase
of new single-family homes for the rental market by
investment institutions and the development of homes for
rent by traditional home-builders. This consumer preference
for single-family rentals is one of the reasons we believe
that the American dream of at least living in a single-family
home is far from dead and ultimately many of those rental
units will turn into owner occupied housing.

The trends outlined above have not gone unnoticed
by the investment community as torrents of cash has flowed
into the sector driving up apartment values and spurring new
construction. In a yield constrained world, the cash flows
associated with apartment ownership have looked increasingly
attractive to institutional and retail investors alike
and that has driven initial yields down to below 5% and to
below 4% in the more favored markets. Just to note, initial
yields on apartment projects were close to 8% at the height
of the financial crisis.
Figure 12 Apartment Vacancy Rate, 1980 - March 2015

However, because we expect interest rates to rise
over the next few years, the decline in homeownership rate
to level off and high new construction levels to negatively
impact vacancy rates, the apartment boom is likely to show
real signs of strain by late next year.

More importantly, with rents rising faster than incomes,
affordability will soon become a binding constraint
on rents. For example, from 2004-2014, the percentage of
households paying more than 30% of their income rent
increased from 40% to 46%.2 With developers building for
the top of the market, meaning high income renters, they
may not yet to be cognizant of this trend, but they will soon
find out that the high-end apartment market might not be as
deep as they think.

Yes, housing is back. It will not be a rerun of the 2005
boom, but starts will soon approach 1.5 million units a year.
The multi-family apartment boom will continue throughout
2016 as developers race to keep up with demand for urban
infill housing. Nevertheless, housing activity will begin to
gradually fade in 2017 as mortgage rates rise and apartment
vacancies increase.

Friday, September 18, 2015

The Fed Non-Move and the Stock Market

Yesterday the Federal Reserve maintained its zero interest rate policy and after briefly rallying stocks sold off sharply and the decline accelerated this morning, What gives? There are two possible explanations for this market behavior. The first is that the Fed is really frightened about the prospects for the global economy. What do they know that the market doesn't? Second by introducing an international mandate, by the way something that does not exist in the Federal Reserve Act, the Fed introduced a new uncertainty into its policy making. Simply put it would seem they are making it up as they go along making it nearly impossible for market participants to make an informed judgement about the future course of policy. Either way this is a recipe for low multiples.

Wednesday, September 9, 2015

Stock Market Volatility: Its More Than the Fed; Its "Stick it to the Man" Politics

The stock market has been trading nervously, to say the least, but it is more than next week's Fed meeting. In fact I believe that it would be far more bullish for the Fed to raise rates than to leave them alone. When historians look back at the current epoch they will not be concerned with whether or not the Fed raised interest rates in September 2015, but rather they will look at the very volatile politics we are now witnessing. Simply put the economy is not working for most of the electorate and its mood is to "stick it to the man."

It is not only the rise of the protectionists Donald Trump and Bernie Sanders in the U.S.; it also involves the imminent rise to power of Jeremy Corbyn, a wacko leftist, in the British Labor Party and the growing popularity of the the rightist Marine Le Pen in France. I would note that solving Greece's financial difficulties is a walk in the park compared to the challenge of the refugee crisis now facing the EU. Financial problems are more easy to deal with than cultural issues. The Eurozone can fail on the immigration issue.

In the U.S. the rise of Trump and Sanders means that passing of the Trans Pacific Partnership deal now being negotiated just might not pass when it comes up for an up and down vote. Don't count on the Republicans to pass it. They are squishy just like most politicians.

Thus it does not matter what the Fed does next week, volatile markets will be with us for awhile.

Sunday, August 30, 2015

My Amazon Review of Craig Nelson's "The Age of Radiance: The Epic Rise and Dramatic Fall of the Atomic Era"

Three Books in One

Craig Nelson has really written three books. The first one on the history of nuclear physics from 1890 – 1960 and physicists involved is terrific. The second one is on the role of nuclear weapons during the Cold War and here his biases show and he leaves much to be desired. The third book embedded in “Radiance” is a history of nuclear power where he emphasizes the three big disasters of Three Mile Island, Chernobyl and Fukushima which highlights the incompetence and the corruption of the nuclear industry. Here he is on pretty solid ground. And he recognizes that despite the disasters nuclear power might in the long run be better than carbon burning power plants.

His history of the science is easy to follow for the lay reader and he draws great insights into the personalities of Marie Curie, Enrico Fermi, Edward Teller, J. Robert Oppenheimer, Leo Szillard, John von Neumann and Otto Hahn. He is at his best when he discusses the life and work of Lise Meitner who rightly deserves credit for her Nobel Prize work with Otto Hahn in splitting the atom. Einstein rightly called her “our (meaning German) Curie.”  Also of note is his discussion of the coincidence of so many leading physicists and mathematicians all being born in early 1900s Budapest. What was in the Danube at that time?

Where he goes astray is in his views on the Cold War. To him Russia is always reacting to moves by the United States. Yet nowhere in the book is a discussion of the massive Soviet build-up that took place in the 1970s. His villain is Edward Teller, the co-developer of thermo-nuclear weaponry and the instigator of Reagan’s strategic defense initiative (SDI) known as “Star Wars”. His animus towards Teller goes back 1940s Los Alamos and his testimony critical of Oppenheimer during his security clearance hearing. To be sure Teller had his faults, but Nelson goes overboard. Nelson also fails to understand that a less than perfect SDI would have great deterrent value because it would increase the uncertainty with respect to a first strike.

So the way I would score it would be 5 stars for the history of science section, 4 stars for nuclear power and 3 stars for the Cold War portion. Net, net 4 stars.