My latest USNEWS Blog on Obama's Corporate Tax/Infrastructure Grand Bargain

See the attached URL below:
http://www.usnews.com/opinion/blogs/economic-intelligence/2013/07/31/obamas-new-corporate-tax-grand-bargain-has-potential-for-republicans

My Amazon Review of Susan Dunn's, "1940: FDR, Willkie, Lindbergh, Hitler-the Election Amid the Storm"

Susan Dunn has written a wonderful follow-up to her "Roosevelt's Purge." We move from Roosevelt's intra-party fight of 1937-38 to his his preparations for war in 1940 and 1941. Her title, although flashy, is much more about Roosevelt than Willkie, Lindbergh and Hitler and the story extends beyond the election of 1940. Roosevelt and the internationalist Hamiltonian Republicans are the clear heroes and clear villains are Lindbergh and the isolationist majority in the Republican Party. Roosevelt dominates the action with his masterly setting up the politics for his unprecedented third term and his great speeches pushing the country towards war. However, Dunn gives too much credit to his speeches but fails to note the lack of immediate action thereafter. For example not much happened after his state of emergency speech in May 1941. In many respects Roosevelt feared that he was getting too far ahead of public opinion, when in fact, he very likely was lagging behind the popular will, at least in 1941.

Dunn's portrait of Willkie shows him clear eyed in the face of the Nazi menace and way ahead of his time with respect to civil rights. Unlike Roosevelt, who was too dependent on the racist southern Democrats, Willkie was a full thoated supporter of Negro rights in the early 1940s. It is here where I have my main quibble with Dunn's book. In order to keep her plot-line going she all but ignores the critical support given to Roosevelt's foreign policy by the very Jacksonian and very racist southern Democrats. Without internationalists like Georgia Senater Walter George, a target of the failed 1938 purge, Roosevelt's whole enterprise of aiding Britain in its time of desperation would have floundered on the rocks. For a full discussion of the South's role in the foreign policy of the period I would recommend Ira Katznelson's, "Fear Itself...."

I also have two other quibbles. She ignored the role of future Secretary of State Dean Acheson's legal opinion in support of the destroyer for bases deal of 1940 and while she mentions the role of German intelligence in aiding the isolationist forces, she completely ignored the the role Britain's agent, William Stephenson in pushing America into the war.

All told Susan Dunn has written a fine book which vividly captures an era where politics really mattered and the American people really cared.

Leading from Behind

President Obama is afraid to lead. While speaking to a gay pride event in the White House, deputy national security advisor Benjamin Rhodes told reporters that Syria's Assad regime crossed the "red-line" with the use of chemical weapons in that country's civil war. My guess is that the red line was crossed sometime ago and the President was unwilling to acknowledge it. It took the deteriorating military situation to get the President off the dime. The next day Rhodes defended the administration's position to provide lethal aid to Syria's rebels,  all the while President Obama was hosting a Father's Day luncheon. All of this was on the front page of today's New York Times. This is not how a President goes to war!

From Egypt to Iran the whole Middle East is in turmoil and our President acted as if nothing were going on. Former Hillary Clinton aide, Anna-Marie Slaughter noted in the same article, "I really worry this is going to be remembered as the United States standing by and watching a Middle East war ignite." Knock Knock we are in a proxy war with Iran in Syria. That fact was emphasized with the critical support Hezbollah, Iran's ally in the region, gave to the Assad forces in the battle of Qusayr. Those forces are now on the march to the rebel stronghold of Aleppo, Syria largest city with a population of three million. With over 90,000 dead the slaughter is only beginning.

The stakes in Syria are enormous. Seventy-five years ago there was another proxy war, in Spain. There a civil war between the loyalists and Franco-led rebels brought in Russia along with its security apparatus on the side of the loyalists and Germany and Italy on the side of their fascist ally. It was a dress rehearsal for World War II. Britain and France stood idly by, sending the very clear message to Hitler that they were unwilling to fight. Unfortunately Obama is sending the same message to Iran and it nuclear ambitions. I hope we are not too late.

"The Housing Recovery: How Strong? How Long?" UCLA Anderson Forecast, June 2013

 

At long last a sustained housing recovery is now underway. Home prices are rising and housing starts have approximately doubled off of their depression lows of a few years ago. This scenario is very much in line with our forecast of one year ago. Nevertheless, the questions remain how strong will the recovery be? and how long will it last? In short, our answers are that housing starts will reach a run-rate in excess of 1.6 million units by mid-2015 and home prices will continue to rise, albeit not at the heady 9% rate of the past year. As a result the housing recovery will last until at least late 2015.

Specifically, we are forecasting that housing starts will increase from the 782,000 units recorded in 2012 to 1.03 million units and 1.35 million units in 2013 and 2014, respectively. For 2015 we are projecting housing starts to reach 1.56 million units. Along the way, multi-family housing starts will boom with an excess of 400,000 units a year being started in both 2014 and 2015.

Although this forecast may appear to be overly optimistic, against the long sweep of history it looks decidedly modest. (See Figure 1) For example, the modern era all-time low for housing starts of 554,000 units in 2009 was approximately half the recession lows reported over the period 1959-2012. Housing was truly in a depression, not a recession, from mid-2008 through the end of 2011.

Furthermore over the entire 1959-2012 time period housing starts averaged 1.47 million units a year, a level that we predict will not be exceeded until 2015. Remember that in 1959 the United States had a population of 180 million people, while today it approximates 315 million, a 75% increase. Thus it can be reasonably argued that, if anything, we are being too pessimistic.

Figure 1 Housing Starts, 1959Q1 – 2015Q4E   Sources: U.S. Department of Commerce and UCLA Anderson ForecastOur forecast is underpinned by the facts that house prices are now rising from a very low base and mortgage rates remain at historical lows. These two factors imply that ownership housing remains very affordable on a national basis and the rise in prices is gradually removing the deflationary fears that gripped the market only a few short years ago. (See Figures 2 and 3) We learned in 2010 that affordability alone is not sufficient to drive a rebound in housing starts.

To be sure the risk remains that the rise in mortgage rates we are forecasting to just under 6% in 2015 could choke off the rebound. Our sense is that with prices once again rising, a gradual rise in mortgage rates will act more as a motivator rather than as an inhibitor to potential homebuyers. Simply put, a sense of urgency will return to the market. Our view is buttressed by the fact that homebuyers are now being motivated to bid aggressively in the face of a lack of

Figure 2 Case-Shiller Home Price index, 2000 – March 2013, Monthly Data, 2000=100.
Source: Standard & Poor’s via Federal Reserve Bank of St. Louis.
Figure 3 30-Year Conventional Mortgage Rate, 2000Q1 – 2015Q4F

Figure 4 Existing Home Sales, 2000 -2015F
 
Sources: Freddie Mac and UCLA Anderson Forecast

Sources: National Association of Realtors and UCLA Anderson Forecast

inventory of existing homes. As prices rise, the amount of existing homes listed for sale will increase and home sales are forecasted to increase from 4.8 million in 2012 to 5.7 million units in 2015. (See Figure 4.) Of course, as the recovery matures, higher interest rates will weigh on the market.

On the macroeconomic side, housing demand will be supported by a gradually improving labor market and the continued rebound in household formations. (See Figures 5 and 6) We project that employment will reach a new all-time high in 2014, seven long years since the prior peak, which would make it the most sluggish recovery in the postwar era. Similarly, household formations which collapsed to a mere 40,000 in 2009, won’t really get back to levels achieved nearly a decade ago until this year, but 2014-15 run-rates of 1.5 million-a-year are certainly supportive of our housing start forecast for those years which are approximately at that level.

Although it is possible to make a case for a stronger housing recovery in the sense that we are coming out of a sustained period of under-building, housing activity is still being held back by a less than ebullient recovery in the broader economy, still tight, albeit easing somewhat in recent months, credit conditions in terms of down payment and credit score requirements for potential homebuyers and the rapid buildup to nearly one trillion dollars in student loan debt. (See Figure 7) Never before have so many young people been saddled with so much non-mortgage debt and that burden will keep them out of the home buying market for years to come.

 
The flip-side of more stringent credit requirements for home purchase and mounting student loan debt is an increase in the demand for rental apartments. After peaking at 69% as far back as 2004, the homeownership rate has steadily declined to 65.4% at the end of 2012, with a further decline likely this year. (See Figure 8) Moreover, multi-family housing demand is being buttressed by a change in consumer preferences for a more urban, as opposed to suburban, lifestyle. In order to accommodate the demand, developers, out
Figure 5 Payroll Employment, 2000Q1 – 2015Q4F
Figure 7 Student Loan Debt, 2003Q1 – 2012Q4
Sources: Bureau of Labor Statistics and UCLA Anderson Forecast

Figure 6 Household Formations, 2000 – 2015F

Sources: Federal Reserve Bank of New York and The Wall Street Journal

Sources: Bureau of the Census and UCLA Anderson Forecast
of necessity, are building more dense projects and they are being encouraged by governmental planning authorities to do just that. One of the major sea changes in the past five years has been the radical shift on the part of government from opposing higher densities to encouraging it. Where density was once considered the bane of the environment it is now considered "green." Thus where multi-family construction in many urban areas was deemed to be supply constrained, that is no longer the case.

The increased demand for apartments coupled with the recession induced collapse in construction has caused the apartment vacancy rate to plunge and rents to increase rapidly. (See Figures 9 and 10). After peaking at 8% in 2010 the 79 city REIS Apartment Vacancy Rate series declined to 4.3% in the first quarter. Concomitantly, rents, according to the consumer price index, are rising at a nearly 3% annual rate, about double the overall rate of inflation.

We believe that the official consumer price index is understating the true rate of inflation for rents because most of the publicly held apartment real estate investment trusts and private surveys have been reporting rent increases of 4% or more for the past two to three years. Why the difference? For starters, the official series over-weights rent controlled cities such as, New York, Los Angeles and Washington, D.C. Furthermore, the process of vacancy decontrol slows down the mark to market process for in-place tenants and rents in smaller apartment buildings tend to lag those of larger developments. Thus, we believe the official series will soon begin to catch up to the market reality on the ground.

With the strong fundamentals outlined above, coupled with the world-wide scramble for yield caused by global central bank policy, investors are buying apartment houses with abandon. Prices have more than surpassed their previous peak of 2007. Put bluntly, with going-in yields approximating 4-5% and with rents rising, apartment house investments look very attractive when compared to the sub-2% yields available on 10-year U.S. Treasury notes. Indeed the frenzy has spilled over to single-family home rentals where both private equity firms and newly capitalized publicly traded real estate investment trusts are buying up single family homes in bulk for the rental market.

Figure 8 Homeownership Rate, 1990 -2013F, Yearend Data, Percent
Sources: Bureau of the Census and UCLA Anderson Forecast

Figure 9 Apartment Vacancy Rate, 1980-2013Q1, Percent
Sources: REIS and Calculated Risk

Figure 10 Consumer Price Index, Rent for Primary Residence, Jan 2000 –Mar 2013
Sources: U.S Bureau of Labor Statistics via Federal Reserve Bank of Saint Louis  

All of the factors outlined above have led to a surge in multi-family construction. (See Figure 11) After bottoming at 112,000 units in 2009, multi-family housing starts more than doubled to 247,000 units in 2012 and are forecast to reach 365,000 units this year.

We fully anticipate that starts will exceed 400,000 units in both 2014 and 2015. Of course this surge in supply will begin to elevate the vacancy rate and cool the rent increases that most investors now expect. In the meantime, higher apartment rents as we noted last year, will cause tenants to once again return to the ownership market
 

ENDNOTES

1. See Shulman, David, "Rebuilding the Housing Economy," UCLA Anderson Forecast, June 2012.

Bond Servants: REITs Under the Lash of the Bond Market

NAREIT starts its annual investor conference this coming week. Until a few weeks ago it was going to be a celebration of the near 20% gain posted by the RMZ Index as of May 21. Since then the world became a very hostile place for REITs with the RMZ declining from 1070 to 969 as of Friday's close, a drop of 9.4%. To be sure REITs are still up 8% for the year, which would normally be a cause for celebration, but not this week.

Although most REIT investors paid lip service to the fact that very low bond yields acted as a tailwind behind the REIT bull market, most of them were caught by complete surprise as to how powerful the negative effect of the 50 basis point backup in 10-year U.S. Treasury yields to 2.16% that occurred in the month of May would be.

My sense is that the back-up in yields is just beginning. Although I do not believe that it will be dramatic as the last few weeks, it would not surprise me to see the 10-year treasury yielding 2.5% at yearend and in excess of 3.5% by the end of 2014. As a result the bond market will become a major headwind in front of REIT share prices.

If REITs were inexpensive, the benefits of a growing economy would work to offset some or all of the negative effects coming from higher interest rates. Unfortunately that is not the case. With REITs trading at around 20X EBITDA they are far from being attractively priced. The true test will come from the private market where it is way too soon to see if cap rates have been affected by the the back-up in rates. If the past is any guide it will take awhile because there is way too much investor intertia in this market, especially where public pension plans are concerned. Thus the effects of rising rates on the private market probably will not be visisble until the Fall.

In the meantime the joys of being a bond substitute will give way to sorrows. As a result selling the rallies might very well be a better strategy than buying the dips.

My Amazon Book Review of Christopher Clark's, "The Sleepwalkers: How Europe Went to War in 1914"

Sleepwalkers is about how, not why, Europe fell into the abyss of war in 1914. It is a terrific work of history, but for the lay reader, it is way too long and gets too bogged down in minutia. Hence four stars instead of five. What makes this book different from the volumes I have read on the origins of World War One is that is puts the emphasis on where it started, the Balkans. After reading the early chapters of the book, Clark proves, intentionally or not, the Bismark aphorism, that the Balkans were not worth the bones of a single Pomeranian grenadier.

For someone like myself schooled in the works of Tuchman (chaotic and inept decision making theory) and Fischer (Germany wanted a war from the get go) Clark's book is an eye opener. First it makes all of the players seem rational and second it puts far more emphasis on the role of France and Russia in starting the war. Both France and Russian planning was based on a "Balkan inception" scenario; something that was given to them on silver platter by the assasination of Archduke Ferdinand in Sarajevo on June 28. Within five weeks Europe was at war. As an aside the fear of growing Russian power not only motivates Germany, but also France in that France feared that in only a few years Russia would no longer need an alliance with them.

Although Clark convincingly covers the intrigues of Belgrade, Venice, St. Petersberg, Paris and London; he does not spend sufficient time on Berlin. I know that might be more of a "why" question than a "how" question, it is necessary for the story. It speaks the need to understand whether Austria-Hungary was an independent actor or a pawn of Berlin.

These quibbles aside there is so much to learn here and there are lessons for today. Afterall the Sarajevo trigger was an act of state-sponsored terrorism.

My Amazon Book Review on Ira Katznelson's, "Fear Itself: The New Deal and the Origins of Our Time"

There have been thousands of books written on Franklin D. Roosevelt and the New Deal. Instead of focusing on the executive branch, Katznelson shifts the focus to the Congress, particularly the southern Democrats who dominated the caucus and chaired the major committees. The author convincingly demonstrates that when the southerners were with him, Presidents Roosevelt and Truman got what they wanted. Conversely when the southerners opposed the Adminstration, the New and Fair Deals floundered. It is here where Katznelson makes an important contribution to our understanding of the New Deal and the early postwar era.

With respect to domestic policy, Katznelson views the approach the southerner took through the prism of race. Specifically where the southerners feared the underpinnings of the Jim Crow south were under attackl they backed away from Roosevelt. Although I largely agree with that thesis, the major failing of the book in my opinion, is that Katznelson ignored the Jacksonian roots of the southern Democrats then sitting in Congress. At its founding the Jacksonian Democrats were both racist domestically and hawkish with respect to foreign policy. Thus while the southerners, opposed Roosevelt dometically after 1938, they stood by him and later Truman in supporting the foreign and defense polcies of the emerging national security state.

I would recommend "Fear Itself..." to both serious students of American history and the casual reader interested in how much the the institutions we now take for granted came into being.