Sunday, March 20, 2011

Minsky and Housing

Prof. Scott Fullwiler explains the basics of MMT in Modern Monetary Theory - A Primer on the Operational Realities of the Monetary System. He cautions that MMT is more than simply an operational description of the modern (post 1971) monetary system.

At its core, there are two parts to MMT. The first is a description of how the monetary system actually works, mostly focusing upon interactions between the central bank, the treasury, and the financial system, though this part also requires a very thorough understanding of the Minskyan-related literature of many MMT’ers (I note this because so many critics of MMT ignore or not aware of the vast MMT literature on financial instability and reforming the financial system). The second is a set of policy proposals that arise from this description and is largely outside the scope of this particular post but which can be found in any number of MMT publications and blogposts (and, again, including the sizeable MMT literature on reforming the financial system).

The Minskian aspect of MMT is often overlooked. However, it lies at the core of MMT macro analysis. Minsky was particularly concerned with the role of private debt and how changes in quantity and quality of debt affect the financial cycle. For example, financial instability rises as risk appetite grows and credit standards weaken to accomodate it. The financial cycle culminates in what Minsky described as Ponzi finance.

Ponzi finance is characterized by a situation in which cash flow is insufficient to service principal and interest without selling assets or borrowing. The housing crisis grew out of Ponzi finance, where buyers and lenders expected loans — mortgages and HELOCs — to be funded from future appreciation of the underlying asset, providing thin or no margin for error. In fact, the probability of error was magnified by lax standards. With no cushion, default was the only option for many, and foreclosures ballooned, while valuation tanked.

Dr. Housing Bubble has just posted an excellent analysis of this with respect to the bubble in residential real estate, as well as how it can be expected to work itself out.

This was entirely predictable based on the sectoral balance macro approach of MMT. The Clinton surpluses set up the debt dynamic by providing too little increase in nongovernment net financial assets to offset demand leakage, with the result that the private domestic sector was force into debt to maintain lifestyle. Creditors obliged with easy credit. The rest is history, which Dr. Housing Bubble summarizes from an insider's vantage. Dr. Housing Bubble lays this debacle directly on lenders, on one hand, and also on the wage dynamic over the past few decades, which has seen real wages either stagnant or falling.

The result of a credit implosion is the abrupt ending of the long financial cycle and an intermediate stage of market clearing before a new cycle can begin. The new cycle starts with much tighter credit standards. Dr. Housing Bubble sees US residential real estate in a clearing stage for the next year or two, with prices dropping further. He sees no return to appreciation in housing for some time after that, owing to the changed credit dynamic and stagnant incomes. Real wages have been declining for some time and are not likely to grow soon, given the current trajectory and climate.

Moreover, growth is occurring in the rental market while home ownership is declining. People are now looking at home ownership in a different light, no longer under the spell that housing values always rise, so that home ownership is the optimal middle class investment. The growth in building permits is now in multi-dwelling units in anticipation of an increase in renters.

1 comment:

John said...

Steve Keen just posted a video of a talk he gave on Australian real estate and credit bubbles:

Anyone interested in an Aussie REIT.