Photo by Adam Winger on Unsplash
Hello,
Welcome to Known Unknowns, a newsletter where you can’t get rid of risk, you can only redistribute it—to the future.
Credit market crunch?
These are strange times. I can’t think of another period of zero or negative real rates for nearly a decade, some of it from market forces. During the pandemic, rates were further compressed by the Fed. And then rates went back up, fast. Once inflation started rising again, this was totally predictable. The result was lots of people and corporations locked in low rates in their mortgages or in their corporate debt.
What this means going forward will depend on the path of interest rates. If they go back down to near zero, in the next few years, we all dodge a bullet: the Fed increases rates, inflation falls, rates go back down before anyone has to refinance, and there are no dislocations or recessions. But if rates stay high, we don’t get off so easy. I anticipate this situation will impact the housing markets for at least several years. So many people have cheap mortgage payments and won’t be able to afford to move. And if inflation returns, real housing costs will be even cheaper and locked in. Unless they absolutely need to, no one is moving, and housing supply will remain constrained. That will cause problems in terms of dynamism and will contribute to stagnation, but at least there won’t be a housing crisis and households will be somewhat resilient.
Corporate debt will be more problematic. The “maturity wall” is approaching, and in the higher-for-longer world, corporations will need to refinance at a higher rate, or just not get credit at all. I can’t imagine that will be good. But at least more debt than ever is high-grade, and high-grade debt can manage a high-rate environment better than low-grade debt can. Also, if there is a recession in 2025/2026, monetary policy may be a player in the corporate debt market. The Fed already went there in 2020. If term premiums are structurally higher because of inflation or debt fears, yields on longer-term (and corporate) debt won’t fall when the Fed cuts interest rates. At this point, I would not put it past them to bring back quantitative easing—or just buy corporates instead of treasuries to “maintain the size of their balance sheet.”
So maybe we’ll still muddle through. But, in my bones, I just can’t believe this is a better outcome. If the housing market is less fluid and prices in the corporate debt market have no meaning in terms of conveying risk, it seems that is setting us up for something unpleasant.
Do you spend too much time with your children?
It is a curious trend that women somehow work many more hours than they did in the 1960s but also spend much more time with their children. In fact, in every rich country except for France, people have been spending more time with their kids. And, as much as people my age like to think we had feral childhoods (we even had our own keys to our houses, and had to use them!), somehow all these former latchkey children grew up to be helicopter parents. Now there is some evidence that a lack of unstructured, unsupervised time is contributing to worsening mental health in children and young adults.
There are many reasons why, most having to do with time-saving technology, more wealth, smaller families, and the elite arms race that makes people think their children need constant enrichment activities and help with their homework. But I also suspect a steady ratcheting-up of risk aversion that is becoming a vicious cycle. Each generation is more shielded from risk than the last, and so they don’t develop good risk-taking skills or an ability to tolerate ambiguity, and they in turn become more neurotic parents, who in turn raise even more anxious children. Of course, there are still plenty of healthy, balanced people out there. But there is also more social pressure to raise children in a certain way.
And this is not only bad for personal well-being but has wider economic consequences. Risk-taking is critical for success in work. Just like your financial assets, your human capital grows more from risk than from caution. Things like moving and changing jobs are what increase your earnings—and entrepreneurs earn more. It is no coincidence that, as we became more risk averse and raised our children to be that way, entrepreneurship rates all fell. And, when we all faced a big shock, suddenly lots of people started businesses again. People often take risks when they face the realization they can’t control the world or just have no choice because they lost their job. But what’s interesting about the post-pandemic entrepreneurship boom is that it went on even as the economy recovered and the labor market was at its tightest in years.
Could it be a return to dynamism that will increase productivity and create jobs? I am not so sure. Many of these new businesses won’t hire employees, and some won’t survive a recession whenever it comes. But some of them will. There are now the tools to work for yourself—technology means you can learn skills and find clients online. I describe how my hair colorist can’t hire assistants anymore because young beauty school graduates strike out on their own without doing the standard apprenticeships. They say, “Why bother, when you can learn hair techniques on TikTok and cultivate a clientele on social media?” Maybe some of the youngs are not so afraid of risk after all…
In other news
I am skeptical of climate swaps that require developing countries to commit to climate goals (in the New York Post! I feel like such a New Yorker—almost as good as being on Page 6!)
Until next time, Pension Geeks!
Allison
Thanks for this post. i was interested in both topics.
On credit risk, there's also the consumer debt sector: credit cards and auto loans. That's also a key risk.
On kids, my wife and I were 8-12 in NYC from 1970 to 1974. We were given much more freedom than gave our three kids who were 8-12 from 1996 to 2005 (six year age spread). NYC was definitely safer for our kids than for us.
We have a one year old grandson and it'll be interesting to see what freedom he'll be given.
I think there is too much focus on lack of existing homes for sale for several reasons:
1. Baby boomers are entering retirement. Unless they are looking to move to a new area for retirement, they are not in a rush to sell their home. A 65 year old with decent income and assets will likely live into their 80s or more. The model from 40 years ago where they die of lung cancer at 70 and their home goes on the market isn't the baseline anymore. Many of these houses won't come on the market for a decade or more.
2. Median new homes have been increasing in square footage every decade for the past 60 years. The cost to build a home is till based on square footage and the lot size is usually bigger. So the median new home and median home size is getting more expensive which makes it less affordable regardless of any other factor. The solution is to build more 1,000 sf - 2,000 sf homes on smaller lots. That works in any financial environment but is generally less profitable for homebuilders in tract housing.
3. There are a lot of lots in cities but they are not in desirable neighborhoods, the end product of decades of urban decay from redlining etc. Many of the homes from before mid-80s have lead pipe and lead paint making them a hazard and less desirable housing in many ways. Many of these are smaller homes on smaller lots, so would be affordable. A strategy to rejuvenate these areas with new housing would open up a tremendous amount of affordable housing.
4. There hasn't been a lot of home construction since the housing crash in mid-2000s. That is 15 years now. Zoning laws, HOAs, etc. make new housing of all types more difficult to build. That needs to get fixed so that the people who currently live in an area can't block all affordable housing construction. Everybody recognizes that lots of new affordable housing needs to be built as long as it is built in somebody else's community. Lots of new housing was being built in the 80s and 90s with interest rates and inflation higher than today. But they used up much of the easy land to build on. Now it is more difficult doing infill housing in areas with established communities that like status quo.