Removing distressed house supply facilitated the economic recovery
Removing the supply of distressed homes created a supply shortage homebuilders responded to by providing more houses, hiring construction workers, and stimulating the economy.
If I understand Keynesian theory properly — which is important to understand federal reserve policy — inflating asset values through low interest rates triggers businesses to expand because borrowing costs are so low, they can make marginal opportunities productive. As businesses expand, they hire more people for their operations. The newly employed create demand for goods and services, stimulating more demand for goods and services, which in turn creates more business demand, puts more people back to work, and so on — a virtuous circle.
Unfortunately, during periods of overcapacity, the expansion proceeds slowly because businesses make use of existing labor, property, plant, and equipment rather than creating new demand. If capacity utilization is only running at 75% to 80%, if businesses saw an opportunity, they would put existing capacity to work. Unfortunately, utilizing existing capacity does little to stimulate the economy, which is one reason the economic expansion of the last eight years has been so weak.
So what’s the answer? Create an artificial shortage of capacity or supply and wait for businesses to respond to the false signal. As strange as it sounds, distorting the economy further actually works.
Take homebuilding for example. We have an inventory of distressed properties temporarily removed from the market with loan modifications and delinquent mortgage squatting. But rather than recycle this inventory, by removing it, we create an artificial shortage requiring builders to respond with new inventory. This puts people back to work in homebuilding and begins the virtuous circle the Keynesians dream about — and it’s actually working. House prices are up, and homebuilders are hiring again.
The bigger lesson here is that homebuilding stocks are going to be volatile over the next several years because homebuilders are responding to false market signals. In the mid-00s, during the housing bubble, homebuilders were responding to false market signals and built many homes we didn’t need. When the housing bubble burst, the industry paid for it with crashing stock prices, and construction workers paid for it by getting laid off for five years.
Is homebuilder hiring reluctance holding back the economy?
The homebuilders are hiring again, but after laying off 90% of their workforce in 2008, they are in no hurry to staff up. I spoke to a hiring manager from a major homebuilder, and he explained it just that way. He told me his company had 25 project managers working for them on sites across Southern California. In 2008, he fired all but two of them — two workers had to do the job of 25. It’s painful to fire so many good, experienced, and qualified people, many of whom were likely friends. Nobody wants to go through that again, so when homebuilding started to pick up, homebuilders didn’t hire, they just made existing staff work harder.
The staff is so overworked that the builders must hire people now, but they are hiring as few as possible, and those that do get hired are expected to work 50-60 hours a week or more. And after the carnage of the housing bust, those overworked homebuilders feel fortunate to have a job.
When the Keynesians construct their theoretical and mathematical models of the economy, they don’t anticipate and can’t model the emotional reactions of hiring managers like the one I talked to; however, these reactions are real and understandable. According to Keynsian thinking, homebuilders should have begun staffing up three or four years ago, which would have stimulated the economy. Instead, these hiring managers reacted fearfully and didn’t hire more people — they utilized their overcapacity; they got more productivity out of the staff they had. The same is true of other industries.
Based on the macro picture for homebuilding, these hiring managers are right to be cautious. Although almost none of them know or care about the myriad of market manipulations creating demand for their product, they were once bitten, so they are shy about hiring today. Since the demand for their product is the result of artificial stimulus and supply manipulation, they may face future layoffs as these distortions come back to reality. I can assure you that none of them want to go there.