Mortgage Availability and Personal Consumption: The Dubious Relationship Breaks Down

What happens to Personal Consumption Expenditures when banks tighten up mortgage lending standards?  With the release of April PCE data, we can now check out a dubious, but widely publicized prediction.


Two months ago the influential Doug Kass repeatedly published a chart that purported to show a near perfect correlation between lending standards as measured in a quarterly Fed survey and year-over-year PCE.  The chart was also posted and discussed at the widely read Calculated Risk blog site.

In a three-part series on "A Dash", we went to the original data sources and performed our own analysis.

Part One. We showed readers that the correlation was exaggerated, that the scale had been manipulated in a deceptive fashion, and that the causation argument did not fit the data.  The existing correlation was probably spurious, the change in each resulting from changes in prevailing economic conditions.

Part Two.  We explained the difference between a confidence interval and a correlation, helping readers to understand the difference between substantive significance and statistical significance.

Part Three.  We compared the chart to various optical illusions, showing why accurate measurement is better than the eye.

The Prediction and the Result

The original Kass chart showed an ominous tightening in lending standards, suggesting that we were on the verge of a similarly precipitous decline in personal consumption.

As one can see from the updated chart, (the new segment indicated by a red line around it) the PCE change was modestly lower.  The rate of PCE growth continues well within the range from the last two years.

The Kass prediction was incorrect.


As we concluded in our original analysis:

The current mortgage market is much different from that of 1990.
Nearly everyone — especially Doug Kass — believes that recent
standards have become quite loose.  Some tightening is a logical
reaction.  There is nothing in the data he presents that shows that
this should result in a decline in consumer spending.

Such a decline might occur, of course.  There may be other reasons
to link housing and the economy.  That is beyond the scope of Doug
Kass’s argument and this response.  The point here is that the data in
the original Kass chart do not support his conclusion.

The next Fed survey of bank officers should be reported any day, so there will be a new data point to add to the chart.

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  • Steve May 1, 2007  

    I forgot all about that. I’m glad you revisited it.

  • Stevey G May 2, 2007  

    You make an excellent point, and when I track back and look at your original blog on this topic, you mention that Doug Kass has been trying to flog this chart remorselessly.
    I think this is part of a tendency of late by many bloggers, some of who should know better and who I am sure have an interest in promoting their bias, to redraw charts/curve fit, focus only on extremely negative news, and make rather spurious assumptions.
    Another example of this has been the recent posting on a number of influential blogs, of the chart comparing the recent stock market up to the end of March against the 1987 stock market crash. I tried recreating the comparison on Excel, and it looked nothing like the fitted chart used on the example. I also look back at the data of the past two days, particularly the relatively strong ISM number, this barely gets a mention anywhere, yet I am pretty sure had this number been sub-50 (or more specifically 45) it would have been all over the blogs as another example of the impending US recession.
    Personally I am no wiser than anyone else when it comes to knowing where the US economy is heading, although I am guessing slow growth but low possibility of a recession is most likely. – However, I must thank you for many of your postings over recent months, I find your analysis has been extremely refreshing and illuminating amongst so much of the dribble I have seen elsewhere. Keep up the good work.
    Stevey G (London)

  • Jeff Miller May 2, 2007  

    Steve and Stevey G —
    Thanks for stopping by and taking the time to comment. I am delighted that some are finding this work to be useful.
    Modern software has made it easy for people to crank out these curve-fitting charts. I taught courses that showed the power of deceptive charts, but I was still amazed at the reaction to the Kass chart.
    People – many people at Calculated Risk — looked at the “Batman section” and inferred correlation. The regulars at that site were quite polite, but clearly thought I was crazy! And on a mission.
    Most did not seem to appreciate that I have not left my professorial roots, and the mission is one of education.
    Thanks again!

  • Sebastian May 3, 2007  

    Stevey G said: “Another example of this has been the recent posting on a number of influential blogs, of the chart comparing the recent stock market up to the end of March against the 1987 stock market crash. I tried recreating the comparison on Excel, and it looked nothing like the fitted chart used on the example…”
    Prof. Shiller’s (“Irrational Exuberance”) long-term EPS/DIV data on the SP500 has been an excellent resource for me when “vetting” such things.
    As an example of how this data can be applied: In February (before the March selloff) of this year, SP500 PE (TTM, as-reported) was around 18, with EPS growth at around 14%. Moderately overvalued, but with good earnings growth. (Standard and Poor’s is the source for this recent data.)
    In August, 1987 (the top before the “crash”, as per Shiller data) the PE was around 20 (a multi-decade high), with TTM EPS growth slightly *negative*. Considerably overvalued, with falling earnings.
    Not exactly an apples-to-apples comparison.:)