Saturday, May 28, 2016

Housing: Part 153 - Price Changes at the start of the bust

You know that thing that happened back in 2006 and 2007 where increasingly predatory loans were going to low income households that couldn't begin to make the payments, and when the Ponzi scheme inevitably came to its end, those low income households started defaulting?

And, then, a domino effect happened, where low income neighborhoods were full of foreclosures that undermined the market, and just made home prices in those neighborhoods collapse even more?  So, the mortgage brokers got out of town with their fees and their bonuses and left lower income households holding the bag?

Remember when that happened?

I do too.

Except, it kind of didn't happen.  (You knew I was going to say that, didn't you?)

Here are scatterplots of zip codes in Los Angeles.  The x-axis is the log median home price in the zip code.  (12 ~ $160k, 13 ~ $440k, etc.)  The y-axis is how the median home price changed in a year.  The scatterplots contain the years 2005-2009.

In 2005, we see the rising prices we all remember.*  But, note what happens in 2006.  Prices start to moderate, but that moderation isn't led by a collapse in low priced homes.  It is high priced homes that were declining first.

By 2007, prices were widely in decline.  But, even by then, homes at the high end were leading the trend.  Remember, by the middle of 2007 the private mortgage market was gone.  Not diminished, basically just gone.  There was no source of credit for unconventional mortgages by then.

It was only in 2008 that low priced homes really dropped.  And, boy did they drop.  Notice that high priced homes were still declining, but the decline was about where it had been in 2007.  Then, high priced homes stabilized in 2009, but low priced homes continued to collapse wildly.

You know what has a stronger influence on high priced homes than low priced homes?  High interest rates.  Because the implied net return (net rent/price) is lower on high priced homes than it is on low priced homes, so the risk free rate effects them more.  There is basically a spread on home equity returns that gets larger as you move to lower priced homes.  In other words, if interest rates cause required returns in housing to go up 1%, high priced homes where the returns go from 3% to 4% will be effect more than low priced homes where returns go from 7% to 8%.  Interest rate policy creamed the high end housing market, and only later, as a lagging effect, did low priced homes collapse.

Of the 22 MSAs I have been looking at (the largest 20, minus Houston, plus San Jose, Portland, and Las Vegas) where Zillow has zip code level data on the trailing 12 month rate of existing home sales and on price levels, in 20 of 22 cities, existing home sales started drying up in high priced homes before low priced homes.  And in 15 of 22 cities prices of high end homes started to fall before prices of low end homes.

This was not a subprime crisis.  It is a misnomer.  It was a moral panic.  What those neighborhoods in 2008 and 2009 needed was a government that would allow banks to sell mortgages to them.  It's 2016, and we still won't let them.

I have included Phoenix and Dallas here too.  It's a common pattern in all city types.

In Phoenix, of course, there was the big price jump in 2005, although there wasn't much difference between high priced and low priced homes.  But, even in Phoenix, high priced homes led the collapse and low priced homes had their crisis well after the collapse of subprime.

In Dallas, there was just 5%, + or -, regular price appreciation, but a lot of low priced zip codes there got to see a couple years worth of 5-20% price drops, too.  Because they needed to learn a lesson.  If we had supported the housing market in 2006 and 2007**, those low income zip codes in Dallas would be full of people who think a house is a safe investment.  That'd be a pretty stupid thing to encourage, wouldn't it?  They are wiser now.  You're welcome, poor Texans.  Job well done, everybody.






*In 2005, LA did see low priced home values rise more quickly than high priced homes, which I think I have gone over here.  I expand on it more in the book.  This only happened in the Closed Access cities (coastal California, etc.).  It didn't happen in the Contagion cities (Phoenix, Miami, etc.)  The reason it happened is because Price/Rent ratios naturally increase as home prices rise, up to about $500,000.  So, this effect was not pushing the high end of Closed Access home prices up, but it was still in effect for most other homes.

** Some will probably react to that by saying, "Oh, so now, the Fed is in charge of making sure nobody ever loses on a real estate speculation?"  No.  It's not.  There is a long distance between micromanaging an asset market and engaging in a multi-year attack on the mortgage market that first exogenously cuts 10% market share from conventional mortgage originators and then creates a liquidity crisis in the mortgage markets that rise up to replace them.***

*** Some will probably react to that by saying, "Oh, so now, the Fed is in charge of making sure nobody ever loses on a reckless MBS with rigged credit ratings?"  No.  It's not....Ah, heck.  It's turtles all the way down, isn't it?****

****As I think through the book, it really is amazing how deeply the premises determine the conclusions throughout this topic.

Thursday, May 26, 2016

Housing: Part 152 - Incomes before and after Rent

Here are some graphs with a little more detail on incomes between cities.  Here I am using Closed Access cities (LA, SF/SJ, San Diego, NYC, Boston) and Other Cities, which in my labels refers to the top 20 cities that aren't either Closed, Open (Dallas, Houston, Atlanta) or Contagion (Phoenix, Riverside, Miami, Tampa).  The Other Cities includes Chicago, Philadelphia, Detroit, Washington, St. Louis, Minneapolis, Baltimore, and Seattle.  A cross section of struggling cities, mature cities and "closed access lite" cities.

Generally, the Open and Contagion cities look like the other cities, but with incomes across the distribution that are 20-30% lower.  And the US outside these MSAs has income levels similar to the Open and Contagion cities, but with a lot less income variance by this measure.  Some of this could be because rural income variance is more likely to happen within a zip code while urban incomes are geographically segregated on a larger scale.

In any event, in 1998, the earliest year of IRS data, it looks like a chunk of median quintile incomes have been taken out of the Closed Access cities and replaced by a range of above-average incomes.  By 2013, the same shift is apparent, but moreso.  But, using Zillow median rents (which aren't available for 1998) to estimate incomes after rent, in 2013, we see that income after rent looks about the same as the income distributions in 1998, except now there is a hump at the bottom of the distribution too.

I think this is related to the migration pattern I have been describing, where high income workers can move into the Closed Access cities to tap into lucrative labor markets.  Since those labor markets are more lucrative because of the limits imposed by the closed access housing policies, this migration creates a bidding war on that limited asset - housing.  At the top of the income distribution are households voluntarily making a move, and natural economic forces push incomes and home prices to an equilibrium that pulls the outcomes for those households back down to a net income level, after rent, that is similar to opportunities in the other cities.

The secondary effect of that voluntary migration is for the housing stock to be bid up across the existing range of units, which raises costs for households at the bottom of the income distribution.  (Why don't we call that trickle down economics?  At least the economic program normally derided as "trickle down" promises growth.  In the Closed Access version, it is deprivation that trickles down.)  In this part of the income distribution, migration comes involuntarily, after costs impose enough distress to induce one more household to move out, making room for more of this migration pattern.  The Closed Access cities are the pattern of distress that seems to be informing American politics these days - a hollowed out middle, high gross incomes at the top, and households at the bottom running to stand still, at best.

The solution to this problem isn't so much affordable housing as it is housing in general.  The nearly 4 million domestic households that moved out of the Closed Access cities from 2000 to 2007 were moving because their homes were becoming too expensive.  Their homes were becoming too expensive because they were the best units available for high income workers who were moving into the city.  I don't think, on net, this problem is ameliorated by imposing local pressures for affordable housing that, in the end, reduce the total number of units.

Steve Randy Waldman has a typically challenging and interesting post up today about this issue.  He makes some good points about the legitimate concerns that are sometimes referred to as Nimbyism.  And, he is probably right that the residents most likely displaced by infill development will be the economically least advantaged.  But, I think there is a bit of a forest & trees thing going on here.  That is happening now.  The most distressed households are the ones that are displaced now.  Now they are displaced by remorseless market forces, haphazardly, a family at a time.  If they were displaced by infill development, it would be in identifiable groups that would be part of local political negotiations that account for some of those dislocations.

Those dislocations are now in the service of dysfunctionality and more dislocation coming down the road while the dislocations of infill development would be in the service of functional, accessible housing in the future.  But, the targets of frustration of the dysfunctional dislocation are vague while the targets of infill dislocation are specific.  This seems to be the bias at the heart of the problem.  And, the problem of Nimbyism seems to be that the power to negotiate against those specific forces of development has become overdeveloped.

The Oceanwide project - a skyscraper in the heart of San Francisco - seems like a great solution to infill expansion that minimizes dislocations.  Yet, if my math is right, taxes, fees, etc. are being imposed on the project that amount to more than $200 per square foot of commercial and residential space.

It seems clear that the overwhelming impediment to these sorts of projects is not the lack of potential for manageable infill development.  It is the political power that is targeted at stopping it.

The equilibrium of the local housing market, then, does not settle based on a supply and demand balance between cost and value.  It settles based on the balance between the amount of kickbacks that can be captured by local political forces today and the certainty that the developer has about how dysfunctional local housing will be in the future.  If there was any hope that San Francisco would ever allow enough development even to simply stop rent inflation, let alone pull it back toward unencumbered costs, a development that had taken on $200 in fees per square foot would not have been feasible to begin with.  It's a sort of strange equilibrium.  The political obstruction is what gives the development its value.  The higher the fees, kickbacks, and obstacles, the more the building itself is worth, as long as the developer can be sure those dysfunctions will remain in place to prevent future developments.

The higher the fees and kickbacks, the fewer new developments, now and in the future, and the higher the rent inflation will be, and we're back to the migration pattern where low income households are displaced anyway, but their anger is just vented at an amorphous market instead of a single developer.

Wednesday, May 25, 2016

Housing: Part 151 - Shadow Banking and the GSEs

It's interesting how derivatives, credit default swaps, synthetic CDOs, etc. are generally derided as the source of the housing boom and bust.  If you look carefully at the timeline of events, these instruments - even the jump in subprime loans themselves - came very late.  I will argue in the book that, rather than a binge of excess, the increase in the use of these securities was actually the first sign of the negative shock of public policies.

It began with the accounting scandals and follow up pressures on the GSEs in 2003 and 2004.  It is generally under-reported and under-remembered because financiers in our narrative of the time can only be rapacious and greedy.  Any repression or contraction is only a sign that finally somebody is putting their thumb on these guys.  So, in 2003 and 2004, when Ginnie Mae, Fannie & Freddie funded half the mortgages in the country, we suddenly knocked 10% off their market share.  If you add the GSEs and Ginnie Mae to the private securitizations (jumbo loans, subprime, Alt-A, etc.), there was no increase in total securitizations.  The private pools were simply filling a huge gap left by an exogenous shock to the system, which cut back on our standard form of public mortgage funding and didn't replace it with anything.

Here is a figure from the Financial Crisis Inquiry Report.  The sub-title is "The funding available through the shadow banking system grew sharply in the 2000s, exceeding the traditional banking system in the years before the crisis."  Notice how the interpretation of the graph actually sort of muddles the timeframe.  But, if you clear your head and look at the graph carefully, what you see is a rise in shadow banking in the 1990s, before home prices and housing starts rose above normal levels.  Then, during the boom, traditional and shadow banking grew together.  Then, in 2005 and 2006, there was a sharp rise in shadow banking.

But, homeownership maxed out in 2004, prices and starts at the end of 2005.  This rise is late in the cycle.  It certainly isn't the cause of rising prices, ownership, and starts in 2000-2004.  What a strange thing to finger as the cause of the boom.

But, going a step further, this rise in shadow banking is really just a sign of the first negative shocks to housing from public policy that was informed by the moral panic we were having.  Next, is a graph comparing the total assets of the GSEs and GSE pools to traditional banks.  It is a mirror reflection of the rise of shadow banks.

The shadow banks were just replacing the GSEs.  And the GSEs were just shrinking because of arbitrary public pressure.

Then, we managed to kill shadow banking in 2008, and by then the entire system was so weak, there was nothing left to fill the gap.  The GSEs didn't recover, the banks didn't recover.  And in 2016, when hundreds of thousands of construction jobs that were lost remain lost, when housing starts have been down for a decade while rent inflation rises at twice the rate of the other components core inflation, when total mortgages, in nominal terms, haven't risen in a decade, everyone's sitting around pondering the deep mystery of why this recovery just doesn't feel right.

Friday, May 20, 2016

Housing: Part 150 - Securitizations and the Boom

I am currently working on demand factors during the housing boom.  I don't know how to proceed here with any description of the period that isn't going to sound crazy to most readers.  Here's a taste of why.

First is the proportion of securitizations, by type.  In 2003 and 2004, with the misdiagnosis of the housing problem already affecting policy, the Bush administration, supported by Congress and the Federal Reserve, started pushing hard against the GSEs.  GSE securitizations, as a result of the pressure, both formal and informal, declined sharply.  In effect, the government knocked out the conventional form of home financing without replacing it with anything.  Since home prices were high because of supply problems, not demand problems, this did nothing to stop the trend in home prices.  Notice in this graph that subprime didn't actually increase that much as a proportion of mortgages, and to the extent that they did, they replaced Ginnie Mae loans, which had similar characteristics.  Alt-A loans replaced GSE loans.

There was a sharp decline in the proportion of homes funded by either Ginnie Mae or subprime loans between the 1990s and 2007 - a drop in market share of more than 10%.  This is why, despite all the hand wringing about deteriorating borrower characteristics, it doesn't show up in national data.

The GSE's barely managed an 8% growth rate from 1998 to the height of the boom.  The subprime and Alt-A loans were not excess - they were the first responses to demand deprivation. If you have to bid up the real estate in Los Angeles or New York City to get into the job market there, you're going to need a mortgage.  That problem doesn't go away just because we pressure the GSEs.

During the period when the GSEs were being pushed around, banks were also filling in the gap.  Mortgages were increasing as a portion of bank assets.  They weren't suddenly engaged in a game of moral hazard, pushing off irresponsible mortgages to securitizations.  As with so many issues here, the facts are in opposition to the normal story.

Part of what I see in the readings, and I'm not completely sure how to address it, is that every single review of the period basically just treats the entire mortgage market as a grab bag of scary statistics to relay about the excess that we all just know was happening, so it confirms our preconceptions.  So, a reading will mention that half of some bank's loans were no doc, and another bank lowered its FICO scores on a certain type of product, and another bank increased the mortgages it issued with low down payments.  But, you have to read carefully to notice that those no doc loans were for jumbo loans with 40% down payments and the low FICO scores were in a region with low home prices and the low down payments were on products with financially secure buyers, etc.  Basically, every mortgage is a compromise among several factors, and it seems to be commonplace to just pick the worst sounding parts, because that's what everyone needs to hear.

So, you go look at national data, and it's like bizarro world.  Nothing much happened with home owner incomes, down payments, mortgage payments, etc., in the aggregate.  It really is just a good, old-fashioned moral panic that we all just had.

Remember, home prices rose until early 2006 but home ownership topped out in early 2004 - which just happens to be when the GSE's were cut down and Alt-A came in to replace them.  The Bush administration basically just undercut the means that regular Americans used to buy homes.  And, remember, Three-quarters of the country lived in places where mortgage affordability was quite good.

In the second graph, note that securitizations actually dropped from trend in 2004 and 2005 when home price increases were at their sharpest.  Sure, it was a high trend (15% per year), but IW readers know that was due, in large part to rising prices in cities that won't build houses.  It certainly wasn't due to prices in places like Dallas and Atlanta and (at that point) Phoenix, where most of the homes were being built.  The private conduits were filling a gap.  Imagine what disaster would have happened in 2004 if they hadn't.  The government knocked out the longstanding method of safely funding mortgages, so it had to be replaced with something.

At every step, our attempts at solving this problem with demand deprivation just created dysfunction and dislocation, and this began as early as 2003.  The reason we had a crisis is because the universal certainty felt about this error would not stop at anything else.  A decade into it, that certainty remains strong.

Wednesday, May 18, 2016

"The right to a limited workweek"

A while back, I took Jared Bernstein to task for defending "the right to a limited workweek".

I was thinking some more about that recently, and I think it might be helpful to compare this to an analogous idea.  The right to a limited education.

Doesn't that sound very wrong?  But, what is the difference between these two statements?  Both work and education represent the outlay of effort for some personal gain.

The gains for work are mostly income, but also include experience, knowledge, and career advancement.

Since education doesn't benefit others directly, we usually don't receive income for education, so the benefits from education are limited to broadening experience and knowledge and career advancement.

Education is frequently described as a public good, even though it doesn't meet the strict economic definition of a public good, because we have some sense that self-improvement is beneficial to the broader community, and historical trends have tended toward public dispensation of some schooling.

Really, is there that much difference between self-improvement in our work and self-improvement in education?  I suspect that, at first, this idea seems a bit preposterous because there are two images in our heads:

But, we are simply importing a bunch of class issues that inform our intuition but that really create a confused set of goals and impressions about work and education.  Our uplifting ideas about education are influenced by an association between being a person of letters and being upper class.  In public debates about the value of education, it tends to be associated with getting a leg up or learning skills that can support a middle class lifestyle.  But, the young vessel up until 3am reading because he just discovered Peter Singer and the kid working nights at 7-Eleven so that we can pick up an associates degree in Computer Science at the local community college are engaged in two wildly different activities.  The fact that we use the same institutions to provide these services and that we call them both "education" leads to a tremendous amount of confusion when we impose our ideals about these services through public policy.

This problem, by the way, is an important reason why private dispensation of services - especially important services like education - should receive the benefit of the doubt over public dispensation.  Those two young students have no confusion about the activities they are engaging in.  The confusion is imposed through public policy.  And, that confusion, as it usually does, ends up trucking in a bunch of upper-middle class subsidies, if for no other reason than that upper middle class demands tend to be more expensive, and because much of education is dripping with signaling and status issues.  Exclusivity is intensely entwined with the motivations, actions, and expectations of that young Peter Singer enthusiast.  This is the human condition.  There is little point in debating the rightness or wrongness of this.  But there is value in understanding it, especially if we are in the business of imposing limits and compulsion through public policy.

It is probably more accurate for us to reverse those two pictures.  At every level of education where I have been a student, including the graduate level, the general lack of usefulness of the nuts and bolts of what students were doing was consistently confirmed by students' implicit and explicit reactions to the work.  Even at the Masters level, even in a subject that was highly focused on tangible skills in a focused industry, shirking was the norm.  Canceled classes were cheered.  We make clear which activities we value.

I didn't shirk at school.  I worked hard at it.  I tell myself that it is because I valued education.  But, it is probably more honest for me to believe it is because I did well, I tested well, and working hard at it was a way for me to distinguish myself and to get better at things where I had an advantage.  Or, maybe if I hadn't been that good at it, but maybe if I was some kid who knew that getting that Associates Degree in Computer Science was my best way to a better life, even if it was going to be difficult - a right to a limited education wouldn't have been much help to either of us.

Oddly, it is the immediate value of work that is its rhetorical Achilles heal.  While we support education because we expect it to have future benefits which are shared between ourselves and others, we have misgivings about work because it creates immediate benefits which are shared between ourselves and others.  Ironically, we are much more forgiving of the wasteful parts of education than we are of work that is productive, because the wasteful parts of education don't benefit anybody.  If the wasteful parts of education were useful enough that someone would be willing to pay us $6/hr to do them, there would be marching in the streets when people found out we were up at 2am cramming for a test.  It would be heinous exploitation.

Of course, in an age of fundamentalism, where everything that isn't prohibited is mandatory, this doesn't let education off the hook.  You have the right to a limited workweek and the right to compulsory education.  I was surprised when I learned that this was the actual terminology that is sometimes employed today.  But, I guess it is no more strange than the right to a limited workweek.

Other IW posts on education. 1 , 2 , 3

PS: Keep in mind, in the current rule change, we are talking about workers making $23,000 to $47,000.  We are not generally talking about indentured servants and monopsonists here.

Monday, May 16, 2016

Housing: Part 149 - Imputed Priorities

Just a brief postscript on yesterday's post.  Considering that in many neighborhoods, for years now, across this country, the costs of owning even a fully leveraged home have been much lower than the costs of renting, I have a question.

In books and articles about the housing boom and bust, it is common to see recommendations of refinancing, cram downs, homeowner subsidies, etc.  Generally, the idea is to get rid of negative equity or to reduce the cost of mortgages for families with financial difficulties.  Sometimes, this is suggested through taxpayer support, sometimes at the expense of the banks and investors that hold the mortgages.

I don't know if I have seen any public policy proposals recommending that we incentivize banks to make more mortgages to households in low priced homes.  This would be preferable to the above scenarios in every way, because nobody would be taking a loss.  The residents would be lowering their monthly payments, mortgage bankers would be earning profits.  Also, the secondary effects would be positive pressure on home prices which would naturally relieve some of the problems with negative equity.  And, support for homebuilding would help pull interest rates up naturally.

What set of priorities leads to the first proposal but not the second?  I understand that a common reaction to this question will be that the second proposal sounds a lot like the sorts of shenanigans that created the crisis in the first place.  I reject the premises that that reaction is built on (see parts 35 to 148).  But, even without arguing the premise, there is the simple mathematical fact that returns on investment for low priced homes are incredibly high relative to borrowing costs.  If you're going to make that objection, I just ask that you make some check on the facts.  I mean, if not now, when?  Is there a level where home prices are low enough that marginal households can safely take on ownership?

Sunday, May 15, 2016

Housing: Part 148 - The implications of the Price/Rent relationship

I am surprised at how regular the relationship between price and price/rent is, even nationally.  Here is a scatterplot of Price/Rent ratios, arranged by price (on a natural log scale).  Even at the national level, the r-squared of the regression is 0.77.

For each doubling in price, Price/Rent rises by 3.4x.  That means that at very low price levels, most of the increase in price is a positive feedback effect.  A $60,000 home sells at a Price/Rent, typically, of 5.8x.  A $120,000 home sells at a Price/Rent of 9.1x.


That means that the $60,000 house rents for $10,345 (annually) and the $120,000 house rents for $13,187.  That means that a 24% increase in rent leads to a doubling of home prices at the low end of the scale.  This is a log-linear relationship, so the effect declines as prices rise, until it appears that Price/Rent ratios do eventually level off within each MSA at prices above about $500,000.

This is why the Closed Access cities were the one group of cities where low priced homes increased at a faster rate than high priced homes - because rising rents and rising expected rents were the key reason why home prices rose in those cities.  Rising rents move homes up the line in this relationship, so they have a strong effect on low priced homes.

Long term real interest rates, on the other hand, serving as a foundation for Rent/Price levels (the inverse of Price/Rent), tend to cause the entire curve to rise.  In effect, what we might call the "home equity spread" - the difference between the implied yield on home ownership and the yield on risk free inflation adjusted bonds - is much higher on low priced homes than it is on high priced homes, so they are less sensitive to changes in the risk free rate.

This is why changes in homeownership were fairly uniform across cities during the boom.  The factor that causes households to own instead of renting is the value of control that comes with ownership.  We can think of a control premium as a discount to the required rate of return one needs on a capital investment.  The difference between these Price/Rent rates is a combination of expected rent inflation, the ability to claim tax benefits, and the effect of credit constraints on demand.  When interest rates decline, households with a higher control premium are more likely to become owners.

If the implied return on homes in a neighborhood is 8%, then the difference between a household with a 0% control premium and one with a 2% control premium is 1/4 of the return. But, if risk free rates decline so that the implied return is 6%, then the difference between those households amounts to 1/3 of the return.  As required returns decline, the relative incentive into ownership for households who are in a position to value control increases.

I would have expected credit constraints to be significant, too, but the fact that (1) homeownership rose in the late 1970s when real risk free rates were low but mortgage payments were difficult because of inflation and (2) marginal new homeownership was focused on the higher income levels during the 2000s when lower credit constraints should have expanded low income ownership, suggest that the control premium is the dominant factor here, not credit constraints.

Now, we can look at a house like this, in Phoenix, currently estimated to be worth $135,000, with an estimated rent of $1,150/month and an estimated mortgage payment of about $600/month.  This is a house with a Price/Rent ratio of nearly 10x.  This isn't even a particularly low-priced house, either.  At current rates, if the household living in this home is renting, they would nearly cut their monthly cash payments in half by buying the house.

If they made no down payment and doubled the interest rate from the conventional 3.4% to a rate of 6.8%, their monthly payment would be about $1,200.  In other words, if control held any value for them, they could get control while greatly lowering their monthly cash outflows - more than a free lunch.  Or, worst case scenario, if they had no savings and a poor credit record, they could get a subprime loan and get the control premium for free.  Sure, they would need to be prepared for maintenance expenses, etc.  On the other hand, they have now frozen their monthly expense at $1,200 while they will pocket the growing value of the home, whereas their rental expenses would have crept up with inflation each year.

Or, here's an $82,000 house in Atlanta, also with an estimated rent of $1,150/month and an estimated mortgage payment of about $425.

You know what would be really helpful for households in these homes that would find value in ownership?  A mortgage!  Even an expensive one!  Even one that you, in your 15x Price/Rent $350,000 two-story would consider outlandish!*

Policy by attribution error is what we have been engaging in.  We conflated two Americas.  The America where Closed Access policies create rising rents that force out low income households and drive up costs, where home prices were far out of the ranges of the rest of the country; and the America where low-priced homes were selling for the single-digit Price/Rent level.

Here is a comparison of foreclosure rates in two parts of the San Francisco consolidated metropolitan area: San Francisco County, where the median home price topped out at $787,000 in 2005 and San Joaquin County, where prices topped out at $415,000 in 2005.  San Francisco County prices are rising because the poor are being forced out and high income households are moving in, because they are a Closed Access city.  San Joaquin County is sort of the first stop for households that are trying to find a compromise between cost and location because of San Francisco's policies.

I have included Orange County and Riverside County also.  Los Angeles has the same pattern.  We got our panties in a wad because of prices in Orange County and San Francisco from aspirational households buying access to high incomes in a Closed Access, fixed pie regime.  So, we "fixed" it by bankrupting the families that were trying to escape it in Stockton and Riverside.

By the way, the median price of a house in San Joaquin today?  $260,000, about 38% below the 2005 peak.  And San Francisco?  $1.1 million, about 40% above the peak.  Please, oh please, political activists in San Francisco, tell me of your deep felt concerns for the working class and the poor.  Please, oh please, tell us how the bankers did this to us.  Please, oh please, preach to us about the evils of deregulation in housing.

The reason that the country is flocking to populists is because the one possible solution to this mess is a solution that is not available to a society mired in prejudice about the financial sector.

The family that would value owning that $82,000 home in Atlanta can't get a mortgage for it, because we are protecting them from hobgoblins.  Every day dozens of cynical op-eds come out somewhere in this country, reporting that some new low-down payment mortgage plan is being marketed, snarking something like, "Oh, yeah.  Nothing could go wrong with that plan." or "Here we go again."  Think about those no-doc loans that did this to us.  For the family that would like to own that $82,000 house in Atlanta, but can't because they can't get a mortgage, you know what factor would be completely unimportant to a reasonable mortgage broker?  Their ability to pay.  Because they would be lowering their monthly expenses.

Think of how we had to impose this bust on ourselves because somebody polled home buyers in San Francisco, and some of them thought home prices would keep rising by 5% or 10% or more each year.  That's unrealistic!  They needed to learn a lesson!  And the bankers were enabling this!

Well, you know what?  Those San Francisco folks were basically right.  And, you know who else thought home prices (and rents!) in San Francisco, or Orange County, were going to keep going up and up and up?  Those families that moved to Stockton and Riverside.  They were right, too.  So, with nothing else to do, and with great sadness and financial distress, they picked up, said goodbye to their friends and neighbors, and moved off to try to salvage a reasonable lifestyle.  Some of them thought they might be able to make a go of it in Riverside or Stockton.  Some thought Phoenix or Las Vegas.  Others, if they could, moved off to farther reaches.  Drive until you qualify is what the cynics that write those op-eds call it.  Except by 2005, you might have had to drive a thousand miles or two.

The thing they were wrong about.  The thing they didn't count on, along with all those households who were buying little $130,000 bungalows in Dallas and Topeka, was that our moral certitude would settle for nothing less than their financial ruin.

One of the oddities of human nature is that we can become so errant as a group that admitting our error would mean that we and those we respect would lose face.  As my research continues to lead me to these conclusions, I am beginning to worry if that is the tipping point that is the main danger facing us.  We have basically fallen back into North, Wallis, and Weingast's Limited Access order.  After creating the understanding of what that means, even they professed a loss of ideas about how a society moves from a Limited to Open Access order of civility and abundance.  Because limited access policies beget limited access reactions.


* I think this attribution error even infects those who work in finance.  People who were working with private MBSs report incredulously that their underwriters were asking for no-doc loans.  It was madness, they report.  And we imagine unscrupulous mortgage originators duping people into irresponsible transactions.  And, it's easy enough to find many anecdotes to support this idea.  Anecdotes by the thousands.  Anecdotes that are frequently true!**  But, I wonder, if we were able to remove the cynicism from our vision.  Is it that hard to imagine that mortgage broker looking at a middle class family looking to buy a starter home selling for something around 10x Price/Rent, which was not unheard of in many cities even in 2005?  And, failing to qualify for a conventional mortgage, the broker suggests a no-doc mortgage.  "You'll have to settle for a higher interest rate until you can refinance, but since you're not really increasing your monthly expenses, I don't see your income as a problem here.  And, if you can refinance in a couple of years, your expenses will really go down, plus you'll be building equity."

That's how mortgage brokers I have talked to think.  Could it be possible that our country is full of people like us?  People trying to do a decent job?  People who have a knack for one skill or another, who like to use that skill to help other people, and make a bit of income along the way?

The hobgoblins have pushed those people out of our imaginations even while they populate our neighborhoods.  As long as they are there we will be dividing ourselves and harming ourselves.

** Home prices topped out by around the end of 2005.  By that time, the Fed had already nearly finished pushing interest rates up.  By the end of 2006, the mortgage origination industry was already in crisis.  Check the dates on all the exposes of fraud and exotic CDO securities that supposedly were the cause of the bubble.  They all happened in 2005, 2006, 2007.  By then, our "solutions" were already at work.  Those things happened after the bust had begun.  This is like the fraudulent S&Ps of the 1980s.  This was really desperation that was the result of things which had already come to pass.  Our mistaken interpretation of the decade leading up to that as a type of fraud leads us to comingle all of these activities in our heads.  But, it was our error that led to both the bust and the desperation.

If you need further evidence that it was our error, scour the nation's op-eds today to see how many people are demanding that we loosen our grips on mortgage originations so that the family who might buy that home in Atlanta can become owners while cutting their monthly expenses in half, and compare that to how many people are calling the next housing bubble.  We are not being reasonable.  If you're not too far gone, reach up, grab the pinnacle of that tipping point, pull yourself over here with me.  We can fix this.

Wednesday, May 11, 2016

Housing: Part 147 - The terrible, rotten view that the Fed's error was providing stability

I was listening to Russ Roberts and George Selgin talk this morning about what bad policy bailouts are.  It hurts my brain to hear such nice and intelligent men go on about something so wrong.

They aren't wrong, conceptually.  Some sorts of bailouts are bad policy.

But, if we had only had more of the right kind of bailouts, then we wouldn't have needed the wrong kinds of bailouts, and Roberts and Selgin both treat firms like Bear Stearns and Lehman in 2007 and 2008 as if they were just recklessly taking advantage of the bad kind of bailouts, when in fact the defining truth of that period is that what they desperately needed were the good kind of bailouts.

Good bailouts = universal stability
Bad bailouts = targeted arrangements made in a panic

One of the unfortunate results of the recent crisis is that many observers seem to disfavor both types of policies because they see the collapse as confirmation of excess.  A disappointingly low number of people looks back on this misery and says, "Huh, we probably should have tried to stabilize prices, including home prices."  Instead, they take the collapse as confirmation of the necessity of collapse.  Even though a dozen other countries stand as examples of how preferable avoiding the collapse would have been.

Here is a graph of Total real estate value for the Closed Access cities and for the US excluding the Closed Access cities (this still includes Contagion cities, like Phoenix, Las Vegas, Miami).  I have expressed it as a proportion of total personal consumption expenditures to normalize it with the nominal economy.

Next is the annual growth rate of real estate values in these areas.  This includes both new building and capital appreciation.  Keep in mind, there is little new building in Closed Access cities, proportional to their existing stock, but new building in the other areas is healthy.

From 1998 to the end of 2005, the non-Closed housing stock had risen by 20%, relative to personal consumption expenditures.  Given the drop in real long term interest rates over that period from about 4% to about 2%, this is a mild rise in values.  Rates first stabilized at just over 2% from 2004 to 2009, and have fallen farther since then.  They have never sustainably moved up from those levels back toward 4%.

Yet, non-Closed real estate began to fall in early 2006.  By the time Bear Stearns fell, non-Closed real estate values had fallen by 11%, relative to personal consumption expenditures.  By the time Lehman fell, they had fallen another 5%.  They would eventually fall an additional 20% from that level, before finally leveling out in 2012.  They remain, to this day, nearly 20% below the levels of 1998 while real long term interest rates are now close to 1%.  Really, was it craven and irresponsible for investment banks to expect that 21st century public institutions charged with maintaining economic stability would prevent home prices in places like Topeka and Omaha from falling more than 30% relative to personal consumption?

Maybe before the next crisis we should settle, once and for all, exactly what banks can expect from our consensus policy, because as far as I can tell, unless they are just piling gold in the vault and lying in the fetal position in a pool of their own flop sweat, there is literally nothing they can expect from federal policymakers in terms of stability that won't lead to unanimous finger pointing at them when the bottom falls out.

PS.  I think we might be able to look at the second graph here for a clue regarding economic trends.  When the Closed Access real estate prices are rising more quickly than in other areas, this is a sign of the Closed Access migration pattern.  This tends to correlate with general economic growth, and it is the reason why it seems like our economy is addicted to debt and can't grow organically without creating asset inflation.  In 2005, when Closed Access real estate appreciation fell back to more general levels, that was the brief time where mortgage growth and new building were still strong enough to be sustainable.  When prices in all areas began to move in concert in late 2005, falling sharply along with housing starts, that is a sign that national, not local, factors were at work.

Note, that is the period where all the accusations of fraudulent securities are made.  That is when CDO squared and synthetic CDO's were being constructed.  Those were the securities that blew up when systemic defaults started happening.  Those securities were insignificant before 2005.  They had nothing to do with the "bubble".  The reason that there was such a demand for AAA securities wasn't because of banking excess.  It is because we had been systematically undermining the market for normal AAA securities.  By 2006, the yield curve was inverted, Fannie & Freddie had gone through a series of steps of removing liquidity from mortgage markets.  The Fed was starving the economy of cash.  What we needed was cash and credit.  What we needed was an institution that could support the mortgage market, so that normal, non-exotic AAA securities could be created.  Synthetic CDO's, falling housing starts, universally falling prices, bankrupt mortgage originators were all screaming for stability as early as 2006.

And, men as clear headed and upstanding as Russ Roberts and George Selgin are complaining in 2016 about how dangerous it is to have policies that lead to bankers expecting stability.  Like that's the problem.

PPS. When 30 year tips yields are back to 2%-3% and home prices in flyover country have risen by 30% relative to personal consumption expenditures, that is when you will know we have returned to some sense of normalcy.  There is an angry, unified consensus in this country to literally, actively, prevent that from happening.  The policies that prevent it from happening will continue to pin interest rates at near zero levels, and, thus, the roars will continue that the Fed is just propping up asset prices with low interest rates, when in fact we are doing the opposite.

Monday, May 9, 2016

Housing: Part 146 - Costs, Prices, and the Evolution of the Housing Stock

Marcus Nunes sent me this interesting article from the Wall Street Journal.  The gist:
Regulatory costs such as local impact fees, storm-water discharge permits and new construction codes, which have risen at roughly the same rate as the average price for new homes, make it increasingly difficult for builders to pursue affordable single-family construction projects, the group argues.
“It really makes it hard to satisfy the lower end of the market, which is a lot of first-time buyers,” said Paul Emrath, vice president for survey and housing policy research at the NAHB, who conducted the survey of about 400 builders across the country.
The cost of regulation imposed during the land development and construction process on average represented $84,671 of the cost of the average new single-family home in March. That is up from $65,224 in 2011, the last time the home-building industry group conducted a similar survey on regulatory costs.
That average cost is much higher than I would have expected.  This is a good example of how the widely held notion that regulations are somehow a way to rein in large corporations and level the playing field ends up, instead, doing the opposite - increasing the costs for low income consumers.

But, I am actually going to push back a little bit on the idea that this is making it hard to expand new housing for lower income households.  The idea that new housing should be focused toward first-time buyers and low income households is a side effect of our housing problem.  There are whole markets in places like inland California, Lad Vegas, and Phoenix, that are focused on serving the low income refugees of the high cost cities in places like coastal California.  This is not the shape of a natural or healthy housing market.  This is the product of a Closed Access problem.  These middle class neighborhoods and middle class metropolitan areas only look the way they do because places like Los Angeles and San Francisco won't accommodate the housing stock required to populate their labor markets, which creates a bidding war for housing in those cities, leaving lower income households as refugees.

In a functional market, instead of buying starter homes in Phoenix, lower income households would be buying aging homes in established neighborhoods in San Francisco.  In a functional market, the new generation of homeowners would naturally want homes built with more valuable amenities and higher quality standards.  Some of those standards will inevitably be reflected in building codes and local compliance standards.  In a functional market, the new housing stock should be filling in the top end of market demand.  Housing activists who insist that new stock must meet demand at the "affordable" end of the market, especially in Closed Access cities where obstacles to new supply are already a problem, are missing the forest for the trees.  If that proposed solution seems necessary, then the local housing market is broken.  There is no way that a city can meet the expectations of the next generation's households by building it's housing stock up at the bottom of the market.


Looking at zip code level data has really brought home this point to me.  Here is a plot of St. Louis, with each zip code arranged by the median home price and the median Price/Rent level.  All cities have the same pattern.

What we see is that, as homes rise in value (in terms of rent), their prices rise at a ratio of about 3:2 with rent.  I think most of the reason for this is that as the value of the home grows, the value of tax benefits grow (nontaxability of imputed rent to owners, mortgage interest deduction, capital gains exemptions).  Much of this is because as the incomes of the owners rise, they are more able to capture the tax benefits.  For instance, low income households don't tend to capture the mortgage interest tax deduction, even where it is available to them, because it doesn't pay for them to itemize their deductions, and they probably don't pay much income tax anyway.

Initially, this should lead us to expect an extreme level of over-consumption of housing among higher income households.  This probably is the case, to an extent.  This is mitigated by income effects, since housing is such a large portion of the typical household budget.  Shelter composes about 1/3 of the consumer price index, for instance.  So, housing supply is induced at the high end, and these tax benefits shift the demand curve to the right until higher income households reach that comfortable level of spending on housing.  These tax benefits increase the amount of home that households tend to live in.

But, I think this effect isn't as strong as this graph might suggest that it is.  As we see in this graph, Price/Rent ratios in lower income zip codes tend to be lower than median Price/Rent.  In the lowest income zip codes, they tend to be in the 5x to 8x range.  (They are higher than that in the Closed Access cities, but the pattern is similar.)  A Price/Rent ratio of 8 translates to a real return on capital of more than 6%, even after costs and depreciation.  This is on par with the highest returning asset classes, like equities, yet for a long term owner-occupier, this comes with no cash flow variance like what would come with equities.  There are risks to homeownership - it has long term exposure to local real estate value trends, and transaction costs are high for short term owners.  But, even with those costs and without the tax benefits, this seems like a good deal.

It also seems like market prices in those zip codes are almost certainly below replacement cost.  And, this is the benefit low income households get from a healthy, normal housing market where new homes are being built at the top end.  If those homes at the top end are being sold at near replacement cost, the old neighborhoods full of homes from the last generation of new builds are being sold at below replacement cost.  A functioning housing market provides a natural subsidy to low income households.

So, these rising compliance costs are a part of the broader problem of putting up obstacles to expanding housing supply.  But, I'm not sure they would be that much of a problem if the rest of the housing market was functioning - if mortgage markets were accessible and if local geographic regions were capable of expanding housing to match demand for housing.  That is because the homes that should be addressing demand from lower income groups shouldn't need to meet these new building standards.  If the housing stock was expanding like it should be, low income households would be buying homes at prices unaffected by those standards.

Thursday, May 5, 2016

Housing: Part 145 - Deconstructing Home Prices

When we look at home price appreciation by city and by income, we can estimate the different factors behind price changes.  Here are three:

1) Broad based price increases.  These reflect changes in real interest rates and the general level of inflation.  Price increases across incomes in the Open Access cities can be our estimate of this factor.

2) Localized changes across incomes.  These reflect local rent inflation and expected local rent inflation.  Or, if one believes in such things, local irrational bubble behavior.

3) Changing prices that differ across incomes.  Since low income households are more dependent on lenient credit markets, home prices in low-income areas might rise more sharply than in high income areas when credit is flowing generously and might fall relative to high income areas when credit is tight.


In these graphs, the green bars (Open Access cities) can be our estimates of real interest rate effects and general inflation.

The various levels of the red (Closed), orange (Contagion), and blue (Other) bars can be our estimate of differing local rent inflation trends.  Some may attribute some of the rise in the Contagion cities (Phoenix, Las Vegas, Miami, Tampa) to an unsustainable bubble, but if the rise is across incomes, this is most accurately thought of as a rent or value expectations bubble, not a credit bubble.

The slope of the bars across incomes reflects credit access.  Outside the Closed Access cities, this generally amounts to about 6% from the lowest to the highest income zip codes, in the period up to 2006.  This is the portion of the boom that we might attribute to credit.

In the Closed Access cities, the slope is more like 25% before 2006.  So, is this due to freely flowing credit?  This is the central factor in the great error of our time.  It has been largely attributed to lenient credit.  Certainly, when fighting over arbitrarily rationed necessities in a Closed Access world, credit is helpful.  But, two clues suggest that it is not a signal of lenient credit.  First, the fact that this pattern only shows up in these cities.  Second, in the credit constrained period after 2006, where the slope of price changes in the Open and Contagion cities is in the negative 30%+ range, the slope in the Closed Access cities is similar to the other cities, closer to negative 20%.

The one set of cities that appears to have had the most positive effect from generous credit has among the least effect from constrained credit.  That is because credit wasn't the causal factor.  The causal factor was the great migration flow of high income households into the Closed Access cities and the forced displacement of low income households.

The third graph, which includes the entire period, makes the odd pattern of the Closed Access cities clear.  While we have hobbled low income housing markets everywhere else, in the Closed Access cities, the inevitable march of rising housing expenses just keeps going.  This will probably worsen as the economy continues to recover.

In the meantime, we have put a stop to all those predatory lenders in Texas funding $80,000 two-bedroom bungalows for school teachers and factory workers, priced at 8 times gross rent.  Good for you, America!  Who says we can't accomplish something big when we all come together for a cause?  Who the hell do those people thing they are, anyway?  People do stuff like that unless you pass rules to stop them.  And, the bankers just have dollar signs in their eyes.  They're not going to stop unless we make them stop.

Isn't it funny, too, how on the right wing end of this erroneous attitude, you tend to hear about how this was a bubble caused by Fed accommodation, federal subsidies to the housing industry, and the GSEs.  Yet, by 2005, the GSEs had been pulled back so much that the family buying a $80,000 bungalow in Texas was likely utilizing completely privatized financing at a time when the Federal Reserve had rates pinned up at 5.25% with an inverted yield curve.

Can someone please clarify for me exactly why we needed to knock 30% off the price of homes at the low end of the market in Texas, Georgia, and a good portion of the rest of the country that looked similar?  If your answer to this is that this was just a side effect of the crisis created by the places with housing bubbles, then please refer me to a single article or book written by anybody in the last decade pleading for more generous credit policies in the majority of the country that never, by any stretch of the imagination, had elevated home prices, so that this home price collapse wouldn't have had to happen to them.  Please show me a single piece of legislation that wasn't some mood affiliation tool about extracting equity from banks on underwater mortgages or some cramdown or mortgage support, but that simply supported new buyers at market prices in the large sections of the country where clearly home prices had fallen below efficient levels because of credit constraints.  Is there any?

Sorry.  I'm trying to stay civil in the book.  I come here to blow off steam.