Thursday, October 30, 2014

The Housing Shortage is Lowering Real Incomes

This is one more follow up to the issue of profits and compensation, and how housing fits into the puzzle.  (Previous posts here and here.)  This issue of Rental Income and Compensation helps to demonstrate how tight monetary policy exacerbates income inequality and reduces real median incomes.  This analysis starts with the understanding that housing markets were, more or less, functional in the 2000's, and the Fed undermined these markets with excessively tight monetary policy that created the financial crisis. (See my Housing label for more extensive discussion of this issue.)  Rent inflation and Rental Income were generally high in the 2000's, which would be very unlikely if homes truly were being overbuilt and overpriced.

The mixture of cyclical, regulatory, and monetary factors keeping households out of mortgage credit markets and limiting housing price appreciation and house construction is causing a housing shortage.  Two signs of this shortage are the sharp rise in net rental income even above the levels of the 2000s (the first graph) and the resurgence of rent inflation (the second graph).

This means that since 2008, Compensation income is being displaced by net Rental income.  For households that rent their residences, this means that real income has been reduced by rent inflation.  For households that own their residences, this means that real income has been reduced by rent inflation, but has been replaced by Rental Income.  So, policies that are keeping home prices down are benefitting households that own their homes at the expense of households that don't.  All households look like they have lower real incomes.  However, real income of home owning households is understated because the high inflation of their imputed rent is being deducted from their compensation income and is being re-constituted as capital income.

The third graph shows relative nominal changes in Compensation and Rental Income since the 4th Quarter of 2008.  Nominal Compensation has increased $1.2 trillion since the end of 2008.  Rental Income has increased by $350 billion.  For home owning households, their experienced real incomes have increased by $350 billion more than what their statistical compensation levels are showing, because this rent inflation generally is not affecting their cash flow.

Non-homeowning households have experienced rent inflation as measured, and the gains from that rent are generally accounted for as reductions in their real incomes, relative to nominal incomes, and as profits to firms in the real estate industry.

The housing shortage is reducing the Compensation share of national income through both mechanisms - home owners and renters.  One path goes to Rental Income and doesn't really affect real household incomes and the other goes to profit and does really affect real household incomes.  Both represent a shift in total income to generally higher income households.

The irony is that so many people seem to agree that rising home prices, by making homes less affordable, are hurting lower income households.  If we don't put the clamps down on the banks, they will just drive us right over another speculative cliff, so the story goes.  Sadly, the tight regulatory and monetary regime that comes out of this flawed reasoning is the thing that is actually hurting low income households.


  1. I agree that there is a shortage in the rental properties market, which is driving up prices there. This is due to a demand-shock, as the home buying rate slows. The market is uncertain where the long-run equilibrium will fall, and so investors are hesitant to bring new rental properties online. If this terms out to be a permanent adjustment, then it will respond. I am not sure (on the rental side) new regulatory frameworks explain much of the story. To the best of my knowledge, CFPB et al are mostly playing with the mortgage and single-family markets. But this could be wrong.

    The question then becomes, why aren't families buying homes. I contend it is simple: prices are too high. You argue (oddly, to me) that it is because prices are too LOW. This is where the disconnect occurs.

    Were this any other market, we would all agree that the signal the market is sending is that rentals are too cheap relative to sales, all else equal. I think we would also agree that the prices in at least some markets are downward sticky (I contend this is true of the housing market, as well). My claim is that this is sufficient to explain rising rental-side prices, and flat prices in the sale-side market. I further claim that the solution is for real housing prices to fall; given sticky nominal prices, this process is slow and painful (particularly in a low-inflation rate environment), and the mechanism is precisely rising rental prices (shelter inflation).

    You APPEAR to argue that the solution is to make the money buyers use to buy expensive homes cheaper, lowering the short-run price on net. I agree this will work - in the short-run. But I contend it is a broken medium+-run solution (see the current education market, and the ore-crisis real estate market). What am I missing?

    1. Glenn, thanks for your comment.

      Mortgage debt service ratios are extremely low. High prices have nothing to do with the current dearth of mortgage credit.


      All available evidence continues to point in the direction of young would-be households being priced out of the household formation market. You continue to insist the solution is higher prices. I continue to be very confused.

      "Mortgage debt service ratios are extremely low."

      So what? This is true for two reasons:

      1) Households have spent the last 5 years leveraging, in response to the recession and the income crisis.

      2) Household formation has collapsed, because housing is too expensive, relative to the long-run path of expected incomes. If you can't afford the property, you won't take out the loan (at any rate).

      This strikes me as a chicken-and-egg problem. You say low average debt-service payments is evidence that housing prices are too low. I say just the opposite. There are two reasons this could be true: the average housing price has fallen, but mortgage activity has stayed the same or increased (a prices are too low story), and housing prices have done anything, but mortgage activity has fallen (a deleveraging story). The reality is clearly the latter, which raises the question of why households are not borrowing.

      Forget for a moment that if housing prices fell, the marginal absence of borrowing in the current environment becomes irrelevant (since the borrowing constraint has relaxed). You want to say that the problem is not that housing is too expensive, but that borrowers cannot get loans. Again, so what? Why is the lower-loan-requirements solution necessarily better than the lower-housing-prices solution?

      There will be no recovery in construction until existing inventory clears. Existing inventory will not clear until household formation picks up. Household formation will not pickup until real house prices as a share of income fall.

    3. Glenn,

      Here is a post with a graph of mortgage payments compared to median income. They are currently very low.

      Here is a post with a graph that compares mortgage payments to rent payments over time. Again, owning is cheap compared to renting now relative to any time in the past 30 years.

  2. Great post. Two relevant links: liberal (in US terms) cities are expensive:

    That would be because of the land-rationing.

    And African-Americans are leaving such cities:

    That would also be due to land rationing. Which also, of course, creates assets strongly prone to demand shocks.

    1. Thanks for the links, Lorenzo. I personally know many people who bemoan "food deserts" and who also march against Wal-Mart. Much of the progressive sense of local egalitarianism seems to come from an aesthetic discomfort with the juxtaposition of people who happen to have different sets of opportunities. This is an interesting dilemma, which I think is doing a commendable job trying to address, although much of the prose over there is a bit dense for me to grasp.

      The unintended consequences of these tendencies do seem to be a problem.

      Can you expand on your last sentence?

  3. Very good post. This seems somewhat analogous to Lars Svensson's criticism of the Riksbank. I believe his argument was that the attempt to reduce household indebtedness via tight money would counterproductively lead to a greater household debt burden. You have a different story with some striking similarities.

  4. Kevin: Excellent blogging of late (per usual).

    Couple ideas: 1. Urbanization. As any nation urbanizes, land values in urban areas soar. Housing becomes more expensive. I see this in my native Los Angeles. Housing is out of sight---as so many people want to live in the city, and not in the rural Midwest. This desire or requirement to congregate leads to higher housing costs, exacerbated by local building constraints.

    2. See this report from Western Asset Management. Inside it shows declining labor share of nonfarm business income. I actually e-mailed the guy to get an exact cite, but I think he never got my e-mail, due to spam filters.

    Keep up the great work!

    1. Thanks Benjamin.

      1) On the one hand, where zoning is too restrictive, it seems like we are definitely leaving $100 bills on the ground. On the other hand, I wonder how this differs from a world where California simply had less buildable land. It would have some of the same effects as zoning restrictions, but we wouldn't be wondering how much better the economy would be if California was bigger. So, it seems like there are two different problems here. Regulatory building constraints are a constraint on supply, but they don't necessarily create a dysfunctional market, given the constraints. On the other hand, the current credit market and monetary constraints on building reflect supply constraints that are a product of a dysfunctional market, where many potential participants would reasonably enter the market, but simply can't get access to it.
      I'm not sure what all the implications and practical differences of that are, but it seems like food for thought.

      2) Thanks for the link. I think the labor share of nonfarm business income comes from the Productivity and Costs report from the BLS. I'm not as familiar with that data.

      The Phillips Curve stuff seems like it assumes the causation goes from wages to inflation. It seems to me that it is likely to go the other way. If the Fed tends to be following naturally fluctuating cycles, then monetary policy will be pro-cyclical, and inflation will correlate with increasing employment. If the Fed tends to create inflation when real interest rates and real wages are rising, then we'd see this Phillips Curve correlation. I don't think there is much doubt that this is the case, is there? The relationship has been weak lately because employment is recovering in spite of the fact that the Fed has retained a hawkish stance throughout the recovery.

  5. This comment has been removed by a blog administrator.

    1. Sorry Benjamin. My fat finger on my smartphone erased your comment. Here it is, I think, for posterity:


      On the Phillips Curve, I go nuts. I think the last time there was a relationship between labor and inflation was the 1960s-70s. 

      I have run two business (never made much money, btw) and been in many more as an employee or freelancer. Every business i was in enjoyed lowered unit costs when production went up. Growth for many years was deflationary.

      Moreover, I think growth inspires investment in plant equipment and training. 

      The more I look at it, in practical terms the 1960s-70s were an aberration, when Big Labor had clout and so did Big Steel, Big Auto, and stodgy retailers alike Sears. Little foreign trade. High MTRs. Heavily regulated transportation, including by price (and regulatory capture). 

      Economists never have jobs in the real world, as leads Fed economists.

      I would say for several years growth would not be inflationary. To get to 5% inflation now would take honking growth for years. 

  6. TravisV here.

    You might be interested in this new paper on home price trends (via Arnold Kling):

    "House price fluctuations take centre stage in recent macroeconomic debates, but little is known about their long-run evolution. This column presents new house price indices for 14 advanced economies since 1870. Real house prices display a pronounced hockey-stick pattern over the past 140 years. They stayed constant from the 19th to the mid-20th century, but rose strongly in the second half of the 20th century. Sharply increasing land prices, not construction costs, were the key driver of this trend."

    1. Thanks Travis. Skimming the article, I don't see any attempt at collecting data on rents over time. The relationship between rents and prices could explain the extent to which factors they consider are in play.

      Until I see someone tackle that issue, these articles are a little disappointing to me because the recent disconnection between prices and rents is the source of interest in the topic, but then everyone wants to lump the recent price movements in with some longer narrative that usually would suggest rising rents, also. The reference to Ricardo seems especially misplaced in this regard. Until that happens, it seems like this work adds more heat than light.

  7. TravisV here.

    Here's a quick Yglesias analysis of Piketty indicating that land rents are a huge component of the gains the top 1% has made over the years.........

    1. I touched on that here:

      That agricultural land was productive capital, whereas the housing stock is for consumption, and its place in a middle class household's portfolio is often basically a pre-commitment of the household's expected future returns to human capital. It is consumption smoothing with a bank as the intermediary between the current household and its future self.

    2. TravisV here.

      Thanks Kevin. By the way, I'm dealing with health issues at the moment so my mind isn't all the way there. Hopefully I'll be better by next week.

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