since 1890, the average appreciation of inflation-corrected home prices in the United States has been only a third of 1 percent a year. That’s why housing hasn’t been a great investment. And in 10 years, it may be almost equally likely that real home prices will be higher or lower than they are today.That is kind of a shocking statement to me. That's like saying bonds are a terrible investment because the redemption value will be the same as the initial face value. You don't buy bonds for capital gains. You buy them for income. Likewise, you don't buy a house for capital gains. You buy it for the rent.
Some people do buy bonds or houses as speculative activities, but of course speculation is a zero sum game. That doesn't have anything to do with whether they are good investments. How can Shiller make this statement? The question is, how much does the house cost, how much would rent be (corrected for homeowner expenses), and how does that compare to alternative investments?
In fact, the fact that home prices in the US have roughly tracked inflation suggests that thinking of a home as an inflation-adjusted bond is a pretty good first step for looking at aggregate home values. There is no way that 30 year TIPS bonds are paying a higher return now than the average rental home is. This has nothing to do with what home prices will do in the next 10 years.
In that column, Shiller also argues against the mortgage tax
But, public housing subsidies are interesting to think about. According to Modern Portfolio Theory, a tradable asset or security that is widely accessible should be bid up to a market price where there are no risk-adjusted excess profits. Optimized portfolios will be diversified, so they will still be exposed to market risk. But any exposure to idiosyncratic risk related to individual securities will not have any excess returns in the aggregate, because that risk can be diversified away.
But, with housing, there is limited access, due to the all-or-none form of ownership that is typical, and there are potential gains from idiosyncratic risk, since such large portions of the market are not, and cannot, be diversified. Also, high transaction costs create a liquidity premium. So it is likely that there are excess returns from home ownership, especially when a home is held for a long period of time, minimizing trading costs.
But, this issue, as is often the case, gets turned on its head. Since home ownership provides excess profits, and these profits tend to go to households with the most access to capital, we tend to think, wouldn't it be fair if everyone could get access to those profits? This is wrong-headed. Profits (accounting for liquidity and idiosyncratic risk) only exist because there is limited access to the market. If everyone gets access, the profit goes away. The solution is to get rid of the profit. But the irony is that, if we get rid of the profit, then moving households into home ownership is not necessarily a benefit. The only equitable outcome for housing policy isn't to subsidize more home owners, it's to make all households indifferent to home ownership.
This is a very difficult distinction for the consensus to accept, because in social policy, we tend to associate middle class behaviors with social improvement, and it is natural to assume that social progress comes from nudging the lower economic classes into that behavior. If middle class behavior involves the accretion of economic rents, universality of middle class behavior is a mathematical impossibility.
A more universal and equitable housing market would come from lower transaction costs, more access to credit, more pathways to ownership, etc. This is a good example of how hard it is to have good public policy in an IMH world. The housing market of the 2000s was a great example of a context where the housing market was more universal and equitable. Low interest rates, low down payments, investor diversification through securitization - all of these trends were pushing down excess returns in housing and expanding the pool of potential home owners. All great things! In a world where rent payments will be fairly stable, how will lower excess profits (economic rents) be manifest? Through higher asset prices! And, what kind of reputation do the housing market and the financial industry of the 2000s have? Public views of the housing market are definitely an example of strong form IMH.
On all sides of the political spectrum, there seems to be a consensus that the Fed is the lap dog of Wall Street, making sure the financial elite earn economic rents. And there also seems to be a consensus that the era of equity and universality in housing was a monstrosity that had to be beaten down. And the consensus complaint is that the financial intermediaries who made that housing market possible, who for the most part are bankrupt, reorganized, or a fraction of their former selves, have been "bailed out" because the Fed dares to inject some liquidity into the chasm that used to be a credit market.
The mortgage tax deduction really made everything worse. For those who could capture excess profits, the deduction increased those profits. And, on a macro level, it creates a two-tiered market, where there is a general price level for landlords, and a higher price level for owner-occupiers who can benefit from the deduction. This means that supply and demand forces for landlord owners will translate into higher rents. This also means that the market for single family homes, especially homes with higher nominal values, is much thinner than it would normally be. There is a market of non-diversified, owner-occupiers with equilibrium prices above the equilibrium price for landlords. When that market broke down in a context where (1) excess profits had been bid down because of wider credit access and (2) the mortgage deduction continued to provide added profit for owner-occupiers, prices had to fall significantly before landlord investors were willing to add support.
So the mortgage deduction creates a less stable, less equitable market. I wonder what the counterfactual would have been if, during the 2000's, we hadn't had the mortgage interest deduction, but we still had low interest rates, securitization, and all of the other accommodations that came out of low real interest rates, low inflation, and financial innovations. Home prices would have been somewhat lower. Home ownership rates would have been lower. There would have been much broader landlord demand for homes. Rent inflation would have been lower. And, I think that it is plausible that there would have been more supply of homes as a result of all of these factors.
Partly, what was going on in the 2000's was that very low long term real interest rates were pushing up the intrinsic value of homes - the value of homes as an investment. This was pushing up the landlord owner equilibrium price of homes. The equilibrium price for owner-occupiers was naturally above that price, at least partly because of the mortgage deduction. And, low nominal mortgage rates pushed that price even higher, as low monthly payments meant that constraints on demand coming from mortgage credit access were much lower than they had ever been in the modern era. (This is a separate effect from the effect of low rates on the actual nominal value of homes as a durable asset.) But, liquidity issues, transaction costs, the microstructure of the realty market, and the inability for buyers in the owner-occupier market to expand their holdings, meant that there were a lot of frictions and price stickiness in the owner-occupier market. This created the opportunity for a lot of speculative activity. But, it also might have kept supply from rising quickly enough to meet demand, because home builders were generally limited to finding buyers among that thin, friction-filled market of owner-occupiers.
If we hadn't had this two-tiered market, there might have been a more robust market for home builders to build for the renting market. The relatively lower amount of frictions in the market might have allowed quantities to more quickly rise to meet demand, even as average prices would have remained lower without the mortgage deduction. Landlord buyers would have been able to build large numbers of homes at prices they could profit from. With the mortgage tax deduction, home builders could hold out for price levels higher than the landlord price level, but they had to find buyers one at a time from the owner-occupier market.
For many reasons, there has been a deluge of capital searching for low-risk investments, and the housing market served as a useful conduit for that capital. In a more landlord dominated market, there would have been a much more robust set of saving opportunities through real estate. There would have been a much larger industry of REITS and mutual funds placing investments in landlord institutions. Savers would have been able to utilize real estate to meet current savings demand without trying to stuff so much of it through the conduit of owner-occupiers and small-time real estate investors.
Put another way, the equilibrium price of houses is the Price to Rent ratio that creates a return equal to other investment opportunities (including non-financial considerations). In a normal real estate market, taking away the mortgage deduction means the average Price to Rent ratio will decrease. This will lead to more quantity supplied from landlord owners, and rents will decline. The declining level of rent, with a stable Price to Rent ratio, will mean that prices would decline further.
In addition to the lower prices this change would encourage, the mortgage market should allow low income households to establish ownership with few obstacles. Down payments should be low, and various payment options should be available. There is no reason to publicly subsidize these things. Anyone who does establish ownership will likely already be earning profits relative to renting households. Private mortgage insurance and securitization were available in the 2000's. There is no reason why we need to bring in the moral hazard problems of public subsidization. Deregulation would suffice. In effect, housing policy should be a policy of creating lower housing prices and then not encouraging households to be home owners.
The main problem with this prescription is that there will still remain this deep cultural association of home ownership with the middle class. As long as we have that association, on the margin, there will probably be households that establish a real estate position when they probably shouldn't. That would subside over time, and, in fact, may already be less of an issue after the collapse of 2008. Generally, the positive cash flows from mortgaged home ownership come after years of rent inflation, so there isn't generally a short-sighted incentive to switch from renting to owning.
So, please, take your mortgage interest deduction and give us back the real estate market of the 2000's. There may never be a better time to do it. This is what so-called consumer rights activists and working class political heroes should be pushing for. So, Who's with me?....I said, Who's with me?!.....
...I think I have one more post worth of this nonsense, for those of you still hanging with me....