Friday, October 30, 2015

Housing, A Series: Part 76 - There are two Americas.

There are two Americas, and there is only one practical way to merge them.  Houses in California and New York.

I have been pointing out how migration patterns in the US are backwards.  Net migration is from high income to low income cities.  I like the North, Wallis, and Weingast idea of open access social orders vs. limited access social orders as a way of understanding free and wealthy societies.  There are a lot of discussions these days about two Americas, the 1% and the 99%, about economic rents and monopoly profits.  I think these discussions are a response to something real, but it is not tax policy or negotiating power at the heart of this problem.  It's limited housing.

In some ways, I think there is something to the usual discussion.  Factors like unionization which were more prominent when incomes appeared to be less variable do have something to do with this.  As I discussed in the previous two posts, when persistent geographical competitive advantages emerge, firms with excess profits are captured, and some variety of methods of extracting those profits will inevitably arise.  Unionization and housing constraints are two forms of these methods.

The difference between these two periods really does have to do with the decline in unions, because unions were probably a particularly tempered way of extracting rents.  Today, the housing constraints that are creating economic rents in our large cities are operating in a context where highly skilled and intensively networking individuals can leverage their incomes practically without limit in the technology and financial fields.  So, it is true that unions in a semi-skilled mass production context put a cap on income inequality while today rent-seeking among tech and finance high performers is leading to a particular rise in the small number of earners at the top of the income distribution.

But, I think we need to be careful about one error in thinking about this distinction.  Both eras had rent seeking.  Both kinds tended to capture excess income for a select group by limiting access to opportunities.  The solution isn't to re-implement the former source of rent seeking.  The solution is to remove the source of economic rents.  This is clear when we look at Washington, DC, which has become the metro area with the highest incomes.  Those high incomes are not related to housing constrictions, but they are related to unionization, since the public sector is the one area where unionization continues to play a strong role.

Instead of trying to be a different version of a limited access society, let's strive again to be an open access society.  This is not as easy an idea to sell as it should be, because open access means letting builders build, letting lenders lend, and letting high income workers work.  But, doesn't it seem like they are the problem?  Of course, our punitive instincts at this point have made things even worse.  The nationwide housing depression that is the result of the collapse of our mortgage market has pushed housing expenses above their comfortable range across the country.  Now if you can manage to qualify for a mortgage, you can access economic rents from anywhere, and some of that additional 5% of incomes that is being extracted for housing can be yours.  Limited access, macroprudence edition!

The two Americas are a largely geographical phenomenon.  Here are several graphs that drive this point home.  Outside of New York City, Los Angeles, San Diego, San Jose, and San Francisco, America is a picture of classical economics.  Housing supply is elastic - in other words, housing markets are relatively efficient, so that if some opportunities for rising income arise, households can move there, and homes will generally be constructed for them at a typical cost.  Populations flow to opportunities, and costs and incomes are pushed competitively until the marginal worker is ambivalent about their set of relative opportunities.

All of these graphs are scatterplots of the 20 largest metro areas.  The x-axis measures net domestic migration and the y-axes are various measures of housing affordability.  The dark red dots are the NY/California problem cities and the US average and the orange dots are the other cities.

By the way, this is all from Zillow.  What a valuable courtesy it is that Zillow makes all of this data available.

1: Rent Affordability

Across the country, households spent a comfortable level of income on housing (rent or imputed rent) of about 25% until the banks met the business ends of our angry pitchforks in 2008.  That has risen to about 30% with the collapse of mortgage banking.  Even with that dislocation, the open-access portion of the country appears to be moving in equilibrium.  But, if you want in to the high income opportunity zones, you're going to have to pay up.

2: Rent

Here is a similar graph, based on median rent.  The cost of tech sector opportunity is about $20,000 per year in rent.  By the way, just taking an unweighted average among the problem cities, both rent and income tend to be about $15,000 above the national average.  This suggests that at the median most of the economic rents are going to real estate owners, and that the higher incomes are a mirage that mostly reflects the cost of entry.

These cities tend to have higher income variance than usual, especially at the top of the income distribution.  This makes sense, if we think through the supply and demand chart from yesterday's post that I have re-posted above.  Low income households will be at the margin of sustainability in these cities.  But, at very high income levels, the real demand for housing will eventually be elastic enough that those households will be able to manage housing expenditures more like people would in a city without a housing constriction.  In other words, when a household's income is high enough, they will naturally decrease their housing expenditures to the lowest level they can live with until their housing expenditures reach that 20-25% comfort range.  This causes de facto income inequality to be higher than measured inequality, because the higher a household's income is, the less of it they will have to pay to landlords.  This leads to high demand for high end housing and high income in-migration, because the value of living in these cities is much higher, in individualized real terms, for high income households than for low income households.

3: Price / Rent

We see the same pattern in price/rent levels.  Across the open access portion of the country, there is no relationship between Price/Rent and migration.  Populations and opportunities equilibrate.  Price/rent levels during the boom moved up somewhat because of the natural effect of real long term interest rates on home values.  But, again, we can see here that the limited access cities create a continual ratcheting up of housing costs and incomes.  The expectation of continuing limited access creates a premium for real estate owners.

One way to think of this is that real estate prices internalize expectations about the future and the value of limited access rents.  The unfortunate news is that we have already paid the full price for the error of our limited access policies and we can never recapture those losses.  That is because past real estate owners already captured the gains from all the expected future limited access rents - in the form of higher rents and in the form of higher Price/Rent ratios that reflected those expectations.  If we manage to overturn these longstanding policies, the value of urban real estate should plummet.  But, at this point, that is simply a transfer from existing real estate owners to new real estate buyers.  It is still worth doing, because it means less of our output will be diverted to unproductive rent collections and it means that costs in our most innovative sectors will be lower when global competition comes to challenge them.  But, the married professionals that cashed out their $5 million homes in LA and retired to mountain villas in the Rockies aren't giving it back.

4: Home Prices

The double whammy of higher rents and higher Price/Rent ratios means that home prices are especially high in these cities.  Again, the rest of the country sees no systematic relationship between migration and home prices.

A similar pattern comes through if we look at home prices  as a proportion of income.  Price to income in California is about twice the rest of the country.

Lastly, here is a chart comparing Home Price/Income ratios for NY, LA, and SF, compared to the national level.  The national level includes these cities, so it was distorted higher by these cities during the boom.  And yet, at the height of the boom national price/rent levels were just reaching the bottom of the range of price/rent levels in these cities.

There was a small inflationary effect on home prices from falling long term real interest rates, but as with all of these measures, this is largely the picture of localized supply issues, not national demand factors.

Also, I think it is worth thinking about our perceptions and the problem of mental benchmarking.  Think of the difference between how we reacted to what we thought were demand-side excesses in the national housing market and how we have reacted to the housing market in New York and California that for decades has operated at higher valuation multiples than anything the rest of the country saw during the boom.  Our sense of outrage is highly dependent on our presumption of who is to blame.  Our presumption was wrong here.  But, the satisfaction we get from public, shared outrage is not so dependent on diligence - in fact it is diminished by it.


  1. There was a Cato conference Oct. 15 on zoning...

    1. Thanks, Benjamin.

      From the Cato article, which I just started reading, "Zoning has shaped American cities since 1916, when New York City adopted the first comprehensive ordinance."

      Guess what decade marked the high point of population in Manhattan......

    2. Amazing. Can we go to zero zoning? Or "use only" zoning? That is, zoned residential but density is left to market?