Monday, April 24, 2017

Housing: Part 221 - The Education Premium

One issue that has been floating around for a while is the education premium in housing.  The idea is that getting into good schools requires living in the right neighborhoods.  Prices in those neighborhoods get bid up, and working class households get locked out of better school districts because they can't afford to buy into the right neighborhoods.

I think there are several interesting things to think about here.

1) Even though the idea that the housing market is riding on a wave of animal spirits, barely tethered to any sort of intrinsic value, seems to be taken broadly as obvious, there are many ways in which everyone seems to assume extreme efficiency.  One example of this is when they speak of federal subsidies like those implicit in the GSEs and tax benefits.  If one thinks those subsidies help to bloat home prices, one must accept that those subsidies are sifted through all sorts of deferred benefits - far future capital gains exemptions, the value of slightly lower interest rates many years into the future, etc.  I agree with this!  These markets are remarkably efficient.  If you really think about the implications of how these benefits would trickle down into market prices, it really is incoherent to complain that these subsidies helped to seed a "bubble".  Either buyers are led to prices that reflect a meticulous arrangement of far-off and imputed benefits, or they just fly off to the stratosphere whenever some noob gets his hands on an approved mortgage contract.  These effects live in different universes.

Now, few of us sit down and work out the present value of future non-taxed imputed rent.  But, that's because these markets are so efficient.  Zip code level prices seem to me to suggest an amazing level of broad market efficiency.  Mian & Sufi found that low end home prices appreciated more than high end prices, and they attributed that to expanding credit access at the margin.  That implies some market inefficiency.  But, the difference in price appreciation they found is actually a product of extreme efficiency.  There is far too much substitution between various overlapping sub-markets in any city for prices at one tier to rise by 20% or 30% more than prices in another tier because of credit access.....Actually, I take that back.  Since 2007, we have enforced such repression in credit markets, removing potential owner-occupiers from the bottom tier of the market so completely, that low tier pricing is especially cheap.  Low tier prices would appreciate more if we re-opened the mortgage market today.  But, it didn't in 2003-2006.  Then, to the extent that credit access was helping to pull up prices, it was fairly uniform across markets.  And, I think because of the maxing out of tax benefits, rising prices tend to moderate above about $400,000 or $500,000.

I'm still unsure how much that effect amounted to (the effect of loose mortgage terms on broad Closed Access prices).  Net out-migration of homeowners from Closed Access cities amounted to tens of thousands of households in 2004-2006.  It seems that new buyers with credit triggered a lot of sellers.  Without the Alt-A market, would prices have been similar to what we saw, but with less selling and out-migration from the Closed Access markets?  The Contagion cities are a different matter.  There was some temporary price surge there based on their particular context of in-migrating renters and those Closed Access sellers with windfalls looking for a place to rest.

Anyway, I'm rambling.  Schools and home prices are another example of how this efficiency is implicit in the complaint.  Housing markets are so efficient, that even the bundled service of education gets filtered into the market price, apparently with a surprising amount of specificity regarding both the quality of the school district and the value that quality bundles with the house.


2) The problem itself is actually just a side effect of the Closed Access problem.  In every city, there are many bundles of services and amenities that form the base value of a given neighborhood.  In most cities, families are actively choosing between those bundles of amenities, of which education is only one.  So, the reason this is a problem isn't strictly because the premium itself exists.  It's because Closed Access cities prevent families from making this choice on the margin.

In most cities, families would be choosing size of unit, commute, safety, neighborhood character, nearby services, and a host of other factors to determine their optimal unit.  Families who prioritized better schooling would make adjustments in all of these other areas.  So, typically, if the median household spends 25% of income on housing, a family that values education in a city with an education premium might live in a smaller unit, a little farther from work, etc.  But, the median household would still tend to spend about 25% on housing.  There are many margins for adjustment.

In Closed Access cities, this margin for adjustment is gone.  The only margin left for adjustment is leaving town for an Open Access city.  So, a family that values education is spending 45% of their income on housing.  They are spending 45% because all of the other margins for adjustment have been tapped out.  So, their choice is to either spend 60% of their income on housing and get better schools, spend 45% on housing for poor schools, or leave town.

It looks like that family's problem is the education premium.  But, it isn't.  Their problem is Closed Access.  They could also have some sort of subsidized housing or rent control, so they would be spending 35% of their income on housing, but they would be stuck in a bad school with the same bad choices.  Closed Access removes marginal options.

So, all of the marginal sources of adjustments that aren't taken as a sort of civil right (square footage, location, etc.) get adjusted away to try to pull expenses back toward the comfortable level.  But, clearly for the majority of households in those cities, all of those adjustments can't get expenses to a comfortable level.  So, the one adjustment that we consider a civil right - a chance for decent schooling for our kids - becomes operative, and the only reasonable way to adjust it is by raising or lowering our expenses.  It looks like a civil rights issue, but it is really just a side effect of Closed Access.  The real civil rights issue is the right to invest capital in real assets without undue harassment from local officials, which has been so watered down that entire mega-cities lack adequate housing.

Thursday, April 20, 2017

Housing: Part 220 - If it looks like a demand problem, you have a supply problem.

I frequently use the supply vs. demand framework to describe the difference between an Open Access vs. Closed Access city, or to push back against "bubble" talk.  But, sometimes, I suppose, this can be misleading, because really all price changes are demand phenomena.
idiosyncraticwhisk.blogspot.com  2017

Here is basically a universal housing supply and demand curve for owned homes in a metro area.  The difference between metro areas is where their supply curves fall.  Closed Access cities have supply curves that are nearly vertical (inelastic) in any reasonable context.  Open Access cities have supply curves that are reasonably flat (elastic) in any context that has been tested.  And the Contagion cities generally look like Open Access cities, but they took on such huge in-migration from Closed Access cities that they reached their supply curve turning points.  (As I have proceeded through the project, in some ways Miami has become a less than perfect fit as a Contagion city, but Florida in general fits the type, I think.)

The difference between these cities is their supply elasticity.  Full stop.  Closed Access cities have both short and long term inelastic supply, Contagion cities developed inelastic short term supply, but they have elastic long term supply (or at least, the demand curve moved back to the elastic portion of the supply curve when the Closed Access migration surge abated), and the Open Access cities have both short and long term elastic housing supply.

But, the irony is that, on the ground, changes in home prices are all going to be triggered by demand, because that's what is more volatile.  So, rising rents, falling real long term interest rates, new tax benefits, etc. all create these volatile price shifts in Closed Access cities, and observers all say, "See!  It's a demand problem!"

Let's say foreign buyers can avoid some sort of capital gains tax, and they start piling into closed access city real estate (because that's where capital gains expectations will be highest), and prices go up.  Pass a law against foreign investment, and prices go down.  See! It's a demand problem!

Or, a major shift in credit policies causes prices to rise or crash.  See!  It's a demand problem!

idiosyncraticwhisk.blogspot.com 2017
But, there are demand shifts in Open Access cities.  If we measure shifts in demand by the number of permits issued, then Open Access cities have much higher shifts in demand than Closed Access cities do.  Heck, during the "bubble", the Contagion cities had more than 1% annual population growth, just from the housing refugees fleeing the Closed Access cities.  Believe me, they know about demand.  The Contagion cities?  Now, there was a demand problem, although even there, the bubble came from the shift in short term supply elasticity when permit issuance couldn't rise match migrant inflows.

But, you usually don't hear about demand problems in Open Access cities.  For some reason there is never a problem of excess foreign buyers in Dallas.  Are there a lot of foreign buyers in Dallas?  I don't know.  Nobody cares.  You want a house, they'll build you a house.  Maybe there are more foreign buyers in Dallas than there are in Vancouver.  Does anybody even bother to measure it?

How do you know if you live in a city with a housing supply problem?  It will look like a city that has a demand problem.  How do you know if your city doesn't have a housing supply problem?  It won't look like it has a demand problem, even if its demand for new housing is twice the national average.

Friday, April 14, 2017

March 2017 CPI

Um....Hmm... Yeah...

It will be interesting to see what happens to June Fed Funds Futures on Monday...

I'm pretty sure, though, that the drop in shelter inflation is due to over-building in high end urban condo markets.  :-p

Wednesday, April 12, 2017

The problem with school choice?

It has recently occurred to me that many people who object to "school choice" policy programs hold these two opinions in their heads at the same time:

  1. Funding good school districts everywhere is important.  We can see how important it is to people because there is a huge premium in real estate where schools are better.  Families seek out better school districts and they are willing to pay to be in those districts.  This ends up being unfair because marginalized families are priced out of those districts and are not able to attend the schools they would prefer to attend.
  2. School choice doesn't work because it is very difficult for families - especially marginalized families - to "shop" for a school.  They don't have the time or the ability to know, really, which schools are better, so the idea that they have a choice is sort of a misnomer.  They will end up in schools that are underperforming, just because it is so difficult to accurately audit the schools to know which ones are performing well for your children.

Thursday, April 6, 2017

Housing: Part 219 - The Post-Industrial transition and housing bubbles.

I have been moving toward a grand theory of economic epochs.  We are moving toward a post-manufacturing economy.  Just as the move from agriculture to manufacturing led to a wave of urbanization, because production at the time needed to be centralized, today the move from manufacturing to services and non-tradables also requires urbanization, for two reasons.  First, because a core of highly networked and skilled innovation workers need to remain in close contact with one another.  And, second, because they now bring with them a large number of non-tradable sector workers who provide services to them.  This is the new economy.  This is the natural transition of a free society to an information economy.  Those workers we are fretting over, whose jobs are being stolen by Chinese workers or robots, are transitioning to new forms of labor just like every generation before them did.  They are becoming nurses, yoga instructors, baristas, nannies, life coaches, construction workers (if we dared let them), tech support workers, etc., etc. etc.  Those jobs need to be near their customers.  They need urbanization.

I just happened to see a graph comparing manufacturing employment across several countries (Hat Tip: Adam Tooze)  The graph compared US manufacturing income to Japan, Germany, and Korea.  Manufacturing employment has been stronger in all three than in the US.  Guess what else they have in common.  None of them had a housing bubble.  And they tend to run trade surpluses.

So, I went to Fred to see if the pattern holds.  And it does.

Source


The housing bubble, trade deficit countries are down there with the US with half the manufacturing employment that Germany has.  They have moved to a post-industrial economy.  That requires urbanization.  Nobody has figured out, politically, how to allow it to happen.  I predict that the first one that does will experience a flowering of equitable economic growth.
idiosyncraticwhisk.blogspot.com 2017
Source: World Bank (via Fred)
PS.  Here's a graph of GINI indexes.  The trade deficit/ housing bubble/ post-industrial economies also have another thing in common.  More income inequality.  A cap on the admittance into the key urban economies has created an economy of exclusion based on a sort of meritocracy.  If you have skills and connections, you can earn an excessively high income, much of which goes to your landlord.

Wednesday, April 5, 2017

Randal O'Toole's American Nightmare

I was recently made aware of Randal O'Toole's book on the housing bubble, "American Nightmare".  I'm embarrassed to say it had escaped my vision before now.

I have developed a sort of "everyone is wrong about everything" attitude about this topic.  But O'Toole basically gets it right.

Most of the book is a brief review of the history of homeownership and urban housing policies, capped off with an explanation of how that history led to the bubble because of disastrous supply constraints that are always at the heart of housing affordability problems.  The credit issues were a result of that problem, not the cause.

He has a 10 point prescription for fixing the problem that is generally pretty good.  It includes more skepticism about FHA, the GSEs, and the rating agencies than I generally hold.  But, his skepticism includes the point that in high cost areas, where low down payments were used to help usher new buyers into homes, we should probably have been requiring higher down payments because constricted housing creates more volatility.  That's a good point, worth considering.  And, he notes that those sorts of measures would be unnecessary, if not for the supply problem itself.

In general, I think ownership should be more about self-selection than about affordability.  Transaction costs are high, so there is a natural self-selection of buyers who expect to own long enough to amortize transaction costs.  Beyond that, it's not like families are choosing between buying a home or living under a bridge.  They will be renting if they aren't buying.  Affordability is only a problem in high inflation contexts because of mortgage conventions and money illusion.  Obstructing ownership for affordability reasons isn't coherent.  Typically, the decision to own reflects some deferred consumption, because of the front-loaded nature of mortgage cash outflows.  The notion that we have to keep households with moderately low incomes from access to mortgage financing, because they will become reckless speculators if we don't, is policy from attribution error.  High down payments are an added obstacle that prevents households from gaining control over their living space.

But, as O'Toole notes, low down payments are really mainly a problem in Closed Access contexts.

I have generally thought well of O'Toole's work on topics like mass transit.  After reading this book, my estimation of the quality of his work on topics that I am not as informed about just went up.  He got the big picture right on this one where others rarely have.

Tuesday, April 4, 2017

Housing: Part 218 - Closed Access real estate is now a cyclical signal

I've been seeing this sort of article recently (HT: JW), about rents or prices dropping at the top end of the housing market.

I think this is one of the potentially useful tactical concepts that can come out of a new understanding of the housing bubble.  This also happened in the bubble.  The first shift in housing markets, in the Closed Access cities in 2006, was a downshift at the top end.  An exodus from home equity had been happening for years before mortgage markets collapsed in late 2007.  For more than a year before mortgage markets collapsed, there had been a fairly conventional decline in home prices that was concentrated at the top tier markets in cities where prices had risen.

That was the correction.  It was minor, local, and focused at the top and in equity (not credit).  Everything that happened after private securitization markets collapsed was a public policy choice that had little to do with the bubble.

The collapse in home equity in 2006 and 2007 was the product of a flight to safety.  Public opinion and public policy has the benefit of being able to impose itself on the country regardless of how obtuse it is, and so, two years after markets had turned to defensiveness, our consensus public policy choice was to teach the supposedly reckless market a lesson and really create a panic.  Nothing is more pro-cyclical than public sentiment strong enough to impose itself.



idiosyncraticwhisk.blogspot.com  2017
Each dot = one zip code. (Source: Zillow Data)  x-axis: log home prices, y-axis: annual log price change
selected western US Closed Access and Contagion cities shown

...Anyway, back to 2006.  Across cities, it was the top end that led the initial contraction.  One explanation for this is that Closed Access real estate has become sort of like a growth stock.  The value of Closed Access real estate is its protected claim on future economic productivity.  This is manifest through expected long term rent inflation in those cities.  So, Closed Access real estate prices are more exposed to long term real growth rates.

The bubble-monger mentality that has been created by Closed Access consequences leads to this pro-cyclical public policy.  Just as the stock market is an early indicator of economic and employment trends, now Closed Access housing is also an early indicator.  But, we can't utilize these indicators for stabilizing public policy because this will be seen as protecting Wall Street or protecting real estate speculators.  Especially now in real estate, these early downshifts are treated as the inevitable collapse of an overheated market, and they are generally welcomed.

I don't think the ingredients are there for a disaster like we saw in 2008 and 2009, but we are still destined to walk right into a contraction while patting ourselves on the backs for it.

If these contractions were based on a permanent shift toward more building in the Closed Access cities, first, we would need to see housing starts far above what they are - at least double - and, second, the first reaction to that regime shift would be a collapse in Closed Access home prices, because they would lose their claim on exclusion.  This would be considered disruptive, so there would be a plurality of forces in Closed Access cities that would come together to ensure continued exclusivity - for the sake of local stability.  Limited access governance begets limited access governance.  Even North, Wallis, and Weingast don't have a prescription on how to reverse this.

But, on the national level, didn't a plurality of forces demand instability? Yes.  The problem is that we have a shortage of (local) supply, and (national) credit markets are mostly a passive effect of this.  But, we mistakenly have thought that we have too much credit, creating too much supply.  So, we tend to err on the side of limiting supply, which can avoid short term local disruptions at the local level, with the cost of long term national exclusion, and we err on the side of limiting credit, which creates short term national disruptions.

The disruptions we would see locally from solving the Closed Access problem would be at a completely different scale than what we are seeing.  They would be on the scale, to the downside, of the price appreciation we saw in the 2000s.  These small scale declines, I think, are more of a sign of marginal cyclical shifts in expectations.  National expected income is declining because of cyclical shifts downward, which means there are fewer rents to claim from exclusion.  This hits Closed Access real estate values.

There seems to be a difference between now and 2006.  In 2006, rents were rising as prices began to contract.  That is because the exodus from home equity happened first and housing starts were already sharply falling.  This cycle is different because there hasn't been as much panic about a housing bubble, and housing starts, while weak, aren't collapsing.  So, there appears to be some softness in rents, too (although this isn't showing up in the CPI data yet*).  But, if that softness in rent was considered permanent, rather than cyclical, Closed Access price contractions would be extreme.



* There can be a lag in rent inflation in the CPI.  It will be interesting to see if CPI rent begins to slow down.  Will that remove inflation pressure, causing the Fed to stop monetary tightening?  The road ahead is interesting.  I'm getting tired of being unclear about it.  It seems like this has been the case for some time.



Monday, April 3, 2017

Housing: Part 217 - Some observations on taxes

I have found a pattern in home prices that I attribute to tax benefits, where high tier homes tend to sell at Price/Rent multiples of maybe 30% or more above low tier homes.  I think the price differentials we saw in Closed Access cities that were blamed on loose credit were actually a product of this factor.  In general, I would prefer to see the income tax benefits of homeownership removed, including the tax exemption of imputed rent, the deductibility of mortgage interest, and the exemptions on capital gains taxes.  The easiest way to do this, I think, would be to generally eliminate taxes on capital.  Many economists, as I understand it, would point out that taxes on capital aren't particularly progressive, because they really fall on owners, workers, and consumers proportionately after wages, prices, and profits adjust to the new equilibrium.  But, actually, I think capital taxation is a bit regressive because of these housing issues.  There is a huge gain to homeowners, especially high income homeowners, that would be difficult to get rid of as long as we tax capital income.  And, increasing property taxes a bit would capture back some of that tax revenue in a way that might be a little bit regressive, but is probably less regressive than the income tax benefits we currently have.

But, there is a caveat I hadn't thought of.  Property taxes are based on market values.  Market values currently reflect those income tax benefits.  So, property taxes are now somewhat progressive.  A home worth $1,000 in monthly rent now might sell for $150,00 while a $2,000 rental unit in the same town might sell for $400,000 (instead of $300,000).  That means that, by rental value, property taxes now are somewhat progressive.  Presumably, if the income tax benefits were removed, that high end home would only sell for $300,000, and their property taxes would also be lower.  So, my preferred tax regime would be more regressive than I have been admitting to.

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There were some changes to the capital gains exemption in the 1990s.  It used to be that you could get an exemption on capital gains when you sold a home, but you had to purchase a new home or be over 55 in order to claim the exemption.  That requirement was removed in 1997.  This has generally been blamed, along with all the other tax benefits, for feeding the bubble, and I agree that the range of tax benefits does tend to inflate prices.

But, I think we may have overlooked the way that this actually made the bust worse.  As I have argued, there was a surge of permanent selling as early as 2003 or 2004 - homeowners selling and not buying back in.  With this change in the tax rules, households could bank their Closed Access capital gains, tax free.  In fact, if you were bumping up against the maximum ($500,000 for a couple), you might be induced to sell by that rule change, to reset your exemption.

Would the exit rate have been so high during the bust if that rule hadn't been changed?  I have to think that, at least, many of those sellers would have repurchased other homes.

These are tough arguments to make when most people think the problem was that the bust didn't come soon enough.  But, given that the bust was largely avoidable and unnecessary, this seems like an example of a disruptive unintended consequence.

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Another piece of fuel to the fire was Bush's Mortgage Forgiveness Debt Relief Act of 2007.  Normally, a household would have to pay taxes on debt forgiven in a foreclosure.  But, seeing the mounting problem in the collapsing housing market, the Bush Administration signed this law in December 2007, providing relief from the tax consequences of foreclosure.

Coincidentally, by February, we were seeing articles like:
Homeowners: Can't pay? Just walk away. and Subprime loans defaulting even before resets. by February, as default rates suddenly spiked, and some homeowners appeared to be defaulting "strategically".

We have seen the bust as an inevitable result of the bubble.  It wasn't.  That has blinded us to the various discretionary policies that, in the end, did make it inevitable.