Thursday, October 1, 2015

Housing, A Series: Part 65 - Reasoning from a Daisy Chain

Following up on Tuesday's post, I would like to think through a sort of narrative of the housing boom.  First, I want to think of a benchmark, where some reasonable amount of housing is available in places like San Francisco.  We might imagine a marginal change in our economy when a bright young computer whiz graduates from the Ivy League and moves west to participate in the tech revolution.  He finds a small 1,500 sq. ft. apartment renting for $1,500 per month in a shiny new high rise in San Francisco proper that has a 10% vacancy rate.  A few years later, we all benefit from his skill and hard work when we download his new app.  He becomes very wealthy.  And, in the meantime, a builder collects those $1,500 rent checks as a normal return on the capital she used to build the high rise.  That's pretty much the extent of the economic effect of our computer whiz's quest.

Now, let's make only one change in that story - a change that describes our world more accurately.  Let's take away that shiny new high rise with a 10% vacancy rate.  That is the only change.  Here, incidentally, is a graph showing (1) the portion of US employees living in the  New York City, San Francisco, or San Jose MSA's and (2) the rate of single unit housing starts.  This is the core of the story of the housing "bubble".  These are the cities with the highest incomes and the most dynamic economic sectors in the country, and the housing boom was facilitating a migration away from them.  This must be a rare story in the history of human migration.  We have found a way to cause people to flee prosperity.

In our more accurate story, our whiz has trouble finding an apartment, but finally finds an old 1,000 sq. ft. apartment for $4,000 per month.  The apartment had been renting for $3,500, but demand for space had been so strong that the landlord raised rents to $4,000.  This was the last straw for the couple who lived in it.  At $3,500, rent was taking half their paychecks already, and they simply couldn't make it work any more.

The couple had been looking at their options, and even though it would mean a 20% cut in wages for jobs similar to what they had in San Francisco, they decided that life in Phoenix would end up being more affordable.  In Phoenix they could move into a spacious 2,500 sq. ft. home for less rent than their little apartment had fetched.  In fact, it was so affordable, they could qualify for a mortgage to buy that spacious home.  And, so they did.

One simple change - one home built in Phoenix instead of San Francisco.  And, the result is a litany of statistical information that describes the 2000s:

1) We still get the app, and the whiz still gets his fortune, although his real income (along with everyone else, as measured) is lower because of rent inflation.  So, there is stagnation in real incomes, though that isn't as much of a concern to our whiz as it is to the custodians and school teachers who, unlike our couple, are still hanging on in San Francisco.

2) There is no new landlord earning a market return on a shiny new high rise.  Instead, there is an old landlord who keeps earning higher and higher returns on her old building as rents rise.  She is still earning a market return, but that return is based on capital gains on the old building that now earns $4,000 rent instead of earning $1,000 on four apartments in the new high rise.  Since computer whizzes keep moving in, it seems that rent increases will continue as long as anyone can tell, so since our landlord foresees more gains in the future, she has raised the selling price of her old building even faster than she has raised the rents.

3) Our couple sees their nominal income fall even though their actual standard of living has increased.  In aggregate statistical measures, though, their move reduces the average real income because their move has a negative effect on nominal income but no significant effect on inflation.  Our whiz created an effect on inflation by bidding up the price of housing in San Francisco.  But, Phoenix encourages new home building, so there is no rent inflation from the new house in Phoenix.  It affects neither the Case-Shiller index of home prices nor the CPI rent level.  And, now they are in debt.

This one simple change - a lack of housing in the places where people would like to live - leads to more debt, more homeowners, more residential investment because of the larger home in Phoenix, lower nominal incomes, lower measured real incomes, higher capital incomes, higher home prices on average, level nominal spending on housing (rent) and falling real spending on housing.

Note the irony that the only character who is clearly worse off in our new version of the story is our computer whiz, who must now spend more of the very high profits he earns from his app on rent.  Off-stage, there are also many low income residents of San Francisco who are much worse off in the second version of our story.

Statistically, this paints a story of stagnant real wages, over-investment in homes, over-indebtedness, and workers who are losing negotiating power and claiming less of the national income.  In the nuts and bolts of our story, though, all of those statistical facts are either not true or are unimportant.

The thing is, we all know these characters.  This is not a contrived tale.  And, the funny thing about this story, which, as we can see, contains all the same familiar people with all the same motivations, but is simply missing a well-placed apartment building, is that to these characters, the narrative is completely different.

The factual narrative is simple: deprivation.  We have deprived ourselves of a unit of housing.  The whiz kid sees it as a deprivation story.  He sees a frustrating sort of entrance fee on the road to his American dream - a large down payment he has to make to break into an innovative industry - a cost that would be difficult if he doesn't happen to come from a wealthy family.  Although, he probably earns some extra income as a result of the barrier to entry that the missing apartment creates into his industry.

The landlord and the couple see a bunch of tech workers coming in and throwing their weight around, bidding up rents.  The couple see these tech workers forcing their friends out of their neighborhoods and undermining their community.  They see excess and wealth ruining the fabric of their town.  They also see a greedy landlord who keeps ratcheting up their cost of living and simply pocketing unearned profits, putting them on an endless treadmill of working harder and harder just to maintain their standard of living.

Their new neighbors in Phoenix see more of that California money piling in, funding one new neighborhood of McMansions after another.  And, everyone else watching this unfold sees greedy banks piling up mortgages on their balance sheets for families that somehow can go from 1,000 sq. ft. renters to 2,500 sq. ft. owners and all those statistics about stagnation and over-investment.

And they all look at this simple picture of avoidable deprivation and they see unsustainable excess and greed.  I say they are deceived both by their own experiences and by the seemingly obvious statistical measures that confirm it.  And, so we are engaged in an ongoing process of engaging the effect of supply deprivation and solving it by imposing demand deprivation.  When we are left with an economy that seems only capable of bubbles or busts, we naturally blame the folks that seem to be holding all the cards - the bankers, the landlord, and the whiz kid.  The rich just keep getting richer.  "Stop the lending, stop the building, tax the whiz kid.  If we do let you build apartments in San Francisco, you can sure as heck bet that we're going to try to stop you from building apartments for people like him.  And, for Pete's sake, stop printing all that money.  Can't you see it's driving up the price of everything and just lining the pockets of capitalists?"

“Tell me,” the great twentieth-century philosopher Ludwig Wittgenstein once asked a friend, “why do people always say it was natural for man to assume that the sun went around the Earth rather than that the Earth was rotating?” His friend replied, “Well, obviously because it just looks as though the Sun is going around the Earth.” Wittgenstein responded, “Well, what would it have looked like if it had looked as though the Earth was rotating?”


  1. Kevin, thank you again for such a clear narrative of what we are doing wrong. I wonder if there is any way to get from your insights to a change in policy.

    1. It's tough. Misplaced anger is a powerful social force. It's very hard for whole groups of people to conclude that they shouldn't have been angry. It's the rhetorical equivalent of admitting, as a country, that we were wrong to go into a war. If my story is right, change would have to come slowly. I think I have developed a broad set of evidence that it would be nice to see widely aired.

      An example of the difficulty: I mentioned to Bob Murphy that a large amount of CPI inflation has been from rent inflation. Bob would be a natural supply-side supporter. But, he is a demand-side hawk. His reaction was to presume that the BEA's inflation estimates for rent are overstated. This would mean that measured inflation has been biased upward, so Bob would have to believe that there has been negligible inflation for nearly 20 years. Keep in mind, Bob thinks loose money was a core problem and one of Bob's biggest embarrassments since the crisis has been his prediction that we would see very high inflation after QE. Yet, to defend the idea that there was oversupply of housing, he was willing, at least momentarily, to believe that his loose money and inflation fears were even more off base than they seem.

      As I draw this to a close, it really seems like it lends itself to a book format. All of the evidence needs to be laid out in a self-contained, careful way, because human nature will lead a lot of readers to dismiss it with hand waving whose incoherence is difficult to understand without the willingness to patiently allow all the aspects of the story to be presented.

      I don't have any connections in the publishing business, and I'm not sure there is natural source of support for a story that is both supply-side and demand-side dovish. For large numbers of readers to let this story get into their heads, I think it would have to be published with some support from authority. The book, in an unorganized form, is basically here at the blog - it's practically written. But, I haven't begun the more difficult process (for me) of finding that support from authority. I don't know if it is possible.

  2. 1,500 sq ft is a small apartment?

    1. In my alternate universe where San Francisco is full of 40 story condo towers.

  3. Great post. Quibble: the standard of living in certain urban areas is not only the size of the apartment but proximity to amenities such as museums, really good restaurants, stadiums, nightlife, other intelligent people. One might also argue a city with a good mass transportation network allows the consumer to dispense with expensive automobiles.

    I totally agree that everything possible to be done to increase the supply of housing in urban markets and also to rip down zoning restrictions, such as single family detached.

    However I do not see the residents of Brooklyn or Newport Beach deciding that more development is what their community needs.

    The Fed just needs to get comfortable with 3% inflation and call it a day.

    1. All excellent points, Benjamin. The size thing is just easier to picture in a story, but you're right. That's my point on the couple in the story. Their real housing consumption goes down even though they move to a larger house that requires more physical investment. That's the double whammy that the housing problem creates. The couple is less productive in Phoenix and the house requires more capital investment for a less valuable home. Both of these issues lower productivity.

  4. u tell an important story, Kevin. that couple moving from SF experiences a miniature divorce. to b with each other as adults, as householders, they give up the place they chose for themselves, likely where they found each other. in different lights u can see my wrinkles. She fell in love with San Francisco Mortimer, not sun belt downtown gridlock without the downtown Mortimer. the housing situation retards human capital at work and in love. the novels r set in paris, the paintings in the countryside. most of us r exiles from both

    no use dwelling on a permanent nuisance, tho. monetary policy is the bit that's run by philosophers

    1. Great comment, Mortimer.

      "no use dwelling..." pun intended? Ha! I think I'm mostly done with the topic, but as I increase the depth and breadth of the topic, I keep noticing new implications. I just realized recently that I was well past part 30 before I realized the importance of the metropolitan supply constrictions, and that has become the core of my narrative now. Maybe I'll get to part 80 and uncover an ancient prophecy about a future glazier who will be our salvation.

      There are issues, such as the way our decentralized regulatory and zoning system probably undermines automation and standardization, that could probably have more potential to improve housing efficiency and quality. I probably won't get into that. I'm just following my nose until I run out of things that seem related to my topic, are interesting to me, and that I have the tools to analyze.

    2. I did not intend that pun. You caught the comic alpha before I did. I also misspeak if I seem to disapprove of your research direction. In fact, I retract my previous comment on the grounds that

      1. u do more than enough explicit measurement and description of actually existing and pending reality - and how! I'm an eager and grateful student - to merit some normative water cooler talk
      2. politics never stops, talk is reasonably priced, and the cause is noble

      I think watching MR's Dani Rodrik interview infused me with some wilier-than-thou second bestism

  5. Great post. I think someone could do a whole series delving into just why, in country full of landscapes like the background image of this page, people worry about density and overpopulation. Some quirk of American, if not human, psychology informs politics ranging from national immigration policy to regional and city-level zoning regulations.

    A few years ago, a new apartment building was proposed on the site of an old lumberyard in my neighborhood. Connected to freeways by a 4-lane relatively traffic-free road, literally across the street from a commuter rail station, and just a few blocks from a walkable downtown, it was about as close as you can get to the perfect spot for a high-rise. Zoning limited the height to 4 stories, of course. Parking would be vastly overprovisioned with an average of 1.5 spaces per unit. Oh, the rhetoric from some of the neighbors! Flyers were distributed portraying Mountain View as Manhattan, with people stacked cheek-by-jowl up to the clouds. It would be a parking nightmare, a noisy blight, a criminal hotspot.

    The apartment building was approved after all, with modifications reducing the density (stepping down to 2 stories on the sides adjacent to existing single-family detached homes), and further increasing car parking. The results are predictable: it's a nice building, there's no parking armageddon, and Mountain View still isn't Manhattan. The rents in the new building are astounding, since the owner quite naturally targeted it to the techies with no or small families who can afford it. (And multiple levels of underground parking aren't cheap to build.) Now the only complaints are about how new development just brings in more of the same rich outsiders.

    So, the politics and the psychology. Why is "Manhattanization" considered the worst thing that can happen to a city? (To misquote Yogi Berra, no one would want to live someplace that's so crowded.) Why do arguments about new development always start and end with car parking and traffic? Why do people always associate density with crime and low quality of life, despite vast evidence to the contrary?

    I suspect part of it is just a general resistance to change and fear of the unknown. People become invested in their surroundings, and no one is more invested than a homeowner who's poured most of his or her life savings into a tiny dump of a house in a fantastically sought-after neighborhood. Even the author of this comment wouldn't necessarily like to see zoning regulations disappear overnight--the hog-rendering plant next door, and all that.

    But calling people grumpy curmudgeons isn't a particularly effective way to assuage their fears and change their minds about development.

    1. Great comment, Ed. Frequent commenter Benjamin Cole has pointed out that the problem extends beyond the core cities, and he has a good point, and your comment is along the same line. There really would be an incredible amount of human development and opportunity if the whole corridor from San Francisco to San Jose expanded its housing supply.

      But, what I find especially galling about the core cities, especially San Francisco and Manhattan, is that the whole point of their existence and the source of their value is the density itself. The reason people move to Manhattan is explicitly the density. Then, you see stories about the housing crisis, and everyone in the story basically says, "Look, we're not against building in general. We just collectively will oppose anything you could possible propose."

      But, here's the thing. You see something like this graphic:
      and you realize, it is possible to build very dense space in Manhattan, as long as it is commercial. So, even though it looks like there is a sort of emergent obstacle to density in general, there isn't. There is only an emergent obstacle to residential housing.

      I think that specific issue points to the problem that we have. We have two conservative political movements in this country - one we call conservative and one we call progressive. The progressive pretense is to always take a position against producers and developers. Since in commercial building there is no purported party that will be rhetorically ennobled by their advocacy, they leave commercial development alone. But, in residential, they explicitly argue, in effect, that they like the city just the way it was after they moved there, and the wrong sorts of people are moving in - except now that is rich people instead of immigrant laborers. It's the perfect position for sustaining their pretenses of egalitarianism while creating ultra-conservative outcomes. They can always take vocal stands against developers, complain about the new rich neighbors, and advocate for affordable housing for low income laborers. Since their activism will prevent there from ever being an actual functional housing market for low income laborers, they can play act like they are liberals while perpetually enforcing ultra-conservativism. And the end result is that these incredible cities that have always been engines of opportunity - and potentially now more than ever - are instead sources of financial stress, where opportunity is limited to high income workers and landowners. The combination of the scale of economic obstruction and self-righteousness is dazzling.

    2. Not only low-income laborers: in various Silicon Valley towns there's talk of subsidized housing for teachers, police officers, firefighters, and so on. One imagines a future where elite techies and financiers are the only players left in the free market, driving the value of single-story 1950s tract houses skyward, while everyone else is put on a waiting list for a government-assigned housing unit.

  6. Donald Trump has his issue backwards. u don't need to build a wall to keep people out. u just have to build nothing (although building nothing turns out to be a lot more expensive, and not just in opportunity cost)

    witness - a million fewer illegal residents in the US since 2007, even while Mexico's population has continued to grow and the northern estados spasmed with irregular war

  7. Great, great comments, Ed and Ghengis. And, Ed, that may be my favorite newspaper article ever. I've been digging into this issue for a year or so, and in the past few months it seems like recognition of the problem has started seeping into the national conversation. It's a good sign.

  8. The litany of second-order effects and unintended consequences is difficult to incorporate into a narrative for voters. I wish mainstream journalists would bring Edward Glaeser type findings to the masses and swing the pendulum on this one. In some ways it's a framing issue...

    1. I agree. It should be a simple story. The history of these cities as sources of opportunity is hardly a secret. "Let them in." Unfortunately, progressivism has become reactionary in this country, so those who should respond to that simple story instead oppose any opportunity that isn't distributed and shaped in precisely the way they demand, and only in such a way that the city doesn't change, which means they basically oppose opportunity or growth. It's a shame.

  9. Being a landlord is not a bad gig but if you don't have great tenants boy can it come with headaches. My father rented houses out for a long time but, bad ones can really wreck a house. I wonder if doing regular inspections would be something that a landlord could do just to make sure things don't go down.

    Daniel Roberson @ Mark Bentley PA