Tuesday, January 12, 2016

Housing, A Series: Part 102 - What do our two housing markets tell us about demand?

In yesterday's post, I neglected to mention one implication of our two housing markets.

Much of the country had reasonable home prices throughout the boom period.  According to Zillow, at the end of 1995, the expense of a conventional mortgage on the median home amounted to less than 25% of the median household's income in about 64% of metro areas (MSAs), weighted by population.  At the end of 2004, 52% of cities remained affordable.  By the end of 2005, with rising interest rates, that was down to 40%.  There was a decline, especially in the last months of the boom, but there was still a large area with generally typical home affordability.  And, this proportion is probably higher in the one-third of the country outside of the largest cities.  And these areas of the country were taking in net migration from the more expensive areas.  There are some notable areas of declining population, but these areas include some of the fastest growing cities in the country.

My point here is that, on the margin, these areas that did not have unusually expensive homes were capable of serving as representative marginal housing markets.  These cities are the baseline for measuring demand-side (monetary and credit-influenced) effects on the housing market.  As we should expect from long-standing tendencies in housing markets, trends in rents and price levels were not exceedingly different from the basket of non-shelter goods and services.

Because the price levels of the Closed Access cities are the result of a supply constraint, the higher prices in those cities are not a product of demand-side factors.  They are the measure of substitutability.  The relative prices in these cities reflect the extra value of the properties which are contained in a limited access location relative to the value of a property in an open access location.

That substitutability reflects an inherent comparable value.  Part of that value comes from higher incomes that I believe are themselves a product of the limited access.  So, the ratio of the value of properties in the Closed Access cities to the Open Access cities isn't constant.  It might be affected by economic growth, innovations in certain industries, demographic and population shifts, foreign capital and population flows into the US, and many other factors.  It is probably even affected by the posture of monetary, regulatory, and credit policies.

That substitutability, or more precisely, the lack of substitutability, was really what fed the arithmetic of the housing bubble.  And, that substitutability is expressed, firstly through rents, and only secondarily through prices.  Monetary and credit policy, aside from being accessible and generous enough to induce reasonable supply (which they clearly are not, now), can't do much to change this relative value.  It would be like using monetary and credit policy to bring down the price of BMW's.  (We never blame the price of BMW's on credit policy, do we?  Since we recognize, intuitively, the notion of substitutability in the auto market, we recognize that, at most, generous credit might lead to more units sold and that monetary policy tends to move all values in tandem.  Nobody would ever argue that we need to tighten credit standards in order to pull the price of BMW's down, and that if Chevrolet prices and production comes down, too, as a side effect, it's just the medicine we have to take to make the category "cars" affordable again.)

As we passed into 2004 and 2005, it looks like economic expansion was increasing the value of those local labor markets and increasing the rental value of those coveted locations.  The relative values of those cities were moving high enough to begin to create some contagion in nearby housing markets.  I really dislike the idea of a "overheating" economy and that we need technocrats to "cool it down" before we overproduce.  That's a dangerous framework, tied in to such other pernicious ideas like that it is the job of the central bank to make sure risk premiums remain high.  But, here we can see how these ideas can seem reasonable.  If you develop real obstacles to creating real economic value that are strong enough, then the economy necessarily becomes a battle for what is available.  It really does become a fixed-pie context.  And, then, all those colloquialisms about the haves vs. the have-nots really do come true.  If you find living in San Francisco personally valuable, then you live in the dog-eat-dog world.  You should want technocrats to "cool down" the economy, and hope you somehow stay warm.

And, since we aren't going to solve these supply-side problems, we solved it with demand.  I don't know, maybe if we had slowed things down slightly, we could have backed migration flows up just enough to reduce the contagion.  But, we slowed things down so much that those Open Access cities which should have been our barometer of demand-side influence switched from being within the range of healthy and normal to being in crisis.  And, if housing markets are any indication, they still are.


  1. Getting ready to hit the sack. But I just think that the banks wanted their houses back. It has worked out well for them. I think it was a giant scam and have said so before. Otherwise, it makes absolutely no sense. You loan out money you know can't be paid back to unqualified buyers. You get fees on their late payments, much like the payday loan industry, and then you collect the house back and get the mortgage guaranteed by the government. That is pure scam. I am seriously drawn to Market Monetarist thinking because we have to move off the bottom, except they can't see a scam happening right in front of them.

  2. I like the BMW/Chevy analogy. 0% financing raised the entire auto industry.

    1. Yes, but generally through higher sales volume, right? I think I might stick with the car analogy in future versions of this project.

      I think one of the confusions in the normal version of the housing story is that lower real long term interest rates cause home values to be higher and lower inflation premiums cause homebuyer demand to be higher by lowering credit obstacles. Since these two factors are difficult to disentangle, people think of it like a car dealer offering financing incentives, and they ascribe all of the effects of low interest rates to the demand factor, whereas I think the value factor is much more important.

      But, in any case I think the analogy may be useful in a couple of ways. One analogy I tend to think of about the "the bankers did this to us!" story is blaming witches for a bad harvest. I say, even if you prove that there are witches in town, that's not proof that they caused the bad harvest. Even if there are witches in town who admit to you, "Yes, I performed incantations to ruin the harvest." that's still not proof that they caused the bad harvest. But, I'm afraid readers will balk at the idea that their understanding of the economy is analogous to a witch hunt.

      I think the car salesman analogy is better, and more salient to modern observers. Car dealers can be untrustworthy. They are famous for trying to game buyers. And they frequently succeed. But, nobody believes that car salesmen can cause the MSRP of BMW's to double. It's implausible. I can say that it is implausible that subprime mortgage originators caused California real estate to double or triple in value without denying the existence of a vast market full of shady mortgage dealers.

      But, there is an additional rhetorical problem, in that the widely shared narrative includes a lot of true beliefs about excesses plus a lot of false beliefs from sloppy thinking. If I point out the sloppy thinking, I'm bound to get the response, "Get a load of this guy. Listen buddy, I was there. Mortgage issuers were going insane." Then, if I say the real stuff happened, but couldn't have caused California real estate to rise so much, the response will be, "All this stuff happened (a combination of true things and sloppy, false things). Sure that could cause prices to spike."

      There are a lot of pillars of questionable facts holding up the housing bubble narrative, and I'm curious how a wider audience of readers is going to process the story when I have to proceed one pillar at a time.

    2. I like features of NGDP Targeting, and certainly the Fed screwed up or maybe it was on purpose. That is my opinion. However, think about it. People got adjustable loans with no creditworthiness. They could afford the initial payments but walked away as they could not refi as promised. So, the banks come along, Kevin and take the houses. Instead of allowing short sales or refis to the owners, they took the houses, and got the mortgages guaranteed by the government and taxpayers, and then sold the houses to their buddies for pennies, to whom they gave credit lines. It was a scam. People with cash could not get the deals the investors got. You had to be in with the banks to get the deals.

      Kevin, check out my link for a simplified article on NGDP targeting with two graphs. But know this Kevin, the tightening when the Fed had to know what was happening, was part of the scam, IMO.

  3. Way OT, but worth thinking about:

    More OT:

    "The Federal Reserve’s most important tool for setting interest rates absorbed a record $475bn of money from financial institutions in its last monetary operation of 2015, in another sign that one of the central bank’s main methods of draining liquidity from the financial system is working.

    The New York Fed said that the US central bank had awarded $474.59bn in one-day fixed-rate reverse repurchase agreements to 109 counterparties in an auction on Thursday, more than a third higher than the previous record set at the end of the second quarter in 2014.

    The agreements allow qualified financial groups — including traditional banks and money market funds — to park cash at the Fed overnight in exchange for Treasury securities and 0.25 per cent interest.

    Analysts and economists have characterised the reverse repo facility, which controls the lower bound of the Fed’s target rate, as crucial to its ability to set short-term rates, and as among the central bank’s most potent tools.

    Earlier this month the Federal Reserve pulled off a historic move, lifting its benchmark rate for the first time in nearly a decade from a range between 0 and 25 basis points to 25-50 basis points."


    A half-trillion in reverse repos? Is the Fed in the business of paying IOER to banks...and then artificially propping up short-term rates?


    1. "in another sign that one of the central bank’s main methods of draining liquidity from the financial system is working."

      Lacking words, Ben. Lacking words.

    2. https://research.stlouisfed.org/fred2/graph/?g=37Ur

      Looks like it may be working. You can't trust people with money, Ben. They just go out and do stupid stuff like build shelter with it. Bunch o ignoramuses.

      I'm kind of kicking myself that I didn't take a long bond position in December, but I just hate positions that depend on bureaucratic errors that could, in theory, be reversed on a dime. A lot of long tail risk there. So, I just watch it happen, hoping it gets reversed, but figuring it probably won't.