Wednesday, June 29, 2016

Housing: Part 164 - The Supply Catch-22

There is a widely held sense that housing costs are positively correlated with mortgage credit.  The truth is mostly in opposition to this, I think.  The irony comes from confusion between ownership and consumption, inflation vs. real consumption, and presumptions about the dominance of demand where supply is the important factor.

If supply was universally elastic, real housing consumption would probably correlate with credit expansion, but the supply that would be triggered by rising home prices would bring down rents.  Nominal housing expenditures, in terms of rent, would grow much more moderately than real housing expenditures.  This is basically what happened in parts of the country during the boom where supply was not politically constrained.

Where supply is politically constrained, there is no way for real housing expenditures to grow, so to the extent that new credit allows marginal households to maintain ownership, demand for housing consumption, in terms of rent, shifts to the right and there probably is some positive correlation between credit and rents.

Whether an increase in available credit or limited access housing policies in cities that can maintain sustainably high wage incomes, in either case the effect is to cause more inelastic demand for housing consumption.  Supply appears to be the more important factor here.  Rent inflation was moderating in the boom and rose sharply in 2006 and 2007 as credit and housing supply growth collapsed.

There was a temporary drop in rent inflation from late 2007 to 2010, as foreclosed households were forced to make a shift in housing consumption while under financial stress, and this created a negative shock in nominal housing demand.  But, in the credit constrained environment we have had since then, rent inflation has moved back up.  This is because constrained credit has created a housing supply constraint across the country.  Housing supply is more important in determining rent inflation than demand that might be triggered by expansive credit, so rents are rising now just as they had been rising in the Closed Access cities when credit was more available.

Since credit creates supply where supply is not politically obstructed, mortgage credit will clearly reduce total housing expenditures.  This is the ironic outcome created by inelastic demand with constrained supply.  To reduce inflationary spending on housing, we have to increase mortgage expansion.

In these Fred graphs, we can see the conundrum.  Real housing expenditures per capita have been flat since 2005 when housing starts collapsed.  Because of the Closed Access cities, real housing expenditures have been declining relative to other spending since the 1980s.  In the first graph, we can see that since the mid 1990s, compared to non-shelter inflation, wages have been growing strongly.  But, for the 15% of personal consumption expenditures that go to housing, that has all been going to rent inflation, which has run roughly even with wage growth.


We can see that in the next graph, which looks at levels instead of rates.  The shelter inflation index dipped below wages after the crisis due to the negative shock from foreclosures, but it is now climbing back up, taking more wages each year even as wages rise while real housing consumption remains flat.

So, the problem is that housing is getting more expensive for the average household.  If we mistakenly see rising credit access as the primary cause of rising prices and rising demand for housing consumption, then we will mistakenly look to more credit constraints as a means to reduce those expenses.  But this will only make the supply problem worse which will only make expenses rise higher.
The problem is that home prices will likely rise if we expand mortgage credit because prices are artificially low right now, due to the severe lack of credit.  This is why housing starts are still so low.  Every excuse under the sun is trotted out for why housing starts are low, but clearly the overwhelming factor is a lack of mortgage availability for the bottom third of the potential homebuyer market.  When home prices rise, this will be taken as a sign that credit does indeed increase housing expenses.  But, a commitment to that credit expansion will lead to more supply and a reduction in rent inflation.  Normally, I would expect prices to be forward looking and for future supply-based mitigations in rent levels to be immediately captured in home prices, pulling prices back down.  But, (1) in the Closed Access cities, there won't be a supply-based mitigation in future rents and (2) at this point, markets will probably require a confirmation of that commitment before prices reflect that effect.  So, prices will probably initially rise across cities.
In the meantime, as often as not, articles I see that bemoan the rising cost of housing call for the very policies that are creating the problem.  And attempts at mortgage expansion are met with anger.  "Here they go again.  The banks are going to stick it to us again."

Tuesday, June 28, 2016

Destabilizing the commercial equilibrium

This article (HT: CH) is a case study in the central role of regulatory burdens in reducing economic growth.  It outlines some of Amazon's hurdles in France.  An excerpt, regarding the temerity of Amazon to improve its service without letting the local authorities warn the city's commercial rentiers and concoct obstacles:
"While this operation is liable to severely destabilize the commercial equilibrium of Paris, this large American enterprise only decided to inform authorities a few days before its launch," the mayor's office said.
Another excerpt:
Earlier this year, it was reported that Amazon was planning to acquire the French shipping company Colis PrivĂ©, in which it already owns a 25 percent stake, but the US company told the AFP last month that it had abandoned those plans for "reasons exterior to Amazon and beyond our control." French newspaper Les Echos later reported that the acquisition fell apart during negotiations with France's competition authority. 
This is really exactly the sort of thing that I have been studying in the housing market.  The fact that moderate rhetoric is built around the consensus that deregulation has been our problem is the central problem of our time.  In housing, the same sort of capital repression that is on display in France keeps out "destabilizing" expansion of the housing stock.  In the case of housing, the rentiers include neighborhood groups and tenant advocates, so the public face of privilege and stagnation is a face we empathize with.  Human nature pushes us to identify with interest groups based on identity and sympathy.  But, it is process that is important over time.

Regulatory limits were raising the cost of housing in our productive cities, and the public reaction to that has been to blame banks for facilitating the funding of the market value of those houses.  It looked like bankers were profiting from rising values, and it bothers people when financiers make profits that are too high.  It seems like they are just pushing papers around - not doing anything useful.  And, they have the capital.  They are the definition of the Man.  If financial repression could have held home prices down so that there was some other form of rationing that determined who would be able to own homes and collect above-market returns, that delivers profits to households individually.  It is actually a system that is more tilted against equity, but we like capital-rich people better in the form of families than we do in the form of financial corporations.

This is the system we have instituted since 2007.  All financial institutions have been nudged to a posture where mortgage finance is unavailable to the bottom half of the economic distribution.  This made the process of economics worse, so while it distributes the profits in a politically friendly way, it creates more economic stress.   This is what is happening in France.  Local merchants are more appealing than a foreign internet retailer, so the politically appealing move is the move that imposes stagnation on Paris while the rest of the world explodes with new retail opportunities.

I have concluded that this tendency was part of the problem in the early part of the housing boom and bust.  There was a legitimate concern in the Bush administration that the GSEs were taking on unnecessary risks and were becoming too large.  But, as has typically been the case in these developments, the political reaction was diverted from the real problem of process to the sensational issue of who was profiting from it.

In the 1990s, the GSEs had begun to utilize capital to keep mortgages on their balance sheet.  Normally, they take the default risk while private investors take the interest rate risk on the mortgages they facilitate.  That takes very little capital.  But, the GSEs started using debt to hold mortgages on their books, adding interest rate risk to their business model.  There are a lot of facets to that story, and maybe there is some justification for doing that, in terms of risk diversification.  But, it changed their business model to one with fairly simple accounting to one where the accounting was complicated.

The concerns about the use of debt and the added risks, once they were filtered through the political process, ended up being expressed in terms of who was profiting.  High CEO salaries and high profits were the salient issues, and the whole affair ended up just becoming a trumped up accounting scandal.  The CEO's were kicked out, and the firms restated earnings.  But, the actual problem was left unaddressed.  Simply increasing the capital required to hold mortgages on their balance sheet would have moderated their activity in that market, but instead, they were required to increase the capital they needed to hold for all activities, including the core activity of facilitating mortgages for securitizations for third party investors.

The whole process ended up causing the GSEs to retrench in 2003 and 2004, leading to the rise of private securitizations to take their place.  Falling interest rates in 2003 also led to a massive round of refinancing at lower rates, which also temporarily cut into GSE profits.  The GSEs continued to manage their balance sheets as they had, since nothing was fundamentally done to actually address that problem.  So, the end result of those political pressures was to reduce GSE activity in conventional mortgages and to increase their activity in the subprime and Alt-A securities that rose up in their place.

What followed were a series of liquidity crises in the mortgage market, and as each financial institution reacted, the public outcries always ignored the underlying processes that were falling apart in order to concentrate on who was profiting.  Who was profiting from making loans, from securitizing them, from concocting synthetic securitizations after we had destroyed the market for actual homebuyers, from foreclosing on defaulted borrowers.  Remember how much concern there was about whether AIG should pay bonuses after they were recapitalized by the federal government?

What we care about is that the wrong sorts of people might profit, and on the whole, we are quite content to obstruct broad economic abundance in order to attend to that concern.

Monday, June 27, 2016

Housing: Part 163 - Some notes on Fannie Mae

I have been digging into Fannie & Freddie's SEC filings recently.

Remember, private securitizations (subprime, Alt-A, etc.) really only were dominant from 2004 to early 2007, and that market had died by late 2007.  Homeownership peaked in early 2004.  The market outside the GSEs is surprisingly unrelated to growing homeownership rates.  I have come to see the rise in private securitizations as a response to the decline in the GSE's that came after the Bush administration pressured the GSE's with regulatory scrutiny, leading to accounting scandals, impositions of new capital controls, etc.  So, it is likely that without the rise in private mortgages, defaults would have risen in 2004 and homeownership would have fallen more sharply then.  The lack of correlation doesn't mean that those markets didn't provide some credit support for homeowners, but it does seem like the GSE's are the primary conduit, on net, for sustained ownership via the entry of first time homebuyers.

While private securitizations had provided support for mortgage markets when the GSE's pulled back in 2003 and 2004, the GSE's didn't provide support for mortgage markets when private pools collapsed in 2007.  In fact, they joined in the collapse.

I have shown in other posts that there was no change in the overall credit-worthiness of homebuyers in the 2000s.  Homeowner incomes were flat or rising until the collapse, then rose after the collapse because the mortgage market for low income buyers has dried up.  We see a similar pattern at Fannie with FICO scores.  FICO scores were very stable until 2008.  Since then, Fannie has basically closed down originations for the bottom third of what was previously a longstanding portion of the origination market.

In the second graph, here, we can see that all of the growth in mortgages outstanding at Fannie Mae have been at FICO scores of 740 or more.

This highlights something that I think may be underappreciated.  I have pointed out many times that the mortgage market has been closed to the bottom half of the population, by income or credit-worthiness.  But, notice here that all FICO categories under 740 had been declining or treading water since 2007.  Originations have been negligible for FICO scores under 660 and low for scores under 700.

Many of those households are basically grandfathered in.  Many probably cannot qualify to refinance existing loans.  So, even existing owners at the low end of the credit spectrum have been disadvantaged by the closed off mortgage market, and find it harder to refinance at lower rates compared to households at the higher end of the credit spectrum.

In the next graph, we can see the sharp drop in mortgages for purchase that began in 2006  2008. (edit: the original x-axis was off on this graph.)  I will probably follow up on this in a future post, but one interesting thing going on here is that first-time buyers at the GSE were strong in 2006 and 2007.  The pain during that period was felt by existing owners who were being squeezed by falling home prices in some cities.  The new buyers in 2006 and 2007 would eventually be the most vulnerable to that problem when prices really collapsed.

In the next graph, we can see that LTV's were relatively normal throughout the period and that when home prices started to collapse, LTV's first ticked up slightly, but by 2008 and 2009, average LTVs (loan-to-value) were falling.  By 2008 the main problem was that market LTVs had risen above the original LTVs for Fannie loans.  In the midst of that problem, Fannie was decreasing the average LTV.  This makes sense from a lender point of view.  Part of what was happening was that there was broad expectation of continuing price collapses.  That expectation was being encouraged by the Fed.  Lenders don't lend on collateral they expect to lose value.  This becomes a self-fulfilling prophecy.

Look at what we see in the last graph.  Even in 2007, Fannie was pulling back on the low end of the market.  Market prices of the homes in their portfolio were falling, and as that happened, they were cutting off the bottom end of the market.

The bottom of the market was collapsing after late 2007 because we stopped providing credit to it.  Low priced neighborhoods didn't lose value because of defaults on risky loans to households that couldn't afford them.  They lost value because from 2006 into late 2007, the market for mortgages to those neighborhoods, whether from private markets or the GSEs, disappeared.  The market disappeared before the defaults piled up.

Since that time, we can see the sharp divergence between the existing pool of mortgages and the marginal new pool of mortgages here.  The typical down payment, which had been steady or rising throughout the boom, kicked up in 2008 and 2009.  The average loan size for the small number of new buyers kept marching up even as the typical home value in the portfolio was collapsing.  Larger loans with larger down payments means that in 2008 and 2009, Fannie was only supporting the very high end of the market.

Before that, the average home value of the existing portfolio and new originations followed along fairly closely with one another.  The moral error of public perception and policy is stark.  The CEO's of Fannie and Freddie at the time are currently being sued by the SEC for having put too much money into the low end of the mortgage market.

I find that the inability of the GSE's to provide support for the mortgage market when it was needed largely comes down to expectations.  We really did will this collapse into existence.  I'll probably have more on that later.

Thursday, June 16, 2016

May 2016 CPI

Here is an update on inflation.  Core inflation was above trend in January and February, giving hope that we might see a persistent upward trend.  But, since then, inflation outside of rent has fallen back toward the 1% range.

The upward pressure on core CPI inflation is coming from shelter.  Core minus shelter inflation is back below 1.5% and shelter inflation appears to be continuing its climb above 3%.

In 1999 and 2004, when tightening cycles began, at least housing had been healthy and tightening began as shelter inflation was moderating.  This shelter inflation is a supply-side problem, not a monetary issue.  Before 2007 it mostly came from supply constraints in the Closed Access cities.  Since then, it has been exacerbated by the nationwide clampdown on lending.

In both previous cases, I think that the real decline in housing expansion that came from tightening led to rising shelter inflation, which induced the Fed into too much tightening - to disastrous effect in 2007.  In this case, we had a shortage of housing and persistently rising shelter inflation already in place when the Fed started positioning itself for contractionary policies.

I was hoping that core CPI excluding shelter would find some support from natural expansion of the economy and save us from ourselves.  But this recent downturn is what I have been fearing.  If the Fed reads shelter inflation as a monetary issue, then they will add deprivation to deprivation.

Maybe we will be saved by the fact that the PCE price index is the Fed's official guide and it is less sensitive to shelter inflation.

The information I am seeing from mortgage and housing markets is mixed.  There are some signals of mortgage expansion and moderate increases in housing starts, but other signals are stagnant.  Some exogenous shift in housing demand and mortgage expansion might also save us.

The fact that shelter inflation continues to be focused on the rental market, not the owner-occupier market, suggests to me that there will not be an imminent uptick in the recovery in homebuilding.

Just as a reminder, notice how in the supposed housing bubble, inflation for renters was always higher than inflation for owners.  Owner rent inflation didn't tick up until after housing starts collapsed.  The demand for housing wasn't triggered by a rise in owner-occupier demand.  It was triggered by inflation in the Closed Access rental market coming from demand to live in those cities and a lack of housing supply.

This is the opposite of the late 1980s and early 1990s where demand was focused on the suburbs, probably triggered in part by the 1986 tax change that made mortgage debt more valuable and increased marginal demand among owner-occupiers.

I think we can explain the movements from 2006-2009 in steps.  (1) 2006 - the nationwide drop in housing starts coming from contractionary credit and monetary policies cuts off supply of homes, leading to imputed rent inflation across cities, whether open or closed. (2) 2007 - the default crisis leads to a shift of foreclosed households out of homes and back into rentals, reducing owner-occupier demand and putting pressure on rental demand.  (3) after 2007 - this pressure keeps rent inflation for tenants high into 2009, and the lack of mortgage availability for marginal households in the owner-occupier market continues to elevate tenant rent inflation today.

Wednesday, June 15, 2016

Housing: Part 162 - The two stories of the housing market in a single graph

Here are housing starts of single unit structures and housing starts of all types minus single unit structures.
The multi-unit structures (blue line) are the story of the Closed Access cities.  There is a hard cap on housing in high density cities.  The cap is at a much lower level than it was prior to the last 20 or 30 years.  People in places like Boston, New York City, and San Francisco think they are experiencing building booms right now because it has been a couple of generations since any of those cities was able to actually allow a building boom.  The blue line is the answer to the question, why has there been secular stagnation for 20 years and why are high income workers doing especially well?

Single unit structures (red line) are the story of the moral panic of the 2000s.  We have closed down mortgage markets, removing the main source of housing expansion in the country as a whole.  This remains at levels similar to the darkest brief recessionary periods of the past.  The red line is the answer to the question, why has the recovery from the recession been so weak?

A while back, I was ready for a treasuries/housing trade as the inevitable recovery of housing would coincide with rising interest rates as capital was redeployed into real estate.  But, I have lost faith in that trade.  I see few signs that either of these problems will be solved before the Fed errs in the direction of contraction.  I would love to be proven wrong.

I suspect that the trade will come eventually, in a slightly different flavor.  There will be a recession where housing performs relatively well.  Maybe instead of taking a long housing/short bonds position during a surprise recovery, the initial position will be long housing/short stocks/long bonds during a contraction.  It depends on how it plays out.  In the meantime, a highly leveraged position as a direct owner in low end rental units is probably the most lucrative place to invest in any context.

Tuesday, June 14, 2016

Housing: Part 161 - Q: Why hasn't the productivity crisis caused a bear market? A: Housing

Gavyn Davies asks the question in the Financial Times.  (HT: TC)  The answer is mine.

The reason that lower productivity hasn't caused a bear market is because the lower productivity is due to our limited access housing regime.  There is a cap on the output of our economic centers.  This limits entry into markets that utilize highly skilled and highly networked labor markets.  This creates higher wages for the high skilled workers that use those markets and high rental income for real estate owners in those markets, since those two groups own the valuable resources (land and human capital) that serve as gatekeepers.  Firms in those markets also benefit from the limited access, and also collect economic rents from excess profits internationally.  They probably gain less than the workers and landowners from the domestic economic rents of limited access, but excess profit from foreign operations adds to their gain.

It looks like US corporate profit has increased its share of domestic income.  This is mostly due to low leverage.  This is deceptive, because leverage doesn't look low in relation to book value.  But, the competitive moat for these firms doesn't exist in capital that is on their balance sheets.  It exists in the limited housing stock that prevents competition in the labor markets where they are established.  So, they effectively have off-balance sheet, non-recourse assets, which show up in national accounts as real estate.  This is one reason why corporate equity values are higher than book values.

For corporate capital management, it is equity value that matters, because that is the market price of equity vs. debt.  On that basis, leverage is quite low.  Operating profits are divided between equity holders and debt holders.  It just happens that now equity holds have a higher portion of the ownership, so profits are higher relative to interest income.  Total corporate income is not high as a portion of national income.  As Matt Rognlie has shown, it is income to housing that has increased as a proportion of national income.

There is no inevitable bear market that results from this, except for the eventual development of some foreign competition that is able to break the Western urban claim on economic rents from valuable labor.  The bear market will come when computer science graduates from Stanford are moving to Seoul.  Until then, all of these groups will continue to earn economic profits and a large nominally valued housing stock, a normally priced stock market, high economic stress, low productivity growth, and low interest rates will probably continue to be the norm.

Monday, June 13, 2016

Housing: Part 160 - Low end housing is profitable

I realized via a twitter exchange that there is a common misperception about housing development.

A tweeter said: "Why would anyone invest in building low/moderate income housing when returns from luxury are better?"

I realized that this is a common refrain among people who want to stop urban development, and it is completely wrong.

The reason developers only want to build "luxury" apartments in the Closed Access urban cores is because the market rental rate in those areas is extremely high because of the housing shortages imposed by people like our tweeter who don't trust market development.  In every city that isn't full of obstructionists, the landlord market is highly weighted toward the low end.  That is because, at market rates, low end real tenant real estate is more profitable than high end real estate.  One reason it is more profitable is because high end homeowners can capture a lot of tax benefits, so they bid the prices of high end real estate up, lowering the returns available to landlords.  The way this plays out is by increasing the demand for housing among high end owner-occupiers and lowering the demand for housing among high end renters, with the end result that there just aren't that many high end renters in cities that aren't defined by housing obstructionism.

This is such an obvious and overwhelming fact to anyone who doesn't live in the Closed Access cities, it's funny that Closed Access obstructionists can repeat this without the incongruity being obvious to everyone immediately.  I must admit that it hadn't quite hit me so clearly until just now.

Just because developers don't like to build units where market rates are $4,000 and rent them for $1,500 because local activists insist on it doesn't mean that $1,500 units aren't profitable where $1,500 is the market rate.  Everywhere outside the Closed Access cities, landlords build sub-$1,500 units like mad.  It's their bread & butter.

I guess I could add this to my list of differences between Closed Access and Open Access cities.  In Closed Access cities, locals say, "Why would anyone invest in building low/moderate income housing when returns from luxury are better?"  In Open Access cities, nobody would think to say it, and if you said it to them, they would say, "Wha?"

And, I noticed that I hadn't posted as many graphs on this as I thought I had.  Here is a graph of zip codes among various MSAs.  The x-axis is median home price on a natural log scale.  The y-axis is the median Price/Rent for that zip code.  At the low end of the price range, it appears that most of the increase in home prices in zip codes where there is an increase in rent comes from the knock on effect of rising price/rent.  This effect declines until home prices reach around $500,000.  In fact, this appears to be the main reason why low priced homes in the Closed Access cities rose faster than high priced homes.  In other cities, where rents were not rising so sharply, there was only a small difference between price appreciation of high priced and low priced homes.

In any case, the relationship, at the zip code level, is systematic.  You can see this simply by going to Zillow and comparing rents vs. mortgage payments or prices of homes at the bottom end to those at the top end.  Prices will vary by much more than rents.

Thursday, June 9, 2016

Housing: Part 159 - The mystery of falling homeownership

The Atlanta Fed has a post up about the mysterious decline in homeownership.  I'm not sure what is so mysterious about it.  From the post:
The ideas have been widely debated, and yet no single factor seems to neatly explain the declining share of the millennial population opting to buy a house....To the extent that these factors are true, they may be affecting the decisions of other generations as well.
It is pretty clear that one single factor does neatly explain 90% of the declining share of homebuyers, of any generation.  The post even links to another Atlanta Fed post with this graph:

The certainty about supposedly shifting credit standards during the boom is so strong and universal that it seems that most people simply cannot accept the extreme shift in credit access that clearly happened during the bust.  This is all we need to explain falling homeownership.  The rest is rounding errors.

Chart 1: Homeownership Rates by AgeNext is the graph from the first link of age group ownership.  Notice a pattern here.  It has been about a decade since the housing market collapsed, so during that time, each age group has basically moved up one category.  And, notice how each age group today has roughly the ownership rate of the lower age group a decade ago.  In other words, 55-64 year olds today have an ownership rate similar to 45-54 year olds a decade ago.

Normally, ownership would rise over time for each cohort, but the cohorts are all frozen in time.  The only one that doesn't match is the 35-44 year olds.  But, it isn't a pure comparison, because the "less than 35" category contains more than 10 years worth of an age range, and the 25-35 subset is the stronger subset, so the 25-35 group was probably well above 50% in 2004.

Now, this isn't pristine.  There are clearly some 1st time homebuyers.  But, they are basically at replacement rates for each age group.  The linked post notes that the 35-44 group has actually declined more than the 35 and under group.  That is because that is the group where most new homeownership would happen if we had a functional housing regime, which we have not since 2007.

This has little to do with preferences.  Much as default rates were 90% about when homes were purchased and had little to do with terms, buyer qualifications, etc., this is about timing too.  Whether your generation has high homeownership rates or not is mostly a matter of whether most of your generation had purchased a home before the country lost its marbles.

Similarly, there are countless stories about how millennials are leaving the cities for the suburbs, as if there are hundreds of thousands of new units being built in the cities to greet them.  Our cities have retreated back to North, Wallis, and Weingast limited access order regimes, but now instead of being ruled by elites negotiating rents, our democratized cities have made everyone an elite.  So, negotiations are interminable.

Tuesday, June 7, 2016

Housing: Part 158 - Low Down Payments and Stability

Subprime loans and highly leveraged homes have taken such a central position in the narratives about the housing boom and bust.  Yet, my review of the data suggests:

  • Local supply and rent were the overwhelming factor behind home prices.  Credit appears to play a very minor role.
  • There was no increase in low income owners during the boom.
  • There may have been no increase in the total number of highly leveraged homes.  There certainly was a decrease in market share of Ginnie Mae + Subprime.
  • Subprime loans don't appear to be related to marginal new homeownership, in the aggregate.
  • Nonetheless, neighborhoods with high numbers of highly leveraged homes were more vulnerable to large price declines.
In sum, the importance of all of this is probably much lower than the amount of attention it has received.  The price declines should never have happened, so the existence of highly leveraged homes should not have been a systemic problem.  But, highly leveraged mortgage options don't appear to facilitate much homeownership.

Further, if one does conclude that credit availability does cause home ownership and home prices to rise, then a regime where credit availability is limited is a regime that creates a deeper divide between owners and non-owners, and increases the relative incomes of those with access to credit.  This is a mathematical inevitability.

In the end, I'm not sure that it matters much at all what policy we have.  Whatever balance we strike in marginal credit markets, the marginal difference is overwhelmed by the effects of our moral panic about private lenders and borrowers.  Marginal borrowers, on the whole, are probably capable of engaging in credit markets like the rest of us do.  They will have higher levels of risk, but I don't think the risk levels in any regime we are considering are outrageous or unmanageable.

Their main risk, though, is that every once in a while the rest of us dirty our pants while we tell each other ghost stories about predators and speculators, and then we go and implement highly disruptive policy shifts.  As unpleasant as some marginal activity in credit markets is, the unpleasantness we impose, through our concern, is an order of magnitude worse.  So, maybe we need to limit access to credit on the margin in order to protect them from us.  At this point, credit constraints are creating large influences on home ownership because we have gone far beyond just cutting down on high LTV loans.

One result of that is that low-end landlords will be making high returns by renting to low income households who are locked out of those credit markets.  That isn't happening because landlords suddenly became more greedy.  It is the inevitable result of closed access policies.  Or, using North, Wallis, and Weingast's language from "Violence and Social Orders", it is a limited access order.  That is what we are imposing, in order to protect marginal households.  Limited access orders, by the way, are not associated with stability.  But, when low income households who didn't have a chance to be owners are evicted, we direct our ire at the landlord, not at the Consumer Financial Protection Bureau.

One last point I would like to consider is the idea of the homeowner-in-name-only where households with no equity had all the upside of ownership, but left the homes with the banks when prices dropped.  The idea is that they were speculating recklessly by trying to take the gains of ownership without actually investing capital.

But, I think that position is more benign than that description implies.  Especially for marginal households in low priced neighborhoods, there is a large premium to control and certainty.  For landlords in those neighborhoods, the risk of bad renters is large, and the premium they earn on the properties reflects that risk.  The main return the homeowner earns in that context isn't the speculative gain from unsustainable expectations of home price appreciation.  The main return is the capture of the premium that comes from being responsible tenants in the home they own.  In effect, this can be the source of their accumulation of equity.

So, even though, in the aggregate, I'm not certain that these loans make much difference, the potential cost of shutting them down, in qualitative and quantitative terms, is high.  The main reason we have to impose those costs is because the rest of us have a tendency toward moral panic.

Maybe one solution is to get rid of the pressures on the GSEs to pursue affordable housing and go back to a concentration on FHA/Ginnie Mae loans.  I don't think there is much difference between using private conduits, the GSEs, or Ginnie Mae as the source of high LTV ownership in practice.  The main difference is that our tendency toward moral panic declines respectively among those sources.  We are much more comfortable with mortgage insurance firms earning profit on Ginnie Mae loans than we are with the mezzanine tranche of subprime originations that provides the same service.  In some ways, the question of why that is isn't that important.  It just is the way it is.  The best outcome would probably be to remove the federal government from the market so that innovations that were less dependent on highly leveraged debt could develop.  But, private ownership programs not based on highly leveraged debt would probably involve some sort of shared equity or some sort of call option arrangement.  Most of those innovations would probably be vulnerable to populist panics and the same national bouts of Munchausen Syndrome that we currently are engaged in.

Monday, June 6, 2016

Housing: Part 157 - We can't win

The current national malaise is a sort of self-imposed vicious cycle imposed by anti-finance prejudice.

First, we have closed off the most productive cities to growth, putting a lid on growth and creating a ratcheting segregation by income.  Then we complain that powerful corporate interests are creating an unlevel playing field that leaves workers behind.  And all the greedy developers want to build is "market rate" units.  How is that going to help low income families?  So we keep the lid on it.

We demand that banks make more loans to low income households and minorities, then we complain when banks make more loans to low income households and minorities, even when the evidence isn't even clear that they did.

But, especially regarding the business cycle, think of how impossible it would be for the outcome to overturn our priors.  We complain that the most vulnerable families always take the worst of economic dislocations.  Yet, in 2007 and 2008, the banks were failing before unemployment significantly rose.  And it was homes in with higher prices that were falling in value first.

So, was the public jumping for joy?  Hey, the business cycle is more equitable!  Now it is powerful economic interests and high income households that suffered first!

No.  Instead, we complained about how those banks had it coming, how they must have been reckless.  So, obviously, we wouldn't just bail them out.  That would cause moral hazard.  How will they learn?

So, by 2008, the dislocation had spread.  Now, in 2008 and 2009, low priced home markets - lagging the banks and higher priced homes - really started collapsing.  More than 80% of foreclosures happened after September 2008.  Then we could start supporting the nominal economy.  We couldn't support credit markets to the neighborhoods where prices were collapsing - that would be predatory!  But, we could support the broader economy, because now people that can be victims were being harmed.  Unsurprisingly, this means that people in low priced homes, where we have almost completely shut down the market for new owner-occupiers, have fared the worst.  And, whose fault was it?  Why, those bankers!  They did this to us!  They are kicking people out of their homes!  Heartless.

Where is our William Jennings Bryan?  Where is the populist who wants the banks to lend and then wants those loans to be paid back?

I was with some otherwise upstanding, reasonable people recently, and the topic turned to corruption and greed in governance.  One person said, Say, that reminds me of a book I'm reading about how, since corporations only care about profits, they keep cutting back on wages and benefits and laying people off, because all the shareholders care about is money.  Say, said another, that reminds me of a report we saw recently about that mine owner in West Virginia who was so greedy he ignored the safety regulations and killed a bunch of his workers.  Why, said another, that reminds me of how Wal-Mart pays their workers so little.  Can you believe, they even put posters in their break room to help their workers get public benefits?  (Can you imagine, the evil?) You know, Costco makes good profits even though they pay their workers more.  Wal-Mart could do that too.  You're right, said another.  It's all about the money.  All they care about.

At that point, unable to help myself, my head exploded.  As I was picking up the pieces to try to stick it back together, I found the verbal description of this graph, to try to explain that there is no there, there.  That there is no creeping corporate grab of national income.  They are chasing hobgoblins.

Now, wait a minute!  We aren't blaming anyone.  We're just asking questions they said.

And, it occurred to me.  They were just asking questions and wondering things.  And, really, in terms of the facts they stated, none of them were technically false.  This is the problem with prejudice.  Our minds aren't built around natural checks and balances.  Our minds are built on connections and categories.  And the center of gravity in this country has moved to this place where corporation and billionaire and bank and greed and corruption are all, by definition, overlapping categories.  Oh, bankers?  Say, that reminds me of criminals!  Interesting.  You know, you've reminded me of highly paid CEOs who lay off people.  You don't say?  That makes me think of billionaires.  You know who came out of the housing bubble smelling like a rose?  Billionaires.  Well, you saw how the Fed was covering their butts, didn't you.  Systems rigged, I tell you.

That graph is a thing.  It's a fact.  A single fact.  There isn't a reasonable place to fit it in among all those associations.  What's a single fact next to a million associations, anyway?  What, is this guy going to try to argue that corporations don't want to maximize profits?  Is he going to argue that bankers weren't making a killing until their little housing Ponzi scheme fell apart?

Virtue among Western intellectuals is about correcting power imbalances.  That is the core focus of our time and place.  How can one possibly suggest that the way to repair our governance and extend abundance more broadly is to extend empathy to the owners - the power brokers - the greedy ones?  So the Fed is just supposed to watch the ticker tape every day so their greedy buddies on Wall Street never have to lose a penny?  And, then they will just keep leveraging up, because to them it's all about the money.  And they'll do the same thing to us again that they did last time.  Nope.  That's crazy.  They need to feel the pain.

The problem with prejudice is it gets built on a foundation of dense interconnected associations.  When ideological communities become fixated on prejudice, one of the services communities provide their members and one of the ways that communities cement their own norms into place is the shared reinforcement of these dense interconnections.  It is very difficult to reason people out of prejudice.  One either needs to have an intensive personal experience that overturns the mischaracterizations or some sort of conversion experience.  But so much of finance and economics is unseen.  That's the defining characteristic of finance and economics, really.  So, how will those intensive personal experiences happen?

There are many people who have had the experience of picking up and leaving their homes because they can't afford to live there any more.  But, what is seen is a greedy landlord or the high income workers moving in.  Many have the experience of paying twice in rent what they could pay on a mortgage for the same house.  Apparently, this hasn't led to a demand for unfettered lending.

Ironically in an age obsessed with inclusiveness, our divisiveness is what defines us.

PS.  I am afraid that a country full of the commenters on the post below simply cannot achieve equitable growth.  We are being ruled by prejudice.  Attribution error invades everything.  Few of these commenters have the slightest idea about the complex factors behind housing.  But, they know the system is rigged.  They know that debt is bad.  Money is behind everything.  It's why houses are too expensive.  (D'uh!  How could you deny that?)  They know that investors are at odds with the goals of the rest of the country.  They will not stand to let it happen.  "It" being anything that could possibly lead to a functional outcome.  Attribution error is all they have - including Reich.  There is nothing to argue against.   The only characteristic of their incoherent points of view is cynicism about everything they don't understand.  Low interest rates mean loose money.  Supply leads to high prices.  Investors make supply go down.  There is a tipping point in human community where when everyone around you is certain about so many things that are wrong, the beliefs themselves are insulation against correction.  What functional policy could these people possibly agree to that would normalize the housing market?

In some ways, it seems like the urban supply problem is the intractable problem and at least in the meantime, we can start to get credit policy and monetary policy right so that it doesn't just make the problem worse.  But, these comments, which really are a version of the public consensus, suggest that even that problem is intractable.

Friday, June 3, 2016

Housing: Part 156 - Credit Access and Economic Inequality

We have learned all the wrong lessons from the 2000s housing crisis.

Here is a graph of implied net returns to homeownership before taxes and capital appreciation, for Dallas.  In Dallas, property tax and capital appreciation over the long term probably roughly cancel each other out.  Much of the reason for lower returns on high priced homes is because tax benefits are more universally captured among those homes - our broadly efficient housing markets reflect the highly regressive tax treatment of housing income in the relative prices of different homes. 2016
Median Price and Rent, by zip code
At the low end of the range in Dallas, return on investment on an unleveraged home appears to be more than 10%.  That means that, even a leveraged purchase with a high interest rate mortgage would be reasonable - especially if that mortgage might be refinanced to a lower rate after a few years of capital appreciation.

I presume that part of the reason for the high return is that the management costs to landlords in low-end neighborhoods tend to be higher.  One of the costs of tenant-occupied real estate is the risk of bad tenants to the landlord.  This may be the most valuable benefit of homeownership - the value of control...the value of knowing the tenant and the landlord have incentives that are aligned.  And, they really can't be more aligned than if the tenant and landlord are the same person.

There is a discontinuity here.  In a negative equity environment, the de facto owner is the bank, and everyone is familiar with stories of the condition homes were sometimes left in by foreclosed families.  So, there is certainly a risk to ownership that utilizes low down payments.

There is a presumption that low down payments were the reason for much of the supposedly overpriced housing stock in the 2000s.  Adding this presumption to the problem of underwater owners, we conclude that low down payment programs aimed at owner-occupiers are a big problem, and the lesson we take away from the period is that we should get rid of those programs. 2016
But, in much of the country home prices were rising at 5-10% during mid 2000s - hardly out of the ordinary, and giving little reason to blame any factor for excessive prices.  In the worst cities - the Closed Access cities - existing home sales and price appreciation peaked in late 2004.  The boom in private pool mortgages happened from 2004-early 2007.  The Contagion cities did see very high appreciation through 2005.  But, much of the activity in those cities was among landlords and investors.  Maybe there is something to be said for limiting the low down payment activity in that market, but if we do regard that problem, we should be careful to distinguish it from the owner-occupier market.  Are the systemic problems associated with owner-occupier defaults the same as those in the landlord market?

The lesson we should learn is that supply constraints lead to volatility and dislocations.  In cities without that problem, there was no price bubble, there was no rush of defaults.

Instead, we have decided that the lesson is that low income households shouldn't have access to ownership.  The control premium is extremely valuable for households that live in low-income neighborhoods.  It puts more families in the position of caring for their homes and for the neighborhoods.  It gives them a tremendous return on investment.  It puts them in a position where they internalize the gains of their own responsible behavior, and it can make them advocates for local changes that increase the value of location.

The lesson is that access and liquidity are public goods.  We should facilitate access and then manage the nominal economy so that real assets have stable nominal values.  It's not the fault of banks and low income buyers that home prices collapsed.

For zip codes with home prices below the median, during the two years 2006-2007, prices in Atlanta were stable and in Dallas rose about 3%.  In 2008-2009, those home prices fell by 22% in Atlanta and 14% in Dallas.  Why?  Why were low priced neighborhoods a lagging factor in cities that never really had a price bubble?  Because while everyone was complaining about how the Fed was stabilizing credit markets to bail out the banks, the one thing we absolutely couldn't stand for was to let those predators make loans to lower income households - that's what created this mess, right?!  So, even though the evidence that any of that ever happened doesn't show up at all in many measures of national homeownership and incomes, we have decided that the lesson we have learned is to created a housing market where those who have access to credit can buy homes and rent them for double digit returns, and the families that live in them get rising rents and none of the benefits of control and access.  The lack of control is just deadweight loss.   It is a cost and a risk to the landlord, and the benefits remain uncaptured by the potential owner-occupiers.

Public postures about low-income households that begin with the presumption that they are incapable of handling their own agency, and that financial institutions are powerful and predatory, seem empathetic, but really they are rooted in elitism, with all the baggage and targeted harm that comes with it.  It seems to me that this elitism has only garnered a populist veneer because it is supported by a foundation of anti-finance prejudice which has become the overwhelming point of view in this country, which led to the invention of a set of accusations that may have little basis in reality.  Prejudice is not known for being sensitive to marginal new information, unfortunately.  It will be very difficult for widely distributed growth to appear in this country again until the playing field in housing is leveled again - whether in terms of ownership or location.

Wednesday, June 1, 2016

Housing: Part 155 - Imagining solutions in San Francisco

Here is a pretty bold idea for the November ballot in San Francisco (HT: Kim Mai-Cutler).  The proposal includes these ideas:
    1. Enact “as-of-right” zoning, which prohibits neighborhood interest groups from dramatically delaying any project they don’t like through bureaucratic regulatory processes (construction can take 8–10 years to approve in San Francisco, compared to a similar process that takes just 17 weeks in Seattle).
    2. End density regulations — much of San Francisco effectively prohibits anything but 2-story single family homes [pdf].
    3. Raise height limits in each neighborhood.
    4. Ensure each new building creates the maximum number of affordable units for residents making less than the median income. Generally speaking, more construction means a higher percent of subsidized apartments for those making the median income or less. For instance, Seattle’s Mayor put forth a plan to build roughly 4 times more affordable units than San Francisco (40,000) — a plan made possible thanks to Seattle’s famous commitment to density.
Those seem like pretty strong shifts in San Francisco policy.  I don't know how realistic the proposal or the plan behind it is, but it would be really interesting to see something like this on the ballot.  Home values in coastal California are so inflated by future rent expectations, that any downward shift in expectations should have a large effect on current prices - like if expected revenue growth for Amazon dropped from 20% to 10%.
If something revolutionary ever did get on the ballot, I would expect the San Francisco housing market to take an immediate hit.  If it had a chance of winning, I would expect home sales and prices to start dropping, possibly, even before election day.  It would be interesting to see the effect that would have on the process of gathering support.  And, since values on long-lived assets are so difficult for the public to understand, I would expect to hear belly-aching about why rents aren't falling along with prices.  So, the only solution to the problem would potentially have headwinds to face from both owners and renters that it would face precisely because housing markets are efficient in ways that Closed Access advocates seem to doubt.