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."


  1. Egads, another great post.

    The left-wing has always been suspicious of prosperity. Now they are joined by the right wing.

    Every day, talk of asset bubbles, financial instability and runaway inflation that will result from prosperity.

    I think recessions bring financial instability. Now I read recessions are valuable for their "cleansing effect" and wiping out weak businesses. The Fed should hike rates and that will eliminate the wesaklings too. That's what I read.

    Do I sense that giving loans to low-income homebuyers is regarded as bad? They might profit from appreciation and that will induce decadence?

    Hooo-boy. Remember, prosperity is suspect. Especially the other guy's prosperity.

    1. "prosperity is suspect. Especially the other guy's prosperity."

      Frame that one.

      Thanks for all the encouragement, by the way. The last couple of weeks, I've been getting a little lost in the weeds on the book. I'm working on my explanations about where credit fits into the story, and there is just soooo much that's been written. It's nice to be reminded that somewhere in the complicated mess I've got a compelling narrative.

  2. I am sure your book is going to be great. Might be good to pre-pub gist of it in The Atlantic, or New Yorker, that sort of venue.

    And, yes, in your narrative and in macroeconomics, there are 100 moving parts.

    This allows for a great deal of mis-analysis, and politics-in-drag posing as macroeconomics.

    No one is ever wrong in macroeconomics. There is always a way to frame the discussion or bring in other facts that support one views.

    Imagine; The entire U.S. macroeconomics profession has a blind sport in property zoning, It is rarely a topic of discussion. Trade, minimum wage, immigration, regulations--all fair game, all hashed out over and over.

    Property zoning? Let's not talk about it.

    And my issue, the criminalization of push-cart vending? No one cares.

  3. Kevin, checking in after a few months away, and I'm still really impressed by the blog. I'm excited about the book. I will be sharing it far and wide.
    I was thinking a bit about earlier posts of yours, and some of the conventional wisdom regarding credit expansion (must be a bubble! kill it!) and I am drawing an analogy you might find useful. Consider new car sales... were the rate to increase, it would be seen as a Good Thing. And maybe so with credit expansion, absent the fears of a bubble... things are happening in the economy, and just as a car is a tool to get around, credit is a tool to smooth nominal housing consumption.
    But the analogy goes further. As you've pointed out many times, people need all this credit because of the Limited Access regime driving up rents. Likewise, people need all these cars because there isn't enough density allowed in walkable city regions where they might not need one. As refugees from SF/NY were priced out of the market there, they'd be more likely to need cars to get around, either commuting from far away or living in Phoenix. Let's call it "qualify until you drive".

    1. Thanks, Mr. Z.

      I think I see what you are getting at. I try to go into this sort of topic in the book a little bit. Economic thinking is built on assumptions of free flow of credit and capital. Since we don't have that in the Closed Access cities, a lot of GDP represents costs to limited access instead of added material utility. The increased rent in Manhattan does get measured as inflation. That means it gets misidentified as monetary excess, but at least it doesn't get measured as real activity. New homes built in those cities probably do get mis-counted as real activity, though, when their high rents are also just limited access rents. But, if I understand what you are getting at, I think you are right. The car, gas, etc. needed to get back and forth to New Jersey each night are counted as real economic activity, when they are really just the cost of access.