Tuesday, July 19, 2016

Housing: Part 167 - Open and Closed Access

Here is a link with estimates of what income is required to affordably buy the median house in various cities. (HT: John Wake)

I think there is a rhetorical subtlety that is sometimes missed in public debates about housing.  There are people who argue that the supply issue is overly simple Econ 101 stuff and that there are many factors that influence housing costs - local incomes, geographic barriers, building costs, etc.

But, scale can be important, and frequently scale can help to simplify problems.  That argument applies in most of the country, shown here within about 20% of the national average.  In those places, causality is absolutely a muddle.  In fact, where causality is a muddle, that might be a sign of a functional system.

But, in the Closed Access cities, the scale of the supply problem has greatly overtaken all those other factors, to the point that an approximation of the problem really can boil down to one issue - supply.  When the scale of that problem recedes, and other factors start to matter, we will know those cities have functional housing markets again.

The same can be said for the slow recovery of the economy from the crisis and the continuing feeling of financial stress.  Normally, there are an uncountable number of factors that make debating about the causes of economic growth, equity in growth, asset prices, and business cycles difficult.

This is true of investment, too.  I don't know how many others look at it this way, but I find that most equities are not worth speculating on.  The potential gains don't outweigh the cost of non-diversification.  Where speculation tends to be profitable is where a firm's success depends largely on a single variable where, for some reason, the connection hasn't been recognized by other investors, or where insight into that variable allows an investor to take a position on the variable by taking a position in a firm.

That used to be what I spent my time on.  But, it appears that I have happened upon an issue where this is the case at the macro level.

The clear factor that deepened the bust and has prevented a healthy recovery is the closing down of the mortgage market for the bottom half of the home owning population.  With a strong positive correlation to income, families are losing their homes and facing rising rents across the country today, not just in Closed Access America, and there is one overwhelmingly important reason - we shut down the bottom half of the mortgage market.

from FHFA 2015 report to Congress
Here are Fannie Mae originations, by FICO score.  This shift is seismic - a multi-sigma shift in underwriting standards compared to at least a half century of practice.

And, the GSEs had not been aggressive during the housing boom about expanding originations.  They had actually been very timid.  The growth in GSE originations sharply turned down from 2004 to 2006.  Origination only turned back up as the private market failed in 2007, and continuing to grow slightly in 2008 and 2009, until it flat-lined, where it remains today.

from Fannie Mae 10-Ks and author's calculations
Look at the comparison of the existing book of mortgages and new originations.  In 2008, the GSEs simply stopped serving the bottom of the market.  Only homes at the top end of their range of valuations were being served.  Not only were the new mortgages highly weighted to top range price levels, but down payments went sharply higher too.  During the boom, down payment levels were rising or staying level over time.  In 2008 and 2009, when we desperately needed to accommodate liquidity in housing, the one source of credit left with the potential for growth - the GSEs - was residing over an extreme rise in down payment levels on approved mortgages.

Keep in mind, the vast majority of the downturn in low priced zip codes happened in 2008 through 2010, after mortgage originations dried up in those areas.  In 2009, many low priced zip codes were still seeing 2% or 3% in monthly declines in prices, month after month.  The boom had long passed.  They needed support.  And we let them fail in what, in the end, was a public policy failure.

Now, we can continue with this new normal, and those with the ability to buy and manage real estate can make quite high returns buying and renting homes at the bottom half of the market, and those homes can remain less expensive, in Price/Rent terms, as higher priced homes are or as lower priced homes used to be.  Maybe there is no public value in encouraging ownership for families with median incomes or below.  Maybe that argument can be made.  But the economic malaise we are experiencing has nothing to do with expansive home ownership.  Ownership had expanded among high income households.  The malaise is related to a regime shift where we have removed the ownership option for households below the median.  So, those households have experienced an extreme shock to net worth and their children will generally lack access to the option of home ownership, if this is the way we decide to keep things.


  1. Great post.
    See we proved 2008 was a housing bubble when we cut off financing home mortgages...

  2. Well, Benjamin, in some states it was a housing bubble, where prices versus rent prices were fundamentally skewed, 4 states to be exact. But, you are right, if you cut off financing, destroy the commercial paper market, force bad loans from SIVS back onto the balance sheet of the banks, you will destroy the sound loans as well!!! For that insight I thank you and Eric.

    So, all you have left is helicopter money!!! Yes, we need helicopter money and it will find its way back to the banks through the people if done correctly as Eric Lonergan proposes.


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