Friday, November 24, 2017

Housing: Part 270 - More on Canada and self-enforced limited access

I have been noting that it looks to me like Canada is setting up for a self-imposed contraction, like the one the US engineered in 2006 and 2007.  Recently, I saw a few pieces about Canadian real estate that seem to confirm my fears, and also make good examples of how limited access orders are self-reinforcing, and how public conversations about housing affordability need to change.

First, here is a piece outlining a plan from a Canadian labor union.  The plan includes:
  • progressive land value taxes
  • added taxes on land value that is derived from public infrastructure improvements
  • tax land speculators, foreign buyers, and short-term rentals
  • use all those taxes to fund public affordable housing
Notice a pattern there?  As taxes go, some of these do actually have some positives.  For instance, taxing land value derived from public investments is interesting and ethically quite defensible.  I wonder if they would pair that with tax credits to land owners who lose value because of new mandates, etc.  Aside from that, while this is ethically interesting, there is a minefield of unintended consequences there.  I don't know if it would actually lead to any sort of improvement in equitable housing development.

The Canadian government also has recently issued its own plan, called "A Place to Call Home".  It funnels $40 billion over 10 years into various programs of public housing and public shelters.

The thing is, what is lacking isn't public expenditures.  The reason Dallas has less of a housing problem than San Francisco isn't that Dallas spends billions more on public housing than San Francisco.  The difference is that Dallas exists in an open access order (to use North, Wallis, and Weingast's terminology), where private capital flows to valued purposes, and affordable housing emerges.  That is the solution to a housing affordability problem.  It's really the only solution.

We can see the problem here with public responses to economic challenges.  It is the development of limited access order dynamics that have created scarcity.  It is the inability of private capital to create emergent abundance that is the problem.  But, fairly universally, once polities enter a limited access order, there isn't a natural political path back to an open access order.  So, while there are some places that appear to be encouraging new private supply, in most areas with a housing problem, that path is met with skepticism and public responses involve a deepening of the limited access order.

Instead of reducing obstacles to the inflow of private capital, proposals tend to coalesce around taxing the economic rents that come from limited access orders and funding public provisions of housing.  Public provisions will never be a sustainable replacement for private capital development.*  And, it is the economic rents themselves that are the problem, so taxing them simply asserts a commitment to permanent dysfunction.

Thinking again about the land value taxes from the union proposal above, those taxes seem to be based on the notion that those properties get their value from access to public amenities.  But, in the problem cities, the vast amount of value comes from limited access.  It comes from exclusion and the resultant economic rents that flow to it.  Properties in Dallas can gain value from being close to mass transit, etc., but that doesn't cause the median home in Dallas to be worth $700,000.

Policies that tax those economic rents appear to solve the problem but they really rely on the permanence of the problem.  The obstacle to that development has little to do with tax and budget policy.  It has to do with dense webs of regulations that prevent reasonable investments from being made.

One way we can see how this problem seeps into public expectations, and how limited access begets limited access, is how there is a widespread fear of "oversupply" in Closed Access cities.  The irony is that for any of these cities to get anywhere close to reasonable supply would take a regime shift in local governance and at least a generation's worth of high rates of new building.  For them to be oversupplied, the price of a new home would need to fall below the replacement cost.

Yet, here is a post on the housing market in Toronto that purports to explain how unsustainable supply cycles drive the market (emphasis mine):
Phase three is the hyper-supply phase, which is the phase I believe we’re entering in Toronto. This is when everyone feels like a real estate investment genius, even though most people can’t even tell you much they paid in interest. Construction starts picking up, and starts to catch up. The supply will inevitably overshoot demand...Toronto is a great example of this right now, with over 70,000 units currently under construction. That’s about one unit per person, projected to move to the region over the next year. Keep in mind that most households are not single person households. The most recent Census pegs Toronto at an average of 2.4 people per home. Basically, we have enough housing in the pipeline for up to two years. This excludes the almost 17,000 pre-sale units hitting the market between October 1 to November 30, which won’t hit the market for three years.
This is a widely shared sentiment.  So, perversely, in cities where there have been years of undersupply, which is the only way to drive prices to double or triple replacement value, any time markets shift to a correction of that undersupply, there is an uproar and a demand for policy responses that lead to economic contraction.  Note the irony.  In cities that don't have undersupplied housing, this uproar doesn't occur, because, homeowners in those cities paid something close to replacement value, and markets aren't likely to push prices much below that.  It is in the undersupplied cities where homeowner value is derived from economic rents, from excluded supply, and markets left to function properly would destroy those economic rents.  That's what markets do.  So, in those cities, in the name of economic stability, growth is purposefully constrained in order to maintain those economic rents.

We will know when Toronto has oversupply when homes are selling for less than replacement value.  Don't hold your breath.

To further the irony, the business cycle is blamed on the natural instability of markets.  ("Everyone feels like a real estate investment genius.")  And, public policy is called on to undermine the market by undercutting demand:
Prolonged phases of high home prices inevitably cause a recession. Higher prices mean a higher percentage of income goes towards servicing shelter costs. The less disposable income you have, the less you have to spend in restaurants or shops. High cost of real estate, and a lack of customers is killer on businesses. This in turn leads to less businesses, and less jobs – creating less opportunity....Investors and governments should not be driven by irrational emotional decisions to appease voters. Lengthening amortizations, flooding the market with additional credit, or creating additional down payment programs don’t help with affordability. They impede a natural cycle, and extend peaks higher than they would typically reach. The higher the peak, the further the fall to the trough will be.
So, the collapse is a natural outcome and should be allowed to continue.  Notice that rising prices and rising supply are implicitly presented as a pair here, unlike above where added supply was presented as the catalyst for the collapse.  Here, it is crimped demand that leads to the downfall.  But, nominal spending is a product of monetary and credit policies.  There is no reason this should have to happen.  The collapse in demand is really a product of public demands to impose the end of the cycle.  And, here we see those demands explicitly.

And, here is where another common problem comes into play.  It is that home prices are frequently referenced as the measure of affordability.  This really has nothing to do with affordability.  Affordability is about rent.  The public policy proposals do address this, but only in terms of public housing, where rents are just an arbitrary policy rate.  There is little talk of market rents.  Market rents are what need to come down, and this can only happen through the unfettered development of private capital.

Notice that, in the earlier portion of this description of the cycle, where rising supply would reduce home prices, the natural co-movement of rent and price is implied.  Both would decline in that scenario.  But, in this later portion of the description, rent has been removed from the story.  Now, affordability is about price.  Affordability is never about price.  Viewed correctly, this phase of the cycle is the phase where, at worst, investors are finally helping to fix the housing affordability issue by lowering rents with supply, and this will create massive capital losses among both new and old homeowners.

The way to break this cycle for good would be for the government to loosen up monetary and credit policy during the hot market and to continue to loosen supply constraints at the same time.  There is no way to do that without suffering much local dislocation, because, the fact of the matter is that, whatever solution these cities try to implement, that solution, necessarily, will end with local housing prices that are back near their replacement values.

So, there is a persistent public outcry to fix the affordability problem together with a parallel public demand to undercut economic growth and housing expansion to ensure that affordability never comes, and a third outcry for rising taxes and rising public provision of affordable housing in a futile attempt to fix the problems caused by the first two outcries.  All of this while bemoaning the mysterious malady that afflicts our economies where monopoly profits seem to keep growing while real wages stagnate.

Added PS: Here we can see some of these dynamics at play in the US.  Here is Neel Kashkari getting abused on twitter by some monetary hawks.  Note, since inflation isn't high, they fall back on high asset prices as evidence of a profligate Fed.  In an open access order with free flowing capital, high home prices would trigger new supply, causing rent to decline, and actually serving the hawks' goals of declining inflation.  But, this can't happen in the Closed Access cities, and broad capital repression in mortgage markets since 2007 means it can't really happen anywhere now.  So, instead of increasing supply and lowering rents, any economic growth (either real or nominal, really) leads to rising home prices.  It isn't monetary policy that is behind the concerns of these twitter critics, it is our limited access order that prevents financial capital from funding physical investment.  And, as in Toronto, this leads them to demand publicly-imposed economic losses.

* By the way, note how the difficulty of accepting emergent order plays out here.  Among those who are skeptical that new supply can create affordability, there is rarely a professed skepticism that publicly provided supply will create affordability.  That is because public supply has arbitrary prices, so that the households who get those units win the affordability lottery and the households that are left out continue to pay market rents, where they either escape our attention, or simply can be described as victims of the uncaring market and political forces that prevent further public supply.  So, perversely, the only source of supply that can realistically create broad affordability is dismissed while the source of supply that could never realistically create broad affordability is the focus of the effort.  This perversity is maintained in spite of the existence of hundreds of cities that stand as proof of reality where private capital creates affordable housing, and the lack of a single city that creates broadly affordable housing without it.


  1. Great post.

    There would be a lot of dislocation with an end or radical liberalization of property zoning in closed access regions---indeed, lenders have a lot of money riding on property zoning as a permanent condition, as do extant property owners.

    Add in the lefty-loos, and their self-righteous contempt for market solutions....

    A very tough nut to crack.

    I will say this: If a propertied-financial class does not end property zoning within a city, then the voters are somewhat "justified" in voting in rent control. A tangled web we weave....

    1. Agreed. The "market rent" on those units is no more of a market price than the controlled price.

  2. Kevin, the paper 'Why are there NIMBYs' suggests that the land taxes might help bring about the changes in zoning and more generous access you suggest. At least if the land tax would be levied on owner occupied housing.

    Basically the paper has some data to suggests that people turn NIMBY when a large part of their net worth (often above 100%, thanks to mortgages) is tied up in one illiquid undiversified asset.

    A land tax would be equivalent to the government taking a substantial equity position in everyone's land, and thus might reduce NIMBY tendencies over time. And NIMBY tendencies are part of what keeps access closed.

    (You can find the paper for free online. I just can't link to it easily from mobile. The author mentions some policy implications, but does not make the connection to (capitalisation of) land value taxes.)

    1. PS Lots of cities in East Germany have a broad supply of affordable public housing. But they created affordability basically by huge drops in demand thanks to migration to the richer west and south, less so by increasing supply.

      On a less cynical note the German housing market as a whole is worth having a look. It's dominated by renting.

    2. Yes. Generally property or land value taxes seem good. But tricky. For instance, now in closed access cities renters groups frequently oppose new building because it will enhance the character of the neighborhood and draw wealthy tenants, making rents go up. I could imagine some owners opposing new developments for similar reasons because their land taxes would go up. It's definitely a fruitful topic, but I'm not sure about all the ramifications.

    3. I don't know a lot about specific German housing policies, but I agree they seem to do many things right. They seem to disincentivize housing consumption while being flexible about supply. That seems smart. It allows things to happen on the margin. I think there are strong tenant protections, including rent control, which could be problematic. But it just goes to show how much supply can help. Rent control is only a problem when constricted supply causes rents to rise excessively. With enough supply, rent control can offer tenants security without creating distortions.

    4. The German example shows that regulations like rent control mostly become a problem when they become binding constraints: you have to see that prices and rents in most of Germany's regional markets are roughly flat over time, thanks to enough supply.

      The rent regulations I remember are mostly: (a) it's hard to kick out tenants. But that's not too much of a problem as long as they still pay market prices. (b) For existing tenants, you can increase rents by arbitrary amounts over enough time, but you have to do it slowly. (There's a limit to the maximum increase your tenants has to agree to by law.) But that's also not a problem, if the market rent isn't increasing a lot.

      'Why are there NIMBYs?' ( points to undiversified owner-occupier as the main culprits: they are somewhat rationally very risk-averse, and so oppose even proposals that would increase the average expected value of their property.

      Germany almost doesn't have NIMBYs, especially not eastern Germany were I grew up: a lot of people rent, and the owners of the rental properties are usually more diversified, so have the luxury of becoming more risk-neutral.

      Apropos of that: Germany's housing cooperatives are also worth a look. From a household's view there are a great way to get exposure to residential real estate. Your shares in the cooperative usually entitle you to rent any of their properties (usually all in one city) at a much reduced rate.

      Some of the old timers I knew paid for their shares in kind: they laboured to construct some of the houses after the war in the 50s.

      'Why Land Value Tax and Universal Basic Income Need each other' ( is an interesting article about how to introduce land value taxes without committing electoral suicide: use the proceeds from such a tax to finance a universal basic income. Thanks to wealth concentration at the top, your typical owner-occupier would still get a net positive income from such a scheme. And on the converse, a land value tax would be absolutely necessary to make sure a universal basic income wouldn't just go straight to the landlords via higher rents.

      (Trying to post again. Please pardon if this was posted multiple times.)

    5. PS I am just about to move to Singapore again. The last time I lived there from 2012 to 2014. I am pleased to see that the housing supply increased by quite a lot in the meantime, and rents have come down.

      Singapore is a weird and interesting place in that regard. About 80% of people live in government built housing.

    6. Interesting. Thanks for the links!

  3. I love your work.
    Here in Philly, we have people worried and concerned about housing affordability even though houses can be bought for $100,000. I don't know the rents but I'm willing to guess that they are pretty low.

    1. Thanks Bill.

      Chicago and Philly are interesting. I think they have some of the pressures the other old metro areas have, so their rate of building is lower than the US average. But it tends to be higher than the closed access cities.

  4. Using a system viewpoint and basic control theory and noting that supply/demand for housing is a feedback loop system where an increase in demand gets developers all excited about providing more supply with a construction time delay. ALL simple proportional feedback systems of this type are unstable when the response time of the control system is the same as the natural frequency (if a vehicle responses was at the same frequency as your responses, you will crash as you over respond with every correction and the error grows).

    When it only takes less than a year for housing to actually be built and the normal cycle frequency for housing seems to be 5 to 10 years, without controls or limits, the system is stable and every time the demand increases, the supply increases to meet the demand and the price doesn't change very much.

    However, when you put zoning and regulators that can take 5 to 10 years to issue permissions to the inside cronies along with the extended pre-permits times (getting all the political players on-board), you have created a mathematically unstable system that will create and pop a bubble.

    The problem is in the time delays and how systems can go unstable. All the suggested corrections don't fix the time delays and can't work even if you captured the excess rents and put it all into government housing with a 5 to 10 year long political planning time, the system will be inherently unstable and they will have to worry about an oversupply at the wrong time. Government projects have long time momentum.

    1. This makes sense in theory, but in practice, the timing of the fall in housing starts wasn't systematically different in Closed Access cities in 2006 and 2007 than it was in other cities, and the price collapse wasn't worse than in cities with more elastic supply. I think this falls in the plausible but not definitive category.

  5. OT and just a complaint into the darkness. Tim Duy is moderate, thoughtful fellow. And he writes this:

    “We do not have much experience with an economy operating near full employment. This sounds odd, but generally the Fed kills the economy soon after reaching that point.”

    Gadzooks---and he is right! If you believe the Fed, we have an economic system that requires moving to greater unemployment in periodic waves.

    So let's see: Let's fight inflation by periodically unemploying millions of people, and defining "full employment" when there are about 1.4 to 1.5 people seeking a job for every job opening.

    Then, let's restrict new housing construction, despite housing being one of the largest costs of living.

    I see no problems here. Why would people want anything except free enterprise?

  6. There is a big problem with your "loosen credit" solution. Supply responses take a long time. In the interim, looser credit pushes up values. As wealth accrues to existing landowners they amass more political influence and will eventually find ways to cut short the supply response. You are left with more wealth concentration and a more fragile economic system, and perhaps not much else.