Sunday, June 3, 2018

Housing: Part 301 - When the canon is wrong, there is little hope for constructive learning

It happened again.  I thought I'd been scooped.  The Mises Institute headline reads: "Housing: High Prices, Few New Units" (HT: JW)  They have noticed that a supply shock in housing is having important effects.  But, conventional wisdom has foiled them.  It is simply impossible to come to terms with the true state of our national housing problem with "bubble" colored glasses on.  This is why a new view on this is so important.  Until conventional wisdom about the housing bubble gets overturned, public consensus about the economy in general and the housing market in particular will be anything but wise.

Let me walk through the article.

First, the tags on the article - "Booms and Busts, Money and Banks" - give insight into the strength of presumptions in the conventional wisdom.  Housing quantities and prices fall under these categories.  Money, credit, fear, and greed.  Instability is inevitable, it is driven by money, and it begins with a boom.  The reason these are the tags is because this is canonical.

It starts by contrasting the current market with the bubble. "At the same time, home prices were increasing, driven up in part by fact that everyone was convinced that housing prices always go up, and real estate — any real estate — was a rock solid investment."

This is also part of the canon.  It doesn't need to be questioned.  And, thank goodness, because there isn't really any way to establish plausibility or causality here.  If you tried to use this sort of assertion as the foundation for a contrarian point of view, it wouldn't fly.  The nice thing about it is that, since it has become part of the canon, it could explain prices rising by 10%, 50%, 200%, or 400%.  And, the higher prices rise, the more we could conclude that people are irrational.

The author notes that building is not nearly as strong as it was in 2005.  This is true.  He says,"Now, some might think 'it's good we not going back to bubble levels.' True enough."

Again, this is an uncontroversial statement.  That there were too many homes is canonical.  So, here, the author exhibits unusual wisdom, by correctly noting that, adjusting for population, housing starts are much lower than they have ever historically been.  This has been the case for a decade.  Here is a graph he shares:

Do you notice anything funny about that graph?  That graph either displays a good measure of housing expansion, which supports the author's point, or it shows that there wasn't anything close to an overexpansion of housing in 2005, in which case it would seem to display a poor measure of housing expansion if the bubble story is true.

IW readers know that this is a good chart, and that it correctly shows moderate housing expansion in 2005 and very low housing expansion since then.  But, the author just breezes right past this oddity in his presentation.  I don't really fault the author, per se, because the bubble is canon.  It resides in a different part of the brain than ideas that require confirmation.  There is no motivation and no point in even paying a moment's notice to whether this chart supports the bubble story, because the bubble story isn't a story that needs support.  It is something we know.  It might be worth pondering why housing starts per household in 2005 aren't higher than they are in the graph here, but surely there are more useful things to do with our time.  That's the point of the canon.  You can't spend half your day confirming that gravity still exists.

But, when the canon is wrong, the truth trolley goes off the rails.

The author notes that the Kansas City Fed has also noticed this problem, and the Kansas City Fed lists the following possible reasons: (1) shortage of qualified construction workers, (2) small builders having trouble funding lot acquisitions and construction, (3) limited availability of lots.

All of these problems would be solved with more money and looser credit.  And, since credit conditions in the mortgage market have tightened to extremes, especially in low tier markets, you might think this would merit a mention.  But, too much money and credit is what caused this mess, according to the canon.  That's like suggesting that birds can fly because gravity doesn't apply to them.  The answer can't contradict the canon.  For the most part, in our daily lives, it wouldn't (and shouldn't) even occur to us to do that.

The author wonders if lower Mexican immigration is a cause of this.  Or "finding inexpensive financing for land acquisition and construction has been difficult as money has been siphoned off to other forms of bubble investment as central-bank produced asset inflation continues."  And, "nowadays, as Brendan Brown has often noted, other investment "narratives" have directed many investors' attention elsewhere. It's no longer assumed that housing prices will always go up. Meanwhile, lumber costs, labor costs, and regulatory costs at the local level continue to push up production costs."

As for rising costs of lumber, regulations, etc., those are plausible, and they might even be true.  But, then low tier housing would be selling at a premium.  Instead, in every city during the bust, low tier housing took on a large discount, and for the most part those discounts remain.  If higher cost was what was keeping supply mysteriously low, wouldn't that make prices move up?  Rents are up, but prices are what builders are concerned with, and prices are very low, given current rents and interest rates.

What could possibly cause relative prices to remain low in low tier markets after a decade of depressed supply?  That answer contradicts the canon.

The author concludes by noting that homeownership rates are lower than they were before the bubble started.
Vacancy rates are down and housing prices in both rental housing and in single-family housing continues to head upward.
Nearly a decade out from the last financial crisis, one is tempted to wonder if we'd have all been better off without constant federal "help" designed to increase homeownership rates and build an "ownership society."
Originations for 720<FICO<760 are also down.
When the canon is wrong, this is how bad it can get.  Without the canon, one might suggest that at the end of a decade when mortgage lending to borrowers with FICO scores of less than 760 has been made especially difficult through public policy (the average FICO score is around 690) that maybe the lack of federal help might have something to do with the fact that there was an unprecedented collapse in homeownership during that actual decade.
And this lackluster production is all happening during a period of expansion. Presumably, it should be easy to find financing to build housing right now, and to find buyers who can pay a price that will cover expenses for homebuilders. That doesn't seem to be happening. 
One would presume, wouldn't one.  One might presume that there would be easy financing to plant strawberries in a healthy economy, too.  But, if the CFPB decided that only people with college degrees should be able to eat them, strawberry farmers might find themselves in the odd position of finding it hard to rent acreage where they could profitably grow strawberries.  High school educated cooks would be forced to only buy more expensive processed foods that used the strawberries.  College educated cooks would be rolling in an abundance of relatively cheap strawberries.  And, the country would be united in castigating strawberry growers for only serving the educated.  (Ain't that how it always is.  You can only make profit selling to the high end, you know. Or by selling expensive pies to people who really can't afford them. Typical late-stage capitalism.)

Related imageAs I said, I can't blame everyone for not seeing something that any reasonable person, by now, is allowed to consider a settled issue.  But, it is amazing how deeply blinded and wrong the consensus can be because of this unavoidable need to ignore information that contradicts the canon.

I feel like Indiana Jones in the Last Crusade, at the leap of faith.  There is a bridge across the chasm between the canon and the truth that nobody can see.  Sane people don't just step off into chasms.  I get it.  Maybe if I scatter enough pebbles, we can all walk across it.  There is a room across the chasm that contains a chalice that can heal our ailing economy and make late-stage capitalism young and vibrant again.


  1. Great post.

    Egads, even right-wing libertarian types cannot think about property zoning in context.

    The meme that there are labor shortages in construction borders on the ludicrous. How were so many houses produced in the past? And with rents in Northern California more at more than $3000 per unit, who is surprised at labor shortages?

    But the Mises Institute solution is to monetarily suffocate the economy into a recession.

  2. I love the housing starts per population chart.
    Related: Scott Sumner has pointed out that construction employment fell by 50% during 2006 and 2007 - his point being that getting workers INTO other sectors was not a problem. So I'd expect those workers would come back if the work was there.
    I wonder if the households that haven't been able to borrow have been saving up, and so they will become potential borrowers over the next few years even if the canon stays in place? Or if this change will become permanent until the canon changes?

    1. That's a good question. There does seem to be some evidence that young households are beginning to re-enter the market. On the other hand, most households pay more in rent than they would otherwise have to pay in mortgage payments, which probably makes saving harder.

  3. - The author of the article (Mr. McMaken) makes a VERY critical error (1st chart). I assume here that - for simplicity sake - the amount of households is equal to the amount of houses.
    - The flaw is the following: he compares the amount of housing starts with the amount of existing houses. And that ratio will ALWAYS fall. Some math will show you why.
    - Let's assume that the amount of housing starts remains flat at say 200 year after year and the amount of existing houses in year one is 10,000. Then the ratio is 200/10,000 = 2%. After 5 years the total amount of houses is (5 * 200) + 10,000 = 11,000. Then the ratio in year 6 becomes 200/11,000 = 1,8%. In other words, the ratio will ALWAYS fall, bubble or no bubble.
    - That's why you should be looking at the housing starts in isolation and not as a ratio of something. See below:!AluvxwylJSzygS62rp5_W5cUQ_bF

  4. - Let's assume that the amount of housing starts remains flat at say 200 year after year and the amount of existing houses in year one is 10,000.
    That's an odd assumption. Assume flat housing new construction and the ratio falls - which means there was no overbuilding and no bubble? So I guess you agree? If you take away your assumption, then the housing starts and ratio would undulate based on demand for new construction. Even if you assume years 1-4 are 200, 220 in year 5 would make your ratio equal to year 1, and thus not endlessly falling.

    1. - Nope. The reason for my assumption (see above) is that if you want to see a bubble (show up) then you shouldn't be using this ratio. Because it will always fall. And this ratio will ultimately fall gradually down to 1 (but never reach 1).

  5. - Nope. I want to show how flawed this ratio is.