Monday, September 24, 2018

Housing: Part 322 - The strange American housing morality play

One of the overwhelming tendencies one finds in the popular literature about the housing market is the nearly universal cynicism about housing consumption and housing finance:
  • Everyone buys too much house.
  • The real estate lobby has Washington on a leash.
  • The GSEs have spent decades lobbying for special treatment and excess lending.
  • The Fed is pumping up bubbles.
  • We lionize homeownership.
  • In the aggregate, homebuying decisions are characterized by speculative thinking.
I could go on and on.  Every book that purports to explain the housing bubble becomes a litany of decades of activities, all meant to get too many homeowners to buy overpriced houses with too much debt.  The rabidity and ubiquity of this treatment of the real estate asset class defines the topic.

The United States does not, on net, subsidize housing.

As with so many issues on this topic, the distance between the consensus and reality is extreme.

Let's look at the subsidies to housing.  For a sense of scale, the BEA estimates total annual rental value of about $2.1 trillion, and net operating surplus (rent after depreciation, expenses, and taxes) of about $1.1 trillion:

There are two biggies.  (Well, one biggie in reality and one in rhetoric):
1) income tax benefits.  This includes untaxed rent, mortgage interest deduction, and untaxed capital gains.  The Treasury estimates that in 2018, these are worth about $230 billion.

2) the GSE subsidy (this is a little cloudier with conservatorship).  When the GSEs were semi-private, it seems that reasonable estimates of their effect on mortgage rates was about 0.25%.  In other words, the implied federal guarantee on their debt led to mortgage rates about 0.25% lower.  Before the bust, they guaranteed about $5 trillion in mortgages.  $5 trillion x 0.25% = $12.5 billion.

Number 1 is much more of a biggie than number 2.  This is why the focus that so many people have on the GSEs baffles me.  As a subsidy to housing, it's a pittance.  I would prefer to get rid of the income tax benefits.  They are regressive and destabilizing.  The GSEs, on the other hand, comported themselves quite well during the bubble, and were a stabilizing factor in the crisis, where they were allowed to be.  As a result of my research, I have become more supportive of the idea that the federal government should provide a credit guarantee on conventional mortgages.  That function is a public good which can only be provided by the government.  The federal agencies should be retained in some form, and the inflationary effect they have on home prices is small.

What about taxes on housing:

There is one biggie:
1) Property tax on residential housing, which is about $250 billion per year, according to the BEA.

On net, these primary factors put negative pressure on housing demand.  Income taxes represent a subsidy of more than 20% of the aggregate net income, property taxes represent a tax of more than 20% of the aggregate net income, and the GSEs amount to a percent or two.

What about other factors?

The realtor lobby wants a lot of housing demand, and they push for maintaining things like the mortgage interest deduction.  But, probably their primary input here is protecting the realtor cartel that charges 6% for realtor services.  High transaction costs clearly pull down the market prices of homes and the demand for housing.

And, what about the 30 year fixed rate mortgage that is supported by the GSE framework?  The 30 year mortgage with a prepayment option puts peculiar risks on lenders, and they require a premium for taking prepayment risk.  That makes mortgages more expensive, which pulls down the market prices of homes and the demand for housing.

There have been other programs related to encouraging home ownership in various ways, but the effect on aggregate demand for shelter or on home prices is marginal.  Certainly not close to the scale of the effects of property taxes and income tax benefits.  Programs meant to increase homeownership can't amount to much.  Consider a very aggressive program that would increase ownership by 5%.  Those households wouldn't necessarily increase their housing consumption by that much, and any pressure they might create in home prices would also be marginal.  So, that program would affect aggregate consumption or prices by 5% x some small percentage representing the marginal new capacity of those buyers to consume more housing.

Nothing else can really come close to the effect of income tax benefits on housing consumption and home prices, and income tax benefits are cancelled out by property taxes.  The only way to rectify this is to argue that property taxes should be ignored.  So, the entire case for claiming that there is some sort of American public mania for housing consumption comes from observer bias.  You have to ignore a very large tax that is imposed specifically on this asset class.  Don't get me wrong.  I think there are a lot of good reasons for having healthy property taxes.  I just don't think you can have them and also claim that real estate is being heavily subsidized relative to other forms of spending.

How do you feel about additional marginal consumption of, say, health care, or education?  Or, for that matter, bananas, or books, or boots?  Compare public expressions about these forms of marginal new consumption to public expressions about marginal new consumption of housing.  At the risk of being a bore, I must say that when I read any history of the housing bubble, it is this universal attitude that strikes me as the fundamental source of irrational public sentiment that caused the crisis.  Once you see it from a different perspective, so that you notice it oozing and dripping rhetorically over every description of the history of American housing, it becomes fairly oppressive.

It's sort of an interesting problem.  For writers, it is a posture that one must take to establish credibility with the audience.  But, starting from that prior, every marginal increase in housing consumption is automatically suspect.  That can only lead to one conclusion.  It should destroy the credibility of the writer, because the conclusion has been predetermined.  For some reason, though, that predetermined conclusion, fundamentally, is the product that the American public wants to consume.  And, the extreme bias this creates is clear.  The national conversation for 20 years has been about what to do about the overconsumption of housing, and real housing consumption has been declining relative to incomes for more than 30 years.


  1. There is a depressing trend for every public policy narrative to be hijacked by political economic groups or political parties for their private benefit.

    Macroeconomists and public policy experts more and more appear to be litigants rather than academics.

    1. It seems like the result of this is just deadweight loss. Who benefits?

  2. Well, at the risk at sounding sophomoric, pedantic and left-wing, usually entrenched groups benefit from controlling the narrative.

  3. It is essential to keep in mind that there is no single American housing story, and averaging various factors across the whole nation is not going to provide a logical explanation for many locations. For example, property taxes definitely do not offset income tax benefits in California!

    I am currently renting in California and recently ran the numbers again. It would cost about $500-1000 more a month to buy than to rent (all costs considered), and price-to-rent ratio is above 20. So the only reason to buy is the expectation of house price appreciation, but to me, one definition of a bubble is when people buy a negative-income asset merely because they expect they can sell it for more later. This has historically been a great strategy in California (let's forget the early 1990s), but it relies on continued anti-development policies to suppress supply and availability of high-paying jobs to enhance demand. As you have said, purchasing a house in a closed-access city is like buying a taxi medallion, but is that such a great idea if in a few years Uber comes along?

    In California, I think there is a widespread perception that people are taking on too much debt to buy houses that are priced way beyond what the sellers deserve. Perhaps that narrative is false, but it's going to be difficult to dislodge it because it seems to fit so well what people see. Of course, California isn't the whole nation, but it has a big influence on elite perceptions.