Housing: Part 341 - Arbitrary categories should not determine sentiment and policy

Housing can be consumed in three basic ways:

1) Tenancy

The capital is provided by an investor.  The investor takes the risk of changing value and the responsibility for maintenance.  The tenant pays for the service of shelter in the form of a cash payment.

2) Mortgaged Ownership

The capital is provided by an investor.  The tenant takes the risk of changing value and the responsibility for maintenance.  The tenant makes a fixed payment to the investor for the use of her capital.  The tenant does not make a cash payment for the service of shelter, because the tenant is also the owner.

3) Free and clear Ownership

The capital is provided by the tenant.  The tenant takes the risk of changing value and the responsibility for maintenance.  The tenant used her own capital, so she makes neither a fixed payment to an investor nor a cash payment for rent.


The production and consumption of shelter is basically the same in all three scenarios.  There is simply a shift between who plays the various roles.  In the first scenario, we say that the investor is providing landlord services to the tenant.  In the second scenario, we say that the investor is providing financial services to the tenant.  In the third scenario, we say (or at least the BEA says) that the investor is earning "rental income of persons".

But really, we're just shuffling around a group of agents who, together, are providing capital for shelter, maintaining the shelter, and consuming the shelter over time.  The way they are shuffled has little bearing on the aggregate amount of capital and the aggregate value of the shelter.  Yet the way we think about each different scenario and the way it affects public policy is tremendous.

In this graph, the top line is the total value of shelter consumed, as a percentage of GDP.  It is pretty stable over long periods of time.  During the 1960s and 1970s, it was 8-9% of GDP.  During the 1990s and 2000s, it was about 10%.  Since the crisis, it has run at more like 11%.  (Clearly, this isn't because we have created more shelter since the crisis.  This is because demand for shelter can be inelastic.  Rent inflation has been high because we are not producing enough new housing, so we are spending more for less.)  All that being said, this is consumption that is stable over quite long periods of time.

In the graph, the next line down is gross value added - the cost of housing before maintenance and upkeep.

The next line down is operating surplus - the net income to the agents providing the capital in each scenario after subtracting maintenance and upkeep, consumption of capital (basically natural depreciation), taxes, and subsidies.

Finally, the red line is the portion of the housing capital income that goes to the investor in scenario 2.  This is actually a bit misleading, because the operating surplus is real income.  It increases over time with inflation.  Interest income includes a premium for expected inflation that is paid in cash over time and appears as financial income when it really is not.

That last red line, then, is a fairly arbitrary measure, both because it doesn't even measure real income and because it is only one type of income from one of the three scenarios of ownership.  But, it is the scenario that is labelled "financial", and it gathers more attention than any of those other, stable, less arbitrary measures.

During the housing bubble, the expansion of the housing stock was allowing households to moderate their housing consumption by moving to cities where the capital providers don't capture economic rents from political oligopolistic power over real estate.  So, the operating surplus to housing (which is the non-arbitrary measure of housing income) was declining.  But, the arbitrary measure got all the attention.

Maintaining lower interest rates that weren't contractionary would have kept the red line low, and possibly would have kept net operating surplus moving lower.  Since then, there has continued to be a lot of focus on the arbitrary red line, and a lot of happiness about how much lower it has moved.  At the same time, the non-arbitrary measure of income to housing has moved up (because of a lack of supply, which is ironically related to that declining arbitrary red line) to a level not seen since the early days of the Great Depression.

By railing against "financialization" and "Wall Street" profits, we have managed to shovel more income into the hands of oligopolists than any housing bubble ever could have.