Part 16: The conclusion to my series on housing affordability

A conceptual starting point for housing affordability and public policy

Here is an excerpt, but the post is short, so please click the link if you're interested.

Understanding this value and the systematic returns that homes provide leads to a somewhat paradoxical conclusion that (1) homeownership is usually a good investment, and (2) the smaller the investment, the better. In other words, an owner-occupied home with a low rental value can be a great investment, but the downside is that it requires living in a home with a low rental value.

The various posts in this series have considered housing affordability with a focus on rent. This focus has led me to the following policy suggestions: we should (1) maintain relatively high property taxes, (2) reduce or eliminate income tax benefits of homeownership, including the non-taxability of the rental value of owned units, (3) eliminate urban supply constraints, (4) reduce regulatory barriers to mortgage lending, especially in low tier markets, and (5) encourage innovation in real estate markets that reduces transaction costs.

I hope you have found some interesting ideas in the series.  I found it useful and enjoyable to systematically lay out a conceptual review of these ideas.

Here is a link to the whole series.

August 2019 Yield Curve Update

I had a brief flirtation with optimism, but the last couple of months have seen a bearish turn. 

This first graph is a graph comparing the Fed Funds Rate and the 10 year Treasury yield.  The orange line is the effective inversion line.  The zero lower bound means that long term yields have a kind of option value, biasing the yield curve upward.  This is my attempt at adjusting for that effect.  The yield curve is highly inverted.

In the meantime, the Fed seems to be tepid about their recent dovish turn.  It would take quite an aggressive posture for them to get ahead of this.  For this to become less bearish, the 10 year yield would need to rise substantially.  It's unlikely to do that without an aggressively dovish move, which the Fed would signal with a sharp decline in the Fed Funds Rate.

I expect the long term rate to bounce around a bit, but it seems unlikely that it will push back away from inversion.

The second graph shows the yield curve at various dates over the past few months.  It has flattened even as short term rates have declined.

Part 15 of my Housing Affordability at Mercatus

As the series nears a conclusion, I question the notion that homeowners are more leveraged than renters, or that, all things considered, the housing boom was associated with a rise in household liabilities.

The idea that paying $700 in rent is preferable to a $300 mortgage payment comes from the idea that a potential home buyer would be adding a new liability to their household balance sheet. It would involve leverage, and leverage is dangerous.
But this idea is, itself, a product of mental framing. There are assets and liabilities that we explicitly include on balance sheets, like the value of a home and a mortgage, or the market value of a corporation’s future profits. And there are assets and liabilities that we don’t explicitly include, like future rental expenses or the market value of a laborer’s future wages.

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The explicit financial engineering that spread before the financial crisis has taken on a lot of criticism over the past decade.  That financial engineering, ironically, created risks and costs that were more transparent and visible than the implicit financial engineering that has been an unwitting side effect of deleveraging Americans’ explicit balance sheets.
A significant part of corporate financial analysts’ academic training is to properly account for the liability of the rents corporations have committed to paying.  Wouldn’t it be prudent for mortgage regulators to account for this liability also when evaluating the benefits and costs of the lending standards applied to households?

Coming to terms with discretion

The development of such a strong canon regarding what caused the housing bubble and what we should expect the economy to do during the recession has led to a subtle issue regarding causes and consequences.

The strength of the canon - that excessive lending and speculating had to be beaten down - and the passion for approaching it, meant that the entire episode has an air of inevitability, even where it was completely discretionary.

I mean, really, take any version of what happened in 2008.  It will have the pretense of inevitability.  Ask, "What caused the financial crisis?" and the answer will contain an implicit transitory property so that the answer will actually be the answer to "What caused the housing bubble?"  The FCIC report is basically entirely built on this premise.

Basically, a=c (things that might have caused a housing bubble = a crisis happened) was so universally accepted, that nobody has paid much attention to the second part of a=b and b=c (things that might have caused a bubble = did cause a bubble) and (the development of a bubble = a crisis).  Of course, much of my work debunks a=b.  This naturally means b=c is essentially a meaningless relationship.  A bubble that never really was could hardly be said to have caused anything.

Now, as far as a=b goes, there are library shelves full of claims about that connection.  Even though one might disagree with them, at least they exist.  But b=c was essentially presumed.  Yet, it wasn't inevitable at all.  In fact, once one is led to doubt whether a=b, one realizes that regardless of whether credit, speculation, etc. caused a bubble, the question of whether a collapse is inevitable isn't settled at all.  The collapse was completely under our discretion, and it was simply the universal agreement about that discretion that made it seem inevitable.  Like an abusive parent hitting a child and exclaiming, "Well, he broke the rules.  What would you have me do?"  The answer to that question was obviously to accept the abuse 100 or 200 years ago, simply because its acceptance was canonized.  It isn't acceptable today.

Simply questioning the premise reveals the dissonance.  The reason the crisis happened wasn't because there was nothing we could do about it.  The reason it happened was that, going as far back as 2006, or arguably even earlier, turning points just kept piling up where policymakers chose contraction, panic, decline, and collapse because to do otherwise would be coddling risk takers, bailing out wrong-doers, letting those who did this to us off the hook.  I don't even think I need to establish the point.  The public record is so saturated with that idea that it is undeniable.  It covers practically every page of every review of the period, every criticism of the Fed and the Treasury.  It's the story we have told ourselves about what happened.

Anyway, I am treading again over this territory, because I came across this graph today (here).

And, it really drives home the damage that those discretionary decisions did.  The places that are hurt much, much worse by cyclical dislocations are the places that are struggling already.  Successful places bounce back.  If not for the recession, "distressed Americana" in this graph would at least still be treading water.  Instead, there is a gash in its flesh in 2009 that isn't going to heal.  And, rest assured, the parts of the country that suffered that gash were not in the throes of a speculative frenzy.  They certainly didn't need to be taken down a notch so that those reckless people that did this to us had to be punished.

If you are concerned about the bifurcation of economic growth in this country, then there is a big giant elephant in the room regarding that issue.  We walked that elephant into the room, and it took a big, elephant-sized crap on the places that really needed stability.

Even if you think there was an unsustainable bubble and excesses had to be painfully purged from the system, consequences be damned:  THIS is the consequence.  Oh, by the way, it didn't need to be done.  a<>b .  But, even if we save that debate for another day, the imposed "discipline" that so universally was hoisted on the economy to knock it down to size had downsides that should be faced honestly.  a<>b, but even if a=b, there are a lot of questions we should have asked about, really, how committed we should have been to b=c.

Housing Affordability, Part 14

Here is my latest post at Mercatus: "Because of Housing, All Taxes on Capital Tend to Be Regressive".  Here is the conclusion.  Go to the link for the details.

 (T)he income tax code, as it exists, has regressive effects regarding housing affordability.Given those effects, it is inaccurate to treat capital taxation in general as a progressive tax. Corporate taxation, in general, creates a regressive rent subsidy. A different tax regime that focused on property taxation rather than generalized capital taxation could plausibly produce public revenue in a way that would be more progressive than a tax code that taxes capital income more generally. This should cast doubt on common presumptions about how and why to change the tax code.

July 2019 CPI Inflation

Core inflation has recovered a bit in the last two months, but we remain in the context of relatively low non-shelter inflation and high shelter inflation, averaging out to roughly on-target total core inflation.

I will probably continue to do these updates for a while, but I suspect the context is set, and specific shifts in inflation won't affect things much in the near term.  Inflation isn't likely to shift sharply in either direction, and in the time frame that is important for the Fed right now, noise dominates information.  So, effectively, Fed discretion will rule, although it will frequently be cast in language of inflation or interest rate control.

The context in place seems to be that the Fed will loosen.  Not so much to avoid a bit of a contraction, but not so little as to be greatly disruptive.  Excess shelter inflation is part of that context, but other factors will come into play, too.

Here, I think the 2008 event is informative.  The Fed is somewhat forgiven for allowing NGDP and inflation expectations to drop so sharply because at that time inflation was slightly above target.  This makes inflation seem like an important short term element in Fed decision making.  But, I disagree with that analysis.  Inflation wasn't anywhere near a level that would have led any sane regulator to sit aside as one panic after another struck the economy.  And, even as the Fed did that, the overwhelming criticism of them was that they were even daring to try to stabilize financial markets.  Even today, many commentators explicitly complain that selected economic agents weren't made to suffer enough.  The financial crisis in late 2008 happened because it was popular.  Slightly above target inflation is simply one of several justifications that were used to allow it to happen.  For any reasonable observer with a straightforward goal of maintaining economic stability, none of those justifications were plausible excuses for allowing such economic dislocations to occur.

The reality in late 2008 was that any reasonable monetary or fiscal policy would have caused a rebound in housing prices, as a side effect.  That would have been taken as indefensible.

We don't have the same dramatic setup today, so the stakes aren't as high.  But, similarly, inflation and interest rates will be used to communicate short term monetary shifts even though those shifts will have little to do with either.

Part 12 of my Housing Affordability series at Mercatus

Are Property Taxes Regressive?

The conclusion:

A region that allows ample new supply and imposes higher property taxes is friendlier to households with lower incomes than a region with obstructed housing supply and low property taxes.

July 2019 Yield Curve Update

The yield curve has taken a sudden turn for the worse.

The Fed's tradition of using interest rates to convey their monetary stance is such a constant source of confusion.  The conversation about yields so often seems to hinge on the idea that the central bank is in full control of interest rates and uses them to make it more or less profitable to borrow and invest.  It baffles me how ubiquitous this sort of idea is in both professional finance and economics.

Recent movements in yields are a great case in point.  It is common to hear this shift described in terms of expectations about Fed rate cuts.  But the whole yield curve shifted down.  This is not a sign that the Fed will be loosening monetary policy more aggressively.  This is a sign that they won't be loosening aggressively enough.  The neutral rate just changed, leaving the Fed behind as a victim of institutional inertia.  That is in contrast to recent times when yields did react to clear signals from the Fed that it was going to be more aggressive.  In those cases, short term rates fell and long term rates increased.

I only update my graph of the adjusted yield curve inversion monthly, so the red dot for July is at about the same spot as it was at the end of June.  Of course, the 10-year rate has dropped 25bp since then.  So, unless some sort of economic or political development greatly improves economic prospects in spite of a tight monetary posture, raising 10 year yields back up, then we are already at a point where, even with short-term rates at zero, the yield curve will be effectively inverted.  This will likely lead to complaints about how the Fed is using QE4 to keep long term interest rates low to boost investment and asset prices, including from many otherwise sensible people who are generously paid to manage other people's assets.

Part 11 of my housing affordability series at Mercatus

Low Property Taxes and Obstructed Housing Supply Are a Bad Mix

"It would seem that raising property taxes would make housing more expensive.  They are, effectively, a tax on materials to build homes.  But the binding constraint to affordable and reasonable housing in twenty-first century America isn’t material.  It isn’t a lack of affordable physical space.  It is the political obstruction to placing those materials in dense urban centers."

With a universal expected market return, lower property taxes and just a small expectation of persistently rising rents can lead to much higher housing prices.  That's the first order effect.  But, as a second order effect, the value of homes as assets that are speculative claims on local political cartels, might mean that lower property taxes will be associated with higher rents.  It seems that higher property taxes might lead to lower quantity demanded, but also lower supply, with a net effect of less housing at higher cost, with cartel real estate owners pocketing the profits.  The political implications of that might change when the oligopolists would otherwise have been middle class pensioner grandparents, but the economic implications don't.

Part 10 of my Housing Affordability series at Mercatus

Property Taxes Can Be a Tax on Monopoly Power.

"If politically maintained monopoly power is going to remain, claiming monopolist profits through taxes is an improvement. The fact that the tax doesn’t affect rents is a sign of efficiency. If rents must be elevated, better that they go to local public services than to the real estate cartel."

The series will continue each Monday with discussion of the effect of various regulations and taxes on housing costs.