Friday, March 23, 2018

Housing: Part 290 - Migration and credit markets

After making yesterday's post, I saw this tweet from Jed Kolko: "America's dense urban counties grew in 2017 at their slowest rate since 2007." with the following chart:

This is one of many recent sources that have been noting developing migration patterns.  Here is another (HT: Jason Schrock)

Earlier, I had developed the opinion that if you have Closed Access cities, then a housing "bubble" would develop regardless of the condition of credit markets.  The bubble was just a product of Closed Access and economic growth.

But, much of the surge of Closed Access out-migration in 2002-2006 was from homeowners tactically selling their properties.  So, I have come around to the idea that the "bubble" was triggered, to a certain extent, by flexible lending markets, which allowed households with high incomes to buy Closed Access homes at prices that were high enough to induce that selling and accelerate the inevitable Closed Access segregation process.

I still think that was the case.  But, it is interesting that as the new economic expansion ages and strengthens, that migration pattern is developing again without the help of an active mortgage market.

Closed Access means that economic opportunity is associated with stress - fighting over a fixed pie.  The high housing costs of the Closed Access cities aren't the product of frenzy and speculation.  They are signs of a painful and unsatisfying battle for access.  People don't like that.  And, when the economy is strong enough to substitute away from that, people choose to substitute.  Closed Access means that households tend to make trade-offs so that they are less productive in order to avoid that stress.

Here is an article (HT: ChargerCarl) that takes a fairly productive stance on supply from a progressive point of view.  From the article:
There’s a “multiplier effect”: Every tech job creates 1.3 other jobs. There are 105,000 low-income households in San Francisco, and despite how expensive it is to live here, they somehow persist. Asked why they stay, even when it would be far more affordable not to, Egan gives a one-word answer: “Jobs.”
Surely, in a safe, growing, stable economy, that answer becomes a less persuasive reason to stay.

So, even without an active mortgage market, the national segregation continues, where workers that can leverage the productive value of those cities push in and the bulk of workers must avoid those cities or move away from them.  Since flexible mortgages aren't as available now, this works through rental markets instead of homeowner markets.

The 2000s mortgage market is widely described as predatory, but really, it was just providing one more tool for households to deal with Closed Access.  That's why it led to a disruptive migration event, because Closed Access has created a lot of pent up stress, and those tools were accelerating the methods households were using to deal with that stress.  So, rent inflation in 2004-2005 was moderate, but today rent inflation is high, because rent inflation is a key indicator of that stress, and mortgage markets in 2004-2005 were relieving it.  In 2005, highly skilled workers could hedge their rent risk by buying Closed Access homes and Closed Access home owners could capture their ill-gotten gains and move on.

Now, since we have limited the availability of credit to many households, this process operates more like a pre-capitalist society or banana republic.  The class of owners can't capitalize their monopoly rents as easily, so they must earn them over time, by using or renting the property.  So, the new investment banker or tech wiz moving into town has to bid up the rent of a service sector worker until they move away rather than bidding up the price of some retired couple's home who then move to Boulder or Phoenix or something.

The mortgage boom did end up creating stress in places like Phoenix because it accelerated that transition, but at its base, it was relieving stress by creating new alternatives for dealing with these latent monopolistic markets and providing means for ownership of those assets to shift.  It just relieved those stresses so effectively that it created new stresses from the high rate of change.

Thursday, March 22, 2018

Housing: Part 289 - The "Credit Bubble" and housing expansion

The mortgage boom in the 2000s was mostly facilitating purchases by qualified borrowers - mostly young professionals with high incomes.  The drop in homeownership since the bust has also been concentrated among those households.

The story of what actually happened was that mortgage lenders had found reasonable ways to lend to young, qualified borrowers with loans that had to be outside conventional norms, because housing markets in Closed Access cities are outside conventional norms.  That pushed prices in Closed Access cities up to levels that reasonably reflected the high rents that come from a persistent shortage of housing.  That triggered tactical selling by existing homeowners.  The aggregate effect of this activity was to lower the population of Closed Access cities as young households with high incomes were able to secure a more generous amount of housing in cities where the total amount of housing is relatively fixed.  That led to depopulation and out-migration.  The out-migration overwhelmed a few cities, like Phoenix and Las Vegas, and caused prices in those cities to spike.

Here are a couple of charts that marginally add to that story, both measuring population growth per new housing permit.

Nationally, we can see that, in terms of this measure, the housing boom was generally a return to normalcy after a decade of reduced housing permits.  The rate of new building during the 2000s was similar to the rate of building that occurred throughout the 1970s and 1980s.

Starting in 1989, there is housing permit data, by metro area.  In the more recent graph, we can see the story I described above.  Closed Access building had been repressed for years.  Throughout the 1990s, the number of new residents outpaced the number of new homes relative to national norms.  Residents were packing into the existing housing stock.  From the late 1990s to 2007, Closed Access households were able to expand their consumption of housing.  By 2005 and 2006, populations in those cities were actually decreasing.  These were generally well-off borrowers making initial steps toward expanding their real housing consumption toward something somewhat normal.

By this measure, if there was anyplace in the US that was overbuilding, it was the Closed Access cities.  But, obviously, they have never come close to overbuilding.  In fact, this apparent surge in homes was actually a surge of migration away from the Closed Access cities.

Much of that surge went to the Contagion cities, and the Contagion cities increased their building in response to it.  That surge in building also has been taken as a sure sign of overbuilding, even though it barely met the need for housing demanded by the new residents.

But, the Contagion cities generally have more population growth per housing permit than the US does in general.  There was a slight downshift in that measure during the boom, parallel with the rest of the country, but new residents per new home in the Contagion cities never dipped below the national average.

Wednesday, March 21, 2018

February 2018 CPI

Sorry, I'm a little late with this month's inflation update.

In February, both shelter and non-shelter inflation were basically on target.  The annual rate of inflation for both continues to move sideways, with shelter inflation above 3% and non-shelter core inflation below 1%.

Shelter inflation is receding a little bit, which is strange, since housing starts continue to be below the level required to maintain a stable supply.  This could be something cyclical, or maybe it is a sign that housing is leaving the phase of disequilibrium and the American underclass is slowly moving to the new equilibrium where their real housing consumption will be lower than it used to be.  Higher rents for less housing, which leads to a long term decline in real housing consumption until it settles back at a reasonable nominal portion of household budgets.

Or, possibly, even without a robust homebuilding market to facilitate it, a strong economy is again leading households to move away from Closed Access cities.  Economic strength would allow them to more confidently make the tradeoff between gross income and cost of living.  One product of higher quit rates might be that more workers quit their jobs in LA to move to Phoenix or Dallas.  In 2005, there was an outflow of both renters and homeowners.  The flow of homeowners was facilitated by generous lending and high prices on their existing homes.  But, the flow of renters would not be as sensitive to housing markets, so that flow might now be strong because of economic confidence.  This data comes with a lag, though.

Tuesday, March 20, 2018

Housing: Part 288 - A tale of two bursting bubbles

Housing bubbles may be about to burst in both Canada and Australia.  It appears as though Canada is following the American model and doing it the wrong way while Australia may be doing it the right way.

In Canada, there doesn't seem to have been much of a supply response.  (See here, here, and here.)  The central bank is raising rates and tightening lending regulations.  Here, Bloomberg uses my least favorite word - "Canada’s biggest housing market has been correcting".  Here, they interview Steve Eisman of "The Big Short" fame, who also uses the word.

This is "correct".  It is something to be accepted - even cheered.  Sucking cash out of the economy will achieve this end.  And, now, "Canadians Using Real Estate To Secure More Debt Reaches New Growth Record"  Why are Canadians tapping credit lines?  Presumably because they need cash.  But, if Canadian officials create cash, that will mess up the correction.  And, Canadians using debt to get cash is just one more sign of their recklessness - exactly the reason they need some discipline.

This all looks like it is heading down the road the US took in 2006-2008.

The bubble in Australia might also be bursting.  But, there, it appears to be mostly for the right reasons.


Here are housing starts in New South Wales (Sydney) and Victoria (Melbourne).  Both have increased approvals of new units to highs not seen in decades, if ever.  Sydney is double the level of a few years ago.

And, rent inflation, which had been generally high since 2007 has finally trended back toward the general level of price inflation.

So, it appears that Australia might be popping the bubble by creating supply.  Prices have only just begun to stabilize, so only time will tell.

Australia has implemented some demand side policies, but the central bank isn't raising interest rates, and the demand side policies don't seem that significant to me.

But, I suspect that if both bubbles pop, both will be generally attributed to "corrections" in demand.

PS: I forgot to add this article from "Better Dwelling", a Canadian housing news site, titled, "Canada Didn’t Skip The Great Recession, We Delayed It. Here’s The Chart", which closes with:
Now the Bank of Canada has two options, they can continue to expand the supply or start to shrink it. Continuing the expansion, i.e. keeping rates low, will cause further asset inflation with a minimal contribution to the GDP. If they raise rates, the supply will shrink, likely triggering a recession. People fear the consequences of a recession, but it actually addresses a very useful purpose. It corrects misallocation of capital, whether human or financial. Our ten year experiment of trying to avoid correcting the misallocation, has only made it worse.
The reason capital is "misallocated" is because monopolistic power of existing homeowners allows them to capture economic rents from the productive economy.  This is the case whether Canada enters a recession or not.  Certainly, Canada can reduce the size of that transfer by hamstringing its economy.  That's what the US did.  But, it doesn't actually work in the long run.  Home sellers and home equity borrowers do capture more of the economy's current production by tapping the value of their real estate assets for spending.  This is a form of consumption smoothing, which utilized the market value of those assets.  But, in the end, those market values are a product of high rents.  The transfer of economic rents to real estate owners happens over time as the rent on their properties rises above replacement value.  Recessions do nothing to stop that.  In fact, we can see that the recession in the US made it worse.  After a brief period of chaos, rent inflation has risen again.  And, we can see from the wild swings in Closed Access migration that economic contraction led households to remain in Closed Access cities in order to have access to higher incomes.  The expansion from 2002 to 2006 was allowing Americans to escape those high rents by moving away from the Closed Access cities.

The social and psychological forces that lead to consensus calls for economic contraction and even panic are fascinating.  But, it really is strange when you take a step back from it.  I hope that eventually we will come to a place of understanding where these intuitions are mostly seen as errors in human nature.  Instead of imposing "discipline" on the market by indulging these intuitions, we must discipline the intuitions.

Sunday, March 18, 2018

Housing: Part 287 - Closed Access and Gentrification

There are many things that housing obstructionists in Closed Access cities say that make sense in a Closed Access context but don't make sense in an Open Access context.  One of the ways that normal economic intuitions frequently fail is that people have a really hard time thinking about second order effects in complex economic spheres, and also people tend to think in terms of power, so that they tend to make inferences that depend on monopolistic assumptions in markets that are competitive.  So, the sorts of things that Closed Access obstructionists say match the poor economic intuitions that people tend to have about competitive markets, and so those things don't naturally meet with rhetorical opposition where they should.

The sorts of things I'm talking about are claims about how allowing more units to be built will raise rents, or claims about how since luxury units are more profitable, they are the only type of unit developers will build, etc.  These sorts of things may be sort of true in some places in Closed Access cities, because those cities have turned housing into a monopolistic asset, but they aren't remotely true in other cities.

I don't think there is enough pushback on those sorts of claims because our poor economic intuitions prevent most people from realizing how wrong they are.  An example outside of housing where intuitions fail us is, say, in grocery stores.  Food has gotten progressively cheaper over decades and generations.  Yet, in cases where, say, cans of soup over time have changed from a standard size of 12 oz. to 10.5 oz, in my experience, many or most people will chalk that up to some sort of conspiracy among food producers to trick us into paying the same amount for a smaller size.  Or, to take another example, I hear people complain that when oil prices rise, gas station prices rise immediately with them, but when oil prices fall, it seems like it takes a while for gas station prices to fall.  This is always stated as if gas station owners simply use this trick to increase their profits above some normal, reasonable level, using a trick to pocket a little extra.

People will commonly intuit a monopolistic conspiracy, even regarding a business whose primary distinguishing feature is a large, illuminated street-side sign with a price that changes daily.  In the same way, someone living in a place where entry-level apartment buildings are going up all over the place can hear that developers only invest in luxury units because those units are more profitable, and yet not naturally notice what a strange thing that is to say.

This is all a long-winded way of getting around to an idea that occurred to me.  I wondered if gentrification pressures might be stronger in Closed Access cities than they are in other cities.  They clearly are stronger, simply because Closed Access forces current residents to have to move away.  But, specifically, what I mean is that since location and social amenities are a more important factor in Closed Access rents, then when a neighborhood is developing and moving "up market", that might have a stronger effect on local rents in Closed Access cities than in other cities.

What caused me to think about this is that I realized the notion that an improving neighborhood would be bad for existing tenants is mainly a Closed Access problem.  In Phoenix, I think most people are naturally happy to see their neighborhoods improve.  Even in a place like Chicago, this mostly seems to be true.  The reason is that rents in most cities mostly reflect the cost of building.  There are some locational premiums having to do with commute times, etc.  And, other factors, such as the value of nearby units or the types of neighbors one has, don't account for that much of a difference in rents.

In a place like Dallas, at the zip code level, except for some rarified areas, rents just don't rise that far above the cost of building, so changes in neighborhood character don't affect rents that much.  In cities like that, tenants have the normal way of reacting to changing neighborhood character.  They like living in a neighborhood that is "moving up" and they don't like living in a neighborhood that is in decline.  (Of course, class, race, and other factors are in play there, and these perceptions aren't always fair.)

But, in a city where demand for housing from potential new tenants is less elastic than the demand for housing from existing tenants, because existing tenants have income limitations, then maybe rents do systematically rise at a rate that is so unfavorable to existing tenants that it reverses the normal reaction.

Here, I have graphed the rent per square foot for every zip code, in order from lowest to highest, for several metro areas.  And, as one might expect, rent per square foot is pretty stable throughout the metro area in Phoenix, Dallas, and Chicago.  It runs 80 cents to $1 in most of Phoenix and Dallas.  Slightly higher in Chicago.  With a few zip codes at the top where rents are much higher.

Interestingly, the pattern in Boston and LA is not that different.  In those cities, most zip codes have similar rents/square foot.  It is just that the entire metro area has inflated rental values.  The difference is that in Boston and LA, there are more areas with relatively higher rents/sq. foot, and the jump from the typical zip code rent to the level of top tier rents is higher.  So, we can see that, on the margin, in some small portion of neighborhoods that might be transitioning from low-tier to high-tier because of peculiar localized development, there might be some areas where rents are especially rising.  But, for the typical zip code, adding some new units along a mass transit corridor that might be targeted at a high tier demographic, probably isn't going to raise rents for locals by 40%.

On the other hand, if the existing units have some sort of rent control, then marginal increases in local rents could displace some tenants if landlords sell into a strong sellers market.  So, in a couple of ways, there might be especially strong localized pressure on rents in Boston and LA, but it doesn't seem to be the case, metro-wide.

In San Francisco, the pressure does appear to be metro-wide.  Rent/sq. foot is quite variable throughout the metro area.  Presumably, the housing shortage there is so severe, and prices are so far from basic cost of construction, that local character and amenities do have a strong effect on rents in most parts of the city.

Sunday, March 4, 2018

Housing: Part 286 - Upside Down CAPM and the Housing Bubble

One of the over-riding themes and lessons about the housing bubble was the realization that we weren't as wealthy as we thought we were.  That we drove up the prices of American assets with debt and then took out more debt using that inflated collateral in a doomed attempt to live beyond our means.

I have discovered that all of that was wrong.  The truth is really more the opposite of that.  We have hung a weight around our collective economic neck, consisting of restricted ownership that requires transfer payments to the politically protected owners.  Home prices during the bubble were a reflection of the value of their restricted ownership.  Debt was a product of attempts to buy those restricted assets.  And debt-fueled consumption was mainly consumption smoothing by the owners of those assets, who could liquidate their real estate by sale or through credit, to consume today from their future claims on ownership.

An idea central to the conventional story is the idea that debt and leverage can be used to increase the total market value of asset classes, and thus creates a sort of false growth.

Part of the foundation of the Upside Down CAPM idea I have been developing is that this is largely false.  It comes from thinking of borrowing from the perspective of a consumer.  But, thinking in terms of a national balance sheet, it is more accurate to think of the nation's assets as the anchor - the left side of the national balance sheet.  The right side of the balance sheet shows us how ownership is divided - between creditors and equity owners.  It is more accurate to think of rising debt generally as a shift in ownership between equity and creditors, with a stable amount of assets.  Debt levels are a pretty slow moving animal, and I like to point out that the frothy markets of the late 1990s happened through rising equity values and rising growth expectations.  Interest rates at the time were high because there was a bias then for equity ownership to have a claim on that growth.  Creditors weren't bidding down interest rates in an effort to avoid risk.  They wanted risk.  And savers looking for risk want to be equity holders, not creditors.

So, how does this hold up if we look at the housing bubble?

This first graph is a graph that has been an emblem of the American spending problem.  Debt keeps rising relative to incomes.  This is unsustainable, it would seem.  Households were dealing with stagnant incomes and they were borrowing in order to keep afloat.

The first problem with that story is that the borrowing was heaviest among the households with the highest incomes.  They represent the vast majority of borrowing and they also represented most of the new borrowing during the bubble, in absolute dollars.

The conventional thinking about this shifts upon this evidence to say that, well, the debt was used to bid up housing in a frenzied bubble, so while the evidence that the bubble was built on lending to households with low incomes may not hold up, the use of debt to push up home prices still sits at the middle of the story.

Of course, I have written, ad nauseam, about how the debt was mostly funding access to Closed Access labor markets, and that rising rents explain rising prices better than credit.  But, what about those crazy high debt levels?  How can I explain that away?  Households taking on new debt amounting to half a year's income, over the course of a single decade?

But, that graph shouldn't bother us because of what's on it.  That graph should bother us because of what's not on it.  We should view the economy as a complete balance sheet, where debt is just one form of ownership.  This is a partial picture.*  Debt is the least important part of the balance sheet.

In this next graph, debt is the yellow line.  In thinking about household net worth, I want to walk through these items one step at a time.  All measures are as a percentage of disposable personal income.

Step 1: Blue Line
Step one is the value of all financial assets.  This is stocks and bonds, etc.  Not housing.  This is the value of capital held by households, except for housing.

Step 2: Red Line
In Step two, we subtract debt from the total value of financial assets.  This is how we should think about household balance sheets.  The blue line is the total (non-housing) balance sheet and the ownership is divided between debt and "equity".  (Some of the "equity" may be in the form of fixed income securities, but here, those are assets on the left side of the balance sheet.  In terms of the household's balance sheet, those are part of the household's net worth, similar to a corporations equity, or market capitalization.)

Step 3: Black Line
Most household debt is used to buy real estate.  In step 3 we add the value of real estate to the total.  If we assume for the sake of simplicity that all household debt is secured by real property (most is), then we can roughly think of the distance between the blue line and the black line as the value of household equity in their real estate.  The distance between the blue line and the red line is the value of real estate funded by debt.

Since debt has already been subtracted from the total, the black line represents American households' total net worth.**

I apologize that I have made this a bit more complicated than it needs to be.  It would make more sense to add up the real estate and financial assets and then subtract the debt from that.  You would still end up at the black line as a measure of household net worth.  But, gross household asset ownership would be at a line higher than the black line, representing the total amount of assets, before accounting for debt.  I have done this because I want to make a point.

Let's look at 2005 with the full perspective of American household balance sheets.  The credit bubble story says that we were borrowing from foreigners in a housing bubble, where that borrowing was propping up the value of that real estate.  If an American household borrowed from foreign savers to bid up the housing stock, then that would leave the blue line where it was, it would lower the red line, and it would raise the black line.

So, let's not give American households any credit for the value of those homes.  Take a look at 2005 to 2007.  In terms of gross financial assets, without housing, American households were in a better financial position than at any time in recent history - roughly on par with the peak of the internet bubble.

You might respond that this is an average and that there is gross inequality.  But, remember, the borrowers were households with high incomes.

You might respond that the stock market was still in a bubble, but PE ratios were under 20x and declining.  Bond rates were at cycle highs (so that valuations were low).

Now, subtract all that debt that Americans used to buy those homes.  The red line.  Even after subtracting debt worth 130% of disposable income, American balance sheets were as healthy as any time in modern history, except for a brief time during the internet bubble.

And, I have been arguing that the CDO boom at the end of the housing bubble was actually the beginning of the bust - part of the shift out of home equity because sentiment was already changing - even though American balance sheets were in great shape.  Notice that household net worth (the black line) was level from late 2005 to late 2007.  But, outside of housing (the blue and red lines), household balance sheets were still growing strongly.  Again, give Americans no credit for their real estate, but saddle them with the mortgage debt.  Even after that, from late 2005 to late 2007, when housing starts were collapsing and the Fed hiked the target rate to 5.25%, American balance sheets were expanding - even relative to incomes.

This is especially the time when American households were supposedly loading up on debt to live beyond their means, and now that home values had stopped rising, the end was supposedly inevitably near.  If we think about the equity and mortgage components of real estate, then, during this time, the distance between the red line and black line shrunk.  In other words, total real estate value was shrinking as a portion of household incomes.  And the equity portion was shrinking while the debt portion was rising.

Household balance sheets were healthy, but they had lost faith in housing markets, and they were disinvesting in home equity.  They still had plenty of net assets, and those net assets, seeking safety that no longer seemed available in home equity, they funded things like MBSs and then CDOs.  If, on net, that activity was the result of a global savings glut, then non-real estate net worth would have been declining.  But, on net, American net worth was rising.

When we only looked at the debt component, we missed all of this.  Part of that debt component is due to the Closed Access problem, that some urban real estate contains a capitalized claim on future political exclusion.  But, when we only focus on the level of debt over time, we miss the broader important factor.  Who borrows?  Rich people borrow. (See chart above.)

The reason debt has increased is because American balance sheets are healthy.  The reason there was a frenzy for AAA securities in 2006 and 2007 was because Americans were wealthier than they had ever been and they were scared about the housing market.  The most expensive housing markets, by far, were markets that we now know, with a decade's hindsight, were not destined for a bust.  Prices in the most expensive cities have performed as well as anywhere.  Yet, even in 2004 and 2005, homeowners were selling out of those markets and moving to other cities in large numbers - disinvesting in equity.

Were households borrowing out of home equity in order to consume?  Many surely were.  To the extent that they were, household net worth would have declined.

Today, American net worth as a percentage of disposable income is well into record levels by all of these measures.

* Oddly this selectivity is...selective.  For some reason, when talking about capital's claim on national income, economists seem to always use corporate profits - ignoring the part of corporate operating profits claimed by creditors.  When talking about household balance sheets, economists seem to only look at debt and ignore equity.  In both cases, the partial view is not very useful.

** There are also a small amount of non-financial assets amounting to about a quarter or a half of disposable income over time, so total net worth is slightly higher, but I have left that out for simplicity here.

Thursday, March 1, 2018

Henry George and Affordable Housing

Philip Bess has an article in American Affairs about the benefits of a land value tax (LVT), which was the idea that led to the fame of 19th century thinker Henry George.  There are a lot of interesting thoughts on urban development in the article, and I generally agree with the points made.

Reading the article triggered some thoughts regarding the land tax and housing affordability.  One of George's conclusions, which Bess refers to, is that having a near 100% land tax (which, effectively, is confiscation of unimproved land, but not the improvements and structures, by the government) would prevent speculative bubbles and would improve housing affordability by removing speculative value from the property.  Here is an interesting description, from the article, of how land ownership would look under a comprehensive LVT:
Land speculation would be impossible because only the use of land would have economic value. In turn, though, an LVT would also benefit land titleholders who would not pay tax on improvements to their land or productive activities undertaken thereon. And why would anyone sell land? One would not sell land to make a profit from the sale (which would not be possible), but rather to relieve oneself of a tax liability. That which one cannot or will not use one cannot own save for a fee. “Ownership” of land extends no further than an entitlement to the use of land, and that which an “owner” cannot use he must pay for or “sell” to someone else. “Buying” and “selling” land under a single tax regime therefore assume slightly different meanings than in ordinary discourse because what is really transferred is a land liability equal to land value—a liability virtually no one would accept if they did not plan to use the land.
George focuses on land banking and speculative ownership which is based on expectations of capital gains.   Here, I think my recent work on the housing bubble might add food for thought to this topic.  The point I have frequently made about analysis of the bubble is that there is a sense of attribution error in human nature deep enough to infect the academy. ("I bought a house in Phoenix in 2005 because I was tired of having my rent jacked up every year in LA, but I had to overpay for it because there were thousands of greedy speculators in the market at the time.")  I rarely see homebuyer expectations framed in terms of the present value of future rents.  Usually, especially during the bubble, they were framed in terms of expectations of future home prices.  Removing rental income from the mental framing of home values causes us to exaggerate the effect of speculation as a process unmoored from intrinsic present values.  I think this is the case regarding the idea that a LVT would eliminate land speculation or price volatility.

First, in terms of affordability, I would like to point out that ownership, first and foremost, is a rent hedge.  A Georgist tax would be a pretty harsh Darwinian imposition on homeowners.  California has Prop. 13 because rising home prices meant that older owners with limited incomes were faced with rising property taxes.  A Georgist LVT would impose that tax at a maximum level.  There would be no rent hedge.  It would be the antithesis of tenants rights.  If you couldn't pay the rising tax on a valuable property, you would have to move out.  George sees this as an advantage, and there are benefits to it.

One benefit would be, as a second order effect, that more housing development would be induced because developers would outbid less productive owners and build more improvements on the land, which they could profit from.  So, maybe where current building restrictions are the cause of high prices, this would solve the affordability problem, and little old ladies wouldn't be faced with rising taxes in the first place.

But, the first order effect would be to remove an important source of stability that is fundamental to ownership in our current system.

So, back to my point about speculation and price volatility, if price volatility is unmoored from the fundamentals, then it would be reduced.  However, if price volatility is related to fundamentals (the rental value of a home) then it would not.

Imagine an owner in an untaxed system vs. one in a system with 100% LVT.  Let's say the structure is worth $200,000 and the land is worth $200,000.  It has an annual rental value (after expenses) of $20,000 - $10,000 from the structure, $10,000 from the land.

Untaxed, a buyer pays $400,000 cash and there are no further transactions.  Under the LVT, a buyer pays $200,000 plus an annual $10,000 tax.  We might  imagine that they invest their other $200,000 in a long term fixed income security that pays $10,000 annually.  So, for the buyer, the transaction is essentially the same.  They need $400,000 to own the house.

Now, what if there is a market expectation that the land rental value will grow by 2% annually because of its location?  All the numbers above are the same, but in year two, the tax would be $10,200 instead of $10,000.  So, now, in order to perpetually control the property, the buyer would need enough savings to pay the initial $10,000 tax, and to grow by 2% each year.  So, the buyer would need to pay $200,000 for the house and save $280,000 to cover the taxes.  So, the total "price" would be $480,000.

Now, since rising rent is a liability for the owner, owners would still want to hedge that risk, just like they do today.  So, we might imagine that banks would offer a service.  They might develop a security that they sell, sort of like an annuity.  They would say, "Pay us a set amount, and we promise to make the LVT payments on a property in perpetuity."  So, now, the buyer would go to the bank, pay them $400,000.  The buyer would own the home and the bank would handle the LVT, so the owner would have no further expenses.

And, if the local housing market became valuable, and there was an expectation that land values would rise 2% annually, the bank would still sell the same security, but they would require a payment of $480,000.  And, if someone wanted to buy the property, they would have to purchase that annuity from the current owner, also at $480,000.  If we think of speculators betting on future rental value rather than betting on short term price increases they expect to reverse (presumably after they sell), then there is no difference in that changing value.

(edit: Changing interest rates would also affect the value, just as they do today.  And, of course, we could further imagine that buyers fund their initial payment for the annuity by getting a loan with a 30 year fixed amortization.)

(edit #2: Upon further thought, even unmoored speculation could happen with those annuities.  So, maybe my distinction between fundamental and unmoored speculation isn't that important.  Everything would basically be the same, except that since the government has taken a long position in the land, which it doesn't have in the untaxed version, for these instruments to work, the bank has to have a short position on the land, which is what the promise to pay the tax is, which it doesn't have in the untaxed version of the story.)

So, we can imagine that, to the extent that home values reflect capitalized future rental value, there really is no difference between the taxed and the untaxed market.  I differ from George on these two points.  (1) I think he, like most observers do, overestimates the significance of unmoored speculation on home prices, and (2) by removing a device for capitalizing future rental values, he can imagine that the value doesn't exist.  But, future rent or tax changes have an effect on current owners whether we imagine that they can hedge them or not.

Friday, February 23, 2018

Housing: Part 285 - There was always a shortage of housing, Phoenix Edition

Phoenix.  The poster child for the boom and bust housing market.  Built so many homes in the developers' lust for profit that it took years to burn off the inventory.

Sources: IRS,
S&P/Case-Shiller and Census data via FRED at St. Louis Federal Reserve Bank
Here's the latest in a long line of graphs that I should have thought to make months ago.  If you are new to this blog, you may be surprised to hear that that is all wrong.  If you are not new, you probably aren't surprised any more by this stuff.

I have combined housing permit data with migration data to review the timeline.

First, a couple of notes:

(1) The migration data is based on IRS estimates of tax filers.  This only covers about 3/4 of Phoenix households, so the total number of migrating households is larger than the numbers shown here.

(2) There is some level of housing expansion that is required to cover natural local population growth and the replacement of old units.  For this exercise, we can assume that the level of building (the black line) from 1995 to 2001 roughly reflects the level needed to meet this need, which during that period appears to have been about 1.5 units per 100 existing households, annually.

From 2002 to 2004, there was a rise in housing units that roughly paralleled the rise in in-migration that was coming due to California's housing shortage.

In 2005, the gross inflow of households continued to rise, but Phoenix builders were already pulling back.  Permits in 2005 were lower than permits in 2004.  Now, notice what happened in 2005.  Net in-migration topped out along with housing permits.  So, how did net migration top out if in-migration was still rising?  The only way it could.  Out-migration had started to rise.  In 2005, in Phoenix, there was a shortage of housing.  And, as a result, home prices in Phoenix in 2005 sky-rocketed.

One explanation I hear in Phoenix for why builders didn't build more in 2005 is that new units were just being bought up by speculators, and they didn't want to feed that bubble.  Another explanation I hear, which is more plausible to me, is that local municipal permitting offices were working at capacity.  The only reason that may not be plausible is that I have not heard builders complain about it.  And, maybe the first explanation is the reason why they didn't complain.  Maybe they would have individually applied for more lots, but they were satisfied with having the entire market constrained for supply because they were convinced that it was a collective action problem and keeping the entire market from developing more lots was beneficial.

It looks to me like that constraint was a significant cause of the spike in prices and of the development of a speculator market, since speculators could put their name in a hat to buy a home one month, knowing that the 10 other buyers in that development who were turned away would be back next month willing to pay more.

In any event, what is clear is that supply started to moderate even when in-migration was strong.

In 2006, in-migration began to fall, because the Fed had engineered a decline in residential investment, employment growth was declining, and the mass migration event was subsiding.  But, note what happened in 2006 in Phoenix.  Permits for new housing units again dropped more sharply than in-migration was.  And, so, because the shortage remained, prices remained elevated and outmigration continued to climb.

These trends continued in 2007. In-migration declined and out-migration increased while new units declined.  The only change was that by the end of 2007, prices were collapsing.  By 2008, out-migration and in-migration had converged so that there was hardly any in-migration into a city that regularly sees net migration rates of above 1% per year.  Prices continued to collapse and building was at a standstill.

Finally, in 2009, out-migration declined.  In-migration also continued to decline, but the decline in out-migration suggests that finally locals weren't being pushed out.

Now, take a look at vacancies in Phoenix.  In 2006, vacancies among owned homes increased.  Homeowners were having a hard time selling houses.  Normally, this is chalked up as the first sign of a market dealing with overbuilding.  But, look at rental vacancies.  There weren't too many units in Phoenix.  Rental vacancies remained low until late 2007.  The reason owned vacancies increased was because we purposefully sucked money out of the economy in a concerted attempt to cool off housing markets.  Rental vacancies were low and households were still having to move out of town, but the market for homebuyers was weak.

By the way, in my 4 categories of cities, this pattern only shows up in the Contagion cities.  The Contagion cities are the cities that had a mass migration event.  In the Contagion cities, as a group, owner vacancy increased in 2006 and renter vacancy increased in 2007.  For years after the crisis, federal policies were based on the idea that there was an national overhang of housing inventory to work off.

None of the other types of cities showed any systematic shift in either rental or owned home vacancy rates.  There was a rise in the "other" category, which was largely due to Detroit.  I will concede that Detroit has an oversupply of homes.

Monday, February 19, 2018

PCE Inflation

I usually update CPI inflation, since it is updated monthly.  Detailed PCE inflation is only updated quarterly, so I haven't tended to review it as often.  But, I thought it was worth checking up on.

Here is PCE (personal consumption expenditures) inflation through the end of 2017.  It follows a similar pattern as CPI inflation.  PCE core inflation is about 1.5%.  But, this consists of housing inflation above 3% and non-housing inflation of about 1%.*

It's always worth a reminder that Taylor Rule based complaints about monetary policy in the 2000s have to ignore the fact that PCE inflation never strayed far from 2%, and that non-housing core PCE inflation was below 2% for the entire period.  It is stunning to think that we live in a regime that has both (1) a central bank that explicitly runs an inflation targeting program and (2) a large contingent of economists who claim that for several years, a fundamental feature of the economy was a central bank that held the target interest rate several points below the neutral rate, creating a massive asset bubble, and the inflation rate averaged less than the consensus target rate for that entire period.  In fact, taking housing out of the measure, inflation has been below target for more than 20 years.

Why should we take housing out of the measure?  It's mostly imputed rent.

To make this easy to imagine, let's imagine a zero inflation target and zero growth.  In year 1, the average household has $50,000 income and $20,000 in cash expenses.  Additionally, the BEA notes that the household owns a home that has $15,000 in rental value, so that, while the household doesn't realize it, they have $65,000 in income and $35,000 in expenses.

In year 2, the central bank accidentally hits its target.  The household still has $50,000 income and $20,000 cash expenses.  But, the central bank notes that the household also owns a home that has $15,500 in rental value, so that, while the household doesn't realize it, they have $65,500 in income and $35,500 in expenses.

The central bank determines that they have erred by $500.  They need to pull back the amount of cash in the economy so that the household returns to a level of $65,000 and $35,000 in expenses.

Now, the problem is that the rental value has nothing to do with cash, so that the central bank can only reduce spending in other areas.  This means that when the central bank tightens policy, the household has $49,500 in income, $19,500 in cash expenses, and still has $15,500 in rental income and expense.  The central bank had to deflate the cash economy in order to meet their target.

The kicker is that the reason rent inflation is above target is because there isn't enough money to fund new construction!

*This is technically a "Housing and utilities" category, so a small part of the housing category itself is "energy", which probably adds a slight imperfection to my "PCE less food, energy, and housing" measure, which I have estimated manually.

Friday, February 16, 2018

Housing: Part 284 - No Bubbles, Only Busts

Timothy Taylor has a post up today on homeownership rates around the globe.

One of the key pieces of information that is a clue about what happened in the US is that US housing markets were not international outliers until 2007.  We had two markets - the Closed Access cities and the rest of the country.  The Closed Access cities looked like places with housing supply problems like the UK and Canada and the rest of the country looked like places that don't have housing supply problems, like Germany and Japan.

After 2007, prices in the US, along with just a couple other small countries, collapsed relative to those other places.  The Closed Access cities collapsed relative to Canada and the country's interior collapsed compared to Germany and Japan.

Benchmarking to the rest of the world, we didn't have a bubble.  We just had a bust.

Well, it turns out that this is the case if you look at homeownership rates, too.  From 1990 to 2005, homeownership here increased from 64% to 69%.  But, that was actually a slower increase than the typical country experienced over that time.  Then, after 2005, homeownership rates collapsed here, along with prices.  In the rest of the world, homeownership rates are still about where they were in 2005.

No bubbles.  Just a bust.

Side note.  Taylor's post includes this interesting bit:
Interestingly, anecdotes suggest that many German households rent their primary residence, but purchase a nearby home to rent for income (which requires a large down payment but receives generous depreciation benefits). This allows residents to hedge themselves against the potential of rent increases in a system that provides few tax subsidies to owning a home.
We have a lot to learn from Germany.  They are one of the countries with stable home prices.  The reason, broadly speaking, seems to be that we subsidize ownership relative to renting and then we put up policy gatekeepers against ownership and obstructions to new supply.  Germany taxes ownership and has fewer obstructions to supply.  We induce a bidding war on limited stock and they discourage consumption of an abundant stock.

But, this seems like it's a bit too far.  I don't think it makes much sense to have two neighbors renting to one another for a tax arbitrage.  We should do away with the subsidies to ownership, but the goal should be a neutral field.

This is one reason why I think low taxes on capital income are beneficial.  If other capital is lightly taxed, then these potential tax incongruities in housing become less important.  And, in the US, those tax incongruities are regressive and destabilizing.  They subsidize high end housing, and they force households to take out large amounts of debt to finance imputed future tax benefits.