Marginal vs. Average Debt to Equity in Housing

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Alejandro Justiniano and others write,

if the relaxation of collateral constraints had been widespread, it should have resulted in a surge of mortgage debt relative to the value of real estate.

In the data, however, household debt and real estate values rose in tandem, leaving their ratio roughly unchanged over the first half of the 2000s, as shown in Figure 3. In fact, this ratio only spiked when home prices tumbled starting in 2006.

Pointer from Mark Thoma.

Suppose that back when lenders asked for 20 percent down, three families bought houses for $100,000 each and put $20,000 down each. Total mortgage debt is $240,000 and total home values are $300,000. The ratio of household to real estate debt is 80 percent.

Next, lenders allow someone to buy a house with no money down. As a result, home prices rise to $130,000. Adding $130,000 debt to the debt of the other three households (ignoring any equity they may have built up through paying down mortgage principal), we have total mortgage debt of $370,000. But total home values are $520,000, so that the average ratio of debt to equity has actually fallen, to just over 70 percent.

As long as home prices are rising, the last thing you should expect is for the average debt to equity ratio to rise. The fact that it did not fall is an indication of how powerful the boom in credit was. Only if you use a silly representative-agent model, in which there is no difference between average and marginal borrowers, would you predict something different. I have not read the paper, but I suspect that is what the authors did.

Four Forces Watch: Gentrification

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Luke Juday and others report,

  • Since 1990, downtowns and central neighborhoods in cities across the country have attracted significantly more educated and higher-income residents.
  • Young adults (22-34 years old) have increased as a proportion of residents in the center of nearly every city in the country, while falling as a proportion across all other areas.
  • Older residents (ages 60 and up) form a smaller proportion of the inner-city population than they did in 1990.
  • In most cities, a decrease in income and education levels from 1990 to 2012 is evident several miles outside the core. How far outside depends on the city, with the sharpest drop being anywhere from 4 to 15 miles from the center.
  • Households below the federal poverty line are migrating outwards from city centers. The poverty rate has increased significantly several miles outside the core in many cities.

Pointer from WaPo.

This is gentrification. I view it as largely resulting from the New Commanding Heights. Universities and hospitals locate in cities, providing employment opportunities for affluent professionals. At the margin, this drives some poor people out of cities and into close-in suburbs. Meanwhile, close-in suburbs are affected by the decline in employment opportunities for low-skilled workers, which comes in part from factor-price equalization and Moore’s Law.

Kevin Erdmann Revisits the Housing Boom

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He writes,

the commonly repeated anecdotes of janitors and checkout clerks being
handed $300,000 mortgages on a hope and a prayer do not appear to be representative. On net, all the new mortgages went to families with incomes around $45,000 and higher.

And elsewhere he writes,

growth in homeownership came from high income households and that households didn’t increase their debt payment/income ratios or their relative consumption of housing during the boom. The evidence against the standard narrative is even more stark when we look at dollar levels, because, despite frequent implications to the contrary, low income households don’t tend to take on nearly as much debt as high income households.

Consider two ratios:

1. Debt-to-income.

2. Debt-to-equity.

Many narratives of the financial crisis focus on debt-to-income ratios. The oppressor-oppressed narrative is that greedy lenders imposed inappropriately high debt-to-income ratios on innocent borrowers, who then could not meet their mortgage payments. The civilization-barbarism narratives stress the use of houses as ATMs and the forced expansion of lending toward irresponsible borrowers.

It seems to me that Erdmann is suggesting that debt-to-income ratios did not got out of line, or perhaps they only got out of line for high-income borrowers. He may be right, although I would suggest looking at the Home Mortgage Disclosure Act (HMDA) data and not just the survey of consumer finances.

Ever since Bob Van Order explained the mortgage default option to me almost 30 years ago, I have viewed debt-to-equity as more important than debt-to-income. If we define sup-prime lending in terms of debt-to-income, then I am inclined not to attach much significance to the proportion of sub-prime loans. To me, the dangerous loans are the ones with low down payments. There is some overlap between those and loans with high debt-to-income ratios, but not enough overlap to equate the two.

Let’s take Erdmann’s analysis of debt and income as accurate. I see no reason to change my preferred narrative of mortgage lending and the housing boom. That is, there was a surge in lending with low down payments. I am pretty confident that the HMDA data support this. In addition, there was a surge of lending for non-owner-occupied homes (speculators).

Think of owner-occupants with low down payments and non-owner-occupants as the speculative component in the housing market. My narrative is that the speculative component soared during the housing boom. These speculators did very well until house prices started to level off late in 2006. Then what had been a virtuous cycle on the way up turned into a vicious cycle on the way down, and the speculative buyers got hammered.

Getting from that to a recession is the more difficult part for me, because I do not allow myself to use the words “aggregate demand.” Instead, to explain the recession I have to make a case that many patterns of specialization and trade became unsustainable, or were finally perceived as unsustainable, while new sustainable patterns were difficult to discover. I might argue that the surge in government economic intervention exacerbated the difficulty of discovering new patterns of sustainable specialization and trade. TARP and the stimulus were largely efforts at redistribution, and that gave people a bigger incentive to focus on grabbing some of the loot than on developing a sustainable new business. Of course, Keynesians will tell you that the problem is that the surge in government intervention should have been bigger and lasted longer.

Piketty and Mort Sahl

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Timothy Taylor quotes from a recent journal article by Piketty, and then summarizes,

In case you didn’t catch all that, Piketty is noting that r>g is not useful for discussing income inequality, and does not necessarily lead to wealth inequality, and that the future of wealth inequality is highly uncertain. Instead, Piketty argues in JEP that when the difference between r and g is relatively large, it will tend to exaggerate the effect of other changes that make wealth more unequal. As he writes: “To summarize: the effect of r − g on inequality follows from its dynamic cumulative effects in wealth accumulation models with random shocks, and the quantitative magnitude of this impact seems to be sufficiently large to account for very important variations in wealth inequality.”

It was the humorist Mort Sahl who would say, “I am prepared not only to retract anything I said but to deny under oath that I ever said it.”

Reluctant Heroes Austan Goolsbee and Alan Krueger

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They write,

It is fair to say that no one involved in the decision to rescue and restructure GM and Chrysler ever wanted to be in the position of bailing out failed companies or having the government own a majority stake in a major private company. We are both thrilled and relieved with the result: the automakers got back on their feet, which helped the recovery of the U.S. economy. Indeed, the auto industry’s outsized contribution to the economic recovery has been one of the unexpected consequences of the government intervention.

Pointer from Tyler Cowen.

I guess there is no such thing as the seen and the unseen. For those of you who do not know, Goolsbee and Krueger were officials in the Obama Administration as the bailout was being executed. Here, if their arms do not break from patting themselves on the back, it won’t be for lack of trying.

Timothy Taylor, I question the editorial decision to publish this piece, even if you also include an article that challenges the auto bailouts. Could you not find a neutral party to tell the pro-bailout side? If not, then what does that tell us?

Human Capital and Chainsaw Arms

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Noah Smith offers this:

So how should we think about human capital? Here’s an analogy that I think works well. You agree that a chainsaw is capital, right? OK, now imagine a chainsaw that you graft permanently onto someone’s arm, like Bruce Campbell in the movie Evil Dead 2. It’s so thoroughly grafted on that you can’t remove it without making it permanently useless.

This chainsaw is very very much like human capital.

My prediction is that this metaphor will become increasingly apt, as implants, drugs, and genetic enhancements become a larger share of human capital. Today’s mouse capital is a preview.

New Commanding Heights Watch

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From the NYT.

Ms. Waugh, like many other hard-working and often overlooked Americans, has secured a spot in a profoundly transformed middle class. While the group continues to include large numbers of people sitting at desks, far fewer middle-income workers of the 21st century are donning overalls. Instead, reflecting the biggest change in recent years, millions more are in scrubs.

Pointer from Tyler Cowen. The New Commanding Heights are health care and education. As they increase employment at the margin while manufacturing production work decreases at the margin, male participation in the labor force continues to decline. Note, however, that female labor force participation has been trending down in this century, also.

Four Forces Watch: Larry and the Robots

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Mike Konczal writes,

There’s been a small, but influential, hysteria surrounding the idea is that a huge wave of automation, technology and skills have lead to a massive structural change in the economy since 2010.

He goes on to say that Larry Summers has demolished this notion, by pointing out that we have not seen rapid productivity growth over this period.

This looks suspiciously like a straw man to me. I am about as big a believer as there is in the significance of structural change, but I do not see a “huge wave of automation” that has taken place over the past five years.

My thoughts:

1. What I do see are the four forces: the New Commanding Heights (demand for physical goods tapering off while demand for health care and education rises); demographic dispersion–what Charles Murray calls Coming Apart; factor-price equalization (American workers confronting stiffer foreign competition); and Moore’s Law (improvements in computers and communication).

2. These four forces have been operating for decades, and there was nothing peculiar about the 2010-2014 period. The New Commanding Heights force has been operating for more than 50 years. The demographic dispersion force got started about 50 years ago, but for the first 25 years or so the impact was small. Instead, the most notable demographic change from 1965 to 1990 was the increase in female labor force participation. Factor-price equalization had to await liberalization of the economies of China and India, which did not really get started until the 1980s and even then took a while to have an impact. Moore’s Law was articulated in the 1960s, but as recently as the late 1980s Robert Solow’s quip that we see computers everywhere but in the productivity statistics seemed apt.

3. The four forces cause the economy to move in the direction depicted in Neal Stephenson’s The Diamond Age. In that novel, we see Thetes, who work very little and live inexpensively (think of a consumption basket dominated by big-screen TVs). And we see Vickies, who work creatively and hard in order to consume unnecessary luxury services (think of high-tuition education, high-end precautionary medical care, and exotic vacations).

4. Larry Summers looks at the last twenty years and sees a “secular stagnation” in aggregate demand, interrupted by the dotcom bubble and then the housing bubble. Instead, I look at the last 15 years and see The Diamond Age starting to become reality. The housing bubble gave Thetes the impression of being wealthier than they really were, and when it popped they had to adjust to reality. (Although one could argue that, illusions aside, they did not lose home equity, because they did not have any in the first place.) The process of adjusting to reality can take time–look at Greece.

5. Consider the statement, “If we had more aggregate demand, then more non-high-skilled people would have jobs and wages would be higher.”

I do not believe that statement, Instead, I believe that nothing short of direct intervention in labor markets (government make-work jobs and wage subsidies, or you could hope for an impact from changes in means-tested programs that reduce implicit marginal tax rates) will change macroeconomic outcomes. But as long as jobs and wages are lower than what Summers/Krugman/Sumner think they should be, there is no way to falsify the statement that “if we had more aggregate demand….” The alleged lack of jobs and wages can be viewed from their perspective as proof that there is insufficient aggregate demand. There is no measure of “sufficient aggregate demand” that exists independently from the desired result of a larger wage bill. Indeed, Sumner would say that the wage bill is a measure of aggregate demand that can be targeted by the Fed.

The Harm of Government Debt

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Tyler Cowen writes,

I worry that the general decline of discretionary government spending may make politics less stable (but also more interesting, not necessarily in a good way). When there is plenty of spending to bicker about, politics revolves around that question, which is relatively harmless. When all the spending is tied up, we move closer to the battlefield of symbolic goods, bringing us back to “less stable and more interesting.” If that is a cause, this trend is likely to spread.

For a longer essay on the way that government borrowing creates political friction, see my essay Lenders and Spenders.

Four Forces Watch: Coastal Incomes

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Derek Thompson reports,

For Flint, Detroit, Youngstown, Cleveland, and Milwaukee, the demise of manufacturing, steel production, and other off-shored blue-collar work have gutted these foundries of good middle-class jobs.

Pointer from Mark J. Perry, who provides two interesting tables and much interesting analysis, including

Not surprisingly, more than half (11) of the top 20 metro areas with the highest median incomes for Americans ages 18-34 in 1980 were in Midwest or Rust Belt states (Flint, Detroit, Chicago, Milwaukee, Youngstown, Cleveland, Minneapolis-St. Paul, Pittsburgh, Toledo, Grand Rapids and Cincinnati). By 2009-2013, only three of the top 20 metro areas by income for young Americans were in Midwest or Rust Belt states: Minneapolis-St. Paul, Chicago and Des Moines (and none of those cities have a strong manufacturing base), and almost all of the top 20 metros by income for young Americans were in East Coast or West Coast states (San Jose, San Francisco, Washington, DC, Boston, New York, Philadelphia, Baltimore, Seattle, etc.).

The force that this illustrates is the New Commanding Heights. As income rises, the demand for manufactured goods tapers off, and much more of the increased income is spent on education and health care.