Category Archives: Housing and housing finance

The outlook for today’s young adults

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Joel Kotkin and Wendell Cox write,

They have entered an economy where the most rapid job growth for their generation has been in generally low-paying professions, such as leisure/hospitality and healthcare, while jobs in higher-paying fields such as information, finance, manufacturing and construction have declined for them. More than 20 percent of people 18 to 34 live in poverty, up from 14 percent in 1980.

The main point of the article is that California housing regulations are harmful to young adults. You can regard the consequent high house prices as a wealth transfer from the younger generation to their parents’ generation.

Affordable Housing is a Supply Problem

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Ed Glaeser writes,

If demand alone drove prices, then we should expect to see places that have high costs also have high levels of construction.

The reverse is true. Places that are expensive don’t build a lot and places that build a lot aren’t expensive. San Francisco and urban Honolulu have the highest ratios of prices to construction costs in our data, and these areas permitted little housing between 2000 and 2013. In our sample, Las Vegas was the biggest builder and it emerged from the crisis with home values far below construction costs.

Pointer from Tyler Cowen.

Glaeser also writes,

No locality considers the impact that their local rules may induce more building elsewhere.

This suggests a new maxim: Environmentalists impose negative externalities. If construction harms the environment, then diverting construction elsewhere harms someone else’s environment. Along the same lines, when we regulate fossil fuels in the U.S., we probably shift production to other countries which have a higher intensity of fossil fuel use than we do.

House price-to-income ratios across cities

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I find this sort of data fascinating. In Detroit, median house price is $38K and median household income is $26K, for a ratio of roughly 1.5 In San Francisco, with a median house price of $1.1 million and median household income of $81K, the ratio roughly 14.7

What should the ratio be? price/income = (price/rent) times (rent/income). Figure that in a city where there is plenty of housing supply, you might spend get by with spending only 1/5 of your income on rent. In an city where housing is scarce, you might need to spend 1/2 your income on rent.

A price/rent ratio is sort of comparable to price/earnings ratio on stocks. It should tend to be lower than stock P/E’s, because of high transactions costs, property taxes, HOA fees, and depreciation.

Historically, according to Robert Shiller, the housing price-rent ratio is around 10 or 12. So, if I take numbers on the low side, namely 1/5 for rent/income and 10 for price/rent, I get a price/income ratio of 2.0. Only Detroit is below that.

If I use high values, of 0.5 for rent/income and 12 for price-rent, I get a price/income ratio of 6.0 Of the 27 cities, 15 fall within a range of 2.0 and 6.0, which means that they are in line with historical values.

Another 6 cities have values ranging from 7 to 9. There are another 5 cities with ratios over 9, topped off by San Francisco.

Of course, the marginal buyer of the median home is not necessarily the person with median income. I think that is safe to say that in the cities with ratios over 9, median-income residents are not the marginal homebuyers. In Miami, for example, my guess is that a fair number of home buyers reside in other cities, and that could raise the price/income ratio within the city. But otherwise, those high ratios could be a sign that speculation is getting out of hand.

Financial Policy if I were in charge

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This afternoon, I am supposed to participate in a discussion of financial regulatory policy. There are so many participants, including big shots like John Taylor and John Cochrane, that I may end up not saying anything. I probably will just hand out the post that I put up in 2010, which I still like very much. Here it is:

1. Extricate the government from the mortgage market as soon as is practical. I foresee reducing the maximum mortgage amounts that of Freddie and Fannie to zero in stages over a period of three years, then selling off their portfolios two years after that. I would even get rid of FHA. I would also get rid of the mortgage interest deduction. My guess is that the market would evolve toward higher down payments, and probably toward mortgages like the Canadian five-year rollover.

2. Housing aid to poor people would take the form of vouchers. No other Federal involvement in housing.

3. I would support a law that says that lenders must not make loans with the intent of exploiting borrower ignorance. Allow case law to develop to define rules and norms in support of that principle, rather than try to come up with fool-proof regulations.

4. Break up the top 10 banks into 40 banks. I think that is the best solution to the “too big to fail” problem, although there is no perfect solution to Minsky-type financial cycles.

5. Replace capital requirements with systems that put senior creditors in line to lose money in a default. Let them discipline the risk-taking of financial institutions.

6. Define priorities for creditors in a bank bankruptcy. I think that the solution to the social value–or lack thereof–of derivatives and other exotic instruments can be handled by the priority assigned to them. I would assign them a low priority. That is, first ordinary depositors get paid off. Then holders of ordinary debt. Other contracts, such as swaps or derivatives, come after that. I think that this would provide all the incentives needed either to curb derivatives or lead them to be traded on an organized exchange. I don.t think that getting them onto an organized exchange should be sought after as an end in itself.

7. Get rid of the corporate income tax, which encourages excess leverage. If the private sector, including banks, had lower debt/equity ratios, the financial system would be sounder.

8. Develop emergency response teams and backup systems that can ensure that the basic components of the financial system, particularly transaction processing, can survive various disaster scenarios, both technological and financial.

The overarching principle I have is that we should try to make the financial system easy to fix. The more you try to make it harder to break, the more recklessly people will behave. By reducing the incentives for debt finance and for exotic finance, you help promote a financial system that breaks the way the Dotcom bubble broke, with much lesser secondary consequences.

[Postscript:

1. I took four books to the meeting, and I got autographs from their authors.

2. We are not supposed to talk about what was said.

3. I did not hand anything out. I requested to be called on at one of the discussions, but my time came just as people had been promised a coffee/bathroom break, so I did not receive very much attention. I tried to say that it is futile to try to make the financial system hard to break. Crises come from surprises, and you cannot outlaw surprises. I suggested instead the approach of making the system easy to fix. Have backup systems to keep ATMs working (Paulson and Bernanke claimed that without TARP the system would have been so frozen that ATMS would have run out of cash. That was a sales pitch that the “common man” needed TARP and I think it was probably a lie, but in any case a backup system would be a good idea.); backup systems for settlement and clearing of transactions on exchanges in case a financial derivatives exchange blows up; and changing the tax bias to favor equity rather than debt.

4. A commenter says that eliminating the mortgage interest deduction would be a blow to the middle class. Actually, if you assume an across-the-board tax cut so that the change is “revenue neutral,” it probably helps the middle class. The benefits of the deduction go mainly to the rich. In fact, you could just cap the deduction at a low level and leave the middle-class borrower alone, and still get most of the revenue from it. But for me, the point of getting rid of the deduction is not to get revenue, but to change the incentives on leverage. So I do not want to cap it. Instead, I would prefer to have it phase out over a period of 5 or 10 years for people who have mortgages.]

The Source of Systemic Financial Risk

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Charles Calomiris says that it is the political system.

There are two important systemic threats to financial stability: government policies that subsidize mortgage risk, and government policies that insure bank debts (and, more generally, that subsidize bank default risk through a variety of channels, including—but not limited to—“toobig-to-fail” protection).

As you know, I have some simple solutions to the problem of subsidizing mortgage risk.

1. Do not provide government guarantees or subsidies for investor loans, meaning mortgages on non-owner-occupied homes. I have linked to a study that found that over one third of mortgage lending in 2006 went to people who were buying a house in addition to the one that they occupied.

2. Do not provide government guarantees or subsidies for loans that extract equity from homes, including second mortgages and cash-out refinances.

These simple, logical steps would have been sufficient to prevent the financial crisis of 2008. However, they would be fiercely opposed by industry trade groups, such as the Mortgage Bankers Association.

Restrict Supply, Subsidize Demand

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The Los Angeles Times reports,

Home builders are not keeping up with demand for homes in California. There just aren’t enough homes being built relative to the growing number of households in California.

What is the “solution” to this supply problem? Subsidize demand:

a lot of local municipalities have first-time home buyer-assistance programs, and people should look at those programs in their area. You also may be able to qualify for additional assistance as a first-time home buyer based on your occupation, for folks like teachers, firefighters and law enforcement.

And people wonder why housing in California keeps getting less affordable.

The State of the Housing Market

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Scott Sumner writes,

It looks like the supply side is being hit by a triple whammy of adverse supply shocks

These are problems with funding, land and labor supply.

I think that the problem boils down to land in a few cities, like San Francisco, Los Angeles, New York, and Boston. And we know that the land scarcity is artificial, due to regulation. Public policy is to subsidize demand and restrict supply. My guess is that as the problem of housing scarcity becomes more apparent (there was a rather uninformative article about it in the WaPo last week), the politicians will work on subsidizing demand.

A Good Start on Mortgage Finance

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According to this story,

The Department of Housing and Urban Development said Friday that the reduction to the annual mortgage insurance premiums borrowers pay when taking out government-backed home loans has been “suspended indefinitely.”

…Borrowers with larger home loans would have seen an even bigger drop in their premium rate.

The premium cut was an abominable last-minute policy of the outgoing Administration. Fortunately, the Trump Administration canceled it before it could take effect. [Update: Today’s WaPo editorial agrees with me.]

The worst aspect of the policy would have been the special rate cut for large mortgages. Offering particularly cheap loans for large amounts is nothing but a gift to young professionals pushing their way into cities where housing supply is fixed.

If you want to make housing more affordable in San Francisco or Brooklyn, you have to address supply. Subsidizing demand without increasing supply simply serves to drive up prices and squeeze out the lower middle class.

Freddie, Fannie, and so-called Privatization

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The WaPo reports,

Steven Mnuchin, President-elect Donald Trump’s nominee to lead the Treasury Department, said Wednesday that privatizing Fannie Mae and Freddie Mac is “right up there on the top-10 list of things we’re going to get done,” setting off a buying frenzy among investors.

I am very leery of this. My preferred approach for getting the government out of the mortgage market is the following:

1. Immediately stop any government support for cash-out refinances, second mortgages, and investor loans. Restrict support to owner-occupied purchase mortgages or refinances that lower the rate and term of the mortgage without the borrower taking out equity. Leave all the other mortgages to the private sector.

2. Gradually lower the maximum loan amounts for government support. As you do this, the private sector will have to fill in. If somebody steps up to issue mortgage-backed securities, fine. If instead what emerges is a model with banks holding the mortgages they originate while using long-term funding methods, then that is fine, too.

If you were to suddenly “privatize” Freddie and Fannie, you might end up restoring the status quo prior to 2008, with these institutions enjoying “too big to fail” status. They can use that status to borrow cheaply in credit markets and behave like hedge funds. I can remember when they were doing exotic things involving securities denominated in foreign currency that had nothing to do with their supposed “mission” of helping housing. These exotic transactions did not cause the firms to blow up then–because they blew up on credit risk instead.

I really detest the model of privatized profits and socialized risks. If you are going to privatize Freddie and Fannie, then you have to figure out a regulatory scheme to avoid socializing the risks. It’s not easy.

California’s Housing Shortage

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Mckinsey folks estimate it at 2 million. Pointer from Alex Tabarrok.

The market clears, of course, but at a price point that is very high relative to income.

Presumably, this is a supply problem. You do not cure a supply problem with mortgage subsidies or rent controls.

They have several suggestions for how to fix it. First,

In California cities with populations of more than 100,000 people, we conservatively estimate that there is capacity to build 103,000 to 225,000 housing units on vacant land that has already cleared the multifamily zoning hurdle (Exhibit 8). One-third of this opportunity is in Los Angeles County. This estimate applies only to vacant and already-zoned urban land capacity and does not account for whether it is economically feasible to build housing onthis land.

Los Angeles County is a big place, and the vacant parcels seem to be all over the map. That leads me to worry about transportation issues. And it leads to their second recommendation.

We estimate that by increasing housing density around high-frequency public transit stations, California could build 1.2 million to 3 million units within a half-mile radius of transit. . . in our “high case,” 34 percent, or one million units, would be in the Bay Area; 8 percent, or 245,000 units, in the Sacramento area; and 30 percent, or 903,000 units, in the Los Angeles area.

An interesting paragraph about the disincentive to approve new housing appears in a footnote:

One reason for this is the small share of property tax that is allocated to the city from a residential development. The city must provide municipal services for the development, yet a large share of the development’s property taxes flows to non-city entities such as the county, the school district, and special-purpose districts such as fire and water districts. In addition, affordable units built by non-profit organizations are exempt from property tax, since such units qualify for the “welfare exemption” outlined in the state constitution. For a given parcel, local governments would often rather approve developments that generate more revenue, such as retail projects, than housing. This “land-use fiscalization” is commonly cited as a barrier to residential development in California.

On the permitting process in general, there is this:

California stakeholders could study other systems to get a fact-based view of “what good looks like”—for example, a robust, participatory, and transparent land-use process where outcomes are measured in days or weeks, rather than years or decades.

The report strikes me as very good.

Along similar lines, see Richard Epstein.

Another piece, recommended by Steve Teles, is David Schleicher’s City Unplanning.

Each time a community board approves a new development, the city could provide a time-limited property tax rebate to residents in the board’s district equal to a percentage of the “tax increment” created by the development (the tax increment is the increase in tax revenues caused by increasing property values18). The payments would head off local opposition to new development