Our Dysfunctional Housing Market

For Sale Homes-Signs.jpg

This is the story of how elites prospered while killing the singular trend that built America, and all that you proles got in return was a dysfunctional housing market. In a reversal of more than 100 years of American history, the unique force that built the United States and the wealth of its inhabitants – geographic convergence – has been stopped. Based on labor mobility and the income convergence it engendered, geographic convergence was our great equalizer, our economy’s ace in the hole: even in the worst of times people could always move from where they were to somewhere else to improve their prospects. Well, they can’t anymore, and the reason is housing.

Who killed geographic and income convergence? Well, we wealthy, older, property-rich elites in desirable zip codes did. Call us the new landed gentry if you like. I would like to say we’re really, really, sorry but I don’t see us doing anything to correct it. It wasn’t on purpose; it was an inadvertent, unintended consequence of well-intentioned laws and regulations concerning land use, zoning, building codes, permits, property taxes and the like. We didn’t undertake those restrictions on building and development specifically to exclude you people (wait – did I really just say “you people?”). Why heck, we’re concerned as all get-out about rising inequality and income disparity, just not in our own neighborhoods, okay? And besides, residential segregation is voluntary, isn’t it? Didn’t you read Bill Bishop's “The Big Sort”? We all naturally prefer to cluster with the like-minded and socioeconomically similar, don’t we?

We used to have a housing market that consisted of buyers, sellers, and the supply of homes for sale. Today, the housing market is artificial and even fraudulent — it's anything but a free market in which inventory is allowed to clear. Millions have defaulted, and millions more are in the pipeline to do so. Because of this massive shadow inventory of underwater and foreclosed homes that is only slowly being leaked out to market, there are millions of people who can’t sell the houses where they live, millions who can’t buy houses where they want to live, and millions who may never get a foot on the housing ladder at all.

The government response — bless ’em, they do represent us — is to do everything possible to keep housing prices inflated. Interest rates are kept absurdly low (if you can qualify, and we do!), and the federal government now guarantees 90% of all mortgage loans (defaults and delinquencies are staggering, but so what?). Inventory is being constrained by banks which have not only been bailed out, but given the ability to rewrite accounting rules, for example, suspending mark-to-market and taking years to move on non-performing loans. Some of your neighbors haven’t made a mortgage payment in years but have yet to receive a notice of default. The result? In some markets, housing mania has returned. Flippers and non-resident investors are flooding in and crowding out people who actually want to buy homes in which to live. We’re inflating the bubble again. Thank you so much — don’t mind the feudalism!

All of this allows us to continue to buy expensive homes with low down payments and monthly payments (relative to income, of course, and ours is larger than yours), max out the tax deduction on the back-end, and escape capital gains taxes on the first $500,000 of profit on the sale of a home. Sweet. I guess they’re trying to goose consumption, but with your flat household incomes, it doesn’t seem to be working.

How We Got Here - In a recent working paper two Harvard economists, Peter Ganong and Daniel Shoag, explain how geographic and income convergence started to slow in the 1960s, when rich people in rich places started constraining land use through regulation. This limited the housing supply in those places, which forced prices up, and started to squeeze out those with lower incomes.

Housing prices have always been more expensive in high-income places, but the difference now is unbridgeable. The result is that people can’t get on the upward mobility ladder, thus increasing the inequality that these same elites bemoan. But they don’t see or understand the connection between this income divergence and their own regulations and restrictions.

What to Do? - I recently had the opportunity to contribute to a symposium hosted by CORE (National Community Renaissance), one of the largest nonprofit affordable housing development corporations in the United States. As a catalyst we used an article by Joel Kotkin and Steve PonTell, CORE’s President and CEO, “Is the Dream Dead? Housing’s Next Challenge.” The authors note that homeownership is at a 15-year low, despite the fact that owning a home is now cheaper than renting in most of the top 100 metro areas, but that lower housing prices have not done much to improve the conditions for lower-income people. Indeed, as people who would normally own housing become renters, price pressure has actually worsened for renters.

Housing has traditionally been the main way Americans accumulated assets, created wealth, raised families, became part of communities, and contributed to social stability. But housing is only one factor squeezing lower and middle income Americans. The real culprit has been stagnant and even declining incomes. The authors conclude, as I read it, that if you want to champion those less well-off, the way to do it is with solutions that are less government-centric: not to give them housing and income, but to take away the barriers to housing, allow the construction of new, market-friendly housing, and boost wealth creation through economic development.

What If Housing Declines For A Generation? - A strong case can be made that the fundamental supports of the housing market – demographics, employment, creditworthiness and income – will not recover for a generation, and that housing has lost its status as the foundation of middle class wealth, not for a generation, but for the long term.

Charles Hugh Smith has written that rising rates of home-ownership require five conditions: favorable demographics, rising household formation rates, a large cohort of creditworthy potential buyers, an economy that generates rising incomes to support home-ownership, and an unshakable belief that owning a house is a favorable and secure investment that will rise in value in the decades ahead.

If the first four conditions have eroded, then the belief in the permanence of a rising housing market will also erode. And they all have in fact eroded:

  • Today's demographics are not favorable to housing on a number of fronts.
  • Household formation is in a long-term decline.
  • Labor's share of the national income has plummeted to historic lows, and
    income has declined, especially for young workers.
  • Part-time jobs and temp jobs do not generate enough stable income to support a mortgage. It's easy to qualify people for a mortgage. The hard part is making sure that they will have enough income and faith to service the mortgage for the next 30 years.

Arnold King of George Mason University has argued that home ownership subsidies have imposed costs on the economy and society that are large and clear, while the benefits of such subsidies are, at best, small and vague. His conclusion: Who needs home ownership?

I’m more worried about Smith's conclusion, which is an idea that few are willing to entertain: the possibility that housing is no longer the foundation of middle class wealth, and that its decline is structural, not cyclical. What if he’s right?

Dr. Roger Selbert is a trend analyst, researcher, writer and speaker. Growth Strategies is his newsletter on economic, social and demographic trends. Roger is economic analyst, North American representative and Principal for the US Consumer Demand Index, a monthly survey of American households’ buying intentions.

Flickr photo by Sean Dreilinger: For Sale signs posted in Lake Oswego, Oregon


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Fingering the vital factors

As long as supply of housing is sufficiently elastic, the median multiple house price stays at around 3.

Why then, has the family home always been regarded as "wealth" and "an investment"? It is quite common for the family home to rise in value in real terms, over its owners lifetime, even in the stable-median-multiple cities.

I suggest that one reason is that in a growing city, the house one bought when one was young, ends up commanding a "location" premium, relative to the houses that have been built since, with the urban fringe pushing out. The median multiple remains anchored down at around 3 by the steady supply of homes on low-cost urban fringe land, but homes at mature locations do indeed rise in value in real terms.

This led to all sorts of wrong assumptions when it came to absurd and unprecedented "100% gains in 7 years", which was only possible in those regions with relentless urban growth containment policies. The reason it took decades for these policies to really do their full harm, is that for much of the time, there remained "safety vent" markets in a region or a whole State, like California, that took the pressure off the price inflation in the ones where growth constraint was enacted. But once there were no longer sufficient safety vent markets, the whole State's prices went crazy.

What Roger Selbert is saying is certainly true about California. But why would much need to have changed in the 200 out of 260 cities, that did not participate in the so-called "US house price bubble"? Why would people's attitudes need to have changed as much in a market where median multiples have stayed within a range of 2.7 to 3.2, in comparison to where they have gone from below 4 (in the 1980's) to 10 or higher (by 2006), and "crashed" back to a still-unaffordable 5 or so?

Furthermore, many of the so-called "anti growth" regulations actually have little effect on median multiples; the crucial one, is whether farmland can be bought for true rural values and developed for urban use without costly fees and delays. There are plenty of "exclusionary" suburbs in the "median-multiple 3" cities, yet the market-wide median multiples are still 3. In contrast, in many cities around the world where median multiples are 5, 6, and higher, no amount of high density, small lots, etc means that housing of any kind is affordable. Look at the UK. It is certainly not MINIMUM lot sizes that are responsible for their chronic problems with unaffordability and social exclusion. The single crucial factor is that in the UK, the planning system results in inflation in the cost of land by hundreds or thousands of percent over true rural values, in any new fringe developments at all. The other so called "exclusionary" regulations are red herrings and a diversion from the real problem.

I suggest there is much less of the "mobility" problem Roger Selbert refers to, in Texas than there is in California. In fact Americans should be counting their blessings. There is no other country in the world that HAS a "Texas" to which people can flee for affordable housing and life opportunity. NO city in Australia or the UK, for example, has median multiples below 6. Where can people trapped in the vice that Roger Selbert talks about, in Melbourne or Sheffield, flee to?

"Home ownership subsidies" are not the problem that Arnold King and others make them out to be, as long as housing supply is sufficiently elastic - meaning freedom to convert rural land to urban - to keep median multiples stable.

".....Based on labor mobility and the income convergence it engendered, geographic convergence was our great equalizer....."

I would add to that, the freedom to convert rural land to urban meant that the cost of "land" in the URBAN economy steadily FELL relative to rising urban incomes, meaning that while wealthier people tended to consume large amounts of it, lower and lower income people (in relative terms) could obtain "something". If you compare the typical affordable-land US city with the typical growth-contained UK one, you will find 90% of people in the US cities enjoying amenities of housing (eg space, location, quality, age and condition, local amenity) that only the top 5% enjoy in the UK.

So the USA's "great equalizer" was not just geographic convergence, but the great democratisation of property ownership through the falling real price of urban land. In contrast, Gibbons, Overman and Resende, "Real Income Disparities in Great Britain" (2011) find that the urban planning system in the UK acts as a multiplier of income disparities, when it comes to actual housing and other life outcomes. Health, for example, is affected by housing quality. And many other life outcomes are affected by the amount of discretionary income one has left over after housing costs. Discretionary income after housing costs is a reason why urban economies in Texas hum along quite nicely even if average incomes lag the "superstar cities" elsewhere. (Ref. "Superstar Cities", 2006; Gyourko, Mayer and Sinai).