Labor immobility

[Daniel Drezner]

Whenever economists of all political stripes compare the U.S. economy to Europe, one of the qualities that is presumed to give America an advantage is our flexible labor markets. Americans are more likely to move to places with better jobs than Europeans.

Which is why Louis Uchitelle's front-pager in today's New York Times is so worrying:

The rapid decline in housing prices is distorting the normal workings of the American labor market. Mobility opens up job opportunities, allowing workers to go where they are most needed. When housing is not an obstacle, more than five million men and women, nearly 4 percent of the nation’s work force, move annually from one place to another — to a new job after a layoff, or to higher-paying work, or to the next rung in a career, often the goal of a corporate transfer. Or people seek... an escape from harsh northern winters.

Now that mobility is increasingly restricted. Unable to sell their homes easily and move on, tens of thousands of people... are making the labor force less flexible just as a weakening economy puts pressure on workers to move to wherever companies are still hiring.

Politicians will not help this process -- indeed, a lot of politics is about wallowing in the anger and bargaining phases. As Daniel Gross pointed out in Newsweek about six weeks ago, the various proposals for bailouts and foreclosure freezes accomplish nothing but delaying the proper functioning of the price mechanism:

In general, cleaning up quickly after popped bubbles is good for the economy, because it enables everybody to move on. Over the years the American economic system has proved to be quite adept at doing so. And as Japan's experience in recent years shows, refusing to deal with the overhang of bad debt can condemn an economy to a lengthy period of slow growth. But I doubt there's the political will to allow the fast price discovery allowed by foreclosures to continue. While it would certainly bring long-term economic benefits, the short-term social, financial, and political consequences of a rapid clearing of the housing mess are too much to bear. As the year goes on, expect presidential candidates and government officials to keep throwing lifelines and buckets full of hope at the housing market.

The Bellows » More Housing, cont.

Over at The Bellows, Ryan Avent is still trying to pull apart local variations in the subprime problem:

Calculated Risk notes that Georgia’s problem loan rate is higher than Florida’s, despite the fact that Atlanta’s home price trajectory looked downright anemic during the boom. What’s with that?

One reason might be that Georgia led the nation in Interest Only loans. Another might be that lenders are able to foreclose quicker in Georgia..

Ok, but why so many interest-only loans? Given the (relatively) low prices in the state you might expect that fewer buyers would need or choose the IO option. But then, there doesn’t appear to be much correlation between prices and IO percentages across the nation. Looking at some of the nation’s more expensive markets, you see that the Bay Area has a huge IO problem, while the New York area is on the low end of the scale. Weird. I’d love to see an explanation of the underlying forces here.

My guess at the primary reason behind the difference is that mortgage brokers are regulated at the state level. States with laxer regulations (or as conservatives would have it, better regulatory capture) got more low-quality loans. This dovetails with the fact that many of the most problematic loans hit trouble even before their teaser rates reset, meaning that there was never any realistic possibility that the borrower would repay the money.

When Hillary Clinton fixes the housing market, she really <i>fixes</i> it.

I meant to blog about Hillary Clinton's subprime mortgage plan last week, but I got sidetracked. Luckily, Matthew Yglesias is talking about it, which reminds me that I really ought to say something.

Now one thing to note about this is that a bit contrary to campaign stereotypes, if you take this literally it betrays a certain naiveté about the way Washington works. Were a president to submit a stimulus plan with these kind of provisions in it to congress, it'd be bad news. You'd end up delaying legislative action on the overall package, and delays are a big problem with fiscal stimulus. You'd also open the door to all kinds of not-strictly-stimulus measures that various members of congress want to tack on. What Barack Obama proposed -- a much cleaner, more streamlined stimulus package that really just focuses on juicing short-term aggregate demand -- is a much better idea.

But that's if you take it literally. Things being what they are, both campaigns stimulus plans were really just smoke and mirrors, with Obama signaling that he can play grown-up technocrat and Clinton signaling that she's got a solution for every problem in her swiss army knife-like arsenal of policy measures. And while it's probably not a good idea to link the foreclosure freeze proposal to a stimulus package per se the underlying idea does seem like a pretty good one. As I wrote in my article on foreclosures there are a lot of neighborhood externalities associated with foreclosures, so it's really worth taking action to minimize them.

It may well be, but only if those measures are not actually completely insane. The good senator is proposing a temporary mortgage holiday, followed by a five-year freeze that will keep at least all subprime mortgages, and possibly all ARMs (there is some disagreement on this) at their teaser rates.

This is a terrible, horrible, no good, very bad idea. Yes, multiple foreclosures can be bad for urban neighborhoods, and it would be nice if there were some way to prevent this. But the way to prevent it is not to have the government unilaterally rewrite the terms of mortgage contracts massively in the favor of the borrowers. The teaser rates these people got can be lower than the rate on a prime fixed mortgage. This is, of course, very nice for the people who bought more house than they can afford. It will not be so nice for anyone who wants to get a subprime mortgage in the future, since this move will probably destroy that market for at least a decade or so to come. It will, of course, be very bad for anyone who happens to be a mortgage lender--aka the people the rest of us want to borrow money from in order to buy houses. This move will leave them with a lot less money to loan out to anyone else, so hello, higher mortgage rates. Higher mortgage rates, for those following along at home, generally mean lower house prices, which means that the problem of negative equity will get worse.

In other words, Senator Clinton would like to destroy the mortgage market in order to save it.

I see this problem as roughly the same problem of pharmaceutical price controls. Yes, we can help some people now, but only at the cost of hurting a lot more people in the future. Those people, of course, don't vote, either because they aren't born, or don't know who they are yet; hence, politicians often ignore them. But that's no reason that the rest of us should follow suit.

The trouble with house prices

Dave Wessel has a good piece at WSJ.com on the difficulty of telling how much your house is worth. There are two main housing indices, the Ofheo index, and the Case-Shiller, but recently they've diverged.

Wessel explains why:

The Ofheo index relies on data collected by Fannie Mae and Freddie Mac, which Ofheo regulates, so it excludes loans too big for Fannie and Freddie to guarantee (those exceeding $417,000) or too shaky (the riskiest of the subprime). Case/Shiller includes those, but its data are limited to 20 major markets because it relies on the costly process of going to local property records for data. One of Mr. Calomiris's complaints is that house prices in these markets may be doing worse than those in other places.

Last year at the annual meeting of the American Economics Association I saw Ed Glaeser give a very good talk on real estate economics. His focus was on just how hard it is to do really systematic empirical or theoretical work in the field; probably the most memorable (and once you've heard it, blindingly obvious) point was that we don't even have a good model for land. Every single house is a unique object; even in communities stamped out with the regularity of a Levittown, views and proximity to the main road vary, and once the houses are old enough to be resold, how well it has been maintained, decorated, and renovated start to matter. The Case-Shiller index is the first attempt to systematize the entire market, and even there, it is geographically limited.

We complain about the insufficiencies of various national accounting measures: GDP doesn't take externalities, leisure, or home work into account; inflation measures are inaccurate; payroll and housing surveys increasingly tend to offer different pictures of the labor market. We forget what a luxury it is to have reasonably accurate figures gathered by a reasonably intelligent method, and compiled into data series that span decades. Reporting on the housing market is a great way to understand just how titanic an achievement was the work of Simon Kuznets.

Marginal Revolution: Was there a Housing Bubble?

Alex Tabarrok looks at the image below and asks the question that dare not speak its name: was there even a housing bubble?

Alex says:

The clear implication of the chart is that normal prices are around an index value of 110, the value that reigned for nearly fifty years (circa 1950-1997). So if the massive run-up in house prices since 1997 was a bubble and if the bubble has now been popped we should see a massive drop in prices.

But what has actually happened? House prices have certainly stopped increasing and they have dropped but they have not dropped to anywhere near the historic average (see chart in the extension). Since the peak in the second quarter of 2006 prices have dropped by about 5% at the national level (third quarter 2007). Prices have fallen more in the hottest markets but the run-up was much larger in those markets as well.

Prices will probably drop some more but personally I don't expect to ever again see index values around 110. Do you? If we don't see the massive drop back to "normal" levels then the run up in prices should be described as a shift to a new equilibrium - much as happened during World War II - see the chart. (It's an important question to ask what changed and why?). In the shift to the new equilibrium there was some mild overshooting, especially due to the subprime over expansion, but fundamentally there was no housing bubble.

What bothers me is that I don't understand why we should have shifted to a new equilibrium. I think I understand the reasons that the equilibrium values shifted between 1940 and 1950:

1. Developments in rail and construction techniques in the 1910-20 brought huge amounts of land under development, and pushed urban buildings rapidly upward, at a time when population growth was slowing, depressing prices
2. The Great Depression kept them low
3. This massive pent up demand translated into a boom in housing demands as incomes recovered
4. The FHA, and then the Veterans administration, basically introduced an entirely new product: the long term amortizing mortgage. Previously, mortgages had been short-term affairs with balloon payments at the end; five years was a very standard term. The long-term amortizing mortgage, especially when helped along with government subsidies, massively increased the amount a couple could pay for their house.
5. Housing demand was then sustained by high rates of real economic growth and population growth, which caused housing demand to skyrocket.
6. Prices leveled off as the automobile brought new land into housing, but since the mortgages kept demand pegged to incomes, they never actually fell
7. The post-1970 fluctuations are money illusion, responses to changes in nominal interest rates.

I find it hard to name a comparable equilibrium changing development in 1997. I am fairly well convinced Ed Glaeser's argument that high coastal real estate prices are due at least in part to the fact that local interests are increasingly effective at blocking new development. But that's been going on for decades; it didn't suddenly change in 1997. One could argue that this was when credit scoring models started getting much better, making more credit available, and indeed homeownership rates soared--but they soared from 64% to 69%. (By contrast, between 1940 and 1950, they went from 43% to 55%.) Also, it turns out that credit scoring wasn't that much better, as proven by rising default rates.

Alex's theory is supported by the fact that housing is bubbling up all over--the US, in fact, experienced rather modest appreciation. I'm tenatively willing to believe that this represents a real expansion of credit availability--but I still wouldn't buy a house right now without a hefty downpayment to cushion the downside risk.

If you build it they will come

Winterspeak asks:

The primary complaint seems to be that rents in Dubai are too high -- which is not unusual. What is unusual is the top demand -- to force property owners to prove occupancy within 12 months of ownership/property completion. Essentially, this argues that owners are keeping their properties empty to drive rents higher. This may be possible if Dubai property ownership was a monopoly, where the owner could restrict supply to increase price (and therefore overall profit) but I think it is quite impossible these days to have the words "Dubai" and "restrict supply" in the same sentence -- the entire city is one enormous construction site.

Does anyone know why rents in Dubai are going up so fast during a period of massive residential construction?

At a guess, the answer is that doubling oil prices have pushed up many incomes in the businesses that cater to the oil industry, which in Dubai is nearly all of them, so that even skyrocketing supply is not keeping up with demand. I'd also expect that the flow of oil money has encouraged people in other parts of the Middle East to seek apartments in Dubai (as well as New York and London and Paris, which is one of the reasons real estate markets are so robust in those cities). This may be why, earlier in his post, he cites a renter's group demanding that landlords prove their apartments are occupied--if I were a middle income renter priced out of the market, I'd be kind of irked at absentee tenants maintaining pieds-a-terre.

All this will undoubtedly iron itself out eventually, one assumes, since as Winterspeak points ou Dubai is basically one massive construction site. But the temporary dislocations can still be painful when you've been dislocated from your house.

Should you buy a house?

I spent some time this weekend traipsing around open houses with my sister, who is hoping to someday soon experience the burdens joys of homeownership.

Prices certainly don't seem to be coming down much in my neighborhood, the U Street Corridor. Smallish two-bedroom houses are listed for $595,000 and up. Since the rent on a similar place would be something over half the monthly mortgage payments and taxes, without taking maintenance into account, I think it is fair to say that the market is still pricing in quite a bit of expected capital appreciation in the house.

Is that reasonable? Not too long ago, I saw Suze Orman on television, urging people not to sink money into their 401(k)s, but instead plow that money into a house. A house, almost everyone I know tells me solemnly, is the best investment you can make.

But as Robert Shiller, the Yale economist, has pointed out, this is a very new idea. For most of history, a house was simply a very long-term durable good, which, like cars and refrigerators, began depreciating the day it was finished. Why do we think differently now?

Shiller's argument, which I find pretty compelling, is that we've been deluded by recent history. Since World War II, a number of developments have conspired to boost the prices of homes, giving a large capital gain to those who were lucky enough to own at the time. This has given us the delusion that house prices rise steadily, when in fact, we have virtually certainly exhausted the pricing gains of those happy developments.

The first boost was the invention of the long-term amortizing mortgage. Mortgages used to be short-term loans of perhaps five years, with a whacking great balloon payment due at the end. This started to change in the 1930's, when the government housing administration, trying to preserve homeownership during the Depression, invented the 20-year amortizing loan. That trend really took off in the 1950's, with the invention of the 30-year loan.

People tend to base what they will pay for a house on how big a monthly payment they can afford. Since everyone started getting 30-year loans roughly at once, without a concomitant boost in the supply of housing, the effect was to raise the prices that current homeowners could charge for their properties. This trend is largely played out, however. Though there was a wan attempt at introducing 40-year mortgages at the height of the bubble, the loans were not particularly popular with either lenders or borrowers. It's conceivable that a couple in their late twenties or early thirties is buying a 30-year house, but a 40 year house stretches the imagination too far, and the income expectations into the social security years.

The second trend is the progressive income tax, which really got going seriously in the 1940's. This gave another boost to homeowners, by making it possible for buyers to afford much bigger payments. While this may fluctuate somewhat over the next few years, tax rates seem to be fluctuating within a fairly narrow band, which means that this upward pressure on house prices will also be limited.

The third trend is the changes in inflation and interest rates since World War II. Prior to the 1960's, inflation tended to be fairly stable, meaning that the true cost of your mortgage was fairly predictable. Then inflation started to take off, making existing mortgages very cheap, and new mortgages very expensive. But starting in 1980, the Federal Reserve got tough on inflation. As the Fed's credibility as an inflation fighter grew, lenders stopped demanding such large premia for long-term lending, meaning that the real interest rates on mortgages fell. Since, as discussed above, potential buyers were more worried about payments than prices, that has given a big boost to house prices over the last quarter-century. But that trend, too, is played out. Inflation is set about where it's like to be for the foreseeable future, fluctuating right around 2%. Both mortgage lenders and buyers are calculating the interest rate they will pay on those low inflationary expectations; hence, no future bonus.

Given all that, future price increases should be limited to roughly the local increase in incomes. And since Washington DC is a government town, unless lobbying gets much more lucrative (and employs a lot more people), I find it hard to look forward to the ultra-rapid income growth that is buoying prices in Manhattan.

There is, however, a wild card: the value of land. While most houses are wasting assets, in some localities, land is getting more valuable. Ed Glaeser argues convincingly that this is because Americans have gotten much more effective at blocking denser development. In the old days, the response to increases in the value of land was to build up, or crowd more houses onto the lot. But now local rent-seekers activists have gotten very good at blocking that sort of development, which means that poorer people are forced ever outwards while rich people dominate the city interior. That's why it seems no longer possible for a journalist to go to two parties in one night in New York any more; all my friends are scattering ever-wider in search of affordable housing. Socially, New York is starting too look more and more like London, with friendships balkanized by long commutes.

There is a lot of new condo development in my neighborhood, but most of it seems, to this New Yorker's eye, shockingly low; six or eight stories at most. So it would seem prudent to put the steadily increasing value of land into the home-buying equation.

But even that doesn't mean I should buy, since presumably all the other buyers also think that land will increase in value. Which means that the mean forecast of the increase in the land's value should already be included in the price. If I want to buy a house as an investment (rather than, say, just a hedge against getting evicted again), then I have to believe that the land value will increase by more than what the average buyer thinks it will; in other words, that I am smarter than everyone else, who is being too pessimistic.

The problem is, I don't see an excess of pessimism around me in the housing market; it still seems to be filled with people who think that housing is a better investment than stocks or bonds. So much as I would love to have a place to call my own, I think I'll sit this one out at least a couple more years.

What about this Bush plan?

The administration has announced a plan to help borrowers in danger of default. Broadly, the terms seem to be:

1) Increasing the number of homeowners the FHA can insure, which will help them refinance at lower rates. The FHA (Federal Housing Administration) doesn't offer loans itself; it just helps people with shaky credit or financials qualify for mortgages by guaranteeing to pick up the tab in case of default.

2) Suspending the tax penalty for people who get their loan values reduced. Normally, the IRS taxes any such reduction, in order to prevent companies from giving their employees "loans" which they then "forgive" as a way of evading taxes on salaries. I wouldn't be precisely shocked if some valued employees with employer-sponsored loans, but without financial problems, see their debt reduced during the tax holiday.

3) A joint initiative between Treasury and HUD to offer as-yet-unspecified help to people in danger of defaulting.

Overall, this seems to me like a pretty good package. It doesn't, as many of the more generous plans do, offer irresponsible borrowers free home equity at the expense of either the lender or the taxpayer. But it does give them a chance to get some breathing space by working out terms with their lender. And it stops the rather horrid practice of taxing people who've had to sell their house for less than the value of the mortgage.

Of course, one wonders how much help the Treasury/HUD initiative will really be--it may just consist of Federal employees saying, in stentorian tones, "You sure do have more house than you can afford, there." But overall, it seems like a pretty good package, and the expense to the taxpayer seems admirably minimized.

Nearly one-third of mortgages responsible for nearly one third of defaults. Reel at 11.

The Wall Street Journal reports:

A survey by the Mortgage Bankers Association found that mortgages on properties that aren't occupied by the owner -- mostly investment homes -- account for between 21% and 32% of the defaults on prime-quality home loans in Arizona, California, Florida and Nevada, states where overdue payments are mounting fast.

Wow! Those investors are a bunch of deadbeats. But wait:

In Nevada, Arizona and Florida, loans for properties that weren't owner-occupied accounted for nearly a third of all home mortgages issued in 2005.

So only in California is that number at all surprising. And it may simply be an outlier; no word on states where defaults by investors are abnormally low.

Letting the air out

My former co-blogger, Winterspeak, muses on the problem with un-swelling the housing bubble:

Now that the air has gone out of the too-cheap credit that helped inflate the housing bubble, the question becomes how to undo the bubble with as little damage as possible.

When the internet bubble popped, this happened fairly rapidly: failed dot-coms closed down, their investors took a beating, and their employees moved onto other jobs, some of them still internet related but at better firms. Some went back to grad school. The end result was that the economy overall was fine, people who had invested in internet firms lost money, and the internet overall continued to grow apace, but now focused on better companies.

I think one inevitable requirement of unwinding the housing bubble market is that housing prices have to come down to fall in line with historic trends. In some areas this means very dramatic decreases -- maybe 40%+ in real terms? I'm not sure what a "deflated housing bubble" would look like if it did not bring prices back to historic norms. We are not going to see price declines of this magnitude unless we have very very motivated sellers, which means banks for older properties (which have been foreclosed on), and builders for newer properties. If prices do not fall, then transactions will dry up. I can see the government stepping in and helping owners (and their lenders) but I'd be surprised if builders will be helped that much. This means that areas that have had the most new construction should see the most dramatic price corrections.

That's good news for me, since Washington, DC was one of the most bubblicious areas. My new neighborhood is crowded with just-completed and partially finished condos.

But so far, prices have remained remarkably sticky. People are putting condos onto the rental market rather than take a loss. On a typical (non-August) day, the Craigslist real estate section is filled with ads touting "Brand new construction!" alongside demands that the renter accept a one-year lease with no smoking or pets.

There's no way to know, of course, but I've long wondered whether these rentals make financial sense. Are they covering their carry, much less the opportunity cost of the capital? Prices won't collapse until investors come to terms with the fact that their prior investment is a sunk cost, and pouring more money down the rathole won't make the problem go away.

That may take a long time . . . long enough that prices may never fall as far as they "should". Faced with selling their home at a loss, most people choose to stay put and pray. Instead, what we're likely to see is a very long period of stagnant prices. Inflation may have to do the work of bringing those prices back in line with historical values. In which case, I'd be better off taking advantage of those great rental deals . . .