In the first 2 posts of this series, I have made the argument that demand for housing becomes inelastic under conditions of locational scarcity, and this is the source of most of the increased spending on and value of housing.
Have you considered the impact of subsidized mortgage rates in this analysis? Another thing that happened post 1970's is the GSEs. I suggest complementary goods analysis between owner-occupied housing and mortgaged borrowing. (Most people buying houses have to borrow money to do so. Everyone with equity in a house has access to borrowing at a lower cost than typical non-homeowners.) That's how the mortgage interest deduction should come into the model. The GSEs play in multifamily, too, so it would be reasonable to add that, but it's probably a smaller effect there. Maybe a bigger effect in multifamily would be the tax preferences that played a big role, especially, in the early 80's.
I got a laugh from a conversation (probably around 2006) with a well-known chief economist in the housing business, who claimed that home prices would drop by 10% if the mortgage interest deduction was eliminated. In response I said, "so, you're saying that home prices are 10% higher than they should be, as a result of the mortgage interest deduction?" He didn't offer an answer.
Over the years, I have reduced my estimate of how important mortgage rates are to home prices. The GSE influence on rates was always small - maybe 0.25% on average. The combination of federal regulations and the GSE qualified mortgage patch today really acts more like a tax wherein the federal government earns excess profits because of their regulated monopoly on default risk. In any case, the effect of the GSEs on price is much lower than things like tax benefits. As I pointed out in the post, this plausible is related to the mid-1980s bump in valuations. To the extent that mortgage access was encouraged through government programs and tax benefits, I think it mostly operated to induce supply and keep rents low for non-owners, and much of the economic stress that has developed in the last decade is the result of losing that benefit.
I agree, in general, that the overall effect of interest rate changes on home prices is small. People who expect a large effect seem to be unaware that the housing markets survived 18% mortgage rates in the 1980s. The other effect of the GSEs, however, has been the standardization of underwriting and, in the late '90s and early '00s, the massive relaxation of underwriting standards for government guaranteed loans and MBS. I think the wide availability of relatively cheap mortgage loans combined with speculative mania in the early '00s to dramatically shift demand for single family housing. The wide availability of 100% financing at very little extra cost over, say, 80%, was oxygen for the fire.
Post GFC, we actually had the interesting phenomenon of jumbo mortgage rates (i.e., non-GSE) being lower than conforming GSE rates, which supports your idea of the GSE universe actually being taxed today, rather than subsidized.
It is helpful to look at "regimes" in the housing and mortgage markets, and I also think it is helpful to look at markets in a granular way. Things that may not have an effect under most conditions could have a significant effect under the conditions in a certain time period, or they might have a significant effect on one subpopulation within the market. There are many interaction effects and non-linearities.
Also, I find a great deal of confusion around what is meant by supply and demand for housing. One well-known economist has referred recently to the drop in existing home sales volume as an indication that demand has declined (as a result of rising interest rates). And, yet, prices still are going up? On the supply side, is an increase in homes listed for sale an increase in supply? Most people seem to think so, but I disagree. Your figure 1 in Part 1 doesn't really help me understand your definitions. Your x-axis is labeled "Quantity of Housing Starts", but the figure is labeled "demand from existing residents". I like that you note, however, that different populations might be at different points on the aggregate demand curve.
Great comments. I like how you think. And, I agree that the language common in RE analysis is sloppy and unhelpful.
Sorry about confusion on Figure 1 in Part 1. By "demand from existing residents" I just meant that the demand curve shown is for the existing residents of a city. And, basically, the turnstile migration that happens in the underhoused cities comes from the fact that the demand curve of new residents wanting to live in those cities is less elastic at the top left than it is for the locals who hit a budget tipping point and must move away. The demand curve shown was for the locals that become outmigrants, but it only happens because there are other potential residents with a higher budget tipping point and a more persistently vertical demand curve who are vying for access to the same city. I realized after I published the post that I had the existing residents in mind when I drew the chart. I hope that makes sense.
In "Shut Out" I walked through the change in lending standards before 2008. My reading of the evidence is that the GSEs made great strides in the late 1990s matching qualified borrowers with mortgages, and it's a shame that those improvements have been falsely blamed for price inflation and also have been put in the same category as some of the speculative subprime lending that happened as the market was turning in 2005-2007. It has been a great loss for families who have traditionally lacked mortgage access.
I have considerable experience with the development and deployment of automated underwriting models and systems. It would be best to have that conversation offline.
I admire Kevin E.'s intellect and patience in addressing these issues.
BTW, young Canadians are talking about leaving Canada. At the core, housing, with a dose of heavy taxes tossed in.
The orthodox macroeconomists insist living standards are higher in North America than 50-60 years ago. To be sure, wonderful technologies are available, from internet smartphones to non-stick pans, to much better flashlights and word-processors. I assume for most types of healthcare, today is better.
But who can raise a family anywhere on the West Coast? After taxes? Let's move the NYC and start a family?
It sure seems to me living standards are lower than 50-60 years ago.
Globalization and labor-busting immigration meet NIMBY?
Have you considered the impact of subsidized mortgage rates in this analysis? Another thing that happened post 1970's is the GSEs. I suggest complementary goods analysis between owner-occupied housing and mortgaged borrowing. (Most people buying houses have to borrow money to do so. Everyone with equity in a house has access to borrowing at a lower cost than typical non-homeowners.) That's how the mortgage interest deduction should come into the model. The GSEs play in multifamily, too, so it would be reasonable to add that, but it's probably a smaller effect there. Maybe a bigger effect in multifamily would be the tax preferences that played a big role, especially, in the early 80's.
I got a laugh from a conversation (probably around 2006) with a well-known chief economist in the housing business, who claimed that home prices would drop by 10% if the mortgage interest deduction was eliminated. In response I said, "so, you're saying that home prices are 10% higher than they should be, as a result of the mortgage interest deduction?" He didn't offer an answer.
Over the years, I have reduced my estimate of how important mortgage rates are to home prices. The GSE influence on rates was always small - maybe 0.25% on average. The combination of federal regulations and the GSE qualified mortgage patch today really acts more like a tax wherein the federal government earns excess profits because of their regulated monopoly on default risk. In any case, the effect of the GSEs on price is much lower than things like tax benefits. As I pointed out in the post, this plausible is related to the mid-1980s bump in valuations. To the extent that mortgage access was encouraged through government programs and tax benefits, I think it mostly operated to induce supply and keep rents low for non-owners, and much of the economic stress that has developed in the last decade is the result of losing that benefit.
I agree, in general, that the overall effect of interest rate changes on home prices is small. People who expect a large effect seem to be unaware that the housing markets survived 18% mortgage rates in the 1980s. The other effect of the GSEs, however, has been the standardization of underwriting and, in the late '90s and early '00s, the massive relaxation of underwriting standards for government guaranteed loans and MBS. I think the wide availability of relatively cheap mortgage loans combined with speculative mania in the early '00s to dramatically shift demand for single family housing. The wide availability of 100% financing at very little extra cost over, say, 80%, was oxygen for the fire.
Post GFC, we actually had the interesting phenomenon of jumbo mortgage rates (i.e., non-GSE) being lower than conforming GSE rates, which supports your idea of the GSE universe actually being taxed today, rather than subsidized.
It is helpful to look at "regimes" in the housing and mortgage markets, and I also think it is helpful to look at markets in a granular way. Things that may not have an effect under most conditions could have a significant effect under the conditions in a certain time period, or they might have a significant effect on one subpopulation within the market. There are many interaction effects and non-linearities.
Also, I find a great deal of confusion around what is meant by supply and demand for housing. One well-known economist has referred recently to the drop in existing home sales volume as an indication that demand has declined (as a result of rising interest rates). And, yet, prices still are going up? On the supply side, is an increase in homes listed for sale an increase in supply? Most people seem to think so, but I disagree. Your figure 1 in Part 1 doesn't really help me understand your definitions. Your x-axis is labeled "Quantity of Housing Starts", but the figure is labeled "demand from existing residents". I like that you note, however, that different populations might be at different points on the aggregate demand curve.
Great comments. I like how you think. And, I agree that the language common in RE analysis is sloppy and unhelpful.
Sorry about confusion on Figure 1 in Part 1. By "demand from existing residents" I just meant that the demand curve shown is for the existing residents of a city. And, basically, the turnstile migration that happens in the underhoused cities comes from the fact that the demand curve of new residents wanting to live in those cities is less elastic at the top left than it is for the locals who hit a budget tipping point and must move away. The demand curve shown was for the locals that become outmigrants, but it only happens because there are other potential residents with a higher budget tipping point and a more persistently vertical demand curve who are vying for access to the same city. I realized after I published the post that I had the existing residents in mind when I drew the chart. I hope that makes sense.
In "Shut Out" I walked through the change in lending standards before 2008. My reading of the evidence is that the GSEs made great strides in the late 1990s matching qualified borrowers with mortgages, and it's a shame that those improvements have been falsely blamed for price inflation and also have been put in the same category as some of the speculative subprime lending that happened as the market was turning in 2005-2007. It has been a great loss for families who have traditionally lacked mortgage access.
I have considerable experience with the development and deployment of automated underwriting models and systems. It would be best to have that conversation offline.
I admire Kevin E.'s intellect and patience in addressing these issues.
BTW, young Canadians are talking about leaving Canada. At the core, housing, with a dose of heavy taxes tossed in.
The orthodox macroeconomists insist living standards are higher in North America than 50-60 years ago. To be sure, wonderful technologies are available, from internet smartphones to non-stick pans, to much better flashlights and word-processors. I assume for most types of healthcare, today is better.
But who can raise a family anywhere on the West Coast? After taxes? Let's move the NYC and start a family?
It sure seems to me living standards are lower than 50-60 years ago.
Globalization and labor-busting immigration meet NIMBY?