Micro versus Macro thinking and affordability

We all are born into a micro world. Everything we need to do to survive or thrive on a personal level requires understanding and acting on micro-level truths. Micro thinking accepts the world as it is and asks, “How do I succeed in this world?”

Macro thinking is about why. “Why is the world this way?” That is what this newsletter is about. Most of us can get away with never or rarely doing macro-thinking. Occasionally, macro-thinking can give you an advantage in micro work. That’s what my Metro Area packages are about. People who work in housing could get away for decades without thinking about the macro side, but we currently live in a temporary period where macro trends might be as important to the long-term success of a business model in housing and construction as micro trends are. That has been the case since 2008.

I have touched on this before. A builder operating on the micro scale will say, “These macro pencil pushers keep going on about supply constraints. They have never worked in the real world. I can’t build more homes because they aren’t profitable. Interest rates are too high. Input costs are too high. Interest from buyers is dead. Land is too expensive. Municipal fees are too high. Everything costs more because lead times are high. We have to wait on permits, on inspections, on supplies. All of that drives up our costs. The ivory tower guys don’t know what it’s like to run a business. I can’t build homes if I can’t make money. The problem is that everything costs too much.”

To a builder that never thinks on the macro level, high costs will always and everywhere be the cause of every problem because that is how you have to model problems at the micro level.

At the macro level, we ask:

Why are interest rates high? (Maybe because a lot of builders are seeking financing, or other sectors are growing and claiming capital.)

Why are input costs high? (Maybe other builders are buying them for better projects.)

Why aren’t there more buyers? (Maybe government regulators have been getting in their way.)

Why is land expensive? (Maybe it’s only expensive relative to the single home you are allowed to build on it, but it would be relatively cheap if you could build 6 homes on it.)

Why are municipal fees high? (Maybe they are high mainly to keep you from building.)

Why are lead times high? (Maybe capacity for inputs is being taxed and when that capacity rises, you will find plenty of demand for more homes.)

At the micro level, it’s a supply and demand story. We aren’t building more homes because there isn’t demand for buying homes at the price it costs to build them. At the macro level, it’s also a supply and demand story. Why are the curves here? How could we move them? What is going to move them naturally?

A series of barriers and shocks - vertical supply curves in some cities and the consumption and migration patterns that caused, the mortgage shock in 2008, the permanent decline in industry capacity that followed, and the additional supply chain disruptions that followed Covid have produced a housing market that has been in some form of disequilibrium for more than 20 years. The supply and demand curves aren’t where they belong. They aren’t where they will stay. They are on a path toward the new equilibrium created by the shocks, and the path is moderated and steered by the various legal and natural constraints.

This is part of what is behind a lot of the recent discussion and debate about American living standards. With my kids, it’s a micro world. Housing costs what it costs. What do we do about it? Cut back. Save while you live at home. Study. Work hard. That’s my job as a parent.

Some of my work here - mostly the stuff that is paywalled - is a combination of the micro and macro. How many homes are going to be built? What will they cost? What investments are likely mispriced relative to what these macro questions suggest they should be priced at?

Some of my work here is macro. Why are homes so expensive?

It is possible that some of my macro analysis is wrong. Maybe I have developed an inflated sense of what is an acceptable minimum lifestyle. Certainly, some of the pressures families feel about the cost of living are related to privilege. At the core of the housing crisis is upward filtering. New residents in the typical urban American home now have a higher income than the previous residents had. Families really hate trading down, socioeconomically. That is the reason real estate value has outpaced income growth by some 80% over the past half century.

A young professional will willingly move from a neighborhood of 2,000 square foot homes with $120,000 income residents into a neighborhood with 1,000 square foot homes and $120,000 income residents in order to move to a new underhoused city. But, the existing residents in underhoused cities that already live in 1,000 square foot homes with $80,000 incomes are not keen on moving into 800 square foot homes in neighborhoods with worse schools and more crime when the neighbors and the rents of their existing neighborhood start to reflect $120,000 incomes.

When I say that my kids are delaying household formation because housing is too expensive, I will admit that we consider maybe 10% or 20% of the city to be off limits because those neighborhoods are unsafe or otherwise below the range of standards we consider acceptable. When I say that rising cost of living affects families with even moderate or high incomes, it is true that part of that cost is self imposed because of privilege. We demand a minimum set of standards that some portion of the community isn’t able to demand.

So, you can dismiss the macro questions and the macro complaints with a micro level “Who the hell do you think you are?” In a way, that’s what a lot of the critics of Michael Green’s posts have been doing. The $60,000 family really doesn’t want to trade down to the $40,000 neighborhood. The $80,000 family doesn’t want to trade down to $60,000. On and on and on. The $150,000 doesn’t want to trade down to $130,000. It’s privilege all the way down. And, meanwhile, yes, while we are all trading down on housing, our TVs and our phones and our health care and our burrito shops all keep getting better.

For those of us that busy ourselves with macro questions, I think the productive conversation to have here isn’t to quibble over the value of TVs and burritos. It’s to ask, “Why do families have to trade down?” The socioeconomic status of your home is a pretty big cue to families about their relative well-being. A lot of their struggles come down to this, and zoning and mortgage regulation are responsible for all of the stress that is directly or indirectly related to housing. Are the positives we are getting from zoning and mortgage suppression worth all this stress?

There is also a common layman reaction to this debate that reflects a micro level approach. Of course housing is expensive in nice neighborhoods. Nobody wants the underclass encroaching on their neighborhood. Of course zoning was meant to keep them out. Of course people are bidding up the prices of homes that are insulated from them.

This is another form of reaction of those that simply live in the micro world and think that the macro level conversation is ignorant of the micro world motivations. But, this reaction is just a consequence of status quo bias. Either a refusal to engage with or ignorance of the macro level.

Yes. A natural demand for socioeconomic segregation is at the root of all these conflicts. The macro level questions are addressing the results. Is our current political framework working? Is this much segregation healthy? Are the rules even producing the segregation that motivated the rules?

And, here, both the skeptical experts and laymen run into an empirical problem. They think the issue is that nice things have become more expensive. The experts think it’s agglomeration economies. Big cities are productive and they attract a lot of newcomers, which drives up the cost. So, when a handful of cities became very expensive in the late 20th century, that seemed to be the obvious cause. Never mind that the cities that became very expensive were among the slowest growing (or even shrinking) cities in the country and were most strikingly characterized by how many families were moving away. ($60,000 families moving to new cities where they could afford to live around other $60,000 families instead of moving into neighborhoods nearby full of $40,000 families.)

We have now run a twenty year experiment where housing construction across the country was as low as it had been in those expensive cities, and they have all gotten more expensive in the same way the original expensive cities had.

And, the way all those cities have become more expensive contradicts the layman’s micro level reaction. Certainly, nice places are more expensive than less nice places. They always will be. But, when there is a housing shortage, it is the least nice places that get more expensive.

They are clearly correct about the motivations for zoning. Everyone wants to be in the nicer places. But, some laypeople who are satisfied by those motivations and who feel defensive about them are also motivated to ignore the macro questions, to the point of remaining ignorant of abstract facts. The primary economic stress created by zoning and mortgage suppression has been that the cost of trading up has gone down. The difference between the cost of the nice neighborhoods and the less nice neighborhoods is much lower than it used to be.

The whole story is empirically upside down from what the defenders of the status quo - both experts and laypeople - think it is.

And, this goes back to my family and our kids. Of course they expect to trade down as they start into adulthood. My wife and I traded down when we started into adulthood. The problem for our kids is that trading down has become more expensive. It has become more expensive to be poor.

My wife and I could move into homes that were 1/3 as nice as our parents’ homes and live at 1/3 the cost. Today, those same homes are 1/2 the cost. So, when our kids hit the bottom of the range of what our privilege considers acceptable, it’s still not cheap enough.

Thankfully for them, it’s a minor inconvenience. They have a comfortable place to live while they work it out. Are they dating less and meeting fewer people than they would if they were living in little apartments where other young families were also starting out? Probably.

But, more importantly, their struggles are a second order effect of the more important struggle. The families in the housing that has become too expensive for my kids don’t have options. They just have rent inflation. And below those families on the socioeconomic ladder, there are families in neighborhoods with crime and poor schools who are paying more of a premium for rent compared to 20 years ago than any of the rest of us are.

The household struggling to maintain previous norms on housing on a $140,000 income is the tip of the iceberg of a bunch of families with $50,000 incomes who are under water.

The problems of the privileged are a signal call of the problems of the less privileged.

It brings to mind the scene from Schindler’s List where the small boy attempts to avoid Nazi soldiers by hiding in the pit of a latrine, and when he does, he finds 3 children already there who tell him to get out. They were there first.

Is that hyperbole? Decades from now, when our grandchildren are watching films about bulldozing tent encampments out of our urban parks, will they think the comparison is hyperbole?

The problem here is that we all experience the benefits of prospering and the pain of struggling at the micro level. Understanding the cause of struggles that seem to be too salient in an otherwise prospering society requires abstractions - macro questions.

At the micro level, if a threat is coming at you, the solution is easy - strike the threat down. But, even if we are asking the questions, we are bound to come up with different answers because abstraction removes the immediacy of our mistakes.

But, for goodness sake, can we at least get to a consensus that we need to work on answers to the questions?