Depression Era Housing Prices

Caplan at EconLog asks why housing prices held their ground for the most part during the Great Depression. Obviously, no one can say why prices are what they are, but my suspicion is that the mortgages played a role somehow. In fact, early mortgages were made interest deductible because it was primarily a business expense, and mortgages did not become a major homeowner vehicle until after the Great Depression began. From the NYT:

It was not until the 1920's and the spread of the automobile that home mortgages outnumbered farm mortgages. In the 1930's, the mortgage industry got a huge assist from the feds — not from the tax deduction, but from agencies like the Federal Housing Administration, which insured 30-year loans, and, over time, the newly created Federal National Mortgage Association, or Fannie Mae. Before then, the corner bank would issue a mortgage and wait for the homeowner to pay them back; now savings and loans could replenish their capital by selling their mortgages to Fannie Mae — meaning they could turn around and issue a new mortgage to someone else.

So in part, the stability of housing prices might have been partly due to FHA induced demand for housing stock, relative to other assets and consumption possibilities.

I'll leave it to my Austrian co-bloggers to decide if this fits into a Austrian/Recalculation story of explaining the prolonging of the Depression by changing the relative prices of capital, or if this aided as a form of liquidity the Fed failed to provide.

Are Housing Prices Clearing? Timing and Matching v. Clearing

As someone who studies local housing markets, I have a hard time understanding what this question is supposed to mean when discussing national aggregates. Nevertheless, from the NAR we learn that:

Existing home sales dropped a record 27.2 percent from June to an annual rate of 3.83 million units, the lowest since May 1995.

Felix Simon comments:

The number is so low that it looks like a statistical aberration: let’s hope it is. Because if it isn’t, the news is gruesome. It means that despite record-low mortgage rates, people aren’t able to buy houses: essentially all the benefit from those low rates is going to people who already own their homes and are taking the opportunity to refinance.

The news also means that there’s a big gap between buyers and sellers: the market isn’t clearing. Sellers are convinced that their homes are worth lots of money, or will rise in price if they just hold out a bit longer; buyers are happily renting, waiting for prices to come down. And entrepreneurial types, whom one would expect to arbitrage the two by buying houses with super-cheap mortgages and renting them out at a profit, don’t seem to have found those opportunities yet.

I have a different take: We are observing the consequences of a adjustment in the timing of housing purchases. In fact, the Reuters article even makes the connection:

"This is a worrisome report and while it reflects the volatility caused by the end of the (government home-buyer) tax credits, it also indicates a deterioration in the underlying trend for housing demand," said Michelle Meyer, senior U.S. economist at Bank of America Merrill Lynch in New York.

The bold emphasis is mine, and I focused it on that part of the statement because the phrasing of it seemed to be intended for maximum scariness: "Volatility caused by the end of the home-buyer tax credits." Why did it cause volatility? People probably moved their housing purchases up by several months or even a few years in order to get the temporary tax credit. This inflated previous housing purchases, and deflated them in the post credit period. The volatility was not caused by the "end of the tax credits" so much as the existence of the temporary tax credits!

This also had another consequence, which is that people probably didn't just adjust on the time dimension, but also in terms of what kind of housing attributes are desired. Remember, no two houses are exactly the same, which makes the housing market a matching game. When a tax credit is on the line, you might settle for a house that you wouldn't have if you had more time. This temporal shift has likely caused a temporal mismatch of housing preferences between buyers and sellers. Having buyers change composition like that is likely to cause funny things to happen.

I would add to support for my claim, based on the article:

1. First time home buyers, who were the ones eligible for the credit, declined in their representation as buyers.
2. The addition to the inventory of previously owned homes for sale did not seem to have a similar increase to match the decline in sales (though it did increase).

The housing market might not be setting a market clearing price yet (which rose 0.7%), but since median national house prices mean very little, I am less inclined to view this data as indicating that a significant price decline is on the way. It could be. I think it could also be very reasonable for sellers to let the mismatch period pass before making big conclusions about what their house might be able to sell for.

Zoning: Regulation, Community Property Right, or Both?

Frank Stephenson at D.O.L. remarks on Levine's Zoned Out:

I do have one quibble--the author can't quite make up his mind what we economists think of zoning:

p. 80: "[T]he very meaning of zoning as a collective property right--a view now broadly adopted by the economics profession ..."

p. 87: "Economists and other social scientists have split on the nature of zoning--with some viewing it as governmental regulation and others viewing it as more akin to a 'collective property right.'"

I have not read the book in question, but I actually would agree that the economics profession is of two minds about zoning: one as regulation and one as a collective property right (CPR). I think your modal economist would see it as regulation, but your modal economist researching and publishing on local public finance or governance structures are more likely to view it as a CPR. Richard Epstein would be an obvious candidate for disagreement.

I'm going to provide some explanation of the CPR view.

On paper, zoning is indeed regulation, having very specific prescriptions with ambiguous intentions. In function, what they are trying to do is protect home owners from negative externalities, both pecuniary and technological. Since all technological externalities (noise, traffic, etc) are capitalized into housing prices in the same way as if a bunch of new housing were constructed in the area, home owners and zoning officials have little reason to differentiate between them.

At the same time, it is extremely difficult to get around the fact that externalities are a big deal, and any nuisance is not just annoying, it is costly. Furthermore, in a world without zoning, new housing can be constructed quickly if demand is expected to rise. If demand falls construction will stop, but the housing stock is not likely to change a great deal (in part because of demolition costs). This makes externality-sensitive housing a rather asymmetric risk. If demand rises in your area, housing will only appreciate at the marginal cost of construction, but if demand falls your price falls steeply.

Furthermore, your neighbors have a pretty good incentive to ignore externalities when they sell their homes. If your neighbor sells their home to someone who wants to renovate the property into a noisy bar, he doesn't have much incentive to consider how this might impact his ex-neighbors. Note that, although the noise is a technological externality, it will have a negative pecuniary effect on the neighboring homes.

Enter the role of zoning. The CPR view begins by thinking of a given municipality as a supplier of institutions and property. The institutions are going to consist of a mix of taxes, public goods, and mechanisms for handling externalities (i.e. zoning). Developers or other commercial producers are on the demand side of this market. They are likely to bring benefits (tax revenue, local demand for property, etc) to an area, as well as new pecuniary and non-pecuniary externalities (congestion, pollution, new supply of alternative residences, etc).

Zoning serves as an exclusionary purpose (like a property right) to these entities, but remains open to change pending some negotiation. In fact, zoning is probably the most malleable legal institution in the United States. While the stated objective of zoning commissions is often ambiguous, in practice they serve the purpose of evaluating demanders of institutions/property to verify that their expected benefits outweigh their costs, which will be signaled through their expected consequence on existing property values.

I don't mean to say zoning is all roses and fine wine, the critics of zoning have good points. Zoning commissions make both type I and type II errors, inflate housing prices, can get captured, engage in regulatory taking, etc. Any industry with more than 30,000 firms would likely have more than a few bad apples.

I think the community property rights view is quite correct in the positive analysis of zoning, but the open question is the normative implication. As of now, I lean towards a more Ostromesque view that zoning is a way that local communities have evolved to deal with externalities, and I would be very hesitant to impose some kind of reform that stripped them of this mechanism.

Rent-Seeking: No Such Thing as Free Eye-Candy

From the Journal of Urban Economics, "Marriage and the City: Search Frictions and Sorting Singles." Abstract:

This paper develops and tests a model where cities play an important role as marriage markets. The idea is simple. Cities are dense areas where singles can meet more potential partners than in rural areas. To enjoy those benefits, they are willing to pay a premium in terms of higher housing prices. Once married, the benefits from meeting more potential partners vanish and married couples move out of the city. Attractive singles benefit most from a dense market and are therefore more likely to move to the city. Those predictions are tested and confirmed with a unique Danish dataset.

So existing property owners would benefit from increased density in the form of having more attractive buyers bidding up their price. Another way to think about this is that as you move further away from the dense city center, you are exposed to less attractive people, but are compensated for it with lower rents.

Realtor Compensation Choice

New from the JREFE:

Real Estate Brokerage Earnings: The Role of Choice of Compensation Scheme

Richard Martin and Henry Munneke

Abstract
One of the more interesting characteristics about the real estate brokerage industry is that workers are presented with a choice regarding the sort of compensation scheme under which they want to work. An overwhelming majority of workers choose what is referred to as a commission split scheme in which the salesperson splits any commission that they earn with a supervising broker that they generally are required to work under. In this case the firm provides office support and administrative services to the salesperson and, in return, the salesperson must split any commissions that they earn with the firm. Under the alternative compensation scheme, workers pay a substantial up-front “desk” fee to the firm and then are allowed to keep 100% of any commissions that they earn. In spite of the large volume of research on the determinants of real estate salesperson earnings, to our knowledge there are no studies analyzing the choice of compensation scheme and its impact on the earnings of real estate salespersons. This study uses data from the 2001 and 2003 Membership Surveys of the National Association of REALTORs® to analyze the impact of the real estate salespersons’ choice of compensation scheme on their earnings.

Ungated version here. Previous TPS discussion on realtor compensation here and here.

Ross: On Realtor Compensation

This is the first entry in the "TPS Discussion" series.

Prompt:

If you are in the market for buying a house with the help of a realtor, one of the more peculiar aspects of this prospect is how the realtor representing the buyer is compensated. The buyer’s realtor, like the seller’s, is compensated by receiving a commission that is a percentage of the final sale price. This is peculiar because it would seem, at least at first blush, that the incentives of the agent are better-aligned with the opposing party during negotiations. What incentive does the realtor have to help the buyer negotiate a lower price? Why is this compensation scheme the dominant model of realty transactions?

Justin's Thoughts:

Let’s ask why this scheme has emerged as something demanded by the prospective buyers. Imagine we are in an environment where you have multiple real estate agents standing on the street and holding up a signs with different contract terms: some ask for a fixed fee; others ask for a % of the sale price. Why over time would the fixed fee realtors be selected against?

I think the answer is that the fixed fee approach places too much emphasis to complete a transaction, and actually would align the buyer’s agent with the seller more than the percentage price approach. To get a sale, the fixed fee realtor simply needs to find a house that provides positive amounts of consumer surplus. This also gives the realtor an incentive to represent any house as a structure that will give me positive amounts of surplus.

However, such a serious investment of money and time means that I want to get the house that best fits my preferences. The house that best fits my preferences is also the one that I will pay the most to get. By paying the realtor the percentage of sale price, I am incentivizing him to both complete a deal and find the house that I will demand the most. The final bargaining stage, which is typically over a few thousand dollars, is simply too small of a perverse incentive to outweigh the positive incentives created in the search process.

Furthermore, on the supply side, real estate agents ultimately will have more success when they let the buyer make the decision. Advising and getting it wrong, or appearing to get it wrong, will wind up with the agent receiving the buyer’s blame much more than the cases where the agent gets the advice right. There is little upside to the agent in a system when they take more responsibility in the negotiating process, and a significant potential downside. Buyers might also choose against the infringement on their sovereignty.

Matt Replies

Anecdotal Evidence That at Least One of My Theories is Right

Health care correlations I wish to explain:

1. There is a positive relationship between health care (access & outcomes) and income in the U.S., Canada, and Britain.
   
2. In Canada, income appears to be more important than in the U.S., and the best evidence suggests it is an absolute (not relative) effect. In Britain, income effects in children are statistically insignificant from 0-4, but become significant afterward and increase with age.
   
3. Health care expenditures do not seem to have much of a relationship with outcomes.
   

#3 seems to contradict #1 & #2, so what could be going on? It makes sense, for the most part to have a income effect in the U.S., but why does it exist in England and appear larger in Canada?

I have hinted on this blog before, that I suspect that the reason the Canadian and English Health Care Systems have an income effect is due to capitalization in the housing market. Everything I could tell about these two health care systems seems to ration their services geographically, just like the U.S. does with its public school system. Therefore, people who care about access to the better hospitals will bid up the price of housing in those areas. This creates the appearance of an income effect without the expenditure effect. Now, this story appears in the U.K. Telegraph:

New figures seen by the Daily Telegraph illustrate for the first time how Government changes in the way the NHS is run have fundamentally altered the way care is provided.

Data from Dr Foster, an independent health care information company, published today (MON) reveals that more than a third of the NHS hospital trusts in England suffered a fall in the number of routine operations they performed last year.

Many hospitals have witnessed a sharp fall in income as a result of health care reforms, including the introduction of a Payment by Results system.

Patients are now able to choose where they are treated, with many snubbing the traditional visit to their local hospital and opting for units with the best treatment records, facilities and, crucially, cleanliness and infection control.

GPs can also choose where to send their patients. Crucially, hospitals no longer receive a guaranteed block grant and are paid according to the number of patients they treat.

Bold emphasis added by me.

From the Department of Hhmmmm...

That was CNN's homepage at 8:18 am Eastern on 10/31/2008.

Stiffling Housing Demand

If this was KPC, the title of this post would be something like "Housing Demand: yer doin' it wrong!"

Anyway, many have suggested that allowing more immigration to help prop up housing prices as a possibility to help slow the spread of foreclosures. However, according to Miriam Jordan of the WSJ the U.S. is doing precisely the opposite (Hat Tip to Philippe Legrain for the article pointer):

Dubbed ITIN mortgages, the loans that made homeownership a reality for thousands of undocumented workers have withered -- although not because they underperformed.

The loan program highlights contradictions in U.S. polices toward illegal immigrants. Even as the Department of Homeland Security sought to deport them, the Federal Deposit Insurance Corp. goaded banks and credit unions to bring undocumented immigrants into mainstream banking if they could prove they had steady income and were creditworthy. Beginning in 2003, when banks and credit unions first offered mortgages to undocumented immigrants, the small segment blossomed. The mortgages performed better than some others, partly because of stringent lending criteria and because they usually had fixed rates over a period of time.
...
But amid the crackdown on illegal immigration and the economic slowdown, the market for immigrants who boast the alternative nine-digit taxpayer ID is dying.
"If you want to buy a house and you're here without papers, now you can forget it," says Jesus Benitez, a real-estate agent who caters to Hispanics in Brooklyn.
...
Bank of Bartlett, a small bank that serves the greater Memphis area, endured the "political heat," says John Byrd, president of Bartlett Mortgages, a unit of the Tennessee bank. "We felt we were doing the right thing; these people had been working here many years and paying taxes." All told, the small bank originated about $20 million in ITIN mortgages over four years, each worth about $100,000. Less than 5% of Bank of Bartlett's ITIN loans are delinquent. Nationally, for loans more than 90 days in arrears, ITIN mortgages had a delinquency rate of about 0.5% last year, compared with 9.3% for subprime mortgages, according to independent estimates.
...
Unwilling to shoulder the risk alone, Bank of Bartlett and others began withdrawing from the ITIN home-loan market -- though they continue to service their current clients.

A Wonderful Day on the Blogosphere

When Bryan Caplan puts out a post on the Tiebout model, and I scroll down to find a comment from Bill Fischel, whose Homevoter Hypothesis I have previously admired as the most underappreciated theory in economics. First, Caplan asks:

The economist Charles Tiebout is famous for analogizing local government to perfectly competitive firms. His model inspired this question on my last public finance midterm:

If the Tiebout model were correct, how would you expect local governments to raise revenue? Carefully explain your answer.

Who wants to take a stab at this? I'll post my preferred answer as a followup.

To which Fischel responds in the comments (#22):

A student pointed this question out to me, so let me give it a try. There is some literature on this that suggests that a land tax is the ideal method. It is incentive compatible (you don't want to trash your neighbor because it would lower taxable values) and it has no deadweight loss. Henry George had a point. I have argued that a system of local zoning with ordinary property taxation (land and buildings) is actually a pretty good approximation of a land tax in a Tiebout model. The citation is (please excuse my pedantic aside) Fischel, William A. 1998. “The Ethics of Land Value Taxation Revisited: Has the Millennium Arrived Without Anyone Noticing?” In Land Value Taxation: Can It and Will It Work Today? ed. Dick Netzer. Cambridge, Mass.: Lincoln Institute of Land Policy. The reason zoning is essential is that it keeps supply of capital inelastic (in fixed proportion to land), so the tax on both is like a tax on land. A related argument is Glaeser, 1996. “The Incentive Effects of Property Taxes on Local Governments.” Public Choice 89 (October): 93-111. I was a little surprised to learn that Bryan had asked this question, since I gather that he does not think too highly of voters' ability to make rational decisions, one of which would be choice of tax base. I would demur on that on the basis of median voter evidence and Condorcet's jury theorem, but now I've really veered from the topic.

I'm actually preparing to speak at Beloit College on Fischel's Homevoter Hypothesis as a prelude to my current research, and I've already incorporated a slide that defends both Fischel from Caplan and Caplan from Fischel. In short, voter's at the municipal level are more likely to pay a price for irrational beliefs and respond by voting wisely with respect to their housing prices.

Three Things to Remember About the Takeover

Keep in mind:

1. Freddie Mac and Fannie Mae were never real private sector firms with the normal accompanying incentives, they are politically designed animals from Washington (Freddie in 1970's by Congress, Fannie in 1938 by FDR).
   
2. The problem is the transparency of asset value. The government does not have any better handle on this than does anyone else, and I cannot see how nationalization changes that.
3. Housing prices are the rare zero-sum game, and are not to be concerned about. Despite what our handsomest policy makers say, home ownership is not a right, and selling at a price higher than you originally paid is definitely not right.

As always comments are open.

Check in with Arnold Kling often at EconLog.

USPS, SSA, DMV - Meet your New Friends Feddie and Fannie

Pseudo-private firms Feddie Mac and Fannie Mae have been seized to "rescue" the mortgage industry. This has a very scary feel to it, I am somewhat comforted by the fact that these institutions were never really private firms to begin with, so on the margin I don't know how much damage they can really do. My bigger concern is that future downturns in the business cycle will require policy makers to "nationalize" something.

Name the Unintended Consequences...Credit Card Reporting

Flying around the blogs is the story that the new housing bail-out bill contains a provision that all credit card transactions must be automatically submitted to the IRS. This begs the following questions:

1. What will be the unintended consequences of this, if passed into law? Fewer e-Bay transactions? Less readable purchase descriptions on your credit statement? More readable?
   
2. I would guess there are somewhere around a billion transactions per day. Can they really do anything practically useful with that information?
3. What does this have to do with housing? I know, riders need not matter.
4. Can they make the data available to economists? Pretty please?
   

Revealed Preferences for Relative Status

Naked Self-Promotion:
As promised, here is a new working paper by Susane Daniels and myself. Titled "Revealed Preference for Relative Status: Evidence from the U.S. Housing Market."

This paper investigates the value individuals place on their relative status in consumption, as opposed to absolute status. Using housing data from five Ohio MSAs, we employ a spatial Durbin hedonic price model to estimate willingness to pay for both relative and absolute status. Using this revealed-preference approach, we find individuals, on average, are willing to pay $7,332 per 100 square feet for an increase in absolute house size, compared with $2,257 for an equivalent increase in relative house size. This strongly suggests that while individuals do desire relative status, they value absolute status significantly more.

Susane Daniels is entering her 4th year of the Econ Ph.D. program here at WVU, and is extremely promising. This is the lead essay of her excellent dissertation on Revealed Preferences for Relative Status. In the other essays, she examines the "relative to who" question, as well as breaking the results down by quintile to tease out the "who cares?"

Who Gentrifies Low-Income Neighborhoods? A Problem for Relative Happiness Literature

New NBER working paper by McKinnish, Walsh, and White. Abstract:

This paper uses confidential Census data, specifically the 1990 and 2000 Census Long Form data, to study the demographic processes underlying the gentrification of low-income urban neighborhoods during the 1990's. In contrast to previous studies, the analysis is conducted at the more refined census-tract level with a narrower definition of gentrification and more closely matched comparison neighborhoods. The analysis is also richly disaggregated by demographic characteristic, uncovering differential patterns by race, education, age and family structure that would not have emerged in the more aggregate analysis in previous studies. The results provide no evidence of displacement of low-income non-white households in gentrifying neighborhoods. The bulk of the increase in average family income in gentrifying neighborhoods is attributed to black high school graduates and white college graduates. The disproportionate retention and income gains of the former and the disproportionate in-migration of the latter are distinguishing characteristics of gentrifying U.S. urban neighborhoods in the 1990's.

This paper will prove problematic for the relative happiness literature (aka positional externalities), where the agents are constantly trying to outperform their neighbors by being in the richest neighborhoods and being the richest of the neighbors (often, it is supposedly signaled with house size, which I will weigh in soon on). If households care so much about relative status, then: 1) Why does gentrification occur? Why would the well-off move to poor neighborhoods? and 2) once the gentrification process begins, why are those who are being gentrified out of their neighborhood so slow to leave?

In short, these problems with that line of literature arise because they usually aren't able to answer "relative to who?" If your answer to #1 is "because they'll be the richest person there", then you must concede that the behavior in #2 contradicts #1. The original residents who were "relatively rich" are not leaving after becoming "relatively poor" to their new neighbors.

If absolute status dominates, there is a simple explanation here: People move to poor neighborhoods because they find great bargains there for housing, and those being gentrified out aren't eager to leave because they are reaping the gains of increased property values because of their new neighbors.

Housing Market Blues and Wha-Hoos!

Business Week and CNN each report on the decline in the Case-Shiller index by 14%. Let's be clear on one thing, which is that in most cases houses haven't disappeared. When Hurricane Katrina ripped through Louisiana and Mississippi, houses disappeared and society was poorer because something it produced disappeared. Here the price is falling, which is bad for home sellers but is equally good (by and large) for new home buyers. Considering that the news was riddled over the past few years with stories on how "outrageously expensive" housing was, I can see no way for the housing market to experience anything but "bad news." Price can only be either too high or too low, according to the media.