Austin Contrarian

Glaeser: Why New York City home prices won't collapse

Because it is dense:

I won’t be surprised if Manhattan prices do drop in the next few years, but I also strongly believe that the future of New York City continues to be bright. Homo sapiens are a social species; almost all of what we know we learn from each other. Dense cities, like New York, succeed when they take advantage of this fundamental aspect of our humanity. They thrive by enabling us to connect with each other, which then promotes learning and innovation. The current downturn will only increase the returns to being smart, and you get smart by hanging around smart people. As long as New York continues to attract and connect those people, the city will continue to thrive.

This supports a point some commenters made in response to one of my posts on the housing bubble, although Glaeser is crediting demand rather than tight supply.

Rethinking Federal Housing Policy

Ed Glaeser and Joseph Gyourko's e-book (pdf) on federal housing policy really is worth a read.  

Glaeser and Gyourko argue that federal housing policy wrongly treats every jurisdiction alike.  The country really has three different housing markets.

First, there are markets with high demand but elastic supply -- e.g., Houston and Atlanta.  Housing in these markets closely tracks the cost of construction.  Because developers cannot supply housing more cheaply than this over the long run, it makes no sense for the federal government to intervene directly in these markets -- there simply is no market failure.  (For the poor, Glaeser and Gyourko suggest outright transfers so they can buy more housing, or housing vouchers as a second-best solution). 

The second kind of market is the low-demand market -- Detroit, for instance --where housing can be had for less than the cost of construction.  It is silly to subsidize the construction of new housing in these places.

The third kind of market is the high-demand, inelastically-supplied market -- the West Coast, the Amtrak corridor in the northeast, and a few other markets in the country's interior.  These markets exhibit government-created market failures.  Tight zoning regulations in these markets combined with high demand have raised the cost of housing well above the cost of construction, sometimes by hundreds of thousands of dollars.  New construction permits amount to a tiny fraction of the housing stock.

The market failures in these jurisdictions endure because local governments have no incentive to increase the supply of new housing:  the benefits from new housing go mostly to non-residents, while the costs from polution and congestion -- not to mention the effect of new competition on housing prices -- fall on existing residents.  

Federal housing policy -- particularly the mortgage interest deduction -- has different effects depending on the market.  In elastically-supplied markets like Houston or low-demand markets like Detroit, the mortgage interest deduction increases consumer demand and stimulates the construction of more housing.

In high-demand, inelastically-supplied markets, though, the benefits of the mortgage interest deduction flow to existing homeowners.  The mortgage interest deduction paradoxically makes housing in these markets less affordable.   

Glaeser and Gyourko argue that federal housing policy ought to target the broken markets.   The goal, they suggest, should be to incentivize the high-demand, inelastically-supplied markets to allow more housing.

They propose capping the home mortgage interest deduction at $300,000 for households in these markets.  (They would phase out the deduction for current existing mortgages for equitable reasons.)  This cap would generate additional tax revenue.  The federal government would then refund that revenue to the local governments (via the states) provided the local governments made sufficient progress toward increasing their housing supply.  Glaeser and Gyourko essentially propose bribing local jurisdictions with their homeowners' tax dollars. 

Needless to say, I think this is a great idea.  Rich housing markets are becoming increasingly stratified by income.  The lower and middle classes are being run out of these markets by high home prices.  Their allegedly progressive citizenry, embarrassed by the increasing inequality, flail about for solutions.  But they won't allow the one thing that would improve affordability over the long-term.   

Incentivizing new development in these cities would benefit the rest of us, too.  The high-demand cities have high demand because they make their citizens more productive.  Restricting access to them creates a net welfare loss for the country as a whole.  

But Glaeser and Gyourko's proposal will be dead on arrival.   The costs of their proposals would fall on a small, clearly identifiable group -- wealthy homeowners in high-priced markets.  These homeowners would suffer a double-whammy, through the loss of their tax deductions and the loss of home value due to increased supply.  Everyone else would benefit, of course, but those benefits would be diffuse.  Local governments would benefit from the extra revenue, but local governments don't vote for senators or congressmen.  If this proposal were enacted, Barbara Boxer would hear the howls of Marin County homeowners from her seat on the Senate floor.  

Christmas Break

No one reads blogs over the holidays, so I probably won't post again until after the New Year.

Happy holidays.

Obscure link of the day

The Codes Project of the Center for Applied Transect Studies.  In case you are interested in the Spanish codes dictating the layout of new towns in the Spanish colonies, the 1928 design standards for Shaker Heights, Ohio, or the Federal Housing Administration's idea of successful subdivision design circa 1940.

This is what I mean by irrational

A bubble exists when people are paying prices that make no sense.  "No sense" as in, "There's no way in hell that this asset will ever generate enough income to pay them back."

Here's a nice illustration. 

The authors of this paper conducted an experiment with college students.  They gave each student some money and some "stock."  Trading was divided into 10 periods.  During each period, students were allowed to trade stock.  At the end of each period, each share of stock earned a divident of 20 cents with a 50% probability or 0 cents with a 50% probability.

The expected value of each share of stock was $1 before the first period (10 periods with an expected value of 10 cents after each period).  At the end of the second period, each share had an expected value of exactly 90 cents.  And so on.  At the end of the 9th period, each share had an expected value of 10 cents.

The students were told before the experiment how to value the shares of stock. But once trading began, the students quickly bid the price of shares well above their expected value.

This was not simply an instance of risk-preferring behavior, as the chart below shows.  Beginning with period 7, the average share price exceeded the maximumpossible total return.  Students paid an average of $1/share during period 7 even though the maximum return -- assuming a share hit the 20-cent dividend four times in a row -- was only 80 cents.  During period 10, shares traded at 90 cents even though the most each share could earn was 20 cents. 

This was not a freak event.  Nine out of ten experiments produced similar results.

If people can react this irratonally in a controlled experiment with clearly defined financial returns, the bubbles in the housing and credit markets are easy to understand.  We should probably be asking ourselves why we don't see more bubbles.

Marriott sticks us with another empty lot downtown

Although Marriott has announced that it will delay the construction of its mammoth hotel on Congress, it has already demolished the storefronts that used to house Las Manitas and the Tesoros Trading Company.  This block will now sit largely vacant until Marriott feels the economy has recovered enough to proceed with construction.

Why demolish the building now?

Dunno.  I can only speculate.  Here are four possible explanations:

1.   Marriott may have been worried that the Historic Landmark Commission would designate this block a historic landmark, a risk since Marriott won't build for another couple of years (at least).  Marriott just preempted future debates.

2. Taxes.  The property is worth more with buildings and hence has higher property taxes.  I have trouble believing that was the reason here, though, since I'm sure almost all the value of that tract is in the land.

3. Liability.  Vacant structures pose all kinds of liability risks -- they're more vulnerable to fires and trespassers.

4. Risk of the unknown.  Austin changes its land-use regulations every time the wind changes direction.  Marriott may have figured that demolishing the building now would hedge it against that kind of risk.

Don't think I'm condoning this.  I'm not.  Demolishing these street-front stores (even if vacant) saddles the rest of us with a painfully conspicuous dead spot on Austin's premier street -- a dead spot that won't be revived for several years.  While other developers are busy trying to inject life into this end of Congress, Marriott is busy squeezing it out. 

Downtown Austin is pockmarked with vacant lots and surface parking lots.  We badly need a mechanism for discouraging property owners from warehousing vacant lots downtown.  The solution is not to shut out all redevelopment to eliminate the risk of this kind of behavior.  What we need is a vacant-lot surcharge or something like it.  A surcharge calibrated to compensate the other downtown property owners, businesses and visitors for the very real cost of blighting a block.  This might encourage property owners/developers to leave existing buildings in place or  to fill in currently vacant lots, even if the structures are inexpensive and small.  

Whether such a surchage would be legal is a question for another day . . . 

When toll revenue comes up short

The Statesman reports that central Texas toll revenue might not meet projections due to the economic downturn:

The combination of sky-high gas prices this summer and then a plunging economy this fall has caused toll road use in Central Texas to stagnate, tollway officials say, and many tollways across the country have seen falling traffic. The sluggish traffic raises questions about whether some roads will be able to pay the decades of debt remaining without tapping tax money.

In the Austin area, although traffic on all four tollways (three run by the state, one by a local authority) is at or above levels of a year ago, two of the toll roads are bringing in less revenue than was projected when money was borrowed to build them. Revenue on Loop 1 for September through November was about 2 percent less than for the same period of 2007.

The overall performance of the three Texas Department of Transportation tollways — traffic has been essentially flat since May — and the lagging development picture in Central Texas suggest that the system of roads could struggle to meet projections of revenue increasing more than 60 percent over the next two years.

I'm sure some this news will elicit some schadenfreude from toll opponents.  Expect to see this shortfall treated as a mark against tolls -- something along the lines of, "Tolls are a failure as a funding mechanism so we may as well use tax revenue."

But the shortfall is not evidence of anything other than that roads are less valuable during economic downturns (fewer people working and shopping) and periods of high gas prices.  All roads are less valuable.  The drop in the value of free roads is masked by the fact that they are free.  Yes, they might be a little less congested, but otherwise there is no way to tell how much demand has dropped because they are unpriced.  With toll roads, the drop in demand has no place to hide.  

And we shouldn't want demand to be a mystery.  Whether a price is charged or not, there is a finite amount drivers are willing to pay for a road.  When the cost of construction exceeds this "shadow price," building the road makes no economic sense -- it means economic waste.   That waste, of course, is passed along to everyone who pays the taxes to fund the road.  We can make a mistake in choosing to build a particular toll road, but we'll have a better idea of the value of that road if we charge a toll than if we do not.

I do believe that our toll system can be improved.  We currently use flat tolls rather than variable congestion pricing; variable congestion pricing is much more efficient.  And we can save ourselves some grief by tolling the right roads.  It makes no sense (economic sense, anyway) to toll a new, lightly-traveled road while leaving the old, congested road untolled.   Let me re-quote Brendan O'Flaherty:

There's no good reason to have a toll on an empty stretch of new road that hasn't been paid off; there's plenty of reason to have one on a congested road that has been paid off.  Since roads are generally uncongested right after they're built and become more congested as they become older . . . , the idea that tolls should be used to pay off a road's costruction cost leads to the worst possible allocation of resources:  high tolls at first that discourage trips that should be made, and no or low tolls later that encourage waiting that should not be done.  It's like taking a vile-tasting medicine when you're young and healthy, and stopping it when you get sick and it could help you.

A corollary is that tolling old, congested roads with proven demand provides a reliable stream of income for funding new roads.  Which means fewer stories about revenue shortfalls.

Tagged

I've been tagged by Wendy Waters (All About Cities).  I'm supposed to list seven facts about myself and tag seven others.

Ok, I'll play.

1. I've never tasted ketchup.
2. I did not wear socks between 1984 and 2002 (yuck, I know) 
3. I took a three-year break from practicing law to go to math graduate school, which is how I ended up in Austin.
4. I'm a horrible public speaker.
5. I grew up on 12 acres of forested land outside a small town in Mississippi, which explains my fascination with cities and urbanism.  (Nothing against the woods or McComb, Mom.)
6. When I was 7, my elementary school was struck by a Category 4 tornado as I was about to walk in.  My mom grabbed me by the scruff of the neck and dragged me back to our 1973 Pontiac, where we rode out the tornado.   (The school bus right in front of us ended upside-down in a ditch.)
7. I got married in Athens. Two days before our wedding, a reporter from Good Morning Greece interviewed us at the Acropolis -- he was interviewing tourists at random -- and asked to cover our wedding. We agreed. The reporter and his crew actually showed up to tape it. Two days later we went to Santorini. We walked into our little villa and, as is my habit when traveling, I turned on the TV first thing. And there was my face on the screen; they were running the piece at that very moment. My wife and I joked we'd never be able to walk down Athen's streets again without being mobbed.  

I tag:

Mike Dahmus (M1EK's Bake-Sale of Bile)

Tim Thomas (Loaded Gun Theory) 

Ryan Avent (The Bellows)

The Overhead Wire (not sure if maintaining pseudonymity)

Adam (Market Urbanism)

Jude Galligan (Downtown Austin)

Matthew Kahn (Environmental and Urban Economics)

Bonus:  Shawn Shillington (if Austinist lets him play)

A modest proposal

In this time of economic turmoil, we need to think hard about how we can use federal tax policy to revive our lifeless economy.  We need bold ideas and bold leadership. 

I have a modest proposal:  Let's exempt from all stock dividends from taxation.  We would no longer treat dividends as ordinary income or any other type of income -- the government wouldn't take one thin dime of this investment income.

But let's not stop there:  let's also exempt all capital gains realized from the sale of stocks.

This policy would have three salutary effects.  First, it would induce a flood of money into the stock market.  We all know the stock market badly needs an infusion of cash right now.  And what's good for the stock market is good for the country.

Second, by encouraging taxpayers to invest in the market, we would simply be incentivizing them to do what's in their own best interest anyway.  We all know that investing in the stock market is a nearly sure-fire way of building wealth over the long-term, the current market blip notwithstanding.

Third -- and this is a more nebulous benefit, I admit -- taxpayers who own shares of stock make better citizens.  They care more about our government's economic policies and the quality of elected officials.  And they have an incentive to get more involved in civic affairs.  My proposal, simply stated, would make us all better citizens, or at least those who could afford some stock.

I really can't imagine a tax policy that would do more to strengthen our economy and civic spirit.

Sure, it might not be completely equitable.  The subsidy would benefit most those who have the most.  There's no way around the fact that someone earning $1 million a year in ordinary dividends would benefit more than someone earning just $100 a year.  Those who couldn't afford any stock at all, of course, would lose out completely, but remember, this is for the good of the country.

I also recognize that exempting dividends and capital gains would cause investors to bid up the price of stocks; the main beneficiaries would be those who already own gobs of stock on the date the subsidy took effect -- you know, the filthy rich.

But it's worth it to encourage badly needed investment in the stock market and make us better citizens.  And, remember, we'd be helping ordinary taxpayers by incentivizing them to do what's in their own long-term interest.

I believe this is a perfectly sensibe and defensible proposal.  After all, we already do it with homes.  

P.S. I thought my sarcasm was obvious, but judging from the comments, it apparently was not.  

Most people would say that these "justifications" are silly reasons to exempt dividend income and capital gains from taxation.  But these are the same justifications usually offered for exempting the imputed income from owning a home and the capital gains realized from their sale.

Bubbles in inelastic markets

I think one of the points I'm trying to make about bubbles is getting lost in all the back and forth:

Bubbles are fundamentally irrational events.

Now, even slight shifts in demand in an inelastic housing market will cause home prices to rise.  They're supposed to rise; that's a simple matter of supply and demand, first-day economics stuff.   But a sharp rise in prices does not a bubble make. Bubbles occur when an asset's price rises above its fundamental value.  In an inelastic market like LA, this means:  Prices first rise because of a shift in demand -- basic economics -- but then take off from there as the mass delirium that causes a bubble takes hold.

I don't think the sharp price increases in central LA, San Diego and DC could be justified by any rational valuation of homes as capital, income-producing assets -- although they certainly could have triggered frenzied investment by new investors. I instead claim they were bubble prices and therefore had to crash. This crash had to happen regardless of the strictness of land-use regulations because even land-use regulations cannot sustain prices (long-term) above a rational value.

But let's suppose I'm wrong and that all price increases were caused by a shift in demand in an inelastic market. The principle works in reverse, too: Slight shifts downward in demand cause steep drops in prices. Since there's no question that the collapse of the subprime markets caused a drop in demand, these inelastic markets had to see a steeper decline in prices than inelastic markets, at least if you accept basic principles of supply and demand.

Supply-and-demand does not tell you where the price increases decreases will be steepest within a metropolitan area, but the price declines ultimately must be blamed on supply inelasticity.

Related Links:

1. Bubbles (Dec. 7, 2008)

2. Bubbles again (Dec. 10, 2008)

3. The housing bubble as I see it (Dec. 16, 2008)

4. Glaeser and Gyourko on the housing bubble (Dec. 17, 2008)

5. Central city land-use regulations and the bubble (Dec. 17, 2008)