Affordability, Housing Prices, and Interest Rates

Elizabeth Warren questions David Leonhardt's article claiming that housing in America today is "affordable":

TPMCafe || Is Housing More Affordable?: David Leonhardt usually does first-rate work, but his housing piece in the NYT this morning has some real data gaps.... [T]he article talks about the purchase price of a new home relative to household income. The problem is that a fully-employed male today makes (in inflation-adjusted dollars) about $800 less than his counterpart thirty years ago. But... median income for families has shot up dramatically in the intervening years because the typical married couple now sends two people into the workforce. In other words, it now takes two earners to pay a mortgage rather than one. A generation ago, a typical wage-earner could buy a typical house; today, it takes two incomes to buy an average home in fully 75 percent of America's cities. And that means housing is just as affordable as it used to be?...

One last point is worth noting: by picking the reference point as the early 1980s rather than the 1970s or the late 1980s, the NYT is benchmarking off the worst housing market in the second half of the 20th Century. Because inflation was out of control and mortgage rates were stratospheric, home buying was curtailed and housing markets suffered. Is that what we want to hold up as the model for comparison?

The data are complex, and I don't think the NYT is trying to slant the discussion. But describing the news as rosy for homebuyers doesn't reflect reality.

Ezra Klein supports Leonhardt:

TAPPED: December 2005 Archives: Warren's book, The Two-Income Trap, has lots of good data on the increasing percentages of family incomes devoted to essentials, so she should be taken seriously on this. On the other hand, the basic point of the article remains a worthy one: the massive increase in housing costs is primarily a phenomenon of heavily populated, coastal, urban or near-urban areas. When you venture beyond the states that reporters tend to inhabit (say, to Colorado, Arizona, Vermont, or Wisconsin), housing chews up a much more reasonable 15 to 25 percent of your income. Now, not every occupation offers geographic mobility, but assumedly we'll all be telecommuting within 10 years anyway, rendering the middle of the country significantly more inhabitable for the folks currently unable to contemplate it.

And Doug Henwood observes:

Doug Henwood: : What a funny article. In 1985, mortgage rates averaged 12.4%, and mortgage debt service (according to the Fed) took up 9.3% of a homeowner's after-tax income. In 2005, interest rates have averaged 5.8%, and the debt service bite, 10.5%. So interest rates have fallen by more than half, yet the servicing burden has risen. Interest rates better stay low or some people will be in trouble.

Let me say a word for what I think is the basic point underlying Leonhardt's article: one reason that housing prices are high is that interest rates are low, and it's interest rates times housing prices that matter for affordability--not either alone.

Comments

[Rob]

But see Ezra really doesn't understand Wisconsin and similar places. Sure you can still get a starter home in around Milwaukee for arounf $150k. But look furtehr out where the housing growth actually is. My parents house is now 10 years old and is valued at about double what they paid for it. Given that taxes are low and the qaulity of schools outside of Milwaukee county proper are really good, more families move there.

[Jonathan King]

So could somebody explain the meaning of this Ezra Klein statement to me?
>
> Now, not every occupation offers geographic mobility, but
> assumedly we'll all be telecommuting within 10 years anyway,
> rendering the middle of the country significantly more
> inhabitable for the folks currently unable to contemplate it.

Does he really mean to say that location doesn't matter, despite the fact that location has *always* mattered? People are moving away from rural Kansas, Nebraska, Iowa, and Missouri for very good reasons, critically including the fact that there is nothing to do out there, and no reason to be there. Prices have always tended to be higher on the coasts, and that is because people want to be there. Clearly, we are in a real estate bubble in many markets, and real price drops of 40% will likely occur in some places. But I don't see why some tremendous surge in telecommuting will make the coasts less attractive, given that the only reason why some people don't live there already is the very tyranny of place that telecommuting will free us from. If you have the money and could live anyplace, why not San Diego?

[save_the_rustbelt]

Just some anecdotal observations from an accountant, but the size and quality of housing today is quite over the top. This seems to be especially true of two career couples.

Many of the houses built in this area are 3500+ square ft. for married couples with 2 or 3 children tops. All the gadgets and accessories are included.

We live in a much more modest house, although on an exceptional lot in a terrific neighborhood, and our house payment is less than our car payment. Somehow we survive.

When I used to see a lot of tax returns the payments were relatively huge compared to just 15 - 20 years ago. Since the payments were huge at modest interest rates you can imagine that the borrowing was high relative to income.

Perhaps one of the problems is that contractors do not want to build "normal" houses anymore. They make more money on the frilly "yuppie-barns."

Perhaps the biggest problem is "keeping up with the Jonese."

[save_the_rustbelt]

Finishing my thought....

Perhaps there is a brewing shortage of "normal" housing because the contractors do not want to build 2200 sq. ft. homes these days. This is likely driving up prices.

[Jonathan King]

save the rustbelt writes:
>
> Perhaps there is a brewing shortage of "normal" housing because
> the contractors do not want to build 2200 sq. ft. homes these
> days. This is likely driving up prices.

Contractors I have known will build whatever gives them the best return. Nobody will build a 5000 square foot plasti-castle unless those are selling well (and can be built on small enough lots). If they are selling well, I bet the larger (but not necessarily fancier) houses yield larger per house profits.

But what concerns me is not the lack of "normal" housing, but the lack of "affordable" housing. Here's an example from the town I grew up in:

http://re.boston.com/sales/View_Ulisting.asp?lid=996-70284406

I think this listing expresses the essence of the problem. Some places have become absolute magnets for higher income families; Sharon did not used to be a ritzy place *at all*, but now it is. Part of that is proximity to Boston, part of it is the long-term effect of snob zoning (1 acre lots are required in most cases). Part of it is pure bubble. But when the cheapest 3-bedroom house in town is this $335,000 beauty:

http://re.boston.com/sales/View_Ulisting.asp?lid=841-372-051106101

You've got a serious problem no matter what the cause is. And in this case, you sure can't blame the builders for over-building.

[trotsky]

I live in a quite charming thank you very much 50-year-old house, without much in the way of modernizing upgrades.

More than the size and/or amenities, it is simply the comfort and construction quality of new houses that just gobsmacks me.

Is there any accounting for the quality differential? Our ancestors the baby boomers were raised in veritable shantytowns, yet somehow thrived.

By the way, what's with Warren's "I don't think the Times is trying to slant the discussion." The newspaper would be doing this because .... ?

[a different chris]

Since this is the "I have a fried" thread I have a friend that is a building inspector.

Although I'm not entirely ready to pronounce today's cornfield-clobberers "high quality" in all respects, there are a lot of things - wiring, insulation - that are noticably improved. And for that you can thank your activist local (and regional) gummint for trying to protect its citizen's safety (from electrical fires) and their pocketbook (do you know what's between your walls? Do you want to dig a hole in one to verify you got what you paid for? Would even an economist from Berkely know what he's supposed to see?).

[anne]

http://economistsview.typepad.com/economistsview/2006/01/paul_krugman_no.html

January 02, 2006

Paul Krugman says there is a housing bubble, a big worrisome bubble located in the Northeast Corridor, coastal Florida, much of the West Coast, and a few other locations
By Mark Thoma

No Bubble Trouble?, by Paul Krugman, Commentary, NY Times: In spite of record home prices, housing in most of America remains surprisingly affordable, thanks to low interest rates. That fact may seem to say that there's no housing bubble. But it doesn't. To see why, we need to brush up on our economic geography and economic history.

Let's start with the good news. A report in last week's Times ... found that for the nation as a whole, the cost of owning the median home is still only 23.7 percent of median family income, ... well below the peak of more than 30 percent reached in the early 1980's.

Now for the economic geography. Last summer I suggested that when discussing housing, we should think of America as two countries, Flatland and the Zoned Zone. In Flatland, there's plenty of room to build houses, so house prices mainly reflect the cost of construction. As a result, Flatland is pretty much immune to housing bubbles. ...

In the Zoned Zone, by contrast, buildable lots are scarce, and house prices mainly reflect the price of these lots rather than the cost of construction. As a result, house prices ... are much less tied down by economic fundamentals... By my rough estimate, slightly under 30 percent of Americans live in the Zoned Zone, which comprises most of the Northeast Corridor, coastal Florida, much of the West Coast and a few other locations. So ... results on affordability aren't surprising: most families live in Flatland, and haven't seen a big rise in the cost of home ownership.

But because Zoned Zone homes are much more expensive than Flatland homes, ... [b]y my estimate, more than half of the total market value of homes in the United States lies in the Zoned Zone. And ... the Zoned Zone accounts for the great bulk of the surge in housing market value over the last five years. So if we want to ask whether housing values make sense... [w]e need to focus on houses in the Zoned Zone. And there the numbers are anything but reassuring.

In the Zoned Zone, ... prices have risen so much that housing has become much less affordable. ... Even so, the current cost of owning a home in the Zoned Zone isn't entirely unprecedented. Roughly similar percentages of median family income were needed to afford houses in the early 1980's.

But that's hardly a comforting comparison, which is where the economic history comes in. You see, the unaffordability of housing in the early 1980's led to an epic collapse in the housing industry. ... And ... was one of the main factors in the worst economic slump since the Great Depression, which brought the unemployment rate to a peak of 10.8 percent at the end of 1982.

It's also worth noting that the reason housing was so expensive in 1981 and 1982 was that mortgage interest rates were extremely high. That made recovery easy, because all it took to make housing affordable again was for interest rates to return to normal levels. This time, with interest rates already low by historical standards, restoring affordability will require a big fall in housing prices.

So here's the bottom line: yes, northern Virginia, there is a housing bubble. ... Part of the rise in housing values since 2000 was justified given the fall in interest rates, but at this point the overall market value of housing has lost touch with economic reality. And there's a nasty correction ahead.

[trotsky]

Housing prices and the inverted yield curve are also, of course, tightly connected, so the bubble will burst when we the United States does _________ to stop the Chinese from buying our Treasury Bonds.

Fill in the blank.

[Kaleberg]

The product of the house price and the interest - that's a good measure. Most people I know "rent their houses from the bank" as one Harvard B School guy put it.

I did some number grinding and houses turn out to cost perhaps 1/3 more than they did in the 1960s, but a lot less than the late 70s and early 80s, at least in comparison with the average hourly wage. You can laugh at my numbers and pathetic methodology at http://www.kaleberg.com/househours

A big reason for house size creep is that land prices are rising. Krugman is right about zoning, which caps land values, but real estate value depends greatly on what your neighbor cannot do. That's one of the reasons people like the coasts, because very few of us can walk on water.

[anne]

Supposing Paul Krugman is right about a coastal housing bubble and coming nasty correction, the questions to be asked are can monetary policy effectively limit the general economic slowing that will result and what could be a proper protection for a household? Should we finally worry, and where are our protections to be found?

[jm]

Those who argue that the prices people are paying for houses are not excessive because interest rates are low are failing to consider the implications of the fact that they are treating housing like a bond investment without taking leverage and liquidity into account.

I find it wondrous how people who ought to know better blithely opine that the proper price for a house is set by the maximum monthly payment buyers can afford, yet ignore the possibility that career or family situation may force them to sell when interest rates are back up nearer their historical average margin above the inflation rate, which itself may be higher than today.

They fail to understand that in effect what they are doing is the same as speculating in bonds with leverage of 5:1, 10:1, or even more.

I find it even more wondrous that this is allowed. The people doing this would never be allowed to speculate in bonds in this way -- I suspect 50% margin would be the limit, and they'd be required to demonstrate some degree of understanding of the risks that the market might turn against them.