Thursday, August 11, 2016

Capital and New Construction

Bankers like to complain about Basel III capital rules. Among other things, they argue that the rules make construction lending more expensive.  A nice summary of those rules notes:

As part of the standardized approach, the final rule requires banking organizations to assign a higher risk weight of 150% to any high-volatility commercial real estate (HVCRE) exposure, defined as “a credit facility that finances or has financed the acquisition, development, or construction (ADC) of real property.” 
This means that lenders must put more capital behind construction loans than other types of loans. Bankers argue that because capital (in the form of paid-in equity and retained earnings) gets paid after debt, it requires higher returns than debt, and therefore higher capital requirements lead to higher lending costs.

In a pure Modigliani-Miller (MM) world, where capital structure is irrelevant to corporate valuation, this argument doesn't make sense.  While debt is cheaper than equity, firms with less leverage are less risky than firms with more leverage, and so as the amount of debt used falls, the return on equity investors require also falls.

But while MM is helpful for thinking about capital structure, it makes some unrealistic assumptions. The most important MM assumption for thinking about capital and banks involves the cost of financial distress.  MM in its purest form assumes the problem away--that debt will always be repaid, and so costs arising from potential default are irrelevant.  One of the current presidential candidates shows that this assumption is problematic.  When lenders (in this case, those who lend money to banks, such as depositors) think there is a chance they will not be repaid, they add a default premium to the cost of debt, and hence discourage leverage beyond some critical point.  Thus the market disciplines the issuance of debt.

Yet for banks who rely entirely on deposits for funding, the MM assumption about the absence of default costs is realistic, because deposits are nearly all guaranteed by FDIC (the exception is corporations who briefly deposit money beyond the FDIC maximum for the purpose of paying workers). Banks (except for those that have bond financing as well as deposits) face less market discipline, and so get debt more cheaply than other businesses.  Let me pause here to note that to me the benefits of deposit insurance have demonstrably outweighed the costs.

To return to the major point, however: for banks that rely on deposits for funding, higher capital requirements do indeed raise costs, because they limit the amount of subsidized debt they are permitted to use.  For those of us worried about an absence of new construction in housing, this is a problem, because while Basel III does raise cost, it is doing so by attempting to prevent banks from avoiding market discipline.  In other words, we are now probably closer to a world in which banks pay a more efficient price for funding construction loans than we were before.  And compared to what we are used to, that price is expensive.  

I would very much welcome other thoughts about this.

Monday, August 08, 2016

Use up-zoning, but don’t give it away


 Los Angeles has three interrelated issues: for a city of its size, it is not, by world standards, very dense (see Figure 1.  The pictures of London and Los Angeles taken from the same height—the two metros have similar populations, but settlement in LA takes up far more land); its housing is expensive relative to its incomes; and its infrastructure (transport and water) should be better.  The absence of density has created a land shortage, which in turn has driven up land (and therefore house) prices, but density is not politically popular, in part because of the perception that Los Angeles hasn’t the infrastructure necessary to support more density.

Yet cites far denser than Los Angeles—such as London, Singapore and Hong Kong—manage to remain quite pleasant and at the same time provide large numbers of people housing subsidies.  Los Angeles can learn from Hong Kong how to fund infrastructure and housing, and from both Singapore and Hong Kong about the provisions of subsidized housing.

The government of Hong Kong uses its greatest asset—land—to fund its operations, and particularly infrastructure.  When the Special Autonomous Region grows, the government puts undeveloped land up for bid, and the highest bidder at auction wins the land.  The reservation price of the land is sufficient to finance the infrastructure needed to support the new development.  Because Hong Kong uses well designed auctions to sell properties, it extracts substantially more revenue than it would if it went through an RFP process.  The revenue allows the government to subsidize housing for more than half the residents of the SAR.

While the city of Los Angeles does not own a lot of land (relative to its size), it does effectively own a lot of development rights, in the form of air rights.  Some cities, such as New York, have given developers air rights in exchange for the production of deed restricted affordable housing (within the deeds, rents or prices are restricted to being affordable).  While the goals of the New York policy are laudable, there is some evidence that the newly created affordable housing crowds out older affordable housing (the same is true of inclusionary zoning policies).  A policy that extracted the maximum amount of revenue from developers in exchange for air rights would be more effective.  It would allow the city to fund the infrastructure necessary to support denser development, and/or acquire property for a housing trust fund that would allow for affordable purchase housing (this is essentially Singapore’s model), or provide subsidies to tenants.

We know auctions are an effective mechanism for the government to raise money; the federal government has generated far more revenues from the sale of the broadcast spectrum and drilling rights since it starting using auctions as its sales mechanism. 

One final note—while Los Angeles needs far more housing, housing supply will not alone solve our affordability problem.  Large, attractive cities around the world all have high house prices.  Building a lot will mitigate the affordability problem, but not solve it.  To accommodate those workers that all cities need, LA will need to provide subsidies, which means it needs to generate revenue.  In a Proposition 13 world, where pure ad valorem property taxes are not available, using auctions for air rights might produce just that revenue.

Figure 1
Los Angeles (above) and London (below) from 40 miles above.  Note LA cannot be contained within the picture at this scale.







Thursday, August 04, 2016

Heather Schwartz, Raphael Bostic and I write about renting in NOLA

The piece is here.

...Between 2000 and 2014, our analysis — which we performed for the John D. and Catherine T. MacArthur Foundation when evaluating their 20-year affordable rental housing preservation initiative — shows that rental affordability has gotten substantially worse in virtually every major metro area. That is not just the case for the lowest-income households. It's no longer a New York City and San Francisco problem; rents are unaffordable in Cleveland, Miami and Portland, too.
Take a family who lives in the New Orleans metro area that earned $10,672 as of 2011. Such a family had earnings in the bottom fifth of the renter income distribution in that region. This hypothetical family would have to spend 67 percent of its income to rent a home that is itself in the bottom fifth of New Orleans's rent distribution. In fact, families like this in the bottom fifth of the income distribution would have to spend more than 30 percent of their income to rent a perfectly matched home that has rent at the bottom fifth of the rent distribution in 280 out of 283 metro areas. The only metro areas where such a family would find affordable rental housing are Decatur, Ala.; Houma, La.; and Johnstown, Pa., which are all small metros.
And the problem is not just for that family at the bottom fifth. To continue with the New Orleans example, we found that families earning at the 40th percentile (e.g., $21,344) and 60th percentile (e.g., $35,574) also would have to spend far more than 30 percent of their incomes to rent homes at the corresponding point in the rental distribution. And this is not unique to New Orleans — in about one-third of metropolitan areas in the United States, renters at the 60th percentile must spend more than 30 percent of income to obtain housing at the 60th percentile of the rental distribution....


Sunday, July 31, 2016

Is Free Trade Good for Everyone? (Reposting, because it seems relevant right now).

Greg Mankiw implies that it is (although not anymore), and that all economists agree that it is.  But it actually isn't.  Who says so?  Economists.

In particular, the workhorse theory of International Trade, the Hecksher-Ohlin Theorem, leads to the Stolper-Samuleson Theorem, which shows that when countries start trading with each other, the relatively abundant factor of production in each country becomes better off, while the relatively scarce factor becomes worse off.   In the US context, this implies that opening up trade will leave capital better off relative to labor, and skilled labor better off relative to unskilled labor.

Does trade increase the total size of economies?  Yes--this is something that economists do agree on. But in the absence of redistribution--something that seems to be anathema to we Americans--more open trade will make low skilled laborers worse off.

In my ideal world, we would pass the Trans-Pacific Partnership (TPP), a potential [quasi]-trade agreement among the US and 11 other countries of the Pacific Rim, and redistribute its bounty such that everyone would be better off.  There is no evidence that our political system would allow this to happen.

Despite all this, I do and will continue to support trade agreements such as the TPP because that there is some evidence that they prevent wars.  Of course, as someone who has had nothing but good fortune in life, it is easy for me to think that the abstract prevention of war is more important than the tangible reduction in other people's already low wages.  

Tuesday, July 26, 2016

Thoughts from California about a year in Washington

The nice people I worked with at HUD asked me to write a short piece reflecting on my year there.


Five Things I have learned from a year in Government (The things I have written below represent no one’s views other than my own).


1. The federal government is staffed by some remarkable people.

I have been most fortunate throughout my career to work with intelligent, committed and

ethical people. My time at HUD has been no different. I have had the privilege of working

closely with remarkable people at HUD and at other agencies. I would name names, but worry

about leaving someone out. Many people who choose to work in government could receive far

more compensation doing something else, but are motivated by a desire to make people’s lives

better.

Government service is honorable service—this was a commonplace as recently as when I was in

college, and remains so in places like France and Japan. We as a society should respect

excellent government work more than we do right now.


2. The federal government relies too much on obsolete technology.

We see throughout the United States examples of under-maintenance of infrastructure, from a

bridge falling into the Mississippi River to tracks in metro systems catching fire. Less visible, but

just as problematic, is an unwillingness to invest in modern technology systems. Within HUD,

for example, the FHA program relies on systems that are driven by coding in COBOL, a

mainframe (!) language developed in 1959 (!!). Because almost no one uses COBOL anymore,

our university computer science departments don’t train students in its use. As COBOL

programmers retire, it will become impossible to find people to maintain the system.

On a more personal level, I was stunned to learn that my HUD PC had a 32-bit operating system

in a world where 64-bit system have been around for PCs for 13 years. As a practical matter,

32 bit systems are limited in the amount of data they can analyze, whereas 64 bit systems are

nearly unlimited. Many doing HUD work rely on large data sets (for example the Public Use

Microsamples of the Census and the American Community Survey). The current standard for

operating systems makes it relatively easy to use these datasets; the old standard requires

compromises.


3. Academics teaching policy issues should spend some time in government, if for no other

reason than to appreciate the importance of details.

Before I joined HUD, I thought I was an expert on mortgage backed securities (I even wrote a

book about them). Spending time with the good people of Ginnie Mae revealed to me that I

really wasn’t. I did understand how to evaluate cash flows from MBS, but I didn’t really

understand how Ginnie Mae operated at all. What I learned is that mortgage default risk is not

the only risk that needs to be managed; issuer risk needs to be managed as well (while

FHA/VA/Rural housing insures mortgages, Ginnie Mae insures the issuers of mortgage backed

securities that fund mortgages). Suppose a mortgage goes into default and so a Ginnie Mae

issuer needs to buy it out of a pool. That issuers needs to have enough cash on hand to survive

until it receives an insurance payment from FHA/VA/Rural Housing. For non-bank lenders, this

could be a problem in times of low liquidity.

We academics are good at thinking about analytics; we are not so good at thinking about

operations. Yet without good operations, analytics lose much of their value.


4. Regulators care too much about details

Regulations about disclosures make the point. Government sometimes worries too much

about the details of disclosures and not enough about their effectiveness.

Consider disclosures for the price of a long-term fixed rate mortgage. For consumers to be well

informed about what they are getting themselves into, they need to know two numbers: total

upfront cash payment, and the all-in interest rate (which might include a mortgage insurance

payment). Armed with these two numbers, consumers can comparison shop in a

straightforward manner.

The first page of the new TRID closing form does this well, and lenders should absolutely be

held responsible for presenting this page accurately. But the details on the following pages are

essentially irrelevant to consumers and, by increasing the length of the form five-fold, make it

more complicated and confusing than necessary.


5. Few people know who the third most powerful person is in the Federal Government.

My guess is that the name Shaun Donovan is not well known outside the Beltway. But pretty

much nothing gets done without the approval of the OMB director.

Wednesday, February 17, 2016

Housing now

From HUD's The Edge.


This past fall, the state of housing reached something approaching normalcy in some dimensions (new construction and price) but continued to worsen in others (rental affordability and the homeownership gap between underrepresented minorities and others).


When President Obama took office in January 2009, residential construction in the United States was at its lowest level since World War II; only 490,000 units were built that month (on a seasonally adjusted annualized basis). By November 2015, that total had risen to nearly 1.2 million units — an increase of 139 percent over the course of the administration. This total has still not, however, reached the average level of new construction over the past 55 years of 1.4 million units.


The below normal (if substantially improving) levels of construction explain why housing prices have recovered substantially from their troughs. Prices in all 20 Case-Shiller cities are well above their troughs, in part because the paucity of construction has led to falling vacancy rates nearly everywhere. In two cities, Dallas and Denver, prices are at all-time highs, and Portland, San Francisco, and Boston have recovered all of their losses. A particularly noteworthy fact is that prices have recovered while the homeownership rate has declined. The price story is an absence of supply story.


Although the demand for owner housing has been stagnant, the demand for rental housing has soared, pushing up rents even in the face of strong multifamily construction. Rental demand has risen sharply for several reasons.


First the marriage rate in the United States has been falling steadily. According to Pew, 65 percent of the “greatest generation” were married by the age of 35; among millennials, the marriage rate is only 26 percent. After taking into account age, education, race, ethnicity, and geography, married couples are 22 percentage points more likely to be owners than singles. If millennials continue to postpone (or avoid) marriage, the ownership rate will continue to fall.


Second, racial and ethnic minorities, again after taking into account the standard list of demographic and economic characteristics, have lower ownership rates than non-Hispanic whites. The population of African Americans, Asians, and Hispanics is growing much faster than the population of non-Hispanic whites. African Americans, for instance, have a homeownership rate that is 17 percentage points lower after controls than it is for non-Hispanic whites. If homeownership rates among the groups whose population is growing fastest continue to lag, the pressure on the rental market will become even greater.


The reasons for lagging ownership among minorities are doubtless varied and complex, but part of the gap almost certainly results from continued discrimination in housing markets and issues with access to credit. Turner and Yinger have demonstrated the continued existence of discrimination, but we will say a few words about access to credit here.


One group of Americans, now very large, does not have access to mortgage credit at the moment: those whose homes went into foreclosure during the global financial crisis. RealtyTrac puts the number of homeowners who were foreclosed upon at [nearly 7] million, or about 5.5 percent of U.S. households. These households overwhelmingly became rental households (some doubled up with other families or moved back to their parents’ homes), and this phenomenon alone put sudden pressure on rental markets.


They also became ineligible for mortgage debt for at least 3 years (the number of years the Federal Housing Administration requires to have followed foreclosure for borrowers to become eligible for a loan) to 7 years (the minimum number of years post-foreclosure government-sponsored enterprises require before issuing a loan). Many of these potential borrowers are about to become eligible again for mortgages, and should thus relieve pressure a bit from rental markets. But many, having been traumatized by the homeowning experience, might decide to remain renters. As it happens, minorities bore a disproportionate share of the foreclosure burden.


The other access to credit issue involves access to wealth and credit scoring. Many researchers have shown that children’s wealth is highly correlated with parents’ wealth. African Americans, who as a group were stripped of wealth and who were over generations systematically denied access to credit, have less wealth than non-Hispanic whites even after controlling for income and education. The absence of wealth among older generations means that it is more difficult for younger generations to accumulate downpayments and establish excellent credit scores. This puts generation after generation of minorities at a disadvantage when it comes to owning a home.


The combination of diminishing numbers of married couples, the fallout from the recession, and access to credit issues have pushed rental demand and therefore rents as well. While there are many methods for measuring rental affordability, perhaps the most telling is that in the vast majority of American metropolitan areas, median-income renter households must spend more than 30 percent of their gross income on the median rental unit. Economists like to talk about “choice,” suggesting that people “choose” to live in expensive housing. But both within and across our cities, affordable rental housing is not a choice that is available to the median-income renter.

Tuesday, October 13, 2015

A book that changed my life


"We believe that the confounding of the aggregate with the individual is as dangerous as it is pervasive...."  Page 81.