Monday, January 31, 2011

Homeownership and Social Justice

I am reading and enjoying Simon Johnson and James Kwak's 13 Bankers. Like a lot of recent stuff (including an OECD report), it takes a swipe, if a mild one, at the virtues of homeownership.   If people think homeownershipp is overrated, I can live with that (even if I disagree with it. Where I do have a problem is when people argue that government "pushes" homeownership on people, whether they really want it or not.

I am not sure that the pushing matters that much--it is entirely possible that people, for reasons beyond financial reasons, want to own houses in particular and real estate in general.  Two things stick with me:

(1) I was talking yesterday with a developer here in India who is trying to building market-rate affordable housing.  He faces a number of hurdles, one of which, he said, is "Indians' obsession with homeownership."

(2) Years ago, when I was in Madison, the guy who cut my hair loved to talk about the rental property he owned in Florida.  It would, he said, be the source of his retirement income.  I asked him why he was so undiversified--why he didn't sell his place and put the money in an index fund.  His reply was that he didn't trust Wall Street, and that he needed an investment that he could "touch" as well as control.  I told him his mistrust of Wall Street was misplaced--shows what I knew at the time.

The point is that there is something about real estate that reduces agency problems,  One may not be able to control markets, but one can control the management of real estate that one owns.  I do remember when I left the rental market for the owner market, I was very happy, not because I thought I would make out financially (house prices in Madison had been stagnant for years), but because I disliked my landlord, and was relieved that I would no longer have to write a check to him. 

This is not to say putting people in houses they cannot afford is a good idea, and I have long been dubious of very low downpayment schemes (I do think homeowners who put no equity into their houses are not really owners).  But it is a little too easy for people who own houses (or have the choice to do so) to say it is not important to make the option available to others.  Freedom to some extent means the ability to take control of one's own life, and to avoid agency issues as much as possible. 

I freely confess that this is all supposition based on informal observation.  Some work has been done on how ownership solves some agency issues, but I think it is an understudied phenomenon.  If anyone wants to help me think about how to model such things formally, I would welcome the assistance.

Thursday, January 27, 2011

According to an informal vote of Indian School of Business MBAs...

...the cities with the most potential for real estate investment in India are Pune and Ahmedabad. 

Wednesday, January 26, 2011

How much freedom to choose?

Ed Glaeser argues that the "moral heart of economics" is "freedom" and in particular the "freedom to choose:"

Improvements in welfare occur when there are improvements in utility, and those occur only when an individual gets an option that wasn’t previously available. We typically prove that someone’s welfare has increased when the person has an increased set of choices.
When we make that assumption (which is hotly contested by some people, especially psychologists), we essentially assume that the fundamental objective of public policy is to increase freedom of choice.

I will leave it to others to dispute the notion that more choices are always better than fewer.  But I can't help but think that it is to easy for those of us who are tenured professors to extoll the virtue of free choice, for the simple reason that we get so many, well, choices.  We get to choose what we write, we to a large extent get to choose what we teach inside our classes, and we can piss our deans off and pay fairly little in the way of consequences.  We might not get a raise or we might have to teach a class that we would rather not, but this is all small beer.  We can make an awful lot of choices and still be economically secure.

Now consider the administrative assistant at a corporation who has a boorish boss and a sick kid.   The company she (he) works for has a good health insurance plan, but if she were to leave, she would find herself unable to get coverage at a reasonable price.  Does she really have choice?

Consider the West Virginia coal miner who goes into a dangerous mine every day, and whose life expectancy is shortened with each hour worked underground.  Now consider the fact that the miner grew up in a West Virginia town with a poor school in an environment where going to college was a rare phenomenon.  Does that miner have a choice?

I could go on, but I think the point is fairly clear.  There are times when government intervention could expand the choice set up a large number of people.

Ed does point out how government can improve choice sets, and for that he deserves credit.  But the more fundamental problem is that market economies produce large institutions that have limited markets inside of them, and therefore sometimes have hierarchies that can be as inhospitable to personal liberty as government bureaucracies.  Elinor Ostrom's Nobel win in 2009 shows that the economics profession is beginning to recognize this problem,  but I am not sure Ph.D. students are broadly encouraged to study it.    


I met with a large developer here in India.  He told me that "rent models," (i.e., discounted cash flow models) don;t work in India--that everyone wants to own property in India, and so India is different.  I remember a Japanese real estate guy telling me the same thing about Japan in the late 1980s.

At least there isn't a lot of leverage here, so the systemic risk of a collapse in prices is lower.  But still....

Tuesday, January 25, 2011

Monday, January 24, 2011

Land use regulation and the cost of housing, Indian style

Mumbai is among the densest cities in the world: as a metropolitan area, it is roughly ten times denser than New York (h/t Alain Bertaud).  Yet residential zoning codes typically have FSIs (the equivalent of a floor-area ratio) of between 1 and 1.33.  This compares with typical central business district FSIs of between 5 and 15 in other cities around the world, and there are places in Hong Kong, which is a very attractive city, where it reaches 20.  

So what happens when the most crowded large city in the world forbids intense development?  Prices get very high.  The most expensive parts of Mumbai are more expensive than Manhattan; the least expensive are comparable to the American Midwest, but people's "middle-class" incomes are perhaps 1/8 as large in Mumbai.

A developer I spoke with last night told me that if FSIs were raised to 4 (still low by world standards), prices would fall by about 50 percent.  While this is not an econometrically determined elasticity, it does make a certain amount of sense.  It would be worth at least doing the policy experiment of raising FSI uniformly.

As for services, well, there are already plenty of people using services.  The average person in Mumbai consumes about 30 square meet of residential floor space, so allowing more vertical development might, if anything, alleviate crowding, both inside and out.  

Friday, January 21, 2011

The present value relationship still doesn't work in India

I had students here in Hyderabad gather data on rents, and then we put together a valuation pro forma.  We determined that the present discounted value of flats here is roughly 40 percent of their sale price.

I have been doing this sort of exercise since I first visited south Asia seven years ago, and I get about the same outcome every time.  It is not credit that is driving this market--many people buy property with cash.  People tell stories about "black money" financing property--this is untraceable, and therefore untaxed, money.    But our calculations imply an implicit tax rate of 60 percent--taxes in India are not that high (in fact, other than an eight percent transfer tax, they are fairly similar to the US).

So the story must be about expectations, and indeed, that is the story I hear.  But current yields are well under 3 percent, and if values rise faster than rents, those yields will get even lower.  Something has got to give.  I just have no idea when.

Thursday, January 20, 2011

The OECD says imputed rent should be taxed

When homeowners own their property with equity, they get a tax benefit as important as the mortgage interest deduction: the imputed rent they pay to themselves goes untaxed.  To think about how this works, consider two nieghbors who own their houses free and clear.  Suppose the houses are identical, and that the nieghbors swap houses, paying rent to each other.  They now have a tax liability that they would not have had they remained in their houses.  Avoiding this liability is tantamount to a tax expenditure--a benefit to those who own their houses without debt.  The OECD is correct that countries rarely tax imputed rent, and argues that this lack of taxation has tilted investment toward housing to the detriment of more productive uses.  It also argues that the benefits to homeownership are overstated.  I am not sure that this is true (see here and here), but I will leave that for another time.

The question is how does one go about taxing imputed rent?  It is not easy.  One could start by imposing an ad valorem tax on property values (such as a local property tax), but that doesn't tax imputed rent per se, because it does not take into account expected inflation (if one person expects her house to go up in value, and another does not, the rent the first person pays is lower than the second).  Alternatively, one could find comparables in the rental market and attribute rents found there to the owner market.  But owner and rental markets are so segmented that this would be difficult to do.

This has implications for fairness; if we don't know what we are taxing, it is hard to know how much to tax it. 

Tuesday, January 18, 2011

Amy Chua and the Reflection Problem

I saw Amy Chua speak some years ago (at the World Bank, I think) about her book, World on Fire. She was an excellent, witty and provocative speaker, so much so that I read the book as a result. And while the book was indeed thought-provoking, it was not convincing. Her basic point was that democracies can produce instability: minorities in democracies can amass economic wealth, which in turn leads to resentment, which in turn leads to political scapegoating and instability and all other kinds of bad things. The problem is she never presented to me a convincing counterfactual; she never showed me how a world devoid of democracy would also be devoid of resentment and instability.

As a result of reading World on Fire, I will not read Battle Hymn beyond the excerpt in the Wall Street Journal (although I understand that the excerpt is not representative of the book). If the book is only a memoir, then it is almost certainly fine, but this is not how it is being represented. Instead, it is being characterized as a comparison between "Chinese parenting" and its results and "Western parenting" and its results. Again, this may be unfair to Ms. Chua, but the book has spurred myriad commentary about the virtues and deficiencies of various parenting styles.

What is lost in all of this is how difficult it is to actually draw inferences about the effects of parenting styles on outcomes. Charles Manski calls this "the reflection problem." Here is Manski:

Here is an identification problem from everyday life: Suppose that you observe the almost simultaneous movements of a person and of his image in a mirror. Does the mirror image cause the person's movements, does the image reflect the person's movements, or do the person and image move together in response to a common external stimulus? Empirical observations alone cannot answer this question. Even if you were able to observe innumerable instances in which persons and their mirror images move together, you would not be able to logically deduce the process at work. To reach a conclusion requires that you understand something of optics and of human behavior.

A like inferential problem, which I have called the reflection problem (Manski 1993a), arises if you try to interpret the common observation that individuals belonging to the same group tend to behave similarly. Two hypotheses often advanced to explain this phenomenon are endogenous effects, wherein the propensity of an individual to behave in some way varies with the prevalence of that behavior in the group; and correlated effects, wherein individuals in the same group tend to behave similarly because they face similar environments and have similar individual characteristics.

Similar behavior within groups could stem from endogenous effects (e.g., group members could experience pressure to conform to group norms) or group similarities might reflect correlated effects (e.g., persons with similar characteristics might choose to associate with one another). Empirical observations of the behavior of individuals in groups, even innumerable such observations, cannot per se distinguish between these hypotheses. To draw conclusions requires that empirical evidence be combined with sufficiently strong maintained assumptions about the nature of individual behavior and social interactions.

Why might you care whether observed patterns of behavior are generated by endogenous effects, by correlated effects, or in some other way? A good practical reason is that different processes have differing implications for public policy. For example, understanding how students interact in classrooms is critical to the evaluation of many aspects of educational policy, from ability tracking to class size standards to racial integration programs.

Suppose that, unable to interpret observed patterns of behavior, you seek the expert advice of two social scientists. One, perhaps a sociologist, asserts that pressure to conform to group norms makes the individuals in a group tend to behave similarly. The other, perhaps an economist, asserts that persons with similar characteristics choose to associate with one another. Both assertions are consistent with the empirical evidence. The data alone cannot reveal whether one assertion or the other is correct. Perhaps both are. This is an identification problem.

Whatever one thinks about Ms. Chua's parenting, we have no firm evidence whether her kids' outcomes are a function of Chinese parenting, Chua-specific parenting, or just her kids' endemic talents. It is a serious problem when we forget that.

Monday, January 10, 2011

Some evidence about state government spending multipliers.

Three abstracts. The findings should give the pain caucus some pause.

Daniel Shoag:

The effect of government spending on income and employment is a central unresolved question in macroeconomics.

This paper employs a novel identification strategy to isolate exogenous and unexpected variation in state government spending. State governments manage large defined-benefit pension plans for which they bear the investment risk. Using a newly-collected dataset on the returns and portfolios of these plans, I show that the idiosyncratic component of their returns is a strong predictor of subsequent
state government spending. Instrumenting with this ‘windfall’ component of returns, I find that state government spending has a large positive effect on income and employment. Baseline estimates indicate that each dollar of spending raises in-state income by 2.12, and that 35,000 of spending generates one
additional job. These effects are not due to in-state investment bias, are concentrated in the non-traded sector, and are larger during times of labor force ‘slack.’ Finally, I consider how these results compare with the predictions of a standard macroeconomic model and outline which features in the model are
consistent with the empirical findings.

Nakamura and Steinsson:

We use rich historical data on military procurement spending across U.S. regions to estimate the e ffects of government spending in a monetary union. Aggregate military build-ups and draw-downs have diff erential e ffects across regions. We use this variation to estimate an open economy government spending multiplier of approximately 1.5. Standard closed economy estimates of the government spending multiplier are highly sensitive to how strongly monetary policy \leans against the wind." In contrast, our estimates "diff erence out" these eff ects because diff erent regions in a monetary union share a common monetary policy. This allows us
to better distinguish between alternative business cycle models. We show that our estimates are consistent with a New Keynesian model with GHH preferences. They are consistent with a small closed-economy multiplier when monetary policy is highly responsive (as in the Volcker- Greenspan era) and a substantially larger closed-economy multiplier when interest rates are less responsive (as at the zero lower bound).

Clemens and Miran:

Balanced budget requirements lead to substantial pro-cyclicality in state government spending outside of safety-net programs. At the beginnings of recessions, states tend to experience unexpected deficits. While all states ultimately pay these deficits down, differences in the stringency of their balanced budget requirements dictate the pace at which they adjust. States with strict rules enact large rescissions to their budgets during the years in which adverse shocks occur; states with weak rules make up the difference during the following years. We use this variation to identify the impact of mid-year budget cuts on state income and employment. Our baseline estimates imply i) a state-spending multiplier of 1.7 and ii) that avoiding $25,000 in mid-year cuts preserves one job. These cuts are associated with shifts in the timing of government expenditures rather than differences in total spending over the course of the business cycle. Consequently, our results are informative about the potential gains from smoothing the path of state government spending. They imply that states could reduce the amplitude of business-cycle fluctuations by 15% if they completely smoothed their capital spending and service provision outside of safety-net programs.

ASSA Interviewing Etiquette

Here is a suggestion for freshly-minted Ph.D.'s looking for Assistant Professor jobs: take time to at least glance at the web sites of the places to which you are applying.  Even in academia, people who are hiring you want to know that you have at least a little interest in the place where they work.

Saturday, January 08, 2011

Apologies to Mark Thoma

I was sloppy in characterizing Mark's comments about Gene Sperling.  He writes:

I think this misstates what I have said. I posted something defending Sperling, and the claim that 
"their grounds are basically that he is a protege of Robert Rubin and that he took money to work (essentially) as a consultant for Goldman Sachs."
I didn't say he was a protege, and said nothing about the money, etc.
I did say that from a political view I thought the administration would be better off breaking its ties with the Clinton administration personnel, just as I said the same thing about Summers. But that is different from saying there is something wrong with Gene in particular other than the political baggage that comes with him.
Here is what I said specifically. First, I echoed a post defending him. Then, I said "I still think a break from the Wall Street connected side of the Clinton administration would have political value."
Tim Duy had much more to say, but those are his words, not mine.

Wednesday, January 05, 2011

Goldman Sachism?

I enjoy Felix Salmon and Mark Thoma's blogs a lot.  In the last day, both have lamented the possibility that Gene Sperling might replace Larry Summers; their grounds are basically that he is a protege of Robert Rubin and that he took money to work (essentially) as a consultant for Goldman Sachs.

I suppose I should disclose that I once got to sit next to and talk with Gene Sperling on an airplane from Jackson Hole to Denver, and he struck me as a person of great intelligence and even temperament.  That doesn't particularly matter--it does matter, however, that the people who I know who know him also regard him as a person of great intelligence and even temperament.  Let me emphasize the temperament part.  He also pushed for the very good idea of imposing Pigou taxes on banks.

So far as I know, his critics do not suggest that he is really personally deficient, but that he is a problem because (1) he worked in the Clinton Administration under Robert Rubin and/or (2) he received money from Goldman Sachs.  To me, the first part is actually a recommendation, but I feel the need to comment on the second.

Goldman Sachs has done things for which it should not be proud.  Does that mean that anyone who worked at/for the place should be disqualified from government?  In its history, the Ford Motor Company has done unlovely things; Boeing has done some not-so-great things; I am not please at some of the things my one-time employer, Freddie Mac, has done.  This does not mean people who worked at Ford, Boeing and Freddie Mac should be disqualified from government.  All these places, as well as Goldman Sachs, have many intelligent, honest, capable people.

If you have a beef with the substance of Sperling, fine.  If you think Furman would be better in the job, that is fine too.  But guilt by association is just too easy, and has its own ugly history.

Top Ten Cities for Real Estate Investment (h/t Wisconsin Graaskamp Center and Francois Ortalo-Magne)

The Association of Foreign Investors in Real Estate surveyed real estate investors from around the world about places and property types.  Among other questions, they asked respondents to list cities that had the best prospects for commercial real estate.  The list:

1. New York
2. Washington
3. London
4. Paris
5. Shanghai
6. Singapore
7. Hong Kong
8. Madrid (!!!)
9. Sydney
10. Los Angeles

Tuesday, January 04, 2011

Urban recovery: Pareto improvement is hard

The first time I visited Pasadena, in 1980, the place was a bit down-in-the mouth.  The corner of Fair Oaks and Colorado (the heart of what would become Old Town) featured disreputable establishments, and many beautiful old houses had fallen into disrepair.  Air quality was dreadful.

Now, 30 years later, Pasadena is among the loveliest and most lively cities I know (it also happens to be where I live).  New Urbanists should love the place: pedestrians fill Old Town and, to a lesser extent, Lake Avenue.  The craftsman bungalows--the sort of houses that people like Andres Duany like to copy--have been restored to their former glory, and range in size from modest to obscenely large.  Air quality, while still not great, is much, much better.  One can see the San Gabriel Mountains every day.

This produces unhappiness on the part of Occidental College sociologist Peter Drier.  He writes:

New US Census data reveal a troublesome reality about the Rose City. Pasadena’s has become a tale of two cities — one that welcomes affluent residents and another in which middle-class and poor families are pushed out by rising housing prices. 
Pasadena officials like to boast about the city’s recent “renaissance,” pointing to the major (and expensive) renovations of City Hall ($117 million) and the Convention Center ($150 million), and the just-approved $152 million facelift for the Rose Bowl, as well as the addition of new condominium complexes and upscale stores. 
 But who, exactly, is benefiting from the city’s renaissance?...
...At the very top, the wealthiest 5 percent of Pasadena households — those with household incomes above $249,841 — have almost one-quarter (22.7 percent) of city residents’ total income. Only five cities – Los Angeles (25.9 percent), Glendale (25.8 percent), Rancho Cucamonga (25.2 percent) San Francisco (23.4 percent) and Oakland (23.1 percent) — have a higher concentration of income among the richest 5 percent.
 In contrast, the poorest one-fifth of Pasadena households — those with incomes below $23,042 — combined have only 2.6 percent of all residents’ income. As Table 2 reveals, only in San Francisco do poor households have a smaller share of citywide income.
In Pasadena, those in the next poorest one-fifth — those with household incomes between $23,043 and $45,174 — bring home only 7.6 percent of residents’ incomes. Together, the poorest 40 percent of Pasadena’s households have only 10.2 percent of Pasadenans’ total income.
...Pasadena lost 2,420 households with incomes below $50,000 — an 8.8 percent drop. By far the biggest losses were among households earning under $10,000. The number of these households fell from 5,273 to 4,094 — a 22.9 percent decline.
None of this should be surprising in light of spiraling rents and house prices, the accelerating conversion of affordable apartments to expensive condominiums, the predominance of new luxury units among the condos approved by city officials and the paucity of affordable housing in Pasadena’s development pipeline. 
So Peter underscores a fundamental problem.  We want out cities (and inner ring suburbs, such as Pasadena) to improve.  But when cities get better, they become more desirable places to live.  To use a metaphor, 30 years ago, Pasadena was a K-car, and now it is an Acura (one needs to travel south to San Marino for the BMW).  Consequently, when cities become successful, they tend to attract richer people and push out poorer people.  This is true in New York, San Francisco, London, Paris, and so on.

So whom does this help?  It certainly helps homeowners, regardless of income, because it leads to greater wealth.  The median person in Pasadena is a homeowner, but just barely; nearly 50 percent of Pasadenans are renters.  Because rents are higher, renters might appear to be worse off.  On the other hand, rents reflect desirability.  If the change of the value of the bundle of amenities arising from living in Pasadena is greater than or equal to the change in rents, renters are at least as well off as before.  Pasadena is cleaner, safer and healthier than in was 30 years ago, and these things are valuable.

The exception is those people who are forced to move because wealth prevents them from choosing to live in Pasadena.  Those who are forced out of their homes are worse off than before, and so a revived Pasadena is not a Pareto improvement (in the strict sense of the phrase) over dowdy Pasadena.

So what should we do?  Discourage the kind of renaissance that Pasadena has produced?  I think not.  I can think of three policy responses that might help.  First, make Section 8 vouchers and entitlement, so that people can choose to live in whatever city they like.  That is a federal responsibility.  Second, use Pasadena's relatively high property values (relative to other communities; not to five years ago) to improve social services.  But that is not possible to do without changes to Proposition 13 (parcel taxes are not as efficient or equitable as ad valorem taxes).  Third, get rid of regulations that make in extremely difficult to build inexpensive units, such as granny flats, in Pasadena.  This is the only lever than is in Pasadena's hands.

It is difficult to get around a very uncomfortable question: should all people have financial access to all communities?  As an economist, I tend to think the answer is no.  As a human being, I am not sure at all.

Sunday, January 02, 2011

Looking for Information on Real Estate Market Conditions in Hyderabad

I will be spending a few weeks visiting the Indian School of Business at the end of January; in the past, I have gotten welcome comments on the market environment in Hyderabad.  Anything that gives me more context is helpful.