Path Dependence?

I am currently in Minneapolis. It is, to me, a great city. My feelings may reflect that it was the large city nearest to me when I was growing up, but they also reflect that it has the attributes of a great city: innovative companies, such as 3M, and Medtronic, wonderful arts, including an orchestra that Alex Ross of the New Yorker wrote,"[sounds] to my ears, like the greatest orchestra in the world," and a vibrant, walkable downtown. The only other Midwestern city with such a jewel of a downtown is Chicago, which is also, of course, a much larger city.

The question is why. Bill Cronon wrote a great book about Chicago, explaining how it became and remains an epic city. The remain part is a function of path dependence--once Chicago made a set of choices about how it would connect with the nature that surrounded it, both physically (through, for instance, railroads) and intellectually (through, for instance, exchanges), it set itself on a self-perpetuating path.

I know of no similar book about the Twin Cities (that doesn't mean it doesn't exist). But it is an interesting question as to why Minneapolis has done so much better than other Midwest metropolitan areas: it terms of educational attainment, income, and population growth, it has substantially outperformed Kansas City, St Louis, Milwaukee, Cleveland, Cincinnati, Toledo, Dayton, Pittsburgh and Buffalo (I could go on, but you get the point). I don't think it is the weather.

Did Arizona just help California's Housing Market?

My colleague Dowell Myers points out that for the housing market in the US to remain healthy, we must "cultivate new immigrant residents." Arizona's new law, which would require immigrants (legal or otherwise) to "carry papers" creates what I would consider to be an atmosphere of hostility to immigrants--all immigrants. I am also awaiting the spectacle of a police officer demanding the "papers" of a native-born Latino.

In any event, people have a propensity to go where they feel welcome, and avoid places where they are not. Hostility to immigrants in general and Latinos in particular seems to be a political loser in California, so Arizona's policies may lead to higher demand for houses in California.

Should Berkshire Hathaway be required to post collateral on underwater positions?

Yes.

(BTW, I own a few Class B shares and am a big fan of Warren Buffett).

A simple financial reform

If an investment instrument has never been through a down-cycle, rating agencies should be forbidden from giving the instrument a grade of BBB (or in Moody's case, Baa) or higher. Instruments that lack history are, by definition, speculative.

Trying to figure out whether synthetic CDOS add value

In principle, I think they could, because they allow investors to invest in a combination of mortgages that are not actually available in the market (the combination, that is), and as such, make markets a bit more complete.

But does the efficiency benefit synthetics create exceed the cost of their opaqueness? Would creating an exchange deliver sufficient transparency to overcome the opaqueness problem?

Bill Wheaton says housing is a sleeping giant that is about to wake up

He says so in a short paper. I think he is right.

What people don't know about household income

I spoke at a Hanley-Wood Conference in Ft.Lauderdale today to a group of Apartment operators. It was a very nice audience.

I asked members of the group to raise their hands when they thought I hit the number at which median income for renters in the US was higher. I started at $60K; nobody raised their hand. But at $50K, a number raised their hands; at $40K, nearly everyone had a raised hand. According to the American Housing Survey from 2007, median income among renters was $28,921. It is possible that number is even lower now. If 30 percent of income paid for rent is "affordable," this means the median renter can afford to pay no more than about $750 per month.

Thoughts from 37,000 Feet

I am on a Virgin America flight that includes, among other things, Wifi. The plane is nicely lit and very clean (because it is new). And it makes me wonder whether the airline business will ever be a sustainable long-term business. There are reasons why it is difficult for the legacies to match the Virgins and Jetblues for amenities.

How many loans are non-recourse?

In California (and other states), purchase money home mortgages are non-recourse loans--if a bank accepts the keys from a borrower, it cannot then go after the borrower for any difference in value between the house and the loan outstanding.

But as I learned from Paul Willen this weekend, once a loan is refinanced, it is no longer a non-recourse loan. For borrowers who have no assets to speak of, the difference doesn't matter much. But for others, the difference is large.

Is it better to model or to converse?

It amuses me when on occasion someone in the real estate business complains that I am "too academic." For starters, given the career I have chosen, I don't exactly consider than an insult.

But it does raise a question: would academics who study real estate be better off spending less time modeling and more time talking to practitioners? As someone who enjoys talking to people in the business, I would say the answer is no. While models have their problems--particularly with respect to precision--well specified models should be free of bias. To give one example, modeling drove me to conclude three years ago that capitalization rates for commercial real estate were unsustainably low. I wasn't sure when they would rise, I was just sure that they would--and as a consequence drive down commercial real estate values. My views were treated with derision by practitioners, who were convinced that we had entered a "new paradigm" wherein cap rates would always stay low and values would forever stay high.

Jim Shilling summed up the issue in his AREUEA Presidential Address. Here is the abstract:

This paper is based on my Presidential Address to the American Real Estate and Urban Economics Association delivered at Washington, D.C., in January 2003. The paper asks whether there is a risk premium puzzle in real estate. I examine this question by reporting on an empirical investigation of real estate investors' expectations over the last 15 years. The results suggest that ex ante expected risk premiums on real estate are quite large for their risk, too large to be explained by standard economic models. Further, the results suggest that ex ante expected returns are higher than average realized equity returns over the past 15 years because realized returns have included large unexpected capital losses. The latter conclusion suggests that using historical averages to estimate the risk premium on real estate is misleading.

I actually do learn a lot by talking to people who do real estate. I just don't learn a lot about future returns.

Small Ironies

I was culling my books over the weekend, and decided to pitch out Milton and Rose Friedman's Free to Choose. This is striking me today as ironic, because I doubt that the West Virginia miners were free to choose much of anything.

At best, they made a choice based on misinformation--they thought they were working at a mine that met safety standards. Those of us who are tenured professors have indeed been free to chose; we can even say whatever we want without fear of losing our jobs. But to think everyone has such freedom is just delusional.

Good Reading

Yannis Ioannides Journal of Economic Literature review of Scott Page's The Difference: How the Power of Diversity Creates Better Groups, Firms, Schools and Choices.

My disappointment with Ted Koppel

I was listening to NPR's Talk of the Nation while driving home tonight: the topic was the federal deficit. They brought in Ted Koppel to talk about it, and he was asked the difference between the national debt and the deficit--and he couldn't answer.

It did not so much disappointment me that he didn't know (although the distinction is pretty easy--the debt is a stock and the deficit is a flow). It disappointed me that given that he knew he didn't know, he still thought he had something worthwhile to say about the issue.

I wonder if we will see a discontinuity in mortgage rates tomorrow

It should only happen if the market didn't believe the Fed would stop buying. Otherwise expectations should have already been built into pricing.

A little more on Mortgage Debt and Aging

I did a quick comparison of average household income for 1989 and 2007 (using the census) and average mortgage debt for those that has mortgage debt (using Survey of Consumer Finances data). In both cases I looked at 45-54 year olds.

In 1989, average household income among 45-54 year olds was $39,934; average mortgage debt outstanding among those who had debt was $39,300, so the ratio was about one-to-one.

In 2007, average household income among 45-54 year olds was $83,100; average mortgage debt outstanding among those who had debt was $154,000, so the ratio was just under two-to-one.

In 1989, the share of households in the age group with a mortgage was 58.3 percent; in 2007 it was 65.5 percent.

The only good news: interest rates have dropped from about 10.5 percent to 5 percent. So in 1989, an average income household that wanted to amortize an average mortgage in 15 years would need to pay 14 percent of gross income to do so; in 1989 it would need to spend 19 percent. So putting this all together, the ratio of debt service to income for amortization by retirement has increased by (.19*.655/.14*.583)-1 = 52 percent. Not good, but not quite as bad as I thought, either.

The long-term impact of the mortgage crisis--and why it keeps me awake

My parent's generation behaved differently than mine in all sorts of ways. A paper of mine with Hendershott shows that they spent less, controlling for education, etc., throughout their life cycle than any other generation. One of the reasons for this is that they paid off their mortgages. According to the American Housing Survey, 70 percent of households headed by someone over the age of 65 have no mortgage at all. Loan amortization became a mechanism for forced saving, and as a a result, those born during the depression are in pretty decent shape financially. A Pew Survey shows that those over the age of 65 feel much more in control of their finances than younger people.

My generation is different. Even under the most benign circumstances, we refinance in a manner that slows amortization. I refinanced in Madison twice to take advantage of lower interest rates--this was, of course, the right thing to do financially. But each time, the amortization schedule reset, and so it extended the period at which the mortgage would pay off. Now yes, one can take the money one doesn't put into home equity and put it in other savings vehicles, but it is not clear that everyone does that. Forced saving is slowed.

But this is not the worst of how people have handled their mortgages. A substantial fraction of borrowers pulled equity out of their houses, putting themselves on a lower savings path even in the absence of falling house prices.

I am going to run some American Housing Survey data on this, but it is hard for me to imagine that 70 percent of my generation will have no mortgage debt when we are elders. My parents' generation has used housing wealth to, among other things, finance long-term care. I hope I am missing something here, but the lack of housing wealth in the future could become yet another challenge as we seek to fund the needs of the elderly.

My Colleague Gary Painter writes about the Impact of Immigration on Midsize City Housing Markets

The abstract:

The recent trend of immigrants arriving in mid-size metropolitan areas has received growing attention in the literature. This study examines the success of immigrants in the housing markets of a sample 60 metropolitan areas using Census microdata in both 2000 and 2005. The results suggest that immigrants are less successful in achieving homeownership and more likely to live in overcrowded conditions than native-born whites of non-Hispanic origin. The immigrant effect on homeownership differs by geography and by immigrant group. Finally, we find evidence that immigrant networks increase the likelihood of becoming a homeowner.

Those who thought the housing tax credit would simply shift sales forward....

...rather than increase sales are probably being vindicated. February was another bad month for existing home sales.

The ultimate in branding?

I was recently at a meeting where all were instructed to turn off their Blackberries. Not iphones. Not cell phones. Blackberries. Everyone knew what was meant, though.

Has Blackberry become the new Kleenex? If so, they need to be careful. Aspirin was once a brand, but it became such a strong part of the lexicon, that Bayer lost the ability to retain it.

Clarification on Sprawl and Zoning

Zoning is not the only reason we are spreading out--as my colleague Peter Gordon shows (go to minute 50), people are spreading out around the globe. Our increasing affluence and rise of the automobile have also led us to spread out. The fact that gasoline is so much cheaper in the US than other places has led us to spread out faster.

But our particular brand of single-use zoning has doubtlessly had an impact on settlement patterns. At minimum, we have insufficient land zoned for apartments. We know this because land zoned for multifamily use often sells for more (controlling for location) than land zoned for single-family use. This is not the market--this is local government holding back the supply of a certain type of land use. Moreover, minimum lot size, set back and street width requirements mean we use more land than necessary to build even single-family housing.