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The Big Problem
The housing market
Robert Lucas, a Nobel-prize-winning economist, famously said, “Once you start to think about growth, it’s hard to think about anything else.” Determining policies that can result in growth like South Korea has experienced over the last half-century is the ultimate economic question. For developed economies like the United States, arguably growth may not be the largest issue. The average American, even the poor American lives a far better life than the vast majority of the world’s population.
The causes of America’s slow economic growth are myriad. Some of them are also complex and intertwined with political and cultural issues. For example, the Jones Act, which restricts intra-US shipping to American vessels, is worse than worthless. It is actively harmful. The act does nothing other than enrich a few American shipbuilders while significantly increasing prices in Puerto Rico and Hawaii. But, those shipbuilders have political sway so the Jones Act remains. More importantly, even if the Jones Act was revoked it wouldn’t have a noticeable impact on the majority of Americans. It’s a terrible policy, but its impact isn’t large when compared to the American economy. Sure its removal might boost GDP by a hundredth of one percent, but it isn’t going to supercharge industry. Overhauling America’s immigration system would have a larger impact, but would have to overcome numerous political and cultural barriers.
All that said, growth in America is worth considering. While this is one of the wealthiest societies the world has ever seen, there is still poverty in America. It may be far away from the typical American suburb or shopping mall, but it certainly exists. Weak growth in America is a problem that needs to be addressed. Like Robert Lucas, the more I think about growth the less I can think about anything else. And the more I think about growth in the United States, the more I think about housing.
The housing market in the United States is in the midst of an upheaval that has not been fully reckoned with. Housing prices have exploded around the country, to the point where there are very few cheap areas left in the entire country. There is only moderate and expensive. If permanent, this shift in housing prices won’t make ripple effects across the American economy - it will fundamentally change it for the worse. This isn’t to say we are in uncharted territory. We aren’t. Home prices have been relatively expensive before. During the early 1980s mortgage interest rates peaked at an astonishing 18 percent. An individual with a $200,000 mortgage would have to pay $36,000 a year in interest. The result was that many were priced out of the housing market entirely. The US economy flatlined from 1979 to 1983.
Although things were bad in the 1980s for homebuyers, there were also ways around those sky-high interest rates. Many loans at the time were assumable, meaning that a buyer could take over a home loan from the seller at the existing rate. This is a huge deal; homeowners who locked in an eight percent interest rate in the mid-1970s could sell their home to a buyer in 1980 and give them that same rate. In other cases, the seller would create a private loan and the buyer would pay the seller directly at a lower interest rate. At one point, over 50 percent of home purchasers relied on an unorthodox method of financing.
Today, such workarounds are largely restricted. Very few loans are assumable. Creative financing is largely gone. Even if such financial instruments were to return, they wouldn’t help much. Today the problem isn’t so much interest rates, which are currently nearing eight percent, but the sticker price. Home values have gone ballistic around the world, with entire countries seeing prices double in just the last five years. The result is that housing is arguably the least affordable it’s ever been. Take a look at the housing price-to-income ratio in the United States over the years:
While the averages are bad, anecdotal data makes things look even worse. In just a decade the US has witnessed the near-total destruction of the cheap housing market. An acquaintance of mine recently sold a condo in Key West for $1,200 a square foot. Want to buy a single-family home in Aspen, Colorado? It’s going to set you back at least $3.5 million. The counterargument to these examples would be that they are resort areas, places for only rich people. To that, I say no place can function properly if it’s own for the wealthy. Rich people generally like to have amenities nearby, and these amenities need to be staffed by the non-rich. And that’s how wealthy areas used to function. There’s currently a condo in Key West with an asking price of $1.1 million. The same unit sold for $40,000 in 1988. Not cheap, but reasonable. In living memory, the island has gone from an upper-middle-class town to one for the rich, and the rich alone. Hippies used to live in Aspen. Hippies!!!
There have always been expensive homes and expensive neighborhoods. This does not impede growth. Wealthy enclaves are fine. Contrary to what much of the internet believes, in 1950 a single-earner making minimum wage could not afford a single-family home. The problem isn’t that there are wealthy neighborhoods or that low income families can’t afford to buy property. The problem today is that there are expensive cities, counties, and even states. Take a look at this chart from the New York Times:
This shows the amount of money a family would need to earn in a year to afford the median home in that city. This paints a disturbing picture of affordability. Of course, San Jose and San Francisco are going to be outliers. They are in geographically constrained areas and home to some of the largest companies on the planet. But moving down the list, it becomes clear the problem is systemic. Los Angeles is the second largest city in the United States and part of one of the most populated metropolitan areas on earth. The median home price would require an income of $200,000 to be affordable. The actual median household income? Under $80,000. Using the generous standard that a house should be no more than three times the average income, that means the typical Angelino can afford a house that costs $240,000. Good luck with that.
Other metro areas are similar. Brooklyn, once a mostly post-industrial area, is now also the realm of the affluent. The average home price there is an eye-popping $900,000. Brooklyn, by the way, is large enough that it would be America’s fourth-largest city if it was an independent municipality. It’s fine that Park Slope is unaffordable, but across all of Brooklyn there should be a spectrum of affordability. There isn’t. Cities across the country are seeing similar trends. House prices have nearly doubled in the last five years in formerly affordable areas like Idaho and Vermont. Owning in a sought-after school district is now solely the domain of the upper class. In all but a few places, it is now impossible for the average household to afford an average home.
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There used to be pockets of affordable housing throughout the country. That housing may not be in the best neighborhood or be a turnkey-ready house, but it existed. Is there any place with a good view of the Rocky Mountains that’s affordable? Just 10 years ago there were plenty. From Golden, Colorado to Spokane, Washington, there were communities throughout the Mountain West where a middle-class income could afford a decent property. Now the entire range is the region of the wealthy. Looking through Zillow data, in neighborhood after neighborhood some homes sold for significantly lower prices, correcting for inflation, throughout the last forty years. Even during the housing boom of the mid-2000s, prices were not as uniformly high as they are today. In most metropolitan areas there used to be some level of affordability. There were places that the median family could afford, but no longer.
This is not sustainable and needs to change before it causes real long-term harm. This problem isn’t going to go away by itself. Is it possible there is an increase in affordability, similar to what happened in the 1980s? Doubtful. What about a market decrease similar to 2007-2009? Highly unlikely. Right now the housing market looks to remain strong for some time. The main reason is interest rates. The entire homeowning world locked into interest rates at or below three percent in 2020. Since then both home prices and interest rates have skyrocketed. So there is no incentive for the vast majority of homeowners to move.
Consider a married couple with an income of $120,000 who bought a three-bedroom home in 2017 for $300,000. They refinanced at 2.75 percent during the pandemic. Today, they have two kids and the parents have increased their income to $160,000. In normal times, they would likely consider moving to a larger home. That, however, is not going to happen in today’s market. Assuming the couple put 20 percent down, their $240,000 mortgage at 2.75 percent equates to a $980 a month payment. That same house today would be valued at $480,000 if it appreciated at the national rate. So the family can sell that house and have a decent amount for a down payment on a nicer house. But because of the increased interest rates, there likely won’t be a house that’s worth moving to. A house that costs $580,000, a significant but not large upgrade, would today have a mortgage payment of $3,350 a month. This doesn’t include insurance or property taxes and would be outside the affordability of a couple who makes $160,000 a year and has two kids. So the family stays put. This scene is happening across the country, and until interest rates come down it will be difficult for the market to broaden.
Worse yet, the high cost of housing leaves people out in the cold. Literally. There are a lot of arguments about the root cause of homelessness. Mental health, drug use, etc. Those may be small contributors, but they distract from the true cause: high cost of housing. This seems so evident that it’s hard for me to understand why the debate even exists. If housing is expensive, fewer people will be able to avoid housing. Thus, you have a state like California, one of the wealthiest areas in the history of the world, with a serious homelessness crisis, while Mississippi, the poorest state in the nation, has one of the lowest homelessness rates in the country. The high cost of housing is easily the number one cause of homelessness in America, and the problem will not be solved while housing is expensive.
The real harm is going to take years to accrue but will be long-lasting. The US is at risk of having an entire set of Americans who can never afford a home. That subset is not those who are less educated or even make less money. It’s the subset that isn’t currently in the homeowners group. Those who are already at the party, homeowners, should be relatively unscathed. Current homeowners will see their property values appreciate and will be able to move to a better property as their incomes increase and interest rates come down. Entry to the party, however, will be reserved for those with above-average incomes. Most of those earning the median income, and certainly those below it, will be consigned to rent forever. The income gap could significantly increase across the country. This is going to affect the structure of cities, tax revenues, population growth, and social movements.
There’s no way to look at the housing market and not become mildly depressed. One can gain some solace from the fact that home ownership is not the end-all-be-all of life. People who say that renting is “throwing your money away” are incorrect. Millions of Americans are perfectly happy to rent forever and would do so regardless of housing prices. A permanently high housing market will not cause a second Great Depression or even a second Great Recession. A permanently high housing market is not an economic apocalypse. It could cause a stagnation, however, the likes of which have plagued countries like Greece and Japan for decades, but the US has never experienced. Decades of little to no growth. A perpetual plateau where poverty, inequality, and opportunity never better. The housing market is the biggest threat to the American economy in the short term.
Fortunately, there is a solution. A solution that isn’t complicated, and one that doesn’t cost money. Impossible? No. And the buds of that solution are already growing. Stay tuned for my next post: The Big Solution.