Half Sigma

Oligopolistic competition between home builders

An article in the WSJ documents how home builders are dealing with the weakening market:

Slow sales have prompted builders and some individual sellers to offer unusually generous incentives to agents whose clients buy a home. Sellers normally pay the buyer's agent 2% to 3% of the home's price. Now many are offering thousands of dollars or other rewards, such as travel vouchers, on top of the normal commission.

Such incentives have long been used to sell some homes. But they have proliferated and become more generous recently as a glut of properties on the market makes it harder to sell homes. "These guys are desperate," Ivy Zelman, a Cleveland-based housing analyst at Credit Suisse Group, says of home builders.

Although there are no national data on the practice, real-estate agents and builders agree that incentives have become much more widespread in recent months, especially in areas such as Florida, Nevada, Arizona and Washington, D.C., where inventories of unsold homes have soared. Builders and sellers also are offering lots of incentives to buyers, including free kitchen upgrades, help with closing costs and even new cars.

Besides being interesting evidence of a possible impending crash in housing prices, it also demonstrates the nature of oligopolistic competion. The new home market is an oligopoly because, in any given geographic area, there is a relatively small number of home builders.

Oligopolies are loathe to compete on price. The acceptable way for oligopolies to compete is via marketing. Thus you see Coke and Pepsi advertisting about how their products fit in with your lifestyle (they haven't even bothered to advertise based on quality since the Pepsi Challenge taste tests of the 1970s), but they will never say you should buy one product because it costs less than the competitor's product.

If a home builder has too much inventory that's not moving, the logical way to get rid of it is to lower the price. But home builders don't want to provoke the other home builders into also lowering prices, resulting losses all around for everybody. So instead, the home builders leave the selling price alone but spend more money on marketing.

I predict that home builders won't be successful holding up prices because a larger chunk of the housing market is individual owners selling their used homes. An individual seller doesn't care about how his selling price affects the market, he just wants to sell. The reason why prices haven't crashed yet is because prices are sticky on the way down. Most people are psychologically unable to deal with losses, so they refuse to acknowledge that their house isn't worth what it was a year ago. Home builders are eager to help the individual owners maintain an unrealistic appraisal of their homes' worth by maintaining high sticker prices on new homes. But home builders seem to be fighting a losing battle.

Morons are running NYC

This article about the sale of Stuyvesant Town and Peter Cooper Village being sold really gets me mad.

No, I'm not mad that it's being sold.

I'm mad about all the incessant whining in the article about the demise of affordable housing. No more affordable housing. Working class being kicked out. Where will they live? Whine whine whine.

Stupid morons, if you want housing in Manhattan to be affordable, MORE HOUSING UNITS HAVE TO BE CONSTRUCTED. But then the morons whine, builders only build luxury housing, builders only build luxury housing, whine whine whine. Well this is what happens when you don't let the builders build new luxury housing. Old non-luxury housing gets converted to luxury housing.

$30 rent on Bleeker Street?

According to the Simon and Garfunkel song Bleeker Street, "thirty dollars pays your rent on Bleeker Street."

Thirty dollars per day would be damn cheap rent to live on Bleeker Street. Can someone help me find this apartment?

Middle class leaving the cities

An article from Sunday's NY Times talks about how cities are becoming places for the rich and the poor but not the middle class.

Unfortunately, the article fails to address the two main reasons for why the middle class have left the cities:

(1) Zoning laws prevent new housing from being constructed, raising the cost of housing so that the middle class can't afford it. But ghetto neighborhoods and public housing remain resistant to increases in housing costs, so the poor remain even though the middle class are forced out.

(2) School systems full of racial minorities and poor children scare away middle class families to suburbs with more homogenous public schools. Only the rich, who can afford private schools, or the poor who don't care because it's their children who are ruining the schools, remain in the city.

The return of multigenerational households

In today's New York Times there's an article about multigenerational households. That's where grandparent, child, and grandchild all live under the same roof.

This generally remains a living arrangement for the poor. The rich will buy their children their own place because the rich understand that there is a big loss of status when young adults live with their parents and they don't want their children to sink in status.

There are several converging trends causing the increase in multigenerational households.

(1) Immigration. Immigrants from Latin American and Asian countries don't realize that multigenerational households aren't the American way.

(2) Increasing out-of-wedlock births. It's the norm for black children to be born without their mother being married, but this trend has also become common for white women. "Births to unwed white mothers were 22.5 percent in 2001, compared to 2.3 percent in 1960." (Source: WaPo article). Single mothers need more help from parents and have less resources available to live on their own.

(3) The declining economic status of young people. Even when women are married, a young husband can't provide as well as he used to. The median real income of young men has been declining. Yet if you look at this U.S. census table, you will see that the median price of a "home" has risen by a huge amount. In year 2000 dollars, in 1960 the median home cost $58,600, and that rose to $119,600 in 2000, an increase of 104%. (Unadjusted for inflation the home in 1960 was only $11,900--damn that's cheap!) The 104% rise in the median home price doesn't even take into account the big rise in housing prices since 2000.

Rising home prices represent a big transfer of wealth from the young to the old, because the average homeowner is older than the average non-homeowner, so the older generation grows richer because of its home ownership while the younger generation has no capital appreciation but faces declining incomes.

We have a housing crisis, not an energy crisis

The more I hear about how the energy "crisis" is huring Americans, the angrier I get. The story, according to the mainstream media, is that Americans are mad that the price of gasoline is so high and Congress has to do something about it.

The real crisis is not in energy, it's in affordable housing. Housing eats up a vastly larger portion of people's salaries than do gasoline and other petroleum distillates. Yet no one complains about the crisis in affordable housing.

Yet the problem of affordable housing is a problem that politicians can actually fix, because the reason why housing is so expensive is because of restrictive zoning laws and labyrinthine construction approval processes. Making housing affordable really is a matter of politicians passing a few laws (or repealling some laws).

In contrast, politicians cannot do much to lower the price of gasoline because its primary ingrediant, crude oil, is a global commodity that's outside the control of U.S. politicians.

Of course I am aware of the dirty little secret--approximately 70% of Americans own their home, and the well off 70% couldn't care the less about the less well off 30%. The 70% probably vote with greater frequency too, and they have more money to donate to political campaigns. So 70% of Americans couldn't be happier when housing costs increase and the bottom 30% of society become even more worse off.

Female labor force participation and the price of housing

The New York Times informs us that female labor force participation is no longer increasing. "Today, about 75 percent of women 25 to 54 years old are either working or actively seeking a job, up from around 40 percent in the late 1950's," but this is down from 77% in 2000 and is less than the 90% labor participation rate for men in the same age bracket.

The article, in my opinion ignores the obvious reasons why work force participation has stalled. For many people, going to work sucks. Whether they have a crap job or their boss is an asshole, work isn't always the rewarding experience that ivory tower sociology professors imagine it to be.

However, I will forgo additional pontification regarding the factors behind the trend in favor of writing about how this effects the price of housing.

I believe that one of the reasons we have seen a huge increase in housing costs since the 1950s is because of increasing female labor force participation. Increasing the percent of two wage earner families increases the amount of money that's available to spend on housing. Because the supply of housing in many markets is fixed (because of zoning laws), prices are bid up. This is basic microeconomics, and it helps to explain why two incomes are often required today where only one sufficed in the past.

The end of the trend of increasing female labor force participation should have a downard impact on the price of houses, yet we have seen big increases in housing prices since 2000 when female labor force participation peaked. This is further evidence that there is a housing bubble.

Houses are expensive these days

Confused about a recent page one NY Times article which proclaimed that houses are actually more affordable today than in the 1980s? Huh, aren't we in a huge uprecedented housing bubble?

Balasco explains why the article is bogus.

Biggest bubble in history

According to an article in The Economist magazine, the current global housing bubble is the “biggest bubble in history.”

Maestro says no housing bubble

Alan Greenspan said today:

Because of the degree of customization of homes, it is difficult to achieve significant productivity gains in residential building despite the ongoing technological advances in other areas of our economy. As a result, productivity gains in residential construction have lagged behind the average productivity increases in the United States for many decades. This shortfall has been one of the reasons that house prices have consistently outpaced the general price level for many decades.

So according to Greenspan, the price of houses has gone up because construction costs have gone up.

Although we certainly cannot rule out home price declines, especially in some local markets, these declines, were they to occur, likely would not have substantial macroeconomic implications.

So there we have it, don’t worry, nothing bad is going to happen. The Maestro said it himself.

Today’s Washington Post housing article

(1) April sales of previously owned homes up 15.1% since April 2004. The largest such increase in 25 years. (Comment: in a normal housing market, prices stay even with inflation.)

(2) “Some analysts warn that the higher home prices go, the greater the possibility of a painful drop in house values at some point.” (Comment: a drops are painful because people can buy homes with 10% down or less, so a drop greater than 10% will cause some homeowners to have negative equity in their house.)

(3) “Meanwhile, the hot real estate market is supporting the nation's overall economic growth by giving consumers more money at a time of lackluster wage growth and high energy costs, analysts said.” (Comment: huge recession coming when housing prices come tumbling down.)

Link: Home Sales Continue at Torrid Pace, WaPo, 5/25/05

Inequality and housing inflation

At Café Hayek, Russ Roberts is still arguing that there is no problem with inequality or social mobility.

Russ says that real (in economist-speak, “real” means adjusted for inflation) income for families in which there are two spouses and both work rose from $50,000 in 1970 to $74,000 in 2000 (presumably that’s in 2000 dollars). An increase of 48%, that doesn’t sound so bad. (I agree with Russ that comparing two wage earner families is the correct comparison to make.)

But let’s look at the price of housing. My parents bought a house in the Staten Island, one of New York City’s four outer boroughs, for $27,500 in 1968. Today they can sell that house for around $425,000.

Now let’s convert that to real dollars so we can make a comparison. According to the BLS, the CPI-U is 194.6 today, 172.8 in July 2000, and 35.3 in October, 1968. So my parents’ current house value in 2000 dollars is $377,390. But the purchase price in 2000 dollars is $134,618. That’s an increase of 180%.

So we see, during the time frame in which real income increased by 48%, the price of a house in Staten Island increased by 180%.

Considering that being able to afford a house is the key criterion that people use to determine how they are doing, the couple earning $50,000 in 1970 is better off than the couple earning $74,000 in 2000. The first couple can afford to buy a house, the second couple can’t.

(Of course this is only an anecdote, and the increase in prices of houses in Staten Island may not reflect other housing markets.)

Apartments are substitute goods for houses

One of the arguments for a permanent increase in housing prices inside the Beltway is the lack of available space. “There’s no place to build any more houses, so prices can’t possibly go down,” is what people say. I’m sure the same reasoning has also been applied to many other metropolitan areas.

It’s nice that people at least understand the economic principle that, if supply is fixed but demand increases, then there is an inevitable increase in prices. (But if they understand this principle, why aren’t they asking politicians to allow more residential construction? Probably the 70% who own homes don’t want prices to go down. But whenever Democrats whine about how the middle class worker can’t afford the cost of housing, but then don’t follow up with the only logical solution to the problem which is to build more houses, they just demonstrate their failure to understand basic economics.)

However, supply of houses isn’t truly fixed, even in an area like inside the Beltway northern Virginia. Michael Higgins writes in his blog today about how old run down homes are being torn down and replaced with new luxury homes, thus increasing the supply of luxury homes.

The second way that demand is satisfied is through the creation of substitute goods. “In economics, one kind of good (or service) is said to be a substitute good for another kind insofar as the two kinds of goods can be consumed or used in place of one another in at least some of their possible uses. Classic examples of substitute goods include margarine and butter…”

The obvious example of a substitue for a house is an apartment or condo. A high rise building occupying the land of just a few houses can contain hundreds of apartments. In the long run, the potential supply of condos and apartments is nearly infinite, even in a “fully developed” area like inside the Beltway northern Virginia. In fact, when I look out my window in Arlington, I see the skyline littered with construction cranes. High rise residential buildings are going up all over Arlington.

Of course people will always pay a premium to have their own parcel of land in a desirable neighborhood. And the bigger the parcel the higher the premium. But there is a definite limit to the premium people are willing to pay. An increasing supply of high rise residential buildings puts downward pressure on the price of houses.

So we see, it’s a fallacy that housing prices can never go down in a “fully developed” area.

Another housing bubble article in the WaPo

I love the ending to today’s housing bubble article:

Nick Koufos, an attorney for the Securities and Exchange Commission, is 36 and has three children. He recently did a cash-out refinance on his Silver Spring home to build a house in Pennsylvania -- to which he plans to retire someday.

"I think it's better to get it done sooner rather than later," he said. "I don't see how I could lose money."

Didn’t this guy’s grandfather ever tell him that there’s no such thing as a sure thing?

* * *

On a military base this week in the Washington DC area, I overheard two Lieutenant Colonels having a conversation.

“I can’t see how housing prices could go down in this area, all the government jobs means demand will always be high,” said one Lieutenant Colonel to the other.

This is the type of wishful thinking you hear every day in the DC area. I look forward to the day when all these idiots lose everything when the bubble bursts and their houses plummet in value.

This is a bad time to buy a house

Tyler Cowen at Marginal Revolution gives what I think is bad advice on housing. He says:

So go ahead and buy that house. Yes, you might be better off by waiting for the price to fall. But don't worry about bursting bubbles, you won't end up worse off.

This is not true. If you buy a house for $600K, and the price drops to $400K because the bubble bursts, that means you lost $200K. Ouch.

What happens if you buy your house, and then lose your job and can’t afford to make your mortgage payments? Well in a rising market, you just sell it and make a profit. But in a falling market you’re in a real bind because if you bought the house with 10% down and its resale value has dropped by 33%, you can’t even afford to sell.

Prior to the new bankruptcy law you’d just file for Chapter 7 bankruptcy and let the bank get stuck with the house (such is the cause of recessions), but now you may get stuck paying for your mistake for many years. (Although, with your “means” calculated based on your last six months of income, if you can stick it out for six months of unemployment you could still get the benefits of Chapter 7—just what our economy needs, another government law which actually encourages people to be deadbeats.)

Even if you can afford to sell your house, you wind up losing your life savings. So my advice is don’t buy a house right now.