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My post last week on the case for homeownership as an investment has received some good feedback (the e-word is hereby banished from this blog), a good chunk of which has been constructively critical. While I responded to specifics in comments, I also wanted to supplement the post by fleshing out the remainder of the argument and adding a couple of points.

It has been pointed out to me that there are certain costs – mostly taxes, insurance, and maintenance – that weren’t included in my spreadsheet and only implicitly in my analysis. This is – for the most part – true! I did handwave away depreciation, as much for the sake of simplicity as anything, but I only touched on the other two to the extent that they’re wrapped up into the rent counterfactual. Let’s delve into that some more.

Rent – the price of shelter to non-owners – is in the simplest analysis driven by the same things that drive all markets prices: supply and demand. That means rents aren’t directly responsive to the costs of housing, but those costs do impact the supply curve. If the costs of creating and renting new housing can’t be justified by rents, then supply will not rise even if demand does, driving up prices until they are so justified. Therefore, in general we should expect the costs of renting shelter to be similar (though not equivalent) to those incurred by the owner of the same. In fact, I bet if you play around with The Upshot’s ‘Buy vs. Rent’ calculator, you’ll find that housing and rental costs are very similar.

This brings me to my next point; while people have pointed out what costs I didn’t include, fewer have mentioned the benefit I didn’t include in my analysis, even though that benefit is much vaster. I focused solely on the capital gains returns of buying a house to demonstrate the power of leverage, but the huge share of the returns to a house are the rents you receive as an owner. This is central to any complete case in favor of homeownership. It is further worth noting that these imputed rents are, in fact, an enormous share of our economy.

a vampire weekend song entitled "david ricardo"

Net imputed rents, as I pointed out in my Piketty thinkpiece which seriously you must have read this thing by now also tend to be fairly stable, returning between 4-6% of the house’s price over time.

seek those rents seek them hard 

This chart actually understates the stability of imputed rents (as the former chart makes clear) since most of that volatility is driven by volatility in the denominator. For context, here’s the Case-Shiller index, since basically forever (with bonus real interest rate series):

 oh hai the aughties

While volatility has more recently increased (consider that my application for the Understatement of the Year Award), note that houses, at the very worst, tend to be inflation proof (the Case-Shiller is a real, not nominal, index) – an asset whose nominal price grows alongside inflation while consistently returning 4-6% annual net returns is, hey, not too bad, and if you can use tax-privileged leverage to buy it, not too bad at all. Especially since we’re going to pay a bundle for housing no matter what we do:

 what would a cake chart look like

…using housing as a vehicle for savings makes an additional sense.

That leads me to an additional point on volatility; here’s Shiller’s stock price index, also since basically forever:

 oh hai the 20s oh and the 90s hello

That looks a lot more volatile than house prices, huh? Which brings us to a key point – as asset price volatility increases, so does the importance of investment timing. This, as Neil Irwin recently noted, can make long-term averages of returns misleading.

seriously though fuck umberto nobody likes that guy anyway

While his examples are obviously stylized, they clearly-enough make the point that otherwise-identical savings behavior in a volatile market can achieve vastly different outcomes depending on the timing of returns even holding long-term average returns constant. Therefore, the relative stability of housing returns – prices + rents – helps savers reduce long term risks.

I want to conclude, though, by taking a major step back and examining the whole purpose of this exercise. When we’re talking about savings from a consumer perspective (not from an investment perspective) what we’re talking about is retirement; and when we’re talking about retirement, we’re always talking about the same somewhat-odd phenomenon. When a person retires, they cease all economic production through labor, yet continue to demand a share of the economic output of their society. We tend to view these claims as just and deserved because they are made by the elderly, who we feel have earned it/are unable to work/are generally venerable (as opposed to similar claims from the non-elderly poor, which we treat very differently) but that doesn’t change the underlying structural nature of the phenomenon, in which we are trying to ensure that a substantial portion of the adult population is consuming an broadly-equally-substantial portion of present economic output while providing no inputs.

Debates about savings and retirement, therefore, are all about how to structure this phenomenon – specifically, what network of programs, policies, mechanisms, incentives, and behaviors we want to establish to justify to the working and capitalists that a portion of their labor and capital outputs be directed to the non-working old, which we often do by creating mechanisms that somehow tether those portions of redistributed present income to guarantees of future income. All governments in wealth nations do this, and the ways in which they vary are influenced heavily by politics, ideology, and other socioeconomic factors. In the United States, our prevalent ideology around a certain kind economic freedom means we tend to be less generous in direct public redistribution and instead attempt to subsidize private savings through the tax code and public insurance – ergo, 401(k)s, the home mortgage interest deduction, and the Pension Benefit Guaranty Corporation. Indeed, the increasing prevalence of that ideological strain is driving defined benefit plans into extinctions in favor of defined contribution plans.

good thing we don't have unions anymore

This leads us to many debates about the best savings vehicles for middle class Americans, yet those debates are to a decent extent a red herring – the vast majority of retirees receive the majority of their retirement income from Social Security, and for many, it’s all the income they have – though to be consistent, I’m nearly certain the figures in the chart below don’t include imputed rents, though I could be wrong, and this is important because 80% of seniors are homeowners:

society secured 

This is very good evidence for the proposition that a vastly disproportionate share of the private-savings-for-retirement subsidy network flows to those who need it least. And it suggests that questions like “houses v. stocks” are, for many Americans, mostly a red herring – if we want to put more money in the hands of retirees, we should simply make Social Security more generous – or, in a better world, maintain it at its current level of generosity while implementing a Universal Basic Income.


stewie "david ricardo" griffin

Linking to Dylan Matthew’s generally-excellent piece on the correct way to manage one’s personal finances, Matt Yglesias says “stocks are on average a much better long-term investment than houses.”

This, of course, is an increasingly common view in the “internet wonk community” (one I consider myself an member of), distinct from the related and equally-prevalent view that ‘homeownership should be much less subsidized than it it now.’

This is also a view I take issue with, which you’d already know if you read my big Piketty #thinkpiece – you read my big Piketty #thinkpiece, right? right? – and one that I think needs a little elucidating and defending in detail.

There are three basic reasons that buying a house is a vastly better investment than current wonkpinion suggests. The first is that making large leveraged investments can pay off hugely even if the underlying growth rate of the purchased asset is slow. Let’s demonstrate.* Let’s take an average American buying an average house in an average way – $200,000 purchase price, 20% down, 4% closing costs, 5% interest rate. Now let’s say the value of that house grows reeeeeeeally slowly – just 0.3%/year, which just so happens to be the compounded annual growth rate of the Case-Shiller index since 1947.

If our average American sells their house after 10 years, their initial $48,000 equity investment will become $67,691.08 – which means their equity grew at a CAGR of 3.5%! If they sell after 15 years, they’ll net $92,209.57, which is a CAGR of 4.45%. Hey, that’s a lot higher than the 0.3% growth rate of the house’s price itself, isn’t it?

It sure is! The amazing power of leveraged investments is that you can turn a little bit of equity into a large return, as Matt Yglesias notes concisely here. Here, in fact, is a nice little graph demonstrating the implied return rate of selling your house after making regular mortgage payments for a given number of years, given the interest rate paid, assuming that meager 0.3% growth rate:

n33ds m0Ar l3vr1j

After 13 years, you’ll get a 3% return even at a very high interest rate; at 19 years, you’ll get a 4% return. In fact, you can assume zero growth and still get a substantial return on your initial investment – as long as you don’t count the regular payments on the debt.

Hey, what about the regular payments on the debt?

Good question! This brings us to my next two points. Because if leveraged investments are so awesome, why don’t we empower (and perhaps subsidize) average people to make large leveraged investments in stocks, which have a much larger underlying growth rate? Beyond all the other problems with that idea (not that nobody has pitched it), the thing about a house is that it has an unusual counterfactual. If you buy stocks with leverage, in theory the payments on the debt should come out of your savings, creating a counterfactual of simply saving and investing that money. But the counterfactual to owning is renting. This creates some curious conditions that lead to my next two points in favor of buying a house – inflation protection and subsidies.

There is obviously some connection between the purchase price of a house (and therefore the amortized monthly payment on the mortgage) and the rent it could fetch – regardless of where you fall on the capital controversy that dare not speak its name, there must be some fundamental link between the price of an asset and its expected returns. However, a mortgage is detached from the imputed rent (the flow of sheltering services) a house delivers, and therefore is nominally frozen in a way that rents are not. So therefore even if a mortgage today is substantially more expensive than the rent payment on an equivalent housing unit, in thirty years even very low inflation will change that drastically. Just 2% average annual inflation entails an 80% increase in the price level over three decades, meaning the annual mortgage payment declines by nearly half over that time. Rent, in the meantime, keeps going up (except in rare cases which can entail its own problems), at least as fast as inflation. Therefore even a mortgage whose monthly payment is more expensive than a rent payment today will be much cheaper than renting in a few years.

Aha, you might say, but there is a problem with this – the magic of compound interest means that the difference-in-monthly-payment savings accrued today by the renter will be much more valuable in retirement than the parallel savings accrued years from now by the owner. This is true! But that’s where the subsidies kick in. Our primary national subsidy for homeownership is to allow mortgage-payers to deduct the interest portion of their payments from their income – and the amortization structure of mortgages means the share of payments comprised of interest are highest right when the mortgage begins, and declines until the loan expires:

interest on your interest

This benefit comes when “housing” costs – really, housing-purchase-debt costs – are at their highest, also because earlier in life is when incomes are their lowest. It is difficult – very difficult – to defend the home mortgage interest deduction as currently structured, as such a large portion of the benefit goes to such a small and disproportionately well-off group. It is worth considering, though, whether the idea at the core of the program is sound. And either way, whether you think we should have them or not doesn’t mean that you don’t consider them when considering what constitutes a good investment under the status quo.

Of course, I haven’t even touched on imputed rents once a house is fully-owned (or, conversely, actual rents), which are of course the most important return to a house, well beyond the capital gains discussed heretofore. But this leads to the most important conclusion: not that houses are such a great investment per se; just that they’re a great investment for people without a lot of capital because of their unique pathway to leverage. If you had half-a-million dollars, should you buy a house (or apartment) to rent or a portfolio of financial products? Almost always the latter. But if you only have an order of magnitude less than that to your name, it may make sense to buy something with a lower return (not to mention wholly undiversified) because you can lever up. Just another way that large capital concentrations can secure higher returns – or at least exercise more freedom of action.

Spreadsheet, as always, attached – calculate your own expected returns on your housing investment!

House Investment

*All of these numbers are real and net-of-depreciation unless otherwise noted.

So late last year Matt Yglesias found a simple and concise way to create a good-enough estimate of the value of all privately-held American land, using the Fed’s Z1. He did not, however, go on to take the most-obvious next step, which was to use FRED to compile all the relevant series to calculate the entire time-series.

I have taken that bold step. Behold – the real value in present dollars of all privately held American land since FY 1951:

it's good to have land

Oh, look – a housing bubble!

But because this is the Age of Piketty, why stop there? Thanks to the magic of the internet and spreadsheets, all of the data Piketty relied on in his book is freely available – and perhaps even more importantly, so is all the data Piketty and Zucman compiled in writing “Capital is Back,” which may be even more comprehensive and interesting. So using that data, I was able to calculate land as a share of national income from 1950-2012. Check it out*:

 this land is my land; it isn't your land


Oh look – a housing bubble!

And why stop there? We know from reading our Piketty that the capital-to-income ratio increased substantially during that time, so let’s calculate the land share of national capital:


image (5)

Oh look – a…two housing bubbles?

It’s hard to know what to make of this at first glance, but after two decades steadily comprising a quarter of national capital, land grew over another two decades to nearly a third of it; and after a steep drop to under a fifth of national capital in less than a decade, just about as quickly rebounded, then plummeted even faster to under a fifth again.

So the question must be asked – why didn’t we notice the first real estate bubble, just as large (though not as rapidly inflated) as the first? There are two answers.

The first answer is – we did! Read this piece from 1990 – 1990! – about the “emotional toll” of the collapse in housing prices. Or all these other amazing pieces from the amazing New York Times archive documenting the ’80s housing bubble and the collapse in prices at the turn of the ’90s.

The second answer is – to the extent we didn’t, or didn’t really remember it, it’s because it didn’t torch the global financial system. Which clarifies a very important fact about what happened to the American economy in the late aughties – what happened involved a housing bubble, but wasn’t fundamentally about or caused by a housing bubble.

For context, here’s the homeownership rate for the United States:

get off my property


The 00’s housing bubble clearly involved bringing a lot of people into homeownership in a way the 80’s bubble did not; that bubble, in fact, peaked even as homeownership rates had declined.

There are a lot of lessons to learn about the 00s bubble, about debt and leverage and fraud and inequality, but the lesson not to learn – or, perhaps, to unlearn – is that a bubble and its eventual popping, regardless of the asset under consideration, is a sufficient condition of a broader economic calamity. Now, it does seem clear that the 80s housing bubble was in key ways simply smaller in magnitude than the previous one; it represented a 50% increase as a ratio to national income rather than the doubling experienced in the aughties even though both saw land increase similarly relative to capital. But there have been – and, no matter the stance of regulatory or, shudder, monetary policy, will continue to be – bubbles in capitalist economies. The policy goal we should be interested in is not preventing bubbles but building economic structures and institutions that are resilient to that fact of life in financialized post-industrial capitalism.

*Piketty and Zucman only provide national income up through 2010, so I had to impute 2011-2012 from other data with a few relatively banal assumptions.

There was a fascinating story on NPR the other morning about the invaluable role public libraries played as shelters and centers for community support in the wake of natural disasters such as Hurricane Sandy. While I could just snark about austerity and move on, I think this actually says something more potent about the nature of the libertarian/progressive divide.

A common rejoinder of conservatives and libertarians to the progressive desire to meet social needs through state action is that private charity would meet that need and is in fact being crowded out by state programs. Allow me to quote at length from a recent episode of EconTalk in which host Russ Roberts and guest Michael Lind go back and forth on the subject:

Russ: I want to go back to one last thing on this issue of this transition to a larger government. You mentioned that after the Great Depression, somewhere in the New Deal perhaps, we had to go to government provision of social welfare services because charities weren’t doing the job. Actually, charities were quite active during the Depression of 1895. They were quite active in the Great Depression. They disappeared when government got much larger. You are correct, as you point out in your article, or in one of your articles, that there’s always been public provision of welfare at the state and local level, though. So it’s never been a so-called libertarian provision of aid to the poor. There’s been a lot more private aid to the poor pre-Great Depression. I think it’s important to point out that the death of serious private charities fighting hunger and poverty for large groups of people ended with the New Deal and the rise of Federal spending.

Guest: You are absolutely right. There is no doubt that government social insurance crowded out a lot of charitable activity. And also that Federal social insurance crowded out a lot of state and county and local.

Russ: That’s correct.

Guest: Now, the question is: Is this a bad thing or not?

Russ: That is the question.

Guest: I asked this once of an 84 year old friend of the family, unfortunately no longer with us, who had grown up on a farm in Missouri. And I was discussing Robert Putnam’s study about the decline of civic activity and so on. So I asked him, because he lived all the way back until–was born around WWI–you know: Did he miss all of these organizations like the Elks and the Moose Lodge and all these fraternal civic organizations? And he said exactly what you said. He said, well they all disappeared because of Social Security.

Russ: That’s right.

Guest: He said, because the only reason 90% of us joined them was because they had health insurance. You know, sometimes the Moose Lodge would have a deal with a doctor, who would see all the members of the Immortal Order of Moose. Or the Elks or whatever. So, they provided health insurance, they provided burial insurance, which was very important for people who did not have the cash to provide for funerals. And also they had old age homes. Old folks’ homes. If you were poor then the fraternal order of Elks would have an old folks’ home. So I said, do you miss that world of diverse civic society? And he said, Hell no. So. You know there may be people who have some nostalgia for that, but I think this actually liberates civil society. You may disagree with me, but it seems to me–I’ll give you an example. During the Communist rule in Poland and in Eastern Europe, jazz clubs were often used as covers for democratic political activism. Okay? So the membership of these jazz clubs collapsed once you had democracy in these countries. Is that a good thing or a bad thing? Well, I think if you love jazz, then really, if the jazz club, even if it’s smaller, now it’s simply jazz lovers. And likewise, the Masons and the Shriners are much smaller than they were in the past. But if most of the people who join the local Shriner Lodge are really interested in Freemasonry, in other words they are not simply interested in economic benefits, which are now provided by the state, it seems to me that’s an improvement for the Shriners. They don’t have all of these people who were there just to get burial insurance.

Russ: Well, I think the question is if you want to assess what a more libertarian charity system, a more private, voluntary charity system, would look like, I’m not sure you want to look at 1927. It probably would be worse in 1927 than it would be today. We’re a much wealthier nation; we have much better ways of communicating and interacting and sharing ideas. And raising money, for that matter. So, when I think about what private provision of some government services would look like, I think about the Harlem Children’s Zone, which Paul Tough talked about on a podcast here a few months ago, where basically an entrepreneur, Jeffrey Canada, thought the government safety net had done such a miserable job with inner city African-Americans and other poor people that he decided to provide it privately in a different way. And does it better. It’s a lot of work. He doesn’t raise as much money or as easily as Head Start or other government programs, government schools, which use tax revenue. But it’s more effective. It’s more humane. It’s more transformative both for the people who live through it and the people who fund it. So, I think the crucial question is–it’s unanswerable, so we can argue about it until the cows come home–the crucial question is: Is it imaginable that privately collectively provided social services might do better? I think they might. I agree you can’t prove it.

Guest: Well, yeah. I guess the question is: Are there enough benevolent billionaires? Because it is mostly the rich who provide the money for charity. Individuals do some. Ordinary middle class. But it’s mostly the rich. The only time we had any experience of this really was in the United States and maybe in some European countries after the decline of feudalism when you had state religious welfare, tax-funded things and the rise of the modern welfare state. You know, from the late 19th, early 20th centuries. And at least at that time, the great industrialists and bankers did not see fit to provide charity in anything matching even a minimal welfare state for people now. Which is one of the reasons why these countries created a welfare state. If, you know, the British and the German and the American industrialists had had this whole alternate funded model, then I don’t think there would have been much pressure for a modern welfare state.

One thing that’s not discussed in this otherwise-fascinating conversation, though, is the change in settlement patterns that characterized the last century of American life. Before the great Depression, the urban share of the American population was somewhere between 50-55%; by 1950 that number had already increased to 64%, and today it is over 80%.

A key factor in all institutions is trust. In a small enough self-contained settling, like a small town, everyone can effectively know everyone else or at least close enough to everyone else to minimize the need for large-scale intervention by mandatory public institutions. If neighbor Bob is in trouble, the block can get together and see him through, knowing that they’ll be the beneficiary the next time. The local doctor makes house visits and collects a little bit from everybody or gets paid in promises or in-kind, and all the men join the Elk Lodge and pay dues that are effectively an intergenerational transfer. The police are minimal, often volunteers, and are usually there to cool off a few drunken fights and band together against external threats like roving bandits, rather than systematic internal threats.

But when everyone lives in a city, where a single apartment building can have a higher population than that small town, this breaks down. It’s not nearly possible for social bonds to create enough interpersonal trust to allow for voluntary self-governance, and even the basic problems of waste management, utility provision, and transportation exponentially grow in scope and complexity and cost as population increases. Without vigorous policing, thievery is common, and while ethnic or religious other in-group-based aid groups can provide some measure of help, they can’t systematically address hunger or poverty or infirmity or illness.

The recognition that, while urbanization is necessary for the kind of growth that has characterized modern society since the Industrial Revolution, it also brings with it its own unique set of problems and challenges, is a foundational basis of progressive ideologies and movements. There was no agrarian socialism. In The Origins of Political Order, Francis Fukuyama summarizes the difficulty of state formation in Africa:

There are relatively few regions in Africa that are clearly circumscribed by physical geography. This had made it extraordinarily difficult for territorial rulers to push their administration into the hinterland and to control populations. Low population density has meant that new land was usually available; people could respond to the threat of conquest simply by retreating further into the bush. State consolidation based on wars of conquest never took place in Africa to the extent it did in Europe simply because the motives and possibilities for conquest were much more limited. This meant, according to Herbst, that the transition from a tribal to a territorial conception of power with clearly conceived administrative boundaries of the sort that existed in Europe did not take place. The emergence of states in parts of the continent that were circumscribed, like the Nile valley, is an exception fully consistent with the underlying rule.

Not that this is exactly parallel, but it does show how population density is if not determinative is fundamentally influential to what institutions emerge within a polity. This divergent understanding of how to meet needs, privately or publically, still drives the rural/urban divide in voting patterns in the United States today.

Just to finish where I started, forgetting about the extraordinary functions of libraries like in the story above, even the ordinary functions of libraries demonstrate the limit of private action. My wife and I have just purchased a house in DC, and once we relocate we want to establish a Little Free Library. But even a hundred or a thousand Little Free Libraries, while conducive to communality and neighborliness, can only serve as compliments to a public library system rather than substitutes that are crowded out by public investment. The very purposes of a public library – to guarantee universal access to certain information, to preserve learning, to serve as centers for communities – are incongruous with private action, which can build bookstores or little neighborhood bookshares but can’t serve the public need for public information. Similarly, if disaster were to God forbid strike Washington, DC, while I certainly believe many private individuals, myself included, would be willing to shelter friends, neighbors, and others who were without power or water or other necessities; but that would be a complement to the guarantee that a library or emergency shelter in a school gymnasium would offer, not a substitute.

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