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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:
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:
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!
*All of these numbers are real and net-of-depreciation unless otherwise noted.
I’ve been working on collecting some longer thoughts on Piketty’s book now that I’ve finished it (so yes, keep your eyes open for that) and in the meantime I’ve been having fun/getting distracted by playing around with his data, and especially the data from his paper with Gabriel Zucman, which, you know, read, then play too.
One thing I realized as I was going through is that Piketty and Zucman may have incidentally provided a new route to answer an old question – were America to at last make reparations for the vast and terrible evil of slavery, how much would or should the total be?
What is that route? Well, they provide certain annual estimates of the aggregate market value of all slaves in the United States from 1770 through abolition:
As you can see, the amount was persistently and stunningly high right through abolition.
Now, without wading too much into heck who am I kidding diving headfirst into the endlessly-resurrected Cambridge Capital Controversy, the price of capital is determined in large part by the income it generates; so the market value of an enslaved person was an implicit statement about the expected income that slaveholders receive from the forced labor of their prisoners. So we can (by imputing the intervening annual values in their time-series, which I did linearly, which may not be a great assumption but it’s what I did so there it is) compute the real aggregate dollar market value of slaves from 1776-1860, then impute the annual income produced by, and stolen from, America’s slaves. For that, I used 4%, being conservative with Piketty’s 4-5% range.
Then you have two more steps: firstly, you have to select a discount rate in order to compute the present value of the total of that income on the eve of the Civil War in 1860; then you have to select a discount rate to compound that through 2014.
Well, that’s where things get interesting. For now, let’s pick 1% for both of those discount rates (which I am doing for a reason, as you will see). That makes the value in 1860 of all the income stolen by the Slave Power since the Declaration of Independence said liberty was inalienable roughly $378 billion*. That $378 billion, compounded at 1% annually for 154 years, is worth just about $1.75 trillion.
But those discount rates are both low – really, really low, in fact. Lower than the rate of economic growth, the rate of return on capital, and lower than the discount rate used by the government. When you increase those discount rates, though, you start to get some very, very, very large numbers. If you increase just the pre-1860 discount rate to 4%, for example, the 1860 figure leaps to over a trillion dollars, which even at a discount rate of 1% thereafter still comes to well over four-and-a-half trillion dollars today. Even vaster is the increase that comes from increasing the post-1860 rate, even if you leave the pre-1860 rate at 1%. At 2%, today’s bill comes due at just under $8 trillion; at 3%, $35 trillion; at the government’s rate of 7%, it comes to over $12.5 quadrillion. That’s over six times the entire income of the planet since 1950, a number that even if we concluded it was just – and given the incalculable and incomparable horror of slavery as practiced in the antebellum United States, it’s difficult to say any amount of material reparation is adequately just – is in practice impossible to pay.
There are three conclusions I think are worth considering from the above analysis:
1) First and foremost, slavery was a crime beyond comparison or comprehension, since compounded by our collective failure to not only to make right the crime as best we are able but to not even make the attempt (not to mention Jim Crow and all the related evils it encompasses).
2) Compound interest is a powerful force. Mathematically, obviously; but also morally. These large numbers my spreadsheet is producing are not neutral exercises – they are telling us something not only about the magnitude of the grave injustice of slavery but also the injustice of failing, year after year, to begin to pay down our massive debt to those whose exploitation and suffering was our economic backbone. And that only refers to our material debt; our moral debt, although never fully repayable, grows in the absence of substantive recognition (or the presence of regressive anti-recognition).
3) Discount rates tell us a lot about how we we see our relation to our past and our future. The Stern Review, the widely-discussed report that recommended relatively large and rapid reductions in carbon emissions, became notable in good part because it triggered a debate about the proper discount rate we should use in assessing the costs and benefits of climate change policy. Bill Nordhaus, hardly a squish on the issue, notably took the report for task for using a very low discount rate – effectively, just over 1% on average.
It is hard to crystallize precisely the panoply of philosophical implications of how discount rates interact differently with different kinds of problems. In the case of climate change, a low discount rate implies that we today should place a relatively higher value on the costs future generations will suffer as a consequence of our activity, sufficiently high that we should be willing to bear large costs to forestall them. Commensurately, however, a low discount rate also implies a lower sensitivity to the costs borne by past generations, relative to the benefits received today. High discount rates, of course, imply the inverse in both situations – a greater sensitivity to the burden of present costs on future generations and the burden of past costs on present generations.
There is no consensus – and that is putting it lightly – over what discount rates are appropriate for what situations and analysis, and whether discount rates are even appropriate at all. And when we decide on how to approach policies whose hands stretch deeply into our past or future, it is worth considering what these choices, superficially dry and mathematical, say not just about inputs and outputs, but also the nature of our relationship to the generations that preceded us and those that will follow.
*2010 dollars throughout.
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:
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*:
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:
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:
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’s not much to add to the specific embarrassment and evisceration to which Matt Yglesias subjects this loathsome David Brooks column over the nexus of arrogance, lack of self-awareness, self-righteousness, and callousness that is his blathering on marriage. But Yglesias does touch on something broader worth elucidating.
In basic econometrics practice there is something called an “interaction term” that can be very very important. Without getting too much into jargon or technical stuff, the basic idea is that you are trying to isolate the effect that two or more different things have when they are combined from the effect each has when they are separate. The interaction term is what isolates and captures that difference. Sometimes, they show that the effect of one thing – say, the effect of marriage on income – is very different depending on the other thing – say, gender. Men might make more money if they get married, women might make less.
My guess is that life is full of these interaction terms, and that poverty is a really, really big one, and therefore the effects of almost everything are different on poor people. When rich parents get divorced, it is emotionally miserable for everyone. When poor parents get divorced, it is emotionally miserable for everyone and can entail substantial economic dislocations and suffering. But the solution isn’t to remain in an unhappy marriage for financial reasons. The solution is to ameliorate financial hardship so people don’t feel trapped in unhappy marriages.
Matt Yglesias wrote a fun post on how massive conservative spending on elections may be causing conservative strategist inflation. What I think this post highlights implicitly is where the broader class of inflationistas goes wrong.
Let’s imagine that the Koch brothers wizarded the $400 million they spent on elections out of thin air. That created part of the conditions for inflation.
But there is a second, much more important condition for inflation – supply side constraints. The fact is that there are only so many elective offices, so many candidates, so many strategists and video produces and email spam writers. When you plow more and more money into a supply-constrained market you get rising prices without a corresponding increase in quality or quantity. That’s inflation.
For inflation to happen on an economy-wide scale you need not only for the monetary authority to create lots of money, you also need that money to exceed any corresponding increase in total output. So to believe that the Fed is about to hyperinflationatize us all into the Dark Ages you’d have to believe that there aren’t any more resources to mobilize with all that money, which is bonkers because lots of people don’t have jobs. Here is a cool map showing unemployment rates in lots of countries. They’re high. Is there nothing productive they could be doing?
Maybe not! Maybe you think that supply and production in energy markets can’t support more employment and that’s what makes now like the 70s. I disagree! But you have to make that case too, not just that “ZOMG FED PRINTING SO MUCH DOLLARS RUN FOR THE GOLDEN BUNKERS.”
Something that annoys me in the minimum wage debate is that the anti-minimum wage folks assume that labor markets (not “the labor market” – there is no “the labor market”) works like other markets.
And there are really, really good reasons for that! But let’s just look at one facet/outcome of that.
If you asked me “in an ideal world, what would be the price of [just about anything],” my answer would be “nothing!” Food? Free! Furniture? Free! Clothing? Free! Computers? Free! Because free implies a defeat of scarcity – that one day we will have replicators and 3d printers and servile robots and abundant clean energy and almost all goods and services will be without cost. That’s utopia.
But if you asked me, “in an ideal world, what would be the price of labor,” I would never, ever say free. Because what economists call “labor” most people call “time” – a finite, substantial quanta of someone’s finite time on Earth.
The right way to think about this is the Star Trek universe, where almost all goods and services are provided costlessly by machines but people still put their time and effort into creative or rewarding projects, the kind of stuff we call today “artisinal production.” That stuff still “costs,” but its mostly a gift and barter economy where people brew their own delicious beer and give it to friends or trade it for delicious, home-distilled bourbon.
Now, the price of labor in our own, non-utopian world, has effects, large and small, on lots of things, and its not obvious what the best balance between the returns to labor vs. capital are, or the best mechanisms for obtaining them. But we also shouldn’t be trying to ceteris paribus drive down the price of labor like we should the price of chocolate or power cords or other commodities.
And because of the totally different way “labor” is conceptualized, and because of the totally different implications and underlying meanings of labor markets, they just don’t work like normal markets in so many key ways.
Put it this way: nobody thinks it’s morally wrong to prefer a brownie to a blondie or white fudge to dark fudge, but people do think its wrong to hire based on skin color. In fact it’s illegal, for very good reason.
When individuals have to cut back on expenditures, they don’t like it, but they do it; but bosses (at least good ones) agonize over firing employees and really loathe doing it.
When individuals have the chance to bargain or get a great deal on a good, they leap at the chance; but even when the economy is bad, employers do not take the opportunity to renegotiate salaries downward. If they have to, they’d rather lay off 5% of their workforce then give everyone a 5% pay cut.
And, just to finalize, think about how much people invest their self-worth into their career. Not that they should. But inevitably many do.
So labor markets are just not really like markets for goods and services at all, and people who insist that “fundamental laws of economics” mean that increased minimum wages absolutely must ceteris paribus reduce employment are making fundamental errors.
Two days ago, Matt Yglesias pulled the pin on a rofl grenade, and yesterday he basked in the lulzplosion. Yet I think it’s worth addressing exactly why it is conservatives have a deep, emotional attachment to doctors – and vice-versa. Indeed, 16 of the 19 doctors in Congress are Republicans.
First, they tend to be old, white, and male.
Second, they tend to be rich.
But even beyond that, there’s lots of strong, deeply-rooted reasons conservatives gravitate towards doctors as vectors for identity politics. They work extremely hard. They are often small business owners or independent proprietors. They are seen (and perpetuate the image of themselves) as beseiged by regulation and government intrusion. They spend many years working extremely hard for little immediate reward, only to be richly rewarded later, a sequencing that matches conservatives views about the virtue of patience, saving, and hard work. And they also do good while still getting rich from doing good and they’re extremely popular which makes them vastly better symbols than CEOs or financiers or even, in some ways, the military, since even though the military is general respected and popular it is also fairly-widely associated with aggression, violence, discriminatory practices, and other negative characteristics that many would avoid.
So suggesting that doctors are actually rent-seekers supping on government cheese served on government silver while drinking fine wine out of government crystal really touches a nerve.
To relate this to another hobby horse of both myself and Yglesias, it’s similar to the reasons conservatives tend to have a giant blind spot around urban land use issues. Essentially, all the identity politics orbit the image of a person in their own, large, private home, being in their own large, private vehicle, owning their own land, away from cities filled with miscreants and students and criminals and socialists and various sundry unwashed masses. That this lifestyle is supported by exactly the kinds of burdensome, costly, stifling regulation they claim to oppose sets off a surprisingly rabid reaction.
Of course, there’s also tremendous cognitive dissonance among conservatives around the very idea that conservatives practice any kind of identity politics, so even brushing that raw patch elicts yowls.
Of course, this could all be changing. Nothing persists but change.
Matt Yglesias has this interesting post on how a firm never really needs profit because what it needs is revenue in excesses of cost which can either become profit or become capital which adds to the value of the firm. This is true and it also raises additional theory-of-the-firm questions along the lines I was discussing earlier. One possible reason for firms is that firms are a mechanism to make managing large portfolios of intertwined capital possible and manageable. That’s interesting!
More interesting, though, are firms that are not like Amazon. Amazon is a firm that has a lot of stuff – a lot of warehouses and robots, for example. Some firms, though, don’t have that – they mostly consist of people and their computers and sundry office supplies. Good examples of this might be Google or Facebook – they’re not valuable companies because they have lots of material stuff (though they do, primarily server farms) but because they have lots of really smart people managing a digital system, as well as patents. That is to say, human capital – and what is a patent if not a quantum of human capital preserved in carbonite?
The question is – unlike Amazon, if these firms were to stumble or even fail, what is there left? The smart people with computers? They would scatter. Patents? Even absent reform, those expire within a very definitive time horizon. Even Apple’s physical infrastructure is mostly predicated on relationships with contractors and partners – the Appleness of Apple is mostly in Cupertino, not Shenzhen.
This isn’t a new question, per se – it’s a question that applies to all kinds of white collar firms, firms that do law and design and architecture and advertising. What makes the newer firms distinct, though, is their scale – even the largest human capital-oriented firms of the past tended to be private partnerships and remained that way even if they achieved national scale, and never achieved national dominance, whereas today’s human capital firms are massive dominant firms that represent large and increasing share of total equity on stock exchanges.
The weirdness of human capital also gets to the issue of student loans, which I’ve discussed before and which Matt Taibbi has recently penned one of his patented jeremiads on. The question of student loans, on the individual level, is the micro twin to the macro question of a firm like Google – how do you stake a claim on what lies within the human mind? You can seize a car or a house for failure to pay (or occasionally these days because whoops type) but you can’t seize a person’s brain or de-educate them if they default on their student loans. When the big automakers went bust a few years ago they were saved from liquidation which was probably a good thing but had they been liquidated there would’ve been, you know, lots of auto plants to liquidate. How do you liquidate Google? What secures your investment? It makes me think that, just as we need methods of financing education that sensibly grapple with the nature of the thing rather than impose existing models of finance that existing institutions were comfortable with even though the adverse consequences are indeed proving severe, we may need to think longer and harder about corporate financing as corporations, more and more, aren’t secured by physical capital.