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So the Marlyand Purple/Red Line debacle. In addition to all the more-often-explicated reason why Americans Can’t Have Nice Trains, one reason I don’t see brought up is how our ancient, arbitrary, and byzantine system of administrative subdivision creates baffling labyrinths of political economy. The Purple Line is located solely in Maryland, even though it is part of a larger system that serves DC and VA; but the latter two don’t want to pitch in first-order costs for second-order benefits, and nobody can make them. The regional authority governing the system has no ability to extract greater resources, and the same political economy under discussion so starves it of resources that it can barely keep its own shit together and is massively unpopular as a result (remember – starving government makes government bad makes government unpopular, that’s the cycle of outcomes and opinions the last few decades of increasingly conservative governances has deliberately tried to perpetuate). Meanwhile, within Maryland the Purple Line is located solely within two counties that are among the wealthier within the state so why should folks not served by the system pay? The federal government has an interest in the Purple Line but hahahah try getting something like this through Congress and anyway why should square state folk pay for coastal trains? But the logic of the project is just so strong and the constituencies for it sufficiently influential that it hobbles through only somewhat nerfed…at the expense of the entirety of a project of another transit project in a large but poorer city located solely within the same state.
This, of course, is terrible. And goes to a longtime hobbyhorse of mine, which I said really well above so I’ll just say again: our ancient, arbitrary, and byzantine system of administrative subdivision creates baffling labyrinths of political economy. There has been plenty of discussion of what the US should do to revise its federal system under conditions of godmode, and I fully endorse unicameral MMP (though not monarchy, that’s just silly, just make the Presidency a less-power, non-partisan office elected to decade-long terms and inculcate norms that generally-beloved national figures should run. Seriously, even for the limited purposes advocated therein you still have the problems of monarchy, which is total lack of desert, the randomness of birth and lineage, etc – just have folks elect a vector for national love and unity that’s still in line with American values of democracy and meritocracy. President Clooney, President Swift, President Ramos, etc etc).
But as long as we’re rewriting our entire system why leave the entire edifice of day-to-day government intact when overhauling the top layer? Especially since once you abolish the Senate the whole reason to leave “states” in place seems pretty silly.
So, here’s how we should run America:
Keep “states” (so we can keep the name of the country, after all) but have like, 8-10 of them, and make them correspond to large regions of unified culture/interest, something like Census regions or the turf covered by Circuit Courts, Federal Reserve Banks, etc, except with no regard for existing state lines. Then, get rid of counties and municipalities and replace them with metropolitan governments, that would cover whole metro areas, and ward governments, that would cover smaller, local areas. So instead of using our current example (which is admittedly one of the more egregious cases because of the unique nature of DC) let’s look at NYC instead – looking at just the NYC MSA, you’re looking at three states (none of whom have capitals proximate or part of America’s largest metro area, in which 1/15th of the entire country resides) comprising 25 counties and hundreds of municipalities, boroughs, wards, unincorporated areas, authorities, etc. Instead, you might have a “state” encompassing everything from Maine to Fredericksburg, VA, a metro generally aligning to the existing NYC metro, and then a quilt of small governments primarily responsible for purely local governments; NYC is tricky because it’s uniquely dense in the United States, but think something the size/population of SoHo, or even smaller.
This, of course, wouldn’t eliminate conflict or solve politics, but it would make lines of responsibility and questions of political economy clearer and more directly adjudicable. If you can create administrative units that largely encompass most of the people who would benefit, either directly or near-indirectly, from something like a major transit investment, and largely leave out people who wouldn’t.
Anyway, this is all politics as something approaching fan fiction but hey it’s Friday and in our real politics we just spent for-freaking-ever debating whether to control-Z national healthcare because [sic] so a little fantasy now-and-then isn’t the worst.
On an administrative note, while I’ve enjoyed the combination of Ello, tweeting a lot, and “being super busy at work,” I hereby declare the extended period of neglect of this particular space over and plan to at least semi-regular post thoughts here (though, hopefully, not at the expenses of doing other things of fun and value). I also plan on at least occasionally sending something out via Tinyletter so now might be good time of inviting me into your inbox every now and then.
PEG has something to say about science. I’m going to let Adam Ozimek say what needs saying about certain more easily refuted parts of the piece; but I’m going to actually focus on where I, well, kind of agree. Well, maybe agree is the wrong word. Let’s try empathize.
This Mother Jones piece crowed about the fact that ‘science-denying’ creationists were attacking portrayals of the Big Bang in Cosmos just as “[a] major new scientific discovery,…has now provided ‘smoking gun’ evidence for ‘inflation,’ a crucial component of our understanding of the stunning happenings just after the Big Bang.” What was this ‘smoking gun’ evidence?
Using a special telescope to examine the cosmic microwave background radiation (which has been dubbed the “afterglow” of the Big Bang), researchers at the South Pole detected “direct evidence” of the previously theoretical gravitational waves that are believed to have originated in the Big Bang and caused an incredibly sudden and dramatic inflation of the universe.
So, people who believe the universe is seven orders of magnitude younger than it actually is in spite of all already-existing scientific evidence because it conflicts with their theology are supposed to be pwned because a mysterious and complex gizmo they haven’t seen, located on the most remote part of the planet, was looking at something they don’t understand and found evidence they don’t understand of a phenomenon they don’t understand linked to a theory of the consequences of that thing they don’t believe happened. Yep. That’ll do it.
Think about it – have you seen that telescope? Do you know what it does? How it works? How can you be sure it’s working properly? What is its actual output – some sort of numbers on a computer? What do those numbers mean? How do you know that? Can you interpret them? How do they fit into the theoretical construct that leads you to believe this particular stream of telescope output corroborates the Big Bang? Do you really understand this?
I don’t think you do. And that’s fine. Most of us don’t understand most things. I probably understand fewer things than most. But one thing I definitely understand is that human beings are alive, if we’re lucky, for just over 700,000 hours, more like 525,000 as an adult, more like 350,000 as an awake adult, of which you’ll spend at least a fifth working and then you have kids and illnesses and hobbies and suddenly you’re out of time to understand complex matters of cosmological theory and telescope construction.
The point is that at some point to believe just about anything in which you are not a seasoned expert you have to trust other humans. And how you decide which other humans to trust isn’t something you can determine by corroborating everything they say, because that’s circular. It’s decided by a whole host of factors, but the point is that it is extremely rational to decide to trust or distrust certain sources as a matter of course.
Yet we resist that, for reasons that are both rational and thoughtful as well as those that are reflexive to elite culture. Watch Joe Weisenthal struggle with it in this convo:
@TPCarney and if today you’re still worried about inflation – but for the wrong reasons – then that still shouldn’t be taken seriously.
— Joseph Weisenthal (@TheStalwart) December 28, 2013
I’ve thought a lot about that short exchange since it happened nearly a year ago, because it so neatly captures the tension between our valuing ideas and open-mindedness and the relentless logic of using sources as filters. Many people who think that hyperinflation is JUST AROUND THE BEND and who have repeatedly warned of hyperinflation over the last decade have many useful and valuable insights; but their vocal and insistent warnings about imminent hyperinflation have also been extremely wrong in a very discrediting way. In the opposite vein, if you did trust the hyperinflationistas, why would you trust a debunking of them from, of all people, Paul Krugman?
In the end, we are all bound not by the objective veracity of the information and the merit of the ideas we hope to adjudicate, but by who we trust to convey and explain ideas and information to us. We trust science, fundamentally, because we trust people who trust science. And once that trust is broken, it can be very, very hard to restore.
And remember that discovery of gravitational waves and the Big Bang? Well, it was wrong. Probably.
Depends who you trust.
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.
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.
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):
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:
…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:
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.
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.
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:
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.
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.