The Unassuming Economist

From a VoxEU post by Gonzalo Paz-Pardo:

“Homeownership among younger households has been decreasing in several major advanced economies. This column shows that increases in labour income inequality and uncertainty are key drivers of this trend. Confronted with high house prices and low, risky incomes, many young households cannot or do not want to risk making such a big, illiquid investment. As a result, they accumulate less wealth.

Figure 1 shows that, in the US, younger generations are less likely to be living in their own homes than older generations were at the same age. Among households headed up by someone born in the 1940s, 70% owned their homes by age 35. This figure dropped to 60% for those born in the 1960s and about 50% for the early ‘millennials’ born in the 1980s. In southern Europe, too, homeownership rates at age 35 have dropped – by over 10 percentage points when comparing those born from 1965 to 1979 with those born in the 1980s. At the same time, young people are taking longer to leave the parental home and live independently (Becker et al. 2008).

Homeownership is a frequent subject of political debate. Owning a house is crucial for the wealth accumulation of most households (Paz-Pardo 2021), and housing plays a role in a well-diversified portfolio (Chetty et al. 2017). Shutting young people out of housing markets may distort their marriage and childbearing decisions (Laeven and Popov 2017), and homeownership rates relate directly to the strength of local communities, social capital, and political engagement (Glaeser et al. 2002, Rohe et al. 2002).

What has driven these changes? To identify the key factors, I build a model of homeownership and portfolio choice over the life cycle with a rich structure of risks (Paz-Pardo 2021). According to the model, it’s not about younger generations not wanting to buy their homes anymore: changes in the economic environment fully explain the magnitude of the drop in homeownership rates.”

From the IMF’s latest report on France:

“Risks from real estate markets require continued vigilance. Over the last decade, household debt grew steadily from just below 60 percent to over 100 percent of disposable income and debt service to disposable income (DSTI) has increased. The deterioration reflects in part the need for higher debt to cover increasing housing prices, resulting in higher LTVs. Consequently, in 2019, the ESRB issued a warning related to medium-term vulnerabilities in the real estate sector, citing higher prices, weaker lending standards, elevated household debt, and rapid mortgage lending growth in France. While supervisory action by the High Council for Financial Stability (HCSF) has capped the deterioration in lending standards, low interest rates, a relatively inelastic housing supply and increased demand for home renovations continued to fuel real estate price growth in 2020 and 2021.

Several features in France can attenuate risks from market corrections to mortgage defaults, but banks’ profits could be at risk. Household repayment risks are contained because, among other factors, mortgage interest rates are fixed, and employment losses are protected by unemployment insurance. Banks are partially protected from potential losses predominantly through mortgage insurance, and borrowers’ legal obligations. However, profit margins on housing loans are estimated to be nil or even negative since 2017. Thus, the large volume of mortgages with long residual maturity and low fixed interest rate creates a persistent risk to bank profitability, which would intensify with selected defaults or increased funding costs of banks.

(…)

To limit excessive risk-taking by banks, borrower-based measures should be maintained and expanded. To shield banks from loan losses, the HCSF issued recommendations (declared legally binding as of January 1, 2022) that banks must limit mortgage length to 25 years and DSTI to 35 percent (up from 33 percent in the guidance)—with up to 20 percent of new mortgage loans excluded primarily for owner-occupied housing. As a result, banks have actively adjusted their lending practices, with falling DSTI. As of August 2021, the banking sector was within the flexibility margin. However, fueled by low interest rates and a relatively inelastic housing supply, house prices continued to increase and mortgage debt-to income remains elevated, reflecting the need to cover increasing housing prices. In addition, downside risks from structural factors remain, such as weak banking sector profitability due to persistently low rates and high cost-to-income ratios, banks’ high market risk exposure, wholesale funding risk, cyber security, and climate change risks. If these trends continue, fine tuning existing borrower-based measures or deploying complementary measures, such as the now available (sectoral) systemic risk buffer, may become appropriate to more broadly limit excessive risk-taking.”

From Econlib:

“Back in 2009-10, I did a number of posts criticizing the theory that rising house prices in the early 2000s represented a “bubble”.  In one post, I pointed to an article in The Economist that criticized Eugene Fama, and bragged that they had presciently foreseen the housing bubble.  In fact, the specific predictions they cited (from an 2003 advertisement for The Economist, since deleted) turned out to be almost entirely wrong, indeed wildly off base.

The Economist did not take kindly to my post:

Mr Sumner disagrees. He seems to think it’s funny that The Economists pent much of the last decade warning that, globally, home prices were rising in a troubling manner. Contrarianism is fun and all, but this strikes me as an odd way to process the experiences that led us to this point.

I responded:

I would note that Free Exchange seemed to enjoy making fun of Fama’s views.

Now The Economist has seen the light:

Perhaps it is just a matter of time before the house of cards collapses. But as a recent paper by Gabriel Chodorow-Reich of Harvard University and colleagues explains, what might appear to be a housing bubble may in fact be the product of fundamental economic shifts. The paper shows that the monumental house-price increases in America in the early to mid-2000s were largely a consequence of factors such as urban revitalisation, growing preferences for city living and rising wage premia for educated workers in cities. By 2019 American real house prices had pretty much regained their pre-financial-crisis peak, further evidence that the mania of the mid-2000s was perhaps not quite so mad after all.

Fundamental forces may once again explain why house prices today are so high—and why they may endure. Three of them stand out: robust household balance-sheets; people’s greater willingness to spend more on their living arrangements; and the severity of supply constraints.”

From Marginal Revolution:

“Paul Krugman is coming very close to admitting a) “real estate bubble” was not the best formulation, and b) Kevin Erdmann was right.”

Tweets from Paul Krugman:

“Aha. An economic mystery solved, I think (with a suggestion from Charlie Steindel). I’ve been noting that we’re currently seeing a surge in real house prices up to 2000s-bubble levels 1/

But the 2000s bubble was geographically very uneven: prices surged in cities with strict zoning, but not in places where developers were free to sprawl => elastic housing supply. This time the price rise is across the board, in fact in some cases higher in sprawl areas 2/

Eg Atlanta v Boston, on a log scale so you can see proportional differences: Boston >> Atlanta last time, if anything Atlanta > Boston now 3/

What’s going on? The answer surely involves weak supply response 4/

And that in turn points to our old friend disrupted supply chains, which have made construction very expensive 5/

Suggests that prices may eventually fall in smaller/less zoned cities, once houses can be built in large numbers 6/”

From Works in progress:

“Ireland had arguably the world’s largest housing bubble and crash in the 2000s, with prices quadrupling in the decade to 2007, even while supply soared, before crashing by more than half between 2007 and 2012. Unsurprisingly, this extreme experience has been the subject of much research. Housing has become a critical economic, social and political issue in many cities across the high-income world. At its worst, it even threatens the very concept of living standards in high-income countries, gobbling up a third or even half of the disposable incomes of individuals and households in some locations. But it wasn’t always like this. Adjusting for inflation, the price of housing in high-income countries underwent ups and downs in the century to the 1960s but the trend was largely stable. Though the timing varies by country, it has only been in the last half-century or so that the price of housing has shot up like a hockey stick.

As the world’s largest economy, the United States has been the highest-profile market to make this transition, along with a number of other countries that have followed the same patterns. Ireland is at the extreme end. Like a Rorschach test, people look at Ireland and see whatever suits them most in making arguments about housing and economic policy.

But many of these arguments rely on simplistic myths about what happened. Contrary to many of these claims, Ireland was not a story of overbuilding caused by laissez-faire policy, or an experience that defied standard economics. Ireland built very few ghost towns – housing excesses, where they occurred, were a product of government tax policy, rather than irrational markets. And supply and demand perform very well in explaining the trends. Failing to understand these basics will mean we are susceptible to making the same mistakes all over again.

I have spent much of the last fifteen years studying the Irish housing system, following it from the heights of the Celtic Tiger bubble to the following crash and the subsequent decade of rising prices. There are, to my mind, three myths that have emerged about the Irish housing market that muddy the waters in our understanding of housing markets not just there but everywhere.”