from Follow the Money

Housing bubbles, the great plains and the coast

May 27, 2005

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Not all parts of America are enjoying a housing bubble. $65,000 will buy a brick home with three bedrooms and a two car garage in Stafford Kansas, though maybe not ten acres of prairie as well.

Low interest rates are the common denominator linking together Greenspan’s frothy local housing markets, but local conditions can dominate low national, if not global, interest rates. If there are more houses than people, it is hard for housing prices to increase much -- even if interest rates are low. Without new investors chasing the windfall gains from the initial surge in prices, there is not as much speculative froth. In those parts of the US where the population is shrinking and incomes are generally low (Note: Timothy Egan’s reporting on the plight of great plains small towns has been excellent), there does not seem to be much of a housing bubble.

To paraphrase Paul Kasriel’s summary of Greenspan, there is no housing bubble in Manhattan KS (where I grew up), but there is one in Manhattan New York (where I now live). That characterization is a bit off. Manhattan KS (a growing university town and regional medical center) is far more frothy than say Stafford or St. John’s KS, but it has a grain of truth.

Even within "bubble" America, there are differences. Interest-only markets like California seems to have a bit more froth than someplace like almost interest-only Washington DC. The rent to price ratio is a bit higher in California than in DC, where rental prices have trended up. All that homeland security and global-war-on-terror related work ... The real estate bubble has generated big money -- at least on paper. Dollar turnover in the housing market was equal to 10% of US GDP in q1. Housing accounts for 40% of all post-.com bubble job creation. The US real estate to GDP ratio is now approaching the US equities to GDP ratio back in 2000.

Update. Calculated Risk has drawn attention to this NY Times article, which notes that real estate may account for 25% of the US economy ...

Since real estate is relatively widely owned, as far as financial assets go, the capital gains are probably not as concentrated as the (paper) gains from the .com bubble. But the surge in housing prices still has enormous distributional consequences. The net worth of those who already own homes -- generally an older group -- has gone up, along with the net worth of those lucky (or smart) enough to get in early. Those who don’t already own homes are worse off; the cost of buying a home has gone way up.

And there is a regional component -- the coasts have generally had more real estate froth than the interior. Alan Greenspan’s everyday low interest rates have been kinder to blue states than red states.

John Berry rightly has highlighted the distributional consequences of the mortgage interest tax credit and other housing tax subsidies:

Altogether, the benefits from those tax breaks are wildly skewed according to income levels and where taxpayers live. In general, higher-income households that can easily afford to own a house without such subsidies get the bulk of the benefits.

Last year the National Bureau of Economic Research published a paper by two Wharton School economists, Todd Sinai and Joseph Gyourko, who used data for the U.S. 2000 Census and other sources to compute the subsidy per owner-occupied unit in each state in 1999.

That subsidy ranged from a low of $2,240 in North Dakota to $12,759 in Hawaii. Among metropolitan areas the disparity was much greater: $26,385 in San Francisco-San Mateo-Redwood City, California, and a scant $1,541 in McAllen-Edinburg-Pharr along Texas’s Mexican border. Some East Coast areas also had huge subsidies and many in states such as Tennessee, Ohio and Louisiana got little benefit.

Given what has happened to home prices on the two coasts since 1999, the unevenness of the value of the combined tax breaks has soared.

(Sinai-Gyourko paper here)

Of course, eliminating this tax deduction is about as politically viable as eliminating agricultural subsidies.

Indeed, there are some similarities between housing subsidies and agricultural subsidies, even if agricultural subsidies transfer income from urban to rural areas and housing subsidies transfer help urban at the expense of rural areas. So long as agricultural subsidies are linked to the amount produced, they transfer more to large landowners than small landowners. Set the price high of say wheat high enough to keep smaller farmers in business and bigger farmers will do very well, at least in the absence of some kind of cap. Tax subsidies for interest payments on housing are worth more if you have a big house with big interest payments and pay a high marginal rate than if you have a small house, small payments and are taxed a low rate.

Since salaries and housing prices both tend to be higher on the coasts, the net result is clear: this is a government policy that favors the haves on the coast over the haves in the interior, and haves over have-nots everywhere. There is no "rent" tax deduction last I checked.

My Midwestern chauvinist side always thought it was amusing that the big, sort-of-national daily papers waxed far more eloquent about eliminating farm subsidies than eliminating suburban housing subsidies. Everyone has constituents.

One last aside: US farm subsidies certainly do need to be reformed, particularly those that have a large impact on poor farmers in the world’s poorest countries. But I also wonder if low-interest rates have not made it more difficult, politically, to get rid of agricultural subsidies, not just housing subsidies. Low interest rates increase the present value of future farm subsidies. To the extent that the market assumes current agricultural subsidies will stick around, they should increase the value of "subsidy-generating" assets -- like land. Alas, I don’t know enough to even try to test this hypothesis.

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