The Elegant Solution to Housing Affordability

Get Out of the Way

Since the internet stock bubble of 2002, economists, politicians and their media cohorts have been yammering about a housing crisis that manifests itself in many ways. One that began with currency devaluation and billions of dollars of subprime loans that were granted in conformity with federal mortgage lending mandates.

Owning a large new house became relatively cheap, little or no down payment was required, and lenders were off the hook when federal mortgage agencies bought the loans. When the originators sold them to federal agencies, they were then packaged as mortgage-backed securities, government approved agencies assigned AAA ratings, mortgage bankers created derivative tranches, and the securitized mortgage pools were sold to institutional investors. What could go wrong?

Because of rising demand for bonds as a hedge against stock market risk, yields had fallen sharply and government employee pension funds became insolvent. Then came the real estate and banking collapse of 2008. And through it all, homelessness continued to grow, pension funds became insolvent again, foreclosures soared, and residential construction came to a halt as markets worked their way through historic oversupply problems.

But why were investors buying these low-yield fixed income securities? Because even in the worst of the 2003 and 2008 crises, the default risk was relatively low and there was collateral in the form of a hard asset that people needed. And all of that seems like ancient history to young people today who are facing high costs, but the story must be told.

Purpose

The laws of cause and effect do not go away because we wish it so. Economic crises are always caused by force – and thanks to modern technology, it is no longer the force of nature. It is the force of government. Meaning centralized authority. And the elegant way to resolve all economic problems is through the decentralized knowledge of market participants in pursuit of their own unique goals.

To understand the housing crisis of the 2020s we must first define it. Primarily, the issue is housing affordability for people in the first ten or fifteen years of their professional careers. That includes both the price of home ownership and the price of financing a home - mortgage payments or lease rates.

For the employed, family age, Gen Z demographic, a good place to start is housing costs as a percentage of after-tax income. Of course, that depends on the individual and does not include their other goals and aspirations. But to the statists in government and media, affordability also means free housing for the homeless segment - which also has acquisition costs and maintenance requirements.

Yet, everyone has unique values, and it’s impossible to define “affordable” for large groups. That is a subjective term, but I will define “elegant” and “radical.” Elegant is simple, efficient, ingenious, and graceful. Radical is focused on root causes and grounded in fundamentals.

Premises

Contributing factors to the home ownership crisis includes home construction costs, residential mortgage rates, resale supply, and zoning regulations. Factors related to residential rental prices include commercial construction costs, debt service rates, government tax credits, institutional investment priorities, and zoning regulations. For urban blight, those include government housing projects, rent controlled buildings, public school degradation, and homelessness.

Certainly, there is not enough space to discuss all of these, but they deserve mention as co-dependent variables - changes to any will affect prices for others. And worthy ideas must be good in theory and in practice. If it sounds good in theory but doesn’t work, it is not a good theory. And to be practical, it must be morally defensible. If it fakes reality, it is not practical.

Essentially, a bold idea for making housing affordable must be “outside the box.” But what is “the box?” The “financial box” is lending quotas, rent controls, property tax levies, tax credits, and “renewable” energy costs. The “economic box” is fiat currency, trade tariffs, lending regulations, energy permits, and “green” construction mandates. And the “social box” is pressure groups, teachers unions, substance abuse, homelessness NGOs, and “carbon footprints.”

As you can see, the paragraph above lists fifteen factors that comprise “the box” of the housing affordability and homelessness debate. You heard it here first. All of which intrude on the numerous factors listed above. Markets are amazingly complex and elegant when left alone. In essence, these are the causes, and they illustrate the numerous contradictions of political over economic power - of central planning trumping decentralized knowledge - of force over the free flow of capital. Money isn’t stupid.

Housing Supply

To nearly everyone, regardless of their economics degree or political stripe, the fundamental law of economics is supply and demand. That means when other variables are held constant, greater supply lowers prices or greater demand raises prices; the problem this solves is scarcity of goods and services. And when prices rise and fall, that triggers changes in behavior and the production of alternatives.

But the real problem is that the common wisdom ignores the prime movers of sound economic theory. A Treatise on Political Economy by Jean-Baptiste Say informed the world that supply creates demand. And The Ultimate Resource by Julian Simon informed the world that human ingenuity is made scarce by the lack of political and economic freedom.

So, to understand the housing supply problem, one must understand its cause – the economic lockdowns that began in 2020. Bear in mind, the Wuhan virus did not cause this. It was political panic by federal and state authorities over a pandemic created by State authorities in Washington and in China. Supply networks that take decades to build were crippled, commodity prices soared, and construction halted.

For a solution, a great place to look is the New York Times bestseller Abundance, by Ezra Klein and Derek Thompson – but only to avoid wasting time on bad ideas - the “entrepreneurial state.” Their solution is to eliminate pesky zoning regulations, build countless public housing and “green energy” projects, and provide a limitless budget for both to a miraculously streamlined government.

The good news is that the dislocations in housing stock, material supply, and labor prices caused by policy makers created opportunities for investors and developers to solve the supply problem. But for that to happen most efficiently, the solution must include getting “outside the box” of rent controls, zoning ordinances, tax credits, and green construction mandates.

Fortunately, markets are resilient, entrepreneurs are creative, capital flows to talent, and consumers have alternatives – including other priorities besides housing. Responding to all of that are the institutional investors who buy existing housing stock in voluntary transactions with willing sellers, evaluate cap rates and demographics, adjust portfolios as market conditions change, and are now building new housing to be held as portfolio assets.

Housing Costs

According to the federal mortgage agency known as Freddie Mac, the rate for 15-year and 30-year fixed-rate mortgage loans grew to 7.0% and 7.8% respectively from 2.7% and 3% between December 2021 and October 2023. Obviously, that represents a 260% increase in less than two years. For new home buyers, that doubled their housing budget needs – if housing prices had not changed. Add to that the rising the cost of utilities, homeowners insurance and property taxes, and you have a housing crisis.

But what is the cause of the historically sharp spike in mortgage rates? To nearly everyone, regardless of their economics degree or political stripe, the fundamental driver of interest rates is Federal Reserve policy. That means when the Fed raises or lowers the Fed Funds rate, it triggers a ripple effect for all lending and deposit rates. However, the Fed’s influence is largely overstated.

In reality, investors were demanding greater compensation for the greater risks to their capital that was triggered by the panicking politicians that locked down production, crippled supply networks, and confiscated trillions from the unspent wealth that was circulating around the globe.

In fact, rising mortgage rates and housing productions are independent, as journalist John Tamny explains in Bringing Adam Smith into the American Home, “To be clear, housing soared in the 1970s when the Fed was aggressively hiking rates. The conventional view that the central bank can engineer rushes to real estate has little basis.” In essence, the only rational solution to the today’s “housing crisis” is to realize that there is no “crisis” in the sense of any abnormal reactions to the complex forces at work.

What does that mean? There are no moral or practical solutions for policy makers – except for one: get out of the way. Inevitably, the elegant solutions must include getting “outside the box” of federally mandated lending practices, “renewable” energy sources, fiat currency spending, and protective tariffs – all of which drive costs higher.

But the real question is whether home ownership is all it’s cracked up to be, as Tamny explains, “That money endlessly migrates to its highest use is the surest signal that people are, in a perfect world, migrating to where their skills can be best deployed. Except that housing can be an anchor delaying this migration.”

Homelessness

From the domain of reason and logic at one end of humanity’s cognitive spectrum, there is faith and force in the opposite domain. And to understand the cause of the homeless epidemic in certain cities in America, Klein and Thompson’s Abundance is a good description of that, “If you live in a city with too few homes, poverty and drug abuse and unemployment and mental illness make it likelier that you will be among those who end up without a home. But the cause of the homelessness isn’t the poverty or the addiction or the unemployment.”

The converse of that is poverty, addiction and unemployment are not likely to cause homelessness in a city with the ideal number of homes. But who decides what is too few, or too many, or who pays for it, or how much it costs, or what qualifies as the standard for a home, or what needs to be enforced by policy makers who believe the rest of us to have the cognitive skills of the barnyard in Animal Farm?

Certainly, the homeless encampments that are wrecking some urban environments and the mental and physical conditions of people who populate those areas need attention and solutions. And like any social problem, that begins with the causes. I am no expert on any of that, but I am also convinced that nearly everyone born is born with a potentially brilliant mind, that our rational faculty is what keeps us alive, that we each have free will – and that we hit the lottery by being born in America.

At the same time, there are cultural forces that are working to destroy all of that – and they must be identified because far too many people are susceptible to dependency. It begins with State mandated progressive schools that rid some students of their independence and excitement for learning with which they were born. Specifically, the politics of collectivism – you owe a duty to society. Then the ethics of determinism – your actions are programmed by nature and nurture. And finally, the economics of oppression – you and your tribe is either guilty or incapable.

In that sociological environment, the fear of independence and loss of self-esteem has consequences: the social pressure of dropping out, turning on, and tuning out leads to increased poverty, unemployment and drug addiction. In turn, that is blamed on money as contemptible, prices as unjust, markets as inefficient, profits as theft, and policy makers as heroes.

Inevitably, the elegant solutions must include getting “outside the box” of teachers unions, “carbon footprints,” and homelessness NGOs.

Independence

In the aggregate, and relative to middle-class disposable income, housing costs have risen sharply in the last five years. For a small sample of the phenomenon illustrated by wealthvieu.com, mortgage payments rose to 37% of household income in 2022 and have leveled off or fallen to above 30%. This is from a low 19.4% in early 2020, but is a bargain compared to the1980s that peaked at 53% in 1981. Of course, this leaves out the price of comparable homes and all of the people priced out of home ownership and are renting.

But for the most important lesson to be learned, we can turn to the 14^th century philosopher named William of Ockham who informed us that among all competing solutions to a problem, the one with the fewest assumptions should be preferred. Also known as Occam’s Razor, it removes policy makers from the housing crisis problem except in one capacity: protect property rights and get out of the way.

Which brings us back to the fifteen aspects of “the box” in which we find ourselves. Every one of them imposes political power over economic power. Every one of them violates individual rights in some way. They flaunt centralized planning over decentralized expertise. Ultimately, the solution is to recognize this is not a crisis, that markets are elegant, prices are just, and money is not stupid.

But most of all, the solutions begin with each individual’s ethical and political independence – that which policy makers fear most - because it renders them irrelevant.