Split the Baby in Half

David Leonhardt's article in yesterday's NY Times made my little heart go pit-a-pat.  I commend it to you.  He fleshes out my argument about housing prices with a lot of data and interviews.  He doesn't quite get the point, but comes closer than I've read from the Mainstream Pundit Brigade.  Do, I suppose, to almost getting it, I was moved to email him, and lay out my argument.  It ended up being two, since I forgot an important bit the first time.  I've edited them together here for simplicity.


Yes, I do read the Times, and thus you, each day.  I find your writing less fawning toward Business than most of your business section colleagues (that may be insult or compliment), thus I saw the headline, and dove in, sure that there would be insights that I haven't found elsewhere.

And there were, but I had to wait to nearly the last graph to find the nugget which explains the whole Great Recession:  it's about median income.

My degrees are in economics (the 1970's), and I learned early on that there are few absolutes in economies (or life, as well); intelligence and income particularly.  When housing prices began diverting from the historical ratio with median income (about 2003), I knew something was up (or corrupt).  I didn't have any public outlet as I do now, but the motivation and consequences were clear.

The motivation:  by regulation and prudent lending practice, *monthly mortgage payment* is effectively fixed as a percentage of median income.  It may fluctuate a bit from time to time and place to place, but not by amounts sufficient to justify housing price appreciation seen from 2001 on.  The only way such prices could be supported is if the lenders (turns out to be mortgage companies, principally) were fiddling the contracts.  Median income, as you know and have written, has been stagnant (more or less) for decades.  Housing is, strictly speaking, a capital expenditure.  I, and others more prominent, have written that housing as real physical investment is an oxymoron, but that is another column.

Quel fromage!!!!  The contracts were fiddled.  Incomes couldn't possibly support the prices.  I've long concluded, but haven't dug through the data, that the only winners in all of this were the Pulte's and Toll's; or at least the CEO's and others gifted with options.

The consequences:  a Great Recession.  It was also clear (being a saltwater economist) that the only thing holding up the economy during Bush II was home equity loans; folks were burning unearned appreciation on consumption.  They certainly weren't garnering higher incomes; well except the top 1 or 2 percenters (II's friends).

I just hoped that your article, as well as your interviewees, would have pursued the relationship between median income and expenditures.  For pure consumption, it's more difficult to say what will be a winner or a loser in the short term, but for housing it's a wash, unless the numbers are fiddled.

I also question the quality of data which contradicts an inverse correlation between interest rates and housing prices.  The problem is the confounding with the fiddling we've been experiencing.  Builders and bankers aren't stupid, though they be sly.  SMSA income data has been available for decades, and the B & B's can easily determine (within whatever margin of error they're willing to pay for) the median mortgage payment that can be supported.  Said mortgage payment is divided between the B and the B; as interest rates fall, house prices will rise to consume the full mortgage payment available.  Conversely, when interest rates rise, housing prices have to fall; there is only so much mortgage payment to be had.  While an undergraduate, 1970, one of my economics professors had a consulting gig with a local/regional bank in western Massachusetts.  Using the SMSA data, he developed an analysis engine he called Shift and Share Analysis.  It was used for just this purpose.

Later in the 1970's I lived in the Boston area, and folks were buying houses at rates above 10%.  Those are the folks who made out very well indeed.  Now is the absolute wrong time to sign a mortgage.  Interest rates can only go up, and unless median income rises (won't happen unless the Democrats hold government for at least three Presidential terms), prices must fall.