Arnold Kling  

What is Bernanke Saying About Housing?

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Ben Bernanke says,


the housing sector continues to suffer from serious imbalances--a marked excess supply for owner-occupied housing accompanied by a stronger rental markets.

If this is true, then there must be some institutional barriers to converting housing stock from owner-occupied housing to rental housing. In fact, Bernanke's main policy recommendation is to make it easier for foreclosed homes that were formerly owner occupied to be converted to rentals.

That is a very different suggestion than what many reporters and bloggers are talking about when they say that Bernanke is calling for "more help" for the housing market. In recent years, "more help" has been equated with foreclosure prevention or subsidies to homebuyers, and that is not what I see Bernanke advocating.

To a first approximation, housing is fungible. By that, I mean that a given rental unit can be sold to an owner-occupant and a given owner-occupied unit can be rented out. To the extent that housing is fungible, it is nonsense to speak of the rental market and the owner-occupied market as obeying different conditions of supply and demand. Yes, there are some legal obstacles to converting some apartments to condos, and there are some legal obstacles to renting out some units with owner-occupants, but to my knowledge nobody has attempted to trot out a theory that those restrictions operate on the margin to create ultra-segmented housing markets.

Next, think of housing in terms of two decisions by households.

1) How much housing services do we obtain?
2) Do we obtain our housing services by owning or renting?

With a fungible housing market , all of the supply-demand action in the housing market is in (1). (2) is just an arbitrary allocation of the housing stock into rental units and owner-occupied units, based on institutional factors, such as tax clienteles (people with low incomes cannot take advantage of the mortgage interest deduction, and hence have an incentive to rent), regulations and subsidies of various kinds, and demographic characteristics (frequent movers are more likely to rent than well-rooted families).

Bernanke seems to me to be saying that housing is not fungible nowadays. In his view, if we see rents rising and prices falling that suggests a problem in converting owner-occupied units to rentals. I am skeptical of this.

The cost of housing has been going up for both owners and renters. For owner-occupants, this higher cost takes the form of low (or negative) rates of home price appreciation.* For landlords, low or negative appreciation is offsetting the increase in rents, so that economic profits may be low.

(*Note that the Bureau of Labor Statistics is correct to say that the housing component of the cost of living is rising. From an asset perspective, there is deflation, but from a cost of living perspective, there is not. This drives Scott Sumner nuts, because he thinks it makes measured inflation a joke. Taking this view to its logical conclusion, Sumner says to focus on nominal GDP, in which housing is represented by spending on new construction.)

In recent years, much of the U.S. housing stock has been unoccupied. Some units were bought during the bubble by speculators, who made bad bets.

Other units of the housing stock have been occupied by people who cannot afford the houses that they "bought" (with little or no money down). They could not have afforded to rent their residences, but they and their lenders implicitly counted on house price appreciation to make the transactions work out. Until these people either sell their houses or go through foreclosure, they are part of the imbalance in the housing market, because they are consuming more housing services than they can afford.

There will be a housing market equilibrium when:

(a). The excess stock of housing has been absorbed. It does not matter whether this absorption takes the form of renting or owner-occupancy.

(b). Households are no longer consuming excess housing services relative to their incomes.

My guess is that the biggest barrier to achieving equilibrium has been policies aimed at preventing foreclosure. Such policies clearly impede (b). They also impede (a), because the longer you delay foreclosure, the more the property gets trashed and the harder it is to sell.

To Bernanke's credit, his speech does not champion foreclosure prevention. The policy suggestion that he pushes the most is to reduce institutional barriers to converting foreclosed houses into rental properties. If such barriers truly are important, then his suggestions would hasten (a). However, my view is that housing is fungible enough for (a) to take care of itself. As long as the market converts enough owner-occupied housing to rental housing, it does not matter whether certain specific homes that were in foreclosure are so converted.


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COMMENTS (8 to date)
Joe Cushing writes:

In Michigan and probably most places a bank has to weight 6 months to a year (usually 6 months) before it can put a house on the market. This is to give the owners time to come out of default. Speeding this process up would help reduce the number of vacant homes and vandalism. This would take away defaulting owners chance to come out of default though. I think Bernanke is trying to do a compromise. Instead of having the banks sell a foreclosed home earlier, they can rent them out. This still gives the owners a chance to come out of default but it also puts somebody in that house. It's a win, win, win, win. Win for the bank, win for the defaulting owner because the house is protected and charge offs are less, win for the renters who have access to housing, win for the IRS as there are less losses to right down.

Joe Cushing writes:

After writing my comment I had another though.

Servicers have the power already to shorten the waiting period for foreclosure and reduce vandalism. They can offer keys in lieu of foreclosure and they can offer opportunities for owners to continue to occupy the home during foreclosure. Servicers are already doing both but they are not doing so at a motivated rate.

Incentives matter:

There is a difference between doing a behavior because you are contractually obligated to do so and doing a behavior because you are motivated to make money. Servicers behavior is the former. We need service contractors that give servicers a greater stake in the income of the loans they are servicing. This would drive greater productivity in this area. Servicers are incompetent because there is no reward for being competent. There's just no money in it.

Art writes:

Taking this view to its logical conclusion, Sumner says to focus on nominal GDP, in which housing is represented by spending on new construction.)

That's true for new construction, where it enters GDP as investment spending, but don't owner-occupied housing services still enter into nominal GDP as consumption spending? If that's true, and some people move from "owning" an underwater house to renting, won't that drive rents up and hence increase the imputed value of owner-occupied services so increase housing's component of GDP?

rj sigmund writes:

landlords want economy of scale

Leora Amdur writes:

In the Florida market there are a lot of people who would buy and rent single family homes or condominums if financing was available. Often, they would like to buy and rent them out until it is time for them to retire.

Currently it is very difficult to finance a residential property held for rental.If you have an existing relationship with a bank, banks are requiring 50% down subject to a very tough apraisal. If you have no pre-existing relationship they won't even talk to you.

Appraisals often come in well below market so that contracts cannot go to closing. This has been great for cash buyers who are closing deals at bargain prices but is very bad for sellers.

It is even difficult for small landlords who own multiple properties for cash flow to refinance so they can add to their portfolios or take advantage of more favorable interest rates.If you own more than 4 properties it is almost impossible to get credit even if leased rents cover all expenses with a margin.

Frequent changes in bank regulations and mortgage guidelines and a general attitude that beating up the banks is good politics makes it unlikely that banks will make loans to small landlords.The administration's program to provide for large scale sale of foreclosures for rental is a way to incentivize large scale investment by large real estate companies after screwing up the market so individuals and small players can't participate.

Bryan Willman writes:

Rental and owner-occupied dwellings are not really fungible, at least not in the parts of the US where I have lived.

They are the "same market" in that they are both dwellings, and a household might live in any of them.

But they are really very different markets in terms of costs, locations, and so on.

That is, dwellings built to be owner-occupied are built to a different market standard than dwellings built to be rented.

Just as there is a shortage of people who can afford to buy those dwellings at current prices, there is a shortage of people who could rent them at reasonable market rents. (Arnold points out that some number of people managed to "buy" houses they could not afford to rent, let alone buy. This is true. So converting them to rentals won't change that.)

Lowering the price to the market clearing price will be required for the dwelling to be buyable or rentable, and won't necessarily change the premium - so bubble priced house reduced to sensible priced house doesn't auto-convert to sensible to rent. A house that is "top of the market" (large, fancy, big lot, etc) in the bubble market won't generally become mid-market or low-market (where most rentals live) in a non-bubble market.

Richard H writes:

I just made a job change from pastoring a church (where we lived in a church owned parsonage) to finding our own place. Not thinking buying was the right thing for us now, we looked for a place to rent. In our small town rural area the rental market was pretty weak. My strategy was to look for places that had been on the (for sale) market a long time and see if the owners would be interested in renting. It ended up working well for us - and the owners have steady income now as they wait for a day in the future when the market is more favorable for a buyer.

Anthony writes:

From the perspective of a household of people, there is a difference between owning and renting, even in the absence of expectations of appreciation:

1) An owner has more freedom to modify a house to her own tastes.
2) renting reduces the risk of large maintenence costs, but adds the risk that maintenence won't actually happen.
3) in the event of a short-term cash-flow problem, owning provides more security against eviction, or at least more time to prepare for a forced move.
4) An owner has more freedom to sublet part of the house for additional income.

Also remember that expectations of appreciation for a homeowner are also expectations of rent increases for a renter.

Therefore, the price of owned housing will be higher than that of rented housing, making the transition of owner-occupied housing to rental housing expensive.

There are probably also institutional and legal barriers to financial institutions renting out foreclosed properties rather than selling them. Some of these institutional barriers (and some of the expense of converting from owner-occupied to rental) may be changeable if Bernanke can convince Congress to do so, but they may look politically unpopular otherwise.

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