High debt, house price risk and income inequality

Over at Capital Ideas, published by Chicago Booth School of Business, there is an excerpt from Amir Sufi & Atif Mian’s book “House of Debt: How They (and You) Caused the Great Recession, and How We Can Prevent It from Happening Again“.

Debt plays such a common role in the economy that we often forget how harsh it is. The fundamental feature of debt is that the borrower must bear the first losses associated with a decline in asset prices. For example, if a homeowner buys a home worth $100,000 using an $80,000 mortgage, then the homeowner’s equity in the home is $20,000. If house prices drop 20%, the homeowner loses $20,000—his full investment—while the mortgage lender escapes unscathed. If the homeowner sells the home for the new price of $80,000, he must use the full proceeds to pay off the mortgage. He walks away with nothing. In the jargon of finance, the mortgage lender has the senior claim on the home and is therefore protected if house prices decline. The homeowner has the junior claim and experiences huge losses if house prices decline. 

I recommend reading the full article if you have time. The reason why this makes sense is that one household’s debt is another household’s asset. A key risk to the New Zealand economy is the outsized proportion of household assets made up by home equity. A way to reduce that risk is to build up the financial assets of households. This is the real benefit of Kiwisaver and state wealth funds like ACC and the NZ Super Fund. They’re reducing the severity of any house price collapse induced recession in the future. If your household has a diversified portfolio of assets – including across asset classes – then house prices dropping 20% won’t have as much of an impact than if your household has almost 100% of its assets in home equity.

The NZ ‘Meet Market': 2013 census update

This morning the NZ Herald had an article by Simon Collins called “If you want to get married, better get a degree“.

They interviewed Paul Callister about the update to a previous paper on assortative mating called “The NZ ‘Meet Market': 2013 census update” – but they didn’t link to it. Any intellectually curious reader would probably want to have a look at the paper being discussed.

So, in 2014, a few decades since the concept of a “hyper text link” was made possible, I had to spend time searching for Paul Callister’s website, find his recent publications and they check that it was the paper being discussed in the article.

It is hilarious! Where on earth do media firms find these people who still think it’s in any way, shape or form acceptable to not link to something you’re writing about?

Close but no cigar again, NZ Herald. This article has been shared on Facebook, shared on Twitter and emailed. But you can’t link to the source document!

I’m going to suggest to readers that if you find this stuff interesting, then there is a recent paper I found by Karl Hememberg that looks at the effect of assortative mating on income inequality.

This is interesting stuff! The lack of intellectual curiosity, the fact that Simon Collins didn’t mention that because a lot of people are thinking about income inequality in the lead-up to the election that research like this could prove surprising to some people who hold those views, the lack of linking the study back to other interesting work that Paul Callister has done, is simply another indication of how low their value add to the national discourse has become.

Class of 2009 struggling in the USA

A study of more than 1,000 members of that graduating class from 25 selective colleges found that two years after graduation, one-quarter of them were still living at home. Thirteen percent had jobs that didn’t require any college education. Most were still getting some kind of financial help from their parents.

Read the whole article over at Vox.

There is a lot of interesting literature about how graduating into a recession can have a permanent negative impact on lifetime earnings. I would add that because of the importance of the first graduate job in determining your “career trajectory”, there will be enormous long term consequences if a non-trivial amount of graduates in New Zealand don’t end up with the sort of jobs they went to university to obtain.

One of the better parts of how New Zealand does tertiary education is that student loan repayments only kick in when you earn more than $19,084 and come straight out of your wages to IRD as opposed to the US situation where some graduates may have several different student loan providers to deal with – and make payments even if their “investment” in education hasn’t earned them a dollar in return.

Secular Stagnation And Housing Craziness

I’ll briefly discuss the idea that balance sheet recessions take a long time to recover from. Debt fuelled asset bubbles don’t always wind down in an orderly fashion. There are bumps along the road. In the New Zealand experience of the GFC, we entered a recession earlier than the rest of the world and now, find ourselves in the monetary tightening phase as some countries like Australia are starting to slow down.

I think that the balances sheet restructuring hasn’t gone far enough. There is still too much private sector debt in New Zealand and no one has adjusted their portfolio allocation behaviour. New Zealand obviously has way too much allocated to property as an asset class and the inability of many people to think clearly about this issue is a major risk, in fact I’d say it is a bigger risk than even officials have indicated in some works.

Whilst I’d agree that servicing ability is what matters for mortgages – I disagree with the idea that highly leveraged housing loans aren’t a key driver of higher house prices. Most first home buying couples are broke and some even need their parents to help with the deposit. That makes them high risk because with labour market insecurity, the fact that many relationships don’t last and external shock risks like another global trade slump, lending money to these people is really silly stuff.

If the loan term has to be extended to 30 years in order for a mortgage to be “affordable”, that’s nothing different to what sub-prime experts Countrywide and Washington Mutual did in the US. They’d come up with fancy interest rate reset or balloon repayment structures to make the monthly payment affordable. When interest rates rose, the music stopped for millions of US households locked into these sorts of contractual agreements some were even fraudulently induced into.

If you look at the contribution employment growth in Canterbury is making to employment growth nationally, then you can’t help but realise that we’re in another asset price fuelled mirage. The balance sheet restructuring necessary to ensure that capital shallow firms can get the financing they need simply hasn’t happened. The only “businesses” that have received funding are farms on the back of high commodity prices.

I don’t think this is going to be fun in the medium term. Constantly deferring the day of reckoning makes the inevitable reversal worse than it has to be. It’s even more worrying when you realise that NIMBY homeowners have enormous political power – the housing sector in New Zealand is basically “too big to fail” as evidenced by National’s announcement last week of more fuel on the fire for first home buyers.

Tax revenue estimates and positional goods

I’m a bit late to the party on tax revenue estimates where Matt Nolan at TVHE and Seamus Hogan at Offsetting Behaviour both weighed in on the Green’s proposed tax changes.

I would add that although estimating tax revenue is extremely difficult, the behavioural response isn’t that complicated for many people who would be affected by the top tax rate kicking in at an income of $140,000.

This level of income is likely to be received by mid-career professionals who have fixed levels of expenditure on positional goods like school fees, automobiles and mortgage repayments. Reducing their after-tax income doesn’t reduce the level of outgoing cash flow commitments many of these households have.

When you add in the desire to maintain relative status, reducing the after tax income of some people in this category could lead to an effect rarely considered by those on the right – people working harder and billing more hours in order to maintain the same level of after-tax income that they did before the top tax rate increased.

Given that the costs of setting up a contracting structure to benefit from a lower company tax rate of 27% include having to renegotiate your employment arrangements and get your employer to incur costs in order to monitor a different type of contractual relationship, I think the level of behavioural response on this level would be a bit lower than you may think.

Of course it’s all speculation. I would point out that the risk of such a proposal is that if the revenue stream doesn’t match what was expected, something else has to come off the table. Spending some time on Google Scholar will make you realise that the literature couldn’t be easily summarised into a sound bite for Morning Report.


Cornwall Park Leases

One of the things that Shamubeel Eaqub talks about in NZIER’s housing affordability paper is the importance of making renting in New Zealand a better substitute for owning.

The Cornwall Park situation is where 21 year rent reviews and the enormous increase in land values of the property owned by the trust has led to tenants getting massive increases in ground rent.

I don’t have much sympathy for people who entered into these sorts of property use arrangements and then, when the trust is exercising its rights, cry out to protect their “economic rent” of not paying the full cost of living in this area by attempting to stave off massive increases in ground rent.

I would have thought that a prudent property owner would have set aside some savings to offset the inevitable increase in ground rent over a 21 year period. What would a diversified portfolio have earned over that period of time with regular contributions?

The real question to ask is how many holidays and automobiles these people have taken during the inter-rent review period. I’d wager hardly any of these people have set money aside for future ground rent increases whilst they consumed the difference in cost elsewhere in their budgets.

I would argue that these sorts of arrangements are actually ideal for improving housing affordability. They are less valuable than freehold arrangements and come with more risk, but they shouldn’t be ignored as an option for improving the supply of housing.

A New Direction For My Blog

Blogging and working full-time is a difficult task. Over the past few years I have written a lot of content that has never made its way to my blog. I simply haven’t had the time to do the fact checking and analysis necessary to produce compelling content. I have ended up writing a lot of short posts when I’d rather be writing more detailed responses to things I’ve read that include more footnotes and awesome charts.

I don’t want to let working full-time turn into an excuse for not writing or writing throwaway blog posts that don’t add any value. We should write and we should publish what we write because without writing down our thoughts we can’t be too sure of what we’re really thinking on any issue. There is a difference between a sound bite and a paragraph, and that difference includes a more accessible way of tracking the changes in your thinking over longer periods of time.

When I think about how the way we consume content has changed over the past decade with blogs, social media, smartphones and less face to face communication, I wonder what we’re losing by not encouraging people to move beyond 140 characters. The problem with Twitter is that, just like all communication that doesn’t take place face to face, context and body language cues aren’t present.

The risk in this situation is that writing a throwaway comment that is misinterpreted by the hive mind and the wider context of what led to such a throwaway comment being made is lost. There are no second chances if a stray tweet is retweeted and misinterpreted by thousands of people. #SocialMediaFail is an ever present phenomenon in 2014 across all types of users let alone some of the political and economic actors who seem to clog up my own Twitter feed :)

Because it is easier to shut out voices we disagree with, I think we need to make a conscious effort to read the writers who outrage us or read the writers who challenge our deeply held beliefs. Skeptical enquiry has a lot of benefits, and I think that in “forcing” myself to read different viewpoints my own views of the world have softened somewhat over the past few years.

I was reading an article recently that explained how people who read fictional novels on a regular basis were more understanding of the perspective of people other than themselves. It might be bunkum – but I’m certainly aware of the bubble I live in. In fact, I’d say that a lot of things I read on Twitter and other websites make me a sad panda because so many people are unaware of the bubble they inhabit and how it can lead to saying really out of touch things.

I’d like to think observing all of this has lead to a greater awareness that there really are different perspectives out there and filtering them all out because we want to construct a bubble where no one ever challenges the way we see the world is a slippery slope towards sounding like an automaton.

The new direction I intend to take with this blog is a more regular writing schedule with a lot more content that is less related to the news cycle or what I’m reading and more linked to a broader story I’m interested in. That story is how my generation will fare in the new normal when the political process is broken.

Compare Study Options

Careers NZ has an excellent tool that draws on the reports produced by the Ministry of Education of what graduates earn in labour market incomes after completing their qualifications.

The tool is available on the Careers NZ website and enables you to compare different levels of study with median earnings for people who studied that qualification and obtained a job.

How much income inequality is driven by poor study choices at age 18? How much of a role do qualifications actually play as opposed to actual job performance? How can an academic talk about human capital when there clearly isn’t a return on investment for many young people? All interesting stuff, and more important to have serious debate about than humdrum political noise.

The Hive Mind And The Policy Panopticon

Did civilised political discussion ever exist? Today, in the networked age, anything that does not conform will be pounced on immediately by the hive mind and condemned.

There is no point engaging in political advocacy because over time, only the people with the worst motives remain in the pool.

We shouldn’t be surprised at the welfare maximising behaviour of List MPs when it comes to free travel and spouting crazy talk like the RBNZ being owned by foreigners.

But we should be surprised at the fact some people still think that there is some sort of egalitarian playing field where everyone gets to contribute.

This was never the case, never will be, and it is a waste of resources to engage in advocacy to create some sort of twisted opinion or policy panopticon to simultaneously enable “direct democracy” and complete subservience to group think.

Non-partisan doesn’t mean what you think it means. In fact, it is an abuse of the English language to say that encouraging voting by young people is a “non-partisan” activity.