Paul Krugman's Money Talks: Living in a Bubble?

Here's more from Paul Krugman on the housing bubble:

Living in a Bubble? Readers respond to Paul Krugman's Jan. 2 column, "No Bubble Trouble?": Stephen Distinti, Brooklyn, N.Y.:  I am writing because I would like a little clarification on your comparison between the state of today's housing market and that of the early 1980's. I understand your two central claims: one, that there can be said to exist two housing sectors, which you have termed 'Flatland' and 'Zoned Zone'; and two, the high proportion of one's monthly income needed to maintain a mortgage in the Zoned Zone is indicative of a housing bubble localized to those markets.

But ... If the proportion of monthly income demanded by a mortgage in the Zoned Zone corresponds to the levels of the early 1980's, does the bifurcated nature of the housing market correspond to the 1980's as well? ... My impression is that in the 1980's the expense of home ownership was more evenly spread across the country... So was there a Flatland and a Zoned Zone in the 1980's?...

Paul Krugman: Today's market actually looks very little like that of the early 1980's. What happened then was that the economy was coming off a period of very high inflation. The Fed drove interest rates very high in an effort to bring inflation under control. (It succeeded, at the cost of a period of very high unemployment.) And those high interest rates made housing unaffordable everywhere. You can see this in the charts that accompanied last week's article by David Leonhardt, which provided a lot of data online. In Flatland cities like Atlanta, the cost of home ownership as a percentage of income is well below its early 80's peak. In cities like San Diego, ownership costs are at record levels. So there's no real precedent for today's situation...

Paul Harrison, Washington: Just a thought -- to what extent does your analysis take into account the change in urban cores? Call it revitalization or gentrification, your choice. Fort Greene in Brooklyn is a perfect example; homes built by the upper class fell into slum status but have now been restored along with their neighborhood. Obviously their prices have soared... This is a trend that did not really exist during the last housing bubble.

Paul Krugman: Gentrification is a real factor, but smaller than those of us who tend to hang around central cities might imagine. A more economistic answer is that rents in the boom cities haven't gone up all that much. This tells us that the underlying demand for housing hasn't soared, just the prices.

Ross Grannan, Falls Village, Conn.: ...I am a real estate appraiser and geography major, so I consider myself somewhat of an expert. I like your zoned vs. flatland analysis of the housing market. I think it is a beginning, but ... what is going on much more complicated than enforcement of zoning laws. ... On the West Coast, ... a builder must prove that there is ... a minimum of water for a home. ... Many of the flatland areas — Nevada, Colorado, Arizona, Texas, Oklahoma — have promoted development that cannot be sustained ... the water issue will rear its ugly head in many places real soon. What is the value of property without water? ...

Housing is cheap in the flatland areas for a reason. Building codes are less stringent, land use planning primarily revolves around the car and no thought is put into sustainability. I think there the reason people choose to pay more for housing in the zoned areas is quality of life, and these same people see the development in the flatland for what is cheap and disposable.

Paul Krugman: I agree with much of this comment, and I'm a dedicated Zoned Zone resident myself. But I don't believe that the relative desirability of, say, San Francisco as compared with Atlanta has soared over the past five years. And data on housing rents don't suggest that there's been a big change in relative demand for housing. It's really interest rates plus, I believe, price speculation driving the divergence between Flatland and the Zoned Zone since 2000.

J. Ullman, Weston, Mass.: You might wish to take your excellent analysis one step further by looking at the growing gap between rich and poor in the zoned zone population. In Manhattan, the contrast between the view looking south and that to the north from the vantage point of Park Ave and 96th St. speaks volumes, and clearly it makes no sense whatever to calculate the average housing costs of the two neighborhoods. ...

Paul Krugman: Indeed. But you shouldn't idealize Flatland, either. At least New York's transit system allows those who can't afford to live in the glamorous parts of the city to commute to jobs. Imagine being poor in a sprawling heartland city with no rapid transit and a poor quality bus system. Central New Jersey is part of the Zoned Zone, but less expensive than the city; still, manual workers can't afford to live anywhere closer than Trenton, and I can't imagine how they get to their jobs.

Daniel K. Cooper, New York: ...I share your perspective that local markets are what matter, and that the national data may obscure as much as they illuminate. But a question on the measure of the bubble — e.g., the proportion of median income to be paid to finance a median-priced home. If the Zoned Zone is where this proportion is highest, it is also where financially able people take second or third or fourth homes. Often ... this is the super-rich, the value of whose residences are at the upper extreme and have little if any influence on the median home value. But this pattern would also include the upper middle class who have a studio apartment in Manhattan as a pied-a-terre, or a winter condo in South Florida or southern California. In terms of value these properties would be much further from the extremes and would have a much more serious influence on the median price of a home in the region.

To the degree that this is the case, I submit that using the median income of the region as a benchmark for measuring a housing bubble is quite imperfect ... Would you concur, or am I overlooking something? ... are you aware of any data to allow for an assessment of this?

Paul Krugman: What great comments I'm getting here! My guess is that pied-a-terres are very rare, even though I personally know lots of people who have them. But I really don't know. And my understanding is that housing data are much less informative than we'd like.

In my neck of the flatlands, where many dedicated flatlanders live, housing is not "cheap and disposable," if cheap is intended to mean poor quality. And as I watch the Oregon rain stream down for yet another day, I'm not all that concerned about running out of water. I can collect all I need by setting out buckets in my yard. But water issues are a concern for many on the west coast, particularly in areas like San Diego and Los Angeles and contrary to the reader comment to Krugman, I don't think those areas necessarily have a better handle on this problem than areas in the flatlands.

Comments

[Bruce Wilder]

The San Francisco Bay area actually has far more acute water problems than does Los Angeles. Los Angeles may be a desert, but it is a desert with William Mulholland and a municipally-owned Department of Water and Power. The region does consume 1.7 billion gallons a day, but what the heck. Seriously, I do think L.A. and Southern California actually is better equipped institutionally to cope with water problems, both because of a longer, water-conscious history and because the conflict of interests is less destructive. Nevada, with its long history of politically powerful, depletion-oriented mining operations, is in much deeper trouble.

As for the "quality" of housing, my personal experience in the homes of decidedly middle-class friends and family in Michigan, is that the last twenty years, with the decline of interest rates, has seen the construction of what can only be described as palatial homes. In an area where careful shopping can get you a perfectly nice <$75,000 2-bedroom, spending $200,000+ has results!

[Mark Thoma]

Yeah, I grew up along the Sacramento river and the farmers were constantly complaining, perhaps with merit, that Southern California had all the political power in Sacramento and had "stolen" the north's water. I think the canal still makes a lot of them angry. There is a group that wanted to form their own state to solve the political problem. You still see signs along I5 promoting the state of Jefferson in both Northern California and Southern Oregon.

[anne]

Important discussion :)

[Lord]

One of the reasons rents are low in the Zoned Areas is they are actually subsidized by the capital gains expected by ownership. Owning and renting in these areas tend to be claims on a job. In flatland, you are fortunate if you have one.

[Mark Thoma]

In most of the north I think, but am not sure, that it is still possible to live off of well water. As it was explained to me long, long ago in a geology class, there is a huge plate underneath the central valley that is tilted and underground water collects above this barrier and gradually moves down the plate underneath the northern part of the valley. But that was long ago and my memory could be wrong, and water tables could have dropped, etc. Most municipal areas use river water anyway.

The reason I remember is that my grandfather always claimed he could "water witch." He believed in ESP, all that sort of stuff (got the Amazing Kreskin for Chrismas one year). He even taught me how to do it (his special way) using a forked willow stick, black electrical tape, the end split just right and, well it doesn't matter becasue I don't believe in it, but he beleived in it. The geology professor, in debunking water witching, said that because of the structure of underground water you could pretty much drill anywhere and hit water so it would seem like they were very good, but it was just the geology.

There is enough water in the north for people to live on, but not for both farming and people. The competition is with the farm sector and that is where the tensions are greatest, at least in my experience, though north-south issues are also problematic. In the south, I don't know where they will find the water they need in the future to sustain growth without drawing more from Arizona or northern California.

[anne]

http://www.calvorn.com/gallery/photo.php?photo=5897&u=4|72|...

Ruddy Duck Drying Wings
New York City--Central Park, Harlem Meer.

[dryfly]

Talking about water I love it.

I live on the banks of the Mississippi (well a half mile from the banks in the bluffs - don't want to be TOO close to the river - not in spring)... I live far enough north so the river is pretty clean too (Minnesota-Wisconsin border area). We got water.

I had a friend from Arizona who always said we should sell them the excess water of the Mississippi & Great Lakes... like it would be no problem to pipe the water to Phoenix.

I told him we'd ship him excess water if he shipped us excess sunshine. Right about now I'd LOVE a little of that excess sunshine... but if I had to chose one or the other, given a choice I'd still take the water.

We gotta learn to live within our means.

[ilsm]

Water 'witching', takes a little faith, a forked willow or a pair of bent welding rods.

I have found leaking underground water pipes with them when the 'electromagnetic effects device' and the site drawings did not help.

On the welding rods; that works on the same principle as the electronic device maybe more sensitive since the rods are nearly 3 feet long and you hold two parallel by the short ends and walk around and they come together over the water flow in pipe.

Having lived in the flats and in the zoned I think Krugman is fairly observant.

[bakho]

Flatland has its own bubble, but it is an "occupancy bubble" not a price bubble. During cheap interest rates, overbuilding occurs. In part, this is because a rental requires lower occupancy to be profitable with lower interest rates. In my neck of the flatlands, low interests produced an incredible boom in new apartment complexes. That construction boom will quickly turn into a construction bust.

In the price bubbles, those newcomers who want to get out past the peak will lose money because they overpaid for a house that is now harder to sell. In the occupancy bubble, landlords are suddenly faced with vacant apartments and having to drop rents to fill them. Heck we even had some apartment complexes offering a couple months free rent to Katrinagees (welcome to snow). For homeowners, those with older houses in the urban core have a tough time competing with widely available more modern structures with modern amenities in the outer zones. Those who wish to move may have trouble selling AND trouble renting. The urban core continues to deteriorate producing a donut effect. This affects school systems with urban schools closing buildings and systems in the donut scrambling to build new schools or installing trailers.

In both cases, after the bubble busts there will be a hangover period of slow sales, houses being on the market longer and sellers having to accept lesser offers. In both cases, the construction of new housing units will decline with demand. It takes good government and community planning to prevent urban deterioration and control suburban sprawl.