Bad Incentives, Bad Outcomes

When it comes to humans, you can usually answer the “why?” question about behavioural observations by examining the incentives. This is especially true in economics, but also true of nearly everything in life, such as why politicians ignore their constituents or adopt unpopular policies. There’s a popular catchphrase to describe this kind of analysis: “follow the money”.

Few people bother to do incentive analysis, and they find themselves perplexed as to why someone else’s actions don’t match their expectations. In most cases, it’s obvious why someone would do a thing once you’ve considered the incentives. Most of the problems today with late-stage capitalism can be traced back to poorly designed incentives.

There’s nothing natural about capitalism–it’s a strictly human invention–and thus we need to design sensible incentives for the thing to work in such a way that we don’t cannibalize ourselves like we’re starving to death.

The so-called “housing shortage” #

One subject that seems to come up continuously in “the news” these days is the problem of housing affordability. One does not have to dig deep to understand why the housing market is such a failure, and you find this problem prevalent across most of the Western world. The answer to why housing is unaffordable is very simple: the incentives are wrong.

If you poke around subreddits like r/REBubble, or read the comments on Hacker News about why housing is expensive, you will commonly see most people blame the same tired scapegoats:

• Zoning laws bad
• Airbnb bad
• NIMBYs bad
• Regulation bad
• Build more homes

These likely all contribute to the problem to some degree, but fundamentally none are the sole or root cause. If anything, all these problems combined contribute a negligible amount to the overall situation of housing unaffordability. If you simply banned all these things, housing would continue to be as unaffordable as ever.

Is there a housing shortage? #

Let’s look at whether there’s actually any shortage of homes. To make my argument, we’ll look at data from the US, but the problem is the same everywhere you go.

Looking at recent vacancy data from the US census, we can see there are around 15 million vacant homes in the US:

You are free to split hairs on the definitions of “vacant”, but 15 million is such an enormous number that I will confidently reject the argument that there aren’t enough homes. If anything, we have too many homes, given how many are vacant.

I see this first hand in New York City: if you walk around at night and look at the big, shiny, luxury condo buildings, you’ll see that the vast majority of the apartments in those buildings are dark, which implies nobody’s home. It’s too much of a coincidence that so many of these apartments are mostly dark at night to assume the explanation is anything other than a low real occupancy rate.

It’s not just luxury condos, but in NYC there’s a problem with rent-stabilized vacant residential units, where landlords are unwilling to rent them.

This issue of vacant apartments in a city like NYC could be fixed in an instant with a vacancy tax in addition to a non-primary residence tax. Ideally, the taxes would be high enough to incentivize not hoarding homes such that it forces all that held-back inventory onto the market at market rates.

Granted, I think you can reasonably make an argument that some percentage of these vacant homes are reasonably vacant: for example, they might be vacant because they’re being repaired or refurbished, but 15 million is about 10% of the total housing stock, which intuitively seems like an enormously large percentage of vacant homes, and this flies in the face of there being a supposed housing shortage.

Why are homes so expensive then? #

So if we reject the idea that there’s a shortage of housing, why is housing so expensive? The answer, of course, is quite simple: we built a system of incentives that treats housing not so much as housing, but rather as a subsidized and highly-leveraged investment scheme. A huge portion of those people holding on to housing inventory do so because they believe they can sell their homes for more at some point in the future.

Leverage drives up the cost of housing, especially when interest rates are artificially low (even the current Fed fund rate of 5.25-5.5% is well below historical levels, which are in the 7-8% range). And in the US in particular, underwriting 30-year fixed-rate mortgages is essentially free money for banks, because the US government guarantees such mortgages so that the banks always make money. The banks have no incentive to do proper risk management (“moral hazard”).

How to fix it? #

The most obvious answer is to fix the incentive system. Stop giving tax breaks to the owning class, stop subsidizing home ownership with complicated financial derivatives and instruments (i.e., the Federal Reserve should never be bailing out banks for underwriting bad loans, and the Fed should certainly not be buying mortgage-backed securities on the open market).

The market is broken because governments have tipped the scales to help the owning class, while simultaneously leaving behind everyone who will never be wealthy enough to acquire their property, leaving the non-owning class in a perpetual state of poverty as real wages continue to decline.

The system as it is doesn’t reward people for doing good work, hard work, or contributing value to society. It simply rewards whoever got there first, or timed their purchase right.

In other words: let’s stop treating housing as a Ponzi or get-rich-quick scheme, and instead treat housing as what it is: housing.

…but more realistically, we’ll likely have business as usual for the foreseeable future, and I suspect it gets worse before it gets better.