Friday, August 11, 2006

Musings on 'Affordability'

The other day I heard one of my favorite economic commentators, Amelia Tyagi, say that about one-third of Americans live in housing they can’t afford. It gave me pause.

If they can’t afford it, how do they live there?

I think the key issue is the definition of ‘affordable.’

‘Affordable’ has multiple meanings. The most basic, literal meaning is the absolute one: do you have enough money to pay for something or not? By that definition, almost nobody lives in unaffordable housing (and those that do are likely to get evicted in the very near future). But that’s an extreme definition, one that can be stretched so far that it’s effectively meaningless. If I make 40k a year after taxes, can I spend 35k on housing? By the most literal definition, yes. By any reasonable definition, of course not.

A more commonplace definition is a price that someone can pay and still have enough to live at a satisfactory level. Obviously, what is a ‘satisfactory level’ will vary from person to person. (Usually, for housing, it’s defined as something like not spending more than 28-35% of income. On the coasts, many of us are in the 40-50% range, because the alternative is living in slums.) That’s where a term like ‘affordable’ becomes both contentious and helpful.

There are many reasons I’m not a libertarian. One of those is that it’s simply not true that other people’s consumption patterns are none of my concern. Of course they are.

Take housing. When other people are willing to take out (or extend) interest-only and negative-amortization mortgages, they push up the price of houses. If I understand math well enough to know the stupidity of taking out that kind of loan, I will find that my prudence will be punished by my being relegated to neighborhoods I want no part of. Since other people have abandoned traditional (or long-standing legal) restraints, I am forced either to live (comparatively) low on the increasingly-polarized economic scale or to take outsized risk. Neither is reasonable. We used to have strict requirements about credit-worthiness, down payments, and amortization, precisely to prevent the kind of runup in precarious lending (and house prices) that has happened over the last few years.

This is not a new concept. “Sumptuary laws” used to prescribe acceptable maximum prices for all manner of goods and services, on the theory that there is a generally-accepted correct price for any given item. Those have largely gone by the boards over the years, on the (generally) correct theory that the market is smarter than any given legislature. Now, the theory goes, excessive prices will be punished by consumers who will either shop elsewhere or substitute other purchases.

The theory breaks down at the ‘macro’ level, where we use the Fed to control interest rates and money supply – a sort of supply-side sumptuary law. We need the Fed to do that, because left to its own devices, the market tends to go unproductively haywire.

When there was something resembling a viable Democratic party, the grand compromise was to do away with most sumptuary laws, but to enact public policies that tended to lead to a relatively football-shaped income distribution and to provide pretty good public schools in most areas. The compromise, and it was a good one, was that certain basic necessities of life were within the reach of most people, but ‘frills’ were left to the open market. (In some relatively egregious cases, frills were even subject to ‘luxury taxes.’ These have been replaced mostly by ‘sin taxes,’ which are taxes on the luxuries available to the working and middle class.) Since the implosion of the Democratic party (late 1970’s, give or take), we’ve fallen into a pattern of removing just about all restraints on income, consumption, and debt. (Interest rates charged by credit card companies now would have fallen afoul of ‘usury’ laws not long ago. Minimum equity or down-payment requirements for mortgages have been lifted. The minimum wage has been left flat for nearly a decade. The financial-services sector has been deregulated to an unprecedented degree. Guaranteed pensions are going the way of the dodo. Unsurprisingly, the Gini index, which measures economic inequality, is at Gilded Age levels.)

(The exceptions to the deregulation trend – agricultural subsidies and defense contracting – both happen to flow overwhelmingly to red states. An astonishing coincidence. Apparently, risk is only for Democrats.)

If people were the fully rational economic actors that economic theory takes us to be, the trend towards deregulation would be mostly positive. But we’re not. An entire scholarly genre (“behavioral economics”) has developed to explain the various ways that people act counter to the ways economic theory says we’ll act. Salesmen have known this stuff for years: “No Payments for 90 Days!” works because many people falsely assume that the pain of spending restraint in the future will be much less than the pain of spending restraint now. Participation rates in 401(k) plans increase markedly when participation, rather than non-participation, is the ‘default’ setting. People are likelier to attend events when they bought tickets than when they were given tickets, even if the event itself is no more appealing. (That’s called the ‘sunk cost’ fallacy.) These have all been documented in the scholarly literature, but they’re also familiar to anybody who has ever dealt with salesmen. Regulations used to exist to prevent the worst abuses that the predictable human failings would allow. Now, it’s devil take the hindmost.

So we’re remaking a society along the lines of a theory that we know, objectively and empirically, to be false. We’re relying on a rationality that we know not to exist. Why the hell would we do that?