The guru’s daydreams: Part 2, Reinventing the past

July 30, 2014 | Cities, Configuration, Density, Housing, Innovations, Markets, Speculation, Technology, Urbanization, ViaTechnik | No comments 94 views

[Continued from yesterday's Part 1.]

By: David A. Smith

As ViaTechnik, which asked me for an email interview (published on ViaTechnik’s blog; July 9, 2014), is primarily a technology and design firm, their initial questions dealt mainly with housing’s and cities’ future:

yoyodyne_buckaroo

The future begins tomorrow!

Problem: People are creating new family units and the retiree population is rising.

Solution: Design live-work and multi-tenancy housing.

VT: How important should adaptability be to architects and designers when considering the design and construction of a building?

DS:  It ought to be huge, because as America urbanizes and America ages, ‘aging in place’ needs to be transforming into ‘extending independent healthspan’ (the period of time when an adult can live entirely independent and happily). Technology (broadband and computing) offers the promise of making the home interactively responsive to a physically less mobile homeowner.

batman_walls_closing_in

Maybe we rethink these movable walls

Flexible-wall configurations could allow larger homes to be subdivided to accommodate a service-oriented intra-home multi-household tenancy: elderly homeowner who rents to two (say) younger people, with the younger people providing services in exchange for living accommodations (and some rent or payment going in either direction to balance the equities). That sort of multi-generational household used to be the norm (and is the norm in emerging nation-cities today) but has been zoned and building-coded and tort-litigated out of existence in America.

dinosaur_extinction

Don’t forget the lawyers

VT: Tell us the most exciting, up and coming construction industry innovation.

DS: Web-based ‘technological housing’ where doors and windows can be opened and closed, energy consumption monitored and adjusted, based on real-time usage.  Ray Bradbury predicted this in a 1950 short story, There Will Come Soft Rains. This has great potential to make the home an independence-enabling environment, not an independence-threatening one.

Problem: Unsustainable stick-built houses in urban areas.

Solution: Modular housing and IBT.

VT: What seems to be the fastest growing design trend right now, and what effect is it having on the industry?

yport_room

It looks manageable from above

DS: Micro-housing, though at the moment it’s over-hyped both in terms of its livability and its practical ability to address housing scarcity.  At least the micro-housing discussion is creating a basis for examining our anachronistic and restrictive building and zoning codes that have failed to keep up with the ‘post nuclear-fission’ of acceptable American family and household configurations.

overhyped

Overhyping is so overhyped

VT: How have design trends shifted in the past few years to accommodate self-sustainability?

DS: Not fast enough. Some design trends are at the architectural-concept stage; few have made it into practical scalable customer-accepted delivery.

faster_pussycat

Speed it up

VT: What kinds of construction technologies are currently on the forefronts of architecture and are showing the most promise?

DS: Industrial building technology (IBT) together with micro-modular housing are both attracting enormous interest, but neither yet solves the scale-customization problem. IBT is viable but only at kilo-scale (1,000 or more homes at a time) and that limits customization.

ixtapaluca_02

Not a CAD/CAM: Ixtapaluca, Mexico

Modular housing produces boxy surroundingscars without wheels – that may be suitable for young adults for a while but doesn’t lend itself to evolving or aging families. In the 1930s, science fiction author Robert A. Heinlein predicted that the artisanal model of home construction – custom-build on-site – would be replaced by true modular construction. Eighty years later, we still haven’t cracked it.

heinlein_1940s

Quirky but undeniably visionary: Robert A. Heinlein

Problem: Population increase and commuting.

Solution: Technology and live-work spaces in homes.

VT: How have design trends shifted to accommodate the rise in urban population?

DS: Transit-Oriented Development (TOD) is the principal visible manifestation of awareness to the consequences of increasing urban density.  But even TOD thinks only in two dimensions, instead of three – that is, the most sustainable means of urbanization involves going up, higher into the sky. This has always been the case; in prior eras, the flat-over-shop was a recognized mode of urban living.  Samuel Pepys, for example, basically worked at home his entire life, because his home was right next door to his Navy Offices.  

pepys_seething_lane

Pepys’s house in Seething Lane

Pepys was also the world’s first blogger, though no one knew this for a hundred and fifty years, as his diary was encoded in his own personal shorthand, and wasn’t deciphered until 1825.

In emerging country mega-city expanding informal neighborhoods that are moving from peri-urban to urban, the most striking change is the replacement of ground-floor bungalows by two and three-story live-work spaces.

383_dharavi_street

Even if totally informal, going up (Dharavi, Mumbai)

VT: How can construction technology positively affect sustainability and population growth?

DS: Reduce transportation requirements by increasing discorporated value chains – people working from home using broadband to create virtual meetings and virtual teams.  

googly_eyes

None of us actually leave home but our google-avatars do

Nothing will ever fully substitute for face-to-face human contact – we are social creatures – but as we boost the functionality of the home office, we can reduce commuting and all its negative externalities.

Problem: Old zoning and building codes.

Solution: Retrofit.

VT: How significant will the understanding of architectural designs by the youth of today impact the industry in the next ten years or so?

DS: Not as much as you’d think, except in retrofit. Something like 90% of all the housing that will exist in ten years exists now; and with the increasing NIMBYism of urban environment, it becomes ever more important to retrofit existing zoning-allowance, or adaptive reuse, even increased density on the same footprint.  So we are not suddenly going to be living in flexible-adaptable domes or pods. But we are only five years away from having new household formation by young adults who have literally had pervasive broadband communication at their fingertips their entire sentient lives.  Omni-broadband is the next essential in all forms of housing.

google_glass_driving

Heads up, the future is coming

VT: To what extent does sustainability impact the methodology surrounding the design of a building?

DS: Certainly there’s a hyper-awareness that up-front construction-configuration choices have a determinative effect on downstream operations and maintenance, and therefore an investment today in something more sustainable (i.e. lower energy cost) will yield benefits for years or decades into the future. However, this tradeoff is only partially calculable: though we have Green Capital Needs Assessments (say), and can do payback or NPV analysis, the assumptions on which the NPV analysis depends – useful life of the improvements, changing energy costs, possibility of generation-skipping future technology that would make our current technology obsolete – create inherent ‘known unknowns’ that make judgment (or faith) a component on green/sustainable energy improvement decision-making.

VT: Is working around the environmental state of an area becoming increasingly difficult on designers and builders?

DS: To focus on designers and builders is, unfortunately, slightly to miss the point.  Designers and builders have to be policy change advocates, because without changes in the building codes and zoning codes, what designers creatively design, builders cannot profitably build.

VT: Where does innovation and sustainability strike a balance?

DS: The balance between importance, necessity, and value is struck in the marketplace, and in modern urban society, the marketplace consists of two overlays: Private actors (people, companies) making individual trades and purchases according to their own perceptions of their self-interest. Public entities, government, which creates the enabling, indifferent, or disabling ecosystemic environment, including laws, subsidies, incentives, and rules.

Holmes_simple_point

The point is simple, really

The marketplace acts like a Darwinian ecosystem, and if innovations die, it is because they are not delivering value perceived by the private actors. You can’t really tell people what to want, but you can use government to change the pros and cons of different choices, and then let the marketplace of private actors decide how they adjust their purchases accordingly. Most mutations die. Most innovation fails. That’s all right; what matters is spotting the rare innovation that works, and then scaling that by delivering it to the market.

samuel_beckett

A man who knew how to look like a sage

I like Samuel Beckett: “Ever tried. Ever failed. No matter. Try again. Fail again. Fail better.”

fail_better

Failing better since 1953

VT: If you could wave your own industry appointed wand, what would you like to see happen?

hindu_guru

Let me chant the incantation to remove all anachronistic zoning

DS: Vaporize the single-family-oriented building codes and zoning requirements and replace them with clean-slate thinking about what new forms of housing configuration are appropriate given the mutability of household configurations, the importance of live-work spaces, the power of technology to make the home smarter, and the need to increase verticality as the ultimate in urban sustainability.

Cities are humanity’s future.  We must make them work.

holmes_train_countryside

“Do you know, Watson,” said he, “I look at these scattered houses, and the only thought which comes to me is a feeling of their isolation and of the impunity with which crime may be committed there.  It is my belief, Watson, founded upon my experience, that the lowest and vilest alleys in London do not present a more dreadful record of sin than does the smiling and beautiful countryside.”

The Adventure of the Copper Beeches

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The guru’s daydreams: Part 1, Inventing the future

July 29, 2014 | Cities, Configuration, Density, Housing, Innovations, Markets, Speculation, Technology, urbanization, ViaTechnik | No comments 109 views

By: David A. Smith

boy_daydreaming

I dream of financial structures that never were, and hey … let’s underwrite ‘em

When I was nineteen, and working as a bellhop at the Newagen Inn (which at the time was a spend-two-weeks .. sojourn), I made the conscious decision that whenever I was asked an earnest and honest question, no matter the subject, I would always give an earnest and honest answer – and, as Winston Churchill said in a different context, my life was much simplified thereby. 

churchill_commons

I shall put a good word in the House of Commons

Though candor simplifies one’s life, it has both its pluses and its minuses.  When my secretary at the time several decades ago was asked by a co-worker how she coped with working with/ for me, she thought for a moment, and then replied, “David will tell you what he thinks.  Sometimes that’s good, and sometimes that’s bad.”  If ever I need an epitaph, ‘twill serve.

here_lies

Sometimes that was good, and sometimes that was bad

That commitment to responding honestly to earnest questions also leads, with the invention of email and the surprising visibility of the AHI Web site, to a stream of random email inquiries, many variations of “Help us, Obi-wan Kenobi, you’re our only hope,” and as I am more susceptible to flattery than is good for me or anyone, I always reply with something.

help_me_obiwan_kenobi

You’re my only hope

Hence, when out of nowhere I received an interview request, from James Carroll of ViaTechnik, whom I knew not from Adam, I accepted, additionally for the curiosity value of being challenged with questions I normally don’t consider, even though I write prolifically, both for Recap Advisors and for Tax Credit Advisor, in which latter publication my monthly column is entitled, The Guru is In. 

doctor_is_in

Financial structuring help, five cents

Other David Smith writing

State of the Market, a regular periodical from Recap Advisors

The Guru is In, monthly column for Tax Credit Advisor

The 2013 Guru columns

The 2012 Guru columns

The 2011 Guru columns

The results were posted on ViaTechnik’s blog (July 9, 2014), which opens with a nice provocative headline:

provocative

Headline: awakening or inciting appetite to read

David A. Smith Tells VIATechnik Why the Elevator Is Due for a Comeback and Explains Why We’re Not Living in Futurist Pods Yet

I’m not sure the elevator ever went away, but we must allow headline writers their hooks.

boat_hook

Got your attention, didn’t I?

While urbanization is on the rise and technological advancements crest every day, not much is changing in the sustainable housing sector.  So, what’s the holdup?

Laws evolve more slowly than does technology, in part because those who profit from obsolete or anachronistic laws have more ability to thwart the creation of new laws than to stop new technology.

protesting_uber

We’ve got to protect our licenses’ capital value

According to David A. Smith, founder of the Affordable Housing Institute (AHI), we’re not going to see anything new in the next decade.  

Actually, we’ll see plenty of new things, but housing changes more slowly than just about any other part of society, for the simple reason that homes are very expensive, very durable assets.

well_not_exactly

VIATechnik interviewed David about what solutions he envisions for sustainable housing in urban areas, and what we can expect to see, not just in the next ten years, but beyond. David A. Smith is a sought-after speaker and consultant on sustainable housing financial ecosystems with 35 years of experience in complex affordable housing transactions, programs, and policies. That boils down to a globetrotting career –

I always liked the word ‘globe-trotting’, reminiscent of Phileas Fogg, and its overtones of pell-mell journeying for its own sake

phileas_fogg

If I go west first, I’ll gain at day at the dateline, won’t I?

– consulting Congress, a U.S. Senate Subcommittee, HUD, and countries ranging from Turkey to India, and Mexico to South Africa.

Not to mention Brazil, Cameroon, Egypt, Ethiopia, Ireland, Kenya, Mexico, Nigeria, Saudi Arabia (yup), South Africa, Tunisia, the UAE, the UK, and somewhere I’ve temporarily forgotten.

Working as a policy advisor and program advisor, he stays focused on changing the housing finance ecosystems permanently, and for the better. On the lighter side, David is a witty writer who adds a dash of comic strip-style snark, making his blog for AHI an unexpected pleasure to read – it can be a no holds-barred review of current industry news that traditional journalists wouldn’t dare dig into.

no_holds_barred

Bad over-acting essential

VIATechnik wanted to pry open David’s lifetime, award-winning, treasure-trove of experience in housing to find out what’s next in building design and technology, and what might be hindering us from becoming more sustainable and economically viable when it comes to urban housing. With great insightfulness, David not only crunches numbers, examines urban building designs and considers impact and economic viability, he references everyone from Charlie Brown to the more obscure Samuel Pepys to science-fiction writer Robert A. Heinlein.  

law_inflationary_revenge

The young will choose how they economically poison the old

I have a mind like used flypaper; just about everything sticks to it.

flypaper

Yes, even posts on roaches

His solutions read like a page from a popular science-fiction novel (like from his own book In the Cube, where he reimagines the buildings of a futuristic Boston), but maybe science fiction is exactly where we need to be looking.

Future_boston_postcard

Where the future begins tomorrow!

We did a little problem and solution analysis of current design and construction in our interview with David Smith to find out:

Problem: Density. 

Solution: Building up.

us_urban_density

Even when we show density metaphorically, we do it by building up

VT: What is the most pressing issue for builders and designers in regards to the environmental state of an area?

DS: As George Lucas found out, ‘environmental considerations’ can be a Romulan cloaking device for neighbors who just don’t want things built near them – this despite the reality that, for any given number of people, higher-density development is better than the homestead-with-picket-fence that is often perceived as greener.

suburbs_pools

Looks green, doesn‘t it?  Isn’t.

VT: Is there a ready solution to the rise in urban population?

make_room_make_room

Time to go up

DS: Transit-Oriented Development (TOD) is the principal visible manifestation of awareness to the consequences of increasing urban density.  But even TOD thinks only in two dimensions, instead of three – that is, the most sustainable means of urbanization involves going up, higher into the sky.

VT: Any new design trends that lend to building higher?

DS:  The elevator is the ultimate in urban TOD, and so far it’s underused as such.  I dramatized this in my science fiction novel In the Cube, set in 2080, where the City of Boston has become a giant arcology extending to more than 150 stories.

Over the years, I’ve written many posts about possible ultimate future cities and their scale, including reviews of Robert Silverberg’s The World Inside, Isaac Asimov’s Trantor, and Arthur C. Clarke’s Diaspar. 

Previous AHI blog posts referencing or emphasizing elevators

March 14, 2006: The earliest apartments, Roman insulae

April 28, 2006: The credit of apartment living: New York City

August 13, 2007:Cities and scale(3 parts)

November 15, 2007: The ultimate future city: The Caves of Steel (2 parts)

December 26, 2007: The ultimate future city: The World Inside

February 19, 2009: Cities and privacy, the case of Rear Window (2 parts)

December 2, 2009: The ultimate future city: Trantor

April 20, 2011: The high-rise’s mahout

April 19, 2013: The world is the building, the building is the world

July 20, 2013: The new urbanism of Tiny Tower

tiny_tower_lift

Your city doesn’t work unless you have plenty of these

[Continued tomorrow in Part 2.]

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Optionality and anti-optionality: Part 2, Loan + Insurance = Lower risk

July 28, 2014 | Banks, Economics, Finance, Foreclosure, Homeownership, Housing, Lending, Loans, Optionality, Rental, Saving, Theory, US News | No comments 238 views

[Continued from last week's Part 1.]

By: David A. Smith

When you’ve got enough to take care of yourself, more claim checks don’t do you any good. But they can do a lot of good for all kinds of other people.

Warren Buffett

As we saw in yesterday’s Part 1, the Economist’s (May 17, 2014) review of a new book by two economists (Mian and Sufi), expounding on a theory that the Great Recession was caused by household over-indebtedness more than by bank collapse, explored the risk profile of debt and concluded, imprudently in my view, that replacing debt with equity would solve homeowners problems.

However, if the capital provider has both downside and upside, the capital provider must reinvent its business model, because the post-borrowing asset management decisions affect the lender (and of course, the borrower will soon come to resent the bank “taking a piece of my profits” in a rising market).

If risk-sharing is added to a pure debt instrument to make it more equity-like, the cost (both up front and over time) will rise, and that is anti-affordability.

Moreover, banks’ difficulties, as measured by the [risk] spread between yields on their short-term debt and that of the government, peaked in late 2008. Yet banks’ lending to business was actually expanding at the time.

mba_cref_duncan_43

Actually, the markets went kaflooey in early 2007: it just took 1½ years to manifest

This implied absence of correlation mixes the Monday-morning wisdom of post hoc analysis with the problem of phase delay: loans take time to originate, and once they are in process, the organization develops a momentum to close them.  It takes an ocean liner up to fifteen miles to stop dead, and just because short-term spreads widened wouldn’t automatically cause the ship’s captain to order all back full.

APTOPIX Italy Cruise Aground

Didn’t allow enough sea room

By the end of the year the spread had returned to normal thanks to the Fed’s vigorous intervention, but bank lending began to contract (see chart).

Again, that could easily be explained by phase delay: the Fed acted fast because it saw the armada of banks slowing down.

economist_spreads_and_lending

Are these things correlated?  Couldn’t prove it by me.

Messrs Mian and Sufi think bank lending has an unseemly hold on contemporary thought. They fault the Fed and the Treasury for lavishing money on banks to boost the supply of credit when the problem was demand.

When the crunch hit in 2008, there were too problems: liquidity and cost.  If the banks had not been given both ample liquidity and ample capital ratios (via TARP), then they would have had to reprice all their debt rollovers at higher rates.  Meanwhile, if the banks had been forced (by FAS 157 or otherwise) to write their assets down based on a higher-interest-rate environment, then there would have been a cascade of defaults, and the global financial system really could have collapsed. 

Poor households’ wealth had evaporated, and with it their desire to borrow, which would have been better dealt with by writing down their mortgages.

It wasn’t just poorer households’ desire to borrow, they had to borrow because they were overlevered and had lost all their optionality.  They had no capacity to borrow, and they had no cash.

The poorest households generally have the least equity in their homes, and are thus more likely to be wiped out when prices decline.

That’s an oversimplification – price declines make no difference so long as the borrower is able to keep making the payments (and in that, Bernanke’s bargain-basement interest rates played an essential stabilizing role). 

henri_rechatin

No downside if you keep taking the same steps every month

This imposes externalities on those with no debt: foreclosures prompt fire sales that drive down house prices more broadly, while falling net worth induces consumers to cut back, wiping out jobs.

Obviously, if a borrower can’t make the payments (because of a disruption in household income), then the borrowers with little home equity suffer a much greater loss-given-default than if the home had enough equity to be worth its mortgage at the foreclosure sale.  All of that traces back to faulty underwriting, not a flaw in the debt instrument itself.

Courts should be able to write down the principal of mortgages as an alternative to foreclosure.

This idea was hot five years ago, and discredited back then.  Why restore it now?

disgraced_me

All that talk about ‘moral hazard’

They recommend “shared-responsibility mortgages” whose principal would decline along with local house prices.

Yes, all those loans could theoretically have been written down, but as I posted throughout the crisis, authorizing and even encouraging ‘strategic mortgage default’ would have been a terrible idea: the moral hazard and securitization-contract obligation problems were immense; and the long-term ecosystemic damage would have been brutal.

There are some flaws to this argument. Falling house prices and net worth help explain why employment started sinking in early 2008, but not why it went into free fall after the failure of Lehman Brothers.

panicking_z

Lehman’s gone down!

What causes a cloudburst?  More prosaically, what panics the herd?  Both are often signaled by a loud noise, and Lehman’s sudden and total collapse was a global signal that a world drunk on risk had had too much.  It was time for a global asset revaluation, and that meant global defaults.

ahi_iuhf_04

After a world drunk on risk, a world of global-regulatory hangovers

By examining only loans from banks to business, they ignore the contraction in consumer credit and in lending by other financial institutions. And had more banks been allowed to fail, the supply of credit would undoubtedly have shrunk further.

Yes, it would have.  TARP worked because it was fast and it was balance-sheet equity.

But their broader point about the danger of debt is correct.

“Debt is the anti-insurance,” they assert.

The authors’ point is correct, but their description of it is wrong: debt isn’t anti-insurance, it’s anti-optionality.

When expressed as a series of payments, insurance looks just like savings: The saver (person who buys the policy) makes periodic regular payments, which accumulate value to the saver.  Only the payoff rules are different: where the saver is always entitled to the total earnings from his or her investments, the policy holder is entitled to a lower payment at the end (surrender value), but higher conditional payments if something bad happens. 

dog_passenger

Has she got driver’s insurance?

So if we pair insurance (a series of payments with a conditional positive payout) with high-leverage borrowing (a series of payments with a conditional big negative payment if the loan goes into default), it’s evident that the resulting synthetic product reduces the borrower’s losses given a default, because the insurance payment mitigates the mortgage risks.  That’s why so many lenders require insurance of one form or another – life insurance, health insurance, hazard insurance – in the aggregated loan product or package.

Insurance + loan = Lower risk in exchange for higher periodic cost.

“Instead of helping to share the risks associated with home ownership, it concentrates the risks on those least able to bear it.”

That’s simply wrong.  Insurance doesn’t concentrate risk, it transfers risk from the policy buyer to the insurance company – or from someone poorly able to bear the risk to an institution with tremendous capacity to bear risk. 

Of course, in shifting the risk (see yesterday’s Part 1), the aggregate risk is increased, so much so that sudden death after a recent insurance policy has become a staple of noir films.

double_indemnity_04

“It’s just like the first time I came here, isn’t it?

We were talking about automobile insurance, only you were thinking about murder.”

What is needed, they argue, is to make debt contracts more flexible, and where possible, replace them with equity.

Debt and equity are the endpoints on a continuum of risk and collateral choices.  Some debt instruments (e.g. mezzanine, participating, subordinated debentures) have equity-like characteristics.  One can slide up and down the risk curve anywhere one wants.

To compensate for the risk of loss, lenders, they reckon, would have to charge a fee equal to 1.4% of the mortgage, or receive 5% of any increase in the value of the property.

Borrowers wouldn’t pay the 140 basis points a year; the markets would compete it out.  And calculating a 5% of equity buildup would be insanely complicated to calculate (even assuming the two parties were of good faith and had perfect information), and when we add the principal-agent risk and the risk of fraudulent or incomplete certification by the borrower, the increase in known administrative costs will surely outweigh the value of the decrease in foreclosure risk.

shiller_on_phone

Yes; yes, I have plenty of money in the bank

The authors also endorse a proposal by Mark Kamstra and Robert Shiller to link interest on sovereign bonds to gross domestic product.  

kamstra_arch

It just trills from the tongue

Though Dr. Shiller’s no dummy, I wonder how the markets would price that risk, as well as the potential for (say) gaming the GDP calculations. 

Such an arrangement would have made it easier for the governments of Spain, Greece and Ireland to keep servicing their debts when their economies imploded.

Not that the ECB would ever allow no-longer-sovereign nations to play with risk spreads in that way.  File this one in the realm of intriguing-but-impossible.

draghi_glares

In the Game of Coins, whoever rules the Draghi rules the realm

University education is also ripe for more equity-like financing, since students do not know how much they will eventually earn.

Now that makes sense, because a university education is an asset whose economic value is both hard to determine and entirely dependent on post-loan decisions by the unreliable borrower (a/k/a the student) –

In Australia and Britain, they pay a fixed percentage of their income; the authors recommend instead linking repayment to the health of the job market, an idea first proposed by Milton Friedman.

– but what makes even more sense is forcing universities to bear first-loss risk on their students who fail academically, and first-loss risk on their students who fail economically.

shcool

Time to rethink that degree

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Optionality and anti-optionality: Part 1, reward later or reward now?

July 25, 2014 | Banks, Economics, Finance, Foreclosure, Homeownership, Housing, Lending, Loans, Optionality, Rental, Saving, Theory, US News | 1 comment 274 views

By: David A. Smith

Money is a claim check on other people’s products and services.

Warren Buffett

Once a month, Mrs. Guggenheim sends the bank the same amount of money. 

peggy_guggenheim_jackson_pollock

Darling, if you have to ask the price, you can’t afford it

Is she saving for herself, or repaying a debt?

Either way, her actions are identical.  Either way, the payments are the same, the timing is the same. 

Yet the scenarios, saving and lending, differ in two greatly profound ways:

1. When is the payoff?  When Mrs. Guggenheim is saving, she receives a lump sum at the end, an accumulated nest egg that is the reward for all her thrift and dedication.

guggenheim_museum

A little nest egg to house all my purchases

When Mrs. Guggenheim was borrowing, she receives the lump sum at the beginning, and she now has cash she did not have before – Buffett’s claim checks redeemable immediately for other people’s products and services.

2. Who has the optionality?  When Mrs. Guggenheim is saving, she has complete optionality: she chooses how much to save, how frequently to make deposits, when she will withdraw savings, and what she will do with the savings.  Mrs. Guggenheim need consult no banker, no financier about these decisions.  It is her money and she does what she will with it.

Optionality defined

Financially, ‘optionality’ means the ability to change strategy without suffering harm.  Optionality includes:

·         Timing of actions.  Save now or save later?

·         Choice of actions.  Buy stocks or bonds?

·         Scale of actions.  Concentrate or diversity?

Once she borrows, however, Mrs. Guggenheim’s optionality is all gone.  The choices of all her tomorrows are condensed into a single big-bang point source today, and whatever whims or inspirations or bonanzas she might have pursued she must now pass by.  Worse, her positive optionality has been replaced with negative optionality: now she must make the payments, on penalty of losing her posted collateral. 

peggy_guggenheim_buying

The art is priceless, but try telling that to a banker

Hence the instant of borrowing is a plunge from high positive optionality into a self-dug trough of anti-optionality – in exchange for a pile of cash. 

All of us know that – the moment of signing on the line which is dotted fills us with dread, and that dread is healthy. 

(Here is why credit cards can be insidious, because the line which is dotted is a dozen or a hundred lines each of small purchases whose cost our psyche swiftly devalues.)

Without vocalizing it, all of us know the optionality chasm between saving and borrowing, and yet despite this, most of us borrow rather than save, because we devalue optionality and overvalue immediacy – and that, more than any other single cause, may be the real reason behind the Great Recession, if one is to believe a new book reviewed in the Economist (May 17, 2014):

House of Debt: How They (and You) caused the Great Recession, and How We Can Prevent It from Happening Again”, by A. Mian and A. Sufi.

amir_sufi

A new book argues that household debt, not broken banks, fuelled the recent recession

Before Ben Bernanke found himself trying to prevent a second Great Depression as chairman of the Federal Reserve, he had become well known in economic circles for explaining why the first one happened. In a paper published in 1983, Mr Bernanke blamed the collapse of the banking system for constricting the supply of credit, which “helped convert the severe but not unprecedented downturn of 1929-30 into a protracted depression”.

Of course, when one owes money, aside from losing one’s own optionality, we subject ourselves to the optionality of others, and when the financial or economic markets are heading south at speed, naturally enough the creditors run for their own lifeboats.

titanic_lifeboats

It’s never good when your lifeboat itself is underwater

Hence a central bank must be a source of continuing liquidity, countercyclical liquidity, and for many years that was thought to be enough.

ahi_iuhf_08

Everybody needs continuing liquidity

The notion that financial crises are transmitted to the broader economy by the “bank-lending channel” has dominated subsequent policymaking. It is why Mr Bernanke fought so hard to stop the panic in 2008 and to recapitalise the banking system afterwards.

In this, he was entirely right to do so, although his decision to hold interest rates deliberately at minuscule levels, albeit fueled by Chinese and other global willingness to buy US paper as the best post in the global capital storm, has slowly and steadily drained savings wealth from America’s elderly and the near-elderly Baby Boomers.

Tim Geithner, who was at the Fed with Mr Bernanke and then became Barack Obama’s treasury secretary, spends much of his new memoir reiterating their argument (see article): “When the financial system stops working, credit freezes, savings evaporate and demand for goods and services disappears, which leads to lay-offs and poverty and pain.”

On the other hand … any given number of payments can be expressed as a big principal with low interest or vice versa.  So of course lowering interest rates increases buying power now, but that places you in the wrong spot for later macroeconomic interest rate movements.

A new book, by Atif Mian of Princeton University and Amir Sufiof the University of Chicago, challenges this orthodoxy. The real cause of the post-crisis slump, they argue, was not the damage to the banks, but the run-up in household debt that came before, which became an anchor on consumption when home prices subsequently collapsed.

That is true enough, yet it’s only one aspect of the damage done by overleverage – the greater damage is in loss of householder optionality (to cut expenses, say, or to downsize by moving to another house).

By analysing the relationship between consumption, employment, home equity and other debts and assets by county, Messrs Mian and Sufi find that consumption fell most sharply in counties that experienced the biggest drop in residents’ net worth. 

By itself, that insight falls into the category of “It is indubitably so, Socrates” findings: true but admitting of many possible explanations.

platos_academy

No man of sense could dispute that

This, they argue, would not be the case if the primary restraint on consumption was damage to the banks brought on by the collapse of Lehman Brothers.

For most people, housing is their large-purchase piggy back, one that they can tap only with some effort and trouble, so in the short and intermediate run, people do not refinance their homes just because they need cash; instead they run up current or credit-card debt, figuring (rightly, at least most of the time) that if the debt becomes large enough to be burdensome, they will refinance the house into a lower interest rate. 

But that model of spending close to one’s monthly budget depends on two beliefs: (a) that my house has meaningful equity buildup, and (b) that I can liquefy that equity buildup through access to a home mortgage financing.  If either belief is shaken, consumer spending drops.

They found similar evidence in county-level employment. In counties where net worth fell most, jobs were slashed not by small companies, which depend most on banks, but big ones—because sales were slumping.

Throughout the Economist’s review, I find myself agreeing with their analyses and seriously questioning the prescription (though not having read the book, I could easily be missing relevant analysis).

atif_r_mian

A Mian great at describing, not so great at prescribing?

Shifting focus from banks to households, leads [the authors] to very different remedies, the most radical of which is to replace many loans with equity-like contracts in which lenders share losses with borrowers.

There are many practical obstacles to these ideas.

While that’s natural enough to propose in the abstract, the Economist is usefully skeptical and analytical:

There are many practical obstacles to these ideas.

The problems aren’t just practical ones, as it seems Messrs. Sufi and Mian misunderstand or fail to appreciate properly the differences between debt and equity. 

underappreciated

They’ll notice me now

Equity is not debt.  Equity is harder to underwrite because it is riskier for the capital provider.  Equity is much harder to administer and share.  Equity costs more than debt.

While debt may be dangerous for the borrower, it is the opposite for the lender.

Moving from debt to equity shifts risk from the borrower to the lender, and in so doing, it shifts risk from the person who has person to the person who lacks control.  Almost by definition, such a shift increases aggregate risk (risk taken by the two parties combined), so if the borrower’s risk is reduced by some quantum, the lender’s risk is increased by a greater quantum.  Risk-shifting away from control is entropic – which has consequences for savers as well, since they are the real counterparty to borrowers (banks being just an intermediary money store).

ahi_money_store_4

Savers prefer the safety and predictability of a debt contract, which is why they accept lower returns on bonds over time than on equities. Many debt contracts exist primarily to satisfy this desire for safe assets—most notably bank deposits

In debt, the borrower – who has control of the asset – takes all of the gains, and all of the losses up to the point of default, whereupon the lender takes all the remaining losses.  When the capital provided is via pure debt, and assuming the borrower has hard equity in the property, then the lender can be comfortable giving the borrower full unmonitored control over the property.  If the borrower makes improvements to the asset (adding a porch, repainting), those improvements are being paid by the borrower’s cash, and as long as they do not diminish the asset’s value, they will improve the lender’s security even as they improve the borrower’s embedded equity.

Borrowers may prefer debt, because it allows them to capture the upside of their investment.

In general, borrowers always prefer debt because they want to see the lowest required payment/ stated interest rate, and they go into a borrowing under-estimating their own risks.

Most of the time that optimism is justified.

Those dynamics change dramatically if the capital provider has both downside and upside –

ups_and_downs

Which of us is at risk here?

[Continued next week in Part 2.]

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Groundhog Day at the Rent Guidelines Board: Part 8, “How the duck did this happen?”

July 24, 2014 | Affordability, Apartments, de Blasio, democracy, Housing, Markets, mobs, New York City, Politics, Rent control, Rent Guidelines Board, Rent Stabilization, Rental, Takings | No comments 169 views

[Continued from yesterday's Part 7 and the preceding Part 1, Part 2, Part 3, Part 4, Part 5, and Part 6.]

By:David A. Smith

gd_08_happened

Phil: Do you know what today is?

Rita: No, what?

Phil: Today is tomorrow. It happened.

– Groundhog Day

Candidate Bill de Blasio, as we saw in yesterday’s Part 7, had campaigned for a freeze on Rent Stabilized rents as part of his overall posture as the most anti-Bloomberg of all the anti-Bloomberg candidates vying for Gracie Mansion.

Sources for this post

The Indypendent (May 11, 2005; powder-blue font)

New York Post (June 24, 2009; brown font)

New York Times (June 24, 2010; violet font)

New York Times (June 27, 2011; yellow font)

The Real Deal (December, 2011; navy blue font)

Rent Stabilization Association blog post (October 11, 2013; sepia font)

New York Observer guest editorial (May 14, 2014; peach font)

New York Daily News (June 11, 2014; emerald font)

New York Daily News (June 13, 2014; blue font)

New York Daily News (June 17, 2014; olive font)

New York Daily News (June 23, 2014; black font)

New York Post (June 23, 2014; teal font)

New York Post (June 24, 2014; orange font)

Curbed New York (June 24, 2014; lavender font)

New York Post (June 25, 2014; gray font)

Rent Stabilization Association blog (June 26, 2014; red font)

Crain’s New York (July 9, 2014; magenta font)

wolf_raven

I connive, you connive, we connive together

Though candidate de Blasio claimed that the Bloomberg Administration was in cahoots with owners, one cannot find it in the numbers.  Going back through the Bloomberg Administration, we find this:

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Ranging from 2.0% to 4.25%

Thus under the first eight years of Mayor Bloomberg’s historic tenure, the one-year increases (ignore the two-year, they’re a distraction) ranged from 2.00% to 4.25% — and the lowest rent increases ever approved since 1969 were 2%.

The smallest increases enacted since the board’s inception in 1969 were 2% for one-year leases and 4% for two-year deals.

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Giveaways not visible, but perhaps that the implicit bias of statistics

Throughout this period, rent stabilized rents have always lagged market, and the market lag appears to have been widening:

nyc_median_rents

Rent stabilized $1,150, market $1,500

Those statistics can also be aligned with these from a Wall Street Journal chart:

rent_to_income

Housing in NYC gets more expensive for everybody

That chart proves several things, only one of which the Journal chose to highlight:

1. Rent Stabilized rent increases have largely tracked market increases.  Whether that should be its objective is another question (beaten insensible in Section 1 of this seemingly endless post), but if the RGB is supposed to shadow the market, neither ‘relatively’ improving tenants or landlords, then it has done so.

“The bottom line is the Rent Guidelines Board has been stacked against tenants for many, many years,” said Comptroller Stringer. 

If the board was stacked against tenants, where is the evidence in past rent increases? 

scott_stringer_leaning_back

Oh man, evidence is way, way over-rated

“When fuel prices were low, when expenses were low, tenants got hit,” Stringer said at an unrelated event at City Hall.

He’s wrong on that too – they may have seen their income drop, but they didn’t see their rents soar.

stringer_spitzer

Say, Eliot, thanks for those tips on telling whoppers

2. New York is becoming more expensive to live in.  For a decade-plus, living in New York City is becoming more expensive.  By strong inference, that means the city isn’t producing enough housing of any kind to keep up with the potential aggregate demand.

3. Rent Stabilized residents are only a bit less affluent than market renters.  If we use $1,150 for the stabilized rents and $1,500 for the market, and we use 33.4% of income for market and 34.9% for stabilized, then the median income of a stabilized renter household is $39,500, while the market households are $53,900, versus New York City’s 2011 median income of $73,700.  Hence rent stabilized tenants averaged 53% of area median income, while market renters averages 73%.  Both sets of renters are low income by HUD standards (80% of AMI or below).

This last point is interesting evidence, and it’s remarkable to me that nobody’s bothered to figure it out or to present it.  Perhaps that’s because that would lead to proposals for means-testing or income eligibility requirements, and upset too many cozy apple carts.

4B. It has all happened before

Phil: Well, what if there is no tomorrow? There wasn’t one today.

– Groundhog Day

Because the supply of rent-stabilized buildings is finite, and slowly shrinking –

The number of rent-stabilized apartments in the city continues to fall. About 10,000 such units were lost in 2009, according to a study by the Rent Guidelines Board that was released this month; it was the largest net loss since at least 2003.

– and no one with any sense will develop property subject to them, landlords become tethered targets for annual political floggings.

In [New York City], vilifying landlords is a common pastime, and politicians curry favor with tenants by pleading for rent freezes.

And after all the sturm und drang, after the absence of airborne chairs, the presence of earplugs and stage-storming tenants, of off-the-wall mayoral reactions, they voted within the range the staff recommended.

occupy_rgb

Not quite

[2010] The city’s nine-person Rent Guidelines Board approved rent increases, criticized as too large by tenants and too small by landlords, that could have been higher.

Might as well have that sentence on auto-fill as it could be written every year, like this one too:

Several board members said that landlords, too, were faced with increased costs.  According to another study by the board, the overall price of running rent-stabilized buildings rose 3.4% from May 2009 to March 2010.

And this one [2011]:

For their part, tenants — citing the lasting impact of the recession — pleaded for a freeze in rent increases –

And this one:

– and an end to the practice of allowing landlords to charge the market rate once the rent at a vacant apartment hits a threshold.

That, as the tenant advocates know, is a decision beyond New York City’s reach; it resides in Albany, where Speaker Sheldon Silver and the mayor’s BFF, Governor Andrew Cuomo, currently hold sway, and will likely do so a year from now when rent control comes up for its quadrennial last-minute reprieve.

4C. See you next year

flax_vote_5100

The moment before Mr. Flax voted (go to 51:00 in the YouTube video)

After all the sturm und drang, after the absence of airborne chairs, the presence of earplugs and stage-storming tenants, of off-the-wall mayoral reactions, the Rent Guidelines Board voted 5-4 for the 1% rent increase, with Mr. Flax casting the decisive vote:

“This moment is a nightmare.  Unlike anyone else on this board, I’ve had intense, intense pressure from both the right and from the left.  Some of it dirty, some of it principled.”

He added (you can hear it on the YouTube at 52:15), “But again, I have to vote my conscience.  This is my proposal.  I apologize, but I vote in favor of the motion.”

After he voted “yes,” the crowd erupted in a chorus boos and shouts of “sellout.” Mr. Flax could be heard on the microphone asking one of his colleagues [Chair Godsil], “How the [expletive] did this happen?”

Whatever it was, you get to do it all over again next year – and New York’s courts still think this is Constitutional.

rgb_1943_hearing

Rent guidelines Board hearing, NYC, 1943 – back then, there was a war on

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