NYU-Stern professor and Manhattan Institute adjunct fellow Arpit Gupta joins Allison Schrager to discuss the state of the U.S. housing market, the long-term consequences of remote work, and the demand- and supply-side impediments to building more housing.

Audio Transcript

Allison Schrager: Welcome to Risk Talking, a podcast about economics. I'm your host, Allison Schrager, and I'm delighted today to be joined by Arpit Gupta. Arpit is an associate professor of finance at NYU Stern and an adjunct fellow here at the Manhattan Institute. His research is wide-ranging, covering subjects from the civic efforts of local journalism to the consequences of remote work on real estate prices. And he joins us this week to talk about all things housing, something that is on all of our minds—where the housing market is going right now and what the post-pandemic reshuffling is going to mean for the business of housing, and for commercial real estate, and why we have such a difficult time building new stuff. So Arpit, welcome, and thanks for joining me.

Arpit Gupta: Thanks so much for having me. It's a real pleasure to be here.

Allison Schrager: All right. So let's just try to figure out what's going on right now. It seems like the real estate market has been, well, screwy for a while. Even just right now, it looks like sales are going down, but prices are still way up. Mortgage rates shot up from really historically low rates, and now they're coming back down again. I mean, what can we make of this? Is the housing market due for some sort of huge price correction, or are things really not so bad?

Arpit Gupta: Yeah, it's really weird. And the way economists often think about this is in the context of something called the user cost model, which is we kind of think that in equilibrium, people should be indifferent between renting and owning. So if we kind of want to think about what's the price of homes, well, we want to think about what's the price of renting, and we want to think about what's the user cost? What is the per-period cost of purchasing a home? We think that those should be kind of the same.

And one of the biggest components of buying a home is of course, the interest that you're going to pay on a mortgage. And so for that reason, we kind of think that interest rates should be very closely connected to the price of homes. And in particular, they should be very closely related to the price-to-rent ratio. So kind of the discount rate or discount factor that we apply on housing should be very closely associated to the interest rate that we're applying for things that are discounted in general.

And that relationship has actually held up pretty well over time. So what we sort of saw over the COVID pandemic is interest rates went down a lot, and in tandem, we saw that price-to-rent ratios really rose a lot. So we're applying a much larger multiple to rents in evaluating house prices. That's sort of why house prices kind of went up so dramatically over the course of the pandemic, in addition to other factors like remote work. And what's really interesting and surprising is that we haven't seen that work in reverse. So as interest rates are heading up, we haven't really seen prices really adjust. We haven't really seen price-to-rent ratios really adjust the way that we would naturally expect.

I think there are two possible explanations for this. So one is that it's just going to happen with a lag. So what kind of typically happens with housing is first, things kind of show up on the inventory margin. So people are more likely to list homes, inventories start piling up, we kind of see that. Then people start slowly lowering their listing prices, and we're kind of seeing that too. And then finally, it shows up in lower transaction prices. We're also seeing sizeable price drops in newly built homes, so those are the homes that you don't really have much of a margin in adjusting. You've kind of built a home and you kind of have to sell it at some price in order to move it, so you're seeing some action there too.

Another possibility is that something is different now compared to before. What might be different? Well, one issue is inflation. So real estate tends to be a reasonable hedge against inflationary environments. We kind of saw that in the 1970s, real estate did pretty well. What that sort of means is you kind have to put cash to work somewhere. You may want to put it in real estate. And so maybe that means that real estate is going to not be as affected by rising rates, just because there's so much demand for it as an inflation edge.

Allison Schrager: Interesting. So I think you're saying it's kind of hard to tell either way if all of a sudden housing prices are going to fall?

Arpit Gupta: Yeah. My baseline expectation, I think still is that we're going to sort of see some price correction in real estate, particularly in some of these markets that you saw a really steep run up in house prices. You sort of saw across a lot of different areas, the Boises, Austins, et cetera, these kind of Sunbelt locations or Mountain West locations that just had really rapid run ups in price. It wouldn't surprise me if we saw it was precisely in those areas that there was more of a price correction.

It wouldn't surprise me if this was a fairly sizeable price correction, just based on the extent to which interest rates have gone back up, but I can also kind of see a world where inflation concerns sort of subside, interest rates kind of go back down in the future, and that would support higher prices as well. So there's a question of sort of how persistent or transitory are these interest rate changes as well that kind of plays into how much we assess the value of real estate. And if you look at the inverted yield curve, if you look at long-term rates being lower than short-term rates, that's sort of a reason to kind of hold on and avoid selling now.

Allison Schrager: Mortgages are based off of roughly the 10-year yield, but there's a risk premium on that too, which also determines mortgage rates. And I didn't realize the extent of it that during the pandemic, the Fed was really buying almost all those sort of new mortgage-backed securities. The market grew, issued agency-backed securities, provided $1.5 trillion. And the Fed's balance sheet on them increased by $1.3 trillion. So do you think now the Fed is ending quantitative easing and exploring quantitative tightening. Do you think that could also could be having an effect?

Arpit Gupta: Yeah. And to be clear, there are, I think two factors that make the Fed important in the mortgage market. So one is just a sheer size and scale of some of these asset purchases, which you sort of alluded to. And a second aspect has to do with how the Fed doesn't hedge their holdings of mortgage-backed securities. So the key risk for owners of agency products, which are produced by Fannie and Freddie, so these are going to be loans under the conforming loan limit that are the vast majority of mortgages made in the United States. These mortgages have the default risk already taken care of by the federal government, so the key risk that investors are worried about in this market is prepayment risk.

And in order to deal with that risk, what most private investors do is hedge on some level. They use interest-rate swap options in order to address the interest-rate prepayment risk that someone will refinance their mortgage in a low-rate environment in the future. And the Fed doesn't do this. They just hold MBS product. They just let it roll off their balance sheet if and when it prepays, and they don't hedge that. And so having more of the agency stock being held by the private sector also kind of means that there's more prepayment risk that kind of has to be hedged by someone by some private investor. And that tends to add a little bit of additional risk premium when someone actually has to correct for that kind of risk.

Allison Schrager: I mean, do you also think going forward, there's just a lot more uncertainty around prepayment risk? Because you base prepayment risk based on past data, but we just had this period where rates were crazy low, below 3 percent. So the share of people who are either going to move or refinance going forward's got to be lower.

Arpit Gupta: It's super uncertain, and an easy way of seeing how uncertain that is to compare the 30-year mortgage rate, so the typical fixed-rate mortgage average to the 10-year rate. To be a little bit more precise, you can use a blend of the seven- and 10-year rate, but let's just take the 10-year rate as the comparable duration product. So it's going to kind of line up with how long people on average are staying in their mortgages. And what you kind of see is that the premium of the mortgage rate relative to that sort of 10-year treasury rate is fairly high. So it's been kind of elevated actually ever since the financial crisis, but even during the Covid period, you sort of saw much larger spikes and increases in this spread. And right now, it's also fairly high, so there's a fairly high premium for mortgage product relative to that 10-year.

And so I think that kind of comes from a few different things. So one is as, as you mentioned that there's just risk and uncertainty around prepayments. There are questions about whether we're going to see future prepayment risks manifest the same way it has in the past, particularly because of the way that interest rates have kind of been changing, they've kind of been going up a bunch. And there's also a lot of capacity constraints in the system. So the capacity constraints just have to do with how quickly mortgage companies are able to process mortgages. It just takes a long time these days to go through all the regulations entailed in mortgage origination.

One thing I've heard, I haven't verified it, but it's a nice saying, nonetheless, is that it takes more labor to produce a mortgage than it does a car these days, based on the amount of background checks and regulatory work that goes into the background. And we have sort of a diminished mortgage supply capacity. Again, it's been kind of diminished a little bit since the financial crisis, but even recently, there's been lots of layoffs at mortgage companies and so forth. And so when there's less capacity to create mortgages, that also means there's going to be a higher spread at origination as well.

Allison Schrager: Although in some ways, I guess that's not all bad, because even if housing prices do fall, you're describing what sounds like a world with much less risky mortgages, especially if there's more background going into everyone who's getting these huge loans.

Arpit Gupta: That's true, and so that risk is going to be a little bit of a savings for the taxpayer. The other way that the federal government has actually de-risked itself is through the issuance of credit risk transfer bonds. So Fannie and Freddie are exposed to several trillion dollars worth of mortgage default risk, and what they've actually done is de-risked themselves a little bit by constructing these, they're sort of synthetic collateralized debt obligations, is really what they are. They're basically bonds that are referenced to the agency securities that are held in someone's balance sheet, so they're synthetic in that way. They're kind of a reference pointer and they basically mean that some private investor is betting that these bonds will not default, so they're paying a fee if the bonds do default. And so the federal government has sort of insured themselves against default on a lot of these securities. So higher mortgage quality and the construction of explicit securities that protect the federal government against default risk are kind of the two ways that the system is a little bit safer than before.

Allison Schrager: Do more people get fixed-rate mortgages than before, too?

Arpit Gupta: Yeah. So a lot of the adjustable-rate mortgage production was really concentrated in these subprime alt A categories. Those market segments have sort of died out, and so we have much more fixed-mortgage production for Fannie, Freddie, as well as the FHA. The jumbo segment, so these kind of larger loans, they have a decent number of adjustable rates. And now in general, we're seeing a little bit of rise in adjustable rates because people are kind of looking at a high-rate environment, they're betting that rates will go down in the future, and so they're picking an adjustable rate. There's also a little bit more clarity about that LIBOR/SOFR transition, I think, which makes people a little bit more willing to go for adjustable rate as well. But the vast dominant amount of our mortgage production is fixed-rate, which is not ideal actually, in some ways.

Allison Schrager: Why not?

Arpit Gupta: So it's obviously good for individual homeowners that are able to lock in and have a secured rate, but American mortgage finance is very weird, and a lot of it just really goes back to our collective decision back in the 1930s that we are going to make this 30-year fixed rate easily pre-payable mortgage the standard mortgage contract. And it's actually just a very weird contract from the standpoint of the financial system, which does not want to create anything like this. There's no country in the world that has naturally this kind of mortgage product. It just is a product that's so high-duration, it is presenting all sorts of interest-rate risk, you've got the default risk, if you're holding it on balance sheet, you've got all sorts of liquidity risk, and so it's just a very complicated product for the financial system to actually hold.

It's one of the reasons we had this S&L crisis back in the eighties when we had all sorts of, kind of like today when we had high interest rates, lots of inflation and banks were kind of restricted in how much they could earn on deposits through something called Regulation Q. And consequently, banks just kind of found themselves in a position where they just didn't earn much on deposits. They were stuck with all these mortgages that were fixed in rate and the whole system sort of collapsed.

And what happened, kind of the follow-up from all that is we moved to this world of securitization, which heavily involves Fannie and Freddie. So I think in an alternate world, if you had a world of more purely private entities, it would look a little bit more, for example, like what commercial mortgages look like. Those tend to be a lot shorter, so it's common to have something like a 10-year period, and they tend to have more adjustable rates in there, in the market for syndicated lending and corporations, also has a lot of adjustable rate lending. So the trade-off we've kind of come to has benefits for homeowners, but has a lot of costs for how the mortgage system deals with these products, and every so often, financial crisis, S&L crisis, we kind of see the consequences of that.

Allison Schrager: I remember thinking during the pandemic when 30-year rates hit 2.6%. I mean, that's just crazy for a risky long-term asset. That just doesn't make sense to me. Unless there's a lot of interference, which it sounds like there is.

Arpit Gupta: Well, there are two parts of that. There's the fact that the 10-year rate was as low as it was, and then there's the risk premium on top of that. The risk premium part is maybe not so crazy. Other countries that have very different mortgage systems don't have mortgage premiums so different from ours in the end, so that part kind of seems okay. And what was super weird though, I totally agree with you, is that the 10-year rate was as low as it was. And how I kind of think about that is, we had sort of this period during the pandemic when you just couldn't spend. If you wanted to buy stuff, you could buy durables, but there were just all these categories of consumption that you couldn't really take advantage of, particularly in services.

And then people started getting all these checks, unemployment checks, stimulus checks, so on and so forth. And so I have some colleagues that have done some work on this. They sort of find that people kind of took a lot of that money and they just invested. Of course, with meme stocks and crypto. But in general, people just put a lot of money in deposits. People were just sort of saving a lot. And the kind of consequence of all that saving activity is that we had pretty elevated asset prices. We had pretty low yields. So I kind of viewed that as a diagnostic of limited consumption opportunities in that period.

Allison Schrager: And there also was a lot of policy to bring in the mortgage market between buying the MBSs and other forms of QE, which targeted long-dated securities.

Arpit Gupta: Yeah, for sure. And that was kind of continuing into 2021 at a time when house prices were already pretty hot, so I think there's definitely a lot of consideration that the Fed may not have done an optimal QE policy, taking into account the fact that housing remained as hot as it was and yet the Fed continued to buy more QE. Of course, there's an element of Monday morning quarterbacking when it comes to second guessing what someone else is doing. But at the time in 2021, of course, there were a lot of people that were concerned about inflation and concerned that the Fed purchases of MBS were going on a little bit too long.

Allison Schrager: I mean, it is sort of also interesting that you referred to the current mortgage rate as high. I guess it is historically, but not really if you go back a little bit further. I mean, 7- to 8-percent mortgages used to be the norm. Do you think we're in a new regime where mortgage rates are just structurally lower and even when all the pandemic stuff washes out and we get past inflation, we are just in a lower mortgage rate regime?

Arpit Gupta: So that sort of depends on what you think has been driving this long-term decline in interest rates, particularly long-term rates. There are, of course, a few different theories for what's doing this, whether that has to do with the supply glut of the rich, whether it's something to do with emerging countries and how much they're saving. A lot of different kind of explanations, but I am generally persuaded that there's something that's brought down long-term rates that sort of seems like it's going to be persistent. And if that's the case, I would sort of expect more just to have some premium above that, of course, but to generally follow at a pretty low level. So my expectation is that the long-term historic trends that have been driving down rates are going to continue. And consequently, we would expect to see fairly low mortgage rates as well.

Allison Schrager: So, speaking of structural changes to housing, I guess the other hot question is work from home, and a lot of people left cities and are continuing to leave cities. You have a recent paper discussing how this is going to change real estate in New York in particular. Do you think we're going to see a big restructuring of where people live and real estate in cities?

Arpit Gupta: I do. And the way I think about this is that remote work is sort of like a transportation technology. So if you look back to how cities have evolved over time, Manhattan has a lower population now than it does in 1920. And kind of the reason is that back in 1920, you sort of needed to live fairly close to where you worked. So there was just a lot of crowding and it was the creation of the suburbs, of commuter rail, of highways, of cars, of all the Robert Moses things that allowed people to de-densify a little bit and kind of move out to the suburbs. And kind of in tandem with that, there was also a lot of improvement in agriculture productivity, actually. So the relative price of agricultural land went down a lot relative to urban land. So we actually de-densified substantially if you compare what cities looked like in the 19th century to the early 20th century.

Then, within that suburban commuting world, you still have people coming in five days a week into office jobs. And remote work means maybe I don't come in at all, maybe I come in a few days a week. Everyone's kind of on a different schedule, but it's a really radical change, maybe the most radical change we've had in 50, 70 years to how people transport themselves. And that doesn't actually necessarily mean people are going to go in one direction or the other, I think, because there are a lot of people that will take advantage of the flexibility of remote work and move to urban areas. But on balance, the issue we've kind of faced is that prices have been going up very steadily in the urban cores. We just haven't been building enough to accommodate the demand for urban centers.

And so we kind of find ourselves in a situation where a lot of people are concentrated in urban areas, not necessarily because they sort of want to be there or they want to be there at that particular price point, but because they kind of have to be there in order to work. And it's sort of these workers that increasingly have more options and seem to be taking advantage of these options to lower their housing costs and move out farther into suburbs, into exurbs, into rural areas, and all over the country. So I generally think that the pandemic actually doesn't have as lasting effects, as many thought. Some people thought that we'd be wearing masks forever and we're all going to not shake hands anymore and so on and so forth. I think most things are actually coming back, but one of the few durable shifts I think is going to be remote work. I think it's going to be very transformational in how people live and work.

Allison Schrager: So you've been doing some work on who left cities. And I hear so many different conflicting things on it, but seems like a lot of the people who've certainly left New York and San Francisco have been very high earners. So how do you square that? Because they're the ones who can afford to stay.

Arpit Gupta: Well, I think that the confound is that it's true they're high earners. They're also the people that tend to, as a function of their educational qualifications, their occupational title, their job roles and functions, have the greatest flexibility in where to go. And so it does tend to be these people that are, let's say relatively affluent within a metropolitan area, but are not able to get as much space as they would ideally like to demand within a city who appear to be sensitive to opportunities to move elsewhere. And of course, many of these people often have kids or are thinking about having kids, and so that's another aspect of moving out to the suburbs or to a lower-density area.

Allison Schrager: So do you think then that maybe as I said, cities like New York going forward, some people like to romanticize that it will be like the good part of the eighties, that we'll have more creative people because we still have a shortage of housing, a lot of the sort of higher net-worth people are leaving.

Arpit Gupta: So I think there are a few concerns and considerations for city governments. And I think the basic concern is something like an urban doom loop. And the problem is that if you have the Exodus of some people, let's say more high-income people, let's say you have commuters that used to come in to the central business district that are no longer there, that tends to have a lot of spillovers and consequences on other residents and on municipal finances. And you can see this a lot of different ways. So think about crime. We used to have a lot of street presence, so people just walking around, whether they're in the subway, at the public transit, or in the streets. Now, there are just sort of fewer people around, let's say, and that tends to create environments a little bit more favorable for crime.

Think about retail. So it used to be the people that would come into the central business district generate all these retail spillovers, because they're buying $14 salads in Midtown or something like that. That revenue's kind of gone, and so there are a lot of different ways in which the revenue, the earnings of those city workers, whether they were physically living in New York and they've left or they were living in the suburbs and are not coming in as often, have a lot of spillovers and consequences on current residents. And so the loss of that is going to then impact the tax base.

You're going to see impacts also from the valuation of commercial real estate, which we can get into more and all of that is going to hit city finances. And so then that forces the city to kind of make a choice. Well, am I going to raise taxes, and that's going to maybe increase the exodus? Am I going to lower the amenities and the quality of public services, and that's also going to result in some people leaving? And so you can end up with this little bit of a spiral of further and further deteriorating services, lower and lower tax base and so on, so forth.

And we've seen many cities kind of deteriorate in this way. New York, of course, had some of these dynamics going on in the seventies and eighties. Detroit is maybe another city that's had these problems extending for a longer period of time. And it really was the entry of a lot of firms, particularly finance consulting tech firms into the centers of cities that really revitalized them in the 2000s to 2010s, and now it's precisely those set of employers and employees that are now kind of thinking about heading out again, and it just raises these risks and considerations for city governments.

Allison Schrager: I saw one estimate that you did that you said commercial office space stands to lose 28 percent of its value in the long run, and that would be, you said fairly catastrophic for New York City's finances and really how the city functions. What can they do about that to hedge that risk?

Arpit Gupta: Yeah. So I think one approach is to try to take advantage of the changing demand for space and opt for more conversions. So we have a lot of office buildings that are lower quality that people don't want to go to as often. We can convert some of them. Not easily, necessarily, but it's something that could be facilitated through changes in zoning to allow those to turn into apartment buildings. And that's going to actually lower the housing costs that people are sort of facing. In general, I think trying to lower housing costs and doing more building is one of the best things we could do because it sort of reverses that doom loop by increasing density, increasing presence, increasing spillovers, all those good things.

Keeping in mind that it's not necessarily that people hate cities, love cities, et cetera. Everything is good at the right price, and really the problem with cities in the decade running up to the pandemic is they were just getting more and more expensive. And so if you look at population moves, even before the pandemic, you see a lot of cities like New York were actually losing population before the pandemic even started, and I think that has really to do with housing costs. We know from work by a number of researchers that low-skilled workers, particularly in urban areas, really weren't getting a good deal before the pandemic because they were spending a large fraction of their paycheck just in order to pay for housing costs.

So cities weren't necessarily offering a great deal to those workers and finding ways of building more housing would accommodate more people in cities and reverse some of those negative dynamics. At the same time, I think cities also kind of need to take a close look at what's happening with transit. So that's a huge area where in New York City right now, we're probably something like 40 percent down in our transit use relative to what it was before the pandemic. The MTA system is going to go bankrupt in a few years if these trends don't change, and so you really have to take a close look and reform that system as well.

Allison Schrager: So one reason that lower-income people felt a need to live in cities or sort of a lot of people needed to live in cities, particularly low-income people who maybe had sort of higher future earnings, living in cities was really critical to sort of skill development and making the right contacts. I mean, do you think work from home's going to change that calculation?

Arpit Gupta: I think so, and it's going to kind of impact workers in different ways. So on the one hand, you have people that are just starting out their career and are interested in meeting people, meeting fellow coworkers, and so forth. I think being in the office at least a few days a week is still going to be quite attractive for some of these workers. At the same time, I think you have other workers, particularly low-skilled workers who were in cities not necessarily for any sort of career development motivation, I would say, but just because that's where the spillovers in consumption were from other workers that were spending a lot. And I think you're seeing the shift of those consumption patterns toward the suburbs, away to smaller cities, and I would expect other workers to follow that. So it's going to be relatively more attractive, let's say to be an Uber driver or to be a restaurant employee outside of New York relative to living in New York.

Allison Schrager: I moved to New York in 2000 and I feel like in retrospect, I might have been here and sort of what felt like, especially if you were young and upwardly mobile, a sort of magical time where it felt like the opportunities were endless. You kind of lived in a terrible apartment. I mean, that was the downside, but you also felt like it was safe and you had unlimited opportunities. Do you think that's no longer going to be the case?

Arpit Gupta: Yeah. So I moved to New York in 2009, and I sort of felt the same way, that it was a great place to be, great place to be young. To some extent, that's probably just a young feeling. It probably just feels great when you're young, no matter where you are. But I think when you look at migration patterns, you do you see that there are many fewer people moving into New York. So we've talked about the exodus, people that are in New York moving out, but there's also lower flow of people into New York City. A lot of that seems to be people that lived relatively adjacent to the metropolitan area, let's say New Jersey, upstate New York, some of these people have been less likely to come into the city, at least during the pandemic period. So my expectation is that may or may not change.

I think even in those dark periods of the seventies and eighties, I think what we saw is a lot of young people still moved into New York City. It was a little bit grittier, it was a little bit more crime, of course, but young people maybe even like that because they can find it more easy to access housing under those conditions. But what you saw in that period is that people were really likely to move out of New York City as soon as they had kids, as soon as they got married. You go straight to a suburban house, and so that kind of dynamic might be a little bit more common on the margin, especially if you're working on a more hybrid system.

We've kind of talked about New York City a lot, but I think the effects are even larger when you look at some other cities like San Francisco in particular. San Francisco, I think is just really the city that seems to be the most hit, so I can definitely imagine a world in which New York is certainly affected on several margins, maybe is no longer the destination it was, at least in relative terms, but San Francisco really gets hit, because that was a city where if you wanted to work in the tech sector, you just moved to San Francisco. That was just a thing you did. And it was a great place for many years. And I can imagine a world in which that may not necessarily be true anymore because of the job opportunities accessible, particularly in tech, all across the country now.

Allison Schrager: Yeah. It seems like whatever's true about New York, in San Francisco is true many more fold. Its crime problem, anecdotally at least appears to be worse. Its housing market got even more expensive and out of control. And as you said, jobs are even easier to do remotely.

Arpit Gupta: Yeah, that's right. And another issue with San Francisco, getting into some of the barriers around housing, have to do with the fact that it's hard to build in San Francisco and it's hard to build in any radius around San Francisco. That's true for both topological reasons, there are lots of mountains and oceans in the vicinity of San Francisco. And then also there are lots of regulatory restrictions that apply not just to San Francisco, but to all of the outlying areas. All of the South Bay municipalities also make it hard to build housing. And so there is just very little affordable housing in any radius around the city. New York is actually different in that respect. For example, Jersey City across the river is building a ton of housing, and so that at least generates some opportunities within the broader metropolitan area, even if New York City itself hasn't been doing very much to expand housing supply.

Allison Schrager: Did the New York Times just write that story, that Jersey City is one of the most expensive places to live?

Arpit Gupta: The prices are high, but I think it's a little complicated when you look at some of these headlines to really think about what are they measuring? Are they looking at new construction? Are they looking at median price? Are they looking at average price? You sort of see a lot of these rent statistics, the average rent in Manhattan is like $10,000 now. And I'm not always sure what precisely they're actually measuring. It certainly is true that prices and rents have gone up in Jersey, that's very consistent in our research. We find that kind of the further way you are from the city center, the more things have increased in both prices and rents. But I think Jersey is at least doing something on that supply margin and trying to increase new construction.

Allison Schrager: I think one of the reasons it seems to me that our housing market is just so wacky everywhere is on the one hand, the federal government seems to subsidize housing demand through creating this very unnatural 30-year fixed-rate mortgage that makes it really cheap and very low-risk to borrow. And then we have on the other hand, local governments restricting supply. So how do you think we could do better in terms of integrating our housing market?

Arpit Gupta: First, I think that's totally right. I think we just have a system that's very demand-focused in insuring credit availability, but not that concerned about lowering the barriers to new housing construction. So I think that's really the fundamental project is thinking about how can we expand new construction? How can we make it easier for developers to build? And let me toss out one other challenge, which is increasing the productivity of the housing-construction sector.

I think another kind of downstream consequence of all the regulations and uncertainty around the permitting and building process is you see that the real estate sector is basically the lowest productivity growth sector kind of in the whole economy or the last several decades. And so it's just been getting increasingly difficult to build, not just because of these regulations and constraints, of course that's a key issue, but also the impact that those have on our being able to improve our production technology. We're just kind of stuck in a low equilibrium where we just are not able to upgrade our technological capacity because any individual firm that's working in the sector just has to negotiate and deal with all these individual little planning, commissions, and councils and so on and so forth in ways that inhibit the right scale of technological improvements.

Allison Schrager: Yeah. It seems like everyone agrees, except for unless you're a hardcore NIMBY that we need to do more to increase supply, but do you think we should really be sort of pushing so hard on demand too? I mean, we seem to have a tax system and a financial system that really biases people in terms of owning housing, in terms of other financial assets. I mean, is that a good idea? Should we maybe not push housing so hard on everyone?

Arpit Gupta: I think that definitely makes sense. I will say in, I guess, some support of the federal housing system that aside from those credit risk transfer bonds that have at least offloaded some of the risk and the risk assessment to the private sector. The guarantee fees, the G-fees that Fannie and Freddie charge have also gone up pretty substantially. So this is the additional premium that Fannie and Freddie charge in exchange for that guarantee. And these days, it's sort of the neighborhood of 50, 60 basis points. In the past, it was kind of more like 20 basis points. So they've actually increased pretty substantially these costs that are then kind of going to the federal government.

So to the extent that people are still choosing Fannie and Freddie these days, they're purchasing a relatively expensive product, at least relative to what it was several years ago, and people have other alternatives. People can go and get mortgages in the private market. The private market has been growing a little bit. Let me just say, it's challenging to think about affecting the role of the federal government here, because we have been doing a lot of modifications to the system in ways that seem to make it a little bit better. And the alternative is this private mortgage system that had a lot of issues of its own in 2008. So it's definitely a tricky balance, but I hear where you're coming from. It doesn't really make sense to be pushing home ownership and the demand side as much while the supply side remains as constrained as it is.

Allison Schrager: I've always been weirdly anti-home ownership. It might just be the financial economist in me who's just like, "Why would I tie my money up in something so illiquid?" But I did buy an apartment during the pandemic. It turned out to be hopefully what was good timing in that I think I closed the week mortgage rates hit bottom, and it was also the bottom of the pandemic market for Manhattan. So now everyone tells me constantly, "Oh, that was so smart of you." Although, at the time it definitely didn't feel that way.

New York did not look like a happy place at the time. And rents, if you recall at that point as well were just . . . Landlords would like rent to anyone at any price, it felt like. So at the time, it didn't feel like a great risk, although right now it looks like it. And I'm still honestly not even convinced it was a great financial decision because we don't know the future in New York. Prices could fall, interest rates could go up, but I am very aware that pretty much a very large share of my wealth is now tied up in this very illiquid asset, and they're building a huge building in front of my window right now.

Arpit Gupta: You're turning into a NIMBY now.

Allison Schrager: I am literally a NIMBY now. Although, do I count as a NIMBY if I'm against a high-end condo?

Arpit Gupta: I think so. That's a lot of what NIMBYs are doing, is complaining about market redevelopment. Half of NIMBYs are complaining about market redevelopment, the other half are complaining about low-income development.

Allison Schrager: Yeah. I might be against low-income development too, just because it would decrease the value of my apartment. I really would actually like them to build something low, but actually have a park that only me and people in my neighborhood have a key to. I have to admit, I do like owning more than I thought I would. As I said, financially, I'm still not sure it was a really good decision for me, but psychologically, I really do like owning. I like the fact I can renovate my kitchen and things like that. Do you think even if in a perfect world where we didn't have huge restrictions on supply, homeownership is something that we should subsidize?

Arpit Gupta: Yeah. I have a few views on this. So economists like to kind of take two perspectives in thinking about issues one where we tell people they're wrong and the other where we're trying to understand where people are coming from. So the economist brain that tells people they're wrong is sort of looking at the financial side of things. You're, as you just said, locking up a ton of your savings into this one asset, it's very idiosyncratic, it's not at all diversified. How does that make any sense? But I think the other perspective, and I go back and forth between these two, is to sort of look at revealed preferences.

And I've done a lot of work in modeling and understanding home ownership, and basically you need to think of people as having something like the preferences you just said, which is they just like owning, they just like renovation in order to understand why home ownership rates are as high as they are. They're just no way of making sense of that statistic unless you think of there as being some psychic, warm-glow benefit to owning, per se. And it doesn't necessarily have to be super crazy. It can have to do with exactly the things that you mentioned. You have more control rights over the unit. You can renovate as much as you like. And the owning stock tend to be very different from the renting stock in many ways. Here in New York, if you want four, five, six bedrooms, you're really looking at owning units rather than renting them. And then certainly, if you're going out to the suburbs, you're going to get a very different housing stock, very different school districts, et cetera.

It doesn't make any sense to me personally. The last thing in the world I want to do is renovate housing. That's the worst possible thing I can imagine doing, but I just look at people's behavior and that seems to be a motive. And the final thing I think about with respect to this choice of owning and renting is something that has to do with sort of precautionary savings motives. So if you look at countries like Germany and Austria that have these incredibly low home ownership rates, lots of people rent, I think one thing that's kind of distinct about these countries is ever since Bismarck, they've had very well-functioning insurance systems. So people hit shocks, they're kind of covered against those shocks. And consequently, you see that Germans don't really own much wealth in general. Actually, median wealth is much higher in Italy than it is in Germany, even though income is, of course, higher in Germany.

Allison Schrager: So they're bigger savers, Italians?

Arpit Gupta: Yeah. Germans are not much into saving. They have lots of cash. They have just lots of deposits.

Allison Schrager: They hate risky assets. I've observed that.

Arpit Gupta: They hate risky assets. They're very concerned about inflation because all their assets are locked up into nominal cash under the mattress and so on and so forth. And actually, it's Italians and people in Spain and so on and so forth that actually have much more in the way of tangible assets, real estate, and things like that. And so that's, I think kind of an interesting policy choice. Whether you want people to accumulate and build up buffers of wealth within the family, within the household, or whether people can kind of expect insurance markets, the state, et cetera, to kind of cover these incidental unexpected expenses, such that people don't need to have very much in the way of wealth buffers on their own.

Another example is Singapore. Singapore, explicitly as a policy objective takes the idea that people should have enough money. And so there are a variety of tools, including home ownership that the government kind of proactively does for savings mechanisms, et cetera, to ensure that people have enough money individually, such that they don't need to rely on the government as much for insurance purposes.

Allison Schrager: So as you point out, I think one of the reasons people might like home ownership—not me personally, I like it for a lot of reasons, but not this, because I'm a rational financial economist—is the feeling like you're building wealth. As I said, I'm convinced I'm sitting on this incredibly risky illiquid asset, but everyone I speak to insists that I am sitting on this annuity that's going to pay me for the rest of my life with certainty. Maybe there's something about our culture or maybe there's just something mentally human about feeling like you own property and that has meaning. And so you also have written about how minorities tend to have much higher loan-to-value ratios because of the racial wealth gap. If housing is a really important part of wealth creation in our country and it's part of feeling part of an ownership society, are there policies we should take to change that or to subsidize housing in some way?

Arpit Gupta: Yeah. So the really interesting tension we were kind of trying to explore in that paper is how does housing as a wealth-building strategy work if you also need to live in a house to access local labor markets? And what I mean by that is you kind of face a choice. You can go to an area like New York, as we've been talking about, that offers great job prospects. Maybe changing somewhat with remote work and so forth, but in general, offers really nice labor market opportunities. Or are you going to pursue wealth-building through home ownership? And particularly if you are living under financial constraints, if you don't have much saved up already in terms of a down payment, most likely, you're looking at home ownership in a place that has less opportunity. So the choice is buy in a low-opportunity place or rent in a high-opportunity place for someone that's kind of constrained.

Obviously, if you build up more and more wealth over a lifetime, you can, as you just did, Allison, buy in a high-opportunity place. Maybe that's the best of both worlds, but for people that are more constrained, you're kind of facing a different set of trade-offs. And the interesting thing about this sort of trade-off is that if you rent, let's say in the high-opportunity area, maybe you're accessing all those great job opportunities, but you're not getting those psychic benefits of home ownership, nor are you getting those wealth-building aspects of home ownership either, though you're getting the benefit of other labor market opportunities. But at the same time, if you go and you buy in a low opportunity area, you're getting that wealth-building, you're getting that psychic benefit of home ownership, but you're kind of trapped in a place maybe that might not be ideal from other perspectives, like school district quality or local labor markets.

And so I think understanding that people face trade-offs and that might be more of a relevant set of constraints people are facing, I think causes us to kind of think differently about the nature of home ownership as a universal vehicle for wealth-building. What we kind of see is that a lot of minority households, a lot of low-income households are kind of accessing housing kind of at the top of the bubble. In 2005-2006 is when a lot of people got into housing. That's when credit standards were enough to enable even constrained individuals, people with no money down to get into homes. And that didn't really move people into home ownership at the right time, nor did it really move people into home ownership in the right places.

People were getting homes in all sorts of places that wound up bearing the brunt of the global financial crisis. So what policies should we do? What might make sense? We explore a couple different things in that project, so one thing to think about is lowering the barriers for people to migrate and move to different areas. Another thing might be place-based policies that improve prospects for people where they are, and you can think of remote work as being an example of one sort of policy that opens up a lot of housing stock, sort of deals with a lot of the NIMBY problems by just expanding where people can live and work across a much broader set of the country.

And I think you can also think about something like property taxes. So people kind of don't like property taxes in general, but I think they're actually very valuable from a policy perspective because it actually solves one of the things people say they care about, which is affordability. Because when you have higher property taxes, that's going to be capitalized into the house price, meaning that two homes otherwise identical, one has higher property taxes, you're going to pay less for it.

So higher property taxes kind of solves the affordability problem in the sense that it's going to lower the price of housing and people are going to find it easier to purchase homes, particularly people that are constrained by their down payments are going to find it easier to purchase homes if and when there are more property taxes, and so doing more to kind of tax those rents that come from home ownership and use that revenue to mean we don't need to rely as much on things like income taxes, which are far more distortionary to the economy, I think would be a healthy reallocation in ways that also prove affordability.

Allison Schrager: So I guess Texas has it figured out, because they have very high property taxes, but no state income tax.

Arpit Gupta: Yeah. I think Texas has a pretty good system. California has a worse system, because it has very low property taxes, the housing is totally unaffordable and I guess they also have high taxes in other dimensions to make up for it. School spending is actually surprisingly low in California. California does not have super high-quality schools, in large part because of this property tax issue. So it's a really weird comparison, just those two states. You see Texas do more of the Georgia solution. They also, of course, had tighter caps on mortgage lending, and so never really had the same problem during the financial crisis as did other states, so they kind of required more down payments and so forth. And in general, it seems, of course they allow more housing construction, so housing tends to be much more elastic there. So in general, it has a lot of advantages I think relative to some of these coastal states that are just dealing with a whole host of economic problems.

Allison Schrager: Well, unfortunately we’re running out of time, although I could keep asking you questions all day. So that is all with Arpit. You can find some of his writing on the City Journal website, city-journal.org, and we'll link to his author page. Although, I also highly recommend you check out his Substack, which he doesn't write enough, because I really enjoy it. But it's fairly intermittent, it's arpitrage.substack.com. Although it's worth it when you do see it, because it's clear it comes somewhat infrequently because he puts so much thought into it, and you'll learn a lot every time you read it. You can also find City Journal on Twitter @CityJournal, and on Instagram @CityJournal_MI. And as always, if you like what you heard on this podcast, please give us a five star-rating on iTunes. Thank you so much for joining us.

Photo by Thomas A. Ferrara/Newsday RM via Getty Images

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