To Fight Inflation, Build Starter Homes

Last month, The Economist published an article called “A global house-price slump is coming”, and I posted this comment on Hacker News: 

I haven’t changed my mind. In my opinion, a housing crash won’t happen, because several trends (balancing feedback loops, in system dynamics lingo) are working against it. So, house prices may decline temporarily, but I don’t think they’ll stay down. 

The Building Shortfall

What’s behind the housing shortfall since the Great Recession? For starters, since 2008, builders haven’t built houses at their pre-crash pace. And when they did build houses during the 2010s, they generally tended to build the most profitable types: large houses at higher price points. Starter homes got short shrift. 

Now, with interest rates rising, housing starts (a term for when builders start building a house) are way down again. But what we need is way more housing starts to make up for a tremendous shortfall. We especially need starter homes. 

The Demographic Crunch

Demographics are also working against house-price declines. For a start, in the US, there are more Millennials than Gen Xers: about 6 million more. And Millennials as a group have entered their family-building and home-buying years, so many of them are looking to buy houses. 

At the same time, more Boomers are choosing to age in place rather than downsize—and this was true even before the pandemic. That might be partly because they locked in low mortgage rates on their existing homes (if they haven’t paid off their houses yet) and partly due to personal choice, but it’s now even more likely because assisted-living facilities had so many restrictive policies and COVID casualties during the pandemic.

The Rate Lock-In

Before this year’s rate ramp-up, mortgage rates were historically low for about a decade in the US. Anyone who locked in a low rate for a 30-year fixed mortgage¹ is probably not going to take on a higher-rate mortgage unless they have to. I think most home sales will be due to death, divorce, or forced relocation, unless the seller intends to buy their next home in cash.

Given all of the above factors, home inventory will likely stay constrained for the foreseeable future. Although further interest-rate hikes may cause home prices to fall, that won’t do much to jostle into motion the people who already have mortgages. And with inventory low, home prices will fall less than they otherwise would. Ample demand will probably persist at any price even slightly within the realm of affordable. In other words: don’t expect a fire sale. 

This isn’t 2008, which was preceded by a housing glut and a huge issuance of adjustable-rate mortgages that left owners stretched, underwater, and facing foreclosure when home prices declined. In 2022, there’s a longstanding housing shortage and a huge pool of existing low-rate mortgages that are making existing homeowners’ mortgage payments ever-lower and more affordable in real terms. 

Foundation of a Remedy

The only thing that could loosen this logjam is counterintuitive and might represent a true leverage point, in the language of system dynamics. In simple terms, the US (and other countries facing similar inventory crunches) could build new starter homes.  

This doesn’t mean, “Incentivize private builders to build more houses through indirect tax credits.” That approach would likely result in more high-end houses and still not enough starter homes, so it wouldn’t hit the right leverage point. 

It also doesn’t mean, “Dump cash into everyone’s pockets, but not enough for a down payment, so they use it on small expenses, pay down debt, or invest it in the stock market.” That approach misses the dartboard, let alone the bull’s-eye.

It means, “Directly build more starter homes, the kind most needed, in the places that most need them (i.e., where people want to live)². Keep doing that until demand and supply match.”

That probably sounds radical. It’s the type of all-hands-on-deck policy in vogue during the Great Depression. But the policies used in recent decades haven’t led to uniquely great outcomes. (Yes, outcomes have been uniquely great for private business and technology in recent decades, but corporate welfare does not equate to a country’s overall welfare). 

Let’s Raise the Stakes 

I’ll take this even further. To build these starter homes, the government could start a new initiative similar to the Works Progress Administration (WPA), offering much-needed employment to people left behind by an economic shift from Industrial Age to Information Age. At good wages and with good benefits, these jobs could replace lost factory jobs and perhaps attract people who’ve dropped out of the labor force. 

Even better, to incentivize working on the project, these jobs could offer a path to buy one of the starter homes: first choice of location and site, a guaranteed mortgage at affordable rates after a certain tenure in the role, and a discount on the list price. 

This type of approach would do several things:

• Address the supply shortage, rather than trying to cause a demand shortage when there is actually a huge excess of demand no matter what else you do. 

• Stimulate the economy with blue-collar jobs to balance out rising unemployment in higher-wage sectors, contributing to a soft landing by helping the people who most need help to get through this period. 

• Get lower-income people invested in the financial economy again, in a way that actually works for them instead of against them, by offering home discounts and a pathway into the middle class, which needs to be strengthened and expanded anyway to ensure long-term societal stability.

• Modernize the pool of available starter homes and use energy-efficient building techniques to keep utility bills low for future homeowners.

All these things point toward “build a lot more starter homes” as a possible leverage point to shift the housing “system” toward a better state. Detailed modeling and simulation could make the final determination of that.

Note: It’s been about six months of Risk Musings! What have I not covered that you’d like me to write about? Which articles have resonated most for you? Please hit Reply and let me know. I’d be happy to hear from you!

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Extra, Extra!

Tangential extras for curious readers: 

1. What Can Be Done About the Global Housing Crisis? Plenty - by Chris Stokel-Walker in Wired - a survey of how different countries approach housing and what has and hasn’t worked.

2. 2022 winter housing market predictions - by Erik J. Martin in Bankrate - this article sort of agrees with my view but for slightly different reasons. Full details in the article.

1. Yes, I’m aware 30-year fixed-rate mortgages are a US thing. I think they benefit seniors and lower-income homeowners, though I’m aware of and open to hearing arguments in favor of fixed-rate mortgages with periodic resets, as done in the UK, Canada, and Australia.

2. Fannie Mae gets deep into, from a US perspective, what types of homes are needed where in this article. But there’s no reason governments couldn’t build different types of homes in different areas of the country.