2018/09/09

Post-crisis, Do Central Banks Wield Too Much Power?

European-Central-Bank

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Paul Tucker examines the enhanced role of central bankers after the global financial crisis.
51hQA4jhxYLCentral bankers are unelected officials but they have always had an outsized impact on economies and the welfare of citizens. After the Great Recession, they have gained even more power and influence as they brought the global financial system back from the brink. Paul Tucker, former deputy governor for the Bank of England who had a front seat as the financial crisis unfolded, said central banks have emerged as a “third great pillar of unelected power alongside the military and the judiciary.”
His book, Unelected Power: The Quest for Legitimacy in Central Banking and the Regulatory State, examines the enhanced role of central bankers and offers principles for them to follow to be good stewards. Tucker, who is also chair of The Systemic Risk Council, joined the Knowledge@Wharton show on SiriusXM, to share his insights.
An edited transcript of the conversation follows.  
Knowledge@Wharton: Considering the title of the book, should central bankers be elected officials?
Paul Tucker: No, it would be the wrong solution. But your question gets to the underlying problem. When we were born, the big decisions were taken by the people that we elected. Now, too many of the really big decisions are taken by judges or central bankers or regulators. We need to be careful about how we design these institutions, and we need to keep them to a narrow role.
Knowledge@Wharton: What are the most important things we need to consider when looking at central banks?
Tucker: I think slightly different problems come up in different jurisdictions. I’ll give an example from the United States and an example from Europe. In the U.S., the Federal Reserve and its congressional overseers need to get to a place where the Fed isn’t suspected, fairly or unfairly, of lending to institutions that are fundamentally unsound, which is bailing them out. That’s the job of politics, not the job of technocrats. It doesn’t matter whether they did do that, they’re perceived by some people on both the right and the left to have done so. They need to shed that perception and shift their policies and the way they explain their policies so that people feel more comfortable with them.
Knowledge@Wharton: How can central bankers help to better educate the public on what they do? Did the global financial crisis give us a better understanding of their role?
Tucker: Former chair Ben Bernanke going on [CBS news show] 60 Minutes was like talking directly to the American people. I thought that was a good initiative. Actually, I think the Fed chairs should go on television a little bit more. I don’t think they should compete with politicians, but they should try and explain what they do in as straightforward a language as they can muster.
“Our societies are now much more reliant on unelected power than on elected people, and this has had consequences.”
The European Central Bank has ended up being the guarantor of the whole economic system, yet they can never solve the underlying foundational problems. That, too, is an instance where the Central Bank has ended up being super powerful, yet it can’t deliver prosperity. It can only deliver stability.
Knowledge@Wharton: How is the Bank of England dealing with Brexit?
Tucker: Reflecting the results of a referendum in which the citizen of the U.K. voted, they need to stick to their basic job, which I think is what they’re doing: keep the economy going. Keep inflation in line with their target of 2%. Keep the banking system stable. That’s gotten more difficult because they don’t know what the deal is going to be. They don’t know what the terms of trade with Europe or the rest of the world are going to be. But they can’t solve that. They need to be responding to what hits them. They can’t be active players in what is a political, even constitutional, debate between the U.K. and continental Europe, and highly, highly charged in domestic British politics.
Knowledge@Wharton: What are the key functions of a central bank? Is it relatively the same in every nation?
Tucker: Yes. In a sense, the idea is simple: You put at arms’ length from the politics of both the executive and the legislative branches the task of maintaining the value of money in people’s pockets and in their bank accounts. This has to do with keeping inflation reasonably low and reasonably stable, and keeping the banking system safe and sound so that the money in bank accounts is going to be worth what people think it’s going to be worth.
That doesn’t mean that individual banks can’t fail, but that the whole system shouldn’t collapse, which of course is exactly what happened in 2007. I think it happened because central bankers — and I was one for a long time — had done a pretty good job at keeping inflation low, but they hadn’t paid enough attention to the resilience of the banking system. But that mission is now accepted again across the world. What’s changed is the politicians are much less involved in the broad swath of economic policy than they were a few generations ago.
Knowledge@Wharton: How specifically has that changed? Let’s use the United States as an example.
Tucker: What is the face that you associate with the United States finding its way out of the Great Depression? President Roosevelt. Whether people liked what he did or didn’t like what he did, that’s the face you associate with it. We’re 10 years after the crisis. There are lots of articles and conferences on 10 years after, and who are the faces? Fed Chairman Ben Bernanke, Treasury Secretary Hank Paulson, Treasury Secretary Tim Geithner. It’s a massive change in only a few generations that we’ve gone from President Roosevelt being the face to a bunch of unelected people being the face of crisis management, rather than President George W. Bush or President Obama. That’s not a point about those men individually. Our societies are now much more reliant on unelected power than on elected people, and this has had consequences.
Knowledge@Wharton: Are we better off now?
Tucker: If I compare it again with the 1930s, I think the Fed was much faster out of its blocks this time in 2008 than its predecessors were in the 1930s. That’s true in Britain, and I think that’s true in continental Europe. It’s part of why we didn’t revisit the horrors of the Great Depression.
“We need to allow individual banks to fail but not the whole system to collapse.”
But what didn’t happen after a few years is big action by government. I’m one of those who thinks that the U.S. government could have come in with some fiscal actions around improving infrastructure across the American continent. I think that would have been good for the productive efficiency and capacity of the economy. It would also have meant that the Fed interest rate could have been a bit higher. There have been costs to what the Fed has done. It has fueled exuberance and a bit of a boom in financial markets. While it’s helped the economy as a whole, it’s hurt … people who rely on income from savings. I do not think this is the Fed’s fault. The Fed or the European Central Bank in Europe, they’ve ended up filling a vacuum left by politicians. As citizens, we shouldn’t be comfortable that the political actors didn’t act.
Knowledge@Wharton: How has the scrutiny of central bankers continued post-crisis?
Tucker: I think this is part of a trend. I’m sure you remember a book by journalist Bob Woodward called Maestro about Fed Chairman Alan Greenspan. The title of that book should make us all cringe. These are meant to be unelected people doing the job given to them by Congress. There should be no question of maestro. You get this slightly politicized scrutiny and debate when people [realize], “These people are in charge,” and no one in the Federal Reserve wants that. But it depends a bit on the design of the institution by Congress, and then Congress being prepared to be the cavalry when necessary.
Knowledge@Wharton: When Yellen was chair, there were many news stories about President Trump questioning the path of the Federal Reserve. What was your reaction to that?
Tucker: In every country with an independent central bank, occasionally politicians make comments about what the central bank should do. You just have to shrug them off in the sense that you’ve been given a job by Congress, or in my case by the British Parliament. They’ve made you independent of politics. They can take that power away. But so long as the power given to you by the sovereign parliament exists, you can’t heed day-to-day commentary from the president or the finance minister or whatever. You just have to shrug that off. I’m sure that’s how central bankers around the world feel about it.
Knowledge@Wharton: You talk in the book about a money credit system and what central banks and institutions can do. What does that mean?
Tucker: The most extraordinary thing about our monetary system is that most of the money all of us have isn’t the money that’s issued by the central bank — it’s monies created by private-sector banks. These private-sector banks are useful because they take decisions about who can borrow away from the state and make it part of commerce. But these banks are fragile. We need to be clearer that central banks have a responsibility, and Congress has a responsibility, for thinking about how we want this mixed money credit system to work.
“A lot of the changes … made in the immediate aftermath of the crisis were good changes.”
We need to allow individual banks to fail, but not the whole system to collapse, as has happened maybe twice in the 20th century. I don’t think we’ve really paid enough attention to what freedoms should banks have, what constraints should be put on banks, and what constraints and obligations should be put on the Federal Reserve.
Knowledge@Wharton: Do we expect to see some loosening for banks in this administration?
Tucker: I’ll say two things about that. First, loosening the reins around the community banks, which is part of what Congress has recently done, strikes many people as a sensible thing. Loosening the constraints on the big banks, that’s not a sensible thing to do. The United States isn’t suffering from a lack of credit or lending.
A lot of the changes that the international community made in the immediate aftermath of the crisis were good changes. But it’s no bad thing after 10 years for people to think, were the right things done? What I think is a mistake is to think that there was over-shooting on every front. On some fronts there was over-shooting, hence rolling back on community banks. But on some fronts, probably not enough was done. The United States still faces a problem in that you’ve got lots of things that are not legally banks, they could get into trouble in just the same way as banks, yet they’re not able to borrow from the Federal Reserve against good collateral. And people haven’t been brave enough to take on the lobbies.
There’s a problem that if you get something that is a new activity that is very like banking that legally isn’t a bank, and initially it’s quite small so you don’t feel you need to respond to it, by the time it’s big enough that actually it matters to the stability of the financial system, they’ve also developed lobbying power. I’ve seen that again and again. I think it’s particularly a problem in the United States.
Knowledge@Wharton: I wanted to ask you about the dynamics between the Federal Reserve and other central banks around the world. How different is the structure here, whether the Fed itself or the Federal Open Market Committee (FOMC), in comparison to other countries?
Tucker: I’m going to make what sounds like a kind of tiny point, but I think it matters a bit. The Federal Open Market Committee, which decides interest rates in the United States, it’s quite a big committee with 12 voters at any one time and five or six or more talking. That’s too many people to have a proper discussion. I’ve ended up thinking that they kind of negotiate with each other via speeches. This is one of the things the U.K. has got right. The committee is nine. It’s one person, one vote.
I think they truly deliberate and change their minds individually in the meeting as they listen to their colleagues. Certainly, I did a couple of times. In continental Europe, it’s even bigger. Whereas I think the United States may have a problem in that respect, I’m pretty sure the continental Europeans do.
“They’ve done a good job at the ECB, but the underlying foundations are weak.”
I want to now tilt the other way that a great strength of the FOMC is the regional representation. This is not an institution that is just from Washington. It’s based around the country. I wish that the leaders in Washington got around the United States a bit more so that the people saw the leaders a bit more. I wonder whether the new leadership there won’t do that. Chair Jerome Powell and the vice chair strike me as trying to speak in relatively straightforward language that the American people can tune into rather than having to read a newspaper to make sense of it.
Knowledge@Wharton: How important is it to have an understanding of the differences in regional market conditions when setting policy?

Tucker: I had a big experience of that kind when I was making monetary policy in the U.K. In the early 2000s, we were moving towards raising interest rates. One of my colleagues, Mervyn King, who was the governor of the Bank of England, had been out around the country talking to people. They were saying, “Lots of people have been turning up from Poland and elsewhere. We’ve got more capacity in this economy than we thought.” And that wasn’t showing up in the data. The anecdote was that the feedback from business around different parts of the U.K. was more accurate than the data. And if that’s true in the U.K., which is much smaller than the size of the United States, that network of intelligence that the Fed has around the enormous landmass of the United States is hugely important.
Knowledge@Wharton: Does that make it more difficult to have unification of something like the European Union, especially from a financial perspective? What role will … the European Central Bank have in the years to come?
Tucker: They’ve done a good job at the ECB, but the underlying foundations are weak. Let me give you an example. Someone sets up a business in Massachusetts. All of their customers, suppliers and employees are in Massachusetts, but all of their equity holders are in California. Then maybe there’s a downturn in the Massachusetts economy, and this firm is a big one and it fails. The downturn is bigger because of the failure of this firm, but some of the risk is borne by California because of the equity market. Most transfers of risk across the economy of the United States are done by the equity market, not the fiscal authority. But when they’re really terrible, then the truth is that there are federal support systems for employees who’ve lost their jobs around the whole country.
In the euro area, there isn’t an equity market that is cross-continental in the same way. Perhaps even more important, there isn’t this catastrophic federal insurance safety net in extremities. That’s what President Macron in France is trying to promote. In a sense, they’re trying to do the equivalent of what was done by the Founding Fathers [in the U.S.] in slow motion because they’re not doing it in the 18th century, they’re doing it in the 21st century.

Why Diversity Is About Much More Than Numbers

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There is now considerable research showing that diverse organizations may enjoy a performance advantage. I certainly know that my thinking is improved, and the decisions I participate in are better, the more diverse perspectives I listen to and learn from. But all around us today we also see instances where differences among people — be they countries of origin, educational background and social status, gender and sexuality, race and ethnicity, physical and mental abilities, or political ideologies — can also create polarizing frictions.
At Wharton, we believe in the power of diversity. But we also know that increasing diversity in our students, faculty and staff is only the beginning. It takes clear thinking and commitment to translate the potential benefits of diversity into better outcomes for everybody. That is true in universities. It is also true for corporations, not-for-profits and governments.
Here are four “shoulds” to ensure that diversity is an asset for all organizations and for society as a whole. My thinking on this topic has been greatly influenced by conversations with my Wharton colleague Stephanie Creary, who teaches a wonderful course on “Leading Diversity in Organizations.”
1. Diversity: Membership in your organization should reflect the rich array of diverse backgrounds and perspectives in society.
Two things are true in many organizations today. One, great efforts are continuing to be made to diversify their membership. Two, there is still a long way to go, not only in further increasing diversity itself, but also — at least as important — in creating an environment in which diversity can be leveraged for the benefit of individuals and the organizations of which they are a part.
2. Inclusion: Every member of your organization should be invited actively to participate in all aspects of your organization.
The point that recruiting a diverse organization is only the first step in realizing the full benefits of diversity was made in a way that really struck me at a panel on leading diverse organizations at last June’s Wharton Global Forum in New York. Janet Cowell, a Wharton alumna who is CEO of a great not-for-profit devoted to increasing the number of women in finance (Girls Who Invest), put it something like this: It is one thing to be invited to the party, but what really matters is being asked to dance.
A somewhat more formal translation: Make sure your organization is diverse, but it is equally important that everyone in your community is invited to participate in everything you do.
3. Belonging: All members of your organization should have the confidence and support to contribute their unique perspectives to every aspect of your organization.
To continue the dance metaphor, when someone at a party is asked to dance, do they just shyly or reticently say, ‘No, thank you’? Or do they feel free to bust out their best moves, whatever they may be? Remember Elaine Benes grooving to Earth, Wind and Fire’s “Shining Star” in a classic Seinfeld episode?
There is a really important point under the humor. Organizations can only really benefit from their diversity if all members in their community feel they truly belong, feel fully safe, and hence have the confidence to be themselves and say what they are thinking.
In the Seinfeld episode, Elaine was completely oblivious to the disdainful reactions of the other party goers to her unusual moves. That was the joke. But that is the opposite of belonging. Here’s my revision of the script: When Elaine enters the dance floor, fully confident she is safe among people she can trust to support her, everyone responds by joining her with their own, idiosyncratic dance moves — all sharing in and benefiting from the experience.
Step 4: Respect: All members of your organization should be respected for who they are and what they have to say, no matter who they are and what they have to say.
As my rewrite of Seinfeld makes clear, a precondition to one’s sense of belonging is the respect of others. When there is respect for everyone’s backgrounds, perspectives, contributions and points of view, there will be trust. Everyone can feel empowered to be their full selves.
“The full potential of diversity can only be realized when all members of an organization feel included, that they belong, and that they are respected for who they are and what they offer.”
This is the ultimate feedback loop for organizations that leverage diversity. It ensures that differences in backgrounds lead to an open sharing of the full gamut of perspectives embraced by all members of the organization, stimulating a rich diversity of contributions. Ultimately, it results in better culture, better decisions and better performance.
It’s important that today’s diversity agenda be about more than the number of women and minorities at schools like Wharton, in executive positions and on boards at finance and tech companies, and about more than having gender and disability-inclusive bathrooms. These are no doubt essential. But they are only the start.
The bathrooms at LinkedIn in the Empire State Building
The full potential of diversity can only be realized when all members of an organization feel included, that they belong, and that they are respected for who they are and what they offer. I laughed at Elaine back then. Now, I wish everyone had joined her on the dance floor and just as confidently boogied on down.
(This article originally appeared on LinkedIn.)

How the Mayo Clinic Built Its Reputation as a Top Hospital

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“How is it that in the middle of a relatively small town of about 125,000 people in Minnesota, you’ve got the number-one-rated health care system probably in the world?”
The question was put to Jeffrey Bolton — the Mayo Clinic’s chief administrative officer — by Larry Jameson, executive vice president of the University of Pennsylvania Health System, during the recent Wharton Leadership Conference. Jameson, who was interviewing Bolton, said he wanted to understand “the Mayo magic.”
Founded more than a century ago by two brothers in the rural Midwest, the Mayo Clinic has built a world-renowned reputation as an exemplary network of clinics and hospitals that has become the preferred destination of patients with difficult-to-treat conditions. Today, the nonprofit health system cares for more than a million people annually from about 140 countries. It employs more than 63,000 people and brings in $12 billion in annual revenue. The Mayo Clinic was ranked number one in the 2018-2019 ‘Best Hospitals Honor Roll’ compiled by the U.S. News & World Report. Indeed, it regularly lands at or near the top of these rankings.
As lifespans lengthen and more money is spent on medical care, places like the Mayo Clinic, which prides itself as being a referral center for advanced and complex cases, will become even more essential. “As people live longer and have multiple different chronic diseases, the need for … advanced services will be ever greater,” Jameson said.
Patients Come First
Bolton said what differentiates the Mayo Clinic from many health care organizations is that the needs of the patient come first. While many medical centers claim the same thing, he said, the Mayo Clinic is actually structured to support it as a goal. The health system is organized to foster teamwork, not hierarchy.
Bolton traced the concept to the clinic’s beginnings in the late 1800s. Brother physicians William and Charles Mayo, along with a small group of other founders including Franciscan nuns, created a model of medical collaboration inspired by helping local victims of a tornado. Teams of specialists provided patient-centered care, although the term didn’t exist then.
An oft-repeated anecdote from the clinic’s early days reflects the organization’s focus on teamwork instead of position. Dr. Will Mayo was once asked by a patient, who was looking for the person in charge, “Are you the head doctor here?” He answered, “No, my brother’s the head doctor. I’m the belly doctor.”
The collaborative model is still alive and well in the organization, said Bolton. Indeed, he added, Mayo is one of the largest integrated group practices — not only within and across specialties but in administration, nursing and technology.
Jameson said he has seen the Mayo Clinic teamwork in action. “I want to underscore that [Jeffrey] is not just blowing smoke. This is the way it really works.” Patients come into the Mayo Clinic and see a doctor. If there’s a deeper problem involved, say with the gastroenterology system or another issue, the patient gets moved that day, or even that hour, to the next specialist, “so problems get solved. And this is what attracts people,” he said.
Bolton noted that part of Mayo’s philosophy has always been that “the wisdom of peers is greater than any individual.” It’s almost expected, he said, that if you see a patient with an issue you’re unsure about, “you pick up the phone and call a colleague — either within your specialty or another specialty — and seek out insight.” And now that Mayo Clinic has electronic medical records, that colleague can also pull up and view the patient’s information.
“[The] wisdom of peers is greater than any individual.”–Jeffrey Bolton
Indeed, Bolton said the Mayo Clinic was the first hospital to maintain standardized information on its patients, starting 110 years ago. Obviously these were on paper and traveled with the patient, but “every physician that saw that patient had the full record in front of them — the medications, the diagnoses.”
Salaried Doctors
Another feature that distinguishes the Mayo Clinic is that it’s a physician-led organization, which is fairly rare. Yet this model leads to better quality of care that routinely lands the clinic atop the lists of best hospitals. Bolton said the Mayo Clinic uses a “leadership dyad” model in which a physician leader is paired with an administrative partner. Bolton himself is the administrative partner to president and CEO John Noseworthy, a neurologist and multiple sclerosis specialist.
Putting doctors in charge of the organization is one way that the Mayo Clinic ensures that it provides the best care for patients. This approach is taken by the entire clinic, including its research and educational branches. “We are really very conscious about having our physicians and scientists co-lead,” Bolton said.
Even the way Mayo physicians are compensated reflects the institution’s collaborative philosophy. Bolton explained that all of Mayo’s specialists, sub-specialists and physician-scientists get a salary after five years on staff. This also is unusual in health care. He added that the salaries are consistent within specialties: All cardiologists are paid the same, all neurosurgeons are paid the same, and so forth. “So there’s no real incentive for driving volume within your practice,” Bolton said. “You’re really, again, focused on what the needs of the patient are.”
Jameson agreed that the salary arrangement removes “potentially perverse incentives that are based on volume.” American medicine is often criticized for being too profit-oriented, sometimes at the expense of optimal patient care.
“You have to come in with a certain mindset, and really focus on the mission.”–Jeffrey Bolton
With its adherence to close peer collaboration, a team approach to care and pre-set salaries, the Mayo Clinic’s foundational tenets go against the conventional image of the American doctor as a lone, brilliant individual who builds a reputation and gains wealth as patients flock to his or her practice. Would some physicians hesitate to work in this kind of environment? “I think you could imagine that the Mayo Clinic really isn’t the workplace for everyone,” said Bolton. “You have to come in with a certain mindset, and really focus on the mission.”
The Money and the Mission
The Mayo Clinic has its own set of challenges, however. A central one involves maintaining both financial sustainability and the quality of care that has made it world-famous.
“Every hospital system that has some Catholic roots has heard the phrase, ‘no money, no mission,’” said Bolton, referring to the Franciscan Sisters’ role in the clinic’s founding. “A lot of people forget, though, the other side of that: ‘No mission, no need for money.’” There are tensions at the clinic around balancing the business side and the humanitarian vision. Some staff members feel it is becoming too “corporate,” but Bolton said the clinic works to continually underscore the values upon which it is built.
Bolton also talked about the complexity of running a hospital system today, including the massive capital demands of health care. “It’s a people-intensive industry, something like the airlines, if you think about capital and people,” he said. Mayo does a lot of charity care and subsidizes a great deal of Medicaid and Medicare business, but needs a certain amount of commercial business to balance that out and generate a profit even though it’s a non-profit. Mayo’s business model needs continued investment and reinvestment to stay at the leading edge, he said.

Why the U.S. Rental Market Is Increasing Inequality

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Wharton's Benjamin Keys, Zillow's Aaron Terrazas and the Brookings Institution's Jenny Schuetz discuss trends in the U.S. rental market.
A lasting fallout from the Great Recession has been a sharp rise in the number of Americans who are renting rather than owning their homes. Sky-high real estate costs, financial insecurity and job instability have pushed many people out of the home-buying market and into rental units, especially in large cities. Following supply and demand, the increase in renters has come with an increase in rental prices. Those prices have eased a bit in the last several months, but there is a disturbing trend in the numbers: Rents for the most expensive places are declining while rents for cheaper places are rising, adversely affecting those on the lower end of the income scale.
The Knowledge@Wharton radio show, which airs on Wharton Business Radio on SiriusXM, invited three experts to explain what’s happening in the rental market. Benjamin Keys is a real estate professor at Wharton and a fellow at the National Bureau of Economic Research; Aaron Terrazas is a senior economist at Zillow; and Jenny Schuetz is a fellow in the Metropolitan Policy Program at the Brookings Institution. The following are key points from their conversation.
It All Goes Back to Supply and Demand
At first glance, it doesn’t seem logical that rental prices would decrease only for higher-end units and not across the board. But the experts said a deeper dive into the data reveals the complexities of supply and demand in the market.
In the last several years, most metropolitan areas have seen a flurry of apartment construction to house new residents who are flocking to cities in search of jobs. Most of that construction has been in luxury units with sky-high rents rather than more affordable accommodations. The resulting glut of upscale units is what is easing price pressure on that side of the market.
“What this latest data is telling us is there are a lot of different submarkets within a given metro area, and when you look at where the building has been going on, it’s really been geared at the very top,” Keys said. “You’re not seeing that same construction at the lower end, so you’re getting this discrepancy between the top and the bottom.”
Meanwhile, Keys noted, there are a lot of lower-income renters who are desperate for housing they cannot find, so the competition is fierce. “Some of it is just a simple supply-and-demand story.”
Terrazas agreed and cautioned against taking a simplistic view of the market. Typically, analysts tend to look at medians and averages in real estate, but they should be examining the “tails” of the distribution to get the full picture of what is happening at the top and the bottom of the market.
While over-investment in upscale rentals has influenced prices, Terrazas said, the numbers also show that more well-to-do millennials are buying homes right now. “Those higher-income young adults who typically rent those apartments have been out buying homes. The labor market is very tight. Interest rates are still very low. Those are the people who have been propelling the purchase market, leaving vacancies in the rental market. That’s not happening for lower-income renters.”
Schuetz thinks the question of why rents haven’t started to soften farther down the price spectrum is an important one to ponder because the discrepancy indicates an imbalance in the market. The lack of middle- and low-income rental units is a problem that has been decades in the making.
“We’ve certainly seen a boom in building in the last several years, but that comes after the absolute trough during the Great Recession. And we’ve been under-building multifamily housing for about 25 years now,” she said. “We’ve seen supply finally start to catch up at the high end. We would expect that’s eventually going to translate into at least more stable rents in the middle of the distribution, possibly lower, but it’s going to take a while for that to happen.”
“You’re not seeing that same construction at the lower end, so you’re getting this discrepancy between the top and the bottom.”–Benjamin Keys
It’s Still Location, Location, Location
Like everything in real estate, location is the mitigating factor. Rental affordability depends largely on where you live. Schuetz recently published a policy paper that outlined two distinct affordability problems in America.
In high-cost cities including New York, San Francisco and Washington, D.C., the dearth of housing means prices are very high even for middle-income earners. Even relatively high-income earners can’t afford to buy homes in those cities, so they are staying in rentals longer. At the same time, bottom-income earners representing 20% to 25% of households don’t make enough money to pay for even modest-quality apartments.
“We’ve got a lot of people who are competing for the bottom end of the market,” Schuetz said. “They have no place else to go, and their incomes just aren’t keeping up with the cost of inflation and maintenance of apartment buildings.”
Housing affordability for low-income families is a national problem regardless of location, she said.
“Rents are going to be lower in, say, rural Texas or Detroit, but the incomes are also proportionately lower,” Schuetz said. “Poor families can’t afford to pay the rent pretty much anywhere; middle-income families are only stretched in the high-cost markets.”
Can Policy Fix the Crisis?
The experts said policy changes at the federal, state and local levels can ease some of the burdens in the housing market. But the changes have to be tactical and specific if they are going to work.
If the dearth of modestly priced rentals is the problem, then building more of them is the solution. Yet many cities have too much red tape getting in the way, Keys said.
“We’ve certainly seen a boom in building in the last several years, but that comes after the absolute trough during the Great Recession.”–Jenny Schuetz
“There are a number of barriers to building, but a big constraint is local zoning policy that inhibits more dense building, especially around transit,” he noted. “A lot of cities are really struggling with the barriers that have been put in place through restrictive zoning.”
At the federal level, existing programs to help lower-income Americans with housing are relatively inelastic, he said. Unlike food assistance or unemployment insurance, housing vouchers and other funds don’t expand and contract to meet fluctuations in demand. That’s unlikely to change under the Trump administration, Keys said, citing a recent New York Times articlethat discussed the inaction of the Department of Housing and Urban Development.
Some individual legislators are pushing policy changes forward, including U.S. Senators Cory Booker, D-N.J., and Kamala Harris, D-Calif. Both have introduced rent relief measures that would provide tax credits to renters, and Booker wants to use Community Development Block Grants to incentivize cities to relax zoning restrictions. But Schuetz said both measures are limited in scope, so they don’t address all aspects of housing affordability.
In California, Democratic state Sen. Scott Wiener introduced a bill to allow the state to override local zoning laws that prohibit high-density construction around transit stations.
“That’s a huge proposal that’s different than anything we’ve ever seen before,” Schuetz said. “Unfortunately, it went down in committee. But I imagine something like that will make a reappearance.”
California is also contemplating expanding rent control to include newer buildings.
“That’s an extremely controversial proposal,” she said. “We have quite a bit of evidence that rent control ends up reducing the housing stock and actually hurting poor families. But there are interesting coalitions building around that because there’s such a sense in high-cost cities that rent has been going up faster than income, and this is a measure to try to help.”
Is the American Dream Dead?
America has long rewarded its citizens for becoming property owners rather than renters. Homeowners are allowed to deduct mortgage interest from their taxes, and they aren’t taxed on profits from the sale of a primary residence.
“That American dream is still very strong but evolving around the edges.”–Aaron Terrazas
That tradition skews the debt vs. equity trade-off towards debt, Keys said. High-income earners, who are more likely to be homeowners anyway, reap the greatest reward from mortgage-interest deductions. It’s a benefit that doesn’t necessarily help those on the margins, he said.
“To the extent that we want to encourage the American dream and get people into a home, and the stability that home can potentially provide as a way to benefit a neighborhood, as a way to build wealth, we don’t think the mortgage-interest deduction is really designed to do any of those things,” he said.
Terrazas cited a Zillow survey that asked Americans in the 20 largest metro areas to characterize their ideal home. Overwhelmingly, across all age groups, a single-family home in the suburbs was the winner. That result challenges the popular narrative about downsizing and city living, he said.
“We’ve heard so much about the shifting preferences of Americans and the decision between renting or owning. In some respects, it’s certainly evolving. In some respects, it’s still very much the same,” he said. “That American dream is still very strong but evolving around the edges.”
Terrazas said the major tax reform bill enacted this year contains changes that “begin to lift Uncle Sam’s finger a little bit away from … pushing Americans toward homeownership.” Those changes include caps on mortgage deduction and loopholes that allow homeowners to deduct a larger portion of their state and local taxes if they rent out a portion of their house.
The Renting vs. Owning Cycle Will Keep Turning
Terrazas said he believes Americans will continue to want to buy homes.
“I don’t think there’s any doubt that buying is going to continue to hold a strong appeal in the American imagination,” he said. “There’s something fundamentally attractive about fixing your housing costs for 30 years as opposed to being subject to 12-month contracts.”
Shifts in the economy and personal finances will influence whether Americans buy homes in their 20s, 30s or 40s, and what kind of property they purchase. But Terrazas thinks a “strong majority” of citizens will be homeowners. However, he acknowledged a steady demand for rentals even as that market slows down.
Schuetz said the strength of the rental market since the recession indicates that renting is the right choice for many people. She said federal policies need to be adjusted to accommodate the fact that renting is “going to part of almost everybody’s life cycle” as people face greater uncertainty over careers, marriage, children and other variables.
“We’d like people to pick the tenure that’s appropriate for their financial situation, their place in the life cycle, their job situation,” she said. “Renters have an easier time breaking the lease and moving to a new city if they get a job offer, and people who haven’t yet made permanent family arrangements may need to change the size of the house they’re living in.”
There’s big advantage to having flexibility, Schuetz noted. “We’d like households to be able to make those decisions based on their personal financial circumstances, not based on federal tax policy that gives them an incentive to buy when maybe that’s not the best decision for them.”