February 10, 2017

Do You Really Own Your Home? Fix It Up With Some Property Rights!

If you’re anything like me, you spend 30% of your day sleeping, 10% cooking, and approximately 60% watching people renovating and selling houses on HGTV. What’s better than sitting back on your functional but not-so-pleasing to the eye sectional sofa in your cramped house to watch people create the open floorplans and tile patterns of their dreams? Many of the channel’s hit shows feature people searching for or creating their dream house, and who better to make that dream come true that the quirky and lovable Chip and Joanna Gaines. The show’s hosts introduce prospective buyers to two or three homes that are well below their maximum budget, leaving plenty of room for renovations. After a bit of cajoling, the family chooses one home and design plan, and the work begins in earnest; breathing new life into a house that has otherwise been neglected. At the end of the show, the remodeled house is revealed, and that episode’s featured family is given a grand tour of the house that is now theirs to enjoy! However, as these families are quickly discovering, the house might not be as much “theirs” as they thought.
How much work would you put into this Fixer Upper?
(Photo credit: chumlee10 on Flickr)
This recent article details how many of the people featured on the show thought they were designing their dream home, but are now sharing that dream with frequent visitors. A large proportion of the homes remodeled on the show are now being featured as vacation destinations on websites including Airbnb and VRBO. The reasoning for this is pretty simple; the homes have become immensely popular with viewers of the show who want a first-hand look at how the house came together, and the rentals provide extra income for the home’s owners. While the home owners from those first seasons aren’t breaking any rules or laws by renting their houses out, the producers of the show aren’t exactly thrilled. Two questions arise out of this disagreement. First, can the producers actually forbid these homeowners from renting out space in their own homes; and as an extension, what other things might you not be allowed to do to your own property? Lastly, how does all of this play out in terms of the incentive to improve your home in the first place?

The producers of Fixer Upper can easily prohibit families from renting out the houses featured on the show, simply by adding a clause in the contract. As mentioned in the article, they have begun doing exactly that. It’s likely that the main reason they’ve chosen to do so is to protect the brand of the show. The show is based around the Gaines family helping other families create a dream home at a price they can afford. It takes away from the mystique of the show if viewers start thinking too much about how those families then have to rent their dream homes out to strangers, renovate additional rooms, and generally not live ‘happily ever after’. On the ‘flip’ side (pun intended), homeowners wouldn’t be willing to sign-up for the show at all, if the contract were to become too overbearing. Plus, there’s literally no way to contract over every single thing that could ever be done or not done to a house. As a result, those things which were not explicitly controlled for in the contract are in what’s known in the property rights literature as the “public domain.” The rights, such as whether the house can be rented our, remain in a sort of limbo until one side or the other claims the right for themselves. In this case, homeowners from the earlier seasons began claiming this right, but the show’s producers decided to take it back by working it into future contracts.

If you sit down and think about it, there are a lot of things that you can’t technically do to your own house/property, at least not without getting explicit approval. For example, most places require you to meet minimum codes of safety to prevent accidents such as fires. Even if you have fully paid off your house, you may not be allowed to add on an addition, add a fire pit, or even paint the house a different color if you belong to certain homeowners’ associations. In fact, there are many different groups, from public to private, that can limit your ability to remodel or even sell your own house. Generally, these rules and laws are put into place using the argument that making these changes have external benefits or costs to your neighbors or others. They are intended to nudge you in the direction of making the ‘socially optimal’ decision of how much to renovate. In some cases these rules are worthwhile, while in others they may be excessive. To examine this further, let’s consider how these restrictions could have a real impact on your decisions when fixing up your dream home.

Deciding to renovate a house is a large undertaking, but it’s not an all or nothing proposition. The couples on Fixer Upper are presented with a plan to make several large changes to improve the livability and design of the house they are purchasing, but there simply isn’t enough budget to fully renovate every room of the house. These un-renovated rooms aren’t featured on the show, since they aren’t new and stylish like the rooms that are fixed up. The interesting thing to think about is, how much more would people invest in their renovations, if they had more rights over their property. For instance, in most places in the U.S. you can be forced to sell your house under the rule of eminent domain. You are required to be compensated, but perhaps not as much as the minimum you would actually accept if you were to engage in voluntary negotiations. Knowing that your property could be bulldozed in order to create a highway for public benefit alters your calculation of how many long term investments you really want to make. It’s harder to justify putting on a new roof that should last 30 years, or renovating a spare bedroom. It’s possible that the optimal level of renovations is something more than what people are currently undertaking. People would almost certainly make more investments in their homes if their property rights were more secure. However, detailing and providing those rights comes at a cost itself, which may mean that we’re already having housed ‘fixed up’ the efficient amount. Although, if Chip and Joanna Gaines are the ones doing the remodeling, I think we can all agree that having more wouldn’t be such a bad thing. 

February 7, 2017

What do Donald Trump and Germans Have in Common? More than You’d Expect!

Unless you live in tornado alley, there’s probably a pretty small chance of a powerful windstorm causing downed limbs and fallen trees on your house or surrounding property; a small chance, but not zero. If you estimate the probability of such an occurrence to be high enough, you may even find it worthwhile to take some precautions and prepare a few items in case you are affected. Maybe you purchase a chain-saw or even a generator, to be ready in the event that a storm does strike. What happens though, if one day your neighbor drops by looking to borrow your chainsaw to cut down some trees on his property? If you think the chance of you needing the saw soon is small, you’ll probably be happy to let him borrow the saw. But what if you happen to catch the weather report on the news, and they're airing a special segment on the devastating impact of past storms. If a statement like that causes you to increase your estimate of a storm’s likelihood, would you change your actions and decide that lending out the saw is just too risky? You may be asking yourself, what does all of this have to do with Donald Trump and the German government? The answer is, both Donald Trump and the German government have made some interesting statements in the previous year that warrant some discussion of how they may cause people to change their actions.

Image: Donald Trump's statements on the probability 
of default may have interesting effects.
(Photo credit: Gage Skidmore on Flickr)

In the case of Trump, he made statements in May of 2016 to the effect of saying that the U.S. can’t default on its debt, because it has the ability to print more money to pay off those debts. How does this statement affect expectations? In order for the U.S. to borrow money and take on debt, it has to find people who are willing to lend the money. The interest rate that those lenders require in order to agree to lend their money depends on how likely it is for them to be fully paid back. For instance, if I were offered the opportunity to purchase a U.S. Treasury Bond today that was worth $100 one year from now, two things would affect how much I would be willing to pay for it; the interest rate and the likelihood of default.

First, I’d factor in how likely it was that I would actually be paid the $100 next year; that is to say, the probability that the borrower (U.S. government) would default on the loan. If you’re lending money to your sketchy neighbor, you might say it’s pretty likely he’ll default. If you’re lending money to Mother Theresa, you may be less skeptical. Here Donald Trump is reinforcing the perception that the probability of the U.S. defaulting on a loan should be approximately zero. This is good from the perspective of the borrower, since it should lead to a lower interest rate that the U.S. has to pay to borrow the money.

Image: What determines your willingness to lend money?
(Photo credit: quazie on Flickr)

The interesting portion of Trump’s statement, however, is how it affects the interest rate in a different way. If you’re lending money, you want to be sure that the money you’re paid back in the future will be able to buy more goods than you could buy with it today. This is the compensation for you delaying your purchase. You’ll therefore decide the minimum amount of interest you must be paid by examining how the rate compares to expected inflation. Trump’s statement seemed to indicate that the U.S. would be willing to print money to pay off current debts. While this makes it cheaper to pay off previous debts in the short-run, it means previous lenders aren’t getting as much buying power as they expected. In the long-run, printing more money unavoidably leads to inflation. Printing a lot of money leads to a lot of inflation. This devalues the currency, meaning you need to trade more dollars for the same number of goods. If you announce intentions to potentially print a lot of money in the future, then lenders will require a higher interest rate now in order to maintain the same amount of purchasing power after the value of the dollar decreases.

In the case of Germany, the German government advised citizens last August to stockpile food and water for ‘civil defense’ purposes. The statement was urging citizens to have 10 days of food and water in reserve, in case of a national emergency that temporarily cutoff supply lines. If people take this statement seriously, it could create some economically interesting short-term adjustments. The demand for stockpile-able items, such as canned food and bottled water, would increase as more people entered the market for these goods. As such, we would expect both the price and quantity sold of these goods to increase, in a short-term bump. However, this increased demand would presumably return to normal levels after the stockpiles were accrued. What would be even more interesting to observe is how producers of these goods read the signals of the higher demand, not knowing that it was only temporary. If suppliers misinterpret the short-term increase in demand as a permanent shift, then they may invest in long-term capital expenditures (such as new machines, larger plants, etc…) to try to keep up with the heightened demand. Unfortunately, these investments would soon prove unprofitable, as demand fell. All because people’s perceptions were changed by a simple statement.

Image: Germans were encouraged to stockpile food and water.
(Photo credit: Julie & Heidi on Flickr)
As you can see, it is not only concrete actions which can have a profound effect on an economy. Mere statements on a topic can alter people’s perceptions and expectations, and expectations form an extremely important part of our decisions on what actions to take today. As always, it’s important to think before you speak, and consider the ramifications of information you convey.

What’s your take on the impact the statements discussed above may have had? Have you recently changed your actions based on a change in expectations (perhaps you purchased a new car or television after your expectation of a raise or promotion at work increased)? Feel free to discuss in the comments below!