The Ryan plan’s strange assumptions for another housing boom, beginning next year

This is another in occasional posts about the federal deficit and debt.

Congressman Ryan’s plan to slash federal spending, which drew the votes of almost every House Republican, doesn’t just rely on dramatic spending cuts. The math behind the plan also assumes that the decreases in federal spending and in taxes will provide an impressive boost to the economy. The rosy economic analysis by the conservative Heritage Foundation upon which the plan relies has been criticized by many economists; in an upcoming post, I’ll look more broadly at some of those critiques.

For this post, I just want to look at one area of the economic analysis: Heritage’s projections for residential investment under the Ryan plan.

The National Journal summarizes the issue pretty succinctly:

The tax and spending roadmap put forth Tuesday morning by Ryan, the Wisconsin Republican who heads the House Budget Committee, is backed by a set of extremely optimistic assumptions about how the budget would stimulate private investment, hiring, and broad economic growth.

[. . .] The forecasters say Ryan’s plan would result in the creation of nearly 1 million more jobs next year, above and beyond the jobs that would be created by normal growth. And that surge would continue, they say, adding 1.3 million jobs above business as usual for each of the next 10 years.

In the near term, many of those jobs appear to be the direct result of a new housing boom: The analysts project an additional $89 billion in residential investment in 2012 under the Ryan plan, and a total of more than $1 trillion in additional housing investment for the next decade. This would be despite the housing market’s continuing litany of post-bubble woes: falling prices, a backlog of foreclosures, and a glut of unsold homes.

We have a huge overhang of existing homes. Vacancy rates are far higher than historical averages. Even if household formation returns soon to its historical average, it will be 2014-2016 before we’ve whittled the inventory of homes down to the point where residential investment can return to its historical average.

Still, the Ryan plan assumes an additional 75,000 households will be created in 2012 above the baseline projections, and that there will be an $89 billion increase in residential investment above the baseline (which is almost certainly itself too high because there is still so much slack in the housing market). That works out to an investment of almost $1.2 million per additional unit added under the Ryan plan. Look at the numbers here.

For 2013, the economic analysis of the Ryan plan assumes a yearly increase of about 1.9 million households and a total residential investment in structures of $621 billion (about 19% higher than in 2012). Those increases are similar to the ones in the baseline projections, but the Heritage Foundation’s numbers are layered on top of the huge boost in residential investment in 2012.

Macroadvisors, the blog for Macroeconomic Advisors LLC, coldly picks apart these absurd predictions in “The Economic Effects of the Ryan Plan: Assuming the Answer?”:

Hilarious Housing?

In the simulation, the component of GDP that initially increases most, both in absolute and in percentage terms, is residential investment. This is really hard to fathom. There’s no change in pre-tax interest rates to speak of, hence the after-tax mortgage rate presumably rises with the decline in marginal tax rates even as the proposed tax reform curtails some or all of the mortgage interest deduction. It’s hard to imagine the financing cost of housing not rising, at least initially. True, the simulation shows the number of households increasing 75 thousand in the first year, but the simulation also shows residential investment jumping $89 billion, or 21%. Given the size of this increase, we can suspect that residential investment was also adjusted up directly. In any event, at today’s real value of approximately $210 thousand per newly completed housing unit, the extra investment is enough to build roughly 425 thousand units in 2012, of which 350 thousand would be empty at a time when we estimate there already is an excess of more than a million units that could be absorbed by new household formation.

And this imbalance only worsens through time. Cumulating the increases in residential investment by perpetual inventory using a 1.5% annual depreciation rate, we calculate that by 2021 the real residential housing stock is up $1.023 trillion. At a decadal average of roughly $234 thousand per newly completed housing unit, this translates into an additional 4.4 million units. By the end of 2021 households are up only 379,000, so that 4 million unoccupied housing units have been built, creating an overhang as large as we estimate developed at the peak of the recent housing boom.

Macroeconomic Advisors is not some fly by night group, but a serious investment consulting firm that is serious about advising (and keeping) clients.

Why would almost 100% of House Republicans vote to end Medicare as we know it (that may sound trite, but the system that Ryan sees really is so different that it needs a new name), when the entire economic plan on which they are voting has not been thoroughly vetted? Is it “courageous” or “bold” to vote for such a dramatic plan if its implications and assumptions are not well understood?