What exactly is “gentrification”? How should we deal with it?

Nov 26, JDN 2458083

“Gentrification” is a word that is used in a variety of mutually-inconsistent ways. If you compare the way social scientists use it to the way journalists use it, for example, they are almost completely orthogonal.

The word “gentrification” is meant to invoke the concept of a feudal gentry—a hereditary landed class that extracts rents from the rest of the population while contributing little or nothing themselves.

If indeed that is what we are talking about, then obviously this is bad. Moreover, it’s not an entirely unfounded fear; there are some remarkably strong vestiges of feudalism in the developed world, even in the United States where we never formally had a tradition of feudal titles. There really is a significant portion of the world’s wealth held by a handful of billionaire landowner families.

But usually when people say “gentrification” they mean something much broader. Almost any kind of increase in urban real estate prices gets characterized as “gentrification” by at least somebody, and herein lies the problem.

In fact, the kind of change that is most likely to get characterized as “gentrification” isn’t even the rising real estate prices we should be most worried about. People aren’t concerned when the prices of suburban homes double in 20 years. You might think that things that are already too expensive getting more expensive would be the main concern, but on the contrary, people are most likely to cry “gentrification” when housing prices rise in poor areas where housing is cheap.

One of the most common fears about gentrification is that it will displace local residents. In fact, the best quasi-experimental studies show little or no displacement effect. It’s actually mainly middle-class urbanites who get displaced by rising rents. Poor people typically own their homes, and actually benefit from rising housing prices. Young upwardly-mobile middle-class people move to cities to rent apartments near where they work, and tend to assume that’s how everyone lives, but it’s not. Rising rents in a city are far more likely to push out its grad students than they are poor families that have lived there for generations. Part of why displacement does not occur may be because of policies specifically implemented to fight it, such as subsidized housing and rent control. If that’s so, let’s keep on subsidizing housing (though rent control will always be a bad idea).

Nor is gentrification actually a very widespread phenomenon. The majority of poor neighborhoods remain poor indefinitely. In most studies, only about 30% of neighborhoods classified as “gentrifiable” actually end up “gentrifying”. Less than 10% of the neighborhoods that had high poverty rates in 1970 had low poverty rates in 2010.

Most people think gentrification reduces crime, but in the short run the opposite is the case. Robbery and larceny are higher in gentrifying neighborhoods. Criminals are already there, and suddenly they get much more valuable targets to steal from, so they do.

There is also a general perception that gentrification involves White people pushing Black people out, but this is also an overly simplistic view. First of all, a lot of gentrification is led by upwardly-mobile Black and Latino people. Black people who live in gentrified neighborhoods seem to be better off than Black people who live in non-gentrified neighborhoods; though selection bias may contribute to this effect, it can’t be all that strong, or we’d observe a much stronger displacement effect. Moreover, some studies have found that gentrification actually tends to increase the racial diversity of neighborhoods, and may actually help fight urban self-segregation, though it does also tend to increase racial polarization by forcing racial mixing.

What should we conclude from all this? I think the right conclusion is we are asking the wrong question.

Rising housing prices in poor areas aren’t inherently good or inherently bad, and policies designed specifically to increase or decrease housing prices are likely to have harmful side effects. What we need to be focusing on is not houses or neighborhoods but people. Poverty is definitely a problem, for sure. Therefore we should be fighting poverty, not “gentrification”. Directly transfer wealth from the rich to the poor, and then let the housing market fall where it may.

There is still some role for government in urban planning more generally, regarding things like disaster preparedness, infrastructure development, and transit systems. It may even be worthwhile to design regulations or incentives that directly combat racial segregation at the neighborhood level, for, as the Schelling Segregation Model shows, it doesn’t take a large amount of discriminatory preference to have a large impact on socioeconomic outcomes. But don’t waste effort fighting “gentrification”; directly design policies that will incentivize desegregation.

Rising rent as a proportion of housing prices is still bad, and the fundamental distortions in our mortgage system that prevent people from buying houses are a huge problem. But rising housing prices are most likely to be harmful in rich neighborhoods, where housing is already overpriced; in poor neighborhoods where housing is cheap, rising prices might well be a good thing.
In fact, I have a proposal to rapidly raise homeownership across the United States, which is almost guaranteed to work, directly corrects an enormous distortion in financial markets, and would cost about as much as the mortgage interest deduction (which should probably be eliminated, as most economists agree). Give each US adult a one-time grant voucher which gives them $40,000 that can only be spent as a down payment on purchasing a home. Each time someone turns 18, they get a voucher. You only get one over your lifetime, so use it wisely (otherwise the policy could become extremely expensive); but this is an immediate direct transfer of wealth that also reduces your credit constraint. I know I for one would be house-hunting right now if I were offered such a voucher. The mortgage interest deduction means nothing to me, because I can’t afford a down payment. Where the mortgage interest deduction is regressive, benefiting the rich more than the poor, this policy gives everyone the same amount, like a basic income.

In the short run, this policy would probably be expensive, as we’d have to pay out a large number of vouchers at once; but with our current long-run demographic trends, the amortized cost is basically the same as the mortgage interest deduction. And the US government especially should care about the long-run amortized cost, as it is an institution that has lasted over 200 years without ever missing a payment and can currently borrow at negative real interest rates.

Selling debt goes against everything the free market stands for

JDN 2457555

I don’t think most people—or even most economists—have any concept of just how fundamentally perverse and destructive our financial system has become, and a large chunk of it ultimately boils down to one thing: Selling debt.

Certainly collateralized debt obligations (CDOs), and their meta-form, CDO2s (pronounced “see-dee-oh squareds”), are nothing more than selling debt, and along with credit default swaps (CDS; they are basically insurance, but without those pesky regulations against things like fraud and conflicts of interest) they were directly responsible for the 2008 financial crisis and the ensuing Great Recession and Second Depression.

But selling debt continues in a more insidious way, underpinning the entire debt collection industry which raises tens of billions of dollars per year by harassment, intimidation and extortion, especially of the poor and helpless. Frankly, I think what’s most shocking is how little money they make, given the huge number of people they harass and intimidate.

John Oliver did a great segment on debt collections (with a very nice surprise at the end):

But perhaps most baffling to me is the number of people who defend the selling of debt on the grounds that it is a “free market” activity which must be protected from government “interference in personal liberty”. To show this is not a strawman, here’s the American Enterprise Institute saying exactly that.

So let me say this in no uncertain terms: Selling debt goes against everything the free market stands for.

One of the most basic principles of free markets, one of the founding precepts of capitalism laid down by no less than Adam Smith (and before him by great political philosophers like John Locke), is the freedom of contract. This is the good part of capitalism, the part that makes sense, the reason we shouldn’t tear it all down but should instead try to reform it around the edges.

Indeed, the freedom of contract is so fundamental to human liberty that laws can only be considered legitimate insofar as they do not infringe upon it without a compelling public interest. Freedom of contract is right up there with freedom of speech, freedom of the press, freedom of religion, and the right of due process.

The freedom of contract is the right to make agreements, including financial agreements, with anyone you please, and under conditions that you freely and rationally impose in a state of good faith and transparent discussion. Conversely, it is the right not to make agreements with those you choose not to, and to not be forced into agreements under conditions of fraud, intimidation, or impaired judgment.

Freedom of contract is the basis of my right to take on debt, provided that I am honest about my circumstances and I can find a lender who is willing to lend to me. So taking on debt is a fundamental part of freedom of contract.

But selling debt is something else entirely. Far from exercising the freedom of contract, it violates it. When I take out a loan from bank A, and then they turn around and sell that loan to bank B, I suddenly owe money to bank B, but I never agreed to do that. I had nothing to do with their decision to work with bank B as opposed to keeping the loan or selling it to bank C.

Current regulations prohibit banks from “changing the terms of the loan”, but in practice they change them all the time—they can’t change the principal balance, the loan term, or the interest rate, but they can change the late fees, the payment schedule, and lots of subtler things about the loan that can still make a very big difference. Indeed, as far as I’m concerned they have changed the terms of the loan—one of the terms of the loan was that I was to pay X amount to bank A, not that I was to pay X amount to bank B. I may or may not have good reasons not to want to pay bank B—they might be far less trustworthy than bank A, for instance, or have a far worse social responsibility record—and in any case it doesn’t matter; it is my choice whether or not I want anything to do with bank B, whatever my reasons might be.

I take this matter quite personally, for it is by the selling of debt that, in moral (albeit not legal) terms, a British bank stole my parents’ house. Indeed, not just any British bank; it was none other than HSBC, the money launderers for terrorists.

When they first obtained their mortgage, my parents did not actually know that HSBC was quite so evil as to literally launder money for terrorists, but they did already know that they were involved in a great many shady dealings, and even specifically told their lender that they did not want the loan sold, and if it was to be sold, it was absolutely never to be sold to HSBC in particular. Their mistake (which was rather like the “mistake” of someone who leaves their car unlocked and has it stolen, or forgets to arm the home alarm system and suffers a burglary) was not to get this written into the formal contract, rather than simply made as a verbal agreement with the bankers. Such verbal contracts are enforceable under the law, at least in theory; but that would require proof of the verbal contract (and what proof could we provide?), and also probably have cost as much as the house in litigation fees.

Oh, by the way, they were given a subprime interest rate of 8% despite being middle-class professionals with good credit, no doubt to maximize the broker’s closing commission. Most banks reserved such behavior for racial minorities, but apparently this one was equal-opportunity in the worst way.Perhaps my parents were naive to trust bankers any further than they could throw them.

As a result, I think you know what happened next: They sold the loan to HSBC.

Now, had it ended there, with my parents unwittingly forced into supporting a bank that launders money for terrorists, that would have been bad enough. But it assuredly did not.

By a series of subtle and manipulative practices that poked through one loophole after another, HSBC proceeded to raise my parents’ payments higher and higher. One particularly insidious tactic they used was to sit on the checks until just after the due date passed, so they could charge late fees on the payments, then they recapitalized the late fees. My parents caught on to this particular trick after a few months, and started mailing the checks certified so they would be date-stamped; and lo and behold, all the payments were suddenly on time! By several other similarly devious tactics, all of which were technically legal or at least not provable, they managed to raise my parents’ monthly mortgage payments by over 50%.

Note that it was a fixed-rate, fixed-term mortgage. The initial payments—what should have been always the payments, that’s the point of a fixed-rate fixed-term mortgage—were under $2000 per month. By the end they were paying over $3000 per month. HSBC forced my parents to overpay on a mortgage an amount equal to the US individual poverty line, or the per-capita GDP of Peru.

They tried to make the payments, but after being wildly over budget and hit by other unexpected expenses (including defects in the house’s foundation that they had to pay to fix, but because of the “small” amount at stake and the overwhelming legal might of the construction company, no lawyer was willing to sue over), they simply couldn’t do it anymore, and gave up. They gave the house to the bank with a deed in lieu of foreclosure.

And that is the story of how a bank that my parents never agreed to work with, never would have agreed to work with, indeed specifically said they would not work with, still ended up claiming their house—our house, the house I grew up in from the age of 12. Legally, I cannot prove they did anything against the law. (I mean, other than laundered money for terrorists.) But morally, how is this any less than theft? Would we not be victimized less had a burglar broken into our home, vandalized the walls and stolen our furniture?

Indeed, that would probably be covered under our insurance! Where can I buy insurance against the corrupt and predatory financial system? Where are my credit default swaps to pay me when everything goes wrong?

And all of this could have been prevented, if banks simply weren’t allowed to violate our freedom of contract by selling their loans to other banks.

Indeed, the Second Depression could probably have been likewise prevented. Without selling debt, there is no securitization. Without securitization, there is far less leverage. Without leverage, there are not bank failures. Without bank failures, there is no depression. A decade of global economic growth was lost because we allowed banks to sell debt whenever they please.

I have heard the counter-arguments many times:

“But what if banks need the liquidity?” Easy. They can take out their own loans with those other banks. If bank A finds they need more cashflow, they should absolutely feel free to take out a loan from bank B. They can even point to their projected revenues from the mortgage payments we owe them, as a means of repaying that loan. But they should not be able to involve us in that transaction. If you want to trust HSBC, that’s your business (you’re an idiot, but it’s a free country). But you have no right to force me to trust HSBC.

“But banks might not be willing to make those loans, if they knew they couldn’t sell or securitize them!” THAT’S THE POINT. Banks wouldn’t take on all these ridiculous risks in their lending practices that they did (“NINJA loans” and mortgages with payments larger than their buyers’ annual incomes), if they knew they couldn’t just foist the debt off on some Greater Fool later on. They would only make loans they actually expect to be repaid. Obviously any loan carries some risk, but banks would only take on risks they thought they could bear, as opposed to risks they thought they could convince someone else to bear—which is the definition of moral hazard.

“Homes would be unaffordable if people couldn’t take out large loans!” First of all, I’m not against mortgages—I’m against securitization of mortgages. Yes, of course, people need to be able to take out loans. But they shouldn’t be forced to pay those loans to whoever their bank sees fit. If indeed the loss of subprime securitized mortgages made it harder for people to get homes, that’s a problem; but the solution to that problem was never to make it easier for people to get loans they can’t afford—it is clearly either to reduce the price of homes or increase the incomes of buyers. Subsidized housing construction, public housing, changes in zoning regulation, a basic income, lower property taxes, an expanded earned-income tax credit—these are the sort of policies that one implements to make housing more affordable, not “go ahead and let banks exploit people however they want”.

Remember, a regulation against selling debt would protect the freedom of contract. It would remove a way for private individuals and corporations to violate that freedom, like regulations against fraud, intimidation, and coercion. It should be uncontroversial that no one has any right to force you to do business with someone you would not voluntarily do business with, certainly not in a private transaction between for-profit corporations. Maybe that sort of mandate makes sense in rare circumstances by the government, but even then it should really be implemented as a tax, not a mandate to do business with a particular entity. The right to buy what you choose is the foundation of a free market—and implicit in it is the right not to buy what you do not choose.

There are many regulations on debt that do impose upon freedom of contract: As horrific as payday loans are, if someone really honestly knowingly wants to take on short-term debt at 400% APR I’m not sure it’s my business to stop them. And some people may really be in such dire circumstances that they need money that urgently and no one else will lend to them. Insofar as I want payday loans regulated, it is to ensure that they are really lending in good faith—as many surely are not—and ultimately I want to outcompete them by providing desperate people with more reasonable loan terms. But a ban on securitization is like a ban on fraud; it is the sort of law that protects our rights.