More on Housing Affordability: Supply versus Demand

Over at TVHE, Matt has followed up on my post here on Gareth Morgan versus the Productivity Commission, arguing that we shouldn't view supply and demand explanations as mutually exclusive. Now I think Matt and I are pretty much in total agreement, but slight differences in language might make our posts seem at cross purposes, so I thought a couple of clarifications are in order.

First, the interesting question is not whether the cause of house-price inflation in New Zealand is supply, demand, or some combination of both. Obviously, since house prices are set by mutual agreement between buyers and sellers, prices are always and everywhere the result of both supply and demand. Rather the issue is, to the extent that house prices are inappropriate for some reason, whether the source of the inappropriateness is acting through supply or demand. Matt frames this by asking whether something is pushing demand for housing beyond what is "socially optimal" (or, by extension, restricting supply below what is socially optimal). Another way of saying this is to ask whether the policy response to high house prices would work by increasing supply (say changes to zoning or consent processes) or demand (say, changes in the tax treatment of housing).

The second clarification is that saying that supply and demand are not mutually exclusive is more than just saying that influences on both sides can contribute to the final effect. In the case of tax policies, the purpoted cause of house-price inflation only makes sense if there is an underlying problem with supply. To illustrate, consider Matt's statement

The key point against supply side issues will be fact that rental growth hasn't gotten as scary at any point -- if there are "too few" houses, then we should really see the cost of housing services/rent pick up.

The idea here is that if house prices are going up faster than rent, then the opportunity cost of owning a rental property must be rising faster than the direct income derived from it, so the only motivation must be the expectation of capital gain. This is true, but the expectation of capital gain only makes sense if the underlying trend is for the demand for housing for non-investment purposes to grow faster than supply. That is, to explain house inflation today as driven by tax-favoured investment, we need to assume a problem with restrictions on supply in the future.

Furthermore, consider what we would observe if there were no favourable tax treatment for owner-occupied housing or income derived from capital gains, but still an expectation of demand growth outstripping supply growth in the future. As long as the capital gains tax rate were not set at 100%, it would still be the case that expectations of future house price inflation would drive inflation in house prices today, there would be a positive after-tax return from capital gains, and hence a slower rise in rents, exactly the observations that Matt suggests might imply the problem is not exclusively on the supply side.

The bottom line here is that the favourable-tax-treatment story simply implies that problems due to insufficient supply will bite a bit earlier than they otherwise would have done. If there is no problem with supply being unable to keep pace with underlying demand, the tax-treatment issue is irrelevant.

Shovel-ready? [Updated]

Canterbury's first earthquake was September 2010. Our big one was February 2011.

Here's the latest Household Labour Force Survey on employment in construction. See Table 7 of HLFS Sept12qtr-tables and the supplementary Canterbury tables.

Prior to Sept 2010, HLFS didn't have a separate accounting for the Christchurch region; I'm not seeing obvious subtables with regional by-industry breakdowns.

Is this quite what you'd expect as part of earthquake rebuilding? Christchurch should have been a shovel-ready project.

I suppose that the counterfactual is that construction typically drops in recessions and that it would have been worse but for Canterbury's rebuild. But the rebuild here - decent chunks of the roading and sewerage infrastructure have to be replaced, huge amounts of housing, lots of businesses - should be multiples of business-as-usual for Canterbury.

It's almost as though some kind of regulatory impediments are preventing people from rebuilding and getting on with things.

The overall unemployment figures are pretty poor. But 900 who want to be trained up to work on the rebuild could consider getting in touch with SCIRT. Update: Matt Nolan notes that HLFS may be biased downwards on construction in Christchurch. I'm going to hoist the whole comment up into the main post here:

I would note that the HLFS isn't counting people who left their permanent residence to go float around in Chch - it will take time for them to turn up in the data (if they do at all).

So you can definitely make a case that self-employment and construction are being undercounted in the HLFS - making QES, and eventually LEED when it comes out, a bit of a better source for this info.

InTrade roundup

Robert Wilbin at Overcoming Bias has a great summary of how the InTrade price divergence lasted as long as it did.

Why was this possible? I don’t have a good answer, but I can suggest one possibility. Some noteworthy aspects of the situation are:

• Americans can’t deposit money into Intrade using credit and debit cards – they have to use bank transfers.
• Bank transfers take at least two days to arrive and cost at least $20.
• Everyone else can choose between cards and bank transfers.
• Cards are instantaneous and free (if denominated in US dollars anyway) but have a $2,000 deposit limit in the first month, and $5,000 thereafter.
• It takes at least a day, probably two, to open a new Intrade account and have it approved.
• There are other significant barriers to entry – knowing about the issue, learning about the fees, opening an account with another betting agency and finally having the time and confidence to correctly place the hedge.
• Intrade seems very widely covered by the US media.

Once someone started doing this, it would take at least two days, probably three, for a wealthy or ambitious person to respond by wiring in enough money to bet against them. In the meantime they would have to hope that the manipulation persisted long enough for them to profit from it. Until then, people outside the USA would be limited to putting at most $2000 or $5000 into their accounts, which is not much, and barely worth the effort for someone with the required skill. So someone could plan to do this over the last few days of the election without facing much resistance.

The volume yesterday on Obama’s Intrade shares was about 600,000. If all of those trades involved one person, who was losing 10 percentage points on each share, they would have blown $600,000 to keep Obama’s odds down. The volume over the previous three weeks is hard to read from Intrade’s graphs, but looks to be about the same again. So a single cunning person willing to lose $1 million could have singlehandedly driven the price difference if they wanted to influence perceptions of the race and encourage voter turnout. Out of the $6 billion spent on the election so far, that’s not a big investment. Intrade will face this problem until they make it easier for wolves to fund their accounts and go out hunting sheep. [emphasis added, strong agreement]

Weaknesses of this theory are:

• Why didn’t manipulation over the previous three weeks prompt someone to move a large sum onto Intrade to take advantage of this?
• Why haven’t wealthy Obama supporters attempted the same trick?

Back in 2008 we saw something similar; we later found out it was somebody hedging against political risk [darned if I can find the link now though]. If your company's fortunes are highly sensitive to political risk, you might well want to lay that risk off at InTrade. I don't know if that's what happened this time around; any company doing it only by trading at InTrade is throwing money away when it generates that gap in prices across markets. But fiddling around between InTrade and BetFair might be rats and mice for somebody with high opportunity costs of time. Counting against that theory: the price support mechanism lasted only until the polls closed in Colorado - the last of the swing states.

An InTrade heavy trader reckoned [a couple days prior to the election] it was a lot of small starry-eyed Romney supporters, but why wouldn't there have been Obama-enthusiasts similarly willing to inflate prices on their side? The article is excellent though - read it [HT: @MikePMoffatt].

I strongly endorse Wilbin's conclusion: it has to be easier to get money into InTrade so that things like this can't persist.

Mike Moffatt at the Globe and Mail's Economy Lab also notes the price difference across markets, pointing to BetFair's tax on winning as part of the problem.

A problem for those who would argue in favour of the forecasting ability of markets is that the probability of Mr. Obama’s victory on prediction market BetFair was consistently ten points higher than on InTrade. This presents a problem – if forecasting models are accurate, should the two markets not be forecasting the same thing? Furthermore, if both markets were truly efficient than this difference should be arbitraged away. In theory you should have been able to buy Obama futures on InTrade and Romney futures on BetFair and make a profit no matter who won. In practice, however, this is made difficult through transaction costs and barriers to entry. In order to comply with U.S. law, InTrade cannot accept payments via US issued debit or credit cards, an inconvenience to American users. But given that hundreds of thousands of shares were being traded on InTrade and transaction costs are minimal, it is quite an efficient market. BetFair, on the other hand, charges significant credit card fees and taxes on winning, which greatly diminishes returns. These transaction costs make BetFair a far-from-efficient market, so this helps explain the discrepancy.

That was part of it, and it was more of it in the time leading up to the day of the election. But the price gap across markets went as high as twenty points - BetFair's trading fees are inconsequential relative to the gap. The fees make it harder to arbitrage, but I don't think that they strongly effect within-market efficiency at BetFair. The biggest problem is the difficulty of getting money into InTrade. BetFair's tax on winnings lets small price differences across markets persist. InTrade's barriers to entry allow massive price differences to persist.

Last night's election reminded me too of a bit of fun on the Iowa Election Markets in 2000. I was trading pretty heavily there, mostly running minor arbitrages where the sum of bids diverged from $1 across markets. But I'd read the prospectus for the _WTA [Winner-Take-All] markets and a lot of folks hadn't. Winner, for IEM, meant "whoever is reported in the New York Times as having received the largest share of total votes" [my paraphrase from memory], not who won the election. In 2000, those differed. And if IEM's servers hadn't crashed, I'd have been able to execute a very large trade buying Al Gore at $0.02. I remembered that not only because it briefly looked like there was a chance that Romney could take the popular vote while losing the election, but also because iPredict's servers crashed while I was trying to back out of some of my short Obama position there [very long Obama at InTrade, very short at BetFair and iPredict]. The iPredict server crash didn't really cost me much - my position there was just about worthless. The IEM crash... that was disappointing.

My prior posts in this series:

• Barriers to Arbitrage
• Documenting the Arbitrage
• Final arbitrage position statement

I've just made my application to get my money out of InTrade, incurring a $20 wire transfer fee. Will report on the final net once everything's converted back to $NZ and all bank fees are paid.

It's been a bit of fun. The posts have been picked up on the twitter feeds running in the sidebar for FiveThirtyEight at the New York Times, so it's been fun getting traffic from there, as well as from Reddit and from the Slate comments threads. 

Final arbitrage position statement

InTrade will not allow me to deposit more than $5000 in a 30-day window, so I can't arbitrage any longer. My current positions:

• 739 shares on Obama at InTrade bought at USD$6.74 per share on average. 
• If Obama wins, I net USD$2389 less credit card exchange rate losses two ways.
• If Romney wins, I lose USD $5001 and credit card exchange rate losses one way.
• AUD$1000 on Romney at BetFair at 4.4.
• If Obama wins, I lose USD$1053 and credit card exchange rate losses one way.
• If Romney wins, I net USD$3335 less credit card exchange rate losses two ways.
• 2959 shares on Romney (mix long Romney short Obama) at iPredict, average price NZD$0.2297.
• If Obama wins, I lose USD$563
• If Romney wins, I gain USD$1849

On net, then, if Obama wins, I'm up $773. If Romney wins, I'm up $183. Less credit card exchange rate fees and realised currency risk in both cases. I expect Obama to win, so I don't mind having an unbalanced position. I'm currently cheering only for that the election be decisive and not go into endless recounts or Supreme Court challenges that push the payout until after my credit card comes due. If you're a voter in a swing state, I strongly encourage you to go with whatever everybody else seems to be doing.

I'd like to resist the temptation to play at range trading on iPredict during the day so I can get a clean final outcome, but I doubt I'll be able to.

Previously: Barriers to Arbitrage (why most folks may not be doing this); Documenting the Arbitrage.

In other news, it's fun to compare these two Twitter searches [ht @LyndonHood]:

• "if Obama wins New Zealand": about 19 people claiming they'd come here if Obama wins.
• "if Romney wins New Zealand": about 14 people claiming they'd come here if Romney wins.

In both states of the world, it's optimal to move to New Zealand. Tiebout gives you the only vote where you're guaranteed to win.

Documenting the arbitrage

The ongoing price difference between InTrade and BetFair offends me. So I decided to do well while doing good. InTrade verified my paperwork. I sent them some money. The Bank of New Zealand delayed things because sending $3k to one 'internet gambling' site followed by an attempt at $1k to another [their term; I say they're futures markets] was deemed suspicious - and rightly so. But, it meant that I had to wait until their call centre opened up at 6:30 am to start playing.

Once you make the plays and figure out the charges, it's fairly obvious why price differences between these two markets can persist. Recall that it isn't easy to set up the accounts in the first place.

I sent AUD$1000 to BetFair. They took a 1.5% credit card fee out of that. I put $1000 on Mitt Romney to win at 4.4 [I had a standing account balance]. If I win at BetFair, they charge a commission on winnings. Since I do not trade frequently, I get no discount on that. So if Romney wins, BetFair will take 5% of my winnings. This adds up on an arbitrage play.

I sent USD$3020 to InTrade. They took $20 to clear a negative balance that was sitting there. InTrade charges a $4.99 monthly fee to keep an account and recently changed the rules so that dormant accounts of zero balance are not charged fees; it was simpler for me to pay the $20 than to set up a new account. I'll just have to remember to withdraw everything from my InTrade account when the play is completed so that it doesn't just erode back down to zero. But I'm going to count that $20 as part of the cost of the overall play. InTrade charges zero fees other than the monthly trading fee. Fortunately, InTrade underprices the candidate who is likely to win. I bought 448 shares of Obama at $6.69 per share.

The tally thus far [updated with a couple of corrections]:

Item	Amounts	Totals
Position	$1,000 AUD + $2,997 USD	$4,034 USD
Account Fees	$15 AUD + $20 USD	$36 USD
Cost:		$4,070 USD
If Obama wins (gross)		$4,480 USD
If Obama wins (net of costs above):		$410 USD
If Romney wins (gross):		$4,400.00 AUD
Less 5% charged on winnings:		$4,230.00 AUD
Net earnings if Romney wins:		$318 USD

I'm unfairly charging the $20 fee against InTrade. But once you put in the 1.5% credit card fee and the 5% tax on winnings, it's not hard to justify a reasonable price spread across the two markets. So my earlier tweet was wrong - in particular, it missed the 5% winnings tax at BetFair. If Obama wins, I'll do well. If Romney wins, I won't lose anything except my time.

So why does the price spread across markets persist?

1. It's a hassle to set up accounts
2. BetFair's tax on winnings limits arbitrage opportunities. 

There's still a bit of free money sitting in the price gap between markets, but I don't really see it being worth putting more money in given BetFair's fee structure. 

I have a fair bit of cash balance sitting at iPredict; I'm placing a large order long Romney and short Obama there - iPredict is currently saying a 77% chance of an Obama victory. They charge trading fees capped at $5 per month per trader, a 1.75% fee on credit card deposits (irrelevant for me as I have cash sitting there), and a withdrawal fee of 2% if you have positive earnings (sunk for me, but relevant for you if you don't have an account there). 

I've standing orders at iPredict selling Obama at $0.76 and buying Romney at $0.24. If anybody takes those up, I'll send more money to InTrade to lay it off. But this involves the hassle of keeping an eye on the iPredict order book so I can move quickly if something happens in the election that moves the odds.

Arbitrage isn't supposed to be easy....

Note: I do have some unhedged currency risk: if the USD/AUD exchange rate moves substantially against me, or if the NZ dollar appreciates substantially against either, I could in some worlds lose a bit. Suppose that a surprise Romney win makes the Australian dollar tank against the US dollar. My winnings in Oz, converted to US dollars, won't look so nice.

Update: I switched to offloading Romney risk onto iPredict, New Zealand's election stock market. It's thinner than BetFair, but if you put up a big order, it might be picked up. And iPredict's tax on winnings is lower than BetFair's - 2% withdrawal fee if you have positive earnings.

Current position then is:

• +2114 Romney at iPredict at $0.24 ($NZD, mix of long Romney and short Obama)
• +670 Obama at InTrade at $6.71
• $1000 on Romney at 4.4 at BetFair.

If I haven't screwed up the spreadsheet, and net of all expected fees, I'm up about $120 USD if Romney wins and up $710 USD if Obama wins. Total stakes USD$5950. So a short period return of 12% if Obama wins, 2% if Romney wins. I expect Obama to win, so I don't mind that exposure. 

Remaining risks not here accounted for: 

• Currency exchange risk: If the US dollar tanks on an Obama win (exceedingly unlikely), I'll take a hit; if the Australian dollar tanks on a Romney win (exceedingly unlikely), I'll also take a hit. Or, if exchange rates just happen to move substantially between now and settlement. The $NZ is relatively high now though - it would be surprising if it spiked upwards.
• If the bank's spread on exchange rates is wide enough, 2% gains on a Romney win turn quickly to zero percent. 
• iPredict isn't a perfect hedge: the other markets pay off on Obama and Romney; iPredict pays out based on which party wins. 

Update: Final arbitrage position statement.

Barriers to Arbitrage

Having noticed a substantial price difference between InTrade and BetFair on the US elections, I figured I'd go and make some money. I've accounts with both, though I haven't traded with either for rather some time. I can buy a Romney contract at BetFair for $2.30; I can buy an Obama contract at InTrade for $6.58. The contracts span the space, have a guaranteed payout of $10, and cost $8.88 plus minor transaction fees. So about an 10% guaranteed return. Time to log in to the old accounts, throw in most of the credit card limit and give it a go.

Then I saw this over on InTrade.

Documentation Requirements

To comply with Irish anti-money laundering regulations we require all Intrade customers to provide the following documentation:

1. Proof of identity in the form of passport or drivers license (must include photo).
2. Two proofs of address in the form of utility bills or bank statements (each different - not for the same utility or bank account), recent tax or insurance statements or certificates etc. These should show your residential address and not PO Box numbers.

You will need to supply this documentation before you can deposit funds, withdraw funds or trade any markets. We understand this is a hassle but it is now a legal requirement for all Intrade customers.

Fortunately, I have this stuff kicking around in a desk drawer. So I've scanned it and uploaded it. And now I wait for verification, presumably along with hundreds of other would-be arbitrageurs.

While waiting, I head on over to the Deposit page to see if it'll let me put in some money [it won't]. And I find this:

Attention US Customers: If your credit or debit card was issued by a US bank then unfortunately you will not be able to use your card to fund your account. New regulations that came into force in the US in 2010 now heavily restrict the use of credit and debit cards on sites such as Intrade.

Ah, yes. American anti-fun legislation that blocks unsophisticated would-be American arbitrageurs from the market.

How can price differences across markets persist? You need enough people with enough forethought to have standing up-to-date accounts on all markets who either are not American or who know how to route around the restrictions imposed on American traders.

I suspect that when I finally get the email from InTrade saying I'm good to go, the arbitrage opportunity will have passed.

Update: When the market does open up for me, I will spend a bit of time reading both contracts pretty carefully. I was almost burned in the Australian elections....

Update: InTrade approved my details at 00:30 NZ time this morning. I deposited $3k. Went to deposit $1k to BetFair to lay off the risk, and Bank of New Zealand declined the credit card transaction, almost certainly because it's part of a suspicious pattern of transactions. And they don't have a staffed phone line until 6:30 am. Great that BNZ is watching out for me; not so hot that they have zero people able to unblock transactions of this sort at legitimate business hours of 5 a.m. At least I knew enough to wait until I had balances sitting on both markets before trading on either...I usually have both markets as separate opened tabs, then try to click both as close to simultaneously as I can.

Update 2: I've made a play, but account fees at BetFair limit potential returns. Detailed here.

Update 3: Final arbitrage position statement.

If I had 4.05 billion dollars...

Disney buys LucasFilm and all anybody can talk about is what will happen with the Star Wars franchise, as though there's anywhere it can go but up.*

Rather more interesting:** George Lucas owned LucasFilm outright. So he now has $4.05 billion burning a hole in his pocket. Forbes put him at $3.3 billion as of September 2012; I guess that goes up a bit now. What do you do if you suddenly have $4.05 billion in liquid assets instead of owning a company valued in the billions?

Forbes notes he recently gave $33k to Obama's victory fund; I'm guessing political contributions aren't high on his agenda. He also gave $175m to U Southern California in 2006. So we might expect a bit of action in the education philanthropy space.

I've no clue what Lucas will do with his now more liquid portfolio. But I know what I'd do: Take half of it and make a big bet on Seasteading. I'd reconcile myself to being really likely to lose the money; that isn't the point. But imagine taking $2 billion, building a half dozen Seastead hubs, getting open-source plans up for anybody else who wanted to do the same, and then sell barge-houses that could dock modularly to any of the hubs. The Seasteading Institute figures it would cost just a bit over $110m to build a Seastead. Double that and you still have change left over for building a half dozen. Worst-case, you only have $2 billion to play with afterwards. Best case, you've entrenched a model that can revolutionise governance.

Not having $4.05 billion, I'll stick to my Octopus-level support.


* Seriously, watch the RedLetterMedia critiques. Anakin gets a cryptic warning that Padme will die in childbirth, and instead of taking her to a med droid for a check-up, he joins Palpatine and kills all the younglings? I swear the script had a section [Fill in reason for joining Dark Side here] and they just left it blank 'till 5 minutes before filming.

** Another fun thought-experiment: do we in 2072 get a 1977 copyright fixed point for Steamboat Wookie?