Final Version

Cosmetic changes occured, but basically, I did a quick once over, printed it out, and turned it in. I have mixed feelings about the whole thing. I did a cubic fuckload of reading on the topic, and dispensed only a small part of what I read. It mostly came out as a data dump from my mind, but well, so it goes.

I feel like I understand a fair amount more than when I started the paper. But I don’t expect an especially good grade. Here’s the final draft, for the curious.

Homelessness is a serious problem in the United States, one which increased dramatically in the middle to late 1900’s and continues to this day. Here, I will examine several approaches and proposals for homelessness in somewhat greater depth. First I will review a model of the housing market presented by Brendan O’Flaherty in “Making Room: The Economics of Homelessness”. I then examine a number of proposed policies regarding homelessness, and examine the outcomes.

In “Making Room: The Economics of Homelessness” Brendan O’Flaherty examines homelessness at length and in detail. He begins by examining what it means to be homeless, and what makes it a legitimate matter for public inquiry. Then he constructs a sophisticated model to explain the operation of the housing market and examine the effects of various changes in the economic climate on the lower end of the housing market as well as the sheer number of the homeless. He then proceeds to examine, and generally debunk the common armchair explanations for increases in homelessness, including drug abuse and mental disorders, without denying that that these factors are prevalent in the population and strongly influence an individual’s likelihood of being homeless in a given housing market. He concludes that the explanation most strongly supported by the data and his model is the growing income disparity, specifically, the upward mobility of the middle class and the resultant reduction in the construction of middle class housing. Finally, he offers prescriptions for a solution to homelessness, with the central element being a shelter allowance.

The basic framework of O’Flaherty’s model describes housing as a collection units each with the single property of quality, which determines construction costs and, in conjunction with housing demand, and operating expenses, market rents. According to this model it costs more to produce housing of better quality, and the better the quality of housing, the more it takes to produce the next higher increment of quality. The maintenance expenses necessary to prevent deterioration of a unit are a fixed value, regardless of quality. These concepts lay the foundations of the model.

Expanding on those concepts allows us to clarify the relationship between rent and quality in the model housing market. After a certain quality threshold, since maintenance costs are fixed, and the marginal construction cost increases with quality, it is more economical to build to the desired quality and maintain the unit than to build it at a higher quality and allow it to decay to the desired quality. Such units never become low rent housing, because it is always more economical to maintain them as high quality housing. Below that level, it is economical to build the unit at some quality, recieving the benefit of the higher quality, or the rent others are willing to pay for it, while the unit decays to the desired quality. This extraction of housing value continues until the quality falls to the point that it can no longer fetch sufficient rent to pay the unit’s operating expenses, including the opportunity cost of selling the land. At that point a unit is redeveloped, or abandoned, so this quality is called the abandonment quality. At the other end of the housing lifecycle, housing construction costs must equal the expected rental returns, appropriately discounted for future rents, from a unit of housing. If the expected value of the rent is less than the construction cost, then it would not be built, and this is the case for very low quality buildings. It is easy to see that given a increasing marginal cost of construction, one can make large quality gains at relatively low cost in the early part of the construction cost curve. The quality at which it becomes profitable to produce housing units is referred to as the construction quality. If expected rent is greater than construction cost, builders would make more units, driving down the expected rental returns, until the cost equals the expected return. Through similar equilibrium logic, it can be shown that the expected returns are equal to the costruction cost throughout the quality interval in which housing is constructed, but not maintained. These tell us a great deal about the fundamental structure of the quality to rent relationship.

The final, and arguably most interesting, condition of O’Flaherty’s model is what he calls the equal-demand condition. The notion is that in a stable situation, the number of units being constructed is equal to the number being demolished, and by extension, that at all qualities an identical quantity of units is available. And so the price structure must manage the demand in such a way that it matches the available housing throughout the housing continuum. He then uses this idea to illustrate an important conceptual point: The richest homeless household and the poorest household in abandonment quality housing must be indifferent or very nearly so between homelessness and abandonment quality housing at the market rate. This understanding of the market prepares us to analyze the effects of various housing market interventions.

Homeless shelters, Public housing, and other forms of direct provision of shelteincluding shelters targeted towards specific populations such as battered women’s shelters, or drug rehab facilities have formed a partial response to the problems of homelessness. They provide a modest standard of living, ideally somewhere between homelessness and abandonment quality, but certainly better than homelessness, either for free or at very low cost. Here I will examine their impact in greater detail.

In order for a shelter to be effective, it has to be a better deal than homelessness for the wealthiest homeless person, the individual among the homeless who would spend the most on housing, which implies that it is also a better deal than abandonment quality housing at market prices. A common response to this is means-testing admission to the shelter. But making sure someone is homeless in order to offer them shelter encourages the marginally housed to leave their privately provided shelter to qualify for public housing. This has been found to be a significant though not extreme effect.

Perhaps the most stunning problems with the direct provision of shelter grouped together are the inefficiency of building low quality housing, and the ramifications of concentrating poverty. Building moderate quality buildings and allowing them to decay to lower qualities makes sense, when one considers the low quality part of the construction curve, where for modest increases in price, builders can gain substantial increases in quality. Higher concentrations of poverty also tend to be associated with increases in criminal activity, and a lack of upward mobility.

Additionally, there are many concerns about payment for the shelter. If it is free, there will almost certainly be more people demanding it than it can house, and if it is not, there will almost certainly be people who cannot afford it. Attempts to scale cost to income provides an incentive to under report income and, in cases of a high benefit reduction to income increase ratio, a disincentive to spend time working. There have been a number of problems with the housing supply programs.

Another program, funded by HUD and distributed through local housing administrations is the Section 8 voucher program, which is becoming the most prevalent housing federal housing assistance program. In this program, a limited number of vouchers are granted to a local housing administration. They in turn distribute these to needy households, at their discretion. The voucher recipients search for housing in the private market. Upon finding housing, there is an inspection of the unit by a HUD official. The tenant pays 30% of their income, while HUD pays the remainder of the rent, up to the Fair Market Rent, (FMR) which is the 40th percentile of rents in that area. Taken together this is a significant and flexible program for improving the quality of housing consumed by individuals.

Section 8 vouchers effectively provide individual households with higher incomes to spend on housing, and even in cases of partial market saturation, this can have strong effects on the market. Increasing the number of tenants who can afford to pay for housing in the deterioration interval increases the expected revenue from a unit of housing and encourages increased housing construction. Simultaneously, the subsidized households consume housing that other low-income households would have consumed, increasing rents at a given quality for the unsubsidized households below the new income of the subsidized household. If the subsidized household were previously homeless, and there is insufficient vacant stock to absorb the hand-me-down/domino effect, increased competition for housing will extend to the abandonment quality, causing those tenants formerly renting that quality of housing to become homeless. Section 8 vouchers are frequently granted to the marginally housed, or those housed in lower rent units. In this case, it simply rotates the relative position of the qualified household higher into the quality distribution of housing, propogating back to the original quality of their housing. Note that the primary problem here is that, to the extent that there are individuals who do not recieve the section 8 subsidy, those individuals may be displaced by subsidized renters who are at a comparative advantage in the housing market.

In “The Triumph of Housing Allowance Programs” Louis Winnick notes that in reality, a substantial fraction of the already housed section 8 voucher recipients remain in the same unit, which is repaired to a higher standard, in which case there is no hand-me-down/domino effect. Another, less heartening, real world consideration is that landlords are often unwilling to accept the bureaucratic hurdles of section 8 tenants, including mandatory inspections, and delays in payment.

O’Flaherty recommends a shelter allowance similar in some regards to section 8 vouchers. Payment is similarly conducted directly between the government and the landlord. The tenant still has the freedom to choose among the stock of private market housing, and sign any lease he can. However, the benefit would be an entitlement for all citizens of a flat rate of payment (he suggests ten to fifteen dollars per day), no matter who or what is housing them. He suggests that the staggering costs of this proposal could be offset by reductions in other programs, such as section 8, or locally run shelters, as well as by taxing the beneficiaries.

The major problems with such a plan are its imprecise targeting, and resultant enormous expense. Given an adult population of 215 million eligible citizens, this program would cost in excess of 750 billion dollars per year, more than half again the cost of social security, currently the largest single category of government expenditure. Employing his suggestion of heavily taxing the benefits for those of higher income seems to violate his advocated policy of non-means-testing. I am left wondering what failure he percieves to be implicit in simply extending something similar to the section 8 housing voucher into a universal entitlement program, though it would clearly be necessary to come up with an alternate definition of the Fair Market Rent. Such an option provides sufficient purchasing power to procure housing for individuals without income while retaining incentives for work, and not unfairly disadvantaging other low income housing consumers.

Bibliography

O’Flaherty, Brendan, Making Room: The Economics of Homelessness,
Harvard University Press, Cambridge, Massachusetts, 1996

Sommer, Heidi, “Homelessness in Urban America: A Review of the Literature”,
prepared for Urban Homelessness and Public Policy Solutions: A One-Day Conference
Januarry 22, 2001

Winnick, Louis, “The Triumph of Housing Allowance Programs: How a Fundamental Policy Conflict was Resolved”, Cityscape, Vol. 1, No. 3, 1995, pp. 95-121.