The Perverse Incentives of Rent Control

Only a couple of weeks ago, within a period of a few short hours, an arsonist went on the rampage in the Castro District of San Francisco. The center of San Francisco's large gay community the Castro saw four fires that were intentionally set.

While no lives were lost 17 people were out on the streets homeless, having lost all their possessions and their homes in just a few minutes.

The Red Cross helped these people temporarily but, now they need more long term solutions. But they also just lost everything they owned so they have lots of expenses.

The wonderful people of San Francisco are trying to help them. They are holding fundraisers to help the people.

And now it appears that there are people with vacant apartments who are willing to help out the victims of these attacks. But rent control laws are getting in the way. The San Francisco Examiner says, "under San Francisco housing laws, a landlord cannot offer a below-market rent without them locking that unit into that rate" under the rental control laws. City Supervisor Scott Wiener said: "As a result of this risk and despite their desire to help, some landlords are hesitant to assist with short-term below-market rentals after a fire, earthquake or similar event." Wow, with laws like that it sure is a good thing San Francisco doesn't have to worry about earthquakes.

As I understand it, a landlord who, out of compassion for someone in unusual circumstances needs emergency short-term housing, and who offers that housing at below-market rent is then forced to continue offering that space at the same rent after the person he was helping moves out. In other words, the short-sighted rent control laws penalize landlords who try to show compassion to people such as the victims of these arson attacks. Supervisor Wiener is trying to pass emergency legislation to allow this sort of short-term rental without stripping the landlord of the right to get market rents for this apartment later.

Let me recount a story of the perverseness of rent control in San Francisco, that I personally know to be true. I was, in fact, told of this incident by the tenant in question.

This tenant was renting an "apartment" which amounted to the entire floor of a large building. His apartment had 7 bedrooms in it. I knew of the apartment but never knew the size until this tenant wanted me to sign a complaint against the landlord because the tenant had 21 cracked windows in his apartment.

This surprised me. I had a rather large apartment in the city myself. And, by my count, had only 23 panes of glass in total in the apartment. That's counting each window as having two panes. So I was shocked by the number of cracked panes and asked how many bedrooms he had. That was when I learned there were 7 bedrooms. Each would have its own windows, as would the lounge and the kitchen and the bathroom.

The conversation was quite enlightening. The tenant didn't work, he didn't need to. He used the rent control laws to make himself wealthy at the landlord's expense. He would rent each bedroom out for a couple of hundred dollars each. In addition he would spread the utilities bills between the tenants. The landlord, however, was only allowed to collect a much smaller amount for the apartment because it was under rent control. In effect the tenant was taking in $1200 in rental income on an apartment he didn't own. But he was legally free to sublease the rooms for any amount he wanted. The owner of the building, an elderly man, however was not so free. He was restricted to getting something like $700 per month for the entire apartment.

I suggested to the tenant that perhaps one reason the landlord was unable to maintain the building was that the bulk of income for living there went to the tenant and not the actual owner of the building. The tenant in question became rather agitated that I dared suggest that he clearly had no right to profit in renting out an apartment he didn't own, while the actual owner was forced to rent it out at rent-controlled rates.

The city did not manage to change the value of the apartment. They said it was worth $700 but the going rate was actually $1400. All the rent control legislation did was transfer that income from the actual owner of the building and gave it to someone who no investment and did nothing to earn it, but manipulate the law to benefit himself.

For an interesting drama/horror film about a man who uses San Francisco's housing laws to victimize a young couple see Pacific Heights. Trailer below.

When nonsense makes sense.

Sometimes insanity makes sense. At least it does in the Bizarro world of politics. Let me tell you a story.

A few years back I was renting some commercial street on the main street in one of our major cities. The space I was renting was about one third of the ground floor. Above me were two floors of tenants.

One day one of the tenants from above came down rather irate. He was planning to file complaints with the city against the building owner, who was a small businessman who had offices next door to my own. This tenant wanted me to add my name to the complaint that would be filed. I was curious as to what it was that had this guy so upset. The conversation went like this.

Me: “So what’s the problem?”

Him: “We have 32 cracked windows in our flat.”

Me: “Thirty-two windows! Exactly how many rooms does your flat have?”

Him: “It’s an eight bedroom.”

Me: “But how much rent do you pay for that?”

Him: “Five hundred a month.”

Me: “Maybe that’s the reason he doesn’t have much money for maintenance.”

What was going on was that you witnessing the effects of rent control. The local city government had said that landlords couldn’t raise rents and thus it froze rents at levels that were years out of date. Of course property taxes and expenses didn’t freeze just the rental income. In the case of this tenant the travesty was that he was allowed to get away with his game. To cut to the chase I threw the guy out and told him I had no intention of signing his complaint.

What I didn’t realize is that while the ground floor had three businesses on it the same space on the third floor was occupied by one massive apartment. Rent control meant that this tenant was allowed to keep this huge apartment at a fraction of the market rate. But it get worse. While the landlord couldn’t make money on the apartment the tenant was.

With eight bedrooms this tenant was bringing in “roommates” who shared his flat. He, however, was able to rent out each room for what he paying for the entire flat. He didn’t have to work since he was able to reap profits from the landlord’s property in ways which the landlord couldn’t. As the tenant saw things it was fine that he profited from the roommates but the landlord, who was receiving only a tiny fraction of the actual rental income had to pay for the new windows.

Having lived under rent control for sometime I quickly realized that this was a con game played by tenants. Even small apartments could be sublet at a profit by the tenant. One tenant in the city once bragged to me how he had a two bedroom apartment. Because rent control reduces the supply of apartments while pushing up demand there is a massive shortage of housing. That means even single rooms in the city could be let out at premium if you were allowed to do so. And he, as the tenant, was allowed to do so. So his entire rent was paid by the roommate’s rental of one room in the flat.

There is very little support for rent control among economists. Most agree that rent control destroys the housing market. It prevents maintenance and by reducing the return on housing it discourages expanding the housing market to meet demand. At the same time the lower rents mean more tenants are attracted to the dwindling supply of housing.

One “beneficiary” of rent control was Cathy Kim of Berkeley, California. Berkeley is a university town and the far Left city council pushed through strict controls on landlords. Kim says that as result when she heard of a studio apartment available she had to take it sight unseen. In addition she started paying rent four months before she needed it otherwise she’d miss out and wouldn’t find a place to live. She notes that while housing supplies in most cities were expanding in Berkeley they contracted under these controls. “Between 1980 and 1990, Berkeley lost 4,613 of the 27,821 rental units tallied by the 1980 US Census (source: Berkeley's current Draft General Plan).”

I confess that as an avid reader I used to scour the bookstores in Berkeley for my library. I would make frequent trips there and spend the day going from shop to shop to buy these books. Recently I decided to relive these memories and found the city to be a dump. I spent an hour on the main street, which was dirty and run down, and found one book worth purchasing before deciding I wasted my time. The city was removed from list of places to shop.

If economists know that rent control is disastrous, and if the impact of rent control is to reduce the supply of housing and lead to a decay in housing stock, then why in the world does it exist?

Because it makes sense! True it doesn’t make economic sense. It doesn’t make sense even in accomplishing it’s purported goal of expanding the supply of “affordable housing”. But it makes political sense. In the past I’ve often discussed the perverse incentives of politics. And if you think about it you will see that the political process can only make bad economic choices.

Politicians as politicians can only do two things. They can restrict projects through regulations, taxes and red tape. Or they can promote a venture through subsidies, contracts, or the like.

The regulations, red tape and taxes reduce the supply of needed services that are actually being provided. After all you can’t tax a business that doesn’t exist. So when a business does exist government makes that business less efficient and more costly. In addition these regulations, rules and taxes reduce the supply of new businesses coming into existence. Often they die before they start because of them.

To counteract this destructive tendency these selfsame politicians then try to encourage businesses. If this is done by reducing the regulatory and taxation burdens it will help. That is the only way government can really help stimulate business -- get out of the way. But politicians frown on anything that reduces their power or influence. So they prefer the use of subsidies, grants, or government contracts.

But what sort of business exists solely because of these subsidies or contracts? A business has to take a string of resources; such as the resources put into the product or service, labor, land, etc., and combine them together. If the product or service that results has more value than the cost of the input they profit because they are creating wealth. If the business consumes more than it produces then it is destroying wealth and thus losing money.

Political intervention in the marketplace means that government reduces the wealth of the society. It makes us worse off by making profitable entities less profitable. And it makes us worse off by propping up entities that consumer wealth instead of producing it.

But couldn’t government actually subsidize enterprises that make economic sense? They could but why? Such enterprises would exist without the subsidies. And susidizing them only takes wealth from poorer consumers and gives the wealth to producers who are likely to be wealthier. Similarly government could speed up the decline of unprofitable enterprises but such businesses would go under without the state’s help. Instead the state has a tendency to push marginal business, that have a chance of surviving, under when unnecessary.

Government intervention doesn’t make sense. Political control tends to destroy enterprises that make economic sense while pushing programs and businesses that don’t make sense. So why do they do it?

Because it sometimes make political sense to do that which doesn’t make economic sense. Let’s go back to our example of rent control. The simple reason it exists is that the number of voters who are tenants exceeds the number of voters who are landlords. These sorts of measures are particular likely to pass by the vote the public. When the masses can decide the tendency is to redistribute rights and wealth from minorities to majorities.

Of course the political system also does the opposite. It redistributes rights and wealth from majorities to minorities. This tends to take place under the legislative system. So we witness Big Energy and Agribusiness pushing for subsidies for disasters like ethanol. In the legislative process it is the minorities that tend to get the support.

So doesn’t it all wash out in the end? Not at all. Let me illustrate it with a domestic quarrel between a husband and a wife. She is angry and breaks his fishing rod. He retaliates by destroying her vase. She gets more angry and slashes the tires on his car. He responds by cutting up the new couch she bought. By making things more even all they managed to do was make themselves worse off.

Since the political process can basically only destroy efficiency where it exists and prop up inefficiency where it exists these measures don’t balance out. They accumulate.

The whole process is like a group of ten people sitting in a circle with the local political walking from participant to participant. From each individual he collects one dollar. When he gets to the last person he hands them five dollars and then starts the process over again. He does this ten times until each person has received one five dollar bonus. This sort of redistribution makes everyone poorer. But they are so happy when they receive their bonus that the tend to see the politician as their friend.

The reality is that government can’t make business more efficient. It can only increase inefficiency and destroy wealth. Only by acting within the proper confines of government: that of protecting life, liberty and property, does it help anyone. Beyond that the State manages to increase the number of losers while making everyone believe they better off. Such are the perverse incentives of politics.

Note on reading: I highly recommend a short book that discusses the role of incentives under both profit management and bureaucratic management. That must-read book is Bureaucracy by Ludwig von Mises. Copies can he purchased from Laissez Faire Books, 1-800-326-0996.