One of the more common notions about the housing bubble is that it was caused by political pressures to increase homeownership. The Antiplanner’s view is that it would be more accurate to say that the bubble was caused by the conflict between policies aimed at increasing homeownership and policies aimed at reducing homeownership (or, at least, single-family home construction). It would be even more accurate to say that the policies aimed at reducing single-family home construction started the bubble, while some of the policies aimed at increasing homeownership made it worse.
As the Antiplanner noted in recent posts, a lot of factors contributed to the recent housing bubble and subsequent financial crisis. But only two factors were so crucial that, without them, the crisis would not have happened.
The two crucial factors were growth-management planning and inadequate ratings of financial risk. Growth-management planning–urban-growth boundaries, greenbelts, growth limits, and other policies aimed at controlling where or how fast regions grow–had three major effects on the economy.
First, it reduced housing affordability. In an unregulated market, median homes tend to cost about twice median family incomes. Growth-management planning quickly pushes this up to three times, and in regions that have had such planning for several decades, median home prices can exceed ten times median family incomes. This major decline in housing affordability in major markets in California, Florida, Massachusetts, and elsewhere contributed to, if it was not the main cause of, political pressures on banks, Fannie Mae, and Freddie Mac to compensate by relaxing their lending standards.
Most metropolitan areas that practiced growth-management planning experienced major housing bubbles, with prices more than doubling in short time followed by a major collapse. Source: Federal Housing Finance Agency.
Second, because housing prices in planned regions were growing much faster than normal, they attracted speculators to invest in housing. The zero-down-payment and interest-only loans offered by lenders responding to pressures to provide more affordable mortgages catered to these speculators who helped inflate the bubble.
Third, growth management not only made housing more expensive, it made prices more volatile. Land-use restrictions and delays in permitting steepened the supply curve for housing, so small increases in demand led to large increases in price, while small declines in demand led to large decreases in price.
The first two points caused prices to rise; the third caused prices to fall. More important, the increased volatility is what surprised the ratings agencies and so many others on Wall Street and in the Fed and other regulatory agencies.
As the Antiplanner has observed before, at least two pieces of evidence show that growth-management planning, and not low interest rates or loosened lending requirements, caused the housing bubble. First, the bubble was pretty much confined to states that had growth-management planning, such as California and Florida, whereas states that did not have such planning, such as North Carolina and Texas, did not bubble even though the latter were experiencing faster growth.
Most metropolitan areas that did not practice growth-management planning did not suffer housing bubbles. Low interest rates and looser lending standards may have caused prices to rise, but the increases in prices were small and were not followed by a major collapse. Without growth-management planning, the average for the USA would have more closely resembled Houston or Dallas than Ft. Lauderdale or Sacramento. Source: Federal Housing Finance Agency.
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Metropolitan areas in California, which began growth-management planning in the 1970s, suffered a housing bubble in the late 1980s. However, metro areas in Florida, which did not implement growth-management plans until the mid-1990s, did not experience a bubble until a decade later. Source: Federal Housing Finance Agency.
Second, states such as California that have had growth-management planning since the 1960s have had bubbles before, even when mortgage requirements were much stricter than in the 2000s. California, Hawaii, and Oregon all had bubbles in the late 1970s. California had a second one in the late 1980s. Florida, which did not have growth-management planning until the 1990s, did not experience earlier bubbles. What made the 2006 bubble so much worse than the 1980 or 1990 bubbles is that so many more states and metro areas had adopted growth-management plans in the 1990s.
I am not the only person who thinks growth-management planning played a key role in the financial crisis. “Stringent land use regulation and restrictive geography reduce the supply elasticity in housing markets,” says a 2010 paper by two economists from the University of Alberta. “In a housing boom with rising demand, the lower elasticity forces house prices to increase by more.”
Given growth-management planning, none of the other policies under debate–low interest rates, loose lending standards, the Community Reinvestment Act–could have been altered to prevent the bubble. The one other factor that could have prevented the financial crisis was if the ratings agencies and banks had understood how planning made housing prices more volatile than in the past. Such an understanding might have stopped the ratings agencies from giving AAA ratings to mortgage bonds that included large numbers of mortgages from California and other growth-management states. It also would have discouraged AIG and other insurers from insuring such bonds.
Instead of examining individual housing markets, the ratings agencies used a method known as Value at Risk. Value at Risk relies on historic volatility to predict future volatility. The agencies knew prices had been volatile in a few housing markets, such as California, but they assumed that increases in one market would offset declines in another, so they gave triple-A ratings to mortgage bonds that included a wide geographic dispersion of mortgages. They also didn’t understand why California prices had been volatile, or they would have realized that new growth-management laws in Florida and other states had increased the volatility of around a third of the nation’s housing.
Historically, only one in 10,000 triple-A-rated bonds defaulted per year. So when the ratings agencies gave triple-A ratings to mortgage bonds and CDOs (bonds made up of mortgage bonds) that paid significantly higher interest rates than Treasury bills, investors lined up to buy them. It wasn’t until 2007 that investors realized the annual default rates on these bonds would be much higher than one in 10,000, which led them to not only flee the mortgage bond market but to pull their funds from investment banks (such as Bear Stearns) and commercial banks (such as Wachovia) that were thought to own large amounts of such bonds.
The overrated mortgage bonds had at least two effects on the bubble. First, the rapid sale of these bonds made easy money available to speculators and other homebuyers, who therefore paid more for homes than they were really worth.
Second, the demand for the bonds proved to be so high that banks created synthetic bonds, meaning bonds not backed by real mortgages but bonds whose value mirrored the price of other bonds backed by real mortgages. The counterparties to the synthetic bonds were a small number of bearish investors who were convinced home prices were going to fall and so bought credit-default swaps (effectively the same as insurance on the bonds). The value of new synthetic bonds created in the second half of 2006 actually exceeded the value of real mortgage bonds, which significantly worsened the effects of the crash when it took place.
Most of the narratives of the financial crisis make it clear that, at many critical points in the growth of the housing bubble, the problems could have been avoided by more accurate ratings. Better ratings would have both reduced the size of the bubble (by forcing tighter credit and reducing speculation) and contained its effects on the rest of the economy (by keeping major banks and other financial institutions from being exposed to declining housing prices).
As the Antiplanner previously noted, the ratings agencies probably would have done a more responsible job if they were working for bond buyers rather than sellers. That was the case before the Securities and Exchange Commission effectively turned the agencies into a legal oligopoly. Introducing more competition into the ratings business is one way to avoid these problems in the future.
Stopping growth-management planning would have prevented the bubble and the financial crisis. Given growth-management planning, better ratings would have prevented worst effects of the financial crisis, while not preventing the bubble itself. SInce the banks and ratings agencies have presumably learned from their mistakes, it seems likely that the next property-induced crisis will not be as severe as this one. But so long as we have growth-management planning, there will still be more bubbles that will cause many individual hardships even if they don’t bring the world economy to its knees.
Lets be totally clear:
A price bubble requires supply restrictions. If supply can always meet demand, a price bubble cannot exist.
Thanks
JK
I’m always a little confused by Randall’s classification of Florida as a “growth-management state”. While there may be growth management policies on the books, the actual situation on the ground throughout Florida reeks of the opposite – unbridled growth. There are speculative developments stopped dead in their tracks in almost every part of the state. And then there’s Fort Myers.
One suggestion I’ve read on other blogs/listservs is that Florida’s “growth management” laws were in name only and did almost nothing to limit or curtail growth. All they did was require developers to expand road capacities in anticipation of the growth they were adding. I have not looked into this further but was wondering if Randall or anyone else here could comment. Exactly how could a place where growth management was stringent enough to cause a bubble appear so clearly to be overbuilt?
I’m always a little confused by Randall’s classification of Florida as a “growth-management state Exactly how could a place where growth management was stringent enough to cause a bubble appear so clearly to be overbuilt?
If you don’t conflate and hastily generalize, the argumentation falls apart.
Plus, the strategy seems to be if you repeat a falsehood [Stopping growth-management planning would have prevented the bubble and the financial crisis. ] enough times, it might become true. In the meantime, the strategy never fails to elicit a chuckle.
DS
JK spaketh:
A price bubble requires supply restrictions. If supply can always meet demand, a price bubble cannot exist.
I suppose Karlock is “technically correct” here. How else to explain the absurd run-up in housing prices in places with NO discernible supply restrictions such as Northern California’s Sacramento and San Joaquin Counties, and Southern California’s exurban “Inland Empire” (Riverside and San Bernadino Counties)? Or Phoenix, for that matter, where there has NEVER been any form of “growth management.” (sic)
In such places, there was no real shortage of available housing for those who really needed housing, but then, traditional buyers with 20% payments and looking for 15 or 30 year mortgages were competing against “everyman” speculators fueled by bank mortgage fraud such as “liar loans” approved by greedy banks, and crooked brokers handing out loans to anything walking in the door with two legs. Of course, contrary to JK’s assertions, there was also no shortage of tulips during the tulip craze in the 17th Century, nor South Seas land in the South Seas Bubble of the early 18th Century.
And to the I’m sure constant consternation of those who believe like JK does, housing prices have help up MUCH BETTER in Coastal California, where DEMAND most certainly continues to outruns SUPPLY thanks to the ubiquitous DOWN-ZONING demanded, and received, by housing value-conscious affluent home owners over the past half century.
Of course, in the S.F. Bay Area, housing demand is weakest in the far northeastern and eastern suburbs, but still very strong in Marin, San Mateo and Santa Clara Counties.
In the meantime, the strategy never fails to elicit a chuckle.
Oh, I see the professional frauds are out in force today. How’d you do today, planner? Make it more difficult to drive somewhere? Went to some bogus “smart” growth or global warming conference? It’s the rest of us that will be chuckling when you get your permanent pink slip one day, when the population realizes that your “profession” has been selling everyone a bill of goods.
Much of what Randall says makes sense. When restrictive land-use regulations are applied, it hampers the market’s ability to supply low-cost housing quickly in response to increases in demand (whether through increased credit availability, higher population growth, or increased incomes). As such, the increased demand leads predominantly to rising prices instead of new home construction, which then leads to speculative investment and ‘panic buying’ from first time buyers who desperately seek to enter the market ‘before they miss-out’.
This kind of behaviour is not possible in places like Texas, where land supply is plentiful and largely free from government interference, because the market is able to supply low-cost housing quickly and efficiently whenever demand rises. As such, prices are prevented from rising too much and speculative investment and ‘panic buying’ is reduced.
Moreover, claims that Florida, Phoenix and Northern and Southern California did not have restrictive land supply are false. I suggest readers familiarise themselves with the following reports:
Phoenix Growth Management
Brookings Institution review of land-use regulations in the USA’s 50 largest metro areas, which shows Florida and California to have significant growth management controls
msetty: I suppose Karlock is “technically correct†here. How else to explain the absurd run-up in housing prices in places with NO discernible supply restrictions such as Northern California’s Sacramento and San Joaquin Counties, and Southern California’s exurban “Inland Empireâ€
JK: Are you seriously saying that one can build a house (or subdivision) in those areas with little delay, on plentiful vacant land?
Thanks
JK
Jim, people like Dan and msetty are merely interested in protecting the vested interests of what is often a highly lucrative career. Needless to say, this precludes ever admitting they’re wrong or having made, and continuing to make, bad or malicious calls (such as the war on automobiles).
JK: Are you seriously saying that one can build a house (or subdivision) in those areas with little delay, on plentiful vacant land?
YES. Particularly compared to the standard practices of Coastal California’s massive downzoning over the past 50 years.
As for Phoenix “growth management” their local and regional plans project 3-4 million more people over
The amazing things is how right wing wingnuts like Metrosucks lie to themselves to maintain their illusions, when all the empirical evidence contradicts their blinkered view. For example, in places like Northern California’s Sacramento and San Joaquin Counties, and Southern California’s exurban “Inland Empire†average housing prices have slid around 60% from the bubble’s peak, while in some places prices have dropped only a bit in comparison. if you do’t believe me, look at the real estate reports. But such facts are soooo inconvenient and don’t support brain-dead “opinions” such as those by JK or Metrosucks.
As for Phoenix “growth management†their local and regional plans project 3-4 million more people over the next three decades..
And getting anything approved there took a fraction of the time of say, somewhere like Santa Monica or Santa Cruz.
Awww, did the poor lib get its feelings hurt?
The zero-down-payment and interest-only loans offered by lenders responding to pressures to provide more affordable mortgages catered to these speculators who helped inflate the bubble.
Yes, but you (and all the commenters) ignore the enabler — the Federal Reserve. Without all the cash made available by the Fed in its never-ending zeal to artificially spur growth, the bubble could not have formed.
I think government policies at all levels were terrible, but, still, the ultimate blame must be placed on the central bank. Next up, the commodities crash of 201?.
As a reader of LewRockwell, I am fully aware of the evil Fed
“As the Antiplanner has observed before, at least two pieces of evidence show that growth-management planning, and not low interest rates or loosened lending requirements, caused the housing bubble.”
I’d like a reply from the Antiplanner on this one.
I meant to post this sooner, but have been busy with work and looking for a new place to live. When looking for a new place to live, I check the parcel viewer to view assessment information. Without exception, here and in Portland, values of houses and property has fallen since the bubble burst.
Now to my point: If the bubble was created by regulations and the UGB, how do you explain drastically falling prices? The UGB and regs are still there, right? It’s not like the UGB was abolished and a bunch of new land was developed and that caused prices to fall.
Certainly, UGB contributes to prices, but it cannot be the major factor. Overlooking the major causes of cheap credit and the speculation associated with cheap credit shows a strong ideological bias.
Craigh:
I don’t think there will be a commodities crash. These rising prices are fueled by inflation. Unless the Fed tightens by increasing interest rates and stops monetizing the debt–all of which seem unlikely–expect commodity prices to continue to increase.
There are several arguments Frank. One, that there is a lot of inflation going on right now due to the Fed, and two, that there isn’t a lot of inflation because banks aren’t using all the new money. What’s your opinion on the matter? I lean toward a mix of the two camps, with an emphasis on the first explanation.