Paulson: Housing Is the Root of the Problem

“I’ve consistently said that when we looked at our financial institutions,” Secretary of the Treasury Henry Paulson said Monday, “the root of the problem lies in this housing correction.” Housing prices went up — and banks and other financial institutions invested in mortgages. Housing prices went down — and banks and other financial institutions failed.

Why did housing prices go up? Because of supply constraints. We know that home builders can meet almost any demand if there are no constraints on land. We know that because, as the latest home price indices reveal, the fastest growing metropolitan areas in America — places like Dallas and Houston — did not suffer from housing bubbles and are not now suffering any serious correction.

We know that supply constraints make prices go up, both because basic economic theory says so and because the biggest price gains in the last decade have been in places like Nevada, where homebuilders ran out of private land to build on, and California and Florida, where government restrictions prevented homebuilders from accessing land that was otherwise suitable for housing.

And we know that, as Harvard economist Edward Glaeser says, “restricting housing supply leads to greater volatility in housing prices.” In particular, “if an area has a $10,000 increase in housing prices during one period, relative to national and regional trends, that area will lose $3,300 in housing value over the next five-year period, again relative to national and regional trends.”
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Restrict supply, and housing prices bubble then crash. California has gone through three bubbles and crashes since it began restricting supplies in the 1960s. The difference now is that many more states — including Arizona, Florida, Maryland, New Jersey, Washington, and most of New England — are emulating California’s example in an obsessive war on so-called sprawl. As a result, close to half the housing in the country was subject to bubbles, which had a much bigger impact on our financial markets than when it was just California, Hawaii, and Oregon (as it was in the first couple of bubbles).

Of course, there are still some people, including most urban planners, who foolishly deny that restricting supply has anything to do with housing prices. Growth-management planning has made states like California and Oregon more desirable places to live, say these Pollyannas, which has increased the demand. Higher prices have nothing to do with limits on supply. After all, people can choose from plenty of high-density housing developments.

In fact, sprawl is a made-up problem. It doesn’t pollute the air. It doesn’t make people fat. It doesn’t waste scarce rural open space. But the war on sprawl does give power to urban planners and others who want to restrict the property rights of private landowners.

With friends like urban planners willing to destroy our entire economy to solve a non-existent problem, who needs enemies?