If you type “housing crisis” into Google search, “2008” is no longer the first result. The subprime mortgage crisis that toppled the global economy just a decade ago has been supplanted on Google trends by “housing crisis 2018.” This time, the crisis isn’t an overabundance of housing; it’s a chronic housing shortage. But economist Kevin Erdmann argues that the 2018 housing crisis is just the second act of the same tragedy.

With local governments issuing fewer building permits and millennials beginning to buy their first homes, millions of Americans struggle to find affordable housing in 2018. The crisis is arguably the worst in California, where about one-third of all city-dwellers cannot afford local rents in every city in the state, San Diego to Sacramento. Economists and policy experts that study housing largely agree that the chronic unaffordability of American housing stems from persistent shortages in the quantity of housing supplied relative to the quantity demanded.

Most housing scholars agree that “not in my back yard” (NIMBY) zoning laws are to blame. In many areas, NIMBY zoning laws have prevented developers from building multifamily housing in residential areas or forced developers to adhere to mandated minimum lot sizes.

What resemblance, then, does our world of NIMBY-induced housing shortages have to do with the pre-2008 world with fast-and-loose credit policies [pdf] and overbuilt McMansions? That pre-2008 world, Erdmann argues, doesn’t really exist. [pdf]

The traditional loose credit story is an easy one to tell––it appeals to populist sentiments (by demonizing rich bankers) and exudes the moral weight of an anti-capitalist parable about greed and gluttony. It makes for a great movie, “The Big Short.”And, to its credit, the traditional credit story even seems to explain much of the financial bedlam of 2008. Banks and investors placed too much confidence in risky mortgage-backed assets, perhaps because they knew Congress would bail them out.

But by focusing on big banks and complex financial instruments, the traditional story overlooks evidence in the real, physical economy of actual houses and homebuyers.

According to the traditional narrative, the housing bubble saw an increase both in the supply of housing and the price of housing, fueled by a combination of loose monetary policy, irresponsible government-backed mortgages, and reckless Wall Street speculation. For the traditional story, the spike in new single-family home construction from 2000 to 2005 is the smoking gun.

Yet during the early 2000s, new residential construction overall was steady, with single-family homes simply displacing multifamily units, like condos and apartments. Many high productivity population centers like New York, Los Angeles, and Seattle faced huge housing shortages during the early 2000s, evidenced by skyrocketing housing costs. Shortages in these cities, dubbed Closed Access cities, were caused, in large part, by laws which made it difficult to construct new housing.

Sound familiar?

Consider these two quotes, both from commentary in the Wall Street Journal, one from 2005 (the peak of the first housing crisis) and one from 2018. From 2005,

What we do have is a serious housing shortage and housing affordability crisis. Despite robust construction, unsold inventory stands at four months, well below its 25-year average. Private builders complain they can’t get land permitted to meet demand.

And from 2018,

A combination of tightened housing regulations, a lack of construction labor and a land shortage in highly prized areas is driving the crisis, according to industry experts….Now, construction isn’t matching rising demand, not only in glamour cities such as San Francisco and New York, but also in metropolitan areas such as Grand Rapids….That, in turn, is pushing up prices at what economists say is an unsustainable pace.

Both complain of high (and rising) real estate prices, and both indicate builders face major hurdles in keeping up with demand. Moreover, both attribute the supply shortage to local authorities’ stinginess with building permits—a direct result of NIMBY laws.

While the traditional story about credit may explain some of the demand side of inflated housing prices, Erdmann’s work demonstrates that more flexible housing policies in Closed Access cities could have headed off the shortage which generated the housing bubble.

Since the recession, federal housing agencies have stopped the credit policies, like “no income, no job, no assets” (NINJA) loans, which made housing deceitfully affordable during the pre-2008 shortages by saddling households with more debt than they could pay. As a result, many potential homebuyers today are giving up on buying altogether.

Erdmann argues that an aggressive federal credit policy was actually the right move pre-2008 because it helped consumers buy housing at historically average levels, even recommending a return to those policies now. But the uncanny resemblance between housing markets in 2005 and 2018 should still be a cause for concern.

For one, another housing bubble is not out of the question, and a housing collapse could still turn consumers skittish [pdf] and decrease spending across the economy. Readopting Fannie and Freddie’s pre-2008 mortgage practices would only exacerbate that risk. The Great Recession should have made it clear that a demand stimulus is not a sustainable solution to a supply problem.

But the ongoing shortage of housing in places that require more workers is also unsustainable. Besides the boom-and-bust risks of housing disequilibrium, housing shortages in Closed Access cities prevent people from working where they will be most productive and earn the highest wages. Over the last half century, one paper from the National Bureau of Economic Research estimates [pdf] that prohibitively high housing prices have thereby reduced America’s growth by about half.

On August 13, Housing and Urban Development (HUD) Secretary Ben Carson announced that the department would change the way it enforces the Fair Housing Act to address the housing crisis. Secretary Carson says he wants to incentivize cities to lower barriers to affordable housing by making HUD grants, which cities use to build and maintain roads, sewers, and other infrastructure, contingent upon conforming to less restrictive zoning policies. Democratic Senator Cory Booker has also introduced legislation that hopes to take on restrictive zoning policy at the federal level.

Supply-focused approaches along these lines address the fundamental problem of the disequilibrium Erdmann describes in the housing market and reduces risk of boom-and-bust cycles that led to the Great Recession.

The political economy problem of land and housing is as old as social science and will no doubt be with us for the foreseeable future, but reforms like Secretary Carson’s and Senator Booker’s are signs of lessons finally learned.

Albert Gustafson is an economics and public policy contributor for Young Voices. Follow him on Twitter @apgustafson

The post Housing Still Suffers the Same Ills That Caused the Great Recession—Just Not the Ones You Think appeared first on Market Urbanism.

Here’s a snippet:

In these days of economists constantly debating the right way to revive the economy, it seems like there is no way to find consensus among economists.  Economists don’t spend much time debating the issues they agree on, and to them, rent control is about as dead an issue as the earth revolving around the sun.  In 1992, 93% of American and Canadian economists surveyed agreed with the statement “A ceiling on rents reduces the quantity and quality of housing available.”  Opposition to rent control among economists spans the political spectrum from Milton Friedman and Walter Block to leftist Nobel Laureates Gunnar Myrdal and Paul Krugman.  In fact, it was the socialist Swedish economist Assar Lindbeck who famously said, “In many cases rent control appears to be the most efficient technique presently known to destroy a city—except for bombing it."

The article is part of a series called “Undead Ideas” and I’m told the article is supposed to feature a humorously hideous illustration of a zombie Richard Nixon, which is the reason for the Nixon joke.  I will share the illustration once it is public.    

Could President Obama resurrect an undead Richard Nixon to implement nationwide rent control in the face of the impending stimflation?  There’s a 93% chance his economic advisors wouldn’t let him do such a thing.  However, Nixon’s undead corpse has been spotted mumbling "I am now a Keynesian" in places like California and New York City where bad ideas never seem to die.

I actually thought of the word “stimflation” on my own, but I checked and learned I wasn’t the first to think of it.  The domain stimflation.com had just been reserved last week…

Here’s a composite, I found:

—–

Wendell Cox also made a contribution to the “Undead Ideas” series with a very good article about housing.  I thought I might, but I don’t have any significant disagreements with Cox’s article.  I was very glad not to see him singling out “Smart Growth” as a culprit, and appropriately blaming land use restrictions in general:

Demand for housing, driven by low interest rates and a growing economy, combined with supply restrictions—such as zoning laws, high permitting costs and “not in my backyard” regulations—to contribute to rapid price appreciation.

and he quoted a great point by Glaeser:

If some aid to expensive states is made conditional on permitting more construction, then pricey places will face incentives to permit more units and promote affordability. Those incentives will encourage restrictive cities and towns to look beyond their borders, and to make America more affordable by permitting more construction in the high-price housing markets that are undersupplied and unaffordable even to the middle class.

The post My Article at FreePo on the Resurrection of Rent Control appeared first on Market Urbanism.

Last week I spoke to a standing-room-only crowd of students and faculty about the current economic and financial turmoil.  I shared the podium with three of my colleagues, who range all the way from far to the left of Barack Obama to very, very far to the left of Barack Obama.  Needless to say, they all blamed, to a greater or an even greater degree, “the free market.”

Now, I do think it’s possible in principle for wide-spread mal-investments to occur in an unfettered market.  (F.A. Hayek writes about the possibility in his Monetary Theory and the Trade Cycle, which you can read online here.)  But enormous speculative bubbles, of the sort we’ve just witnessed in the housing market, are typically the result of government interventions and policies.

So in my talk on this highly complex issue I tried to make three points:  (1) the immediate cause of the financial panic on Wall Street was the housing bubble with its sudden rise in mortgage defaults; (2) the free market, which stands for minimal government and the absence of privilege or discrimination, did not create this bubble; and (3) government (and Fed) policy and pressure did, by undermining lending standards across the board and pushing lending rates artificially low.

This blog has already referenced Russell Roberts’s fine collection of blog posts on the problem, and if you’re already familiar with the issues then obviously there will be nothing new here for you.  But I think it might be useful to have a list of “names and dates” that make the above case.  The following is not meant to be exhaustive (e.g., it doesn’t even mention important international factors), but is only an outline of the major legislation and policies relevant to the housing bubble.

(Caveat:  My expertise in economics is not in finance, but I did study a lot of this stuff at one time.)

***

LEGISLATIVE & POLICY TIMELINE

1913:    An act of Congress creates the Federal Reserve System, America’s first true central bank, to act as the government’s bank and as a lender-of-last resort for its members.

1920s:    The Fed quickly discovers that by buying and selling Treasury obligations (i.e., “open-market operations”) it can increase and decrease the supply of money and credit and thereby manipulate market rates of interest.  The Fed inflated the money supply by 60% in the 20s, which resulted in economic boom as well as systemic malinvestment, and rampant speculation on margin on Wall Street.  (Sound familiar?)  The best account of the episode is Murray Rothbard’s America’s Great Depression.

1929-33:  As we know, the economy then crashed and burned.  But that was a necessary stage in the economic recovery from the previous decade’s massive malinvestments, as producers tried to re-align their decisions with consumer preferences.  Unfortunately, a slew of policies, such as the Fed’s 30% contraction of the money supply, and legislation, such as the Smoot-Hawley tariff, delayed recovery for twelve years.

1938:  FDR creates the Federal National Mortgage Association (“Fannie Mae”), which is charged with buying and insuring residential mortgages in order to lower interest rates and promote home ownership.  Home ownership rises from 43% in 1949 to 62% in 1960.

1970:  Congress creates the Federal Home Loan Mortgage Corporation (“Freddie Mac”) that, together with a re-constituted Fannie Mae, bundles home mortgages into “mortgage-backed securities” (MBSs) for sale to investors.

•    Fannie and Freddie are known as Government Supported Enterprises (GSEs).

•    By 2008 Fannie and Freddie had issued more than 60% of MBSs, of which they themselves held $1 trillion and insure about 50% of all MBSs.

•    The perception that the federal government guarantees Fannie and Freddie’s viability further lowers the cost of risk and increases their profit margin, on the order of about $2 billion per year, as estimated by the Congressional Budget Office and the Treasury Department.

•    This implicit guarantee is realized in part, when beginning in 2006 rising loan defaults jeopardize Fannie and Freddie and prompts President Bush to nationalize them in August 2008.

1975:    Congress passes the Home Mortgage Disclosure Act (HMDA), requiring lenders to provide detailed information about mortgage applicants.

1977:  Jimmy Carter signs the Community Reinvestment Act (CRA), requiring banks to conduct business across the entirety of geographic areas in which they operate, in an attempt to combat “redlining.”

1991: Bill Clinton expands HMDA to include comparisons of rejection rates by race.

1992:    The Boston Fed promotes the government’s mandate to increase home ownership, specifically among minorities, by advocating a relaxation of lending standards, including:

•    Eliminating a lack of credit history as a barrier.
•    Permitting a lower share of income than the standard (28/36) on mortgage payments.
•    Permitting lower down payment and closing costs.
•    Nontraditional sources of income are OK, including unemployment benefits.
•    Banks can be punished by fines if HMDA data show higher rejection rates of minorities.

(One of my colleagues at this point accused me of blaming minorities for the housing crisis.  Be very careful, people will play this card!  Clearly, the responsibility for the crisis lies not in the intended beneficiaries of the CRA, but to the CRA itself and to the lax standards that it later encouraged across the entire mortgage market, both prime and sub-prime.)

Beginning in 1992:  Fannie and Freddie were encouraged to purchase “affordable” mortgages from banks – i.e., mortgages that followed “flexible lending standards” to promote the goals of the CRA.

•    Pressure from Congress and presidents Clinton and Bush helped promote the “subprime” market.  (Note:  You could underwrite subprime paper even before deregulation of 1999.)

•    Congress and the Administration pressure Fannie & Freddie to accept a growing percentage of their portfolios in subprime mortgages and also MBSs, of which by 1992 they held over $1 trillion.

•    Home ownership rises from around 64% in 1994 to 69% in 2005.

From 1998 to 2006:  There’s a great housing boom in the US.  Prices rise from just under $60K to over $90K (in 1983 dollars), owing in large part to “flexible standards” and the Fed’s interest-rate policy.

•    The “Federal Funds Rate,” which the Fed targets by using open-market operations, plunged from around 6% in January 2001 to 1% in January 2004.

•    While this was largely in response to the recession and 9/11, it also reinforced Congress and the President’s goal of expanding home ownership and fueling the ongoing housing boom.

2006:  In the third quarter of that year, defaults and “foreclosures started” began their sudden climb for prime (from around 0.16% of loans made to 0.43% in Q4 2007) and subprime mortgages (from around 1.5% to 3.7%) AT THE SAME TIME.  Thus, contrary to conventional wisdom, subprime defaults did not precipitate the prime-market defaults.

•    Stan Liebowitz shows that it was in the market for adjustable-rate loans, particularly in low-income areas, that foreclosures were the most dramatic.  These are the kind of loans that speculators prefer because of their low initial rates (with low or no money down owing to the “flexible standards” which were becoming the practice across the industry) and because speculators expect to re-sell (or “flip”) the houses before the rates were set to increase.

•    In percentage terms, the increase in foreclosure rates was significantly higher for prime adjustable loans (69%) than for subprime adjustable loans (39%).

2008: Investment banks and other financial institutions that, after years of encouragment from the government and GSEs, hold a significant part of their assets in MBS with defaulting loans — such as Bear Stearns, Lehman, AIG, Fannie and Freddie — see their asset values plummet and go belly up. Panic races across the rest of the Wall Street, the Dow Jones crashes again and again. In the midst of the panic, the government nationalizes a significant and ever growing percentage of the financial market.

So here’s the short version:  (1) Government legislates and the Fed helps to implement flexible standards in the mortgage industry in conformity with the CRA.  (2) Throughout the 1990s and early 2000s, government pressures Fannie and Freddie to purchase an increasing proportion of MBSs and subprime loans (based on flexible standards), while at the same time (perhaps unintentionally) loosening traditional lending standards across the board.  (3) From 2001 to 2004 the Fed deliberately drives interest rates down (as much as 5 percentage points).  (4) This all fuels in a speculative housing boom beginning in 1998, financial innovations on Wall Street based on MBSs and other derivatives in the early 2000s, and a housing bust in 2006.  (5) This in turn precipitates an historic financial collapse and equally historic bail-out in September 2008.

Greed and speculation are obviously an integral part of this story.  (They are as constant as gravity in ANY politico-economic system.)  Given the scope and depth of involvement in it by government institutions and policies, however, blaming our current woes on “the free market” is nonsense.

***

I drew on many sources in putting this timeline together, but the following were my principal ones:

Stan Liebowitz, “Anatomy of a train wreck.” [pdf]

Roger Congleton, “Notes on the financial crisis and the bail out.” [pdf]

The post Talking points on the housing bubble appeared first on Market Urbanism.

As a great follow up to his posts at CafeHayek on government’s intervention in the housing market, Russell Roberts discusses the situation and bailout with reason.tv:

Also…

Here’s the video from an Economics forum discussion at MIT (my Alma mater) on Wednesday: The US Financial Crisis What Happened? What’s Next?

And another forum at USC. [HT Richard’s Real Estate and Urban Economics Blog]

The post Market Meltdown and Bailout Videos appeared first on Market Urbanism.

Housing markets without the benefit of hindsight

Fannie reaches its goals–sort of

Zero Down!

Fannie and Freddie’s other mission

Section 8

Bill cared too

Affordable equals “subprime”

Calm down

And don’t forget Andrew Cuomo

Shiller and fundamentals

The role of the CRA

It’s not the CRA

No money down, revisited

Bear Stearns, the CRA, and Freddie Mac

Stiglitz on the crisis

The post Russell Roberts on Government Intervention in Housing appeared first on Market Urbanism.