The National Centre for Policy Analysis recently released its analysis of the Great Recession and accompanying housing crash in a report entitled "The Housing Crash and Smart Growth". In this report, the author, Wendell Cox, a scholar with the National Centre for Policy Analysis and a visiting professor at the Conservatoire National des Arts et Metiers national university in France, discusses the housing bubble, how it formed and how the magnitude of the issue varied across the United States and how it relates to urban planning.
Mr. Cox opens his report by acknowledging that the Great Recession was worsened by the bursting of America's housing market which, in large part, reached "bubble proportions" due to the relaxation of mortgage loan standards which allowed many Americans to buy homes that they simply could not afford. It was this massive increase in demand that drove home prices into the stratosphere.
From 1999 to 2006, housing prices seemed to ride a never-ending escalator upwards. This created a feeling among many homeowners that prices would never drop resulting in many Americans taking equity out of their homes in the form of additional mortgages. Homeowners regarded home ownership as a risk-free venture; prices would always rise allowing endless extraction of equity. Low interest rates combined with creative lending strategies by banks and other lending institutions resulted in the issuance of both subprime and variable interest loans to households with poor credit ratings. This resulted in a marked increase in the demand for homes which, in turn, resulted in an increase in price and that resulted in an increase in supply. Homeownership in America rose steadily after World War II; in 1940, only 44 percent of households owned their own homes, this rose to 62 percent by 1960, 65 percent by 1995 and peaked at 69 percent in 2006. Accompanying the increase in home ownership level was an increase in the average size (and price) of America's single family dwellings; in 1973, an average home was 1525 square feet, this rose by 47 percent to 2248 square feet in 2006. I find that statistic particularly interesting in light of my own life experience; as a baby boomer, most of my peers were raised, quite comfortably, in 1000 square foot bungalows (often with 3 or 4 children in a family). This is certainly not the case today.
Mr. Cox notes that during the years between the end of World War II and the early 1970s, the median selling price of an average American home was less than or equal to three times the median household income in most markets. This ratio began to break down during the 1970s in certain states that began to impose stronger real estate development regulations. This median price to median income ratio accelerated markedly during the 1990s and 2000s when the median price rose far faster than household incomes which were basically stagnant. On a nationwide basis, the gross value of United States housing stock doubled from $10.4 trillion in 1999 to $22.7 trillion in 2006 as shown on this graph:
From the peak of housing stock value in the fourth quarter of 2006, values have dropped by more than $6 trillion. There goes that "wealth effect".
When the growth in the value of housing stock is compared to household incomes between 2000 and 2007, the gross value of the stock of houses in America rose a staggering $5.3 trillion more than household income. This number alone explains a great deal of why there was such a flurry of foreclosure activity once the impact of the Federal Reserve's tightening in the early part of 2004 and throughout 2005 and 2006 took effect.
While house price increases were very steep in some markets, others noted relatively minor price increases. For example, house prices in the 10 major real estate markets with the greatest price increases compared to income, rose by an average of $275,000 relative to income. In contrast, major markets with the least rise in prices saw house prices rise by only $5000 relative to income. In general, house prices rose the most on the East and West coasts of the United States and the least in "Middle America". As well, house prices rose most in metropolitan areas that are encumbered with heavy land use regulations (i.e. New York, San Diego and Miami) and least in less restricted cities (i.e. Houston and Atlanta).
Now let's take a brief look at what happened to mortgage debt during the same period from 2000 to 2007. During that period, the gross value of residential mortgages in the United States rose $4.8 trillion more than household incomes. Mr. Cox states that "...assuming that the distribution of mortgages tracked escalating prices, 83 percent of the rise in house values occurred in the 20 markets with the greatest escalation in housing costs relative to income..." and "...these markets account for only 26 percent of the nation's owner-occupied housing stock...". Basically, he is suggesting that there were other factors in play that created and then destroyed the housing bubble; liberal lending policies alone were not to blame for all of today's housing market woes.
Mr. Cox goes on to discuss how land use regulation can artificially create housing supply shortages. Certainly, nature plays a role in limiting housing developments; one need only think of the presence of mountains or bodies of water as barriers to further development. Land use regulations can artificially suppress the amount of land available for residential development; as the supply of developable land is decreased because of regulation, the price of available developable land rises. Land use regulation can take two forms as follows:
1.) Prescriptive regulation: regulations are designed to stop or contain the spread of urban areas into rural areas in an attempt to force travel by public transit in more compact cities.
2.) Responsive regulation: regulations are designed to allow development to take place based on market preferences.
In normal regulatory situations, land and associated regulatory costs amount to 25 percent of the cost of building a house. A study of the land and regulation costs for new homes in 11 major United States markets shows a very wide variation. The study assumes that any house price that is more than 125 percent of its actual construction costs is likely due to excessive land and regulation costs. In general, housing prices were far less affordable in markets with a prescriptive regulatory environment that attempted to control development; the three worst markets in the United States being Portland, Oregon with added land costs of $76,200, Washington-Baltimore with added land costs of $90,700 and San Diego with added land costs of $239,100. Not surprisingly, housing markets with the more onerous prescriptive regulatory environments accounted for 89 percent of the rise in house values. Interestingly enough, 25 percent of America's homeowners live in responsively regulated major markets which accounted for only 11 percent of the aggregate increase in house values. This is even further proof that the "wealth factor" associated with homeownership was not evenly spread throughout the United States.
Now let's look at what happened as the bottom fell out. Losses in the value of homes was even more concentrated geographically than price increases. House values in prescriptively regulated markets accounted for 94 percent of all value losses between 2007 to the fall of 2008 for an average loss of $97,000 per house. In comparison, houses in responsively regulated markets lost just 6 percent of their value for an average loss of $12,000 per house.
To close, I would like to take a brief look at Mr. Cox's summary of the markets that have suffered the most since the fall of 2006. Between 2000 and 2006, most of the house price increases in the United States were found in 11 major markets. These included Los Angeles, San Francisco, San Diego, San Jose, Riverside-San Bernardino, Sacramento, Las Vegas, Phoenix, Miami, Tampa-St. Petersburg and Washington, D.C. (notice the sun connection excluding Washington?). These very heavily regulated markets accounted for 56 percent of the increase in aggregate house values across the nation as prices were rising before 2006 but have only 28 percent of America's homeowners. In the period from the peak in 2006 to the fall of 2008, average house values in these markets dropped an average of 25 percent and accelerated after the sudden demise of Lehman Brothers and the "launching" of the Great Recession in 2008. Despite these massive downward price adjustments, in the first quarter of 2010, the median house price in San Diego (a prescriptive regulatory market) was $380,000 which would require 35 percent of the median income of a household. In comparison, a median house is priced at $140,000 in Dallas-Fort Worth (a responsive regulatory market), requiring only 15 percent of the median income of a household.
It is interesting to view the American housing market debacle from a planning viewpoint rather than simply blaming lax lending policies and the role of speculation. While the latter two played some role in the run-up of housing prices, it appears that land use over-regulation is at least partially to blame for the housing bubble in certain markets. Some changes in land use regulation may have prevented such a dramatic run-up in prices in certain markets (basically California) during the period up to 2006, increasing the supply of homes at a pace that was closer to the increase in demand that resulted from laxity in lending practices. Apparently, once again, it is the old supply and demand story.
There just has to be some way to blame the Fed for this!