Is there a housing “bubble”?
Debate has swirled recently around this question. But one factor behind increased prices in the housing market seems to be frequently left out of the debate or only mentioned in passing—government.
Then-Federal Reserve Chairman Alan Greenspan proclaimed last May 20 that the nation’s housing market was “frothy.” He also said that “it’s hard not to see that there are a lot of local bubbles.” However, he declared that “we don’t perceive that there is a national bubble.”
I’ve never put much stock in “bubble” talk. After all, one of the great benefits of private markets over government is that markets are self-correcting. When mistakes are made in the private sector, prices and profits adjust and resources are reallocated accordingly. This, of course, stands in stark contrast to government, which usually subsidizes failure. Sometimes market correction happens gradually, other times a bit more suddenly when new information becomes available. Often, though, when a substantial change occurs in the market, particularly a negative one, the potential role of government must be explored.
In fact, government is playing a part in driving up housing prices in many local markets. And the nature of this government action raises questions about the effect being a “bubble” or something far more sustainable.
What are the reasons being discussed and debated about recent increases in housing prices? One is monetary policy. Some wonder if the policy is too loose and spilling over into a housing “bubble.” Others simply note that interest rates have generally been falling for some time, including a rather dramatic slide starting from late 2000 to the middle of 2003. Even after recent increases, interest rates are still at dramatic lows when viewed over the past four decades. This obviously has been a positive development for the housing market.
Other factors were correctly identified by Brian Wesbury in his May 31 op-ed in the Wall Street Journal (“Mr. Greenspan’s Cappuccino”). They included an increase in the older population that has higher rates of homeownership, and federal tax treatment of housing (including the deductibility of mortgage interest and property taxes, and favorable capital gains tax treatment).
However, a negative factor on the supply side is driving up home prices in many markets, namely, government creation of scarcity. That is, governments often aggressively pursue policies that limit the supply of housing. Such policies, whether intended to do so or not, result in much higher prices.
In the Wall Street Journal on May 26, economist Thomas Sowell warned about the potential ills of interest-only mortgages. That’s worth contemplating. But even more telling was one paragraph about why housing was so expensive in the San Francisco Bay area. He wrote: “It is the land—and the high price of the land is due to severe restrictions on building anything on it. Before those land use restrictions—’open space’ laws, planning commission requirements and environmental regulations—became severe during the 1970s, California housing prices were very much like those elsewhere in the country. Since then, California housing prices have been some multiple of the national average. Nowhere is this more true than in the San Francisco Bay area.” Indeed, the area ranked as the most expensive for homes, at $698,200, according to a Bloomberg report on May 20. But it is not alone in having government restrictions pushing prices higher.
In fact, government regulation, restrictions, fees, and other barriers driving housing costs higher even have been recognized by the U.S. Department of Housing and Urban Development (HUD). HUD has done two studies making this point. In 1991 its publication “‘Not In My Back Yard’: Removing Barriers to Affordable Housing” explained: “Millions of Americans are being priced-out of buying or renting the kind of housing they otherwise could afford were it not for a web of government regulations,” including “a maze of Federal, State, and local codes, processes, and controls.” Among the many controls noted were upzoning, exclusion of multifamily housing, requiring developers to add amenities and pay larger fees, slow and burdensome permitting, prohibitions on accessory apartments, building codes that prohibit rehabilitation of existing buildings, rent control, restrictions on manufactured housing, and environmental regulations.
The story hasn’t changed, as reflected in the February 2005 HUD report, ‘”Why Not in Our Community? ‘ Removing Housing Barriers to Affordable Housing.” That report noted: “While regulatory barriers are not the only factors responsible for increasing housing costs, they are major factors.” It highlighted increased complexity of environmental regulation, using “smart growth” rhetoric to restrict growth and development, continued rampant NIMBYism (Not In My Back Yard), impact-fee expansion, building-code barriers, and obstacles to rehabilitation and development in urban areas.
The February report concluded: “Removing affordable housing barriers could reduce development costs by up to 35 percent.” That number is not pulled out of thin air, with 13 different econometric studies cited that point to the substantial costs inflicted on housing due to government regulation. And that list was not exhaustive. Note the following findings, for example:
• An April 2004 study—”Regulations and Housing Development: What We Know and What We Need to Know”—by Michael H. Scholl at New York University concluded: “Existing research suggests that a wide range of federal, state and local regulations, including building codes, environmental laws, land use regulations, impact fees, as well as the government procedures to administer these regulations, reduce the supply of housing and generate substantial costs.”
• A December 2004 study—”Regulation and the High Cost of Housing in California”—by John M. Quigley and Steven Raphael at the University of California-Berkeley, analyzed “the effect of regulations governing land use and residential construction upon the course of housing prices in California.” They found that “current regulations have powerful effects on housing outcomes,” including making rental and owner-occupied housing more expensive and reducing the housing stock. At one point, the authors observed: “Housing prices and rental rates are roughly 30 to 50 percent higher in the most regulated cities relative to the least regulated cities.”
• In a December 2004 study—”Why Have Housing Prices Gone Up?”—Edward L. Glaeser of Harvard University and the National Bureau Economic Research, Joseph Gyourko of the University of Pennsylvania, and Raven E. Saks, also of Harvard, hit on the crucial point: “In sum, the evidence points toward a man-made scarcity of housing in the sense that the housing supply has been constrained by government regulation as opposed to fundamental geographic limitations. The growing dispersion of housing prices relative to construction costs suggests that these regulations have spread into a larger number of local markets over time.”
Things Are Worse
Between the 1991 and 2005 HUD reports the situation got much worse. The bad policies noted in 1991 have only been expanded in scope, strategy, and geography. Ponder that, as Ronald Utt noted in a November 8, 2002, report (“Review of HUD’s 1991 Report: Not In My Back Yard: Removing Barriers to Affordable Housing”), most regulatory barriers to housing are promulgated by roughly 39,000 local governments across the nation. Getting an exact handle on these regulatory costs is not easy, but the general direction and effects are unmistakable.
Utt argued, “based on overwhelming anecdotal evidence from around the country, that such barriers are being erected at an accelerating pace, that multiple barriers exist in many communities, and that over time many of the existing barriers are made more severe when the initial implementation fails to slow growth to the degree hoped , or as community preferences against growth change.”
Utt also highlighted that citizen efforts to impose land-use restrictions have expanded “without recent precedent, “adding that this is “not easy to explain.” But actually, it is. In a speech at MIT in October 2002, Anthony Downs of the Brookings Institution cogently argued: “I believe a majority of suburban governments deliberately pass regulations aimed at maintaining or raising housing prices within their jurisdictions because they are politically dominated by homeowners, who want to maximize the market values of their homes. . . . Since their homes are their major financial assets, they pressure their governments to oppose cost-reducing changes in regulations. . . . Therefore, as long as we leave full regulatory power over housing planning and construction in the hands of local governments, there is no realistic chance that housing costs can be reduced by changing regulations that increase those costs.”
The 1991 HUD report also noted this local incentive factor and urged states to become more involved. Since then, various states have done so, and their policies, for the most part, have only reinforced local efforts to limit growth and building. Government turns out to be a problem at all levels.
All of this points not so much to a looming “bubble” in housing, but a perverse regulatory push, or at least floor, on prices. Housing will continue to react according to economic conditions, including economic growth, income levels and growth, and interest rates, for example. But this aggressive and expanding effort led by government to restrict the amount of housing cannot be ignored. Those regulatory restrictions push costs higher and restrict the market’s ability to respond to price signals.
It’s difficult to imagine this regulatory floor being removed completely because it would require a fundamental shift in philosophy. In recent decades, a dramatic increase in an entitlement/activist view of government has combined with an erosion of property rights. That has led to these vastly enhanced barriers imposed by state and local government to slow or stop the expansion of housing in various parts of the nation. And I ‘m sad to say, it seems that this phenomenon only promises to spread.