Cause of the Housing Bubble, Burst and Recession Revealed: It's Growth Management

Dwight Merriam's picture

Those of us whose professional lives are inextricably linked to the real estate development economy in one way or another have had plenty of time in the last year to twiddle our thumbs and attempt to figure out what the heck happened. This much we know - there was a housing bubble some places, it burst, and the economy collapsed. Have you ever slipped and fell – one those unexpected spectacular aerial feats where your feet fly out from underneath you, you look down your legs and see your toes at eye level pointing to the sky, and you say to yourself "this is really going to hurt when I land"? That's what this year has been like for many, some of whom are still waiting to hit hard because they had projects in the pipeline and they are grinding their way through "inventory" of unfinished work. Plus, we started from a high plateau. Wall Street types call the unexpected but apparent life in the market during the first part of a recession "dead cat bounce" which Forbes defines as "a temporary recovery from a prolonged decline or bear market, after which the market continues to fall." Even a dead cat dropped from a very high place will bounce a little when it hits the ground

NOTE: This post was originally published on International Municipal Lawyers Association Local Government Blog, available at http://imlablog.wordpress.com.

I have been reading all I can on what happened (to see me so engaged makes my law partners think I have work), though it's uncomfortable at times as it feels a little like getting to know someone really well by reading their obituary. The experts tell us that the housing bubble was caused by several factors.

1. Too much home ownership. Think of your local affordable housing programs. Most produce housing for ownership. Homeownership has increased from 64% in 1994 to 69.2% in 2004, an all time high. It's a chicken-and-egg thing. Maybe the high level of ownership is driven by the easy credit, but it could be the other way around. Compare our ownership with other countries. In Switzerland 34.6% own, Germany 43%, France 55%, Austria 56%. For the first time in a half century, home ownership in Great Britain declined in 2007. Too many people with too little money own too many homes. It's cheaper to rent and some people who own homes should not have been enticed to buy them.

2. Buying for speculation rather than shelter. A study by the National Association of Realtors a few years ago found that 23% of homebuyers specifically identified their purchases as investments. Another 13% said they bought vacation properties, real estate which inherently has a speculative component. Think of all the house flippers you have had to listen to at parties, bending your ear about how they bought with a low interest adjustable rate mortgage so their carrying costs would be low, tidied up the place, and sold it for some big profit? California (of course, it's always California) has a licensed real estate agent for every 52 people. Compare that with say, veterinarians. California has the 8th highest per capita ratio of veterinarians, yet they have just one for every 5617 people – in short you're more than a hundred times more likely to encounter a real estate broker than veterinarian in California.

3. Low interest rates. The plain fact is that money has been and is cheap. Cheap money was brought to us in the first instance by the dot.com crash in 2000 and the Federal Reserve cutting its short-term rates to the lowest ever, down to 1% from 6.5%, to overcome the 2000-2001 recession.

4. Residential real estate as a safe harbor. So, after NASDAQ dropped some 70% when the dot.com bubble burst, people took what money they had left and put it in residential real estate, figuring that had to be safe. That drove up the price of housing, as did the easy credit, over-emphasis on ownership, and herding instinct encouraged by the media touting investment in residential real estate.

5. Bad lending practices. This we have all heard enough about that to accept it as a principal cause for the bubble and its bursting. Now, however, many foreclosures are of good loans, ones with relatively low loan-to-value ratios, and fully-amortizing at fixed rates. The problem has become that the bursting bubble has wiped out jobs which has eliminated income which has led to defaults – all in a cascading effect.

So, that's my take on what happened, but along comes Randal O'Toole, a Senior Fellow of the Cato Institute, which might be fairly described (not by themselves) as a libertarian think tank in Washington, DC. O'Toole is a burr under the saddle of planning. In 1996 he wrote The Vanishing Automobile and Other Urban Myths which lambasted New Urbanism and Smart Growth. In 2007 he published The Best-Laid Plans: How Government Planning Harms Your Quality of Life, Your Pocketbook, and Your Future which the advertising says "reveals how government attempts to do long-range, comprehensive planning inevitably do more harm than good by choking American cities with congestion, making housing markets more unaffordable, and sending the cost of government infrastructure skyrocketing."

Here he is pitcured on one of the sites with his biography. You can get information here also.

randalotoole

Planning magazine, published by the American Planning Association, is quoted on the Cato website as saying "O'Toole today looks a lot like Jane Jacobs did in 1961. They're both outsiders with a detailed grass-roots view of how planners-with the best of intentions-are following a fashion into disaster."

You got the picture. I don't agree with him for the most part, but he's a good writer, a good speaker, and he is thought provoking. Planning needs to be challenged if nothing more than to ferret out the mistakes, the weaknesses, the false assumptions, and thus make it better. His latest burr, an especially prickly one, is an October 1, 2009 report for Cato entitled "How Urban Planners Caused the Housing Bubble."

He asks why California and Florida are ground zero for burst bubbles and Georgia and Texas escape largely undamaged. The answer, he says, is simple – the former two states have growth management, the latter two don't, and growth management constrains supply, driving up prices. When the bubble gets big, it bursts.

The solution? He says " states and urban areas with growth management laws and plans should repeal those laws and dismantle the programs that made housing expensive in the first place." No bubble, no burst, no recession.

Ask yourself what metropolitan area has the absolutely toughest growth management system? You will likely answer: Portland, Oregon. I went to the latest Case Shiller index for year-over-year prices and see that Portland with a highly constrained market is down 14.4%. Atlanta, essentially a free-fire zone when it comes to development, is down 15.3%. And Detroit, it's a complete tragedy, is down 23.6%, barely beaten by Miami at 29.5%. Google "Detroit growth management" and the first hit is the Detroit Economic Growth Management Corporation. Its job is to promote growth.

We must remember that the big bubble, big loss markets are for the most part ones that had enormous increases in value, so the bursting brings them back to the ground (no Balloon Boy hoax here). Detroit is quite different as it never enjoyed the up swing and its devastation is almost entirely to be attributed to the loss of jobs. It really is about employment now. Augusta, Maine, with steady employment from the state capital, has had no bubble and no burst.

Growth management may be part of the problem in some markets, but the true cause of the housing bubble is far more complex than that.

Dwight Merriam is a lawyer representing developers, local governments, landowners, and advocacy groups in land development and conservation issues.

Comments

Comments

Todd Litman's picture
Blogger

Smart Growth Impacts on Housing Values

I'm surprized that Dwight Merriam so uncritically accepts O'Toole's arguments. If you examine data at a more disaggreated level you find that more compact, smart growth areas have much lower foreclosure rates than sprawled, automobile-dependent areas. This occurs because residents of smart growth locations are more vulnerable to unexpected events such as fuel price spikes, a vehicle failure or crash, or a job loss. In smart growth locations residents spend less on transportation, have more mobility options (for example, they can respond to financial constraints by reducing their vehicle travel or reduce their vehicle ownership), and they have better access to job opportunties.

Housing values are ultimately based on consumer demands, and several current demographic and economic trends are increasing consumer demand for smart growth locations and reducing demand for sprawled, automobile-dependent locations. These include aging population, rising future fuel prices, increasing traffic congestion, changing consumer preferences, and inceaing health and environmental concerns. Several recent studies have attempted to quantify these shifts (Ewing 2007; Nelson 2009; Litman 2009). They indicate that two decades ago (1990) about two-thirds of households preferred sprawled locations and less than a third preferred smart growth. The split is now about fifty-fifty, and within two more decades (2030) less than one third of households will prefer sprawl and more than two thirds will prefer smart growth.

These shifts play out in current foreclosure patterns. Smart real estate investors are putting money into more accessible, multi-modal development and reducing their investments in sprawled locations. As the 2009 "Emerging Trends in Real Estate" report explains:

Energy prices and road congestion accelerate the move back into metropolitan-area interiors as more people crave greater convenience in their lives. They want to live closer to work and shopping without the hassle of car dependence. Higher-density residential projects with retail components will gain favor in the next round of building. Apartment and townhouse living looks more attractive, especially to singles and empty nesters—high utility bills, gasoline expenses, car payments, and rising property taxes make suburban-edge McMansion lifestyles decidedly less economical. (ULI 2009)

This is not to suggest that nobody will live in large-lot single-family homes in the future, but the current supply of such housing is sufficient to meet all projected demand for the foreseeable future; a lot of ageing baby boomers will be selling their homes during the next two decades as they retire, resulting in a glut, so values are likely to decline, while the value of homes in compact, walkable, transit-oriented communities are projected to increase. Communities and developers that respond to these market shifts can succeed. Those that continue past policies are likely to fare poorly.

For information see

Joe Cortright (2008), "Driven to the Brink: How the Gas Price Spike Popped the Housing Bubble and Devalued the Suburbs," CEOs for Cities (www.ceosforcities.org); at www.ceosforcities.org/files/Driven%20to%20the%20Brink%20FINAL.pdf.

Reid Ewing (2007), “The Demand For Smart Growth: What Survey Research Tell Us,” Planning, American Planning Association; at www.smartgrowth.umd.edu/pdf/Research_Dec07.pdf.

William H. Frey (2009), "Big City Populations Survive the Housing Crunch," Brookings Institution (www.brookings.edu); at www.brookings.edu/opinions/2009/0701_housing_frey.aspx.

Jonathan Levine, Aseem Inam, Richard Werbel and Gwo-Wei Torng (2002), "Land Use and Transportation Alternatives: Constraint or Expansion of Household Choice?," Mineta Transportation Institute, Report 01-19 (www.transweb.sjsu.edu/publications/01-19.pdf).

Todd Litman (2009), "Where We Want To Be: Home Location Preferences And Their Implications For Smart Growth," Victoria Transport Policy Institute (www.vtpi.org); at www.vtpi.org/sgcp.pdf.

William H. Lucy and Jeff Herlitz (2009), "Foreclosures in States and Metropolitan Areas: Patterns, Forecasts, and Pricing Toxic Assets," University of Virginia (www.virginia.edu); at www.virginia.edu/uvatoday/pdf/foreclosures_2009.doc.

Arthur C. Nelson (2009), "The New Urbanity: The Rise of a New America," University of Utah Metropolitan Research Center; summary at www.froogalizer.com/news/research-on-homeownership-rate-through-2030.html. Also see The Next $40 Trillion: Texas Trends (www.texasarchitect.org/texastrends.ppt).

ULI (Annual Reports), "Emerging Trends in Real Estate," Urban Land Institute (www.uli.org); at www.uli.org/ResearchAndPublications/EmergingTrends/Americas.aspx.

David Villano (2009), “The Slumming Of Suburbia: The Poor Are Fleeing Our Cities, But Life Is Not Always Greener, Even When Affordable Housing Comes With A Two-Car Garage,” Miller-M cCune (www.miller-mccune.com); at www.miller-mccune.com/business_economics/the-slumming-of-suburbia-994.

Eric Weiss (2008), “Gas Prices Apply Brakes To Suburban Migration,” Washington Post, 5 August; www.washingtonpost.com/wp-dyn/content/article/2008/08/04/AR2008080402415....

Todd Alexander Litman
Victoria Transport Policy Institute
www.vtpi.org
"Efficiency - Equity - Clarity"

Merriam And O'Toole

"I'm surprized that Dwight Merriam so uncritically accepts O'Toole's arguments."

I don't think he accepts O'Toole's arguments at all. He shows that O'Toole is wrong when he writes:

"Ask yourself what metropolitan area has the absolutely toughest growth management system? You will likely answer: Portland, Oregon. I went to the latest Case Shiller index for year-over-year prices and see that Portland with a highly constrained market is down 14.4%. Atlanta, essentially a free-fire zone when it comes to development, is down 15.3%."

Charles Siegel

Far More Complex is Right

O'Toole would probably be taken more seriously by the planning community if he took into account the full complexity of real estate markets and the causes of their perpetual cycles. Real estate cycles have been occurring since the 1800s, when the prevailing growth management policy was known as "manifest destiny":

http://img61.imageshack.us/img61/4561/re18yrcycle0ej.gif

The 5 reasons you listed in your article are barely acknowledged by O'Toole, if at all. As a resident of Atlanta, I can attest to the fact that this area has been crippled by a collapsed housing market, with the state ranking 8th in the nation for foreclosures, despite our notoriety for sprawl:

http://www.realtytrac.com/contentmanagement/pressrelease.aspx?channelid=...

Houston is repeatedly idolized by O'Toole as a magical place with invisible hands where bubbles don't happen. Thus, we should replicate their cowboy development model of single-family homes alongside skyscrapers and adult video stores (see Galleria). Aside from all of the obvious externalities, this is amazingly myopic in its complete disregard for Houston's real estate bubble and crash of the 1980s, which was actually exacerbated by few restrictions on supply and resulted in a glut of vacant properties. While some have attributed this to the oil bust, studies have shown that "during the three-year period between 1982 and 1984 Houston added 164,000 units (16%) to the stock of housing, 50% more than could have been absorbed, even if the Houston economy had maintained its high rate of growth" (Smith, 2001).

Now more than ever with the nation's cumulative collection of cycles, free and efficient market lemmings like O'Toole are increasingly irrelevant. His selection bias and ignorance of endogenous imperfections within real estate economics further relegate him to a level of absurdity.

A more plausible solution would be to explore additional regulatory alternatives that could perhaps address these imperfections and help smooth out cycles of periodic irrationality.

- Reference:

Smith, Barton; William Tesarek. House Prices and Regional Real Estate Cycles: Market Adjustments in Houston. Real Estate Economics. Vol 19, No 3. Pgs. 396-416. 1991. http://www3.interscience.wiley.com/journal/120783900/abstract

Michael Lewyn's picture
Blogger

Florida

Anyone who thinks growth management in Florida has any teeth at all clearly hasn't lived in Florida (at least not in North Florida where I've lived for the past few years!) The development and road lobby are as supreme there as in the 1950s!

good assessment

I think you have pretty much nailed the causes of the housing boom and subsequent bust. A couple of things to add: exotic mortgages (which you sort of mentioned in bad lending practices) and the GSEs (Fannie and Freddie bought some ridiculous mortgages).

Of course, you had to go ahead and bring up O'Toole which, like Pavlov's dog, instantly spurred negative comments from the legions of antisprawlers who despise him. I think your last statement says it all: "growth management may be part of the problem in some markets, but the true cause of the housing bubble is far more complex than that."

Peak oil will equal growth management

In 2001/2001 I remember watching Alan Greenspan on Capitol Hill informing us that the housing market could never become one big bubble that bursts because the housing market was like a glass of champagne comprised of tiny little bubbles that upon reaching the top would burst, always to be followed by yet another bubble and yet another and another...I started thinking to myself, what happens when the champagne goes flat? Being one of those dismal economists, I waited and waited, expecting each passing year to be the year it happened, for almost eight years when ta-da.

Good straightforward pieces have been written about The Panic of 2008, but unlike this one I'm commenting to now, they tend to lack any historical perspective whatsoever and can most definitely be broadened beyond the past two years to at the very least a decade and, if I had more time, the past sixty some odd years. Greenspan lowered the Fed Funds Rate (FFR) from 6.5% to 1.0% during 2001-2003, which he argues did not cause the housing bubble. Because it would be overly simplistic to argue that the Fed's interest rate manipulations during the early years of this decade caused the housing bubble, in a sense he is correct; it would be more appropriate to view the Fed as the “great enabler” of the range of monetary excesses that led to the bubble and the subsequent bust. But it is clear that the Fed set and kept its official target rate too low for too long during much of 2001-2005. Such mistakes inevitably occur when you give a person or a group of people too much power. So before the bubble, housing had been an unsustainable mirage of wealth for Americans.

In no way should the, if you will, “masses” or especially so-called experts have construed subprime mortgages to be a safe investment, Ever-risky lending practices led or, better, expedited what Minsky termed “Ponzi Borrowing,” which occurs when an entity is unable to pay either the principal or the interest and yet they are able to borrow more and more. This is pretty much the root cause of the recent housing market crash. How did the banks get away with their subprime mortgaging practices for so long? Because Greenspan deregulated the industry, which he acknowledged to be a mistake: “Those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity, myself included, are in a state of shocked disbelief.”

Which means he hasn’t read his Adam Smith, who would in no way have been shocked: “[The capitalist class] ought always to be listened to with great precaution, and ought never to be adopted till after having been long and carefully examined, not only with the most scrupulous, but with the most suspicious attention. It comes from an order of men, whose interest is never exactly the same with that of the public, who have generally an interest to deceive and even to oppress the public, and who accordingly have, upon many occasions, both deceived and oppressed it."[i]

“The Federal Reserve had broad authority to prohibit deceptive lending practices under a 1994 law called the Home Owner Equity Protection Act. But it took little action during the long housing boom, and fewer than 1 percent of all mortgages were subjected to restrictions under that law…In 2008 the Fed greatly tightened its restrictions. But by that time, the subprime market as well as the market for other kinds of exotic mortgages had already been wiped out. Mr. Greenspan said that he had publicly warned about the “underpricing of risk” in 2005 but that he had never expected the crisis that began to sweep the entire financial system in 2007.”[ii]

Representative Henry Waxman: “You had the authority to prevent irresponsible lending practices that led to the subprime mortgage crisis. You were advised to do so by many others. Do you feel that your ideology pushed you to make decisions that you wish you had not made?”

Greenspan: “Yes, I’ve found a flaw. I don’t know how significant or permanent it is. But I’ve been very distressed by that fact.”

Greenspan: “This crisis has turned out to be much broader than anything I could have imagined. It has morphed from one gripped by liquidity restraints to one in which fears of insolvency are now paramount.”

Greenspan: “The evidence strongly suggests that without the excess demand from securitizers, subprime mortgage originations (undeniably the original source of the crisis) would have been far smaller and defaults accordingly far lower.”

Alas most economists are asserting that this young generation will fare worse than their parents’ generation, the first time that that has happened in American history. When oil production peaks then subsequently dwindles? That's going to be all the growth management that we need because we as a society are going to have no choice but more compact development.

[i] http://www.adamsmith.org/smith/won-b1-c11-conclusion-of-the-chapter.htm
[ii] http://www.nytimes.com/2008/10/24/business/economy/24panel.html?_r=3&hp&...

David Parvo
Most Senior Fellow
The Placemaking Institute
http://placemakinginstitute.wordpress.com

The irony of Greenspan

and the Federal Reserve System is rather epic. How a self-described "free-market" guy could possibly think expansionary monetary policy is free market is beyond me. To this day, he does not seem to understand the irony of central banking as government interference. Austrian school economists are surely chuckling at Mr. Greenspan as they see no need for a central bank. There is almost every reason to believe that the existence of said central bank is the cause, not the cure of boom and bust. As we debate this now, helicopter Ben is busy devaluing the USD into developing country status destroying our purchasing power.

As for securitized mortgages, buyers might do more than simply check the credit rating (issued by a rater looking for more business).

We will probably have much more compact development and less of everything, not so much because of peak oil, but because the average American's puchasing power will continue to decrease thanks to the Federal Reserve and the US Treasury. Fed money creation is "paid back" with inflation, government debt is paid back with inflation and/or higher taxes. With total gross income falling and at best stabilizing in the near future, the American consumer could see quite a different future.

As Dwight began to analyze,

As Dwight began to analyze, there is not a correlation between smart growth and the housing bubble. In fact, if one diggs further into the data, they'll find the opposite trend. Places without strong growth management like Riverside, Phoenix and Florida have been hit the hardest.

Definitely a correlation

There's definitely a correlation there... places like Riverside got a lot of spillover demand from Los Angele where it's tough to build new housing units to keep up with supply (making it difficult to impossible to build anything is most CA cities preferred mode of growth management). I mean you can't honestly argue that Riverside (or the Tracy and Antioch up north) would have grown like it did without all that demand being pushed out there from LA (or SF and San Jose). I don't know enough about FL to comment on the situation there, but Phoenix was a victim of CA's "growth management" in two ways... lots of Californians moved out there because CA is unaffordable to the middle class, and all the majority of housing speculators in Phoenix were Californians flush with recently acquired housing equity money. Now, I don't think it's casual as O'Toole does, and agree with Dwight that it's more complex, but there's definitely some correlation there.

(edited slightly).

Source of the housing bubble

Dwight Merriam hits all the correct, conventional causes of the housing bubble. But the root cause was all of the approvals for housing developments handed out by local officials and planning departments. No approval for a development means no subprime mortgages, no mortgage backed securities, no structured investment vehicles, and no credit default swaps preying on mortgage backed securities that the rating agencies failed to rate correctly from the get go, and hence no brink of financial meltdown.

Randall O'Toole completely misses the point: lax local land use planning led to an oversupply of housing that drove down home values. Calfornia, Nevada, Arizona, and Florida are the poster children for all to see.

Hmmm?

You are arguing that no new housing developments would have stopped the bubble? Leaving aside the fact that real estate was just one of the many bubbles blown by our monetary policy, you argument fails to account for places like Detroit and Baltimore, that were epicenters of subprime mortgage lending despite having virtually no new housing development to speak of... or places like Houston that have no limits on development but did not experience a housing price bubble at all... or places like San Francisco that had a large run-up (and now decreases) in housing prices with hardly any new development at all. All of the financial instruments you list were around way before the housing bubble (structured investment vehicles played a big role in Enron) and have been used both successfully and unsuccessfully in the past.

Credit-induced asset bubbles pop... nothing can really prevent that from happening.

Housing Bubble

I agree. The bubble was caused by irrationally exhuberant demand and lending, not by too much supply.

Limiting the supply of housing would not have eliminated the bubble and probably would have made it worse by helping to drive up housing prices and thereby reinforcing the irrational boom psychology.

Charles Siegel

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