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