The U.S. mortgage meltdown has dominated business news for
months. The crisis seems to deepen daily, and its impacts are felt
throughout an increasingly interdependent financial world. Only
recently, the Organization for Economic and Development (OECD) and
the International Monetary Fund (IMF) have suggested that losses of
an additional $250 billion to $1 trillion may yet be in
the offing. In the ongoing debate over the causes and cures of the
mortgage meltdown, one of the most important factors has been
virtually absent: the role of excessive land use regulations in
exacerbating the extent of losses.
What Is Excessive Land Use Regulation?
As we know from introductory courses in economics, scarcity
raises prices. In a number of metropolitan markets across the
country, excessive land use policies have been adopted, such as
urban growth boundaries, huge areas recently declared off-limits to
development, building moratoria, confiscatory and unprecedented
impact fees, and excessively large minimum lot sizes.
These policies, often referred to as "smart growth," create a
scarcity of land, artificially raise the price of housing, and,
again, have increased the exposure of the market to risky mortgage
debt. When more liberal loan policies were implemented,
metropolitan areas that had adopted these more restrictive policies
lacked the resilient land markets that would have allowed the
greater demand to be accommodated without inordinate increases in
house prices.
A few voices in the wilderness on both sides of the political
spectrum have pointed to the role of excessive land use policies in
driving up housing costs. For example:
- Liberal economist Paul Krugman of The New York Times
put most of his conservative colleagues to shame in noting that the
house price bubble has been limited to metropolitan areas with
strong land use regulation.
- Conservative Thomas Sowell, no stranger to being a voice in the
wilderness, has made similar points.
- More recently, Theo Eicher of the University of Washington
produced a working paper placing much of the blame for house price
escalation on land use regulation in cities around the nation.
Consequences of Excessive Land Use
Regulation
How does all of this relate to the mortgage meltdown and the
subprime crisis? It is very simple. There is no question that more
liberal loan policies were the proximate cause. But the strict land
use regulations forced prices up much more than would have been the
case if the previous more traditional yet environmentally sound
regulation had been retained.
Places like California, the Northeast, the Northwest, and
Florida have implemented excessive land use controls. As a result,
their land use planning systems have not been able to accommodate
the stronger demand created in the more profligate lending
environment. At the same time, as a result of its more relaxed land
regulation, much of the rest of the nation was far better able to
accommodate the higher demand. This includes the high-income
world's three fastest-growing metropolitan areas with a population
of more than 5,000,000: Atlanta, Georgia, and Houston and
Dallas-Fort Worth, Texas.
This is illustrated by developments in the nation's 50 largest
metropolitan markets. Between 2000 and 2007, house prices increased
an average of more than $275,000 compared to incomes (house price
to household income ratio) in the 10 markets with the greatest
price escalation or the greatest affordability loss. Among the
second 10 markets with the greatest affordability loss, prices rose
$135,000 relative to incomes. By contrast, in the markets with the
least affordability loss, house prices increased only $5,000. (See
table.)
What the 20 markets that have lost the most affordability have
in common is excessive land use regulation. Virtually everyone
knows the distress that such cost increases mean for America's
households.
But there are broader economic consequences that have expanded
to the international market. From 2000 to 2007, the gross value of
the U.S. housing stock rose $5.3 trillion relative to household
incomes. It is estimated that $4.4 trillion of this increase
occurred in the 20 most escalating markets, all of which are
characterized by excessive land use planning. In each of four
markets (Los Angeles, New York, San Francisco, Washington, and
Miami), the aggregate escalation above incomes was a third of a
trillion dollars or more.
While there have been modest house price reductions in the most
expensive markets, far larger drops would be required to restore
previous levels of housing affordability in the most expensive
markets. Moreover, Bureau of the Census estimates indicate that
many of the markets that have lost so much affordability are also
losing large numbers of households to more affordable areas of the
country, which could suggest that house prices may well drop even
further.[1]
Over the same period, the nation's gross residential mortgage
exposure rose $4.8 trillion relative to household incomes. If the
distribution of mortgage exposure increase tracked with the
increase in excess value noted above, then 83 percent is
attributable to the 20 most escalating markets-again, all with
restrictive land use planning or smart growth. Stated another way,
if price-escalating smart growth policies had not been adopted in
state capitals, county courthouses, and local planning commissions,
the financial risk in the current crisis would be at least $4
trillion less. This is a very high concentration of excess mortgage
exposure, since these markets account for only 26 percent of the
nation's owner-occupied housing stock.
The tragedy is that when most of these decisions were made,
there was not the slightest consideration of economics-the upward
pressure on house prices-or the number of households that would be
denied home ownership in the years to come. Yet these local
decisions played a major role in what The Economist
magazine called a near global collapse.
Exacerbating the International Finance
Crisis
Simply put, without smart growth, the international financial
crisis that has raised so much appropriate concern would have been
much less severe. Thus far, the policies of the Federal Reserve
Board have failed to take notice of this important connection. Any
serious effort to prevent a repeat of such destructive price
volatility will require removing these destructive land use
regulations that have done so much to destroy housing affordability
in many markets while adding inordinately to the financial distress
that is being felt around the world. Economics-challenged state and
local politicians must not be permitted to steer the international
economy into an iceberg.
Wendell Cox is principal of Demographia, a St. Louis public
policy firm; a visiting professor at the Conservatoire National des
Arts et Metiers in Paris; and a visiting fellow at The Heritage
Foundation.