Housing Price Bubble: Learning from California


In a letter to The Wall Street Journal (February 6) defending California’s greenhouse gas (GHG) emissions policies, Governor Arnold Shwarzenegger’s Senior Economic Advisor David Crane noted that California’s high unemployment is the result of “a bust of the housing bubble fueled by easy money.” He is, at best, half right.

The “bust of the housing bubble” occurred not only because of “easy money,” but also because of the very policies California has implemented for decades and is extending in its battle against GHG emissions.

The nation has never had a housing bubble like occurred in California. The Median Multiple (median house price divided by median household income) in California’s coastal metropolitan areas had doubled and nearly tripled over a decade. Housing costs relative to incomes reached levels twice as high as those experienced in the early 1990s housing bubble, which was bad enough.

This is all the more remarkable because even before the bubble the Median Multiple in the Los Angeles, San Francisco, San Diego and San Jose metropolitan areas was already elevated at 1.5 times the historic norm.

“Easy money,” by itself, does not explain what caused the unprecedented housing bubble in California. If “easy money” were the sole cause, then similar house price escalation relative to incomes would have occurred throughout the country.

Take, for example, Atlanta, Dallas-Fort Worth and Houston. These are the three fastest growing metropolitan areas in the developed world with more than 5,000,000 population. Since 2000, these metropolitan areas have grown from three to 15 times as fast as Los Angeles, San Francisco, San Diego and San Jose. While 1,800,000 people have moved out of the four coastal California metropolitan areas to other parts of the country, 700,000 have moved to Atlanta, Dallas-Fort Worth and Houston from other parts of the country. This is where the demand would have been expected to produce the bubble. But it did not. House prices remained at or near historic norms and average house prices rose one-tenth that of the California coastal metropolitan areas.

These three metropolitan areas were not alone. Throughout much of the nation, in metropolitan areas growing both faster and slower in population than coastal California, house prices simply did not explode relative to household incomes.

In touting “smart land use” as a strategy for greenhouse gas emissions, Crane misses the other half of the equation. Indeed, it is so-called “smart land use” (“smart growth”) that intensified the housing bubble in California. “Smart land use” involves planners telling the market where development will and will not occur. In the process it ignores the price signals of the market. Owners of land on which development is permitted naturally and rationally raise their asking prices, while owners of land not so favored can expect little more than agricultural value when they sell. The result is that the land element of housing prices exploded, fueling the unprecedented bubble. Restrictions on supply naturally lead to higher prices, whether in gasoline, housing or anything else.

California has placed restrictions on development with a vengeance. For nearly four decades, California has woven a tangled web of land use restrictions that have made the state unaffordable. When the demand rose in response to the “easy money” the land use planning systems were unable to respond and a rapid escalation in housing prices followed. The same thing occurred in other areas with excessive land use regulation, such as Las Vegas, Phoenix, Seattle, Portland, New York, Washington and Miami, though the house price escalation was not so extreme as in coastal California.

On the other hand, where land use still allowed a free interplay of buyers and seller (consistent with rational environmental requirements), the housing bubble was largely avoided. Average house prices in Atlanta, Dallas-Fort Worth and Houston rose only one-tenth that of Los Angeles, San Francisco, San Diego and San Jose.

When the bubble burst, the far higher house prices naturally tumbled more than in other areas. The price was paid well beyond California and the other “smart land use” markets around the nation. From Washington to Wall Street to Vladimir Putin and Chinese Premier Wen at Davos, everyone knows that the international finance crisis was precipitated by the US mortgage meltdown.

It all might not have occurred if there had been no “smart land use” markets with their exorbitant and concentrated losses. Overall, the “smart land use” markets represent little more than 30 percent of the nation’s owned housing stock, yet produce more than 85 percent of the housing bubble values at their peak. California style “smart land use” intensified the overall mortgage losses by more than five times. If the losses had been more modest, there might not have been anything like the current mortgage meltdown. With more modest losses, the world financial system might have been able to handle the damage without catastrophe, just as it did with the “dot-com” bubble earlier in the decade. The many households that have lost much of their life savings or retirement income would not be facing the future with fear. And even personally frugal taxpayers of the world would not be the principal stockholders in failing banks.

California needs to wake up and face the reality. The intensity of the housing bubble was of its own making. More “smart land use” is just what California does not need. This is the lesson the rest of the nation needs to learn rather than repeat.

David Crane letter to the editor: http://online.wsj.com/article/SB123381050690451313.html
Domestic migration data: http://www.demographia.com/db-metmic2004.pdf
Analysis of the housing bubble: http://www.heritage.org/Research/Economy/wm1906.cfm
House price losses by peak Median Multiple: http://www.demographia.com/db-usahs2008y.pdf
Las Vegas Land Market Analysis: http://www.demographia.com/db-lvland.pdf
Phoenix Land Market Analysis: http://www.demographia.com/db-phxland.pdf


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Can't talk about the elephant in the room

How about the effect of proposition 13 on what type of houses are built? Without writing a book on the subject here is a fact (personally learnt unfortunately). Since prop 13 lowers taxes in perpetuity on any residence you own (BTW, it could be a rental), then the money has to come from somewhere. They call them development fees. Like to the tune of $20K to permit a 3,000 sq. ft house with existing services (renovation). So, if a developer has to pay similar fees, would he not want to recover those costs, by building the largest, fanciest house?
Maybe, maybe not, but you can't blame Cal. costs on the land use only. BTW, the weather might be a factor. Can you compare a barely liveable place like Atlanta to S.F ?

"\rant\" Prop. 13 is an outrageous law, barely constitutional. How can identical houses be taxed at different rates. Hint: Get rid of the "widows and orphans" nonsense. I am tired of subsidizing waste. This is a capitalist country(?) "/rant"

Can't talk about the elephant in the room

NBS is correct to refer to development fees or whatever you care to call them.
However, these have caused price inflation and distortions in a host of markets, Auckland NZ included, which do not have proposition 13.
I suspect prop 13 may make things worse but development levies do seem to be part of the Smart Growth package which is based on the notion that newcomers are a cost and must pay a fine to cover those costs..
They are a massively regressive tax as you suggest..
Development levies of 20,000 on a lot worth 50,000 will normally create a considerable hurdle for the purchaser.
The same levy on a lot worth 500,000 is barely noticed.

Owen McShane, Kaiwaka, New Zealand.
Director, Centre for Resource Management Studies.

Wow, how come the real

Wow, how come the real reason of Ca bubble is not even mentioned amongst this capitalist blog? Anyways I'm going to tell your deaf ears the truth, as hard as it is for you pompous elitist to swallow it.
The bubble was caused by the modern technical, internet age of civilization....Fat Cats from all over the globe found an easy way to make a quick easy buck by internet research on the fastest rising RE properties in the world, specifically U.S. since the regulations on foreign buyers are virtually non existent. Ca, Fla, Nv, and Az popped up on all their computers with pretty pictures. Within days they make purchases that use to take months of continental air flights, driving tours and mounds of financial paperwork, forecasting future investment profits.
Throw in the specialty programs that Bush allowed, ie. (Low fed rates, interest only loans, liar loans) and now you have Frank the Gambler playing the game that only the Fat Cats used to exclusively have to themselves.
So now these clowns are competing with Joe Citizen trying to buy a home for his family as he is finding 3-4 offers per day on each home he looks at. He wants in on the gravy train too so desperation sets in and bidding wars take hold. Greed rears it's ugly head and everyone jumps for a piece of the pie. (developers, RE agents, appraisers, contractors, banks, brokers)
And here we are, the fall of capitalism starts picking up speed.

Wendell's ideological blinders = poor arguments with bad logic

It's obvious that Wendell is of the free market fundamentalist persuasion and believes that there should be no intervention or restrictions on development - that profit of developers should have higher priority than other social needs and considerations, including democratic, environmental, community/economic sustainability, etc. He obviously has an ax to grind against "smart growth" and other types of planning that restrict and regulate development and land use.

Let's start with some of Wendell's false assumptions:

CLAIM #1) California's high housing prices compared with low priced housing markets in the interior of the US are SOLELY the result of restrictive "smart growth" policies.

Some factors that Wendell has not considered that affect the relative prices of different housing markets:

a) The availability of employment and strength of the economy
- California has been the epicenter of many crucial and fast growing industries, such as hi-tech in Silicon Valley and Creative Design in SF area; Hollywood and defense contracting in the LA area, which as led to faster increases in median personal/family income than most other areas

b) The desirability and quality of life, i.e., the relative demand differences between different housing markets, hence, the willingness to pay a premium to live in Çalifornia
- California is considered to have the best climate in the US, with much of the state, particularly near the coastal areas, experiencing a Mediterranean Climate
- Certain established urban centers of California are considered by many to have superior cosmopolitan culture compared to many other places; many high quality universities as well as a culture of higher education add to the desirability for many people to locate there; other cultural attributes - liberal, creative, entrepreneurial, ethnic, etc., that draw people from all over the world.

c) The number of independently wealthy people who chose to locate in California, as opposed to other locations, thereby increasing demand on housing apart from simple employment and earned income factors.

d) The limited space available for development
- Many coastal areas have been maxed out already and simply have no more room to grow. There are many more millions of people who want to live in the desireable coastal areas of California than is physically possible. The few remaining nature preserves that are placed off-limits to development near the coastal areas around LA and SF metropolitan areas would only meet a small fraction of the demand, and would seriously erode the quality of life if converted to development, while doing little to correct the gap between short supply vs excess demand.
- Part of the reason for lack of space for development is due to lack of smart growth policies in the past along with certain subsidies which skewed and encouraged inefficient suburban land use that gobbled up all the available land with a low population per square mile. The Los Angeles metropolitan area epitomized this situation.

CLAIM #2) The rates of collapse in housing prices are steepest in California's highest cost and most restrictive housing markets.

WRONG. The locations with the LEAST restrictive development policies have experienced the steepest declines:

Examples of locations with least restrictive and fastest growth:

city.............decline from peak
San Bernardino...-70%
Los Banos.........-75%

Examples of locations in California with most restrictive or "smart" development and slowest growth:

Santa Cruz..........-28%
San Louis Obispo... -22%
San Francisco......-19%
Mill Valley...........-10%

Areas outside of California with steepest median price declines, all had lax restrictions on development:

Las Vegas........-50%
Cape Coral, Fl....-65%
Lehigh Acres, Fl...-80%

If I had more time I would point out many other flaws with Wendell's analysis, but suffice it to say that even just a cursory overview of the facts can easily disprove many of Wendell's assertions.

cock eyed sprawl theory

Wow Wendell you are way off the mark..... I've been flying over the Western United States for the past 20 years. Much of California (Los Angeles, inland empire, central valley) is the very definition of sprawl. How about Las Vegas and Phoenix, they have run in all directions into the deserts around them with little noticeable limits. ("excessive land use regulations"????)
Three terms on the Los Angeles County Transportation Commission!!!! hahaha I'll think of you next time I pass through LA and get stuck in traffic.
I do agree that land use limitations can drive housing prices up, but "quality of life" is measured in many ways.

cock eyed sprawl theory


Wendell's claims are not

Wendell's claims are not coming out of left field but have been developing for a long time and in many places around the world. In a report to the Governor of the Reserve Bank in New Zealand, in 1996 (ie twelve years ago) I drew a clear connection between Smart Growth, employment and inflating land prices, and outlined the possible consequences. (The ARC is the Auckand Regional Council - a regional planning authority for greater Auckland.:

Here is the opening summary. Not bad for twelve years ago. I can send the pdf of the 120 page report if you are interested:

The Principle Findings of this Report Are:
General Principles





Local Government and the Supply, Demand and Regulation of Land
• Local government has a responsibility to ensure that an adequate land-bank is available to meet rapid and unforeseen increases in demand.

• Unless sufficient sections are available and ready for occupancy, an increase in demand can lead to a vicious cycle, whereby, at the end of the cycle, the land-bank is no better supplied than at the beginning.

• Pressure on rural fringe land will increase rather than decrease over the next decade. Contrary to much planning mythology, economic efficiency and the need to make the best use of rural land, demand that the 'lifestylers' should be allowed to have their way. There is no shortage of agricultural land.

A page later:

The High Cost of "Providing for Growth by Containment"
The ARC policies of containing growth
The major cause of ongoing increases in housing costs is the ARC's policy that Auckland's growth should be managed by a policy of containment which restrains growth outside the present urban limits, (which are currently under review) while concentrating development within the present urban limits. These policies rest on the unfounded assumption that the present city form is unsustainable. These arguments are without foundation both in fact and probably in terms of the Act. Opinion surveys and Census Data, indicate that the Regional Policy Statement seeks outcomes which the majority of Aucklanders do not want, and are likely to resist, and are contrary to present practice. Such a massive re-direction of preferences must introduce high costs with downstream effects on the whole economy.

Owen McShane, Kaiwaka, New Zealand.
Director, Centre for Resource Management Studies.

Owen, I don't think anyone

I don't think anyone would disagree that in theory urban growth boundaries have the potential to increase land costs and thus housing costs. Such policies can be especially destructive when combined with density limits and minimum lot size restrictions. So it wouldn't surprise if Auckland was implementing it's policies in a way that had an inflationary effect on the price of land. But that's not all that Cox is arguing. He goes far, far beyond that to claim that growth boundaries and land use restrictions are the "root cause" of the current world financial crisis. As I and others have repeatedly pointed out, many of the housing markets currently with the steepest price declines, foreclosures, and associated financial losses had the weakest growth controls - i.e. inland California, Las Vegas, and Phoenix. If you look at any national indicator of the U.S. housing market - starts, homeowner vacancy, months of supply - they would indicate an unprecedented glut, not scarcity, of homes. This evidence is entirely inconsistent with Cox's "constrained supply theory" of the bubble.

Your points are well taken, but our housing crisis in the U.S. is of a fundamentally different nature than your experience in New Zealand.

The author picks and chooses

The author picks and chooses his examples to support his dubious argument that housing bubbles are caused by anti-sprawl regulation and efforts to curb GHG emissions. Some glaring factual omissions compromise the quality of the analysis.

I agree to the extent that anti-sprawl regulations restrict supply and result in higher prices. However, it is over-reaching to argue that they create bubbles. A bubble is a specific type of price increase that is very rapid, speculative, and unsustainable.

Anti-sprawl regulations have existed in parts of coastal California for many years without a housing bubble occurring. The onset of the bubble corresponds to the availability of "easy money" (to use the author's shorthand). With the contraction of available credit, some of the markets with the biggest bubbles have suffered the most...despite there having been little if any change in anti-sprawl regulations over the past two years. Moreover, the credit contraction has reduced the demand for sprawl.

Additionally, not all of California can be described as "Coastal California". Two California markets with the most extreme bubbles are the Sacramento Metropolitan Area and the Central Valley (Stockton/Modesto/Merced). These formerly agricultural-dominated areas have seen conversion of large tracts of farmland into residential subdivisions. Parts of the Sacramento Metropolitan Area, specifically the Roseville and Elk Grove areas, were among the most rapidly growing areas nationwide during the recently ended growth phase. The price rise in these inland communities durring the bubble was completely out of line with the longer-term supply-demand fundamentals as demonstrated by the magnitude of the subsequent crash. The lack of anti-sprawl regulations in these areas did not prevent bubbles. http://flippersintrouble.blogspot.com/

A third point is that sprawl is, in part, caused by an increasing demand for larger homes at cheaper prices than can be found closer to employment centers. In many cases, governments have allowed sprawl to occur without providing proper mass-transportation infrastructure.
Artificially low gas prices make homes in far-out suburbs or exurbs attractive to many.

Finally, it seems more likely that the credit bubble has caused sprawl (at least in part). This is due to the rapid expansion of prices of normally expensive housing in "Coastal California" to ridiculous levels. Homebuyers, priced out of places like San Francisco and San Mateo Counties, are pushed further and further east. Over the past couple of years, as the housing bubble has deflated, we have seen some parts of eastern Contra Costa County (formerly rapidly growing) emptying out due to lack of demand. These distant housing tracts have little reason to exist in the absence of cheap money, cheap gasoline, and a lack of concern about the environment.

The author begins his article by referring to the high California unemployment rate but does not bring up this issue again. It is not clear whether he is suggesting that anti-sprawl regulations have resulted in the high unemployment rate. If so, that argument is not made within the article.

It's sad but true that...

I've made many of your points in previous Cox articles. In one of his more recent essays (New Survey: Improving Housing Affordability – But Still a Way to Go) he totally mischaracterizes Paul Krugman's view of the bubble. I was always unimpressed with Cox's arguments but when he co-opted Krugman, an economist I greatly respect and enjoy reading, I felt compelled to write a lengthy rebuttal. Yet I have the feeling that Mr. Cox will continue to write the same article, over and over again, replete with the same over-generalizations, unsubstantiated claims, and personal prejudices, despite how often your or I or any other reasonable person point out how flimsy his pet theory is.

One claim of Mr. Cox's in the comments I found particularly puzzling:

"The thesis is not that smart growth impacted foreclosure rates. It is that the unprecedented house price increases that were fueled by smart growth resulted in an intensity of foreclosure losses that the market could not withstand."

This is an absolutely meaningless distinction in the context of his larger argument. If he is saying on average home prices in CA declined 8x more than they declined in Atlanta it is inescapable that you will have a higher foreclosure rate in CA than in Atlanta, holding lending standards constant. This is simply because you have a greater proportion of properties worth less than the value of the mortgages, which is probably the strongest predictor of eventual default.

This echoes a claim he made in the comments section of an earlier article. He said:

"The thesis is not about housing price declines, it is about financial losses in the housing sector, which have been concentrated in the smart growth markets."

Again, if you understand the role of leverage and the financial system it's obvious that there is no distinction to be had here. I have to conclude that Cox is seriously confused about what he is and is not arguing.