Housing Boom and Bust in France

The amicable Vincent Benard has posted his presentation from the American Dream Coalition conference in Seattle, Washington. This post is in English! (No cutting a pasting into translators required!!).

Housing booms and busts are nothing new to Europe. If you want to understand the seeds, read his post. He boils it down to two necessary ingredients: Credit expansion by a central bank and too much land use regulation. On these points I completely agree.

Toddler Economics

For years the Parent/Child relationship has been used as a metaphor for the role of government both pro and con. There is a an implicit assumption that the family is a microcosm of socialism. Even the very free market F.A. Hayek believed that we act altruistically or socialistically at the family level. This inspired me to think about my children and how I maintain order at home. I am beginning to see the virtue of running my household more like a free market.

I joined Economist Bryan Caplan’s virtual book club a few weeks ago as he analyzes Murray Rothbard’s “For a New Liberty”. I have also been influenced by my friend Brian Phillips who is an Objectivist a la Ayn Rand.

Both Rothbard and Rand believe that the path to a moral society is to establish clear property rights. I’m not certain about it being moral, but if it helps me achieve my ends, then I’ll use it.

Here are my applications to toddler economics, of which I have two:

The living areas of the house are clearly a case of “Tragedy of the Commons”. That is, no one really “owns” the space so we all abuse the space, especially my boys. Therefore, the common areas must become the property of Mom and Dad. We allow the use of these areas by our boys if they follow our rules.

To encourage them not to abuse the “common areas” we have established a rule of use for the living areas and different rules for their rooms (being their property). Possession and proximity are the rules of temporary ownership for property brought into the living areas. That is, if child A leaves a toy on the couch and is now playing in the kitchen, said toy can become the temporary property of child O on possession. Permanent ownership is still conferred on the child of original ownership. In their rooms, all toys (property) are under their complete and permanent ownership. That is, if child A leaves a toy on his own bed, child O cannot take even temporary possession without explicit permission or compensation from child A. Thus, an incentive is used to maintain toys outside of the living areas.

Another minor rule for individual rooms is the right to exclusion. Child O may prevent child A from entering his room. Child O has the right to exclude child A from taking temporary possession of any property owned by child O within child O’s room.

On the subject of noise. We are all owners of our own bodies, and thus also our ears. If Child A shouts/screams this is a violation of property rights. He has caused me pain without compensation or permission. Therefore, shouting is only allowed outside and within their rooms with the door closed. At night, shouting violates the rights of the other child who is trying to go to sleep. This again is a violation of property rights.

And finally, to running and throwing objects in the house. The objects within the living areas of the house are the possessions of Mom and Dad (mostly Mom). To subject our property to risk of destruction without permission or compensation is a violation of our property rights. Because there is an objective probability that our property may be broken, throwing balls and running in the house are forbidden.

Any other thoughts? It’s actually pretty cool how this is working out.

Housing Bubbles Around the World

The blame for the American housing bubble has been a battle between the Left and the Right. The Left wants to vaguely blame deregulation and a yet still undefined "Greed". The Right over plays its hand by including minor distortions caused by the Community Reinvestment Act, Fannie Mae/Freddie Mac, and Barney Frank. Both sides, with some cause, have blamed the Federal Reserve and it's easy credit policies. As I have said before, they ignore land use planning, to their peril.

Wendell Cox and Hugh Pavletich, released their 5th annual Demographia International Housing Affordability Survey: 2009. (HT: ObjectifLiberte).

Lots of pretty charts and graphs, not a standard and dull academic paper, so at least skim it.

What hurts the case for much of the Right and destroys the claims on the Left, is the international nature of the boom and bust. How exactly did regulation in the United States cause housing booms and busts in the U.K., Ireland, Canada, Australia, and New Zealand? How did regulation cause a massive boom on the West Coast, Florida, and the Northeast, but not in Texas, Georgia, and North Carolina when the latter states have more population growth?

For regular readers, none of this will come as a surprise because I've already linked to half the articles and studies mentioned in the paper.

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In related news:

Last year I attended the 6th Annual Preserving the American Dream Conference in Houston. This year, the conference is being held in Seattle. I thought it was fantastic last year. I was able to speak to aforementioned Wendell Cox for a few minutes, which was a treat. Also note that Vincent Benard, who writes Objectif Liberte and occasionally leaves comments on my site, will be making the trek from France to present at that conference as well.

On Bubbles and Rationality

Henry Blodget with The Atlantic, writes an article today on market bubbles and rationality. He provides a pleasant reprieve from all of the blame game going on. He thinks we each need to take responsibility. This is admirable, but it fails to recognize that as much as we like to think that we have libertine free will, our behaviors are often shaped (but not dictated) by the legal and economic framework that other people have subjected us to. Here are his two money paragraphs:

But most bubbles are the product of more than just bad faith, or incompetence, or rank stupidity; the interaction of human psychology with a market economy practically ensures that they will form. In this sense, bubbles are perfectly rational—or at least they’re a rational and unavoidable by-product of capitalism (which, as Winston Churchill might have said, is the worst economic system on the planet except for all the others). Technology and circumstances change, but the human animal doesn’t. And markets are ultimately about people.
...
First, bubbles are to free-market capitalism as hurricanes are to weather: regular, natural, and unavoidable. They have happened since the dawn of economic history, and they’ll keep happening for as long as humans walk the Earth, no matter how we try to stop them. We can’t legislate away the business cycle, just as we can’t eliminate the self-interest that makes the whole capitalist system work. We would do ourselves a favor if we stopped pretending we can.

Mr. Blodget is correct in that bubbles are a normal and rational phenomenon. That we see bubbles not just in housing and tech stocks, but in Beanie Babies and baseball cards reveals that it is an inevitable human phenomenon. However, he goes too far when he claims that nothing can be done. We need to dig down and understand how a bubble starts.

There must be a first mover. A bubble can not start unless an item has gained value above historical rates of return and it must be gaining value at rates superior to most other investments. While homes were gaining 15% annually in some markets, this understates the huge rate of returns available when these homes were purchased on the margin. That is, if you put $25,000 down on a 200,000 home, a 15% increase in value increases your equity by 120%. In short, the critical mass of dupes that feed a bubble must have real data to be duped. Something has to be pushing up that value before so many fall for it like suckers.

This "unnatural" rate of return can be created by a number of forces: A restriction on supply, an artificial expansion of credit, or a government subsidy. Whenever any government policy is considered, especially one of significant scale, the potential for a bubble should be considered. These side effects can be avoided by careful analysis, or more easily through a dogged hostility to market manipulation through legislation. A bubble may be hard to stop, but we can prevent so many from getting started.

Mr. Blodget relates a tale of the thinking involved in the real estate bubble and it starts with this:

In fact, for as long as we can remember—about 10 years, in most cases—house prices haven’t gone down. (Wait, maybe there was a slight dip, after the 1987 stock-market crash, but looming larger in our memories is what’s happened since; everyone we know who’s bought a house since the early 1990s has made gobs of money.)

This is the first mover. There is a sense that unnatural rates of return are normal and that a housing bust is unlikely. Why were rates of return unnatural? The artificial restrictions of various housing restrictions. His entire tale rests on the proximate cause of government intervention.

In the end, however, Mr. Blodget is correct. The ultimate cause is us. Our desire to control the behavior of others through the force of government led us to pass these housing restrictions. Whether its to keep poor people out by banning dense housing, or to reduce the evils of urban sprawl and SUVs, so many of us want someone to make the world better for us by making it worse for someone else.

English Real Estate Prices

Here in the U.S. we tend to think of ahousing bubble as something new. However, it is clear from S&P Case-Shiller data that home prices in Los Angeles rose 69% between Jan. 1987 and Jan. 1990, then they proceded to drop 27% over the next 6 years. It is also insightful to look at the experience that other countries have had with land use planning.

According to Vincent Benard at Objectif Liberte, England passed a "Town and Country Act" in 1949, and then expanded it in 1965. This was a series of laws to "protect" English cities from bad development by creating review committees. Since that time, it has been much more difficult to build new homes. My theories on home prices and supply restrictions predict that this will cause abnormal growth in home prices, followed by speculation (a.k.a. extrapolation), then a bust. Did this happen?

Let me define abnormal growth in home prices as being a point in time where home prices grow significantly above income growth. We saw this ratio of home price/income grow from a traditional multiple of 3 up above 10 in our bubble.

The chart below reveals that this is not the first home price bubble in England, but the 4th gyration. (HT: Objectif Liberte)

This notion is reiterated by this graph of real home prices (I assume this means inflation adjusted).

I have said before that I think the housing bubble will repeat itself. Looks like England proves this all too true.

Nice Essay on Property Rights, Houston, and No Zoning

Brian Phillips at his Live Oaks blog has a nice essay about Houston and it's rejection of zoning. He makes the moral case of maintaining my home town's rejection of a rampant form of anti-market thought that has gone mostly unnoticed by most national economists.

His words:

Those in favor of tighter land use regulations voice numerous arguments in support of their proposals. Such controls will improve our quality of life, stabilize property values, and empower the citizens. But underneath all of these arguments lies one unspoken premise-- some individuals may impose their values upon others. Some individuals may use force to dictate the actions of others. Which means, the values of some may be sacrificed to others.

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Houston has become the star of the Lone Star state because it has implicitly rejected this premise. Houston has largely respected property rights, and has thus not used political coercion to dictate the actions of individuals.

History Bears Repeating

Here on my blog and other places I have expressed concern that the housing boom that occurred before 2006 will repeat itself. I base this on the fact that few cities are doing anything to unwind their housing supply restrictions which were the cause of the high prices to begin with. Adding to this a priori analysis, when looking at historical prices there is evidence that this was actually the second boom-bust cycle for Southern California.

Bloomberg has an article suggesting that others agree with me.

California may rebound more quickly from this decline than regions with fewer delinquencies and vacant homes, according to Zandi of Moody's Economy.com. The foreclosure process is ``more efficient'' than in states such as Florida where courts are involved, and Californians are typically ``more optimistic'' about housing after experiencing busts that were followed by property booms, Zandi said.

``They know it's going to be a good investment five or 10 years down the road,'' Zandi said. ``The fundamentals are good: supply constrained markets with lots of population growth, a solid and diversified economy and important global links'' in Los Angeles and San Francisco, he said.

Just beautiful.

Urban Planning's Great Leap Forward

Unfortunately, some of my fellow political and economic friends aren't aware what a serious threat to personal freedom urban planning really is. Many people don't notice or mind it because it is usually packaged with overly romanticized pictures and isn't talked about much by elite commentators. Of course, I have written before that housing supply restrictions, exacerbated by urban planning, is the only reasonable explanation for the housing crisis.

From the Wall Street Journal:

Jerry Brown's War on California Suburbs

Selected Quotes:

"In the meantime, Mr. Brown is taking aim at the suburbs, concerned about the alleged environmental damage they cause. He sees suburban houses as inefficient users of energy. He sees suburban commuters clogging the roads as wasting precious fossil fuel. And, mostly, he sees wisdom in an intricately thought-out plan to compel residents to move to city centers or, at least, to high-density developments clustered near mass transit lines.

Mr. Brown is not above using coercion to create the demographic patterns he wants. In recent months, he has threatened to file suit against municipalities that shun high-density housing in favor of building new suburban singe-family homes, on the grounds that they will pollute the environment. He is also backing controversial legislation -- Senate bill 375 -- moving through the state legislature that would restrict state highway funds to communities that refuse to adopt "smart growth" development plans. "We have to get the people from the suburbs to start coming back" to the cities, Mr. Brown told planning experts in March."

FYI - "Smart Growth" means development is centrally planned by the government.

The article isn't just about Mr. Brown, Joel Kotkin offers some other good points to rebuff the urban planners.

"Research by Mr. Modarres, co-author of the powerful book "City and Environment," demonstrates that people living in nodes -- Pasadena, Torrance, Burbank and Irvine -- often enjoy considerably shorter average commutes than do a lot of inner-city residents."

"Mr. Modarres also points out that forcing developers to build near transit lines, a strategy favored by "smart-growth advocates," does not mean residents will actually take the train or bus. A survey conducted last year by the Los Angeles Times of "transit oriented development" found that "only a small fraction of residents shunned their cars during rush hour.""

"There is also little punch behind the science used to justify the drive to resettling the cities -- and plenty of power behind the argument that suburbs are better for Mother Earth. Several prominent scholars -- including University of Maryland atmospheric scientist Konstanin Vinnikov, University of Georgia meterologist J. Marshall Shepard and Brookings Institution research analyst Andrea Sarzynski -- have found there is little evidence linking suburbanization to global warming, pointing out that density itself can produce increased auto congestion and pollution."

Great Leap Forward?

Sacramento, How Not to Plan a City

In the Wall Street Journal today there is a lengthy article extolling the wonderful possibilities of smart growth in Sacramento, California. The author, likely being ignorant that “Smart Growth” caused the housing crash never stops to think about the consequences of central planning.
Sacramento decided to pursue smart growth vigorously a few years back in what the author seems to imply as prescient and enlightened. Sacramento so embraced Smart Growth that the article uses this quote to describe what is happening there:

“"They're really the model," says Steve Winkelman, a transportation expert at the Center for Clean Air Policy.

I say that smart growth leaves cities vulnerable to housing market booms and busts. Who’s right?

Well, according to RadarLogic’s April RPX Monthly Housing Market Report, Sacramento, the very model of Smart Growth, has experienced the worst housing decline of any city they track in America.

Free Market - 1
Smart Growth - 0

RCM Op-ed "A Tale of Two (Housing) States"

There is never a problem so small that central planners cannot make far worse. So-called “Smart Growth” regulations have crippled the market’s ability to produce a stable home price environment and have aided the housing and credit crises.

In the ‘90s, urban sprawl became a buzzword amongst environmentalists and the urban planning community. It was supposedly ugly, polluting, and destroying open space. The most objectionable quality, however, was that our cities did not fit the idyllic patterns of the Europe experienced on college semesters abroad. Parts of the country, notably California, gave license to urban planners to force new development patterns mimicking those of centuries past. By employing a myriad of limits and mandates, the plans forced growth into dense urban centers. The ideas hopped the pond and spread the world over.

Not understanding that the economics of home construction will not match a predetermined plan, new myopic regulations ran amok. The supply of new homes in these Smart Growth markets began to slow. By rationally responding to this new artificial restriction on supply, home prices rose rapidly. For a while, Smart Growth was making many people very rich on paper.

Other cities, however, imbibed much less of the Smart Growth kool-aid and prices stayed low.
According to the S&P Case-Shiller Index, home prices in the Los Angeles and San Diego metros soared by 18% and 15% annually between 2001 and mid-2006. At the same time in the Atlanta and Dallas metros prices grew a mere 4.4% and 3% annually. Index data prior to 2001 is unavailable for Dallas, but home prices in Atlanta grew at the same 4.4% between 1991 and 2001. Adding to this price paradox is that Atlanta and Dallas were consistently among the fastest growing metropolitan areas in the United States.

It was then in mid-2006 that home prices in many of the highflying cities hit their all-time highs. Afterwards, home prices began to ease in L.A., San Diego, and San Francisco all before the foreclosures began to rise. The stock price of Countrywide hit an all-time high on Feb 2, 2007, showing that mortgage-lending investors had little idea of what was coming.

Home prices when rising at double-digit rates in a liquid market allow many to avoid foreclosure. Equity was growing too quickly to catch many people underwater on their mortgage. When home prices rose to more than ten times median income in California, demand simply could not continue to rise. Flat and then falling prices revealed how many people really could not afford to own a home.

For California, RealtyTrac data shows that foreclosures did not appreciably rise until August of 2006, but home prices were already flat in L.A. and falling in San Diego and San Francisco. Within six months, foreclosures in California grew by 30% and then a whopping 256% more within a year. The massive wave of foreclosures did not occur until nearly a year after prices had already started to drop.

The credit crisis began in part by the way that mortgage-backed securities are priced and by the highly leveraged nature of the mortgage lending industry. This home price boom wreaked havoc on a financial system unaccustomed to such volatility. Ratings are given to mortgage-backed securities based on backward looking analysis of defaults. In an environment where rapidly rising home prices mask foreclosures, risk premiums were too low and values too high on these securities. This practice had been a reliable model due to decades of steady trends. The mortgage lending business model was based on borrowing at low interest rates, lending to consumers at higher rates, and reselling the overpriced mortgage bundles to institutional investors. This system was unprepared for the fundamental changes brought by Smart Growth.

Defaults began to climb as prices fell, causing both the rate and severity of foreclosures to increase. At the same time interest rates were rising. The margins for mortgage lenders disappeared, and some companies collapsed. Any company or hedge fund that leveraged itself assuming faulty valuations of mortgage-backed assets was suddenly in trouble as well.

With less demand for their mortgage bundles, fewer loans were arranged. A vicious cycle set in where falling prices left more people underwater on their loans leading to more foreclosures. More foreclosures increased the supply of homes on the market leading to falling prices.

Painting Smart Growth as the culprit becomes inevitable because other theories on the housing crisis offer no explanation for geography. The Dallas metro was not experiencing the same surging prices as Los Angeles, but the differences do not stop there. Foreclosure rates in Texas have remained flat in the last two and a half years. Even with all the alleged and rampant fraud, resetting of ARMs, and irresponsible borrowers, Texas saw no surge in foreclosures. The only effect seen is slower sales after tightened credit requirements late in 2007. In Texas, there never was a bubble nor would there ever have been a credit crisis.

The only rational explanation for the differences between cities experiencing the housing crisis, and those that are not, is the prevalence of “Smart Growth” legislation. Sinister mortgage lenders and reckless borrowers are not the culprits. This housing crisis is an unprecedented disaster because of unprecedented meddling in the economics of housing development by the peddlers of “Smart Growth”. This scenario will happen again and again if its distortions are not removed.

The Tyrant Next Door

“I’m all for capitalism, but not in my neighborhood!”

This has become the unspoken creed of many a do gooder. While most Americans support the free market at the state and national level, they don’t seem to be quite so keen on it at the local level.

In many suburban areas, deed restrictions have become a way of life. We want our neighborhoods to look nice and we want our neighbors to maintain their property about as well as we maintain our own. A couple of years ago I received a nice little letter explaining that if I left my empty trash can in the front yard again that I would receive a $75 fine. After the trash truck came by my visiting mother-in-law had placed it on the side of the house where I can’t see it when I pull my car into the garage. Oddly enough while I received a scolding for my trashcan, no rules exist to stop the new neighbor across the street from cutting down four 50-year old live oak trees.

Neighborhood enforcement boards have earned a bad reputation in recent years by letting a select few go on power trips. A man in my neighborhood was cited for parking a boat on the street for a mere 4 hours between midnight and 4 a.m. en route to a fishing tournament. You have to wonder what kind of psycho is goose-stepping around the neighborhood at the wee hours of night looking for infractions. It is annoying, but we were all given the rules when we moved into the neighborhood. Nobody forced us to buy a house there.

In some old neighborhoods, there are no deed restrictions. In Houston, there is no zoning either. For decades, this wasn't an issue. The residents just went about their lives and the neighborhoods maintained their modest appearance. However, over the last decade interest in living in the center of the city has grown dramatically. Old and small houses are being replaced by townhomes packed onto the old lots. The Not-In-My-Back-Yard (NIMBY) crowd now wants the city to allow new deed restrictions to prevent other property owners in their neighborhoods from building townhomes. Some have been successful, so more are trying. They want to keep their neighborhoods the way they have always been. Well, at least since the last time a developer came in and tore up an old family farm to build the neighborhood, and the time before that when the farmer tore up unspoiled wilderness.

In Bellaire, a close in suburb of Houston, they have had restrictions to prevent townhomes on the books for years. The unforeseen consequence was that old homes were still torn down and monster homes took their place. You cannot afford to tear down a house to build another one unless you have a lot of money. If you have a lot of money, you probably are not going to build a small house. Of course, the NIMBY crew doesn’t like these either because the new homes tower above their small homes. In Austin, they have now made restrictions to prevent townhomes and “McMansions”, effectively preventing redevelopment in large swaths of the city.

This means that there are fewer areas for redevelopment. This drives up the prices of available land and prevents those with modest means from moving into the city. This also gives a bigger incentive for developers to seek easier targets, like poor areas with little neighborhood organization. This has consequences as well. Low-income neighborhoods often have unbelievably cheap rents in old buildings that cannot be replicated by new construction.

What is the answer? More regulation and government programs of course. All across the U.S. government organizations are building or subsidizing “affordable housing”. In San Francisco, every new home is required to give money towards affordable housing, increasing the cost per home between $22K and $44K according to a recent article from reason.com. San Francisco is already one of the most expensive places to live in America and now they have added even more costs on top of that. However, another sticky problem arises when deciding where to build the affordable housing. The NIMBY crowd gets fired up again using our courts to make sure it’s not in their back yard.

Yet another consequence from preventing denser development is “Urban Sprawl”. Ironically, the same anti-development people are against urban sprawl. The opponents of urban sprawl believe that having cities more spread out leads to more pollution and loss of open space. What’s their answer to urban sprawl? That’s right. More regulation and government programs. Cities like Portland, Oregon have instituted growth boundaries around their cities, outside of which development is very restricted. These boundaries force density and limit the supply of land for development.

Economics 101, when you limit supply, what happens to price? It goes up. Is it any wonder why a house in Houston, which has no zoning and little land use regulation, costing $200K goes for $850K in San Francisco, which has stringent development restrictions? Not all forms of restrictions are bad, but the untended consequences of excessive regulation have driven the price of homes in some cities beyond what the average person can afford.

The fundamental problem is that we cannot regulate our way to paradise. Every regulation is going to have an unforeseen side effect, prompting the “need” for more regulation. Everyone has different preferences for how they would like to live and what they want their city to be like. When property rights are taken away our cities become dominated by those who yell the loudest or have the most money. Even though I may look like a curmudgeon from time to time, I feel safe in erring on the side of property rights.