Smart Growth Played Major Role in Housing Crash
There is general agreement the financial crisis that began with the failure of Lehman Brothers on September 15, 2008 was made worse by the bursting of the U.S. housing price bubble.
It is also generally acknowledged that some of the fuel for the housing bubble came from a relaxation of mortgage loan standards that allowed many families to purchase homes they could not afford with loans on which they subsequently defaulted.
New and excessive demand for mortgagees drove up home prices faster than the increase in the housing supply.
Big Differences Depending on Location
It is less well understood that the U.S. housing bubble was not a monolithic event. It varied substantially by geography. Gross national house value increases and losses were overwhelmingly concentrated in metropolitan areas with more restrictive land use regulations—known by a variety of names, such as compact city policy, growth management, and smart growth.
Many metropolitan areas with these land use restrictions were not able to respond to the increased demand for homeownership caused by the greater availability of mortgage credit. The inevitable result was higher prices, which encouraged speculation in real estate and increased house prices even more.
Thus, from 2000 to 2007, among the nation’s 50 largest metropolitan markets:
- In the 10 markets with the greatest rise in prices compared to income, the cost of a house rose by an average of $275,000[STK1] .
- Among the second 10 markets with the greatest price escalations, house prices rose $135,000.
- By contrast, in the major markets with the least housing cost rises, house prices increased only $5,000.
Concentrated in Few Cities
Furthermore, 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 major markets with the greatest escalation in housing prices.
For the nation as a whole, house values more than doubled between 1999 and the peak of the bubble. From the peak in the fourth quarter of 2006 until the end of 2010, home values fell more than $6 trillion. Losses after the bubble burst were even more concentrated than house price gains.
- From the peak of the bubble in 2006 to the Lehman Brothers’ collapse on September 15, 2008, more heavily regulated metropolitan markets accounted for 73 percent of the nation’s aggregate value losses.
- The average loss from 2007 to the Lehman Brothers’ collapse was $175,000 per house in the 11 markets with the greatest run-up in prices and the greatest fall.
- All prescriptively regulated markets (more heavily regulated markets) accounted for 94 percent of losses, or an average of $97,000 per house.
- Responsively regulated markets (less restrictively regulated markets) lost just 6 percent of their value, an average of $12,000 per house.
Artificially High Prices
With prices falling and mortgage interest rates rising, households were no longer able to refinance, causing many new homeowners to fall into delinquency and foreclosure.
If the prescriptively regulated metropolitan areas had instead had responsive land use regulations, prices likely would have escalated at a much lower rate during the housing bubble.
This is because the land price premiums that grew during the bubble would have been less likely to develop, at least not to the same degree. If the housing markets in the prescriptively regulated areas had replicated the performance of the responsive markets, I estimate the house value losses from the peak of the bubble to the start of the financial crisis would have been $0.62 trillion—one-fourth of the actual loss of $2.44 trillion. The average loss per house would have been $17,000 instead of $67,000.
These more modest losses might not have set off the financial crisis, or it might at least have been less severe.