Smart Growth Plus Sub-Prime = Toxic Mix or Panacea

“On April 29, 2008 Wendell Cox of the Heritage Institute wrote an article entitled: How Smart Growth Exacerbated the International Financial Crisis.

“On May 18, 2008 Jim Tankersley of the Chicago Tribune wrote an article entitled: Oregon’s Growth Limits Help Ease Housing Pain.

Wendell Cox argues: 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.

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…..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.

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.

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.

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.

Jim Tankersley reports: Here at the western edge of the Portland metro area, green fields flow into fir trees and foothills and eventually the Coast Range….If this were Phoenix or the San Francisco Bay area, real estate experts say, master-planned subdivisions would carpet these fields all the way to the mountains. Instead, their foot-high grass faces out on just one new, 15-lot cul-de-sac, buffered by strict growth controls that help North Plains maintain its rural feel and help shield Oregon from the housing crisis stunting the national economy.

While home prices fell by about 20 percent in the Sun Belt and the Midwest over the last year, values here in the northwest corner of Washington County rose 4.5 percent….Prices overall in the Portland metro area dipped slightly; only Charlotte fared better among major cities….Portland’s longtime fight against sprawl ensured that the supply never got too far ahead of demand….In Portland’s western suburbs, the growth boundary makes towns denser and houses more expensive….This is the heart of Oregon’s Silicon Forest, a corridor of chip manufacturers and software engineering firms that drove much of the state’s economic and population growth in recent years….It all adds up to higher, more stable home prices that rose in boom years but never hit Silicon Valley-size peaks. And that has a crucial effect on the rest of the economy.

Foreclosures have dominated the discussion of the housing crisis in Washington and on the campaign trail, but economists say they don’t hurt the economy nearly as much as falling prices, which strip homeowners of borrowing power, retirement nest eggs and sale profits to spend….

But not in Portland. “The market’s done much better than most,” said Jerry Johnson, a Portland land-use economist with the firm Johnson Gardner and a leading analyst of the region’s development trends. Builders, he added, “have had a little trouble getting ahead of themselves and what they would have done if they weren’t constrained.”

Some free-market economists say growth restrictions price lower-income families out of home ownership, hinder economic expansion and inflame the housing crisis….Other skeptics say Oregon’s economy, which was late to reap the post-Sept. 11national economic recovery, is headed for a delayed crash. Oregon Business magazine headlined its May cover story on the local housing market “The Party’s Over.” Some prominent home builders, who mostly operated in corners of the area with more available land and less growth than the western suburbs, have seen their businesses collapse. Housing sales are slowing statewide. A February study by Global Insight and National City Corp. ranked four Oregon cities in the top 15 “overvalued” metro areas in America.

Yet most Oregon analysts say they are confident prices here will hold. Rents are rising, they note, which could push tenants to buy homes. The region’s economic mix appears stronger than most, which suggests persistent demand. In suburban Washington County, principal planner Andy Back said building permits have dropped substantially, reducing the chance that new supply will drive existing-home values down….

JMc’s Comments:

It’s good to know that land planners have the power to shake the entire global financial system and bring it to its knees. Oh that it was true. But the sub-prime scam wasn’t driven by the scarcity of residential product due to “destructive land use regulations” (wonder if the Heritage Foundation every saw a “productive land use regulation”) replacing “more traditional yet environmentally sound regulation” (I’m not even going to comment on this one) without “the slightest consideration of economics” (guess the author missed the extensive literature and law cases discussing the economic impact of land restrictions – although I will admit that there probably hasn’t been much discussion about Portland’s land planning laws crippling the international financial system -seems like everyone from the city planning commission to the World Bank missed that one.)

The sub-prime scam wasn’t built on real estate supply and demand but on the over abundance of cheap credit and low lending standards. If the underlying asset was truly scarce and in high demand, the loans might not be sub-prime. (Not to mention all of the other sub-prime messes such as credit card debt, auto and boat financing, etc., unless you want to blame restrictions on parking lots and boat docks – but don’t give them any ideas.)

But yes, smart growth limits do both reduce the supply of new construction and increase the costs. So do roads, sewers, fire and health safety systems, sound and safe construction techniques, etc. Housing would be much, much less expensive if anyone could build anything anywhere. But homeowners don’t like it when the neighborhood burns down because of someone’s faulty wiring or a garbage dump moves in next door. So as with so much else, it is a balancing of what the community wants, restrictions it is willing to endure, and what it can afford – which is complicated by different sections of the community having different wants, tolerances, and purchase power. What the sub-prime market did was to temporarily inflate purchase power and thus inflate demand – and now the moment has passed and deflation is setting in.

Where supply was elastic, the increase in purchasing power resulted in increases in supply and the decline in purchasing power in oversupply.

Where supply was inelastic, the increase in purchasing power resulted in increases in prices and the decline in purchasing power resulted in declining prices.

Tenants are better off in the first case since the oversupply will dampen price increases as the local economy recovers. Investors are better off in the second case since the lack of oversupply will allow for price increases earlier in the local economic recovery.

Take your choice.

PS – In Manhattan the City bent over backward to accommodate developers but purchasing power grew faster than a growing supply driving prices up even as restrictions were loosened.

PPS – Free market economists have criticized Oregon’s laws since they were first introduced by a Republican Governor 35 years ago. I suppose it could be an example of predict a downturn long enough and you’ll eventually be right.