Misunderstanding the Bubble and Burst in Sacramento

An opinion piece in the Sacramento Bee by Sean Wirth of the Environmental Council of Sacramento could not have been more wrong in its characterization of the causes of the housing bubble in Sacramento.

The article starts out promisingly, correctly noting that:

  • The housing bubble spawned the Great Recession
  • Demand exceeded the inventory of houses in the Sacramento area
  • Sacramento prices "soared sky high"

But it is all downhill from there, with the suggestion that the extraordinary price increases in Sacramento were the result of too much suburbanization (the theological term in urban planning circles is "sprawl"). In fact, all things being equal, house prices tend to escalate where the supply is more constrained, not less. Where suburbanization is allowed, the market can supply enough housing to avoid inordinate house price increases. Where suburbanization is severely constrained, a legion of evidence indicates that house prices are prone to rise. It is all a matter of basic economics. George Mason University economist Daniel Klein puts it this way:

Basic economics acknowledges that whatever redeeming features a restriction may have, it increases the cost of production and exchange, making goods and services less affordable. There may be exceptions to the general case, but they would be atypical.

Housing is not atypical and Sacramento house prices soared in response to the tough use regulations. By the peak of the bubble, the Median Multiple (median house price divided by median household income) had risen to 6.8, well above the historic norm of 3.0. Many houses were built, but not enough to satisfy the demand, as Mr. Wirth indicates. Building many houses is not enough. There need to be enough houses to supply the demand, otherwise land prices soar, driving up house prices.

Unless a sufficient supply is allowed, speculators and flippers will "smell the blood" of windfall profits, which are there for the taking in excessively regulated markets.

During the housing bubble, house prices rose well above the historic Median Multiple norm only in metropolitan areas that had severe constraints land use constraints (called "smart growth" or "growth management"). This included Sacramento, other California markets, Miami, Portland, and Seattle and other markets around the country.

At the same time, more liberal development regulations allowed a sufficient inventory of housing to meet the demand in high growth areas like Atlanta, Dallas-Fort Worth, Houston and Austin. In each of these places (and many others), the Median Multiple remained near or below the historic norm of 3.0, even with the heightened demand generated by a finance sector that had lost interest in credit-worthiness. As would be expected, speculators and flippers avoided the traditionally regulated markets, where an adequate supply of affordably priced housing continued to be produced.

Wirth expresses understandable concern about the house price losses since the bust. From the peak to the trough, the drop in Sacramento median house prices was more than 55%. However, this is to be expected once a serious economic decline is precipitated, especially in the sector that precipitated the crash (in this case housing). Economists Ed Glaeser of Harvard and Joseph Gyourko of Wharton have shown that not only (1) are house prices higher in more restricted markets but also that (2) there is greater price volatility in more highly regulated markets. Indeed, it is likely that the housing bust would have been much less severe or even avoided altogether if constraints on land had not driven the prices and subsequent mortgage losses so high in California and a few other states that they could not be absorbed by financial institutions. At the time of the Lehman Brothers collapse, 11 "ground zero" markets (including Sacramento), all highly regulated, accounted for 75% of the mortgage losses in the nation, with a per house loss rate of 15 times that of traditionally regulated markets.

Wirth's article expresses opposition to a Sacramento County decision to allow more development to occur on the urban fringe. He would prefer to force development into the existing urban footprint. The economic consequences of such folly are well known. In Australia, such policies have driven led to a doubling or tripling of house costs relative to incomes. The annual mortgage cost of the median priced house has risen to 50% of the median pre-tax household income, in a country that defines mortgage stress at the 35% level. Before the adoption of smart growth policies, Australia's housing affordability was similar to that of liberally regulated markets in the United States.

Avoiding the next housing bubble requires not repeating the mistakes that led to the last. Sacramento's young and lower income households can only hope that the additional land approved by the Board of Supervisors will be enough of a safety valve to keep housing affordable so that they can become owners rather than renters.

Photograph: Sacramento (author)

Comment viewing options

Select your preferred way to display the comments and click "Save settings" to activate your changes.

Jobs Impact

I find it interesting that there is no mention of the tepid job market in Sacramento as a housing factor. Common sense suggests that good paying jobs have to exist in order for area residents to sustain their mortgages

Look for the scenario in the Sacramento region to worsen as state cutbacks reach new levels and area quality of life continues to decline. My family and I are counting our lucky stars as we just relocated from the Sacramento area to Denver before the bottom falls out.

Michael Scott
Centro Inc

I'm not sure Mr. Cox got it!

My op ed never claimed that suburban sprawl escalated home prices. Quite the opposite, it was their over abundance that exacerbated the effect of the bubble bursting and reduced prices to the point that they have affected the entire economy. The economy was red hot when home prices were high and jobs and tax revenues were a plenty. Were they too high? Yes they were, as a result of the perfect storm of artificially low interest rates and ridiculously lax lending practices. To make my point from a different trajectory, what would have happened if the state and the county had not added so many tens of thousands of "excess" housing units? Prices would still have soared, but would they have dropped as badly and have had as large a negative effect on the overall economy? Well, for starters, there would not been much of a market for subprime loans because given the limited inventory only fully qualified borrowers would need to be considered for loans. Existing owners may well have been swept up in the subprime frenzy, but the pent up demand from a constained market would have minimized the effect because sales could have been made when properties became distressed, thus dramatically reducing the foreclosure rate.

The level of toxicity in the securities created with home mortgages would have been lessened because of better loans being underwritten, and foreclosures being avoided. This would have helped avoid the crisis that is heralded as popping the bubble. The bubble that did exist because of over inflated home prices would have been burst anyway when interest rates went up or prices escalated past what wages could support. But it would not have brought the entire economy down with it.

You make my point for me when you say constrained markets escalate values. Exactly! Constrained development is what we need now to bolster home values, get more wealth into the economy, and get people back to work. Wages and interest rates can do the rest to keep homes affordable.

There is a growing body of research that indicates that open space and preserves have a positive effect on home values. What would you rather have, smart infill practices that bolster local home values and improve the overall quality of life of existing residents because of reduced commute times and pollution, or fringe growth that clogs up the roadways and our lungs, and threatens our fical and physical quality of life?

Some Agreement, More Disagreement

Thank you for your comments.

Just a couple of points.

We apparently agree than constraining land supply increases house prices, which of course is consistent with economic theory and virtually all of the research.

Higher house prices do not necessarily mean a higher standard of living. Until the coming of restrictive land regulation, median house prices ranged generally between 2 and three times median households incomes (1950-1970). In areas where more restrictive land use regulation has been enforced, house prices have risen relative to incomes. That does not improve the quality of life, it retards it. It means that housing is less expensive to all, including lower income households and further, it means that households have less discretionary income.

The higher densities favored by these policies increase the intensity of traffic congestion (roads are less clogged) and slows travel times (see: http://www.newgeography.com/content/001444-new-traffic-scorecard-reinfor...). "More intense traffic congestion produces more intense air pollution as well as more greenhouse gas emissions. It is well to remember that public health was the rationale for air pollution regulation. Air pollution’s negative impacts are so local that they are measured in the quality of life of individual people, especially those in close proximity to the unnecessarily overcrowded roads that result from higher densities.

It seems to me that our task should be to encourage economic growth, while providing the best standard of living for households in every income category. The higher costs of housing that result from more restrictive land use regulations work against achieving any such objective.

Best regards,
Wendell Cox

Three Points

1. You can't explain the spectacular rise in housing prices (which happened even in places like Austin and Houston) simply by looking at housing supply. The primary driver of the increase wasn't a dramatic shift in supply-- it was the reckless lending policies that increased the demand for housing, both by homebuyers who would not have previously been allowed to get mortgages and by newly minted "investors" who looked at residential real estate as an easy way to make money.

2. The difference between median multiples in Sacramento and somewhere like Austin has more to do with what was happening to the local economy than what was happening to housing prices. Austin's economy exploded in ways that sleepy Sacramento could only dream of.

3. To suggest that Sacramento has had a severe regulatory regime that restricted housing supply over the last 10-15 years is just not accurate. To understand the full picture, look beyond the limits of the county itself and see what has happened in the region as a whole (e.g. El Dorado County, Sutter County, etc.) Builders have had no difficulty finding places to put up new homes. Consequently, the local economy came to depend on housing construction for growth. Rather than having a construction industry that responds to economic growth (which would have permitted the median multiple to remain lower), residential construction became the engine driving local economic activity.

great point

You can't explain the growth in housing prices without at housing supply -- but Mr. Cox never looks at housing supply! His analysis only looks at housing prices, not housing supply! He wants us to believe that the bubble in housing prices is in itself proof that land use regulations were the cause of the problem.

As you point out, this argument completely ignores financial factors like interest rates and bank lending policies, which were obviously huge contributors to the housing bubble. But it also ignores the data on housing construction during the bubble years, which shows that housing construction outpaced household growth even in the places Mr. Cox describes as "excessively regulated markets".

I looked up the Census Bureau data on population and housing unit growth: Sacramento County's population increased by 12% from 2000-2007 (2007 being roughly the peak year of the bubble), but the number of housing units grew by 15%. If anything, too much housing was built during the 2000s, not too little. This was true for not just Sacramento, but other so-called highly regulated markets. For instance, in New York City there was a 30- or 40-year high in housing construction, in spite of the fact that there is no greenfield land to build on. Why are we supposed to believe there is an excess of land use regulation in these places?