Was There a Housing Bubble?
By David Henderson
In his recent book Shut Out, Kevin Erdmann, a finance expert and visiting fellow at the Mercatus Center at George Mason University, has two main messages. The first, which is not controversial among economists, is that restrictions on residential construction in coastal California and the urban Northeast have constrained supply so much that housing in those areas is virtually unaffordable for people in the lower- and middle-income classes. His other message is more controversial, that the financial crisis last decade was not due to a housing bubble but, rather, to bad policy decisions based on the idea that there had been a bubble. Whereas I was already convinced of his first point, I, like the majority of economists, was skeptical of his second. But because of all the data and reasoning he brings to the issue, I now find myself at least 90% convinced.
Probably because his second point is the more controversial, Erdmann spends about the first half of the book making that case. At times his narrative gets bogged down and his language is often sloppy. For example, he uses the word “shortage” to refer to a situation where demand increases but supply doesn’t. Economists, however, tend to reserve that word for situations where the price fails to clear the market such that quantity demanded exceeds the quantity supplied. The good news is that he often saves the day with pithy, clever quotes that sum up his message. Also, the more than 100 graphs he uses in the book seem like overkill, but that is better than underkill.
Types of cities / Erdmann makes his case by looking at the diverse characteristics of U.S. cities rather than lumping them all together, and by studying changes in housing prices and rents over time. He focuses on the 20 largest U.S. metropolitan areas and divides them into four categories: Closed Access cities, Contagion cities, Open Access cities, and Uncategorized cities. The five Closed Access cities are New York City, Los Angeles, Boston, San Francisco (including San Jose), and San Diego. In those cities, local and state governments have imposed strong restrictions on construction.
Erdmann seems a little vague about when those restrictions got really tight. His narrative suggests that it was in the 1990s, but there’s no index to help one look for a clear answer; he did confirm in an email to me that he dates it to 1995. In those cities, housing starts, even in economic expansions, have been low, incomes have been high, rents have been high (and rising) even relative to incomes, and there were large rates of out-migration of households with low incomes.
The above are the opening 4 paragraphs of David R. Henderson, “Was There a Housing Bubble Last Decade?” Regulation, Winter 2019/2020, pp. 63-65. Read the whole thing. [Scroll down about 60 percent of the way.]
Thanks to Jeff Hummel for improving a previous draft and to Kevin Erdmann for promptly answering the questions I emailed him.