Mosca: In the executive summary of your policy analysis, “How Urban Planners Caused the Housing Bubble,” you wrote, “Everyone agrees that the recent financial crisis started with the deflation of the housing bubble” but let’s get into what caused the bubble and why is it so important to understand its root causes. How will this help us in the future to know the causes that relate to fixing the credit crisis?
O’Toole: A lot of people blame the Federal Reserve Bank for keeping interest rates low and the Community Reinvestment Act for encouraging lenders to offer loans to marginal homebuyers. If you look at the data for individual states and metropolitan areas, you find there was a big housing bubble in California and Florida but there were no housing bubbles in places like Texas and Georgia even though Texas and Georgia were growing faster than California and Florida. So, why did California and Florida have a bubble and Texas and Georgia not? If you look at it in more detail you find only about a dozen states had big housing bubbles, a few more states had smaller bubbles, but the vast majority of states did not have any bubbles at all. It turns out that the states with housing bubbles were all practicing some form of what urban planners call ‘growth management.’ Urban planners for decades have believed that it was important for people to be packed into small urban areas. These urban growth boundaries ended up boosting the price of land inside the city and making housing more expensive. There was another consequence. Normally, there is a competition between cities and between cities and counties over how to attract development. Cities and counties want to get tax paying development so they compete with one another and then try to make it easy for developers to get permits to develop vacant land. Once an urban growth boundary has been drawn that competition is heavily restricted and nobody can develop outside the boundary so then cities begin to say as long as people can’t go anywhere else, we might as well impose all kinds of restrictions and they develop an honourous permitting process that can take years to get a permit to put in a small subdivision. In a lot of cases they can make it impossible. They can make it so that there is a very high risk that you will never get a permit.
Mosca: Is there an example of this in our country?
O’Toole: One example of this is in Dallas, where it costs about $10,000 per home to get a permit to build but in San Jose, it costs $100,000 when you count the risk that you’ll apply for a permit and after 5 years you’ll never get one. The point is that these kinds of restrictions make housing more expensive. They not only make housing more expensive, they make housing prices more volitile. A small increase in demand can lead to a large increase in cost but a small decrease in demand can lead to a large drop. Instead of seeing housing prices grow slowly, we see these big bubbles and bursting of the bubbles and collapses and bubbles and collapses over and over again. We’ve already seen three major bubbles in California since these rules started being implemented in the 1970s.
Mosca: Your paper noted that in 2005 both Alan Greenspan and Ben Bernanke argued that there was no housing bubble and that people need not fear that such a bubble would burst. Do government officials, whether they are elected or appointed, rely on professionals like you, other professionals and associations, organizations, folks that have the street smarts when they make determinations, when they make future predictions and discuss policy decisions, and would statements like this be eliminated, eradicated, maybe better decisions would be made?
O’Toole: They made the classic error of looking at national data when really the bubbles were local. Unfortunately, by 2000 enough states had passed growth management laws that almost 45% of all housing in the country was effected by a bubble. Even though it was only about a third of the states, states like California and Florida are heavily populated and had a disproportionate influence over housing. Even though nationally it didn’t look like there was a bubble, there was a huge bubble in California, a huge bubble in Florida as well as Arizona, Oregon, Washington, Nevada and a handful of other states. Do local officials listen to people like me? No. It turns out that local cities and counties almost all have urban planners on their staff. My blog is called ‘The Anti-Planner’ because I think urban planners don’t have enough knowledge. Yet, they are considered the experts by politicians and their staffs. Most urban planners have never taken a serious course in economics or urban economics and they make these recommendations to draw urban growth boundaries and restrict development without thinking about what is going to happen to housing prices.
Mosca: What is the flip side of that?
O’Toole: They claim that they need to restrict growth or have compact development because they need to preserve farmlands. The United States has a billion acres of farmlands and they only use less than 400 million acres for growing crops. All of the cities and towns in the country are only about 100 million acres and they are no threat to our farmlands. The urban planners claim suburbs cause obesity and need to force people to live in higher densities so that they will walk more and drive less and not become obese.The data shows that the suburbs don’t cause obesity. There are only slight differences between suburbs and urban areas in terms of weight.
Mosca: Some say the bubble occurred because the Federal Reserve kept interest rates low?
O’Toole: If the Federal Reserve keeping interest rates low had caused the bubble then we would have seen a bubble in Houston and Dallas and Atlanta and Omaha and other cities but there was no bubble in those cities. In fact, it’s amazing to think about this but housing prices not only did not bubble in Houston, and as of the second quarter of this year, they haven’t even declined. The housing market there is alive and well and builders are responding to demand. There are many other major metropolitan areas where there has been virtually no decline in prices. Sales might have slowed a little bit but prices are still holding steady and that really shows that what the Federal Reserve Bank was doing with interest rates didn’t cause the bubble.
Mosca: Have there been other times in our history where interest rates were low and there were no housing bubbles?
O’Toole: If you look across the history, you see we did have some housing bubbles in the past but they were all in states that had some of these growth management laws. The difference between the past and today is that a lot more states have the laws whereas back in the ’70s only three or four states had them.
Mosca: Are you saying that these trends all go back to restrictive growth management policies?
O’Toole: That’s right. In 1961 Hawaii was the first state to pass a growth management law. In 1963 California passed a law that morphed into growth management. Then, in 1970 and 1973 Vermont and Oregon passed growth management laws. So, in the 1970s we had four states that had such laws in those four states saw big housing bubbles in the 70s and then a collapse in 1981 when the Federal Reserve bank increased interest rates in order to combat inflation. Then another housing bubble happened in the late ’80s and a collapse in the early ’90s in again these same states plus a couple more. Then, in the 1980s and 1990s a whole bunch more states pass these growth management laws including Washington and Florida and Arizona and they too had big bubbles in the recent episode. We had about one dozen to 15 states with big bubbles recently whereas before we only had three or four states.
Mosca: The second place many put the blame is the Community Reinvestment Act, stating that encouraging lenders to offer loans to “marginal homebuyers” caused this housing bubble?
O’Toole: If you look at the data, you see that a lot of the foreclosures are for people who received zero down payment loans. The Community Reinvestment Act and other pressures encouraged more homeownership but did not cause the housing bubble. Instead high housing prices in states like California and Florida led politicians to demand that the Federal Housing Administration, Fannie Mae and Freddie Mac make more loans or buy more loans that had less restriction. We had Fannie Mae and Freddie Mac starting to buy zero down payment loans, starting to buy loans with other less restrictions than they had used in the past and so that added into the housing bubble a little bit and made the consequences more serious although it didn’t cause the high housing prices in the first place. It was a response to the high housing prices. Instead of treating the source of the high housing prices, we treated the symptoms and that just made it worse.
Mosca: That’s important to clarify right there.
O’Toole: It’s not the only example of that. Urban planners saw the housing prices going up and convinced politicians to pass a new restriction called inclusionary zoning or mandated affordable housing where home builders were required to sell 15 to 20% of all their housing units at below market rates to low income buyers in order to “make or provide some affordable housing” but in fact all they were doing was making the overall housing market less affordable because builders of course responded to this by raising the prices of their other homes and building fewer units which added significantly to housing prices in cities that passed inclusionary zoning ordinances.
Mosca: I’m going to stay positive and say elected officials are trying to pass legislation, create ordinances, regulations, amendments, and zoning to help those who need and perhaps they do not look beyond what they are doing to the overall picture?
O’Toole: They need to start listening to people other than urban planners who don’t understand enough economics to fight their way out of a paper bag. Urban planners rely largely on the fads and myths about urban areas and because of these fads and myths their policy advice is terrible and led us into this terrible housing crisis that has caused this recession.
Mosca: What do you say to the people who blame “Wall Street” because they failed to properly assess the risks of sub-prime mortgages?
O’Toole: There is some blame to be handed out there but it’s interesting when normally you borrow money to buy a house the lender requires a 20% down payment and there is a good reason for that. Housing prices do fluctuate a little bit but they rarely fluctuate more than 20% over a few years. They rarely go down as much as 20%. Only if some economy totally collapses are you going to see housing prices go down by more than 20%. So, by requiring a 20% down payment, they are making sure that people do not get underwater. When you start imposing these growth management rules, you make housing prices more much more volatile and you start seeing swings where a 20% down payment isn’t enough to keep people from being underwater. Instead of maintaining or increasing the 20% requirement though both lenders like Freddie Mae and Fannie Mac or mortgage purchasers like Fannie Mae or Freddie Mac and then Wall Street went ahead and started buying mortgages that had less than 20% down payment, 10%, 5% and then eventually zero percent. Wall Street could be to blame but really the problem is that Fannie Mae and Freddie Mac started buying these loans at a 0% down payment. When Fannie Mae and Freddie Mac put their stamp of approval on it, then it became okay for Wall Street to do it. Wall Street didn’t assess the risk properly.
