Worries are mounting over home prices flirting again with the stratosphere, even as we claw out of recession. Here we go again, it seems. Too much money. Too much borrowing. Too much activity in housing construction. Just another wave in our bubble-and-bust economy.
But this gets it wrong. The reason prices have been on a roller coaster for the past 25 years is that we never have had enough activity in housing construction. This was true even in 2005.
In the past 25 years, the number of homes in the United States has risen by 25%, and the population has risen by 24%. That may sound like enough housing, but in the 25 years before that – because of long-term trends like smaller families – the number of homes increased by 60% to accommodate a population growth of 30%. We've stopped building enough – and, oddly, one reason is that we're too focused on price alone.
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Since 2007, officials at the Federal Reserve and federal financial regulators have fixated on limiting money and credit because they fear a repeat of the high home prices we experienced leading up to the Great Recession. In doing so, they clamped down on construction, and no housing market without enough actual homes can truly be affordable.
Local policies also deserve plenty of the blame. Restrictive zoning and complex building policies are a national epidemic, as cities, suburbs and other municipalities make affordable housing increasingly difficult to build. This makes it especially expensive to live in places such as Los Angeles, San Francisco or the Boston-New York-Washington region stretching from Massachusetts to Virginia – which also happen to be where many of the best economic opportunities exist. Taken together, it also means that America has fewer and more-expensive homes overall.
Both the national and local cases illustrate how, in the case of housing, the rules of supply and demand matter as much as ever. We obscure this truth if we fail to recognize that prices are not the disease itself; they're the most serious symptom.
We often think of those people burned by falling prices because they borrowed or lent into hot housing markets before the crash of 2007. We think about how, over the past two or three decades, home prices have had a devilishly cyclical influence on the economy. And about how rising home values have enabled debt-fueled consumption during economic expansions, and how foreclosures and negative equity have worsened economic contractions.
None of these things should be taken lightly, but they can distract us from the supply side of the puzzle: the housing market's ability to provide homes to the right people, at the right prices, in the right areas, at the right times.
It used to be the case that housing supply was very cyclical, which in many ways was a healthier dynamic. In the 1960s and 1970s, housing construction, more than prices, would rise and fall through economic expansions and contractions. In early 1970, for instance, new homes were being built at an annual pace of 1.8% of the existing stock of homes. The economy heated up, and by mid-1972, that was up to 3.3%. In each of the four economic expansions from the mid-1960s to the mid-1980s, extra housing construction amounted to a temporary boost of at least 1%.
In contrast, during the two building boom cycles that peaked at the end of 1998 and the beginning of 2006, housing starts activity only increased from 1.2% to 1.5% and then from 1.3% to 1.7%, respectively. In other words, the housing market's ability to cyclically increase supply since the 1980s just hasn't amounted to much. Higher prices are the result.
The only time housing starts have been highly cyclical in the past three decades was when they collapsed from 1.7% of the housing stock in 2006 to 0.4% in 2009. Even with the recent strength in housing markets, starts are barely back over 1%. Some have been surprised by the resilience of the housing sector during the COVID-19 recession, but it's pretty hard to crash if you were never able to lift off.
It's more of a mystery why construction collapsed so deeply after 2006, when we hadn't had a significant supply boom for decades. But even this event, which still casts its long shadow over housing policy in 2021, points back to supply and demand.
A consensus developed that speculators wound up funding the construction of millions of homes nobody needed, eventually causing the market to crater. That consensus was wrong. By historical standards, we were never approaching "too many" homes.
Building fewer homes in 2004 and 2005 would not have prevented the housing crisis that followed. Building more homes before 2004 would have. Building a whole lot more in the areas where people wanted to buy them was the solution. Instead, we pulled the parking brake, and we've been driving with it on ever since. Supply can't get up to speed as easily as it used to.
Today we face the same crossroads. We need to let housing construction be cyclical again. Maybe we'll find that we can put more homes to good use. We should embrace more lenient urban land use administration. Momentum has been building in this regard recently. For example, Sacramento, California, is considering joining Minneapolis and Portland, Oregon, to allow duplexes and triplexes throughout the city. And, in the meantime, the new construction we need in order to make homes more affordable in the long run will require a commitment to reasonably generous conventional mortgage lending and accommodative monetary policy.
If we continue to apply short-term thinking by trying in vain to hold down prices with tight lending and monetary policy, we'll also continue pushing down construction activity and fuel the bubbles that are created by short supply in the long term.
There is a massive amount of untapped potential in the American economy. An important facet of that potential is the expansion of housing so that people can live where they choose to and can do so affordably. The first step to realizing that potential is to stop being afraid of it.
