Tag Archives: policymaker

The Economics of Housing Supply

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chart by Smallman12q

Housing economists Edward L. Glaeser and Joseph Gyourko have posted The Economic Implications of Housing Supply to SSRN (behind a paywall but you can find a slightly older version of the paper here). The abstract reads,

In this essay, we review the basic economics of housing supply and the functioning of US housing markets to better understand the distribution of home prices, household wealth and the spatial distribution of people across markets. We employ a cost-based approach to gauge whether a housing market is delivering appropriately priced units. Specifically, we investigate whether market prices (roughly) equal the costs of producing the housing unit. If so, the market is well-functioning in the sense that it efficiently delivers housing units at their production cost. Of course, poorer households still may have very high housing cost burdens that society may wish to address via transfers. But if housing prices are above this cost in a given area, then the housing market is not functioning well – and housing is too expensive for all households in the market, not just for poorer ones. The gap between price and production cost can be understood as a regulatory tax, which might be efficiently incorporating the negative externalities of new production, but typical estimates find that the implicit tax is far higher than most reasonable estimates of those externalities.

The paper’s conclusions, while a bit technical for a lay audience, are worth highlighting:

When housing supply is highly regulated in a certain area, housing prices are higher and population growth is smaller relative to the level of demand. While most of America has experienced little growth in housing wealth over the past 30 years, the older, richer buyers in America’s most regulated areas have experienced significant increases in housing equity. The regulation of America’s most productive places seems to have led labor to locate in places where wages and prices are lower, reducing America’s overall economic output in the process.

Advocates of land use restrictions emphasize the negative externalities of building. Certainly, new construction can lead to more crowded schools and roads, and it is costly to create new infrastructure to lower congestion. Hence, the optimal tax on new building is positive, not zero. However, there is as yet no consensus about the overall welfare implications of heightened land use controls. Any model-based assessment inevitably relies on various assumptions about the different aspects of regulation and how they are valued in agents’ utility functions.

Empirical investigations of the local costs and benefits of restricting building generally conclude that the negative externalities are not nearly large enough to justify the costs of regulation. Adding the costs from substitute building in other markets generally strengthens this conclusion, as Glaeser and Kahn (2010) show that America restricts building more in places that have lower carbon emissions per household. If California’s restrictions induce more building in Texas and Arizona, then their net environmental could be negative in aggregate. If restrictions on building limit an efficient geographical reallocation of labor, then estimates based on local externalities would miss this effect, too.

If the welfare and output gains from reducing regulation of housing construction are large, then why don’t we see more policy interventions to permit more building in markets such as San Francisco? The great challenge facing attempts to loosen local housing restrictions is that existing homeowners do not want more affordable homes: they want the value of their asset to cost more, not less. They also may not like the idea that new housing will bring in more people, including those from different socio-economic groups.

There have been some attempts at the state level to soften severe local land use restrictions, but they have not been successful. Massachusetts is particularly instructive because it has used both top-down regulatory reform and incentives to encourage local building. Massachusetts Chapter 40B provides builders with a tool to bypass local rules. If developers are building enough formally-defined affordable units in unaffordable areas, they can bypass local zoning rules. Yet localities still are able to find tools to limit local construction, and the cost of providing price-controlled affordable units lowers the incentive for developers to build. It is difficult to assess the overall impact of 40B, especially since both builder and community often face incentives to avoid building “affordable” units. Standard game theoretic arguments suggest that 40B should never itself be used, but rather work primarily by changing the fallback option of the developer. Massachusetts has also tried to create stronger incentives for local building with Chapters 40R and 40S. These parts of their law allow for transfers to the localities themselves, so builders are not capturing all the benefits. Even so, the Boston market and other high cost areas in the state have not seen meaningful surges in new housing development.

This suggests that more fiscal resources will be needed to convince local residents to bear the costs arising from new development. On purely efficiency grounds, one could argue that the federal government provide sufficient resources, but the political economy of the median taxpayer in the nation effectively transferring resources to much wealthier residents of metropolitan areas like San Francisco seems challenging to say the least. However daunting the task, the potential benefits look to be large enough that economists and policymakers should keep trying to devise a workable policy intervention. (19-20)

Treasury’s Overreach on Securitization Reform

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Treasury Secretary Mnuchin Being Sworn in by Vice President Pence

The Department of the Treasury released its report, A Financial System That Creates Economic Opportunities Capital Markets. I will leave it to others to dissect the broader implications of this important document and will just highlight what it has to say about the future of securitization:

Problems related to certain types of securitized products, primarily those backed by subprime mortgage loans, contributed to the financial crisis that precipitated the Great Recession. As a result, the securitization market has acquired a popular reputation as an inherently high-risk asset class and has been regulated as such through numerous post-crisis statutory and rulemaking changes. Such treatment of this market is counterproductive, as securitization, when undertaken in an appropriate manner, can be a vital financial tool to facilitate growth in our domestic economy. Securitization has the potential to help financial intermediaries better manage risk, enhance access to credit, and lower funding costs for both American businesses and consumers. Rather than restrict securitization through regulations, policymakers and regulators should view this component of our capital markets as a byproduct of, and safeguard to, America’s global financial leadership. (91-92, citations omitted)

This analysis of securitization veers toward the incoherent. It acknowledges that relatively unregulated subprime MBS contributed to the Great Recession but it argues that stripping away the regulations that were implemented in response to the financial crisis will safeguard our global financial leadership. How’s that? A full deregulatory push would return us to the pre-crisis environment where mortgage market players will act in their short-term interests, while exposing counter-parties and consumers to greater risks.

Notwithstanding that overreach, the report has some specific recommendations that could make securitization more attractive. These include aligning U.S. regulations with the Basel recommendations that govern the global securitization market; fine-tuning risk retention requirements; and rationalizing the multi-agency rulemaking process.

But it is disturbing when a government report contains a passage like the following, without evaluating whether it is true or not:  “issuers have stated that the increased cost and compliance burdens, lack of standardized definitions, and sometimes ambiguous regulatory guidance has had a negative impact on the issuance of new public securitizations.” (104) The report segues from these complaints right to a set of recommendations to reduce the disclosure requirements for securitizers. It is incumbent on Treasury to evaluate whether those complaints are valid are not, before making recommendations based upon them.

Securitization is here to stay and can meaningfully lower borrowing costs. But the financial crisis has demonstrated that it must be regulated to protect the financial system and the public. There is certainly room to revise the regulations that govern the securitization sector, but a wholesale push to deregulate would be foolish given the events of the 2000s.

The Economic Implications of the Housing Supply

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Ed Glaeser and Joe Gyourko posted The Economic Implications of the Housing Supply which is forthcoming in The Journal of Economic Perspectives. In it, they

review the basic economics of housing supply and the functioning of U.S. housing markets to better understand the impacts on home prices, household wealth and the spatial distribution of people across markets. Section II documents the state of housing affordability in the U.S., and begins with three core facts about housing supply. First, when building is unrestricted by regulation or geography, housing supply curves seem relatively flat, meaning that we can approximate reality by referring to a single production cost. Second, both geography and regulation severely restrict the ease of building in some parts of the country. These constraints raise building costs both directly, by increasing time delays and reducing the amount of available land, and indirectly, by ensuring the homes are produced more on a one-by-one basis rather than in bulk. Third, the supply of housing is kinked and vertical downwards because housing is durable. (2, citation omitted)

These are themes that Glaeser and Gyourko have touched on before, but this essay does a service by updating them ten years after the financial crisis.

Glaeser and Gyourko have consistently hit on some important points that can garner attention at the national level , but there has been no real action on them as of yet:

  • where supply is regulated, housing costs more;
  • heavy land use regulation in places like NYC and SF reduces the nation’s overall economic output; and
  • existing homeowners tend to oppose new projects, which is consistent with their financial self-interest.

Glaeser and Gyourko do not give up hope that policymakers can craft solutions that deal with the political economy of housing construction. One first step would be to develop a toolkit of carrots and sticks that can be employed at the national and state level to incentivize local governments to take actions that are in the interest of their broader communities and the nation as a whole.

We know we need more housing in highly productive regions. We just need to figure out how to build it.