This week’s essay continues our examination of the housing crisis. Last week we looked at the restrictions upon supply that have hindered the construction of additional housing. This week we will focus on the artificial increase in demand that adds fuel to this fire. We will also examine some possible solutions that are being offered.
Stoking Demand
An economic shortage can occur one of two ways; a decrease in supply (which we discussed last week) or an increase in demand (or both). Upon examination of government policy we can see serious artificial increases in the demand for housing, particularly single-family housing.
The main way that the government has done this is by an explicit policy of artificially cheap money via the Federal Reserve. By forcibly lowering interest rates the Fed has greatly increased the buying power of consumers. The chart below from The Mortgage Reports web site shows this phenomenon:
The link is not simply economics in action, it is mathematical. If buying power goes up, because they can afford a larger loan, as occurs in a lower interest rate environment, then the increased buying power this confers upon consumers will push up prices as these newly empowered buyers compete for houses.
It does work in reverse too. Buying power has been reduced since the Fed began to lift rates, even though those rates are nowhere near market set rates. Interestingly, what this has done is trap many homeowners in their current residences because higher rates mean they cannot trade up. Therefore the supply of existing homes for sale is greatly reduced. This chart from Ycharts shows the movement of home inventory. This has kept prices a bit lower, but still elevated because of the ratio of supply to a still artificially stoked demand. What cannot be gainsaid is that for a long time US monetary policy has been artificially lowering interest rates and thereby artificially increasing demand, thereby contributing to the housing shortage.
The other main means the government has of stoking demand, especially for single family homes is via the tax code. The mortgage interest deduction is a driver of artificially increased buying power. This is not nearly as powerful a tool as it used to be. In 2017 the government limited the amount of the loan available for the interest rate deduction to $750K from $1 million. Also the standard deduction was doubled. If you take the standard deduction and do not itemize you receive no benefit from the mortgage interest deduction. The majority of taxpayers do not have enough deductions to make itemizing viable, so they take the standard deduction. Approximately 135.2 million take the standard deduction and 20.4 itemize and of those 16.46 million claim the mortgage deduction. This according to Investopedia.
Nonetheless this tax code treatment of mortgage interest does increase the buying power of a segment of the home buying market, primarily the upper middle level. This does have the impact of putting upward pressure on home prices, and artificially increasing demand.
Offered Solutions: A Way Out?
There have been several solutions offered to this crisis from across the political spectrum, which is an indication that almost everyone recognizes that there is a problem. The first type to look at are calls for deregulation. Even the left of center Atlantic magazine wants to get rid of most zoning codes in an effort to liberalize the construction of housing.
There is no question that ending or significantly streamlining zoning would help with the building of more housing. In contrast to the cries of chaos that emanate from opponents of zoning reform one can point to Houston which has never had zoning, and it has thrived. Allowing for contractual relationships (development covenants, etc.) to drive usage, and types of housing will certainly help increase the housing supply. Many states are getting involved by banning localities from enacting zoning and heavy regulation of use and types of housing. Whatever one thinks of stripping cities of local control, the economic impact will be to bring on more housing supply, putting downward pressure on prices. The record of success of the statewide efforts however, has been mixed.
My own suggestion is to first get rid of all zoning and let the market takeover the process of determining the needs of consumers. Short of that I would suggest (I make no claim to originality here, I just can’t remember where I heard the idea), that cities create 4 zoning levels from highest to lowest. Zone 1-single family detached. Zone 2 multifamily residential. Zone 3 commercial and retail. Zone 4 industrial. Allow anyone to build on a lower zoning level. That is you can build a single-family detached house on an industrial tract, you just can’t complain later. However, you would not be able to build in a higher zone. So, no retail in a single-family neighborhood. While not perfect, it might pass, and it would at least bring certainty.
The second solution offered is our old friend rent control. Make housing affordable say the proponents. Even if this is just temporary, it will alleviate pressure on home prices and help those priced out of rental housing. Many proponents of this claim that studies have shown that some rent controls do not reduce the stock of rental housing, which is the claim of economics.
This claim seems specious, and upon examination it is. The rent control policies that they claim did not reduce supply had so many exceptions that they did not effectively amount to rent control. One jurisdiction that tried true rent control was St Paul, Minnesota. They enacted a draconian policy in 2021, without exemptions for new construction or allowances for inflation. Predictably supply dried up, almost instantly. Existing permits were canceled, and new permit requests vanished. St. Paul has since relaxed their law, but it still is harsh enough to do damage. All this is examined in this article.
Economically rent control is price control. Simple logical thinking will tell you that if you cap the price of a good, you will have less of it. One barley needs to look at historical data to know this. Yet, history is full of examples of all price controls reducing the supply of goods and services.
The next offered solution is what is today called “social housing”, previously known as public housing. The proponents have offered no rationale as to why this should work now when it did not work before, other than the name change. First, there is the problem that all government run programs run into, that is the inability to calculate. Absent freely set prices there is no way to rationally determine the correct amount of a product (housing in this case), nor where to build, nor the type of housing. Also you must coordinate all the resources, land, labor, material, etc, and rationally allocate them to a finished product. There is a reason why clear-thinking economists won the socialist calculation debate.
Also, there is no reason why non owners of this “social housing” have any more incentive to take care of something that they do not own, nor worked to acquire. It is simple human behavior that explained the massive deterioration of public housing, that ultimately led to its demolition in most cases. There is no rational reason to believe the cry of “this time will be different”. Also since this is a political solution, it will have political obstacles. You think NIMBYISM is bad regarding zoning? Try and get approval for public social housing. In an interesting case Vienna has been held up as a success story, but it turns out that most of the public housing was built by private companies. Sound economic thinking tells us that this is a trip down the same policy dead end.
Some have offered as a solution the rollout of vouchers. We can easily dispense with this idea. This is just an artificial increase in purchasing power. The only difference from forcibly lower interest rates is that it is a more direct route, but with the same results. Enabling people to afford more housing without increasing the supply only creates more dislocation, and perversely an increase in housing costs for the working class.
On the whole the deregulation ideas offered will help marginally, the trouble being that they do not go nearly far enough. The rent control/social housing/ voucher path is doubling down on unsound government interference in the market. These policies, if enacted will exacerbate, not alleviate the problem.
Effective Stewardship (Sound Economics) Tells the Tale
The way to deal with this very real problem is by taking an honest look at the underlying economic causes for such a long-term supply/demand imbalance. Multiple restrictions on supply and a systemic stoking of demand brought us this housing crisis. The sooner we honestly recognize this the sooner we can enact real solutions.
The panoply of land use and zoning restrictions needs to be repealed wholesale and the market allowed to build the amount and types of housing that consumers want. In order to allow this to occur all trade barriers and protectionist restrictions put in place need to be removed. Allow construction materials to arrive where they are needed at market prices. Finally, the labor that is needed to build additional housing needs to be allowed into the country to do the work that must be done by humans.
In the end what you do with economic knowledge is up to you. Everyone needs to recognize that politics cannot change economic reality. We have clearly identified the problems, in doing so we have identified the solutions. In order to implement effective stewardship of that which God has given us we need to act upon that reality.
Praise Be to God
