Housing Bubble summarized..

http://www.cato.org/pubs/pas/pa646.pdf Charles Kindleberger’s classic book Manias, Panics, and Crashes describes six stages of a typical bubble. First, a displacement or outside shock to the economy leads to a change in the value of some good. Second, new credit instruments are developed to allow investors to take advantage of that change. This leads to the third stage, a period of euphoria, in... [more]

http://www.cato.org/pubs/pas/pa646.pdf Charles Kindleberger’s classic book Manias, Panics, and Crashes describes six stages of a typical bubble. First, a displacement or outside shock to the economy leads to a change in the value of some good. Second, new credit instruments are developed to allow investors to take advantage of that change. This leads to the third stage, a period of euphoria, in which investors come to believe that prices will never fall. This often results in a period of fraud, the fourth stage, in which increasing numbers of people try to take advantage of apparently ever-rising prices. Soon, however, prices do fall, and, in the fifth stage, the market crashes. In the sixth and final stage, government officials try to impose new regulation to prevent such bubbles from taking place in the future.14 All of these stages are apparent in the recent housing bubble. The key point of this paper is that because growth controls did not allow heightened demand for housing to dissipate through new supply, the result was an immense price bubble in states housing nearly half of the nation’s population The demand for housing is inelastic: few Americans are willing to live without a home.15 The vast majority of Americans, moreover, prefer a single-family home with a yard.16 The same is true for Canadians and, likely, the people of most other nations.17 While people are willing to live in multifamily housing, most see such housing as only temporary until they can afford a single-family home. This suggests that the demand for single-family housing may be even more inelastic than for housing in general. Inelastic demand curves mean that a small change in the supply of new homes can lead to large changes in price. In a recent attempt to prop up sales, the National Association of Realtors produced a television ad claiming that “on average, home values nearly double every 10 years,” which is a growth rate of about 7 percent per year.21 This is true only when areas with restrictive landuse regulations are included in the average. Without supply restrictions, housing prices grow only if median family incomes grow. Even then, most of the growth in median housing prices is due to people building larger or higher-quality homes, thus increasing the value of the median home. The actual value of any given home will not grow much faster than inflation. The best thing the government can do is allow home prices to fall to market levels. To do this, states and urban areas with growth management laws and plans should repeal those laws and dismantle the programs that made housing expensive in the first place. This will obviously be easier to do in states like Florida, where value-to-income ratios have returned to affordable levels, than in California, where housing remains unaffordable unaffordable. But repealing California’s grotesque planning laws will probably help kick-start its economy, which in many respects is in even worse shape than Michigan’s. States and regions that have been considering growth-management laws and plans should firmly reject them. Both Congress and the states should reject proposals to impose California-style policies aimed at creating more compact cities, supposedly to reduce driving and greenhouse gas emissions. The costs of such policies will be extremely high and their beneficial effects will be negligible. Bubbles and credit crises happen too often as it is. Governments should not increase their frequencies and depths by creating artificial housing and real estate shortages [less]