Misconceptions aboutthe Housing Bubble
In 2005, both Alan Greenspan and BenBernanke argued that there was “no housingbubble” and that people need not fear that sucha bubble would burst. Greenspan admittedthere was “froth” in local housing markets butno national bubble. Bernanke argued thatgrowing housing prices “largely reflected strongeconomic fundamentals” such as growth in jobs, incomes, and new household formation.
How could they have gone so wrong?“Bubble deniers point to average prices for thecountry as a whole, which look worrisome butnot totally crazy,” Princeton economist PaulKrugman wrote in a 2005 newspaper column.“When it comes to housing, however, theUnited States is really two countries, Flatlandand the Zoned Zone.” Flatland, he said, hadlittle land-use regulation and no bubble, whilethe Zoned Zone was heavily regulated and was“prone to housing bubbles.”
Krugman’s choice of terms is unfortunatebecause most of “Flatland” is in fact zoned.What makes the Zoned Zone different is notzoning but
, a broadterm that includes such policies as urban-growth boundaries, greenbelts, annual limitson the number of building permits that can beissued, and a variety of other practices.
, which limits a city’s growth toa specific annual rate, is a form of growth-man-agement planning that was popular in the 1970s.
, which discourages rural develop-ment and encourages higher-density develop-ment of already developed areas, is another formthat is more popular today. No matter what theform, by interfering with markets for land andhousing, growth-management planning almostinevitably drives up housing prices and is closely associated with housing bubbles.Harvard professor Harvey Mansfield criti-cizes economists for failing to foresee the hous-ing bubble.
But, in fact, many economists didsee the bubble as it was growing and predictedthat its collapse would lead to severe hardships.For example, as early as 2003
observed, “The stock-market bubble has beenreplaced by a property-price bubble,” and point-ed out that “sooner or later it will burst.”
By 2005, it estimated that housing had become“the biggest bubble in history.” Because of theeffects of the bubble on consumer spending,
warned, the inevitable deflationwould lead to serious problems. “The wholeworld economy is at risk,” the newspaper point-ed out,
adding, “It is not going to be pretty.”
did not predict thecomplete collapse of credit markets, it was cor-rect that the bubble’s deflation was not pretty. After home-price deflation led to the creditcrisis, it became “conventional wisdom that Alan Greenspan’s Federal Reserve was respon-sible for the housing crisis,” notes HooverInstitution economist David Henderson in a column in the
Wall Street Journal
AlthoughHenderson disagreed with this view, severalother economists writing in the same issueagree that by boosting demand for housing,the Federal Reserve Bank’s low interest ratescaused the housing bubble. “The Fed ownsthis crisis,” charges Judy Shelton, the author of
Other people blame the crisis on theCommunity Reinvestment Act and other fed-eral efforts to extend homeownership to low-income families.
Those policies, along withunscrupulous lenders, fraudulent homebuy-ers, and greedy homebuilders—all of whomhave also been blamed for the housing cri-sis—have two things in common. First, they focus on changes in the demand for housing.Second, they are all nationwide phenomena.National changes in demand should havehad about the same effect on home prices inHouston as in Los Angeles. But they did not. As this paper will show, just as prices rosemuch more dramatically in Krugman’s ZonedZone than in Flatland, prices later fell steeply in most of the Zoned Zone but—except forstates where home prices declined because of the collapse of the auto industry—prices hard-ly fell at all in Flatland. As late as the fourthquarter of 2008, home prices remained stablein many non-bubbling parts of the country.This suggests that the real source of the bub-
As late as thefourth quarter of 2008, home pricesremained stablein many parts of the country.