Demand subsidies are ineffective without increased flexibility in supply

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Saturday, March 31, 2012

How can housing policy be responsive to today’s urgent needs (e.g., foreclosures, a sluggish housing market, affordability, etc.) and simultaneously address long-term trends (e.g., an aging population, growth of younger households)?

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Our housing market currently suffers from a combination of weak demand and excess supply. The first thing our federal housing policies can do is to stop adding to that problem. Programs, such as the Neighborhood Stabilization Fund, that encourage increased supply in already glutted markets should be discontinued, or at least have those recourses moved elsewhere. Credit regulation should also be mindful of restrictions that reduce the supply of credit, which reduces the demand for housing. To some extent the current problems are the opposite of our long-run problems. Today’s excess supply will eventually be absorbed, with or without government intervention. Demand will rebound, with or without government intervention.

Despite the differences between our short- and long-run housing needs, there exists a commonality between them; the responsiveness of changes of housing supply to changes in demand. Many of the federal subsidies for homeownership, such as the mortgage interest deduction or the existence of Fannie Mae, Freddie Mae and the Federal Housing Administration, increase the demand for housing by expanding households’ ability to borrow. In a world where supply can quickly meet this increased demand, we will witness little, if any change, in prices.

In a world where supply is sluggish (or as we economists say, inelastic), then this increased demand will drive up prices. Eventually some supply is forthcoming, then resulting in a reduction in prices, or a boom and bust. In many metro areas, however, supply is still quite constrained. Median home prices in cities, such as San Francisco, are still multiples of median family income and are unaffordable by any measure. It was not always so. Up until the 1980s, prices in cities like San Francisco and San Diego were not far above construction costs. It has been the growth of local supply restrictions, such as zoning, referendums on new construction and comprehensive planning, which have driven up the price of housing in many of America’s cities.

These supply rigidities contributed to the recent boom and bust. They will also determine just how affordable housing is over the next few decades. All the demand subsidies in the world will amount to little without increased flexibility in housing supply. Make no mistake; there is an immense amount of developable land in the United States, and even in the coastal areas. The choice is whether we remove these barriers to construction or continue along the path of violent swings from excess supply to shortage.

Mark A. Calabria is Director of Financial Regulation Studies at the Cato Institute.


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