When I first started blogging, a number of Austrian commenters told me the real problem was not tight money.  Rather there had been “malinvestment” in housing, especially in the “sand states”.  The recession was the price we had to pay for all of this poorly thought out investment.

That theory never even made sense in 2009.  If the problem was malinvestment in housing, then resources would have shifted to the other 95% of the economy. Instead, output fell in almost all sectors.  (I’m referring to 2008-09; resources did shift to other sectors during the 2006-07 construction slump.)

Today it makes even less sense. The NYT has an article on the housing market in North Las Vegas, which was the epicenter of the bust. It’s now booming:

Amazon has opened two huge centers in North Las Vegas for distributing goods and handling returns, bringing thousands of jobs. A third facility is on the way. Sephora, the cosmetics company, recently broke ground here for a giant warehouse.

With nearly a quarter-million people, North Las Vegas is one of the fastest-growing cities in the country. It’s also young — the average resident is just 33 years old.

The Times reports that prices are soaring and homes typically sell in three days.

I agreed that there had been some excessive housing construction in the inland portion of the sand states, perhaps because builders expected the US population in 2050 to be 50 million higher than is now predicted.  (Recall that 2006 was the year of the immigration crackdown.)  But I argued that these cities were fast growing, and this problem was relatively mild.  In my view the malinvestment is better termed “too early investment”—some houses were built a few years before they were needed.  The Austrian counterargument was that these houses would remain empty for decades, and eventually depreciate sharply (in a physical sense.)  It looks like I was closer to the truth.

I would add that Kevin Erdmann’s take on the crisis is being increasingly confirmed by events:

A 35-year-old mother of two, with another child on the way, she works in a clothing shop and drives for Uber to earn extra cash. She has had to move three times in five years.

BTW, the NYT has this picture of a downtrodden resident, who is forced to rent rather than own:

You can see the picture more clearly in the NYT article. I couldn’t help but notice the Pottery Barn look.  The downtrodden have certainly come a long way from the 1960s, when the NYT carried pictures of shacks in Appalachia and slums in the Bronx.

I know, I’m a heartless out of touch elitist who doesn’t understand how much people are suffering.

PS.  Ten years after Lehman, market monetarists should feel really good about how things are playing out.  Not only is the boom in the housing market tending to confirm the MM/Erdmann view of the world, but more and more policymakers are talking in terms that sound suspiciously market monetarist.  Clare Zempel directed me to an article discussing Janet Yellen’s take on what we should do next time:

Elaborating on how the central bank should think about what to do if rates have to be cut to zero again in the future and can’t go any lower, she said the Fed should promise now that it will keep rates low enough to let a hot economy make up for lost time.

David Beckworth has now done over 100 podcasts, but the recent interview with Kevin Erdmann would easily make the top ten in terms of general interest.  Kevin has a new book coming out soon (as well as a planned follow-up book), which put together many of the ideas in his blog posts on the real estate bubble and bust.  The podcast necessarily only covers a portion of this material, and I’ll just discuss a portion of the podcast.  But you should definitely get the book when it comes out, as it is loaded with lots of fascinating information that goes against the conventional wisdom.  And that’s because Kevin actually took the time to take a close look at the data.

One big theme is the “closed access” cities such as NYC, LA, the SF Bay Area and Boston.  These are the heart of the new, high-skilled information economy.  For the first time in history, however, we have been seeing people fleeing the engines of prosperity.  This is because of tight building restrictions that force out lower income workers as professionals move in, searching for jobs.  This worsens the economic prospects of low-income workers, and makes our overall economy less productive.

Another theme is that the housing bubble has been misinterpreted.  During the boom, it was higher income people who got the vast majority of mortgages in the closed access cities.  Large numbers of lower and moderate-income people were priced out and fled to the “contagion cities” such as Phoenix, Vegas, Riverside, Tampa and Miami, pushing up prices in those markets.  Contrary to what people assumed at the time, the high prices in closed access cities were not a bubble, rather a rational response to actual and expected rent inflation.  Consistent with Kevin’s view, prices in these cities have returned to bubble highs, despite the headwind of tighter lending standards than during 2006.  There were certainly not too many houses being built in those areas during the boom, rather NIMBYism caused too little construction.  And even in places like Phoenix it’s not clear the main problem was too many houses, as rent inflation kept rising even after the bubble burst.  At the national level, housing construction was not unusually high during the boom years, if you account for all types of housing.  Rather housing construction has been unusually low since 2007.

This is just the tip of the iceberg of Kevin’s work.  I believe Kevin’s story is basically correct, although I interpret the early housing bust (2006-07) slightly differently.  We both agree that tight money depressed housing prices during 2008-12, but Kevin thinks the Fed became a problem in 2006, partly due to somewhat tight money and partly due to Fed communication that the housing market had excesses that could lead to a substantial price drop.  I put a bit more weight on the post-2006 drop in expected future immigration.  The expected US population in 2050 is now 50 million lower than what the Census Bureau expected back in 2006, and 40 million of that decline had occurred by 2012.  The decline is mostly due to lower expected rates of immigration, although a falling birthrate also plays a role.  Recall that 2006 is the year that Bush’s immigration reform project failed and border controls were tightened.  Since then, net immigration from places like Mexico has fallen to a trickle, and it was this immigration that was helping to underpin the housing markets in the contagion cities.

I presume that immigration was not the only issue, but it might help to explain why housing began falling a bit earlier than NGDP growth.

PS.  Kevin’s book will be entitled: Locked Out: How the Shortage of Urban Housing is Wrecking our Economy

Tyler Cowen recently linked to an interesting William Fischel paper from 2016:

In the 1970s, unprecedented peacetime inflation, touched off by the oil cartel OPEC, combined with longstanding federal tax privileges to transform owner-occupied homes into growth stocks. The inability to insure their homes’ newfound value converted homeowners into “homevoters,” whose local political behavior focused on preventing development that might devalue their homes. Homevoters seized on the nascent national environmental movement, epitomized by Earth Day, and modified its agenda to serve local demands, thereby eroding the power of the prodevelopment coalition called the “growth machine.” The post-1970 shift in the American economy from industrial employment to knowledge-based services rewarded college graduates and regions that specialized in software and finance. Residents of suburbs in the larger urban areas of the Northeast and West Coast used existing zoning and new environmental leverage to protect the growth rate of their home values. The regional spread of these regulations has slowed the growth of the economy and perpetuated regional income inequalities. I argue that the most promising way to modify this trend is to reduce federal tax subsidies to homeownership.

1.  Consider it done.  The 2017 tax bill will lead to 60% fewer people using the mortgage interest deduction.  That didn’t take long!  Seriously, I do think this reform will help, but we should not expect miracles.  So far it doesn’t seem to have dramatically slowed the rate of appreciation in home prices, although it’s plausible that the increase would have been a bit faster without the tax change.

2.  The environmental movement did have some major successes, such as cutting air and water pollution.  But the requirement for “environmental impact statements” now seems like a major mistake, and indeed might actually hurt the environment by making it harder to build in major cities.

3.  Not to get too picky, but the idea that OPEC touched off the Great Inflation is a myth.  Here’s inflation before the oil shock of October 1973:

During the early 1960s, inflation averaged a bit over 1%/year.  Monetary stimulus beginning in the mid-1960s pushed the rate up to 6% by the end of the decade.  A slightly tighter monetary policy led to a very small recession, and pushed inflation down to 4.3%.  Price controls then pushed (measured) inflation down to 3% in 1972.  But those controls were used by Nixon as cover to pump up NGDP growth to 9% right before the 1972 election.  By the third quarter of 1973, year over year NGDP growth was running at over 11%, and 12-month CPI inflation was up to 7.4%.  And this is all before the first OPEC oil shock.  It was a demand-side problem.

BTW, budget deficits also played no role in the Great Inflation, as they were quite modest during this period.  If budget deficits caused inflation, by 2019 we’d be well on our way to hyperinflation.  Overall, the Great Inflation was almost 100% monetary policy, even as year-to-year volatility was impacted by oil prices (after October 1973).

Despite these nitpicks, the Fischel abstract sounds basically correct to me—it’s a good way to frame the housing problem.

One of the big mysteries is why the housing market crashed after 2006.  The later part of the crash (2008-12) was obviously partly due to the Great Recession.  But what about 2006-08?  I’ve occasionally argued that a decline in expected immigration may have played a role.  Here are some census estimates of the US population in 2050, first made in 2008, and then in 2012:

That’s a striking decline in just 4 years.  More recently, the Census Bureau has further reduced their 2050 estimate, to 388 million.  (Current population is 328 million.)  And while part of the explanation is falling birth rates, immigration seems to be the main story:

A comparison of the bureau’s 2008 and 2012 projections for the year 2050 indicates that most of the 39.2 million gap in the total population forecast is due to scaled-back assumptions about the level of new immigration to the U.S. But another notable factor in the lowered population projection was that the bureau also lowered its forecasts for birth levels.

Ignoring the amnesty bulge in 1990-92, US immigration levels peaked in 2006, at over 1.26 million per year (close to the earlier 1907 peak).  At this time, there was also a high level of illegal immigration, including Mexican workers drawn in by the housing boom.  Total immigration might well have been close to 2 million per year.  It looked like immigration was about to push America’s population much higher.

All that changed after 2006.  Bush’s push for immigration reform (which would have boosted immigration levels) failed in Congress.  Border security was tightened and the net level of illegal immigration from Mexico slowed to almost zero. Not just due to tighter border security, but also a weaker economy in the US and relatively better prospects in Mexico. (Also lower Mexican birth rates.)  Now net immigration is probably closer to 1 million/year, although it’s hard to be certain.

The massive wave of expected immigrants was disproportionately pouring into the “sand states”, such as southern California, Nevada, Arizona, Texas, and Florida.  With the exception of Texas (which never had a house price “bubble”) those areas were the epicenter of the housing crash.  I am not saying that the immigration slowdown was the only factor. I’ve already mentioned the recession, and tighter lending standards also played a role.  Maybe there really was a bubble. But I don’t see how such a massive drop in expected population growth could not have played a significant role, especially in the states that were expected to receive those immigrants.

Over at Econlog I have a related post.  It punctures two myths:

1.   The myth that immigration is making America more diverse. (We’re going to stay about 75% “white”).

2.  The myth that immigration is reducing the share of Americans who vote Republican.

Check it out.

PS.  I’m not sure why I didn’t know this, but it’s really quite interesting:

The Immigration Act of 1924, or Johnson–Reed Act, including the National Origins Act, and Asian Exclusion Act (Pub.L. 68–139, 43 Stat.153, enacted May 26, 1924), was a United States federal law that set quotas on the number of immigrants from certain countries while providing funding and an enforcement mechanism to carry out the longstanding (but hitherto unenforced) ban on other non-white immigrants. The law was primarily aimed at further decreasing immigration of Southern Europeans, countries with Roman Catholic majorities, Eastern Europeans, Arabs, and Jews.^[1][2][3][4] The law affirmed the longstanding ban on the immigration of other non-white persons, with the exception of black African immigrants (who had long been exempt from the ban). Thus, virtually all Asians were forbidden from immigrating to America under the Act (subsequent court rulings would determine that Indians were not white and could not immigrate).^{[citation needed]}

Contrary to popular belief, Latin Americans were not prohibited or limited from immigrating under the law. In most states and under federal law, persons of mixed white and Native American ancestry were considered white; this principle was interpreted under the Act to allow Latin Americans to immigrate as “white persons.” Moreover, unlike Eastern and Southern Europe, no nationality-based quotas were placed on Latin American immigrants. Thus, the law allowed unlimited Latin American immigration, just as it allowed unlimited northwestern European immigration. Ironically, the 1965 immigration law that replaced the 1924 Act, though abolishing racial preferences and national quotas, would effectively place greater restriction on Latin American immigration.

So the racist immigration bill of 1924 (I’m not being sarcastic, it was racist, as people defined “race” at the time) favored blacks and Hispanics over Eastern and Southern Europeans?  Can someone confirm the accuracy of this Wikipedia post?  This means the 1965 bill did not have the effect that everyone seems to think it had, as the immigration surge after 1965 was mostly from Latin America (until recently). And what about when Eisenhower expelled illegal Mexican workers?

PPS.  Below I have a graph of immigration up to 2006, when it seemed to be exploding (mentally block out the 1991 spike to see the trend), and then another showing immigration up to 2016. (2017 data, not shown, showed a slight slowdown from 2016):

Nine years ago I did a post discussing how the CPI was distorted by mis-measurement of housing prices:

Good News! There was no housing crash.

At least according to the US government.

The BLS claims that housing prices are up 2.1% in the last 12 months.  Why does this matter?  For all sorts or reasons, but first let’s try to figure out what really happened.  According to the BLS, housing makes up nearly 40% of the core basket of goods and services.

Category    weight     inflation

Housing     39 %             2.1%

Other         61%              1.4%

Overall      100%             1.7%

Suppose that instead of rising 2.1%, housing costs have actually fallen 2.1% over the past 12 months?  In that case the core rate would be zero.  Which number seems more likely?  For much of the past year house prices have been falling at more than 2% a month.

Bloomberg reports a new academic study that reached similar conclusions:

New research shows that the CPI is slow to reflect changes in prices—and, equally important, understates the degree to which prices move up and down. The problem stems from the way the government calculates the price of shelter, a category that makes up one-third of the index.

Three economists have developed an alternative measure that captures price moves as soon as they occur and shows the full range of changes. If it had existed in 2008-09, when the economy was in the deepest recession since the Great Depression, it would have shown far deeper deflation than the Bureau of Labor Statistics registered. The official CPI, they write in a new paper, was overstating inflation by 1.7 percentage points to 4.2 percentage points annually during the Great Recession. More recently, they write, the problem has been the opposite: Annual readings have understated inflation by 0.3 to 0.9 percentage points. Those are huge disparities given that forecasters make a big deal of fluctuations of just one or two tenths of a percentage point in the official rate.

Here’s a graph that shows how big a difference it makes:

That correction is actually a bit larger than even I would have expected.  But even if their method is not perfect, I have little doubt that the basic point is correct; the CPI is less volatile than an alternative price index that reflects actual market prices in the economy.

The problem they point to is similar to the one I mentioned back in 2009. The BLS uses rent payments on existing contracts that do not reflect the market rent on apartments currently on the market.  During a slump, it’s not unusual for a new tenant to get one or two months free rent:

The economists behind it are Brent Ambrose and Jiro Yoshida of Pennsylvania State University’s Smeal College of Business and Edward Coulson of the Merage School of Business at the University of California at Irvine. Their latest version is described in an April 20 academic paper titled “Housing Rents and Inflation Rates.” The key difference from the CPI is that their measure factors in only new rental leases, including those of new tenants and old ones who recently renewed. The BLS, in contrast, also includes rent paid by tenants whose leases weren’t up for renewal in the latest month, which means it’s slower to pick up on changes in market conditions.

Kudos to Ambrose, Yoshida and Coulson for putting a spotlight on a very important flaw in the CPI, which many professional economists use too uncritically.