Housing and Economics

Keith McBride on August 07, 2017 in Macroeconomics

In Strong Towns today, Chuck Marohn gives some insight into what’s going on in California’s housing market.

(By the way, if you’re interested in local government policy, I highly recommend spending some time on the Strong Towns website.  It’s a fantastic resource, and has some fascinating information and ideas.)

This is a great, thought-provoking piece, and I’m going to go ahead share the thoughts it provoked for me.

In summary, California’s already-high housing prices are continuing to rise.  The state is calling it a “Housing Crisis” and focusing on supply-side solutions:  subsidies for new construction or low-income housing funded through fees on new development, or through new state debt.

But Mr. Marohn touches on the part of this equation that is not being analyzed:

“Yet, I’m not satisfied that this is a supply problem. By my calculations, California added around 230,000 people last year while they built a little over 100,000 housing units. That’s one unit per 2.3 people, below the 2.9 state average reported in the 2010 Census. How is price spiking so drastically if supply is keeping up with demand?”

Exactly.  If supply is medium, and demand is medium, then why the dramatic price increase?  It defies free market economics principles.

I would suggest that, as usual, free market economics don’t apply here, because housing is not a market in which these principles can apply.  In order for “laws” of supply and demand to work, economists apply an avalanche of assumptions to simple hypotheticals, to the point where the analyzed market in order to be sufficiently “free” can only exist in a vacuum.   The supply-demand principles do not apply to housing because it lacks perfect competition, lacks participants with absolute knowledge, and it doesn’t allow participants alone to dictate the supply and demand.  Especially as it relates to demand.

Talking about changes in the “affordability” of housing without discussing the lending climate is like describing the taste of something by how it felt when you poked it with your finger.  Housing isn’t “affordable” for anyone, really, unless they can borrow money for it.   Housing price dramatic increases in 2003-2007 had very little to do with what was affordable and more to do with what banks were willing and allowed to lend.

I don’t know the current mortgage lending regulations on banks in California, but I am curious to see if the recent price-spike has more to do with the lending climate and less with actual housing supply and consumer demand.