Rethinking Federal Housing Policy Rethinking Federal Housing Policy How to Make Housing Plentiful and Affordable Edward L. Glaeser Joseph Gyourko The AEI Press Publisher for the American Enterprise Institute WASHINGTON, D.C. Distributed to the Trade by National Book Network, 15200 NBN Way, Blue Ridge Summit, PA 17214. To order call toll free 1-800-462-6420 or 1-717-794-3800. For all other inquiries please contact the AEI Press, 1150 Seventeenth Street, N.W., Washington, D.C. 20036 or call 1-800-862-5801. NATIONAL RESEARCH NRI INITIATIVE This publication is a project of the National Research Initiative, a program of the American Enterprise Institute that is designed to support, publish, and disseminate research by university-based scholars and other independent researchers who are engaged in the exploration of important public policy issues. Library of Congress Cataloging-in-Publication Data Glaeser, Edward L. (Edward Ludwig), 1967- Rethinking federal housing policy : how to make housing plentiful and affordable / Edward L. Glaeser and Joseph Gyourko. p. cm. Includes bibliographical references and index. ISBN-13: 978-0-8447-4273-1 ISBN-10: 0-8447-4273-2 1. Housing policy—United States. 2. Housing—Prices—United States. I. Gyourko, Joseph E., 1956– II. Title. HD7293.G5 2008 363.5'820973--dc22 2008040992 12 11 10 09 08 1 2 3 4 5 © 2008 by the American Enterprise Institute for Public Policy Research, Wash- ington, D.C. All rights reserved. No part of this publication may be used or repro- duced in any manner whatsoever without permission in writing from the American Enterprise Institute except in the case of brief quotations embodied in news articles, critical articles, or reviews. The views expressed in the publications of the American Enterprise Institute are those of the authors and do not neces- sarily reflect the views of the staff, advisory panels, officers, or trustees of AEI. Printed in the United States of America This book is dedicated to Edmund Chaitman and Joseph Gyourko, Jr., our fathers, in gratitude for their inspiration and guidance. Contents LIST OF ILLUSTRATIONS xi ACKNOWLEDGMENTS xiii AUTHORS’ NOTE xv INTRODUCTION 1 The Plan of the Book 6 Our Proposal 12 1. HOW DO WE KNOW WHEN HOUSING IS “AFFORDABLE”? 16 Poverty and Housing Affordability 17 Affordability across Space 19 How Should Housing Affordability Be Measured? 21 2. THE STATE OF AMERICAN HOUSING 24 Housing Consumption over Time 25 House Prices, Income, Amenities 32 Housing Prices and Construction Costs 40 3. PUBLIC INTERVENTION IN U.S. HOUSING MARKETS— A HISTORICAL PERSPECTIVE 48 Housing Regulation and Externalities 48 Correcting Market Failures 52 In-Kind Redistribution 54 Conclusion 56 vii viii RETHINKING FEDERAL HOUSING POLICY 4. CURRENT POLICIES—PRICE AND QUANTITY CONTROLS 58 Price Controls 58 Quantity Regulations #1: Building Codes 62 Quantity Regulations #2: Land-Use Restrictions 64 Hybrid Price and Quantity Controls: Inclusionary Zoning 81 Massachusetts Chapter 40B 82 The Mount Laurel Decision 84 Conclusion 86 5. OTHER INTERVENTIONS IN HOUSING MARKETS—TAXES AND SUBSIDIES 88 The Tax Code and Homeownership 88 Credit Market Interventions: The Rise of Fannie Mae and Freddie Mac 99 Project-Based Subsidy Programs for the Development of Affordable Housing: Public Housing and Low Income Housing Tax Credit Programs 102 Tenant-Based Subsidies for the Consumption of Affordable Housing: Section 8 Vouchers 115 CONCLUSION: TOWARD A NEW NATIONAL HOUSING POLICY 119 The Growing Affordability Problem in Markets with High Land Costs 121 One Size Does Not Fit All 123 Can the Federal Government Induce Localities to Permit More Construction? 126 Reforming the Home Mortgage Interest Deduction 131 Ensuring the Poor Can Consume Some Minimum Housing Quality: Vouchers 132 Summary and Conclusion 135 APPENDIX 1: ECONOMIC INCIDENCE ANALYSIS OF A SUBSIDY 137 Per-Unit Subsidies to Demand 137 Limited Subsidies to Demand 139 Supply-Side Subsidies 140 CONTENTS ix APPENDIX 2: IMPLEMENTATION OF OUR PROPOSED POLICY REFORM 142 Summary of Our Reform Proposal 142 Defining Elastic and Inelastic Regions of the Country 145 Funding the Program: Reforming the Home Mortgage Interest Deduction 161 Reforming Supply-Side Policies: Administering the New Home Mortgage Interest Deduction Program in Counties with Inelastic Housing Supplies 168 NOTES 173 REFERENCES 187 ABOUT THE AUTHORS 193 INDEX 195 List of Illustrations FIGURES I-1 National Constant-Quality Real House Price Index, 1975–2007 2 2-1 Size of Existing Renter- and Owner-Occupied Homes 25 2-2 House Size per Person 26 2-3 House Size per Person by Income Quartile 27 2-4 Homeownership Rates for the Nation and Select Cities 32 2-5 Growing House-Price Dispersion across Metropolitan Areas 33 2-6 Real Rents, 1950–2000 36 2-7 Rent as Share of GDP per Capita 36 2-8 County-Level House Price Map of the Continental United States 37 2-9 House Prices and Real Incomes 38 2-10 House Prices and Weather 39 2-11 House Prices and New Construction 41 2-12 Manhattan Prices and Permits 42 2-13 Real Construction Costs over Time 43 4-1 Distribution of Single-Family Minimum Lot Sizes, Greater Boston Area, 2000 66 4-2 Fraction of Communities in Greater Boston with Wetlands, Septic, Subdivision, and Cluster Provisions, 1975–2004 69 4-3 Home Prices and Local Land-Use Regulation 76 4-4 Permits and Local Land-Use Regulation 77 5-1 Incidence and Inelastic Supply 96 5-2 Incidence and Elastic Supply 98 xi xii RETHINKING FEDERAL HOUSING POLICY A1-1 Demand Subsidies and the Elasticity of Supply 138 A1-2 Partial Demand Subsidies 139 A2-1 Permits and Median House Prices in Large Counties 148 TABLES 2-1 Comparison of U.S. Housing Consumption with Major European Countries 28 2-2 The Decline of Substandard Housing in the Stock 29 2-3 Homeownership Rates (U.S. Averages) 30 2-4 2007 Median Housing Prices of Existing Single-Family Homes in Metropolitan Areas 34 2-5 2007 Construction Costs in Markets with 1 Million+ People 44 2-6 Ratios of Price to Construction Cost over Time 46 4-1 Wharton Residential Land Use Regulatory Index (WRLURI), by Census Region and Division 71 4-2 Wharton Residential Land Use Regulatory Index (WRLURI), by State 72 4-3 Wharton Residential Land Use Regulatory Index (WRLURI), by Metropolitan Areas with Ten or More Observations 74 5-1 Aggregate Benefit Flow in Billions of 1999$ 90 5-2 Benefits per Owner and per Household, 1999 92 5-3 A Picture of Subsidized Households, 2000 104 5-4 Statistical Overview of the LIHTC Program, 1987–2005 105 5-5 Tax Credit Allocations, 1987–2005 108 A2-1 Permit Issuance in Large U.S. Counties 147 A2-2 Large Counties with Inelastic Housing Supply 150 A2-3 Large Counties with Elastic Housing Supply 152 A2-4 Large Counties with Low Demand 156 A2-5 Large Counties with Moderate Elasticities of Supply 160 A2-6 Large Counties with Inelastic Housing Supply— Mortgage Interest Cap Program Effects 166 Acknowledgments We thank Henry Olsen for inspiring this work, two anonymous reviewers for very helpful comments, and Jim Poterba for his considerable insight into American housing and tax policy. As always, our home institutions, the Taubman Center for State and Local Government at Harvard University and the Zell/Lurie Real Estate Center at the Wharton School of the University of Pennsylvania, provided the supportive intellectual environment needed to complete this project. Finally, Andrew Moore and Cristiano Costa provided excellent research assistance. xiii Authors’ Note This manuscript was completed before Fannie Mae and Freddie Mac were taken over by the federal government. While some revisions have been made to reflect this change, our book is not intended to be a critique of those two government-sponsored enterprises or of the mortgage finance system in general. We provide a more broad-based evaluation of the many different types of policies intended to promote housing affordability, only a few of which work through the mortgage market. One of the lessons from our analysis is that Fannie Mae and Freddie Mac did little to make housing more affordable. The prime beneficiaries of these institutions were their management and shareholders until just before their collapse, not the tax- payers or even middle-income homebuyers. The current housing crisis is indeed something of an indictment of the entire existing housing policy edifice. Policies have focused on supporting housing demand through tax breaks and cheaper credit, while allowing housing supply to get ever more restricted in many areas of the country. Subsidizing demand when supply is fixed not only leads to higher prices but also enables greater housing price volatility. Historically, the most painful price swings have been in places where new construction is restricted. If federal agencies push demand-side aid, such as easy credit, when prices are high, then this aid will only exacerbate the swing of the housing price cycle. Paul Romer was right: “A crisis is a terrible thing to waste.” The demise of Fannie Mae and Freddie Mac provides the opportunity to rethink hous- ing affordability policy more generally. It is essential that we learn from past mistakes, which have been plentiful and costly, and which go well beyond those that will be associated with restructuring Fannie and Freddie. We argue for a clearer diagnosis of the underlying problem, which inevitably xv xvi RETHINKING FEDERAL HOUSING POLICY leads to a focus on local government restrictions on new building that limit supply and help push prices up in our most expensive markets. The very nature of the recent bust in housing prices cannot be fully comprehended without understanding the role of local supply constraints. Not only are the supply-constrained markets on our coasts the most expensive, but they are more volatile, experiencing greater boom and bust cycles, both now and in the past.