In this episode, we sat down with Kevin Erdmann, the author of “Shut Out” and “Building from the Ground Up” for an extensive conversation on US housing, starting in the early 2000’s through today.
His research points to inadequate housing supply in key large cities, such as New York and Los Angeles, driving the 2008 housing crisis rather than oversupply in “destination” cities such as Phoenix and Las Vegas.
Misdiagnosing the problem led to a severe underbuilding following the crisis, as tight credit conditions effectively prevented new entry-level housing from being built just as the millennial generation was entering the prime home buying age. Covid, then, led to further dislocations especially in smaller markets. We ended the conversation with some policy recommendations.
💡 Name: Kevin Erdmann
💡 What he does: Kevin Erdmann is the author of “Shut Out” and “Building from the Ground Up.”
💡 Company: Independent Housing Researcher
💡 Noteworthy: Kevin Erdmann is a former small businessman and a researcher in housing, monetary policy, and financial markets. In 2015, Erdmann began to reconsider a range of evidence contradicting commonly held beliefs about the pre-2007 American housing boom. His first book “Shut Out” was published with the support of The Mercatus Center at George Mason University, where he continued to develop a revolutionary new approach to the practical roles of housing, debt, and money in recent American economic trends.
⚡What nearly everyone gets wrong about the 2008 crisis. The official story about the housing crisis is that the Federal Reserve cap rates were too low for too long, which led to aggressive lending. This created additional demand which drove prices up. But this is a small part of the picture: housing restrictions in large markets drove away residents to smaller “destination” markets, creating a run-up in prices there. The Fed misdiagnosed the problem, hiked aggressively and caused a severe recession. “There was a credit boom during the 2000s, and we noticed that prices were going up at the same time that this credit boom was happening, and so the way we interpreted all those events is, ‘This credit boom caused prices to go up, and they especially caused prices to go up where supply is constrained.’ That’s a rhetorical choice to treat the supply as this constant. […] But we could very easily — and in fact, more accurately — say that supply constraints cause housing costs to go higher, and sometimes access to credit can make it go even higher when there’s a lack of supply and adequate demand to live in a certain city.”
⚡ Longstanding supply problem in the housing market. A severe lack of urban housing is a new development in the American economy. Because it is new, it has been underappreciated as a core driving factor in American financial upheavals and stresses of the last two decades, and Kevin has developed a new framework for understanding this issue. He explains the problems the housing market has and how to solve them. “We have housing cycles like every economy has cycles. But when you have that supply problem, the cycles keep rising and falling against a rising cost basis as the rates in these cities keep going up and up and up. And so, what happens is that when you’re living through a supply-constrained era, inevitably, that feels like a series of ever more irrational and unsustainable cycles because it starts to feel more normal when you’re actually at the bottom of a cycle where there isn’t demand for housing; that mistakenly feels like normal. And then, when the cycle goes above the new higher cost level, then it seems like, ‘This is the biggest cycle we’ve ever had, but we’ve gotta get control of these cycles.’ And that idea started to take control of the Fed’s thinking.”
⚡How has housing changed since the Great Recession? After the Great Recession, since the problem was misdiagnosed, credit remained very tight and the underbuilding continued. This strongly affected the availability of entry-level housing as the millennials were entering their prime home-buying years. “We stopped lending to really — I don’t think it’s a stretch to say — the bottom half of the owner-occupier market. Pretty much throughout that period, if you look at the New York Fed’s housing debt, and credit report for credit scores 760 above, borrowing in real terms has basically gone along without much of a dip and then has gone up during these refi periods. All the credit scores below 760 — after 2007 — dropped to less than half of what they had been previously; generally, something like a 75% decline in lending on those lower credit scores.”
Hard Constraints on Home Building
“We’ve developed such hard constraints on home building, especially in certain cities — in the books, I call them ‘closed access cities’ — which are New York, and Boston, and LA, and the San Francisco area mainly. And so, it doesn’t take any more than just a moderate boom and demand for housing for problems to start to arise in those markets. They don’t even allow enough buildings for just a moderate amount of population growth. I think it’s probably underappreciated that really those cities are the four metropolitan areas with the lowest amount of housing production. Objectively, that is the one reason they’re outliers.”
The Lending Standards at Fannie Mae
“If you compare the change in, say, the average FICO score in a Fannie Mae mortgage, it tracks pretty well with the New York Fed’s estimate of the average credit score on a new mortgage. So, in general, the Fannie Mae book parallels what happened in the rest of the market, and before 2008, year after year after year, the average FICO score on a new mortgage of theirs was in the 710 range. Over the years leading up to 2007, the values of the homes on those mortgages kept going up, but they also tracked the value of the homes on their existing houses that they previously gave mortgages on, and those were going up too. So the values were going up, but it was the same borrowers in the same houses getting the same mortgages. And the values of those houses just happened to be going up over time, when between 2007 and 2009, the average FICO score at Fannie Mae went from 710 to something like 750, which is a huge change. It’s several times larger than any previous deviations in average FICO scores. And it’s stayed that way since. And at the same time, from 2007 to 2009, when the average home in the Fannie Mae Book of Business and the average home across the country declined by 27%, the average value of a new home that Fannie Mae approved a new mortgage for went up by something like 30% or 40%.”
Demand for Housing During COVID
“That, for idiosyncratic reasons, increases some people’s demand for housing because of working from home or moving away from the expensive cities or all these processes that are at work. And now, when that happens, it’s like the 2005 boom but turned up. Now, the increase in demand is even more moderate than it was then; it’s even less accurate to call it a boom. In the context of the ‘60s or ‘70s, the amount of demand for housing now would’ve been a blip on the road; nobody would’ve even noticed it. It’s so much lower than cyclical changes in demand were back then; it’s absolutely nothing that we shouldn’t have been able to handle, but none of these cities had vacancies available to soak up that little bit, and every city has too many limits to multi-family buildings. So multi-family housing production is maxed out; it’s as high as it’s been for the last 30 years.”
[08:31] “Anytime you have any increase in the demand for housing, you think of it as units per capita. If you are unwilling and unable to increase the number of units, then your capita has to change.”
[31:53] “If you look cross-sectionally, across cities, there was this idea that prices have become unmoored from rents, that the fundamentals have become unimportant. And that’s why credit gets blamed.”
[32:16] “One of the tricks — where the data is easy to misinterpret — is that in cities where rents are higher, in any context, the price-to-rent ratio tends to be higher.”
[34:07] “Prices are unsustainable, but they’re unsustainable because of supply, and the way supply works to create unsustainability is through the rents rising.”
[00:00:08] Hello and welcome. You’re listening to Signals by AlphaSense, and I’m your host, Nick Mazing. In this episode, we’re joined by Kevin Erdmann, whose research has completely flipped upside-down the conventional wisdom about the 2008 housing crisis and the aftermath going on to today, Kevin, welcome to the podcast, and can you tell our listeners a little bit more about yourself?
[00:00:49] Kevin Erdmann: Sure, and hi, Nick. Thanks for having me. Yeah, I, for about six or seven years now, I’ve sort of been an accidental researcher on this topic and, and I’ve been working quite a bit with the Mercatus Center at George Mason University. Currently, I’m an Affiliated Senior Scholar with them
[00:01:06] and, and over that period of time, I’ve written two books, Shut Out and Building from the Ground Up, and several supporting papers, which we’re continuing to put out over time, just re-imagining the importance of a lack of supply in the housing market and really in the economy in general,
[00:01:26] the supply of housing, excuse me, on the housing market and on the economy in general and how a lot of the other factors are affecting home prices in the economy have been sort of overstated because of an underestimation of the importance of that issue.
[00:01:42] Nick Mazing: We’re going to have the links in the show notes to the books, and I’m gonna talk a little bit more here as to how I discovered you, because, you know, I, I know a lot of the other guests and I didn’t know you until recently. So, I, I saw crazy tweet a few months ago that the housing crisis was caused by too little housing rather than too much housing,
[00:02:03] Nick Mazing: and, you know, when you see something, and, by the way, the aftermath of the housing crisis is still with us because Fannie and Freddie are still in the receivership and we’re seeing a lot of the dynamics still playing out because of the policy response, which you assert is wrong. And when you see something crazy on Twitter, right, what can you do? Like, mute, block or go and read more?
[00:02:23] So, I went and read more. I read your whole thread, then I bought your second book, and then I bought the first book, and I read them and, and I reached out, and just for, you know, if you’re, you know, new in this world, the conventional wisdom about the housing crisis is that essentially, you know, called the official story is that the Federal Reserve kept rates too low for too long.
[00:02:46] The government was separately pushing home ownership, and this led to more demand in a price pi response, but they were all marginal borrowers with a lot of loans, without declared increase and things like that. They were getting adjustable-rate mortgages, and then when the rates started going up, the domino started falling because those mortgages were securitized across the system, and the entire financial system blew up.
[00:03:11] So, you had Lehman Brothers, largest corporate bankruptcy in the world ever. When they, when they declared bankruptcy and I worked with Lehman Brothers, Bear Stearns, Washington Mutual, Countrywide, Merrill Lynch, the Landes Bank in, in Germany, et cetera, they all had these mortgages, and they took them down, and it is very important.
[00:03:33] Now, you have an alternative explanation, but this alternative explanation is based on the exact same that everybody knows, you look at the same K-Shield indicators, you look at the same census data migration patterns. You look at the same Federal Reserve data like everyone else, but those pieces of the puzzle come together very differently.
[00:03:54] We have a very different explanation about what happened. Very different policy recommendation. So, it’s almost like, you know, it’s, I’m overstating, but it’s almost like Galileo, right? You see the, the sun going up and down. You think it’s, is it rotating around you? Are you rotating around the sun, right?
[00:04:10] So, can you give us the fundamental net framework about what happened?
[00:04:14] Kevin Erdmann: Yeah, I, I think one way you could sort of state that, that story you just laid out is, is that, you know, the conventional way that, that we’ve been talking about the housing bubble and bust in the financial crisis is to sort of treat housing supply and housing constraints what an economist would call “housing elasticity” is a constant,
[00:04:36] so it’s harder to build a house in LA than it is in, in Dallas, and then when things happen, and things change in the housing market, you know, so the, so there, there was a credit boom during the 2000s and, and we noticed that prices were going up at the same time that this credit boom was happening,
[00:04:54] Kevin Erdmann: and so, the way we interpreted all those events is, oh, this, you know, credit booms caused prices to go up, and they especially caused prices to go up where supply is constrained, and to, really, that, you know, that’s a rhetorical choice to, to treat supply as this constant, this thing we don’t have control over, and we don’t, you know, we don’t consider the possibility of it changing,
[00:05:18] so we really just, rhetorically have decided that credit is, credit access is something that can change, and so we placed the blame on it, just as a result of that framing, but we could very easily and in fact more accurately say that supply constraints cause housing costs to go higher and sometimes access to credit can, can make it, you know, can make it go even higher
[00:05:44] when there’s a lack of supply and, and, and adequate demand to live in a certain city and, and I think, really, as time has, has only strengthened the, that, the idea of using that sort of framework because we, we got rid of all of those mortgage products and here we are back again with the same price-to-rent ratios and the same high prices
[00:06:06] Kevin Erdmann: and, except now it’s at a low, it’s at an even lower production, construction rate. So, so I think what happened is, we’ve developed such hard constraints on home building, especially in certain cities. I, I, in the books, I call them “closed-access cities,” which is New York and Boston and LA, and the San Francisco area mainly
[00:06:29] and, and so, really, it doesn’t take any more than just a moderate boom and demand for housing, for, for problems to start to arise in those markets. They really don’t even allow enough building for just a moderate amount of, of population growth. I think it’s probably just underappreciated that really, those cities are, those are the four metropolitan areas with the lowest amount of housing production that objectively, that is the one reason that they’re outliers.
[00:07:00] There may, people call them “superstar cities” and, you know, maybe they’re, you know, maybe they’re superstars. Maybe people do want to live there, but, objectively, the reason that the, that they’re having problems and that they create these housing price booms is because they, even, you know, if you look at Los Angeles over the last 20 years, it compares unfavorably to even like Cleveland and Detroit in terms of housing production.
[00:07:28] Kevin Erdmann: So, a moderate increase in housing demand that shouldn’t have caused problems had to cause problems because when Americans have a moderate increase in demand for housing, there’s no room for that demand to, to expand in those cities. And so, it necessarily has to lead to some sort of migration event of American segregating into and out of the most expensive,
[00:07:53] exclusive areas and that, that migration event that got triggered in 2004, 2005 and 2006, and, and, really, we’re seeing the same sort of migration event today, although it’s taken a very different shape because COVID is involved in all these other factors, but anytime you have any sort of increase in, in the demand for housing, you think of it as sort of, you know, units per capita,
[00:08:17] if you can’t, if you’re unwilling and unable to increase the number of units, then your capita has to change and, and that means people have to effectively, a, a process of discomfort develops in a city like LA where the poorest residents have to get, some of the poorest residents have to get uncomfortable enough that they move to Phoenix to make a moderate amount of supply available for the
[00:08:43] Kevin Erdmann: normal number of people that want to move into LA or, or the children that are born to families in LA that now are moving out, and, and getting their own house, somebody has to feel enough pain staying in LA to move away from it. And so, you get this sort of counters, first, a countercyclical population
[00:09:03] trends in these cities when this economy’s doing great population in LA or New York tends to be flat or, or even decline. And so, you know, that’s when the economy’s doing good. It has to be paired with this housing, cost-motivated economic discomfort that goes hand in hand with it,
[00:09:24] Kevin Erdmann: as long as we have these cities, that won’t expand and grow as cities have done over centuries.
[00:09:33] Nick Mazing: And you, you have the framework of housing refugees, right? And, really, the math, imagine, you know, half a percent of New York moving to, you know, Tampa or, or, or whatever, it’s just gonna blow up the local market. So, can you tell us how things played out in those boom cities? And then, what happened when, you know, the Fed misdiagnosed the problem essentially?
[00:09:55] Kevin Erdmann: Yeah. Yeah. So, you know, what happened is, we have this, this longstanding supply frictions problem, but it, but we keep interpreting it and living under that problem. We have housing cycles, like every economy has cycles, but when you have that supply problem, the cycles keep, keep rising and falling against a, you know, sort of a rising cost basis as the rents in these cities keep going up and up and up.
[00:10:26] And so, what happens is, when you’re living through a supply-constrained era, inevitably, that feels like a series of evermore irrational and unsustainable cycles because you’re not, it, it actually starts to feel more normal when you’re actually at the bottom of a, of a cycle where there isn’t demand for housing,
[00:10:51] you mistakenly, that mistakenly feels like normal. And then, when the cycle goes above the new, higher cost level, then it seems like, “Well, this is the biggest cycle we’ve ever had, but we’ve gotta get control of these cycles.” And if, you know, that, that idea started to take control of, of Fed thinking, you know, the Fed actually was, had some conversations in 2005 that were very level-headed, that actually fit very well with my way of thinking
[00:11:19] and as we went through 2006 and 2007 and the housing market slowed the, the, and the economy started, you know, moderating, it wasn’t, it was sort of on the edge of recessionary trends for a while going into, you know, the true recession or the official recession, as their
[00:11:41] attempts to slow everything down sort of accumulated instead of operating the way they normally would’ve over the course of most of the 20th century or post World War II era, they, they sort of became more and more convinced of their critics-notion that they had caused a bubble, that they had caused overproduction and housing,
[00:12:01] Kevin Erdmann: that they had that, that they, this idea that they had lost control of the business cycle sort of became canonized before the actual contraction came. So, really, you get to some points, you know, by late 2007, they actually had, you know, they had a housing-focused meeting in, in Jackson Hole at the end of August in 2007
[00:12:24] and, and at that meeting, they, they talked about and looked at all these leading indicators that come from housing when, you know, one of the first things that happens in a, in a most contractions is that housing starts to decline and housing starts by August 2007 were far, you know, they had started declining by the first quarter of 2006, and they were well
[00:12:48] below the peak by August 2007 and, and at that meeting, they talked about how in all the previous post-World War II recoveries, it was the recovery of housing starts that sort of leads the recovery of the general economy and, and they really decided that they couldn’t do that because this idea that housing is overproduced and, and there was a bubble and
[00:13:15] there had to be a certain amount of pain felt by the investors in order to discipline the markets and all, all these sort of ideas were floating around, they knew the process that leads into and out of recession, and they effectively washed their hands of it before the crisis even happened.
[00:13:32] And then, when the crisis did happen, instead of, instead of the blame going to those decisions that actually happened in late 2007 and 2008 of sitting and watching housing starts continue to drop to unprecedented low levels on a per capita basis and not stimulating enough to, to grow ourselves out of it,
[00:13:53] instead of the blame going to that, the blame, the conventional wisdom put the blame on what they had done back in 2005. Everyone was convinced that there was nothing that could be done about 2008 because of things that the Fed had already done in 2005, and there’s real, there was really no reason why they couldn’t have, couldn’t have stimulated enough to reverse housing production.
[00:14:15] Kevin Erdmann: There, there, there’s no city. There’s this, this idea that across the country we built too many houses and then there was a glut of houses and that led, that led to all these price declines, but when you disaggregate city by city, by city, there just isn’t a city, there’s not a single city that, that happened,
[00:14:32] clearly, it didn’t happen in LA, New York, they, they haven’t had enough houses for decades. It didn’t happen in Phoenix, in Las Vegas, and Florida because there probably, most, so many people were moving from New York and LA that they couldn’t keep up with the demand until that migration suddenly stopped because the Fed slowed down the economy so much
[00:14:51] and in the rest of the country there just wasn’t a building boom. You’d look from, from St. Louis to Kansas City to Columbus to, you know, to Dallas, pick a city, and they were basically building houses in 2005 at the same rate they had been in 2002 or, or whenever, and by the time the recession hit, every city was already, you know, basically at half the rate of building that they had been previous, you know, they were half the rate of building that hadn’t been excessive to begin with, so, so yeah.
[00:15:23] Nick Mazing: And, you know, there we have it. That’s the framework. That is what interested me into that, that, you know, you had, you know, very delayed and wrong policy response, and when you look at the actual markets is, the boom city is what actually just trying to get the, you know, build up for what you call in the book “housing refugees” from the large cities
[00:15:43] and it’s very disproportionate, right, in terms of, you know, we have a large city with a small percent living or the fraction of a percent, it’s actually a lot for, you know, Phoenix and, and Florida and, and, and some those, Las Vegas, some of those destination cities. Now, let’s look at the period after the Great financial crisis until COVID.
[00:16:02] So, everyone, if, if you look at the housing start chart, right, just dramatic underbuilding for, you know, the first part of the decade, and, at the same time, at the same time, you had, in terms of demographics, you had the millennial generation hitting prime-home buying age, you had very strict mortgage requirements.
[00:16:25] I mean, you have the data in the, in the book, the average credit score for the borrowers stayed up. In other words, it was very, underwriting was very tight, and you have a lot of data on essentially low-price homes being out of reach for many people who should be owning instead of renting because, you know, they could dramatically lower their payments in, you know, certain markets
[00:16:51] and, so, can you tell us kind of the, what happened after the Great financial crisis until COVID using your framework?
[00:17:02] Kevin Erdmann: Yeah, I think the, the, so, you know, we have the recession, and then by the end of 2008 the Fed is back to managing relatively stable, moderate growth levels and, but, over the course of 2008, of course, Fannie and Freddy get taken into conservatorship. They’re under control of the, the federal government,
[00:17:22] you know, effectively the FHA and, and Fannie and Freddy are the only game in town and partly because of the shock of the, of the boom and bust, partly because federal regulators initiated a whole host of regulatory limits on who could get mortgages because of this idea that poor underwriting had created above,
[00:17:45] Kevin Erdmann: so, you know, I, probably should back up a bit. I, I don’t deny any of the things that happened in CDO markets or CDSs or sloppy underwriting, but connecting, blaming the, the high prices on that connecting that to a bubble, that connection has been made with really very little direct connection,
[00:18:05] it was satisfying enough as an explanation, and it, and this idea that prices were unsustainable, so motivating that, that we sort of accepted, you know, nobody’s really demanded a lot of connecting tissue to really blame the high prices on, on these credit markets and it sort of amazing, when you look at the, the difference, you know, if you look at how much attention has been put on analyzing the types of credit that were available, banking regulations, home ownership, program, you know, all the, all these, the, there are so many studies looking at the effect that all those things could have on prices,
[00:18:46] and there’s so many books that just, you know, that purport to be about the bubble, and they’re all personal studies of the, of the CEOs, of the banks and everything, right, you just can’t find, there is no, really, there’s sort of one slight study on housing supply during this, this whole period and, and, you know, if you look, if you read the studies that, that tried to put, explain the bubble through lending, excessive lending,
[00:19:17] they depend on, there, there’s a supply element that they depend on, and usually, there’s sort of a, you know, there’s this idea that, okay, where supply is constrained, all the excess led to higher prices, and where it, where, where supply isn’t constrained, all that excess lending led to overproduction,
[00:19:37] and so, that’s why prices went down everywhere because some places had prices that had gone too high and some places had production that had been too high and, and either way, when you took away the, the excess demand from lending, both of those markets had room for falling prices, but nobody ever actually
[00:19:58] studied the supply element. They just, they intuited it from the supply and demand model and just assumed that excess supply must have been there, but if you, you look from city to city to city, there, it, the supply, what didn’t happen that nobody actually bothered to interrogate it, or maybe they did try to interrogate it and
[00:20:20] it didn’t fit the story and that they, they, you know, you could easily assume that it, there’s, it’s an outlier, you’re looking at, you’re not applying it right, you know, for some reason you’re not able to find the nugget of truth in it, and nobody’s really demanding that you do a thorough review of it,
[00:20:36] and so, you move ahead, you know, and, and everybody moved ahead without really anybody confirming this thing that turns out to be, to not have happened at all. So, so anyway, back to the answer to your question, so what happens is we blame lending, or we blame the bubble on excess lending and sloppy underwriting,
[00:20:59] and so, lending was tightened extremely, an example, you know, I, I track the Fannie Mae, so, the lending standards and the, they seem to track pretty well, the Fannie Mae seems to be a pretty, you know, if you compare the change in, say, the average Trico score in a Fannie Mae mortgage, it tracks pretty well with, say, the New York Fed’s estimate of the average credit score on a new mortgage.
[00:21:26] So, so, so, I think, in general, the Fannie Mae book parallels what happened in the rest of the market and, oh, you know, before 2008, year after year, after year, the average FICO score on a, on a new mortgage of theirs was in the, maybe the 710 range and now, over those year, over the years leading up to 2007, the values of the homes on those mortgages kept going up, but they also tracked the value of the homes on their existing
[00:21:55] houses that they previously gave mortgages on, those are going up too. So, the values were going up, but it, it was the same borrowers and the same houses, getting the same mortgages and the values of those houses just happened to be going up over time. Between 2007 and 2009, the average FICO score at Fannie Mae goes from 710 to something like 750, which is a huge change.
[00:22:17] It’s, it’s several times larger than any previous deviations in average FICO scores, and it’s stayed that way since and at the same time, from 2007 to 2009 when the average home in, in the Fannie Mae Book of Business and the average home across the country declines by 20 some percent in value, the average value of a new home that Fannie Mae approves a new mortgage for over the, between 2007 and 2009 goes up by something like 30% or 40%.
[00:22:49] So, by, so, in 2006, the, the average existing home in the Fannie Mae book, is, I’ve, I, I’m slightly guessing that the number’s been something like $210,000 and the average new mortgage is on a home worth $210,000. By 2009, their average, the average home that they’d previously lent to was down to, say, 180,
[00:23:14] and the average price of a home that they’re lending to Afresh is, like, 300. It’s, like, this huge gulf, they, so effectively we stopped lending to really, I don’t think it’s a stretch to say the bottom half of the owner-occupier market. Pretty much throughout that period, if you look at the New York Fed housing, debt and credit report, for FICO score, for credit scores 716 above,
[00:23:40] borrowing PA in real terms has basically gone along without much of a dip, and then is, you know, has gone up during these refi periods. All the, all the credit scores below 760 dropped after 2007, dropped to less than half of what they had been previously, generally something like a 75% decline in lending on those lower credit scores.
[00:24:06] Kevin Erdmann: Now, the, the lending to those during the boom, lending to those credit scores didn’t increase as a percentage of total lending, that you can’t really see any evidence during the subprime boom of a change in the average credit score of borrowers. We can quibble about things that would affect that on the margin, but it’s just anything that happened during the subprime boom is, is a small fraction of this major change lending
[00:24:32] that happened after 2007, and you can see the reflection of that change in home prices across the country in cities that had bubbles, in cities that didn’t have bubbles, in cities that had a building boom, in cities that didn’t have a building boom, every city across the country, directly in coincidental with his change in lending standard,
[00:24:54] Kevin Erdmann: low-income, neighborhoods with low incomes where credit, you know, credit availability is important, dropped in value by 20, you know, 15%, 20%, 25% compared to neighborhoods with higher incomes that aren’t as credit-constrained and, you know, it just, it leaves a mark on the, on the housing market that just nobody,
[00:25:16] nobody has acknowledged or noticed it because every bad thing that happened after 2005 was automatically just, “Oh, well, that happened because of what we did in 2005.” So, it sort of didn’t matter what sort of policy damage any policymaker created, excuse me, in 2008, it would all get blamed on the policies that happened before
[00:25:39] and it did, you know, so, that’s one of the oddities to me of the conventional wisdom is, did we need a 5% correction home prices? Maybe that’s really all that was necessary, and most of that would’ve been in, maybe the Phoenixes and the Floridas and Texas probably should have just, I actually had price appreciation in 2008 and 2009.
[00:25:58] So, would 5% have been enough? I don’t know. Would 10%? I don’t know. We ended up with something like 30%, but prices could have gone down 60%, and the conventional wisdom would’ve been, well, I guess 60% is what it takes to, to go back to normal. There, there’s no effort to sort of quantify what was enough
[00:26:18] and I think it turns out, when you really look closely at it, enough was very slight, and most of what happened was actually a result of these late changes in lending standards that really had nothing to do with anything that happened before 2007, and, again, you can see the result, you can see the late changes within each city of the top end
[00:26:40] Kevin Erdmann: generally, top-end prices leveled out, and bottom-end prices collapsed after 2008 because we took away mortgage lending from those, from those neighborhoods.
[00:26:52] Nick Mazing: So, you know, to, to recap, not enough supply, housing, refugees, wrong policy response because the problem was misdiagnosed and then following the crisis, you know, you estimate that, call it roughly half of the potential home-buyer market is just locked out because of availability of credit and so on, and that brings us to COVID and what happened, you know, during COVID and, and the, the post-COVID period and I can see some of the dynamics that you describe because obviously they’re very recent and now that I, now that I know about your framework, I think it’s relatively easy to identify and, you know, you have, essentially, I mean, driven by COVID, but called “housing refugees” from, with either home equity or, or, you know, big-city paychecks leaving New York, leaving San Francisco, moving to city like Boise and just completely blowing up the local housing market because just supply, like, measured at the very beginning, supply elasticity is, is is a very different beast when it comes to housing and I personally know people who moved from San Francisco to Boise, literally, Nashville, Arizona, you know, people from New York who moved to
[00:28:02] North Carolina, moved to, to Tampa in, in, in Florida, so since, and we also have, or, you know, I don’t know how the market will go, but we had a pretty serious run-up in housing prices since, you know, and then now the Fed is obviously, you know, jacking up rates, so what happened after COVID, during your framework?
[00:28:26] Kevin Erdmann: Yeah, I probably should back up a little bit, sorry. You, you asked great questions, and then I’m giving you far too long answers, but, if we, you know, the prerequisite or the, the, the sort of context leading up to COVID, you know, because of these changes in, you know, those changes in lending basically effectively shut down a half million,
[00:28:46] you know, before 2007, there were a half million, more than a half million homes built and sold new homes every year at price points below, say, $200,000 or $250,000, and that just dried up. That wouldn’t wait. So, we basically killed the entry-level, single-family home market, and the way I would describe is, you know, again if you look close, if you look cross-sectionally across cities, there was this idea that prices have become unmoored from rents,
[00:29:19] that the fundamentals have become unimportant, and that’s why, you know, credit gets blamed, and so, you know, we have to tighten up credit to solve that problem, but if you look cross-sectionally if you look from city to city, rents actually explain everything. One of the sort of tricks of the, that where, where the data sort of is easy to misinterpret is that in cities where rents are higher in really, in any context, where rents are higher, the price-to-rent ratio tends to be higher.
[00:29:49] So, so the most, the, easily, the most powerful way to increase the price-to-rent ratio is to have a context of rising rents, whether that’s over time or within a city or, or across cities. So, so partly what happened is rents rising, rents are such a powerful factor in increasing your price-to-rent ratio that they actually made the price-to-rent ratio look like it was more from fundamentals when it was actually just systematically,
[00:30:15] I mean, it’s amazing when you, when you really dig into the data, how fundamentally-driven everything is, rents were far more important as a factor in home, in relative home values in 2005 or 2006 than they have been in 1991 or 1995 and they’ve continued to get more important because we’ve continued to constrain supply.
[00:30:38] So, anyway, long story short, the solution, all the solutions to bring down prices were meant to bring down what were supposedly unsustainable high prices, and again, you know, think about that, that’s not, it’s not necessarily wrong to see those prices as unsustainable, say the, you know, a low-end home in LA that’s selling for 12 times income, the income of its local residents, that is unsustainable,
[00:31:02] but the way that the unsustainable is playing out and the motivation for that sustainability is that there’s not enough houses in LA, and so, rents on those families have to rise high enough to, to be unsustainable. So, they’ll move away from LA, so, prices are unsustainable, but they’re unsustainable because of supply and, and the way supply works through to create unsustainable is through the rents rising,
[00:31:27] so, but, we didn’t do anything to solve the rent problem, so, you know, if you think of rent here and prices here, we pushed prices down and rents stayed the same. Well, this was the price that was inducing new building, so now you’ve got the price here. And so, now in city, after city, after city, those, those families, now they’re actually just retracting themselves into the existing housing market because the price point is too low to induce new building.
[00:31:53] Kevin Erdmann: And so, the only thing that could happen, and the thing that, that clearly did happen over the next 10 years is that we kept enforcing these lower price-to-rent ratios, and rents rose, and they had to keep rising until they were high enough the prices were back to this level where they can induce new building.
[00:32:13] Now, we’ve sort of barely gotten back to that point, now we still can’t, the builders still can’t sell those houses to the people that live in them because the CFPB and the FHFA are looking over their shoulder and saying, “No, the, they’re not qualified, this, this family that’s paying $2,000 a month rent isn’t qualified for a $1,400 a month mortgage.”
[00:32:33] So, so we, somebody else, has to build the house and rent it to them. So, now we have this build-to-rent market that’s just bare, you know, just getting its feet on the ground, and so, that’s sort of where we are for 10 years leading up to COVID, where we are harvesting all the vacancies that are out there, the vacancy rates in every city from Detroit to New York City are, are declining, declining, and declining every year.
[00:32:59] Kevin Erdmann: And, so there’s, so there’s no excess inventory out there to, to soak up minor cyclical changes in demand. The rents are, you know, keep pushing up and up and up because now rents have to take a larger portion of a family’s income to induce the building that will actually stabilize those rents.
[00:33:16] So, all these pressures are pushing up, so there’s less room to give, the costs are already higher, and now this COVID thing comes along. That, for idiosyncratic reasons, increases some people’s demand for housing because of work from home or moving away from the expensive cities or, you know, all these processes that are at work,
[00:33:34] and now when that happens, it’s sort of like the 2005 boom, but everything’s turned up even, you know, now the, now the increase in demand is even more moderate than it was then, you know, it’s even, it’s even less accurate to call it a “boom”, like, you know, the, the, it, in, in the context of the sixties or seventies, the amount of demand for housing now is, would, would’ve been a blip on the road,
[00:34:00] like, nobody would’ve even noticed it. It, it’s so much lower than, than cyclical changes in demand were back then the, it’s absolutely nothing that we shouldn’t have been able to handle, but none of these cities had vacancies available to, so soak up that little bit, and every city has too many limits to multi-family buildings,
[00:34:20] so multi-family housing production is really sort of maxed out. It’s as high as it’s been for the last 30 years. It used to be higher in the sixties and seventies before we created all these obstructions to housing in the cities, so that, so that there’s only so much we can do building new multi-units and the families that, you know, might be building the single-family home,
[00:34:45] some of the single-family homes can’t get mortgages, so all these cities now are having housing bubbles at rates of production that are generally much lower than what they were anywhere in 2005. And so, yeah, we’re just, it’s just in, in a way, it’s everything that was happening then, but even worse, the main difference is that, in 2005, the people moving out of the, families moving out of San Francisco and LA and New York were generally the poorest families or sort of a combination of people cashing out their, their real estate value and moving away,
[00:35:22] or the poorest families being bit out because of rising rents. And so, it, it was associated with rising rents in LA, San Francisco and New York City, and now with the COVID thing, it was sort of the opposite that people were actually moving out because the amenities of those cities had been affected by COVID.
[00:35:39] And so, we had this, temporarily, we had this sort of weird period where rents were actually going down in New York and San Francisco and LA and going up everywhere else where everyone is moving still. The one way I would describe that is in the supply context, we have a city like LA is gonna lose whatever it is, 60,000 or 100.000 households every year,
[00:36:03] and so, really, the main question is, which household is it gonna be? In 2005, it was a lot of those were the poorest households, in 2021 a lot of those were the richest households that somebody was gonna have to move away, right? And so, depending on who’s moving away and what their motivations are, that affects how rent is playing out in LA,
[00:36:26] but it sort of has the same effect in the cities where they’re moving to, and so, now it’ll be interesting to see what happens. I think some of that is sort of settling out, and we’re getting back to the, the more standard, you know, rents are starting to rise again in the coastal cities, but we’re sort of in this weird situation where production of new housing really does need to increase
[00:36:48] Kevin Erdmann: and unless we loosen lending standards, it’s gonna have to increase through build-to-rent, through private equity and institutional bill landlords and, of course, now because, because this supply situation is perennially underestimated, there’s a lot of pushback of, oh, it’s the, the private, the build-to-rent buyers and the, the I buyers and the private-equity owners that are driving up prices, you know, they’re the ones, they’re the source of demand now.
[00:37:17] And so, that must be the reason prices are going up and so, there’s sort of a backlash against them, which is really probably my greatest worry about policy issues in the housing market going forward. If, if that backlash really does end up manifesting itself as, as through policy, that limits the ability of private equity to build new rental housing.
[00:37:39] I don’t know where we get new housing from. At that point, every form of housing has been basically made illegal. So, I think there’s several sort of steps of, you know, there’s that, you need to, if this is where we are, we need to make it legal for private equity to build houses, it’d be nice if private equity
[00:37:56] Kevin Erdmann: can build apartments more often, an then infill development, it would be nice if people look moving to the Phoenixes and the Floridas, if everyone that wanted a new house and to be an owner of that house, could, but really before that, it’d be nice if they could just get a house in or a condo in LA or New York or San Francisco.
[00:38:13] So we, we sort of have the best optimal world and we’re about four steps away from that now, and I’m afraid we’re going to five steps away and five may be a step too many.
[00:38:22] Nick Mazing: Mm-hmm, and this leads to the final question for today. It’s exactly focused on policy. If you look at, you know, the recent legislation in California, which loosen building, if you look at, you know, the New York government, she had a tweet out recently with the county’s map in New York City and how New York is not adding housing units in any proportion to the jobs that have been created, unlike New Jersey, Connecticut, you know, in the, in the metropolitan area.
[00:38:52] So, you know, certainly, even democratic governance understand the supply point and has got something, I mean, it’s taken more than a decade, I guess, if you use your framework. So, and it really, it hampers innovation, hampers advancement if somebody who will be an entry-level employee actually is, is, is beat out.
[00:39:12] So, let’s talk briefly about policy, right? If you were made the housing czar today, what kind of policies would you push for?
[00:39:20] Kevin Erdmann: Mm-hmm. Yeah, I mean, I think really those sort of four steps I went through is sort of the framework I would use. First, first, in terms of stopping the bleeding, I would not put any, you know, in fact, you frequently, you’ll see this, if some of the newly-elected officials have a big, or have a big, you know, housing policy statement, and it’ll usually involve some, some form,
[00:39:43] you know, getting the foreign buyers or the non-local landlords out of, you know, something that incentivizes local buyers over the, and just as a general rule, I’d say, any, any policy that has “no,” if there’s a “no” in it anywhere, let’s look for something better. So, you know, something like that seems like it could be helpful, but that “no” is really going to end up just cutting off supply at some, at some point in the process of creating new housing.
[00:40:12] Then, the next level up from that, you know, some of those investors that are investing in single-family homes, which really probably prefer to be investing in infill development, you know, and, and I think we, we should be embracing this, this, what appears to be a sort of a new era of urbanization of, of young professionals moving downtown and actually,
[00:40:32] the city, all these cities we have that have developed as car-centered cities, which is fine, that’s the, that’s the century we just came out of, had this great new technology, we could move around a lot easier and there’s not necessarily anything wrong with some of the ways we developed under that, but now, but, you know, cities are an ancient form of human
[00:40:56] Kevin Erdmann: interaction and, and aspiration and, and, and development, and they’re important. We need them. They’re useful, and if we’ve sort of put the clamps on being able to make new cities because we have all these arbitrary rules about how tall the building can be, how far away from that road it could be, how many units, units it can have, that really don’t,
[00:41:20] they don’t actually help anything really. Most of the time they’re just arbitrary and, and effectively, you know, especially, I’m here in Phoenix, you know, Phoenix is a city of something like 5 or 6 million now. When a lot of those neighborhoods were built, it was a city of a million or less. There’s, it’s ridiculous to think that a neighborhood a half mile from downtown built when the city was less than a million people should still have the same form structural form that it did when it was built.
[00:41:50] If you go to any, any city, we all look up to and appreciate your visit and, and, and look in awe at it’s a, is a place where the structures that are in place now are the fourth or fifth thing that’s been there, right, cities have to be able to do that and when we let them do that,
[00:42:07] it’ll be a better world. So, obviously, that zoning component is, is important, and, you know, it, part, it’s a collective action problem, right? It every, what’s happened is, is we don’t have a good sort of governance structure around the metropolitan area, and so, every little region with its own governance, you know, basically is designing its local housing policy around the idea that, you know, “We don’t want to be the bad part of town,”
[00:42:36] and so, what’s happened is everybody is putting in rules to try to not be the bad part of town. There’s still a bad part of town, like, there’s still people, there are people that exist that nobody wants to have as neighbors. It’s that, you know, that’s the, that’s really the fundamental problem, and there’s no solution to it,
[00:42:53] but everyone putting these rules in place to try to avoid being their neighbor doesn’t actually solve the problem. It, it actually has just created new problems, and there’s still a bad part. There has to be a bad part of town. Those people live and they, they’re gonna live somewhere. So, I don’t even think there’s a net cost of any kind to removing those rules
[00:43:15] and we’ve just strangled the, the ability of a city to grow and change by, by implementing, Anyway, so, yeah, the first thing would be, you know, don’t stop the, the build-to-rent. The second thing would be, let them build apartments where they want to, more easily than they do now. The third thing is, reverse all these mortgage regulations that we put in since 2007, that
[00:43:37] they didn’t address anything that was the actual problem and they’ve, the main result of them has been to raise rents because they basically obstructed entry-level, single-family housing and if, you know, you could think about it mathematically, if in a city that allows building to happen, the price of the average house is gonna be what it cost to build a new one,
[00:43:59] like, that’s just basic economics, so the economics of housing is, is this price-to-rent relationship. Well, if you push, if, if our policies in, in lending, which people explicitly talk about them this way, the idea is to push the price-to-rent ratio down. That, that was really the explicit purpose of mortgage lending.
[00:44:19] The only thing that can happen is that it makes rents higher, so making mortgages unavailable, the, the direct result of that is to make rents higher, is to make housing costs worse. So, you know, I, I, I always would get pushback on this because people conflate those, the changes that family-made, Fred, Freddie Mac and all that with the Subprime Movement Bust
[00:44:42] but, really, we could get rid of all those new, you know, we, we, I think it, if it, if I was the czar, is, if I’m following your question, I would start from scratch and see what we really need.
[00:44:54] Nick Mazing: Mm-hmm. Mm-hmm.
[00:44:56] Kevin Erdmann: And then, of course, finally, it’s just LA and New York and San Francisco, just in general need to.
[00:45:01] Nick Mazing: Always a problem.
[00:45:03] I live in New York, so I can talk about it.
[00:45:05] Kevin Erdmann: Yeah. They just need to be cities. It’s ridiculous.
[00:45:09] Nick Mazing: So, Kevin Erdmann, thank you very much for joining us today.
[00:45:14] Kevin Erdmann: Yeah. Thank you. It’s been a pleasure.
[00:45:17] Nick Mazing: This was a fascinating discussion. Kevin Erdmann, Housing Scholar, author of Shut Out from 2019 and Building from the Ground Up from 2022, we’ll have the links in the show notes, and we’ll also link to Kevin’s blog and, and his profiles as well. My name is Nick Mazing. This is Signals by Alpha Sense.
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