Reader AG sends in this interesting analysis of the financial crisis and considers how land-use restrictions in various parts of the country may affect the aftermath.

One thing I haven’t seen discussed much is the effect of land use restrictions on inflating housing prices. Coming from CA, you probably have a much clearer perspective on that than I do, however, that effect would seem to me to be not only non-trivial, but also highly non-linear. In most places where land use restrictions are small (Houston, Dallas, most non-coastal cities), the percentage of the assessment/valuation for a house due to the land on which the house is built is pretty small with the actual dwelling comprising the bulk of the valuation. In coastal cities or where land use restrictions prevent supply from meeting demand (under normal conditions), I would think that the land is a significant, perhaps even majority, of the valuation.

Looking at this in context with the CRA [Community Reinvestment Act -- MW], those areas where the CRA would be most needed/desired are precisely in those areas where land use restrictions would artificially inflate the cost of a house in the first place. Then, continued restriction of the supply while artificially increasing the demand would exponentially inflate the cost of home ownership to the point that even normal, middle-class borrowers, would be cut out of the market (silicon valley or Seattle are other examples.) In places in the Midwest, there really hasn’t been too much of a run-up in prices simply because more houses could be built – supply could expand to meet the demand. Thus, we have a couple of different results.

We have areas where supply is restricted and demand was encouraged leading to very lofty prices which may not yet have fully returned to a rational level. In those locations, demand has to fall off as there is still limited existing supply. Those locations will normalize pretty quickly, I would think. In other areas, there is a supply glut and prices will stagnate, maybe fall a bit, until the glut is pushed through the system. These areas are going to take a while to digest that glut, much longer than locations with a restricted supply. In a few places, I think, there is very little mismatch between supply and demand, so prices may well continue their steady upward move. To try to put that in more user-friendly terms, the recession will be deeper, but shorter in those locations with significant land use restrictions, but shallower and longer in the rest of the country.

We may also see second order effects from state-wide tax policies wherein states with lower tax rates (TX, TN, etc.) will see less of an impact (due to continued job growth) even in the face of a nationwide downturn. This seems reasonable to me, although without looking at the data, I hesitate to draw such a conclusion. The first point, however, regarding land use restrictions, is an obvious and significant factor. If this is the case, I would expect little to no recessionary effects in states like TX (except what bleeds across the borders), higher effects in higher tax mid-western states (like IL), with the most significant effects in coastal states (CA, OR, WA, NY, etc.) Imagine, dropping many rocks, of varying sizes, into a pond are roughly the same time and watching the ripples move outward.

There's definitely a large supply of new houses here in the St. Louis area, but we haven't seen our prices drop very much. The house I bought in 2006 is worth pretty much the same today (according to Zillow).

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