A vital but widely misunderstood aspect of our financial crisis

Summary:  an analysis of the core problem in the US housing market, a problem often ignored by analysts.

The years from 1929 to 1933 were, for America, a succession of breaking idols and abandoned faiths, some of them the notions of willful children, some deeply ingrained in the character of the nation.

The Years of the Locust:  America 1929 – 1932, Vivian Seldes (1933)

The core of the housing crisis is overbuilding, which has created an excess supply of housing units (broadly defined). Today there are roughly 4 – 5 million vacant housing units above historical average rates (as a % all units). For example, the Census Department’s Housing Vacancy Survey shows that 2.8% of owner-occupied units (i.e., not rentals) are vacant, almost 2x the historical average of 1.5%.

These vacant units are a burden to their owners, tieing up capital and costly to maintain.  Whether sold or rented, they drive down prices.  Excess supply is difficult to absorb for high cost and long life goods like housing.  There are no easy fixes, and these vacant homes might vex the market for several years.

Measure to encourage homeownership or home purchases are of marginal effectiveness (e.g., tax breaks, lower interest rates, government aid).  Almost everyone is already living in a “unit”.  For example, at what interest rate would you buy a 2nd (additional) home in your neighborhood for your family to live in?  These programs can increase space occupied by households, helping people move into larger units.  Also, by reducing the cost of living, these programs might encourage some formation of new households by getting adult offspring out of their parents’ homes.

There are two powerful solutions

(1)  Eventually our population will increase to fill these homes.  But slowly.

Our population grows (net new households) from more children leaving home than households disappearing through death.  And net migration into America.  These rates change over time.  Our slowing economy might already be slowing the rate of in-migration.  A recession or political turmoil in Mexico might send floods of people north into America.

(2)  Not so creative destruction

Many vacant homes will be destroyed, the fast track to fixing this problem.  Empty houses get vandalized, destroyed by the owners (spite or insurance fraud), occupied by squatters or meth labs, or wrecked by the forces of nature.  In regions with net out-migration (e.g., Detroit) homes remain vacant for long periods, often abandoned by their owners (valueless but costly due to taxes and maintenance).  As anyone familiar with the history of the South Bronx knows, empty homes acts as an infectious blight that can devastate larger areas.  After a decade or two, the result can look like Dresden after the bombing in 1945.

Here is one government program to fix the housing crisis:  buy and destroy homes.  The government did this with food during the Depression, in order to increase food prices (to help farmers).  That was tough on food consumers, just as destroying houses would increase living costs.  Despite what politicians say, that is how most government programs work — aiding one group at the expense of another group (often a much larger but less organized group).

Effects of too many vacant homes

The excess number of vacant homes will exert downward pressure on home prices and rents (in aggregate, vacant homes tend to become rentals).  Prices will stabilize eventually, when they reach a point at which investors will voluntarily accumulate inventory – vacant homes, which they will maintain until they can be sold or rented.  Under normal circumstances there is little housing inventory.  Due to the cost of homes (tied up capital, often financed) and the expense of maintaining them, there is little voluntary inventory.  For example, builders like to have new homes sold prior to completion.

This is one way of calculating a floor price for homes.  I have seen no attempts to determine this number, but it implies a low ultimate price for homes.  Below the equilibrium price calculated by the usual metrics, such as price to rent or home price to income ratios.  That is because too many vacant units is a disequilibrium, preventing normal dynamics from stabilizing the home marketplace.

How did this happen?

There are many reasons.  A combination of speculative activity (the Minsky cycle), excessive subsidies, lax lending, lax regulation of lenders, etc.  Does it matter now?  The crisis itself will force massive changes to home construction, finance, and ownership dynamics.  When things settle down we can look at the resulting situation and discuss reforms.  Until then discussing reforms is building castles in the air.


Much of the capital to build these excess homes came from foreign investors.  I doubt they are happy with the results.  Their views — our creditor’s views — on how the process should change might have more weight than ours (the debtors and future borrowers).

In this country we have long considered the Federal Reserve master of its own domain, able to direct and effect our course.  As the rest of the world’s economies emerge we will be forced to consider that our central bank is just one in a global community of central banks.  As that occurs foreign central banks will, rightfully, have more influence and input in our decisions and we will be forced to consider that.

— Charles Kindleberger, speaking in 2002 to Joshua Rosner of Graham Fisher, as reported in his report of 16 September 2008.  Kindleberger was a historical economist and author of over 30 books. He is best known for his 1978 book Manias, Panics, and Crashes.  Rosner’s summary:  “We are not alone, we are but one player in a global community and right now we are not holding many of the cards.

Originally published at Fabius Maximus and reproduced here with the author’s permission.