Housing’s Drag on the Economy

By Ike Brannon

Nearly every household in the country spends a sizable proportion of its income on housing. The median household allots over one-third of its income to keeping a roof over its head, and the annual expenditure of the median earner’s income on housing has increased by 35 percent since 2000.
People for the most part aren’t spending more on housing because they are buying bigger or nicer houses, although some of that obviously has taken place. But most of this growth has been driven by an increase in cost. Housing prices have grown steadily in recent decades and are nearly twice as high today as they were 25 years ago, on average—a pace that far exceeds gains in income for the average household. After a sizable retrenchment in 2008-2010, prices have nearly returned to pre-recession highs, although some regions of the country are languishing.



When demand for a good increases, it normally triggers an increase in the supply, but this has not been happening all that much: New housing starts fell almost 80 percent from the pre-recession peak to the 2009 trough, and today are at only 60 percent of those heady pre-recession numbers. So things have bounced back over the last seven years, but home-building is still well below historical norms.

The sustained, profound decline in housing starts cannot merely be explained as a hangover from the housing bubble. Nine fallow years of homebuilding have left us with a housing shortage. We can glimpse this in part by looking at rates of ownership, which have fallen from 69 percent to 63 percent in the last decade. Home ownership has fallen even more among young adults, declining from a peak of nearly 50 percent in 2004 to under 42 percent today.
The housing market’s biggest constraint at the moment is tight credit standards. Most mortgages are purchased and bundled into securities that are essentially guaranteed by the federal government in one way or another. However, in order to prevent the sorts of excesses that created and exacerbated the Great Recession, the government retains the right to put the housing risk back onto the bank if it finds any problems with the mortgage. As a result of this, banks are understandably more cautious in making loans. More prudence is not an altogether bad thing, but there are families who have good credit and a decent income who are finding it difficult to purchase an affordable home.
The regulators are also putting more pressure on banks to rein in “unusual” housing loans. When I approached my hometown bank in central Illinois, where I have banked all my life and whose president I have known almost as long, about getting a nonconforming mortgage for a house in Washington, he told me he would rather not do it—not because it would be a risky bet for him (our down payment would be 50 percent) but because he and his lending team would find themselves burdened with paperwork to justify to their regulator a loan that would be anomalous in their portfolio, regardless of its surety.
What’s more, federal regulations requiring new houses to be more energy efficient and environmentally friendly have greatly added to the cost of residential construction in the last eight years. A home builder from central Illinois told me recently that his construction costs for a new home have increased by one-third in the last eight years, making the purchase of an existing home much more affordable than building a new one. While energy-efficiency should be worth a premium to buyers, modern heating and air conditioning and the like save homeowners money, but only in the long run. Research indicates that most consumers completely discount savings like this that go beyond three years.
Developers in many communities also face substantial bureaucratic inertia. In the wealthy neighborhoods in Washington (and other large cities), every new development invariably faces substantial opposition from local neighborhood committees, city councilors, zoning boards, and a surfeit of activists worried more about, say, their free on-street parking than housing costs for their less-well-off brethren. These constraints on new housing help make middle-class housing even more unaffordable.
The dearth of new homes has had a significant impact on the economy. An analysis by Moody’s Analytics suggested home construction boosted GDP by 1 percentage point at its peak in the mid 2000s, and in 2009-2012 its dearth reduced growth by 1.5 percentage points per annum.
The impact that sluggish home construction has had on the broader economy is substantial. A report by the NFIB estimated that the construction of a new home creates, on average, three new full-time jobs. By that metric the 2016 data showing we had one million fewer housing starts than before the Great Recession translates to three million fewer jobs.
A return to a healthy housing market would create an enormous boost in the employment of blue-collar men, a cohort that was hit particularly hard by the Great Recession and remains in a funk. There are currently seven million men between the ages of 25 and 54 without a job—fully 12 percent of this population, which a generation ago economists referred to as the “hard-core employed” for their invariant—and low—unemployment rates.
There are myriad reasons for this seismic change, of course—that most women remain in the labor force after having children means that there is less urgency for married men to work, and fewer of these men support a family these days for that matter.
But a major source of blue-collar jobs has always been home construction, and a large number of those jobs have vanished with the decline in housing. President Trump’s proposal to drastically increase infrastructure spending may help this group, but building roads and bridges is not terribly labor intensive. While such investment would be welcomed by this group, the level of job creation from it would be dwarfed by the effect of a more vibrant housing market.
The potential economic gains from a rebound in housing could be significant, at least in the short run. If the construction of new homes merely returned to the long-run average of the 1970s and 1980s that would mean a million more homes being built each year. If we returned to the per-capita rate of new home construction experienced in those decades, it would amount to another two million homes constructed per year.
Home-building at that pace would add another $300-$600 billion a year to GDP, which exceeds 3 percent of GDP. The mythical 4 percent growth rate goal that so many derided as unrealistic during the 2016 presidential campaign could actually be within reach, at least until real labor shortages would start to constrain the economy. Given the number of discouraged workers in the economy that could take some time to occur.
We make numerous mistakes in housing policy: Myriad regulatory restrictions depress the construction of new homes, and the mortgage interest deduction sacrifices tens of billions of dollars to encourage the wealthy to spend more on housing while doing little to nothing to help middle-class buyers afford homes.
While changing either of those factors may be difficult, there are other means to boost home construction. Fannie Mae and Freddie Mac have operated under the equivalent of a yellow flag since Treasury put them into conservatorship in 2007, and the Obama administration’s issuance of its Third Amendment to the conservatorship in 2012, sweeping their entire net wealth into Treasury’s coffers each quarter, amounted to a red flag. Removing Fannie and Freddie from their current limbo and recapitalizing them one way or another could boost financing for housing construction. This would doubly benefit blue-collar workers, not only creating jobs but also providing more affordable homes as well.
While constructing more housing is by no means a panacea for the cohort of blue-collar men who have been buffeted most severely by the economic dislocations of the last twenty years, it would represent a tangible step towards improving their lot.
We can—and have in the past—gone too far in singing the praises of home ownership, and overenthusiastic boosting of home construction led to a financial disaster. But the decade-long retrenchment has now led to significant problems for the economy as well. Maybe there’s a happy medium.