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Business Observer Thursday, Jun. 4, 2009 11 years ago

Ground Zeroes

Economic research reveals a series of government missteps led to over-regulation of the housing industry in Southwest Florida, “tragically distorting” housing and creating the root cause of the real estate crises.
by: Jay Brady Government Editor

Economic research reveals a series of government missteps led to over-regulation of the housing industry in Southwest Florida, “tragically distorting” housing and creating the root cause of the real estate crises.

Before the housing boom kicked off in 1997, a typical lot in working class Lehigh Acres was $5,000. At the peak of it, that same lot may have sold for $55,000.

And now, according to Brad Hunter, of housing development tracker Metrostudy, it's back at $5,000 and may not have yet hit bottom. In one zip code in this 96-square-mile unincorporated city in east Lee County, one in eight housing units faces foreclosure.

Similar stories played out in nearby coastal Cape Coral, a pre-platted city of 114 square miles. There, a typical non-waterfront lot went from $20,000 to $110,000 in five years and is now back in the $20,000 range. Data from foreclosure expert RealtyTrac, shows one Cape Coral zip code has one in five dwellings in foreclosure.

And in North Port, a 105-square-mile, pre-platted community up Interstate 75 in Sarasota County, it has been more of the same. Middle-class working families, retirees and investors all were chasing homes or lots there because there weren't many other options in moderate price ranges in the county. The frenzy rose to a feverish crescendo as 2005 turned to 2006, and the bubble began to burst. There, in zip code 34286, one in 29 homes have been in foreclosure.

A group of experts have weighed in on the root causes of the meltdown that led to the national economic crisis now spreading throughout the globe. And although some point to different regulations on all different levels of government, these experts agree that regulation — that is, over-regulation — was the root cause.

Some have pointed squarely at Florida, and specifically Southwest Florida, as the geocenter of this economic apocalypse. An Aug. 9, 2007, “Financial Times” article citing the sudden and large price drops here says “Sarasota, Fla., is at the centre of the U.S. housing bust that sent shockwaves through global markets.”

Two days later, in a “Sarasota Herald-Tribune” front-page story about the British paper's article, Florida real estate analyst Jack McCabe disputes Sarasota being “the epicenter.” He asserts that Naples, Fort Myers and Cape Coral had the largest price drop in the U.S., though the new lower prices were still about double what they were in 2000.

More regs = price volatility
One of the earlier analyses of the real estate bubble as it began to deflate may be found in a Nov. 6, 2006, “Business Week” story titled “Boom! Bust! Boom?” Writer Peter Coy asks the question, “How do you know if your own local market is the kind that will snap back or the kind that will languish indefinitely?”

For answers, Coy turned to several experts including Harvard University economist Edward Glaeser who studies housing markets. Glaeser's conclusion: “'Restricted supply leads to more volatility in prices.'” Sarasota County's median price changes from 2000 to 2007 reflect the volatility. (See table.)

In 2000, the median price in Sarasota County was $122,000. By the first quarter of 2006 it exceeded $350,000 and by 2007 had dropped back to $253,200. The current average foreclosure price is $135,761, still relatively high in the region, so it's likely the median has fallen further and may have further to go.

Coy sums it up: “Places where new home construction is a long and expensive process ... tend to experience big price movements, both up and down.” Florida has become infamous for its voluminous growth management laws — legislation that the secretary for the Department of Community Affairs describes as “huge” and “bloated.”

Add to the growth management laws unwieldy state, regional and local permitting processes, plus some of the highest impact fees in the nation, and Florida and Gulf Coast communities fit the bill for boom and bust based on overregulation. With the lot and home price volatility of Sarasota and Lee counties, evidence abounds that over-regulation played a big part in the economic demise of the region and beyond.

Ironically, it appears it wasn't the pre-platted communities' own regulations that did them in (Lehigh Acres, in fact, is unincorporated), but the regulations of their counties, Lee and Sarasota, that may have played the villain in this real estate economics drama. The immediate surrounding counties — Manatee, Charlotte and Collier — weren't providing much of a relief valve because they also tightened development rules and increased building fees.

In a column published in the Review last August titled “Land Market Distortions,” economists Wendell Cox and Ronald Utt conclude: “These severe land use regulations lead to denying young and moderate income households the American dream of home ownership. It has also led these same people to use risky mortgage finance schemes to overcome the high housing costs these regulations have caused.”

Driving to qualify
The first half of this decade was marked by daily headlines decrying the lack of affordable housing, particularly in Sarasota and Collier counties.

And Lee County was no bargain, either. Prices hit an all-time high there in December 2005, when the median cost of an existing single-family home reached $322,300. Family incomes couldn't keep up.

The only viable options for purchasers of homes under $300,000, or lots costing less than six figures, were places such as North Port, Lehigh Acres and Cape Coral. As shown in the table, these cities were getting larger shares of their respective county's new growth this decade despite the absence of basic services, commercial centers and employment opportunities.

Lee County Planning Director Mary Gibbs says, “We used to call Lehigh Acres the sleeping giant,” and points to cheaper land as the magnet because of the pre-platted lots that don't have expensive central utilities or permitting nightmares.

Now, with bank-owned home sales accounting for 74% of Realtor-assisted sales in April, the Cape Coral-Ft. Myers metropolitan area can claim the most giant median price percentage drop between the first quarter of 2008 and this year's first quarter — a stunning 59.1% decline. The county unemployment rate as of April was 11.9% while the state unemployment rate stood at 9.3%.

The peak median home price in Sarasota County breached $350,000 in the first quarter of 2006 before falling currently to $253,200. The April unemployment rate for the county is 10.2%.

The median home price drop of 40.8% over the last 12 months for the Sarasota-Bradenton-Venice market area ranks it No. 7 in the country. Nationally, home prices have dropped 32.2% since the peak in July 2006 and 13.8% in the last four quarters.

Evidence of workers not being able to find housing in close proximity to jobs in Sarasota and Lee counties is found in commuter data. Before the bust, more than 14,000 more commuters drove into Sarasota County than commuted out. A similar situation was occurring with workers driving from Lee to Collier.

'Seals of approval'
Local and state regulations are not the only culprits, but it's not difficult to connect the dots suggesting that growth laws, particularly in Florida and California, gave rise to looser monetary policy and relaxed lending standards leading to mortgage-backed securities, credit-default swaps and collateralized debt obligations.

These now-infamous structured investment vehicles enabled banks to insure certain loans, allowing them to make more loans with their available capital. For people desperate for housing they could afford, it enabled them to be homeowners, and federal government policies and actions supported that.

One major policy shift came in 1997 with elimination of taxes on residential capital gains up to $500,000, and that's when the Case-Shiller house price index began its nearly 10-year climb. The experts say the rising home values, as for any appreciating asset, drew buyers' attention, which became self-reinforcing, drawing in less and less sophisticated, and more speculative, purchasers.

But it was when the Securities and Exchange Commission and the Federal Reserve gave their blessings to the major ratings agencies, allowing them to give their triple-A seals of approval on thousands of these investment vehicles, that “made the whole system work,” according to Gillian Tett, author of Fool's Gold, a recent book about the financial meltdown of 2008.

In May, “Fool's Gold” book reviewer James Freeman, assistant editor of the Journal's editorial page, wrote, “... Ms. Tett's reporting describes not an out-of-control free market but one tragically distorted by government regulation.”

To address the growing affordability problem, both the Clinton and Bush administrations pursued aggressively expanded home ownership, not seeing that it would lead to relaxed credit standards.

President Bush issued “America's Homeownership Challenge” to the real estate and mortgage finance industries to encourage them to close the gap between homeownership rates of minorities and non-minorities.

With prices rising after 1997, The American Dream Downpayment Act was signed in Dec. 2003 at the urging of sponsors Sen. Mel Martinez, R-Florida, and U.S. Rep Katherine Harris, R-Sarasota.

That was a big turnaround from 2000, when lenders NationsCredit and EquiCredit were brought before a congressional committee accused of making high-interest-rate loans to lower-income borrowers, known as predatory lending.

Expected appreciation
On May 20, President Barack Obama blamed lenders and irresponsible borrowers as he signed “The Helping Families Save Their Home Act.”

In March 2008, Kevin Hassett of the American Enterprise Institute, rebutted that claim in a paper titled, “Regulations Are at the Root of U.S. Housing Mess.”

He explains the prevailing story that the housing bubble somehow resulted from the misbehavior of greedy homebuyers and risky lending practices is nothing more than “a tremendous convenience for politicians,” arguing it's an oversimplification saying with a bit of sarcasm, “A bubble is the explanation of a price swing that remains when all others have been rejected.”

Hassett explains a number of contributing causes at the federal level, including low interest rates and increased credit availability for less-qualified borrowers.

He also joins the chorus citing growth management planning that effectively restricted housing supply and references the 2006 work of economist Randal O'Toole, who concluded that “'the price of a median home in the 10 states that have passed laws requiring local governments to do growth-management planning is five times the median family income in those states. In contrast, a median home in the 22 states that have no growth-management laws ... cost only 2.7 times the median family income.'”

At their peak, in Lee and Sarasota counties the median housing price was about 5.6 times median family income in Lee, 5.8 for Sarasota, 4.5 for North Port and ranged up to 5.1 in Cape Coral and Lehigh Acres. (See table.)

A median multiplier of 3.0 or less is considered affordable.

Many devoted more than 50% of their income to housing — more than the 30%-35% recommended maximum. To help offset the high costs, working families sought out pre-platted communities. There, land prices and what
O'Toole calls “planning taxes,” were much lower due to the lots supply, but it had become the only game in town. The sleeping giants were awakened.

That worked somewhat for these communities' homebuyers for a period of time before rising costs due largely to regulations and fees in surrounding areas forced up prices in the pre-platted communities, too. The heavy leverage needed for working class homebuyers ultimately became the undoing of financial institutions as prices fell, adjustable loans reset and unemployment rose.

For decades, the national, state and local housing markets had trended up. With Gulf Coast county governments' restrictions on lot supply, and higher impact fees on the horizon, reasonable investment-backed expectations were for continued new housing limits and higher new home building costs. Thus, the upward price trend was expected by the market to continue.

The expected price appreciation was also part of lenders' thinking according to Hassett. As long as home prices rose they could cover their losses from loans to less-qualified homebuyers if borrowers defaulted.
Hassett's conclusion: “The evidence is clear. Regulations that inhibit the supply response to higher prices are the primary culprit in this mess.”


Economists whose studies show correlation between high housing costs, subsequent real estate bust and heavy land-use or housing finance regulation:

• Wendell Cox, Institute for Economic Policy Studies
• Theo S. Eicher, University of Washington
• Steven Gjerstad, Chapman University
• Edward L. Glaeser, Harvard University
• Joseph E. Gyourko, University of Pennsylvania, Wharton School
• Kevin A. Hassett, American Enterprise Institute
• Stephen Malpezzi, University of Wisconsin
• Christopher J. Mayer, Columbia Business School
• Jeffrey Miron, Harvard University
• Randal J. O'Toole, Cato Institute
• Todd M. Sinai, University of Pennsylvania, Wharton School
• Vernon L. Smith, Chapman University
• Ronald D. Utt, The Heritage Foundation

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