Everyone agrees that the recent financial crisis started with the deflation of the housing bubble. But what caused the bubble? Answering this question is important both for identifying the best short‐term policies and for fixing the credit crisis, as well as for developing long‐term policies aimed at preventing another crisis in the future.
Some people blame the Federal Reserve for keeping interest rates low; some blame the Community Reinvestment Act for encouraging lenders to offer loans to marginal homebuyers; others blame Wall Street for failing to properly assess the risks of subprime mortgages. But all of these explanations apply equally nationwide, while a close look reveals that only some communities suffered from housing bubbles.
Between 2000 and the bubble’s peak, inflation‐ adjusted housing prices in California and Florida more than doubled, and since the peak they have fallen by 20 to 30 percent. In contrast, housing prices in Georgia and Texas grew by only about 20 to 25 percent, and they haven’t significantly declined.
In other words, California and Florida housing bubbled, but Georgia and Texas housing did not. This is hardly because people don’t want to live in Georgia and Texas: since 2000, Atlanta, Dallas–Ft. Worth, and Houston have been the nation’s fastest‐growing urban areas, each growing by more than 120,000 people per year.
This suggests that local factors, not national policies, were a necessary condition for the housing bubbles where they took place. The most important factor that distinguishes states like California and Florida from states like Georgia and Texas is the amount of regulation imposed on landowners and developers, and in particular a regulatory system known as growth management.
In short, restrictive growth management was a necessary condition for the housing bubble. States that use some form of growth management should repeal laws that mandate or allow such planning, and other states and urban areas should avoid passing such laws or implementing such plans; otherwise, the next housing bubble could be even more devastating than this one.