The word “shortage” has a very specific meaning. It refers to the inability to purchase a good at the current market price (or at any price). Rent control, which restricts the legal price of apartments below their market or equilibrium price, creates shortages. Many people would like to rent an apartment at or below the legal ceiling, but no apartments are available. 

The distinction can also be seen at the grocery store. $5 for a dozen eggs might be more than I am willing to pay, but this does not mean there is an egg shortage. When I am willing to pay the $5 price but there are no eggs on the shelf at my local grocery store, then I am experiencing a local (and likely temporary) shortage. 

By this reasoning, the US does not have a housing shortage. But it does have scarcer and higher-priced housing than people want. 

Prices signal relative scarcity – the interplay between supply and demand. FA Hayek famously argued that prices coordinate market activity and encourage consumers to act in prosocial ways: cutting back on their consumption of items that become relatively more scarce and increasing their consumption of items that become relatively more abundant. 

According to Hayek, it really doesn’t matter, in the moment, exactly why the price of a good rises. It could be that a supply shock has reduced the available supply. It could be that the demand has increased. It could be both. It could even be the case that supply increased but demand increased even more (think Nvidia and graphics cards). What matters to market participants for the purpose of calculation and decision-making is the resulting price.

Which brings us to the problem at hand: high house prices. There are many ways to assess how expensive houses are. We can look at indices like Case-Shiller (Figure 1). In real, inflation-adjusted terms the median price of a house is about eight times what it was forty years ago and one and a half times what it was four years ago.

Figure 1

We can look at the ratio of media housing prices to median income (Figure 2). The median price went from about 2.5 to 9.5 times median income.

Figure 2

We can also look at how affordable houses, including mortgage principal and interest payments, are relative to income (Figure 3). The US housing affordability index shows housing prices are less affordable than at any time in the past 35 years. 

Figure 3

These comparisons all tell a similar story: houses have become relatively scarcer over the past thirty years, especially over the past four. While some claim an “undersupply” of houses relative to past trends and relative to population growth drives the higher prices, that undersupply itself has likely resulted from decades of government intervention driving effective demand for housing ever higher.

The federal government has been boosting effective demand for housing since the early 1990s. The Community Reinvestment Act empowered regulators to loosen lending standards in terms of smaller down payments and lower credit scores. Although the reduction in lending standards was implemented in the name of making housing more affordable, it had just the opposite effect. As Peter Wallison has pointed out, 

“In 1989, nearly 90 percent of U.S. housing markets were considered affordable, with homes costing only three times more than annual family incomes. However, by 2005, after the affordable-housing goals had worked their ‘revolution,’ less than 33 percent of U.S. markets were deemed affordable under this standard, and 20 [percent of] markets were deemed severely unaffordable.” 

Housing looks more and more like the education and healthcare industries, through ever greater government involvement and distortion. The federal government influences the housing market by heavily regulating mortgage finance. It also distorts the market through tax code deductions for mortgage interest and various credits for first-time home buyers. Federal agencies continue to increase regulatory barriers to land use as well as increase energy efficiency and standards for materials.

The Federal Reserve was also a major culprit inflating housing values in the early 2000s and post-COVID. It will continue to be the culprit in its unwillingness to allow housing prices to return to earlier levels. The Bernanke Fed was quite explicit about its goal to “reinflate” the housing market after the 2008 Global Financial Crisis.

But states, counties, and municipalities also get involved in a myriad of ways from ever-stricter building codes to new energy efficiency standards and requirements, to longer and more costly permitting processes. Furthermore, zoning restrictions limit what kinds of housing can be built and where it can be built. Although these regulations seem piecemeal and decentralized, they have been driven indirectly by the effects of national policy.

Another effect is the relentless drive at the federal level of ESG priorities in housing such as subsidizing solar panels, encouraging more expensive energy efficiency designs, and handing out large sums of money for “sustainable housing” projects run by local governments. The problem of local “frozen neighborhoods” emerges from what Gordon Tullock called “the transitional gains trap.” 

When demand has been juiced through artificially low interest rates and regulatory reductions in underwriting standards, people can afford to buy more house – driving house prices way up. Subsidized mortgage financing artificially boosting home prices creates a ratchet effect. Rapidly rising housing prices over the past thirty-five years represent a real and significant gain for existing homeowners who see their equity increase. 

As their equity grows, though, homeowners become increasingly concerned about maintaining the high market price of their house. And unfortunately, due to extensive local governance of housing and its inability to move the way cars or people or factories can, these homeowners can enact anti-competitive laws to reduce the creation of new housing supply.

Tullock called this trap “transitional” because the gains are temporary. Existing homeowners benefit from a jump in housing prices, but new homeowners don’t. They had to pay more for their house. But both existing and new homeowners stand to lose if housing restrictions ease, new supply enters, and housing prices decline.

Reducing interest rates to low levels will not ultimately solve the affordability problem. In fact, returning to low interest rates will perpetuate the ratchetting of the transitional gains trap. Proposals to give even larger tax credits or government grants to first-time homebuyers will have the same effect. As Wallison also notes, “The great irony here is that when the affordable-housing goals were adopted by Congress, homes in the US were among the most affordable in the world.” 

We should jettison the nomenclature of “affordable housing.” We should not encourage, or even allow, government-owned and operated housing. Breaking the transitional gains trap will require broad-based support beyond those who stand to lose initially if housing prices decline. Opening up greater competition in housing will likely require state-level action rather than decentralized local reform (not that I am against that!). 

Deregulation of all kinds – in transportation, resource extraction, labor licensing, permitting, etc. – will reduce the cost of producing new housing. If local governments push ever more requirements on developers and homeowners – what appliances or materials they can use, mandating solar panels or parking and lot sizes, and the like – housing will become ever more scarce and more expensive over time. Reversing the transitional gains trap in housing will be tricky and costly to incumbents (just talk to a taxicab medallion owner). But it will generate significant long-term benefits in the form of more affordable housing for everyone.