Urban Returns

Is it really necessary for the federal government to introduce new market distortions?

For the reasons I just gave, I don't believe that our past subsidies to suburban development justify maintaining those investments.  End them and let the chips fall where they may.

But even if reasonable people can disagree about that, I see no argument for creating new subsidies.  But that is exactly what our federal government is about to do.

The FHA is a major player in the mortgage business.  It insures mortgages for home buyers who otherwise would not be able to get credit or scrape together a down payment; this allows some to buy homes with as little as 3.5% down.  Without the FHA guarantees, the mortgage market would be much smaller.  A few years ago, its share of the market was 2.7%.  This seemingly small share had an outsized effect by scooping up the biggest credit risks and reducing the risk for private mortgage insurers.  In any event, its share of the market has ballooned recently:  according to Friday's WSJ, its market share reached 23% in the second quarter of this year.

And now the FHA is about to adopt new rules explicitly encouraging home buyers to purchase single-family, detached housing in the suburbs rather than attached (condos) in urban cores:

Until now, almost any condo development could apply to FHA for “approved” status, therefore making FHA financing available in that development.  In addition, in developments that were not approved, “spot approvals” were sometimes available for individual units.  (The lender applied for an approval for the unit you wanted to buy, in spite of the development not being approved).

Following are the new guidelines:  (This is not pretty, so prepare yourself)

1. There will be NO more spot approvals.

2. All development not considered primarily residential are out.  For instance, a development with more than 25% of the total floor area dedicated to commercial business use is out.

3. Noise issues is a new concern, so any development within 1,000 feet of a highway, freeway, or heavily travelled road, 3,000 feet of a railroad, 1 mile of an airport, or 5 miles of a military airfield will become ineligible for approval.

4. If the property has an “unobstructed view , or is located within 2000 feet of any facility handling or storing explosive or fire prone materials, it is not insurable - we're not talking just fireworks factories here.  A gas station 2 blocks away can disqualify this development.

5. Any property located within 3000 feet of a dump, landfill, or superfund site, is ineligible.

6. No more than 10% of the properties can be owned by a single investor, including builders or developers who are renting out or have not yet sold vacant units.  For 2-3 unit developments, no one can own more than one unit.

7. No more than 15% of the homeowners can be more than 30 days late on their homeowner dues.

8. For new developments, at least 50% of the units must be sold prior to applying for FHA approval (valid presales include those with purchase agreement and lender validation of an approved loan in process)

9. A minimum of 50% of the units must be owner occupied or sold to owners who intend to occupy as their principal residence.

10. Projects in designated wetland and flood zones will not qualify.

11. All current condominium project approvals will be invalid (with the exception of projects approved on or after October 1, 2008) and projects must be re-approved under the new options available.  Going forward, all projects will require recertification every two years.

Perhaps most insidiously, the FHA will no longer insure more than 30% of the units in a single condominium development.

I understand that the FHA has been taking large losses on its guarantees.  I also understand that condominiums are riskier to insure than single-family homes.  Some of these new regulations seem reasonable -- it's probably a bad idea to invest in a condominium when the condo association lacks the resources to pay for upkeep.  Higher risks justify higher premiums, too.

But these new regulations seem purposely designed to push new homeowners out of dense, urban areas to the suburbs.  They exclude many mixed-use developments (#2).  In a central city, it is hard to find a condominium not within 1,000 feet of a highway, freeway, or heavily travelled road, 3,000 feet of a railroad, or one mile from an airport (#3).  Allowing developers to tap into FHA guarantees for entire single-family subdivisions but only 30% of condominium units naturally will encourage developers to shift to single-family subdivisions.  These new regulations are fundamentally anti-urban.  

Even if it is somehow possible to defend our existing scheme of suburban subsidies, is it really possible to defend introducing new market distortions?   

(Cross-posted at Austin Contrarian; comment there.)

Path dependence

Ryan Avent has had some back and forth with Tyler Cowen and Will Wilkinson over roads and rail.  Tyler and Will acknowledge that, yes, our reliance on roads rather than rail has been influenced by long-standing government subsidies.  But by now we have sunk so much into roads, and have built up so much road infrastructure, that the marginal cost of adding to our road network is much lower than creating a viable rail network from scratch.  In other words, our past investments have had a lock-in effect, and there's no wishing it away.  

Ryan responds that Tyler and Will are committing the "sunk costs" fallacy, but I'm not sure that's right.  Past investments matter a lot because they have generated network externalities.   One million dollars spent extending an already extensive network is often worth more than one million sunk to build a network from scratch.  

But Ryan is right that past investments in suburban infrastructure do not require us continue throwing up barriers to denser developments:  

In practice, the US is far from done building.  Tens of millions of new homes will be built in the coming decades.  Hundreds of billions of dollars will be spent on transportation infrastructure.  The current built environment has, as a result of decades of government policy, taken on a rather suburban, auto-centric tilt.  So what?  No one is suggesting that we tear down all of that and replace it with something entirely new.  I, and others, are suggesting that making it easier (or, you know, legal) to build in a denser, more walkable fashion would be advantageous.  Similarly, given the burden of maintaining such a large and costly road infrastructure, it might be wise to devote a larger share of dollars for new construction to substitute technologies.

And bear in mind that a technology's lock on the market is not always as secure as it seems.  A small initial advantage allowed VHS to dominate the videotape market, all but squeezing out Betamax.  But it did not save VHS from the DVD, even though a vast infrastructure had been created to support VHS:  video players, Blockbuster, video cameras and a complete library of titles.  All wiped out by a superior technology.   

Now imagine the government had subsidized VHS to help it fend off insurgencies from new technologies.  At best, many of us would still be stuck with an inferior technology.  At worst, there would be no DVD.  The government should let these things work themselves out in the marketplace; that's the true libertarian position.

All of this means that the government should let denser development happen.  Stop the  subsidies and tax policies -- including subsidies to new highways -- that encourage shifts to the suburbs.  There are perfectly sound economic arguments for investing in rail lines in some situations; make those investments.  Many home buyers, probably most, will continue to settle in the 'burbs.   But we can't anticipate shifts in technology.  Nor shifts in preferences or energy costs.  We think we can.  But we really, really can't.   If the housing market would continue down today's path anyway, fine, but the government shouldn't lead it by the nose.  

(Cross-posted at Austin Contrarian.  Comment there.)

Yet another entry about high-speed rail

The national bloggers continue to debate the feasibility of a high-speed rail link between Houston and Dallas.  Up to bat:  Megan McArdle.

I think reasonable people can disagree about the feasibility of HSR, especially since we're just trading  back-of-the-envelope calculations of HSR's costs and benefits.  Although I've argued HSR opponents underestimate the benefits to business-class passengers, in the interest of fair and balanced coverage, let me point to Richard Green's discussion of a more rigorous effort to tote up the costs and benefits.  The authors of that particular study give HSR the thumbs down.

And while I'm in a contrary mood, let me suggest one other potential cost of a Houston-Dallas line.

Everyone agrees that in order for such a line to succeed, it must draw airline passengers to rail.  Lots and lots of airline passengers.  If the airlines lose, say, half of their Houston-to-Dallas traffic, they will have to cut the number of flights between Houston and Dallas.  Obviously.  Many consider that a feature, not a bug.

But what about the effect on other routes?  American is able to offer service from Dallas to virtually every American city because of the huge number of passengers flowing into DFW every day.  Cutting that inflow will reduce the economies of scale that support so many flights.  Ditto with Southwest out of Hobby.    Houston is a huge feeder for DFW, if the number of Bush-to-DFW flights is any indication.  Similarly, Love is a huge feeder for Hobby, judging by the 24+ daily flights.  Networks can be delicate things.  Shrinking one route could sicken other segments. 

HSR could very well make it easier to get from Houston to Dallas and vice versa.  But it could very well make it harder to get anywhere else.   

Cross-posted at Austin Contrarian; comment there.