The red lights are beginning to flash on the dashboard of the housing economy in the United States and around the world. As 2022 comes to a close, it has become clear that easy money in 2021 led to a buying frenzy and higher housing prices. As the values of those purchases fall and interest rates climb, financing for housing production will freeze up. And as 2023 unfolds, consumers are likely to see prices decline but the costs of borrowing money rise to put housing out of reach. Builders are bracing for a slowdown like the one that hit the industry back in 2009, which inaugurated a decade-long slowdown in housing production. What should policy makers at the state and local level do to avoid a repeat of the last housing collapse?

Since the end of World War II, government-backed loans have enabled a boom in single-family housing construction and acquisition. Congress created Fannie Mae and Freddie Mac, in the words of the Federal Housing Finance Agency, to “perform an important role in the nation’s housing finance system – to provide liquidity, stability and affordability to the mortgage market. They provide liquidity (ready access to funds on reasonable terms) to the thousands of banks, savings and loans, and mortgage companies that make loans to finance housing.” By 2009, confidence in this backing had tempted investors to bet on risky mortgages that allowed many people with thin credit to borrow money to buy houses; when those debtors couldn’t pay, all that bad debt was worth more than the asset value of many of the companies that owned it. 

Suddenly, a white-hot housing market with lots of buyers, sellers, and builders completely shut down. Housing is expensive and complicated to finance, even when people with solid employment, great credit, and cash have to borrow. When lending decreased, so did buying and, thus, building. But builders also borrow to build. When a housing producer buys land, secures labor and materials, he does so with borrowed money. When consumer lending stopped, and the customers for their products disappeared, builders were often left with land, projects in progress, or houses they couldn’t sell—and debt payments that still needed to be made. This cycle is repeating itself.

A story in the Wall Street Journal digs into the crisis:

“After a pandemic-fueled buying spree that unleashed the most powerful U.S. housing boom in 15 years, demand has plummeted as mortgage rates have risen. Finished homes are sitting on the market, hundreds of thousands of new ones are expected to be completed in the coming months, and many builders are cutting prices. Existing-home prices are declining from their springtime peaks, and single-family home construction in September fell 18% from a year earlier.”

Many developers and builders have watched these developments and are not prepared to deal with them. I spoke with a builder in Nashville, Jeremy Seaton, who told me the same story from the Journal post: many builders, he says, borrowed money to build as prices ramped up and people surged into the market. “Now there are people holding on to debt payments of $34,000 per month,” he said, “and they can’t find any buyers.” 

Many of these builders are facing potential bankruptcy, which would mean layoffs and more bad debt. But it would also mean that secondary and tertiary business in the housing economy will begin to feel the same effects. The timing couldn’t be worse as inflation is adding to production costs and making everything more expensive. While the sticker price on a home climbed rapidly, in today’s inflationary environment, people can’t pay for the house. 

The Economist explains this phenomenon in a recent post:

“Take, for example, someone who a year ago could afford to put $1,800 a month towards a 30-year mortgage. Back then they could have borrowed $420,000. Today the payment is enough for a loan of $280,000: 33% less.”

This is aggravated by regulation. Seaton kicked up a bunch of dust with local officials in Nashville earlier this year as his permits were stuck in the review process. There was no problem with his compliance with the codes—something that for most builders is a matter of course—but apparently no one had reviewed and signed off on the documents that would allow the project to continue. It is often the case that projects hit a standstill not for a lack of supplies or labor, but because someone downtown hasn’t stamped a document three times. 

Many on the left blame high prices on the “greed” of developers and builders, but this simply isn’t the case. Prices are determined by costs and what buyers can afford to pay. Banks and lenders condition loans on a loan-to-value ratio (LTV) of 20 to 25 percent, meaning projects have to cover more than just the costs. As costs rise, there is no place to recover those costs but from raising the price, and lenders expect to see a return higher than just breaking even. 

But when local government can’t or won’t review projects, time slips away, and economic variables change. Today, that’s exactly what is happening. The music has stopped playing, and the lengthy development-approval process means many lenders, developers, and builders aren’t going to find a chair. Many might be unsympathetic, as by nature a market involves risk and reward; some people win, some people lose. But the problem doesn’t end with lost money and jobs. As production declines in the next year, so will supply. 

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Government can get in front of this crisis by getting out of the way. We know that economies are cyclical and there will be a recovery. After the last downturn ended and the lights came back on, housing prices “skyrocketed.” The media loves that word, and it filled the headlines along with calls for everything from more taxes on new housing to rent control. Rarely does the government recognize higher prices as evidence of too much money chasing too few goods. The public screams about rising prices and elected officials and candidates for office promise to punish people making money from that suffering with rules, regulations, taxes, fees, and fines. Of course, this reduces production, raises costs, and fuels even more inflation. 

Now is the time to incentivize building. How? Not with more money but with fewer rules. Earlier this week, I spoke with a sympathetic elected official who agreed, in principle, that regulation slows production, adds costs, and thus, boosts consumer prices. But how, she asked, can overworked bureaucrats review so many proposals? We need more money for planning departments, she suggested, to reduce the slowdowns experienced by builders like Seaton. 

That’s a reasonable answer, but the wrong one. Local governments don’t need more people to review growing code compliance requirements but fewer requirements. If the rule book gets smaller, fewer people can do the job and faster. If state and local governments act today to review their codes to remove anything that doesn’t directly benefit health and safety, it could help get some projects to market more affordably even in the near future. And when the economy does recover—which it will—and demand begins to rise, prices won’t surge and consumers will have the benefit of a more balanced housing market. Beginning the process of unwinding a decade of regulatory efforts to punish the private sector for profits should begin now; in the coming storm facing the housing economy, the ship needs less ballast, not more.