New Geography

Tag: Financial Crisis

  • The Financial Crisis: Bubbles Deflating Worldwide

    The mortgage meltdown is much more than an American affair. Real estate bubbles have developed in all major English speaking countries – US, Canada, UK, Ireland, Australia and New Zealand.

    Over the past year, house prices have dropped 12 percent in the United Kingdom. The annual decline is approaching 10 percent in Ireland, while median house prices have dropped six percent in New Zealand. In each of these countries, the price declines started after the United States. Further, each of these nations has experienced massive nationwide housing inflation, in part, I believe, as a result of highly restrictive land use policies. These policies, often known as ‘smart growth’ have made it virtually impossible to build new housing on the fringe of urban areas inexpensively.

    Where prices will finally settle, no one knows. Some analysts soothe the market claiming that the bottom is near. But many, including The International Monetary Fund, predict the worst of the mortgage crisis is yet to come in the United States. Similarly, former chairman of the council of economic advisors, Martin Feldstein suggested last week that prices would fall to their pre-bubble levels, as did I in this space as well. That’s what bursting bubbles is all about – prices that drop to pre-bubble levels.

    Canada is another story. Like the United States, housing costs remain within historic norms where there is traditional land use regulation, while restrictive land use regulation has led to a housing bubble in some markets. This is especially true in Vancouver, where there has been some minor price softening in recent months. Bank of Nova Scotia officials have indicated that they do not expect the kind of bubble bursting in overpriced Canadian markets that has occurred in the United States, at least partially because there was a lower volume of profligate lending (subprime, etc.) in Canada.

    Janet Albrechtsen, a columnist for The Australian writes in The Wall Street Journal that the Australian financial system also is healthier than America’s, at least in part because of more stringent mortgage regulation. If her analysis is right, Australia could be spared the mortgage meltdown that is engulfing America, the United Kingdom, Ireland and New Zealand. Thus, far, there is little indication of declining house prices in Australia.

    That does not mean there is no bubble. Even with strong banks, Australia has a problem. A housing bubble as pervasive as the United Kingdom has developed in Australia, despite its wiser financial regulation, House prices have risen to from two to three times the historic Median Multiple (median house price divided by median household income) norm of 3.0.

    The Australian bubble, like in the United Kingdom, Ireland and New Zealand (as well as parts of the US) has been spurred by overly restrictive land use regulation, which forces land prices up and causes them to explode even with moderate increases in demand. In response, the Median Multiple has increased to more than double the historic norm in all major capital cities. As a result, younger and future Australians have to pay far more of their income for housing than those who came before. So, while superior regulation may have kept Australia’s banks healthy, the prospects of many younger members of society have been greatly diminished. They will have been the victims of the largest inter-generational transfer of wealth in the nation’s history.

    Despite Ms. Albrechtsen’s optimism, it is not yet clear that Australia’s bubble will not eventually burst. Certainly falling commodity prices could hurt the employment situation, particularly for middle and working class Australians who are now struggling to pay ever higher percentages of their incomes for housing. Australia may have remained ‘the lucky country’ so far in terms of real estate. But whether that will persist in the coming months is still open to question.

    Note 1: http://www.demographia.com/dhi.pdf.

    Wendell Cox is a Visiting Professor, Conservatoire National des Arts et Metiers, Paris and the author of “War on the Dream: How Anti-Sprawl Policy Threatens the Quality of Life.”

  • Financial Innovation: Wall Street’s False Utopia

    In the popular media much of the blame for the current crisis lies with sub-prime mortgages. Yet the main culprit was not the gullible homebuyer in Stockton or the seedy mortgage company. The real problem lay on Wall Street, and it’s addiction to ever more arcane financial innovation. As we try to understand the current crisis, and figure ways out of it, we need to understand precisely what, in the main, went wrong.

    I have studied financial innovation for years and worked with some of the best minds in that business. In 2003, I wrote in Beyond Junk Bonds that financial innovation is the “engine driving the financial system toward improved performance in the real economy”. Innovative debt securities, like collateralized mortgage obligations (CMOs), I had hoped, would add value to the economy by reallocating risk, increasing liquidity, and reducing agency costs. Like the broken promises of communism, it turned out to be a utopia that was not achieved.

    CMOs were designed to diversify risk by shifting risk to larger, better capitalized and diverse institutions. Traditionally, a bank in Riverside, California would write and hold the mortgages for homes in the area. Then, if some negative shock impacted jobs and income in the area, that bank would have to absorb all of the resulting defaults. This would put the local bank at an inordinate risk. With CMOs, the risk would be spread out across banks and investors in a broader geographic area. Since CMOs could be held internationally, even a nationwide economic downturn might have little impact on any single mortgage holder.

    Unfortunately, the dealmakers sold the riskiest pieces to a few hedge funds, thereby consolidating the risk rather than allocating it broadly. The result was the spectacular crash of Bear Stearns and the incendiary damage done to a slew of US and international financial institutions.

    CMOs were supposed to produce more money available for lending to homeowners than would otherwise have been the case. Instead it produced more paper, more heavily leveraged and less secure. Securitized mortgages were misused to the extent that $45 trillion in bonds were issued on $5 trillion in assets; it’s as if someone bought insurance for 9 times the value of the house. By 2007, the market was over-sold: more bonds had been sold than could be delivered, possibly even more than had been issued. On average, nearly 20% of CMO trades have failed to settle since 2001, driving down the price of the bonds.

    CMOs should have been used to protect against conflicts of interest between managers, stockholders and bond holders (agency costs). Instead, the same companies that issued the CMO were buying large positions in the securities. Most CMOs are typically initiated by banks seeking to remove credit risk from their balance sheets while keeping the assets themselves. Normally, these securities are issued from a specially created company so that the payments from the riskiest borrowers, i.e. the sub-prime mortgages, can be separated from the more credit-worthy payees. A trustee and a portfolio manager receive fees from the newly created company.

    While CMOs reduced some of the risk to the local banks, it also led some of those banks to lend imprudently. With the cash flowing easily back to the banks after the CMOs were sold, some lenders became increasingly risk-seeking – the opposite of the intended purpose of CMOs. Companies like Bear Stearns, who acted as trustee and portfolio manager for the CMOs, also purchased the CMO securities (usually through a subsidiary hedge fund).

    Critically missing from the market for CMOs was the lack of a standard for the issuance. In more than one case, when a CMO investor attempted to foreclose on a property for mortgage delinquency, courts found insufficient documentation to support the CMO’s lien on the property. Without legally binding “receipts” of ownership, CMOs
    have had insufficient real backing — producing results we are still trying to cope with.

    Sure, sub-prime mortgage defaults were the straw that broke the camel’s back. But Bear Stearns was in financial difficulty three to six months before the sub-prime mortgage default rate spiked. The real fundamental problem lay in the multiple sales of mortgages through CMOs – the result of too much faith in financial innovation. Experts believe that, for every $1 of mortgage that defaulted, the investment banks fell behind as much as $15 in payments on the CMOs. These, not the actual mortgages of homeowners, represent the bulk of the securities that Treasury Secretary Paulson wants $700 billion to buy.

    Susanne Trimbath, Ph.D. is CEO and Chief Economist of STP Advisory Services. Dr. Trimbath’s credits include appearances on national television and radio programs. Dr. Trimbath is a Technical Advisor to the California Economic Strategy Panel and Associate Professor of Finance and Business Economics at USC’s Marshall School of Business. Dr. Trimbath was formerly Senior Research Economist at the Milken Institute and Senior Advisor on the Russian capital markets project for KPMG.

  • Mortgage Credit Crisis: Homeowners Also Need to Look in the Mirror

    There is more than enough blame to go around for the sub-prime mortgage crisis, and the unraveling financial disaster. But I believe the fundamental blame lies in two places: A purely American NIMBY myth about homeowners being the only genuine contributors to their communities and a capitalistic axiom, presumably started and perpetuated by a troika among realtors, homebuilders, and mortgage lenders, that the only way for middle-income Americans to truly create wealth is through homeownership.

    The main mechanism for translating these two, fundamentally flawed “principles” into an action plan was hatched not under the rightly derided George Bush but the widely considered economic stalwart, Bill Clinton. It was Clinton who in his second term decided that what the United States really needed was to become the greatest nation of homeowners ever. The goal: Move the country from roughly 64% homeowners to over 67%.

    It was the role of the two Government Sponsored Entities, Fannie Mae and Freddie Mac, to oblige this national imperative by creating very aggressive mortgage products that, for all intents and purposes, diluted the true nature of homeownership by drastically reducing the level of investment and commitment on the part of the homeowner. Loan-to-value ratios (LTVs) rose, in some cases above 100% of the home’s value so that closing costs and other expenses could be financed as well. At the same time the amount of a homebuyer’s “skin in the game” dropped precipitously, sometimes below zero, with some homebuyers walking away from closing tables with their front door keys and cash.

    Some of us in the development community were alarmed by these aggressive first-time homebuyer mortgage products. Homebuyers would be shoe-horned into homeownership, putting little to nothing in to initiate the transaction. However, as soon as interest rates climbed or home value fell, these first-time buyers were left hopelessly overextended. This disaster-in-the making was compounded by the commodification of what was once a personal asset.

    The bundling of mortgage loans into mortgage-backed-securities (MRBs) completed the separation of borrowers from their lenders. At the same time, the home itself was transmuted from fundamental shelter to an investment instrument (as the realtors association likes to refer to it, the main wealth creator for middle-income Americans).

    As soon as there was any cushion at all between the principal amount of the mortgage and a home’s fair market value, it was often immediately monetized through a second mortgage or equity line of credit. At the same time, owners of MRBs had to rely on mortgage servicers to manage and monitor timely mortgage payments and overall collateral values for huge mortgage pools and parsed segments thereof, often secured by a wide array of homes in disparate markets and sub-markets across the country.

    And yet, policy makers, the housing and mortgage industries, and capital markets all touted this great new system for wealth creation. Why?

    Because, after all, housing prices will just continue to go up, right?

    That was the fundamentally flawed foundation on which this house of cards was built, with everyone along the way—homeowners included—pocketing the cash from what were double-digit, annual increases in value in some markets. The positive consumer sentiments from the good economic times of the Clinton years, that not even the 9-11 tragedy could quash for too long, dovetailed with a blatant disregard from Main Street to Wall Street to our Nation’s Capitol for the incomprehensible national debt that was accumulating, mirrored by record consumer debt. Spend, spend, spend became the national mantra and motto. We had been transformed from a producer nation to a consumer nation.

    Whether it was houses, cars, electronics, apparel, home furnishings, appliances, entertainment, dinners out, whatever you can think of: If it was for sale, Americans were buying it and in record numbers. Much of these manifestations of perceived wealth were financed by the seemingly never-ending appreciation in home values and the astronomical mortgage-related debt that was being amassed in reliance on unrealistic expectations regarding those values.

    To be sure, there are a lot of lower and moderate-income households — many of whom are immigrant families targeted specifically as potential first-time homebuyers — who were sold a bad bill-of-goods in the form of subprime mortgage products. If anyone deserves a bailout, it is probably them. But most Americans knew what they were doing and now should pay the price.

    This includes a large number of people who could afford a home but couldn’t purchase the McMansion of their dreams with a conventional mortgage. So they went with something a little more exotic and much, much riskier that allowed them to stretch just a little farther, to continue their conspicuous consumption and help the domestic economy keep rolling along.

    So in the end, it’s neither fair nor accurate to blame just the big guys on Wall Street: This crisis was also made by ordinary Americans as well, egged on by flawed policies about homeownership and wealth-creation, allowing obsession to overtake reason.

    If, as Gordon Gecko said in the movie Wall Street, “Greed is good,” then as a nation, we’re about as good as it gets. There is plenty of blame to go around indeed.

    Peter Smirniotopoulos, Vice President – Development of UniDev, LLC, is based in the company’s headquarters in Bethesda, Maryland, and works throughout the U.S. He is on the faculty of the Masters in Science in Real Estate program at Johns Hopkins University. The views expressed herein are solely his own.

  • Bubble Opportunity: A New Life for Public Housing?

    The globalization of housing markets stood at the center of the vast, now unraveling, economic change of the past decade. The creation of new investment vehicles in the 90s diverted vast amounts of capital into housing markets around the world. The results were many and varied. Design features began to converge, with gated communities following shopping malls into cites in Latin America, China, Turkey and most other countries. Home prices began to rise, with The Economist even publishing a table of global house prices, indicating those with the most inflated costs (Spain and the UK usually led this undesirable ranking).

    It’s been clear for the last few years that housing was becoming the primary investment vehicle for many American families, who otherwise had a negative savings rate. Everything that happened up to 2007 was built on that premise. So here we are in 2008, facing an unraveling not just of the housing market and its financial networks, but much more besides. As the cliché has it, the devil is in the details, and those are getting much less attention. Obsessed with design features and public-private contrasts, it is hard for many urbanists to return to the old-fashioned concern for what is happening ‘on the ground’. Long gone are the days when researchers tramped the streets; now Google and GIS have replaced shoe leather.

    This is unfortunate, because there is a ‘new geography’ emerging from the wreckage. During the bubble, home buyers would purchase larger and more expensive homes because that was how they maximized the returns on their investment. And, for several years, that worked. Now, as I roam around in my neighborhood, I see that it’s the newest and largest homes that are standing empty.

    Why? In large part these were speculative constructions, and the speculation went awry. Elsewhere in this relatively affluent part of Phoenix, small subdivisions are standing virtually idle, the construction workers long returned to Central America. But this is one of the costlier parts of town. In the blue-collar West Valley, the impact has been hardest on the new master planned communities of relatively affordable homes. These were examples of what is sometimes termed in the trade ‘qualifying by driving’—that is, the homes are cheap because they are a long way from job concentrations. Many first time buyers were lured into home ownership with the teaser rates that have been replaced by higher monthly payments, along with higher gas prices. The result: whole developments with a forest of ‘for sale’ signs.

    Most discussion of the mortgage crisis has been at the elite level — where it impacts banks, Wall Street investment houses, interest rates, liquidity. But on the street level, there are other, less obvious, consequences. Animals are abandoned as owners decamp; untended swimming pools breed mosquitoes. Abandoned dwellings in far suburbs don’t attract vagrants but they do get used by human smugglers as drop houses, since there are few neighbors to notice. Owners stop paying their HOA dues and maintenance is neglected, even as the dues escalate for those who stay behind. And much of the time there is no-one to do the work, due to the disappearance of the Latino labor-force.

    So what happens now as the current crisis blows through suburban neighborhoods and some form of federal bailout comes into place? If a new Resolution Trust agency begins to buy up hundreds of thousands of single family homes, we could find ourselves face to face with a new form of public housing that hasn’t been seen since the end of the First World War. In the UK, for instance, local government built many thousands of duplexes, in what are now inner suburbs, for returning soldiers. These were high quality dwellings which provided excellent accommodation for decades, until they were sold off, at suitably inflated prices, by the Thatcher government. Over time, this design experiment was forgotten, as public housing across Europe and the US became associated instead with the construction of vast apartment complexes that turned into visions of hell, strewn with burned out cars. Only in Singapore was this kind of failure avoided, for very specific social, political and cultural reasons.

    So, we may be on the verge of reconnecting with that original vision of public housing, one that emphasized homes in neighborhoods rather than vast and anonymous apartment blocks. For this to happen, the impulse to scoop up these bad mortgages and dump them back on the market at fire-sale prices will have to be avoided.

    Instead, the Federal government should venture back into the public housing sector by keeping these bad mortgages and re-letting the properties that it accumulates. There are two good reasons for this. First, they are, in the main, desirable homes of acceptable quality, so there will be no stigma attached to public housing. Second, because no-one will be building publicly-owned houses from scratch, they will not be concentrated in public housing enclaves. Rather, they will be diffused across the city, concentrated in some neighborhoods to be sure, but not to the exclusion of other forms of tenure. Of course, some existing owners will be less than pleased to find renters living next door—but at least the grass will be mowed and the pool will cease to stink.

    How to prevent this crisis from reoccurring when things get better? Rules need to be observed. Three times your income dictates your mortgage, and you can’t buy a home in an HOA if you aren’t going to live in it. This would greatly restrain speculative frenzy. And let’s take advantage of this crisis by making affordable homes available to families in a variety of forms—as permanent rentals, as leases, or as leases-to-own. And most important, this new public housing will not be concentrated in the inner cities, far from most employment opportunities, or in dense Stalinesque apartment complexes. For years, planners have been wringing their hands about how to get low-income housing into desirable neighborhoods. Perhaps fate has now shown them the way forward.

    Andrew Kirby is the editor of the interdisciplinary Elsevier journal “Cities.”This is his 20th year as a resident of Arizona.

  • How Low Can House Prices Go?

    There is much speculation among economists and others about how close we are to the bottom of the collapse of housing prices. This is, of course, an important question, and goes to the heart of the wisdom or folly of the proposed $700 billion government bailout of financial markets, which is a consequence of their own profligate lending practices.

    You would think that the experts would look at history. We have decades of experience with housing prices. Indeed, for at least the past six decades, median house prices have tended to be around three times an area’s median household income. It bears looking at where house prices are today compared to that standard.

    And looking at it from the perspective, we may have a long way to go. As late as 1999, there was only one major metropolitan market among the top 100 with a median multiple (median house price divided by median household income) exceeding 5.0 (Honolulu), according to data compiled by the John F. Kennedy School of Government at Harvard University. The national median multiple was less than 3.0. By 2006, 23 markets, all highly regulated, had median multiples of more than 5.0.

    Last week, we estimated that the aggregate value of the owned housing stock in the nation had risen nearly $5.3 trillion since 2000. Approximately 85 percent of that figure – $4.5 trillion – had occurred in metropolitan markets with severe land use regulations (strategies often called “smart growth”). These areas accounted for only 30 percent of the nation’s population. The large, more traditionally regulated markets experienced an estimated value increase approximately $200 billion, while outside the major metropolitan markets, the increase was approximately $500 billion.

    If you accept this logic we may not be close to the bottom yet in many markets. Based upon an analysis of housing price declines from the peak, it appears that the losses in the highly restricted markets have taken back between one-third and, at most one-half, of the unprecedented house price increases relative to incomes.

    If the economists and analysts had been paying attention, they might have looked at what happened in the last bubble, in bubble-land itself, California. From the middle 1980s to the housing bubble of the early 1990s, median house prices rose nearly 40 percent relative to household incomes in California’s largest markets (Los Angeles, San Francisco, Riverside-San Bernardino, San Diego and Sacramento metropolitan areas). By 1996, after a particularly deep recession in the early 1990s, the median house prices had declined to their previous household income relationship.

    Yet there the bubble of the 2000s dwarfs what happened in the 1990s, a decline set off by a severe economic decline, particularly in Southern California. In the latest run-up California house prices doubled relative to household incomes in the five largest California markets by 2007. In effect the present bubble topped out at about a 2.5 times increase from pre-existing prices relative to the previous bubble. In 1985, the median multiple in these Golden State markets was 3.7, not much above the historic norm. By 1990 the median multiple had peaked at 5.3 and fell to 3.9 by 1996, rising to 4.2 by 1999. By September of 2007, the median multiple in these markets had risen to 9.1, far above the 1990 peak of 5.3.

    It is not inconceivable that history will repeat itself – that prices will fall to the equilibrium level that has been the rule for so long. That would mean that the bottom may not yet be in sight. Moreover, it could well mean that the house prices reached at the peak of the bubble will never return except in another bubble, or in a hyper-inflating economy (another potential consequence worthy of concern).

    In the next few weeks there will be no shortage of speculation about whether or not the bottom has been reached. Before house prices began to collapse in the highly regulated markets, many analysts gleefully reported on the unprecedented house price increases as if could continue without relation to the economy. The law of gravity appeared to have been repealed.

    But my guess is Newton is still a very relevant person. If so, we should expect additional price decreases of 30 percent or more could occur in already declining markets such as Los Angeles, San Diego, Washington, D.C. and Miami. Similar declines from now could take occur in places like New York, Boston and Seattle, which have only recently experienced a downturn in prices.

    Of course, it is always possible that smart growth regulation in these markets might have created a new floor that prevents prices from falling to historic norms. That would be good news for the owners of real estate – largely older and Anglo – in these areas. On the other hand, it would be disastrous news for millions of households and the next generation, many of them younger and minority, who will now have to remain on the sidelines of the housing markets of their choice. For many the choice may be moving to one of those places – like Indianapolis, Dallas-Fort Worth or Kansas City, Houston or Atlanta – where the opportunity to own a home still will exist for those without trust funds and elite occupations.

    Wendell Cox is a Visiting Professor, Conservatoire National des Arts et Metiers, Paris and the author of “War on the Dream: How Anti-Sprawl Policy Threatens the Quality of Life.”

  • How to Protect Main Street While Saving Wall Street

    The current discussion in Washington can either lead to a rapid processing and recovery at the local level or a long drawn out destruction of local economies. This is particularly true of regions – Las Vegas, Phoenix, San Bernardino-Riverside, much of Florida – that have been hardest hit by the foreclosure crisis.

    The current discussion is being limited to maximizing the yield on the securities that the Federal Government would acquire and then sell at auction nation wide. The disconnect that needs to be bridged lies with the focus on securities. In reality, these mortgages, however arcanely packaged, represent residential real estate. The smoke and mirrors of securities too complicated to understand must be cleared away. Otherwise, a few Wall Street interests will do even more damage and reap all the returns.

    The key issue, then, is not how the paper gets marketed but how to maximize real estate values locally. If the Feds dump securities that then lead to high levels of absentee ownership in local communities for example, many neighborhoods will be seriously damaged. If local regions can manage the disposition of these assets – higher returns will be realized and goals such as home ownership and local economic development can be advanced.

    We have seen this before. In the 1980s, the Federal Home Administration dumped large numbers of foreclosed homes on the market in San Bernardino. Instead of finding buyers, speculators preferred to rent these residences out. The result was a long-running decline in parts of the city, one that could now be further exacerbated.

    Again in the 1990s, the Federal Resolution Trust Corporation dumped apartments, commercial, office and Industrial properties. Depressing real estate values in local economies, it killed many deals and devastated local property taxes.

    But this time the Inland Empire will not be alone. If these securities are purchased nationally, Wall Street speculators could transform significant parts of formerly middle class suburban areas into largely renter-dominated badlands.

    What we need is a locally controlled intermediary – perhaps a Regional Asset Value Recovery Corporation (AVRC) – that would seek to maximize asset value by taking full advantage of local real estate knowledge. Such a regional public-private partnership could help retain value for real estate assets while stabilizing communities, and minimizing the fiscal impact on the taxpayer.

    These local groups – using both government and private matching funds – would be able to use the crisis to bring new life, and new homeowners, to these communities. This is something we are already working on in San Bernardino and Riverside counties, geographically known as the Inland Empire. This area is among the most impacted regions in the country.

    San Bernardino and Riverside county governments, along with more than 15 city governments within those counties and over 30 business owners, are prepared to come together to manage the acquisition and disposition of properties. The group would manage the unraveling of income streams so that packaged mortgages can more suitably be restructured for the benefit of homeowners. It would also capture other current Federal resources, for instance the New Market Tax Credits, and fully utilize them in order to “prime the pump” of housing recovery.

    Among the priorities of this entity would be to ensure the housing stock is maintained or renovated to meet basic health and safety standards. Abandoned housing stock is posing a serious public health risk. Addressing those risks has a direct impact on federal, state and local governments and on asset value.

    It would also work to create opportunities to meet low and moderate income housing needs. On the one hand, not everyone can buy. Making units available to rent in the right areas would be a good way to maintain and support value. On the other hand, eventually, price stability and performance by tenants makes those same tenants candidates as future homeowners. The AVRC would be the right vehicle to undertake those efforts.

    Another primary focus would be to maintain local property taxes and critical services. Depressed property values have an obvious ripple effect on local government’s ability to provide basic government services. Local communities stand ready to partner to protect our economy, their communities, their taxpayers, and their homeowners. We cannot leave the health of our communities solely to the discretion of either Washington or Wall Street.

    Tony Mize
    President, Workforce homebuilders

    Jeff Burum
    President, Inland Empire Opportunity Fund
    Chairman, National Community Renaissance

    Steve PonTell
    President, La Jolla Institute
    Germania Corporation

  • Back to Basics: The Financial Crisis Requires a Paradigm Shift

    It’s tempting to look at the current financial meltdown – and the proposed bailout – with a Bolshevik mentality. Let’s line up the investment bankers, hedge fund managers up against a wall and spray them with an odorous substance.
    If it were only so easy. Rescuing Wall Street may not solve many problems but letting the investor class implode won’t help many people either.

    What we really need is not a revolution against capitalism, but a paradigm shift within it. We need to move away from fads and quick bucks, and towards productive investment. If we don’t make that shift, the current bubble will simply recreate itself again, perhaps in ill-thought out speculative ventures painted “green” but motivated by the same shortsighted greed.

    Instead let’s stop the whole bubble cycle and get back to basics. That means shifting our investments towards productive activities such as manufacturing and basic infrastructure– and training the critical skilled workers that a ‘real’ economy needs. It means shifting investment priorities by providing incentives for entrepreneurs whose main interest is to build companies, not flip them.

    Over the past decade we have seen a repeated pattern. Americans innovate, start new companies and bring a moribund economy back to life. This takes place primarily in the suburbs and the expanding growth regions. Then the markets heat up and there’s rapid asset inflation. This happened in the late 1990s with dotcom stocks, and more recently in real estate creating a huge wealth effect, particularly in elite cities. Both instances ended with a dispiriting crash.

    Breaking this pattern is an important issue for all of us, but most importantly for our children. America’s robust population growth necessitates rapid long term, and widespread, economic growth. That means moving away from a financially oriented economy to a production oriented one.

    Most Americans cannot sustain themselves trading paper. We also need robust growth in a host of productive industries – energy, fiber, food, manufacturing goods and high-end business services – that can provide decent employment for someone other than Wall Street bankers, well-placed developers and dotcom entrepreneurs.

    For these broader based industries to grow, we need to improve basic infrastructure for moving goods, providing energy and educating skilled workers. American firms in fields from farm equipment and aerospace to textiles still compete with China and India. In an era of high-energy costs, we can drive more of our manufacturing closer to home, if we can provide them with better technological, transportation and human resources.

    Tragically we have ignored both infrastructure and industry. This can be seen from the largest cities to the smallest towns. “One looks back at that map ‘Landscape by Moses,’” writes the noted sociologist Nathan Glazer in looking at the legacy of New York City’s “master builder” Robert Moses, “and if one asked what has been added in the fifty years since Moses lost power, one has to say astonishingly: almost nothing.”

    Indeed, despite the staggering private wealth generated by the stock market and real estate in New York, the city’s public infrastructure has been largely neglected. Its industries are dying and new ones have trouble expanding. There are billions for new stadiums and other elements of Mayor Bloomberg’s “luxury city” but not much for the diverse entrepreneurial firms particularly in the outer boroughs.

    The city controller’s office has estimated that infrastructure spending levels in the late 1990s and early 2000s were barely half of what was required to maintain the city’s streets, main roads, and railways in “a systematic state of good repair.” Subways and rail lines in America’s richest city are frequently shut down after heavy rains due to flooding caused by poor drainage. Brownouts and blackouts, in part caused by underinvestment in energy infrastructure, have become common during summer high-use periods.

    Similarly, California’s once envied water-delivery systems, roadways, airports, and education facilities are in serious disrepair. In the 1960s, infrastructure spending accounted for 20 percent of all state outlays, but as the technocratic perspective took hold in Sacramento, infrastructure spending fell to just three percent of all expenditures, despite the rapid growth of the state’s population.

    Many communities have decided that instead of attending to basic needs, to invest in spectacular new convention centers, sport stadiums, arts and entertainment facilities, hotels, as well as luxury condos. Some have poured money into projects that they think will attract a few big corporate executives with luxury boxes or opera tickets. Others have poured their resources into ways to lure “creative” professionals with edgy museums, jazz clubs and cultural centers.

    These approaches are built around the deluded notion that Americans can thrive simply by being more clever and creative – even more self-fulfilled – than our competitors. China, India, or other low-wage nations won’t be content to concede higher-end economy activity to us. Software design, special efforts, high end legal services, architecture, fashion and even hedge funds all migrate to places where wealth is being created.

    In the coming years, for example, Mumbai, Dubai and Shanghai will employ their enormous wealth – gained in such unfashionable pursuits as writing computer code, drilling oil or making steel – to break into the lucrative businesses formerly dominated by Wall Street, Hollywood or Silicon Valley. You cannot give up productive, wealth-generating enterprises without consequences. Over time this also will hit all but the most elite workers.

    In contrast a policy that focuses both on old fashioned and new, green infrastructure would spur positive impacts on employment across a broad spectrum of activities. We could use new bridges, roads, trains, energy transmission facilities to help resuscitate the Great Plains as well as the beleaguered Great Lakes so they sustainably exploit the natural resources and logistical advantages that made them productive hotbeds in the first place. We can turn our cities, both old and new, into ideal spots for the nurturing of hosts of growing industries by providing adequate skills training, new transportation systems and updated power grids.

    Governments at every level can and should play a critical role in this great project, both in financing physical infrastructure and providing critical skills training. But given the financial realities today, we also need to take advantage of private capital available both here and abroad for such investments.

    So rather than simply rescue Wall Street, or let it hang out to die, let’s figure out how to redirect it. We need to shift incentives away from mindless speculation and the creation of ever more obscure financial instruments. Instead let’s find ways of encouraging investors to make their profits in ways that spur production and widespread wealth creation.

    Joel Kotkin is the executive editor of Newgeography.com.

  • The Smart Growth Bailout?

    One way to see the federal rescue of the home mortgage market is to call it “the smart growth bailout.” True, the proximate cause lay with profligate lending practices. The flood of mortgage money covered the entire country, irrespective of state, regional or local land use regulations. That’s where the similarity stopped.

    During this decade there has been an unprecedented divergence of housing prices among U.S. metropolitan areas. Generally, the difference has been associated with strong land use regulations. Where restrictions are greater, house prices rose strongly relative to incomes. Where more traditional regulation remained, house prices also rose, but only modestly.

    This is illustrated by the change in the Median Multiple (median house price divided by median household income). In the more regulated metropolitan markets, it rose from 3.5 to 6.0, a 70 percent increase. In the more traditionally regulated markets, the Median Multiple rose from 2.7 to 3.0, remaining within historic norms.

    Economics teaches that scarcity or rationing leads to higher prices. Smart growth policies ration land for development through the use of urban growth boundaries and prohibitions or restrictions on building on vacant land. In such an environment, higher house prices can be expected.

    “The affordability of housing is overwhelmingly a function of just one thing, the extent to which governments place artificial restrictions on the supply of residential land,” said Donald Brash, governor of the Reserve Bank of New Zealand (the national central bank) for nearly 15 years.

    America has become two nations with respect to housing costs and housing cost increases. Princeton economist and New York Times columnist Paul Krugman put his finger on the cause of the difference more than three years ago. Others have made similar findings, such as Edward Glaeser at Harvard, Theo Eicher at the University of Washington and Kate Barker of the Bank of England. House prices have exploded in highly regulated markets, while they have changed little where traditional land use regulations still apply.

    The predictable economic effects have occurred with a vengeance in more regulated (smart growth) metropolitan markets. From 2000 to 2007, the median house price rose an average of $174,000 in the more regulated metropolitan markets with more than 1,000,000 population. In the less regulated markets, the average increase was $12,500.

    The easy money was available everywhere in the nation increasing the demand for housing in most markets. But in most of the nation, housing price increases were modest, as planning systems allowed new housing to be provided at historically competitive prices. For example, in Atlanta, Dallas-Fort Worth and Houston, the three fastest growing metropolitan areas in the high-income world with more than 5,000,000 population, housing prices changed little in relation to household incomes. Furthermore, from 2000 to 2007, 2,550,000 million people (domestic migrants) left the more restrictive metropolitan markets for elsewhere in the country. That pretty well dismisses the idea that demand was the primary cause of the price escalation.

    Demand, in and of itself, does not increase price. But, when higher demand is experienced in an environment of limited supply, price increases occur. Where there were strong land use restrictions, there were strongly escalating house prices. The restrictions drove prices up because land regulations had reduced the supply of developable land, thereby raising the price. The planners may have succeeded in their objection – slowing suburbanization (or if the pejorative term is preferred, “sprawl”) – but they also created a pricing bubble that made things much worse.

    It is estimated that the overall housing stock owned in the third quarter of 2007 was slightly over $20.1 trillion. If the Median Multiple of 2000 had been preserved, the aggregate value today would be approximately $14.8 billion. Of the $5.3 trillion increase in value, it is estimated that $4.5 trillion of this can be attributed to the 25 metropolitan areas with the most severe housing regulations. This means that 86 percent of the increase took place in areas accounting for only 30 percent of the nation’s population. The other 70 percent of the nation had an overall increase in value of less than $800 billion, or 14 percent of the total “bubble.” More than 65 percent of the higher value occurred in ten metropolitan areas – Los Angeles, San Francisco, San Jose, San Diego, Riverside-San Bernardino, New York, Boston, Washington, Miami and Baltimore. These metropolitan areas account for little more than 20 percent of the nation’s population.

    And just as the highly regulated metropolitan areas led the way up, they now are leading the way down. It is estimated that the house value losses in the more regulated metropolitan markets is approaching $1.5 trillion, while the losses in the more traditionally regulated metropolitan markets are estimated at less than $150 billion.

    None of this is to suggest that smart growth has only negative ramifications. To the extent that smart growth removes barriers to the development of higher density housing or less costly housing where it is demand is a good thing. But the land rationing policies proposed under “smart growth” clearly have reaped a very bitter harvest.

    The end of this catastrophe may be in sight (or it may not be). Housing prices, particularly in the inflated markets, have started to fall. This is true not only in the United States but in other highly regulated markets such as the United Kingdom, Australia and New Zealand.

    Yet the bottom line remains: Without smart growth’s land rationing policies, the severe escalation in home prices would never have reached such absurd levels. But the disaster in the highly regulated markets will be with us for years. The smart growth spike in housing prices turned what might have been a normal cyclical downturn into the most disastrous financial collapse since 1929. Now the taxpayers are being asked to bail out the mess that smart growth advocates, no doubt inadvertently, have created.

    Wendell Cox is a Visiting Professor, Conservatoire National des Arts et Metiers, Paris and the author of “War on the Dream: How Anti-Sprawl Policy Threatens the Quality of Life.”

  • What’s the Biggest Flaw in the Administration Bailout Plan?

    The biggest flaw in the Administration bailout package: It could all happen again. The system doesn’t need just fixing, it needs decentralizing. Financial institutions should be big enough to fail—and never any bigger. We need compartmentalization, also known as federalism.
    The current crisis was caused by mega-financial institutions that could gamble their money—and lose it. And they did. But first, they grew to the point where they couldn’t be allowed to fail. That’s why even a staunch free-marketeer such as Larry Kudlow supported the AIG bailout. “A collapse of AIG would have been unfathomable,” he wrote on Saturday. “It is simply too interconnected globally.”

    Well OK, then, AIG was too big. When even free-marketeers want the government to step in, that’s proof that size matters. In a bad way. But the American people cannot let themselves be hostage to the financial megalomania of casino-capitalist empire builders.

    It might, indeed, be the responsible thing to vote for a bailout, but it is irresponsible to allow such a meltdown to happen again. And it will happen again if banks, investment houses, and insurance companies are allowed to grow this big once again. Adding another layer of regulations and record-keeping will make work for more lawyers and more accountants, but if the basic business model survives—gambling with other people’s money, and lots of it—then we will right back into deep doodoo soon enough, except that the dollar totals will have a few more zeroes. Remember Sarbanes-Oxley? What good did that do?

    As my colleagues at the New America Foundation, Sherle Schwenninger and Michael Lind, have argued for years, we need different kinds of banks to do different things. So the Depression-era Glass-Steagall Act—which solved this problem once before—should be restored, so that the bank down the street once again is limited to only accepting deposits from its neighborhood and only making loans to locals. That’s a boring low-margin business, to be sure, but it’s mostly a safe business. Meanwhile, on Wall Street, investment bankers and speculators would be free to speculate, but they wouldn’t be free to speculate with the capital base of Main Street.

    In addition, the states should reclaim their role as laboratories of democracy—and laboratories of the economy. Leaders of each state should figure out how much money they are losing in this deal—that is, how much of that projected $1 trillion they are “contributing.” Or, to put it another way, how much of an income transfer is the state of New York reaping? How much is Manhattan gaining at the expense of all the rest of us?

    Politicians across the 50 states might be tempted to demagogue these wealth-transfer data, but there is the not-so-little concern of avoiding a depression.

    Instead, politicians should say, “I will vote for this bailout, AND I will also insist that we compartmentalize, or federalize, the solution. How? We should establish a state bank, or a regional bank, to keep capital right here in (fill-in-the-blank) state or region.” If South Carolina and North Dakota keep more of their money in the first place, to be invested in local projects, that will be good news for South Carolinians and North Dakotans. And it will be bad news for money-hungry Manhattanites, plotting their next incomprehensible derivate swap; they will be free to gamble their money, and nobody else’s.

    And that would be good news for the rest of us.

    This was originally posted on politico.com.

    James P. Pinkerton worked in the White House under Presidents Ronald Reagan and George H. W. Bush. Since leaving government in 1993, he has been a columnist for Newsday, a contributor to the Fox News Channel, and a regular on Fox’s Newswatch show.

  • Rebuilding the Idea of the City: The Present Crisis in Perspective

    New York long was a product of the harbor economy. Before there was a Times Square or a Grand Central Station, Lower Manhattan, then ringed with docks, was oriented to the railroads and factories of the Jersey coast to its west and the merchants and manufacturers of Brooklyn across the East River. The decline of Lower Manhattan as an economic engine is in large measure a reflection of the fall of that harbor economy as first Manhattan and then its partners in Brooklyn and Jersey City de-industrialized.

    Still, there’s cause for optimism. In the last two decades, the old harbor economy of trade and industry, severed by the collapse of manufacturing, has been re-knit on the basis of the service economy. By the middle of the 1970s, even as New York was at its nadir, the growth in service sector jobs began to exceed the decline in manufacturing jobs. And despite the impact of 9/11, New York continues to attract the key element of the modern economy, talented people; college applications are up for next year.

    One sign of New York’s vitality is that so many places want to be considered the city’s ‘sixth borough’ — Fairfield County, Conn., Jersey City and even Philadelphia. This dispersion has brought both opportunities and challenges to New York itself.

    My optimism has been tempered by two questions and a frightening possibility. First, attempts to accommodate all the interest groups has slowed the entire rebuilding of Lower Manhattan. Second, the Bloomberg administration — for all its posturing about rebuilding downtown — continues to focus as well on expanding the far west side of Manhattan and downtown Brooklyn as well as various new stadia. With a recession already underway, one that is centered in part on the critical financial industry, it would seem more prudent for the city to narrow its priorities.

    Perhaps a better focus would be to seek how to revive the harbor economy first envisioned by ironmaster and former Manhattan mayor Abraham Hewitt, the son-in law of Peter Cooper, and the corporate lawyer and anti-Tammany reformer Andrew Haslett Green. Their vision was one of a vast united city united by new bridges across the East River as well as a rebuilding program for the city’s crumbling docks, streets and transit facilities. In the late 19th Century, basic infrastructure and opportunity were inextricably intertwined.

    The upshot was extraordinary. New York became “the engineers’ city.” New York City bonds were issued to build bridges across the Harlem and East Rivers, and tunnels under the Hudson connecting New York to New Jersey as well as the subway system that became the city’s circulatory system for labor. These tied Brooklyn and Lower Manhattan together into a single economic unit. With this New York became not only the largest city in the U.S. but its busiest port, a paradise for small manufacturers and a headquarters city for national corporations.

    New York’s consolidation also promoted a rapid expansion of the urban area. Even at a time when centralization seemed to be in the saddle, the wildly crowded and extraordinarily expensive downtown began to shed some of its functions. Given the extraordinary cost of land, those who stayed increasingly worked in skyscrapers like the Woolworth Building, which opened in 1913.

    In the 1920s, even as New York surpassed London as the world’s financial center — a designation that may not be reversing again — the functions of the downtown were narrowing. The opening of Penn Station in 1910 gave Long Island and New Jersey easy access to midtown. It helped set off a real estate boom in Times Square, which was intensified three years later when Grand Central Station opened. The Holland Tunnel followed in 1927. Not surprisingly in the 1920s most new construction was in midtown, a trend that continued even into the depression years when Rockefeller Center was built, with midtown beginning to eclipse Lower Manhattan.

    While midtown grew, the port thrived; in the 1920s half of U.S. export and import traffic moved through the harbor. Eighty-five percent of the traffic landed on the New York side and then had to be moved across the Hudson on “lighters.” This was the so-called “Manhattan Transfer.” The problems of cross-harbor traffic were magnified by the control exerted on both sides of the harbor by the local political machines.

    As a response harbor congestion during World War I — at one point trains were literally backed up to Pittsburgh — the new bi-state Port of New York Authority turned very effectively to constructing the Lincoln Tunnel and the Outerbridge, Goethals, George Washington and Verrazano bridges linking New York to New Jersey by car and truck. By 1950 New York had it all, including a vast and varied manufacturing sector, the largest port and undisputed dominion over the financial, cultural and media life of the nation.

    What Went Wrong and Right
    In the early 1970s the harbor economy fell apart. Even though the financial sector grew, the fastest growth was in government workers engaged not in basic city services but rather in social services and make-work health care jobs. Between 1960 and 1975 spending tripled in constant dollars, while the city population was declining slightly. The money went to public assistance, health social services and housing. Redistribution rose from 26 percent of NYC expenditures in 1961 to 36 percent in 1969 and has stayed at about one-third.

    This change in economic character transformed New York from a city that fared well in recessions to one more susceptible to wide swings in employment and growth. Taxes rose, city services deteriorated and businesses fled.

    The city, of course, is in much better shape today, largely due to the reforms of mayors Koch and Giuliani and some favorable trends in the global economy. New York is clearly a better place to live and work than it was just two decades ago.

    In part, the decline of manufacturing finally began to pay off for New York. De-industrialization, a disaster for some sections of the city, had been an opportunity for others to upgrade their quality of life by turning manufacturing lofts into living spaces. Old manufacturing districts like SoHo became “funky.” First, they attracted artists who were soon followed by Wall Street yuppies. New York became a magnet for twenty-somethings, a dating bar for young college graduates. Brooklyn also is bustling with business and shopping districts, with a wave of gentrification beginning in the brownstone neighborhoods of Park Slope, Carroll Gardens and Fort Greene.

    “The restoration of the brownstone belt,” explained Carl Weisbrod of the Downtown Alliance, “was a crucial element in the revival of Lower Manhattan. Just as at the turn of the century, Brooklyn’s tony neighborhoods were once again the neighborhood of choice for many location decision-makers, senior managers in investment banks, partners in law firms, and bank executives.”

    With the nexus between Manhattan and Brooklyn restored — intertwined by the best mass transit connections anywhere in the county — the chance to reinvent the great harbor economy is better now than any time in fifty years. Instead of turning its back on the harbor that created and sustained the city or centuries, the future depends, in large part on n turning the waterfront into an asset.

    It’s beauty and recreational possibilities can make downtown into an attractive live-work location. And then there are the extraordinary possibilities presented by 172 acre Governors Island, a five-minute ferry ride from either Lower Manhattan or Brooklyn’s Red Hook, Governors Island, with its golf course, playing fields and historic buildings.

    The future of the city once again will depend on capitalizing on the waterfront. Born a harbor city, New York can be reborn once again as a city the lives and thrives on its waterways — if the city can decide that this again represents its priority for the future. We will probably have to wait for a Mayor with a name other than Bloomberg for that process to start.

    Fred Siegel is a Professor of History at Cooper Union in New York.