Monday, January 9, 2012

Housing Permit Regulations Increase Home Price Volatility And Negatively Affect Current And Prospective Owners

From The Federal Reserve Board Finance and Economics Discussion Series, "Supply Constraints and Housing Market Dynamics " by Andrew Pacioreky:
[Housing] supply constraints increase volatility through two channels: First, regulation lowers the elasticity of new housing supply by increasing lags in the permit process and adding to the cost of supplying new houses on the margin. Second, geographic limitations on the area available for building houses, such as steep slopes and water bodies, lead to less investment on average relative to the size of the existing housing stock, leaving less scope for the supply response to attenuate the effects of a demand shock. My estimates and simulations confirm that regulation and geographic constraints play critical and complementary roles in decreasing the responsiveness of investment to demand shocks, which in turn amplifies house price volatility.
That said, what is striking about volatility is that it negatively affects current owners as well as prospective future ones. This volatility particularly hurts homeowners looking to cash out -- often, the old -- and younger, less wealthy buyers seeking their first homes. Other owners may be at least partially hedged, to the extent that the price of their current home covaries with the price of their desired future one (Sinai and Souleles 2005, Paciorek and Sinai 2010), but even hedged owners face problems if they end up "underwater" on their mortgages (Ferreira, Gyourko and Tracy 2010).

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