Re-thinking the so-called Housing Bubble with Kevin Erdmann

Episode Summary

Executive Summary: Kevin Erdman argues that the Great Recession was misdiagnosed as a story of housing overbuilding and reckless lending; instead, housing was chronically undersupplied in major cities, and post-2008 credit tightening worsened the bust by shutting marginal buyers out of ownership. The conversation ties housing shortages, migration shifts, and Fed policy to broader macroeconomic instability and persistent affordability problems.

Main Topics: Reframing the Great Recession as a housing shortage story (Priority: 5/5): Erdman rejects the conventional bubble/oversupply narrative, arguing that most homes built before 2008 were occupied and that there was no realistic national surplus large enough to explain the crisis. Closed-access cities and constrained housing supply (Priority: 5/5): He distinguishes cities like New York, Boston, LA, San Francisco, and San Diego as places with severe supply restrictions, high incomes, and high housing costs that push lower-income households out. Policy mistakes and the soft landing that wasn’t (Priority: 5/5): The Fed and policymakers interpreted falling residential investment as desirable, then doubled down on the wrong diagnosis as the bust unfolded, treating the collapse as proof of a bubble rather than a policy-induced demand shock. Post-2008 credit tightening and loss of liquidity (Priority: 5/5): After 2008, lending standards rose sharply, especially for lower-end owner-occupiers, removing liquidity from the market and depressing prices in the bottom half of housing markets nationwide. Owner-occupier value versus landlord market value (Priority: 4/5): Erdman argues that homeownership creates value by eliminating landlord-tenant agency problems, not merely through capital gains, and that this is underappreciated in policy discussions. Migration, segregation, and city-level divergence (Priority: 4/5): In constrained cities, demand is rationed through outmigration and segregation rather than just price increases, while open-access cities like Austin can absorb growth without severe displacement. Future policy and macro stabilization (Priority: 3/5): He previews a follow-up book and suggests broader stabilization tools such as nominal GDP targeting to reduce procyclical policy reactions and future housing crises.

Key Arguments: The mainstream narrative of overbuilding is inconsistent with the fact that the homes in question were largely occupied; the scale of excess supply needed to trigger the crisis was implausibly large. In fast-growing cities like Atlanta and Phoenix, typical population and housing growth rates make true oversupply difficult to generate without extraordinary building that did not occur. The Federal Reserve and policymakers mistakenly viewed shrinking residential investment as a successful soft landing, when housing supply was already being cut off before the broader economy collapsed. After 2008, credit regulations and GSE practices sharply raised borrower quality thresholds, cutting off marginal buyers and causing the worst price declines in the low end of housing markets. Reduced liquidity at the bottom of the market lowered prices by excluding potential owner-occupiers, similar to how moving an asset from a liquid market to a less liquid one reduces valuation. Housing’s economic value to owners comes significantly from eliminating landlord-tenant agency problems and providing long-term control over the dwelling, not just from price appreciation. Closed-access cities function as restricted asset markets where scarcity generates economic rents and forces lower-income residents to relocate, while open-access cities can accommodate growth through construction. The apparent homeownership boom before 2008 reflected earlier access to ownership for younger, higher-income households rather than mass lending to unqualified borrowers. The post-2008 decline in homeownership was broad-based across incomes, but the key market effect was the removal of credit access for owner-occupiers near the lower half of the market. Broader stabilization failed because policymakers and the public interpreted falling prices and foreclosures as evidence that more tightening was necessary, creating a self-reinforcing crisis.

Data Points: Bernanke Fed stance: 2011 - Bernanke was still describing the economy as working off an oversupply of housing years after the crisis began. Policy rate: 5.25% - Fed policy rate had risen to 5.25 by June or July 2006 during the pre-crisis tightening cycle. Residential investment effect on GDP: about 1% per year - By mid-2007, residential investment had cratered and was dragging down GDP growth by roughly one percentage point annually. Housing starts: cratered by mid-2007 - Used as evidence that a supposed soft landing had already occurred before the full financial panic. Borrower FICO shift: around 710 to around 750 - Average borrower credit scores jumped sharply in 2008 as lending tightened. Homeownership rate: from about 64% to 69% - During the boom, the national homeownership rate increased by roughly five percentage points. Homeownership rate after bust: bottomed slightly below initial rate - Post-bubble homeownership fell back to around or below the pre-boom level. Owner vs renter income gap: about 120% higher in the mid-1990s; about 180% higher by 2007 - Average owner income was much higher than renter income, and the gap widened during the boom. Low-end price decline: 20% to 30% or more - After credit tightened, lower-tier home prices in many cities fell substantially relative to high-end prices. Housing expenditure share: about 12% of GDP - The U.S. spends roughly this share on rental expenses, with much of the increase driven by high-cost metros. Rental burden in San Francisco/San Jose: 40% to 45% of median income - Illustrates the high housing cost burden in closed-access cities. Rental burden in open-access cities: about 25% of income - Examples like Omaha or Nashville spend a much smaller share of income on rent. Depreciation assumption: 2% to 3% - Used in discussing net returns to housing and the role of maintenance/upkeep. Implied homeowner return: 5% to 8% annually - Estimated net returns to housing based on BEA-style accounting and assumptions about depreciation. Single-digit price-to-rent ratios: observed in many U.S. homes - Erdman argues these areas clearly support ownership for long-term households. Low-end mortgage payment example: $300-$400/month vs. $1,000/month rent - Illustrative example of how improved credit access could substantially lower housing costs for owner-occupiers. National housing flow: about 1.5% of units per year - He argues that roughly this share of housing stock must become available annually through new construction or migration.

Pivotal Quotes: "it wasn't overbuilding; it was a housing shortage" — Kevin Erdman: Core thesis of the book and the interview's main reframing of the Great Recession. "we had canonized the idea that a collapse in the housing market was inevitable" — Kevin Erdman: Explains why policymakers and the public interpreted falling housing activity as confirmation of the bubble story. "the natural value that flows to an owner-occupier by eliminating the agency problem of having to deal with a tenant being different than the owner" — Kevin Erdman: His explanation of why ownership has intrinsic value beyond capital gains.

Implications: For listeners and policymakers, the big lesson is that housing markets should be judged by supply constraints and credit access, not just prices. The transcript suggests that easing construction barriers and avoiding procyclical credit tightening could improve affordability and reduce future macro shocks.