Why is the Economy Still Weak? Blame Lending Policy that Ignores Efficiency!

Bill Irwin of the New York Times asks “Why is the economy still weak?” and blames five underperforming sectors. Housing is not only his leading culprit, but he claims that it exacerbates the weakness of the second-worst sector—durable goods consumption (stuff like furniture and appliances).

So why is housing still weak? Irwin does suggest the beginning of a reason, but does not carry it through in his piece this week. So I will do this next.

Irwin hypothesizes that “It may be that a broader shift is underway in the desire and ability of young adults to get homes of their own.”

But what is that broader shift and can we do anything about it? (The answer to the latter and more interesting question is “Yes.”)

As I pointed out most recently here, young adults tend to prefer location efficient neighborhoods—areas that are walkable and have good transit service, which leads to homeowners paying less out of their budgets for transportation costs. And ALL homebuyers want energy efficiency in their homes, which reduces their energy bills.

These transportation and energy costs are not trivial. The savings from moving to higher efficiency over the course of a 30-year mortgage are larger than the average mortgage itself.

What is the problem?

Why isn’t the homebuilding industry supplying higher energy and location efficiency? It’s not because they don’t want to.  Leading Builders of America supports lending reforms that count energy efficiency savings because they would rather build efficient homes, if only their buyers could qualify to buy them. And developers are smart enough to recognize that location efficient development, which allows more homes to be built on a given parcel, is more profitable.

There seem to be only two explanations for the ongoing shortfall of construction:

  • New homes with these desired characteristics are unaffordable, or
  • Lenders assume that these new homes are unaffordable and are unwilling to underwrite loans for them

(If there are additional reasons, I would like to hear readers’ ideas on what they are. Things that have changed since the decade before the boom-and-bust decade.)

How can we find out which explanation is correct? Well, the nation tried to address the affordability issue for the last two years by the Federal Reserve’s “quantitative easing” policy that lowered mortgage interest rates. I predicted that this wouldn’t do much almost two years ago, because it failed entirely to address the second problem. And it turned out that indeed it hasn’t worked: housing construction is hardly higher than it was then, and is about half the level that we need for a growing population.

What is the solution?

Now that we have seen that the first explanation is wrong, we ought to try the second approach: considering energy and transportation expenses on an equal basis as mortgage, taxes, and insurance expenses when determining who qualifies for a loan.

What are the upsides of this experiment? First, if I am correct, it will allow lower income prospective buyers to qualify for mortgages, opening up the market to people who can afford the house and its associated transportation and energy costs. Right now, the supply of efficient homes is not keeping up with the demand, so prices are high and buyers are priced out of the market. By removing the artificial barrier of lenders telling households who truly can afford a given home that they cannot qualify for a mortgage, more families will be able to buy homes so more will be built.

Also, it will greatly reduce environmental impacts: greenhouse gas emissions, water use, water runoff and its associated pollution. And it will reduce the amount of time spent in traffic, enhancing family life and encouraging healthier life patterns.

But equally importantly, it will reduce mortgage defaults, which are painful to the defaulting family and damaging to the economy: default rates for moderately location-efficient and energy efficient homes are about half those of less efficient ones. This result can be seen from a Fannie Mae study, an NRDC-sponsored study, and a University of North Carolina study.

What if I am wrong?

Well, these reforms are free and easy to implement. Since they reduce defaults, they are good for us even if they don’t facilitate new construction. And even in the most pessimistic case, they will open the door for home ownership for SOME families who could not otherwise qualify for a mortgage. This increases their economic freedom -- which is something everyone ought to support.

Irwin’s article concludes with the following: “… if you think that the American economy is capable of humming along a good deal faster than it is…then it’s no mystery which sectors are to blame for the crummy economy.” He means that low housing construction is the main culprit.

And if you know which sectors are to blame, the next step is to adopt policies that can get us out of a “crummy” economy. That is exactly what we are proposing.