Why US Housing Prices Have Risen Faster than Inflation Since 1997

It’s no secret that housing prices are a real concern in many American cities. The average price of a home in San Francisco, CA? $1.62 million. How did we get here?

Federal Government and the Housing Market

Markets are tricky things. There is a tendency to try and make them work a little bit better by changing the rules, or giving an advantage. But in doing so, a market can easily get distorted and suddenly not work as well. So even the best of intentions can end up leading to bad results. Such is the story of the U.S. housing market.

In the depths of the Great Depression, the federal government created Fannie Mae to facilitate the home mortgage market. Fannie Mae began purchasing and securitizing home mortgages. (“Securitize” means to create shares of ownership that can then be sold as investments.) This increased flow of money caused the mortgage market to grow — and so did homeownership.

In 1977, Congress passed the Community Reinvestment Act (CRA). Until then, “redlining” and other racist practices kept homeownership out of the hands of people of color and the poor. The CRA encouraged lenders to increase their home mortgages to these communities that had been subject to rank discrimination.

In 1997, the government perhaps went a step too far. In November of that year, Fannie Mae helped two investment banks (one being the notorious Bear Stearns & Co.) securitize and sell CRA home mortgages. The practice soon spread to other mortgages.

The rest, as they say, is history. An epic boom in securitized mortgages led to an epic bust.

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And once the smoke cleared, and the market went back to normal…. well, it is a new normal. As shown, the post-bubble rate of inflation still tracks substantially higher than inflation. Like college costs, and medical costs, housing costs cannot continue a climb like this forever. And in the meantime, the market gallops beyond what had been the underlying fundamentals.

What’s to be done? Well, the genie probably can’t be forced back into the bottle. So even more market incentives and advantages are needed to make sure housing stays affordable. Here in Seattle, we’ve recently enacted “incentive zoning” that allows for increased height in exchange for affordable housing (or payment into a fund that supports it). Good stuff, and a step in the right direction.