The Bulldozer Solution to the Housing Crisis

Hal Singer —  24 October 2011

My inaugural blog on two-sided markets did not elicit much reaction from TOTM readers. Perhaps it was too boring. In a desperate attempt to generate a hostile comment from at least one housing advocate, I have decided to advocate bulldozing homes in foreclosure as one (of several) means to relieve the housing crisis. Not with families inside them, of course. In my mind, the central problem of U.S. housing markets is the misallocation of land: Thanks to the housing boom, there are too many houses and not enough greenery. And bulldozers are the fastest way to convert unwanted homes into parks.

(Before the housing advocates lose their cool, an important disclaimer: Every possible effort should be made to keep a family in their homes, including taxpayer-financed principal modifications for deserving, underwater borrowers. My proposal applies only to vacated homes that have completed the foreclosure process.)

Until the Washington Post ran an article last week, titled Banks turn to demolition of foreclosed properties to ease housing-market pressure, I was reluctant to admit my position in public. I had whispered my idea into the ears of several finance professors, but none was willing to stand behind it. And for good reason: How can one advocate bulldozing a home when so many families are losing their homes?

According to the Post, some of the nation’s largest banks have begun giving away abandoned properties to the state and even footing the $7,500 bill per demolition. In 2009, Ohio passed a law creating “land banks” with the power and money to acquire unwanted properties and put them to better use, like community gardens. Similar laws were passed in Georgia, Maryland, and New York. Wells Fargo donated 300 properties nationwide last year, and Fannie Mae donated 30 properties per month to the Cuyahoga (Ohio) land bank. The story even identified a “land bank expert” at Emory University. Now that the Post has given me cover of plausibility, let’s discuss the costs and benefits.

One of the first lessons in an undergraduate microeconomics class is that bulldozing homes to create construction jobs is a bad idea. Even after those new construction workers rebuild the bulldozed homes, society has the same amount of homes as before but lacks whatever output those workers could have created in the alternative. The objective of economic policy is not to maximize jobs—if that were the case, entire cities would be bulldozed and reconstructed—but rather to allocate resources efficiently. Because so many economists have this lesson in mind (and because so many are pacifists), it is hard to embrace any policy that involves a bulldozer.

But this bulldozer scheme is motivated for different reasons. Too much land has been allocated to homes, many of which were built in bubble during the early half of last decade. As a result, too many neighborhoods in America are afflicted with abandoned properties. A vacant house is estimated to be worth half its normal market value. Imagine trying to sell your house at market rates when a close facsimile is available across the street for half the price! To add insult to injury, the excess supply of abandoned houses invites vandalism and neighborhood blight—the textbook negative externality—further depressing home values. Using data from foreclosures in the Cleveland area, Kobie and Lee (2010) show that the length of time that a home is in foreclosure has a significant drag on neighboring home values.

Well-functioning markets tend to equilibrate supply and demand, but housing markets are highly inefficient in this regard because of the time lag between beginning construction and selling a home: A housing boom sends signals to builders that new construction will be profitable. By the time the housing bust comes, the new builds become permanent mistakes.

To illustrate this “market failure,” consider downtown Miami. A drive down Brickell Avenue reminds one of New York City. Whereas there used to be one row of high-rises on the bay-side, the avenue now boasts rows and rows of developments as far as the eye can see. Had the developers known that many of these complexes would stand empty—the Census Bureau estimates that a whopping 18 percent of Florida’s homes stood vacant in March 2011—they would have tempered their enthusiasm. According to the Florida Association of Realtors, the inventory overhang has sent home prices plunging: the median price for homes sold in January 2011 was seven percent less than January 2010, and prices are expected to fall by another five percent in 2011.

And why is this so troubling for the economic recovery? According to the Fed, the nation’s stock of household real estate declined by $6.5 trillion since 2006. A family spends its income based in part on its perceived wealth; when housing values decline, families spend less. Economists call this the “housing-wealth effect.” Case, Quigley and Shiller (2006) found a statistically significant and rather large effect of housing wealth upon household consumption, and weak evidence of a stock market wealth effect.

A robust stock market might offset this decline in wealth (and hence spending), but the Dow hasn’t cracked 13,000 since April 2008. In the meantime, families are hoarding their cash. The $6.5 trillion elimination in household wealth puts the President’s $300 billion jobs-stimulus program in perspective: If the housing-wealth effect is dragging down spending, then a one-time injection of $300 billion dollars won’t have much of an impact. In contrast, a 10 percent increase a housing wealth—housing values are off 30 percent since 2006—would increase consumption between 0.4 and 1.4 percent according to Case, Quigley and Shiller.

When applied to vacated homes that have completed the foreclosure process, the bulldozer scheme would eliminate some of the excess supply of housing, which would temper the downward pressure on home values. In the place of a cluster of abandoned homes sucking the life of a neighborhood, imagine a children’s park, a dog park, or a community garden. Now that the banks have figured out bulldozing can be cheaper than maintaining the properties, paying taxes, and marketing the properties, the only thing stopping this idea from gaining traction is public sentiment.

My lunch crowd, comprised of economists, retort that the elimination of excess housing supply via bulldozers might be a boon to existing homeowners but would punish future homeowners. But wouldn’t a future homeowner prefer to invest in a slightly more expensive asset class with expected growth over a less expensive asset class with negative expected growth for the foreseeable future?

Finally, the bulldozing scheme need not be mutually exclusive with other schemes to relieve the housing crisis. Other ideas are worth trying, even if they wouldn’t spur much economic activity. Some are calling on Congress to eliminate the barriers keeping underwater homeowners from refinancing their mortgages. According to Macroeconomic Advisers, such a plan might boost GDP growth by 0.1 to 0.2 percentage points, as it merely redistributes money from lenders to borrowers. Others have called for massive debt forgiveness, achieved via a federal program to purchase troubled mortgages and give homeowners better rates. As Ezra Klein of the Post points out, however, the politics of using taxpayer dollars to pay off mortgages are impossible to crack. To stabilize the housing market, Larry Summers calls on government sponsored enterprises to finance mass sales of foreclosed properties to those prepared to rent them out, and to drop their posture of opposition to experimentation for programs such as principal reductions.

Whichever course we take, speed is of the essence: The housing drag is not going away on its own. According to RealtyTrac, the nation’s banks, along with Fannie Mae and Freddie Mac, have an inventory of more than 816,000 foreclosed properties, with an additional 800,000 working their way through the foreclosure process. Insisting that each of those homes be paired with a family—a noble cause—is tantamount to pushing off recovery for several more years.

I modestly propose to remove a fraction of these homes from inventory. If you don’t like the ring of a bulldozer scheme, how about “The Neighborhood Parks” scheme? Even if I can’t convince any economists to get on board, environmentalists should be pleased.

11 responses to The Bulldozer Solution to the Housing Crisis

  1. 

    It’s all about marketing. Label the plan ‘Sustainable’ and you’ll get Solyndra type backing.

  2. 

    Dave Bing and the city of Detroit are actively bulldozing and – presumably – collecting the raw materials from the old homes. (Scavenging is an active business model these days.) Some buildings just need to go.

  3. 

    I think that using Brickell is a poor comparison if you are looking for wealth creation. The rental market in Miami is incredible right now. While initially, there were huge vacanies in the area, savvy investers have realized that those individuals that suffered from foreclosure now need a place to live. Good luck finding a vacant 2 bedroom in this neighborhood. Rent in the average Brickell avenue condo went from 1600/month in 2009 to hovering around $2200/month today. The real problem, where bulldozing may be a solution, are the areas where high vacanies rates mirror high unemployment rates. With the downturned economy, many areas like Detroit, have lost industry as well as having a high vacant housing rate. In theses areas, where presumably the population has shifted in an attempt to follow employment, houses are likely to remain vacant. The question is now, with a surplus of vacant houses, but a decrease in income tax, how will the City/State finance creation and maintenance of parks?

    • 

      AES,

      If I recall correctly, the vacancy rate for homes in Miami-Dade county is 12 percent. My guess is that home values along Brickell are a fraction of what they were circa 2006, even if rental rates are “high”. What concerns me is the negative spillover effect on Brickell properties from vacant high rises that are two and three blocks off Brickell. Although I agree that the bulldozer idea is best suited to depressed areas, it could serve a similar purpose in affluent areas that have been overbuilt.

      Hal

  4. 

    Keep in mind, most of the places where this is happening were horrible a decade ago. The real estate crash just forced the issue.

  5. 

    why not auction them off to investors for whatever they will bring? Require the investor to maintain ownership for at least 1 year to discourage flipping, and require the buyer to submit the house to a habitability inspection in 6 months. Even a badly dilapidated house will be worth a few dollars to someone on those terms. The new investors would then have a strong incentive to initiate whatever repairs are necessary.

    If no one will bid under those terms (ie, too torn up to be worth anything to anyone) THEN tear it done.

    But this plan lowers rental prices by increasing supply, and thus helps working class people far more than the straight tear down plan does. The strict tear down plan is one I would characterize as one that seeks to support the well off at the expense of the poor, and that’s just not right.

    • 

      WWS,

      Because land banks are targeting depressed neighborhoods, it’s not fair to characterize this plan as assisting the “well off” only. Unless you define “well off” as “anyone who owns a home.”

      Hal

  6. 

    This proposal is a symptom of the desperation of our society to reflate the bubble and get back to a debt driven economy. Bulldoze all you want. That economy is dead and destroying wealth will never make us collectively wealthier. Letting housing prices drop to the point that people that want and need houses can afford to pay for them is the real solution. Housing prices collapsed because we finally ran out of “greater fools” convinced that house prices could only go up, leverage only worked one way (to magnify profits), and a pulse qualified you for a loan. We cannot go back to the old ways for at least a generation (until everyone burnt by the bubble is dead). Let the market function to find the real price of real estate, accept the pain that our foolishness caused, and learn to live within our means. That is the solution. Some houses that are unwanted and unneeded will be dismantled. Your silly efforts at price controls by artificial scarcity will fail as they always do.

    • 

      Gary,

      I’m a big fan of markets, but I am concerned that markets can’t deal with two problems here. First, the construction boom was a permanent mistake. In most markets, excess supply can be removed by taking unwanted products off the shelf. Second, you ignore the externality argument–when my neighbor’s home sits vacant for twelve months, my property value suffers. My “silly” proposal does not seek to restore home values to their 2006 bubble levels, as you suggest, but instead seeks to stop the decline in housing prices. As long as home prices fall, expect output to follow.

      Hal

  7. 

    After some of the houses sit empty for several years with no heat or ventilation bulldozing may be the best alternative, from a maintenance and economic standpoint.

    The dry wall, insulation, etc. will be beyond salvage, and the cost of repair may be too high to justify the work.

  8. 

    This is well reasoned. My intuition had been leading my towards the bulldozer as well. Sorry I couldn’t give you a hostile comment. Here’s a hypo to generate hostility: Why not have certain people that were foreclosed on bulldoze their own home? It’ll give them a job, providing short-term stimulus to the people who need it most, while still having all the economic benefits you outlined…