When analysing the US housing bubble, four states stand-out for the way in which home values rose into the stratosphere before crashing and burning: California, Nevada, Florida and Arizona (see below chart).
Given the first three markets were covered in previous posts (see above links), I now want to analyse the Arizona housing market – with particular emphasis on its largest city, Phoenix – to determine why prices bubbled and then burst in such a violent manner.
In the lead-up to the crash, Phoenix’s economy was booming. New jobs were being added at a fast pace and per capita incomes were growing strongly:
With confidence riding high on the back of seemingly solid fundamentals and rising asset prices, along with easy access to credit, Arizona households borrowed heavily. Per capita debt accumulation surged in the mid-2000s to levels far in excess of the national average:
But Phoenix was living on borrowed time. With the national economy turning south in the wake of the sub-prime crisis and the collapse of Lehman Brothers, Phoenix home prices, which had already been falling gradually, began to slide fast. After home prices peaked in May 2006, it took another 18 months before Phoenix’s unemployment rate began rising:
And the pain is widespread, with around one in seven mortgages 90 days in arrears – well in excess of the national average:
So what went wrong? Could anything have been done differently to prevent the housing bubble/bust?
Certainly, if credit was less readily available, households would have been constrained in their ability to bid-up prices. But easy credit was only part of the problem. Another key driver of the rampant price escalation and then collapse was the way in which land was supplied for housing.
Throughout the 2000s, Arizona was one of the fastest growing metropolitan area in the United States with more than 1,000,000 population (see below chart).
However, despite there being ample developable land on the urban fringe to accomodate this population growth, the actual quantity of land available for development was heavily restricted on two counts:
- The State of Arizona passed statewide planning laws in 1998 and 2000, which included the implementation of high impact fees on new development and urban containment devices. In a 2006 study of land-use policies in the 50 largest metropolitan areas of the US, the Brookings Institution ranked Phoenix as ‘growth management’, which is the same ranking as Florida and California.
- The overwhelming majority of potential developable land in Arizona is either owned by the state and federal governments, preserved for conservation, or otherwise off-limits to development.
On the second point – the lack of available land for development – the below graphics highlight the land supply situation in Phoenix.
First, a pie diagram, extracted from the Arizona State Land Department Annual Report, showing how only 17.5% of land in Arizona is privately owned:
Second, a map showing the lack of developable land around Phoenix:
There is evidence that the Arizona State Land Department, whose mission is to “optimize economic return for the Trust beneficiaries”, heavily restricted sales of land to the market in an effort to maximise revenues, causing builders and developers to bid-up land price in period auctions to ensure their supply of land for construction (called ‘land banking’).
Whereas the price of land for housing sold for around $40,000 per acre immediately prior to the bubble, at the peak average land prices fetched nearly $200,000 (see below chart).
And with the state rationing the supply of fringe land, average residential land prices rose throughout Arizona:
Obviously, this land price inflation was a principal cause of the house price escalation as well as the delayed supply response to the rapidly growing population and rising house prices (see below chart).
Had land around Phoenix been freely available for development, developers would likely not have paid such high prices for the land sold by the state government and Phoenix home prices would never have risen to such heights or crashed as violently.
Phoenix is yet another example of where excessive government interference in the supply of land has combined with easy credit to create a speculative bubble followed by a painful bust.