The housing crisis isn’t over yet, as prices around the country continue to plummet. Despite the market’s continuing collapse, most commentary and analysis has managed to overlook one of the key factors in the creation of the original bubble: land use regulation that artificially limited the housing supply. Even worse, taking Rahm Emmanuel’s maxim to heart (let no crisis be wasted), officials at the city, state, and federal levels are coming up with regulatory and legislative measures to re-inflate this bubble.

The latest Moody’s Economy.com report on housing carries sobering news (except perhaps for those it drives to drink). Moody’s expects house prices to fall even further in the most distressed markets, bottoming out at 66 percent below the peak in Miami, 58 percent in Phoenix, 56 percent in Las Vegas and 53 percent in Los Angeles. These losses are similar to those I predicted if house prices were restored to historic norms.

Moody’s, however, appears to be wrong in claiming that the markets with the most “nonprime and investor” lending experienced the greatest “run-up” (and decline) in prices in the housing bubble. Nonprime, or sub-prime lending was widespread around the country. There was no correlation between sub-prime lending shares and price increases, as our analysis of Mortgage Bankers Association and house price increases indicates. There was substantial sub-prime lending just about everywhere, while there were substantial house price increases only in some places. The radical variations in house price increases  between states and metropolitan areas are not explained by variations in sub-prime lending.

The critical difference was in the ability of metropolitan housing markets to respond to the increase in demand from sub-prime lending with housing supply. Some markets did very well, such as Atlanta, Dallas-Fort Worth, Houston and much of the Midwest and South. In these places, house prices rose little relative to household incomes during the housing bubble. A Dallas Federal Reserve Bank analysis notes that the Houston market had a large share of sub-prime lending, which had little effect on house prices. On the other hand other markets, especially in California, but also in Florida, the Northeast, Seattle, Portland, Las Vegas and Phoenix, experienced unprecedented house price increases relative to household income. Each of these expensive markets have prescriptive land use regulation strategies such as urban growth boundaries, large lot zoning, infill requirements and building quotas, all of which drive housing prices up.

It is not surprising that these markets attracted more than their share of speculators (“investor lending”), who saw no point in investing in markets where prices were not rigged by regulation.

In prescriptive metropolitan markets, land was rationed so severely that prices were driven to two or three times historic norms. The role of prescriptive land use regulation in ballooning house prices has been noted by many of the world’s leading economists, such as Nobel Laureate Paul Krugman, Bank of England Monetary Policy Committee member Kate Barker and former Reserve Bank of New Zealand Governor Donald Brash. The Dallas Federal Reserve Bank analysis notes the role of such regulation in the recent housing bubble:

Demand for housing, driven by low interest rates and a growing economy, combined with supply restrictions—such as zoning laws, high permitting costs and “not in my backyard” regulations—to contribute to rapid price appreciation. Figure 2 shows how low levels of construction in the face of strong demand contributed to significant price appreciation…

Among the major metropolitan areas with prescriptive land use regulation, median house prices rose $174,000 on average from 2000 to 2006. Over the same time, metropolitan areas with traditional regulation (responsive land use regulation), house prices rose less than $13,000. Obviously, a lot of housing affordability was lost where there was prescriptive land use regulation.

The spurt of demand from the sub-prime easy money drove prices up in these prescriptive land use markets, while it had comparatively little effect on the markets with traditional (“responsive”) land use regulation. The Dallas Federal Reserve Report notes:

… that Atlanta, Dallas-Fort Worth and Houston “weathered the increased demand largely with new construction rather than price appreciation because  of the ease of building new homes.

None of this is to suggest that the easy money did not increase demand and did not play a role in the house price increases. But as the logic of the Dallas Federal Reserve Bank analysis suggests, easy money alone was not enough to have produced the extreme housing bubble that has burst. The critical element was prescriptive land use regulation.

This second government regulatory failure -- prescriptive land use regulation -- sealed the fate of many housing markets, driving house prices to the stratosphere. Such markets were set up for house price losses of an intensity not seen even in the Great Depression. For example, just in the last year, median house prices dropped more than $200,000 in all of the coastal California markets and more than $100,000 in inland California markets and Washington, DC. Some markets are down more than 40 percent. Other prescriptive land use regulation markets experienced declines of more than $50,000. Meanwhile, among responsive land use markets, average price drops were a fraction of those in prescriptive land use markets, at under $10,000. The holders of mortgage debt were simply unable to sustain losses of this magnitude.

Had prescriptive land use policies not been in place, the losses would have been far less severe and the mortgage meltdown would have been far less severe. With barely 30 percent of the nation’s owned-housing stock, the prescriptive markets accounted for more than 85 percent of the housing bubble value. If the housing supply vent had been allowed to operate in the prescriptive markets, the loss in the value of the nation’s housing stock would likely have been one-fifth or less that of the actual loss.

But there is more. It is generally acknowledged that the international financial crisis, the worst world-wide financial crisis since the Great Depression, was set off by the US mortgage meltdown. Had there been no prescriptive land use regulation, chances are that the house price bubble would have been far smaller and the international financial crisis would have been substantially less severe or avoided altogether.

Government, which is principally responsible for the crisis by allowing or even encouraging profligate lending while stingily restricting development, offers little hope. It appears poised to repeat the same kinds of mistakes that lengthened the Great Depression. The pending stimulus package includes tax credits for home buyers, and there are proposals to reduce mortgage rates, despite the fact that current rates are the lowest in living memory.

During the Great Depression, government strategies to prop-up wages only made things worse, as economists Harold L. Coe and Lee E. Ohanian pointed out in a recent Wall Street Journal commentary. The federal government’s efforts to maintain housing prices that never should have reached even their now discounted heights could similarly extend the current recession or depression (International International Monetary Fund head Dominique Strauss-Kahn now calls it a depression). Whatever their short term impacts, proposals such as these are like trying pump air into a balloon that has already burst. More pressure is not going to do the job.

In fact, however, the long term recovery and sustainability of the housing market requires understanding what went wrong. If the land use regulations that had so much to do with the intensity of the downturn are not repealed, then it could happen again.

Economists Ed Glaeser and Joseph Gyourko have noted that house price volatility is greater where there is more prescriptive land use regulation. Avoiding volatility is a matter of great importance. Had it been avoided, the many households who have lost their houses or seen their savings depleted in this downtown would be far better off. Hope for the economy would be much greater, because many households would not have seen their resources so decimated that restoration of previously normal consumption levels may never occur.

California has been the epicenter of the current crisis. Yet the state’s leadership naively believes that the very policies that have destroyed its economy and provided much of the impetus to destroying the world economy are essential to its fight against greenhouse gas (GHG) emissions. As late as last year, Senate Bill 375 was enacted, which restricts land use even more than before. Even before that, state Attorney General Jerry Brown was going around the state suing local governments to force even greater restrictions. Part of it is a hopeless, faith based presumption that forcing people into transit can make a big difference. More importantly, Brown and the rest of the California leadership believe that more restrictive land use strategies can materially reduce GHG emissions. In fact, however, such strategies are no based upon no more than clichés and slogans. Based upon a University of California compendium, it is clear that land use strategies could provide no more than a modest down payment in the urban transportation sector alone. And, such policies are likely to be hideously expensive, both in financial and human terms.

Because California is so large, its land use regulations are a matter not just of statewide, but also nationwide and worldwide concern. The rest of the nation and the world should send a message in unison: “never again.”

Writing in The New York Times, Glaeser suggests dealing with prescriptive land use regulation through the pending stimulus package:

If some aid to expensive states is made conditional on permitting more construction, then pricey places will face incentives to permit more units and promote affordability. Those incentives will encourage restrictive cities and towns to look beyond their borders, and to make America more affordable by permitting more construction in the high-price housing markets that are undersupplied and unaffordable even to the middle class.

That would be a good start. Starting the process of dismantling overly prescriptive land use regulation would put the nation on the road toward improved housing affordability and toward developing a sustainable, stable housing market that is out of reach of the extreme regulation that did so much to cause the current crisis.

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Wendell Cox is principal of Demographia, a St. Louis based public policy firm, a visiting professor at the Conservatoire National des Arts et Metiers (the largest university in France), and a three term appointee to the Los Angeles County Transportation Commission. He is also co-author of the Demographia International Housing Affordability Survey, now in its 5th annual edition.