Is the Sun Setting on the American Dream?

90% of California's renters are now frozen out of the housing market. It could happen in your state too-unless the causes are understood.


In the recent past we have seen the prices of single-family dwellings, the inflation-driven mortgage rates, and the down payments required from first-time homebuyers all soar to unprecedented heights. From 1970 to 1980 the median price of homes nationwide galloped from $23,000 to $63,000an increase of 170 percent, compared to an increase in the general consumer price index (CPI) of about 91 percent.

In California, this shocking statistic takes us from a median home price of $26,000 in 1970 to $95,000 in 1980. (And by mid-1981 the median California home price had topped $105,000.) It is significant, incidentally, to note that the price of an average California home was only about 15 percent above the national average in 1970, while today it is over 50 percent more expensive. In other words, while all American homes were increasing in price by 170 percent, California homes were mushrooming in value by 265 percent.

Unless we understand the forces that have given rise to these effects in the housing market, and unless we take corrective steps, we can expect to see the "housing crisis" as a boldface, uppercase headline throughout the 1980s. Indeed, the public believes that high home prices, mortgage rates, and down payments are the elements of a crisis.

How can we explain the current numbers? Let's start at the very beginning. For 200 years, America was a place where the most desperateand most promisingfrom all around the world came in search of a very special kind of life. It wasn't that this nation looked, felt, or smelled so different, and it had little to do with the fact that America was a particular spot on the map. What brought these teeming masses to our shores by the millions was a very different sort of law and tradition. Social scientists refer to it as a "unique institutional framework," and surely it was. But for the human beings who gave up everything to come here, it was all melted down into that one word: opportunity. America was a place where, if you were ready to sow, then by God you could reap.

And for a space of history spanning two phenomenal centuries, the people who came settled into a style of living that became the envy of the world. Each generation made its commitment to the future, to their children, to progress. As immigrant parents struggled long hours through difficult working conditions, they lived on the very hope that their sacrifice might indeed be their children's gain.

Success might have come at a high price, but today there is no need to debate the point: it did, indeed, come. This great struggle to pass a better way of life from one generation to the next was an effort of great charity, even nobility. And the heroic efforts of many were known but to a few relatives, friends, and neighbors.

It is not news to anyone that this American Dream has been rapidly fading of late. What may prove more interesting is the way in which, for many people, political forces of remarkable proficiency have shattered the dream.

A recent survey by the Los Angeles Times found that in the southern California area, young married families with two wage earners are generally able to afford a hometheir own piece of the American Dreamonly if their parents give them the down payment. (This, incidentally, is usually possible only if the parents refinance their family home.)

As recently as 1970 a clear majority54 percentof Los Angeles city renters could afford to purchase a home. By 1979, the city's Community Development Department found that only 16 percent of these tenants had any real hope of ever purchasing their own home. Throughout California today, 90 percent of the state's renters cannot afford to buy the median-priced home. In the span of just four years between 1976 and 1980, fully half of those who could have afforded this purchase were eliminated from the market. Incredibly, in less than one decade, we have gone from a situation where most people who rented did so because they preferred such a choice, to a situation where the vast majority of renters simply have no other feasible option.

This is not to suggest that the life of the renter is tough as such. On the contrary, the residential rent index in the San Francisco-Oakland area increased slightly less than the consumer price index (excluding shelter costs) from 1975 to 1979. On the other hand, rents increased marginally faster than did the CPI (excluding shelter) for the Los Angeles-Long Beach-Anaheim and the San Diego areas.

These figures suggest that the behavior of rents cannot support the contention that there is a rental housing crisis. The problems arise when renters try to shift to home ownership.

There is an interesting sociological note to all of this. These captive renters tend to be either youngpredominantly between the ages of 20 and 40or relatively poor. The traditional ladder upon which each generation climbed, and to which the poor of all generations flocked, has been dropped overboard. At the same time that the equity of homes in established upper-middle-class neighborhoods skyrockets at a pace shocking even to those who own such homes, the gates around the "nice neighborhoods" slam shut to all those yet outside. Unless one's parents are already on the inside and use some secret passageway to let their children in, a permanent stratification of the social classesan unprecedented phenomenon for Americalooms imminent.

Ominous sociological trends support this fear. The bulk of "first-time" housing buyersthose fueling the demand for housing servicesare, predictably, between their mid-20s and mid-30s. This 25-34 age group will only get larger over this decade. The postwar baby boom has now graduated and entered the job market. They will soon begin looking to purchase their piece of the American Dream. In particular, the 30-34 age bracket will reach its peak size in 1992. This contingent is relatively larger in California than in the rest of the nation, presenting even more concern.

When you add credit charges to the steep increase in the price of homes, you can see the whole picture. Take the median-priced home and calculate the monthly payment for a 30-year mortgage on 80 percent of the purchase price at the market rate of interest. For the total United States, that 1970 monthly payment was $140. In 1980 it was $549. The California figure went from $165 to $844a "modest" increase of 411 percent! What these price explosions mean for average consumers is quite clear: they should have bought during the last decade.

This much is safe to say: those who venture into the home-buying market for the first timethat is without aid of equity in their own homeneed no convincing that what we have on our hands, especially in California, is a first-class, certified social crisis. The young and the less-than-affluent have been cashed right out of the middle-class suburban housing market by the millions.

Of course, this is not the result intended by many of those who have been most active and articulate in championing the "reforms" that have destroyed the young American's Dream and the poor American's Dream. But as any economist must testify, intentional policies always entail unintended consequences. To sort through a situation and discover what factors account for which consequences, an economist such as myself looks at demand and supply.

First, the demand side: persistent inflation has pushed many households into higher marginal tax brackets, so the favorable tax treatment of owner-occupied dwellings has increased in importance. The deductibility of mortgage interest and property taxes, together with the fact that the value of housing services does not have to be declared as income, means home ownership has been a terrific investment.

In addition, we live in an era in which the political system has everyone's property rights "up for grabs." Given that two-thirds of Americans own their own homes, however, one's stake in an owner-occupied single-family dwelling is the safest property right around. Thus, the demand for owner-occupied dwellings has increased.

Normally, this increased demand would stimulate the production of housing, and price increases would be modest at best. In California, however, the supply of housing has been regulated in such a way as to hamper that increased production in the last decade. With the supply response blocked, there has largely been a response in priceshigher prices.

How has the supply of housing been inhibited? By local governments' adoption of measures aimed at controlling growth in their areas, such as restrictive zoning laws and moratoriums on new water and sewer hook-ups; by building codes that impose costly standards and delay technological advances; by rent controls that discourage housing investments; and by limits on converting rental units to condominiums (ironically, for many people, the first rung on the homeownership, equity-building ladder). All these measures have had the effect of reducing the supply of available land and housing over what they might have been absent those policies. The ultimate result has been an increase in housing prices.

At a recent conference sponsored by the San Francisco-based Pacific Institute for Public Policy Research, the extent of some of these effects were laid out:

Item: Economists Lloyd Mercer and W. Douglas Morgan reported the results of their study of Santa Barbara County housing. They found that growth-control regulations and restrictions accounted for more than 27 percent of the increase in real housing prices during the 1972-79 period.

Item: Urban studies expert Bernard Frieden looked at four proposed developments in California. He reported that local government growth restrictions resulted in the approval of only 3,445 units out of a proposed total of 25,514, for a net loss of 22,069 housing units.

Item: Economist H.E. Frech analyzed the actions of the Coastal Commission in Ventura County. (In addition to local governments, California has coastal commissions set up to protect the coast from development.) Frech found that the typical resident living in a region between the coast and a line 13 miles inland, while benefiting in some respects, was a net loser because of Coastal Commission-caused increases in housing costs.

Item: Norman Karlin, a legal scholar, and Carl Dahlman, an economist, reported on their several studies of zoning measures. Zoning, they concluded, has evolved into a device principally for protection of the investments and lifestyles of existing residents, to the exclusion of moderate- and lower-income families.

Item: Economist Richard Muth concluded that the so-called crisis in condominium conversions is nonexistentthat cumulative conversions of rental units to condominiums have had only a miniscule effect on the stock of rental units and on the rental market. Puzzling over why there is a popularly perceived condominium conversion crisis, Muth suggested that it may be a politically motivated phantom crisis; it may be in the interest of politicians and others in government service to assert the existence of a crisis in order to increase political support among their constituency of renters.

Item: Legal scholar Robert Ellickson studied inclusionary zoning, whereby local government authorities require, as a condition for permit approval, that builders sell a portion of new housing units at below-market (and sometimes below-cost) prices. The beneficiaries of this program of income redistribution are supposed to be low- and moderate-income families. In practice, almost all inclusionary units have been "given" to families in the middle third of California's income distribution.

Now the obvious question is, If these policies have these effects, why did local governments ever put them into place? The answer is not difficult to fathom.

Suppose you live in a nice neighborhood. You have a nice place. You like your neighborsor at least their lifestylesand the folks at the supermarket are reasonably pleasant. You've seen your American Dream come true.

Now just a block or two away (you hear through a friend), someone is planning to replace a couple of nice old homes with a big, new three-story apartment house for 35 people. Apartments! Your streets are already crowded enough at 5:00 P.M. The line at the Post Office is sufficient. Finding a parking spot at the grocery store is already a minor challenge. You don't need any more neighbors to befriend; your bridge or tennis foursome is already complete, thank you.

And just like that, you and many of your neighbors are right down there at city hall extolling the virtues of open space, low density, and the natural ecology. The wealthier your community is, the more impressive will be the turnout.

You find that you have many votes behind you; you quickly learn at city hall that you have many friends before you. The local politicians will be pleased to greet you and listen to you whenever you and your well-dressed friends come calling. You represent votes, while the prospective apartment dwellers do not. The apartment building permit? Denied!

Okay. You've blocked the apartment, and your nice neighborhood has been saved. That is just swellprovided you own your own home or own an apartment building nearby. But, if you are just a renter in this environmentally concerned part of town, you've got a problem, because your rent is going to go up. Given some level of demand, when the supply of housing is restricted, prices are forced upall else equal.

So while homeowners in the neighborhood all go back to their nice, quiet living rooms to gloat over home prices in the classified section, the apartment dwellers now have to make their trip to city hall. This time it will be to protest those despicable landlords who, in taking unfair advantage of a "temporary" housing crunch, just jacked up those rents as high as the market would bear. Whatever the past level of rents, all of a sudden landlords have turned "mean" and "greedy."

Well, the city council will put a stop to that. Rent controls will take what Jane Fonda calls "the greed quotient" out of the apartment business.

And there is your one-two housing market punch: First you use "environmental" zoning to eliminate all new construction of low- to middle-income units, then you go to rent controls to make certain that the existing residents won't have to pay the price to keep others out. The benefits will be had by established homeowners and tenants, and the costs will be borne by apartment owners and potential low- to middle-income homebuyers and tenants now excluded from the neighborhood. Mission accomplished.

What was the unintended consequence in this instance? True enough, the existing residents can be seen as acting solely in their own financial interest, and in this they profit handsomely. Yet it is in the manipulation of seemingly public-spirited laws and officials that the political "invisible hand" of unintended consequences leads to complications.

Surely it costs something to keep nice neighborhoods nice, which has come to mean "nice and not growing" in today's status quo world. Indeed, the very proposition that outsiders are being turned away by restrictive zoning vividly demonstrates that these prospective residents are being made to bear a formidable costthe lost opportunity to move into a nice neighborhood. And for the privilege of possessing a resource now more scarce in supply, monopoly returns will accrue to existing homeowners as huge property value windfalls.

Empirical evidence is now piling up to overwhelm the last elements of doubt. Bernard Frieden of the Massachusetts Institute of Technology has masterfully detailed the politics of no-growth zoning in his 1979 volume, The Environmental Protection Hustle. Studying the San Francisco Bay area, Frieden found that wealthy homeowners' associations were expert in allying with professional environmentalists to limit, not all growth, but the most dastardly kind of growth: middle-income housing. Frieden found several instances in which progressive, new, environmentally enhanced developments were sacrificed in favor of permitting only "downzoned" upper-middle-class housing. In some instances, even public parks and open space (and free bus service to local BART terminals) were thrown out in the quest for "environmental purity."

A recent study conducted by economists Jennifer Wolch and Stuart Gabriel confirms such observations. "Local land-use regulations," they conclude, "have a perceptible and significant impact on Bay Area housing prices." Specifically, they find that "land-use controls implemented by the local governments together account for approximately 14% of the price of a typical Bay Area home." And as cited above, state regulations, such as those imposed by the California Coastal Commission can additionally push home prices much higher still.

The Wolch and Gabriel analysis is of further interest in revealing the sociological make-up of those communities that tend to be the most restrictive. When they divided Bay Area cities into "restrictive" and "unrestrictive" categories, they found that "not only are virtually all residents of 'restrictive' cities white (93%), but their mean annual income is $21,499, or 34% higher than incomes of residents of 'unrestrictive' cities. They are also much more likely to be white collar workers, as opposed to blue collar or service sector employees." As expected on the basis of the analysis, housing prices are 75 percent higher in restrictive cities. Understandably, then, the authors of this study express some skepticism that the real reasons for exclusionary zoning ordinances are the ones explicitly advanced"service adequacy, environmental protection, and fiscal balance."

I maintain that the individual legislators, regulators, and citizens' groups that achieved the policies necessary to grant such perverse and discriminatory results intended nothing of the sort. They intended only to respond, as best they knew how, to the political pressures directly on them. It was not their intent to reward the rich and penalize the poor.

But good intentions are clearly overrated. They are not sufficient compensation for those who suffer, nor are they a reasonable excuse for those who gain. The numbers tell their own story, swell sentiments notwithstanding. From 1977 to 1979, the percentage of first-time homebuyers fell by an incredible 50 percentfrom 36 percent of all homebuyers to merely 18 percent. Today, according to the Federal Home Loan Bank, only 15 percent of the prospective homebuyers would even be able to afford the monthly payments.

Many critics of escalating home prices say loudly: "The housing crisis is killing everyone!" In fact, though, not all homebuyers are equally affected. While the percentage of first-time homebuyers has been reduced, the ability of repurchasers to buy homes has been another story altogether. The figures for 1979, for example, show that the average purchaser was able to realize almost $31,000 from the sale of an existing home, while the median down payment for all homes was but $12,300. In other words, many established homeowners were able both to move to new quarters and to cash in a money dividend on the increased value of their single-family home investment.

Just as not all individuals are affected in similar directions, not all geographical regions are alike. Even a sweeping generalization comparing the entire western United States can point out some interesting disparitiesand lead us to conclusions with far-reaching implications. A progressive climate for family home development helped allow the South to hold median home prices 40 percent below those in the West in 1979, despite the fact that 46 percent of the southern homes purchased were brand new, as opposed to only 29 percent of those bought in the West. An obvious clue is provided just herenew homes are relatively more abundant in the South. Further illustration is provided by the interesting statistic that the median age of a house bought in the southern United States in 1979 was only three yearsas against nine years in the West.

While pundits, spokespersons, legislators, and desperate young families uniformly blame the villain of "high costs" as the root of all housing evil, a more careful and subtle analysis is appropriate. Housing prices have unquestionably gone through the roof in other parts of America, but in California they have shot through the ceilings of 30-story highrises. Most emphatically, this cannot be explained away by "the high cost of money," "avaricious construction unions," or "greedy developers."

The demonstration is simple: Look at Houston, Texas. They must certainly pay as much for credit as we do; otherwise they would get no financing. Their real wages and profits must, in real terms, be very close to ours, else California would play host to a large number of Houston migrants in search of California treasure. Quite to the contrary, Houston is the fastest-growing major city in America. The one real differencethe significant variable, as economists sayis the government's land-use policy. Houston has none. There, consumers are free to bid onand to useany land they desire so long as they are willing to pay the price. That price must be sufficient to outbid all the competition, which is only to say that such land will go to its highest value as determined by the buying public.

As Bernard Siegan has demonstrated in his remarkable book, Land Use without Zoning, Houston's lack of land-use controls is actually a more efficient system in protecting neighborhoods than the scandal-ridden, bribery-prone, zoning boards found elsewhere. If given the chance, the private market really is capable of allocating a scarce commodity like land.

And the results are simply remarkable. With a booming population (not unrelated to the favorable regulatory climate), demand for housing has soared in Houston. Unlike California, the consequence of soaring demand has been soaring supplynot soaring price. Small price increases have stimulated tremendous new investment in affordable housing.

We must not allow the phrases "high cost of building" and "high cost of financing" to become the brisk brush-off whereby shapers and makers of public policy avoid analytical scrutiny of land-use policy. The human cost of dreams interrupted by the cruel threat of exploding home prices does not afford us the luxury of ignorance. We must seek to understand the political persuasiveness of elitist legislation and, concomitantly, to address the far deeper question of how legitimate environmental concerns may be met at a cost shouldered equitably.

Stirring platitudes and oodles of "concern" have created, by intent or gaffe, a monster. This monster has taken an entire generation of young men and women hostage in their very homesor, we should say, in their apartments. Unless enlightened research leads the way to progressive legislation to unlock the gates of that American dreamland of initiative, enterprise, and entrepreneurship, the very best we will be able to say is that we perpetrated a social injustice with nothing but the "nicest" of intentions.

Let the record show that we understand the nature of the problem: High-income communities have used zoning and other growth-control measures to restrict the supply of housing. As a consequence, house prices have soared, and middle- and lower-income families have been excluded.

Wouldn't it be an act of courage if elected officials in California and across the United States would take the following steps: (1) Declare a two-year moratorium on growth control measures and other policies, such as rent control and "inclusionary zoning," now directedwith the best of intentions, of courseat undoing the exclusionary consequences of the former measures; and (2) Revise the law so that the courts engage in judicial review of such policies, with a particular eye toward the effects they have on reducing the supply of housing for middle- and low-income families.

There is little that can be done on the demand side that will not merely rearrange the existing stock of housing. The solution must come through supply. Americans want more less-expensive housing units. The solution is to decontrol the supply side.

M. Bruce Johnson is a professor of economics at the University of California, Santa Barbara, and president of the Western Economic Association. A member of the Board of Trustees of the Reason Foundation and research director of the Pacific Institute for Public Policy Research, he is the editor of the Pacific Institute's recently released book Resolving the Housing Crisis. This article is adapted from a speech delivered at a California Chamber of Commerce Housing Crisis Conference. Copyright © 1981 by the Pacific Institute for Public Policy Research.