How High Gas Prices Triggered the Housing Crisis

Republican presidential candidate Rick Santorum made headlines last week when he suggested that high gas prices made mortgages unaffordable, causing the recent housing bubble to burst and sending the economy into recession. It may sound far-fetched, but it is precisely the theory that I and a pair of coauthors presented in a working paper released five days before Santorum’s remarks.

We are actually a bit more nuanced, arguing that unexpectedly high gas prices triggered the collapse of the housing market — igniting a fire fueled by easy credit, lax lending practices, and speculation. It is a provocative claim and one with broad implications, but it is also a claim supported by economic theory and empirical evidence.

The federal government’s Financial Crisis Inquiry Commission asserted in its 2010 report that “it was the collapse of the housing bubble . . .that was the spark that ignited a string of events that led to a full-blown crisis in the fall of 2008.” And a broad, if not unanimous, consensus among economists suggests that the ongoing economic malaise was induced by a financial crisis caused by the housing crisis. Relatively less well-understood is what caused the housing crisis in the first place.

We contend that a persistent upward trend in gas prices starting in 2005 — and the doubling of gas prices between 2005 and 2008 — altered the calculus of suburban living, causing homeowners to revaluate the wisdom of long work commutes from suburban and exurban communities into city centers.

For at least half a century, economic theory has held that the price of owner-occupied housing is declining in distance from the city center — all else equal — and that ever-declining costs of transportation induce sprawl, as households trade off the time-inclusive costs of commutes for the opportunity to own homes and land.

For much of the housing boom from the mid-to-late 1990s through 2005, gas prices were relatively low and flat — under $2 per gallon in real 2011 dollars and under $1.50 in nominal terms. Housing was developed on the outskirts of cities, in part because of constraints on growth within them. Low down-payment requirements and the growth of subprime lending, combined with high expectations for housing price appreciation, attracted relatively low-income households to the housing market and induced a phenomenon known to realtors as “Drive Till You Qualify,” whereby prospective homeowners would drive out from city centers until they reached communities in which they could afford mortgages.

The boom resulted in the newest and lowest-income homeowners settling farthest from cities and gambling that rising home equity would allow them to renegotiate mortgages before rates climbed. They were most exposed to a gas price shock as they faced the longest commutes — 50 miles or more in some communities. And they were least able to absorb the costs of higher commutes. Some households couldn’t afford mortgage payments and defaulted, others found themselves underwater and preferred to walk away instead of throwing good money after bad. Foreclosures rose and the market unraveled from the outside in. 

Antioch, California is one of the communities that suffered most during the collapse. A resident who commuted 45 miles to San Francisco would have seen his gas costs for work trips climb $3,000 annually at the height of the gas price shock. His total commute cost would have constituted fully 41 percent of the mean annual expenditure among U.S. households in the lowest income quartile.

There is no doubt that subprime lending and speculation fueled demand for housing assets. But these are uniquely American phenomena. The housing boom and bust is not. A similarly volatile cycle was observed in Britain, Spain, France, and Ireland, among other countries that while not exposed to the aggressive lending in the U.S. would have been affected by global energy market dynamics.

And presumably new mortgage products and easy credit were available throughout the U.S. Why then did the impact of the housing crisis vary so much by location? How then to explain that both the percent decline in home values and the increase in foreclosure rates grew in magnitude with distance from major city centers? Or that seven of the twenty metropolitan areas with the highest foreclosure rates in 2010 were California cities located in outlying areas like Modesto, Riverside, Stockton, and Merced?

Moreover, while the prevalence of risky loans made the housing market susceptible to collapse, had home prices kept rising in 2007, instead of turning down, rising home equity could have been used to renegotiate risky loans, thereby concealing and even resolving the market weaknesses.

Low interest rates assuredly made credit — and thereby housing — cheap. But the housing boom began before interest rates fell, and it persisted after they rose. And with interest rates near their lower bound, why is the housing market still in the tank?

And if you think the housing market was in a bubble, you may be right. It is true that all bubbles burst — by definition. But even the eminent bubble expert, the economist Robert Shiller, concedes we don’t know why the housing bubble burst when it did. Or do we?

With gas prices approaching $4 per gallon nationally, and the latest data on the housing front showing home prices at post-collapse lows, it would seem the housing boom of the last decade has saddled us with a housing stock ill-suited for the future we face. If consumers expect gas prices will remain high — or that climate policy will raise costs of commutes independent of energy market dynamics by raising gas taxes or imposing prices on carbon emissions — then the suburbs — home to roughly 50 percent of American households—may not soon recover from the collapse as urban living becomes relatively more attractive. With one-in-four households underwater and unable to withdraw home equity to finance consumption, a slow suburban housing recovery bodes poorly for short-run growth in aggregate demand and a broader economic recovery.

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  1. Matt Graham says:

    I submit also that people would have lost jobs due to companies they worked for having to pay more for fuel.

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  2. Simon says:

    Hidden due to low comment rating. Click here to see.

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    • Patrick says:

      Hidden due to low comment rating. Click here to see.

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      • Gaidig says:

        Not if they do their homework – in that case, they’ll realize that the oil supply from drilling efforts initiated now won’t be available for another 10 years. So, gas prices *might* go down in 10 years when they expect the supply to increase. Maybe.

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    • Adam says:

      For a real understanding of “speculators”, read this:

      http://mainstinvesting.blogspot.com/2012/03/who-are-oil-speculators.html

      There is a gross misunderstanding of oil and gas prices – it would serve us all to understand the history behind oil and how we perceive the high costs.

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  3. Patrick says:

    Yep, ain’t nothing $2 a gallon gas wouldn’t fix.

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  4. Mike B says:

    The problem is that when you cram huge numbers of people together almost any little thing can start a deadly stampede. The housing market was for years in a highly unstable state and just about anything could have caused the collapse. The truth is that since the Dot Com bubble burst the United States was relying on a housing based economy. That is almost the very definition of unsustainable and if gas prices didn’t set of the panic, something else would have. The solution is not to somehow increase the value of unsuitable suburban homes, but to force both banks and homeowners to come to terms with the fact that those investments need to be written off.

    Urban areas continue to offer huge deals in terms of housing, but a number of factors are preventing the necessary population shifts. Perhaps a program where middle class folks in low value suburban homes can swap places with people people in urban homes. If urban neighborhoods were transformed from poor to middle class, the housing stock would instantly appreciate, which would return wealth to those people who got burned driving until they qualified.

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    • twobeef says:

      I get the idea that the lesson to be learned here is that there was no one single problem in the collapse. There was a clusterfuck of different things going on in this country, and anyone who tells you that any one single thing was the problem or any one single entity is to blame is full of themselves.

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    • Gaidig says:

      You make a good point – suburbs and exurbs aren’t the only source of affordable housing. The idea that all the people who make less money drive until they qualify and therefore all the people in the fringes were all the people who were especially vulnerable to forced changes in their budgets ignores the fact that inner cities all over the U.S. are typically poor neighborhoods. Affordable housing with short commutes was and continues to be available. There is also an aversion to urban neighborhoods in certain social circles that drove/drives the urban sprawl as well, and we can’t ignore that as a cause.

      Unfortunately, a housing swap would just make people who currently live in the poor neighborhoods in the inner city even more poor and more vulnerable, but it really is too bad that we can’t use abandoned housing stock for that. Bad neighborhoods would improve and everyone’s housing values would increase, while increasing commuters’ spare time and decreasing their vulnerability to volatile energy markets. Unfortunately, fear is the biggest obstacle.

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  5. CdrJameson says:

    Can’t you just buy a more fuel efficient vehicle?

    Here in the UK fuel costs roughly $8.70 per (US) gallon, so buying a more efficient car can save you more than the loan to buy it costs. (It helps that fuel efficient cars tend to be cheaper to buy and tax too)

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    • Richard says:

      How do you propose that one affords to buy a more fuel efficient car? That costs more money, which they probably don’t have. You aren’t going to save much in the US from a standard sedan to a more fuel efficient car. You will only see a bump of a few mpg, and if you’re already in the mid-20′s, you aren’t going to save much money.

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      • James says:

        These people have cars, don’t they? So at some point they presumably bought those cars. They could have, whenever they made the purchase, have opted to buy a fuel efficient car (which would probably have cost less than the one they did buy), since it hardly was a secret that gas prices would climb. They chose to buy the gas-guzzler instead, just as they chose to go for the teaser mortgage.

        I think Aesop covered this in one of his fables.

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      • Pshrnk says:

        Mid thirties in my corolla 16K brand new and will go at least 200k

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  6. Greg Marshall says:

    I run a Community Education program that provides a wide variety of workshops to my local community. The explanation above dovetails with the consumer patterns I saw with my customers. Six months before the housing collapse, my registrations dropped like a rock. As gas peaked in price, I lost 20% of my customers in one quarter. Six months later numbers kept sliding right into the housing decline. What was interesting is that early decline got us looking around and prepared as we could tell something was wrong…just didn’t guess how wrong.

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  7. Mitch says:

    What about the nature of of the mortgages themselves? Many of them were issued with artificially and deceptively low teaser rates that got jacked up to unaffordable levels after the introductory periods ended.

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  8. DanC says:

    Higher gas prices led to the Fed increasing interest rates as a record number of ARM were resetting. Also higher gas prices kicked the cane out from under the auto industry causing major problems in the midwest. Not to mention the travel industry in Florida and Nevada. California was just mismanaged but the housing crisis was most like what you describe (plus the higher interest rates on ARMs).

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