Housing in our major cities is becoming increasingly unaffordable. I think we all know this by now.
Most people recognize that this is due to supply constraints that limit the amount of new housing being completed every year to house new people. That is, the price elasticity of supply (or responsiveness of supply to rising prices) is too low.
The CMHC studied this exact metric in a large 2018 research report on the drivers of home price growth in Canada’s five largest metropolitan areas between 2010 and 2016, and estimated that housing starts in Montreal, Calgary, and Edmonton rise one percent to two percent for every one percent increase in home prices. In Toronto and Vancouver however, housing starts only grow by 0.5 percent and 0.3 percent, respectively.
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Unsurprisingly, Toronto and Vancouver are leading the pack in terms of our housing affordability crisis.
Most people also recognize that the most meaningful of these supply constraints take the form of land-use rules that set large parts of our cities aside as being effectively out of bounds for new housing development. These rules are informed by a not-in-my-backyard (NIMBY) sentiment that pits incumbent homeowners against newcomers, whether they’re young people or immigrant families.
As former CMHC President and CEO Evan Sidall puts it, succinctly, “homeowner NIMBYism makes affordability worse.”
But “most people” isn’t “all people.”
Some people reject this simple explanation to a simple (if serious) problem and think that new housing supply will not and can not improve the situation. They think this because, as they put it, the real problem is that housing has become “financialized.”
In 2019, a Toronto City Councillor wrote about this for Spacing magazine.
“That’s financialization and it has nothing to do with the simple supply and demand curves taught in high school. It makes housing more expensive. It increases the concentration of wealth. It is an insanely risky way to run the biggest economic sector in the world.”
This word, financialization, has gained traction among some progressive politicians and activists who recognize that housing affordability has become a problem but who reject the efficacy of supply side solutions, that is, of land use liberalization and increased development activity.
So, what does it mean? I understand financialization to mean three things.
First, the increased legibility of housing by global capital markets.
Thanks in large part to the internet, the housing market has become more efficient as information asymmetries have eroded. It’s now much easier for an analyst in New York City, London, or Hong Kong to get a good understanding of distant housing markets and allocate capital accordingly.
Second, the process by which housing in major cities has become attractive as a store of value, due in large part to its predictable scarcity.
Housing in most major North American cities is predictably scarce because a series of land use and other rules have made it hard to build. These are the supply constraints I mentioned above. As a consequence, housing values in these cities typically increase at a higher rate than inflation. This makes housing attractive as a store of value.
Finally, an inflating money supply that contributes to and exacerbates the increased demand brought about by both of the points above.
To restate the point, these are all demand-side factors impacting housing prices and affordability. They do directly have to do with the simple supply and demand curves taught in high school.
Which is not to say that financialization couldn’t be a problem, or that we shouldn’t explore relevant solutions. Predictable scarcity for instance could become predictable abundance given — you guessed it — land use liberalization and increased development activity.
Author’s note: Hub contributor Ginny Roth and I will be discussing the topic of housing affordability with GMU economist Bryan Caplan on June 7th at 7:45 PM EST. Register at blueforum.ca with promo code HUB for free access.