The WFH "Urban Doom Loop" Thesis Revisited
Flashing Back to my 2010 Climatopolis Book's Core Thesis
Some top real estate economists have made the national news for their important thesis of the “Urban Doom Loop”. In short, the combination of persistent WFH and higher interest rates has meant that center city office towers in Superstar Cities such as San Francisco now sit 1/2 empty and this reduction in economic activity has lowered commercial rents, raised vacancies, lowered tax revenues and asset values. This has made bankers, who hold mortgages for these buildings, nervous as they face greater loan default and delinquent payment risk.
Here is their technical working paper and here is some news coverage. I congratulate them but in this piece I will offer some comments about how this important hypothesis could be used to justify a new round of spatial bailouts.
Urbanists tend to ignore that the $ no longer spent in center cities is now spent in the suburbs and exurbs and online. This is a pecuniary externality that economists should not forget. As rents decline in superstar cities, this raises the well-being of the Middle Class. Quality of life will actually improve in Superstar Cities because this is a competitive strategy to attract and retain the footloose.
I understand how a smart economist can tell a “domino story” such that one default by a bank sets off a chain reaction. I recognize this threat exists but what I want to discuss is how spatial special interest groups will use this worry to try to access “other people’s $” to bail them out for their own investment choices.
For those who subscribe to the Business Insider, you can read one of my pieces responding to their piece here.
In my 2010 Climatopolis book, I discussed how cities will adapt to rising climate change risk. If Miami faces a truly existential flood risk from sea level rise, then billions of dollars of real estate owned by private citizens would be at risk. Out of self interest, these place based asset owners would take proactive steps using private markets and voting and pressure local officials to build up a resilience plan to cost effectively protect their asset. Note that self interest drives this adaptive effort. If this logic interests you, read my PERC piece titled Climatopolis Revisited.
The rise of WFH poses new spatial competition challenges for superstar cities such as Manhattan and San Francisco. In my 2022 Going Remote book, I argue that this is a good think for urban America as a whole.
Back in 2019, our superstar cities were highly elitist. They weren’t pricing traffic and they weren’t building housing. They catered to the elites. Now they face competition and rather than adapting, they plead poverty! A libertarian would say; “Mayor of San Francisco, issue some municipal bonds and use the proceeds to police your city , improve street safety, address the homeless challenge and introduce school choice. Compete for footloose workers and jobs!”
My Climatopolis logic would ask why local home owners aren’t applying more pressure on the Blue City Mayor to take steps to improve the city’s quality of life to make it more competitive. Are we to believe that Mighty NYC and San Francisco are passive victims in the face of the challenges they now face? Why are their leaders being so slow to respond?
I have a theory.
Big Blue City Mayors anticipate that President Biden will be re-elected in 2024 and then a large Urban bailout will occur by taxing suburbanites and Red State voters. This has creates moral hazard effect of slowing down the making of difficult decisions to prune the public sector in big cities and to streamline commercial real estate conversion laws.
Would the adaptation process by cities be faster right now if the Federal Government could commit to no "Blue Bailouts”?
In my Climatopolis book, I asked; “If Milton Friedman ran FEMA and committed to not using Federal $ to rebuild cities injured by natural disasters, would cities do a better job protecting themselves?” My answer in 2010 and 2023 is “yes”. Our Superstar cities are not poor and use their own $ to better compete for people and firms who are voting with their feet that their demand to live and work there has declined.
For those of you who counter that we must protect poor people in these cities from the upcoming cuts, this is a fair argument but in this age of Big Data —- these individuals can be identified and sent a check. Read my 2017 piece on helping poor people to adapt to emerging spatial risks.
The Urban Doom Loop narrative has the effect of preparing the national taxpayers to be ready to bailout these commercial real estate owners and their banks because defaults on their loans could destabilize local banks who held undiversified spatial portfolios. Such banks should not be allowed to flip one sided coins. They made a bet that in retrospect was a bad bet. Why must people in Kansas cross-subsidize their losses? If you say well there is systematic risk, I don’t think that economists are smart enough to know such risk when we see it.
The Urban Doom Loop also interests me because it suggests that urban agglomeration is fragile. The old spatial persistence literature would not have predicted this! Ed Glaeser’s Triumph of the City and Enrico Moretti’s The New Geography of Jobs were important books that argued the opposite. Does the Urban Doom Loop theory feature a microfoundation that face to face interaction in dense urban cores no longer offers great advantages? If Face to Face interaction continues to be the key to economic growth, then won’t our Superstar Cities make a quick comeback? How could the urban agglomeration equilibrium be so fragile?
Pivoting back to the determinants of adaptation, I posit that expectations play a fundamental role here. Adaptation is fueled by not being able to access Other People’s Money!! Adaptation is fueled by developing human capital and coping strategies to cope with new situations.
Adaptation to climate change and adaptation to WFH really have many common features. I will return to this point soon. In my 2022 book, I argue that WFH helps us to adapt to climate change by decoupling where we live from where we work and thus giving us a large menu of places to live (some of which are safer in terms of climate risks).
UPDATE: Suppose the Biden Administration Offered a 40% (Federal)/60% Local matching grant to accelerate commercial building conversion into residential housing. A construction boom would take place in these cities. Construction unions would get rich here and the vacant capital stock would be redeployed faster. Would this stabilize commercial building values and reduce concerns about the next defaults and bank runs? Cities should have “skin in the game” for preparing for the consumer city transition. Providing safe, green, child friendly cities with more housing opportunities would go a long way in reducing out flight. I can’t say that I endorse this idea but I want my few readers thinking about how to configure Federal $ to encourage adaptation rather than to reduce adaptation effort.