From: http://volokh.com/

http://papers.ssrn.com/sol3/papers.cfm?abstract_id=302388

Zoning and the Subprime Mortgage Crisis:

Randal O'Toole has an interesting post rounding up evidence showing that zoning and other government land-use restrictions have played a major role in causing the subprime mortgage crisis. Zoning helped cause the crisis in two ways: by artificially inflating the price of real estate, and by increasing the likelihood of a "boom-bust" cycle in real estate prices.

As Harvard economist Edward Glaeser and UPenn economist Edward Gyourko showed in this 2002 paper, restrictive zoning greatly increases housing prices by artificially reducing the amount of land on which new housing can be built and also by reducing the amount of housing that can be built even in those areas where residential construction is permitted. Glaeser and Gyourko show that zoning restrictions account for a high percentage of the total cost of housing in some of the nation's most expensive real estate markets, such as California and the major East Coast cities. O'Toole's post cites more recent research that supports this conclusion (including his own). Higher housing prices helped cause the subprime mortgage crisis by forcing homebuyers to borrow more money in order to purchase homes of a given size and location. If prices had been lower, so too would homeowner indebtedness. Fewer buyers would be on the verge of default as a result of a market downturn; their debt burden would likely be much smaller relative to their income.

More recent research by Glaeser and his colleagues (summarized here) shows that restrictive zoning not only drives up housing prices, but also makes them more volatile. Presumably, this is because zoning makes it more difficult for property owners to make marginal changes in land use in response to market signals, thereby increasing the chance that adjustments will be put off until the housing market actually collapses. Obviously, the sudden nature of the recent market downturn exacerbated borrowers' difficulties in repaying their mortgages.

More at the above URL