Where is Ronald Coase when the Minnesota Legislature needs his advice on rotting houses?
Coase, a professor at the University of Chicago, won the Nobel Prize in economics in 1991. He doesn’t know diddly about water infiltration, but his ideas are still helpful.
The controversy centers on how long builders should be legally liable to repair defects in houses. Historically, if a carpenter built a house, he was responsible for fixing obvious or substantial defects of workmanship. Most problems showed up quickly.
Sticking doors, creaky floors or leaks around a poorly flashed chimney were the sorts of problems an average homeowner could notice.
Minnesota law specifies three terms of builder liability: one year for “defects caused by faulty workmanship or materials”; two years for heating, plumbing and electrical problems; and 10 years for “major construction defects.”
Unfortunately, many newer homes, built in the last 25 years to energy-saving building code standards, are showing up with significant water infiltration damage including mold and even rotting of the structure. Such problems are not apparent immediately. In fact, a latency period of six to 10 years seems common. Historically, builders seldom encountered complaints that long after finishing. Their insurance costs and bidding reflected that.
So far, lawsuits have not clearly delineated whether water infiltration damage falls under the one-year “faulty workmanship” or the 10-year “major defects” rubric. Moreover, builders argue that the 10-year term of liability is driving up their insurance costs and the price of new homes.
We need to recognize two questions here, one looking backward and one forward. Looking backward, our society has built many houses that will have very short useful lives or will require megabucks to fix. That is water already over the dam, or perhaps under the window flashing. The fight now is about who will bear the cost.
The issue looking forward is more important: How do we minimize such damage in the future? Here Coase can help. He would tell us to make the law more specific in terms of what category water damage falls into and to clear up any ambiguity about the length of time builders will remain on the hook for repairs.
Coase argued that, from the point of view of society, it is not very important exactly how property rights are specified. It is, however, terribly important that they are specified very clearly. All parties involved should understand their rights and responsibilities. Judges should not have to make heroic assumptions about legislative intent.
His example was a railroad with steam locomotives crossing an arid prairie. Sparks from the locomotive stacks might cause damaging fires. Society could have a law making railroads strictly liable for paying any damages from fires caused by their locomotives. Or, it could exempt railroads from damages and make property owners bear any losses.
The alternatives might differ in fairness, but both would be efficient. If the railroad were liable for damages, it could either pay all such damages that occurred or put spark arrestors on the engines to reduce fires, whichever was cheaper.
If the landowners were liable, they could absorb the losses, construct firebreaks or other measures to minimize the spread of fire, or pay the railroads to install spark arrestors — again, whichever was cheaper.
Don’t get hung up on which alternative is more fair. Coase assumes away transaction costs of litigation and so forth. But his central idea is important. In either case, there is an incentive for someone to address the problem with the lowest possible use of resources.
Resources will be wasted, however, if liability is left in limbo. If outcomes depend on the whims of judges or juries and court decisions are inconsistent, neither railroad nor landowner has a clear incentive to solve the problem.
Our Legislature could pass a law freeing builders of responsibility for any defect found after one month. It also could pass a law that kept builders responsible for 99 years. It could set any period between these extremes. As long as the rule is enforced consistently, however, there will be clear incentives.
If builders have unlimited liability, they will put extra care into making sure that houses are not susceptible to harmful water infiltration. If buyers know they bear the risk, they will be careful in choosing builders and may hire independent inspectors to check the work.
Which specific guaranty term is “fair” is highly subjective. But as long as liability is clearly specified, waste of society’s resources will be minimized. That is an important and under-appreciated consideration.
Note that economists cannot help much in settling disputes about existing houses. That damage is a sunk cost, and little can change it. These disputes are almost entirely about fairness.
Note also that houses will cost more. If builders are liable for longer periods, their insurance costs will rise and the increases inevitably will get passed along to homebuyers.
That leads to the important question of why so many newer houses have severe problems. That, however, is the subject of another column.
© 2004 Edward Lotterman
Chanarambie Consulting, Inc.