Honestly, I thought this was a dumb theory when he first floated it five years ago, but Krugman trotted it out _again_ earlier this month. And I keep rereading it, because I keep thinking he's gotten it exactly backwards.
http://www.nytimes.com/2010/04/12/opinion/12krugman.html (embedded in this column is a link to the earlier column). In this column, he tries to make sense of why Texas prices haven't dropped as far as they have in Georgia, which comes out a little odd, given that he neither contemplates the local economies of Georgia (specifically Atlanta) and Texas, nor does he contemplate their history in previous expansionist phases (viz. previous S&L crisis in Texas). Instead, he draws a weird conclusion about "And the contrast between Texas and Georgia suggests that consumer protection is an essential element of reform." Which, I might add, I agree with. But I do not agree with how he got there.
Recently, some housing bears (you know, those annoying people who sold their house at or near the top of the bubble and then rented while waiting for things to crater -- blogging about it all the while) have been buying. They are a little embarrassed about this, because they are still _quite_ bearish about housing prices, and are excusing their decisions because we're probably going to bump along like this for a while and the wife was really wanted to live in a real house and the kids were getting bigger and so forth. The New York Times is producing articles about renting vs. buying and little calculators to help you decide. I have a point here. I swear.
Here's the point. Can you find a rental house (I'll even let you include townhomes and condos, but they have to meet our shopping criteria which included an unfinished basement or comparable storage; we looked at some condos, in fact) even remotely like the one I bought in the town I bought it in? Or, hey, I'll be generous, one of the towns which shares a border with my town. Good fucking luck. How can I do a rent vs. buy comparison when there is no comparable to rent?
And that's why the Zoned Zone bubbles while Flatland doesn't theory falls apart. In Flatland, a bubble does not manifest as higher prices -- it manifests as sprawl. Sprawl to a point where no one can actually live with the implicit commute. In the Zoned Zone, bubbles manifest as high prices at the low end (where you _can_ find rental property which is comparable). It's a bubble whether that price looked ridiculous or not. And if, after the bubble pops, the house never sells again but is instead razed, well, you won't notice that the price went down. A lot.
I guess the clearest way to explain the difference between Flatland and the Zoned Zone goes something like this. In Flatland, after a bubble pops, you can rent a house on your block for less than your monthly mortgage payment. Reliably. Possibly a much, much nicer one than you have hocked your soul for. In the Zoned Zone, finding a house to rent is difficult, the pricing will be all over the place -- and it won't be nicer than the houses that the owners live in.
ETA: Zoned Zone is such a dumb name. Zoning isn't what protects Seattle, SF, NYC, etc. Geography is what protects prices in those areas. Leaving Portland, OR out of the discussion, I don't think anyone in the US has successfully held the line on zoning rules enough to raise prices _without_ geography playing an important part. One could seriously wonder how so many European countries have managed that, only of course fuel prices are a factor, and a whole lot of weird agricultural policy differences probably matter, too.