Home > The Economics Profession > The housing bubble should not have been hard to see

The housing bubble should not have been hard to see

from Dean Baker

Economists and other policy types are working hard to maintain the absurdity that the housing bubble was hard to see. Hence we have Federal Reserve Board Governor Jeremy Stein pontificating on how the Fed should deal with bubbles and the Post playing along with the gag.

Let’s just run through the basic facts.Nationwide house prices had sharply departed from a 100 year long trend in which they had just kept pace with the overall rate of inflation. At the peak of the bubble in 2006 they were more than 70 percent above their trend level. Housing construction rose from its average of 3-4 percent of GDP to over 6.0 percent of GDP. This was at a point when the demographics would have led observers to expect a drop in construction since the baby boom cohort was seeing their kids move away from home and would have been looking to downsize. On top of this, the vacancy rate was already at record levels as early as 2002. It kept rising to new record highs year by year after that.

The savings rate had dropped from a pre-stock bubble average of more than 8.0 percent to near zero at the peak of the bubble. Again, the demographics with the baby boom cohort in its peak saving years would have led one to expect a rise in the savings rate.

Any economist who could look at these monstrous divergences from normality and not recognize a bubble really needs a new line of work. And this is before we even talk about the explosion of the subprime market, the Alt-A market, and the huge number of homeowners buying houses with no money down.

Folks this was really really easy. The economists and other policy types who are trying to say it was difficult to see are just covering their rears.

  1. February 12, 2013 at 3:59 pm

    As far as I can see root cause is that commercial banks were allowed to issue money (deposits) for people to buy houses and simultaneously recognize the “value” of these same houses on the asset side of their balance sheets. With house buyers acting as low-friction intermediaries, this is bound to cause a bubble. If banks were pinting money for people to buy gold in exchange for loans “backed by gold” that would create a very obvious monetary and price spiral and people would cry foul. But with houses for some reason they have a blind spot. They mistakenly threat housing as productive capital rather than correctly as a nominal cmmodity.

    Why didn’t it happen earlier? I don’t know. Maybe the housing market was less liquid or less leveraged on the part of the buyers decades ago. Or maybe it’s the magnitude of idle capital compared to the size of the productive economy that’s unprecedented.

    • Ryan
      February 17, 2013 at 8:01 pm

      Even if homes was actually productive capital, the production that homes would produce would quickly delude the market, and cause economic actors owning homes to go under as their return on their investment goes below the interest they must pay on their debt.

      Regardless if the industry is real estate or financial instruments, the federal reserve didn’t anticipate the 1929 crisis either.

  2. February 17, 2013 at 8:55 pm

    Why are any “bubbles” hard to see?
    Because no one has defined their cause and have only been able to identify them when they are almost ready to burst.
    A “bubble” is created when there is an excessive amount of ‘credit expansion’ fueling an increase in price regardless of any change in value. When the “next biggest fool” can’t get the credit expansion to continue the fueling, the “bubble” bursts.
    Ask the Hunt brothers about their silver adventure.
    Ask Greenspan why he did not choose to use that method in 2001, (margin increase).
    Justaluckyfool asks a simple question, Would there have been a “Tulip Bubble” if all transactions were capitalized at 100%? A 1929 “Stock Market Crash” if all losses were payable on demand if they were at 100% liquidity? And the Housing Bubble”, they may not even as of today been de -leveraged because of “credit expansion of such incomprehensible amounts” that perhaps we have not yet have experienced the full burst.

    But even better yet, Does anyone see in any way, just perhaps, maybe Gresham’ s Law
    coming into play? Bad money (Bank created money -via interest on credit expansion) will take Good money (Sovereign issued currency and coin) out of circulation.
    Or didn’t anyone notice that you may have to pay a premium to use cash instead of debit or credit card. Or that there was a run on the banks in 2008; however, the public took there withdrawals in a form that other banks accepted for deposit –AS IF IT WERE CASH !

    Since 1926, Noble Laureate Frederick Soddy stated, “Banks are insolvent” in his “The Role of Money”. Why is it so hard to see anything ?
    But there is still hope. As long as RWER and others continue to allow open discussion,
    then perhaps , just maybe, social media could be an “unintended consequence that could be innovation” that could be the path to a great solution.

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