Sunday, May 24, 2009

The basic story was and is the housing bubble. How could they miss an $8 trillion housing bubble?

From Dean Baker:

"Sorry Greg, This Crisis Was Completely Predictable and Predicted

Gregory Mankiw uses his NYT column today to give us an explicit "who could have known?" about the economy crisis. He tells readers that: "fluctuations in economic activity are largely unpredictable."

No, this crisis was completely predictable. The problem was that the leading lights in the economics profession completely missed the boat and are now using their platforms to tell the public that it wasn't their fault.

The basic story was and is the housing bubble. How could they miss an $8 trillion housing bubble? What were they smoking?

We have a hundred year long trend, from 1895 to 1995, when nationwide house prices just track the overall rate of inflation. Suddenly in the mid-90s, coinciding with the stock bubble, house prices begin to hugely outpace inflation.

The run up in prices cannot be explained by any obvious shifts in the fundamentals of supply and demand. Furthermore there is no remotely corresponding increase in real rents. And, the vacancy rate for housing rises to record levels.

If economists could not see this bubble, then they should look for another line of work. Sorry, this fluctuation was entirely predictable. The people whose job responsibilities including recognizing a dangerous bubble like this one just blew it completely. It speaks volumes about the nature of the U.S. economy that almost all of those people still have their jobs, unlike the tens of millions of other workers who lost their jobs or can only work part-time because of the incompetence of the economists.

--Dean Baker


I think it's fair to criticize people for missing the housing bubble, but the appearance of Debt-Deflation might well have caught many intelligent people by surprise. It certainly caught William Gross by surprise.

On the housing bubble, I don't believe that it was totally crazy from a human point of view, but it was economically crazy. I mean by that the desire to own a house was driven by fears of being impoverished during old age. For twenty years, we've heard warnings that we will not receive social security. Pensions have also been seen as less viable. Consequently, many people looked into saving more for retirement. This was sensible.

However, many people find it very hard to save for retirement. Hence, it seemed sensible to see if they could find savings from their monthly expenses. This led to the perception that renting is a sucker's game, and that the only real possible for saving for retirement was to turn rent or housing expenses, which are necessary, into an investment. This was not a stupid idea.

The bubble was dependent on this perception, and another one often heard during the bubble, which is that, if you don't buy a house now, then you never will. That was the real motivation behind the asinine theory that housing prices always go up.

I guess you can tell that I believe that people were taken advantage of in this crisis. This motivation also fed into the tech bubble.

To not understand the panic that many people feel about retirement will skew the explanations of what really caused this crisis.

I know that other countries don't fit this theory as well as the US, but I haven't seen enough data to discount it.

I could say more about this issue, but I simply want people to understand why people felt desperate to own a house.

Posted by: Don the libertarian Democrat

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