Baker on housing wealth effect

The basic story is straightforward. The run-up in house prices created by the bubble created $8 trillion in housing bubble wealth. Standard estimates of the housing wealth effect suggest that this would increase annual consumption by 5-7 percent of this amount, or $400 billion to $560 billion a year. This would have been equal to 3-4 percent of GDP.

Loose macroprudential policy gave the economy about a $500 billion / year stimulus which filled the output gap left by inadequate demand from trade and government spending. It was unsustainable.

The Problem Is Not Debt: Consumption Is High Not Low by Dean Baker

Economists and economic reporters continually try to make the problem of the weak economy and prolonged downturn appear more complicated than it is. After all, if it is very simple then these people would look foolish for not having seen it coming and figuring out a way around this catastrophe. Fortunately for us, if unfortunate for them, it is simple. 

One of the efforts to make it more complex than necessary is to assign an outsized role to the debt associated with the collapse of house prices. This is the argument that we heard on Morning Edition this morning. The argument is that when house prices plunged after the housing bubble burst in 2007, homeowners were left with large amounts of debt, pushing many of them underwater. This debt supposed discouraged them from spending, leading to a sharp falloff in consumption. 

There is a big problem with this story. Consumption is not low, it is actually still quite high. The graph below shows consumption as a share of GDP. It is actually higher than during the bubble years and essentially at an all-time peak. That makes it a bit hard to explain the downturn by weak consumption. (Some folks may recall hand wringing about inadequate savings for retirement, as in this NYT column by Gene Sperling yesterday. Too little savings and too little consumption are 180 degree opposite problems, sort of like being too heavy and too thin.) 

There would be a modest decline in consumption from the peak bubble years if it was shown as a share of disposable income (tax collections are lower today than in 2004-2007), but it would stiill be unusually high by this measure. The basic story is straightforward. The run-up in house prices created by the bubble created $8 trillion in housing bubble wealth. Standard estimates of the housing wealth effect suggest that this would increase annual consumption by 5-7 percent of this amount, or $400 billion to $560 billion a year. This would have been equal to 3-4 percent of GDP.
...

FOMC during the bubble defltation

Frances Coppola tweets:

Working my way through FOMC minutes from 2004 to 2008. Fascinating. The FOMC members primary concern is always exactly the same.

Their concern is always that core inflation will "fail to moderate" - even when staff projections are that it will fall.

But they are always really upbeat about growth, even when staff projections are that growth will fall. They ignore their own staff.

And they ignore markets, too. Investors were pricing in lower rates due to falling growth expectations from Jan 2007 onwards.

But the FOMC? Nah. Main risk in their view was inflation (even though it was falling). They kept interest rates elevated.

Baker on Geithner

Stress Test: The Indictment of Timothy Geithner by Dean Baker

housing bubble

Nope, Robert Samuelson Is Wrong Again, the Housing Bubble Did Cause the Recession by Dean Baker

mortgage fraud

Why the Justice Department Inspector General Report on Mortgage Fraud Matters by David Dayen

housing bubble

Why Was the Housing Bubble So Much More Damaging than the Dot.Com Bubble? by Jared Bernstein

housing and monetary policy

House Prices and the One-Armed Policymaker’s Dilemma by John Cassidy

Subprime and general euphoria. Wealthy get better credit.

Fannie and Freddie (single-payer housing)

Socialize housing finance! by Michael Pollack

(via Doug Henwood)

What Janet Yellen Did and Didn't Get Wrong About the Housing Bubble by Matt O'Brien

...As Scott Sumner points out, housing starts halved between January 2006 and April 2008, but unemployment only went from 4.7 percent to ... 4.9 percent. 

He seems to agree with DeLong more than Baker. DeLong has pointed to this and I remember commenters saying there's a lag. Two years is a long lag and then the jump was sudden as there was a financial crisis.

Obama's unforced error

MORE JOBS AND HIGHER MIDDLE CLASS INCOMES AS ECONOMIC POLICY JOB #1: HOUSING POLICY EDITION by DeLong

Konczal on Summers and Housing

Yellen, Summers and Rebuilding After the Fire by Mike Konczal

...Given what this blog normally covers, I’d be remiss to not mention housing and financial reform. During the Obama transition, Larry Summers promised “substantial resources of $50-100B to a sweeping effort to address the foreclosure crisis” as well as “reforming our bankruptcy laws.” This letter was crucial in securing votes from Democrats like Jeff Merkley for the second round of TARP bailouts. A recent check showed that the administration ended up using only $4.4 billion on foreclosure mitigation through the awful HAMP program, while Summers reportedly was not supportive of bankruptcy reform.

Canadian Housing Bubble

Worthwhile Canadian Comparison by Krugman

How Do You Say "Housing Bubble" In Canadian? by Dean Baker

Employers: Never Bid Up Wages (bias in the media and with economists)

It's So Hard to Find Good Help: Businessweek Edition by Dean Baker

Businessweek tells us that homebuilders would be building more homes, if only they could find qualified construction workers. Hmmm, that must mean that wages for construction workers are soaring as the shortage causes employers to bid up wages in an effort to grab workers away from competitors or hold on to their current workforce.

That's not what the data say. According to data from the Bureau of Labor Statistics, after adjusting for inflation the average hourly wage in construction has risen by just 0.9 percent in the five years from 2007 to 2012. Note that this a total increase of 0.9 percent over these five years, not an annual increase. If there is a labor shortage, it's not showing up in wages for some reason. (Of course the unemployment rate for construction workers was reported at 13.2 percent in April, which also does not seem to indicate a labor shortage.)

The more obvious explanation for the fact that construction remains depressed is thenear record vacancy rates. Presumably many of these empty homes will have to be filled before builders get more aggressive about building new ones.

Zero Hedge one of Time's best Twitter feed's? What?!?

Yglesias and Franke-Ruta were listed in Time's best political Twitter feeds!

Found these at Time's website looking for:

The Housing Mirage by Rana Faroohar

But perhaps the biggest takeaway from the current housing "boom" is that the conventional wisdom no longer holds. It has long been said that you can't have a sustainable economic recovery in the U.S. until the housing market is back. In truth, it may be the other way around. Until you have more jobs, rising wages and a middle class that can afford to take out a mortgage from a bank that will actually lend to it, you can't have a real housing recovery.

Also:

Every Every Every Generation Has Been the Me Me Me Generation by Elle Reeve

(via Atrios & Scott Lemieux)

Bubbles, Gorton, Krugman and Cyprius-Iceland-Ireland.

The Яussians Are Coming! The Яussians Are Coming! by Krugman

...
As long as you haven’t bought into the Barney-Frank-did-it school of thought, you realize that the global crisis of 2008 was in a fundamental sense made possible by the erosion of effective bank regulation. As Gary Gorton (pdf) has documented, we had a 70-year “quiet period” after the Great Depression in which advanced countries had very few major financial flare-ups; Gorton argues, and most of us agree, that the key to this quietness was a constrained, regulated financial system that also limited the opportunities for excessive non-bank leverage. 

But this regulation in turn depended, to an important extent, on limited international capital flows; otherwise regulations made in Washington or elsewhere would have been bypassed via havens like, well, Cyprus. And once capital controls began to be lifted in the 1970s we entered an era of ever-bigger financial crises, starting in Latin America, then moving to Asia, and finally striking the whole world. 

So what are we going to do about this? Cyprus, as a euro-zone country, should really be part of a euro-wide safety net buttressed by appropriate regulation; it’s insane to imagine that the euro can be run indefinitely with merely national deposit insurance. But euro-area deposit insurance doesn’t seem to be in the cards — and anyway, there are plenty of other potential Cypruses out there. 

All of which raises the question, is the era of free capital movement just a bubble, fated to end one of these years, maybe soon?

Correcting Brad DeLong on the Housing Bubble by Dean Baker

I see that Brad has a post saying that the economy was adjusting nicely to the bursting of the housing bubble until the financial crisis set in. He notes that housing construction fell by 2.5 percentage points of GDP between 2005 and 2008. This was replaced by an increase in gross exports of 2.0 pp of GDP and increase in equipment investment of 0.5 pp. Everything was moving along nicely until the financial crisis in 2008.

I see things a bit differently. First, gross exports don't create jobs, net exports do. When we move an auto assembly plant from Ohio to Mexico, we are not creating additional jobs with the car parts exported to Mexico. That's intro textbook stuff. If we look at the net export picture, the gain is only about 1 pp of GDP. Furthermore it is hard to see the improvement in the trade picture having gone very much further without a further decline in the dollar. (That was a possibility, but far from a certainty -- depends on policy decisions elsewhere.)

The rest of the gap was made up by a surge in non-residential construction (can you say bubble?), which rose by more than 33 percent as a share of GDP, or more than 1 pp of GDP. This boom led to considerable overbuilding in retail, office space and most other categories of non-residential construction. Assuming the burst of spending in non-residential construction was another bubble, then the portion of the demand gap filled through this channel was destined to be temporary. It was inevitable that this bubble would also burst and we would need something else to make up the hole in demand.

The other factor in the mix is the drop off in consumption. Savings rates had been driven to nearly zero by the wealth created by the housing bubble. It seems to me inevitable that consumption would fall in response to the disappearance of this wealth. The financial crisis gave us a Wily E. Coyote moment where everyone stopped spending at the same time, but I would argue that this just brought the decline in spending forward in time.

The savings rate remains much higher today than at the peak of the bubble, although still low by historic standards. (It's currently around 4.0 percent, the pre-bubble average was over 8.0 percent.) We have two alternative hypotheses here. I gather Brad would say that people are spending at a lower rate because they are still freaked out by the financial crisis. I would argue that they are spending at a lower rate for the same reason that homeless people don't spend, they don't have the money.

Homeowners are down $8 trillion in housing equity as a result of the crash. I would expect that loss of wealth to have a substantial impact on their spending. I gather Brad does not.

This is what bothers me about his graph. It leaves out the loss of the wealth effect. The popping of the stock market bubble in 2000-2001 wasn't as damaging because it didn't have the same loss of demand related to the wealth effect.

The FHA and the Role of Government When Markets Fail by Jared Bernstein

Commenter "readerOfTeaLeaves" writes at OTE:

To put in another (background) layer, which has been brilliantly documented by Sen. Elizabeth Warren, in the background of these housing problems were underlying, quiet changes to the usury and banking laws. These changes occurred in the 80s and 90s, while the GOP controlled Congress and had great sway over federal judicial appointments that interpret legislation related to usury and banking. 

By the early 2000s, the economic pressures for housing – in part because it represented access to good schools (and consequent social mobility) – were almost unprecedented. And many families were loaded with debt at usurious rates that had *not* been permitted in the 30s, 40s, 50s, or 60s because we still had usury laws back then. 

But changes to the banking and usury laws preceded the 2000s, and by 2008 ‘finance’ had become about 40% of America’s GDP. 

I’m not defending FHA (which is beyond my knowledge base). Nevertheless, GOP political expediency in smearing federal agencies, without admitting their own culpability in making changes to usury and banking laws that affected economic security for millions of Americans, is a sign of intellectual cowardice. Is the GOP actually incapable of recognizing the linkages between the fact that suddenly banks could change 16+% interest on credit cards, and the fact that ‘finance’ morphed out of proportion to the rest of the economy…?

The Housing Bubble Should Not Have Been Hard to See by 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.

What's Holding the Economy Back? The Collapsed Housing Bubble, End of Story by Dean Baker

HOW TO GOVERN AMERICA IN 2013 II: MORTGAGES, HOUSING, AND THE RECOVERY by DeLong

The claim that cuts in state and local (and federal!) spending are dragging down the economy are well-founded. The claim that mortgage debt overhang and depressed consumption are not dragging down the economy is not well-founded.

Baker says that right now: 

The claim is the dropoff in consumption due to the debt burden of these homeowners explains the weakness of the recovery.

Some simple arithmetic shows the absurdity of this view. The amount of underwater equity is estimated at between $700 billion (Core Logic) and $1.1 trillion (Zilliow). Suppose that we can disappear this debt through some decree, how much additional consumption would we see? If we assume that these households spend an incredibly large share of this increase in their net wealth, say 15 cents on the dollar, this would imply additional consumption of between $105 billion (Core Logic estimate) and $165 billion a year (Zillow estimate).

However we would have also destroyed the wealth of the mortgage holders. Let's assume that they just spend 2 cents on the dollar of their wealth. This would imply a net boost to demand of $91 billion to $143 billion. While this would be a helpful boost to the economy, equivalent to a government stimulus program of this size, this would hardly be sufficent to make up a shortfall in annual output that the Congressional Budget Office puts at close to $1 trillion.

I'm confused.

Underwater Homeowners Cannot Explain the Weak Recovery by Dean Baker

The claim is the dropoff in consumption due to the debt burden of these homeowners explains the weakness of the recovery.

Some simple arithmetic shows the absurdity of this view. The amount of underwater equity is estimated at between $700 billion (Core Logic) and $1.1 trillion (Zilliow). Suppose that we can disappear this debt through some decree, how much additional consumption would we see? If we assume that these households spend an incredibly large share of this increase in their net wealth, say 15 cents on the dollar, this would imply additional consumption of between $105 billion (Core Logic estimate) and $165 billion a year (Zillow estimate).

However we would have also destroyed the wealth of the mortgage holders. Let's assume that they just spend 2 cents on the dollar of their wealth. This would imply a net boost to demand of $91 billion to $143 billion. While this would be a helpful boost to the economy, equivalent to a government stimulus program of this size, this would hardly be sufficent to make up a shortfall in annual output that the Congressional Budget Office puts at close to $1 trillion.

Calculated Risk:

Next Thursday, the BEA will release the second estimate of Q3 GDP. The consensus is GDP will be revised up to 2.8% annualized growth, from the advance estimate of 2.0%. This would be a pretty sharp upward revision.