America's housing bubble still deflating
As they failed to spot the bubble, most economists seem oblivious of the threat of further market falls to come Dean Baker
If house prices fall by 15% in 2011, the likely cut in consumer spending could cost 1% in GDP. Photograph: Reuters/Shannon Stapleton
How many economists does it take to see an $8tn housing bubble?
The answer to that question has to be many more economists than we have in the United States. Very few economists saw or understood the growth of the $8tn housing bubble, whose collapse wrecked the economy. This involved a degree of inexcusable incompetence from the economists at the Treasury, the Fed and other regulatory institutions who had the responsibility for managing the economy and the financial system.
There really was nothing mysterious about the bubble. Nationwide house prices in the United States had just kept even with the overall rate of inflation for 100 years from the mid 1890s to the mid 1990s. Suddenly, house prices began to hugely outpace the overall rate of inflation. By their peak in 2006, house prices had risen by more than 70%, after adjusting for inflation. Remarkably, virtually no US economists paid any attention to this extraordinary movement in the largest market in the world.
Had they bothered, they would have quickly seen that there was no plausible explanation for this jump in prices in either the supply or demand side of the market....
Therefore, it should have been easy for any competent to economist to recognise the housing bubble. Moreover, the dangers for the economy should also have been apparent. The boom in construction (both residential and non-residential) had raised its share of GDP by more than 3 percentage points above its long-term average. In addition, the creation of $8tn in housing bubble wealth predictably led to a consumption boom, as households spent on the basis of the new equity created by the bubble.
All of this presaged disaster for the time after the bubble burst....
Yet, almost no economists saw what was clearly in front of their eyes. They thought everything was just fine, until the house of cards eventually collapsed in 2007-2008.
Unfortunately, the reign of error is not over.
As with Iraq, the reward for being right is to continue being ignored. Baker continues, to explain the appearance of a new housing slump:
House prices in the United States are again declining and most of the economics profession remains clueless. The Case-Shiller 20-city house price index for October (the data is released with a two-month lag) showed a decline of 1.3% from September. This implied an acceleration from the prior month's decline, which is now reported as 1.0%. In other words, house prices are again declining at double-digit rates. A more careful examination of the data reveals the underlying logic. Prices are declining most rapidly in the bottom third of the market. Prices for this bottom tier of the market were in freefall in recent months in several cities.
The reason is that a first-time buyers' tax credit ended in June. This credit caused many buyers to move their purchase forward. People who might have otherwise bought in the second half of 2010 or in 2011, instead bought in the first half of 2010.
This tax credit had the effect of ending the plunge in house prices in 2009, and even leading to small rise in the second half of the year. But with the credit now expired, the price decline is resuming....
If house prices drop by another 15%, completing the deflation of the housing bubble, this would imply a loss of $2.5tn in housing wealth. If consumers spend 6 cents for every dollar of housing wealth (near the middle of the range of estimates), this would mean a fall in consumption of roughly $150bn or 1% of GDP. This will be a substantial drag on growth over the next two years that will, no doubt, surprise most economists.
And, of course, the ongoing hangover from the previous collapse continues, as foreclosures just keep on going, and going, and going.
Two other economists weigh in with sobering echoes. First, Krugman notes how truly minor the "good" employment news is:
Curb Your Enthusiasm
Not the kind of job report that has you jumping for joy. Things appear to have stopped getting worse, but that's about all.
Then Brad DeLong notes that it's only the high-end retailers who had a cheery Christmas this year:
Two-Tier Recovery Jonathan Birchall:
FT.com / Retail & Consumer - Holiday US same-store sales disappoint: Gap, the largest speciality retailer, reported a 3 per cent drop in comparable store sales growth against last December.... American Eagle and Aeropostale, the youth fashion retailers, reported comparable sales declines respectively of 11 per cent and 5 per cent.... Large mainstream department stores... Macy's saw its comparable sales increase 3.9 per cent, JC Penney 3.7 per cent and Kohl's 3.7 per cent. Target, the discounter, saw comparable sales rise just 0.9 per cent against last December....
More upmarket retailers continued to outperform the rest of the sector. Nordstrom, the fashion department store, reported an 8.4 per cent increase in same-store sales, while Saks, its luxury rival, saw an 11.8 per cent increase. Victoria's Secret... saw comparable sales increase by 8 per cent.... Abercrombie & Fitch, the youth fashion retailer, saw sales jump 15 per cent against last year...
Needless to say, virtually all the Versailles political commentary assumes that nothing remotely like this is actually going on with our economy. It's like the Democrats almost entirely ignoring the issue of unemployment for the past two years.
You could call it a repeat, except that it never ended the first time.