10/23/10 5:48 PMYes, There Was a Housing Bubble Identifiable at the Time - Grasping Reality with Both Hands

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Grasping Reality with Both HandsThe Semi-Daily Journal of Economist J. Bradford DeLong: Fair, Balanced, Reality-Based, and Even-HandedDepartment of Economics, U.C. Berkeley #3880, Berkeley, CA 94720-3880; 925 7080467; delong@econ.berkeley.edu.

Economics 210aWeblog ArchivesDeLong Hot on GoogleDeLong Hot on Google BlogsearchAugust 18, 2010

Yes, There Was a Housing Bubble Identifiable at the Time

Paul Krugman rolls the videotape:

Wrong To Be Right: Yves Smithsays most of what needs to besaid about the Boston Fedstudy saying that nobody couldhave called the housing bubble.I’d just add that it’s helpful tolook at what we knew backwhen. Here’s a picture fromKash of house prices up toearly 2005; by the way, thesewere OFHEO prices, whichmost now believe understated the rise, which was better shown by Case-Shiller.But here’s what it looked like.... Given this kind of picture — and given the factthat the late-80s rise in southern California was, in fact, a bubble — how couldyou not be very worried? And when you looked at the rationalizations for highhousing prices being given at the time, it was obvious that they were questionable.

Sorry: the evidence just screamed bubble. No excuses for those who didn’t want tohear it.

I was one who thought I was relatively sympathetic to the "housing price rises arejustified" arguments--after all, I believed in the global savings glut which shouldpermanently reduce real interest rates and so raise the prices of long-duration assets, Ibelieved that it was rational to expect higher oil prices in the future and thus greaterlocational land-value differentials, and I believed that America had filled up for many

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10/23/10 5:48 PMYes, There Was a Housing Bubble Identifiable at the Time - Grasping Reality with Both Hands

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purposes--that housing prices would rise on average in the future, and an expectedcontinual rise makes it rational for prices to jump now.

As I wrote in 2005:

May 24, 2005:

Housing Bubble - Grasping Reality with Both Hands: Up until six months ago, Icould account for housing prices in terms of scarcity (they aren't building manyhouses near the California coast any more) and low interest rates. That's gettingless possible with each passing day...

July 25, 2005:

Worrying About the Housing Bubble - Grasping Reality with Both Hands: DeanBaker is more than worried about the housing bubble.... "Given how far out of linehouse prices have grown from fundamentals, there is no way to avoid enormouseconomic damage when the bubble collapses. However, the sooner house pricesdrop, the less damage there will be."

I can see three scenarios for getting out of things without serious damage:

1. Interest rates stay low for a long time, so the bubblyness of the housingmarket deflates gradually.

2. The housing market collapses, but the dollar collapses too. If the FederalReserve then follows an accomodative monetary policy, workers who lose jobsin construction and consumer services will be able to move relatively smoothlyinto jobs making goods for export.

3. The housing market deflates at the same time that businesses' animal spiritsrecover, and so workers who lose jobs in construction and consumer serviceswill be able to move relatively smoothly into jobs making and installing capitalgoods.

September 18, 2005:

Dealing with the Housing Bubble - Grasping Reality with Both Hands: MarkThoma reports Janet Yellen's views on the housing bubble:

Economist's View: Yellen: There is a Bubble But Don't Pop It With MonetaryPolicy: [W]hile I'm certainly not predicting anything about future house pricemovements, I think it's obvious that the housing sector represents a risk tothe U.S. outlook. This brings me to the debate about how monetary policyshould react to unusually high prices of houses--4or other assets, for thatmatter.... [P]olicy should be calibrated to the wealth effects of house prices onoutput and inflation. The debate lies in determining when, if ever, policyshould be focused on deflating the asset price bubble itself. In my view, the...decision to deflate an asset price bubble rests on positive answers to threequestions. First, if the bubble were to collapse on its own, would the effect onthe economy be exceedingly large? Second, is it unlikely that the Fed couldmitigate the consequences? Third, is monetary policy the best tool to use todeflate a house-price bubble? My answers... are, "no," "no," and "no."... Inanswer to the first question on the size of the effect, it could be large enoughto feel like a good-sized bump in the road, but the economy would likely to beable to absorb the shock... In answer to the second question... the Fed [wouldhave] time to cushion the impact.... In answer to the third question... a tighterpolicy to deflate a housing bubble could impose substantial costs on othersectors of the economy that would lead to equally unwelcome imbalances...

10/23/10 5:48 PMYes, There Was a Housing Bubble Identifiable at the Time - Grasping Reality with Both Hands

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other strategies, such as tighter supervision or changes in financial regulation,would not only be more tailored to the problem, but also less costly to theeconomy...

Yes, people could have knowed. Some of us did.

Brad DeLong on August 18, 2010 at 10:31 AM in Economics, Economics: Finance,Economics: Macro | Permalink

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Comments

Neal said...I knowed too!

Reply August 18, 2010 at 10:36 AMsave_the_rustbelt said...Most of the states were not involved, didn't knowed and didn't cared, until we startedpaying the price for the mistakes of Wall Street, Florida and California.

One of the news magazine shows (Sixty Minutes?) caught it and did a Florida bubblestory (2007, early 2008?).

Reply August 18, 2010 at 11:41 AMSimon van Norden said..."...the Boston Fed study saying that nobody could have called the housing bubble. "

Paul Krugman, I think, distorts what the authors say. I mean, the freakin' TITLE oftheir paper is "Reasonable People Did Disagree [sic]..." Even in the abstract, theyacknowledge the "...number of economists who argued forcefully for a bubble ..."

I don't see that as a claim that nobody could have called the housing bubble. I don't seethat as a claim that there was no perceived risk of a housing bubble. I see them makingthe reasonable empirical point that, prior to a collapse, it is hard to convince everyonethat there is a bubble. I think that is different in important ways from what Krugmanwrites that they claim.

Reply August 18, 2010 at 11:56 AMjohn c. halasz said...The housing bubble peaked nationally at the end of 2005. Seeing a bubble in themiddle of 2005 is scarcely an signal accomplishment. Dean Baker called it in themiddle of 2002. But it wasn't just a housing bubble, it was a generalized credit bubble,

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stemming from the Wall St. machinery of structured securitization and derivatives.

Reply August 18, 2010 at 12:07 PMBrad DeLong said in reply to Simon van Norden...Let me put it another way: I was predisposed not to believe in a housing bubble--thedifficulties in purchasing more than one single-family residence, etc. But if even Ibelieved in a housing bubble by early 2005, how could anybody reasonable not believein one then?

Yours,

Brad DeLong

Reply August 18, 2010 at 12:18 PMBarbara said...I second what john h. said. If it had JUST been a housing bubble, would it have beenso catastrophic? Yes, prices deflated dramatically in certain markets, but isn't it reallythe lax underwriting of credit risk and the securitization in the credit markets, whichincidentally, played no small part in the price escalation, that made the popping sopainful?

Reply August 18, 2010 at 12:57 PMGearg said...The paper looks at what economists actually said. It doesn't argue that no one knewbut that many, really most economists - again, economists - would say things like, "Itlooks like a bubble but maybe that's not bad and we don't know that it will endhorribly because maybe it will just slow down and, even then, maybe I'm wrong aboutit being a bubble." The point of the paper is to show how economists acted. It's obviousnow that pessimists were right, but read the paper and you see that it wasn't so easyfor a policy maker to make out the correct path when fully half the economists weresaying it's not a worry, well maybe it is but I'm not really sure and other hedgingvariations.

Take 10 minutes and look at the paper. It is a report about how economists actuallyacted not an argument that no one knew or that nothing should have been done or anyof those other, jump-to-a-conclusion misreadings being peddled off a summary. Thepaper is, if anything, a picture of the difficulties of making policy because you certainlycan't trust professional economists to get things right or to speak clearly about them.

Reply August 18, 2010 at 01:32 PMBob Athay said...By early 2005 it wasn't at all clear to me that there was a housing bubble in the DCarea. My gut instinct was that prices had been rising too rapidly for too long, and thatsome sort of correction was coming, but it wasn't at all clear that we were going to seea collapse. The DC area tends to be recession-resistant (but not recession-proof!) soNorthern VA typically didn't experience the kind of boom-and-bust cycle that otherareas of the country sometimes do. But then, I hadn't been paying much attention tothe market because I had no expectation of moving anytime soon. As it turned out,Prince William County's assessed value for my house peaked in 2007 or maybe the yearbefore. By 2009 it dropped to less than half the 2007 figure and lower still for 2010.

One thing that was evident even to me (a hard-core applied science geek) was thatsomething was drastically different about the consumer credit market. The volume ofjunk mail promoting too-good-to-be-true deals on mortgages, credit cards, student

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loans, etc. was nothing short of obscene: just throwing it away took noticably more ofmy time than ever before. Obviously not a healthy sign. In hindsight, the deregulationof the 1980s and 1990s set us up for a truly spectacular fall.

Reply August 18, 2010 at 02:19 PMchristofay said...Washington is a one-company town where the industry is resource extraction (IouwaSenator Ghastly, "if you want health care work for the federal government"). There is aworking Obama and Rahm "brain trust" now know as the Cat Food Commissionworking to retain for itself our national resources. Either the serfs will tire of it or itwill reach exhaustion. The turn will come.

The present bubble is fedgov bonds, so the test is whether you are an observer/doer ora central planner. The central planner will say we have the magical beans to avoidcollapse, unfortunately the course for the other side isn't as clear.

Reply August 18, 2010 at 03:08 PMJoe Smith said..."As early as August 2004, Mr. Rosenberg, Chief Economist at Merrill Lynch for NorthAmerica, published a detailed analysis regarding the precarious state of the Americanhousing market. Rosenberg warned that there could serious problems ahead in anEconomic Commentary entitled: "Housing: If not a Bubble Then an Oversized Sud." "

Reply August 18, 2010 at 08:32 PMBob Athay said in reply to christofay...Yes, the DC area is sustained by the business of government and in the last 60+ yearsthe business of government never shrank, at least as far as I can tell. I don't think I'dcall it a one-company town, though. That implies too much order. This place thrives onchaos.

I really don't know what you mean by a bubble in government bonds. A bubble in realestate or tech stocks grows because people believe that the thing they're buying will beworth more in the future. I can't imagine buying bonds because I believe that I couldsell it later for more than I paid for it. Rather, I buy bonds because (a) I believe thatit's a safe investment or (b) it pays a better return than other securities withcomparable risk.

Reply August 18, 2010 at 08:34 PMpurple said...Forget the California coast; we all know why that is expensive. The housing bubble wasmost pronounced and unexplainable in places like Vegas and Phoenix, the swamps ofFlorida and Stockton, CA.

Reply August 19, 2010 at 02:32 AMpurple said...Anecdotes are useful too. If one has contact with the real world, repeated stories ofnurses, cops and teachers loading up on a half-dozen or more houses (in said Modesto,Stockton, Merced) should have rung alarm bells. All the time using their initial equityas leverage.

Truly madness.

Reply August 19, 2010 at 02:37 AMCoreilly said...I wasn't in the market so it didn't affect me that directly but my Road to Damascusmoment for the bubble was when one of the character's on The Soprano's (Carmen?)

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Me: Economists:

PaulKrugmanMark ThomaCowen andTabarrokChinn andHamiltonBrad Setser

Juicebox

Mafia:

Ezra KleinMatthewYglesiasSpencerAckermanDanaGoldsteinDanFroomkin

Moral

Philosophers:

Hilzoy andFriendsCrookedTimber ofHumanityMarkKleiman andFriendsEricRauchwayand FriendsJohn Holboand Friends

said they should put their money in REIT's because they never go down.

Reply August 19, 2010 at 07:28 AMComments on this post are closed.

Academic Gone WildThe Moderate Voice - Oct 06, 2010Nothing exemplifies the nastiness and hatefulness of some arguments amongacademics as the no-quarter campaign of Berkeley economics professor BradDeLong ...Related Articles » « Previous Next »

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10/23/10 5:48 PMYes, There Was a Housing Bubble Identifiable at the Time - Grasping Reality with Both Hands

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