After the Housing Bubble Bursts
By Dean Baker
t r u t h o u t | Perspective
Tuesday 24 October 2006
Every new release of data on the housing market provides more evidence that
the housing bubble is finally bursting. Compared with year-ago levels, nationwide
housing starts are down 18 percent, sales of existing homes are down 13 percent,
and new homes sales are down 17 percent. Inventories of both unsold new and
existing homes are at record levels. Prices have already begun to fall in many
parts of the country, and seem certain to fall much further before the market
stabilizes.
The housing downturn will almost certainly lead to a recession, and most likely
a severe recession. Housing construction and sales directly account for more
than 6 percent of GDP. In the recessions in the mid 70s and early 80s, housing
fell off by close to 50 percent. However, the impact of a downturn in housing
is likely to be more severe this time around. House prices had not gotten so
out of line with fundamentals in these earlier periods, nor had housing wealth
fed so directly into consumption.
Homeowners have been borrowing more than $700 billion a year from the equity
in their houses. This borrowing has pushed the savings rate into negative territory
for the first time since the beginning of the Great Depression. As a result
of this massive borrowing, the ratio of mortgage debt to home values has never
been higher. With home prices falling, millions of homeowners will soon lose
the ability to borrow against their homes. This will force people to curtail
their consumption. It many cases, it will cause people to lose their homes,
as they will not be able to maintain their mortgage payments.
The economic picture over the next couple of years is likely to be one of rapidly
falling house prices, rising default and bankruptcy rates, which will be associated
with job loss and sharply higher unemployment. The soundness of banks and other
financial institutions that are heavily dependent on mortgage debt may be jeopardized.
This is not a pretty picture.
Not many economists are projecting this sort of dark future. Economists never
seem to project anything other than clear skies, even when the clouds are right
upon them. In the fall of 2000, six months after the stock market crash and
just a few months before the beginning of the last recession, not one of the
"Blue Chip" 50 economic forecasters saw a recession on the horizon.
In fact, the most pessimistic forecast for the next year was that the economy
would grow at a modest, but respectable, 2.2 percent pace.
The downturn following the collapse of the housing bubble is likely to be far
more severe than the downturn from the stock bubble. Housing wealth is far more
evenly distributed than stock wealth - most middle class families own a home,
relatively few have any significant wealth in the stock market. The other reason
that the collapse of the housing bubble is likely to have more severe consequences
is that there is not likely to be another bubble to inflate to pull the economy
out of the downturn. The Federal Reserve Board relied on the booming housing
market to lift the economy in 2002-2003 when it otherwise would have been stuck
in the water. There is not another obvious asset category that could play the
same role in the wake of a collapse of the housing bubble.
If the pain of a housing crash is unavoidable at this point, it is important
to at least do some accurate scorekeeping. The fact that the housing market
was experiencing an unsustainable bubble should have been apparent to any competent
analyst. House prices nationwide (there are always large regional differences)
had always tracked the overall inflation rate. In the years since 1997, house
prices rose by more than 50 percent after adjusting for inflation. No one had
any remotely serious explanation for a fundamental supply or demand factor that
could explain this run-up in prices, leaving a speculative bubble as the only
plausible story.
For whatever reason, the vast majority of economists and policy analysts devoted
their attention to far less important issues. The analysts who did focus on
housing insisted that there was no bubble, with very few exceptions. As a result,
there were no warnings; in fact, many homebuyers were urged into this inflated
market, sometimes with a big push from the government, or even non-profits trying
to promote wealth building.
Tens of millions of families bought homes at bubble inflated prices and now
face the prospect of seeing their life savings disappear in the housing crash.
We may not be able to get these people's money back, but we should at least
be clear on who sent them down the wrong path. Hopefully, the economists, bankers,
realtors and other bubble proponents will not be in a position to wreck economic
havoc yet again.
Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer (www.conservativenannystate.org). He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.
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