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Home Publications Blogs Beat the Press Correcting Brad DeLong on the Housing Bubble

Correcting Brad DeLong on the Housing Bubble

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Wednesday, 06 March 2013 15:24

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 -- it 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.

[Correction: The earlier version said "net exports" in the first paragraph.]

Comments (19)Add Comment
prices vs construction
written by tom, March 06, 2013 4:02
Yes, DeLong starts counting from the dropoff in construction, but prices didn't start falling right away, and even after prices started falling it probably took a little while for the people to recognize this, with respect to the wealth effect.
...
written by Tom, March 06, 2013 4:24
I get that the housing bubble burst cost wealth, but isn't that for many just a paper loss? Short of having your ARM called in and that kind of stuff, it seems to me your houses value going down is similar to your stock going down until you sell, your loss is only on paper.I lost value in my home, but only on paper until I sell. I never really eased up on spending until the financial crash.
Savings
written by bakho, March 06, 2013 4:52
Paying down debt on an underwater house is "savings".
...
written by JSeydl, March 06, 2013 5:02
I think the 1st paragraph should say gross - not net - exports if we're reporting what Delong wrote.
Not just "Wealth Effect"
written by Troy, March 06, 2013 6:02
Trillions of cold, hard cash was being redirected from the world's savers to the world's spenders (us) 2002-2008.

When the free money flow ended, so did the party we were having.

It amazes me that nobody with a major media presence sees this. I feel like I'm in a Twilight Zone episode.

http://research.stlouisfed.org/fred2/graph/?g=ggP

shows everyone were borrowing $100B/month at the peak of the bubble (2006).

They weren't just borrowing this money, they were spending it! The positive velocity effects were enormous, not just in the housing sector but wherever this hot housing money went to, which of course was everywhere.

Problem was that in 2005-2006 the greatest fools had been found already, the suicide lending products could get no more fraudulent or insane, and the system shifted into "distribution" mode.

Home prices peaked in 2005 and slowly started their fall. This was accelerated as all the suicide borrowers decided the housing market was no longer fun to play in and let the title go back to the beneficiary.

gah. I don't know if the PtB of 2002-2007 intentionally allowed this housing bubble to bloom, or they were too incompetent to even see it, and I don't know which alternative with that is worse.
Fred-FU!
written by LSTB, March 06, 2013 6:47
It appears Dean's double-bubble hypothesis (residential then nonresidential construction driving consumption) is better than DeLong's gross exports one.



...But consumption is back while residential construction isn't, which makes this line confusing:

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.


But people are spending the money. It's coming from somewhere. I thought the bigger problem was the trade deficit, not consumption.

This is all confusing me.
...
written by Troy, March 06, 2013 8:31
>But people are spending the money. It's coming from somewhere. I thought the bigger problem was the trade deficit, not consumption.

http://research.stlouisfed.org/fred2/graph/?g=gh9

blue is the consumer debt bubble flow.

red is the federal debt flow. (Can't call it a bubble since .gov can't run out of cash like Casey Serin did)

Trade deficit is a big problem for velocity, yes. $500-$600B a year leaving our paycheck economy, going to who-knows-where.

I think it's no coincidence that the Fed is printing $480B+ a year to replace that.
"WTF?"
written by watermelonpunch, March 06, 2013 8:35
Did I just walk into bizarro world or something?
People Don't Have Money - Really?
written by Paul Mathis, March 06, 2013 10:12
Then why are auto sales back to normal levels and up 50% from the bottom of the Great Recession? Everyone seems to have plenty of money to buy new autos and retail sales in general have been gaining too.

Brad's theory fits the facts.
Car Sales are still down
written by Dean, March 06, 2013 10:35
Paul,

you should look at the data http://ycharts.com/indicators/auto_sales. Auto sales are around 15.3 million annual rate now, they were over 17 million in 2006. Assuming 1 percent annual growth, we should be getting close to 18 million on our bubble trend rate.
...
written by Troy, March 06, 2013 11:59
>Then why are auto sales back to normal levels and up 50% from the bottom of the Great Recession?

Cars wear out and people need working cars.

Not everyone is unemployed and the recovery we've seen since 2009 has returned some normalcy to most people.

http://research.stlouisfed.org...es/PAYEMS/

Demographically, we have the baby boom echo entering their mid-20s, this will produce some more recovery spirit, as will the baby boom shuffling off into retirement I think.

But how we're going to pay off that retirement is the tough question if higher taxes are off the table. We need to raise taxes $5000 per capita to close the fiscal deficit.

NOT going to happen.
...
written by Troy, March 07, 2013 12:07
http://research.stlouisfed.org/fred2/graph/?g=ghu/

car sales per capita (age 25-54)

so current sales rate is what the recession of 1990 hit. Go us!

can I say here that FRED has given me a better exposure to understanding than just about any other source I can think of?

If the PtB had anything like FRED in the 2000-2008 period what happened on their watch is utterly inexcusable.
fixed link . . .
written by Troy, March 07, 2013 12:12
Only idiots...
written by Anitiderivative, March 07, 2013 12:18
Only idiots try to demarcate these two effects.

RU you SRS?

Then again, this is what economists do all the time, they try to demarcate the housing bubble crash from the housing bubble crash.

They were one of the same phenomena.


This debate is not futile
written by FRauncher, March 07, 2013 5:33
I tend to support Dean, that the real economy is more important than the financial.
Maybe due to my lesser understanding of finance. None the less, it is evident that the financial effects magnify the disaster, and that the US (and global) financial system is broken. Chicago Plan anyone?
A premise of the housing bubble
written by winstongator, March 07, 2013 7:04
is that you had consumers expanding their debt loads, if a way that was only sustainable with rising home prices - banks were in the same boat. When home prices started falling, you stopped being able to do a cash-out refi, or sell your underwater home. That was always going to be a drag. The banks problems did cause panic in businesses, which led to more consumer panic (don't buy a car or TV when you are unsure of your job prospects).

I would agree that the net loss of demand was roughly the same, but sharper with a deeper bottom, than shallower and lasting longer. Really sustaining gov demand prevented an all out collapse, and is even more apparent to me when I remember the panic of the end of 2008
...
written by skeptonomist, March 07, 2013 10:00
Why exactly was there a bubble in non-residential construction? This does not seem to fit into the story of a simple asset bubble, or even one assisted by reckless and fraudulent loaning to naive and unqualified house buyers. Business people were not expecting to retire on their appreciated equity. I can suggest two possibilities offhand; either it was just group psychology which causes people to be over-optimistic in a boom, or those hard-headed business people were taken in by overly-favorable lending terms. Such terms were a result of lack of regulation and deliberate stimulation (low short-term rates) by the Fed.
Dean, My Question Is Not Answered
written by Paul Mathis, March 07, 2013 12:32
If people don't have money (i.e., so-called "balance sheet recession"), then why are auto sales up 50% from the bottom of the recession? How did people buy all those millions of new autos without money?

Obviously, they did have money and when incentivized to spend it, they did so. People were hoarding their cash out of fear of losing their jobs until the recession bottomed. 130 million had jobs and money to spend.
House price increases are not "wealth" but income redistribution
written by Blissex, March 07, 2013 2:42
«Homeowners are down $8 trillion in housing equity as a result of the crash. I would expect that loss of wealth»

PLEASE never say that house price capital gains are "wealth", they are just inflationary, improductive income redistribution upwards.

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Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.

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