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Home Publications Blogs Beat the Press How Do You Say "Housing Bubble" In Canadian?

How Do You Say "Housing Bubble" In Canadian?

Saturday, 15 June 2013 07:18

Paul Krugman has a nice post on the housing bubble in Canada. Needless to say, I strongly agree. It is painful how so many people refer to this downturn as the result of a financial crisis.

I have often posed the simple question of what would be different right now if we had not had the crisis but house prices were exactly where they are today. Would firms be investing more, would people be consuming more, would we see more building in spite of near record vacancy rates? It's hard to see the answer to any of these questions as being yes.

The failure to recognize the last housing bubble and its risks was an act of astounding incompetence by people in policy positions and really the economics profession as a whole. The failure to see the continuing risks posed by renewed bubbles should be enough to sentence these people to the sort of hardcore unemployment experienced by people with no marketable skills.

One item that Krugman misses in comparing household debt in the U.S., U.K., Canada, and the euro zone is that the overwhelming majority of the debt in the U.S. is 30-year fixed rate mortgages. The interest rate on these mortgages will not change if long-term rates rise by 2-3 percentage points as folks like CBO predict.

On the other hand, the standard mortgage in the UK is an adjustable rate mortgage. In Canada it's typically a 5-year mortgage that has to be paid off or refinanced at the end of the period. It's easy to see what happens in these cases when interest rates rise and it's not pretty.



Since I've been asked in e-mails and twitter comments I'll present again the patented Dean Baker Bubble Bursting Formula for Central Bankers:

1) Talk

2) Regulatory Powers

3) Higher Interest Rates

By "talk" I don't mean mumbling "irrational exuberance." The point would be for the central bank to use its research capacities to document the existence of a bubble in every possible way. The Fed employs hundreds of economists. There is nothing more important that they could have been doing in the years 2002-2006 than documenting the existence of the housing bubble. (Instead many were doing the opposite. For example, a vice-president of the NY Fed co-authored a paper arguing that there was no run-up in prices, the problem was just a faulty price index.)

Then the central bank could use its enormous megaphone to highlight this research in every possible forum. This means that Greenspan and other governors should have been talking about the housing bubble in every congressional testimony and public speaking engagement.

This would get the facts on the table where the financial industry could not possibly ignore them. I know that many economists are dismissive of the idea that this sort of talk could have an impact on the financial markets or homebuyers but what is the downside?

Talk is cheap; the worst case scenario is that it has no impact. I've been told that this would hurt the credibility of the Fed. Who gives a flying f***? Tens of millions of people are suffering because the Fed let a housing bubble grow unchecked, by comparison the Fed's credibility is not worth wasting a moment's thought.

The use of regulatory powers will differ by the type of central bank. Many central banks have little under their authority other than the narrow pursuit of monetary policy. However the Fed has direct regulatory responsibilities for a large portion of the financial system. Some of this could be simple. For example the Fed was supposed to produce guidelines for mortgage issuance ever since the mid-1990s. (It eventually did, in 2008.) Other regulatory steps might involve more heavy-handed assessments of loan quality.

Greenspan pooh-poohed the importance of this authority by noting that only a third of mortgages were issued by banks under the Fed's direct supervision. His comments ignored that both one-third is still a lot of mortgages and that the Fed sets the gold standard. If the Fed laid out guidelines that other issuers clearly were not following would they still be able to sell their mortgages all over the world in the secondary market? And if they couldn't sell them, they wouldn't issue them.

Perhaps the Fed's regulatory efforts would have no effect, but again what is the downside, more concerns about lost credibility?

Finally the Fed could raise interest rates. Higher interest rates will burst a bubble, but of course they will also slow the economy. This makes it a last choice. (Let me repeat this for all the folks who say that I want the Fed to raise interest rates to combat bubbles --- raising interest rates should be a last choice.)

Let me also suggest that if the Fed or any central bank is raising interest rates to counter a bubble then it should say this explicitly, as in "we are raising interest rates by 0.5 percentage points today. We will continue to raise interest rates until house prices are back below their level of two years ago." My guess is that this sort of explicit targeting of house prices would have a sobering effect on the housing market. (Would you buy a home at today's prices if the central bank announced a commitment to lower them by 15-20 percent?) 

I know this might sound strange among the cult of central bankers who worship at the alter of inflation targeting. This is a radically different course that would mean temporarily losing sight of the inflation target. Even the idea of targetting house prices probably sounds strange, after all they could be wrong.

My response is the same as with the other two: weigh the relative risks. If central bankers can't talk about targeting house prices because it sounds strange then they should look for another line of work. In fact, whoever does the hiring of a central banker should require any candidate for central bank head to say they are targeting house prices 4 or 5 times during an interview just to make sure that they are capable of doing it.

In terms of abandoning the inflation target, this should be a joke. Should the ECB be boasting to the population of the euro zone countries that they have met their targets for price stability? I'm sure that is very consoling to the folks in Spain: "sure we have 27 percent unemployment, but at least the inflation rate is under 2.0 percent."

As far as the risk of being wrong, well life is uncertain. Any decision by central banks could be wrong. Is it that big a concern that house prices might be temporarily depressed below their correct market level? Presumably the central bank will not have shut down their research department. If it turns out that higher house prices really are justified by the fundamentals of the market the central bank should be able to figure this fact out without going through a decade of wrong-headed anti-bubble policies.

So there it is, the anti-bubble recipe. There is no excuse for a central bank allowing a bubble to grow large enough that its collapse will wreck the economy. The central bankers who fail this test should be at the front of the unemployment lines.

Comments (16)Add Comment
written by Last Mover, June 15, 2013 8:20


See more on this topic by Dean Baker at this link which includes the following:

The moral of this story is that the problem is not first and foremost a financial crisis. It might be fun to watch the Wall Street and government boys sweat as they stay up late trying to keep the big banks from drowning in the cesspools they created. But this is all a sideshow. No one saved us from a "second Great Depression," they just saved the jobs and wealth of the Wall Street crew.

The economy's real problem is simply the loss of demand created by collapse of the bubble. Throwing even more money at the banks is a way to ensure that they don't suffer from the consequence of their own greed and stupidity. It is not a way to restore the economy to health.
written by skeptonomist, June 15, 2013 9:17
The important questions are; why was there a world-wide housing bubble and why was there near-universal devastation? Local housing bubbles have always been commonplace, but rarely threatened entire nations by themselves. They have often been symptoms of broader boom or bubble times, as there has been a kind of contagious speculative fever. Even on a nationwide scale housing tends to be cyclic, but had not itself previously led to anything like the late crash. There was a huge housing boom in the US after WW II, which did not lead to a dangerous bubble.

What made the last bubble so bad was the financial operations involved, which made it advantageous for banks and others to overpromote house buying. These include specifically, bundling to hide the shakiness of individual mortgages and pass on the risk and credit-default swaps which apparently reduced the risk of individual bundles but introduced a huge systemic risk. It is painful to see how Dean keeps minimizing the importance of these things.

Let's ask the question whether it is possible to have superhuman Maestros who will recognize bubbles and the dangers thereof and somehow blow their magic whistles which will harmlessly deflate the bubbles. Yes, authorities did not recognize the bubble and/or did not act to counter it, but this is how authorities have *always* acted. Instead of asking for behavior which humans have never demonstrated themselves to be capable of, how about working for regulations which will contain overexpansion automatically? The New Deal did this to a large extent, and there were few devastating crashes until regulations were overturned and financiers devised new ways to circumvent existing ones (they are always doing this). The relevant changes were in banking and finance, not in the housing or real-estate industries.

In the real world central banks have only limited powers to control the economy even if the Maestros were not subject to human failings, and giving them too much responsibility has been a major part of the rise of finance and banking.
written by Peter K., June 15, 2013 11:16
I think Canadians just say "housing bubble."

What should policy makers be doing? Talking down the bubble? Preparing infrastructure projects to do during the balance sheet recession? Work-sharing?
Perhaps the world wide bubbles form because finance is now so coupled world wide
written by John Wright, June 15, 2013 11:39
I am also skeptical that the authorities have much willingness or incentive to "take away the punchbowl" even if DO believe there is an evident bubble.

The playbook has more of an IBG ("I'll be gone") strategy that Alan Greenspan illustrated when he grabbed his $8 million book advance and exited the Fed before the housing bubble popped.

Do we have a system that rewards those that regulate for stability?

I think the answer is no, because the financial industry knows the US government is there to back up bad bets when they go wrong and the USA financial regulators hope to preserve their options for future jobs in the financial industry or politics by being accommodating to the industry.

Observe Gary Gensler's recent job loss at the CFTC as he attempted more regulation of finance.

And world wide bubbles can form as banks/institutions/business schools now have a large international coupled presence.

If people do lever up in Canada, there are some differences between the USA and Canada that can magnify the effects on the Canadian borrower.

1. Canadian mortgages are full recourse, so people can't walk away as in the USA. So the lender can go after the borrower's assets and future wages.

2. Canadian mortgage interest is NOT tax deductible, so the borrower sees all of the incremental cost of a higher interest rate.

As far as the government's exposure, mortgage insurance is more common in Canada than in the US.

Will the mortgage insurance industry need a future government (possibly involving USA insurance companies) bailout?
written by david s, June 15, 2013 1:01
I've been wondering when Mr. Baker would comment on Canada. I've had a few conversations with Canadians about the nearly unchecked rise in real estate over the past few years and they've often expressed a lack of concern--"well gosh, prices keep going up, and people keep buying."

I wonder what impact foreign investors have on markets in places like Toronto and Vancouver. But, maybe that won't matter. When there's a retreat it will probably look just like what happened here.

Of course, I refuse to say when it will happen. I don't have the resources to short anything (but I wonder if anyone is).
written by JDM, June 15, 2013 3:52
I wonder what impact foreign investors have on markets in places like Toronto and Vancouver.

I don't how much at present, but in the runup to the turnover of Hong Kong in the 90s Vancouver had Hong Kong money pouring in to the west coast. Because of this they largely escaped a housing price slump that the rest of Canada went through. This has had a lasting effect on Vancouver housing prices since there're higher than they would overwise have been.
Krugman "I’m not exactly making a prediction here"
written by Grayson, June 15, 2013 9:04
Krugman says in his piece:

"Of course, people have been saying this for several years, and it hasn’t happened yet"

and wisely concludes/hedges:

"I’m not exactly making a prediction here"

Econ pundits have been calling for a collapse/crash in Canadian housing prices (whatever that means) since 50% ago.

David Rosenberg has been quite consistent that there is no bubble in Canada, and he lives there and is a bear of bears.

On a separate note how exactly are things working out for you all in San Francisco, NYC etc compare and contrast to Vancouver... Toronto etc.
Could do it but won't
written by Jennifer, June 15, 2013 9:59
If you've read any of the financial crisis books, it's clear the information was out there, regulators just chose to overlook it. There is an amazing description in Ron Suskind's book "Confidence Men: of a NY Fed meeting not long after Geithner took over. Robert Shiller-of the Case-Shiller housing index who had been on the advisory board for 14 years, reports data clearly backing a housing bubble. Geithner's reaction? He removes Shiller from the board.
written by skeptonomist, June 16, 2013 8:57
Dean gives three ways the Fed and other authorities could act against bubbles. Maybe these things would do some good, but there is no actual evidence that they would control bubbles, even if they were actually tried.

As for raising interest rates, the Fed did that, raising federal funds from 1.0% in May 2004 to 5.25% in July 2006. Did this quell the bubble? What exact effect did it have? Shouldn't this in itself have sent a strong signal to the economy that it was expanding too fast? Interest rates are acknowledged to have special importance in the housing market.

The Fed talks all the time, but people who make the decisions in the economy don't necessarily listen if they don't think it is in their interests. Bernanke has been calling for more fiscal stimulus for a long time, but has Congress listened? Many economists seem to be under the illusion that non-economists are as preoccupied with monetary policy and the Fed as they are.

There was little chance that Greenspan especially would wield heavy-handed regulatory powers, since he is a Randian and a proponent of deregulation - he was advocating deregulation as soon as he took office. Just before the crash Bernanke boasted in the "Apology to Milton and Anna" speech that he had the tools to control things even if there was a crash - he also was opposed on principle to intervention against bubbles. Should there be a law against Randians or others opposed to regulation as Chairmen of the Board of the Fed?

There is abundant reason to think that the expansion of housing was a deliberate objective of the Fed after the 2001 recession. This made them and any other authorities involved very unlikely to suddenly reverse course and admit that they made a big mistake. If discretionary regulation or other restraint is to be applied in cases like this it will probably have to come from outside the Fed. Who would that be?
written by Jeffrey Stewart, June 16, 2013 9:11
"I'll present again the patented Dean Baker Bubble Bursting Formula for Central Bankers:" -D. Baker

So you're not against patent protection in all cases?
written by skeptonomist, June 16, 2013 9:24
Probably we could agree in retrospect that boosting housing starting in 2001 was a mistake by the Fed, since prices were not low at that time and had been trending up. But what else was the Fed supposed to do? How could it stimulate the economy without doing it through housing? Krugman and others were talking at that time about how the Fed might have "room" for a housing boom or bubble. If there was room it disappeared quickly, but by that time the economy was improving and if the Fed had started drastic tightening it would have been excoriated for killing a boom. Fed officials are aware of this sort of thing if Dean is not.

Controlling the economy with monetary policy is not as easy as it looks (to some people).
written by watermelonpunch, June 16, 2013 8:25
Controlling the economy with monetary policy is not as easy as it looks (to some people).

Should it be?
And should that be the way society goes about trying to control the economy?
written by Rob, June 17, 2013 5:36
Canada has had the same low interest rates as everyone else in response to the downturn and no shock to reduce people's tendency to take on debt. I give it a 9/10 will crash to some degree. In Saskatchewan speak: "housing's really been giving er and she's gonna biff it sooner or later". But I have often heard claims that Canadian prices have always been higher than elsewhere so direct price comparisons always look bad.
bubble busting
written by pjm, June 17, 2013 9:10
Skepto, AFAICT, the phenomenon of bubbles is a poorly understood/under-theorized portion of economics (so infatuated with equilibria) and hence the focus of relatively new approaches in research such as agent-based-modeling. That said, your claim that there is "no evidence" just doesn't seem particularly dispositive.
Permanent solution
written by Matt, June 17, 2013 4:07
The only sure-fire, permanent solution to the "housing" bubble is a land value tax. Tax land rents at close to 100%, and you'll never have a bubble in any sector of real estate again.

It's the most obvious thing in the world. It's a flat-out crime that economists are screaming it from rooftops.
written by Amileoj, June 18, 2013 3:00
This is good as far as it goes but you left out a absolutely crucial additional responsibility of the Fed's.

As skeptonomist comments above: "what else was the Fed supposed to do? How could it stimulate the economy without doing it through housing?"

For there is something else the Fed could have done, to replace the demand (and hence the growth) that, in the event, was provided by the housing bubble. It could have strongly encouraged expansionary fiscal policy.

This would have been an important reason to avoid your #3 solution-raising rates. On the contrary, rates needed to stay low to create political room for bigger deficits.

But more encouragement than that was clearly needed. The Fed needed to call on Congress and the President to run larger deficits. It needed to make explicit that such deficits were a much more effective and sustainable way to promote growth than letting a housing bubble develop.

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About Beat the Press

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.