CEPR - Center for Economic and Policy Research


En Español

Em Português

Other Languages

Home Publications Blogs Beat the Press It Was the Housing Bubble, Stupid

It Was the Housing Bubble, Stupid

Friday, 04 May 2012 05:09

I really don't like to beat up on Ben Bernanke. I don't know him personally, but everyone I know who does says that he's a really nice guy. And, there is no doubt he is a very smart economist. But he shares the blame for the downturn with his former boss, Alan Greenspan. Even worse, he still seems resistant to getting the story right.

He gave a speech last month in which he forgives himself and others in policy positions for being surprised by the dangers posed by the collapse of the housing bubble. He noted that we lost $10 trillion in wealth when the stock bubble collapsed and that was no big deal. Why should we have expected it to be a big deal when we lost $10 trillion in wealth when the housing bubble collapsed? He then goes on to comment on the wonders of bank leverage and financial crises.

Bernanke should know that both sides of his assertion are seriously misleading. First, the wealth lost in the stock crash was stock wealth. The wealth effect from consumer spending on stock wealth is generally estimated to be much lower than the wealth effect from housing wealth. The range from the former is typically estimated at 3-4 cents on the dollar, as opposed to 5-7 cents on the dollar from housing wealth.

Also, housing wealth has a much more direct effect on stimulating demand through construction than stock wealth has in boosting investment. Residential construction was more than 2.0-3.0 percentage points of GDP ($300-$450 billion a year in today's economy) above its trend level at the peak of the bubble. By contrast, the investment generated by the stock bubble was no more than 1-2 percentage points of GDP.

More importantly, the loss of wealth from the stock bubble was temporary. If Bernanke consulted the data (Table L.213) that his organization publishes, he would notice that by March of 2004, the stock market had already recovered more than half of the value it had lost. Its valuation at that point was only a bit more than $4 trillion off its 2000 peak and was actually above the 1998 year-end level. Since no one spends based on daily movements in the stock market (i.e. there is a lag between when stock prices rise and when people adjust their spending), the negative wealth effect at that point would have been limited.

By contrast, housing wealth has continued to decline. We have now lost close to $8 trillion in real housing wealth compared to the bubble peak in 2006. And, there is no plausible story whereby housing wealth will come back quickly.

The other part of Bernanke's story that is wrong is that the collapse of the stock bubble was no big deal for the economy. While the official recession was short and mild, lasting from March of 2001 to November of 2001, the economy continued to lose jobs through 2002 and didn't start to create jobs again until September of 2003. This is shown clearly in the employment to population rate; data that I recall Bernanke citing in a talk in January of 2004 when he was explaining why it was necessary for the Fed to still keep the federal funds rate at the extraordinarily low level of 1.0 percent.

Employment-to-Population Ratio


Source: Bureau of Labor Statistics.

 The reason why this argument is important is that financial crisis can be complicated and mysterious. They are hidden in complex financial assets on balance sheets that almost no one sees.

By contrast, bubbles are simple. They sit there expanding in broad daylight. Could any sentient being miss the stock bubble or the housing bubble?

And, the demand gap created by their collapse is really straightforward. Residential construction is off by 4.0 percentage points of GDP as we deal with a badly overbuilt housing market. That's $600 billion a year in lost demand. Consumption has also plunged, with the saving rate going from near zero at the peak of the bubble to 4-5 percent at present. That implies a loss in annual consumption demand of $400-500 billion. Add in another $200-$300 billion in lost demand due to the collapse of the bubble in non-residential real estate and the contraction of the state and local government sector in response to lost tax revenue and you have a gap in annual demand of $1.2-$1.4 trillion.

This is all very simple. The arithmetic we learn in third grade should cut it.

By contrast, what are the financial crisis promulgators talking about? I enjoyed the crisis as much as anyone, but what demand should we be seeing right now that we are not seeing because we had the financial crisis?

That is a real simple question that I would like to hear answered. Consumption is actually still unusually high relative to disposable income. The financial crisis cult thinks it should be higher, why?

Investment in equipment and software is almost back to its pre-recession share of GDP. That is very impressive given the large amounts of excess capacity in most sectors. Even non-residential construction has bounced back, in spite of the overbuilding in many sector due to the bubble.

In short, if the crisis cult has a story let's hear it. If they don't have a story, then Bernanke and his followers should look for another line of work.

Comments (19)Add Comment
Additional cause of lack of demand
written by Robert Salzberg, May 04, 2012 7:13
Great piece.

Another piece of the puzzle is the reduction in real median wages over the past decade.

Another reason the stock and housing bubble cannot be compared
written by Bill Turner, May 04, 2012 7:25
Stock ownership is not as broadly based, especially if you remove ownership through retirement accounts. And, since much of the general public owns their stock not only in retirement accounts, but also in mutual funds, the loss much of the general public likely felt quite removed from the gyrations.

Home ownership is far more personal. You are in it every day and make payments against it monthly. You know very clearly what you paid. You see your neighbors home foreclosed and abandoned...
Housing wealth is number and quality of houses, house price inflation is purely redistributive
written by Blissex, May 04, 2012 7:37
«We have now lost close to $8 trillion in real housing wealth compared to the bubble peak in 2006. And, there is no plausible story whereby housing wealth will come back quickly.»

I am fully disgusted by this apology of class war and the exploitation of working people by propertied people.

Housing "wealth" has not changed a bit: the houses are the same as before.

What hasd changed is house prices, that is house inflation. When house prices rose by 8 trillion, without any change in housing wealth, 8 trillions of largely low tax or tax free capital gains were transferred from workers to proprietors through a windfall created by policy).

House price inflation is purely redistributive policy, from people with no or less property to people with more property.

Too bad that so many people think that when income from wages goes up 50% because of higher productivity that's inflationary and bad, but if over the same period property income goes up 50% without any material justification that's non-inflationary and deserved by investors.
written by skeptonomist, May 04, 2012 8:27
Bernanke says that he and the Fed are not responsible for asset bubbles; this is nothing new, he said that before the housing collapse. Why not accept that the Fed is unwilling as well as unable to control asset bubbles and try to think of other ways to do it, instead of constantly exhorting Bernanke and other Fed people to do things they can't and/or won't do?

During the Greenspan era a silly myth grew up that the Maestro could prevent crashes. Somehow this type of myth lives on despite events in the real world. In 1928 the first Maestro (head of the NY Fed) Benjamin Strong claimed that the Fed could "flood the street" with money and that the mere existence of this capability would prevent panics. How did that work out? Nothing since has occurred in the real world (as opposed to the imagination of economists) that would justify the level of confidence that is still placed in the powers of the Fed.
written by j, May 04, 2012 9:51
I don't want to come across as a troll and no disrespect but my family and I felt the stock bubble pretty quickly. It's unnerving to see $20,000 in a mutual fund vanish within the span of a year and never come back. That's a lot of money to an average person.

Well, it seems like we need government to increase spending on something and at the bare minimum hire back all the people that were laid off. Given the anemic hiring conditions, the government dollars would probably be well spent on jobs to keep people's job skills fresh. Then we could do something about our dated infrastructure to catch up with our global counterparts for long term productivity gains.

Maybe people should be spending more but it is hard when people's wages are flat, benefits are vanishing, and some places have created almost zero jobs for years that impact other members within a household. I think the repubs are right. We need trickle economics but the sprinklers are installed on the wrong lawn.

If you give the middle class and the people striving for middle class money then you get trickles up, down, left, right, and even sideways without any thought. We all saw how things were booming when ordinary people thought they had money. If that isn't an testament to reducing inequality, giving people better wages and freeing up disposal income then I don't know what is.
written by liberal, May 04, 2012 9:57
blissex wrote,
Housing wealth is number and quality of houses, house price inflation is purely redistributive

The real key here isn't the house, but the land under the house.

Homes depreciate; land appreciates. And there was a bubble because land is in fixed supply.

That caveat noted, I agree with everything you say.
Housing Wealth Will Come Back
written by Paul, May 04, 2012 10:41
Once the government restores mortgage lending standards to their historical norms, once unemployment drops below 5% and once the foreclosure inventory is cleared from the market, houses will increase in value. But right now, government policy is to discourage demand by consumers because anti-Keynesians have control of the media and government. Stupid people are running the show, but just as in Europe, that will change.
"badly overbuilt housing market"
written by Tom, May 04, 2012 11:04
Is it badly overbuilt? Rent rates indicate otherwise.
Land bubble
written by Matt, May 04, 2012 11:47
Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble. Land bubble.

Oh, and Blissex is right. People don't understand the true nature of land rents, and economists refuse to teach them. They're just licenses to steal, and we'll never get anywhere until they're made the primary basis of taxation.
Fire Departments are Responsible for Putting out Fires, Central Banks Are Responsible for Preventing Dangerous Asset Bubbles
written by dean, May 04, 2012 12:08
That's the story. they have the power, it is their job. It is not optional -- there is no one else to do it.
bernanke is a troll for the wealthy, that's all he ever has been or ever will be
written by mel in oregon, May 04, 2012 1:07
so unemployment has dropped another tenth of a percentage point. ho hum, i'm underwhelmed. the media seems to think that once unemployment drops low enough, why everything will be hunky dory & all the poor & middle class can sing zip-a-dee-doo-dah. well not so fast. back when the united states was a less unequal society, the top marginal tax rate was 91% (under eisenhower, a republican). a lot of people with only a high school education could make a salary or wage of $50,000 a year adjusted for inflation. back then (the late 40s, 50s, & 60s) a family of 4 could get by on 1 income. unions were much stronger, family ties were much stronger, kids could & did play outside until dark, & people were unrushed & you knew your neighbors. but along came reagan with his tax cuts for the wealthy, his destruction of unions, & his ayn rand/grover norquist ideas that government was the enemy, & giant corporations are your buddy. and every president since has followed this line to a tee. so what's happened to the poor & middle class? they're deeply in debt, with no hope. curing unemployment is a small part of the problem. how about college grads in their 20s with a debt load of $25,000 as they start their careers? how about all the bankrupt people that lost everything because of a medical emergency? how about the trillion dollars owed on credit card debt? how about the 8 or 10 million people living in a home owing more on their home than it's worth? how about all the boomers that lost their pension or their 401k? as the greatest american, martin luther king said, "am i supposed to thank you for pulling the knife out of my back?" the wealthy stink, they always have, & they always will!
housing crash led to stock market crash
written by Barkley Rosser, May 04, 2012 1:38
One big difference between the dot.com bubble crash and the housing bubble crash is that the former actually stimulated the already ongoing housing bubble, while the latter led to a stock market crash that was even more dramatic than that which happened at the time of the dot.com bubble crash, not to mention that both went global, which was not the case in 2000-01.
written by David, May 04, 2012 3:11
Fire Departments are Responsible for Putting out Fires, Central Banks Are Responsible for Preventing Dangerous Asset Bubbles
written by dean, May 04, 2012 12:08 PM
That's the story. they have the power, it is their job. It is not optional -- there is no one else to do it.

I'm not disagreeing by pointing out that Bernanke did put out the fire, by having the Fed go much farther beyond its traditional role when intervening in the (relatively new) market-based credit system (MBS derivatives); this new role is definitely necessary in order to circumvent bubbles (especially in financials). But Bernanke was also part of the gang of arsonists that ignored the flames and smoke, taking action only when it threatened to spread to the mansion on the hill. Then they're glad that only 1 to 2 per 10 residents 'died' due to their negligence; they find this cause for self-admiration (or else how could they stand to look at themselves in the mirror in the morning?).

Meanwhile financial alchemists will probably continue to try to transform illiquid assets into liquid assets, in the private sector, far (or so the alchemists think) from the prying eyes of the Fed. What's a Fed to do? Well, they better come up with something quick.
There was no housing bubble
written by S Bayer, May 05, 2012 5:29
This cannot be emphasized too strongly. There was a real estate bubble, not a housing bubble. The trajectory of commercial real estate prices matched that of residential real estate. The impact of the collapse was felt differently of course, on the one hand by homeowners, on the other hand by life insurance companies.
Why not restate GDP for prior years to a realistic number
written by John Wright, May 05, 2012 11:29
Perhaps the government should look at the bubbles of the last decade and do a restating of past decade's GDP and unemployment rate. This would be similar to companies that restate past earnings when necessary (or forced).

Take out some of the financial/real estate bubble GDP numbers and state what an unbubbled/less leveraged economy would have achieved GDP wise.

Restate the past decade's unemployment rate to a higher number to account for bubble jobs that should not have existed.

This would give the US citizens a better understanding of what was unrealistic about prior years and what might be attainable in the future.

It Was The Debt
written by Lawrence Littlefield, May 05, 2012 12:10
To me both the housing bubble/bust and the financial crisis are the short term (heart attack) manifestations of a longer term trend (cancer).

Over 35 years a rising share of Americans, working its way up the education and economic ladder, have had lower pay -- if deferred pay such as retirement benefits are included. So who did the world's companies sell to? Those same workers, who somehow spent more.

The differences between wages and spending was at first covered up by more workers per household, and total household income continued to decline. Then future income in retirement was taken away, which didn't affect then current and now past spending. The final phase was a debt bubble, which the housing bubble was just a part. Our total debts ran from 150% of GDP to 350% of GDP before declining.


That chart says it all. The worst part of the housing bubble was not only the excess debt on actual first time home buyers, as in the late 1980s bubble, and the wasted resources due to excess construction and speculation, as in Texas in the early 1980s bubble, but also the cash out refinancing and HELOCs used to keep the consumer debt driven party going. It isn't just those who bought to sold themselves into debt slavery. It is people who could have paid off their homes.

The consumer debt binge covered over an increasingly inequal distribution of income. But it also changed the meaning of the paper wealth held by the wealthy. It is no longer backed by real assets that generate real goods and services that people will pay for. It is only backed by promises of many people to live poorer in the future in exchange for living better (or at least not worse) in the past. Now we face a global crisis of demand. People cannot buy with money they are not paid.
Land bubble
written by Matt, May 05, 2012 5:15
S Bayer: Land bubble. It wasn't even confined to built-up real estate. It was the sites that bubbled in value; people who talk about 'housing' or 'office space' miss the point that great build-up was facilitated and justified by rising site values.
written by David, May 06, 2012 11:51
Littlefield's post. No doubt that debt buildup was based in some respect on the expectation that the capitalists would share their gains more equitably with their laborers.
written by James, May 07, 2012 6:32
Well. The GDP would be lower but our necessary goods are going up in price, and I hear tell from our better above we need higher taxes too.

You know, we'd like to have some savings built up so we aren't always in crisis when time get tough. But lots of you Princeton fellas keep telling us simple folk we are causing a problem. Down my hood in Tret'en, somehows the relatives that is always spendin a lot always end up sleepin in the extra room and then the dawg barks since he's outside. I'm guessing the ole professer gets an alotment from the govment so he aints worried bout sleeping on the streets.

Then that smart fella in the New York paper tells us what we really need is for the government to spend even more.

Tell ya what were gonna do then, we are gonna have to saves more cus' our money mayn't be worth so much.

You standin me fella?

Write comment

(Only one link allowed per comment)

This content has been locked. You can no longer post any comments.


Support this blog, donate
Combined Federal Campaign #79613

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.