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Home Publications Blogs Beat the Press Ryan Avent at the Economist Still Has Not Heard of the Housing Bubble

Ryan Avent at the Economist Still Has Not Heard of the Housing Bubble

Friday, 31 December 2010 08:37

It would be such a great thing if the people who made and wrote about economic policy learned third grade arithmetic. Then they would be able to recognize little things like $8 trillion housing bubbles before they reach such enormous sizes where their collapse can wreck the economy.

The latest person flaunting his ignorance in this area is the usually sensible Ryan Avent who tells us that, "I find the arguments for another big drop in national prices to be rather implausible."

Avent gets many things wrong in making his case. Among the biggest is his assertion that price to rent ratios are about normal. In fact rents are roughly at the same level they were at in the mid-90s in real terms, while real house prices are still close to 30 percent above their mid-90s level. This basic measure suggests that prices still have considerable room to fall.

Avent's effort to explain the price decline reported in recent months' data on short-term economic fluctuations makes no sense. House prices have never responded in any significant way to short-term economic conditions. House prices have never fallen in the past because of 3-4 months of weak job growth or soared because of a similar run of strong job reports. In other words there is zero reason to believe that house prices would be moved in any noticeable way by 1-2 good or bad quarters.

If you look at the Case-Shiller data there is a very simple story. The first time buyers credit supported the market first and foremost by pushing up prices in the bottom tier. This support disappeared when the credit disappeared. Prices in the bottom tier have been plummeting in the few months of post-credit data that we have available. In the four available months since June, prices in the bottom tier fell by 6.4 percent in Seattle, 8.0 percent in Portland, 12.5 percent in Minneapolis, and 23.0 percent in Atlanta.

The logic is that the credit most immediately affects the bottom tier. (This is where first time buyers mostly buy.) It will soon feed over into the higher end homes, since the people buying these homes are selling homes in the bottom tier.

In terms of the fundamentals, the basic story is that we continue to have a record supply of vacant units. It was an astounding failure of the economics profession that almost no one in a prominent position was able to see an enormous and dangerous development like the housing bubble. It shows the incredible lack of controls within the profession that no one seems to have paid any career consequence for this failure.

As economic theory would predict,  when there are no negative consequences for poor performance, we see more of it. That appears to be the case as the people who write and talk about the economy still don't seem to have a clue about the housing bubble and its impact on the economy.

Comments (7)Add Comment
Rent Control and Shortage is the Problem - Not a Housing Surplus
written by izzatzo, December 31, 2010 9:13
In fact rents are roughly at the same level they were at in the mid-90s in real terms, while real house prices are still close to 30 percent above their mid-90s level. This basic measure suggests that prices still have considerable room to fall.

Exactly backwards Mr Whose Your Nanny. Any economist knows it's the other way around, that rent prices have considerable room to rise, up to the equivalent value of house prices.

When two goods like renting or owning are highly substitutable, any change in asset value is always reflected in its corresponding rental value. For example, just look around at all the rent-to-own and own-to-rent activity as one of many examples of proof.

In fact, that's why there's a surplus of vacant housing units now - because rental prices are too low, certainly not high enough to cover the original book value paid by the owners of relativly scarce housing.

Excess housing vacancies are simply the mirror reverse of excess rental vacancies during the last decade. Houses as assets became more scarce relative to houses as rental units during the so-called "bubble", which was actually a shortage of housing correctly reflected by free markets in higher prices.

While it's understandable how socialist economists would claim that housing units are in surplus and prices need to fall, true free market economists realize it's rental units in a shortage condition instead, for which prices need to rise.

Free markets should be allowed to adjust rental prices upwards, high enough to pay off the past sunk cost of housing, rather than engaging in the constant government interference designed to hold them down with various forms of rent control.

Stupid liberals.
I see the Trolls are at work early this morning.
written by Motorod, December 31, 2010 9:51
Thanks for this fine article, Mr. Baker. Keep up the good work.
written by Howlin Wolfe, December 31, 2010 12:12
Izzatnutso is displaying his usual ignorance, expressed as "sometimes ill-informed, sometimes uninformed, but NEVER in doubt".
Rent control doesn't exist in most places. To posit that as a cause is a typical straw-man fallacy that people who identify as tribal conservatives use when they fashion "arguments". But, that lack of doubt has to rest on something, I guess. Because his team is the bestest!!
the bubble
written by muckdog, December 31, 2010 12:47
I think a lot of smart folks saw the housing bubble for what it was, with the usual caveat that bubbles can go on longer than anyone expects. The folks who got sucked in unawares were the late stage buyers. The liar loans, if you will. They saw folks making $40K on a quick flip and wanted a piece of it. Kind of like tech stocks in 1999-2000. So they took a beating.
mad north-northwest
written by diesel, December 31, 2010 3:15
Everything "free market conservatives" say is one hundred and eighty degrees misaligned with the truth. In this sense, what they say is a parody. izzatzo parodies the parodies of the free marketeers. He is but mad north-northwest (which, by the way is the magnetic deviation in Europe, so Hamlet is saying that his internal compass points to magnetic north and though this is not "true" North, his navigation is unerring and his madness mere appearance, as he really knows the difference and the need to compensate, hence the phrase).
muckdog...defining the bubble
written by pete, December 31, 2010 5:15
Indeed a bubble is defined by knowing we are in one. Anything else is an error in valuation, not a bubble. Could be a gross error, but an error nonetheless. In a bubble economy, the idea is you are willing to pay $100 for something if you think you can sell it tomorrow for $110, even if you think it is really worth $90. The difference is that if its a bubble there are solutions, i.e., looking at real values. If its an error, well, its an error...Most people confuse these two. Even Dean, who claims $8T in wealth was lost, which is not true in a bubble event...no wealth is created or lost by the trading.
Their brains are different
written by DamnedLiberal, December 31, 2010 11:58
stupid right-wingers

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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.