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

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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.