CEPR - Center for Economic and Policy Research


En Español

Em Português

Other Languages

Home Publications Blogs Beat the Press The Secret of the Weak Recovery: We Had a F***ing Housing Bubble

The Secret of the Weak Recovery: We Had a F***ing Housing Bubble

Monday, 06 May 2013 04:08

The problem with economics is not that it's too complicated; the problem is that it's too damn simple. This problem is amply demonstrated by all the heroic efforts made by economists to explain the weakness of the current recovery.

We've had economists tell us that the problem is that we are now a service sector economy rather than a manufacturing economy. The story is that inventory fluctuations explain much of the cycle. Since we don't inventory services, we will have a slower bounceback in terms of production and employment. (There is a simple problem, since we don't inventory services, the downturn should also be less severe in a service dominated economy. How does this story fit with the worst downturn since the Great Depression?)

We've also been told that the problem is underwater homeowners who can't spend like the good old days because they are underwater in their mortgages. The problem with this one is that we only have around 10 million underwater homeowners, the vast majority of whom have relatively modest incomes. The emphasis is on "only" because, while 10 million is a lot of people to be underwater, it is not a lot of people to move the economy.

The median income for homeowners is $70,000. (Median is probably appropriate here rather than average, since it is unlikely that many wealthy people are underwater.) Suppose that being above water would increase consumption by each of these homeowners by $5,000 a year. This is a huge jump in consumption for people with income of $70k. (Do we think these homeowners are saving an average of $5,000 a year now?) This would lead to an increase in annual consumption of $50 billion a year or less than 0.3 percent of GDP. This would be a nice boost to output, but it would not qualitatively change the nature of the recovery.

Today we have Robert Samuelson telling us that the reason employers are not hiring is uncertainty:

"Businesses have become more risk-averse. They’re more reluctant to hire. They’ve raised standards. For many reasons, they’ve become more demanding and discriminating. These reasons could include (a) doubts about the recovery; (b) government policies raising labor costs (example: the Affordable Care Act’s insurance mandates); (c) unwillingness to pay for training; and (d) fear of squeezed profits."

Hmmm, they're worried about squeezed profits when the profit share of income is at its highest level in more than 60 years? The story of the Affordable Care Act raising costs could at best only explain the behavior of a small group of businesses (firms with close to 50 employees who do not currently provide health care insurance).

But there is a simple way to test the idea that firms would otherwise be hiring but are deterred due to uncertainty about the future: look at the length of workweeks. The logic is simple; increasing hours per worker and hiring more workers are alternative ways to meeting increased demand for labor. Adding work hours involves none of the commitments that apply to hiring addtional workers. If uncertainty, as opposed to lack of demand, is keeping businesses from hiring, then we should be seeing a big increase in the length of the average workweek.

We don't. The length of the average workweek fell by 0.2 hours to 34.4 hours in April. This compares to an average of more than 34.5 hours in the 2006 and 2007. In short there is no evidence that employers are seeing the sort of demand that would justify increasing the size of the workforce but are being kept from doing so because of the concerns raised by Samuelson.

If none of these stories, or any of the others that economists develop to stay employed, explain the length of the downturn, what does? Well, it's pretty damn simple, we had a housing bubble driving the economy before the collapse and there is nothing to fill the gap created. The bubble led residential construction to soar to more than 6.0 percent of GDP at the peak of the boom in 2005. It is now a bit over 2 percent of GDP implying a loss in annual demand of more than $600 billion. The $8 trillion in housing wealth created by the bubble led the saving rate to fall to almost zero due to the housing wealth effect (people increase annual spending by 5-7 cents for each dollar in housing wealth). With the saving rate hovering near 4 percent, we have lost close to $400 billion in annual consumption demand. 

The cumulative loss of annual demand is more than $1 trillion. What did we think would replace this demand? Investment in equipment and software is actually close to its pre-recession level measured as a share of GDP. Furthermore, this component of investment has never been a much larger share of GDP, even in the Internet bubble years. Why would anyone expect it to expand rapidly at a time when many firms still have large amounts of excess capacity? (Structure investment is depressed because there was a bubble in non-residential construction as well, leading to large amounts of excess capacity in most areas of non-residential construction.)

Do we somehow think that consumers will spend at the same rate after they have lost $8 trillion in housing wealth as when they had this wealth? Why? Net exports could fill the gap, but the dollar has to fall. Net exports could fill the gap, but the dollar has to fall. (I repeated that one in case any economists are reading.) The value of the dollar is the main determinant of our trade deficit, if we want a lower deficit then we will need a sharp decline in the dollar, which has not happened.

This only leaves the government sector to fill the gap with deficits, which our Serious People types have demanded that we hold down. So, based on the good old intro econo that tens of millions have been subjected to, we know that this recovery will be slow and weak. We simply lack a component of demand to fill the gap created by the housing bubble.

If it seems absurd that economists can't see something this simple, readers should realize that this is a common problem. Just last Friday Robert Samuelson had a useful column that pointed out the huge imbalances that persist in the euro zone and pointed out that the region's crisis is far from over. While he is exactly right, the amazing part of the story is that competent economists somehow did not see these imbalances developing.

As I pointed out, several of the current crisis countries already had incredible trade deficits long before the crash as the world's leading economists were celebrating the "Great Moderation." 

Current Account Balance as a Percent of GDP

Greece -6.533 -5.785 -7.637 -11.388 -14.609 -14.922
Portugal -6.433 -8.327 -10.323 -10.685 -10.102 -12.638
Spain -3.508 -5.248 -7.353 -8.961 -9.995 -9.623

                                           Source: International Monetary Fund.

How did the folks at the European Central Bank think that these deficits would fall to a sustainable level without some sort of disastrous crisis? This one should have been simple, but the world's leading economists all missed it.

I recall back in the 1990s and the last decade when both Republican and Democratic economists wanted to invest Social Security funds in the stock market. (Democrats generally wanted to invest the fund collectively rather through individual accounts.) I tried to point out that both were assuming impossible rates of return given the fact that the stock market was at price to earnings ratios that were far higher than historic averages.

When this issue was highlighted in the debate over President Bush's privatization plan (see the No Economist Left Behind test) Brad DeLong suggested that we do a paper on it for a Brookings conference. I didn't think that this simple arithmetic could warrant a Brookings paper, even though the issue was hugely important. To get it in Brad (along with Paul Krugman) added a model of optimal consumption paths given a declining rate of labor force growth. While the model was fine, it had nothing to do with the basic issue that the stock market was over-valued at the time that people were thinking of investing workers' Social Security money in it. The model did add sufficient complexity so that we got the Brookings crew to take the simple argument seriously.

The same story held during the housing bubble years. I had many people ask me why I didn't publish anything in journals on the bubble in the years 2002-2007 when I was writing for CEPR's website and popular publications. The reason is that it was too simple a story for any serious journal.

The basic story was that house prices had diverged sharply from their long-term trend and there was no plausible story rooted in the fundamentals of the housing market that could explain this divergence. While this was certainly compelling in my view, the American Economic Review is not going to publish an article that shows house prices just keeping pace with inflation for 100 years and then suddenly rising by 70 percent in real terms from 1996-2006. It would be necessary to somehow make the story complicated to get economists to take it seriously.

To my view this is the fundamental problem of economics. There is a need to find ways to make economic issues complex even when they can be explained by the simple economics that we teach in econ 101. This is not a pretty picture.



Aaron Pacitti, the co-author of the paper I referenced that attributes the slow pace of recovery to the increasing importance of the service sector, called my attention to the fact that the paper does not address the question of the severity of the downturn. The point is that given the severity of the recession, we should expect a slower recovery in an economy with a relatively larger service sector.


Comments (21)Add Comment
written by Squeezed turnip, May 06, 2013 7:25
Are economists cutting their throats by not using Occam's razor? Also, they need more courses on systems of differential equations: they could remain sophisticated and still actually understand the choke hold Rehn, Osborne, Ryan et al. have put on the system. Bullies just care about winning,.not understanding.
They Can't Get What They Refuse to Accept - Chronic Depressed Demand
written by Last Mover, May 06, 2013 7:28
Day in and day out Dean Baker posts evidence of demand in various forms that demonstrates on a relative basis, current demand is around trend levels independent of the bubble or recession.

Whether consumption, investment or government, whether relative to GNP, income or some other appropriate baseline. Not even factors like "debt overhang" seems to affect these ratios.

The point proven is in the aggregate, the economy is in a stagnant equilibrium below that necessary to achieve full employment, despite current demand being relatively where it was in the past that actually achieved full employment.

This is why the VSPs are looking for something they can't find. It's simply not there. The aggregate economy is essentially in equilibrium below full employment and isn't going to pull out anytime soon absent specific targeted fiscal spending designed to fill the output gap that will not and cannot close itself.
Weak Recovery Due to Government Incompetence
written by Robert Salzberg, May 06, 2013 7:34
The weak recovery is entirely due to the fact that the government hasn't filled the $1 trillion hole in demand left by the collapse of the housing bubble.

Of course, the government wouldn't have to fill the whole hole, a promise to spend what the American Society of Civil Engineers says is needed to repair our infrastructure would do just fine at a fraction of the cost.

The housing bubble was the cause of the economic collapse but the weak recovery is entirely due to the incompetent government response.

See Dr. Krugman's op-ed today for the particulars:

Great article!
written by DV, May 06, 2013 7:52
Keep 'em coming.
Perhaps the full employment economic formula has been absent in the USA for years?
written by John Wright, May 06, 2013 8:15
In the recent years, from 1998 to 2012, the USA has approached full employment only when a bubble (Internet, Housing) is growing.

So only when the economy is on performance enhancing drugs does the USA book full employment levels.

I see the recent behavior of the Very Serious People as an attempt to preserve their wealth and occupations.

If the USA financial industry is 2 to 3 times it should be for efficient capital allocation purposes (Paul Woolley), then there are many highly paid VSP people in the USA performing socially useless (possibly even harmful) financial jobs.

And the large USA defense and growing internal security industry are useful for potential foreign resource grabs and preserving USA internal civil order in the future.

So the VSPs are doing well and are well positioned for the future.

It may be completely unreasonable to expect the aggregate VSP class to change anything.

And the VSPs will have no difficulty finding economic experts, op-ed writers and politicians to defend the VSP positions.

On July 1, 2012, Chris Hedges borrowed from Karl Popper and stated "Most people attracted to power are at best mediocre, which is Obama, or venal, which is Bush."

Obama had a chance to do financial industry reform, but instead largely preserved the industry as it was.

Looking to the VSPs for full employment solutions is a false hope.

This argues for a stagnant USA employment picture for years.
written by Ryan, May 06, 2013 8:39
I'd love to see the unhinged sorority girl read this post. But more seriously, I appreciate your plea against making things complicated simply to attract attention. My impression is that we've had at least a dozen explanations for why this recovery is different. But journals at some point ought to be interested in the correct explanation
written by skeptonomist, May 06, 2013 8:44
The argument about the length of the work week is unconvincing. There has been a trend toward cutting back permanent employees and hiring part-timers, so that benefits do not need to be provided. This presumably tends to decrease the length of the work week. Employers can do this because of high unemployment, and there is high unemployment because of weak demand. So again, yes there is uncertainty, but no reason to think it is due to Obamacare, tax rates (lower than ever) or fear of regulation (not really increased) instead of just lack of demand.

Major boom-and-bust cycles were more common in the times before governments took a major role in economies - on the whole government has probably been a moderating influence since its decisions are not based on private demand. To claim that governments are responsible for cycles is pretty silly, but that's what we usually get from Samuelson.
written by Ken Miller, May 06, 2013 10:18
I'm not an economist. I greatly appreciate your writing. I notice what seems to be a conflict between you and Brad DeLong that I don't know how to adjudicate; I'd be very interested to hear your comments on this. As I understand, you have maintained that the crisis was caused by the burst housing bubble and not the financial crisis. But DeLong, in http://delong.typepad.com/sdj/...ging.html, writes (with accompanying figures): "And so unemployment started to rise in 2006 as construction workers were fired, right? And unemployment reached its peak in 2008 as the pace of shrinkage of construction reached its peak rate, right?


Between 2005 and the start of 2008, an enormous sectoral adjustment--a switch of spending away from housing--takes place without rising unemployment. Capital and labor moved out of housing, but on net they didn’t move into unemployment. There is a small boom in business equipment investment, as money that had been flowing in the housing gets redirected and businesses soak it up. There is an export boom as foreigners who used to be funding housing switch to buying US export. From 2005 through 2008 we have a very nice structural adjustment, a sectoral reallocation, an adjustment to change--but not a la Schumpeter. No cold douche. One is not needed. Sectoral reallocation and creative destruction proceed much more smoothly and rapidly when unemployment is low than when it is high. It is, after all, moving people from employment to unemployment that moves people from their existing occupations not to higher-value occupations but rather to an occupation--unemployment--that has absolutely no value at all. It is only with the coming of the financial crisis, with the recognition of how little control over their derivatives books the major money center banks had, with the collapse of risk tolerance in the economy as a whole, the flight to safety, and the subsequent collapse of spending that you have the rise of unemployment. And as unemployment rises sectoral reallocation stops." I'd appreciate any insights from you on this. Thank you.
some countries like Greece actually defrauded folks
written by pete, May 06, 2013 10:52
Greece and probably otheres entered into off-market currency swaps because the ECB allowed them to NOT market their derivatvies positions to market. This fraudulent activity allowed them entrance into the Euro zone. Thus, while the swap positions lost value do to the 30% change in the value of the Euro, it already was an off the books liability. This is shameful and this behavior should not be rewarded. As Krugman noted, wages in Greece and other places went up far faster than productivity and now are Keynesianishly sticky downward.
elite ponzi scheme
written by gladwyn d'souza, May 06, 2013 11:04
The pigs bankrupt resilience for short term gain? Because of the globalization of banks makes easy big ticket credit for houses and cars. So it’s a Ponzi scheme that bankrupts the countries like Nicaragua and Kenya at the bottom of the food chain where the tribes lose out for perceived value in resources like timber and water?
written by Gerald Malan, May 06, 2013 1:13
Just this note about the housing bubble: One of the misleading indicators of home sales in the build-up prior to about 2004 was the fact that while housing sales were robust, nobody was paying attention to the size of the deals. While the number of transactions were touted by the NAR and others, the fact was that people were down-sizing into smaller and generally less costly units.

This trend helped shape the bubble in another way including the embrace of sub-prime financing which again were for smaller properties.

Working real estate agents and mortgage brokers knew this from their reduced incomes.
written by denise, May 06, 2013 3:17
So many economists have been wrong about so many things, over and over, that it's kind of mind boggling that people still take what they say seriously. Journalists seem to just pick any random economist and quote or paraphrase whatever he has to say and that's the story the public gets. The tv talking heads and opinion writers like Samuelson can go on being wrong for the rest of their lives and it doesn't affect their careers in the least.

What is it going to take for the media to stop feeding us this crap? And what is it going to take for the profession to hold itself to higher standards? Has anything at all changed in our universities, or are we still cranking out a new cookie-cutter batch of these guys every year?

We deserve better.
written by Keith, May 06, 2013 4:52
What is this "housing bubble" of which you speak?
Weak Recovery Due 2 F***ing Uncertainty
written by James, May 06, 2013 11:16
U guygs said WTF? Exactly.

But Vanguard CEO McNabb said so and of course his country club boys too...

McNabb: "Uncertainty is the enemy of recovery"
Balancing the federal budget is the defining economic issue of our generation. Bill McNabb calls for decisive action to protect the economy and restore confidence to the markets.
Read Bill's analysis

This is what a customer of Vanguard F***king get. BS analysis to justify their fees.
written by watermelonpunch, May 07, 2013 12:14
By "uncertainty"... perhaps it's a language vocabulary error? Sort of like when people say, by mistake, "I could care less", when what they really mean is they don't care at all and should have said, "I couldn't care less."

Like businesses are certain demand isn't picking up... but instead people describe it as being "uncertain" (demand will pick up) ... so then the improper use of vocabulary, and the incomplete expression of the thought, leads people to "fill in the blanks" inappropriately about what they might be "uncertain" about.
And of course they fill in the blanks with whatever suits their particular agenda.

When the reality is that yeah, businesses are sure uncertain whether demand will pick up at some point in the future. I imagine it's "true" that businesses are ALWAYS somewhat uncertain about what demand will be like "at some point in the down-the-road future".
The only time they wouldn't be "uncertain" of that is, of course, if there's a bubble they don't recognize, and they think there's some kind of "new normal" going on. Not sure anyone with sense would want that kind of "certainty".

I think of Marvin the Paranoid Android who said he saw no reason to "make stuff up" because reality was already bad enough as it is without inventing any more of it.

But the financial services industry has found a way to profit on the made up "new reality" they've invented, that doesn't really exist, for a number of years now.
(Would economic theory cover them continuing to do so since it's been working?)

And then of course economists who share the agenda, or perhaps just want to sound as smart as quantum physicists, find ways to explain this reality that can't be observed...
Get a lot of economics jargon to parallel muons & bosons, and maybe they figure they can pull it off for awhile longer.

Eventually perhaps people will realize that it's not that hard to understand. Not like trying to answer the question, "What happened before time began?" That's a tough one for sure, so the astrophysicists certainly have something on their hands there.

But even the ancient Egyptians didn't need observations from a radio telescope or calculations on redshift to see that their pharoah's commission of the Sphinx spurred their economy.

Of course if the current crowd in Washington and on Wall Street, had been in charge of the Cro-Magnons, it would probably now be full blooded Neanderthals arguing about economics & uncertainty.
written by liberal, May 07, 2013 6:53
denise wrote,
So many economists have been wrong about so many things, over and over, that it's kind of mind boggling that people still take what they say seriously.


After the housing bubble, economists as a whole should be considered a laughingstock. (Yes, Dean isn't, but he's the exception that proves the rule.)
denise, beware of economists and *economists*
written by pete, May 07, 2013 4:15
Economics is the study of the allocation of scarce resources. There is a general framework, some models, which get tweeked from time to time. There is a vast literature, theoretical and empirical. Much like any social science. There is a vibrant academic community, which seeks the answers in open debate to the lead definition. These guys publish in peer reviewed journals of varying degrees of rigor. The top journals are very exclusive. The literature evolves, fads come and go, and so forth, like any social science. Much as history changes as new sources are revealed, economic findings can change as new data or statistical treatments arise. The basic premise of the study of economics is not altered, and it is a valuable pursuit.

Then there are paid economists like at Heritage, Brrokings, AEI, or folks like Dean, who are supposed to follow certain guidelines in their research (e.g., anti government, or pro union, etc.) These guys typically do not publish peer reviewed articles, do not attend academic conferences, instead they just bash each other or the academics with these unrefereed blogs or articles. I would refer to this as shooting from the hip. They probably could not make tenure at a decent university, and are better off pay-wise at one of these biased thinktanks than at a Cal State University.

Then there are company chief economists...I have never understood what they get paid for. But most of them are completely wrong about 50% of the time. Companies have them on staff much like we have vestigal parts of our body. They are relatively cheap, and make people feel better. Kind of like a king with a wizard.
Samuelson analysis
written by gary fitzgerald, May 07, 2013 5:09
Your (d) analysis shows this is actually a lie. Your (b) analysis shows this is more propaganda than economic analysis. Your (c) analysis shows this is irrelevant to the issue of hiring. But your (a) analysis misses the point. According to your analysis, average hours worked is going down. Work hours only decrease when demand decreases. When demand decreases, you can characterize the future as uncertain (of course, you have to believe that there is some magical event that may happen in the near future to restore demand). You can characterize it as "doubts about the economy" but that is more of a misrepresentation of the situation. When demand is weak the only accurate way to describe it is as no recovery. Thus, the reason why employers aren't hiring is because they don't see any signs of recovery. Samuelson doesn't want to say this because the obvious question is how do we increase demand, and nobody wants to talk about that. Since he can't talk about that, he has to talk around it, minimize it and misdirect the conversation whenever possible. To me, that is what your analysis shows.
written by Eric377, May 08, 2013 8:29
Why is the $8T of lost housing 'value' thought to be a net drag on economic activity? I don't get that. I own a house and it experienced a pretty healthy decrease in notional value over the past 6 years but still, it only effects me if I sell it. I'm not out-of-pocket a dime at this moment and should I sell and believe I missed $80,000, then some lucky so-and-so will be $80,000 better off. If I woke up one morning and my garage had disappeared, then I would say I lost something immediately real. That hasn't happened....at least through this morning.
Eric, this is the conundrum of the socalled wealth effect.
written by pete, May 08, 2013 10:25
We could all place a value on a rock in the middle of the water. If we bid that up, would we be wealthier? Seriously, my Moms hose appreciated 10X over 30 years. She was not wealthy. If she sold it and rented, her rent would have been 10X what it was 30 years ago. Housing as wealth is nonsense.
Denise, beware.
written by Calgacus, May 08, 2013 5:24
Pete: Economics is the study of the allocation of scarce resources. No, it isn't. Once you've said this, you've already gone neoclassical. Just think of it as studying actual economies, empirically. The standard, natural (peacetime) state of monetary economies is unemployment and deflation, where resources are abundant, but money and jobs are not.

There is a vibrant academic community, which seeks the answers in open debate to the lead definition. These guys publish in peer reviewed journals of varying degrees of rigor. The top journals are very exclusive.

Yes, the "top journals" (and the top universities) are exclusive of anything that makes sense. They publish nothing but shit, and hire morons. Fake rigor, that just appears to be mathematical, that makes mathematicians vomit. There is no vibrant debate, but increasingly ludicrous and microscopic refinement of the same unrealistic and incoherent models and zombie ideas. There is simply no interest in economics there, and hasn't been since the fall of Keynesian economics in the 70s.

"Folks like Dean" are as rare and precious as diamonds. Who cares whether they work? In any honest debate measured by logic and evidence, even by the declining and inadequate standards of the rest of academia, they would turn the prestigious quacks into laughingstocks. They regularly do.

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.