Asleep at the Wheel

Dean Baker
The Guardian Unlimited, April 28, 2008

See article on original website

Alongside bankers, realtors and the Federal Reserve, professional economists should be faulted for ignoring the US housing bubble.

Virtually everyone now acknowledges that the economy is in a recession brought on by the crash of the housing bubble. The unemployment rate is already up by 0.7 percentage points from its year ago level. With the economy now shedding jobs at the rate of almost 100,000 per month, it is certain to go much higher.

As the labor market weakens, workers' bargaining power will diminish. Wages will fall further behind inflation, with health insurance and pension coverage certain to shrink. Based on prior recessions, even if the 2008 recession is relatively mild, it will be at least four years before we again see the 2007 levels of unemployment.

In addition to the normal labor market impact of a recession, the housing crash is causing millions of people to lose their homes. The latest data show foreclosures running at a 2.8 million annual rate in March. Tens of millions of homeowners are losing much of their lives' savings, as plunging home prices destroy their equity. Millions of middle class baby boomers will now find themselves reaching retirement with nothing but their Social Security.

This is just the beginning of the downturn, but it is already clear that we're looking at really bad news. This raises the obvious question: where were the economists? Why didn't they notice the housing bubble and try to warn the public about the disaster that was building?

This question has been directed toward former Federal Reserve Board Chairman Alan Greenspan, but few have asked the question of the economics profession as a whole. Economics is explicitly a policy oriented discipline, and there are few policies that could conceivably have had greater impact than measures to stem the growth of the housing bubble before it grew to such dangerous proportions. Yet, the housing bubble was largely absent from the agenda of economists until it began to collapse last year.

It really should not have been hard to detect the housing bubble. Government data showed that house prices had just tracked the overall rate of inflation from 1953 to 1995. When house prices suddenly began to vastly outpace the rate of inflation in the mid-90s, with no obvious explanation, and no corresponding increase in rents, it should have been fairly evident that something was wrong.

Economists should at the least have been searching desperately for some fundamental factor that could explain such an extraordinary departure from past trends. When this search failed, they should have done everything possible to sound the alarm, warning of the dangers of a collapsing bubble to homebuyers, to lenders, and the economy as a whole.

At its peak in 2006, the run-up in house prices had generated more than $8 trillion on housing bubble wealth, more than $110,000 for every homeowner in the country. Much or all of this wealth will be destroyed as prices correct. This should have been enough money to warrant serious attention from the economics profession.

But, economists had their attention focused elsewhere. Some of these economists were focused on the budget deficits that the country ran in the bubble years. These deficits may have posed somewhat of a problem, but the recession resulting from collapse of the housing bubble will cause the country to run much larger deficits.

Many economists were focused on overhauling the Social Security program. After all, the Social Security trustees projected a shortfall of $4 trillion over the 75-year planning horizon. Somehow that projected shortfall doesn't seem all that serious compared to the prospect of losing $8 trillion in housing wealth over a span of 2-3 years.

There were other issues that got economists' attention. We had the trade deal with the Central American countries; six countries with a combined GDP that is less than the state of Michigan. And there were those plans to eliminate the 40-hour workweek.

Alongside the bankers, the realtors, and of course Alan Greenspan, the economics profession deserves to be called to account. Any economist who bothered to look should have been able to easily recognize the housing bubble. They failed to see it because they just could not be bothered.

For some reason, most economists could not even fathom the idea of a multi-trillion dollar bubble in the housing market even after they just witnessed the collapse of a $10 trillion bubble in the stock market and the ensuing recession. Yet again, the country is paying an enormous price for the extraordinary incompetence displayed by the economics profession.

Dean Baker is the co-director of the Center for Economic and Policy Research (CEPR). He is the author of The Conservative Nanny State: How the Wealthy Use the Government to Stay Rich and Get Richer ( He also has a blog, "Beat the Press," where he discusses the media's coverage of economic issues. You can find it at the American Prospect's web site.