The Meltdown Lowdown, No. 8

Dean Baker
The American Prospect Online, May 29, 2008

See article on original website

This week in economic news: House prices continue to plummet, speculation is probably not to blame for high gas prices, and new corruption is exposed in the mortgage industry.

House Prices: Going Down Fast

Remember the good old days when house prices only went up? Well, those days are long gone. The March Case-Shiller indexes, the best measure of house prices, show that prices are falling faster than ever.

Case-Shiller 20-city index shows house prices declined by 14.4 percent from March 2007 to March 2008. The annual rate of price decline over the last quarter (that is, the amount the price would decline if prices dropped for the rest of the year as fast as they have dropped this quarter) was 25.1 percent in this index. Since the peak of the housing bubble in July 2006, the 20-city index shows a drop of 16.4 percent.

Prices are dropping most rapidly in the formerly hot markets. Over the last year, prices in Los Angeles, San Francisco, and Miami are down by 21.7 percent, 20.2 percent, and 24.6 percent, respectively. In the last quarter, prices in these cities have been dropping at 37.6 percent, 37.3 percent, and 34 percent annual rates.

Prices are now falling almost everywhere. Over the last quarter, prices in Washington, D.C., Chicago, and Boston fell at annual rates of 26.3 percent, 22.1 percent, and 13.9 percent, respectively. Over the last 12 months, prices in these cities are down 14.7 percent, 10 percent, and 5.9 percent, respectively.

This rate of price decline virtually guarantees a flood of defaults and foreclosures later in the year. It is difficult to understand what the economists who say that we are through the worst of the mortgage crisis could possibly mean. The banks have not written down the hundreds of billions of dollars of losses that will surely result from this wave of foreclosures. When they do, it will be an enormous hit to their balance sheets.

Wait, Haven't We Seen This Movie Before?

Anyone want a copy of Are You Missing the Real Estate Boom? The Boom Will Not Bust and Why Property Values Will Continue to Rise Through the End of the Decade: And How to Profit from Them? The book was written by David Lereah, formerly the chief economist with the National Association of Realtors. Mr. Lereah was the most widely cited expert on real estate in major media outlets, including The Washington Post, from 2004 to 2006. has used copies available for 39 cents. Of course, given the rate at which house prices are falling in some cities, 39 cents could soon be enough money to buy a house.

As long as we're talking about bubble-hyping best-sellers, that classic from the stock bubble days, Dow 36,000: The New Strategy for the Coming Rise in the Stock Market, goes for 46 cents on Amazon. Fortunately, in case you can't scrape together 46 cents because you got wiped out with the collapse of the Nasdaq, the book's co-authors, James K. Glassman and Kevin Hassett, still frequently share their wisdom in The Washington Post and other major media outlets.

$4-a-Gallon Gas; Are the Speculators to Blame?

The run-up in crude oil prices over the last year has certainly been extraordinary. Very few people predicted $130-a-barrel oil at this time last year. The $4-a-gallon gas (which is only loosely connected to the rise in crude prices) is really nailing workers with big cars and long commutes.

Many members of Congress are asking whether this run-up is due to speculation or the fundamentals of supply and demand in the oil market. Put me in the fundamentals camp. You would have to pull a lot of oil off world markets for this increase to be explained by speculation, and the data shows no evidence of any extraordinary run-up in oil inventories.

At the same time, speculation can, at least temporarily, cause prices to overshoot. In other words, a run-up driven by fundamentals could very plausibly drive oil prices up in the neighborhood of $100 per barrel, with some speculative demand adding another $20 to $30 per barrel for a period of time.

Even if speculation is a factor in pushing up prices, there is no simple way to remedy the situation. Speculators don't carry identity cards. One measure that could take some of the exuberance out of speculation would be a modest tax (0.02 percent, for example) on trading in oil futures and other financial transactions. Such a tax would have almost no impact on normal business dealings but could make speculation considerably less profitable and could also raise more than $150 billion a year, by my calculations.

Of course, if speculation is a big factor in pushing up oil prices, then we could have a little fun by releasing some oil from the national reserves. We probably wouldn't have to release too much oil to break the back of the speculators; in fact, announcing the plan might be sufficient to do the trick. It might be worth a try.

NPR Uncovers Yet More Corruption in the Mortgage Industry

Tuesday, a segment on National Public Radio answered one of the questions that millions have been asking: How could the investment banks not know that much of the information for the mortgages they were packaging was bogus? The answer is that the investment banks did know, and they told the people investigating the quality of loans in their pools to shut up.

NPR also reported that some of the investment banks had contracts with New Century, one of the largest sub-prime lenders, which committed the banks to rejecting less than 2.5 percent of mortgages that it sold them. Of course, such a contract is an invitation to fraud, since New Century knew at least 97.5 percent of its mortgages would be approved, regardless of the fitness of the borrower.

Why would a bank ever agree to this sort of contract? Well, the idea is that once you package the loans in securities and sell them off, they are someone else's problem. Your bank and its managers have made their money on the fees. When the pyramid collapses, the execs can be off enjoying their retirement and let others pick up the pieces.

Many of us knew that something like this must have been going on at the banks that were bundling the mortgages, but NPR did an important public service in connecting the dots. With luck, some civil and criminal actions will be directed against the bank executives responsible.

May Jobs Report

Since The Meltdown Lowdown will be on vacation next week, here are some advance comments about the May jobs report that will be released a week from Friday. The report will be another blow to the recession deniers. Look for the economy to shed 80,000 jobs with the unemployment rate rising to 5.2 percent. Construction, both residential and nonresidential will be the big job-loser. Job growth in the health-care sector will slow somewhat (we can't all work in hospitals).

Among demographic groups, expect to see the biggest jump in unemployment among teens and young workers. This will actually a sharp jump in employment in April, which was most likely just an aberration.

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.