Krugman 10 years after Lehman
I have to link to this column, which is better than Krugman’s average.
It is mostly Krugman’s usual shrill praise of fiscal stimulus. I find two things notable. One is that he has no time or column inches for unconventional monetary policy. He’s back to “monetary policy was ineffective because we were at the zero lower bound on interest rates.” Being an extreme skeptic about the effectiveness of QE and all that, I am pleased.
Second he stresses housing not high finance
Why didn’t financial stability bring a rapid bounceback? Because financial disruption wasn’t at the heart of the slump. The really big factor was the bursting of the housing bubble – of which the banking crisis was a symptom. As Figure 2 shows, the housing bust led directly to a dramatic drop in residential investment, enough in itself to produce a deep recession, and recovery was both slow and incomplete.
[figure 2 about here[
The plunge in home prices also destroyed a lot of household wealth, depressing consumer spending in general.
He pretty much has gone full Dean Baker. I very much agree with Baker.
So what has the macroeconomics profession learned ? Hmmm there still is no housing sector in the work horse models — it is assumed that all investment is business fixed capital investment. There is still no effect of perceived wealth on consumer spending — the Euler equation still rules.
In contrast there is now a huge literature on the importance of financial instability for macroeconomic aggregates. The simple point that the financial crisis was brief and the great recession wasn’t has not been reflected in the academic literature (which I have read).
update: See Barkley Rosser (in comments) noting he wrote independently from Dean Baker (and sometimes earlier).
Also Krugman wrote another post about it with FRED graphs
It is interesting that if you are a star (Krugman or Bernanke) you can grab em by the reduced form & do extremely simple empirical work. Sadly, one must have a reputation for people to take seriously one’s impressions when eyeballing FRED graphs.
Robert:
Perhaps I missed what is being said by Baker and Krugman. It would not be the first time . . .
Housing would not have skyrocketed without the influx of easy money from loose requirements for principal and secondary mortgages, refinancing taking out equity, and the influx of foreign funds looking for safe haven in treasuries. Ninja and no – money down mortgages, fraud, Robo-signatures, etc. and the funding not going to zero percent treasuries ended up in the “supposedly” safe next best thing being mortage back securities. The market was flooded with money from many sources brought on by bansks and non banks tossing money at whatever seemed like a financially good gamble. The already FED weakened GS Act was pushed to the side and the National Banking Act changed to allow banks to gamble with their funds on the market.
These risk tranched securities had little reserve backing them up. The S&Ps of the world rated them as being good value and secure. They were backed by no reserve CDS and countering naked CDS. The rest is history. The housing bust was caused by Wall Street greed and their collapse causing Main Street to bail them out. The Housing market collapsed as people lost their jobs, could not find refinancing, and if they could find financing the interest rate was high. All caused by a Wall Street financial collapse.
The Housing market collapse was the result Wall Street not minding the store and their own greed. We are heading in this direction again. As I said, I may be misinterpretting what you have said.
A full Dean Baker would be to argue that action was needed to prevent the bubble in the first place.
“The really big factor was the bursting of the housing bubble – of which the banking crisis was a symptom.”
Of course that ignores the REALLY big factor which was the rampant extraction of home equity to pay off debts resulting from past spending and directly fund more spending.
Greenspan & Kennedy Study of Equity Extracted
From: https://www.federalreserve.gov/pubs/feds/2007/200720/200720pap.pdf
(Table 2 Line 1 from Page 16 & 17 and Line 29 from Pages 18 & 19)
Year ———- (1)Free cash — (29) Home purchase — Free Cash-Home purchase
1991 ———- $262.2 ————- $114.8 ——————– $147.4
1992 ———- $212.2 ————– $90.8 ——————– $121.4
1993 ———- $193.2 ————– $81.2 ——————– $112.0
1994 ———- $223.4 ————– $91.1 ——————– $132.3
1995 ———- $184.5 ————– $74.3 ——————– $110.2
1996 ———- $277.1 ————- $108.8 ——————– $168.3
1997 ———- $276.0 ————- $101.1 ——————– $174.9
1998 ———- $348.9 ————- $132.3 ——————– $216.6
1999 ———- $467.2 ————- $184.8 ——————– $282.4
2000 ———- $553.4 ————- $211.0 ——————– $342.4
2001 ———- $626.9 ————- $227.0 ——————– $399.9
2002 ———- $757.8 ————- $275.1 ——————– $482.7
2003 ——— $1003.3 ————- $387.1 ——————– $616.2
2004 ——— $1170.1 ————- $410.1 ——————– $760.0
2005 ——— $1428.9 ————- $538.2 ——————– $890.7
Note: Dollars are in Billions. Free Cash minus Home purchase is my calculation. That column is included because I did not want to assume that home sales did not fund home purchases.
Homeowners’ demand for loans allowed the investment bankers to extract fees to set up securitization of those loans. The investment bankers’ demand for loans allowed mortgage brokers to write loans which would always be bought. And mortgage brokers imperative was to write loans and no appraiser was going to stand in the way of that. (They could always find a cooperative appraiser.) And that caused the housing bubble.
As you can see in the table, home equity extraction rapidly increased after 1995. So after NAFTA was passed and manufacturers were scurrying to Mexico, Americans began to depend on borrowed money to maintain their standard of living.
And that borrowing hid the effects of free trade treaties on the US economy.
To be more accurate that borrowing hid the effects until the bankers began to wonder about the quality of some of those loans, especially when they defaulted within a year or two. Getting a loan became a little more difficult and that quickly burst the housing bubble.
The reduction in loans also exposed the fact that large numbers of American consumers/workers were poor. They had been poor for some time but no one noticed until the lending was tightened.
By about mid 2007 Bear Stearns was bailing out its special purpose entities to the tune of billions of dollars. And by December 2007 we were in the Great Recession.
There would not have been a housing bubble if the investment bankers had not set up a reckless demand for home loans. There would not have been a debt bubble if American consumers had not be tried to maintain a standard of living that their incomes no longer supported. (After free trade took effect.)
It has been 10 years of stagnant wages, and a growing number of blighted cities, suicides and drug overdoses. And the investment that most corporations prefer is a stock buyback. Private investors like putting their money into the stock market because apparently it no longer depends on the health of the American economy. Or they purchase houses, which makes for more unafforable housing and higher rents.
TANTA!!!
https://www.calculatedriskblog.com/2008/12/in-memoriam-doris-tanta-dungey.html
I also agree with Dean and was ahead of him on certain crucial points back then publicly, which he agrees is the case, although not as prominently.
Regarding the lack of housing in macro models, where it is is in the old “structural” Wharton type models that at least the Fed Board of Governors keeps around in its backroom to compare with the silly DSGE and VAR ones.
@Barkley Rosser sorry. I just associate the claim that the bubble bursting alone pretty much explains the severity of the Great Recession with Baker. I shouldn’t have suggested he was the first to argue that.
Dean Baker warned of the housing bubble before it burst.
Yes finance had a lot to do with inflating the housing bubble. The debated point is whether the financial crisis is key to the severe recession or if bankers etc caused damage through house prices.
High household debt (including home equity loans) is clearly important. I think there is a legitimate debate about how large the effect of house prices would have been even without household debt. Note Krugman discusses the effect of house prices on house building. There would be such an effect even if houses were bought for cash (no mortgages). Also the effect on consumption is partly an effect of reduced perceived wealth (also relevant to those who own the house outright having paid off the mortgage) or a binding liuidity constraint for those who would borrow on home equity if they had any but don’t.
My sense is that genuine experts (Mian, Sufi and students including Verner) are quite sure that household debt was critically important & not just in 2008.
I personally am interested in seeing how far one can get with just fluctuations in housing prices and expected future housing prices. I think one key factor is the absurdly high 2000-2006 expectations of house price appreciation & the dramatically lower expectations by 2009. This would cause a dramatic decline in housing investment even if there were not financial frictions. I have guessed one could get quite far towards an explanation of the great recession. The key is that the story has nothing to do with lending standards, financial frictions or liquidity constraints.
http://angrybearblog.com/2014/02/half-of-whats-wrong-with-the-recovery-in-one-chart.html
In general, I think housing prices matter even once you have considered household debt.
http://angrybearblog.com/2018/05/the-relative-price-of-housing-and-subsequent-gdp-growth-in-17-developed-countries.html
http://angrybearblog.com/2018/05/housing-prices-and-recessions-ii.html
That same housing bubble created a modest boom by late 2005 and a labor market boom in 2006-7 with 4.1% wage growth. Debt drives growth. Sadly, all the debt since 2001 has been to satisfy US consumer markets and self-gratification. That is why taxes need to be raised(instead of useless tariffs, raise income taxes on the rich and drain the swamp while government investment raises creating long lasting growth).
This cycle is the same scam. Except the huge debt surge is in non-banking financial companies. The Quicken Loans bubble is shall be named.
I think you are mischaracterising Paul Krugman’s view of unconventional monetary policy. My memory is that he was mildly sceptical about its effectiveness but his models did not suggest it would be harmful (no runaway inflation or bond vigilantes). In other words, can’t hurt, might help.
On fiscal policy at the zero lower bound he seems to have been consistent as long as I have been reading him.
Perhaps someone can reference a blog post or article which will correct my understanding?
The banks artificially created an immense amount of AAA buyers that did not exist through the fraud they committed aided by crooked appraisals and the ratings firms fraud. When the payments did not come in as AAA payments should, the market collapsed.
Follow the delinquency rate. Those losses to investors created the financial crisis as they scrambled to save something either through sales and/or insurance.
The problem isn’t that RE prices fell. The problem is that excessive lending allowed people to borrow more than the had any reasonable expectation of paying back. The RE bubble was driven by falling interest rates until ~2003. After that it was only ever crappier underwriting that allowed debt levels (and house prices) to continue to spiral upward. And it was crazy financial games with pooling and trancheing debt that encouraged banks to make ever worse loans that they could sell off for the creation of Private Mortgage Backed Securities. So when you scratch the surface of the RE crash, you have the finance industry.
And yes TANTA VIVE! (it is hard to imagine that it has been 10 years)