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Elites Demanding Austerity Also Ignored Housing Bubble

Dean Baker writes to the question of who is pushing the fiscal cliff idea:

Elites Demanding Austerity Also Ignored Housing Bubble

it was somewhat shocking to see a book review in The New York Times by Noam Scheiber, an editor at The New Republic, that longed for the day when we will have people who can use data to identify housing bubbles before they grow so large as to pose a serious danger to the economy.

The personal slight is beside the point; the issue is that our elites are being allowed to construct an alternative reality that absolves them of responsibility for the ruined lives all around us. The reality is that people in positions of authority chose to ignore the evidence of a rapidly growing bubble and those trying to call attention to the dangers it posed. Instead, we have Scheiber giving us the “Who could have known?” story. His case is that the dynamics of the bubble were just too complicated for people to grasp given the tools available at the time. The people who clearly warned of the bubble, using data, simply did not exist in Scheiber’s universe.

If it were just Scheiber saying this on a rant somewhere, he could be easily dismissed as a crank. While he is a prominent writer on policy and politics, prominent writers say ridiculous things all the times.

But this was not just a random rant. It was a book review in The New York Times, by far the nation’s most prestigious newspaper. It is a paper that employs fact checkers and prides itself on accuracy. Would The New York Times allow a book reviewer to bemoan the fact that no one had questioned the existence of weapons of mass destruction in Iraq prior to the war?

And the bubble warners were not entirely below The New York Times’ radar screen. In fact, several Times reporters had picked up on warnings of the housing bubble. In fact, Paul Krugman, perhaps the most famous economist in the world, used his New York Times column in 2002 to warn of the dangers posed by the housing bubble.
Given this history, how can an ill-informed book reviewer get away with making what is obviously an untrue assertion in a New York Times book review? The simple answer is that Scheiber’s “Who could have known?” story is quite comforting to people with power in this country.

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Housing equity withdrawal drove the bubble, not so much the building

Tim Duy also points to Bill McBride and Josh Lerner adding to the discussion of the narrative of housing in our economy and how that should affect policy.  I would add of course the variety of responses by the mortgage industries (see Naked Capitalism) since that started in earnest round 1998 (MERS).  I think this idea can be further refined and tied to other aspects of our troubles globally.

What Are We Expecting From Housing?, by Tim Duy: Josh Lehner and Bill McBride note that the manufacturing slowdown does not necessarily indicate recession, something I noted as well. Another version of that story is seen by comparing the ISM headline number with the new orders data:
 …During the 2002-2005 period, arguably the height of the housing bubble, residential construction contributed an average of 0.4 percentage points to GDP growth each quarter. In the first quarter of this year, the contribution was 0.42 percentage points. So, barring the occasional pop in the data, housing is already contributing to GDP growth about what we would expect.
 …Certainly we can envision accelerated home building triggering an increase in both manufacturing (capital equipment) and consumer (job/income growth) activity as well; these tend to be interconnected activities. So maybe the overall impact is a bit higher.


So here is the question: What was more important in holding the economy close to potential output, residential construction itself, or the housing price bubble? I tend to believe the price-driven balance sheet effects were driving dynamics over this past business cycle. Absent a healing of household balance sheets (or, relatedly, monetary policy that supported such healing via somewhat higher inflation expectations to reduce debt in real terms), I would expect overall growth to remain subdued, despite a rebound in residential construction. The latter is helpful and important, but not by itself a magic bullet.

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