Originally Posted by mcbear
nice charts, and some have merit but none address the issue.
The economy is more complex than is intimated in this thread. By looking at a single aspect one can believe everything is peachy (like Jayhawk appears to believe) or that the world is turing to shit before our very eyes as others seem to believe.
Here's a useful perspective.
We Told You So
by Mark Thornton
This article was excerpted from a chapter in a forthcoming book, â€śThe Economics of Housing Bubbles,â€ť in Americaâ€™s Housing Crisis: A Case of Government Failure, edited by Benjamin Powell and Randall Holcombe.
There are three basic views of bubbles that are held by economists. The dominant view among modern mainstream economists, including the Chicago school and proponents of Supply-Side economics, is to deny the existence of bubbles and to declare that what is thought to be â€śbubblesâ€ť is really the result of â€śrealâ€ť factors. The second view, which is espoused by Keynesians and by proponents of Behavioral Finance, is that bubbles exist because of psychological factors such as those captured by the phrase â€śirrational exuberance.â€ť The third view is that of the Austrian school, which sees bubbles as consisting of real and psychological changes that are caused by the Fed. This view has the advantages of being able to identify the economic cause of bubbles and directs us to policy choices that would prevent future bubbles.
Until very recently, most people agreed with the majority of economists, that there is no such thing as a housing bubble â€“ housing prices, they said, â€śnever go down.â€ť Although there is much diversity in the mainstream camp, it is well illustrated by two economists from the Federal Reserve Bank of New York who recently examined concerns about the existence of a speculative bubble in the U.S. housing market. While McCarty and Peach did find that a housing bubble could have a severe impact on the economy â€“ if it existed and were to burst â€“ they ultimately concluded that such fears were unfounded:
Our main conclusion is that the most widely cited evidence of a bubble is not persuasive because it fails to account for developments in the housing market over the past decade. In particular, significant declines in nominal mortgage interest rates and demographic forces have supported housing demand, home construction, and home values during this period. (2004, 2)
Furthermore they found â€śno basis for concernâ€ť for any severe drop in housing prices. In the past when the U.S. goes into recession or has experienced periods of high nominal interest rates, they found that any price declines have been â€śmoderateâ€ť and that significant declines can only happen regionally so that they would not have â€śdevastating effects on the national economy.â€ť
This is essentially the view of Alan Greenspan the former chairman of the Fed and Ben Bernanke the current Chairman. In particular, Greenspan was aware of the possibility of a housing bubble, but he offered many reasons to suggest that it did not exist, and that if one did exist it would not be a major problem. The Chairman is usually so incomprehensible and misleading that I have labeled his testimony before Congress as â€śGreenspamâ€ť (Thornton 2004a). However, on the topic of the housing bubble he was clear and direct and worth quoting at length.
The ongoing strength in the housing market has raised concerns about the possible emergence of a bubble in home prices. However, the analogy often made to the building and bursting of a stock price bubble is imperfect. First, unlike in the stock market, sales in the real estate market incur substantial transactions costs and, when most homes are sold, the seller must physically move out. Doing so often entails significant financial and emotional costs and is an obvious impediment to stimulating a bubble through speculative trading in homes. Thus, while stock market turnover is more than 100 percent annually, the turnover of home ownership is less than 10 percent annually â€“ scarcely tinder for speculative conflagration. Second, arbitrage opportunities are much more limited in housing markets than in securities markets. A home in Portland, Oregon is not a close substitute for a home in Portland, Maine, and the "national" housing market is better understood as a collection of small, local housing markets. Even if a bubble were to develop in a local market, it would not necessarily have implications for the nation as a whole. (2002)
As the bubble was reaching its peak, Greenspan (2005) did admit that there was some â€śapparent frothâ€ť in some local housing markets, but overall he found that conditions in the housing market were actually â€śencouraging.â€ť Incredibly, in his first speech after leaving office Greenspan said that the â€śextraordinary boomâ€ť in the housing market was over, but that there was no danger and that home prices would not decrease (Bruno 2006). The new Fed chairman, Ben Bernanke (2006b), has admitted to the possibility of â€śslower growth in house prices,â€ť but confidently declared that if this did happen he would just lower interest rates. Bernanke also believed that the mortgage market is more stable than in the past and noted in particular that:
Our examiners tell us that lending standards are generally sound and are not comparable to the standards that contributed to broad problems in the banking industry two decades ago. In particular, real estate appraisal practices have improved. (2006a)
Apparently he overlooked the then booming sub-prime market.
A second view of housing bubbles and bubbles in general is that they do exist, but that they are fundamentally caused by psychological factors. Many people and many important economists subscribe to this view of bubbles, including Keynesian economists and proponents of Behavioral Finance, such as Robert Shiller. From this perspective the business cycle is seen as the ebb and flow of mass consciousness and emotions. Real factors may play a role, but the important causal factors for deviations in the business cycle are psychological. Booms develop because people become confident and then overconfident in the economy. Investors likewise are confident and increase their tolerance for taking risk. Rising profits and asset prices lead to â€śspeculativeâ€ť behavior where economic decisions are no longer based on old rules and procedures, but on the bravery instilled by a â€śnew era.â€ť As the investment mania sets in the bubble expands. Then, for whatever reason, people begin to lose faith and new investments are exposed as disappointing. Economic reports and statistics turn sour, and stories of scandal begin to appear in the press. Many investors remain determined that this turn of events is only temporary, but results grow worse, prices continue to fall, and investment projects are postponed, halted or cancelled. The mood of the market is one of gloom or even doom. The economy enters a depression. This psychological camp did predict the housing bubble but their â€śsolutionâ€ť is to call for a mass array of government programs, regulations, and bailouts â€“ as if the government isnâ€™t already intimately involved in every aspect of housing.
The third view holds that there are changes in both real factors and market psychology during bubbles and that both are driven by the cause of the business cycle â€“ the Fed. This view of bubbles is based on the Austrian business cycle theory (hereafter ABC theory). This is a minority view held by Austrian school economists. According to the ABC theory, if the Fed does follow a loose monetary policy, then a bubble can develop somewhere in the economy, whether it be in tulip bulbs, stocks, or real estate. If the new money is directed toward housing, a bubble will develop in housing. Austrian economists further emphasize that the additional resources allocated to housing are resources that are not available elsewhere in an economy, so that while more resources than normal are allocated to housing construction, fewer resources are available to other areas of the economy such as manufacturing, which will experience higher costs for its inputs such as labor and materials and will produce a proportionately smaller output. It is this mismatching of resources across industries and sectors that has to be resolved â€“ painfully â€“ in the inevitable bust or correction.
more at: We Told You So by Mark Thornton