Yes There WAS A Housing Bubble

This article was first published by me at talkmarkets:

Scott Sumner is dead wrong about the housing bubble last decade. Here is his view on the matter, recently published on his interesting blog, The Money Illusion:

There are two powerful pieces of evidence against the claim that the US housing market was overvalued.  First, many who made that claim also said the same thing about housing markets in Canada, Australia, the UK, and other countries.  And yet many of those other countries did not crash.  Even worse, America’s housing market has mostly recovered, and yet I see almost no one currently saying “America’s in a huge housing bubble, and when it crashes we’ll have another Great Recession”.  So why continue to claim the 2008 recession was caused by a housing bubble that no longer even looks like a bubble at all?

The problem with his analysis is that last decade, mortgage rates were far higher, while prices were similar to current prices in the bubble states. Yes, if you look nationally, as seen in the chart below, prices are higher everywhere now. But that figure is deceptive. The median price in California in the bubble was around $500,000 and that is about where we are now. It is in the bubble states where prices were high. Those were mainly California, Florida, Arizona and Nevada.

Nationally, prices are higher now but the housing bubble was confined to 4 states last decade.
And remember, Robert Shiller has said we have seen overheating in housing since 2012!

So, the bubble consisted of people who were given low teaser rates in certain states, and would be unable to pay once those rates went away. What actually happened in the bubble states is that when the crash came, many mailed in the keys, but in many wealthier neighborhoods, there was no attempt to foreclose right away, as the value of the housing was more important to banks than foreclosing and getting them back. And the Fed lowered rates after the housing crash, allowing some to save their homes. Yet many wealthy owners did walk away from their mortgages.

Yes, Sumner is correct that the Great Recession, Fed tight money, etc., made the housing crash worse. That is the great contribution of Market Monetarists to the debate. Tightening the money supply, which in one instance took the form of the commercial paper market decaying, took away business credit, which caused massive layoffs. The CP market financed subprime mortgages and it was ruined as the last chart below shows. That tightening took away HELOC's which added to the tight money situation. HELOC frenzy was a part of the housing bubble. Even a Market Monetarist, Marcus Nunez understood that the housing bubble was related to the Great Recession through HELOC's gone wild and then curbed. And the Fed was culpable as banks started taking away HELOC lines of credit.

Nominal GDP was falling. But to say there was no bubble ignores the toxic loans, the pay option arms, the loans that could not be paid back the day they were written. To say there was no bubble ignores the ability of homeless people to get loans during that time. No credit check housing is a bubble!

In the bubble and pre bubble, home ownership went from low/mid 60's to high 60's as a percentage of the population, as the following chart shows. The bubble was in who owned the homes and their ability to pay. Sumner is rewriting history, and he does not need to do so to prove NGDP declined. It simply is not necessary for him to do so.

Ownership skyrocketed in the last decade before falling back to earth.
Collateral mortages are helping keep the Canadian housing bubble going. They are mortgages that allow lending to the borrower without the need to refinance. They are risky, bubblish loans. Homeownership rates among young people in Canada between the ages of 20 and 34 are below 45 percent! That could be a bad sign unless foreigners take up the slack. 

The UK is experiencing a comeback of risky loans. These nations are maintaining their housing value in many cases by really risky lending. They are markets in jeopardy. Economic shocks could prove damaging to these markets. The control of inventory may determine if house prices stagnate and avoid a crash. Certainly house builders have cut back on production in the USA and this is most likely the world over. This was not the case in the last decade's great housing bubble in the USA.

The following chart shows the higher interest rates in the last decade compared to this decade. Couple this higher mortgage rate regime (and the need to qualify people through teaser loans) with the percentage of owners that far exceeded historical norms, and the bubble state high prices, and you had a massive US 4 state housing bubble!

So, Sumner does not make the case that there was no housing bubble. I don't know why he would even try. He and his MM friends have adequately shown that the destruction of markets was not offset by Fed action to save homeowners. He should be satisfied with that contribution.

Rates in the last decade were significantly above 5 percent. 

Commerical Paper Market Financed Subprime Mortgages


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