In previous post on the efficient market hypothesis, I sympathized with Scott Sumner’s overly demanding definition of identifying a bubble, because his definition prevents people from taking credit for spotting a bubble an implausible number of years before it popped. The example I gave was Dean Baker, who I recalled as predicting the current housing bubble in 1948. Dean corrected me in the comments, reminding me that it was in fact 2002 when he “called” the bubble, and he links to the paper where made the call.
I strongly suggest that anyone who harbors a notion that Dean called the bubble read his paper, from August of 2002, and consider whether he was calling the housing bubble that popped in 2006, or whether he was calling a housing bubble that hadn’t begun in any appreciable way.
Why don’t I think Dean actually called the bubble? First, in his paper Dean specifically refers to the period of time before we can expect prices to fall as “months”. In his conclusion, he sums up his predictions like this:
..it is likely that the HPI will follow the rent index in the months ahead, first showing considerably slower growth. In later months, it is likely that that the HPI will fall in real terms, and possibly in nominal terms, until it is back near its pre-bubble position relative to the rent index.
He is referring here to slower growth in the “months ahead” and a fall in the house price index in “later months”. In fact, house prices didn’t peak until the second quarter of 2006, four years or 48 months after Dean wrote this paper. From his choice of words here he makes it pretty clear that he did not have anything like that in mind.
Another problem is that national house prices are still above where they were when Dean spotted a “bubble”. According to the most recent Case-Shiller house price indices, the U.S. national house price average is now where it was in late 2003, a year after Dean claimed that house prices were going to fall 11% to 22%. Prices falling well below where they were when you cried bubble is a bare minimum requirement for calling a bubble. Dean has not met this very minimal requirement.
You might think prices are going to fall another 25% and prove Dean right, but prices would need to fall much more than that. If Dean was correct that there was an 11% to 22% bubble in 2002, then after the huge buildup in housing supply that occurred from 2002 to 2006, you’d expect the eventual fall in prices to bring us much lower than 11% to 22% below the 2002 price level. To put it simply, if I said “the supply of gold right now is too high to support the prices we are seeing, prices are going to fall 10% from here”, and then the supply of gold quadruples, prices need to fall more than 10% to prove me correct. This is even more true when you consider that the popping of a huge housing bubble is more destructive than the popping of a small housing bubble, so prices should be lower than Dean forecast due to a much larger destruction of wealth than he expected.
Dean’s a nice guy and all, but I think it really is inaccurate to characterize him as having called this bubble.
10 comments
Comments feed for this article
Saturday ~ February 6th, 2010 at 2:33 pm
Dean Baker
Adam,
I deliberately did not put in a date on the end of the bubble because I consider them to be driven by irrational behavior. I don’t know how long irrational behavior can persist — it was certainly longer than I expected. Of course, I did not anticipate that Greenspan would push ARMs when fixed rates were at a 50-year low, the SEC would relax its leverage restrictions on investment banks, and that mortgage issuers would start filling in numbers for mortgage applicants.
In terms of the current market valuations, I think that the Fed buying $1.25 trillion of MBS, the first-time buyers tax credit, and the FHA decision to emulate the worst of the subprime lenders has had an impact on market prices. I’ll admit to not having anticipated these measures, but I expect that after they end that house prices will resume their decline.
Saturday ~ February 6th, 2010 at 2:48 pm
Adam Ozimek
Dean,
Considering that the damage to wealth and the excess supply are worse than you expected, how much farther do prices need to fall in order for your assessment of a 11-22% bubble as of 2002 to have been correct? And if they don’t, will you acknowledge that your bubble did not exist? It seems to me that until that occurs, you’re prediction is incorrect.
Saturday ~ February 6th, 2010 at 4:57 pm
Dean Baker
I don’t know that wealth destruction was worse than I expected — the S&P is about 30 percent lower than its peak. That doesn’t seem a hugely surprise to me. Obviously, I anticipated even greater destruction of housing wealth than we saw.
Anyhow, I would make any predictions contingent on removal of special government supports. Does that seem strange? If I predicted that the price of oil would rise and then the government imposes strict mileage standards, does that make me wrong because oil prices don’t subsequently rise?
Perhaps we disagree that the government supports have an impact on house prices. As I said, the three on my list are:
1) the Fed MBS purchase program;
2) the first-time buyer tax credit;
3) the huge expansion of the role of the FHA (30 percent of purchase mortgages in 2009);
Do you think that any or all of these special government interventions have not boosted house prices? My expectation is if they are to end, then house prices would resume their decline. If all three ended simultaneously, my guess would be that house prices return to trend levels in 18 months. Is that concrete enough.
Saturday ~ February 6th, 2010 at 6:18 pm
Adam Ozimek
In your 2002 paper you said:
“The collapse of the housing bubble, implying a drop of between 11 and 22 percent in the average of housing prices , will destroy between $1.3 trillion and $2.6 trillion in housing wealth…. The loss of this much housing wealth will reduce consumption by between $80 and $160 billion.”
and about a month ago you said:
“The other major cause of the downturn is the loss of $6 trillion in housing wealth due to the collapse of the bubble. People consume based in part on their housing wealth. Economists have known this for probably 100 years. If they lose $6 trillion in housing bubble wealth, then we should expect annual consumption to fall by between $300 billion to $400 billion.”
So the wealth destruction, and it’s impact on GDP, is clearly worse than you expected. So I stand by my point the real world needing to be worse than your previous forecast for you to have been correct.
In August 2002 the Case-Shiller 20 City HPI was at around 131.22, which means an 11% to 22% drop would have brought it down to 116.79 to 102.35. As of November 2009, it was at 146.28. Is it your contention that without these housing policies, house prices would be 20% to 30% lower? Adjusting for the fact that the impact on GDP was 2 to 5 times as bad as you thought it would be, that number should probably be 30 to 40% in order for your forecasts to be correct.
Is that how far your saying prices would fall without government support? That seems pretty drastic ,especially since in December you wrote that house prices were only 15% above long term trend.
Also, it’s really not much of a forecast if you condition it on things that nobody thinks will happen, especially when you couch it in demands like the policies be removed “simultaneously”.
Sunday ~ February 7th, 2010 at 9:18 am
Dean Baker
Come on, my whole analysis is in real terms. If you adjust the Case-Shiller data for inflation you get that it is around 7 percent below its 2002 level. So, yes, I expect that a 15-20 percent further decline would take the rest of the air out of the bubble. Could the measures I cited be holding up house prices by this amount? Well the first time buyers’ credit is almost 4 percent of the average house price. I think that this credit together with the extraordinarily low interest rates and the FHA’s huge role can certainly add 15 percent to house prices.
As far as wealth destruction — you’re referring to wealth in the housing sector itself. This certainly explains a sharper downturn that I would have expected if the bubble had collapsed in 2002, but I don’t think that you want to make an argument that house prices are supported by the wealth created in the housing market.
Sunday ~ February 7th, 2010 at 11:03 am
Adam Ozimek
Yes, there is plenty of literature showing that house prices are pro-cyclical with GDP and consumption. So there is a feedback loop where a house price drop that lead to a recession would lead to house prices falling further. Furthermore, the higher the bubble goes, the more excess stock of housing will get built, and so the lower the equilibrium price when then bubble pops. And the larger the rise and fall the worse the impact on consumer credit will be, which will also drive prices down. All these things which are worse than you thought are pushing prices down, and should, ceteris paribus, push them well below your forecast. Taking the policies you mention into consideration, this doesn’t mean prices would necessarily be lower than you forecast but these things are certainly counteracting those policies impact on prices to some extent.
In either case, even if you believe that house prices will continue falling enough to make your forecast correct, house prices have not yet fallen enough to make your forecast correct. Meaning the bubble you “identified” in 2002 has yet to materialize.
Saturday ~ February 6th, 2010 at 6:51 pm
the economic fractalist
The Economic Fractal’s Second Modest Proposal: The IRDC US Political Party
The IRDC Super Party: The Independent Republican Democrat Centrist Super Party
The global monetary-banking-financial system that forms the basis for possibilities of reasonably fair and socially beneficial economic growth is …. simply … broken.
The self designated defacto fixers of that broken system are in fact both the principal causal elements of the broken system and the members and beneficiaries of the current broken system.
With the old system’s failed and bad rules enforced by its current principal beneficiaries, the broken system will never be fixed.
There will only be more disproportional rewards for the owner of the broken system: the self acknowledged too big to fail financial industry.
Kindly consider this. The rewards and benefits of the members of the financial cartel are in reality much greater than the often quoted nominal 2009 over 2007 gains. That 2009 purchasing power of the cartel’s members’ earnings is denominated in surviving dollars in an environment of a 20 percent reduction in US citizen net household wealth over the last 30 months and a 5-6 percent increase in unemployment that reduces the demand side cost of wages. Real estate can now be purchased for both 15 percent less and with lower interest rates.
(The leveraged damage done to US citizens are relatively greater than other world citizens and their fiat currencies… any questions regarding a rising dollar relative to other fiat currencies?)
Those 2009 dollars earned, but for congressional intervention and tax-payer re bankrolling, by a bankrupted financial industry, can now buy 20 percent more than in 2007 more and likely 30-40 percent more later in 2010.
The Financial Industry members have made out like the bandits they are.
Cicero two millennium later speaks: Res ipse loquitor….
What would be a sine qua non metric target for a successful stable fair real economy? One possibility would be a working citizen benefited monetary financial system where, for example, graduates going into an engineering careers or teaching careers earn more than graduates going into the financial industry.
With the owners of the monetary system firmly in control of congress, is there any possible hope for remedy?
Perhaps.
Perhaps it is time for the establishment of a coalition super party – the IRDC party.
The IRDC party, the Independent Republican Democrat Centrist party (the C could also represent Constitutionalists) likely already includes the philosophical, if not the I want to be re-elected – majority of US congress people.
The Centrist IRDC platform is simple. Create a fair economic system that values hard work and economic creation of useful real goods and services and conversely implements effective new rules which restricts private citizen or corporate wealth creation from manipulation of the monetary system.
Politicians could run either as an IRDC candidate, an independent, a republican, or a democrat supporting the centrist principal platform of restoring real fairness and worth to the economic system. After successful election republicans, democrats and independents who ran on their respective republican, democrat, and independent tickets and who supported the IRDC platform could then join a majority IRDC caucus and be a member of a majority party entitled to chairmanship of key committees.
Think about it. The IRDC Super Party – a great reckoning for Wall Street and the Wall Street run world.
The establishment of a Super Party Constitutional and Centrist majority offers the chance to begin anew with new rules and underlying new principles to engender fairness and a rationale allocation of wealth for the 21st century. (A drop in the bucket of time but so good for the world’s grand children.)
Saturday ~ February 6th, 2010 at 7:35 pm
Greg Ransom
Read William White’s BIS reports beginning in 2003 — White is the central bank economist who “saw the future”. All the rest are just pretenders.
Thursday ~ April 8th, 2010 at 3:26 pm
Thomas
Read Baker’s paper. Sure sounds like he called the bubble to me. Qualitatively, he nailed it.
I just bought a house so I wish he were wrong, but after the government incentives are gone and interest rates go up we will see significant drops in prices, likely below 2002 levels.
Sunday ~ December 19th, 2010 at 2:18 pm
Svetaprettygirl
Please! Leave more information and more links about next themes:
1. britney spears boyfriend adnan
2. dating rendez vous
3. meet new people play the dating game online
4. bangladeshi dating
5. dating perfect match