Housing Bubble - More Graphics

In yesterday's post, commenters Foxfier and Hal (GT) requested a graph of housing prices vs. inflation. Couldn't find that, but jparsons.net provides pictures of the housing bubble in inflation adjusted terms.



Note that there has been a long term trend where housing prices have outstripped general inflation. Why this is so, I don't know. But we can see from the graph above that this bubble still has not deflated to the long term trend. If you think that the long term trend is also an aberration caused by years of government tax and other policies that have subsidized housing, there may still be a further drop.

One more graph that I believe to be more relevant, housing prices vs. rental equivalent. The reason it is more relevant is that the rental market is a substitute good to the good of home ownership. It is irrational to believe that they will diverge in the long term.

Note the divergence really gets rolling at the end of the Clinton era when we have Fannie Mae pushing loans to everyone, regardless of qualification.

Housing Bubble Still Not Deflating

Today's WSJ headlines shows that housing prices are still declining. This is actually a good thing, but should have happened sooner. The sooner we get to market clearing prices, the sooner the whole of the U.S. economy will recover. I will repeat myself.

When the housing bubble deflates or any other asset bubble, buyers move into the market to snap up bargains. In housing and in many other areas, that initial investment is followed by renovation and restoration, causing an uptick in economic activity. This is why I have repeatedly said that the official policy of the government should be to let housing prices fall to free market levels. Through its various attempts to prop up the market, including the failed HAMP program, they have damaged the economy by delaying the deployment of fresh capital into the market.

And I also repeat this graphic to show the futility of propping up the housing market.

Economy Gaining Speed - Unemployment Up

Or so says the Reuters headline. I know everyone is on the Egypt situation 24/7, but with unemployment again rising, despite economic output increasing, I want to keep the focus on the economy. Unemployment is again at 9.8%. The Administration itself has never addressed the unemployment issue other than to make things worse through deficit spending. Meanwhile, Paul Krugman continues to call for deficit spending and loose money.

Krugman also takes conservatives and Paul Ryan to task for misreading the situation in England and Ireland.

On the eve of the financial crisis, conservatives had nothing but praise for Ireland, a low-tax, low-spending country by European standards. The Heritage Foundation’s Index of Economic Freedom ranked it above every other Western nation. In 2006, George Osborne, now Britain’s chancellor of the Exchequer, declared Ireland “a shining example of the art of the possible in long-term economic policy making.” And the truth was that in 2006-2007 Ireland was running a budget surplus, and had one of the lowest debt levels in the advanced world.

Krugman is in fact correct. Here is what Paul Ryan had said:

Just take a look at what's happening to Greece, Ireland, the United Kingdom and other nations in Europe. They didn't act soon enough; and now their governments have been forced to impose painful austerity measures: large benefit cuts to seniors and huge tax increases on everybody.

Krugman lays the blame on Irish banks.

So what went wrong? The answer is: out-of-control banks; Irish banks ran wild during the good years, creating a huge property bubble. When the bubble burst, revenue collapsed, causing the deficit to surge, while public debt exploded because the government ended up taking over bank debts. And harsh spending cuts, while they have led to huge job losses, have failed to restore confidence.

I agree that the Irish went through a property bubble that collapsed. But he fails to account for the government policy that was significantly to blame. At exactly the wrong moment, the government stepped in to save the banks by guaranteeing bank deposits. From a U.K. Telegraph article in September 2008:

Ireland's government said it will guarantee Irish banks' deposits and debts for two years, seeking to calm investor concern after banking shares fell 26pc in Dublin.

The government said it will safeguard all deposits at six financial institutions in response to turmoil in financial markets.

Predictably the bad debts of the banks were offloaded on to the Irish government, wrecking its finances.

So the real lesson is that the government needs to distance itself from guarantees to banks and exposing itself to the risk in property bubbles. Time to unwind and privatize Fannie Mae, whose purpose was to lift home ownership to above market percentages. Property bubbles driven by bad government policy seem to be at the root of both Irish and U.S. economic hard times.