Remember the stock market bubble? With everything that's happened since
2000, it feels like ancient history. But a few pessimists, notably Stephen
Roach of Morgan Stanley, argue that we have not yet paid the price for our
past excesses.
I've never fully accepted that view. But looking at the housing market, I'm
starting to reconsider.
In July 2001, Paul McCulley, an economist at Pimco, the giant bond fund,
predicted that the Federal Reserve would simply replace one bubble with
another. "There is room," he wrote, "for the Fed to create a bubble in housing
prices, if necessary, to sustain American hedonism. And I think the Fed has
the will to do so, even though political correctness would demand that Mr.
Greenspan deny any such thing."
As Mr. McCulley predicted, interest rate cuts led to soaring home prices,
which led in turn not just to a construction boom but to high consumer
spending, because homeowners used mortgage refinancing to go deeper into debt.
All of this created jobs to make up for those lost when the stock bubble
burst.
Now the question is what can replace the housing bubble.
Nobody thought the economy could rely forever on home buying and
refinancing. But the hope was that by the time the housing boom petered out,
it would no longer be needed.
But although the housing boom has lasted longer than anyone could have
imagined, the economy would still be in big trouble if it came to an end. That
is, if the hectic pace of home construction were to cool, and consumers were
to stop borrowing against their houses, the economy would slow down sharply.
If housing prices actually started falling, we'd be looking at a very nasty
scene, in which both construction and consumer spending would plunge, pushing
the economy right back into recession.
That's why it's so ominous to see signs that America's housing market, like
the stock market at the end of the last decade, is approaching the final,
feverish stages of a speculative bubble.
Some analysts still insist that housing prices aren't out of line. But
someone will always come up with reasons why seemingly absurd asset prices
make sense. Remember "Dow 36,000"? Robert Shiller, who argued against such
rationalizations and correctly called the stock bubble in his book "Irrational
Exuberance," has added an ominous analysis of the housing market to the new
edition, and says the housing bubble "may be the biggest bubble in U.S.
history"
In parts of the country there's a speculative fever among people who
shouldn't be speculators that seems all too familiar from past bubbles - the
shoeshine boys with stock tips in the 1920's, the beer-and-pizza joints
showing CNBC, not ESPN, on their TV sets in the 1990's.
Even Alan Greenspan now admits that we have "characteristics of bubbles" in
the housing market, but only "in certain areas." And it's true that the
craziest scenes are concentrated in a few regions, like coastal Florida and
California.
But these aren't tiny regions; they're big and wealthy, so that the
national housing market as a whole looks pretty bubbly. Many home purchases
are speculative; the National Association of Realtors estimates that 23
percent of the homes sold last year were bought for investment, not to live
in. According to Business Week, 31 percent of new mortgages are interest only,
a sign that people are stretching to their financial limits.
The important point to remember is that the bursting of the stock market
bubble hurt lots of people - not just those who bought stocks near their peak.
By the summer of 2003, private-sector employment was three million below its
2001 peak. And the job losses would have been much worse if the stock bubble
hadn't been quickly replaced with a housing bubble.
So what happens if the housing bubble bursts? It will be the same thing all
over again, unless the Fed can find something to take its place. And it's hard
to imagine what that might be. After all, the Fed's ability to manage the
economy mainly comes from its ability to create booms and busts in the housing
market. If housing enters a post-bubble slump, what's left?
Mr. Roach believes that the Fed's apparent success after 2001 was an
illusion, that it simply piled up trouble for the future. I hope he's wrong.
But the Fed does seem to be running out of bubbles.
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