Counterpunch March 9, 2010
The Rise and Demise of the Housing Bubble
Stop Calling It a Financial Crisis
By DEAN BAKER
The politicians and the media continue to refer to the economic
downturn as being the result of a financial crisis. This is wrong.
We have 15 million people out of work because the housing bubble
that drove the economy since the last recession finally burst. The
financial crisis may have been good entertainment for those who
like to see huge banks collapse, but it was a sidebar. The real
story was the rise and demise of the housing bubble.
Those who claim that the real problem was the financial system and
its faulty regulation can be disproved with a single word:
“Spain.” Spain is noteworthy because it now has an unemployment
rate of more than 19 percent, the highest rate in any of the
wealthy countries. Spain did not have a financial crisis. In fact,
its well-regulated financial system is often held up as model for
the United States.
Spain did have a horrific housing bubble. As a result, the share
of construction in the economy rose from less than 8.0 percent of
GDP at the end of the 90s to 12.3 percent in 2007. By comparison,
it is typically less than 6.0 percent of GDP in non-bubble years
in the United States. This rapid rate of construction led to
enormous overbuilding, which meant that a collapse was inevitable
with construction falling to far below normal levels.
The run-up in house prices also had the predictable effect on
consumption. Because people believe that the run-up in house
prices is based on fundamentals, homeowners assume that their
newly created housing wealth is real and they spend accordingly.
Spain’s saving rate fell from just under 6.0 percent in 2000 to
3.0 percent in 2007. When the housing wealth created by the bubble
disappeared people naturally cut back their consumption.
This is Spain’s crisis. According to the IMF, housing starts in
Spain fell by 80 percent from the peak of the boom. While total
construction has not fallen as much (repairs and non-residential
construction did not decline nearly as much), if construction in
Spain fell by 50 percent, this would imply a loss in annual demand
of more than 6 percent of GDP. That would translate into a drop in
demand of more than $800 billion in the United States.
Similarly the loss of housing wealth reverses the housing wealth
effect. If consumption fell enough to return the savings rate to
its pre-bubble level, then this would imply a loss in annual
consumption demand of more than 3 percentage points of disposable
income. In the U.S. this would amount to more than $300 billion in
lost annual consumption.
There is no easy mechanism to replace more than $1 trillion in
lost demand. This is why Spain’s economy is in a severe slump
right now. Note that just about all analysts agree, Spain’s
financial system was well regulated and it had none of the loony
loans and outright corruption that pervades Wall Street and the
U.S. financial system. Yet, it is suffering from this economic
downturn even more than the United States.
The moral of this story is that the problem is not first and
foremost a financial crisis. It might be fun to watch the Wall
Street and government boys sweat as they stay up late trying to
keep the big banks from drowning in the cesspools they created.
But this is all a sideshow. No one saved us from a “second Great
Depression,” they just saved the jobs and wealth of the Wall
Street crew.
The economy’s real problem is simply the loss of demand created by
collapse of the bubble. Throwing even more money at the banks is a
way to ensure that they don’t suffer from the consequence of their
own greed and stupidity. It is not a way to restore the economy to
health.
Restoring the economy to health is about finding a replacement for
the demand lost as a result of the collapse of the bubble. In the
short-term, this means increased government spending and tax cuts.
Deficits put money in the economy, and using the old-fashioned
view that people work for money, we can determine how much money
we need to spend for the government to get the economy back
towards full employment levels of output.
In the longer term, we need to move towards more balanced trade,
with higher exports and fewer imports making up for the demand
lost due to collapse of the housing bubble. This will require a
lower-valued dollar – everything else in the trade picture is just
for show.
We do need financial reform. We have an incredibly wasteful and
reckless financial industry. But bad financial regulation by
itself did not give us 10 percent unemployment, nor would good
regulation have been sufficient to prevent it. Just ask the
workers in Spain.
Dean Baker is the co-director of the Center for Economic and
Policy Research (CEPR). He is the author of Plunder and Blunder:
The Rise and Fall of the Bubble Economy and False Profits:
Recoverying From the Bubble Economy.
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