Dean Baker: The Housing Bubble Pops

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from The Nation:


The Housing Bubble Pops
Dean Baker


The housing market is in its worst downturn since the Great Depression--and it's taking the rest of the economy down with it. Most forecasters insist there won't be a recession, although the August job losses forced even optimists to acknowledge that the meltdown is causing serious economic problems. (When it comes to recessions, the professionals seem to be the last to find out: On the eve of the last downturn, in the fall of 2000, all the Blue Chip 50 forecasters predicted solid growth for the following year.)

The downturn should not have been a surprise. House prices rose at an unprecedented rate over the past dozen years. For a hundred years, from 1895 to 1995, house prices nationwide increased at the same pace as the overall inflation rate. Since 1995 inflation-adjusted house prices have risen by more than 70 percent. It should have been clear to economists that this run-up was being driven by a speculative bubble. There was no change in the fundamentals of supply or demand that could have explained the rise.

Like Japan's in the 1980s, the US housing bubble coincided with its stock bubble. While the two bubbles burst simultaneously in Japan, in the United States the stock collapse actually fueled the growth of the housing bubble. Investors, after losing much of their wealth in the stock crash, viewed housing as safe. The housing bubble in turn fueled the recovery of the US economy from the stock crash recession of 2001.

Soaring home prices pushed construction and home sales to record levels. Even more important, the run-up in home prices created more than $8 trillion in housing bubble wealth. This wealth fueled a consumption boom, as homeowners withdrew equity from their homes almost as it was created. The savings rate plummeted to near zero in 2005 and '06. People used their homes as ATMs, borrowing to take trips, buy cars or just to meet expenses.

This pattern of growth could not be sustained. Record house prices were supported by a tidal wave of speculation, as millions of people suddenly became interested in investment properties. As prices soared, financing arrangements became ever more questionable. Down payments went out of style. Adjustable-rate mortgages and interest-only loans, even negative amortization loans (in which mortgage debt grows month by month), became common. ......(more)

The complete piece is at: http://www.thenation.com/doc/20071001/baker