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Wednesday, November 09, 2005

Bernanke and the Housing Bubble

by Calculated Risk on 11/09/2005 08:51:00 PM

The Center for Economic and Policy Research released a new report today: "Will a Bursting Bubble Trouble Bernanke? The Evidence for a Housing Bubble". Dean Baker and David Rosnick conclude:

This paper has briefly examined three trends that strongly support the view that the recent run-up in house prices is driven by a speculative bubble, rather than fundamentals. First, it notes the unusual gap between the run-up in home sale prices and rents at both the national level and in many of the most inflated metropolitan markets. .... When such gaps have developed in the past, they usually have been followed by sharp declines in house sale prices.

The second factor suggesting that the current run-up reflects a bubble is the extraordinary pace of home construction in recent years. ... This pace of construction substantially exceeds that rate of new household formation. It is also worth noting that virtually no economists projected a sharp price in home construction in the mid-nineties, so most of the economists who expect the current pace of housing construction to persist, badly erred in their projections for housing construction in the past.

Finally, the wealth effect resulting from the recent run-up in house prices has led to a sharp decline in the savings rate. In recent months, the savings rate has turned negative. If construction continues at its recent pace and real house prices stay at current levels, then the savings rate will become even more sharply negative over the next decade.
...
It is not plausible that an economy will sustain a negative savings rate for any substantial period of time. This would imply that households’ non-housing wealth is continually declining. The more likely scenario is that housing prices will fall back in line with their historic values.
...
The costs of a collapse of the housing bubble will be even greater than the costs of the collapse of the stock bubble, because housing wealth is much more evenly held. The failure of the economics profession to adequately warn of the stock bubble was an act of extraordinary negligence. Missing the housing bubble is an even bigger mistake.