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July 27, 2005

Worrying About the Housing Bubble

Dean Baker is more than worried about the housing bubble:

CEPR Press Release (07/07/05): The ABC of the Housing Bubble: The “Housing Bubble Fact Sheet” provides an overview of the housing market and its implications for the economy:

  1. Over 2 million housing units are being built annually, while the number of households is only growing by 1.4 million a year.
  2. Some regions of the U.S. have experienced a 60 percent increase in real home prices, while the average for the country as a whole is 45 percent. Historically, real home prices have not increased... house prices have just kept pace with the overall rate of inflation.
  3. The collapse of the housing bubble will have a larger impact than the collapse of the stock bubble, since housing wealth is far more evenly distributed than stock wealth.
  4. The collapse of the housing bubble will likely throw the economy into a recession and require a federal bailout of the mortgage market. It could lead to a loss of 3.6 to 4.5 percentage points of GDP.
  5. Given how far out of line house prices have grown from fundamentals, there is no way to avoid enormous economic damage when the bubble collapses. However, the sooner house prices drop, the less damage there will be.

I can see three scenarios for getting out of things without serious damage:

  1. Interest rates stay low for a long time, so the bubblyness of the housing market deflates gradually.
  2. The housing market collapses, but the dollar collapses too. If the Federal Reserve then follows an accomodative monetary policy, workers who lose jobs in construction and consumer services will be able to move relatively smoothly into jobs making goods for export.
  3. The housing market deflates at the same time that businesses' animal spirits recover, and so workers who lose jobs in construction and consumer services will be able to move relatively smoothly into jobs making and installing capital goods.

Posted by DeLong at July 27, 2005 10:40 AM