I was listening to a BBC radio news show this morning in which they proclaimed today as the 10th anniversary of the beginning of the financial crisis based on the date in 2007 when the French bank BNP Paribas first blocked withdrawals from hedge funds that specialized in U.S. mortgage debt. The show then said that following this move house prices began dropping.

Really, folks? House prices began falling after this date? That's not what the data show.

At the most aggregate level, the Case-Shiller national index for the U.S. was already down 3.4 percent from its peak in 2006 by August of 2007, but there was enormous dispersion around this figure. House prices in Phoenix had fallen by almost 10.0 percent from their peak the prior year. Prices were down 7 percent in Los Angeles, 11 percent in San Diego, and 10 percent in Washington. And the momentum was clearly downward, with prices in many of these cities falling at the rate of more than 1.0 percent a month.

But wait, it gets better. If we turn to Case Shiller tiered indexes, we find that prices for homes in the bottom third of the San Diego had fallen by more than 13 percent, in San Francisco they were down 12 percent, and in Seattle, they were down 10 percent. 

In short, prices had already fallen sharply in many areas and there was every reason to think they would drop further. This is before we got to the official beginning of the financial crisis.

This is not a trivial point. The reversal of ordering matters because the key problem was an over-valued housing market. All of the fraudulent mortgages and exotic financing would not have given us a worldwide financial crisis if they had not been based on a hugely over-valued housing market. The key problem was the bubble. If we don't recognize this fact, then we have learned nothing.


As I have argued elsewhere, it is convenient for economists to blame the financial crisis rather than the bubble, because finance can be complicated. After all, who knew that AIG had written $600 billion worth of credit default swaps on mortgage backed securities?

On the other hand, the bubble was pretty simple. We had an unprecedented nationwide run-up in house prices with no plausible explanation in the fundamentals of the housing market. Rents were going nowhere and vacancy rates were already at record highs before the crash. And the bubble was clearly driving the economy. Residential construction was at a record high as a share of GDP and consumption boomed based on the bubble generated housing wealth. When the bubble burst, there was no source of demand that could replace the lost construction and consumption, which is the story of the Great Recession.

Anyhow, the rewriting of history is not encouraging for our ability to prevent another crisis. At the moment, there are no bubbles driving the economy. But the world's economists have taken advantage of this rewrite of history so that they are not even looking in the right direction.

The recent run-up in the stock market and the rise of house prices to high although generally not bubble levels have led to a surge in consumption with savings rates again at unusually low levels. If the stock market were to suddenly fall by 10 to 20 percent (certainly a possible scenario) and house prices were to fall back by 10 to 20 percent in the most over-valued markets, we would see a serious hit to growth, although not necessarily a recession and certainly nothing like what we saw in 2008–2009.

But this set of events would likely catch most of the economic establishment by surprise because they are not looking for bubbles: they only care about banks' balance sheets. No, we have not learned the lessons from the housing bubble.