Heather Long had a column in the Washington Post telling us that "it feels like 2006." As someone who did his best to warn of impending disaster in 2006, I can say that it doesn't look at all like 2006. It is frustrating, but perhaps not surprising, that the economics profession and economic reporters have done their best to learn absolutely nothing about their enormous mistakes at that time. (Fortunately for them, economics is not an area where people are held accountable for the quality of their work, so this failure cost almost no one their job or even led them to miss a scheduled promotion.)
The basic story of real world 2006 was that the impending disaster was not hidden. It did not require some super-sleuth to figure out what was wrong. It required access to widely available government data and knowledge of third-grade arithmetic.
We had an unprecedented run-up in nationwide house prices. The national average had risen by more 70 percent since 1996, after adjusting for inflation. This followed a century in which house prices had just moved in step with inflation. And, this was a nationwide story. It was not just a few hot housing markets on the coasts, prices were soaring in Chicago, Minneapolis, and even Detroit.
Furthermore, this run-up was clearly not connected with the fundamentals of the market. Unlike the last five years, nothing was going on with rents. They were just rising in step with the overall rate of inflation. Furthermore, we already were seeing record vacancy rates even before the collapse of the market. In short, we had a gigantic neon sign hanging over the housing market saying "bubble."
I should also add that the bad loans fueling the bubble were hardly a secret either. The National Association of Realtors reported that more than 40 percent of first-time homebuyers put down zero or less (they borrowed to cover closing or moving costs) on their homes in 2005. And, there was widespread talk of "NINJA" loans, which stood for no income, no assets, no job.
And, the housing bubble was clearly moving the economy. The wealth effect from an $8 trillion run-up in house prices led to a huge consumption boom. The savings rate fell to a record low. In addition, there was a construction boom which raised the housing share of GDP to 6.5 percent at its peak in 2005. This compares to a more normal share in the range of 4.0 percent.
It was a hundred percent predictable that the collapse of the bubble would destroy trillions of dollars of housing wealth, leading to a reverse of the wealth effect. Contrary to what was often claimed at the time, there was no surprise that consumption was weak in 2009–2012 compared to the bubble years, it would have been surprising if it were not.
And, it was virtually certain that construction would fall well below its normal level as a result of the massive overbuilding of the bubble years. In fact, it fell to less than 2.0 percent of GDP at the trough in 2009.
The combined drop in consumption and housing construction led to a loss of annual demand equal to more than 6.0 percentage points of GDP, more than $1.2 trillion in today's economy. There was no excuse for a macroeconomist or someone writing on the economy to have missed this looming disaster.
By the way, while the financial crisis was lots of fun, it was a sidebar. By 2010 and certainly 2011, the financial system was pretty much back to normal. The economy was still far from healed because we did not have a source of demand to replace the demand generated by the housing bubble. Focusing on the financial crisis is a way to confuse the issue. Yes, I was not aware that AIG had issued $600 billion in credit default swaps on mortgage-backed securities. But the tale of the collapse of the housing bubble and the Great Recession would have been little different without this ungodly act of stupidity.
So what makes Long think 2018 is like 2006? She tells us that David Rubenstein, co-founder of the Carlyle Group, Harvard economist Kenneth Rogoff, and Citigroup chief executive Michael Corbatt are worried. While Rogoff did raise some warnings back in 2006, if the other two were troubled at the time, they only shared their concerns with their clients.
Let's look at the list.
Item number one is North Korea. The prospect of war with two less than stable heads of government controlling nuclear weapons is certainly a serious concern. Although, it's not clear that it has much to do with the collapsing housing bubble.
The second concern is China. Long mentions both the possibility of a trade war and a credit collapse in China. A trade war could be a modest negative on growth. We would pay more for imports. However, this is not Great Recession or any recession stuff. In fact, it is entirely possible that an improvement in our trade balance with China could add to growth, if not counteracted by higher interest rates from the Fed.
China experts have been warning about a credit collapse in China for more than two decades. As a non-China expert, I would say that its capacity to paper over credit problems is, if not infinite, is very far from reaching its limits. The debt is mostly in Chinese currency, which is of course printed by China. The country continues to run a large trade surplus and has massive amounts of accumulated reserves.
The next item is the Fed. We are warned that it could raise interest rates more rapidly than is expected. This would indeed slow growth, but not lead to an economic collapse. Rogoff is brought in to warn that higher rates would collapse the stock market.
Higher rates would, in fact, be a hit to the stock market, but so what? Unlike the bubble years of the late 1990s, few companies are using stock sales to finance investment. The hit to the economy would be through consumption. Suppose consumption falls back by two percentage points of GDP (a very large drop) over a 2–3 year period. This is a serious drag on growth, but again not a recession. And, this assumes no offsetting policy, like lower interest rates from the Fed.
Next up is a bursting tech bubble. This is a real concern. Companies like Uber, which have never made money, have market caps of more than $50 billion. And Amazon, which just scrapes into profit-making territory, has a market cap of almost $700 billion. If investors get the idea that profits matter more than the lofty rhetoric from the CEOs, the shares of these and other high-flying tech companies could take a bath.
That won't sink the national economy, but Silicon Valley and Seattle would look very different after this sort of correction. At least housing will be much more affordable.
The next item is "the bottom 60 to 80 percent go bust." It is not clear what is meant here. Most people have not been doing well for the last four decades, but things are actually getting somewhat better for the bottom 60 to 80 percent in the last few years. The labor market has tightened and real wages are moving up, at least modestly.
Long does raise political concerns over rising populist sentiments. These are appropriate since many people are tired of policies designed to redistribute income upward. But it's hard to see how this makes the world look like 2006. It looks more like 1980–2018, the period in which the government has been working to make the rich richer.
The last item is the failure by the US government to invest in the future. Long talks about the failure to invest in infrastructure, education and other areas that are important for future prosperity (e.g. combating global warming). The concerns are real and serious, but also are longstanding and not related in any obvious way to 2006.
In short, the economy has many very real and pressing problems, but we are not facing the imminent collapse of a bubble as we did in 2006. This is not a helpful way to frame the issues.