May 05, 2014
Robert Samuelson actually has a lot of sensible things to say about bubbles in his column today, until we get near the end:
“it was not simply the bursting of the housing bubble that created the Great Recession. Consider the contrast between the 1990s’ tech-stock bubble and the housing bubble. Both inflicted multitrillion-dollar losses. Yet the first caused only a mild recession while the second plunged the economy into a deep and stubborn slump. Why?
“The difference is this: The housing bubble spawned a broader financial panic; the tech bubble didn’t. No one knew which banks held “toxic” mortgage securities and which didn’t. Large deposits fled banks, which in turn reduced lending (banks’ loans fell nearly $600 billion in 2009). Borrowers cut their expenses. Firms laid off workers; consumers curbed spending. It was the panic that did the most damage.”
No, it actually was the collapse of the housing bubble that caused the Great Recession. First Samuelson is badly mistaken about the “mild” recession that followed the collapse of the stock bubble. While the official recession was short and mild, the economy did not begin to create jobs again until the fall of 2003 almost two years after the end of the recession. And, it didn’t get back the jobs lost in the downturn until January of 2005, at the time the longest period without job growth since the Great Depression. And even then the growth was only coming on the back of the housing bubble.
But, contrary to Samuelson, the real difference between the two bubbles was simply that the housing bubble was more important in driving the economy than the stock bubble. It led housing to rise to 6.5 percentage points of GDP, more than two percentage points above its long-term average. When the bubble burst, the overbuilding caused housing construction to collapse to 2.0 percent of GDP, creating a gap in demand of 4.5 percentage points (@ $770 billion a year in today’s economy).
On top of that, the housing wealth effect is stronger than the stock wealth effect since housing wealth is more evenly distributed. As a result, there was an even bigger consumption boom in 2004-2007 than in 1999-2000. At the peak of the stock bubble the savings rate fell to just over 4.0 percent of disposable income. It fell to less than 3.0 percent of disposable income at the peak of the housing bubble. (The decline in the savings rate was in fact likely even larger than the official data indicate because of a measurement problem. Measured disposable income rose sharply relative to GDP in these bubbles, possibly because capital gain income was wrongly being recorded as normal income.)
The loss of this bubble driven consumption also created a gap in demand. Throw in the loss of demand from the collapse of a bubble in non-residential real estate and we are looking at a shortfall in demand of more than 8 percent of GDP (@ $1.4 trillion in annual demand in today’s economy). The financial stuff was a lot of fun, but really beside the point. What did Samuelson think would replace this lost demand, Jeff Bezos newspaper purchases?
There was no mechanism in the economy that would allow it to replace this demand. The collapse of the housing bubble pretty much guaranteed a prolonged and severe downturn barring a vigorous policy response.
Note: Typos corrected.
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