November 05, 2010
That seems to be the argument in a Washington Post column by David M. Smirk. I’m not kidding, here is the essence of the argument laid out in the 3rd and 4th paragraph of the piece:
“A more compelling theory [than inadequate stimulus] is that global assets remain overvalued. Specifically, the price of real estate debt and sovereign debt on bank balance sheets, propped up by government actions, remains too high. The economy can’t gain traction until these prices reflect realistic valuations.
Asset prices are important because America has never had a recovery without residential housing leading the way. Real estate values are still high by historic standards. The value of all real estate is roughly $18 trillion, with mortgage debt about $10 trillion. The ratio of mortgage debt to GDP value is 56 percent. In the 1960s and 1970s, the ratio was 29 percent. In the late 1990s it was only 38 percent.”
Smirk is right that real estate is still over-valued, but it is hard to understand how a decline in real estate prices will boost the economy. What matters for a residential housing lead recovery is the need for residential housing. This results from excess demand for housing. We have record levels of vacant housing in the country right now. We will have to see quite a drop in housing prices in order to fully absorb the existing supply.
This gets back to the mortgage debt part of the story which has nothing to do with current real estate values, but rather with their past values. Of course the mortgage debt to GDP ratio is too high, that is what happens when you have a housing bubble. People borrow against inflated housing values. Unfortunately, the Washington Post did not have room for columns from people making this point in the years from 2002-2006 when the housing bubble was growing.
It is not clear how Smirk thinks that a drop in housing prices helps this picture. This will worsen the debt burden of homeowners, leaving them with less wealth thereby further reducing consumption. The decline in house prices must happen (we can’t sustain bubble-inflated prices indefinitely), but it makes the immediate economic situation worse, not better.
In the real world, this recovery cannot be led by housing construction because this is not the traditional sort of recession. The normal recession comes about because the Fed raises interest rates to slow the economy. This leads to a plunge in housing construction creating pent-up demand. When the Fed decides to take its foot off the brakes and get the economy going again it just lowers interest rates, triggers the pent-up demand for housing and the economy takes off.
This recession was the result of the collapse of a housing bubble which led to a huge excess supply of housing. Interest rates are also just about as low as they can possibly be, taking away the option of further declines by simple Fed actions.
Apparently Smirk and the Post failed to notice the difference between this recession and prior downturns. Therefore we get this attack on Obama and Paul Krugman that is incoherent in just about every way.
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