May 01, 2014
That sounds pretty scary since the last time we had one it cost us almost 9 million jobs, wiped out the wealth of a large portion of the middle class, and led to a recession from which we still have not recovered almost seven years later. Thankfully Samuelson doesn’t have much of a case.
First off, the last bust was so severe because we had a serious housing bubble that was driving the economy. House prices were more than 70 percent above their trend level creating more than $8 trillion in bubble generated housing equity. The record high prices led to a construction boom, with residential construction reaching a record high share of GDP. In addition, the wealth effect from the bubble equity led to a record high share of consumption in GDP as the saving rate fell to near zero.
When the bubble burst construction fell from record highs to record lows. The boom led to enormous overbuilding and the vacancy rate reached new records. At the same time, consumption fell sharply as the housing wealth that had been driving it disappeared. This was the basis for the recession and seven years later we still do not have any source of demand that can replace the demand generated by the housing bubble.
Now Samuelson warns us of another housing bust. Really?
Samuelson doesn’t even argue that housing construction will fall from its level of 2013, which at 920,000 was less than half of the bubble peak. He doesn’t say prices will fall at all. (They’re currently around 10 percent above trend levels.) Where’s the bust?
The story, insofar as there is one, is that housing will not be driving the economy in 2014. It’s not clear why anyone would have expected it to be driving the economy. Existing home sales in 2013 were at or somewhat above trend levels. In the mid-1990s, before the bubble started driving the market, existing home sales averaged around 3.5 million a year. If this is adjusted upward by 20 percent for population growth in the last two decades we get 4.2 million, a rate that is substantially below the recent pace.
This simple arithmetic makes far more sense than Samuelson’s explanation that prices are too low for sellers but too high for buyers. In other words, we are seeing roughly the amount of home sales that we should expect to see in a normal economy.
Housing construction is still somewhat below normal levels but this is easily explained by the fact that vacancy rates are still extraordinarily high, although down from the recession peaks. Furthermore, the new normal is likely lower than the old normal for simple demographic reasons. With the baby boomers in their 50s and 60s, they are likely to be moving down the ladder in terms of house size rather than up.
The share of health care spending in GDP is about 6 percentage points higher than it was two decades ago. That has to come from somewhere. In other words, housing is likely to be a somewhat smaller share of the economy going forward than it was even before the bubble.
So the only surprise here is that anyone could have expected housing to play a large role in the recovery in 2014. Any serious analysis of the data would not lead to this conclusion.
Comments