Two economists published an op-ed in today’s Wall Street Journal, “From Bubble to Depression?” that is interesting because it purports to explain why the housing crash wrecked the U.S. economy whereas the dotcom crash did not. One interesting portion of the article recalculates the U.S. inflation rate during the housing bubble, using actual costs for purchasing real estate rather than “owners’ equivalent rent”, a fictional concept introduced by government bureaucrats trying to keep the published CPI low. Inflation calculated using the costs that buyers faced would have been 6.2% instead of the published 3.3% for 2004. The authors point out that consumer interest rates were about 6% and inflation was about 6%, which made money free for consumers and they borrowed.
What solutions do these megabrains of Economics (one of whom has a Nobel in Economics) offer for our current mess? None!
I believe the (oversimplified) difference here (from just another dumb engineer’s perspective) is that most of the dotcom bubble was inflated market capitalization of the (ir)relevant companies, causing an excess of people entering the field, getting jobs, getting high pay, etc. – all soft things.
However, the housing market caused money to be spent building more houses, and more house, than economic growth could pay for – i.e. the first is a surplus that is fungible – people can find new jobs, put the life experiences to work, even if they’re serving fries. However, houses, neighborhoods, roads, storm systems, etc. are all hard objects – once built they are sunk costs.
There is no quick recovery of sunk costs – excess houses, or even excess house (that is one priced higher than you can pay) are going to sit empty, until someone sucks up the loss and puts the hard asset back to work, or it rots in place.
The fix is stabilizing the economic situation, with stable interest rates and stable tax rates, and predictable political activity, and letting the market work its magic of optimization over the necessary variable of time.
This doesn’t make the political class look good in the shower though, nor gain them campaign dollars, so good luck with that.
I posed this comment on Prof. Jim Hamilton’s blog on the OER:
“I have absolutely no economic background — so I have to ask this question. Since rent is used as a proxy for shelter cost in calculating inflation, and given that there is a lag between housing prices and rent and given that in any feedback system, delay is critical in terms of whether the feedback is opposing instead of reinforcing — has that been taken into account in choosing rent as a proxy? Wouldn’t it be better to also include the cost of buying in some form to reflect the degree of inflation faster?”
And Prof JDH replied:
“The thing that makes home prices difficult to put into the CPI directly is the fact that, when the price of a home goes up, that represents a capital gain for the homeowner. Other things being equal, when you’re earning a capital gain just by living in your home, it means that the cost of living in that home is cheaper, not more expensive. The correct economic concept would be the user cost, which subtracts capital gains but adds in your interest and other expenses. In equilibrium, rent should correspond to user cost, but in practice, OER can be a pretty imperfect measure. The issue is that nobody has come up with a better way to do it.”
http://www.econbrowser.com/archives/2007/03/about_that_down.html
Thrill-
You got it!
Nobody wants to take (or even hear about) the solution that is most likely to put us on the road to prosperity. As you suggest, it is slow, painful, and so simple that nobody can possibly take credit for the “brilliant plan.” Everyone wants snake oil.
The fact that Summers is in and Volcker is out is symbolic of where we stand.