Dean Baker Blames it on the Bubble
Writing in The Guardian, Dean Baker of the Center for Economic and Policy Research (CEPR), apparently puts the blame for the recession entirely on the housing bubble, and not at all the financial crisis.
Blame it on the bubble: Dean BakerPoliticians and the media continue to refer to the economic downturn as being the result of a financial crisis. This is wrong. We have 15 million people out of work because the housing bubble that drove the economy since the last recession finally burst. The financial crisis may have been good entertainment for those who like to see huge banks collapse, but it was a sidebar. The real story was the rise and demise of the housing bubble.
Those who claim that the real problem was the financial system and its faulty regulation can be disproved with a single word: Spain.
Spain is noteworthy because it now has an unemployment rate of more than 19%, the highest rate in any of the wealthy countries. Spain did not have a financial crisis. In fact, its well-regulated financial system is often held up as model for the United States.
Spain did have a horrific housing bubble. As a result, the share of construction in the economy rose from less than 8% of GDP at the end of the 90s to 12.3% in 2007. By comparison, it is typically less than 6% of GDP in non-bubble years in the United States. This rapid rate of construction led to enormous overbuilding, which meant that a collapse was inevitable with construction falling to far below normal levels.
The run-up in house prices also had the predictable effect on consumption. Because people believe that the run-up in house prices is based on fundamentals, homeowners assume that their newly created housing wealth is real and they spend accordingly. Spain's saving rate fell from just under 6% in 2000 to 3% in 2007. When the housing wealth created by the bubble disappeared people naturally cut back their consumption.
This is Spain's crisis. According to the IMF, housing starts in Spain fell by 80% from the peak of the boom. While total construction has not fallen as much (repairs and non-residential construction did not decline nearly as much), if construction in Spain fell by 50%, this would imply a loss in annual demand of more than 6% of GDP. That would translate into a drop in demand of more than $800bn in the United States.
Similarly the loss of housing wealth reverses the housing wealth effect. If consumption fell enough to return the savings rate to its pre-bubble level, then this would imply a loss in annual consumption demand of more than three percentage points of disposable income. In the US this would amount to more than $300bn in lost annual consumption.
There is no easy mechanism to replace more than $1tn in lost demand. This is why Spain's economy is in a severe slump right now. Note that just about all analysts agree, Spain's financial system was well regulated and it had none of the loony loans and outright corruption that pervades Wall Street and the US financial system. Yet, it is suffering from this economic downturn even more than the United States...
I dunno. I find this explanation that accuses others of being oversimplistic in pinning the recession on the tail of the financial crisis somewhat oversimplistic, itself. My own take is that while the implosion of the housing bubble was certainly at the center of the most recent downturn, a downturn that actually can be traced to as early as 2006 even if not yet a technical recession at that point and time, a problematic banking sector riddled with derivatives trading to the hilt, etc., etc., etc., readily allowed what might have been "just" a protracted period of sub-par growth interspersed with some occasional quarters of negative GDP, to turn into an all-out jungle recession, very difficult to manage, and by the very nature of extreme banking crisis, to come within striking distance of throwing the world economy into a Very Great Depression, a depression even worse than that of the 1930s.
So, while I would probably agree that the housing bubble lies at the heart of the downturn's origins, in no way just by itself explains the severity and difficulty of the global recession/depression.
What say you?
Blame it on the bubble: Dean BakerPoliticians and the media continue to refer to the economic downturn as being the result of a financial crisis. This is wrong. We have 15 million people out of work because the housing bubble that drove the economy since the last recession finally burst. The financial crisis may have been good entertainment for those who like to see huge banks collapse, but it was a sidebar. The real story was the rise and demise of the housing bubble.
Those who claim that the real problem was the financial system and its faulty regulation can be disproved with a single word: Spain.
Spain is noteworthy because it now has an unemployment rate of more than 19%, the highest rate in any of the wealthy countries. Spain did not have a financial crisis. In fact, its well-regulated financial system is often held up as model for the United States.
Spain did have a horrific housing bubble. As a result, the share of construction in the economy rose from less than 8% of GDP at the end of the 90s to 12.3% in 2007. By comparison, it is typically less than 6% of GDP in non-bubble years in the United States. This rapid rate of construction led to enormous overbuilding, which meant that a collapse was inevitable with construction falling to far below normal levels.
The run-up in house prices also had the predictable effect on consumption. Because people believe that the run-up in house prices is based on fundamentals, homeowners assume that their newly created housing wealth is real and they spend accordingly. Spain's saving rate fell from just under 6% in 2000 to 3% in 2007. When the housing wealth created by the bubble disappeared people naturally cut back their consumption.
This is Spain's crisis. According to the IMF, housing starts in Spain fell by 80% from the peak of the boom. While total construction has not fallen as much (repairs and non-residential construction did not decline nearly as much), if construction in Spain fell by 50%, this would imply a loss in annual demand of more than 6% of GDP. That would translate into a drop in demand of more than $800bn in the United States.
Similarly the loss of housing wealth reverses the housing wealth effect. If consumption fell enough to return the savings rate to its pre-bubble level, then this would imply a loss in annual consumption demand of more than three percentage points of disposable income. In the US this would amount to more than $300bn in lost annual consumption.
There is no easy mechanism to replace more than $1tn in lost demand. This is why Spain's economy is in a severe slump right now. Note that just about all analysts agree, Spain's financial system was well regulated and it had none of the loony loans and outright corruption that pervades Wall Street and the US financial system. Yet, it is suffering from this economic downturn even more than the United States...
I dunno. I find this explanation that accuses others of being oversimplistic in pinning the recession on the tail of the financial crisis somewhat oversimplistic, itself. My own take is that while the implosion of the housing bubble was certainly at the center of the most recent downturn, a downturn that actually can be traced to as early as 2006 even if not yet a technical recession at that point and time, a problematic banking sector riddled with derivatives trading to the hilt, etc., etc., etc., readily allowed what might have been "just" a protracted period of sub-par growth interspersed with some occasional quarters of negative GDP, to turn into an all-out jungle recession, very difficult to manage, and by the very nature of extreme banking crisis, to come within striking distance of throwing the world economy into a Very Great Depression, a depression even worse than that of the 1930s.
So, while I would probably agree that the housing bubble lies at the heart of the downturn's origins, in no way just by itself explains the severity and difficulty of the global recession/depression.
What say you?