Paul Krugman Gets in Touch with His Inner Friedrich Hayek

Not Hayek the post-WWII libertarian political philosopher, but Hayek the interwar business cycle theorist.

Hayek's theory of depressions was that they started when, for some reason, interest rates got too low--below fundamentals. If interest rates are low, asset prices are high--above their fundamentals. Because financial markets are sending false signals that capital--whether in the form of machines, business organizations, commercial buildings, or housing--is very valuable, the market shift resources into capital-producing sectors and adds to its capital stock.

Someday, however, interest rates return to their fundamentals. When they do, asset prices fall sharply: it becomes clear that there are a lot of business organizations, machines, commercial structures, and houses that do not produce value to cover their costs. The last thing needed is more investment. Workers, entrepreneurial energy, and capital have to be shifted out of capital-goods production and into the production of consumer goods and services. And, said Hayek, it is that painful, lengthy, but necessary process of shifting resources out of capital-goods production that we call a "depression."

In Hayek's monetary overinvestment theory of the business cycle, the magnitude of the depression depended on the magnitude of the required structural shift, which depended on (a) how much interest rates had been pushed below fundamentals, (b) how long they had been pushed there, and (c) how much damage--in terms of capital investments that should not have been made given fundamental values--the false prices fed to the real economy by the financial sector had done.

It was a corollary to Hayek's main theory that lowering interest rates when a boom was ending was a counterproductive thing to do. It would push off the depression, yes. But only at the price of magnifying the overinvestment imbalance and thus magnifying the magnitude of the depression when it finally arrived.

It was bad luck for Hayek that he proposed his theory just as the Great Depression arrived. It was not a plausible theory of the Great Depression, not a plausible theory at all.

But today we see Arch-Keynesian Magister Paul Krugman flirting with a Hayekian line wobble:

Running Out of Bubbles - New York Times: Remember the stock market bubble?... [A] few pessimists, notably Stephen Roach of Morgan Stanley, argue that we have not yet paid the price for our past excesses. I've never fully accepted that view. But looking at the housing market, I'm starting to reconsider.

In July 2001, Paul McCulley, an economist at Pimco, the giant bond fund, predicted that the Federal Reserve would simply replace one bubble with another. 'There is room,' he wrote, 'for the Fed to create a bubble in housing prices, if necessary, to sustain American hedonism.... [I]nterest rate cuts led to soaring home prices, which led in turn not just to a construction boom but to high consumer spending, because homeowners used mortgage refinancing to go deeper into debt. All of this created jobs to make up for those lost when the stock bubble burst.

Now the question is what can replace the housing bubble.

Nobody thought the economy could rely forever on home buying and refinancing. But the...[I]f the hectic pace of home construction were to cool, and consumers were to stop borrowing against their houses, the economy would slow down sharply. If housing prices actually started falling, we'd be looking at a very nasty scene.... That's why it's so ominous to see signs that America's housing market... is approaching the final, feverish stages of a speculative bubble.... In parts of the country there's a speculative fever among people who shouldn't be speculators that seems all too familiar from past bubbles - the shoeshine boys with stock tips in the 1920's, the beer-and-pizza joints showing CNBC, not ESPN, on their TV sets in the 1990's....

[I]t's true that the craziest scenes are concentrated in a few regions, like coastal Florida and California. But these aren't tiny regions; they're big and wealthy, so that the national housing market as a whole looks pretty bubbly. Many home purchases are speculative; the National Association of Realtors estimates that 23 percent of the homes sold last year were bought for investment, not to live in. More than 30 percent of new mortgages are interest only, a sign that people are stretching to their financial limits.

The important point to remember is that the bursting of the stock market bubble hurt lots of people - not just those who bought stocks near their peak. By the summer of 2003, private-sector employment was three million below its 2001 peak. And the job losses would have been much worse if the stock bubble hadn't been quickly replaced with a housing bubble. So what happens if the housing bubble bursts?...

Mr. Roach believes that the Fed's apparent success after 2001 was an illusion, that it simply piled up trouble for the future. I hope he's wrong. But the Fed does seem to be running out of bubbles.

I would admonish him for this wobble away from Keynesian orthodoxy toward Stephen Roach-Friedrich Hayek deviationism. But I feel the same way. With each month that passes Roach and Hayek look a little bit better.

Comments

[PaulC]

Hah! Another Krugman lie:

>Nobody thought the economy could rely forever on home buying and refinancing.

Right now I'm sitting here thinking that the economy can rely forever on home buying and refinancing. And I bet I'm not alone. Liar! Liar!

[PaulC]

> Because financial markets are sending false signals that capital--whether in the form of machines, business organizations, commercial buildings, or housing--is very valuable, the market shift resources into capital-producing sectors and adds to its capital stock.

Speaking of excess capital stock, I'm a firm believer in the building opacity index as a rough way to gauge the health of the local economy. Here in South Bay, when you look at a fancy new office building constructed since 2000 or so, there's a good chance that you can see straight through to the other side, discerning sky, clouds, jets out of San Jose Airport, and an occasional egret or heron if it is close enough to the bay.

While there's a certain cheery optimism to all the new office space, I'm of the view that in practice the older, opaque buildings make a greater contribution to the economy.

[Kathleen]

and I was hoping he was getting in touch with his inner Salma Hayek. that would be interesting

[pgl]

Recovering economist Duncan Black thought this was a wobble as well. But the housing "bubble" is one of the hotter unexplained economic events of the day.

[PaulC]

Anecdotally speaking, I had been figuring for a while that we were out of the woods with respect to prices going below what we paid for our house in 2003. Lately, I'm seriously starting to wonder about that even. I have lost any confidence that prices are going up based as a rational consequence of short supply in the Bay Area, so I just figure anything can happen. I suspect that people with ARMs and cash-out loans are going to be hurt very badly.

[anne]

Darned worrisome.

[Andre]

It's reasonable to revive old-time thinking about recessions, because this last one was an old-time recession, brought on by a decline in business investment, not consumer spending.

[snsterling]

I think Krugman is losing his marbles. He's the last person I would expect to switch over to the side of the bubbleheads.

[ricardo]

Not an economist here (i enjoyed a couple semesters of economics back at yale in the '70's...never met paul krugman there, sadly), rather, an architect living on the fringes of the rust belt where a house can still be purchased for under $50k. However, we also have bubble phenomena nearby with waterfront properties of $1 million +...

Seems to me that if the old wage/price inflation model were still relevant, interest rates would have risen long ago (with the asset bubble pricked, much as Volcker raised interest rates back in the late '70's)...but with globalization and a seemingly infinite supply of low cost overseas labor, wages have yet to seriously pressure prices...and the punch bowl (including housing froth) is filled to the brim.

Curious that the administration is grandstanding to have the yuan re-valued...when we start importing Chinese inflation with a floating yuan,I imagine the Fed will have no choice but to hide the punch bowl...and the housing party may well be over.

[touche]

Consumer debt reached $10 trillion about a year ago. Its probably $11 trillion today:
http://research.stlouisfed.org/fred2/series/CMDEBT/

[anne]

There are alternate resolutions to the deficit and housing strains in the economy. There is minimal household saving and a federal deficit which has resulted in a balance of trade deficit. The trade deficit is being funded by importing capital. China, Japan, Brazil, South Africa, and others are supporting our trade deficit. Should the dollar begin to seriously decline in value against the Chinese Yuan in particular capital inflows would lessen and long term interest rates would rise. But, this brings us to housing. An increase in interest rates could seriously threaten the housing market and a weakening housing market would threaten the economy. We are then vulnerable to any lessening of capital inflows.

But, we are as well vulnerable to a slowing in the housing market as the Federal Reserve continues to raise short term interest rates. A slowing in housing growth induced by the Fed would weaken the economy as surely as a decline in the value of the dollar against the Yuan, though long term interest rates in this instance would decline. We have then alternate resolutions to our growing imbalances, and both of the resolutions are rather ominous. What troubles me is finding no ready and likely policy to counter the dangers of the housing bubble and deficits.

[ricardo]

Let me elaborate my worldview...lol.

I believe the US has two economies now...the coastal ones enjoying asset inflation and another, rust belt economy (i.e. a Wal-Mart nation with low, stagnant wages and no pricing power). So far the Fed has overlooked the truly astonishing asset inflation in the coastal economies (I imagine it's not reflected in their CPI statistics...). However, when Wal-Mart nation starts importing Chinese inflation (because it has imported their wage price inflation...a kind of globalization end-game) then watch out because that inflation will truly be reflected in the CPI.

[economaniac]

Never understood this - "Workers, entrepreneurial energy, and capital have to be shifted out of capital-goods production and into the production of consumer goods and services." What the heck are all those capital goods producing if not consumer goods and services? The idea of capital deepening depends on a substantial portion of the economy being engaged in producing capital goods the sole purpose for which is producing other capital goods. So what are they?

Construction is notoriously low in capital intensity so I don't understand the connection between Hayek and the housing bubble. Maybe this should be understood as a switch from demand for consumer durables to nondurables, but I don't think that works for the Austrian argument.

If you reframe the argument in terms of income and wealth distribution it makes a lot more sense.

Capital intensive industries tend to produce mass market goods so continued strong investment in capital tends to create an oversupply unless it is accompanied by equally strong wage growth. As we have seen, declining interest rates can provide support for growth in consumer spending for a while, but at some point they stop going down and the virtuous cycle turns vicious. Seems to me that is the central problem facing modern economies - they tend to concentrate wealth and income but depend on broadening prosperity to suck up all the goods that form the basis for that wealth.

[anne]

Ricardo

The Administration has already moved away from pushing for a floating Chinese currency against the dollar or for setting aside of Chinese capital flow controls. There is no reason to expect much in the way of a price increase here from Chinese export taxes or a modest controlled increase in value of the Yuan. Inflation? I do not think so, and the bond market is offering no warning. Rather I worry about economic weakness either from selectively bursting housing bubbles or weakness brought on by rising interest rates with less foreign central bank support of the dollar.

[roublen vesseau]

So what was Hayek's policy response to such a depression? What is Roach's, for that matter? Roach, like Marx, may be diagnosing the problem correctly, but is his solution any different than "purge the rottenness out of the system"?

[cynic]

Is this too much credit for Hayek? How about Wicksell and the natural rate of interest?

[jm]

See Murray Rothbard's "America's Great Depression" at
http://www.mises.org/rothbard/agd.pdf

[jm]

Interest rates do not have to rise to end the real estate bubble. All that is necessary is that real estate prices rise to such a level that no one can imagine them rising higher. As long as mortgage interest rates are greater than zero, that limit will eventually be reached.

Of course, if continuing Asian mercantilism pushes interest rates to or below zero, then there is no limit. With an interest-only loan at zero percent, there's no limit to what you can pay. With negative interest rates, the more you pay, the more you make.

And why shouldn't interest rates go negative? After all, it costs banks money to manage accounts, so if there's enough money sloshing around, why shouldn't they demand that depositors pay them to store the money? And because there will always be some source of deposits, the banks can still have a positive spread even with negative rates, the lending rate just has to be less negative than the rate paid to the depositors.

Yes, the trees can grow to the sky!

[jm]

A wonderful and relevant piece by Paul Kasriel of Northern Trust
http://www.northerntrust.com/library/econ_research/daily/us/dd052605.pdf

[Jennifer]

How does an investor protect a portfolio in such a scenario? Stocks, bonds? What holds up if housing price stop rising?

[Bill]

If the cause of the recession is over-investment, why is one of the "requirements" for Soc Sec reform that it either increase national savings or at least not reduce it? Pretty soon we'll all remember why Soc Sec was set up to PAYGO - the fear that the world was creating too much savings and we needed more consumption.

[anne]

http://flagship4.vanguard.com/VGApp/hnw/FundsHoldings?FundId=0123&FundIntExt=INT

Whatever do these numbers mean? The Vanguard REIT Stock Index has a price earning ratio of 38.8, a return on equity of 9.1, and an earnings growth rate of -5.5%. These numbers make absolutely no sense to me. What am I missing about valuation?

There surely seems to be a speculative climate for homes in selected American regions, but I wonder if that extends to commercial real estate as well so I thought to use the REIT Index as a gauge. The earnings growth rate extends over 3 years and is heavily negative at -5.5%. So REIT earning have been slowing; actually the earning growth rate has been negative for more than 4 years, but REIT gain in price. How curious.

[TM]

The tax reform of 1986 hammered the overinvestment in real estate tied to tax sheltering - it might be worth revisiting that history (which did not go all that well - the S&L debacle followed, but then Gulf I happened...)

[dc]

how do you get a speculative bubble caused by macro factors that only reveals itself in a micro manner?

gee, maybe NYC, DC, Boston, San Fran and LA are like, you know, way better places to live than everywhere else????

gee - beach front properties have gone way up?? no way!! that must be a bubble. i mean, relative to 10 acres of prairie in kansas they should be the same price right??

[drkwanda]

I'm no econo historian but the Hayek line about overinvestment seem prescient in this case. Are you being ironic/facetious about the 1920s or was Hayek right there too?

[ricardo]

TM...

Fiscal policy attacking a bubble??? Why can't we just wait for the Fed or the invisible hand to correct it???...lol.

[Neil Craig]

Floating new bubbles.

How about starting a lunar homestake & asteroid bubble? The US just sells off ownership of asteroids & plots on the Moon & leaves it up to the owners to move in (which also generates economic activity). I bet right now you could get $ several billion for the deep Lunar North Pole craters where there may be ice.

Granted there is a slight problem that they don't own it but then the Pope didn't own America when he gave it to Spain & Portugal.

[Unstable Isotope]

Stop it, Brad, you're scaring me.

[jm]

Interesting to see above, "... is his solution any different than “purge the rottenness out of the system”?" It seems everyone believes this is the tack Hoover in fact took, and a primary cause of the depression.

It wasn't.

From Murray Rothbard's "America's Great Depression" at
http://www.mises.org/rothbard/agd.pdf, pages 209-210:

QUOTE
As his admiring biographers, Myers and Newton, declared, “President Hoover was the first President in our history to offer Federal leadership in mobilizing the economic resources of the people.” ... As Hoover later proudly proclaimed: It was a “program unparalleled in the history of depressions in any country and any time.”

There was opposition within the administration, headed, surprisingly enough, considering his interventions throughout the boom, by Secretary of Treasury Mellon. Mellon headed what Hoover scornfully termed “the leave-it-alone liquidationists.” Mellon wanted to “liquidate labor, liquidate stocks, liquidate the farmers, liquidate real estate,” and so “purge the rottenness” from the economy, lower the high cost of living, and spur hard work and efficient enterprise. Mellon cited the efficient working of this process in the depression of the 1870s. ... But Mellon’s advice was overruled by Hoover, ...

Hoover acted quickly and decisively. His most important act was to call a series of White House conferences with the leading financiers and industrialists of the country, to induce them to maintain wage rates and expand their investments. ... Hoover phrased the general aim of these conferences as “the coordination of business and governmental agencies in concerted action.” The first conference was on November 18, with the presidents of the nation’s major railroads.
UNQUOTE

Hoover ignored Mellon's advice. Rothbard argues persuasively that the depression would have ended sooner had it been followed.

[jm]

Regarding Hoover's actual behavior at the start of the depression, see also:
http://hoover.archives.gov/exhibits/Hooverstory/gallery06/gallery06.html

It is sad that nearly everyone seems to believe that Hoover took Mellon's advice. Indeed, Krugman's op-eds include not just one but two instances of "... reminiscent of the disastrous advice given by Andrew Mellon, Hoover's Treasury secretary ..."

It's not what you don't know that hurts you ...

[Lee A. Arnold]

In my plumbing hat I just walked through at a 1400 sq. ft. condo north of Wilshire two blocks from the beachcliffs in Santa Monica, 2 and a half baths, small kitchen, needs work, asking $989,000--lots of people showing up.

[Brad DeLong]

The problem with Rothbard's argument is that the Great Depression was a credit-collapse depression, not an overinvestment-hangover depression. Wage levels did, after all, fall by a quarter between 1929 and 1933, and there were no signs that that was stimulating employment in sectors that ought to have been expanding. The reason? They couldn't get any financing because deflation had crippled the financial system.

The right way to bet is that further deflation a la Mellon would have made the Great Depression even worse. To talk about an overinvestment-hangover in 1933 was, as British monetary economist R.G. Hawtrey put it at the time, the equivalent of "Crying, 'Fire! Fire!' in Noah's flood."

[anne]

What a curious period this has been. We are becoming Friedrich Hayek :)

[Robert Waldmann]

The heretic J. Bradford DeLong must confess his sins to St Maynard. You know perfectly well that you have been fascninated by the Heyekian model since you were an undergraduate. Your effort to accuse Paul Krugman of the Hayekian/Arian Heresy based on the claim that not all capital is Homoosian is pure projection.

Arian refers to Arius a theologian who disagreed with the Nicean crede and not to any alleged race. Homoosian means "of the same substance," the Nicean crede holds that God the son and God the father(and the holy spirit) are homoosian. However, I now realise that the Solovian doctrine that capital is schmoo is fundamentally Nicean and that the Hayekian Heresy is similar to the Arian Heresy.

I am shocked that even Paul Krugman has feet of clay (I thought he had feet of putty)

[punisher]

Salma vs. Friedrich, for the scorecard:

http://www.csun.edu/~dgw61315/dgwhayek.html

[jm]

But the fact that overinvestment wine was not flowing freely in 1933 is a matter separate from whether the system was suffering a hangover from the financial bathtub gin that flowed so freely in the Roaring '20s.

[jm]

The key issue regarding whether the proper way to deal with an overinvestment hangover is "hair of the dog that bit you" is that that appproach may only lead to an even worse hangover (and eventually to cirrhosis of the liver). We seem finally to be performing that experiment, and will know the answer in time.

[snsterling]

"Whatever do these numbers mean? The Vanguard REIT Stock Index has a price earning ratio of 38.8, a return on equity of 9.1, and an earnings growth rate of -5.5%. These numbers make absolutely no sense to me. What am I missing about valuation?"

Anne, the problem is those are GAAP earnings which include depreciation of things which appreciate. REITs are evaluated using Funds From Operations instead. GAAP earnings don't make sense for most companies, it's just worse for REITs. And I have no opinion as to whether or not REITs are expensive currently.

Do a Yahoo Search on "depreciation REIT FFO". Here's the first result

http://www.investoralternatives.net/ia/Articles/Alternatives/REIT_ValuationIntro.htm

[Hamilton Lovecraft]

And why shouldn't interest rates go negative?

The scary part here is that this suggestion no longer seems substantially more absurd than everything else I hear in politics and economics.

[jm]

"Mellon cited the efficient working of this process in the depression of the 1870s."

Brad, was there no credit collapse in the depression of the 1870's?

Can anyone steer me to references on the 1870's depression?

[chris]

Are we using more than 10% of the fiber optic cable put in place in the late 90s yet? That was one real economy statistic indicating there was over investment in the internet bubble years. The way to treat it would have been to recognize the froth in the over investment and try to tamp it down by raising interest rates while it was happening. that's called being proactive taking away the punch bowl just when the party was getting started. It would have thrown our self-image into a down turn as we would have missed years of Wired articles celebrating our creative economy where foos ball playing web site designers are going to change the world. the tech stock mania did meet Greenspan's definition of inflation, a material change in behavior.

And we have a change in expectations now with real estate. some large portion of the houses being sold now are vacation homes or for speculation. People probably don't really know why they're buying being confused by the noise in the media on home prices never go down. Money is readily available. It's cheap. Sit still and you can be buried with mortgage and credit card solicitations. Feeling lonely, sit by the phone and strangers will call offering to lend money. Oops, sounds like over investment, luckily we have the new bankruptcy laws to protect our infra-structure during a down turn. The Fed rate is below the inflation rate.

We defeated communism but now we have Mr. Magoo's steady hand on the national tiller navigating by the stars that are too obscure for the rest of us. By controlling one interest rate he steers 300 million people and $10 tril in transactions. The boom in that personality cult is about to wither.

I've been following what's the contemporary Austrians since about 1995 with most of the reading being on market commentators. It has been the view that makes sense. What was worrisome were economists like Delong and Krugman that didn't make agreeable noises once in a while in sympathy with a business cycle overinvestment boom and bust view. Now I can feel a little assured that Krugman entertains this theory.

So leave these critical tools to Greenspan and Bush, owner's equivalent rent, hedonic massaging of cars and pcs, the job birth/death model, the $150 credit for income for free checking and a whole bunch of tech stock savvy punting, real estate speculating rational actors.

What happened to the word savvy? For a while it was a real buzz word amongst us boobus americanus.

[drkwanda]

Thanks for the answer to that question -- I wasn't aware of that distinction between the over investment depression and the credit collapse depression. My next question then is, if Mellon's advice was all wrong on the credit collapse depression because it would have caused further deflation, does that mean he would be right if we head into the Bush/Greenspan/Over Investment depression in the next few years -- that the way to get out of the problem is to follow a liquidationist policy? For those of us hoping another Depression brings the Dems back to power by reminding people that the unregulated economy is the dangerous economy, this seems like sobering news. Hard to run as the Party that will fix everything - we have the liquidation plan!

[chris]

continuing on with Jim Glassman's comments, what are we going to do? We're going to accept a lot more inflation. Liquidating hurts. That's why it's called the price finding market clearing mechanism amongst the Austrians to give it a reasonable sounding term. When prices for tech stocks and housing go up, it's due to our virtue. When prices go down, it's a national crisis, we got to do something now otherwise someone from the mesaage board community might take the death threats against Greenspan seriously.

the rational actors say the signs from the bond market show we're on a steady course. I say the bond market is sending a signal but it's called a head fake, go enjoy, someone has to buy those bonds. If the Austrians focus on the distortions caused by too low interest rates, what looks more distorted than our current economy?

the Austrian theory sounds like a good explanation. Applying the reverse rule, can Prof Delong explain what the heck's going on?

[Jonathan W. King]

So here are some questions I have about interest-only mortgages. You just don't see these in central Missouri, so I'll confess I'm kind of in the dark about how these would work.

1) Is it really true that these essentially didn't exist 5 years ago?

2) I'm assuming these require 20% down or else you're paying PMI as well, right?

3) Are these really infinite term loans, or are they usually short-term (e.g., in 5 years you owe the full principal)?

4) Does anybody actually securitize these loans officially? If not, who actually holds a portfolio of such nonsense? And who are their bankers?

[chris]

Watching the UEFA cup soccer final between Liverpool and AC Milan, the ref just made a questionable call giving a penalty kick to Liverpool tieing the game in the 2nd half. It's clear the English player just overran his feet and wasn't pushed by the Milanese. No ref viewing of replays to confirm or overturn the call, just play on. Milan was winning 3-0 at the half and it looked like it was going to be a romp.

In the States we have the football ref call review rule, shifting justifications for the Iraq adventure, refloating sunk ships in a Pentagon Millenium challenge war game, and Greenspan's treatment of the burst bubble rather than treatment of the bubble.

The one thin book I read about the Japanese/American battle for Midway, the U.S. played a war game before the war started and lost the Philippines. the Japanese played one before their Midway attack, lost their carriers, the admirals said no that can't be. they refloated the theoretical weaons and went on to lose the battle, the war, and a lot people.

[Jonathan W. King]

Hmm...so I just checked out the primary publicly traded PMI companies. There are like five of them.

United Guaranty is an arm of AIG (uh oh...)
GE Morgage Insurance Corporation is wholly owned by GE.
PMI Group Inc. is independent, as are MGIC Investment, and the Radian Group.

The independent ones all pay dividends, but the rate is less than 1%. They all have PE ratios around 10, which initially surprised me, but which I guess makes sense given the risk they have on board.

And, man, that must be substantial risk, given bubble-like real estate prices we see in some markets. Plus, there are only five of them. I suppose they must all have re-insurers, and whole syndicates of them, but since these are the guys who are going to get stuck with PMI-covered properties if things turn south, this situation does not look so nice.

Oh yeah: most or all of the shares of these companies are owned by institutions and mutual funds, with a notably high stake owned by what appear to be hedge funds. That's not giving me a warm, squishy feeling either.

[A. Zarkov]

Will someone explain how the Fed pulled down long-term interest rates? It seems to me that the real culprit is China, because China buys long-term US Treasury Bonds with their ample supply of dollars. On the surface it looks as though the Chinese are irrational because what will they do with all those dollars when they redeem those bonds at some future date? I say “on the surface,” because I think there is method to their seeming madness. They want to become the premier world power when US industry is completely hollowed out.

[tante aime]

If you think of the housing market the way a mortgage manager does, as one of the last great revenue streams in America, a gigantic maelstrom of silver dollars swirling across the sky for the savvy Wall Street buccaroo to lasso, hogtie, junior and REIT, filling their Isle of Man bank accounts with lucre, then it's no great stretch when the high-tech typhoon dried to a dusty rivulet, all that funny money had to go somewhere.

Somewhere reality-based, but fraught and filled with emotion. Hmm. Apple pie futures? Nope. Umm, how about Mom's Options! Naww. I got it! Home!! Home, home on the range. There's no place like home.

So the crack splitters set to work, diverting their passive capital venture funds into housing, and wallah, prices of homes in Riverside, California, of all the god-forsaken places in the US, are going up 67% a year.

Our own home, that we held for three years until 2002 for just a small premium after the market had stalled, doubled that premium only eight months later when the buyer flipped it and moved on. Why not? Flipping your way into a mansion is a lot easier than building ten duplexes to earn your own townhouse, free and clear.

The question to ask, of the 23% of pure investors, how many are foreign, and how many domestic? Of the 77% who live in the home they're flipping, how many are recent immigrants? You drive this bubble as fast as you find new players with net assets. Americans are tapped out.

The other question to ask, where is the expansion really happening? In $120,000 ramblers, or 12,000sf mansions on waterfront? Where those two curves intersect, that's the flux. Then you analyze the players and places in detail, and determine the rate of change of that flux. Having found that, then assuming a prepodydian and incremental change in mortgage rates, you can solve the calculus:

˙ x = ˙(y − x)
˙ y = rx − y − xz
˙ z = xy − bz

Everyone will laugh at you, trying to call the cusp, until the hammer finally drops (what an apt metaphor), then they'll laud you as a visionary genius.

Figuring that, like foreign trade, those holding the "stuff" are in better position than those holding the "paper", you can understand why mortgages themselves are flipped in great blocks as fast as they're assembled, derivativized, juniored and REIT'd out the yingyang.

So if you don't want to do the math, or don't trust your calculations, just watch Fanny and Freddie. Last time I looked, they're heading into big water, as are US all.

Some properties in Hawaii have gone from $7,500 a lot to $75,000 in less than two years, and they're still just scrabbly hot basalt with no water, sewer and unreliable electricity, way out in the jungle. A little ad hominem.

[bakho]

This latest PK was like a re-read of his Ice Age column:

http://www.pkarchive.org/theory/iceage.html

only without the "Mammoth Meat". Krugman was correct about the ice-age and why should housing not eventually return to more normal trends?

Besides, PK is not predicting the Second Great Depression. He is merely stating that housing prices are above trend and a return to trend means lower prices. Duh.

And- Why is it that the criticism is always seen as leveled at monetary policy? Monetary policy has to work with fiscal policy. The original sin was cranking up interest rates in the late 90s when fiscal policy was collecting over 20% of GDP in taxes. Monetary policy is too blunt an instrument to address bubbles in limited market sectors. Taxing the excess profits was the appropiriate squeeze. The next sin was a failure to enact appropriate fiscal policy to address unemployment in 2001. The Fed then overreacted instead of lobbying for fiscal help. As I recall, the PK columns at the time were all about the "liquidity trap" that basically neutered monetary policy. The ball was in the fiscal court and Bush punted. The Fed tried to compensate were caught in the liquidity trap zone. The Fed essentially lowered interest rates in an ineffective zone. Interest rates went so low that only now, monetary policy is finally coming back into play. Go back and re-read PK and you will see that he was unconvinced that lowering interest rates was effective policy. Duh.

The PK criticism was that when the Fed was working overtime to prevent deflation, Bush and fiscal policy was slacking. As well all now know, Bush does not view his fiscal policy as a means of regulating the economy. Bush views fiscal policy as a way to reward or punish his political supporters and political enemies. It is not correct to view PK comments as a critique of monetary policy. It is a critique of the abysmal Bush fiscal policy. Further this PK column is advice to "investors" that the short term interest rates for housing are unlikely to continue long term, just as he earlier predicted that "an ice-age cometh".

[chris]

Part of the banks finding a way to cover their losses is going to be a trax payer bail out. If we can't impeach Bush, averaging down Greenspan's reputation now is one step in helping our fiance system. Misplaced confidence in our greatest ever central planner.

[MTC]

Probable cause of Krugman's wobble/apostasy:

Country name.
Five letters.
Starts with a J.

[anne]

http://www.nytimes.com/2005/05/28/business/28home.html?pagewanted=all

Is Your House Overvalued?
By DAVID LEONHARDT

Four days after Alan Greenspan, the Federal Reserve chairman, pronounced the nation's housing market frothy, a new report on home prices this week suggested that he might have been understating the situation. Even after one of the steepest run-ups on record, home prices have jumped another 15 percent over the last year.

While gleeful about their apparent riches, homeowners in many of the hottest areas are also growing concerned. How, exactly, does one know if the family palace is sitting atop a bubble about to burst?

The answer might have less to do with the sale price of your neighbor's house and more to do with something most homeowners ignore: the local rental market.

The easiest way to gauge a home's value is to borrow a tool from the stock market. In the most basic method of analyzing a stock, investors look at its price-to-earnings ratio, a comparison of a company's share price with its annual profit. The higher the ratio, the more expensive a stock is relative to its underlying value.

Houses have their own version of such a ratio. Take the price of a typical house in an area, divide it by the amount that house would cost to rent for a year and the result is what might be called a rent ratio, an imperfect but still telling measure of real estate.

That ratio today shows that housing is not nearly as overpriced as stocks were in the late 1990's. But many areas are showing signs of irrational exuberance.

Rents act as a reality check of sorts for home prices, a way to see how economic fundamentals, rather than psychology, are affecting the market. In only a small number of areas - including Washington, Baltimore, Las Vegas, Jacksonville and the Long Island suburbs of New York - are rents rising at a decent clip.

In the last five years, the rent ratio in many coastal cities has more than doubled, according to an analysis for The New York Times by Economy.com, a research company. In San Francisco and San Jose, Calif., it has spiked to nearly 35 on average - or about equal to the price-earnings ratio Microsoft's stock reached in 2000. In West Palm Beach, Fla., and San Diego, the ratio is almost 30. In New York, Miami and Los Angeles, it is about 25....

[anne]

Jennifer:

The problem with bubbles is that they can last and last. We may suspect but do not know for sure whether there is a broad housing bubble. There may even be a commercial real estate bubble. We do not know how long a bubble may go on, or what effect there might be in an ending to price appreciation in real estate.

Nonetheless, as in 2000, we need to be invested, but to be prepared for a market turn. That means a portfolio that has emphasized a diveersity of reasonably priced securities. We are not Warren Buffett, though we can own Berkshire Hathaway shares, but there is a reason Buffett has been building a portfolio of utilities here and abroad. Reasonably priced, paying dividends that are competitive with bonds before any capital gains. International utiliies? International drug companies? We can look about.

Remember also the selection of moderate duration bond funds at Vanguard. Yields are surely not what they were in 2000, but there is safety and better returns with patience than in a money market. Bonds have had an astonishing run since January 2000.

[Jörg Wenck]

"interest rates return to their fundamentals"

Please advise your readers on the methodology you use to identify the exact value of this enigmatic entity.

[I'm not a Hayekian--although I admit I'm tempted. I'm not sure what the enigmatic entity is.]

[Buckley]

California and the coastal regions of Florida are certainly the most extreme examples of housing bubbles, but I'm a banker in rural, central Georgia and people are actually "flipping" lots here. Not just real estate professionals and deep-pocketed investors either, but ordinary, middle-class folks.

Like everyone else, I have no idea when the correction will come, but it will likely be swift and painful for many.

[matt]

I don't for a second doubt that beachfront property on the Outer Banks of North Carolilna should be higher than prairie land in Kansas that isn't under cultivation with some commodity crop.

That being said, things are still out of control. I bought a modest four bdrm house 1500' from the beach in Corolla, NC, just north of Duck, in 1999 for $145,000. I sold it in 2003 for $325,000. I then purchased a two bedroom condo in Myrtle Beach, SC, for $90,000 in June, 2002, and recently sold it for $190,000.

While I enjoy being able to do this I'm not fueling the bubble. But the speculators out there buying paper and flipping the paper, well, it smells way too much of the S&L debacle that another Bush presided over and resulted in another large debt which the American taxpayer is still burdened with.

There is a bubble. I don't honestly believe that real estate should be any different than any other speculative endeavor, but there are people who refuse to believe that you can lose money in this market. That certainty is what drives people to make purchases, sight unseen, of plots of land in swamps like the 1920s Florida scam.

What happens when the exuberance drives the price of houses beyond the reach of the first-time home buyer? What happens when there aren't enough families who can go for the $5000 per week nut to rent the monster homes that have been built on the Outer Banks? Will these be more buying opportunities at fire sale prices or will this seriously affect the primary home market to the extent that prices will come back down to earth and more modest homes will be built instead of the McMansions that are proliferating?

Don't get me wrong, I like making money with out much effort, but I also like knowing that I can use my property during the winter when no one is there or for a couple of weeks in the summer. You can't do that with a piece of paper that is continually getting flipped just to artificially inflate the price of the underlying asset.

[anne]

Buckley

Friends have been telling me they find the same speculative trade in property in similar rural settings. I was told quite a while ago flipping was the theme of several television comedy episodes. After all, the idea really does become contagious :)

[PaulC]

I don't have the background to answer this, but is it possible that the best economists are almost always right in presenting a model of what could plausibly happen, but almost always wrong as soon as they go out on a limb and say that their model explains what's happening now.

Several comments have criticized Krugman for shifting his position, but I think what has shifted is the second part. He still knows all the models, and the models he prefers still work as well as ever. But as for guessing which applies right now in the face of insufficient information, all he can do is place a wager. It might be better than most non-economists can do, but it might not be that much better, and it might be worse than some people can do out of just happening to have the right kind of intuition for the current situation--or simply holding doggedly to the same single bullet theory until it finally happens.

I noticed some people have already made statements about the Great Depression being the wrong kind of depression for a certain action to work. The reasonable suggestion is that the business cycle is more complicated than just up and down. For another example, you can't get very far lumping together all natural disasterd: earthquakes, hurricanes, floods, tornadoes, droughts. If you tried to figure out which was happening based on just changes in population, you wouldn't be in a great position to send the appropriate response.

I'm not even saying that economists aren't looking at enough information. They might not be doing anything wrong at all within their limits; I just think there is kind of an unreasonable expectation that they have the tools to determine what model if any explains what's really happening. It seems that that's not even their expertise. You usually hear about economists getting a Nobel for proposing a new model (or working out the math of an existing one). Does anyone get rewarded for figuring out which economists were right about which time periods?

[Bruce Webb]

"some large portion of the houses being sold now are vacation homes or for speculation"

Bingo. There are huge incentives built into the tax code for owner occupied housing. You have to buy housing for yourself in one manner or another so you can discount the cost of rent. You get a writeoff for taxes and interest so you can discount roughly 20% of those costs. That is your starting point for whether investing in an owner occupied residence makes sense. Your actual investment is the margin between what it would cost to rent added to what your tax liability is reduced from property taxes/interest compared to your mortgage payment. In a lot of markets that monthly investment is pretty close to zero, the trick is having the down payment in the first place

I am a veteran so I was able to use my VA guarantee to get me into a zero/zero: no money down, closing costs folded into the loan. I moved from renter to owner for less than $200 dollars. At this point I can only lose money on this investment if housing moves south at more than the rate of my savings on rent and my tax break combined with whatever principal I am repaying. My condo would have to be shedding value at about $1200 per month to make that happen. If you want to be hyper-technical you could discount that against whatever interest you could otherwise earn of your principal payment, but in the early years of a typical loan you are talking pennies. So once you are in to owner-occupied housing you are on the gravy train: all the appreciation (due to new capital gains rules) is taxfree, and your ongoing investment is largely offset by whatever the value of having a place to sleep and store your belongings (with your own key) would cost you otherwise.

The key here is "owner occupied". Me buying a house for $350,000 in my neighborhood may make perfect sense, some dude in Phoenix paying that same amount for that same house may be a perfect idiot. Because he gets pretty much zero of the offsets I get.

So we can prick the housing bubble, real estate can flatline and even decline and most owners in most markets will not suffer any real hardship. They can just ask themselves "would I be saving money by renting?". And five or six years into any conventional loan the answer will be "Hell No".

I issue building permits for a living, so I have a finger on the housing market. In Northwest Washington State inventory is tight and prices are strong but I have only seen a couple signs of speculation. I did have a couple of out of state buyers last week picking up 56 acres that had been on the market for a long time, they made some assumptions about development potential that were not supported by the zoning. Oops. I had some calls about a property in my County being auctioned in Arizona that was not actually a legal building lot. Oops, oops. Someone is going to buy that property, someone is going to have a rude surprise.

I believe the bubble is real, it is even popping up here, and raw speculators in real estate may be up for a shock, but for owner occupied housing the only immediate question is whether you can afford your current mortgage payment compared with whatever alternative you would be faced with. If I worked for an employer that moved me every three years I might be worried. But as long as you are able to stay in the same job/housing market there is a big cushion built in.

[Bruce Webb]

I don't mean to discount the risk. I have a acquaintance in construction who bought a fixer based on sweat equity, a guy who was pushing his credit right to the edge and still thought it a good idea to borrow money at a big rate to buy tech stocks. Right before the bubble burst. I have another friend who has a good job at a good wage who inherited the house he lives in. He invested in tech early and rode the bubble right to the top. We begged him to cash out even a third of his gains, we are talking a guy making $40k sitting on close to a $1,000,000 in stock. But by God he was going to sit by Cisco and Intel.

I had to change bars. Because I am kind of a "I told you so" guy and I liked both of these guys too much to pull that on them.

[anne]

Paul C

Interesting comment to think about, as I will.

Bruce Webb

I do understand.

[A. Zarkov]

Bruce Webb:

“So once you are in to owner-occupied housing you are on the gravy train: all the appreciation (due to new capital gains rules) is taxfree, ...”

Not as I understand the tax law. Having just sold my primary residence, I looked into this. If two people own the property then they get a $500,000 exclusion. If a single person owns it, then the exclusion is $250,000. For example if I buy my principle residence for $500,000 net of all fees and expenses, and sell it for $900,000 net of improvements, commissions, repairs etc., then I will pay capital gains taxes on $150,000. It must be my principle residence for at least two years. It doesn’t matter if you buy a new house, or keep your $250,000 profit. That’s the current tax law as I understand it.

[anne]

Bubble or else :)

http://www.nytimes.com/2005/05/27/business/27hedge.html

Hedge Funds Are Stumbling but Manager Salaries Aren't
By RIVA D. ATLAS

At hedge funds, the rich just keep getting richer.

Across Wall Street, fees for businesses from trading stocks to investing in mutual funds have been falling. But at hedge funds, those exclusive investment partnerships for the wealthy and institutions like pension funds, fees have stayed dizzyingly high, even as billions of dollars have poured into the industry and performance, on average, has faltered.

Last year, the top-paid hedge fund manager, Edward S. Lampert of ESL Investments, earned $1 billion, according to a survey to be released today by Alpha, a magazine published by Institutional Investor that follows hedge funds. That is the highest sum in the four years the magazine has been tracking these managers' incomes.

The average hedge fund manager on Institutional Investor's list of the top 25 earners made $251 million in 2004, up from nearly $136 million three years earlier.

The secret to the wealth of hedge fund managers is how they get paid. Instead of receiving a fixed percentage of the funds they manage, as mutual fund managers do, hedge fund managers generally make '1 and 20' - 1 percent of assets under management and 20 percent of profits.

That means that a $1 billion hedge fund manager earns $10 million just for opening the doors, and a lot more if his fund performs well. Investors are willing to pay more for these managers' talents because, at a time when stocks are doing poorly and yields on short-term Treasury securities are low, hedge funds hold out the hope of a better return.

This promise has become so seductive that the top hedge fund managers can basically name their price....

[anne]

Mentioning public investment lunacy

http://www.nytimes.com/2005/05/28/national/28coins.html

How does the Ohio Workers' Compensation Bureau come to decide to invest in rare coins, and are missing rare coins even rarer?

[anne]

http://abstractart.20m.com/Picasso-self_portrait.jpg

I have several especially rarer than rare Picasso's. Of course, Picasso's really do hold value, and I so dearly love the work, but still :)

[Daniel Rodríguez Herrera]

Brad, how is it that the austrian business cycle theory was not a plausible theory of the Great Depression? Hayek did predict, using that theory, that the Great Depression was coming.

[anne]

Brad DeLong

'The problem with Rothbard's argument is that the Great Depression was a credit-collapse depression, not an overinvestment-hangover depression. Wage levels did, after all, fall by a quarter between 1929 and 1933, and there were no signs that that was stimulating employment in sectors that ought to have been expanding. The reason? They couldn't get any financing because deflation had crippled the financial system.

'The right way to bet is that further deflation a la Mellon would have made the Great Depression even worse. To talk about an overinvestment-hangover in 1933 was, as British monetary economist R.G. Hawtrey put it at the time, the equivalent of "Crying, 'Fire! Fire!' in Noah's flood."'

[Dan]

I need more convincing on the causes of the Great Depression. It seems that the overinvestment of the late 1920s led to the credit collapse of the early 1930s.

[A small role only. It was the *deflation* of 1930-1933 that played the major role in the credit collapse. There simply wasn't that much "overinvestment" no more than in 1907 or 1893--and yet the Depression was much, much bigger.]

There were asset bubbles in more than just the stock market in the twenties including a particularly frenzied real estate bubble in Florida. Overinvestment now leads to a credit collapse later as the worthless investments get weeded out of the system.

The thing about most economic theories in my opinion is that they are all right some of the time and wrong some of the time. The difficulty is understanding which setting is ripe for which theory.

[James]

Brad,

To call the great depression a credit crunch depression rather than the result of overinvestment is to misunderstand Austrian business cycle theory. In ABCT, the central bank first drives rates too low which induces entrepreneurs to make investments in types of capital not suited to producing the goods that people actually want. Just the same, these businesses are able to get by while interest rates remain low. Subsequent rate increases (that you call the credit crunch) increase costs and push those businesses out of the range of viability and the results are liquidation, unemployment and depression. But ABCT includes these "credit crunch" effects from rate increases as well as the expansion. For a very good recent treatment of ABCT, see http://www.auburn.edu/~garriro/strigl.htm by Garrison. The parts of the cycle that Garrison calls forced saving correspond with the "credit crunch" to which you attribute the depression of the 1920s and 30s.

[Brad DeLong]

Rate increases? What rate increases? The Federal Reserve *lowered* interest rates sharply from 1929-1933. The "credit crunch" was the result of deflation rather than of interest rate increases.

[jm]

"The right way to bet is that further deflation a la Mellon would have made the Great Depression even worse."

But is this necessarily the right way to bet?
It is also possible that deflation just did not go far enough. Clearly it did not go far enough to reignite demand in the absence of money supply growth through the fractional-reserve banking mechanism.

But as the URLs posted earlier testify, the Hoover adminstration engaged in numerous stimulative policies, and the common belief that Hoover followed Mellon's "liquidate...liquidate" advice is completely opposite to the truth. And though Hoover's actions were followed by Roosevelt's even more stimulative policies, the economy continued to languish for seven more years. Why did the credit-generating mechanisms not recover?

We are now engaged in a great experiment on whether the employment of extreme measures to prevent credit collapse and deflation after an excess-liquidity fueled bubble can in fact enable a smooth return to normality.

As of this moment, these measures seem to have prevented deflationary collapse only by creating a second bubble in real estate whose disintegration may cause even more grievous harm. Perhaps there is no painless way to recover from a binge, and Mellon was right that it's best to liquidate and purge the rot as quickly as possible.

If Mellon was so wrong, how did the economy recover from the 1870's depression? Was there no credit collapse in the depression?

[jm]

I have a strong suspicion that, once a central bank has allowed a liquidity-fueled speculative mania to develop, an eventual deflationary collapse is inevitable -- though it may not come until repeated attempts to escape by inflation have reached Weimar Republic levels of insanity.

As more and more of the public becomes convinced that deflation will never be allowed, the "moral hazard" effect takes over as we see it taking over today in real estate.

The stock market bubble can't even really be said to have ended. Most of my friends remain convinced that stocks will continue to be a good investment, despite the fact that P/E ratios remain near historic highs, and are at least twice the levels normally seen at market bottoms. We can see from the mutual fund statistics that there has been no real retreat from stocks.

[Russell Nelson]

Brad DeLong:

How can a deflation cause a "credit crunch"? If the currency is being deflated at 5% per year, I would be happy to loan you money at zero percent because I'd make 5% per year.

[No you wouldn't, because your borrower's revenues have been falling at 5% per year, and they don't have the cash flow to pay the interest on their existing loans. You really don't want to be a junior creditor to somebody already underwater.]

[anne]

Ah, yes, but I must be willing to borrow and you must wonder whether I will be able to pay you back or whether the security will be worth what it was when you appraised it. After all, I will be paying you with ever more valuable dollars if I can :)

[Russell Nelson]

Well, then, I just don't see anything different about a change in the price of money downwards versus upwards. You adjust the nominal interest rate to set the real interest rate, and you take your chances just like always. The real problem when the price of money changes is that you'll get stuck on the wrong side of the chance. That's why relative price stability of money is a commerce enabler.
-russ

[jm]

Russell Nelson:

Easy-credit fueled booms in which people buy assets without repect to their true value always come to a bad end. The assets' prices must then fall to below their true value before anyone will want to buy them.

You can see this in Japan, where real estate prices had to fall about 80% from their peak before people started buying. Until the fall, it was a classic "greater fool" market, with nearly no limit on the prices people would pay, and banks willing to lend 100+% of value in loans with land as collateral (because real estate prices could never go down).

But today, the dictum in Japanese real estate is "Kane wo umanai fudousan wo kau na!" ("Never buy land without positive cash flow!") Since it took years for prices to fall the 80% needed to make that possible, while landowners kept praying that if they could just hold out a little longer the good old days would return, the market simply congealed. Land wasn't even sold when people died and their heirs owed inheritance taxes -- they just let the government confiscate the land (and the government warehoused it rather than selling it, to keep prices from falling even lower).

When no one is willing to sell at a price anyone is willing to buy at, no transactions take place, and no new loans are made.

[jim brady]

mmm..

This shows me just how ignorant the great really are about what to do in extreme financial circumstances. Humble me too. But I have a few random thoughts that may prompt some thoughts in others:
1. I have always thought that the Japanese problem was a good argument for really getting away from an obsession with the pro's and cons of redistribution. Nobody ever says it, but I think what the Japanese should have done was to print (yes print) money and spread it as evenly through the population as they could. No build up in debt which just accumulates to the rich and raises future taxes on the poor. No bailing out of the rich. No subsidies to building cum civil engineering tycoons. Give the money to people who will spend it. After all the Japanese were running a surplus, they just needed to spend more. It would have popular and effective. (I'm not sure whether the IMF/WTO rules would allow though, and I know the Japanese Law did not allow it at the time).
2. The problem for the US is that it is not running a surplus. Au contraire! This is the real crux of the issue. Domestic policy in such an environment could end up having perverse consequences. If the US just printed money to stave of deflation, it could be the tipping point that leads to a US dollar implosion, with massive real income effects, real interest increases, maybe hyperinflation and unknowable international repercussions.
3. One problem with the simple keynesian view is that it doesn't take enough account of the problem of moral hazard. Perhaps the Austrians express themselves clumsily but this is the only sense in which the need for a payback is something more than psychobabble (they are Austrian after all). Risk margins having been sinking into very dangerous territory. No amount of ex-post reaction will be able to avoid a painful adjustment and new sources of growth will be needed. The real problem in the current US Economy is not excessive productive capacity, but too much unproductive investment. That one of the fastest growing cities in the US in the last decade is Las Vegas is a symptom of the problem. The US Economy resembles a vast Casino. You need a way of reflating that still punishes the irresponsible.

P.S. To out myself I'm a perennial sceptic of every school of orthodoxy. I don't think any view of the world always is relevant. In this case I see a problem with the old free trade holy cow. Yes you will enhance productivity by free trade. But you also lose policy levers (see point 2 above) and you import insecurity (i.e. increase risk). This is particularly today with the massive shock to the world trading system caused by the fall of the iron curtain. I'm not in favour of complex preferential and quota systems, but I still believe significant revenue and marginal protection providing tariffs make sense, particularly when income tax rather than VAT raises the most revenue.

[Jennifer]

"That one of the fastest growing cities in the US in the last decade is Las Vegas is a symptom of the problem."

Interesting.

[jm]

"...but I think what the Japanese should have done was to print (yes print) money and spread it as evenly through the population as they could."

Printing money in such a manner is simply fraud. Economics is about achieving optimal allocations of resources aligned to society's true desires. This requires honest, accurate communication. It has been found that the best way to accomplish that is, generally, to do the communication through prices. When the prices are falsified, things start going wrong.

"No build up in debt which just accumulates to the rich ..." Is everyone who has been frugal and saved money to be considered rich? Most of the people I see who are commonly considered "rich" did not attain that position by saving money and lending it out, they attained it by borrowing vast sums at interest rates suppressed by the machinations of politicians and bureaucrats (and often by finding creative ways to not pay it back -- but that's a separate issue).

[jim brady]

jm
I was arguing that this should be a general policy, in which case your arguments would be perfectly valid, but only as an emergency measure to ward off the greater evil of debt deflation. It can not be accused of appropriating peoples saving when there is deflation.
The problem Japan finds itself in now, is that it still has deflation, but now it has the time bomb of expanding debt. If it didn't issue the debt, but found other direct ways to encourage spending it would be better off. And it wouldn't have the problem of the huge pile of foreign reserves it has built up. The build up of government debt also acts to crowd out riskier private investment.

[jim brady]

jm oops - that should read
I was NOT arguing ...

[chris]

ooww las vegas
ain't no place for a poor boy like me

[Dave]

"Many home purchases are speculative; the National Association of Realtors estimates that 23 percent of the homes sold last year were bought for investment, not to live in." - pk

Just a comment on his numbers here. ONLY 23 percent of homes were bought for investment. That means 77 percent of the housing market is for consumption. Before we all worry about a bubble here, let's just remember that most of the housing market is NOT bubbling with speculation. Perhaps at least a part of it is due to recent technology advances that allow people to live in nicer climates. I won't elaborate on that here. The point is if just housing prices were to collapse, 77 percent of house owners would still have their homes and the gains of living in that house before a collapse. The speculators would have no such gains. As such, those that misspeculate will face the greatest losses.

I'm sure the austrians here understand that the real problem here is credit expansion, as alluded by Mr. Krugman's quote of Paul McCulley on how homeowners were able to refinance themselves deeper into debt. From Mises, "When the interest rate is artificially lowered by credit expansion the false impression is created that enterprises which previously had been regarded as unprofitable now become profitable." That same wise man, "But it is... clear that even the greatest expansion of credit cannot change the difference in the valuation of future and present goods." He continues to with the assumption that credit expansion will create inflation which will cause businessmen in nearly unprofitable ventures to turn the credit expansion boom into a credit expansion bust, unless there is a further credit expansion or interest rate reduction.

Although the "housing bubble" is an interesting topic, I do believe the Austrian argument is more with the credit expansion. A lot of the discussion seemed to be more about housing speculation, which seems minimal at 23% of that market.

Which leads me to the speculation, maybe we aren't headed for a depression because the late 90's bubble was largely a tech sector bubble rather than a system-wide bubble, as was the case in the Great Depression. Nearly everybody speculated on the market in general, but not everybody speculated in tech, just as not everybody is speculating in housing. Then again, I'm a young optimist just hoping not to live through a depression created by the old fools running the show.

A link for the Mises quotes: http://www.mises.org/etexts/mises/interventionism/section3.asp