Dealing with the Housing Bubble

Mark Thoma reports Janet Yellen's views on the housing bubble:

Economist's View: Yellen: There is a Bubble But Don't Pop It With Monetary Policy: [W]hile I'm certainly not predicting anything about future house price movements, I think it's obvious that the housing sector represents a risk to the U.S. outlook.

This brings me to the debate about how monetary policy should react to unusually high prices of houses--4or other assets, for that matter. ... As a starting point, the issue is not whether policy should react at all; I believe there is quite general agreement that policy should be calibrated to the wealth effects of house prices on output and inflation. The debate lies in determining when, if ever, policy should be focused on deflating the asset price bubble itself. In my view, the ... decision to deflate an asset price bubble rests on positive answers to three questions. First, if the bubble were to collapse on its own, would the effect on the economy be exceedingly large? Second, is it unlikely that the Fed could mitigate the consequences? Third, is monetary policy the best tool to use to deflate a house-price bubble?

My answers to these questions in the shortest possible form are, "no," "no," and "no." ... In answer to the first question on the size of the effect, it could be large enough to feel like a good-sized bump in the road, but the economy would likely to be able to absorb the shock... In answer to the second question on timing, the spending slowdown that would ensue is likely to kick in gradually... That would give the Fed time to cushion the impact with an easier policy. In answer to the third question on whether monetary policy is the best tool to deflate a house-price bubble, ... For one thing, no one can predict exactly how much tightening would be needed, or by exactly how much the bubble should be reduced. Beyond that, a tighter policy to deflate a housing bubble could impose substantial costs on other sectors of the economy that would lead to equally unwelcome imbalances. Finally, it's possible that other strategies, such as tighter supervision or changes in financial regulation, would not only be more tailored to the problem, but also less costly to the economy. Taking all of these points into consideration, it seems that the arguments against trying to deflate a bubble outweigh those in favor of it. ... But let me stress that the debate surrounding these issues is still very much alive.

Comments

[Barkley Rosser]

Furthermore, every time the Fed attempts to "tighten" (by raising the fed funds rate), long term rates, and thus mortgage rates, seem to go down, or at least do not go up. So, how are they supposed to squeeze out such a bubble anyway?

I saw Lawrence Lindsey give a speech in Washington last week in which he forecast that "liquidity problems" arising from the end of the housing bubble would cut somewhere between 1/2 and 2% off the growth rate of US GDP next year. Do not know where he got those numbers.

[Jean-Philippe Stijns]

I just love how Fed economists, however brilliant, seem to be all in denial of their paying attention to asset prices. As if the latest string of interest rate hikes did not have anything to do with them. Of course, it's sort of part of a Fed economist's job description to say things like that since, for one thing, asset prices are not officially part of the Fed's legal mendate. In any case, since people tend to spend when their stock portofolio goes up and borrow when housing prices do, these two aggregate asset prices are as good as any other leading indicators of spending and liquidity and therefore just as useful to target, it would seem to me...

[kharris]

JP Stijns,

I'm not so sure Fed folks are denying that they are looking at asset prices. In fact, they seem unable to shut up about asset prices. In the past, they have also made clear that, while they don't target asset prices per se, they do take into account the real economic impact of asset price changes. When real estate driven employment is a major factor in closing the output gap, when rising consumption is driven in very large measure by rising home values, saying that you take into consideration the real economc impact of asset price changes is a pretty strong statement.

[save_the_rustbelt]

Just to repeat myself, most of the country does not have a housing bubble, or anything close.

There is a country between the east coast and the west coast, if some of you care to notice.

[Bruce Wilder]

Part of the "policy" difficulty, which Ms. Yellen must get around is embarassment. It is very convenient for Ms. Yellen to talk about whether the Fed should be deflating the housing bubble, a year or two AFTER such a policy would have been sensible.

Another part of the "policy" difficulty is the bizarre fixation of policymakers on the Fed Funds Rate target. Perhaps this is an academic disease, a tendency to fix on simple abstractions. If the economic situation calls for moving long-term rates, they should move long-term rates. Talking about the housing bubble is a convenient way of avoiding questions about the yield curve.

And, finally, there's the sleight of hand involved in Ms. Yellen's final pass: "Finally, it's possible that other strategies, such as tighter supervision or changes in financial regulation, would not only be more tailored to the problem, but also less costly to the economy." Gee, you think the Fed has anything to do with the regulation of banks? Hmmm.

[s9]

save the rustbelt writes, "There is a country between the east coast and the west coast, if some of you care to notice."

Yes, but let's be honest... how many of the nation's houses are located there? Have you *been* to Wyoming lately?

[bakho]

It is nice to know that the Fed has the good sense to know when to butt out. The housing bubble could best be addressed by changing the loan requirements. Unfortunately, Congress is not about to buck the banking, developer and real estate lobbies. The proper way to have addressed the 1990s stock bubble was with tighter SEC rules and oversight, but Congress didn't want to buck the lobbyists then, either. Money has corrupted our politics to the point that Congress will no longer stand up for the best interests of the American people.

[Jay]

I've got some questions. Is it possible that lowered progressiveness in the tax structure can contribute to an asset bubble? After all, the number of houses stay the same, and the number of people that think they are entitled to that caliber of house stays the same, but they've all got more cash because of the tax cuts.

Since there is little to no housing bubble in the middle of the country, is it also true that income differentials are less in the middle of the country? So that the tax cuts had less of an effect, or affected a smaller percentage of the people in Kansas than in California?

Is the difference between the top and bottom quintiles of home prices less in Kansas than CA? What about the top and bottom quintiles of income? Is there a connection?

Is there a sort of "top-end-only" inflation that kicks in? There's only one house at the top of the hill, and the guy that owns it paid one dollar more than the second bidder. If they doubled their money, the bids would be correspondingly higher. Frankly, I've been wondering whether you can make the case that a more progressive taxation scheme doesn't really affect anyone's standard of living by much, or restrict their choices much.

[Ron Sturtevant-Stuart]

I noticed an article in the paper the other day, that suggested that low interest loan companies are not performing very well, and told my wife that this might well be the tipping point...

Ron

[Jonathan W. King]

s9 writes:
>
> Yes, but let's be honest... how many of the nation's houses are located there? Have
> you *been* to Wyoming lately?

There are rather a lot of houses in the Midwest, I can assure you of that just by looking around. :-) But it's easy enough to see why you really can't have much of a bubble through large chunks of the Midwest: even if millions of people were moving in every year, most of the growth would or could occur where the next best and highest use of the land needed to build housing would often be "cow pasture". I live in Columbia, MO, and the pattern of single family housing development here is pretty easily predicted by looking at where the next decent-sized chunk of marginal agricultural property is. And Columbia is growing a lot faster than Wyoming or North Dakota; about 2% per year over the last 15 years or so. Housing prices are pretty close to flat in real, mortgage-rate-adjusted terms.

On the one hand, this makes Columbia a lousy place to play any speculative games (unless you're building retail or apartment buildings for students), and it means that you really won't be bragging about how fast your house is appreciating. On the other hand, I'm guessing that when the bubble markets do pop, some of the people who will have lost a ton of money won't be able to buy where they used to live (ironically enough) but will be able to buy in your better college towns in the Midwest.

I think my greatest fear is that the puncture of the housing bubble could come back to haunt us in other ways. I always worry about random hedge fund traders and how their illiquid and exotic positions could interact. I've never heard anybody from the Fed or anywhere else say anything convincing along the lines of "we have a good handle on what the hedge fund and derivatives guys are doing".

[piotr]

To elaborate a bit on bakho: the proper tool to deal with a bubble is to adjust regulation.

Note that what we are talking about would be rules concerning downpayments and interest only mortgages. Perhaps one could limit the percentage of mortgages that an originating lender can pass to other institutions (so they would bear at least some of the risk). Such rules would do nothing to affect the asset values in less heated market and even less to affect job-creating investments.

[Barkley Rosser]

Given the reaction of the long term bond markets to the Fed's increases in the fed funds rate, probably what they should do if they really want to push up long term rates in an effort to pop or squeeze the housing bubble is to lower short term rates. I am only half kidding.

[a]

Do you want housing prices to go down without touching interest rates? Decrease the tax deduction for mortgage interest...

[realist]

there may be something going on between the coasts, but 51% of the land mass in the continental u.s. contains less than 3% of the population.

many of these areas don't need a bubble to pop. colorado has the highest forclosure rate, and texas has the highest number of foreclosures. had there been a bubble in those states, this wouldn't have happened.

i agree that the fed is too late to do anything about the bubble, and greenpan didn't like being blamed of 1987, backed down in 1996 and, in the last year, encouraged buyers to use adjustable rate mortgages. anyway, it looks like fnma may pop the bubble without fed help.

[James Wimberley]

For an allegorical musical version of Das Kapital, with updated economics: Capital (Catherine Zeta-Jones in her "Chicago" night-clup vamp outfit) sings "I'm forever blowing bubbles.."

[save_the_rustbelt]

s9:

I wish I had been to Wyoming, I know some trout are waiting for me there.

Last I looked at the map, Cleveland, St. Louis, Chicago, Columbus, Inidanapolis and many more are in "fly over" country.

The feds are working hard to destroy our jobs so Wall Street can be more prosperous. Who wants those dirty old manufacturing jobs anyway?

"Fries with that?"

[bakho]

Location, Location, Location. The coasts have bubble prices, because location is so much more important. In the Midwest, one marginal cornfield is about as good as another. It is only a matter of running sewer and water. Instead the Midwest goes through a cycle of overbuilding followed by a bust of a decade or two it takes to populate the overbuilt units. This keeps prices from going up, but does not necessarily keep prices from going down. The challenge in much of the Midwest is getting Urban renewal. Many of the cities and small towns abandon the housing units downtown, leading to urban blight. College towns have the advantage of converting older houses first to Kiddie Condos and then tearing them down to build student apartments. However, much of the non-college town Midwest lacks that dynamic of a sizeable population with money for rents, but no automobiles (or the lack of ability to park on campus and thus to drive.)

[glenn hefner]

Save the Rustbelt, I, too, am from the Midwest - Central Illinois, from a town surrounded by marginal cornfields. It may be true that most of the US geography is not part of the bubble, but I think you're kidding yourself if you think those in the midwest won't be hurt by the popping of multiple bubbles on the coasts, throughout CA, FLA, Phoenix, Las Vegas, and wherever else. The echo of the bubble popping could be much louder than original noise.

[matt]

save the rustbelt:

The feds are working hard to destroy our jobs...

I thought all this started when the corporate geniuses decided to escape the onerous unions and decided to move to more business-frinedly environments. Then it became unprofitable for them to pay decent wages to the people they employed because of transfer pricing policies of transnational corporations, in most cases, their own overseas subsidiaries, so the cost of labr had to be decreased again until the only way someone could reasonably expect to feed their family was to become a "contractor" working o other people's homes, or holding down two jobs.

The feds are complicit in this by allowing corporate thieves to transfer profits off-shore without paying their way and by ignoring the fact that no court decision has ever affirmed the rights of a corporation as an individual. Until that little fiction is fixed by popular rejection of the concept and by some brave future court overturning Santa Clara County, or better yet, clarifying that decision to strip corporations of their phony personhood, stop laying the blame at the doorstep of the feds. It's the avarice and complete lack of conscience on the part of corporate America that has cost this country jobs.

That and the fact that the very people who would benefit from the lost jobs cheer their heads off whenever another union is busted speels doom for us.

[Jonathan King]

bakho writes:
>
> The challenge in much of the Midwest is getting Urban renewal. Many of the
> cities and small towns abandon the housing units downtown, leading to urban
> blight.

This is the one thing that still has me scratching my head. Around Columbia, there are several small cities with what could be beautiful downtowns that have been all but abandoned. But, in most cases, it wasn't to build anything that would be an obvious magnet to draw you away from downtown. Instead, you get either isolated or clustered trailers in the middle of nowhere, or bad housing built decades ago that should be written down as a loss. I know that part of the problem is population loss, but that doesn't explain what happened to (say) Moberly.

> College towns have the advantage of converting older houses first to Kiddie
> Condos and then tearing them down to build student apartments.

And there's another route: put the faculty members in the older houses and fix them up. I guess the commonality here is that you've infused a fairly large amount of money into communities that also have stable or growing populations. And you also have a centrally located employer, which means that in-town locations do have some added value (sometimes not a lot, but at least the number isn't negative).

> However, much of the non-college town Midwest lacks that dynamic of a
> sizeable population with money for rents, but no automobiles (or the lack of
> ability to park on campus and thus to drive.)

Columbia is not the only college town in the whole world, but there are relatively few students who don't have cars here. I used to think the bid determinant would be the lack of cars, but I don't think it is just that. Students also like to congregate, and I'm guessing they actually prefer a higher density to some degree. From my perspective, they only flee to the suburbs or exurbs when they leave school, get married, and have kids. And that might be another advantage of college towns: they're usually full of faculty children who do their part to raise standardized testing scores. I didn't think I would ever see this, but more students in Columbia are hanging around the place after they graduate, and what *looks* like an increasing number then don't leave. I guess you could call this the "Madison Effect". It's the Madisons of the Midwest that seem to be doing the best these days, and while housing prices are going up, it's just nothing like Boston or San Diego. This is probably a good thing in the long run.

[Jussi]

Can someone please explain to me how 'housing bubbles' are NOT anti-social?

Don't they encourage needless spending on whims, and make affordable property unaffordable for those on the lower rungs?

[Dano]

Johnathon King writes:

From my perspective, they only flee to the suburbs or exurbs when they leave school, get married, and have kids. And that might be another advantage of college towns: they're usually full of faculty children who do their part to raise standardized testing scores.

Correct. This is seen in the Soc. and even microecon literature where there are more advantages to the young (loosely: creative class) in cities as there are more choices. After your choices are made, you get out of the noise and bustle to the burbs. Not everyone, but many.

Best,

D

[wkwillis]

When the dollar renormalises and we have to start making our own stuff again, you flyover people will have your housing boom to offset their metrocoastal housing bust.

[piotr]

A comment on students with cars. At Penn State, students do not get good places to park, which means that they would need to take a bus from te parking lot, which means that one can as well take the bus to campus if they live off campus. Thus there is big market for appartment complexes, and this also create supply and demand for appartments of somewhat higher standard (grad students, young faculty, and other moderate income persons, then there are well-to-do retirees etc.) Thus the market gives some suburban/exurban sprawl but also high density developments, and the downtown is lively -- stores go out of bussiness no more frequently than in the malls.

Surrounding non-college towns often experience blight because of factory closures etc.