Paul Krugman rolls the videotape:
Wrong To Be Right: Yves Smith says most of what needs to be said about the Boston Fed study saying that nobody could have called the housing bubble. I’d just add that it’s helpful to look at what we knew back when. Here’s a picture from Kash of house prices up to early 2005; by the way, these were OFHEO prices, which most now believe understated the rise, which was better shown by Case-Shiller. But here’s what it looked like.... Given this kind of picture — and given the fact that the late-80s rise in southern California was, in fact, a bubble — how could you not be very worried? And when you looked at the rationalizations for high housing prices being given at the time, it was obvious that they were questionable.
Sorry: the evidence just screamed bubble. No excuses for those who didn’t want to hear it.
I was one who thought I was relatively sympathetic to the "housing price rises are justified" arguments--after all, I believed in the global savings glut which should permanently reduce real interest rates and so raise the prices of long-duration assets, I believed that it was rational to expect higher oil prices in the future and thus greater locational land-value differentials, and I believed that America had filled up for many purposes--that housing prices would rise on average in the future, and an expected continual rise makes it rational for prices to jump now.
As I wrote in 2005:
May 24, 2005:
Housing Bubble - Grasping Reality with Both Hands: Up until six months ago, I could account for housing prices in terms of scarcity (they aren't building many houses near the California coast any more) and low interest rates. That's getting less possible with each passing day...
July 25, 2005:
Worrying About the Housing Bubble - Grasping Reality with Both Hands: Dean Baker is more than worried about the housing bubble.... "Given how far out of line house prices have grown from fundamentals, there is no way to avoid enormous economic damage when the bubble collapses. However, the sooner house prices drop, the less damage there will be."
I can see three scenarios for getting out of things without serious damage:
- Interest rates stay low for a long time, so the bubblyness of the housing market deflates gradually.
- The housing market collapses, but the dollar collapses too. If the Federal Reserve then follows an accomodative monetary policy, workers who lose jobs in construction and consumer services will be able to move relatively smoothly into jobs making goods for export.
- The housing market deflates at the same time that businesses' animal spirits recover, and so workers who lose jobs in construction and consumer services will be able to move relatively smoothly into jobs making and installing capital goods.
September 18, 2005:
Dealing with the Housing Bubble - Grasping Reality with Both Hands: 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.... [P]olicy 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... 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... the Fed [would have] time to cushion the impact.... In answer to the third question... 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... 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...
Yes, people could have knowed. Some of us did.
