The present crisis has been labeled a “financial crisis”, the conventional wisdom being that its roots can be found in the housing boom and subsequent bust which, on its turn, was the result of lax monetary policy, with the Fed having kept interest rates “too low for too long” during 2002-2005.
I deal with the housing boom. This can be divided in two parts: “Overbuilding” and the “House price bubble”.
The idea that there was a building “frenzy” in the 1990s and 2000s is illustrated in Chart 1. The somewhat cyclical pattern of house starts is broken in 1990, after which starts increase almost continuously for the next fifteen years to 2005.
As Chart 2 indicates, that is consistent with the rise in the rate of population growth, which rose form 1% in the 1965 to 1989 period to 1.2% for the next 10 years. A substantial portion of this rise was due to immigration, with the number of immigrants doubling from an average of 500 hundred thousand prior to 1990 to 1 million thereafter.
Chart 3 shows that the house stock population ratio reached a ‘steady state’ in the late 1980s. It appears, therefore, that the rising trend in house starts was just sufficient to maintain the house stock-population ratio constant.
Interestingly, note from Chart 1 that in 2000 and 2001 house starts dropped somewhat, bringing the house stock-population ratio below the “steady-state” (SS) level. That mostly explains the so-called “crazy” number of house starts in 2002 – 2005 period. But as Chart 3 shows that was just enough to bring the house stock population ratio back to the SS level.
It appears, therefore, that there was nothing “suspicious” or even “speculative” about the 1991 – 2005 home-building boom. What about the construction bust that followed? Once you see that the house stock population ratio has remained close to the SS level, the construction bust reflects mostly the sharp drop in population growth, which has averaged just 0.89% since 2005. Also, because of the crisis, in 2009 – 2011 the increase in the number of households fell considerably. While household formation averaged 1.1 million in 2006 – 2008, it dropped to just 338 thousand in 2009 – 2011. In 2010 there was an absolute decrease 0f 82 thousand in household formation.
While the data do not indicate that there was house “overbuilding”, what about house prices?
The set of charts below graph the Case-Shiller Home Price Index (HPI) for six different cities in different regions and states of the country. Note that there is little, and frequently none, resemblance at all in the price behavior in different places. The shaded area in each chart represents the period during which interest rates were deemed “too low for too long”. Contrary to the conventional wisdom, I don´t see this fact having explanatory power for house price behavior.
The set of Charts below show the behavior of house prices for the states in which the cities in the above set are located. These are quarterly house prices from the Federal Housing Finance Agency (FHFA). Again, prices behave very differently in the different states. In addition, I compare house prices in Texas and Nevada and provide an explanation for the differences in price behavior that transpire.
Unlike California and Massachusetts, Nevada, like Texas, did not have aggressive land development and zoning law restrictions. But suddenly, after 2002, prices in Las Vegas (and in Nevada in general) soar. That may be signaling that speculative activity increased (maybe they took their casinos “to the street”). On the other hand, beginning in the early 2000s, environmentalists managed to obtain restrictive legislation on land development. This would have the effect of restricting house (land) supply and thus raising house prices.
Data on house permits (single units)may give some indication of what drove prices to soar in Nevada. In the Charts above observe that in Nevada permits increased significantly after 2002. Would this be related to expectations of increasing land development restrictions over time? The fact is that permit behavior in other areas did not change during the period. The Charts below illustrate the argument showing permit behavior for Nevada and Texas.
If it´s a bubble, it´s a funny one. In some places house prices increased a lot and fell relatively little, such as in Colorado and Massachusetts. In others, such as California, prices rose quite a bit and also fell hard. In Texas prices increased steadily but did not reverse.
In most places, prices peaked in the first half of 2006, more than two years before the “cow stepped into the swamp” (where the “cow” stands for NGDP). By the time NGDP “drowned” in the second half of 2008, house prices and house construction had almost finished the “adjustment”. (Again, Nevada house prices being an exception).
Despite all that, before the spending crash, in the second quarter of 2008 unemployment was still a “healthy” 5.3%. It would soon soar. Financial troubles had flared up in several institutions since early 2007. And by the time Lehmann folded, NGDP had already dropped by about half the final plunge.
A recession was maybe inevitable given the magnitude of the shocks. What was NOT inevitable was the recession becoming “Great”. That´s the Fed´s doing. Just as the Fed is mostly responsible for the sluggish (in fact, almost nonexistent) recovery. But never mind, there´s the ‘blanket excuse’ that this is what´s to be expected from a “financial crisis”.