It’s surprising how often I agree with Dean Baker. In It’s the Housing Bubble, Not the ***** Credit Crunch he writes:
No one will lend me $1 billion, that’s how bad the credit crunch has gotten. There are probably reporters at major news outlets who would print that.
…they are still badly misinforming the public, first and foremost by attributing the economic downturn to a credit crunch.
This is truly incredible. Homeowners have lost more than $5 trillion in housing wealth. There is a very well established wealth effect whereby $1 of housing wealth is estimated as leading to 5 to 6 cents of annual consumption. This implies that the loss of wealth to date would cause consumption to fall by $250 billion to $300 billion annually (1.7 percent to 2.0 percent of GDP). If you add in the loss of around $6 trillion in stock wealth, with an estimated wealth effect of 3-4 cents on the dollar, then you get an additional decline of $180 billion to $240 billion in annual consumption (1.2 percent to 1.6 percent of GDP).
These are huge falls in consumption that would lead to a very serious recession, like the one we are seeing. This would be predicted even if all our banks were fully solvent and in top flight financial shape. Even the soundest bank does not make loans to borrowers who it does not think can pay the loans back (except during times of irrational exuberance).
Isn’t the credit crunch a major cause of the stock market wealth loss? Without that people would be wealthier and would thus spend more. Also, the credit crunch and its news cycle made housing demand even worse. While it is not everything, it is also not nothing.
Is the “well-established wealth effect” a simple correlation of spending and home prices?
The government can’t fix deflated property values unless they start buying up everybody’s homes, or send in units of the military to tear down the excess homes that have been overbuilt. But the Feds can fix a “credit crunch” by printing money. Perhaps then the media is a puppet of the government, who is trying to monetize the debt?
“Is the “well-established wealth effect” a simple correlation of spending and home prices?”
Surely you are aware that one of the central tenants of the religious left is that correlation proves causation.
Now that households want to save more, we need to make sure those savings are traslated into investment. Infrasturcture is a prime need: roads, bridges, airports. This will require ways to channel federal (borrowed) dollars to states and cities. A lower dollar will evenutally encourage investment in capacity for exporting.
Peter, Thanks. I’m going to analyze the S.F. Fed paper on my own blog for my own benefit. The problem is that when authors make claims based on studies, I like to see the actual study that they’re using myself. This was very useful recently when I analyzed a post on Reason by S. Chapman about wages. I managed to find the paper he quoted on my own, but it would have been easier if he had linked to it on his post. I did read the paper a bit differently than he did, so it turned out to be very useful. I’ve also seen statistics on borrowing against our houses over the last few years which, on first look, bothered me. But I’m still puzzled by the worth, if there is any, to these surveys comparing housing prices in an area and what homeowners believe their houses are worth. They remind a bit of studies done of people who eat out a lot, and are asked for the calorie count of their meals, and are surprised to learn that the two differ quite a bit. The question then becomes, when they are so informed, do they change their eating habits?
The recent drop in gas prices is probably comparable in value to the loss in wealth. Net we are in the same place.
I will lend you so much money but I have not so much money..
Is it realistic?
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