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Deflating Housing Bubbles - The Reality

“Deflating Housing Bubbles - The Reality”

Hugh Pavletich
Co – author
Annual Demographia International Housing Affordability Survey
New Zealand

October 24, 2008

If one is prepared to accept what is generally portrayed in the media – the economy is pretty much run by Finance Ministers, Reserve Banks and Treasuries, “turning on and off the taps” to stabilize the economy, by tweaking interest rates and injecting billions here or there.

The reality however is considerably different.

“Inflating bubbles” are hugely popular and it is rare for the Authorities to alert the public to the significance and consequences of them. Politicians revel in the “bubble revenue” being generated. As these bubbles pop and deflate, the Authorities continue the charade, by conveying the impression that they have “things under control” and the capacity to provide “stability”. The term “fundamentally sound” is trotted out with nauseating solemnity and repetition.

With respect to housing - the “language” has changed over the years, to the extent that even economists, urban planners and property appraisers / valuers (who of all people should be “schooled” in the destructiveness of bubbles) have generally convinced themselves that property inflation is beneficial.

We had been constantly bombarded by economists / property commentators in the media, promoting the idea to the public, that housing inflating at 10 and 20% per annum is “growth”(with the income / price relationship completely ignored) which was further reinforced by the extraordinary concept of the “wealth effect” of property inflation. And confusing the terms ”boom’ and “bubble” as well. This is no different than a doctor telling you how much better you will be with cancer. Any member of the medical profession telling one that – would rightly be considered a crank or a quack.

Two years ago a US housing market commentator stating at one stage “It’s the growing markets that are having the problems”. If he had said “It’s the inflating markets that are having the problems” – he may have illustrated to the readers, that he knew what he was talking about.

But the “political dynamics” of an inflating housing bubble are the polar opposite to those of a deflating bubble. What we are currently experiencing globally – is an unprecedented “mother of all bubbles” deflating - creating massive political, social and economic disruption. As these costs become increasingly obvious, the “constituency for change” is quietly strengthening. Once these “costs” are adequately appreciated and understood and felt – the general public and policymakers will be in no hurry to repeat the experience.

Something similar – but hopefully not as severe - as what the Germans experienced with hyper –inflation through the years of the Weimar Republic – which has instilled through the generations a lasting aversion to inflation. We should not be surprised the German housing market has the policy settings in place to minimize the risks of housing inflation.

As these current bubbles (led by the unprecedented housing bubbles) are deflating – also deflating is the political and public esteem for the three major professions involved with these issues –urban planners, economists and property appraisers / valuers. They all have much “soul searching” to do.

One only has to observe the confusion - and indeed panic - within the economics profession at the moment –and the near unanimous calls in vainly attempting to “re liquefy” the collapsing bubbles (with furious advocacy from the self serving - in the main business players such as Wall Street, the US National Association of Realtors and the National Association of Home Builders - for example) – without considering for a moment, the true costs of allocating scarce recourses in these endeavors – and even - whether they work or not. Most of this “good money after bad” taxpayer funded welfare will end up down a big hole – never to be seen again – and likely prolong (like the Japanese 1990 bubble) the recovery process.

In the “panic to re liquefy’ –the most important structural issues have barely been considered.

One shouldn’t be surprised by this – as former Federal Reserve Chairman Dr Alan Greenspan is well known for stating that “one doesn’t know there is a bubble until after the event” (UK Independent article 2002 Outlook: All is vanity as Alan Greenspan bubbles in Jackson Hole - Business Comment, Business - The Independent). The Economist expressed alarm mid 2005. Even as late as around September 2007, it was clear that Dr Greenspan failed to grasp the enormity and significance of the unfolding events (Financial Times Report and Reuters Report).

During 2005 - the current Federal Reserve Bank Chairman Dr Ben Bernanke, just prior to being nominated to the position in testimony to the Congress, stated that he did not think the current boom in housing was a bubble, as reported in the Washington Post Bernanke: There's No Housing Bubble to Go Bust. Dr Bernanke got the position, it would appear, because of his deep understanding of the Great Depression. And no doubt because of his “profuse apology” on behalf of the Federal Reserve November 8, 2002 in a speech on the occasion of Milton Friedman’s 90th Birthday – for the Feds role during the Great Depression.

By October 2008 he was obviously having a “180 degree rethink” as this report Fed Rethinks Stance on Popping Bubbles - indicates. In the meantime, within the establishment ranks of economists, it would appear others besides Dr Bernanke are having a “rethink” – if this recent Speech: The Limits of Central Banking (October 8, 2008) - Philadelphia Fed by Charles I Plosser, President and CEO of the Federal Reserve Bank of Philadelphia is any guide.

Is it good enough that these be “learning on the job” positions – with respect to what could be described as “fundamental knowledge”?

Dr Anna Schwartz, now 92, (wife of the late Milton Friedman) as reported The Weekend Interview - “Bernanke is fighting the last war” – is with much justification – a highly respected economist. While no doubt the appropriate responses may have to be somewhat more nuanced than Dr Schwartz is suggesting within this short article (she is a breath of fresh air however) –one wonders if the interventions to date have been more of a welfare scheme for the finance sector and business interests – or - in the wider public interest.

Why is it that economists, urban planners and property appraisers are so confused about the dynamics and consequences of property market bubbles – when property industry practitioners and particularly “market developers” are acutely aware of them?

These issues are discussed within Scoop: Housing: Taking A Bubble Bath To Reality; Scoop: Housing Affordability – The Shift To Reality; Scoop: Understanding Housing Bubbles and Scoop: Bank Economists At Sea On Housing. The reality of course is that experienced property market practitioners know full well they likely face bankruptcy, if they don’t understand the dynamics of property market bubbles.

Put extremely simply – the magic number is “3”. If urban housing markets exceed this (allowing for reasonable geographic and / or physical constraints) on the Median Multiple (house prices divided by gross annual household incomes) - that particular market is entering bubble territory and market developers know to exit.

The potential for “bankruptcy” is a wonderful motivator - to encourage those with their own money and reputations on the line – to keep their eyes wide open.


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