I read “False Profits” by Dean Baker a few days ago. The subtitle of the book is “Recovering from the Bubble Economy” – which pretty much sums up what the book is about. The author has some interesting opinions about what happened with the economy – and some issues he has with the economic leadership at the time.
One of the key points of the book is that the heart of the economic crisis was not derivatives, exotic loans, etc – but a housing bubble. Real Estate simply became overvalued and when it fell it caused a ripple of consequences to the economy. Not only was the wealth generated and lost by the housing itself – but it fed a lot of consumption in the economy that was also lost.
The heart of the problem is that no type of asset will endlessly go up – at some point it goes down. Stocks go up and down – even if over a long time period they go up. Housing has gone up and down over time – but the general trajectory is up. Gold, other metals, even bonds, go up and down in value. To assume anything will forever keep increasing signficantly is just denying reality. But our society seemed to buy into it - as it was making us money and driving the economy.
Another interesting point the author made was how this affected the baby boomer generation – in terms of their readiness for retirement. I can’t back it up but he says that baby boomers that don’t own a house are actually in better shape than those who do – that too many baby boomers made their house their primary wealth vehicle – not retirement funds, stocks, bonds, etc.
One of the interesting measures of whether a housing market is overheated is the ratio of rental prices to real estate prices. During the “boom” times the cost of buying a house was significantly higher than the cost of renting the same property – to the point it was far higher than historical values. One of the facts he presents is that from 1996 to 2006 house prices went up by more than 80 percent – vs. rental prices increased by just 4 percent. One of the suggestions he makes is to tie real estate appraisals to rental prices – to keep a real estate market from becoming overheated.
While exotic mortagages (such as interest only, loans where no documentation was required – which still drives me crazy) helped fuel the crisis – I think they were a symptom of the problem – not the problem itself. The reason people went after these loans was that houses prices were so expensive it made it much more feasible – as it lowered the initial payments. These loans then became deeply embedded in the financial system – as they were traded and re-traded, etc.
This boom also boosted the economy in general – as many jobs were created to build and maintain houses. Also, many people took equity out of their homes – which they spent. So it did juice the economy – it’s now were feeling the cost of this. It was good then – but not so good now.
Overall I think again the most important point is that we had a bubble – in that we had a type of asset that was significantly over-valued and finally was unsustainable. What concerns me about economies is that this seems to happen often – such as the dot-com boom, stock booms, etc. That the fundamentals of the economy are lost in hype and then we all suffer. I’m not sure how to solve this (the author has his own ideas) – but it does concern me.
