The Crash Course - Chris Martenson [47]
That bubbles happen isn’t the surprising part of this story; rather, it’s that well-educated people responsible for knowing about such things have apparently never learned that bubbles aren’t rare and random events but are very common and predictable features of the economic landscape. In their defense, perhaps these people have learned about bubbles, but then mistakenly overestimate their ability to manage their destructive effects (yes, I am talking about Alan Greenspan here).
By way of illustration, the Federal Reserve entirely missed the opportunity to nip both the 1990s stock and 2000s housing bubbles in the bud, and even devoted considerable internal resources to the task of proving to itself that no housing bubble existed. Even as a number of analysts and commentators (including me) were warning of a housing bubble back in 2004, the Fed released a study titled “Are Home Prices the Next Bubble?” which concluded that the answer was no.
Here’s the main conclusion of that paper:
Home prices have been rising strongly since the mid-1990s, prompting concerns that a bubble exists in this asset class and that home prices are vulnerable to a collapse that could harm the U.S. economy. A close analysis of the U.S. housing market in recent years, however, finds little basis for such concerns. The marked upturn in home prices is largely attributable to strong market fundamentals: Home prices have essentially moved in line with increases in family income and declines in nominal mortgage interest rates.6
All of that sounds perfectly logical, and the paper is stuffed with comforting and supportive data, but it is also completely and hopelessly wrong. Although they should arguably have known better, the Fed’s researchers were simply doing what millions of people did; namely, falling prey to the belief that somehow “this time it’s different.” That’s just how bubbles are. People take leave of their senses, using all manner of rationales to justify their positions, but then suddenly one day the illusion lifts, and what was once unassailably true no longer makes any sense at all. Once that tipping point occurs, there’s really nothing left to do but track the speed of the bubble’s collapse and the damage it will cause.
The Housing Bubble
Let’s focus a bit more of our attention on the housing bubble that burst in 2007. It is important to show just how obvious this bubble was. Anyone with a tiny bit of bubble history under their belt and access to some publicly available data can appreciate its clarity.
Because a bubble occurs when asset prices rise beyond what incomes can sustain, I’m not so interested in the actual prices of houses all by themselves, but I am keenly interested in the ratio of house prices to income. Because the amount that people can afford to pay sets an ultimate limit on house prices, it is impossible for median house prices to forever rise faster than median incomes. Sooner or later, when illusions lift, that dynamic comes to a halt, and at that point, the last buyers will be in the same position as the last purchasers of tulip bulbs in 1637.
Figure 11.3 compares median household incomes to median house prices. If what the Fed research paper said was correct and housing prices rose in alignment with incomes, the two lines would overlay each other perfectly and never depart, but that’s not what we see. Instead we observe that even before the year 2000, median house prices elevated away from median incomes and were hopelessly separated by the time the Fed was convincing itself no bubble existed in 2004.
Figure 11.3 Median Income and Housing
Sources: Census Department (Median Income) and Office of Federal Housing Enterprise Oversight (Housing).
The housing bubbles of 1979 and 1989 (marked