The Price of Everything - Eduardo Porter [108]
Prices provide the most important signals in an economy, guiding people’s decisions on where to invest their resources to get the best return they can. People who shop around to get the best possible price for their plasma TV are doing us all a favor. They get a better machine, have more money left over to buy other things, and improve the odds of success of the company that makes good products for less, boosting the economy’s efficiency. Successful technology companies that profit from the work of highly qualified workers will offer higher wages—a higher price—to attract better-qualified applicants. Workers will keep raising their qualifications as long as the return—measured in better wages—is worth the investment in time, money, and effort.
This virtuous cycle, however, depends on relative prices being right. They must do a good job assessing the relative costs and benefits of different types of TVs. When prices go wrong, these decisions are distorted, often to devastating effect. This, unfortunately, happens depressingly often. Between 2000 and 2006, housing sucked in an unprecedented share of U.S. resources, as Americans rushed to buy a home in the belief that home prices would rise forever. The rush of money boosted house prices by some 70 percent on average. Builders rushed to build more. Then the bubble popped. Home prices fell almost a third from their peak in the spring of 2006 to their trough in early 2009.
The enormous bubble that lifted home prices skyward before slamming them down again didn’t do much for homeownership. The share of Americans who owned their home increased by 1.5 percentage points between 2000 and 2004, to a peak of 69.4 percent. By the end of 2009 it had fallen back to 67.3 percent, where it was in the spring of 2000 before the party started. The fall, however, was devastating. For a few scary months, the world economy tottered perilously near disaster. The most hallowed institutions of American capitalism were humbled. The share prices of Citigroup and Bank of America fell more than 90 percent from their peaks. General Motors, whose chief executive had claimed more than half a century earlier that “what was good for the country was good for General Motors and vice versa,” collapsed into the government’s arms—unable to borrow money or sell cars.
And this wasn’t an exclusively American drama. Between 2000 and 2007 house prices rose by some 90 percent in Britain and Spain. By the end of 2009, British home prices had fallen about 16 percent from their peak and Spanish homes about 13 percent.
WHEN PRICES GO OFF THE RAILS
The housing bubble might be the most painful case of financial excess in recent memory, but it surely isn’t the only one. Through the ages, virtually every potentially profitable new frontier opened up to investment has led to a speculative bubble, as investors have scrambled to tap into its promise only to stampede in retreat a few years later. A decade before the housing crisis we experienced the dot-com bubble. The NASDAQ index, heavy with technology stocks, quadrupled between 1996 and March of 2000. Drunk on information technology’s promise, people poured retirement savings into companies like Pets.com, which achieved fame, though never profit, on the strength of a cute ad with a sock puppet. In 2000, AOL could use its pricey stock to take over media