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The Bubble

Among all the crisis-era talk about potential mistakes in the realm of financial regulation or deregulation, I think there’s been surprisingly little discussion of the underlying underlying issue — the crash in the housing bubble. Perhaps there’s been little discussion of it because there clearly isn’t some kind of pat regulatory solution whereby you ban housing price bubbles. But at the same time, I think the issue needs to be discussed more because the failure to do anything about the bubble reflects some really broad social and institutional failures.

The striking thing about the housing bubble, after all, is that it was extremely clear cut:

Not only was there never any reason to believe that the underlying value of the average American home had doubled between January of 1987 and March of 2006, but it was absolutely absurd to believe in March of 2006 that prices would, in general, continue to appreciate. And yet not only did many people believe that they would continue to appreciate, but many loans were issued that only made sense on the theory that appreciation would continue.

Now of course the situation was (and is) somewhat more complicated than that one chart can indicate. Homes can improve in quality. And in certain regions there are objective limits (imposed either by geography or regulatory fiat or both) to the supply of homes, so real price increases shouldn’t be out of the question. There was plenty of room for reasonable disagreement about the trajectory in any given city or neighborhood, or whether prices would ever fall all the way back to that 100 line. But in the main it was pretty clear that a speculative bubble was under way — rent/buy spreads were out of whack with historical norms, home ownership rates were out of whack with historical norms, and people were clearly making purchasing decisions that were predicated on the assumption that price increases would continue indefinitely.

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Which isn’t to say that congress should have passed a law saying “nobody can pay a speculative premium for a house.” But by the winter of 2003–2004 things had already reached a point where responsible public officials and other kinds of civic leaders should have been trying to inform the public and calm things down. Instead, politicians were mostly doing nothing, Alan Greenspan was recommending that people get ARM mortgages, and the press was encouraging people to shift from a “these past seven years of price appreciations have been nice for incumbent homeowners” mentality to a mentality of rampant speculation. And the press wasn’t, it seems to me, doing this by coincidence — they were doing it because of a corrupt relationship between their real estate coverage and real estate advertising revenue. And public officials who could have been complaining about that didn’t say anything. And then of course there’s the irresponsible behavior of the financial institutions themselves. And that last bit is an important piece of the puzzle.

But it’s hardly the only one. A lot of us were warning back in 2004 and 2005 that things were headed out of control, and I really don’t think we were saying anything especially insightful or brilliant — we were just observing the obvious facts that prices and rent/buy ratios were at unusual levels and there was evidence of speculation everywhere. But the people with the big megaphones didn’t want to speak up.