For several years Dean Baker warned US citizens that housing prices were following an unsustainable path. Prices were rising because elite investors, along with most other people who didn’t even know it, foolishly bet on them continuing to rise. Regular folks felt way more secure than they should have felt. Their houses were their piggy banks. They used home equity to buy things or just to pay off their bills. Rich people made a ton of money by betting on the housing bubble continuing forever – in other words denying that there was any bubble at all.
The bubble finally burst in 2008. All that home equity regular folks relied on largely disappeared. Even elite investors, typically insulated from the consequences of their greed, were in deep trouble. By that time, Dean Baker’s running calculations showed that US houses were overvalued by about 8 trillion USD. The entire global economy suffered the consequences. Other countries – Spain, the UK and others– had also built up enormous housing bubbles that burst at about the same time.
Since the mid-1970s rich countries have greatly undermined the wages and job security of most of the population. Consumption has come to be sustained by asset bubbles. When these bubbles burst, as they did in 2008, governments have to very quickly decide how to make up for the lost demand.
The US government’s choice has been to grudgingly apply an inadequate stimulus for a while – and of course bail out the elites profited disproportionately from the bubble. There are already signs that the US is prepared to let another housing bubble inflate. Why?
The rational alternative is unaceptable to elites. It goes against everything they've done for the last 35 years. The rational alternative is to strengthen wages, improve job security, and make huge PUBLIC investments in things like heath care and alternative energy. The utterly insane option is to let another housing bubble develop to sustain economic growth and hope it lasts for several years so that somebody else can deal with the mess. That worked for Bill Clinton. With a little better luck, it might even have worked for George W. Bush.
Now both Dean Baker and Paul Krugman are warning Canadians about their housing bubble. Baker argues that the steps required to gradually deflate the bubble make sense even if you believe the warning signs aren’t as bad as he makes out. He advocates three steps
- Canada’s Central Bank must alert people so they are aware of the risks of buying a house now, re-financing to pay for future or past purchases.
- The use of regulations to prevent high risk mortgages
- Higher interest rates that explicitly target deflating the bubble
I noted to Dean Baker that the government, even if it deflates the bubble gradually, will have to make up for the lost demand in order to prevent slow growth and unemployment. It is the same problem, except in slow motion, that you have when the bubble pops suddenly. You must make up for the lost demand but that involves reversing everything elite policymakers have done for over three decades. Even if you win the argument on the existence of a bubble, how do you get them to reverses course?
Baker’s answer to me was not comforting, but he isn’t obliged to be comforting:
Once you have a bubble like the one in Canada there is no pretty path forward. The point is to prevent it from developing. If the U.S. had done this in 2001 and 2002 then the recovery from the stock bubble would have been slower. It would have required more stimulus and/or a lower valued dollar. Both would create more jobs and put workers in a position to raise wages. (yes, higher wages are central) Anyhow, better to go that route and struggle on the best ways to make the economy grow then go the route of bubbles and crashes.
Canadians, like other people in other countries, will either strengthen wages and tame their financial elite, or continue to endure bubbles and crashes. As always, sane policy will not get implemented without a fight