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Karl Smith has a post on the recovery in the Las Vegas housing market. I noticed there were a few suspicious statistics—for instance housing starts were up sharply, but from a very low base. So I decided to check it out by googling stories on the Phoenix housing market, and immediately found similar stories:

In another sign that metro Phoenix’s housing market is slowly recovering, hundreds of homes across the region sold by banks after foreclosure or through short sales are being flipped by investors for almost double the price they paid just a few months earlier. With metro Phoenix’s median home price steadily climbing this year, speculators have seized on an opportunity to make fast profits and are selling houses across the region at prices not seen since the beginning of the housing boom in 2003-04. Home prices have climbed as the supply of houses for sale has shrunk. The number of homes for sale in the Phoenix area is half of what it was last May, and the median price is up by an astonishing 30 percent since then. . . . An east Phoenix home bought through a short sale for $218,000 in September sold in late February for $560,000. The home was completely remodeled, but the price was still an eye-popping 156 percent more than the investor paid. A home in Chandler, built in 2005, sold through a short sale in November for $255,000 and was then flipped by an investor for $410,000 in March — a 61 percent profit in five months. A former foreclosure home in central Glendale was bought for $131,000 in January and flipped in mid-April for $243,000, an 85 percent jump. The investor added stainless-steel appliances and replastered the swimming pool at the ranch-style home. In Goodyear, a 2,000-square-foot home in the Estrella Vista community was purchased from the lender for $88,000 in January. The investor repainted the home, put in new carpet and resold it for $188,000 in mid-April for a 113 percent gain. “There are hundreds of recent examples of foreclosure or short-sale homes that have sold to investors who have been able to resell them quickly for much higher prices,” said Tom Ruff, managing director of AZ Bidder, a Phoenix-based online foreclosure-auction firm. . . . It’s now clear metro Phoenix’s housing market hit bottom last fall, according to the experts.

Another article mentioned that Phoenix housing starts are up sharply, although the level remains well below the boom years. So it looks like Karl is right; the US housing market has found a sort of equilibrium.

I’d like to make four claims:

1. The misinvestment in the housing boom was far smaller than widely believed.

2. The cost of bailing out the big banks was much smaller than widely believed.

3. The cost of bailing out small bank depositors was much bigger than widely believed.

4. The 2008 policy errors of the Fed were the “real problem.”

The US population grows by almost 3 million per years. The 2003-06 housing fiasco can be summed up as follows. We allocated too many resources into housing construction, which meant we built a few million houses a few years too early. How costly is that? Well houses often last for 100 years. I frequently visit a completely typical and fairly new house in Arizona, worth about $200,000. It’s obvious this house will last well over 100 years. If that sort of house is built a few years early, there is economic waste–but not as much as many people suppose. One mistake is to look at the big fall in housing values. Much of that is actually a fall in land values, which doesn’t represent resource misallocation. The actual price of houses fell by much less. The flow of wasted housing services is substantial, but trivial compared to the waste caused by mass unemployment.

The second overrated problem is the big bank bailout. Like housing over-investment it is a big problem in absolute terms, but vastly overrated in relative terms. The big banks are repaying the loans, which is rather amazing given this was a once in 100 year banking fiasco. If they are able to repay their loans in this situation, what sort of disaster would be required for them to actually cost the taxpayers money? Perhaps a once in a 1000 year fiasco.

In contrast, the small bank fiasco is vastly under-rated. Just as in the 1980s, the smaller banks lent vast sums to risky development projects, and lost big when the Great Recession hit. The cost to taxpayers will be well over $83,322,000,000. BTW, contrary to widespread opinion, payments made by FDIC represent taxpayers money. The FDIC fees paid by banks are simply a cost of doing business, and are passed on just as oil companies pass on most of the gas tax to consumers.

The most underrated problem of all is the Fed policy fiasco of 2008. You’d expect a fierce Bernanke critic and supporter of higher inflation like Paul Krugman to be all over the Fed. Their tight money policy of 2008 drove the economy into deflation by early 2009. And by the fall of 2008 the TIPS markets told us this was happening. So what does Krugman say about Fed policy during the crisis?

But surely, I argue, the Fed did deliver negative real interest rates by cutting rates quickly and avoiding deflation. This prods Krugman into rare praise: “I have actually very few complaints about monetary policy here through some point in 2009. I thought that Ben [Bernanke] responded aggressively and forcefully, which was the right thing to do. He stepped in with the original QE [quantitative easing] and stabilised the economy. “The question is, what did he do as we started to look more and more like Japan? At that point the logic says you have to find a way to get some traction. Fiscal policy might be great. But if you’re not getting it you should be doing something on the Fed side and I think that logic becomes stronger and stronger as the years go by. And it’s sad to see that the Fed has largely washed its hands of responsibility for getting us out of the slump.

This quotation just blew me away. And it made me realize just how big the gap is between market monetarists and mainstream Keynesians. Recall that the big crash in both NGDP and RGDP occurred between June and December 2008. At no time during this crash were we at the zero rate bound. The Fed even refused to cuts rates after Lehman failed in September 2008, even though 5 year TIPS spreads had fallen to 1.23%, and it was obvious we were going into a recession. Let me say that again, they had a meeting 2 days after Lehman failed and didn’t cut rates below 2%. Rates didn’t get to zero until mid-December 2008 when the great GDP crash was nearly over. It was too late to prevent the Great Recession by that point. How many more smoking guns do we need?

It seems like Krugman doesn’t take a “target the forecast” perspective. He doesn’t seem to share Svensson’s belief that the Fed should always set interest rates at a level expected to hit the dual mandate. After all, by October 2008 we were clearly going to fall far short of the mandate, and rates were still 1.5%.

Or maybe Krugman does agree with me, and like 99.9% of economists he was totally focused on the banking crisis in the fall of 2008, and never realized that Fed policy was far off course. Perhaps some readers can dig up old Krugman posts from that period to see what he was saying about monetary policy.

I think it’s the age old problem of “the seen and the unseen.” The housing fiasco and the big bank bailouts were headline news. The news media didn’t spend much time on the massive bailout of small bank depositors, and provided zero coverage of the Fed’s ultra-tight money policy in 2008. Still, one would hope that (nearly 200 years after Bastiat) economists weren’t still taking their lead from newspaper stories.

PS. Here’s a graph showing NGDP at monthly frequencies:

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This entry was posted on May 28th, 2012 and is filed under Misc., Monetary Policy. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response or Trackback from your own site.



