Examining the Possibility of Bubbles on the Horizon

Predicting the future is often difficult and regularly produces failures due to the sheer amount that’s happening in the world, but I think this op-ed by one of the few economists who spotted the significant housing bubble is worth reading.

Ever since the collapse of the housing bubble in 2007–2008 that gave us the Great Recession, there has been a large doom and gloom crowd anxious to tell us another crash is on the way. Most insist this one will be even worse than the last one. They are wrong.

Both the housing bubble in the last decade and the stock bubble in the 1990s were easy to see. It was also easy to see that their collapse would throw the economy into a recession since both bubbles were driving the economy. We are in a very different place today.

The stock market is high. By any measure, price-to-earnings ratios are far above historic averages, but they are nowhere near as out of line as they were in the 1990s bubble.

The current value of the market is roughly 24 times after-tax corporate profits, based on the first quarter’s data. This compares to the historic average ratio of 15-to-1. But at the peak of the bubble in 2000, the ratio was over 30-to-1.

[…]

It is true that profits are unusually high as a share of national income. This reflects a big increase in the profit share in the weak labor market following the Great Recession, and more recently the Republican tax cut passed last fall.

It can be hoped that labor regains some of its lost share and pushes profits downward. But there is no guarantee that this will happen, and stock prices that reflect current profit levels can hardly be said to be in a bubble.

House prices are also well above trend levels. Inflation-adjusted house prices are around 30 percent above their trend levels. But they are still about 14 percent below bubble peaks. Here too, the higher than normal level seems to reflect the fundamentals of the market.

Unlike the housing bubble years, rents have been rising far more rapidly than the overall rate of inflation over the last five years. This indicates that there actually is a shortage of housing pushing up house prices, not a speculative bubble.

[…]

Not only is there little evidence of bubbles just now, there also is no case to be made that bubbles are driving the economy. In the late 1990s, it was clear that the stock bubble was driving the economy. Through the stock wealth effect, the run-up in stock prices led to a consumption boom that pushed the savings rate to then-record low levels. In addition, investment surged as this was a rare period in which start-ups were actually financing investment by issuing shares of stock.

When the bubble burst, investment plunged, and consumption fell back to more normal levels. This gave us the 2001 recession. While most economists see this as a short and mild recession, we actually did not recover the jobs lost until January of 2005, which at the time was the longest period without net job growth since the Great Recession.

In the housing bubble years, the consumption triggered by the run-up in house prices sent the savings rate even lower than at the peak of the stock bubble. In addition, housing construction rose to 6.5 percent of GDP, compared to an average of roughly 4.0 percent.

Not surprisingly, when the bubble burst consumption fell back to more normal levels. The overbuilding of the bubble years led construction to fall far below normal levels, bottoming out at less than 2.0 percent of GDP in 2010. This enormous loss of demand was the cause of the Great Recession.

High stock and housing prices are not driving the economy in the same way as they did in the 1990s stock bubble or the housing bubble of the last decade. Investment remains modest by any measure. Housing construction is getting stronger, but very much in line with longer-term trends.

Consumption is high as a result of stock and housing wealth. But even in an extreme case, where the savings rate rose back to Great Recession levels, it probably would not be sufficient by itself to cause a recession and certainly not a severe one.

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Deregulating the Banks and Risking Another Economic Disaster

The economic crash that happened around 2008 was truly horrible, as many who lived through it are aware. The negative effects of the crash were felt overall worldwide and included trillions of dollars lost in worker pensions and savings, chronically high unemployment, trillions of dollars worth of lost output, and lots of other residual suffering. There were also woefully inadequate positive changes — there have been insufficient measures to help the vast majority of the population and the criminogenic structure of the too big to fail banking industry is mostly the same as it was in 2007.

All of these considerations about the economic crisis warrant thinking about why it happened in the first place, so that the same foolish mistakes that caused immense human suffering don’t have to be repeated again. Beyond possibly referring to the inevitable instability of the state capitalist economic system, it’s rational enough to look back to 1999, when a large part of the consequential deregulation happened.

In 1999, the U.S. Congress passed the Graham-Leach Act that (among other things) repealed important sections of the 1930s Glass-Steagall Act. Glass-Steagall’s important provision was that it by law set a firewall between depository banking and investment banking. There were unpunished violations of this law by the banks over the decades, but it’s a rational law and it did quite well at its specific purpose, which is to try to prevent the reckless gambling with consumer savings that’s actually still allowed today.

The big story of why the crash happened though is the housing bubble that the big banks and certain other financial corporations (with immoral behavior and using predatory lending practices to consumers) largely created. This housing bubble was evident enough to reasonable economists that don’t serve plutocratic interests, but there are few of those, so only a select few economists spotted the bubble early on.

“We had a 8 to 10 trillion dollar housing bubble over the decade from ’96 to 2006,” said economist Dean Baker, who in 2002 predicted the bubble and the recession it caused. “House prices rose by more than 80 percent by one measure, 100 percent in excess of inflation. Over the prior hundred years — 1895 to 1995 — house prices had just kept even with inflation. This should have been real simple.”

The housing bubble did drive the economy forward through what’s known as the wealth effect, where people (primarily lower- and middle-income people) spend more money — typically 5 to 7 cents on a dollar — if they have a higher net worth. The higher spending (estimated at between 400 to 500 billion dollars a year, about a twentieth of $8 trillion, and about $3000 per 2018 U.S. household) drove more demand and contributed to some economic gains. These gains came with a heavy cost though, and that cost was the bubble popping and causing the worst economic collapse since the Great Depression.

Why the Great Recession was as bad as it was in the U.S. is actually fairly simple. About $8 trillion worth of housing bubble wealth disappeared with the bubble’s pop, and with that went a lot of consumer purchasing power or what’s known as demand. The main problem for the Great Recession being as horrendous as it was is due to there not having been enough demand in the economy, or to use different terms, the vast majority of people were screwed over too hard and weren’t given adequate resources to recover with. Instead, the U.S. government (and some other governments with different measures) acted with urgency to bail out the financial corporations that primarily caused the crash problem.

The story of the big bank bailouts is particularly noteworthy because it was unnecessary. Actually, a strong majority of the U.S. population was opposed to the bailouts, and if the U.S. had a real, functional democracy, that strong majority opposition would have translated into policy. The bank bailouts were unnecessary though because it was known how to keep the financial system operating when the banks failed — this was seen in the S&L crisis of the late 1980s, for example. There were also simply other ways to help most people — the central bank of the U.S. that loaned trillions of dollars at extremely low interest rates to failed banks could have been used for numerous superior purposes, such as providing an investment stimulus that would actually fully compensate for the shortfall of demand. The stimulus enacted by the Obama administration simply wasn’t large enough, and many people suffered for that.

Now today on March 15, 2018, it’s being reported that the U.S. Congress is about to deregulate the banks again. The process of another significant economic recession and expensive public bailout are a real possibility. This is noted as banks such as Morgan Stanley and Citigroup wouldn’t even exist today if they hadn’t been bailed out, and it’s disturbing that the deregulation will allow them increased opportunity to boost profits through extracting money from consumers via fraud.

It’s also noted as the implicit regulation — that there will be a bailout if a big bank fails — also remains in place, and this implicit subsidy (which prompts riskier financial activities) has been estimated by the IMF to cost about $70 billion ($550 per U.S. household) annually. This is yet another drain on the economy through the corrupted financial system, which could be eliminated or reduced through enacting a financial transactions tax, breaking up the big banks, and/or bringing democratizing measures to economic institutions.

In sum, the history of this deregulation and misregulation of the financial sector presents a clear picture of the problems it causes. More people must be aware of this and organize effectively to prevent these same unnecessary mistakes from being made yet again.