Working in Iowa
When Something Doesn’t Work, Do It Harder
Dec 1, 2009
By Dave Swenson
By Dave Swenson
There is a pervasive amount of economic goofiness of late. Last week Department of Commerce reports indicated existing U.S. home sales were up, due largely to first-time buyer tax credits. The widely watched Case-Schiller housing index also ticked upward. As if on cue, reporters from National Public Radio to the New York Times were heralding the imminence of recovery and the major role that home building would play in lifting us out of this recession.
Like Ronald Reagan said: here we go again. There are lots of clichés about forgetting the past and repeating mistakes, etc., but the housing bubble and its antecedents are mistakes whose lessons must not be ignored. So, to invoke another cliché, how about we get the horse before the cart this time?
First we need to get a handle on exactly what buys a house. With an unemployment rate in excess of 10 percent and promising to stay at that level for months, it is obvious that the number of income earning households, that thing that buys a house, has been seriously constrained. On average and across the country there is not a clamor for new houses. Demand is therefore muted. And while supply is slowly drawing down, there are still quite a lot of unsold homes and a very large supply of vacant rental units. Obviously, there is no imminent boost to demand or major drawdown of supply that will send a signal to build new homes anytime soon.
Next, the chief ingredient in actually forming a home-buying household is a job. Jobs take young adults out of their parents’ homes and into their own household. Jobs provide singles the confidence to marry and form families. Jobs and only jobs are the primary indication of economic well-being and household creation.
Housing growth is a response to vibrancy in the rest of the economy. It is not the cause of a vibrant economy. A house is a capital good consumed by persons with incomes. The more people with incomes, the more houses required. But the housing bubble, and all of the attendant fraud, greed, and regulatory tomfoolery associated with it got it all backwards.
Folks believed that housing was driving the economy. If we build, we will prosper. And as housing prices continued to grow, more new construction was spurred, and the economy had a nice positive feedback loop that told it everything was okay. As houses hyper-appreciated, many consumed the future capital gains in the form of increased present consumption. They bought furniture, new cars, motorcycles, and any number of big and little ticket items knowing full well that houses never went down in value. Their houses were ATM machines to be periodically emptied. They piled up debt unmindful of the costs because it was all a sure deal.
The upshot not only was a housing bubble, but a concomitant commercial expansion bubble. In short, we had a housing industry and a consumer goods industry that had expanded beyond current earnings. Not only did we get too many houses, we got too many stores, too many shops, too much domestic manufacturing activity, too many jobs in unsustainable firms, and too much state and local government revenue as well. It was all a phony economy.
I move back to my first point. Income earning households buy houses. The demand for housing is both a function of the number of those households but also of the amount of income those households make. It was evident to many that housing prices were growing through this decade at a pace far in excess of household income growth. Logic would have therefore dictated that the growth in housing prices was disconnected from its underlying and most important tether to reality: real growth in household income. The greater the disconnect, the greater the bubble, and the harsher the crash.
And crash it did.
So, lesson one. The overall economy must consume most if not all of its surplus in housing and commercial property as well as production capacity before it can begin to grow again.
Lesson two. Once the overall economy has a sense of regular and growing service and commodity demands, it will begin to produce more of those items. Eventually it will take on more workers and pay them incomes.
Lesson three. As workers become more and more confident that their jobs and incomes are secure, they will become more and more risk tolerant and venture into purchasing big ticket items like cars, washers and driers, sofas, and houses.
Lesson four. Houses will accumulate in balance with household formation and income growth.
So there you have it: the economy improves and housing follows. Let’s try to get it right this time.
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Dave Swenson is a long-time analyst of Iowa political, social, and economic issues. He is a staff research economist at Iowa State University and an extension-to-communities economics educator. He also teaches community and regional planners (those nefarious agents of totalitarian control) how to do economic things in their profession.
