Wednesday, April 27, 2011

Economists did see the bubble coming

Economists have been lambasted for not alerting the public that a bubble was in the making in US real state, except for a few oddballs. Of course everyone is wiser in hindsight, but what did economists actually say? It never hurts to look at the facts.

Martha Starr analyzes statements in 24 California newspapers from 2002 to 2007. From 1998 to 2005, the state's house prices increased by more than 10% each year. This prompted the newspaper to run 379 stories with 688 statements by economists on house prices. Academics were clearly warning that house prices were not sustainable. Economists employed in the real-industry, however, were resolutely optimistic. What emerges is a mixed message that gave no guidance to the public, which was even reassured by positive messages from the Federal Reserve.

It is entirely possible opinions could have diverged based on the same evidence. But it seems more likely the professionals were not acting in good faith. They had everything to lose from predicting an end of house price growth. The media should have learned not to trust such biased speakers, yet they continue to be interviewed. Now as to why Greenspan and then Bernanke were so optimistic is beyond me. There speeches are definitively strategic and while they may have realized there was a problem, they may have tried to prevent a bubble from bursting too brutally. Then all the credit to them for trying. But one cannot postpone indefinitely a bubble from bursting, and they knew that.


Anonymous said...

I think that this is revisionist history. Very few academic economists talked openly about the perils of the housing bubble (with Shiller being a notable exception). In fact in 2005 the Journal of Economic Perspectives (which often represents the consensus in the profession) published the now infamous paper by Himmelberg, Mayer and Sinai that said that there was basically little to worry about:

As far as I know the authors never published a mea culpa, showing us why they got it so spectacularly wrong.

Economic Logician said...

Anonymous: you are citing just one example to support your argument. What about the hundreds that Starr is using?

Barkley Rosser said...


Congrats on getting linked to by Mark Thoma.

On the substance, yes, there were economists, and quite a few actually, who were raising questions, particularly starting in 2005, but it is also a fact that with the exception of Shiller they were largely unable to get much play at the commanding heights of the profession, or very loudly or clearly in the media.

Economic Logician said...

David Lereah has been the chief cheerleader of the real estate industry, trying to ridicule the academics calling for a bubble: Wikipedia discussion.

Martha Starr said...

BR is right: The academics who called it early and called it right were generally not the 'barons' of the profession, but rather people at forecast and real-estate centers of California universities -- especially Ed Leamer and Christopher Thornberg of UCLA.

'Anonymous' raises an interesting question though: Why did the only high-end scholarly paper poo-poo the possibility that home prices were getting alarmingly overvalued? Publication bias?

As EL says: former NAR chief economist David Lereah notoriously fueled the bubble with his justifications for runaway price expectations. Check out his 2006 book, "Why the Real Estate Boom will not bust -- and how you can profit from it" . oops.

Gary Anderson said...

If you consider that off balance sheet banking was permitted at Basel 2 in 1998, you know that the Fed had it's marching orders from Basel and nothing was going to stop the securitization ponzi. If they had to lie they would lie, as the predatory lending gripped mainstreet and the banksters got wildly rich.