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America’s Houses of Cards

There are times when being proven right brings no pleasure. For several years, I argued that America’s economy was being supported by a housing bubble that had replaced the stock market bubble of the 1990’s. But no bubble can expand forever. With middle-class incomes in the United States stagnating, Americans could not afford ever more expensive homes.

As one of my predecessors as Chairman of the US President’s Council of Economic Advisers famously put it, “that which is not sustainable will not be sustained.” Economists, as opposed to those who make their living gambling on stocks, make no claim to being able to predict when the day of reckoning will come, much less identifying the event that will bring down the house of cards. But the patterns are systematic, with consequences that unfold gradually, and painfully, over time.

There is a macro-story and a micro-story here. The macro-story is simple, but dramatic. Some, observing the crash of the sub-prime mortgage market, say, “Don’t worry, it is only a problem in the real estate sector.” But this overlooks the key role that the housing sector has played in the US economy recently, with direct investment in real estate and money taken out of houses through refinancing mortgages accounting for two-thirds to three-quarters of growth over the last six years.

Booming home prices gave Americans the confidence, and the financial wherewithal, to spend more than their income. America’s household savings rate was at levels not seen since the Great Depression, either negative or zero.