A response to your responses
Thanks for all the thoughtful responses. And for all readers who want to take the smart criticisms offered thus far and fling them in my face, I’ll be discussing bubbles today at the New America Foundation in Washington, D.C.
Justin Fox is right that not all bubbles are created equal. It may be that bubbles may be beneficial when they have to do with a “real innovation like the Internet or the telegraph,” and less likely to do so when the innovation is purely financial. But as the U.S. economy becomes increasingly dominated by finance, it may be that financial innovation can prove beneficial.
It’s quite possible that nothing good will come out of the real estate/housing credit bubble, as Jesse Eisinger suggests. But I happen to think that the culture of re-financing, which was enormously beneficial to millions of Americans, will stay with us after the bust. (See the Alan Greenspan/James Kennedy paper on how the re-financing/home equity boom contributed mightily to consumer spending in recent years.) Five years from now, if real estate broker commissions are lower, if the mechanisms for re-financing are intact, allowing millions of people to lower the cost of their housing when interest rates cycle down, if transparency-creating services like Zillow and Domania make the vast real estate market more efficient, if mortgages come embedded with regional housing price options, if home equity insurance is a widely available product—it’s possible that thin gruel I dished out to Jesse might begin to thicken.
Daniel Altman (seconded elsewhere on the site by Nathan Newman) dons his economist’s hat and makes the shrewd point that bubbles represent a misallocation of resources and carry immense opportunity costs. The money invested in Worldcom at its peak could more fruitfully have been invested in other enterprises or social goods. I’ve heard this line of argument a fair amount from folks with economics background. And I largely agree. I would probably have preferred that our society take the billions invested in Worldcom and used it to create endowments for scholarships, or to offer universal health care, or to put a computer in every home. But none of these was on offer.
But I find these arguments less than completely compelling because I’ve never lived in, worked in, or read about an economy that allocates resources with such rationality and intelligence. Looking back at American history—from Jamestown in the early 1600s to Silicon Valley today—it seems to me we’ve had a lot of fits and starts, land and resource rushes, bubbles and boomlets, failure and experimentation--and plenty of irrational exuberance. I think that this tendency to excitement, greed, and risk-taking is embedded in our national character.
As Paul Kedrosky points out, like it or not, bubbles are how new commercial infrastructure gets built in this country. Alexander Hamilton lost the argument about a centrally-planned program of infrastructure investments a long time ago. Sure, the government provides incentives and inducements, and sometimes takes a direct roll. But you’d be hard-pressed to find a commercial infrastructure—canals, roadways, railroads, bridges, radio, telephone, the internet—that the government or some group of businesses rolled out efficiently. Nathan Newman believes the haphazard way broadband was rolled out has left us behind other countries. Could be. But what was the alternative? Sure, the deployment of broadband by Comcast, Qwest, Verizon, and Global Crossing was a messy and still incomplete process. But imagine if it had been entrusted to the Bush administration. We’d be communicating through Dixie cups connected by string.
Now, here’s a larger question for the investors and economists to chew on: it’s frequently easy to calculate the costs of bubbles to the economy—the decline in market caps, bonds that defaulted, and so on. But how do you capture the upside? Suspend your disbelief for the moment, and start with the premise that Google would not be the company it is today if not for all the foolish investments and behavior of the 1990s. Beyond its immense market cap, what is the value of Google to the economy today? And to you personally?
I'm sorry, but by chance I happen to have posted my thoughts about the real estate bubble, which I respectfully submit are at least as apt to be correct as the prognostications of economists, astrologers, or other such mystics.
They are as follows:
Wagner and the Real Estate Boom:
http://www.billingsgatereport.net
May 15, 2007 8:40 AM | Reply | Permalink
First it is hard to see how there has been more than a temporary misallocation of resources in the housing bubble, we are not talking .webvan here, we are not talking millions of miles of underused fiber, or warehouses full of electronics steadily becoming obsolete, we are talking a couple more months of inventory in a product with a 50 year product life. Certainly individuals could have made better investments than sitting on blocks of condos in Vegas, but it is hard to see how this is a problem for the overall economy, any cash used to service those mortgages flowed right back into the investment pool.
This is not to say there hasn't been pain, people entering the market at the wrong time might get squeezed back out with a loss, people needing to exit the market for other reasons like a relocation are at a disadvantage, but from a societal perspective people losing money on an investment is not a tragedy. In the long run all those houses will have inhabitants.
Which take us to the credit 'bubble'. Over the last dozen years new financial products have emerged that allow the careful homeowner to manage his equity as a totally liquid asset. Clearly there are downsides to this, you can start with a HELOC and end up broke and homeless in Vegas in a couple of weeks. On the other hand it has opened up whole new avenues for homeowners and as such levered the societal advantages of homeownership itself.
People decry the concept of using your house like a piggy bank. But in fact the Bank of Bruce's Condo is a pretty sound bank and what makes it so is the ready availability of HELOC (Home Equity Line of Credit). I carry my equity in my wallet, I haven't used it but it is there and available on demand. Moreover now that I have it it is decoupled from my income, even though I am between jobs the money is there.
Given this credit cushion it would make sense in principle to dump every bit of income beyond expenses to pre-pay mortgage principal. Because in real world terms you get a guaranteed return of whatever your mortgage rate is, and this will remain true in any environment where you expect your equity to remain positive. This remains true even in a declining market right to the point when your equity hits zero. Of course this is offset by interest on the HELOC, the key here being to have the HELOC but use it only in relative emergencies.
A by-product of this is to make a hash of the whole notion of National Savings, we really don't have a framework for thinking about shifting banking into real estate, into quite literally converting your equity into a checkbook and converting your cash savings into principal pre-payment. The math works fine but it sure ravages the traditional notion of savings.
What it does mean is that leveraging yourself into a house has more advantages then ever, that is if and only if you make more than you spend on a monthly basis or are really, really confident about your appreciation (the trap that snared too many in the last year.) Because in this new financial environment housing equity is quite literally money in the bank if it want it to be so. While a house may not always be the best investment, on a cash flow basis it will always be a better investment than simple savings, the interest not paid on the pre-payed principal will almost always outgain interest earned on the savings (if you refinance at an unusually low rate the gap can close but rarely will it disappear).
A lot of the sturm und drang over national savings may be in large part the product of people rationally doing the math on equity vs savings. Economists for some purposes treat all market participants as fully informed and for others, like 'bubbles' like they were irrational. The truth is somewhere in the middle. It would be somewhere between difficult and impossible to determine how many people were actively managing their finances this way, (I don't know whether lenders report this kind of pre-pay activity, I doubt it). But it would explain some oddities that show national savings actually going negative, some of it might just be parked in places invisible to standard metrics.
So the credit bubble may transform household finance going forward with equity becoming totally liquid to anyone with good credit. Whether this is Great For The Economy will have to wait to be seen.
May 15, 2007 10:02 AM | Reply | Permalink
I fail to see how Americans mortgaging their homes to the hilt is good for them. It helped the bottom line of the corporations who have move off shore taking jobs with them when they sell their slave wage goods back here import free and doing so helped create a huge trade deficit that further cheapens whatever savings American homeowners might be lucky enough to still have. It helped the FED make money off their fiat money scam, investment bankers and commercial banking corporations also profited. However bottom line, it just created a larger debt for citizens to try to dig out of and very many of them will not make it and lose their homes. A very few people made a hell of a lot of money and some like to call that prosperity for America, but it is no such thing.
Globalism, as practiced, which is a part of the economic elitist’s bag of self-enriching policy slight of hand is rip off of the once strong American middle class economy built on the back of American labors and small buisness men. Eventually, which I believe will be the not too distant future, this rotten economic house of cards will come crashing down and when it does I hope the sharks that are raping this economy are held responsible. Poverty and squalor is the author of street crime, sickness and suffering ergo I see the elitist pumping the life’s blood out of the system and into their pockets as very violent people and think they shoul be dealt with accordingly.
If all the above is not bad enough the willfully ignorant, spoiled rotten, presidential sock puppet and the spineless, sold out congress's spending on corporate welfare and the insane Middle East foreign policy is driving this country into total insolvency and a debt that cannot be managed, worse these greedy soulless men and their sycophants they have bought to run the government don't give a damned, they are all getting richer and that all they care about. There will be an accounting.
May 15, 2007 11:12 AM | Reply | Permalink