New Economist on House bubbles, their effects and ways to contain them
According to economists there are several potential threats to the US economy; most prominently on the agenda are the current account deficit, the housing bubble and perhaps the Gung-Ho fiscal policy carried out by the Bush administration(?). The CA has been vigorously discussed but with the introduction of the Dark Matter thesis the American economy is seemingly indestructable; see also Brad Setser on the origins of Dark Matter for a more differentiated view as well as my own contributions here and here. The housing bubble has also been been widely discussed particularly by the New Economist, and before we dig the points in his latest post let me put up a mainstream view of the global economy.
Let us assume for a moment, for the sake of argument, that the American CA actually does matter and that the US housing bubble actually is a problem and a threat to the US consumer confidence and consumption. Following the saving glut argument which says that the US is spending for the rest of us; i.e. on the back of our savings the housing bubble and its potential eruption becomes an interesting variable or as I will argue the potential variable. Lazy as I am, I have no empirical evidence on this but I am quite sure that a substantial amount of US consumption is financed through mortgages on houses. Now, what happens when US consumers no longer will be able to us their houses as ATM machines? Their consumption drops sharply and if the saving glut argument has any bearing at all, we should worry when American consumer confidence drops because the following recession will be global not just American.
I am not sure whether I can accept all parts of the argument above but I do belive that a drop in American consumer confidence and consumption will have large effects globally and as such house/asset bubbles and the ability to contain them and essentially burst them with a fizzle rather than a boom is interesting.
This is exactly what New Economist deals with in his latest post on US housing bubbles which is based on a report (110 pages!) by HSBC economists Ian Morris and Ryan Wang - A Froth-Finding Mission: detecting US hosuing bubbles. Incidentally the post also serves as an excellent hub for his other posts on the matter. The main argument seems to be that only certain hotspots in USA can be coined as housing bubbles but that they are big enough to worry about.
From the paper:
"We suggest that about half of the US housing market is frothy and that this ‘bubble zone’ may be overvalued by as much as 35-40%, (...) What’s troubling is that even a perfect ‘soft landing’ in the form of flat national house prices would be consistent with a 35-40% collapse in existing home sales. The gush of liquidity from mortgage equity withdrawal would dry up, resulting in a growth drag worth over 3% of GDP."
"To my mind the HSBC report's analysis and conclusions are about right. There's no nation-wide bubble, but there is enough overheating in major parts of the United States for there to be serious downside growth risks should they burst."
As I mentioned above the discussion about how to contain the bubble is crucial; are we heading for a hard or soft landing? New Economist is optimistic of central bankers' ability contain house bubbles.
"I do not consider this to be the greatest threat facing the US or global economy. As I have argued before, the experience of both the Reserve Bank of Australian and Bank of England is that housing bubbles can successfully be deflated over a 2-3 year period by steady rate hikes and clear, consistent messages to investors."
What about their willingness I ask? Furthermore, rate hikes will conflict with the fundamental issue of dealing with dropping consumer consumption should this trend really catch on. In my opinion the Fed might realize that it has acted too late!