That Hissing Sound | Paul Krugman - New York Times (August 8, 2005)
... In Flatland, which occupies the middle of the country, it's easy to build houses. When the demand for houses rises, Flatland metropolitan areas, which don't really have traditional downtowns, just sprawl some more. As a result, housing prices are basically determined by the cost of construction. In Flatland, a housing bubble can't even get started.But in the Zoned Zone, which lies along the coasts, a combination of high population density and land-use restrictions - hence "zoned" - makes it hard to build new houses. So when people become willing to spend more on houses, say because of a fall in mortgage rates, some houses get built, but the prices of existing houses also go up. And if people think that prices will continue to rise, they become willing to spend even more, driving prices still higher, and so on. In other words, the Zoned Zone is prone to housing bubbles. And Zoned Zone housing prices, which have risen much faster than the national average, clearly point to a bubble. ...
... In Flatland, which occupies the middle of the country, it's easy to build houses. When the demand for houses rises, Flatland metropolitan areas, which don't really have traditional downtowns, just sprawl some more. As a result, housing prices are basically determined by the cost of construction. In Flatland, a housing bubble can't even get started.
But in the Zoned Zone, which lies along the coasts, a combination of high population density and land-use restrictions - hence "zoned" - makes it hard to build new houses. So when people become willing to spend more on houses, say because of a fall in mortgage rates, some houses get built, but the prices of existing houses also go up. And if people think that prices will continue to rise, they become willing to spend even more, driving prices still higher, and so on. In other words, the Zoned Zone is prone to housing bubbles.
And Zoned Zone housing prices, which have risen much faster than the national average, clearly point to a bubble. ...
In other words, the Zoned Zone is prone to housing bubbles.
If those who have the privilege of living in the Zone, actually pay for the privilege - ie through the use of a location benefit levy or tax on land rental values - then the problem gets solved, because the rental value gets captured for public, not private, benefit. "Any economic unit can emit money. The serious problem is to get it accepted" Hyman Minsky
But there was something else going on: a general belief that bubbles just don't happen. What's striking, when you reread Greenspan's assurances, is that they weren't based on evidence -- they were based on the a priori assertion that there simply can't be a bubble in housing. And the finance theorists were even more adamant on this point. In a 2007 interview, Eugene Fama, the father of the efficient-market hypothesis, declared that "the word `bubble' drives me nuts," and went on to explain why we can trust the housing market: "Housing markets are less liquid, but people are very careful when they buy houses. It's typically the biggest investment they're going to make, so they look around very carefully and they compare prices. The bidding process is very detailed."Indeed, home buyers generally do carefully compare prices -- that is, they compare the price of their potential purchase with the prices of other houses. But this says nothing about whether the overall price of houses is justified. It's ketchup economics, again: because a two-quart bottle of ketchup costs twice as much as a one-quart bottle, finance theorists declare that the price of ketchup must be right.
But there was something else going on: a general belief that bubbles just don't happen. What's striking, when you reread Greenspan's assurances, is that they weren't based on evidence -- they were based on the a priori assertion that there simply can't be a bubble in housing. And the finance theorists were even more adamant on this point. In a 2007 interview, Eugene Fama, the father of the efficient-market hypothesis, declared that "the word `bubble' drives me nuts," and went on to explain why we can trust the housing market: "Housing markets are less liquid, but people are very careful when they buy houses. It's typically the biggest investment they're going to make, so they look around very carefully and they compare prices. The bidding process is very detailed."
Indeed, home buyers generally do carefully compare prices -- that is, they compare the price of their potential purchase with the prices of other houses. But this says nothing about whether the overall price of houses is justified. It's ketchup economics, again: because a two-quart bottle of ketchup costs twice as much as a one-quart bottle, finance theorists declare that the price of ketchup must be right.
We were tickled to find that the work's introduction includes a discussion of soaring housing prices and their effect on consumer spending; it even anticipates a bursting housing bubble. Writes Greenspan: "There is no perpetual motion machine which generates an ever-rising path for the prices of homes." Greenspan, however, didn't foresee a housing mania spilling into the general economy, toppling banks and brokerage houses and paralyzing key portions of the credit system.
Greenspan, however, didn't foresee a housing mania spilling into the general economy, toppling banks and brokerage houses and paralyzing key portions of the credit system.
Frank Delaney ~ Ireland
