Sunday, July 20, 2008

L-ish Economic Prospects: Paul Krugman

Here's an op-ed with some interesting "facts" about housing numbers...and what this economist sees for the economy's recovery. As usual, bolding courtesy of Real C'ville - The Bubble Blog.

L-ish Economic Prospects


Home prices are in free fall. Unemployment is rising. Consumer confidence is plumbing depths not seen since 1980. When will it all end?

The answer is, probably not until 2010 or later. Barack Obama, take notice.

It’s true that some prognosticators still expect a “V-shaped” recovery in which the economy springs back rapidly from its slump. On this view, any day now it will be morning in America.

But if the experience of the last 20 years is any guide, the prospect for the economy isn’t V-shaped, it’s L-ish: rather than springing back, we’ll have a prolonged period of flat or at best slowly improving performance.

Let’s start with housing.

According to the widely used Case-Shiller index, average U.S. home prices fell 17 percent over the past year. Yet we’re in the process of deflating a huge housing bubble, and housing prices probably still have a long way to fall.

Specifically, real home prices, that is, prices adjusted for inflation in the rest of the economy, went up more than 70 percent from 2000 to 2006. Since then they’ve come way down — but they’re still more than 30 percent above the 2000 level.

Should we expect prices to fall all the way back? Well, in the late 1980s, Los Angeles experienced a large localized housing bubble: real home prices rose about 50 percent before the bubble popped. Home prices then proceeded to fall by a quarter, which combined with ongoing inflation brought real housing prices right back to their prebubble level.

And here’s the thing: this process took more than five years — L.A. home prices didn’t bottom out until the mid-1990s. If the current housing slump runs on the same schedule, we won’t be seeing a recovery until 2011 or later.

What about the broader economy? You might be tempted to take comfort from the fact that the last two recessions, in 1990-1991 and 2001, were both quite short. But in each case, the official end of the recession was followed by a long period of sluggish economic growth and rising unemployment that felt to most Americans like a continued recession.

Thus, the 1990 recession officially ended in March 1991, but unemployment kept rising through much of 1992, allowing Bill Clinton to win the election on the basis of the economy, stupid. The next recession officially began in March 2001 and ended in November, but unemployment kept rising until June 2003.

These prolonged recession-like episodes probably reflect the changing nature of the business cycle. Earlier recessions were more or less deliberately engineered by the Federal Reserve, which raised interest rates to control inflation. Modern slumps, by contrast, have been hangovers from bouts of irrational exuberance — the savings and loan free-for-all of the 1980s, the technology bubble of the 1990s and now the housing bubble.

Ending those old-fashioned recessions was easy because all the Fed had to do was relent. Ending modern slumps is much more difficult because the economy needs to find something to replace the burst bubble.

The Fed, in particular, has a hard time getting traction in modern recessions. In 2002, there was a strong sense that the Fed was “pushing on a string”: it kept cutting interest rates, but nobody wanted to borrow until the housing bubble took off. And now it’s happening again. The Onion, as usual, hit the nail on the head with its recent headline: “Recession-plagued nation demands new bubble to invest in.” [You may have seen this in a comment by Diana on an earlier post; if not, click here.]

But we probably won’t find another bubble — at least not one big enough to fuel a quick recovery. And this has, among other things, important political implications.

Given the state of the economy, it’s hard to see how Barack Obama can lose the 2008 election. An anecdote: This week a passing motorist shouted at a crowd waiting outside a branch of IndyMac, the failed bank, “Bush economics didn’t work! They are right-wing Republican thieves!” The crowd cheered.

But what the economy gives, it can also take away. If the current slump follows the typical modern pattern, the economy will stay depressed well into 2010, if not beyond — plenty of time for the public to start blaming the new incumbent, and punish him in the midterm elections.

To avoid that fate, Mr. Obama — if he is indeed the next president — will have to move quickly and forcefully to address America’s economic discontent. That means another stimulus plan, bigger, better, and more sustained than the one Congress passed earlier this year. It also means passing longer-term measures to reduce economic anxiety — above all, universal health care.

If you ask me, there isn’t much suspense in this year’s election: barring some extraordinary mistakes, Mr. Obama will win. Assuming he wins, the real question is what he’ll make of his victory.

[Sure, Krugman is quoting Case-Shiller for some of his stats, and our MSA isn't part of this Index. As you know, however, the majority of economists use this index as the standard for the housing market nationwide--even though there are always exceptions. Some folks believe Charlottesville/Albemarle is an "exception;" some folk don't. Time will tell.]

Click here for the original article.


sebastian said...

the new york times has been full of stories about the economy and housing over the past few days. krugman says housing prices have fallen about 17% and still have a ways to go...other articles over the past few days say the correction will be 15-25%. not just in cities on the case-shiller, but everywhere. and that the "correction" will be even larger in places that have already been nosediving...florida, las vegas, los angeles.

i'm in c'ville...but i think i'm going to start looking. time for some investment property? or some new digs?

Dave Phillips said...

It was a great week to be a bubble blog. Lots of great material for you to post. There was enough bad, nasty stuff to make the most optimistic person question whether the world was about to end. Then, just before we dove head first over the cliff, oil prices plunged and the stock market shot up. It was a crazy week and I appreciate the fun discussions we had.

matt. s. said...

I am glad you started questioning... better late than never.

I guess you didn't question when Paulson said last spring that housing markets are "recovering." You probably didn't question when he said last summer that "the subprime crisis is contained."

Perhaps your hope was renewed each month as the NAR inevitably spun every report, whether up or down, into "we're at the bottom" stories.

Maybe you believed Bernanke as he assured you of his "strong dollar" policy, even as the charts show the dollar consistently falling under his watch.

I suppose any remaining doubts are removed when our fearless leader appears on tv to tell us our economy is "fundamentally strong."

Dave Phillips said...

No reason to get snippy at me (or is that snarky?). I think you'll find that I question everything - even what I say - and believe nothing on its face. Nothing we read or hear is without spin, mis-interpretation, or slant. That's a fact, but there are little other facts we can all agree on.

I'm a firm believer in the probability that there is more than one right answer to every question. The problem is that we are often debating the answer to two or more different questions.

If we were keeping score last week, snarky outscored sparky 36 to 14. It was probably 36 to 0 until Friday.

matt s. said...

I'll keep working on my snark. No need to defend yourself against my straw man attack.

I just dropped back in to share more happy news. Wachovia Bank is shutting down their mortgage lending.