You Heard It Here First

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Everyone is talking about the housing bubble bursting and the problem of subprime mortgages. People in the mainstream media blame unscrupulous lenders and hope the worst is over.

LRC and Mises.org readers were alerted to the housing bubble long before anyone else. Frank Shostak alerted readers in March 2003, Christopher Mayer alerted readers in August 2003, and I reiterated these warning in February and June of 2004.

I recap all the correct Austrian predictions and the attempt of the Fed to cover up the story here.

We can also now say that Austrian economists also predicted the end of the housing bubble. Of course all bubbles come to an end, but Austrians are alert to this fact, while most others are not. Between Frank Shostak’s initial alert of the bubble and the peak in the Housing Sector Stock Index on July 29, 2005 the index increased by almost 200%. Stocks of course are generally a good leading indictor.

My article, Is the Housing Bubble Popping? appeared on LRC on August 8th and it clearly indicated that the housing bubble was showing the first signs of its undoing. Since the peak, the index has fallen by 42% on a split-adjusted basis — losing more than half of its previous gain. In the fall of 2005 there was still plenty of talk about home prices never declining in the mainstream media and still plenty of time to sell your real estate investments with a hefty profit.

In contrast to what you hear on bubble vision (i.e. CNBC), Wall Street and the mainstream media, the housing bubble problem was not caused by unscrupulous lenders. It was caused by the Federal Reserve and its artificial injections of credit. When an abnormal amount of credit comes into the loan market, the interest rate falls and loans are given out to less credit-worthy borrowers. Don’t blame banks and lenders for all the bad investments. It was the Fed’s fault; with some blame going to Freddie Mac and Fannie Mae which are also public-private partnership monsters created by the federal government.

We should also not believe that this is the "beginning of the end" of the housing bubble problem. I would suggest it is safer to view it as only the "end of the beginning." The correction will probably be longer and more painful than most people expect. For example, Alan Levenson, the chief economist at T. Rowe Price, wrote that the housing recession had just about run its course:

"The housing correction appears to be running its course, without having had a significant impact on the broader economy. Given all of the gloom, how is this possible? — a slower pace of new construction — finally appears to be losing steam, secondary impacts have yet to play themselves out full. They may not be as strong as some anticipate, however."

~ T. Rowe Price Report, Summer 2007, p. 17

Levenson is a smart guy and I hope he is right and I am wrong.

And don’t expect a good solution from the Fed. The Bank of Japan tried to save their economy with zero interest rates and the decline in real estate prices in Japan lasted for over 15 years.

Mark Thornton [send him mail] is an economist who lives in Auburn, Alabama. He is author of The Economics of Prohibition, is a senior fellow with the Ludwig von Mises Institute, and is the Book Review Editor for the Quarterly Journal of Austrian Economics. He is co-author of Tariffs, Blockades, and Inflation: The Economics of the Civil War and is the editor of The Quotable Mises.

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