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David's Macro Blog

Analysis and commentary on business, economics, real estate, financial markets, and other fun topics


Tag: Calculated Risk

Is it possible that the great equity bubble of 2007 could fool the person best positioned to detect it?

Calculated Risk states in his post “A Comment on Fed Chairman Ben Bernanke” that Ben Bernanke misread the real estate bubble as Fed Governor, then as Chairman of the Presidential Council of Economic Advisers, and later as Federal Reserve Chairman.

How can Fed Chairman Ben Bernanke miss the biggest bubble in history?  Not only did he have the best education at Harvard, MIT, and Yale, but he also had access to all the data, experience, and team members that came with his powerful positions and titles.

In July 2005 Bernanke said:

“We’ve never had a decline in housing prices on a nationwide basis.  What I think is more likely is that house prices will slow, maybe stabilize … I don’t think it’s going to drive the economy too far from its full-employment path, though.”

From this one quote, made at the peak of the boom, we can see two things.  First, Ben did not believe that housing prices would fall much if any and that it was not conceivable that prices would fall across the country in all markets.  Secondly, any decline in housing prices would not slow the economy much to cause a significant increase in unemployment.

Now, just 4 years later we can see that we had the biggest housing boom (and bust) in history AND that the crash caused us to experience the unemployment unparalleled since the Great Depression.

In this case, a big trend (in asset prices and leverage) caused even the most well trained and experienced economic thinker, who has access to the best data, to get swept up and lose track of the fundamentals.

Why did this happen?  Share your opinion by commenting below.

Historically we often think of a recession as a sharp drop in economic output followed by a sharp rise. This is called the “V-shaped” recovery. The current “Great Recession” had a sharp downturn but so far no recovery after 18 months, and most talk is of an “L-shaped” or “U-shaped” rebound.

Why is this?

There’s an excellent post on Calculated Risk blog (one of my favorites) about economic growth engines that typically pull us out of recession with a sharp upward swing in activity.

The top two economic growth engines are residential investment and personal consumption expenditures.

Since we’ve had the largest residential real estate bubble in history and massive over-consumption, both due to very loose credit, these two growth engines are NOT poised to restart economic growth anytime soon.

In fact, just the opposite is true. Any recovery will be held in check by the massively overbuilt inventory of residential real estate and the inability of consumers to tap savings and credit to purchase consumer goods at the level needed to “stimulate the economy”.

Thus, while it looks like we avoided the Great Depression II, we’ll probalby remain in the Great Recession I for some time.

What do you think? Whether you agree or disagree, please add your comment below and show me you’re alive!