April 12, 2010

Krugman sets us straight on the housing bubble

Naturally, we all turn to Paul Krugman when we want to understand what's going on in this crazy world of ours. Although he is no stylist (unless you believe that most sentences should begin with prepositions and conjunctions), Krugman is famous for being rigorous and logical. In today's column, for example, the Nobel Laureate explains (very patiently) why the state of Georgia has experienced so many bank failures. Just in case you were thinking that a big part of our problem in the housing bubble was caused by securitization of lousy mortgages and big banks committing fraud, Paul explains otherwise, using Georgia as his prime example. The problem there was that many smaller banks were unregulated, and a 1980s-style, S&L crisis was the real culprit. Thus, in our upcoming financial reform, we should not be overly concerned with banks Too Big to Fail, but with regulating the banks in Atlanta. The logic that this internationally renowned economist uses to reach this somewhat iconoclastic conclusion is unassailable, and quintessentially the work of the kind of mind which earns and wins Nobel Prizes. Here is the sweet spot of his insight:

To appreciate Georgia’s specialness, you need to realize that the housing bubble was a geographically uneven affair. Basically, prices rose sharply only where zoning restrictions and other factors limited the construction of new houses. In the rest of the country — what I once dubbed Flatland— permissive zoning and abundant land make it easy to increase the housing supply, a situation that prevented big price increases and therefore prevented a serious bubble.

Most of the post-bubble hangover is concentrated in states where home prices soared, then fell back to earth, leaving many homeowners with negative equity — houses worth less than their mortgages. It’s no accident that Florida, Nevada and Arizona lead the nation in both negative equity and mortgage delinquencies; prices more than doubled in Miami, Las Vegas and Phoenix, and have subsequently suffered some of the biggest declines.

If you are scratching your head right now, you should not feel slow or uncomprehending. My first time through, I was also reduced to: WTF did he just say? It is true that Florida, Nevada and Arizona lead the way in the catastrophic aftermath of the housing bubble, with California bringing up a close 4th. Yet if we follow the Oracle's logic, the reason is that Florida, Nevada, Arizona and California do not have permissive zoning and abundant land. So the problem in an area like Las Vegas, Nevada is not that huge securitizers, such as Bear Stearns and Lehman Brothers, provided an end market for subprime loans made up of no-down, no-doc, no-income, interest-only, neg-am adjustable rate mortgages which were freely available to pole dancing real estate speculators; no, that is a red herring. The problem is that Las Vegas, in its tight-ass regulatory way, had such restrictive zoning and land use laws that the city fathers (or godfathers) just wouldn't allow any growth in housing, thus artificially inflating the price of the existing housing stock. This anti-sprawl approach only allowed the metro area of Las Vegas to grow 17% in the eight years between 2000 and 2008. In Riverside, California, another Ground Zero area in Foreclosure Nation, the story is much the same. Between 2000 and 2008, Riverside's population only increased 20%. Clearly, what happened was that all those people moving into the area simply rented rooms from existing homeowners, drawn to Riverside by its scenic and cultural advantages (Riverside is often compared to Paris, or at least to the sewers of Paris).

This, you see, is what "you need to realize." Paul saw it first: if California, Nevada, Arizona and Florida had simply allowed house construction and population growth, they could have been spared the fate of the housing bubble.

In my naive, pre-Krugmanite days, I mistakenly believed that a chief driver of the housing bubble was the availability of easy credit, and not the tight, anti-growth philosophy of Las Vegas and Phoenix. My overly simplistic analysis proceeded on the assumption that if interest rates and terms are initially so low that a kid on a paper route can sign and close on a million dollar house, this will naturally ratchet up the housing market to unsustainable levels.

It seems like a surprising thing to say about a Nobel Laureate, but I'm reaching the conclusion that Krugman literally has no idea what is going on in the United States. I'm beginning to see that his failure ever to mention the offshoring of American manufacturing jobs owes to his myopic adherence to his "free trade" principles, the subject of his highly suspect Nobel Prize (I think he won because of all of his anti-Bush columns, a favored approach of the Swedish jury.) He doesn't seem to understand that the United States has any sort of long-term budgeting problems. Krugman appears to latch on to some isolated circumstance, such as the large number of bank failures in Georgia, and then reinterprets an obvious history (securitization of mortgages created a mirage of "safety" by bundling loans, when actually the effect was to correlate the entire national housing market into a death spiral) by arguing that a fringe, local effect is actually the dominant paradigm.

A recent profile suggested he writes some columns while sitting in a lawn chair at his condo in St. Croix. I wonder if he gets his data by holding sea shells to his ear.

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