Do you count the wealth created by the bubble as lost wealth?

It matters, because the 3% in lost consumption would therefore be mis-placed consumption if the wealth was bubble wealth.

Dean,

Q. Yes, but what caused the housing bubble?

A. Bottom up demand from population increases, causing hyper-inflation in housing.

Q. Why was there a need to allow MBS (EZ) mortgages.

A. The population increase cause a glut of labor resulting in flat wages. With a dwindling number of workers who could qualify for a traditional mortgage, the bankers had to create a vehicle (MBS) to ensure profitability.

Wage control and housing-inflation were deemed good policy and immigration enforcement was relaxed. However the administration did not account for globalization which inhibited employment growth.

BLS Employment Growth over NonInstCiv Population Growth by Decade:

1980s
Population Growth = 20,865,000
Employment Growth = 17,685,000 (85%)

1990s
Population Growth = 21,667,000
Employment Growth = 16,998,000 (78%)

2000s
Population Growth = 24,795,000
Employment Growth = 11,953,000 (48%)

Q. Why did the housing bubble burst?

A. The bankers and Greenspan knew that immigration was an intregal part of the demand side of housing inflation. The refinancing scheme was halted at exactly the same time that Comprehensive Immigration Reform failed for the second time.

Current policy:
Now the administration is artificially attempting to freeze housing equity. On the other hand, they are promoting high-skill immigration in a flat employment market. The displacement of high-skill workers will result in more failed mortgages.

To restore the American wage-earner to globally competitive levels, housing valuation must be allowed to fall. Housing costs are the primary driver of salary requirement.

FYI: Housing re-valuation will not be a harmful as some imagine. About 50% of all houses have no first mortgage.

1. “The news media almost completely missed the housing bubble.” FALSE. The media loudly and frequently broadcast the anti-housing bubble sentiments of economists, public-policy makers and investors.

2. As a result, they are still badly misinforming the public, first and foremost by attributing the economic downturn to a credit crunch. FALSE. The media again is blatantly airing the sentiments of economists, public-policy makers and REIT insiders.

3. Attributing the economic downturn to the bursting of the housing bubble is a vastly oversimplified association. The sources of economic downturn are best explained by looking at the complex interplay of irrational speculation, fraud / lack of transparency, and weak regulations that occurred simultaneously in multiple investment markets.

4. While you blame others (the media) for spreading misinformation, you, as an economist, might consider the virtues of self-examination and professional humility. See “Communicating economics in good and bad times” at http://www.res.org.uk/society/pdfs/newsletter/july08.pdf for some ideas on the merits of such contemplation.

Sorry Dean, but unless you can offer an explanation of this, I strongly disagree: "Homeowners have lost more than $5 trillion in housing wealth."
Only those who bought in the Bubble zones in the Bubble years have taken a beating. AND of those, only the ones who've sold at a loss have lost anything.

Bailey,

It's not a question of how much homeowners have been hurt. They were spending based on the market value of their home. With this tanking, they will be cutting back their consumption.

Hi Dean. After searching your archives, I think I understand that you get the $5 trillion figure for lost household real estate wealth by applying the case shiller index (now down about 20% from peak) to the peak level of household real estate value published in the flow of funds accounts (about $20 trillion). The FoF data shows 'only' $731 billion of lost housing wealth through Q2, but this jumps to about $4 trillion if we apply the CS decline to the peak values which is much closer to your $5 trillion figure. I believe the FoF value data is based on the OFHEO price indexes, which cover only houses with conforming loans, so I presume you consider the CS price measures to be more reflective of the overall housing market (as many do).

Could you confirm how you arrive at the $5 trillion figure?

Dean, it may not matter what caused this economic mess because you are right to focus on the effect on consumption of dropping house values.

But, how do we both revise our mortgage industry to allow the use of homes as consumption piggy banks without reinflating the bubble?

There is a very well established wealth effect whereby $1 of housing wealth is estimated as leading to 5 to 6 cents of annual consumption.

Can you tell me where I can find this analyzed?

Would you be willing to discuss the role of the mortgage interest deduction in inflating leverage? I'm amazed that few people really get that both home prices and tax code inflates to account for this item, that you either pay to Uncle Sam or the Bank, that the standard deduction makes this not nearly as big a gift to the middle class as many believe. In the last analysis, banks and local property assessors are the main beneficiaries of this tax preference.
I'm not aware of any vocal advocacy for the removal of mortgage interest deduction. It would be fairly easy to grandfather all existing mortgages for 12 years and phase it out over this period. Deleveraging overinvestment in homes in this way should have salutory effects on this market. I believe that most middle income persons would benefit more from stabilizing and flattening of home prices throughout their life mainly by from paying less interest to the banks. Yes, no?

I don't know about the wealth effect, but there was an interesting report last month from the Minneapolis Fed that casts some doubt on whether a "credit crunch" has occurred.

http://www.minneapolisfed.org/research/WP/WP666.pdf

In the line of Mary's comments on the Tax Deduction for Interest -- this is a subsidy for the banks.

Wouldn't a clear, 35% tax credit on interest plus principal, be better? One with a $50 000 max per year, and a $220 000 lifetime max -- the lifetime max being 10* the prior year median taxable wage (from IRS). Thus, it grows yearly, but slowly.

I don't watch television frequently, but I did watch Fox News on Saturday's to get a roundup of their investment picks. Analysts on Fox News were calling the housing bust three years prior to the crash. Don't believe me, look up some old show transcripts.

Dean is spot-on. While those trillions of dollars of losses did get concentrated in certain parts of the financial industry (the parts where mortgages were bundled to avoid early-payback risk, and the parts that were over-leveraged, both susceptible to systemic housing price decreases), the point is the trillions of dollars of losses that affect everyone, the credit stuff is a mild side effect.

Weaver blames immigration, however overall home ownership reached an all-time high, so obviously there was "creative underwriting" all around. When people I knew in the Internet industry left their jobs to write mortgages, something began to smell fishy to me.

I recently came across your blog and have been reading along. I thought I would leave my first comment. I don't know what to say except that I have enjoyed reading. Nice blog. I will keep visiting this blog very often.

Joyce

http://www.webtraffictrigger.com

Analysts on Fox News were calling the housing bust three years prior to the crash. Don't believe me, look up some old show transcripts.