Question for Economic Experts: Can You Say "Housing Bubble"?

The answer for many economists is apparently "no." Many of the most important figures in economic policy over the last decade, including luminaries like Alan Greenspan, Ben Bernanke, Robert Rubin and Henry Paulson, could not see the $8 trillion housing bubble growing right in front of their eyes. As the bubble grew larger, and the financial system became ever more highly leveraged, these folks saw nothing but blue skies ahead.

Not only did these folks miss the bubble, even now, they still can't seem to understand the housing bubble as its collapse throws the economy into the worst downturn since the Great Depression. That is the only possible explanation for Henry Paulson's 4.5 percent mortgage rate policy.

The bubble has largely deflated in many parts of the country, however, prices in many of the former bubble markets still must decline another 20 percent to 30 percent to return to trend levels. It does not make sense to apply the same policy to both bubble and non-bubble markets.

In non-bubble markets, it might be appropriate to use aggressive measures, like extraordinarily low mortgage rates, as a tool to stabilize house prices. We want to avoid the scenario in which falling house prices create an expectation of further declines in house prices. This expectation can become self-fulfilling, as potential buyers defer purchases, causing house prices to fall further.

By contrast, in the bubble markets, supply hugely exceeds demand at current prices. The only way to restore stability to these markets is to have prices return to levels that are consistent with the underlying supply and demand conditions. The effort to sustain prices at their current bubble-inflated level will be no more successful than an effort in 2000 to keep the NASDAQ at its 5,000 peak.

Even worse, to the extent that we can artificially prop up house prices in these bubble markets, we would just be passing along the pain to a new contingent of homebuyers. We are not going to have 4.5 percent mortgage interest rates forever. Suppose the economy recovers in a few years and mortgage rates rise back to a more normal 6.5 percent to 7.5 percent level.

Whatever effect low mortgage rates had in sustaining house prices will be reversed. House prices will complete their correction and today's homebuyers may well be seeing losses of 15 percent to 20 percent when they sell their homes in five years. For a house selling at $250,000, this price decline translates into a loss of $38,000 to $50,000.

Losing $38,000 to $50,000 would destroy the bulk of most homeowners' wealth. That does not seem like very good policy.

Unfortunately, most of the promoters of the housing bubble still have not owned up to the harm caused by their policy. Millions of people are facing the prospect of losing their home, and tens of millions of people are losing their life's savings, because the people who are supposed to know better didn't. They encouraged people to buy homes and/or borrow against them in what was quite obviously a bubble-inflated market.

Before Paulson is allowed to carry through with his scheme to use public money in an attempt to reinflate the housing bubble, he should be forced to publicly explain how he thinks this policy will work. There are clearly people who will be badly harmed by temporarily reinflating the bubble. Unless Paulson can explain how the benefits will outweigh this harm, he should not be allowed to pursue his blanket policy of providing 4.5 percent mortgages everywhere.

As it is, Paulson and other people in policy positions have not even acknowledged that we have a housing bubble that is in the process of deflating. Paulson could not possibly be so incompetent that he still doesn't see the housing bubble, but for some reason he can't bring himself to talk about it.