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Why the Country's Top Economists Keep Making Wildly Stupid Claims

Underwater homeowners can't explain the weak recovery. It's reduced demand and wiped out housing wealth.

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There is no mechanism that would allow the economy to easily replace the combined loss of between $1 trillion and 1.2 trillion in demand that would be predicted from the collapse of the housing bubble. Therefore it is hard to see why anyone would feel the need to look to explanations involving the indebtedness of underwater homeowners, the whole downturn is easily and simply explained by the collapse of the bubble.

In this respect it is worth noting that, contrary to the impression given by the article, consumption remains unusually high relative to disposable income, not low.


                             Source: Bureau of Economic Analysis and author's calculations.

As can be seen consumption as a share of disposable income is well above the level of the 60s, 70s, 80s, and even the 90s prior to the point where the stock bubble led to a consumption boom in the late 90s. If anything, we should be asking why consumption is so high, not why it is low. (Adjusted disposable income refers to the statistical discrepancy in the national income accounts.) In short, the underwater homeowner story is an explanation for a mystery that does not exist.

There are a number of other points in this piece that incorrect or misleading. For example, it refers to the Obama administration's failure to address the situation of underwater homeowners as:

"a persistent and largely unaddressed problem that represents the missing link in what many economists consider the administration’s overall strong response to the recession."

Actually, many economists did not view the administration's response to the recession as strong, pointing out at the onset that the proposed stimulus was woefully inadequate. These economists were not surprised by the subsequent weakness in the economy.

At another point it explains to readers:

"Some people reduced spending because they had lost their homes to foreclosure, damaging their ability to borrow. Others no longer could tap home-equity lines of credit. Still others, facing high monthly payments, used every extra penny to pay off debt."

This comment is extremely confused. If someone loses their home to foreclosure, then they are no longer in debt, except in the extremely rare case where a lender pursues a deficiency judgement against the homeowner. Lacking the ability to borrow because they are not homeowners or losing access to a line of credit because they have no equity are not problems of indebtedness, they are problems of lacking equity in their homes. This is the standard housing wealth effect story. No one has proposed that the government should not only eliminate the negative equity of underwater homeowners, but also give them substantial positive equity so that they can again borrow against their home. Therefore this argument has nothing to do with the underwater homeowner story that is the central theme of this piece.

The economics profession did an astounding amount of damage to the country as a result of its complete failure to see the housing bubble and the dangers it posed to the economy. Economic reporters also failed the country by not being able to exercise any independent of thought to understand that the bulk of the profession was missing something important. (There were prominent economists like Robert Shiller at Yale and Paul Krugman who did warn of the bubble.) It is unfortunate that economics reporters still write pieces that rely exclusively on economists who could not see an $8 trillion housing bubble. 

Btw, we certainly should be trying to help underwater homeowners as a simple matter of fairness. We bailed out Wall Street billionaires, it seems a pretty minimal proposition to offer assistance to homeowners who bought into a bubble that all the top economists insisted did not exist.