We did not have a housing bubble, according to Charles Laven, President of Forsyth Street Advisors. We had a credit bubble. Five years after the Great Recession, we have gained some perspective on what happened. What can we do to make sure it does not happen again?
The current recovery, especially related to jobs and job growth, has been painfully slow. Compared to the last four recessions, job losses were considerably greater during the Great Recession. As the graph below from REIS Inc. clearly shows, the recovery period since the recession ended in 2008 has also been significantly longer.
Normally, the housing sector helps to spur job growth and lead the United States out of a recession. It is one sector of the economy that provides lots of jobs and is not subject to significant foreign competition. Housing also creates many related jobs in building supplies and real estate services.
As Table A below shows, once prior recessions ended, housing construction usually picked up. In the four years following the end of the recession in1974, 1981 and 2001, construction of new houses averaged 5.7 percent, 40.5 percent and 23.4 percent more than during the last year of the recession. It was a major engine generating economic growth and jobs.
The exception was the recession of 1990. As chart A shows, the housing market in the four years after the end of the recession stayed relatively flat. In fact, it averaged 6.5 percent less construction. However, at 665,300 units, it was not a drag on the economy.
When we look at the Great Recession, we see a very different picture: the drop in housing construction was severe. In 2008, housing under construction was 780,900 units. The following year it dropped to 495,400 and during the next four years averaged 40.56 percent less than in 2008. The pronounced lack of housing construction has been a setback to the economic recovery and an important reason that jobs were lost and job growth is limping along so slowly.
After the Great Recession, many commentators talked about the "housing bubble" and how problems in the economy were the result of the unprecedented run up in housing prices. For eight years, housing prices in the United States increased at double digit rates, fueling vast amounts of speculative buying and the psychology that housing was a great investment and could only go up. Describing the problem in that way makes it very difficult to construct a solution. How do you change human nature to eliminate bubbles? How do you prevent developers from building too much housing?
On the other hand, if we view the problem as a credit bubble, we might be able to protect ourselves and speed up the recovery time after future recessions. While no one can predict when the housing market will crash or how far it will fall, the loosening of credit standards for mortgages is easy to gauge. For example, in December 2007, the New York Times reported, "Fed officials noticed the drop in standards as well. The Fed's survey of bank lenders showed a steep plunge in standards that began in 2004 and continued until the housing boom fizzled."
So while it is difficult to know if we are in a housing boom or a housing bubble, we can easily detect when mortgage standards have dropped. Now that the U.S. government controls Fannie Mae and Freddie Mac, we are in a strong position to help establish and maintain appropriate mortgage standards. We should take full advantage of this powerful tool.
It is an oversimplification to focus solely on the housing market as either the cause of the Great Recession or the only reason for the slow recovery. However, it did play a large role in both and we need to take steps to prevent this pattern from happening again. A clear definition and understanding of the problem along with better utilization of new and existing tools is a good place to start.
John H. Vogel Jr. is an Adjunct Professor at the Tuck School of Business
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