Housing Slump Continues: Are Economists Ready For Reality?

Tim Iacono The conclusion that most economists are naive, sometimes dangerously so, is something that has been hinted around at here for years, but now that the Wall Street Journal seems to concur, maybe it's time to stop asking the question and just say it.

Most economists are naive.

Or, maybe they're just too optimistic. Actually, in many cases, the two adjectives describe the same phenomenon - the willingness to suspend belief that something bad is likely to happen (or is already happening) due to a lack of real-world experience.

Merriam-Webster defines the word thusly:

2 a : deficient in worldly wisdom or informed judgment; especially : CREDULOUS
2 b : not previously subjected to experimentation or a particular situation

The nation's housing market is a perfect example of how this naïveté can be dangerous and, more importantly, expensive. Anyone listening to a raft of predictions last summer or fall regarding the future course of the housing boom, and then taking the plunge after rosy talk of an imminent rebound would be sorely disappointed today.

David Lereah, the recently departed and much-discredited chief economist at the National Association of Realtors, serves as a prime example of this.

There seem to be far too many practitioners of the dismal science who simply look at numbers or charts then err on the side of optimism, failing to consider that the numbers and charts represent real people in the real world with all their real faults and real emotions.

The fact that we now live in a world where speculative bubbles are more the rule than the exception does not make their job any easier.

Two stories in the Saturday edition of the Wall Street Journal make this case rather well. Sadly, both are behind the subscription wall, but it really isn't necessary to do much more than read the headline to understand the message.

Economists See Housing Slump Enduring Longer
Downturn Is Expected To Keep Growth Tepid
By JAMES R. HAGERTY, JONATHAN KARP and MARK WHITEHOUSE

Economists are giving up on the idea that the U.S. housing slump will be quick and relatively painless.

Instead, more are concluding, the downturn that began nearly two years ago will last at least through the end of 2007, remaining a major drag on the U.S. economy. The culprits: a glut of homes for sale and growing caution among lenders who now regret being so free with their mortgages during the boom.
...
Late last year, some economists were saying the market would start bouncing back by the middle of 2007. That hasn't happened, partly because inventories of unsold houses have continued to grow and a surge in mortgage defaults has made lenders much more reluctant to grant credit to people with spotty payment histories.

David Resler, chief economist at Nomura Securities International Inc. in New York, says he is surprised by the degree to which speculation caused builders to overestimate demand, leaving a glut of houses and condominiums.

Surprised indeed.

All Mr. Resler had to do was talk to a few prospective condo buyers camped out in front of sales offices around the country in 2004 or spend an afternoon observing the goings-on at the office of a subprime mortgage broker to understand what was really happening.

And, speaking of "subprime", which by now must be a candidate for addition to Merriam Webster in 2008, the world's most famous contemporary economist was in the news again over the weekend.

Did Greenspan Add to Subprime Woes?
Gramlich Says Ex-Colleague Blocked Crackdown On Predatory Lenders Despite Growing Concerns
By GREG IP

Alan Greenspan was arguably the country's most powerful financial cop in his 18 years as chairman of the Federal Reserve. But Mr. Greenspan's regulatory record has received far less scrutiny than his management of the economy.

That may be changing. A former colleague says Mr. Greenspan blocked a proposal to increase scrutiny of subprime lenders under the Fed's broad authority. That added scrutiny might have helped curtail questionable lending practices now blamed for soaring defaults by mostly low-income borrowers. Democrats in Congress are now turning up the heat on regulators, especially the Fed, for failing to do more to stamp out those practices, and the Fed appears increasingly likely to overhaul its approach.

Edward Gramlich, who was Fed governor from 1997 to 2005, said he proposed to Mr. Greenspan in or around 2000, when predatory lending was a growing concern, that the Fed use its discretionary authority to send examiners into the offices of consumer-finance lenders that were units of Fed-regulated bank holding companies.

"I would have liked the Fed to be a leader" in cracking down on predatory lending, Mr. Gramlich, now a scholar at the Urban Institute, said in an interview this past week. Knowing it would be controversial with Mr. Greenspan, whose deregulatory philosophy is well known, Mr. Gramlich broached it to him personally rather than take it to the full board.

"He was opposed to it, so I didn't really pursue it," says Mr. Gramlich, a Democrat who was one of seven Fed governors.

All of this makes me think that comments by your humble scribe appearing in BusinessWeek last year about economists and wedgies offered an excellent insight into this matter:

Do I Deserve a Wedgie?
By Michael Mandel

Seeing that Mike Mandel and Chris Farrell are two of the authors goes a long way in understanding what it's about.... Both of these guys are so far out of touch with Main Street -- one of these days some laid-off worker is going to give both of them a wedgie. --Tim Iacono, commenting on bigpicture.typepad.com

The topic back then was dark matter - the elusive substance that explains how laid off manufacturing workers shouldn't feel so bad.

Fast-forward to mid-2007 and a case could be made that David Lereah might someday soon become uncomfortable in his nether regions were he to meet up with a truck driver who is now upside down on his late-2006 condo purchase after heeding the economist's advice.

Comments

[omooc:]

You are overstating the case. I read the WSJ article as well, and thought nothing of it. After all, when an "economist" is under the employ of an organization, he/she has to take his/her employer's viewpoint. "Suspending belief" is not the same as "ignoring facts;" the former is subjective, to which everyone is entitled, while the latter is objective, non-mentioning of which disqualifies one as a professional, be that person an economist or a security analyst. omooc

2007 Jun 12 09:04 AM

[deano:]

Regarding your comment about the truck driver and his being upside down on his condo: When did we start feeling sorry for human beings for being stupid when getting into shaky financial deals? The subprime market wouldn't even exist if people would use their heads instead of emotions when getting into bad deals.

2007 Jun 12 10:08 AM

[emily x:]

Dean's comment does not take into consideration the power of a) watching everybody else in the country profit from real estate, which herd mentality is certainly not unknown among Wall St investors; and b) the power of marketing, which has *everything* to do with why we make the choices we do. It's easy to point to the other guy andf say "Fool!" esp. if the other guy makes a lot less than you, or works a less prestigious job.

But most big decisions (marriage, for example), and especially most big purchases, get their start in life as an emotional pull -- which marketers know very well. A home purchase in paarticular has a large component of emotion, as anybody who's ever bought a house knows -- even if it's an investment property. And the last year or 2 of the bubble was a very emotionally charged time. People felt that it was now or never -- get in however you can, or miss the profit boat completely! -- and real estate professionals, including subprime lenders, were most definitely feeding that frenzy, you would be very naive to think otherwise.

2007 Jun 12 10:49 AM

[Unimpressed...:]

Economists breed in the vacuum of academe, completely devoid of reality. Their only contact with humanity is through clueless professors and the books and papers they and their colleagues create to justify their existence. Their biggest crime (sin?) is representing applied economics as a science. It is, at best, soothsaying and fortune telling through the correlation of distorted and manipulated data.

Alan Greenspan was a living proof of this phenomenon; a perfect example of the Peter Principal run amok. His talent was obfuscation and disingenuous deflection that he used to great effect on the clueless purveyors of deceptive twaddle who masquerade as fully qualified and knowledgeable U.S. Senators and Representatives. That Wall Street followed his dictates was proof positive of their dedication to the purported philosophy of B.T, Barnum: “There’s a sucker born every minute”.

In their continuing adulation of this B.S. artist, his followers chose to forget, or ignore, that little Alan lead this country’s into 7 major recessions that he manufactured from a booming economy. How many fortunes were made through short selling by the mavens of Wall Street as they encouraged their deluded followers to buy, buy, buy?

At a reported $150,000 per speech/presentation, little Alan continues to exert undue influence on world economic issues. For the protection of our current and future economic successes, he should be incarcerated in an old age home for the demented as quickly as possible and denied any further contact with the world. He speeches, books, papers, and utterances should be gathered together an taught in advanced business schools as an example of the success that can be achieved through the application of the absurd and the Big Lie. Alan was a true master and guru of this economic philosophy and his applied skills in the application of deception, misinformation, disinformation, boredom, and disingenuous babble. If he had chosen another life career, he would have achieved untold wealth as an evangelist and faith healer!

To further prove the contention that economics is a tool of the highly successful con artist, take a long and educated look at the housing market. For the past several years, based upon glowing predictions of vast wealth possibilities in real estate and the endless future of the bull market, people were encouraged to spend whatever it took to acquire a house or invest in housing. With the resources of the many stretched to the breaking point, these economic gurus and investment advisors reversed their prognostications to foretell of a housing market collapse. I won’t go into all the related manipulations that are, now, coming to light, but it is obvious that voodoo of economics was, once more, applied to make unconscionable profits for the insiders, on the way up and on the way down.

And, the beat goes on! Long live the economists! Without them, politicians and Wall Street mavens would have to find honest jobs.

2007 Jun 12 01:48 PM

[LeeCarlson:]

Can't help but agree with Ernest (Above),..as for me, I just don't read what the economists say as they
don't live in the real world ! Even the NAR economists,...With regard to Emily, above,..buying a home for yourself may be partly an emotional experience, but buying investment property, especially for immediate resale, is super high risk as many have found out ! This is where "crunching the numbers" and asking the right questions from those that have gone on before, would have helped a lot ! Having lived in FL for the past 27 years, I have seen nothing to compare with the insanity that took place in the past few years,..people buying million dollar tiny waterfront condos that cannot possibly pay for themselves tells me that the buyers of those properties had more ego and money than brains, and being "emotionally charged" means nothing more than they left their common sense at home before making that kind of decision ! Being a Realtor for the past 26 years, common sense told me to avoid selling those properties when they started !! Sure I could have made a fortune during that short time, but then I would have had to listen to years of complaining by "emotionally charged" SELLERS now, who suddenly realized that they made a very big bad mistake and simply want to get their money back !!
This is the kind of situation that Economists should report on, but most are fearfull of their Employers ,..meaning builders, bankers, NAR, etc. Zero down loans and subprime loans were never
mentioned by those famous Economists and a one month uptick in the market does not indicate a "Trend" !! In my experience, following the "herd" is very poor advice ! Want proof,..just look at the stock market plunge just before the start of the new R.E. BULL market ! Real Estate is a safe investment , right ? YES,..if you buy it right and do the math,..or is that asking too much ?
Lee Carlson

2007 Jun 12 02:25 PM

[tomcat1945:]

I've been a real estate investor since the late 1970's and have witnessed several up/down market cycles. Eventually everything reverts to the historical mean. When prices increase too much...they correct downward and when prices decrease too much it leads to the next up cycle. Not rocket science...just common sense. Those who buy in at the top get hurt and either lose money, or must hang on until the next up cycle to bail out.

The problem with the latest boom is that in many ways it was artificially created...with massive liquidity because of extremely low rates. The current correction may be worse than those in the past. Once liquidity is reduced demand stalls and prices drop. It will likely take longer to revert to the mean this time because prices increased so much in a short period of time. It shouldn't require an economist to figure this out. Just ask anyone who bought at the peak(s). They'll tell you more truths than most economists. It boils down to street smarts rather than book smarts!

2007 Jun 12 08:13 PM