Housing in Ireland, the US, and Australia, Part 1

During my debate with Cameron Murray, when I made my standard remarks about the 2000s housing bust being the result of policy errors rather than the inevitable reversal of a bubble, I was surprised to hear Dr. Murray cite Ireland and Spain as confirmations of the bubble narrative.

I hadn’t heard that reference in a while. In “Shut Out”, I quoted economist Paul Krugman in comments to the Financial Crisis Inquiry Commission. He said, “It’s hard to envisage us having had this crisis without considering international monetary capital movements. The U.S. housing bubble was financed by large capital inflows. So were Spanish and Irish and Baltic bubbles.”

The global glut of capital was a popular explanation for the housing “bubble”. In “Shut Out” I challenged the claim from a few angles. Read “Shut Out” for all of that. Here, I just want to limit the discussion to the observational bias that tends to come along with “bubbles”.

One of the toxic elements that made the financial crisis inevitable was that, increasingly, pundits, economists, and policymakers, were calling the housing market a bubble. That implies that prices and activity are unsustainably high.

For the most part, they weren’t, and so, as a minor downturn in housing starts became a major downturn in housing starts and that, finally, in the second half of 2007, became a downturn in home prices, those declines into disequilibrium provided confirmation bias to the bubble-callers.

When Richard Fisher saw the financial world collapsing around him in September 2008, he wasn’t embarrassed by his poor performance as a voting member of the Federal Reserve. He was emboldened, as the collapse proved he had been right about a bubble. The worser it got, the righter he felt. He was making speeches about how all of you morons were bound to eat your shirts, one way or another, no matter how enlightened the Fed was.

Bubbles end up with this odd hindsight bias. Bubbles are defined as periods with unsustainably high prices. So, when we look back, we only see bubbles where there were significant declines in prices. Bubbles, as perceived, are defined by their busts.

Figure 8-3 is a chart from Ben Bernanke that I cited in “Shut Out”. Bernanke treated the international capital flows as a cause of housing bubbles. And, you can see that, per Krugman and Murray, the US, Spain, and Ireland are in the upper left quadrant - capital inflows and rising home prices.

But, they don’t cite Ireland, Spain, and the US because of the boom from 2001 to 2006. They cite Ireland, Spain, and the US because of the bust from 2007 to 2010. And, in fact, most of the countries in the upper left quadrant didn’t have busts. Prices pretty much just kept going up.

As I wrote in the footnote in “Shut Out”, “Many countries, such as Canada, Australia, the United Kingdom, France, and Sweden, have seen housing appreciation as strong as appreciation in the US, Spain, and Ireland, yet prices remained high. Capital flows haven’t ended and interest rates haven’t risen. If global savings caused the housing bubble, it is the countries that didn’t have a bust that should provide the best examples. In hindsight, the bust makes Spain and Ireland seem like good examples of housing bubbles, but it actually makes them poorer examples of the relationship between housing bubbles, interest rates, and capital flows.”

The United States, Ireland, and Spain are pretty unusual, really. Most of the globe either had moderate home prices before 2008, or they had elevated home prices that have just kept going up. It was especially ironic to hear Dr. Murray cite those countries again, from his home base in Australia.

I think it’s a fascinating peek into the collective observer’s bias that took over in the years leading up to and following 2008. What other claim could you possibly ever hear someone describe as a global phenomenon by noting that it happened in Ireland and Spain?

The pinnacle of this observer’s bias, for me, is in “Inside Job”, the film that became the most popular documentary about the crisis. It won the Oscar in 2011 for Best Documentary Feature. It has a 98% reviewer rating and 91% audience rating at Rotten Tomatoes. The first 5 minutes of that film are about banks in Iceland. And those 90%+ viewers accepted Iceland as a very important lever through which to talk about global housing economics.

And, the point I made in the previous post strikes me afresh, seeing that the release date for that movie was 2010. When people were making this movie, watching it, & giving it awards, what did they think about low tier home prices in Atlanta? Those homes, which hadn’t been particularly highly valued, had lost nearly half their value by the time the movie was in production, and by Oscar season had lost nearly 70%.

Do you think any of those viewers were apt to support public policies that would stabilize those home prices? Would any of them have even questioned whether that 70% was inevitable or necessary?

The fires weren’t even put out yet on the Atlanta housing market when the accolades were being draped on the public defense of the arson. The topic of that movie, applied to Atlanta, was, “Get a load of these idiots who didn’t think low tier Atlanta would lose 70% of its real estate value.”

There was no space in the collective conscience for anything short of crisis.

In the next post, I will look more at Ireland.

To the extent that I have looked into it, Spain does actually look to me like it went through a housing boom and bust with some of the conventional trappings. It seems like, maybe, foreign capital flowed into second homes and vacation properties, and then dried up. That might be a reasonable description of some of what happened there.

I think comparing Ireland, the US, and Australia can give us some useful reference points to understand what was happening then and what is happening now.