So, it turns out there are actually 4 kinds of asset bubbles.
And not all of them are created equal.
Over at The Washington Center for Equitable Growth, Nick Bunker highlights new research that looks at asset bubbles since 1870, which finds that these bubbles really break down into four types.
- Equity bubbles without credit bubbles
- Credit-fuelled equity bubbles
- Housing bubbles with average credit growth
- Leveraged housing bubbles
The fourth and final kind of bubble — a leveraged housing bubble — is not only the one that a) we had most recently in the US, but is b) the worst.
The three economists find a hierarchy for the effects of bubbles. Bubbles in equity assets that aren’t financed by credit aren’t particularly virulent. In fact, Jorda, Schularcik, and Taylor find that these bubbles don’t make recessions any worse. Or at least, there is no statistical difference. Debt-fuelled equity bubbles are more damaging, making recessions more severe and subsequent economic recoveries slower. Yet housing bubbles are even more damaging. Even in the absence of a large credit build up, housing bubbles are quite harmful to the broader economy.
But when mixed together with credit, leveraged housing bubbles become extremely powerful. The economists find that economies that experience these kinds of bubbles don’t fully recover from the recession until, on average, five years after the bursting of the bubble. Indeed, consider how weak the current U.S. recovery has been or the long depression in Japan after the collapse of a real estate bubble there. These results have obvious implications for macroeconomic policy, particularly when it comes to monetary policy. We should be on the look out for credit-fuelled housing bubbles.
The reason why, as Bunker outlines, is that the leveraged housing bubbles tend to impact the segment of the economy that is most sensitive to recessions: the middle class.
Financial assets like stocks and bonds are more widely held among wealthier individuals while things like homes are more broadly owned. And so the bursting of the tech bubble in the early 2000s resulted in a less severe recession than the post-housing bubble financial crisis.
When the housing bubble burst everyone was impacted, because while the tech bubble was a broad stock market mania, it is one thing to lose a bunch of paper wealth when stocks crash but another to get kicked out of your house (the value of which you may have been borrowing against to buy stuff, too).
On Tuesday, we got more signs that the housing market is coming back to life, asnew home sales rose 2.2%in May to the fastest annual rate since February 2008.
The Federal Housing Finance Authority’s latest home price index showed that while prices increased less than forecast in April, home prices are now back to levels not seen since February 2006. This index is also just 2.3% below its absolute housing bubble peak.
The S&P 500, meanwhile, is just a few points off its record high.
On Monday one of our contributors noted that the San Francisco housing market certainly looks like it’s in the middle of a “Bubble 2.0.” And in May, Business Insider’s Matt Rosoff, who runs our San Francisco office, wrote about just how crazy the real estate market is out there and why it is the ONLY thing people in San Francisco can talk about.
And so there is a pretty good argument that the San Francisco market is experiencing euphoria. The question, of course, is how much that market has levered up to chase prices higher.
Around the US, however, the amount of disposable income people are using to pay off their mortgages has fallen sharply since the financial crisis, a good sign that there isn’t tons of excess in the broader housing market.