Walter Block, “Austrian Thymologists Who Predicted the Housing Bubble,” LewRockwell.com, December 22, 2010.Now the first point that should be made is that the heterodox Keynesian economist Dean Baker (who seems to be associated with Post Keynesianism) clearly identified a housing bubble in August 2002 in a Center for Economic and Policy Research paper:
Dean Baker, “The Run-Up in Home Prices: Is it Real or Is it Another Bubble?,” Center for Economic and Policy Research, Briefing Paper, August 2002.Since the paper was published in August 2002, and Baker was no doubt coming to the view that a housing bubble was in progress months before by looking at the housing data, it is obvious that some economic observers were coming to this view as early as the first half of 2002. That is to say: a housing bubble was being identified at around this time, and the further asset price inflation in housing predicted by some commentators. In this paper, Baker also predicted a serious economic crisis coming from the collapse of the bubble:
“The collapse of the housing bubble, implying a drop of between 11 and 22 percent in the average of housing prices, will destroy between $1.3 trillion and $2.6 trillion in housing wealth. …. In the late eighties Japan experienced a simultaneous bubble in its stock market and its real estate market. The collapse of these bubbles has derailed its economy for more than a decade. A similar collapse in the United States, coupled with a poor policy response, could have similar consequences here.”Those are insightful predictions.
Dean Baker, “The Run-Up in Home Prices: Is it Real or Is it Another Bubble?,” Center for Economic and Policy Research, Briefing Paper, August 2002, pp. 3–4; see also 14–15.
Furthermore, by 2004 onwards, we can also find Marxists identifying a housing bubble and coming economic crisis:
Nick Beams, “Greenspan Testimony Points to Deepening US Fiscal Crisis,” World Socialist Web Site, 16 February 2004.Now does anyone seriously think that these correct identifications of an asset bubble in housing vindicates the Marxist theory? Some Marxists tell us that Marxist theory explains the 2008 financial crisis, but I do not think so at all. And even if some Austrians called an asset bubble in housing, it does not follow at all that their underlying economic theory is right.
Nick Beams, “Australia at the Forefront of Housing Bubble,” World Socialist Web Site, 27 September 2004.
César Uco, “Is the US housing boom turning toward bust?,” World Socialist Web Site, 6 August 2005
Nick Beams, “US Housing Crisis could Spark Serious Economic Downturn,” World Socialist Web Site, 3 September 2007.
Both Austrians and Marxists have economic theories that are fundamentally flawed, even though some of them correctly identified a housing bubble. The doctrinaire Marxists have their absurd historical materialism, the belief that the rate of profit will always fall, the erroneous labour theory of value, and the idea that socialism is inevitable, while many Austrians have a system flawed by a fantasy business cycle theory, an incoherent and logically inconsistent demand for no fractional reserve banking, and insufficient attention to subjective expectations and the role of investment decision-making under uncertainty.
It is obvious that Austrians identifying a housing bubble from 2003–2004 onwards should not regarded as having any special predictive power. They were merely identifying an on-going phenomenon. It is, furthermore, notable that when some Austrians identified a housing bubble in the first half of 2002, so too did the Keynesian economist Dean Baker.
We must remember that any “predictions” after 2002 are not even predictions at all: they represent people identifying an existing asset bubble that was becoming worse.
I. Alleged Austrian Predictions: 1999–2003
Let us review some of these alleged “predictions” below in chronological order from 1999–2003 cited by Walter Block:
(1) Thomas J. DiLorenzo, “Regulatory Sneak Attack,” Mises Daily, September 16, 1999.So what are our conclusions from this analysis?
There is no prediction of any housing bubble in this article: it is mostly an attack on US government regulation. At one point, DiLorenzo attacks the “Community Reinvestment Act,” complaining that it forces bank “to make bad loans and grants to politically-connected ‘community groups.’” That, however, is not any prediction of a housing bubble in the 2000s.
(2) Ron Paul, “A Republic, If You Can Keep It,” US House of Representatives, January 31 and February 2, 2000.
In this speech, Ron Paul does not predict any housing bubble in the 2000s. The closest Paul comes to any sort of prediction on housing is here:“If one cares about providing the maximum and best housing for the maximum number of people, one must consider a free-market approach in association with a sound non-depreciating currency. We have been operating a public housing program directly opposite to this, and along with steady inflation and government promotion of housing since the 1960s, the housing market has been grossly distorted. We can soon expect a major downward correction in the housing industry, prompted by rising interest rates.”Yet it is obvious that Paul is here thinking of a correction of existing 2000 housing prices, not a massive 2000s bubble in real estate and a financial crisis in 2008. The word “soon” strongly suggests Paul was expecting the correction in the next year or two after 2000, as from 1999–2000 the Fed had raised the Federal Funds rate and was widely expected to raise it further in 2000, owing to the dot.com boom. This speech shows no prediction of the 2000s housing bubble.
(3) William L. Anderson, “The Party is Over,” Mises Daily, February 20, 2001.
A careful reading of this article shows clearly that Anderson nowhere predicts the housing bubble of the 2000s. In fact, the words “houses,” “housing,” “homes”, or “bubble” do not even appear in the article at all. Anderson does make this remark about real estate:“The stock market boom and various real estate booms have either ended or are nearing their end and the next stage of money growth will now affect consumer prices.”In other words in February 20, 2001, William Anderson thought the stock and real estate booms of the 1990s had ended or were about to end: there is no prediction of a massive continuing housing bubble in the 2000s. We also have this priceless gem from Anderson praising financial deregulation:“the amount of economic regulation has fallen tremendously in the past three decades. In 1970, all the financial, transportation and telecommunications sectors were highly cartelized industries. All are much more open and competitive today. In fact, one can easily declare that the prosperity of the 1990s would not have been remotely possible without removal of government restrictions that hampered those industries in the 1960s.”Unfortunately, it was the deregulated financial sector that was the main cause of the 1990s and 2000s bubbles.
(4) Ron Paul, Congressional Record, US House of Representatives, September 5, 2001.
Here Ron Paul identified the emerging housing bubble (quoted in Paul 2008: 220):“Refinancing especially helped the consumers to continue spending even in a slowing economy. It isn’t surprising for high credit-card debt to be frequently rolled into second mortgages, since interest on mortgage debt has the additional advantage of being tax-deductible. When financial conditions warrant it, leaving financial instruments (such as paper assets), and looking for hard assets (such as houses), is commonplace and is not a new phenomenon. Instead of the newly inflated money being directed toward the stock market, it now finds its way into the rapidly expanding real-estate bubble. This, too, will burst as all bubbles do. The Fed, the Congress, or even foreign investors can’t prevent the collapse of this bubble, any more than the incestuous Japanese banks were able to keep the Japanese ‘miracle’ of the 1980s going forever …. With the current direction of the dollar certainly downward, the day of reckoning is fast approaching. A weak dollar will prompt dumping of GSE securities before treasuries, despite the Treasury’s and the Fed's attempt to equate them with government securities. This will threaten the whole GSE system of finance, because the challenge to the dollar and the GSEs will hit just when the housing market turns down and defaults rise. Also a major accident can occur in the derivatives markets where Fannie Mae and Freddie Mac are deeply involved in hedging their interest-rate bets. Rising interest rates that are inherent with a weak currency will worsen the crisis.”A video of this speech is here:
This was an identification of the bubble and prediction of a “bust.” Some six months later, Dean Baker said much the same thing. However, Ron Paul predicted that a “weak dollar will prompt dumping of GSE securities before treasuries”: he was wrong. It was the bursting of the real estate bubble and defaulting mortgages that prompted the crisis in mortgage backed securities: the financial crisis then occurred in the investment banking sector and spread to the commercial banking sector. No dumping of US treasuries occurred. These failed predictions have to be borne in mind, with Paul’s prediction of a housing market crash.
(5) James Grant, “Sometimes the Economy Needs a Setback,” New York Times, September 9, 2001.
This article does not predict or identify any housing bubble. Instead it is a discussion of the 1990s tech boom and US business cycle.
(6) Gary North, “How the FED Inflated the Real Estate Bubble by Pushing Down Mortgage Rates: Report As of 2002,” Reality Check, March 4, 2002.
Unfortunately, this is not available online, but as an identification of the housing bubble it was made only a few months before Dean Baker published his own identification of it, and Baker was no doubt also coming to this conclusion in the months before August: so here an Austrian like Gary North simply displayed the same insight as a prominent Keynesian.
(7) Robert Blumen, “Fannie Mae Distorts Markets,” Mises Daily, June 17, 2002.
Robert Blumen refers in passing to the housing bubble here in this 2002 article, but this was also the same time that Dean Baker was calling the bubble: so again an Austrian commentator displayed the same insight as a prominent Keynesian at much the same time. What is particularly interesting about Robert Blumen’s analysis is that he denies that houses are capital goods, the usual absurd trick that Austrians use to try and make the housing bubble fit in with their Austrian business cycle theory:“A careful parsing of Raines’s and de Soto’s statements is required to arrive at a consistent understanding. A home is an asset, and it is wealth, but it is not capital in the economic sense; i.e., it is not a good that is an intermediate artifact of a time-consuming production process. Housing is a consumption good. True, it is a durable consumption good, and it may rise in value over time for many reasons, but it is not capital.”Blumen also observes correctly that much of the 2000s mortgages were in fact refinancing and home equity loans, and the debt incurred used to pay credit card debt or fund purchasing of consumer goods: this is the opposite of the process required by the Austrian business cycle theory, which requires credit flows to capital goods investment (I will return to this issue below in section III).
(8) Walter Block lists “undated” predictions or identifications of a housing bubble by Peter Schiff, but such undated predictions are worthless.
Some Austrians claim that Schiff predicted the housing bubble in an interview in May 2002, which you can watch below in these videos.
Peter Schiff does not predict or identify any housing bubble in this interview. The interviewer (not Schiff) refers briefly to “housing prices up” (in part 1), but that is all. Instead, Schiff predicts a bear market in US stocks from 2002 onwards (a false prediction); and a US dollar collapse that would send US interest rates through the roof (another false prediction). At 7.25 onwards (in part 1), Schiff refers to a “bubble” that already exists, but it is clear he is referring to stocks and shares, not housing. So much for Schiff’s predictive power.
(9) Hans F. Sennholz, “The Fed is Culpable,” Mises Daily, November 11, 2002.
In the first part of his article, Hans F. Sennholz merely talks about the 1990s tech boom in stocks and shares. He states that “[e]conomic bubbles have plagued the American economy ever since the First United States Bank opened its doors in Philadelphia in 1791,” but conveniently forgets that the US had no central bank for most of the 19th century, yet asset bubbles also occurred frequently. In a rather surprising analysis, Sennholz seems to think that raising margin requirements could have helped to prevent the 1990s tech bubble, which can only mean that he is suggesting that appropriate financial regulation should have been imposed to prevent it (a strange view for an Austrian).
Towards the end of his analysis, Sennholz identifies the housing bubble and predicts a bust:“The most ominous of all cycles, which touches millions of people, is the boom-and-bust sequence in real estate. Just as in equity markets, these bubbles are clearly visible in their price-earnings ratios or price-rental ratios that greatly exceed those of healthy markets. Abundant credit at bargain rates of interest causes housing prices to soar, especially in growing communities, which fosters not only feverish construction activity but also enlarges the mountains of debt, even consumer debt. Fannie Mae, the publicly owned and government-sponsored Federal National Mortgage Association, reports that soaring housing prices and falling mortgage rates are allowing homeowners to refinance $1.4 trillion of mortgages in 2002, up from $1.1 trillion last year. In both years homeowners are estimated to take out some $100 billion in equity. The real estate bubble is bound to burst as soon as the distortions become visible to ever greater numbers of participants.”However, Dean Baker had already done this months before Sennholz in August 2002. Moreover, Sennholz makes an inaccurate prediction: he calls a “U.S. Treasury bubble,” and predicts that “the bubble will burst and the market value of all notes and bonds will drop drastically.”
(10) William L. Anderson, “Recovery or Boomlet?,” Mises Daily, July 7, 2003.
In this Mises.org article, Anderson talks of a “mini-boom,” but it is clear he is thinking of the stock market and general economic conditions, not an asset price bubble in housing:“In recent weeks, the stock market has staged a mild rally. Though the most recent unemployment numbers are well over six percent, Republicans, as well as a few market analysts, are claiming that the long overdue economic recovery has arrived. While I wish that were the case, the facts demonstrate otherwise; this is not a recovery, but simply an unsustainable mini-boom that makes the long-term economic picture even worse. .... Thus, any upturn whether in economic statistics or in the stock market is almost certain to follow the patterns not of economic recovery but rather a mini-boom. I say ‘mini’ because there is no way that this particular boom, as pathetic as it is, can be sustained for a long time, unlike the boom of the late 1990s. In fact, the Fed's recent actions can only force more malinvestments which themselves will have to be liquidated in the future.”In short, there is no identification of an asset bubble in housing here.
William L. Anderson, “Recovery or Boomlet?,” Mises Daily, July 7, 2003.
(11) Ron Paul’s Address to the House Financial Services Committee, September 10, 2003.
This speech was delivered on September 10, 2003 (you can read it in Paul 2008: 380–381), and Ron Paul correctly identifies (not predicts) an on-going housing bubble and predicts troubles for indebted homeowners:“Despite the long-term damage to the economy inflicted by the government’s interference in the housing market, the government's policy of diverting capital to other uses creates a short-term boom in housing. Like all artificially created bubbles, the boom in housing prices cannot last forever. When housing prices fall, homeowners will experience difficulty as their equity is wiped out. Furthermore, the holders of the mortgage debt will also have a loss. These losses will be greater than they would have otherwise been had government policy not actively encouraged overinvestment in housing.”You can also watch this speech quoted here:
However, this was over a year after Dean Baker had correctly identified the bubble too, and predicted a serious downturn when the bubble collapsed. Ron Paul displayed no great predictive power here.
When we review the various alleged Austrian “predictions” of the 2000s housing bubble most of them collapse. Of the eleven claims made, six (54%) do not even identify the housing boom, and certainly do not predict any such thing. Two (18%) identify the bubble, but after Dean Baker did (in August, 2002).
The 2002 identification of the bubble by Gary North (March 4, 2002) and Robert Blumen (June 17, 2002) was only a few months before Dean Baker’s paper published in August 2002, and Baker himself must have been coming to the same conclusion in these months. So these Austrians just displayed much the same insight as a progressive Keynesian economist.
The only early identification of the housing bubble that does stand out is that of Ron Paul in a speech to the US House of Representatives on September 5, 2001. However, even here Ron Paul made a number of failed predictions, so his predictive power was hardly spectacular.
II. What about After 2003?
The Austrians showed no great predictive power in 2003 or afterwards in identifying the bubble and the economic effects of a crash. There were heterodox and Post Keynesian economists who predicted a financial crisis caused by a housing bubble and excessive debt. The most obvious example is the Post Keynesian Steve Keen of the University of Western Sydney (Australia), who from 2006 was predicting a major financial crisis (see Steve Keen, “‘No-one saw this coming’ Balderdash!” July 15th, 2009, Debtwatch.com).
Moreover, Dirk Bezemer, Professor of Economics at the University of Groningen (Netherlands), has also done a survey of economists and economic commentators trying to establish who predicted the crisis by looking at those with (1) a serious economic model that was used in analysis, (2) predictions that went beyond identifying the property bubble to the implications for the real economy, (3) predictions on the public record, and (4) correct estimates of the timing of the crisis (see Dirk Bezemer, “‘No One Saw This Coming’: Understanding Financial Crisis Through Accounting Models,” Groningen University, 16 June 2009). Here is Bezemer’s list, with my additions in italics:
Forecast date: 2002Now of these eleven commentators and economists:
Dean Baker, US, Co-director, Center for Economic and Policy Research;
Forecast date: 2005
Fred Harrison, UK, Economic commentator
Forecast date: 2006
Dean Baker, US, Co-director, Center for Economic and Policy Research;
Michael Hudson, US, Professor, University of Missouri;
Steve Keen, Australia, Associate professor, University of Western Sydney;
Jakob Brøchner Madsen, Denmark, Professor, Copenhagen University;
Robert Shiller, US, Professor, Yale University;
Nouriel Roubini, US, Professor, New York University;
Kurt Richebächer, US, Private consultant and investment newsletter writer;
Forecast date: 2007
Wynne Godley, US, Distinguished scholar, Levy Economics Institute of Bard College;
Eric Janszen, US, Investor and iTulip commentator;
Peter Schiff, US, Stock broker, investment adviser and commentator.
(1) Five (45%) are Heterodox/Progressive Keynesians or Post Keynesians (Baker, Godley, Hudson, Keen, Sorenson);So in other words eight (72%) of the eleven made accurate predictions about the bubble and crisis and were non-Austrians. The largest group (45%) were actually Heterodox Keynesians.
(2) Two (18%) are basically maverick neoclassicals (Roubini and Shiller);
(3) Two (18%) are in the Austrian tradition (Richebächer and Schiff).
(4) One (Fred Harrison) calls himself as a Georgist (a follower of Henry George)
(5) One is a combination of Austrian and Post Keynesian (Janszen).
(on the classifications, see Barkley Rosser, J. “Did Heterodox Economists Do Better At "Calling It" Than Mainstream Ones? August 28, 2009).
The idea that Austrian economists were the only ones to predict the actual crisis of 2008 is utterly false. Moreover, just because some Austrians correctly called the housing bubble, it simply does not follow that the Austrian Business Cycle Theory (their explanation of the crisis) has been vindicated. Many other economists from different schools also called the housing bubble and a financial crisis. Are we, for example, to say that because Fred Harrison correctly predicted a housing bubble that his actual Georgist economics is therefore proven right? This simply does not follow, nor does it follow that Austrian economics is correct, merely because some Austrians identified the housing bubble as Harrison did.
III. The Austrian Business Cycle Theory (ABCT) does not Explain the Crisis
The Austrian Business Cycle Theory (ABCT) holds that central bank fiat money or fractional reserve banking-induced increases in credit (unbacked by commodity money) drives down the monetary rate of interest, causing it to go below the Wicksellian natural rate of interest. This causes malinvestment in capital goods sectors. However, the unique Wicksellian natural rate of interest does not exist, and is a pure fantasy (see here and here). The ABCT does not explain or deal with reckless lending by banks to people for mortgages or consumer goods, and nothing about financial or real asset bubbles, and nothing about financial crises. The irrelevance of ABCT to the real estate bubble of the 2000s and financial crisis of 2008 can be seen in a passage in Rothbard’s Man, Economy, and State (2004 : 994–1008):
“What happens, however, when the increase in investment is not due to a change in time preference and saving, but to credit expansion by the commercial banks? …. What are the consequences? The new money is loaned to businesses.110 These businesses, now able to acquire the money at a lower rate of interest, enter the capital goods’ and original factors’ market to bid resources away from the other firms. At any given time, the stock of goods is fixed, and the [new money is] … therefore employed in raising the prices of producers’ goods. The rise in prices of capital goods will be imputed to rises in original factors. The credit expansion reduces the market rate of interest. This means that price differentials are lowered, and … lower price differentials raise prices in the highest stages of production, shifting resources to these stages and also increasing the number of stages. As a result, the production structure is lengthened. The borrowing firms are led to believe that enough funds are available to permit them to embark on projects formerly unprofitable.After this, Rothbard (2004 : 996–1004) expounds ABCT in its usual form. But his footnote has profound significance: “[to] the extent that the new money is loaned to consumers rather than businesses, the cycle effects discussed in this section do not occur.” In other words, the mechanisms causing recession or depression as postulated by both Rothbard’s theory and the earlier Hayekian versions of ABCT do not occur if the money is mainly loaned to consumers! ABCT assumes that newly created credit money is mainly loaned out to businesses (causing malinvestments in capital goods), and not to consumers to a significant degree. In this case, we can already see that Rothbard’s version of ABCT cannot be a serious explanation of the housing bubble in the 2000s and the financial crisis of 2008, because credit flowed to housing, a consumption good.
110 To the extent that the new money is loaned to consumers rather than businesses, the cycle effects discussed in this section do not occur. (Rothbard 2004 : 995–996).
Moreover, many of these mortgages loans were refinancing and home equity loans, and the money obtained from the debt not used for new housing construction at all, but to pay credit card debt down or purchase more consumer goods. In fact, the Austrian Robert Blumen’s (June 17, 2002) admission that houses are not capital goods severely contradicts the Austrian Business Cycle Theory explanation of the 2000s crisis.
The best the Austrians have is a Ron Paul identification (not prediction) of the emerging housing bubble in late 2001, with a number of other false predictions, such as his idea that a “weak dollar will prompt dumping of GSE securities before treasuries.” Other Austrians were also wrong in predicting a collapse in the value of US Treasury notes and bonds. In particular, Peter Schiff’s failed predictions in May 2002 also stand out. Above all, Ron Paul was followed only six months later by the Keynesian Dean Baker also calling a housing bubble and a serious crisis when that asset bubble collapsed.
Furthermore, many economists from 2002–2004 – Marxists, maverick neoclassicals, New Keynesians, Post Keynesians, and even a Georgist – also called the housing bubble and predicted a severe economic crisis.
A graph of US housing prices in constant dollars can be seen here:
USA CPI-Deflated House Price Index.It is obvious that astute observers could have see an explosion in housing prices by 2000-2002. The idiocy of the Austrian business cycle theory was not necessary to see the astonishing upward trend, or to call a bubble.
Paul, R., 2008. Pillars of Prosperity: Free Markets, Honest Money, Private Property, Mises Institute.
Rothbard, M. N. 2004 . Man, Economy, and State: A Treatise on Economic Principles, Ludwig von Mises Institute, Auburn, Ala.