The Biznestate Cycle
-by the Mysterious Flying Miser
I recently had a discussion with a friend about the difference between real estate cycles and real estate bubbles. I thought it would be a good idea to look a few of them up and perform an analysis that might provide some differentiating characteristics. Interestingly enough, what I came across were a few articles layering the concepts of bubbles and cycles in a completely unexpected way.
Firstly, I found the following at http://www.foldvary.net/works/cycle.html, by Fred Foldvary, an economist at Santa Clara University:
Table 1. The Real-Estate Cycle in the US
| Peaks in Land Value (Years) | Interval | Peaks in Construction (Years) | Interval | Depressions | Interval |
| 1818 | – | – | – | 1819 | – |
| 1836 | 18 | 1836 | __ | 1837 | 18 |
| 1854 | 18 | 1856 | 20 | 1857 | 20 |
| 1872 | 18 | 1871 | 15 | 1873 | 16 |
| 1890 | 18 | 1892 | 21 | 1893 | 20 |
| 1907 | 17 | 1909 | 17 | 1918 | 25 |
| 1925 | 18 | 1925 | 16 | 1929 | 11 |
| 1973 | 48 | 1972 | 47 | 1973 | 44 |
| 1979 | 6 | 1978 | 6 | 1980 | 7 |
| 1989 | 10 | 1986 | 8 | 1990 | 10 |
| 2006 | 17 | 2006 | 20 | 2008! | 18 |
“Real-estate values and construction have peaked one to two years before a depression, and have stayed at peak levels until the onset of the downturn. The historical evidence is consistent with the theory that speculative booms in real-estate prices and construction act as an impetus for the downturn itself. For an explanation, see my article: “The Business Cycle: A Georgist-Austrian Synthesis.” American Journal of Economics and Sociology 56 (4) (October 1997): 521-41. An updated explanation (2007) is in my booklet, The Depression of 2008, by the Gutenberg Press.”
I was surprised to find this table (referenced by multiple other authors), since I have been so imbued with the mantra that “there is no national real-estate market”. According to this dude, not only is there a national real-estate market, but it has been tightly predictable and consistently linked to the US business cycle for about 200 years.
The thing about this table that immediately stood out to me is that our two great real-estate bubbles (today’s bubble and the one preceding the Great Depression) both occurred on time for a normal period of the real-estate cycle, indicating these bubbles were no more than exaggerated versions of a completely periodic event.
The second thing that stood out was that the normal 18-year interval between house-price peaks was only disrupted immediately following the Great Depression. Presumably, the long rise in prices was potentiated by the steep drop preceding it. So what does that say about prospects for future house-price moves in this country? Should people who invest in US real estate immediately following the current crash expect to enjoy steady, long-term appreciation?
Upon further investigation into the above blatant and simple dataset, I came across a 2007 paper, entitled “Housing is the Business Cycle“, by Edward Leamer of the Kansas City Federal Reserve Bank, the partial introduction and conclusion of which I have manually typed (you’re welcome) below:
Introduction
…
“Indeed, if you look up ‘real estate’ in the index to Mankiew’s (2007) best-selling Principles of Macroeconomics, you will find real exchange rates, gross domestic profit (GDP), real interest rates, real variables, and even reality, but no real estate. Under “housing”, you will find a reference to the consumer price index (CPI) and to rent control, but no reference to the business cycle. I have not been able to find any macroeconomic textbook that places real estate front and center, where it belongs
“But it’s not just a problem with our theory. The National Bureau of Economic Research (NBER) macroeconomics data miners have largely missed housing too. The index to Vector Zarnowitz’ (1992) Business Cycle, Theory, History, Indicators, and Forecasting has no reference to real estate or housing. (Actually, there are no ‘h’s in the index at all). Likewise, the index to James H. Stock and Mark W. Watson’s edited volume, Business Cycles, Indicators and Forecasting, has no references to residential investment or to housing. Housing is treated with the same level of interest that building permits has in the index of leading indicators: one of many things that might predict a recession, about as interesting as x7 in the list x1, x2, x3, …,x10.
“There is substantial, mostly older literature on the modeling of residential investment (e.g., Alberts 1962, Fair 1972, Ketchum 1954, de Leeuw and Gramlich 1969). This literature takes the overall business cycle as a given and explores the effects of income and interest rates on residential investment. By including interest rates as explanatory variables, this literature does explicitly explore the link (between) monetary policy (and) housing, but when Maisel (1967), for example, reports that residential investment is an important channel through which monetary policy affects the economy, that finding is treated like the discovery that alcohol (exerts its effects) by depressing the central nervous system, which is a mildly interesting fact that doesn’t at all affect how much we drink. Another round of grog, please.
“Something’s wrong here. Housing is the most important sector in our economic recessions, and any attempt to control the business cycle needs to focus especially on residential investment. But housing presents a special control problem because monetary policy affects mostly the timing of the building, but not the total building. After a surge of building, there has to be a time out, like we are experiencing today, before building can get back to normal and before this channel through which monetary policy affects the real economy is operative again. The Fed can stimulate now or later, but not both.
“The difference in the dynamics of inflation and housing create a problem for the conduct of monetary policy that is aimed at both inflation and housing-related employment. Inflation is very persistent, and needs to be fought every day. For housing, it’s the cycle that is persistent. Once the cycle starts, it keeps on going, like a pebble thrown into a smooth pond of water. The best time to fight the housing cycle with tight monetary policy is when the wave is starting to rise, not when it is cresting. The worst time to stimulate the economy with loose monetary policy is when the wave is starting to rise. That is going to make the crest all the higher, and the crash all the more catastrophic. You know of which I speak, I suppose.
“To put the point as clearly as possible, what I am advocating is a modified Taylor rule that depends on a long-term measure of inflation having little to do with the phase in the cycle and, in place of Taylor’s output gap, housing starts and the change in housing starts, which together form the best forward-looking indicator of the cycle of which I am aware. This would create pre-emptive anti-inflation policy in the middle of the expansions when housing is not so sensitive to interest rates, making it less likely that anti-inflation policies would be needed near the ends of expansions when housing is very interest-rate sensitive, thus making our recessions less frequent/severe.”
…
Conclusion
“The Pertinent Facts: It’s a Consumer Cycle, not a Business Cycle
“Housing makes an incidental contribution to normal economic growth. The average growth of GDP since 1947 has been 3.47% per year. Only 4.6% of that growth has originated in residential investment.
“Though unimportant in normal periods, weakness in housing is a critical part of US economic recessions. Excepting the DOD downturn in 1953 and the internet comeuppance in 2001, problems in residential investment have contributed 26% of the weakness in the economy in the year before the 8 recessions since World War II, and 11% of the weakness in the 2-year periods commencing with recessions.
“Most of the other leading weakness is also on the consumer side. In the years before recessions, 20% of the weakness is from consumer durables, 10% from consumer services, and 9% from consumer nondurables. Thus, consumers contribute a total of 65% of the leading weakness. In contrast, business spending contributes only 10% of the weakness before recessions, 8% is from equipment and software and 2% from business structures. Most of the weakness on the business side coincides with the recession rather than leading it.
“The first item to soften and the first to turn back up is residential investment. The temporal ordering of the spending weakness is: residential investment, consumer durables, consumer nondurables, and consumer services before the recession. And then, once the recession officially commences, business spending on the short-lived assets equipment and software, and last, business spending on the long-lived assets offices and factories. The ordering in the recovery is exactly the same.
…
Policy Targets
…
1. “Smooth the business cycle.
Happiness and well-being are much affected by the collective unwanted idleness we call recessions. It would be helpful if our monetary authorities could do something to make recessions less frequent, less severe, and more short-lived. Housing surely deserves attention in that enterprise.
2. “Keep us working productively.
Happiness and well-being can also be affected if our financial markets absorb too much of our productive time and energy, and if savings are diverted into unwise real investments. It would be helpful if our monetary authorities did what they could to limit the speculative bubbles that absorb our labor and time and that divert savings into low-yielding investments. Housing surely deserves attention in that enterprise.
3. “Limit the redistribution of wealth caused by financial market disruptions
The part of your wealth that comes deservedly from hard work and special foresight is not a problem for me, but I am made miserable when my wealth is transferred to you by unstable and uncaring financial markets. It would be helpful if our monetary policy makers could minimize the extent to which turbulence in financial markets causes redistributions of wealth from one group to another as, for example, when unexpected inflation transfers wealth from lenders to borrowers. Since housing price appreciation effects a substantial redistribution of wealth from renters (future owners) to current homeowners, housing surely deserves attention in that enterprise.
4. “Keep our balance sheets accurately reflecting reality.
Happiness and well-being can also be affected if we do not save enough to provide for the material needs of our elderly. The real assets on which our future depends are the factories and equipment and knowledge and homes that are needed to produce the GDP of the future. The numerical valuations of these assets that we record on our hard drives are only a shadow of those real assets, a shadow that is sometimes larger and sometimes smaller than the real thing. For us to do our planning correctly, we need these numbers to reflect reality. We want our measured asset values to increase when our investments and discoveries make us confident that future GDP will be greater than we had originally thought. We do not want a monetary system that allows us to put phantom assets onto our balance sheets and that signals to us that hard work and savings are not needed to prepare for our retirements. Housing surely deserves attention in that enterprise. Of particular concern is the fact that, absent a change in the technology for transforming residential land into housing services, the contribution of our residential land to GDP is about the same now as it was 5 years ago, but on our hard drives we are recording real values for this land that are double what they were.”
So, what do you guys think? Is housing the business cycle? If so, should the Federal Reserve try to balance out the business cycle by paying special attention to residential investments?
