When the housing bubble bursts ... I've been trying to figure out the impact on the general economy when the housing bubble finally bursts. I was reading this IMF report and they have some analysis:
World Economic Outlook, April 2003, Chapter 2: When Bubbles Burst
imf.org
The conclusion: Housing busts last longer than equity busts and have a deeper impact on the overall economy
• Housing price busts have larger wealth effects on consumption than do equity price busts. Private consumption fell sharply and immediately in the case of housing price busts while the decline was smaller and more gradual after equity price busts. These findings are consistent with recent research that found larger short-term (impact) and long-run effects of changes of housing wealth compared with equity wealth (e.g., Chapter 2 of the April 2002 World Economic Outlook; Bayoumi and Edison, 2003; and Case, Quigley, and Shiller, 2001).20
• Housing price busts were associated with stronger and faster adverse effects on the banking system than equity price busts. The behavior of private credit and broad money clearly suggests that, relative to equity price busts, housing price busts had larger adverse effects on the capacity and willingness of the banking system to lend, which in turn may explain the more severe real economy implications—for example, the sharper decrease in private investment. Standard banking system indicators support this conclusion (Figure 2.5). First, banks faced more rapid increases in provisioning costs with housing price busts, reflecting larger amounts of nonperforming loans. Second, the capital-to-asset coverage of banks decreased by more and faster, implying that their lending capacity is more constrained. Third, pretax profits of banks are lower after housing price busts, indicating a reduced willingness to lend. Moreover, in some cases, banks were affected by solvency problems after housing price busts. Indeed, according to the chronology of banking crisis reported by Eichengreen and Bordo (2002), all major banking crises in industrial countries during the postwar period coincided with housing price busts.
• Housing price busts were more likely to have been preceded by a boom so that there were larger imbalances
to be unwound. As discussed earlier, the connection and incidence between boom and bust is stronger for housing than for equity prices. This matters because in a regression analysis of the main determinants of the adjustment in asset prices and investment following an asset price bust, the authors found evidence that there are significant bull-bear market feedback effects. Specifically, the results suggest that the change in the average growth rate of asset prices three years before and after the bust increases with the level of the average growth rate in the three-year period ending with the bust. Similarly, the magnitude of the adjustment in the average growth rate of investment in machinery and equipment and in construction was found to increase with the three-year average growth rate up to the bust. These findings are consistent with the commonly held belief that asset price and investment correction following an asset price bust are proportional to prior excesses.
• Equity price busts on average occurred about once every 13 years, lasted for about 2 1/2 years, and involved price declines of about 45 percent (though the busts in the mid-1970s averaged about 60 percent). Housing price busts on average occurred about once every 20 years, lasted about 4 years, and involved price declines of about 30 percent. While only about one-fourth of equity price booms were followed by busts, about 40 percent of housing price booms ended in busts. Both types of busts were highly synchronized across countries. |
