The Housing Recession

Fascinating piece by David Leonhardt in today's New York Times, ruminating on the roots of the current crisis. What really struck me is the following paragraph:

But people - by "people," I'm referring here to Mr. Greenspan, Mr. Bernanke, the top executives of almost every Wall Street firm and a majority of American homeowners - decided that the usual rules didn't apply because home prices nationwide had never fallen before. Based on that idea, prices rose ever higher, so high, says Robert Barbera of ITG, an investment firm, that they were destined to fall. It was a self-defeating prophecy. [Boldface added for emphasis.]

Leonhardt is basically arguing that America engaged in a collective act of flawed logic. We inferred that national median housing prices would never fall, because they never had. On that foundation, we made decisions. For example, everyone paying attention trusted that mortgage securities would be safer if they included mortgages from around the country, because even if the market faltered in some regions, it would remain strong in other regions, limiting defaults.

Here's what I find fascinating: Our logic was flawed because it was self-aware.

National housing prices had never fallen because we didn't think of housing as a national market. The very idea of a national housing market, in other words, was what made the bubble possible and the pop inevitable.

To play that out a little more slowly, as I've written before, market bubbles form when participants in a particular market start paying irrational prices. Historically, our real estate marketplaces were regional. So bubbles were regional. And so were the consequences. In recent years, however, we started talking about a national real estate market -- a national rise in prices, a national set of reasons for that rise, a national opportunity to buy real estate.

And now we are dealing with a national bust, and maybe our first housing recession.