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The Economics of Housing Bubbles By Mark Thornton1

In America’s Housing Crisis: A Case of Government Failure Edited by Benjamin Powell and Randall Holcombe

Dr. Mark Thornton Senior Fellow Ludwig von Mises Institute 518 West Magnolia Avenue Auburn, AL 36832-4528 334-321-2146; fax 2119 mthornton@mises.org * Comments are welcomed. Please do not quote without permission. *

The author would like to thank Robert Blumen, Kevin Duffy, Robert Ekelund, Mike Pollaro, Jeff Scot, Jeffrey Tucker, Doug Wakefield, Paul Wicks and the editors of the book for their commentary and assistance. All error remains my responsibility.

1

The Economics of Housing Bubbles

Nothing better illustrates government failure and the housing crisis than the housing bubble. Government policies make homes increasingly expensive and beyond the economic reach of first-time home buyers. Then as interest rates rise and housing prices fall, many home buyers find themselves with bad investments that they can no longer afford. What started as a government effort to improve the prospects for home ownership through a policy of “easy money” ends up having unintended consequences that will leave many Americans economically scarred for the rest of their lives.2 When an economic bubble pops many people suffer economic harm. In the case of a housing bubble, this includes home owners, particularly new home owners who buy homes during the peak phase of the housing bubble. However, the harm also spreads to labor because of unemployment, and creates a loss of value to owners of capital, particularly in housing-related industries. At the individual level many people are forced into bankruptcy. On the macroeconomic level the bursting of the housing bubble can send the overall economy into recession or depression. Housing bubbles concentrate their impact in the home building, materials and furnishings, real estate sales, and mortgage businesses. On top of all that, people suffer psychological consequences



References: Bernanke, Ben S. 2006b. Reflections on the Yield Curve and Monetary Policy. Remarks before the Economic Club of New York, March 20. Available at: http://www.federalreserve.gov/boarddocs/speeches/2006/20060320/default.htm. Bruno, Joe B. 2006. Former Fed Chair Says Housing Boom Over. Associated Press, May 19. Available at: http://biz.yahoo.com/ap/060519/greenspan_speech.html?.v=2 Bureau of the Census Cantillon, Richard. 1755 [1931]. Essai sur la Nature du Commerce en Général. Edited with an English translation by Henry Higgs, London: Frank Cass and Company. Cochran, John P. 2004. Capital, Monetary Calculation, and the Trade Cycle: The Importance of Sound Money. Quarterly Journal of Austrian Economics. 7 (spring): 17-25. French, Doug. 2006. The Dutch Monetary Environment during Tulipmania. Quarterly Journal of Austrian Economics. 9 (spring): 3-14. Gallaway, Lowell and Richard Vedder. 2000. The Fraud of Macroeconomic Stabilization Policy. Quarterly Journal of Austrian Economics. 3 (fall): 19-33. Greenspan, Alan. 2002. Monetary Policy and the Economic Outlook. Testimony before the Joint Economic Committee of the U.S. Congress, April 17. Available at: http://www.federalreserve.gov/boarddocs/testimony/2002/20020417/default.htm Greenspan, Alan Greenspan, Alan. 2005b. Mortgage Banking. Speech to the American Bankers Association Annual Convention, Palm Desert, California (via satellite), September 26. Available at: http://www.federalreserve.gov/BOARDDOCS/SPEECHES/2005/200509262/default.htm. Higgs, Robert. 1987. Crisis and Leviathan: Critical Episodes in the Growth of American Government. New York: Oxford University Press. Higgs, Robert. 2005. Resurgence of the Warfare State: The Crisis Since 9/11. Oakland, Calif: The Independent Institute. Holcombe, Randall G. 1995. Public Policy and the Quality of Life: Market Incentives versus Government Planning. Westport, Conn: Greenwood Press. Krugman, Paul. 2005b. That Hissing Sound. New York Times, August 8. Available at: http://www.nytimes.com/2005/08/08/opinion/08krugman.html?ex=1281153600&en=712 5767d2baf3fae&ei=5088&partner=rssnyt&emc=rss Lloyd, Carol McCarthy, Jonathan and Richard W. Peach. 2004. Are Home Prices the Next “Bubble”? FRBNY Economic Policy Review (December): 1-17. Mises, Ludwig von. 1912 [1981]. The Theory of Money and Credit. Indianapolis, Ind.: Liberty Classics. Shiller, Robert J. 2000. Irrational Exuberance. Princeton, N.J.: Princeton University Press. Shiller, Robert J. 2004. Are Housing Prices a House of Cards? Project-Syndicate.org, September. Available at: http://www.project-syndicate.org/commentary/shiller17 Shiller, Robert J Shostak, Frank. 2003. Housing Bubble: Myth or Reality? Mises Daily Article (on line), March 04. Available at: http://www.Mises.org/story/1177 Shostak, Frank Thornton, Mark. 2004a. Bull Market? LewRockwell.com, February 9. Available at: http://www.lewrockwell.com/thornton/thornton11.html. Thornton, Mark. 2004c. Housing: Too Good to be True. Mises Daily Article (on line), June 04. Available at: http://www.Mises.org/story/1533. Thornton, Mark. 2004d. Who Predicted the Bubble? Who Predicted the Crash? The Independent Review. 9 (summer): 5-30. Thornton, Mark. 2005a. Skyscrapers and Business Cycles. Quarterly Journal of Austrian Economics. 8 (spring): 51-74. Thornton, Mark. 2005b. What is the "Dark Side" and Why Do Some People Choose It? Mises Daily Articles (on-line), May 13. Available at: http://www.mises.org/articles.asp.

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