Ready, Fire, Aim! - Mihail's Public Blog: More talk of bubbles

Thursday, June 2, 2005

More talk of bubbles

According to this New York Times column by Paul Krugman that I missed last week, "the National Association of Realtors estimates that 23 percent of the homes sold last year were bought for investment, not to live in. According to Business Week, 31 percent of new mortgages are interest only, a sign that people are stretching to their financial limits."

In July 2001, Paul McCulley, an economist at Pimco, the giant bond fund, predicted that the Federal Reserve would simply replace one bubble with another. "There is room," he wrote, "for the Fed to create a bubble in housing prices, if necessary, to sustain American hedonism. And I think the Fed has the will to do so, even though political correctness would demand that Mr. Greenspan deny any such thing."

As Mr. McCulley predicted, interest rate cuts led to soaring home prices, which led in turn not just to a construction boom but to high consumer spending, because homeowners used mortgage refinancing to go deeper into debt. All of this created jobs to make up for those lost when the stock bubble burst.

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