While everyone else in the world is focused on the policy implications of today's speech from Fed chair Ben Bernanke, I want to talk about his analysis of the economy.
Basically, Bernanke told us today that the economy has been lagging because home prices keep falling.
Unfortunately, the recession, besides being extraordinarily severe as well as global in scope, was also unusual in being associated with both a very deep slump in the housing market and a historic financial crisis. These two features of the downturn, individually and in combination, have acted to slow the natural recovery process.
Notably, the housing sector has been a significant driver of recovery from most recessions in the United States since World War II, but this time—with an overhang of distressed and foreclosed properties, tight credit conditions for builders and potential homebuyers, and ongoing concerns by both potential borrowers and lenders about continued house price declines—the rate of new home construction has remained at less than one-third of its pre-crisis level. The low level of construction has implications not only for builders but for providers of a wide range of goods and services related to housing and homebuilding.
Moreover, even as tight credit for some borrowers has been one of the factors restraining housing recovery, the weakness of the housing sector has in turn had adverse effects on financial markets and on the flow of credit. For example, the sharp declines in house prices in some areas have left many homeowners "underwater" on their mortgages, creating financial hardship for households and, through their effects on rates of mortgage delinquency and default, stress for financial institutions as well. Financial pressures on financial institutions and households have contributed, in turn, to greater caution in the extension of credit and to slower growth in consumer spending.
I find it reassuring that Bernanke understands that, at bottom, the problem is with asset prices. We're just poorer than we thought we'd be, which means we cannot afford to pay what we thought we might for homes.
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