As obvious as this sounds, moderate change over time is usually less painful than sudden dramatic shifts. This was true when I played with balloons as a child. If the balloon popped in the first hour, I was devastated. If it deflated overnight, I took it in stride.
This gradual-is-better phenomenon is equally true when bubbles in asset prices must disappear.
Recent news suggests that the housing market bubble that developed over the last three years may be slowly deflating — at least here in the Twin Cities.
Housing permits are about even with last year’s and are 20 percent under the level in January 2004, which was the peak since 1999. Existing homes are getting somewhat harder to sell — particularly for those categories that experienced the greatest price growth such as very expensive homes and town houses.
This moderate slowing is good news. New construction and prices of existing houses rose at unsustainable paces during the past four years. Society usually suffers less when a build-up slowly runs out of steam rather than smashes into a brick wall.
Slow stops are not entirely painless, however.
The inventory of for-sale homes is reportedly 30 percent higher than in 2004. Selling many homes — especially those priced over $500,000 — is taking much longer. Many sellers must cut prices to get rid of their houses. Some who bought recently are getting less than they paid only two or three years ago. That hurts the families involved.
Builders, lumber yards and others involved in constructing new homes may not be happy to see a 20 percent decrease in business from 2004. Companies will sell fewer materials, workers will get less overtime, and fewer people will have jobs. Those affected by slowing construction will have less to spend. Car dealers and other retailers also will feel some effects.
Yet a moderate amount of economic distress experienced by only some households is much better than sharp pain felt by nearly all. That might happen if the bubble in housing markets popped suddenly.
Dramatic collapses in asset prices — whether for financial assets like stocks and bonds or for physical assets like housing — can slash consumer spending and business investment, causing a dramatic recession. That happened in the United States in 1929 and in Japan at the end of the 1980s.
Recovery from such painful abrupt stops can take a long time. The U.S. economy only returned to growth with the outbreak of World War II. Japan’s economy stagnated for 15 years.
Moderate recent slowing in our area does not mean the U.S. economy is out of the housing-bubble woods just yet.
In recent decades, few nations that experienced housing price increases like ours succeeded in making the transition to sustainable levels without undergoing a recession. A year or two of moderate slowing will have to pass before we can relax entirely.
© 2006 Edward Lotterman
Chanarambie Consulting, Inc.