The recent passing of former Fed chair Alan Greenspan has elicited defenses of his legacy, with even some of my free-market economist colleagues arguing either that (a) the Greenspan Fed was not responsible for the housing bubble and/or (b) the housing bubble wasn’t the cause of the 2008 financial crisis. In the first part of this series, I provided evidence that Greenspan’s Fed helped to fuel the US housing bubble. Now in this second part, I’ll argue that the bursting of the housing bubble was related to the financial crisis in 2008 and the ensuing Great Recession. (This two-part written series dovetails with InFi podcast episode #143.)
Alan Reynolds Argues Housing Wasn’t the Culprit
To give a specific foil to my own perspective, below I reproduce three tweets from economist Alan Reynolds (with whom I often agree on other topics, particularly tax policy). In the wake of Greenspan’s death, Reynolds made the following arguments to defend the former Fed chair:
Reynolds’ tweets speak for themselves. In the rest of this post, I won’t necessarily rebut each of his arguments, but I’ll provide enough counter-evidence that I hope will convince the reader: the housing bust really was connected the financial crisis / Great Recession.
The Connection Between Home Prices and Construction Employment
My big-picture narrative for what happened in the 2000s is that artificially cheap credit from the Fed (along with other foolish government policies) pumped up the housing bubble. Once the Fed blinked and began raising rates, the bubble’s growth slowed and eventually reversed.
These financial events corresponded with “real,” physical investment flows, as well as the channeling of human labor power. In the following chart, we see the connection between a national home price index, and employment in construction:
To be clear, the blue line is showing the year/year growth in home prices nationally, while the green line is showing the level of employment in construction. From the start of 2000 through the end of 2003, construction employment was about 6.8 million workers (and with a dip after the recession).
But with the surge in home price growth (rising blue line) in early 2004, more and more workers were sucked into construction. But once home price growth began falling, construction employment peaked at about 7.7 million in early 2006, stayed there for about a year, and then began crashing.
We can also see the relation between home price growth and new residential housing starts:
As someone who has generated plenty of FRED charts in my day, let me say you rarely get a tighter fit than what we see above. As we can see, for at least three decades there was a very close connection between the annual growth in home prices, and the number of new housing starts. When home price growth fell (eventually going negative in 2007), housing starts fell with it.
At this point, we have established quite solidly that the boom/bust in market prices of housing corresponded to the flow of “real” labor hours and other physical material into the housing sector. Now we just have to make one more connection: Did the boom and bust in housing have anything to do with the Great Recession and financial crisis of 2008?
Housing and the Great Recession
According to the NBER, the “official” start date of the Great Recession was in the 4th quarter of 2007, which of course was well before the financial crisis that struck the world in September 2008. So do the movements in housing that we documented above, have anything to do with the national economy?
In the following chart we show the connection between construction employment and the national labor market:
Construction and Total Private Employment versus Unemployment Rate
In the chart above, we see that the national unemployment rate (blue line, left axis) oscillated up and down vis-à-vis construction employment (green line, right axis). The red dotted line shows total private employment minus construction. (There is a scaling factor of 11 applied to keep the lines close on the graph.)
As the chart clearly shows, if we are trying to figure out where the Great Recession “started,” it clearly began in construction. Employment in construction peaked in 3rd quarter of 2006 at 7.7 million, then sheds 200,000 workers to 7.5 million by the 1st quarter of 2008. The national unemployment troughs in 4th quarter of 2006 at 4.4 percent, the steadily rises to 5.0 percent by 1st quarter 2008. (I am using quarterly averages in the chart.)
In contrast, if we instead look at total private employment minus construction, then there’s no indication at all that the worst recession since the 1930s is coming. From 3rd quarter 2006 (when construction employment peaked) through 1st quarter 2008, total private non-construction employment grew from 106.9 million to 108.5 million. To repeat, when the national unemployment rate began rising before, and going into, the Great Recession, construction employment was falling off a cliff while all other private employment was still rising.
What else would the data have to look like, to vindicate my Austrian perspective? (For more, see my book Understanding Money Mechanics—which is available as a free PDF—from the Mises Institute.)
Dr. Robert P. Murphy is the Chief Economist at infineo, bridging together the dependability of Whole Life insurance policies with the benefits of blockchain-based finance.
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