THE ONCE-buoyant housing market is clearly in trouble. Last year, housing prices around the country fell for the first year since the Depression. In Southern California, one of the epicenters of the housing and housing-credit bubble, the pain has been acute. Local subprime lenders such as Ownit Mortgage Solutions in Agoura Hills and New Century Financial in Irvine have filed for bankruptcy protection. MortgageDaily.com estimated that 12,000 mortgage jobs have been cut in California since January 2006. Foreclosure rates are rising.
The bubble has clearly popped. Congress is holding hearings and vowing reforms. Mortgage firms are pulling back credit from customers they would have been happy to help a few months ago. And at every price point of the market, you can hear the recriminations and sense the shame that inevitably set in after a bubble. How could we be so stupid? Why did we take that 40-year, no-money-down, adjustable-rate, interest-only mortgage to buy that unfinished condo in the hopes of flipping it for a quick profit?
This isn't the first time this cycle of boom and bust has taken place in the U.S. It's not even the first time it has taken place this decade. The same process unfolded with the dotcom business in 2001 and 2002. And if history is any guide, the housing bubble won't simply leave behind a bunch of unemployed mortgage brokers and over-employed foreclosure experts. No, like the Internet bubble before it (and the railroad and telegraph bubbles before that), the housing bubble, which will hurt a minority of consumers, is likely to leave behind or lead to some innovations that will prove beneficial to a majority of consumers over the long run.
Bubbles are generally inspired by new technologies (the railroad), new ways of doing business (the Internet) and new economic assumptions (housing prices never fall and interest rates never rise) — and frequently by a combination of all three factors. After a few years of good fundamentals, experts — economists, authors, entrepreneurs and promoters of all types — lead their fellow citizens to believe that it is safe and desirable to invest in the hot area.
In February 2005, for instance, David Lereah, then the chief economist of the National Assn. of Realtors, published a book entitled, "Are You Missing the Real Estate Boom? Why Home Values and Other Real Estate Investments Will Climb Through the End of the Decade — and How to Profit From Them." (Housing prices peaked a few months later, naturally.)
Responding to such calls, people flood into the markets. From 1998 through 2006, the number of real estate agents nearly doubled, from 718,000 to 1.37 million. From September 2001 to July 2005, the S&P Homebuilders Index (which measures the price of homebuilding company stocks) rose more than six times.
As with every bubble, the onset of irrational exuberance pushed up asset prices and markets to unsustainable levels, setting up the inevitable pop. But innovation and growth don't end just because bubbles pop.
Americans tend to process failure very quickly. The losing companies go bankrupt or are consolidated, and we're frequently left with new commercial infrastructure that serves as a powerful platform for new business models. The companies that strung up telegraph wire in the 1840s generally failed. But Western Union used the telegraph to build a business based on sending money via wire — one that still thrives today. Railroads went bankrupt by the dozen in the 1880s and 1890s. But new businesses that relied on cheap freight networks, like Montgomery Ward and Sears, emerged from the rubble. Companies that invested billions of dollars to build the Internet infrastructure in the 1990s, like WorldCom and Global Crossing, crashed. But new enterprises that relied on cheap, universal broadband — MySpace, YouTube, blogs — thrived in the post-bust years.
Bubbles have silver linings because the infrastructure built during bubbles — the physical infrastructure and the cultural infrastructure — doesn't get torn down after they pop.
So what has the United States gained from the housing bubble? Well, we certainly gained a lot of physical infrastructure. Broadly speaking, all that new construction and renovation (fueled by home equity lines of credit) has upgraded the nation's housing supply. Yes, some of the homes built at the tail end of the bubble will be sold at deep losses. But towers of unsold condos in Miami won't be torn down. They'll be turned into hotels or office buildings or dormitories.
I'd also include in this physical infrastructure the new services that were built in the 1990s to appeal to bubble participants, like mortgage websites where lenders compete for the business of individuals. Or Zillow.com, the wildly popular service that uses public data and sophisticated algorithms to appraise home values. Such services, which won't be shut down just because the subprime market went bust, empower consumers and contribute to greater transparency in the housing market — outcomes that benefit all consumers.
By encouraging people to look at the world differently and to try new modes of doing business, bubbles also create important, lasting cultural infrastructure. Take, for example, the whole mentality that built up in recent years of refinancing and home equity. With each passing year this decade, more people became aware that it is possible to borrow against home equity at 8% instead of borrowing on credit cards at 18%, and that they could refinance fixed-rate mortgages at lower levels when interest rates fell.
There's more. In 2006, housing index options began trading on the Chicago Board of Trade — these securities, used only by professionals now, are a form of insurance on home prices that could find a broader application. (Alas, people tend to see the necessity for insurance and hedging only after the fall.) Some organizations are already experimenting with what is called "home equity insurance" — policies that would protect people from a decline of value in their home equity.
Of course, at this point in the cycle, it's hard to imagine the economy-wide good that could arise from the problems in the housing sector. After all, it's easy to calculate the losses that an individual suffers after a bubble bursts. If you bought a share of Global Crossing at $50 and the stock went to zero, you were out $50. But the gains that accrue to everybody as a result of bubbles are much harder to quantify. What's the value of Wi-Fi to the U.S. economy?
What's more, it's nearly impossible to see the upside when we're wallowing in post-pop despair. Think back to 2001 and 2002, when the gloom surrounding the Internet was as thick as traffic on the I-5. Did anybody out there imagine that a tiny company in Northern California bearing an odd name — Google — would be worth nearly $150 billion by May 2007?Copyright © 2015, Los Angeles Times