What Came First: The Decline In Housing Or The Mortgage Crisis?

We're awash in a great sea of complicated answers to the question of what caused the Lesser Depression. Why? The story's rather simple.

For those who would say it all comes down to deregulation, the repeal of Glass-Steagall, and sub-prime loans, please answer this: How could a collapse in loans that comes well after the sharp drop in housing starts supposedly reach back in time and cause that preceding sharp drop in housing starts? Or how could failures of financial institutions travel time to kick off the decline in housing starts before they started failing?

The delinquency rate on single family residential mortgages averaged 2.2% between 1991 and 2007. Let's presume that wasn't a time of extraordinary caution and thus that 2.2% represents a reasonably ordinary rate of delinquencies. That rate dipped below 2 in 2003 and didn't get back up to 2 until the fourth quarter of 2006. Delinquencies didn't climb past 2.2% until the 2nd quarter of 2007, over a year after housing starts began plummeting. It seems quite clear that since there was no rash of delinquencies until well after housing starts crashed, we can't reasonably blame the decline in starts on the delinquencies. In other words, failing sub-prime loans simply don't work as an explanation without time travel.

Bank failures run a similar course. None in 2006 while housing starts drop sharply. Three in 2007. But 25 in 2008. Housing starts fell off the cliff long before banks started failing.

But then, what did go along with the housing starts decline? Why did they stop starting so many? Could it be that folks stopped being willing to pay ever higher prices?

Yep. In early 2006, housing prices tapered, peaked, and then started dropping a bit. And then they went flat for a while. Sellers resisted selling for less than they'd hoped a few months earlier. It's easy to understand reluctance to drop prices when it had so recently been a sellers market. But before long, prices joined in at the same angle of descent they'd set up in housing starts. Of course those two declines would feed into each other. With prices no longer rising and worse declining, it just doesn't make sense to build as much.

And what happens when we don't build as many houses? There's a bit of lag in effect. After all, once a start happens there's usually a few months of building. But as some months go by with a continuing sharp drop in house component orders and furniture sales, we get a decline in employment.

And once we have a decline in employment, fewer people can afford houses and fewer people can hold off on selling houses ... at any price.

In short order, not long after employment started down from the October 2006 peak, the bottom fell out from under house prices after March 2007.

Which brings us to the 2nd quarter of 2007. Remember that? That was when delinquencies started up past the norm for the preceding decades. So here's the question: did all this happen because collapsing sub-prime loans hopped a ride on Dr. Emmett Brown's DeLorean back to before the home prices, housing starts, and unemployment all started down? Or should we perhaps consider that maybe reality actually went in chronological order?

What came first? Home prices stopped rising and housing starts fell. Then unemployment. And we don't get into issues with mortgage-backed securities and complex derivatives until after those three got together. Can someone show us a working time machine or reference to all of this in Nostradamus? If not, no matter how much sub-prime loans and Glass-Steagall's repeal might have made the aftermath worse, it might make sense to presume they didn't have a thing to do with causing the whole mess.

The Cost of Balanced Budgets and a Longer View on Presidents and Jobs From Ike To 2012

I'd usually heard the 50s described as more or less a golden era of rising prosperity. But till recently I tended to skip over digging into that decade's economic data to focus on the Great Depression up through World War II (when not mucking about the peaks and valleys of more recent times). So I have to admit this chart surprised me.

starting with Ike, the first President fully covered in the monthly POP data; to June 2012

I was expecting that adding in the Republican Presidents before Reagan would show that prior to Trickle-down / Supply-side economics / Reaganomics infecting the Republican party, they'd done better. I expected to be illustrating the post-Depression glory days of the Republican party via Ike, Nixon, and Ford. Instead, the data gave me what we see above. In jobs, Nixon and Ford both did worse than Johnson, Carter, and Clinton. While Nixon and Ford did better than Obama's marks for his full term so far, they each did worse than during his tepid recovery span from February 2010 on to the latest data. And then there's Ike -- whom we admire -- down there with the likes of the Bushes. I didn't want to see that. Frankly, I wanted to believe Ike pulled off the Clinton trick of balancing the budget while improving employment. But I can't deny the data.

If we look a bit further back, before the dates in the data used above to put payroll growth in perspective via population growth, we can at least compare Ike's raw payroll figures to those from FDR (since 1939) and Truman, but that only rules out claiming Ike's dismal jobs performance as part of a longer trend.

Ike's sad job numbers with context: at least he's not Bush II

It's not a pretty picture for Ike, which I'm sad to see. Thankfully there's still much to admire from President Eisenhower in the highway system and his work for civil rights. I still like Ike. I still think I'd have voted for him if I'd been old enough at the time. But his economic record is tarnished.

In his defense, President Eisenhower did start his term with a 2.6% unemployment rate during that first full month. It's hard to improve on 2.6% unemployment. Still, unemployment rose dramatically to 6.9% by the first full month of his successor's term. Ike's shift: +165% unemployment. That's a rather lousy fumble. And while the Eisenhower years saw increasing family incomes, the same can be said for the Kennedy / Johnson years except without the rising unemployment, as over the course of their span they reduced that rate from the 6.9% that Eisenhower left them back down to 3.4% by the end of Johnson's Presidency.

So what went wrong? Let's look at the modern history of balanced budgets:

• At Republican urging, FDR tried to balance the budget with spending cuts and it brought us the Recession of 1937-38. 
• After World War II we saw dramatic cutbacks in spending with balanced budgets in 1947 through 1949 and the recessions in 1945 and 1949. (Of course, the war spending was unsustainable; there was probably no way to avoid recession in the late 1940s.)
• Truman balanced the budget in 1951. But like the later Clinton-era balanced budgets this one was done while expanding federal outlays ... rather swiftly increasing from the 1948 lows. Then after we slowed spending at the end of the Korean War, we got the recession of 1953.
• Eisenhower balanced the budget in 1956 and 1957 and we got the Recession of 1957.
• Eisenhower balanced the budget again in 1960 and we got the Recession of 1960.
• Nixon balanced the budget in 1969 and we got the Recession of 1970.
• While Clinton balanced the budget in 1998 lasting through Bush's first budget in 2001, the balancing in these years was done without reducing the growth of federal outlays but rather through moderate increase of tax rates. As such, this particular instance was thoroughly different from most previous balancing of the budget (except Truman's).

There were also some recessions that didn't correspond to these balanced budgets: the oil shock under Nixon, the extremely high interest rates under Reagan, the S&L crisis under Bush I, the Dot-Com crash under Clinton and Bush II, and the housing/finance crash under Bush II. I'm not suggesting that all recessions are caused by cutting to achieve balanced budgets. However, it would seem that balancing our national budget via cuts -- even if only in inflation-adjusted terms as in 1960 and 1969 -- tends to lead to recession.

The impact of Eisenhower's budget balancing exploits are particularly of interest for its parallel to job losses in the Great Recession. Private payrolls dropped by 2.385 million between August 1957 and June 1958, a 5.26% decline. By comparison, that's just barely below the 5.47% decline during the worst job-loss months of the Great Recession from August 2008 through June 2009. Remember that saying about doing the same thing and expecting different results. If we implement massive cutbacks like Eisenhower with our sequestration fiscal cliff, we can expect yet another massive fall just like the Eisenhower recession ... and we've not climbed far enough back from the jagged rocks as it is.

In case after case, budgets balanced with spending cuts have brought on recession. And now the Republicans are once again pushing us to balance the budget with dramatic spending cuts. Democrats may not be leading the charge, but Obama like FDR is far too willing to accept the Republican push for cuts. If we don't turn away from this push to slash budgets, previous experience shows us it will hurt the economy. When we make the debt more manageable by growing our economy such that the debt shrinks by comparison, that's tended to work out well. When we clumsily attempt to tackle the debt directly by slashing spending to balance the budget in the hopes a primary surplus, the records shows it tends to work out poorly.

When It Went Wrong

When did things start down? Where was the bump in the road that triggered the Great Recession? In this election season, that question matters in the short term for trying to choose the folks most likely to not send us back down the same path. Partisans from both major parties would love to tell us things when wrong under the other party's watch, but only one side can say it accurately. So when did it start?

To begin answering that question, we can't just look at GDP or unemployment alone. While those may tell us when things really got bad, they don't tell us when the problem started. To get a better idea of when the problem started requires focusing further back than when it became obvious to everyone. The overall economy was hammered by a financial crisis, but that financial crisis didn't just spring up on its own. The financial crisis was triggered by a stumbling housing market. So when did housing tumble off the cliff?

Housing fell off a cliff in 2006; in 2007/8, it was just still falling from 2006.

Building permits peaked on September 2005 and then proceeded to fluctuate through January 2006. Housing starts peaked in January 2006. Then after January 6th, both building permits and housing starts tumbled off that cliff, followed soon after by residential construction. Between the January 2006 peak and the start of the 110th Congress in January 2007, housing starts dropped by 38% and residential construction dropped by 15%. The housing industry was collapsing throughout 2006 and bringing layoffs starting with housing and spreading into related domestic industries such as window and cabinet making. Following on housing's decline, manufacturers new orders hit choppy waters in 2006, . By the end of 2006, the effects weren't yet enough to seriously shake unemployment or turn GDP negative, but the decline did start to show in other measures and a slackening of quarterly GDP growth. The annual growth in consumption per capita for 2006 started back down from what we'd seen in 2005.

Demand/person slowed down in 2006 ... before getting to an actual drop.

Put it all together it's really only a technicality that the recession didn't hit until late 2007. In fact, the economy was already in rough shape in 2006, with really lousy growth evident over the 2nd and 4th quarters of 2006, to the point of quarterly GDP growth just barely staying out of negatives.

2006 wasn't technically recession; but it was darn close.

Clearly, the first wave of what became the Great Recession was well under way during the watch of the 109th Congress (2005-2006) under President Bush II, even though we hadn't reached technical recession yet. What happened during the 110th Congress was just that it became clear that the problem -- which was already under way -- was spreading from housing into finance and from there to everything else. The curtain covering over the problems was pulled away in 2007-2008, but the trouble was there before the curtain pulled away. Republicans held majorities in both Houses of the 109th Congress, as they had for almost all of the time since 1995 (except for a slim Senate flip in part of the 107th Congress). By 2006, Republican policies had held sway in both the executive and legislative for years and they were still in control. While there's room for debate as to how much involvement government had in the creating or allowing the mess, the weight of evidence says that if one were going to blame governance, the party to blame for that mess is Republican.

Gravity and Education Spending

There's a CATO Institute graph going around that paints a very distorted picture as if we had some sort of continuously skyrocketing federal spending on education. In truth, that's not the case at all. We saw a very large -- but very brief -- spike on account of the Great Recession. The CATO graph neglects to include the estimates for 2011 and 2012 spending that show it going back down.

Data from http://www.gpoaccess.gov/usbudget/fy11/pdf/hist.pdf

Sometimes what went up comes back down. And that's without even adjusting for inflation.

The 2010 through 2012 figures are estimates. But CATO included the 2010 estimate, so why not the rest of the picture so that we could see it comes back down?

What happens if we adjust for inflation and population?

Not only does the brief boost go away, but it looks like its going to go below 2005 levels.

Update: for a little pre-2005 context, see Education Spending, the Prequel (pre-2005).

Private Payrolls Versus Govt Payrolls

Over the course of the Great Recession, we naturally dipped a bit in our percentage of all payrolls from private employment. At first, over the course of 2008 and very early 2009, private payrolls were dropping significantly faster than government payrolls. That has since reversed.

The dotted red line indicates the level of the first full month of President Obama's tenure.

As 2009 wore on, the bleeding in private payrolls slowed (from -0.73% in April to -0.29% in May and eventually dwindling to -0.04% in November). The change in private payrolls turned positive in March 2010 and the tally's been growing every since. Meanwhile, except for a spike in May 2010 from Census hiring, govt payrolls fluctuated in the same narrow band from late 2008 until plummeting after the Census work. By January 2012, govt payrolls dropped to a five year low at a level not seen since July 2006.

Private payrolls on the larger scale at left; govt payrolls on the smaller scale at right.

Growing population casts the drop in government payrolls with an even larger impact. By 2010, we reached a 20 year low as far as the number of government workers per capita.

Year	Govt workers per million Americans	Annual change
2008	73.94	0.36%
2009	73.47	-0.64%
2010	72.70	-1.05%
2011	70.94	-2.42%

As Daniel Gross put it, describing the increasing private share of all payrolls, "Socialism? Hardly."