McKelvey Lectures on Housing Bubble
Amid fears that the collapsing market will trigger a recession, Goldman Sachs Economist and Vice President Edward McKelvey, OC ’68, brought some perspective to the crisis with his lecture “Brave New Business Cycle.” In McKelvey’s view, despite trouble in some sectors of the economy, new innovations have created a more balanced business cycle that is less prone to severe recessions or rapid growth.
While these developments might reduce the severity of recessions and the danger of inflation, McKelvey pointed out they produced “a slow take-off in 1991” and following the ’91 recession companies were slower to hire than in past recoveries. “Two hundred [thousand new jobs a month] used to be a good bid on a post recession employment report,” said McKelvey. “Now it’s 100 to 200 [thousand].”
Not all of these new economic innovations have made for greater stability. According to McKelvey, the most important change in the American economy, and the one that is a source of so much agitation lately, is the deregulation in housing finance. “The old system [of housing finace] was highly overregulated,” said McKelvey. These restrictions led to a shortage of capital to finance home buying, a point McKelvey emphasized by recounting how when he was buying his first house, the main obstacle was not his own credit worthiness, but the bank’s ability to actually provide the funds.
The restrictions that hampered home lending were lifted over the course of the 1980s, eliminating these obstacles, but “we may have gone to the point of too much of a good thing.” The emergence of a secondary market in home loans, where investors can purchase mortgages that have been bundled together, has made it easier for the banks to access capital, but has decreased the incentives for lenders to verify the quality of loans since they are re-packaged and sold to investors.
These changes contributed to a boom in the housing market beginning in the late 1990s that saw residential investment and housing prices reach a several-decade high and create what McKelvey called “a housing department way out of whack.”
The consequences of the housing bubble and its subsequent collapse have been a surplus of homes equal to almost an entire year of house construction, rising foreclosure rates, a tightening of mortgage credit standards and a sharp decline in asset-backed commercial paper outstanding.
Mortgage difficulties could also affect consumer spending as result of home equity loans, pointed out Oberlin Professor David Cleeton during the presentation.
“I’m quite concerned for the potential of all that; there are many different ways for housing finance to affect the rest of the economy,” said McKelvey.
Despite the troubles afflicting housing, McKelvey was not too pessimistic, though he did predict “a further slowing in US growth... a modest [one percentage point] rise in unemployment and more easing from the Fed,” as well as “a high risk of recession.” Still, McKelvey said he did not think the economy would actually fall into a recession.
The source of the Goldman Sachs economist’s equanimity in the face of the troubles wracking housing finance was his belief that new developments in other sectors have made for a more stable economy. The changes that underlie Edward McKelvey’s “brave new business cycle” are a more competitive economy as result of deregulation and more international trade, the revolution in information technology and more responsive, just-in-time management.
In McKelvey’s analysis, greater competition has forced firms to keep prices down, while the growth of international markets has allowed companies to hedge against domestic economic problems and just-intime production allows for quicker response to market change, moderating recessions and booms.
According to the presentation, the chances of the housing market returning to normalcy in the near future appear to be slim. Despite falling home prices, there is still “a long way to go to restore affordability.” When a student asked when she should purchase a house, McKelvey answered, “Not until 2009.”