gjerstad & smith - rethinking housing bubbles; the role of household and bank balance sheets in modeling economic cycles (2014)

[...]... consequence of excess risk-taking in asset bubbles Bankruptcy is also the “surgical therapy” for excising negative equity in household and bank balance sheets and for allowing the system to resume its economic development Thus, the Federal Deposit Insurance Corporation (FDIC) managed the failure of 465 banks from 2008 through the end of 2012 (51 banks failed in 2012, down from 92 in 2011) These were... appreciated by the economics profession, the investment community, and policy makers Our primary objectives in the chapters that follow are to examine the role of housing in past recessions, with a special focus on its role in severe cases that take the form of balance sheet recessions – that is, recessions that accompany severe deterioration in the balance sheets of households and financial firms – and to demonstrate... and banks with the daunting task of rebuilding balance sheets Beliefs about the effectiveness of fiscal policy originated primarily after 1939, when the expansion of government expenditures became prominently associated with the accompanying sustained recovery from the Depression.17 Not a part of this pattern of thinking is that by the end 16 17 One of the authors (Smith) sat in Alvin Hansen’s Money and. .. payments and, in some cases, with lower principal balances At the time, all of these actions were seen by citizens and experts alike – just as they are now – as aspects of the economic distress, not as central to the process of healing balance sheets and resuming the flows of economic activity and growth 1.3.6 Will New Models Save Us? Against all of this background, The Economist (2013) offered a startling... microeconomic thinking, and neither has it informed economic policy Economic analysis focuses on the flows of economic activity, not the balance sheet conditions that underlie and facilitate or impede those flows From this perspective, we envision the economic Trim: 6in × 9in Top: 0. 5in Gutter: 0.87 5in CUUS212 2-0 1 CUUS2122 /Gjerstad ISBN: 978 0 521 19809 7 16 January 30, 2014 11:36 Rethinking Housing Bubbles... network of flows connecting nodes, with decisions being made at each node If these decisions are also constrained by negative equity balances and the prospect of further declines in home prices, then payment flows through the nodes are reduced by precautionary actions; debt reduction; and budget-stretching by households, banks, and firms In the nodal-network metaphor, we think of the normal flows through the. .. answering these questions and accounting for the abrupt turns and reversals as economic thinking and policy lagged behind the twisting curve of events Both Keynesian and microeconomic equilibrium analyses model flows of goods, services, labor, and capital investment When household and bank balance sheets are predominantly in positive equity, these flows behave with far more regularity than when they are... severe economic downturns during that period (i.e., the 1973–5 recession and the 1980, 1981–2 double-dip recession) Trim: 6in × 9in Top: 0. 5in Gutter: 0.87 5in CUUS212 2-0 1 CUUS2122 /Gjerstad ISBN: 978 0 521 19809 7 Economic Crises, Economic Policy, and Economic Analysis January 30, 2014 11:36 3 Clearly, the role of households in economic cycles – operating through their acquisition of credit-financed... massively disrupted the ordinary flows of economic activity across decision-making entities.9 This large decline in household wealth contributed significantly to a disruption of the normal flows of goods and services as well as the payments for them, including the flows of payments for labor services Reduction by households of their expenditures relative to income – especially for new housing units and consumer... one in the United States between 1924 and 1934 or between 2001 and 2013 – have significant effects on household wealth We explore both the income and the wealth effects in detail in Chapters 3 through 5.12 1.3.3 When Household Balance Sheets are Damaged, so are Bank Balance Sheets The Great Recession is the economic consequence of an extensive balance sheet “crunch” in the household sector, wherein a . 6in × 9in Top: 0. 5in Gutter: 0.87 5in CUUS2122-FM CUUS2122 /Gjerstad ISBN: 978 0 521 19809 7 January 31, 2014 15:25 RETHINKING HOUSING BUBBLES The Role of Household and Bank Balance Sheets in Modeling. 6in × 9in Top: 0. 5in Gutter: 0.87 5in CUUS2122-FM CUUS2122 /Gjerstad ISBN: 978 0 521 19809 7 January 31, 2014 15:25 Rethinking Housing Bubbles The Role of Household and Bank Balance Sheets in Modeling. in 2002 for his groundbreaking work in experimental economics. Dr. Smith has joint appointments in the Arg yros School of Business and Economics and the School of Law at Chapman University, and