Missing the housing bust

Released minutes of Federal Reserve meetings in 2006 indicated the majority of members were not concerned about the housing market, and they did not foresee a crash in this market that would pull down the rest of the economy. How could such smart people ultimately be so wrong? N.C. State University economist Mike Walden answers.

“Well, they were in good company … because most of us — … economists and financial experts — did not see the extent of the housing crash. Now … in our defense, when you go back and look at the housing market historically, it’s always been a very localized market. It’s very unusual for housing markets nationwide to move together.

“Also, for those folks who were worried about homeowners and home buyers overextending themselves with mortgages, actually mortgage payments as a percent of income *were) at a very traditional level during this housing boom. So, from that measure, we did not see that homeowners were extending themselves.

“But I think this failure to really see the housing bust coming really does reveal a flaw, if you will, in economic forecasts, and that is, it’s very difficult for us professional economists to see turning points in the economy. It’s much easier for us to use so-called straight line forecasting when there’s something that really radically changes the economy, moves it either up or down dramatically. That’s very, very hard to see in any kind of standard projection.

“But I do think that our miss, if you will, on the housing crash has sensitized us now to worry more about asset booms and the potential asset bust following that. So I think we are looking at markets now around the world — for example, in the commodity market or some real estate markets in foreign countries — as potential sources for another big turnaround.”