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Affluent Investor | May 28, 2017

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How Stock Market Crashes are Different From Housing Market Crashes

(Photo by Iman Mosaad) (CC BY) (Resized/Cropped)

(Photo by Iman Mosaad) (CC BY) (Resized/Cropped)

You did not need the Fed simulation model, Ferbus, to know that there is a difference between housing market crashes and stock market crashes. At the 2005 meeting the FOMC devoted five presentations on the special topic “Housing Valuations and Monetary Policy” by senior Fed research personnel.

This research established the proposition that home prices had risen unsustainably relative to home rentals, thereby constituting a price bubble. Here is a quote from S.Gjerstad and my book Rethinking Housing Bubbles, 2014.

“[The Fed] used the impact of the 2001–2002 stock market crash to estimate the fallout from a potential 20 percent drop in housing prices based on how changes in wealth impact household spending (Williams, 2005, p. 18): it seems clear the magnitude of the current potential problem is much smaller than, and perhaps only half as large as, that of the stock market bubble.”

“The contrast between the dotcom crash (2000–2002) and the housing collapse (2007–2009) renews an important lesson going back to the 1920s and 1930s. Whenever stocks fall “off the cliff,” the combination of tough margin requirements and callable loans serves well to confine the balance sheet damage to investors with minimal impact on their lenders. However, when housing prices collapse against fixed long-term mortgage obligations, household equity falls dollar for dollar with the declining home prices. The resulting household balance sheet damage extends directly to the banks, causing them to severely restrict new loan activity.”

Dr. Vernon L. Smith was awarded the Nobel Prize in Economic Sciences in 2002 for his groundbreaking work in experimental economics. Dr. Smith has joint appointments with the Argyros School of Business & Economics and the School of Law, and he is part of a team that will create and run the new Economic Science Institute at Chapman.

Dr. Smith has authored or co-authored more than 250 articles and books on capital theory, finance, natural resource economics and experimental economics. He serves or has served on the board of editors of the American Economic Review, The Cato Journal, Journal of Economic Behavior and Organization, the Journal of Risk and Uncertainty, Science, Economic Theory, Economic Design, Games and Economic Behavior, and the Journal of Economic Methodology. He is past president of the Public Choice Society, the Economic Science Association, the Western Economic Association and the Association for Private Enterprise Education. Previous faculty appointments include the University of Arizona, Purdue University, Brown University, the University of Massachusetts, and George Mason University, where he was a Professor of Economics and Law prior to joining the faculty at Chapman University. Dr. Smith has been a Ford Foundation Fellow, Fellow of the Center for Advanced Study in the Behavioral Sciences and a Sherman Fairchild Distinguished Scholar at the California Institute of Technology.

In 1991, the Cambridge University Press published Dr. Smith’s Papers in Experimental Economics, and in 2000, a second collection of more recent papers, Bargaining and Market Behavior. Cambridge published his Rationality in Economics: Constructivist and Ecological Forms in January 2008. Dr. Smith has received an honorary Doctor of Management degree from Purdue University, and is a Fellow of the Econometric Society, the American Association for the Advancement of Science, and the American Academy of Arts and Sciences.

Dr. Smith is a distinguished fellow of the American Economic Association, an Andersen Consulting Professor of the Year, and the 1995 Adam Smith Award recipient conferred by the Association for Private Enterprise Education. He was elected a member of the National Academy of Sciences in 1995, and received CalTech’s distinguished alumni award in 1996. He has served as a consultant on the privatization of electric power in Australia and New Zealand and participated in numerous private and public discussions of energy deregulation in the United States. In 1997 he served as a Blue Ribbon Panel Member, National Electric Reliability Council.

Dr. Smith completed his undergraduate degree in electrical engineering at the California Institute of Technology, his master’s degree in economics at the University of Kansas, and his Ph.D. in economics at Harvard University.

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