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In a fascinating time line of what policy makers were thinking and doing leading up to the Great Real Estate Crash of 2008, Bruce Bartlett - former Treasury Department economist - discusses Greenspan's decisions and other research papers from economists at the time:

There were, in fact, many warnings dating back more than seven years--but in the euphoria of rising home prices, no one listened. As time went by and no crash occurred, many of those doing the warning lost credibility or decided that perhaps they were wrong and moved on to other issues.

I first created a folder on the housing bubble back in 2001 and began collecting material on the subject. The very first piece I filed was an article from a September 2001 issue of Forbes called "What If Housing Crashed?" by Stephane Fitch and Brandon Copple. Read today, the article was remarkably prescient.

He goes on to track Alan Greenspan's comments and decisions regarding the so-called "Housing Bubble" (note: Greenspan dismissed the idea of a bubble all along the way), and in 2002 filed with the Bush Administration what was to be the seminal report warning that something was amiss:

In June 2002, I filed a report by economist Ed Leamer of UCLA noting that the ratio of home prices to rent was rising rapidly and that this represented a kind of price to earnings ratio for the housing market.

Like the stock market's P/E ratio, when it rises rapidly above historical norms in a short period of time, it's is a good sign that there is a bubble--and that it could burst quickly.

Greenspan continued to deny that a bubble existed and economists were still studying the hell out of it:

In September, economists Karl Case and Robert Shiller presented a very detailed analysis of the housing market to the Brookings Institution's panel on economic activity.

While conceding that economic fundamentals were favorable to rising home prices, they also noted that there were elements of bubble psychology in the housing market. Case and Shiller pointed to an increase in the buying of real estate for investment purposes and high expectations of housing price increases.

They also observed an increasing sense of urgency and opportunity among home buyers, who were plunging into real estate for fear of being left behind as they perceived their friends and neighbors growing richer--classic signs of a bubble.

As Bartlett reports, "by 2004, concerns about a housing bubble were pervasive throughout the popular media. But responsible authorities continued to throw cold water on them."

And then there was this:

The first report I have pointing to the potentially disastrous effects of a collapse in housing on financial institutions came from economist Paul Kasriel of Northern Trust on July 30, 2004. He noted that 60% of banks' earning assets were mortgage-related--twice as much as was the case in 1986.

If the housing market were to go bust, Kasriel warned, the banking system would suffer significant damage. And since the banking system is the transmission mechanism between the Fed and the economy, any serious downturn in that sector could make monetary policy impotent, thus pulling down the entire economy.

The point about impotent monetary policy is key as we head into 2009 with interest rates at basically zero percent. All that's left to drag us out of this mess is a massive fiscal boost, the likes of which haven't seen since the Great Depression. In fact, President-elect Obama just gave a major speech today about his plan and how it should help mitigate the wreckage caused by this housing bubble.

Bartlett goes on in his article to detail the first column he wrote he wrote on the housing bubble - on December 15, 2004. As he writes:

I concluded it would be "unwise to buy a house in the expectation of future price increases like those we have seen." I advised every homeowner to get out of adjustable-rate mortgages and into a fixed-rate mortgage as soon as possible.

Like most naysayers, they are too few and too soon. Bartlett nails the trick about the prediction business when he concludes:

Unfortunately, it is in the nature of economic and financial forecasting that being right too soon is insignificantly different from just being wrong. And forecasters that are wrong when most of their community is also wrong never suffer for it. The trick is to be right just a little bit sooner than everyone else--but only a little bit.

Krugman also comments on Bartlett's column:

Bruce Bartlett mentions this 2004 NY Fed paper as one of the things that convinced him not to worry about a housing bubble. I remember that paper; I also remember why I discounted it.

There were really two things. First, although the paper mentioned regional differences, and even pointed out that supply is less elastic in some places than others, it didn't home in on what seemed to me to be a key point: the seemingly moderate national real price rise was an average of flat real prices in the middle of the country, and enormous rises on the coasts, which were very hard to explain in terms of fundamentals. (I got a lot of this insight from reading Calculated Risk.)

Second, I was suspicious of the argument that low interest rates can justify huge price appreciation, because it seemed to me that people were forgetting something: if and when interest rates rose again, the same logic would imply big price declines, and buyers should have been (but weren't) taking that possibility into account.

Indeed, the historians are going to have a field day over this mess. They are just beginning the process of sorting it all out...i.e. who was right, who was wrong, who's responsible...etc...

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