Why the housing bubble is just one chapter in a larger story

When the housing boom was reaching its crescendo in 2005, there were a few lonesome voices out there explaining that it was merely a symptom of a much larger, worldwide credit bubble. Between emerging countries in Asia like China and South Korea and oil-rich states like the UAE and Saudi Arabia, there was simply too much money sloshing around outside the U.S. in search of a decent return, and of course Wall Street was promising investors that it had stumbled upon the latest "can't lose" financial instruments: mortgage-backed securities.

But it seems that explanation didn't tell the entire story. According to a fascinating article in Harper's by Eric Janzsen, in recent years the U.S. has set itself up for a regular series of booms and busts to keep the economic fires stoked. Ten years ago it was the Internet and the "new economy," and now we're seeing the down cycle of the housing boom, to be followed by certain segments of the commercial real estate boom (mostly notably retail and, to a lesser extent, office uses). Next up? Alternative energy. Get ready for the greening-and-browning of America:

A financial bubble is a market aberration manufactured by government, finance, and industry, a shared speculative hallucination and then a crash, followed by depression. Bubbles were once very rare—one every hundred years or so was enough to motivate politicians, bearing the post-bubble ire of their newly destitute citizenry, to enact legislation that would prevent subsequent occurrences...

Nowadays we barely pause between such bouts of insanity. The dot-com crash of the early 2000s should have been followed by decades of soul-searching; instead, even before the old bubble had fully deflated, a new mania began to take hold on the foundation of our long-standing American faith that the wide expansion of home ownership can produce social harmony and national economic well-being. Spurred by the actions of the Federal Reserve, financed by exotic credit derivatives and debt securitization, an already massive real estate sales-and-marketing program expanded to include the desperate issuance of mortgages to the poor and feckless, compounding their troubles and ours.

That the Internet and housing hyperinflations transpired within a period of ten years, each creating trillions of dollars in fake wealth, is, I believe, only the beginning. There will and must be many more such booms, for without them the economy of the United States can no longer function. The bubble cycle has replaced the business cycle...

The bubble machine often starts with a new invention or discovery. The Mosaic graphical Web browser, released in 1993, began to transform the Internet into a set of linked pages. Suddenly websites were easy to create and even easier to consume. Industry lobbyists stepped in, pushing for deregulation and special tax incentives. By 1995, the Internet had been thrown open to the profiteers; four years later a sales-tax moratorium was issued, opening the floodgates for e-commerce. Such legislation does not cause a bubble, but no bubble has ever occurred in its absence...

The media stood by cheering, carrying breathless profiles of wunderkinder in their early twenties who had just made their first hundred million dollars; business publications grew thick with advertisements. The media barely questioned the fine points of the new theology. Skeptics were occasionally interviewed by journalists, but in general the public was exposed to constant reiterations of the one true faith. Government stood back—after all, there was little incentive for lawmakers to intervene...

The U.S. mortgage crisis has been labeled a “subprime mortgage crisis,” but subprime mortgages were only a sideshow that appeared late, as the housing-bubble credit machine ran out of creditworthy borrowers. The main event was the hyperinflation of home prices. Risks are embedded in price and lurk as defaults...

Bubbles are to the industries that host them what clear-cutting is to forest management. After several years of recession, the affected industry will eventually grow back, but slowly—the NASDAQ, for example, at 5,048 in March 2000, had recovered only half of its peak value going into 2007. When those trillions of dollars first die and go to money heaven, the whole economy grieves.

The housing bubble has left us in dire shape, worse than after the technology-stock bubble, when the Federal Reserve Funds Rate was 6 percent, the dollar was at a multi-decade peak, the federal government was running a surplus, and tax rates were relatively high, making reflation—interest-rate cuts, dollar depreciation, increased government spending, and tax cuts—relatively painless. Now the Funds Rate is only 4.5 percent, the dollar is at multi-decade lows, the federal budget is in deficit, and tax cuts are still in effect. The chronic trade deficit, the sudden depreciation of our currency, and the lack of foreign buyers willing to purchase its debt will require the United States government to print new money simply to fund its own operations and pay its 22 million employees.

Our economy is in serious trouble. Both the production-consumption sector and the FIRE sector know that a debt-deflation Armageddon is nigh, and both are praying for a timely miracle, a new bubble to keep the economy from slipping into a depression...

There are a number of plausible candidates for the next bubble, but only a few meet all the criteria. Health care must expand to meet the needs of the aging baby boomers, but there is as yet no enabling government legislation to make way for a health-care bubble; the same holds true of the pharmaceutical industry, which could hyperinflate only if the Food and Drug Administration was gutted of its power. A second technology boom—under the rubric “Web 2.0”—is based on improvements to existing technology rather than any new discovery. The capital-intensive biotechnology industry will not inflate, as it requires too much specialized intelligence.

There is one industry that fits the bill: alternative energy, the development of more energy-efficient products, along with viable alternatives to oil, including wind, solar, and geothermal power, along with the use of nuclear energy to produce sustainable oil substitutes, such as liquefied hydrogen from water...

The next bubble must be large enough to recover the losses from the housing bubble collapse. How bad will it be? Some rough calculations: the gross market value of all enterprises needed to develop hydroelectric power, geothermal energy, nuclear energy, wind farms, solar power, and hydrogen-powered fuel-cell technology—and the infrastructure to support it—is somewhere between $2 trillion and $4 trillion; assuming the bubble can get started, the hyperinflated fictitious value could add another $12 trillion. In a hyperinflation, infrastructure upgrades will accelerate, with plenty of opportunity for big government contractors fleeing the declining market in Iraq. Thus, we can expect to see the creation of another $8 trillion in fictitious value, which gives us an estimate of $20 trillion in speculative wealth, money that inevitably will be employed to increase share prices rather than to deliver “energy security.” When the bubble finally bursts, we will be left to mop up after yet another devastated industry. FIRE, meanwhile, will already be engineering its next opportunity. Given the current state of our economy, the only thing worse than a new bubble would be its absence.