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The Baltimore Sun

Back when quickly rising home prices struck many as a good thing, economist Dean Baker was a veritable wet blanket.

In August 2002, he published a paper suggesting that the country was caught in a housing bubble, that a price slump was inevitable and that there could be a huge loss of equity, "a surge in mortgage default rates" and "serious stress on the financial system." He was so convinced, he sold his condo in 2004 to become a renter.

That all seems prescient now.

Baker, co-director of the Center for Economic and Policy Research, a think tank in Washington, doesn't claim to be more far-seeing than the droves of experts and economists who at least initially took a "don't worry" stance. He thinks people weren't paying enough heed to history, which showed that home prices tend to rise in step with the overall increase in the cost of living.

Baker, 49, lives in Washington with his wife, Helene Jorgensen. He spoke to The Sun recently about housing, his former home and where he thinks the market is headed. What made you start worrying about the housing market?

When you suddenly see this big run-up in house prices without any historical precedent, that in itself should be cause for concern. I went to what other economists were saying to try to explain it, and none of it really made any sense, things like population growth and income growth. ... After the recession, income growth was very weak, so that couldn't explain much, and population growth - we already had the baby-boom cohort owning homes. On the supply side, we were actually building homes at a pretty rapid pace. ... All you're really left with is a bubble as the explanation for why prices were rising. There's certainly precedent for that: Think of Japan, where you had a stock bubble and a housing bubble.

I came to believe that was probably the case in the U.S. Rents were not rising particularly rapidly, also suggesting this wasn't fundamentals in the housing market, because if this was something fundamental pushing up sales and prices, ... you'd expect to see some comparable run-up in rents. Was there a defining, lightbulb moment for you?

It was [then-Federal Reserve Chairman Alan M.] Greenspan that got me thinking about it. He gave testimony in the summer of '02 before Congress. ... He talked about the increase in housing prices, which was already evident at that point, ... and he gave explanations as to why it was not a bubble. And nothing he said made any sense. That was when I really started to look at this closely.

I debated a lot of people on the issue. ... They'd make these broad statements - "housing is always a good investment," "house prices don't fall." That's not really much of an argument. Did you feel like a lone voice?

Pretty much a lone voice, particularly the first year. You put your theories in action when you sold your home.

It was kind of a fluke-ish event. We had bought a condo in D.C. at the end of '96. It had almost tripled in price, and we were sitting there thinking, "It's very likely to fall." We sold in May 2004 and moved a few blocks over, renting a unit very similar to the one we sold. ... In fairness, it wasn't just a financial decision. If we'd really been in love with the apartment ... but we'd been there for seven years. There were a few things that made it less than perfect in our minds, so it made it easier to move, in that way. Given the fact that we were moving, there was no doubt in our mind that we wanted to rent, not own, at that point. Did you have to convince your wife?

She's also an economist - we're an exciting couple. She was totally supportive of the idea. We were kind of talking about it, and we both agreed it was a good thing to do. There was no arm-twisting on my part. Are you still renting now?

Yep. We're waiting. Have you ever regretted that decision?

We like our current place. No, we're pretty satisfied with the move. We're pretty confident - prices have already come down, and I don't doubt they'll come down quite a bit more. Could the bubble - and thus the slump - have been avoided?

Oh, you could have avoided the bubble. I think it was a combination of greed and disastrous policies. I blame Greenspan. I think it's the Fed's responsibility to avoid asset bubbles like that. There are a variety of things he could have, should have done. First and foremost, just talking about it. ... Warning people about the bubble, saying, "We've got a really big problem here." ...

People are talking about this being 20-20 hindsight. No, this is stuff I knew at the time, other people knew at the time. Subprime [lending] has been around for a while, and it suddenly jumps from being 9 percent of the market in '02 to being [nearly] 25 percent of the market in [2006]. If you knew nothing else, that's all you knew, that should have set off all sort of alarm bells. How bad do you think the downturn will be when all is said and done?

My expectation is we're going to lose pretty much all of the run-up we've seen, and it could even overshoot, which would imply $8 trillion loss in housing wealth and a real decline of 40 percent. That's a pretty big hit. ... I look at the Case-Shiller indices - I think they're the best indexes of house prices - and the latest data that came out last month show home prices falling at a very rapid pace. ... If that continues, something like it, we should get through the adjustment, or at least the vast majority of it, this year. Which is good in a variety of ways, but it means a lot of people will, in a very short period of time, see a large chunk of wealth disappear. Then what? Back to a normal housing market?

It might take a while. Because banks having taken such big hits, I suspect they'll be very cautious in their lending. ... House prices will begin to rise modestly, basically rising in step with inflation. But for the economy, I think our troubles will just be beginning because people were spending based on their housing wealth. If you lose $6 [trillion] to $8 trillion in housing wealth, you suddenly have a lot of people, many near retirement, who thought they had substantial equity in their homes and now find out they have essentially nothing. So that's going to leave a really big hole in the economy. People had been spending, so they're going to have to start saving in a very big way. And that could lead to a prolonged period of very weak growth. Do you think now is a good time to buy a home?

Across the Midwest, the South, upstate New York, you can find lots of places where housing looks pretty reasonably priced, isn't much different than it was 10 years ago. But places like the D.C. area, New York, Boston, it's hard for me to see that those prices don't still have a long way down to go. What about the Baltimore area?

Baltimore didn't have as much of a run-up as D.C., but it did have one. My expectation is you're going to see a lot of that, if not all of that, eliminated. ... Prices won't fall back to where they were in the '90s, even adjusting for inflation. They'll probably stay higher. But they'll certainly come down from their peak in '06. Are you thinking of buying again?

There's a good chance. My wife looks at the paper a lot. We haven't gotten to the point of going down and looking at any places, but we're keeping our eyes open. If something jumps out at us, we'll take a look at it.


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