from Follow the Money

Memo to John Snow: Do housing bubbles count?

December 22, 2005

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Blog posts represent the views of CFR fellows and staff and not those of CFR, which takes no institutional positions.

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Budget, Debt, and Deficits

John Snow's latte-drinking budget mythmaking has gotten plenty of (fully warranted) criticism already, but I'll still pile on.

Snow argues that the large budget surplus at the tail end of the Clinton Administration was the product of the stock market bubble.  No doubt true to some degree.   But what counts is that the Clinton Administration saved rather than spent the windfall, building up ammunition for a counter-cyclical fiscal policy. 

Today, the .com bubble has been replaced by the .home bubble.   Or at least localized .home froth.   Housing prices in much of Kansas (and, for that matter, most of the depopulated, poor, rural Great Plains) have not kept up with housing prices on the coasts, or in other places experiencing rapid growth.    No matter though - the market cap of US housing is not driven by the market price of homes in shrinking small towns in the great plains, but rather by metropolitan New York, Washington, Boston, Los Angeles, San Francisco, Las Vegas, Miami and the like.


If the housing market starts to deflate and the housing ATM shuts down, that will have consequences for US interest rates (see Paul McCulley), for US equities (see Barry Ritholtz), and, I would suspect, for the budget. 

I wish I knew of a good estimate of the impact of rising house prices on both the federal budget and local government revenues (think property taxes).  But with the federal deficit now heading back up to the $400 billion (it would be higher but for the social security surplus), it seems pretty clear that the Snow Treasury has not built up the kind of fiscal buffer in (relatively) good times that would make running counter-cyclical fiscal policy easy should .home froth dissipate.

The .com capital gains windfall (and the income tax windfall from folks exercising stock options) was not the prime reason for the fiscal improvement in the Clinton years either.   Revenues rose for a host of reasons, and expenditures were kept under control -- without, generally speaking, a boost from very low policy rates that lowered the government's interest bill.   In 2005, I would bet, the combination of relatively low US interest rates, a one-off surge in corporate tax revenue and the direct and indirect effects of housing froth probably made the budget look to be in better shape than it really is, given the administration's tax cuts and its other policy initiatives.   Prescription drugs and keeping a big chunk of the US Army in Iraq do cost money.   Time will tell.

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