In Ben Bernanke's lectures he suggested that the main reason for the difference in the outcomes of the dot-com bubble and the housing bubble had to do with special circumstances of the housing market. This article from fivethirtyeight suggests something which may be a contributing factor as well. Despite the fact that the amount of wealth lost in both bubbles was actually very similar, the distributional impacts of the two bubbles were very different. The dot-com bubble was in stocks, which are typically only owned by wealthy investors who don't go into debt to get them, while the housing crisis involved many more poor people who went into severe debt to buy their home. Because loss of wealth for the poor will result in a harsher drop in consumption, this distributional impact may be part of why we had the Great Recession rather than a more minor one like in 2001.
Do you think this effect played a part in why this recession was much more severe? Or would this effect too small to really contribute to such a huge drop?
I tend to agree more so with the fivethirtyeight article and the the idea that the distribution of losses made the housing crash so much worse. When the dot-com bubble burst in 2001, the internet was still in it's infancy and I feel as if the average American invested very little, if any in dot-com stocks. Therefore if the majority of stockholders were the very wealthy, who could still survive these losses without having dramatic affect on the economy, it makes sense why the recession in 2001 was much smaller. The housing bubble and mortgages that go with it, were a much more prominent issue, especially considering the majority of the Americans with large mortgages were the middle and lower income families. Therefore once this bubble burst, they lost a much greater portion of their wealth than the wealthy did in the dot-com bubble. It makes sense that this loss for the less wealthy directly decreased the amount of money they had for consumption.
ReplyDeleteBharath makes a good point about how much of the wealth lost in the housing bubble was from middle to lower income families and equated to a larger percentage of their wealth as opposed to large stock investors. We must also consider how the housing mortgages were packaged with of debts and investments into CDO's, which tied the housing market into far more financial sectors than the dot-com bubble. This shock crippled the American economy by depriving far more Americans of their investments and savings and drastically lowered overall consumption. This is why a strong middle class is crucial for a strong economy. The middle class can consume far more than any upper class and consumption is what drives the economy.
ReplyDeleteI definitely agree with Bharath and Jay in the income distribution theory behind the difference in severity of the bubbles. I think another reason would be the fact that at the time of the dot com bubble, the internet was fairly new and not too many people knew about it, so only the wealthy were going to take the risk and invest in this sector. So fewer were affected and since the wealthy were investing, the disappearance in their wealth was not as costly as it was for those in the housing market. The housing market is known to everyone and before the great recession, people believed that housing prices could only go up. So a lot of people invested and got mortgages because it couldn't fail. However, it did and more people lost their money, but this time is was from all socioeconomic statuses. So I believe it was a combination of the knowledge/how new the industry was and the distribution of wealth from the different crisis.
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