The '08 Election and the Housing Bubble

There's been a lot of discussion over the last few years about how another terrorist attack on American soil might influence the electoral fates of the Republican and Democratic parties. The conventional wisdom among the Beltway crowd seems to be that such an event would obviously help the GOP (as everything always does). The reasoning goes like this: Americans trust the Republican party more on security issues, particularly in presidential elections, and therefore anything that brings the threat of terrorism to the forefront helps the GOP. I suspect the electoral reality is a little more complex than that-- and a little more context-dependent. That said, I have little doubt that potential '08 candidates like John Edwards, Hillary Clinton, and Mark Warner--who have very little foreign policy experience and are likely to face an opponent like John McCain--realize that such an event could potentially dash their presidential dreams.

But there's another potential X factor in the '08 election that has so far received almost no attention: the housing market. Take a look at this graph from Sunday's New York Times (h/t Atrios).

The graph, which was put together by Yale economist Robert Shiller, shows just how inflated current housing prices are by historical standards. A growing chorus of economists is predicting that the floor may be about to fall out from under the housing market. The bubble appears to have already popped in many regions; sales have slowed to a trickle and the market is clogged with unsold inventory. The other day Paul Krugman has this to say:

[W]ith prices falling in many areas, the speculative demand for
houses has gone into reverse, as people try to get out with a
profit while they still can. There's now a rapidly growing
glut of unsold houses. This is a recipe for a major bust, not
a soft landing.

Moreover, it could be both a deep and a prolonged bust. Since
2000, much of the nation has experienced a rise in home
prices comparable to the boom in Southern California during
the late 1980s. After that bubble popped, Los Angeles house
prices began a slow, grinding deflation, eventually falling
20 percent (34 percent after adjusting for inflation). Prices
didn't begin a sustained recovery until 1996, more than six
years after the downturn began.

Now imagine the same thing happening across a large part of
the United States. It's an ugly picture, and not just for
people and companies in the construction business. Many
homeowners -- especially those who bought their houses with
interest-only loans or with minimal down payments -- will
find themselves in financial distress. And the economy as
a whole will take a hit.

A collapse of the housing market might well send the U.S. economy into recession, perhaps a prolonged one. And unlike the bursting of the tech-stock bubble, which disproportionately affected the upper middle class and rich, the bursting of the housing bubble would be a body blow to the middle class. For most families, their house is not only their home, it is their chief asset and investment. And a great many people in recent years have paid their bills by borrowing against the rising value of their homes.

If the housing market collapses, all bets are off politically. Many people will be hurting and desperate and angry, and the economy will instantly become issue #1 in all political races, no matter what is happening in Iraq or the war on terror. Politicians who don't adapt quickly to this new playing field will be left in the dust.

Because the Bush administration has been in power for the last six years, it will--whether fairly or not--bear the lion's share of the blame for the crisis, and this will put Republican candidates in a difficult position. After all, Republicans have been touting the wonders of the Bush economy for many years now. Finding a coherent way to explain to people just what the hell happened may prove to be a formidable challenge to even the most skilled Republican politicians.

Such a development might provide a unique opportunity, however, for someone like John Edwards, who has made fighting poverty his signature issue. Edward's brand of economic populism might be just what a weary electorate is looking for come '08. And more emphasis on economic (as opposed to foreign policy) issues could only help Edwards, particularly in a race against someone like McCain.

The bursting of market bubbles and the resulting economic fallout are notoriously difficult to predict. It's entirely possible that the slowdown of the housing market will have only a moderate impact on the rest of the economy, or that the real impact will be felt only after the '08 election. But there's a very real possibility that between now and November 2008, the housing market will head South and take the rest of the economy with it. And if that should happen, the '08 political calculus will change dramatically, and perhaps in unforeseen ways. Candidates on both sides would be wise to start giving this contingency some thought.