The Unassuming Economist

Turns in the economy take economists, even the best of them, by surprise. In late-August 1990, Alan Greenspan, then chairman of the Federal Reserve, said that “those who argue that we are already in a recession are reasonably certain to be wrong”—of course, the recession had already begun. His successor, Ben Bernanke, predicted in 2007 that the “subprime problem [in the housing sector] is contained.” Yet, without forecasts, as this excellent new report from the World Economic Forum notes, we would be driving a car “while looking only in the rear view mirror rather than through the windscreen.”

There are few economic forecasts more important than those of the real estate sector. As Ed Leamer has said, “housing is the cycle.” Collapses in this sector have been associated with severe crises, including the global financial crises of recent years. While this crisis increased the spotlight on the residential sector, much less is known about the commercial real estate sector.

This report is thus welcome for the information it provides on the commercial real estate ecosystem—the main players and their motives. But the report is far more ambitious. Its goal is to provide an early warning system for commercial real estate crashes. Moreover, the intent is to build a system that can be scaled up to the global level—it is currently applied to 10 U.S. cities— and also applied to other asset classes, including the residential real estate sector.

So, does the effort succeed? Yes, in my view. The authors show that the risk of crashes in the commercial real estate prices in U.S. cities can be linked to developments in a few macroeconomic indicators—inflation rates, bond yields, consumer confidence, employment—and to growth in the sector’s net operating income. There is thus no complex or secret ingredient needed to assess the risks of crashes: one only has to look out the windscreen.

This is a useful exercise even if, as the authors readily admit, they do not try to understand the deep causes of what leads sharp run-ups in commercial real estate prices in the first place. As they note, often “one does not need to know the causes of a condition to be able to diagnose the effects of the condition.” Academics may have the luxury of debating what causes ‘bubbles’ in real estate markets—or indeed if they even exist—but policymakers have to deal with the consequences of cleaning up the mess when there is a crash, regardless of why it happened. Whether there was a bubble in house prices in Ireland in the 2000s will be the topic of numerous doctoral dissertations; what the policymaker takes from episode is that the cost of cleaning up after the crash was 40 percent of the country’s annual income.

The IMF is happy to have been part of the advisory and steering committee that has guided this report and the other important work carried out by the World Economic Forum’s Asset Dynamics group. We share the desire to pay close attention to the real estate sector, to devise policies to ward off crashes, and to put in place policies that will minimize the costs of crashes that will nevertheless occur. As our Deputy Managing Director Min Zhu declared in 2014, “the era of benign neglect of house price booms is over.” I look forward to the extension of the early warning system developed here to other cities and to sectors, including residential real estate.