Gasoline prices didn’t cause the housing crash

By Felix Salmon
March 8, 2012

It’s becoming something of a tradition for presidential candidates to (a) ritually attack high gasoline prices as being all manner of evil; and (b) suggest that there’s something the President can do to bring them down. Four years ago, both John McCain and Hillary Clinton supported the idiotic gas tax holiday; now, it’s Rick Santorum’s turn.

Calling for the United States to aggressively tap domestic energy sources, Rick Santorum said Monday that the nation’s economic crisis four years ago was caused by high gas prices.

“We went into a recession in 2008 because of gasoline prices. The bubble burst in housing because people couldn’t pay their mortgages because we’re looking at $4 a gallon gasoline,” he said. “And look at what happened: economic decline.”

This conjures up visions of the Santorum Strategy for economic growth: first, start blowing bubbles. Second, prevent anything which might possibly burst those bubbles from ever happening. Result: permanently bubblicious growth! What could possibly go wrong.

Any self-respecting economist, upon seeing this kind of logic, should and would run very far in the opposite direction. Unless, of course, that economist’s name is Steve Sexton. Santorum’s remarks “may sound far-fetched”, he writes, “but it is precisely the theory that I and a pair of coauthors presented in a working paper released five days before Santorum’s remarks.”

Oh dear.

Both the paper and Sexton’s blog post are titled “How High Gas Prices Triggered the Housing Crisis”, and both are very silly. Sexton actually articulates the Santorum Strategy in his blog post:

While the prevalence of risky loans made the housing market susceptible to collapse, had home prices kept rising in 2007, instead of turning down, rising home equity could have been used to renegotiate risky loans, thereby concealing and even resolving the market weaknesses.

Translation: if home prices had kept on going up in 2007 rather than going down, then we wouldn’t have had a housing-market crash. Thank you, Professor Sexton. That’s a bit like saying that if the price of technology stocks had kept on going up in 2000 rather than going down, we wouldn’t have had a stock-market crash. Sexton’s only venture away from banal tautology here is when he suggests that rising house prices could have “resolved” the weakness in the market — despite the fact that America in general, and California in particular, was full of subprime borrowers with no way of ever paying back the amounts they had borrowed. Extending the housing bubble for a year or two longer would only have perpetuated the Ponzi and made things even worse.

So even if it’s true that rising gas prices pricked the housing bubble and caused it to burst, we should be thankful that gas prices went up when they did: they saved us from an even more painful market crash a few months or years down the road.

But of course it’s profoundly silly to even try to identify the proximate cause of a bursting bubble. That’s what bubbles do, is burst. They all do it, sooner or later, for any reason or no reason. “Even the eminent bubble expert, the economist Robert Shiller, concedes we don’t know why the housing bubble burst when it did,” writes Sexton, as though this is evidence that Shiller just isn’t clever enough to have Sexton’s piercing insight about gas prices. In fact, what Shiller is saying isn’t really a concession at all: it’s an integral part of his thesis. You might be able to identify bubbles — Shiller certainly has a good track record on that front — but you can’t identify when or why they’re going to burst. Or, as John Maynard Keynes famously put it, “the market can remain irrational far longer than you or I can remain solvent”.

On some level, then, it doesn’t even make sense to say that bubble-bursts have a cause. For one thing, there’s absolutely no way to demonstrate causation, as opposed to simple chronological sequencing. And more generally, if a cause could be anything from rising gas prices to worries over Chinese drywall to a butterfly flapping its wings in Tokyo, trying to pin down a single cause is the ultimate fool’s errand.

But Sexton is a determined chap, and so he pulls out all manner of extremely odd arguments to buttress his thesis. For instance:

There is no doubt that subprime lending and speculation fueled demand for housing assets. But these are uniquely American phenomena. The housing boom and bust is not. A similarly volatile cycle was observed in Britain, Spain, France, and Ireland, among other countries that while not exposed to the aggressive lending in the U.S. would have been affected by global energy market dynamics.

In other words, you can’t blame subprime for the housing bust, since subprime happened only in America, but the housing bust was global. Since energy prices are global, on the other hand, they can explain the housing bust everywhere.

One big problem here, of course, is that if energy prices are global, then there’s really not anything the government can do about them, and the whole Santorum line of argument more or less falls apart. The second problem is that Sexton isn’t really talking about energy prices, he’s talking about gasoline prices. Which are something else entirely. Let’s look at gasoline prices in the UK, shall we?


As you can see, they’ve had a big run-up of late, but they hit a low point around the beginning of 2009.

Now, let’s have a look at the annual change in residential property prices in the UK:


The first thing to note here is that the big picture is pretty much the same in London as it is in England and Wales more generally. But London is pretty much immune from Sexton’s theory of property prices, which is that they fall when gasoline price hikes increase commuting costs. Londoners commute, but they don’t generally commute by car.

The second thing to note is that prices were rising until mid-2008, at which point they started falling, with the fastest rate of decrease coming in early 2009. Which happens to coincide with the low point of gasoline prices. The fall in UK house prices coincided with the big fall in UK petrol prices, not a rise.

Meanwhile, if Sexton’s blog post seems to have a weak grasp on the global, his paper errs far too much in the opposite direction, obsessing about house prices in California to the exclusion of just about everything else. Yes, prices in California suburbs fell a lot during the housing crash — and I daresay that an increase in the cost of commuting was part of the reason why. But that doesn’t mean that movement gasoline prices caused the national housing bubble to burst: it hardly, for instance, helps explain the price action of condos in Miami Beach.

All of which leaves just one big question: why on earth would a Berkeley economics professor publicly aligning himself with the primary-campaign rhetoric of Rick Santorum? I haven’t a clue on that one.

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16 comments so far

nice post on all counts, Felix.

Posted by KidDynamite | Report as abusive

I’d vote for Felix ahead of Santorum, any day.

Maybe we can forge a birth certificate?

Posted by TFF | Report as abusive

At worst(best) higher gasoline prices slow spending, encourage conservation, domestic manufacturing over foreign manufacturing and development of alternative fuels. We would need to see not only higher prices but a high rate of change to see anything like the kind of shock suggested to cause a crash. To say high gas prices in 2008 caused the recession is revisionary economics at best, lying at worst.

Posted by Sechel | Report as abusive

Here’s an interesting quote from that working paper. Sexton says:

“… others [have] argued that a monetary contraction in 2005 induced the housing bust… however… Greenspan and Bernanke… contended that the Federal Funds rate controlled by the central bank should have only a modest impact on the housing market, which is more likely driven by long-term interest rates charged on mortgages.”

Sexton goes whole hog for that Bernanke / Greenspan line of thinking and later notes that since monetary contraction didn’t affect the bubble immediately, the Fed’s 2005 rate hikes should ruled out completely.

But as Kindleberger famously pointed out; in a bubble, people will get access to credit in a million different ways as long as the bubble is still inflating. Tighter monetary policy may not have had an immediate effect on house prices because people sought ever more imaginative ways to get access to credit after the rate hikes (NINJA loans, IO loans etc.) and lenders were ever more eager to extend that credit. But the Minksy Moment cannot be delayed forever and it came due two years later.

Which leads me to another factor going against his “gas prices” theory and going in the pro-rate-hike theory: that the two-year lag between the Fed’s rate hikes and the collapse of the bubble seems to correlate very nicely with the first wave of defaults on all those two-year ARMs that reset in 2007 — an occurrence, which most would agree, signified the beginning of the crash (not to mention that those two-year ARMs were predicted to default by a lot of marginally talented investors who got stinking rich by realizing that two-year resets on NINJA loans were prime candidates for default).

Anyway, all of this is purely academic and really of little consequence. As Felix said, “Bubbles burst. It’s what they do.” Who really cares how or why? That’s focusing on the wrong thing.

Posted by Sprizouse | Report as abusive

Nice article, but this quote is hokum “There is no doubt that subprime lending and speculation fueled demand for housing assets. But these are uniquely American phenomena.”

Is he trying to say that only in the US does the free market operate? Is he implying there are no speculators in London, Paris, Tokyo, Hong Kong, et all? Surely he’s not trying to say that British Banks like Northern Rock did not go bankrupt because of their large sub-prime customer base?

What a plonker.

Posted by FifthDecade | Report as abusive

TFF, you’re setting the bar low again. The question isn’t who you would vote for over Santorum, but who you wouldn’t. That’s a much shorter list.

And I can say I agree with KidDynamite on this, without qualifications.

Posted by KenG_CA | Report as abusive

I usually say that those who don’t understand the housing bubble live in places that did not experience rapid price increases. But he teaches at Berkeley??? Yeah, prices in CA were perfect. Look at Sacramento, as the Bay area is benefiting from some really good performance in tech. That he is so close to the problem and yet can’t see it would make me rethink the principle of tenure.

Posted by winstongator | Report as abusive

Santorum yet again shows that he lacks the mental capacity to be president. He shouldn’t even be running for president but unfortunately there are far too many ignorant voters in the US who desperately want to believe that the institutions they hold so dear, namely big business, would not have engaged in such a risky and potentially devastating housing scheme. Even when presented with overwhelming evidence that Wall Street, the mortgage lenders, and the ratings agencies cooked up the biggest financial swindle in the history of the US, they won’t believe it because it undermines their faith in the good old USA. Far too many Americans, when confronted with all the facts, turn away to embrace what they believe rather than admit the ugly truth. Handing them some fable about high gas prices being the culprit solves the whole problem, restores their faith in America and paves the way for the oil industry to lead them around by the nose some more.

Posted by lhathaway | Report as abusive

People who have experienced stability for most of their lives, who are suddenly faced with dramatic changes such as those we faced in the first decade of this century, are likely to look for simple explanations, whether they are plots, conspiracies, collusions, or other acts by all-powerful groups.

These people are also voters, and politicians (not just Santorum; remember the hope and change motto that was never delivered upon) are more than willing to feed those impulses. That’s why I tend to be sanguine about elections. Whatever statements made during campaigns rarely if ever become policies after the election.

Posted by Curmudgeon | Report as abusive

Curmudgeon, lhathaway: right on. It is that return to the egg, even though the shell is weak it is warm and cozy, rather then face reality. Our ability to adapt is unfortunately reliant upon being able to “smooth it all over” in our brains… so the simplistic and less complex answer “seems” like the best as it eases stress…

Sadly it means the population is at risk for becoming sheeple and the Presidential hopefuls reply on their “team” to put the right words in their mouths so they can foster just that mentality.

Posted by youniquelikeme | Report as abusive

I’m not prepared to call voters with different world views than I “sheeple”. Their vote is just as legitimate as mine, and it behooves candidates to address their concerns in some way. The fact that many candidates do so in a way that cheapens their legitimacy undermines the election process. I will give this to Obama: Hope and change is a more positive message than ‘energy prices are too high’. Even if neither promise is delivered on.

Posted by Curmudgeon | Report as abusive

so if the big run up in gas prices caused house prices to fall, in his muth model simulation, why didn’t the decline in gas prices at the end of 2008 send house prices back up again?

Posted by mort_fin | Report as abusive

Santorum is an idiot. But having said that, the relevance of London real estate prices is not well-established by the writer. That’s kind of disingenuous. If you look in America where the real estate crashed hit the hardest, it’s in the far-flung suburban commuter areas (southern california, Central California, Las Vegas, Florida, etc.). Not San Franciso or Manhattan. It is well documented that when gas went to $5 a gallon in California, many households were spending $1,000 to $1,500 a month on gasoline. That can only go on for so long before something gives.

I understand the writer’s argument that it does not matter what ‘pricked the bubble.’ But it does matter what drags the economy down in general. For better or for worse, the phenomenon of mysteriously volatile gasoline prices appears to hurt America more than help it. We can’t budget for it or plan around it. There are things that can be done about this. Make the real-world supply of oil more transparent. Every producer knows what every well head is producing. We don’t need to know that detail, just net volumes. Most oil and gas in the world (including America) are government-owned to begin with and the minerals are ‘leased’ to the producer so the producer can sell them. So report it all on a single web site somewhere. This is how much oil is being pumped in the world today. This is how much is being refined, stored, etc.

Then let the open market decide what to do with that data.

Posted by AlkalineState | Report as abusive

I don’t regret using that word (as icky as it sounds…) because it pertains to the ability of man to allure with positive words (look at the billions spent to create teams, PACS and ads to and “sell” the candidates) relying on cognitive blindness (EG: to waging war as a country is caught up in economic trouble) and misdirection (the tactic used here) to distract and manipulate what they hope will be the majority.

Everyone’s vote is legitimate, of course, by law. Voters need to be skeptical, turn on their spin detectors, stay informed, check the facts and the ability of a candidate to fulfill the promises before they climb on board. That would make the vote much more legitimate. (rather then being distracted by good looks and a free hamburger)

Positive messages do sound good, yes, but let’s call it what is is … spin doctoring… and perhaps in this case laying the groundwork for future projects like extracting dirty oil, pipelines before environment, making drilling laws more lax.

Posted by youniquelikeme | Report as abusive

Nice one Felix. But then this is just the Nth chapter of the ongoing saga: “Freakonomics: Economic Intellectual Garbage Can of the Blogoshpere”.

I can’t wait for the movie!

Posted by LeroyDumonde | Report as abusive

Being concerned over high gas prices is just another example of the remarkable shortsightedness of the world. Long term, only good will come of it– alternative fuels, decreased reliance on foreign oil, better air quality, ect. Furthermore, its going to happen no matter what. There’s a finite amount of the stuff. May as well get on with it.

I feel like the rest of the world’s blood boils when they hear Americans complain about gas prices, given how cheap gas is here.

Now that I’ve put in my two cents on gas prices… Great article. Santorum is an idiot. So is this economist from Berkeley.

Posted by CapitalismSays | Report as abusive
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