Fed and Housing Bubble
Below is a list of articles and quotes that discuss whether the Federal Reserve Bank was responsible for the housing bubble and the subsequent subprime crisis:
- Eric Englund writes in April 22nd 2006 the article “The Federal Reserve and Housing: A Cluster of Errors?” warning about the link between interest rates and housing prices:
The hyperreality conjured by the Federal Reserve’s relentless inflation of the money supply is characterized by a populace which believes that a permanent plateau of prosperity has been attained. This is the boom phase of the trade cycle. [...] When the bust phase of the trade cycle materializes [...] then the real horror show will unfold. Let’s face it: highly leveraged Americans have little to no chance of ever paying back their enormous mortgage debts. [...]
The Federal Reserve “engineered” America’s housing bubble. [...] [I] quote from page 1 of a September 2005 study sponsored by the Board of Governors of the Federal Reserve System titled House Prices and Monetary Policy: A Cross-Country Study [...]: “Like other asset prices, house prices are influenced by interest rates, and in some countries, the housing market is a key channel of monetary policy transmission.”
With the bursting of the NASDAQ bubble signaling that the U.S. was heading into a recession – not to mention the shock of 9/11 – the Federal Reserve took desperate measures by goosing the money supply and driving the Fed Funds rate down to 1%. These monetary central planners knew that housing demand was very much interest rate sensitive, and they were counting upon the opiate of easy credit, at remarkably low interest rates, to stimulate the “animal spirits” of Americans in order to set the housing market ablaze.
Robert P. Murphy writes an article on April 4th 2008 stating that the Fed’s role in the housing bubble is a classic illustration of the Austrian business cycle theory of the economy:
[The] Figure [on the right] seems to be the textbook illustration of how the Federal Reserve conducts its open market operations: When it cuts the federal funds target rate, it pumps reserves into the system, i.e., expands the monetary base. On the other hand, when the Fed raises interest rates, it slows the rate of monetary expansion. Except for the large blips due to the Y2K scare — when the Fed flooded the system with liquidity and then sucked it right back out — the early 2000s fit the pattern perfectly. That is, when Greenspan cut the target rate from January 2001 through June 2003, the monetary base grew rapidly. Eventually the base growth came back down to moderate territory, but that was when the Fed was ratcheting up interest rates, just as we would expect.
- Ben Bernanke is quoted in an article in the Washington Post on October 27th 2005 written by Nell Henderson to doubt that the housing bubble burst:
Ben S. Bernanke does not think the national housing boom is a bubble that is about to burst, he indicated to Congress last week, just a few days before President Bush nominated him to become the next chairman of the Federal Reserve.
U.S. house prices have risen by nearly 25 percent over the past two years, noted Bernanke, currently chairman of the president’s Council of Economic Advisers, in testimony to Congress’s Joint Economic Committee. But these increases, he said, “largely reflect strong economic fundamentals,” such as strong growth in jobs, incomes and the number of new households.
“House prices are unlikely to continue rising at current rates,” said Bernanke, who served on the Fed board from 2002 until June. However, he added, “a moderate cooling in the housing market, should one occur, would not be inconsistent with the economy continuing to grow at or near its potential next year.”
- When the Housing Bubble burst, Alan Greenspan on 8th of April 2008 in an interview on CNBC defends the role of the Fed in the housing bubble:
More than two dozen economies have had housing bubbles and all are related to the dramatic decline in real long-term interest rate that occured from the 1990ies onwards. [...] You can fully explain the bubble by what is going on globally.
A paper by Christian Upper and Andreas Worms from the Deutsche Bundesbank explains the connection between monetary policy and long-term interest rates.
Two blog-posts (from 2005) discussing Greenspans views on the Long-Term-Interest-Rates are “Greenspan on interest rate mystery and the “Long-Term-Interest Rate Mystery” by Kash Mansori.
- Jeffrey Rogers Hummel and David R. Henderson write that they “Blame Federal Gov’t, Not The Fed, For Subprime Mortgage Problems“:
The better way to judge monetary policy is by the monetary measures: MZM, M2, M1 and the monetary base. Since 2001, the annual year-to-year growth rate of MZM fell from over 20% to nearly 0% by 2006. During that time, M2 growth fell from over 10% to around 2%, and M1 growth fell from over 10% to negative rates. [...] Monetary policy was not expansionary.
First, the federal government contributes to what economists call moral hazard. [...] [P]eople who buy their repackaged loans [...] assume an implicit federal government guarantee. [...]
The second way the feds contributed to the subprime mess was with a little-noted change in regulations by the comptroller of the currency in December 2005 that acted as the trigger. [...] The comptroller started requiring banks to require minimum payments on credit card balances, causing increases of at least 50% for most cards and as much as 100% on others. Many people who hold subprime mortgages are people for whom a higher monthly payment on a credit card would be a problem. [...] With the new regulation, you instead make your credit card payment but miss your mortgage payment, a widely observed transformation in the traditional American delinquency pattern. [...]
The third federal contributor to the subprime crisis is the Community Reinvestment Act. This act, first passed in 1977 and beefed up in 1995, requires banks to lend to high-risk areas that they otherwise would avoid. Those banks that fail to comply pay fines and have more difficulty getting approval for mergers and branch expansions.
- Unfortunately, there is not enough time to go deeper into the debate, but it should be pointed to these links: Greenspans Article in the FT from March 18th 2008 “We will never have a perfect model of risk”, criticism and his response.
