The Fed Should Take More Responsibility for the Housing "Bubble"

I didn’t find much in Greenspan’s testimony over and above what has already been noted here previously.  Rates are expected to rise but that is not news. He noted that inflation is in check, and he acknowledged recent data indicating some potential weakness by saying “While the incoming data highlighted some downside risks to the outlook for economic growth, the FOMC judged the balance of information as suggesting that the economy had not weakened fundamentally.” 

The acknowledgment that incoming data have indicated some downside risk is farily new. Elsewhere he states “"In our view, realizing this outcome will require the Federal Reserve to continue to remove monetary accommodation. This generally favorable outlook, however, is attended by some significant uncertainties that warrant careful scrutiny."”  The uncertainties he's referring to are rising input costs, particularly labor and oil, and an increase in long-term interest rates and the potential problems that could cause in the housing market.

It’s interesting to me that the Fed is not taking responsibility for the housing “bubble” even though monetary policy causing low interest rates had a hand in creating it.  If, in fact, low interest rates have caused a misallocation of resources towards the housing sector such that there are now risks, and there's a case to be made that it has, then the Fed should be more active and forceful in dealing with and forestalling the potential consequences.  That is, if Fed policy has enticed households to make decisions that put them at risk over the long-run, decisions they would not have made if the interest rate were at its natural level, then the Fed has a responsibility to do more than wash its hands of this sector of the economy and say its only role is to clean up after any crash that might occur.

It would have also been nice to hear about the causes and consequences of budget deficits and how that impacts monetary policy and economic risks in the future, but those issues were not addressed.

For more, see Angry Bear, Caroline Baum, The Washington Post, The New York Times, the Monetary Report to Congress, and Greenspan’s prepared remarks.  If I can find the video or a transcript of the Q&A I will post them.

Update #1:  Clarifying a bit, I am ready to believe those who say there is no significant deviation from fundamentals and hence less to worry about than if it were a true bubble (except for some areas such as coastal regions), though there are risks and it is the Fed's hand in creating those risks that I am addressing.  Nobody knows for sure how vulnerable this sector is so it is good policy to attenuate such risks to the extent possible.

My complaint is the way in which the Fed has disassociated itself from any responsibility for creating the environment that caused risks to emerge.  For example, the Fed could be more aggressive on the regulatory front in an attempt to ensure that low interest rates do not induce excessive risk taking by households, especially those living near the margin that will be most vulnerable to increases in interest rates.  It's really nice to get people into houses - I'm all for that, one hundred percent - but not if it causes financial distress and years of cleanup afterward (there's that bankruptcy bill thing) as households are induced to assume more risk than they can handle.

I suppose in the end we can say it's a free market and people should have known better, that they should have been more forward looking, but when prices are set below equilibrium in an attempt to stimulate the economy, market intervention to manipulate interest rates is present making the fundamentals themselves a result of policy intervention, and that has consequences.

Update #2:  I forgot to mention this.  Whether you like policy under Greenspan or not, this is a really bad idea:

One lawmaker, Rep. Brad Sherman, D-Calif., said he was introducing a bill that would allow Greenspan to serve for another five years, removing the current requirement that will force him off the Fed board next Jan. 31.  "Does my wife have a vote on this?" Greenspan joked, referring to NBC News reporter Andrea Mitchell.

This makes the Fed Chair much too sensitive to political considerations.  What legislation will be passed if they don't like a Chair?  There are good reasons for the Fed to be independent.

Comments

[anne]

Now you really are trying to worry me. I have been trying to decide whether to be comforted or disturbed by Alan Greenspan's dismissal of concern for an eventual end to rising real estate prices. You think there should be concern, just as I am temporizing away. I agree.

[Movie Guy]

The Federal Reserve did more than just lower interest rates.

Greenspan openly campaigned for consumers to switch from fixed rate mortgages, and further campaigned for "greater mortgage product alternatives to the traditional fixed-rate mortgage".

Here is just one example:

Per Jason Wright at Caluculated Risk:

http://calculatedrisk.blogspot.com/2005/07/greenspan-on-housing.html

For the record, here are Greenspan's actual words on February 23, 2004:

"Recent research within the Federal Reserve suggests that many homeowners might have saved tens of thousands of dollars had they held adjustable-rate mortgages rather than fixed-rate mortgages during the past decade, though this would not have been the case, of course, had interest rates trended sharply upward.

American homeowners clearly like the certainty of fixed mortgage payments. This preference is in striking contrast to the situation in some other countries, where adjustable-rate mortgages are far more common and where efforts to introduce American-type fixed-rate mortgages generally have not been successful. Fixed-rate mortgages seem unduly expensive to households in other countries. One possible reason is that these mortgages effectively charge homeowners high fees for protection against rising interest rates and for the right to refinance.

American consumers might benefit if lenders provided greater mortgage product alternatives to the traditional fixed-rate mortgage. To the degree that households are driven by fears of payment shocks but are willing to manage their own interest rate risks, the traditional fixed-rate mortgage may be an expensive method of financing a home."

----

Remember, this was the nation's financial god talking...

[Movie Guy]

Greenspan, today:

"The apparent froth in housing markets appears to have interacted with evolving practices in mortgage markets. The increase in the prevalence of interest-only loans and the introduction of more-exotic forms of adjustable-rate mortgages are developments of particular concern."

[Movie Guy]

Hey, Alan, they did what you wanted to do.

Complaining now without accepting responsibility for personal encouragement is disingenuous.

[Joe]

What are you guys complaining about? Greenspan works for multi-national bankers, the financial industries, not you and me. It's your fault to believe what he says. He is exactly the one who created two hugest bubbles - in stocks and real estate in the last 100 years. Now that the poor little guys have to pay mortgage companies again in just over one year to refi to fixed rate...thanks to his suggestion...

[calmo]

I find the initiative, coming from a Dem, to extend Greenspan's tenure, surprising. Berry at Bloomberg thinks the process of hunting for a replacement is moving too slowly and AG will still be at the desk come Jan 31.
'Have to agree with your sentiments that the Fed had a major role in fostering the housing bubble and a major role in the record deficits.
I don't expect AG to accept responsibility for either in any measure.
It has been a long time since the Fed was independent in any meaningful way. I make it about 4yrs and 8 months, you?
Last thing: Knowing the evil you have, may be much preferred to the evil you don't know but can expect at the hands of this administration.

[Mark Thoma]

Movie Guy - Thanks for the link to the 2004 speech.

says...

The longer he stays the better. It increases the odds he's still around when the bottom falls out.

[Movie Guy]

Mark,

Here's the link to Greenspan's entire speech.

Greenspan - Understanding household debt obligations - 23 Feb 2004

And observations of the FDIC.

FDIC - Consumer Sector Outlook for 2005

Also Slate's article.

Alan Greenspan: ARMed and Dangerous - The Federal Reserve chairman's weird affection for adjustable-rate mortgages, Feb 27, 2004