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The Fed's Role in the Housing Bubble:

The WSJ had an interesting symposium on the role of the Fed in the housing bubble. Contributors included David Henderson, Gerald O'Driscoll, David Malpass, Judy Shelton, Vincent Reinhart, and our own Todd Zywicki.

common sense (www):
There was an editorial a few days ago in the WSJ by Greenspan claiming they really didn't have much of a roll. That the housing bubble was caused by interest rates beyond their control. During my college years, I really thought Greenspan was doing a great job. Now, with the benefit of hindsight, I see that was not so. What is worse in my mind, however, is his unwillingness to take blame for his part in the current bubble, and his willingness to throw the free market under the bus. No one person is completely responsible for the bubble, but Greenspan surely played some part.
3.29.2009 10:53am
Tony Tutins (mail):
In terms of offering high rates of return on investments, sub-prime mortgages were the junk bonds of the new millenium. The root cause of the collapse was that Wall Street firms and their rating agencies consciously blinded themselves to the higher risk of default that was priced into the interest rates. They did so by using valuation models with faulty assumptions built in, including default rates for conventional mortgage borrowers.

The fed's responsibility here was keeping the prime interest rates so low that desperate Wall Streeters tried to turn junk into gold.

Had some wag or newsman started calling securities comprising subprime loans "junk mortgages" perhaps this could have been averted.
3.29.2009 11:38am
PersonFromPorlock:
I think that interest rates were at worst a contributing factor. The real mischief was done by the belief that value is indistinguishable from price and that higher prices showed higher value, the growth in 'value' justifying higher prices yet. Everyone - buyers, sellers, lenders, agents - had an interest in believing this.
3.29.2009 11:56am
Pro Natura (mail):
One reason that
Wall Street firms and their rating agencies consciously blinded themselves to the higher risk of default that was priced into the interest rates Wall Street firms and their rating agencies consciously blinded themselves to the higher risk of default that was priced into the interest rates
was that government policies promulgated by Barney Frank and other prominent Democrats suggested that Fannie May and Freddie Mac would guarantee protection against mortgage defaults. The Community Recovery Act encouraged get-rich-quick speculation based on the issuance of bubble mortgages and like instruments to low-income persons with virtually zero possibility of repaying them.

Liberals like to forget this, but there was a virtual cottage industry five to ten years ago generating research that "proved" low-income minorities were being discriminated against in the then current mortgage markets. Such "research" always led to an op-ed piece demanding a lessening of restrictions on mortgages to people who couldn't afford them. I remember one such piece in the Boston Globe that was so wrong-headed I actually wrote a letter to the author pointing out her errors.
3.29.2009 12:07pm
Allan Walstad (mail):
The justification (as opposed to the actual reason) for the existence of the Fed is the idea that economists can know enough to engage in economic engineering, to regulate and manage the marketplace in order to keep things on an even keel. Events prove that, so far, they can't. You get all these differing opinions among professional economists as to what went wrong and how to fix it.

The Fed was established in 1913 and by 1929 we had the great crash. In the 70s we had stagflation, and since then we have these recurrent bubbles and busts. As Walter Williams pointed out in an op-ed a couple months ago, in the century prior to 1913 the price level changed by very little. Since then, the value of the dollar has fallen by a huge factor.

Establishing the central bank was a mistake. Correcting that mistake will be much more painful than simply having refrained from committing it in the first place--as is typical of mistakes.
3.29.2009 3:35pm
Times Current (mail) (www):
The quote in that article from Greenspan saying "There are numbers of us, myself included, who strongly believe that we did very well in the 1870 to 1914 period with an international gold standard" has me scratching my head.

I'm not an expert in either history or economics, so perhaps I have my facts wrong or mis-interpreted. First, I believe it was a bi-metallic standard, not a gold standard. But that is a minor point.

More importantly, the Long Depression occurred from 1873 to 1879. Then, railroad speculation fueled a huge bubble (with no Fed, and the gold standard in place.) This cumulated in the crash of 1893, which was the most severe financial crisis in the history of the US apart from the Great Depression, with near 20% unemployment, and a large segment of the population simply walking away from mortgages they could not pay (sounds familiar, doesn't it?)

As I understand, things began to recover in 1896 with McKinley, due in large part to the Klondike gold rush and a rapid increase in the money supply (i.e. more gold became available overnight.) Until, of course, the panic of 1907 which lasted several years and resulted in the creation of the Fed in 1913 to try and come up with a better system than that which plagued the US with the worst and most volatile 45 year economic period in its history.

So, Greenspan's 44 year period that worked "very well" saw two depressions and an additional major crash, for a total of 16 years out of 44 in the worst sort of financial turmoil? By this logic the period from 1929-1945 was pretty darn good and what we are going through today is fantastic!
3.29.2009 3:52pm
Syd Henderson (mail):
3.29.2009 3:35pm
Times Current (mail) (www):

More importantly, the Long Depression occurred from 1873 to 1879.

Actually, that only covers the Panic of 1873. The Long Depression is the entire period from 1873 - 96. Among the features were the Free Silver movement (aiming to inflate the currency), the rise of the Greenback and Populist Parties, extremely close presidential races and really remarkable shifts in Congressional representation that makes 1994 and 2006 look shabby. The railroad network was extending so food prices were going down and farmers were in financial trouble. (It didn't help that the government was actively encouraging people to become farmers at a time of overproduction.) It was also the time of the Second Industrial Revolution which also brought prices down, demonstrating the depression was not all bad, except for those nasty Panics and the government running out of gold in the early 1890s.
3.29.2009 4:17pm
Tony Tutins (mail):

was that government policies promulgated by Barney Frank and other prominent Democrats suggested that Fannie May and Freddie Mac would guarantee protection against mortgage defaults.

So why did mortgage lenders charge interest premiums for such loans, if they expected these GSEs to bail them out? Was Barney Frank really winking at Bear Stearns and Merrill Lynch management, saying, "Come in, the water's fine."?

Once again, the root cause reduces to Wall Street greed and stupidity. Get your loan guarantees in writing, and don't expect something for nothing.
3.29.2009 5:30pm
frankcross (mail):
Alan Walstad, you only discuss the post-Fed history. You will find a lot more economic depressions before the Fed than after it. And vastly more volatility in inflation
3.29.2009 8:09pm
Doc W (mail):

Once again, the root cause reduces to Wall Street greed and stupidity.

Greed, stupidity, and a whole lot of other character flaws have been with us since the beginning. The question is what institutional arrangements best constrain self-interest and direct it toward the general good. Adam Smith characterized merchants as predisposed toward conspiracy against the public. His solution was the free market, rather than government power levers that tend to get manipulated by the very elements they are supposed to constrain. Despite more than two centuries of empirical confirmation, seems a lot of people still haven't figured that out.
3.29.2009 8:32pm
Doc W (mail):
Frankcross, without a Fed, the U.S. grew wealthy and powerful and became more efficiently productive than Europe, while assimilating large numbers of immigrants. Prices may have gone up and down, but they didn't just go up and up. I was just referring to a column by economist Walter Williams. Williams also pointed out that the Fed was supposed to protect against large numbers of bank failures, but again, the maximum number of failures in one year came after the Fed was established. As far as I'm concerned, though, the biggest problem with the Fed is that it allows the pols to evade short-term consequences of their infantile lack of spending discipline.
3.29.2009 8:43pm
theobromophile (www):
I saw the symposium in the paper the other day. Wonderful series of articles... nothing too profound to say, other than that it's interesting to see how people of a different political bent will focus on - or, sadly, fail to address - certain elements of the housing crisis.

As for the housing bubble specifically: I thought, in 2001, that the rate of increase and the increase in price would level off; there just wouldn't be buyers in ever-increasing price brackets. People will strain for a while, and stretch their budgets to accommodate a home, but, eventually, there's only so much money that people make and can give to this endeavour.

I'm not sure if the same will come to pass with college tuition, since there's such a strong redistributive effect, and the advertised price is rarely the one paid. Eventually, fewer and fewer families will pay the sticker price, which will essentially be used to get very wealthy students to pay for their middle- and lower- class peers.
3.29.2009 11:31pm
frankcross (mail):
The US did well without a Fed. We have done consistently better with a Fed. The Fed bungled the Great Depression era. That's true. But since that time it has been very effective.
3.30.2009 10:39am

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