The availability of these alternative mortgage products proved to be quite important and, as many have recognized, is likely a key explanation of the housing bubble.…..The most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards.– Ben Bernanke, “Monetary Policy and the Housing Bubble”, Speech at the Annual Meeting of the American Economic Association, Atlanta, Georgia, January 3
NOTE: Every week I write a Client Note for my clients. For a limited time, I am allowing non-clients to sign up and receive the Client Note. You can sign up at the top right hand corner of the website. I will also be posting the notes on my blog with a 24-48 hour delay from time to time. Here is this week’s.
On Sunday, Fed Chief Ben Bernanke gave a speech at the annual meeting of the American Economic Association in Atlanta, Georgia. I read the speech with increasing incredulity this morning.
The speech addresses the claim made by many that the Fed’s easy monetary policy played a key role in inflating the recent housing bubble and is thus at least partially responsible for the subsequent bust which infected the entire economy and led to recession. Through a series of sophistic maneuvers, Bernanke exculpates the Fed from any blame.
He first argues that monetary policy was not especially accomodative from 2002-2006, using the widely accepted Taylor Rule, if one substitutes forecast inflation for current inflation. This despite the then unprecedented lowering of the Fed Funds rate to 1% for a full year from June 2003 to June 2004 (Fed Funds Chart Attached).
He then goes on to argue that the dramatic increase in housing prices cannot be explained by the low level of the Federal Funds rate. Based on historical relationships, the econometric models of his team show that housing prices should not have risen as high as they did as a result of the level of the Federal Funds rate. Further, the housing bubble was worldwide and a cross country analysis of 20 industrialized countries shows an extremely weak relationship between easy monetary policy and house price appreciation.
What then explains the housing bubble?
Two things: A deterioration in lending standards and a savings glut in parts of the emerging world that found their way into the US and other industrialized nations and pressed down long term interest rates.
In other words, two things that are pretty much outside of the control of the Fed and therefore not their responsibility. It was the bankers and China!
What is his solution? Stronger and better executed regulation of lenders.
In arguing so, he provides cover for his current policy of 0% federal funds rate and all the so called “quantitative easing” programs. Apparently, these shouldn’t cause bubbles and other problems down the line either.
The Sophists were a group of teachers in Ancient Greece in the time of Socrates and Plato. Plato attacked them for teaching their students to win arguments without concern for the truth. The Sophists used rhetoric and other techniques to persuade their audience and didn’t concern themselves with truth or ethics.
Bernanke’s speech is a fine specimen of sophism. Personally, I find it hard to believe that he believes his own words. But he wants us to believe them for his own reasons.
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