Two Titans of monetary policy are clashing over the role low interest rates played in the housing bubble. One is right, and one is wrong.
Irvine Home Address … 103 RINALDI Irvine, CA 92620
Resale Home Price …… $539,000
I was born with the wrong sign
In the wrong house
With the wrong ascendancy
I took the wrong road
That led to the wrong tendencies
I was in the wrong place at the wrong time
For the wrong reason and the wrong rhyme
On the wrong day of the wrong week
I used the wrong method with the wrong technique
Wrong — Depeche Mode
Someone is wrong. Last week a controversy erupted between Ben Bernanke, Chairman of the Federal Reserve, who claims Low rates didn’t cause the housing bubble. This was countered by John Taylor, creator of the widely accepted Taylor Rule for guiding monetary policy, who claimed The Federal Reserve did inflate the housing bubble with Low Rates. Which one is right?
First, lets review what they actually said. Ben Bernanke’s speech sets the stage:
“As with regulatory policy, we must discern the lessons of the crisis
for monetary policy. However, the nature of those lessons is
controversial. Some observers have assigned monetary policy a central
role in the crisis. Specifically, they claim that excessively easy
monetary policy by the Federal Reserve in the first half of the decade
helped cause a bubble in house prices in the United States, a bubble
whose inevitable collapse proved a major source of the financial and
economic stresses of the past two years. Proponents of this view
typically argue for a substantially greater role for monetary policy in
preventing and controlling bubbles in the prices of housing and other
assets. In contrast, others have taken the position that policy was
appropriate for the macroeconomic conditions that prevailed, and that
it was neither a principal cause of the housing bubble nor the right
tool for controlling the increase in house prices. Obviously, in light
of the economic damage inflicted by the collapses of two asset price
bubbles over the past decade, a great deal more than historical
accuracy rides on the resolution of this debate.“
If policy makers draw the wrong conclusion from history, it is likely they will implement the wrong policies and take the wrong corrective measures. This debate is important. Back to the speech,
“… U.S. house prices began to rise more rapidly in the late 1990s. Prices
grew at a 7 to 8 percent annual rate in 1998 and 1999, and in the 9 to
11 percent range from 2000 to 2003. Thus, the beginning of the run-up
in housing prices predates the period of highly accommodative monetary
policy. Shiller (2007) dates the beginning of the boom in 1998. On the
other hand, the most rapid price gains were in 2004 and 2005, when the
annual rate of house price appreciation was between 15 and 17 percent.
Thus, the timing of the housing bubble does not rule out some
contribution from monetary policy.”
This is accurate. It is difficult to blame low interest rates for the problem when prices began to rise unsustainably before interest rates went up, and it doesn’t explain why prices are not still at peak levels now that the Federal Reserve has lowered mortgage interest rates to unprecedented levels.
In his rebuttal to Ben Bernanke, John Taylor made the following statements:
“The evidence is overwhelming that those low interest
rates were not only unusually low but they logically were a
factor in the housing boom and therefore ultimately the bust, … It had an effect on the housing boom and increased a lot
of risk taking,” said Taylor, 63, who was attending the
American Economic Association’s annual meeting.”
If you read what Taylor said carefully, you see that he said the rates were “a
factor in the housing boom and therefore ultimately the bust.” Well, duh, I knew that. It is one thing to be a “factor” and quite another to be the “cause.” Bullets are a factor in shooting deaths, but people pulling the trigger is the cause.
Bernanke goes on:
“With respect to the magnitude of house-price increases: Economists who
have investigated the issue have generally found that, based on
historical relationships, only a small portion of the increase in house
prices earlier this decade can be attributed to the stance of U.S.
monetary policy. This
conclusion has been reached using both econometric models and purely
statistical analyses that make no use of economic theory.”
It is the same conclusion I reached in The Great Housing Bubble:
“The catalyst or precipitating
factor for the price rally was the Federal Reserve’s lowering of
interest rates in 2001-2004.
Many mistakenly believe the lower interest rates themselves were
responsible by directly lowering mortgage interest rates. This is not
accurate. Mortgage interest rates declined during this period, and this
did allow borrowers to finance somewhat larger sums with the same
monthly loan payment, but this was not sufficient to inflate the
housing bubble. The lower Federal Funds rate caused an expansion of the
money supply, and it lowered bank savings rates to such low levels that
investors sought other investments with higher yields. It was this
increased liquidity and quest for yield that drove huge sums of money
into mortgage loans.
The expansion of credit took four forms: lower interest rates,
lowering or eliminating qualification requirements, different
amortization methods, and higher allowable debt-to-income ratios. Lower
interest rates expand credit by allowing larger sums to be borrowed
with the same payment amount. In 2000, the interest rate on a 30-year
mortgage was 8.05%, and in 2003, it was 5.83%. This reduction in
interest rates accounts for 20% to 50% of the increase in house prices
experienced during the bubble. “
Mark Thoma at Economist’s View in a post Did Low Interest Rates or Regulatory Failures Cause the Bubble? put it this way:
“In response to the question of whether the Fed’s low interest rate policy is responsible for
the bubble, most respondents point instead to regulatory failures of one type or another. Ben Bernake has also made this argument.
However, I don’t think it was one or the other, I think it was both.
That is, first you need something to fuel the fire, and low interest
rates provided fuel by injecting liquidity into the system. And second,
you need a failure of those responsible for preventing fires from
starting along with a failure to have systems in place to limit the
damage if they do start.”
The real debate Bernanke and Taylor are having has little to do with housing and everything to do with how the Federal Reserve is setting interest rate policy. Taylor disagrees with Bernanke’s actions as he has failed to adhere to the Taylor rule, so Taylor is pointing to every ill in our society as a result of Bernanke’s failure to do what he wants. It makes for interesting headlines, but with respect to housing, it is a tempest in a teacup.
Irvine Home Address … 103 RINALDI Irvine, CA 92620
Resale Home Price … $539,000
Income Requirement ……. $115,061
Downpayment Needed … $107,800
20% Down Conventional
Home Purchase Price … $731,500
Home Purchase Date …. 12/5/2006
Net Gain (Loss) ………. $(224,840)
Percent Change ………. -26.3%
Annual Appreciation … -9.3%
Mortgage Interest Rate ………. 5.27%
Monthly Mortgage Payment … $2,386
Monthly Cash Outlays ………… $3,480
Monthly Cost of Ownership … $2,870
Baths 2 full 1 part baths
Size 1,878 sq ft
($287 / sq ft)
Lot Size n/a
Year Built 2006
Days on Market 7
Listing Updated 1/4/2010
MLS Number P715845
Property Type Condominium, Residential
According to the listing agent, this listing may be a pre-foreclosure or short sale.
***APPROVED SHORT SALE!!!!*** Highly Upgraded Kitchen With Granite Cunter Top, Laminated Hardwood Flooring Trough Out, Charming Fieplace In Living Room. Walk to Woodbury Community Park, Pool, Spa & Playground. Close to shopping & Freeway and More!
What does it mean to be an approved short sale? The lender has pre-approved full asking price? Big deal. And why all the asterisks and exclamation points?
Cunter? I am not going to touch that one….
Trough Out. I probably would have made that one compound, but perhaps that is just me.
With our low interest rates, someone will jump on this one quickly. There are not many resales in Woodbury under $300/SF… yet.