Writing in the Wall Street Journal yesterday, Alan Greenspan accepted little, if any, responsibility for fueling the housing boom:
I do not doubt that a low U.S. federal-funds rate in response to the dot-com crash, and especially the 1% rate set in mid-2003 to counter potential deflation, lowered interest rates on adjustable-rate mortgages and may have contributed to the rise in U.S. home prices. In my judgment, however, the impact on demand for homes financed with ARMs was not major.
Demand in those days was driven by the expectation of rising prices--the dynamic that fuels most asset-price bubbles. If low adjustable-rate financing had not been available, most of the demand would have been financed with fixed rate, long-term mortgages. In fact, home prices continued to rise for two years subsequent to the peak of ARM originations (seasonally adjusted).
Greenspan comes close, here, to committing the "speculative bubble" fallacy, but he does stop just short: he merely says that the bubble was "driven by the expectation of rising prices". And I am sympathetic to what he says. The boom in U.S. housing prices was pretty much par for the global course, and it's not obvious that a higher Fed funds rate would have prevented it or even slowed it down noticeably.
That said, however, the main reason why the housing bust seems to be much worse in the U.S. than elsewhere is surely those ARMs – which, as Greenspan concedes, were a function of low short-term interest rates. They allowed many people to buy houses they couldn't afford, which in turn created a massive solvency crisis. David Leonhardt, yesterday, explained the dynamic:
As home prices rose ever higher in other parts of Southern California, Paramount became all the more attractive — and prices eventually soared there as well. By last year, the typical house sold for almost $500,000, up from $200,000 in early 2003.
Many of those sales depended on adjustable-rate mortgages with tantalizingly low initial payments, and now that those mortgages are much harder to get, there aren’t many buyers willing and able to pay $500,000.
So long as people can afford their mortgage payments, you're unlikely to have a massive housing bust. The problem in the U.S. is those ARMs, which are resetting to levels which people can't afford. The housing bust (if not the housing boom) is Greenspan's legacy, and it would be nice if he were a little more honest about it.