WSJ Housing Bubble Symposium: Greenspan Supporters Not Extinct

by: Tim Iacono

This WSJ op-ed "symposium" about whether or not the Federal Reserve caused the housing bubble is reminiscent of that period, a year or two ago, when it became clear to all but the most clueless observers that home prices had peaked and it might be a long way down.

Back then, you could only get paid shills and the most dimwitted economists to say good things about housing (e.g., the chief economist at the National Association of Realtors and college professors in California and New York) and now the same appears to be true when it comes to defending the Fed.

In responses to the question, "Did the Fed cause the housing bubble?", only David Henderson of the Hoover Institute was able to muster a "No", part of his reasoning being as follows:

Moreover, if the Fed was the culprit, why was the housing bubble world-wide? Do Mr. Greenspan's critics seriously contend that the Fed was responsible for high housing prices in, say, Spain?
But to the extent that the federal government is to blame, the main fed culprits are the beefed up Community Reinvestment Act and the run-amok Fannie Mae and Freddie Mac. All played a key role in loosening lending standards.

He goes on to prove that the ranks of Greenspan sycophants has not yet dwindled to zero.

But, clearly, the man has some serious internal conflicts about monetary policy.

I'm not claiming that we should have a Federal Reserve. We simply can't depend on getting another good chairman like Mr. Greenspan, and are more likely to get another Arthur Burns or Ben Bernanke. Serious work by economists Lawrence H. White of the University of Missouri, St. Louis, and George Selgin of West Virginia University makes a persuasive case that abolishing the Fed and deregulating money would improve the macroeconomy. I'm making a more modest claim: Mr. Greenspan was not to blame for the housing bubble.

Four of the five other pieces confirm what has become conventional wisdom - though there were many other forces at work, low interest rates and lax regulation by the central bank were primary causes of the late great housing bubble and the current credit crisis.

Vincent Reinhart, a resident scholar at the American Enterprise Institute, stands alone in blaming Congress for giving the Fed too difficult a task in promoting full employment and price stability, though obviously he too seems to have missed what were the most important prices at the time - housing.

Some highlights...

From Gerald P. O'Driscoll Jr, a senior fellow at the Cato Institute, formerly a vice president at the Federal Reserve Bank of Dallas:

First, Mr. Greenspan writes as if mortgages were of the 30-year variety, financed by 30-year money. Would that it were so! We would not be in the present mess. But the post-2002 period was characterized by one-year adjustable-rate mortgages (ARMs), teaser rates that reset in two or three years, etc. Five-year ARMs became "long-term" money.

The Fed only determines the overnight, federal-funds rate, but movements in that rate substantially influence the rates on such mortgages.

From David Malpass, president of Encima Global LLC.

The blame for the current crisis extends well beyond the Fed -- to banks, regulators, bond raters, mortgage fraud, the Bush administration's weak-dollar policy and Lehman bankruptcy decisions, and Congress's reckless housing policies through Fannie Mae and Freddie Mac and the Community Reinvestment Act.

But the Fed provided the key fuel with its 1% interest rate choice in 2003 and 2004 and "measured" (meaning inadequate) rate hikes in 2004-2006. It ignored inflationary dollar weakness, higher interest rate choices abroad, the Taylor Rule, and the booming performance of the U.S. and global economies.

Even by the Fed's own backward-looking inflation metrics, the core consumption deflator exceeded the Fed's 2% limit for 18 quarters in a row beginning with the second quarter of 2004, while 12-month Consumer Price Index (NYSEARCA:CPI) inflation hit 4.7% in September 2005 and 5.4% in July 2008. This despite the Fed's constant assurances that inflation would moderate (unlikely given the crashing dollar.)

From Judy Shelton, economist and author of "Money Meltdown".

The Fed owns this crisis. The buck stops there -- but it didn't.

Too many dollars were churned out, year after year, for the economy to absorb; more credit was created than could be fruitfully utilized. Some of it went into subprime mortgages, yes, but the monetary excess that fueled the most threatening "systemic risk" bubble went into highly speculative financial derivatives that rode atop packaged, mortgage-backed securities until they dropped from exhaustion.