During the late 90s, Greenspan claimed that stock market bubbles could not be identified while they were going on, only in retrospect, after they had burst. And in a twisted rendition of the efficient markets theory, Greenspan stated that any attempts by the Fed to manage asset prices would substitute the judgements of government planners for the informed decisions of millions of investors who had rationally and efficiently bid the stock prices up to ridiculous levels. The New York Times, for example, says “Mr. Greenspan and other officials have long argued that it is not their job to influence the price of assets whether stock prices or real estate. Rather, they contend, the central bank’s job is to keep inflation low and to promote the maximum sustainable growth without fueling inflation.”
Later, while taking his victory lap, he complimented the Fed’s performance in addressing the fallout from a bubble while at the same time preventing a recession. Now, the “bubble bursting” debate is being played out again over the housing bubble. {
What Greenspan revisionism tries to deny is the Fed’s role in creating bubble. Bubbles do not “just happen” and they are not entirely the product of investor behavior. The housing bubble is a creation of the Fed’s policy aimed at preventing a recession from occurring by lowering interest rates. Without an extraordinary expansionary monetary policy, the stock and bond bubbles of the 90s could not have taken place. Bubbles need credit in order to inflate. When the credit stops, the bubble is deprived of life support.
Using free-market rhetoric about efficient markets and rational investors to justify a “hands off” policy toward popping bubbles, while flooding the markets with new money is disingenous. The process of financial asset inflation is a creation of the Federal reserve system and fractional reserve banking. Interest rates are a controlled price, managed by the central bank through provision of more or fewer bonds and bank reserves. Low interest rates, then, are the tranmission channel for credit into the housing market and the driver of the housing bubble. Yet Fed governors discuss asset price inflation as if it were an entirely exogenous phenomenon over which they have no control or influence. See also Stefan Karlsson’s excellent blog on the mysterious phenomenon of lower interest rates that has central bankers scratching their heads).
For the last couple of years, Greenspan has denied that there could be such a thing as a nationwide housing bubble, citing some specious reasons, such as the illiqudity of homes (yet homes are now sold some times multiple times before they are even built, and some times more than once in the same day) and because housing markets are local, not national (yet Japan had a housing bubble that has since deflated by about 70%). In a stunning example of the pot calling the kettle black, he has publicly criticized Fannie and Freddie before congress for expanding their lending activities excessively and fomenting systemic risk.
Recently, Greenspan has admitted that there is some speculation going on in the home market. The New York Times reports, Fed Debates Pricking the U.S. Housing ‘Bubble’ (note the use of irony quotes around the word bubble).
- If the housing market has become a bubble, as increasing numbers of economists warn, would the Federal Reserve try to deflate it? The idea runs counter to a deep-seated view at the central bank, which refused to puncture the stock market bubble of the 1990’s and continues to view its main job as preventing inflation rather than influencing the prices of stocks, bonds or real estate.
But this time, a few people are beginning to challenge the Fed’s spin game:
But many economists say the housing market poses a different challenge from the stock market. For one thing, they say, the Federal Reserve’s policies have played a much more direct role in the housing boom than they did in the technology-fueled stock bubble. “This time around, the Fed’s policies have played a part,” said Nigel Gault, a senior economist at Global Insight, an economic forecasting firm in Lexington, Mass. “Its policy has been to boost the housing market and the consumer through very low interest rates.” Others worry that the Federal Reserve has tacitly encouraged risky speculation through its role as a chief regulator of the banking industry, which has steadily relaxed lending standards and allowed home buyers to borrow more money through higher-risk loans. “The Fed chairman cleaned up the mess caused by the bursting of the technology and telecom bubbles, by creating another bubble,” wrote Edward Yardeni, chief economist at Oak Associates. “Now he has failed to stop the alarming deterioration of mortgage lending standards to stop the housing bubble.”
Here, the New York Times asks Is Your House Overvalued? They are not sure, but they do repeat the oft-heard argument in defense of the current housing boom, that houses are not over-valued because interest rates are low. Here we see the same problem as the Fed commits when it treats interest rates as an external variable. It ignores the fact that the Fed has a lot to do with setting interest rates and maintaining them at below market values relative to the amount of savings. Houses are over-priced because interest rates are too low, and this is due to Fed policies. Case in point: Everybody’s an Investor Now and in the New York Times, Meet the Flippers.
Where is this all going? In the UK, taxpayers are subsidizing the issuance of mortgage credit. According to this week’s GSE Report, Fannie mae expands its purchase of 40-year mortgages.
