Does the Left Know We Had a Housing Bubble?
Over the last week, speaking at a variety of events, I heard three different representatives of the Left; first a Democrat US Senator, then a senior member of the Obama Administration, and finally a “consumer” advocate, all repeat the same narrative: all was fine in the housing market until predatory lenders forced hard-working honest families into foreclosure, which reduced house prices, bringing the economy to a crash. That’s correct, apparently the Left believes we all would still be seeing double-digit home price appreciation if it wasn’t for those evil lenders.
Undoubtedly foreclosures, especially those that result in houses that remain vacant for a considerable amount of time, have an adverse impact on surrounding property values. Many constitute a serious eye-sore and provide a haven for criminal activity. But did foreclosures really drive down prices, or were foreclosures first driven by price declines resulting from a bursting housing bubble? While causality is always difficult to establish with certainty, we do know that the rate of house price appreciation peaked and started declining about 18 months before the dramatic up-turn in mortgage delinquencies. If one prefers a more rigorous test, economists at the Boston Fed have directly tested if prices first drove foreclosures or whether foreclosures drove prices. Their results conclude that its was declining prices that matter, and that the price effect of foreclosures is minimal.
Why does any of this ultimately matter? Because if we craft policies to avoid the adverse impacts of the next property bubble based upon a narrative of “consumer protection” — as is being pushed by the Obama Administration, we will do little to avoid the creation of the next housing bubble and its damaging aftermath. Instead we should be focusing attention on those policies that contributed to the creation of the housing bubble: expansionary monetary policy and the Federal government’s blind pursuit of ever-expanding home-ownership rates at any cost.
Bernanke’s Part in the Housing Bubble
Recent weeks have seen a swirl of speculation over whether President Obama will or will not re-appoint Ben Bernanke to the Chairmanship of the Federal Reserve Board, when his current term as Chair expires in January 2010. Almost all of the debate has centered on his actions as Chairman. This narrow focus misses an important piece: his actions, and words, as a Fed governor during the build-up of the housing bubble.
What should have been Bernanke’s greatest strength as a Fed governor and later chair, his understanding of monetary theory and his knowledge of the Great Depression, has ended up being a weakness. While correct in his analysis of the role of “debt deflation” — where the deflation increases the real burden of debts and correspondingly weakens the balance sheet of both households and businesses — in the deepening of the Great Depression; his obsession with slaying the Great White Whale of Deflation provided intellectual cover for the Fed’s ignoring and contributing to the housing bubble. Like the proverbial general, he was fighting yesterday’s battle, rather than today’s.
While core inflation was moderate and increasing at a decreasing rate between 2001 and 2005, this measure ignores the dramatic up-tick in house prices during those years. First, housing makes up the single largest expense for most households, ignoring housing, especially after one subtracts out energy and food from the definition of inflation, gives a narrow and distorted picture of inflation. Even if one were to focus solely on rents, the 2000s were an era of increasing housing costs.
Separate from the impact of housing prices on inflation is the role which housing plays as the collateral for the primary piece of household debt: a mortgage. Even were the US to suffer a bout of mild deflation and the real burden of their mortgages increased, this would likely have little impact on household balance sheets in an environment of increasing home prices.
Admittedly Bernanke was then only a “governor” and not yet Chair of the Fed, but he was the Fed’s loudest voice when it came to combating deflation and arguing for lower rates. Additionally there have been zero public acknowledgements by either Bernanke or the Fed that its policy earlier this decade contributed to the housing bubble and financial crisis. Without admitting to the occasional mistake, we have no way of judging whether Bernanke has learned from any of his mistakes, and hence less likely to repeat them.
In weighing Bernanke’s record at the Fed, judgement should not solely consider his actions as Chair, but also consider his words and deeds while the housing bubble was inflating. How one responds to a impending disaster is as important as to how one helps to clean up after the disaster has struck.
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