Low rates didn't cause bubble, Bernanke says

[Beet]

I think a couple things can be said:
1) Rates were too low, and the Fed should have known better
2) There were bigger problems going on than just low rates

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WASHINGTON (MarketWatch) - The Federal Reserve had a role in inflating the housing bubble, but it wasn't low interest rates in the U.S. that fueled speculation in housing around the globe, Fed Chairman Ben Bernanke said Sunday.

Rather, it was lax supervision of toxic mortgages by the Fed and other bank regulators -- along with excessive flows of capital around the globe -- that inflated the bubble, setting up the world economy for what may have been the worst economic crisis in modern history, Bernanke said. Read full text of his speech.

In twin speeches at the annual meeting of the American Economic Association in Atlanta, Ga., Bernanke and his vice chairman, Donald Kohn, responded to critics who suggest that the Fed's policy of very low interest rates from 2001 to 2005 was the major cause of the housing bubble.

"The magnitude of house-price gains seems too large to be readily explainable by the stance of monetary policy alone," Bernanke concluded in his speech. Comparisons with other major economies shows that countries with relatively higher interest rates had larger housing bubbles, he said.

Bernanke conducted a kind of post-mortem on the housing bubble. Using historic relationships, he concluded that low interest rates were responsible for about 5% of the change in housing prices, while greater global capital flows explained about 30% of the change.

The biggest cause of the bubble was exotic mortgages and the decline in underwriting standards, he said. Buyers were able to lower their initial monthly payments, which allowed prices to soar to unsustainable levels.

"Both lenders and borrowers became convinced that house prices would only go up," Bernanke said. "Borrowers chose, and were extended, mortgages that they could not be expected to service in the longer term. They were provided these loans on the expectation that accumulating home equity would soon allow refinancing into more sustainable mortgages. For a time, rising house prices became a self-fulfilling prophecy, but ultimately, further appreciation could not be sustained and house prices collapsed."

"That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary," Bernanke said. "Stronger regulation and supervision aimed at problems with underwriting practices and lenders' risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates."

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The first commenter (who was voted down) said:

I tend to agree with the following statement: "The biggest cause of the bubble was exotic mortgages and the decline in underwriting standards, he said. Buyers were able to lower their initial monthly payments, which allowed prices to soar to unsustainable levels."

At the time, I was getting offers at least 3 times a week to "refinance" with a beginning rate of 1%. I've been in the business of investing in RE for almost 20 yrs. and I KNEW BETTER. I knew that these kind of ARM loans would be "negative amortization" type loans. But the average person who took out these loans did not have the knowledge that I did. They were duped into taking out the loans and didn't understand what the ramifications would be (i.e. additional principal added to the back-end of the loan, over time). While I agree that they should have consulted with an Attorney before signing for these loans, I think many of them just took the loan officer's word for it (i.e. that they could refi the loan later, when the property went up in value).

[k-onmmunist]

He's decieving himself if he thinks low interest rates didn't allow the boom to get out of hand.

[Mint]

Um, he said that to be fair he just downplayed the degree. That said why would anyone believe him? Of course he's going to say this. Just like he said the crisis in housing was 'contained' and we weren't in recession when it was clear to most americans that we were.

[Bo]

Bernanke is saying this so that people will give him and Greenspan less blame for the bubble and financial crisis. Of course he knows that low interest rates caused the housing bubble, he's just trying to protect his reputation.

[Beet]

Bernanke is saying this so that people will give him and Greenspan less blame for the bubble and financial crisis. Of course he knows that low interest rates caused the housing bubble, he's just trying to protect his reputation.

I agree to an extent. I posted this because I think that Bernanke makes some good points, but obviously the Fed has an interest in deflecting blame away from itself. And Bernanke's technical attack on the Taylor rule, claiming that using forecast inflation rather than current inflation makes the Fed's policies more reasonable, misses the point. It ignores non CPI inflation and the general excessive growth of the credit cycle. Despite what they say, I think the Fed is more shaken up than their bravura self defense here would suggest. It's common sense that one reason so many started refinancing in 2002 was low interest rates.

[Bo]

Bernanke is saying this so that people will give him and Greenspan less blame for the bubble and financial crisis. Of course he knows that low interest rates caused the housing bubble, he's just trying to protect his reputation.

I agree to an extent. I posted this because I think that Bernanke makes some good points, but obviously the Fed has an interest in deflecting blame away from itself. And Bernanke's technical attack on the Taylor rule, claiming that using forecast inflation rather than current inflation makes the Fed's policies more reasonable, misses the point. It ignores non CPI inflation and the general excessive growth of the credit cycle. Despite what they say, I think the Fed is more shaken up than their bravura self defense here would suggest. It's common sense that one reason so many started refinancing in 2002 was low interest rates.

I don't think the Fed is forced to follow the Taylor Rule--they can choose to follow it or not follow it.

[phk]

It was just a perfect storm is basically what he was trying to say. Lowering standards, global imbalances and low interest rates all at the same time.

[opebo]

It isn't precisely reasonable to say 'low interest rates caused' 'the bubble', as if that were a definitive illness and symptom.

The reason for excessively low interest rates is that this is the only policy lever allowed us by our right wing government.  What is missing in the modern economy is redistribution and demand-support.  Obviously we should have low interest rates, but in addition to this it is necessary to for the State to redistribute wealth on a massive scale, both through all-encompassing welfare programs and through legislated increase in working class incomes (such as unionization, etc). 

The illness is - the capitalism, and its intrinsic inequality and demand-dearth.  To blame the palliative it was given - low interest rates - for not curing the problem, is like blaming the morphine for not curing the cancer patient.

[phk]

I really wish there was a simulation where we can hold certain events like "mortgage underwriting standards" and "1% federal funds rate" and isolate it. I have a feeling he has good points but is still not giving enough weight to the low Fed Funds rates from 2001 to 2005.

[Bo]

I really wish there was a simulation where we can hold certain events like "mortgage underwriting standards" and "1% federal funds rate" and isolate it. I have a feeling he has good points but is still not giving enough weight to the low Fed Funds rates from 2001 to 2005.

Of course he isn't giving enough blame to low interest rates? Why would he? He knows low interest rates largely caused the bubble (along with some other less important factors), but he does not want to damage his buddy Greenspan's reputation.

[opebo]

I really wish there was a simulation where we can hold certain events like "mortgage underwriting standards" and "1% federal funds rate" and isolate it. I have a feeling he has good points but is still not giving enough weight to the low Fed Funds rates from 2001 to 2005.

Of course he isn't giving enough blame to low interest rates? Why would he? He knows low interest rates largely caused the bubble(along with some other less important factors), but he does not want to damage his buddy Greenspan's reputation.

But the point is that it wasn't low interest rates that caused the bubble, Nappy.

[○∙◄☻¥tπ[╪AV┼cVê└]

They needed to keep the rates artificially low to re-select Bush.

[phk]

Looks like most Academics Economists actually agree with Bernanke.

LAURENCE BALL, JOHNS HOPKINS PROFESSOR: “If only mortgage lenders had insisted on documentation of income, we might not be having this whole discussion.”

MICHAEL BORDO, RUTGERS PROFESSOR: “The Fed didn’t cause the house price boom per se. Its causes were varied including government policy to encourage home ownership going back to the 1930s but especially the CRA (Community Reinvestment Act), lax regulation, inappropriate business practices etc. But loose monetary policy provided much of the fuel.”

BRAD DELONG, BERKELEY PROFESSOR: “If you believe that the Fed kept the fed funds rate 2% below its proper Taylor-rule value for 3 years, that has a 6% impact on the price of a long-duration asset like housing. Even with a lot of positive-feedback trading built in, that’s not enough to create a big bubble. And it wasn’t the bubble’s collapse that caused the current depression–2000-2001 saw a bigger bubble collapse, and no depression.”

BENJAMIN FRIEDMAN, HARVARD PROFESSOR: “A democracy gets the regulatory policy it chooses.  If the public elects office holders who do not believe in regulation, and those office holders appoint people to head the regulatory agencies who also do not believe in regulation, then there will be no regulation no matter what the statutes say.”

MARK GERTLER, NEW YORK UNIVERSITY PROFESSOR: “If we could go back in history and make one policy change, I’d go after sub-prime lending. Absent non-prime lending, the likely outcome of the housing correction of 2007 would have been a mild recession like 2000-2001, and not the debacle we experienced.”

MARVIN GOODFRIEND, CARNEGIE MELLON UNIVERSITY PROFESSOR: “Interest rate policy was appropriately stimulative in the 2002-3 period. But rates should have been raised less mechanically and more aggressively in 2004-5 on grounds of the usual macroeconomic conditions. The appreciation of house prices was but one of many indicators which called for a somewhat more restrictive interest rate policy at the time. A somewhat tighter stance of interest rate policy then could have cut off the last year or so of the house price appreciation and prevented the worst part of the subsequent adjustment.”

CHRISTOPHER HOUSE, UNIVERSITY OF MICHIGAN PROFESSOR: “While the interest rate was below normal for some time it may not have been far below normal.  In the wake of the 2001 recession, inflation was low (it was below 2 percent for much of 2001 – 2003) and the economy lost jobs for more than two years (job losses continued until roughly August 2003) so it is not unreasonable for the Fed to have kept interest rates low.  The low interest rate likely contributed to the housing boom somewhat but it is unlikely that it was the main cause of the crisis.”

KENNETH KUTTNER, WILLIAMS COLLEGE PROFESSOR: “The ‘bubble’ didn’t really get going until 05-06, by which time the Fed had raised rates to more or less normal levels.”

JEFFREY MIRON, HARVARD PROFESSOR: “The more fundamental way in which the Fed contributed to the bubble was via the “Greenspan put,” namely, the assurances the Fed gave markets that, whatever might happen, the Fed had both the ability and the willingness to clean the mess up afterwards, without too much pain. This stance played a major role in Wall Street’s excessive risk-taking.

JONATHAN PARKER, NORTHWESTERN PROFESSOR: “The Fed did not have the legal authority to change or enforce regulations in most of the areas where these actions could have mitigated the crisis – if the Fed did have such authority or ability, or if any agency did, we could now get by merely by tweaking the system.”

GARY RICHARDSON, UNIVERSITY OF CALIFORNIA IRVINE PROFESSOR: “The connection between low rates and the housing bubble was indirect. Low rates encouraged homeowners to refinance mortgages. To handle this wave of refinancing, financial institutions expanded capacity to write mortgages (roughly doubling employment in the mortgage-writing industry). After the refinancing wave passed, financial institutions kept the expanded mortgage-making resources in use by finding new ways to extend mortgages, which led to the creation of exotic mortgages and the extension of loans to hitherto unqualified buyers.”

CHRIS SIMS, PRINCETON PROFESSOR: “There may not have been a great deal that the Fed itself, without legislative cooperation, could have done about the situation as the housing bubble developed … In the atmosphere of those boom years, anyone who favored increased regulation and damping of the flows of commissions and bonuses that were driving the boom had difficulty making an impact.”

JON STEINSSON, COLUMBIA PROFESSOR: “Excessively easy monetary policy by the Fed played at most a minor role in causing the housing bubble. Those that think that excessively easy monetary policy by the Fed played a major role must think that the Fed can have a major influence on real interest rates for a very sustained period of time. It is not clear to me that this is true.”

[TeePee4Prez]

It was just a perfect storm is basically what he was trying to say. Lowering standards, global imbalances and low interest rates all at the same time.

This is definitely the right answer.  I would blame a large part on lowering standards and exotic mortgages for this than interest rates, but interest rates definitely had a factor.  As an accountant, hearing what some people were making and what they paid for a house from some of these clowns on TV almost made me have a few strokes.  How can one make $50,000 a year and afford a $750,000 house?  HOW?  And some smooth talker tried to convince them they're making the dream purchase of a lifetime and their increased equity would realize further dreams.  The financial illiteracy in this country is mind boggling.