Link: http://online.wsj.com/article/SB123672965066989281.html

In the Wall Street Journal today, former Federal Reserve Board Chairman Alan Greenspan authors an editorial titled, “The Fed Didn’t Cause the Housing Bubble“. The thesis of the article is that the rise in housing prices from 2002-2006 were caused by huge capital inflows from emerging markets and by low mortgage interest rates, not by the low Federal funds rate the Fed piloted during the period arising from the last recession (2002-2005). As such, the explanation that “the easy money policies of the Federal Reserve produced the U.S. housing bubble that is at the core of today’s financial mess,” is the wrong one.

Mr. Greenspan’s asserts that he “agrees that it was indeed lower interest rates that spawned the speculative euphoria. However, the interest rate that mattered was not the federal-funds rate, but the rate on long-term, fixed-rate mortgages.” While this may be technically correct, it’s like saying that it’s the calories in the ice cream that make me fat, not my desire to eat it. All interest rates in the economy, to one degree or another, are influenced heavily by the short-term interest rates that the Fed controls. Blaming the consequences of one’s actions on some intermediate linkages is rather silly.

The Fed’s main policy intrument, targeting the Federal funds interest rate, is linked to home mortgage rates in the following way: they influence long-term risk-free interest rates (such as those on Treasury bonds) in conjunction with an interest-rate risk premium; and these influence long-term mortgage interest rates in conjunction with a varying default risk premium. While short-term rates are much more elastic than long-term rates, it is undeniable that the fulcrum Fed funds interest rate is much more deterministic of mortgage interest rates than either changes in the yield curve or variations in default risk premiums. The only interest rates that are not set by markets (or by reactions to other rates) are set by the Fed. They are the prime mover.

Another curious thing about Greenspan’s defense is his insistence that the fed-funds rate became decoupled from mortgage interest rates:

U.S. mortgage rates’ linkage to short-term U.S. rates had been close for decades. Between 1971 and 2002, the fed-funds rate and the mortgage rate moved in lockstep. The correlation between them was a tight 0.85. Between 2002 and 2005, however, the correlation diminished to insignificance.

This is overstating the case. The mortgage rates did not correlate well at this time because the fed-funds rate was so low: long-term rates on mortgages or other securities had hit rock bottom around 5.75% and did not move above 6% until the fed-funds rate approached 4%. Besides, if the correlation prior to this period was so strong, was Greenspan not even more reckless with his easy money policy? The average spread between mortgage rates and fed-funds rates between 1971 and 2001 was 2.85%. If that had applied during 2003 and 2004, we would have seen hideously low rates on 30-year mortgages below 4%.

The great improvement in monetary policy made by the Fed in the last thirty years was the narrowing of its policy focus to price stability and away from macroeconomic stabilization (this looks all but discarded by the Bernanke Fed). For this I give Greenspan much credit. During the years in question, from 2002-2005, inflation was well under control, and I suppose that gave Greenspan comfort. But as in other policy areas, chasing effects rather than employing sound process is where the source of the problem lies. As we now know, CPI inflation is not the only bad effect that may result from an easy money policy. Asset price inflation and over-investment are other effects that must be considered.

It is better yet to craft monetary policy that attempts to emulate the process that market participants would employ in a free banking system, absent a monetary authority. In other words, the Fed should have targeted a Federal funds rate that was their estimate of what would clear the market of savings and investment without interference. This may not be easy since market actors respond to the Fed and not vice versa. But it could certainly be said that it is in no way conceivable that such an interest rate was 1.00% between the summers of 2003 and 2004, as the Fed funds rate was.

Link: http://www.washingtontimes.com/news/2009/mar/11/subsidizing-bad-decisions/

There is all kinds of juicy stuff in this article.

As a renter, I personally have had this feeling a lot in the past six months:

Why should taxpayers who live in apartments, perhaps because they did not feel they could afford to buy a house, be forced to subsidize other people who could not afford to buy a house, but who went ahead and bought one anyway?

Or, since the push for “affordable housing” was what created the subprime mortgage fiasco, how about this:

The same politicians who have been talking about a need for “affordable housing” for years are now suddenly alarmed that home prices are falling. How can housing become more affordable unless prices fall?

The political meaning of “affordable housing” is housing that is made more affordable by politicians intervening to create government subsidies, rent control or other gimmicks for which politicians can take credit.

Affordable housing produced by market forces provides no benefit to politicians and has no attraction for them.