In this story at Aljazeera(?), Dean Baker, co-director of the Center for Economic and Policy Research, looks back at the late, great housing boom that turned to bust and offers some suggestions for what Federal Reserve Chairman Alan Greenspan should have done.

First, the Fed has responsibility for maintaining the stability of the US economy. Alan Greenspan should have recognised the bubble and done everything in his power to burst it before it grew to such dangerous levels.

Step one in this process should have been to document its existence and show the harm its collapse would bring. This means using the Fed’s huge staff of economists to gather the overwhelming evidence of a bubble and to shoot down anyone who tried to argue otherwise.
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Second, the Fed has enormous regulatory power beginning with setting guidelines for issuing mortgages. They first issued draft guidelines in December of 2007. It was not hard to find abusive and outright fraudulent practices in the mortgage industry, if anyone in a position of authority was looking for it.

Finally, the Fed could have used interest rate increases to rein in the bubble. This should have been a last resort, since higher rates would have slowed the economy at a time when it was still recovering from the collapse of the stock market bubble.

To maximise the impact of any rate increases, Greenspan could have announced that he was targeting the housing market. He could have said that he would continue to raise rates until house prices were brought back to a more normal level.

This surely would have gotten the attention of the mortgage industry and potential homebuyers. Would it have been an extraordinary action from a Fed chair? Sure, but so what? It might have prevented the devastation now ruining tens of millions of lives.

Well, if there’s one thing no one has ever accused Greenspan of it’s being a party-pooper.

All of these actions – though sensible – would have required the former Fed Chief to dramatically change his way of thinking that, at the time, saw markets as self-regulating, a view that he later, famously found a flaw in (see Greenspan finds a flaw from 2008).

The Federal Reserve’s new white paper about the U.S. housing market released just yesterday – The U.S. Housing Market: Current Conditions and Policy Considerations (.pdf) – contains the following paragraph and a good deal of supporting rationale for their  recommendation to sell GSE-owned foreclosed properties in bulk to investors so that they can be converted in bulk into rentals.

The price signals in the owner-occupied and rental housing markets–that is, the decline in house prices and the rise in rents–suggest that it might be appropriate in some cases to redeploy foreclosed homes as rental properties. In addition, the forces behind the decline in the homeownership rate, such as tight credit conditions, are unlikely to unwind significantly in the immediate future, indicating a longer-term need for an expanded stock of rental housing.

While, on the surface, this makes a good deal of sense after the nation painfully learned a few years ago that home ownership wasn’t what it was cracked up to be and, ever since, home prices have been falling while demand for rental properties has grown, a massive conversion of REO properties into rental properties would also have the convenient side effect of helping the Fed keep inflation low, giving it more leeway to print up another trillion dollars or so for the greater good, should the need arise.

How so?

Recall that, part of the reason that the housing bubble grew so big was that the inflation statistics include rental prices as a proxy for the cost of home ownership, a change that was made all the way back in 1983 and that forever changed how inflation is reported and how high home prices could rise (see this Seeking Alpha article on the subject from a few years back that still ranks quite high on a search of “owners’ equivalent rent”).

After years of being subdued because everyone wanted to own a home (and nearly did), lately, rents have been rising – up about 2 percent over the last year – and, since rents account for 40 percent of the Fed’s “core” inflation rate, you can see why lower rental prices might be in the central bank’s interest.