Federal Reserve | timiacono.com - Part 55

Federal Reserve Blissfully Unaware in 2006

The intertubes were abuzz yesterday after the release of the Federal Reserve’s 2006 policy committee meeting minutes in which it seems the central bank was blissfully unaware of the trouble ahead for housing and credit markets, a point nicely illustrated below from the Wall Street Journal’s Little Alarm Shown at Fed At Dawn of Housing Bust($).

“So far we are seeing, at worst, an orderly decline in the housing market,” he said.

Mr. Bernanke predicted a “soft landing” for the economy as 2006 ended, not a housing bust that would trigger the worst financial crisis since the Great Depression.

Timothy Geithner, then president of the New York Fed and now Treasury Secretary, playfully offered this forecast about Mr. Greenspan’s legacy: “I think the risk that we decide in the future that you’re even better than we think is higher than the alternative.”

Amazing stuff (no, not really)… For those still playing catch-up on this, some more links:

FOMC: Transcripts and Other Historical Materials, 2006 – Federal Reserve
Inside the Fed in 2006: A Coming Crisis, and Banter – NY Times
Fed 2006 Transcript: Riding Housing Roller Coaster With Eyes Shut – WSJ
Fed’s image tarnished by newly released documents – Washington Post
Richard Fisher Compares the Housing Bubble to Brad Pitt’s Baby – WSJ
On bank self-regulation and other Greenspan fairy tales – Credit Writedowns
The Fed’s Undistinguished Macro Discussions Circa Jan 2006 – Capital Spectator
Comments from FOMC meetings which resulted in laughter – Economist
So This Central Banker Walks Into a Bar…. – Crossing Wall Street
The Federal Reserve Is…Gasp…Funny – NetNet

What Greenspan Should Have Done

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.

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).

Ron Paul Continues to Confound

Not having watched much of the back-to-back debates for the GOP presidential nomination over the weekend, it’s just a guess (but a pretty safe one) that Rep Ron Paul (R-TX) continued to be a great source of cognitive dissonance for anyone watching. For those finding a way to avoid completely dismissing his views out of hand, this story at Mother Jones provides a handy  Venn Diagram that can be used to sort things out.

This related item at lewrockwell.com indicates some of the nation’s brightest business minds aren’t that confused about Paul, CNN’s Erin Burnett recently noting an “astounding number of top business leaders were OK with the idea of a Ron Paul presidency”. Pimco’s Bill Gross was the only name mentioned, though, I’d love to hear who the others are.

The Fed’s Ulterior Motive in REO Rentals

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.

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