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Book ChapterDOI

Federal Reserve Policy and the Housing Bubble

01 Jan 2009-Cato Journal (John Wiley & Sons, Inc.)-Vol. 29, Iss: 1, pp 451-459
TL;DR: The U.S. housing bubble and the fallout from its bursting are not the results of a laissez-faire monetary and financial system as mentioned in this paper, but the result of poorly chosen public policies that distorted interest rates and asset prices, diverted loanable funds into the wrong investments, and twisted normally robust financial institutions into unsustainable positions.
Abstract: The U.S. housing bubble and the fallout from its bursting are not the results of a laissez-faire monetary and financial system. They happened in an unanchored government fiat monetary system with a restricted financial system. What Happened and Why? Our current financial turmoil began with unusual monetary policy moves by the Federal Reserve System and novel federal regulatory interventions. These poorly chosen public policies distorted interest rates and asset prices, diverted loanable funds into the wrong investments, and twisted normally robust financial institutions into unsustainable positions. There is no doubt that private miscalculation and imprudence have made matters worse for more than a few institutions. Such mistakes help to explain which particular firms have run into the most trouble. But to explain industry-wide errors we need to identify price and incentive distortions capable of having industry-wide effects. Here I will make two main points. First, the Federal Reserve's expansionary monetary policy supplied the means for unsustainable housing prices and unsustainable mortgage financing. Elsewhere (White 2008) I have discussed the growth in regulatory mandates and subsidies that exaggerated the demand for riskier mortgages, most importantly the implicit guarantees to Fannie Mae and Freddie Mac that combined with HUD's imposition of "affordable housing" mandates on Fannie and Freddie to accelerate the creation of a market for securitized subprime mortgages. (1) Second, the Federal Reserve has undertaken self-initiated new lending roles that constitute a shadow bailout program more than twice the size of the Treasury's $700 billion bailout program. There is unfortunately little evidence that the Fed's new lending has helped to resolve our financial problems, rather than to delay their resolution. The Credit Supply Bubble Some authors, considering the relationship of Federal Reserve policy to asset bubbles, ask only: Should the Fed actively burst a growing bubble? If so, how? As posed, their questions suggest that asset bubbles arise independent of monetary policy, and the only Fed role to be discussed is that of bubble-buster. A more important pair of questions is: Does Fed policy as currently conducted tend to inflate assets bubbles? If so, how can we reformulate policy to avoid that tendency? Call our objective a non-bubble-prone or "non-effervescent" monetary policy. The economics profession has not reached a consensus on what the optimally non-effervescent monetary policy is, but it is now widely agreed that it isn't holding interest rates too low for too long. It should also now be clear that a Fed policy that deliberately ignores asset prices, as though consumer prices alone were a sufficient indicator of excessive Fed expansion, is also not the way to avoid inflating asset bubbles. In the recession of 2001, the Federal Reserve System under Chairman Alan Greenspan began aggressively expanding the U.S. money supply. Year-over-year growth in the M2 monetary aggregate rose briefly above 10 percent, and remained above 8 percent entering the second half of 2003. The expansion was accompanied by the Fed's repeatedly lowering its target for the federal funds (interbank overnight) interest rate. The Fed funds rate began 2001 at 6.25 percent and ended the year at 1.75 percent. The Greenspan Fed reduced the rate further in 2002 and 2003, pushing it in mid-2003 a record low of 1 percent, where it stayed for a year. The real Fed funds rate was negative--meaning that nominal rates were lower than the contemporary rate of inflation--for an unprecedented two and a half years. A borrower during that period who simply purchased and held vacant land, the price of which (net of taxes) merely kept up with inflation, was profiting in proportion to what he borrowed. How do we judge whether the Fed expanded more than it should have? One venerable (albeit no longer popular) norm for making fiat central bank policy as neutral as possible toward the financial market is to aim for stability (zero growth) in the volume of nominal expenditure. …

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Citations
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Patent
02 Sep 2014
TL;DR: In this article, a system and methods for calculating a savings amount for loan refinancing is described. But, the system is limited to a single user and the user's credit level and the current monthly payment, APR, and payoff amount associated with the current loan, and the method further determines a saving amount based on a comparison of the input data with historical savings data accessible to the widget and displaying the savings amount in the graphic user interface.
Abstract: Systems and methods are provided for calculating a savings amount for loan refinancing. According to one implementation, a method includes displaying a graphic user interface comprising a widget at a client device and receiving input data from a user regarding a loan. In some embodiments, the input data may include the user's credit level and the current monthly payment, APR, and payoff amount associated with the user's current loan. The method further includes determining a saving amount based on a comparison of the input data with historical savings data accessible to the widget, and displaying the savings amount in the graphic user interface.
References
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Posted Content
TL;DR: In this article, a counterfactual simulation with a simple model of the housing market shows that this deviation may have been a cause of the boom and bust in housing starts and inflation in the last two years.
Abstract: Since the mid-1980s, monetary policy has contributed to a great moderation of the housing cycle by responding more proactively to inflation and thereby reducing the boom bust cycle. However, during the period from 2002 to 2005, the short term interest rate path deviated significantly from what this two decade experience would suggest is appropriate. A counterfactual simulation with a simple model of the housing market shows that this deviation may have been a cause of the boom and bust in housing starts and inflation in the last two years. Moreover, a significant time series correlation between housing price inflation and delinquency rates suggests that the poor credit assessments on subprime mortgages may also have been caused by this deviation.

598 citations


"Federal Reserve Policy and the Hous..." refers background in this paper

  • ...John Taylor noted the Fed’s deviation from the Taylor Rule in his 2007 Jackson Hole Symposium paper (Taylor 2007)....

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  • ...6 Taylor (2007) arrives at similar findings after running slightly different counterfactual simulations....

    [...]

Journal ArticleDOI
TL;DR: This article analyzed the need for financial regulations in the implementation of central bank policy and found that financial regulations cannot readily be rationalized on the basis of macroeconomic benefits, and that financial regulation is sometimes justified on macroeconomic grounds.
Abstract: Financial deregulation is widely understood to have important economic benefits for microeconomic reasons Since Adam Smith, economists have provided arguments and evidence that unfettered private markets yield outcomes that are superior to public sector alternatives But financial regulations - specific rules and overall structures - are sometimes justified on macroeconomic grounds This paper analyzes the need for financial regulations in the implementation of central bank policy Dividing the actions of the Federal Reserve into monetary and banking policy, we find that financial regulations cannot readily be rationalized on the basis of macroeconomic benefits

347 citations


"Federal Reserve Policy and the Hous..." refers background in this paper

  • ...By purchasing securities the central bank supports the money stock while avoiding the danger of favoritism associated with making loans to specific banks on noncompetitive terms (Goodfriend and King 1988)....

    [...]

Posted Content
TL;DR: The authors analyzes the need for financial regulations in the implementation of central bank policy and argues that regulations are not essential for the execution of monetary policy because high-powered money can be managed with open market operations in government bonds.
Abstract: The paper analyzes the need for financial regulations in the implementation of central bank policy. It emphasizes that a central bank serves two functions. Central banks function as monetary authorities, managing high-powered money to influence the price level and real activity; and they engage in regular and emergency lending to financial institutions. The authors term these functions monetary and banking policies, respectively. They emphasize that regulations are not essential for the execution of monetary policy because high-powered money can be managed with open market operations in government bonds. By its very nature, however, banking policy involves a swap of government securities for claims on individual banks. Just as private lenders must restrict and monitor individual borrowers, a central bank must regulate and supervise the institutions that borrow from it. Virtually all economists agree that there is an important role for monetary policy to stabilize prices and real activity. Banking policy has been rationalized as a source of funds for temporarily illiquid but solvent banks. To assess that rationale, the authors develop the distinction between illiquidity and insolvency in detail, showing the distinction to be meaningful precisely because information about the value of bank assets is incomplete and costly to obtain. Nevertheless, they explain why the cost of information per se cannot rationalize banking policy. On the basis of such considerations, they find it difficult to make a case for banking policy and the regulatory and supervisory activities that support it.

231 citations

Posted Content
TL;DR: In this paper, the authors focus on the relationship between monetary policy and the recent turmoil in the markets for housing, housing finance, and beyond, and discuss the role of monetary policy in resolving such crises and preventing future crises.
Abstract: My remarks focus on the relationship between monetary policy and the recent turmoil in the markets for housing, housing finance, and beyond. I begin with a review of the period leading up to the crisis. I then use this review as a basis for discussing the role of monetary policy in resolving such crises and preventing future crises.

150 citations

Book
01 Jan 1997
TL;DR: Selgin explores the differences between these monetary and natural conditions, and proposes solutions of his own as discussed by the authors, concluding that persistent unemployment is a non-monetary or 'natural' economic condition, which no mount of monetary medicine can cure.
Abstract: This book sets out to explain the complexity of why increased production does not that always bring with it lower prices. According to the book, those who look upon monetary expansion as a way to eradicate almost all unemployment fail to appreciate that persistent unemployment is a non-monetary or 'natural' economic condition, which no mount of monetary medicine can cure. Selgin explores the differences between these monetary and natural conditions, and proposes solutions of his own.

138 citations


"Federal Reserve Policy and the Hous..." refers background in this paper

  • ...Instead it should allow consumer goods prices to fall when productivity gains reduce the costs of production (see Selgin 1997)....

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