Friday, April 08, 2005

The Fed Is On The Hook For This One, Mr. Shiller

I admire Robert Shiller for pressing the case that a bubble exists in housing. But he reveals his institutional bias in this LA Times editorial. Not once, but twice he attempts to exonerate the Federal Reserve for it's creation.

It works like this; bubbles existed before there was a Fed, so therefore the Fed can't be responsible. "Bubbles grew and burst long before there was a Federal Reserve setting interest rates...So what brought this bubble to an end in the fall of 1887? It cannot have been the Fed raising interest rates, there was no monetary authority then."

I'm not buying it. Pre-Fed bubbles had their causes, but I don't see the relevance. We do have a "monetary authority" now and they blew it. The home price bubble is largely a credit bubble and a bunch of old newspapers isn't gonna change the facts.

Mr. Shiller need look no further than this CNN link to see who thinks debt is such a great thing.

29 Comments:

At 1:49 PM, Anonymous Anonymous said...

The point that shiller is trying to make is that there have been booms to busts throughout all periods of time in history... bubbles and greed are a part of human nature... the federal reserve isn't the mother of invention...

 
At 2:09 PM, Blogger http://piggington.com said...

I thought the point was to try to dispense with the idea that the bubble can only burst if the Fed raises interest rates too much.

piggington

 
At 2:12 PM, Anonymous Anonymous said...

There is no bubble in texas and the industrial midwest has been in stagnation/recession for a long while now. If the fed had raised interest rates enough to stop the bubble on the coasts, it would have destroyed the midwest industrial economy.

The Federal Reserve has one tool at its disposal, overnight interest rates, while Congress has an infinity of tools, in the form of changed laws. If anyone is to blame, it is Congress, for favoring real-estate over all other forms of investment. Mortgage interest and proprty tax deduction, huge exemptions from capital gains taxes, favorable depreciation rules, the implicit government backing of Fannie mae and Freddie Mac--the list goes on and on. Put the blame where it belongs, on Congress.

I should also note that the Federal Reserve is a creation of Congress and answers to Congress. If the Fed stands in the way of a bubble, the Fed will be abolished. That is political reality. The only thing the Fed can do is wait until the fever breaks and then try to clean up the mess. The Fed should also warn about the bubble beforehand, so they can say "I told you so" afterwards. They failed to do that with the stock market bubble and they aren't doing it sufficiently with the housing bubble, and they can be faulted for that. But words are cheap in Washington. If the Fed were more outspoken, I suspect people would start ignoring what they had to say.

 
At 2:13 PM, Anonymous Anonymous said...

I thought the samething. I wonder when Greenspan steps down next year. Prof Shiller while not likely to selected as chairmen, might be locking for for a member appointment.

These last two bubbles are Greenspans fault. He had plenty of authority to stop them. I think with the real estate bubble Greenspan is even more to blame, however. The housing wealth effect meant that in an otherwise crappy economy there were lots of otherwise I got mine smug homeowner to vote for Bush. Greenspan is a political hack.

 
At 2:15 PM, Anonymous Anonymous said...

Unless the mortgage machine starts inventing new products like Japan's infamous 100 year loan, the housing bubble will pop soon, regardless of whether interest rates rise dramatically. The mortgage industry better hurry though, because time is running out. A few more months of flat appreciation should do the trick.

 
At 2:24 PM, Anonymous Anonymous said...

That is crap. Greenspan has been asked point blank for years if there was a housing bubble from 2000 thru the end of 2002. He has been on the side "There is no bubble crowd". In late 2002 he hedged a bit then came back to say that what ever housing bubble there was it was confined to local markets. Which is crap. There is a big Real Estate bubble in Red State America in places like Indianapolis. Ask your average Red-State if he/she could afford a 20% drop in home valuation. It does not sound like much to somebody on the coast but it could be ruinious to them.

It is the Feds job to consult the the Treasury on banking policy. These exotic morgages should have been nipped in bud. Instead they have been the driving force for the last 2 years.

Greenspan is such a wanker. We should call him Greenspansan because he is turning the entire RE market Japanese.

 
At 2:24 PM, Anonymous Anonymous said...

That is crap. Greenspan has been asked point blank for years if there was a housing bubble from 2000 thru the end of 2002. He has been on the side "There is no bubble crowd". In late 2002 he hedged a bit then came back to say that what ever housing bubble there was it was confined to local markets. Which is crap. There is a big Real Estate bubble in Red State America in places like Indianapolis. Ask your average Red-State if he/she could afford a 20% drop in home valuation. It does not sound like much to somebody on the coast but it could be ruinious to them.

It is the Feds job to consult the the Treasury on banking policy. These exotic morgages should have been nipped in bud. Instead they have been the driving force for the last 2 years.

Greenspan is such a wanker. We should call him Greenspansan because he is turning the entire RE market Japanese.

 
At 2:29 PM, Anonymous Anonymous said...

Greenspan has to share some of the blame for all of these bubbles. You guys should read more Doug Nolan or at least some Bill Fleckenstein. Greenspan is a great believer in inflation and the way the fed calculates inflation these days is laughable. They don't include energy, food, or housing!! And the average person thinks inflation is low right now. hahahahaha!!!

 
At 2:34 PM, Blogger John Law said...

if you want to know why the US is deindustrializing- look the the Fed. the Fed's job now seems to keep inflation "low." their bias has been toward printing more money the resulting inflation has caused the US to become less and less competitive faster than it probably would have.

 
At 2:37 PM, Anonymous Anonymous said...

piggington,

You are partly right. Surely Greenspan could slow housing contruction by raising shortterm interest rates. Some Builder would have to charge more/or there would be less money to be made if they borrowed short term to build. But otherwise as long as fools will pay any price. The bubble will continue.

Lots of folks are still speculating because they expect the feds to raise interest rates as a clear sign of a top to the RE is coming.

But the Fed has larger regulatory responsiblity and they are simply not acting.

The fed could do nothing to raise rates and the housing bubble could collapse due to a run on dollar. That could very well happen if Dubya keeps saying that the bonds in the SS trust fund are just pieces of paper.

 
At 2:50 PM, Blogger Ben Jones said...

(bubbles and greed are a part of human nature)

True and Shiller does a good job of explaining that. But could this bubble have occurred without massive, historic levels of "accomodation"? We are talking trillions in the last 4 years.

Professor,
(I thought the point was to try to dispense with the idea that the bubble can only burst if the Fed raises interest rates too much)

I will re-read it. He seemed to suggest that the bubbles just happen, magically by psychology alone. When you look at lending standards the last few years, somebody wanted to keep the party going.

(If anyone is to blame, it is Congress)

Also. I post on that all the time. Who created the GSEs? This sordid mess will need the whole cast to carry the load.

(If the fed had raised interest rates enough to stop the bubble on the coasts, it would have destroyed the midwest industrial economy)

That comes up lately. How about a direct economic shot in the arm for Texas, like allowing its citizens to deduct their state taxes, as most other states can?

(He had plenty of authority to stop them)

Isn't that why we have an "independent" central bank? To make the hard decisions that politicians shy away from?

(These exotic morgages should have been nipped in bud. Instead they have been the driving force for the last 2 years)

Just that measure alone may have prevented this bubble, at least to the degree we see now.

(You guys should read more Doug Nolan or at least some Bill Fleckenstein)

I do, see some of my March posts. If you think I'm hard on the Fed, read some of Bills' stuff.

Thanks for commenting...Ben

 
At 3:04 PM, Blogger John Law said...

if you read about almost any historical figure in the 1700s or the 1800s you'll always find blurbs about someone speculating in land. I've read books on Jefferson and I've read Ambrose's "Undaunted Courage." speculation is alway mentioned.

 
At 3:11 PM, Anonymous Anonymous said...

A 100 year loan can't beat the already popular interest only loan. We're near the end. How near I don't know, but there's not much left that hasn't been done already.

Whoever listed Congress' pandering to real estate forgot the $400 million down payment giveaway. It does make sense, though. Local governments have just as much incentive to inflate as the RE agents do.

 
At 3:17 PM, Blogger deb said...

People are irrational with or with out the Fed. It is mostly psychology at work. I think they have made the bust worse by helping people leverage themselves, but the people would have done it somehow with or withou the Fed. Tulips, the South Sea, you name it. Where there is a will to speculate, the people will find a way. That is why I think this bubble will be burst by a change in psychology, not fundimentals.

In the early 90's rates were falling dramatically. That didn't stop prices from falling. Affordability was growing by leaps and bounds, but people didn't want to buy real estate (in So Cal) because of psychology. They didn't BELIEVE it would go up.

 
At 3:36 PM, Anonymous Anonymous said...

some more examples of the psychology of speculation: Cabbage Patch kids, Tickle me Elmo, and Beanie babies.

 
At 3:41 PM, Anonymous Anonymous said...

deb,

I the early 90' California was hemoraging jobs in the defense industry on top of a recession after years of a run up in prices.

Bubbles are usually accompanied with not so much a chance in psychology as much as a change in economic/conventional wisdom, a new rational. Such as "In the New Economy, Stocks prices are no longer necessary tied to earnings".

That does not occur as if it was a virus that has spontaneous mutated and then spread by contact.
The new mindset is created and then promulgated by interested parties and then broadcasted by a compliant media.

Overnight, the new wisdom was for average folks to think of their homes an investment vehicle. Not a place to live and raise a family. Not as a hedge against inflation. Folks had to be taught to think that way and they were. By the Real Estate Industry, Bankers, Home Builders, the media .... The instutions that who had responsiblity to educate the public namely government stepped aside and then jumped on board.

 
At 4:00 PM, Anonymous Anonymous said...

Deb,

To continue, I would arque that this bubble is unique. In comparison to most others it is filled with folks who deluded themselves or were deluded, into believing that inspite of the fact that they are massively in over their heads that they are doing the right thing. After all many folks do need a home. It is very understandable for folks to become deeply attached to a home as opposed to a stock ticker or a beanie baby.

"HomeOwners Good/Renters Bad" has been familiar mantra. Even if the Home Owner only intend to sell after a couple of years to the next willing sucker and move on, while the renter has lived and contribute to the local community for decades.

What is sad is lots of homeowner who had no intention of getting rich, who simply wanted to own a home and raise a family are going to get screwed. You can argue whether folks who were otherwise virtuous had to buy and hold a stocks that cost them dearly. They could have sold instead of riding the stock to the bottom. But can you blame a perverted psychology for families that simply wanted to own a home.

Folks who brag about how much they made on the Real Estate bubble ought to think about that one. This bubble really is a big game of Screw thy Neighbor.

 
At 4:56 PM, Anonymous Anonymous said...

(The only thing the Fed can do is wait until the fever breaks and then try to clean up the mess. The Fed should also warn about the bubble beforehand, so they can say "I told you so")

That is the only thing the Fed can do now. There were many things it could have done before. There is a post in the comments of one of the articles about what China is going to prevent a housing bubble. They have 4 or 5 really innovative things that almost rule out speculation in their real estate. That is the problem here: everyone got speculating and now we have a bubble. Greenspan could have increased the money supply but limited RE speculation like China did and EVERYONE would have been much, much better off.

Can you imagine where our country would be if we had spent trillions of dollars on research, manufacturing and equipment rather than our stupid houses ! We'd be the powerhouse of the world, shipping stuff to China rather than buying stuff from China.

 
At 5:07 PM, Blogger Tim said...

The Fed's charter is to "influence money and credit conditions in the economy in pursuit of full employment and stable prices".

The real problems are that:

1. The Fed does not consider asset prices (housing, stocks, bonds) in their "price" calculation.

2. Cheap Asian imports and currency pegs cause consumer goods prices to be unnaturally low.

The Fed should have acknowledged both of these factors and adjusted monetary policy accordingly - instead they said there is no inflation, and took rates down to innappropriate levels, and promised to keep them there until we started to create jobs. Well, we did create jobs - manufacturing jobs in China and construction jobs in this country.

Well done.

 
At 5:56 PM, Blogger deb said...

My point is that I don't think the Fed, or any branch of the gov't, can completely control people's willingness to speculate. There are times when people simply follow the herd and do things that they would not otherwise think wise, simply because everyone else is doing it. Yes, there are fundementals that will shape how things play out, but there have always been, and will always be "bubbles". It is just part of human nature.

 
At 6:15 PM, Anonymous Anonymous said...

Completely agree that that speculating is inevitable. The correct course of action by the government is to let those who speculate foolishly suffer the consequences of their folly so they will behave more wisely in the future. Yes, there are spillover effects to the rest of us from specualation, but there are also spillover effects from people not taking care of their health. We don't want a nanny state.

If the government tries to soften the blow of a bursting bubble, then it encourages future folly (moral hazards). If the federal reserve or other government entity tries to prevent folly, then speculators will not learn the proper lesson but wll instead turn in frustration against the federal reserve or other governement agency which is standing in the way of their getting rich quick and cause that agencies powers to be severely diluted, which could ultimately lead to something really bad, like hyperinflation. This is the lesson of history.

 
At 6:35 PM, Anonymous hellboy said...

This all started in my opinion back in 1997 when Mr. Magoo and his chums decided to bail out Long Term Capital. The Fed got together with Goldman and a few other banks that had exposure and came up with a way that nobody would fail. This set the stage for the subsequent misprizing of risk that now exist in the global financial markets. Anytime any hint of a crisis or slowdown was seen the Fed just printed more money. In 2000, it was print more money because people are loosing their shirts in the stock market. In 2001, it was print more money because of the 911 disaster and we don’t want people to re-trench right now. All throughout 2003, it was print more money because deflation might be upon us.

At every turn easy Al and his buds have tried to take the downside out of the equation ostensibly for the good of the nation of course. The problem is that capitalism doesn’t function well when risk is priced at near zero. Capitalism isn’t called “creative destruction” for nothing. The appropriate pricing of risk prevents the misallocation of capital. When capital is misallocated we all know this can be very disruptive. The Fed knows this too but because they are so concerned with full employment they have forgotten their original mandate which was to ensure stable price levels( not full employment )and not the price level direction.



“Unless the mortgage machine starts inventing new products like Japan's infamous 100 year loan,”

Did the 100 year loan save the Japanese market?

"Influence money and credit conditions in the economy in pursuit of full employment and stable prices".

When the Fed was first created that sentence didn’t include “full employment”, the only goal was stable price levels. I think they should go back to just worrying about stable price levels and leave the employment to the politicians.

 
At 6:52 PM, Anonymous Anonymous said...

While Shiller isn't the strongest advocate of the thesis (most of his credibility seems to be his well-timed publishing of the original book on the stock market crash), I agree with his conclusion. He doesn't do an incredible job of explaining what seems to be somewhat obvious: that the demand side of the demand/supply equation is being driven to a large degree by speculation, easy credit terms and the low monthly payments that are consequent of a low-interest rate environment. Those conditions create more buyers, buyers that are demanding second third and fourth homes for investment, demand created by people at the margin who may well be unable to afford a house at current prices if the usual 20% down and 30 year fixed criteria are applied. Thus, it seems easy to argue forcefully that demand is articificially high (drive by speculation and low interest rates and easy credit). On the other side of the equation is supply. Its pretty easy to argue that supply is limited in places like San Francisco, but huge communities have arisen in the last few years in places where land is abundant, look at the areas North of Sacramento, cow pasteurs turned into vibrant communities of planned housing, with all the big box stores like WalMart and Home Depot to boot. Thus, a lot of supply has also been created. What seems to be the most likely outcome is that at some point the artificial demand will subside, be it from an end to speculation when investors realize they are cash flow negative because the rents don't cover all the costs, and appreciation flattens, not to mention higher interest rates (oops I mentioned it), and a new equilibrium will take place. In other words, prices will go down. How long it will take for the new equilibrium to be reached and the extent, if any, spiraling down effect that it will may cause, seem to be the only unknowns at this point. For the short term though it seems that the psychology of the herd will keep it going for just a while longer. But if you're reading this post maybe the psychology is changing as you read.

 
At 7:24 PM, Blogger Ben Jones said...

(capitalism doesn’t function well when risk is priced at near zero)

Anon,
Excellent point and post. Thank you for taking the time.

(He doesn't do an incredible job of explaining what seems to be somewhat obvious: that the demand side of the demand/supply equation is being driven to a large degree by speculation, easy credit terms and the low monthly payments that are consequent of a low-interest rate environment)

Thanks for that because it gets to the heart of my problem with Mr. Shiller. He is the point man, in the eyes if the media, and he is not clearly saying this could have been avoided. If we all suffer through the bust and we only remember one thing about it, it should be what caused the bubble...Ben

 
At 7:45 PM, Anonymous Anonymous said...

"My point is that I don't think the Fed, or any branch of the gov't, can completely control people's willingness to speculate."

Here are some of the things that China and others did:

1) Charge a capital gains tax on any house sold before 1 year of living in it.

2) Make people pay their mortgage off completely before they buy another house or the next person to buy it has to use cash.

3) Put a maximum on how much leverage a home or person can have.

4) Limit how much the borrowers can lend in the housing area.

5) Don't have the government guarantee house loans. Leave that up to the banks.

6) Don't let real estate developers control the land. Make the land available to everyone via public auctions. Builders can contract to the individual land owners.


I think a few of these measures would have went a long way to controlling the speculation.

 
At 10:29 PM, Blogger John Law said...

I think it's pretty amazing to sit back and watch a housing bubble, a consumer credit bubble and stock market bubble take hold over 5 years. it's a mass illusion. it will be a long time before we see on of those again.

 
At 7:06 AM, Anonymous Anonymous said...

Hi, Ben...

sorry... but i disagree with you... i do think that the fed left the rates too low for too long but they're not the only ones to blame... as i said before, the federal reserve isn't the mother of invention... the fed, along with many others, are merely enablers... hopefully, congress will soon realize that the current system is broke... and that the GSEs must be banned from insuring home mortgages...

 
At 7:06 AM, Anonymous Anonymous said...

Hi, Ben...

sorry... but i disagree with you... i do think that the fed left the rates too low for too long but they're not the only ones to blame... as i said before, the federal reserve isn't the mother of invention... the fed, along with many others, are merely enablers... hopefully, congress will soon realize that the current system is broke... and that the GSEs must be banned from insuring home mortgages...

 
At 10:49 AM, Anonymous Anonymous said...

You can say that the consumer is to blame, but we all know that if you give consumers money they will build speculative bubbles. It happened in 1929, the 1970s in silver, gold and oil, 1999 and now 2005. Are you surprized ?

Greenspan had to increase liquidity to prevent a depression. But he could have easily put limits on RE borrowing and he could make a comment on the existing bubble being unsustainable.

 

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