Bernanke is wrong; Low interest rates did fuel the housing bubble.

[girl gone mad]

Bernanke gave a http://www.federalreserve.gov/newsevents/speech/bernanke20100103a.htm">speech yesterday in which he essentially exonerated the Fed and it's accommodative interest rate policy of any responsibility for the speculative bubble in housing and the subsequent systemic liquidity/insolvency crisis.

But the picture Bernanke painted is incomplete. As Barry Ritholtz http://www.ritholtz.com/blog/2010/01/bernanke-cause-of-credit-crisis/">blogs, Bernanke ignores the very real impact the low Fed Funds rate had in creating demand for higher yielding securities. Pension fund and bond fund managers, with hundreds of billions of low-risk dollars at their disposal, needed to show a better return than 1%. Thus the market for AAA-rated mortgage backed securities opened up, and fly-by-night mortgage chop shops were happy to step in and meet that demand.

From http://www.ritholtz.com/blog/2010/01/bernanke-cause-of-credit-crisis/">The Big Picture:

An honest assessment of the crisis’ causation (and timeline) would look something like the following:

1. Ultra low interest rates led to a scramble for yield by fund managers;

2. Not coincidentally, there was a massive push into subprime lending by unregulated NONBANKS who existed solely to sell these mortgages to securitizers;

3. Since they were writing mortgages for resale (and held them only briefly) these non-bank lenders collapsed their lending standards; this allowed them to write many more mortgages;

4. These poorly underwritten loans — essentially junk paper — was sold to Wall Street for securitization in huge numbers.

5. Massive ratings fraud of these securities by Fitch, Moody’s and S&P led to a rating of this junk as TripleAAA.

6. That investment grade rating of junk paper allowed those scrambling bond managers (see #1) to purchase higher yield paper that they would not otherwise have been able to.

7. Increased leverage of investment houses allowed a huge securitization manufacturing process; Some iBanks also purchased this paper in enormous numbers;

8. More leverage took place in the shadow derivatives market. That allowed firms like AIG to write $3 trillion in derivative exposure, much of it in mortgage and credit related areas.

9. Compensation packages in the financial sector were asymmetrical, where employees had huge upside but shareholders (and eventually taxpayers) had huge downside. This (logically) led to increasingly aggressive and risky activity.

10. Once home prices began to fall, all of the above fell apart.

I have no faith that Bernanke can right our economic ship when he is still unwilling to address all of the root causes of the ongoing crises. He has already demonstrated himself to be an unwilling regulator. Now it is also clear that he will be unwilling to shift monetary policy, even when confronted with another massive mis-allocation of risk.

[theoldman]

1. Yes and No.

There was a housing bubble in the 1970's without very low interest rates. The prime movers for present housing bubble were NINJA loans and wild speculation.

[Skink]

2. Bernake actaually came out for tighter regulation of the housing market.

Give him a break.

[girl gone mad]

3. Bernenke is all talk on regulation.

How quickly some forget.

"At this juncture . . . the impact on the broader economy and financial markets of the problems in the subprime markets seems likely to be contained." Ben Bernanke, March 2007

Bernanke failed to regulate the banks in the years leading up to the crisis, instead choosing to diminish criticism with happy talk. One of his key job tasks was regulator in chief, but he clearly preferred abusing his helicopter license.

It's impossible to take Bernanke seriously when he says he is for better regulation, yet spends his days http://www.woodstockinst.org/blog/blog/regulators-argue-for-status-quo-and-oppose-the-consumer-financial-protection-agency/">lobbying against the Consumer Financial Protection Agency, a measure that every serious reformer has endorsed.

Sorry, he hasn't earned a break.

[sendero]

4. Prove it..

... besides the most damage was done on Greenspan's watch anyway.

[stevebreeze]

5. and just who is the number one financial regulator?

how stupid do they think the public is?

[johnaries]

6. He has admitted that the problem was lack of regulation

He had "big shoes" to step into, following Greenspan and the "legacy" that Greenspan left behind. Since then, Greenspan has admitted that he was wrong.

Bernanke has a huge mess to deal with. At least he admits part of the problem.

This is a "systemic" problem that will take a long time to correct. But at least Bernanke is looking at it seriously.

[girl gone mad]

7. He can't be that serious if he isn't even willing to acknowledge that monetary policy

from 2002-2006 played a big role in creating the bubble.

[johnaries]

8. 2002-2006? It goes beyond that.

As Alan Greenspan admitted "I was wrong".

Laissez-faire practices led us into the first Great Depression, and every time it's reared it's ugly head since it has been a disaster.

[JohnWxy]

11. Bernanke is talking only about 2000- 2008 time period, and he has a good point that during this time

exotic loans became a big part of the debt supporting the housing market. He states that regulation of lenders would have been a more 'surgical' approach to the housing bubble - in direct contradiction to his former boss's firmly held belief in unregulated markets. i agree though, I don't think this means you can generalize that low interest rates do not contribute to a situation of out-of-control asset prices.


Bernanke is making the point that the accomodative monetary policies were appropriate following the recession of 2001. I do find it a little bit of a stretch to say that continuing an accomdative monetery policy 3 years after a recession wouldn't cause one to question why continuing such accomodative policy should be necessary.

(I think the accomodative policy was continued because of Greenspan. It's purpose was to keep a sick economy looking better than it was. people's real incomes were continuing a decline and without easy money a lot of buying would have dried up not just for housing. Plus, the Bush administration was funding the Free-Iraqi-Oil War with debt. This extra demand for money was a driver of interest rates too. Greenspan had to keep interest rates low to keep the economy from caving. He was protecting the Bush administration. Could Bernanke have dissuaded Greenspan from this continued accomodative policy? ... can one Cardinal get the Pope to change his direction on a major point of doctine?..I don't THINK so.)

Bernanke makes a brave case for his point that the use of accomodative monetary policy was not the main driver of the housing bubble. Of course, he refers to the period early in the decade, when we were coming out of a recession. He makes the point that regulation of lending practices would have been a better tool for controlling the housing bubble(especially in the case of the use of 'exotic' loans such as ARMs and Option ARMs) compared to the "blunt instument" of monetary policy. This is in direct contradiction of his former boss's strongly held faith in an unregulated financial sector.


---------------------------------------------------------------------------------------------------------------------------------------------------------------
Bernanke: "With respect to the magnitude of house-price increases: Economists who have investigated the issue have generally found that, based on historical relationships, only a small portion of the increase in house prices earlier this decade (like when coming out of the recession of Mar - Nov 2001, Ben?__JW) can be attributed to the stance of U.S. monetary policy.12 This conclusion has been reached using both econometric models and purely statistical analyses that make no use of economic theory."


Then speaking of exotic loans:

"The availability of these alternative mortgage products proved to be quite important and, as many have recognized, is likely a key explanation of the housing bubble. Slide 8 shows the percentage of variable-rate mortgages originated with various exotic features, beginning in 2000. As you can see, the use of these nonstandard features increased rapidly from early in the decade through 2005 or 2006. Because such features are presumably not appropriate for many borrowers, Slide 8 is evidence of a protracted deterioration in mortgage underwriting standards, which was further exacerbated by practices such as the use of no-documentation loans. The picture that emerges is consistent with many accounts of the period: At some point, both lenders and borrowers became convinced that house prices would only go up. Borrowers chose, and were extended, mortgages that they could not be expected to service in the longer term."

~~
~~

"What policy implications should we draw? I noted earlier that the most important source of lower initial monthly payments, which allowed more people to enter the housing market and bid for properties, was not the general level of short-term interest rates, but the increasing use of more exotic types of mortgages and the associated decline of underwriting standards. That conclusion suggests that the best response to the housing bubble would have been regulatory, not monetary. Stronger regulation and supervision aimed at problems with underwriting practices and lenders' risk management would have been a more effective and surgical approach to constraining the housing bubble than a general increase in interest rates."

(note: Mr. Bernanke was appointed chairman of the Federal Reserve Feb 2006.__JW)


"In March 2007, we issued interagency guidance on subprime lending, which was finalized in June. After a series of hearings that began in June 2006, we used authority granted us under the Truth in Lending Act to issue rules that apply to all high-cost mortgage lenders, not just banks. However, these efforts came too late or were insufficient to stop the decline in underwriting standards and effectively constrain the housing bubble."
(more)
-----------------------------------------------------------------------------------------------------------------------------------------------------------------------


Now, Mr. Bernanke perhaps did not feel it was necessary to point out something everybody should know by now. Predatory lenders were causing concern all over the country. Urgent pleas to Alan Greenspan to reign in predatory lenders fell on deaf ears. Alan Greenspan 'knew' the market would police itself. In 2003 50 States Attorney's General attmpted to enforce consumer protection laws against predatory lenders the Bush adminisration took action.

Predatory Lenders' Partner in Crime - The Bush administration

"What did the Bush administration do in response? Did it reverse course and decide to take action to halt this burgeoning scourge? As Americans are now painfully aware, with hundreds of thousands of homeowners facing foreclosure and our markets reeling, the answer is a resounding no.

Not only did the Bush administration do nothing to protect consumers, it embarked on an aggressive and unprecedented campaign to prevent states from protecting their residents from the very problems to which the federal government was turning a blind eye.

Let me explain: The administration accomplished this feat through an obscure federal agency called the Office of the Comptroller of the Currency (OCC). The OCC has been in existence since the Civil War. Its mission is to ensure the fiscal soundness of national banks. For 140 years, the OCC examined the books of national banks to make sure they were balanced, an important but uncontroversial function. But a few years ago, for the first time in its history, the OCC was used as a tool against consumers.

In 2003, during the height of the predatory lending crisis, the OCC invoked a clause from the 1863 National Bank Act to issue formal opinions preempting all state predatory lending laws, thereby rendering them inoperative. The OCC also promulgated new rules that prevented states from enforcing any of their own consumer protection laws against national banks. The federal government's actions were so egregious and so unprecedented that all 50 state attorneys general, and all 50 state banking superintendents, actively fought the new rules.

But the unanimous opposition of the 50 states did not deter, or even slow, the Bush administration in its goal of protecting the banks. In fact, when my office opened an investigation of possible discrimination in mortgage lending by a number of banks, the OCC filed a federal lawsuit to stop the investigation."
-------------------------------------------------------------------------------------------------------------------------------------------------------------------


Mr Bernanke's point that easy monetary policy didn't contribute to THIS housing bubble, seems to hinge upon the fact that we were coming out of a recession 2001. But how long did it take to come out of that recession and how much was accomodative monetary policy necessary to keep rates down in the face of a growing national debt? He makes the case that Regulatory policy would have been the better way to go and with that I have to agree, since there was NO REGULATION OF FINANCIAL INSTITUTIONS during the Cheney administration. Still, in general, easy money does not advisable in the situation of rapidly rising asset prices.

[pa28]

9. Bernanke made an effort to pass absolution on Fed in his speech.

He made a case that the Fed acted perfectly while misguided borrowers, lenders and pent up capital flows were entirely responsible for the bubble. Anybody but the Fed.

This struck me as insincere as nobody is more aware of the Fed's scope of influence than Bernanke himself.

Delivery style aside you have to be troubled by the conclusion here. He's saying that he would repeat Greenspan's course of action in 2002-06 if presented with exactly the same set of circumstances.

[blue97keet]

10. He did point a finger at the flood of capital from overseas

fueling the securitization mess. Too politically incorrect to discuss the trade deficit directly?