JILL SCHLESINGER /
MONEYWATCH/ January 20, 2013, 5:52 PM
Fed missed the housing bust
CHIP SOMODEVILLA/GETTY IMAGES
(MoneyWatch) Who would want a detailed, public record of our business decisions? Unfortunately, if you are an esteemed Fed governor, you must confront your exact words from meetings that occurred 5 years ago. The central bank released 1,566 pages of transcripts from each of the Fed’s eight monetary policy meetings in 2007, which is customary. What is not customary, of course, is that 2007 was the year that one would have hoped that our most esteemed bankers would have gotten the drift that there was something rotten in the nation’s housing market.
Clearly Chairman Ben Bernanke would like to take back this January 2007 comment: “The housing market has looked a bit more solid, and the worst outcomes have been made less likely.” Or his June remarks, which may have been a “bit” of an understatement: “A bit of cooling in the financial markets might not be an entirely bad thing.” Bernanke is not alone in his misjudgment of the economic and financial industry landscape. Outgoing Treasury Secretary Tim Geithner, who in 2007 was the NY Fed president, said “Direct exposure of the counterparties to Bear Stearns is very, very small compared with other things.” Oops!
There was one Fed governor who nailed the situation. Janet Yellen, who at the time served as the San Francisco Fed president, expressed the danger that loomed in June 2007: “I still feel the presence of a 600-pound gorilla in the room, and that is the housing sector. The risk for further significant deterioration in the housing market, with house prices falling and mortgage delinquencies rising further, causes me appreciable angst.”
Yellen’s prescience is reminiscent of Brooksley Born, the late 1990s chairman of the Commodity Futures Trading Commission, who was the only regulator who saw the danger of over-the-counter derivatives, the vehicles that a decade later would contribute to the financial crisis. The big difference in 2007 was that Yellen was not the lone voice and she was not bullied by her colleagues.
Still, Yellen could not rally the other central bankers to her cause. In September 2007, she reiterated her concerns: “A big worry is that a significant drop in house prices might occur in the context of job losses, and this could lead to a vicious spiral of foreclosures, further weakness in housing markets, and further reductions in consumer spending. … at this point I am concerned that the potential effects of the developing credit crunch could be substantial.” Yellen is currently the Vice Chair of the Board of Governors of the Federal Reserve System and if she was seen as a potential successor to Ben Bernanke prior to this release, these comments beef up her chances in a big way.
Eventually, the Fed did recognize the magnitude of the problem, but as is often the case, the governors were late in their diagnosis and remedies. That’s why so many economists are worried about the central bank’s ability to withdraw its easy monetary policy when the U.S. economy improves. With the current low level of inflation (running below the Fed’s target of 2 percent on a year-over-year basis) and the high level of unemployment, the Fed will keep buying bonds and pushing money into the system until further notice. But will the Fed be able to predict when its time to stop?
Right now, economic growth is stuck in a low gear of about 2 percent annually, but when it reaccelerates, perhaps due to an uptick in global growth or a housing sector that perks up, the Fed could once again be behind the curve. When that happens, inflation will re-emerge; bonds will finally see the much-predicted sell-off; and the Fed will likely cringe when future transcripts are released.
This week, evidence of housing’s recovery will continue to trickle in. There’s little doubt that 2012 was the year that housing bottomed nationally. Prices were up about 6 percent; existing and new home sales rose by about 15 percent each; and housing starts increased 28.1 percent.
While this is good news, the housing crash created quite a hole. Prices are still down about 30 percent from the peak and even with the big jump in starts, 2012 ranks as the fourth lowest year since the Census Bureau started tracking starts in 1959 (the three lowest years were 2009 through 2011).