Jan202012

The federal reserve missed the housing bubble and its effects

It is shocking — and a little frightening — to see how clueless and inept the people in charge of our money supply really are. Recent releases of federal reserve open market committee transcripts clearly show the federal reserve completely missed the housing bubble, and they grossly underestimated its impact on the economy. If policy makers do not identify the problem, they can’t craft policies to properly react to the problem. The people in charge at the federal reserve under Alan Greenspan — many of whom are still there — are embarrassingly inept.

“Dear Mr. Greenspan, I think you’re pretty terrific … ” Treasury Secretary Timothy Geithner (then the president of the New York Federal Reserve Bank)

Alan Greenspan’s ship of fools

The Fed’s FOMC is supposed to steer the US economy to prosperity. As we now see, it was completely rudderless in 2006

Dean Baker — guardian.co.uk, Wednesday 18 January 2012 11.42 EST

In keeping with its policy of releasing transcripts with a five-year lag, the Federal Reserve Board recently released the transcripts from its 2006 Open Market Committee (FOMC) meetings. There is much there to cause pain and amusement.

In the latter category, there is probably nothing that can beat Treasury Secretary Timothy Geithner (then the president of the New York Federal Reserve Bank) telling outgoing Fed Chairman Alan Greenspan:

I’d like the record to show that I think you’re pretty terrific, too. And thinking in terms of probabilities, I think the risk that we decide in the future that you’re even better than we think is higher than the alternative.”

I think the probability is high of Alan Greenspan’s legacy being viewed as a complete failure. His guidance of the fed, including the failure to regulate credit default swaps among other transgressions, led to the economic collapse of 2008. He was the architect of Armageddon.

But there is more than obsequiousness on display here. There is also profound ignorance of the economy among the nation’s top economic policymakers.

Keep in mind: 2006 is the year that the $8tn housing bubble hit its peak and began to deflate. In other words, this covers the period in which the Titanic hit the iceberg and began to take on water. But no one on this sinking ship is even thinking about the lifeboats.

There is no one in the eight FOMC meetings who suggests that the economy faces any serious turbulence ahead. There is not even discussion that a mild recession could be in sight.

That is really scary. These guys didn’t have a clue. They were caught completely by surprise by a housing bubble so obvious that part-time bloggers like me could see it.

In fact, at the last meeting of 2006 (pdf), we hear Janet Yellen, who was then the president of the San Francisco Bank and is now vice-chair of the board of governors, comment that:

“There are some encouraging signs that the demand for housing may be stabilizing … After a precipitous fall, home sales appear to have leveled off … Finally, the gap between housing prices and fundamentals might not be as large as some calculations suggest.”

Needless to say, this wasn’t quite right. Monthly home sales fell by almost 40% over the course of 2007. House prices, which were just edging downward month to month up to that point, would begin to decline far more rapidly. By the end of 2007, there were falling at a rate of almost 2% a month.

The gap between house prices and fundamentals is not as large as some calculations suggest?

Actually, it was exactly as big as calculations would suggest.

In addition to the direct impact that this sort of price decline had on the housing sector, it also implied a loss of almost $400bn a month in housing equity. It was inevitable that a loss of wealth of this magnitude would slow consumption.

The FOMC seemed utterly oblivious to the fact that the savings rate had been driven to record lows by the wealth generated by the housing bubble; and that this consumption boom would end when the housing bubble wealth disappeared. People who no longer had equity in their homes could not borrow to support their consumption.

Furthermore, those who had expected that home equity would support them in retirement would soon discover that they had to cut back in a big way on consumption in order to rebuild their savings.

… Here’s what Frederick Mishkin, a Federal Reserve Board governor who later played a starring role in the movie Inside Job, had to say about the risks from the housing market in that same December 2006 meeting:

“I don’t see any indications that we will have big spillovers to other sectors from weak housing and motor vehicles. In that sense, there’s a slight concern about a little weakness, but the right word is I guess a ‘smidgen,’ not a whole lot.”

… The public may be powerless at the moment to force our political leaders to take the steps necessary to bring the economy back to full employment. However, we certainly have the ability to ridicule the incompetence of those responsible for this preventable disaster. We should take full advantage of the opportunity provided by the latest Fed transcripts. This might not provide the same respite for a scared and suffering nation as movies did in the Great Depression, but it’s a start.

When it comes to ridiculing the federal reserve, I am willing to do my part.

Flipper who bought an REO for nearly 50% off peak purchase price

Today’s featured property is a flip that was bought from the bank. The quick markup and resale looks suspiciously like a flop, but with the new pergraniteel inside, this was more likely a quick cosmetic renovation and a true flip. If they get their asking price, they will probably make $75,000 or more after fees and costs.