There’s much debate going on regarding whether the Fed’s too-lax monetary policy in the mid 2000’s was a leading cause of the U.S. housing bubble. Economists such as Stanford University economist John Taylor (author of the Taylor Rule) recently argued in the Wall Street Journal that it was, but many others, including Fed Chairman Bernanke, say the reasons lie elsewhere.
Many of the conditions that existed prior to and during the period are not likely to be present going forward and for this reason, no matter what the Fed does with monetary we likely will not see another U.S. housing bubble.
- No-Doc Loans. Lenders were basically writing mortgages for nearly any borrower who could fog a mirror. If this hadn’t existed there’s a strong chance the financial crisis might never have happened in the first place.
- The Community Reinvestment Act (CRA) mandated that all banking institutions that receive FDIC insurance be evaluated by Federal banking agencies to determine if the bank offers credit (in a manner consistent with safe and sound operation as in all communities in which they are chartered to do business in. But a 2002 study explored the relationship between the CRA and lending looked at as predatory noted that banks could receive CRA credit by lending or brokering loans in lower-income areas that would be considered a risk for ordinary lending practices. CRA regulations as then administered and carried out by Fannie Mae and Freddie MAC, did not penalize banks that engaged in these lending practices.
- Sub Prime Lending. According to NYU economic professor Mark Gertler, “If we could go back in history and make one policy change, I’d go after sub-prime lending. Absent non-prime lending, the likely outcome of the housing correction of 2007 would have been a mild recession like 2000-2001, and not the debacle we experienced.”
- Lack of Regulatory Authority. The Fed did not have the legal authority to change or enforce regulations in most of the areas where these actions could have mitigated the crisis. If the Fed did have such authority or ability, or if any agency did, we could now get by merely by tweaking the system.
- Boom Mentality. In the atmosphere of those boom years, anyone who favored increased regulation and damping of the flows of commissions and bonuses that were driving the boom had difficulty making an impact.
- Massive Borrowing. When looked at in totality, it was the global borrowing binge that ultimately lead to the great collapse. Household debt as a percentage of disposable income grew to especially high levels in the 1997-2007 period, with many areas reaching well over 100% and some (The Netherlands, Ireland and Denmark) approaching 200%.
- Housing as an Investment. Consumers viewed their house as an “investment” that could only gain in value, but the new perception is likely to be very different. Karen Pence, who runs the Federal Reserve’s household and real estate finance research group, argued at the American Economic Association’s meetings this week that homes are actually a terrible investment due to high transaction costs, lack of diversity, illiquidity in down markets, and the correlation between employment and price.