The Fed Should Take More Responsibility for the Housing "Bubble"

I didn’t find much in Greenspan’s testimony over and above what has already been noted here previously.  Rates are expected to rise but that is not news. He noted that inflation is in check, and he acknowledged recent data indicating some potential weakness by saying “While the incoming data highlighted some downside risks to the outlook for economic growth, the FOMC judged the balance of information as suggesting that the economy had not weakened fundamentally.” 

The acknowledgment that incoming data have indicated some downside risk is farily new. Elsewhere he states “"In our view, realizing this outcome will require the Federal Reserve to continue to remove monetary accommodation. This generally favorable outlook, however, is attended by some significant uncertainties that warrant careful scrutiny."”  The uncertainties he's referring to are rising input costs, particularly labor and oil, and an increase in long-term interest rates and the potential problems that could cause in the housing market.

It’s interesting to me that the Fed is not taking responsibility for the housing “bubble” even though monetary policy causing low interest rates had a hand in creating it.  If, in fact, low interest rates have caused a misallocation of resources towards the housing sector such that there are now risks, and there's a case to be made that it has, then the Fed should be more active and forceful in dealing with and forestalling the potential consequences.  That is, if Fed policy has enticed households to make decisions that put them at risk over the long-run, decisions they would not have made if the interest rate were at its natural level, then the Fed has a responsibility to do more than wash its hands of this sector of the economy and say its only role is to clean up after any crash that might occur.

It would have also been nice to hear about the causes and consequences of budget deficits and how that impacts monetary policy and economic risks in the future, but those issues were not addressed.

For more, see Angry Bear, Caroline Baum, The Washington Post, The New York Times, the Monetary Report to Congress, and Greenspan’s prepared remarks.  If I can find the video or a transcript of the Q&A I will post them.

Update #1:  Clarifying a bit, I am ready to believe those who say there is no significant deviation from fundamentals and hence less to worry about than if it were a true bubble (except for some areas such as coastal regions), though there are risks and it is the Fed's hand in creating those risks that I am addressing.  Nobody knows for sure how vulnerable this sector is so it is good policy to attenuate such risks to the extent possible.

My complaint is the way in which the Fed has disassociated itself from any responsibility for creating the environment that caused risks to emerge.  For example, the Fed could be more aggressive on the regulatory front in an attempt to ensure that low interest rates do not induce excessive risk taking by households, especially those living near the margin that will be most vulnerable to increases in interest rates.  It's really nice to get people into houses - I'm all for that, one hundred percent - but not if it causes financial distress and years of cleanup afterward (there's that bankruptcy bill thing) as households are induced to assume more risk than they can handle.

I suppose in the end we can say it's a free market and people should have known better, that they should have been more forward looking, but when prices are set below equilibrium in an attempt to stimulate the economy, market intervention to manipulate interest rates is present making the fundamentals themselves a result of policy intervention, and that has consequences.

Update #2:  I forgot to mention this.  Whether you like policy under Greenspan or not, this is a really bad idea:

One lawmaker, Rep. Brad Sherman, D-Calif., said he was introducing a bill that would allow Greenspan to serve for another five years, removing the current requirement that will force him off the Fed board next Jan. 31.  "Does my wife have a vote on this?" Greenspan joked, referring to NBC News reporter Andrea Mitchell.

This makes the Fed Chair much too sensitive to political considerations.  What legislation will be passed if they don't like a Chair?  There are good reasons for the Fed to be independent.