Thursday, April 23, 2009

Housing bubble could have ended in 2003

Economist John Taylor, inventor of the Taylor Rule, has a new book blaming the Federal Reserve for stoking the housing bubble. He says the bubble could have ended in 2003 if the Fed did the right thing:
The crisis that began in 2007 and worsened in 2008 was caused, Taylor says, because the Fed abandoned the [Taylor] rule earlier in the decade. Between 2002 and 2004 interest rates were cut even though the rule required them to be raised. In 2004 and 2005 the gap between the actual and the recommended interest rate was between two and three percentage points. Taylor describes a model simulation in which interest rates followed the Taylor-rule path during this period instead of diverging from it so markedly. The housing boom would have ended in 2003 instead of 2006, he says; house prices and levels of mortgage debt would not have risen so high. In short, monetary policy was the primary cause of the boom and subsequent bust.
We already had a sizable bubble in 2003, but it got much bigger in the following three years.


  1. What I think is left unsaid, at least in the article, is why there was a bubble in 2002 in the first place. When I look at the Case-Schiller graph, I see an upward trend starting 1998ish and going well past previous real estate bull markets at the 2000-2001 point. That would indicate to me that something done in 1997-1998 may have triggered this bubble. Another problem I have with most analysis of the housing bubble is why wasn't it contained only in the US. There were bubbles in Spain, Ireland, and other countries across the globe. Are the real estate markets there dependent in some way on what the Fed does here?
    My hunch on all this is that things started going wrong with the Asian currency crisis, the devaluation of the ruble and the West's response to them.

  2. Also, there was truly a mania/obsession created by the media around real estate flipping, rising values, home decorating, you name it. all those shows in Britain and the USA. I feel like some sort of overall conspiracy by all those who had a vested interest in people going gaga over houses, like realtors, mortgage brokers, investment banks, home depot, MTV cribs, etc.

  3. I think the question of why it was global is intersting. Three theories I'd propose are
    1) Low borrowing costs and high liquidity in the US spill over into the global economy.
    2) The financial instruments which fed money into the US housing market, such as MBS's, were copied in other markets.
    3) In our much more globally connected entertainment/social environment the housing mania at the consumer level spread across countries and continents easily.

  4. John,
    You are right, something happened around 97-98. 1995 was the year the spark ignited.

    In 1995 congress mandated that HUD, with the help of Fannie and Freddie, guarantee loans to the underprivileged.

    Here is the headline straight from the horses mouth (HUD's Website Press Release in 2000).


    See this link.

    If you read the quota's in place and the numbers specifically directed at minorities and low income families, it is staggering. The industry saw it coming prior to 2000 and this is when the frenzy began. This is likely where the subprime and "creative" lending practices began. NINJA's, Sub-Prime, Alt-A's and Option ARM's were targeted at this audience.

    This single regulation gives you an idea of how massive this problem is.

    Then 9-11 hit, that did not help and Greenspan decided it would be in our interest to keep the frenzy alive.

    OK, enough, I'm about to hurl...