As the housing bubble entered its waning hours in 2006, top Federal Reserve officials marveled at the desperate antics of home builders seeking to lure buyers.So, for all the criticism you might give Ben Bernanke, apparently he's the least incompetent of the bunch.
The officials laughed about the cars that builders were offering as signing bonuses, and about efforts to make empty homes look occupied. They joked about one builder who said that inventory was “rising through the roof.”
But the officials, meeting every six weeks to discuss the health of the nation’s economy, gave little credence to the possibility that the faltering housing market would weigh on the broader economy, according to transcripts that the Fed released Thursday. Instead they continued to tell one another throughout 2006 that the greatest danger was inflation — the possibility that the economy would grow too fast.
“We think the fundamentals of the expansion going forward still look good,” Timothy F. Geithner, then president of the Federal Reserve Bank of New York, told his colleagues when they gathered in Washington in December 2006. ...
The transcripts of the 2006 meetings, released after a standard five-year delay, clearly show some of the nation’s pre-eminent economic minds did not fully understand the basic mechanics of the economy that they were charged with shepherding. The problem was not a lack of information; it was a lack of comprehension, born in part of their deep confidence in economic forecasting models that turned out to be broken.
“It’s embarrassing for the Fed,” said Justin Wolfers, an economics professor at the University of Pennsylvania. “You see an awareness that the housing market is starting to crumble, and you see a lack of awareness of the connection between the housing market and financial markets.”
“It’s also embarrassing for economics,” he continued. “My strong guess is that if we had a transcript of any other economist, there would be at least as much fodder.” ...
The committee consists of the governors of the Federal Reserve and the presidents of the 12 regional banks.
“The speed of the falloff in housing activity and the deceleration in house prices continue to surprise us,” Janet Yellen, then president of the Federal Reserve Bank of San Francisco, said in September.
One builder she spoke with, she said, “toured some new subdivisions on the outskirts of Boise and discovered that the houses, most of which are unoccupied, are now being dressed up to look occupied — with curtains, things in the driveway, and so forth — so as not to discourage potential buyers.” ...
But the Fed’s chairman, Ben S. Bernanke, appears as the most consistent voice of warning that problems in the housing market could have broader consequences.
The general consensus on the board, summarized by Mr. Geithner, was that problems in the housing market had few broader ramifications. “We just don’t see troubling signs yet of collateral damage, and we are not expecting much,” he said at the September meeting.
Mr. Bernanke initially agreed, telling colleagues at his first meeting as chairman, in March, “I think we are unlikely to see growth being derailed by the housing market.”
As the year rolled along, however, Mr. Bernanke increasingly took the view that his colleagues were too sanguine.
”I don’t have quite as much confidence as some people around the table that there will be no spillover effect,” he said. ...
One fundamental reason for this blindness was that Fed officials did not understand how deeply intertwined the housing sector and financial markets had become. They also were convinced that financial innovations, by distributing the risk of losses more broadly, had increased the strength and resilience of the system as a whole.
I'll admit I didn't know that the housing bubble would cause a financial crisis. The best I can say for myself is that I expected a failure of Fannie Mae and Freddie Mac, but also expected more diversified financial institutions to be OK.
However, I expect people with Ph.D.s in economics to know a lot more about this stuff than I do. (After all, I'm a software developer, not an economist.) I especially expect it of economists who are supposedly so good at what they do that they get appointed to a post at the U.S. Federal Reserve.