Monday, November 03, 2008

The housing bubble could have been popped

Alan Greenspan, among others, has argued that the housing bubble could not be popped, even if the Fed wanted to pop it. Economist Arnold Kling disagrees:
Megan McArdle questions whether Fed policy could have popped the housing bubble. I think that the housing bubble could have been popped easily by putting curbs on loans with low down payments. That could have been done in several ways. First, forbid Freddie and Fannie from doing anything to support low-down-payment mortgages. (Alternatively, rigidly require Freddie and Fannie to hold sufficient capital against the loans. That would have made them uneconomical to buy.) Second, adjust bank capital requirements to get rid of the loophole that allowed these high-risk loans to get low risk ratings when securitized. Third, just issue a warning against the practice.

Bernanke was a member of the Fed starting in 2002, and he could have advocated any of these policies. In my view, he shares with Greenspan any blame for not trying to pop the bubble. ...

In any case, one can argue that if the housing bubble had been popped, the excess risk-seeking funds would have gone elsewhere, creating a different bubble. I still think that the policy of encouraging high leverage in housing, a policy which continues to this day, was wrong.


  1. The only problem is, this article was written with the full knowledge that not popping the bubble led to the potential collapse of world financial markets. It is only because things are now so bad that an early "popping of the bubble" is even an article.

    Think of the mentality of the business & finance community in 2002-2003. A good percentaget of people in the community didnt see all this as a problem. Thus, if someone stepped in and tried to pop the bubble at that point, there would be massive howls of protest - your interfering with the market!!! This regulation is unnecessary!!! etc. etc.

    Now that we have seen the consequences of letting the bubble grow unabated, the idea of burting future bubbles before they get to big is paletable - but there is no way you could have sold that line of thinking to anyone in 2002-2003.

  2. Restritions on Fannie and Freddie would never have flown. Kling's in la-la-land.